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Developments in Auditing and Assurance - Exam Preparation
As you will appreciate, 2020/21 was a turbulent time for many businesses as the consequences of the ongoing economic and social challenges caused by the Covid-19 pandemic made themselves felt. It is against this background of economic uncertainty that the 2022 sitting of DAA has been set and you should be prepared to consider the commercial impact of these times on any risk assessment you explore.
I emphasise to students that 20% of the paper is considering wider accountability and is therefore almost as important as Issues of Quality Control. 15% of the paper relates to ideas of ethics and public interest and how this relates to the actual conduct of assignments. In common the Paper 15, these issues will be incorporated within the scenario as well as featuring as stand-alone questions on occasion – and as all questions are compulsory students must engage with these topics in their studies.
I therefore highlight a number of emerging issues which students should ensure familiarity with. This article is not intended to be exhaustive but should signpost candidates towards their wider professional reading and towards auditing standards and issues in practice which they might engage in more deeply.
Students should also be familiar with the specific more advanced areas of auditing practice that are only examined on DAA as well as some of the basic ideas of auditing and governance and financial reporting coming from prior studies – as an accountant you are not able to forget your prior technical knowledge as you progress!
A diligent review of the detailed syllabus for DAA and the textbooks should highlight these specific technical concerns. In order to be adequately prepared in this area. you should go over the syllabus and identify the specific accounting standards that are highlighted and ensure that you understand the accounting issues within them.
The examiner’s main observation on the performance of most papers in prior sittings concerned the lack of depth that students brought to their answers. Where students did have a grasp of the issues under consideration, they often failed to develop the discussion to show their application to the case in the question. I hope that the discussion around examination technique above has helped and that these detailed notes around current issues deepen your understanding.
The impact of COVID-19 on reporting and audit:
The extent of the impact of the COVID-19 pandemic on global and domestic business activity can not be overstated. The implications for corporate reporting and therefore to audit are pervasive and require a considerable commercial awareness. There is a lot of guidance available from the International Federation of Accountants to support both accounts preparers and auditors at this time. The key resource which students may find helpful is:
This explores the impact of the pandemic on professional judgement and scepticism, audit planning and risk assessment, audit evidence, auditing accounting estimates, going concern, auditor reporting and subsequent events. I have outlined some of the issues in this article but for more exhaustive discussion, engagement with this resource is recommended.
For discussion of the auditors’ response to moving to remote audit working IFAC have detailed some helpful advice in:
The most significant changes to accounting standards in recent days relate to both IFRS 16 Leases and IFRS 15 Revenue Recognition as they create significant new accounting judgements around the lease classification and revenue and creates additional subjectivity in both aspects of accounting.
As new standards which are more complex and often not compatible with previous practice, the risk of error in application and the possibility for management bias being reflected in the estimates is significant. Both standards have also required additional disclosure which needs to be balanced and meaningful to enable users of the financial statements to understand the impact of assumptions on the figures. IFRS 16 is now mandatory and students should be familiar with the treatment required.
One key area which is causing concern to the IASB relates to the treatment of onerous contracts. In May 2020 IAS 37 was amended to clarify that the ‘costs of fulfilling a contract’ comprise both:
the incremental costs – e.g. direct labour and materials; and
an allocation of other direct costs – e.g. an allocation of the depreciation charge for an item of property, plant and equipment used in fulfilling the contract.”
There are also concerns around IAS37 Provisions, Contingent Liabilities and Contingent Assets which were recognised by the initiation of a project in early 2020 to explore:
aligning the liability definition and requirements for identifying liabilities in IAS 37 with the Conceptual Framework for Financial Reporting;
clarifying which costs to include in the measure of a provision; and
specifying whether the rate at which an entity discounts a provision should reflect the entity’s own credit risk
Although the outcome of these deliberations are far from clear as yet, this does identify the issues inherent in the treatment of provisions in corporate reports, and hence the level of risk in their audit currently.
For IFRS 16 Leases students should be aware of the reclassification of leases from operating leases recognized in the income statement to finance leases recognized in the statement of financial position with the resultant non current asset recognition and consequent depreciation. This raises a number of subjective areas for the audit – namely the valuation and impairment of non current assets (already recognized as a challenging area of high subjectivity) and the valuation of the lease and the recognition of its costs through the income statement. Students are advised to ensure that they understand the key issue in IFRS 16 and so could explore how they would audit the resulting figures.
IFRS 3 Review and impact on Goodwill testing and impairment
Following the review of IFRS3 Business Combinations in 2015, the IASB has been reviewing four significant areas of concern within this accounting area, namely:
The effectiveness and complexity of testing goodwill and impairment
The issues around accounting for goodwill subsequent to its initial recognition
The identification and fair value measurement of intangible assets
The information regarding the subsequent performance of the acquiree
These issues relate to areas of concern to auditors where professional judgement is key. The Discussion Paper was published on March 19th 2020, and a familiarity with the problems raised in the debate do represent an area that students should be familiar with as the problems they create were emphatically exposed by corporate reporting during the pandemic. Therefore, students should focus some attention around why accounting in these areas is problematic and how the auditor may find it difficult to find persuasive evidence to support director’s assertions around impairment of fair values for both goodwill and other non-current assets.
Other Core Issues – Auditing Standards
DAA represents the culmination of your audit knowledge and asks you to demonstrate that you can apply this in practice to complex business areas. One key issue that arises in student work is a lack of application of more basic and fundamental audit processes to these complex areas. In addition to the auditing standards discussed in connection with exam technique above, the auditing standards which students need to ensure they are familiar with and can apply to these types of questions include:
ISA 540 Audit of Accounting Estimates(revised)
As paper 15 is considering complex accounting issues in practice, by default every paper will require students to explore and apply how audit of such accounting estimates will be carried out and evidenced. The standard has been subject to recent debate – most specifically around the issue of professional scepticism and management challenge – and how auditors show evidence of such in their consideration of the estimates. These issues are explored in more depth further in this article.
ISA 560 Subsequent Events
Under ISA 560, we must make enquiries of both the management and those charged with governance regarding the issue that is a subsequent event, understand to this which may mean that the consequences of the event cast doubt on either the going concern assumption or the valuation of any key assets. We must also extend discussions to gain external confirmation from other relevant professionals who may be involved with and understand the likely outcome and impact on relevant values – this could include surveyors, solicitors, actuaries for example.
ISA 570 Going Concern
As DAA contains a case study based upon a real company, the issues you are facing around the audit will naturally encompass an assessment of risk. The questions may ask you to consider the risk in terms of Business Risk and Inherent Risk and be exploring the ideas of ISA 315 in a complex area or it may involve a formal consideration of the going concern issues or may involve applying issues of risk in the external environment to the valuation of such assets as inventory or goodwill or other tangible non-current assets to name a few.
In terms of the understanding of risk, this must require a consideration of the impact of the global Covid 19 pandemic which has caused such turmoil – and may continue to do so for a while yet – together with the ramifications of this in terms of soaring energy and raw material costs and the impact on supply chains.. Although you will be engaged in a scenario that relates to a current year end or time period, this will have been affected by the trading conditions of the last two years. Therefore, in the risk assessment for any case study company you must consider to what extent their sales and supply chains have been affected by the restrictions imposed as the world responded to the virus and how much resilience they have in terms of financial headroom to weather the impact on their activities. You should therefore familiarize yourself a little with the differing responses by international governments to supporting their economies through the crisis to have a sense of where activity may be especially exposed to problems. There will be very few businesses, beyond perhaps healthcare and food sales, where sales activity will not have been adversely affected. However, even in these sectors there has been considerable disruption in supply! Therefore, you should ensure that you are very familiar with the ideas in the appendix to ISA 570 Going Concern regarding indications of going concern problems.
ISA 701 Communicating Key Audit Matters
Audit reporting is a core and key component of DAA – both the issues around traditional audit reports and other types of assurances. Students are therefore advised to ensure that they understand the way in which audit reports should be modified ( including the use of the emphasis of matter paragraph) in light of likely issues arising due to the pressures on business from Covid 19.
ISA 701 requires auditors to discuss the key audit matters in their report as a mechanism for improving communication of audit with stakeholders. Students should ensure that they understand the requirements of ISA 701 and can apply these to discussing high risk issues arising within the audit.
ISA 710 Comparative Information – Corresponding Figures and Comparative Financial Statements
DAA is heavily based around a case study or real life scenario – acting as an intermediary between more tradition exam papers and the multi disciplinary case study. As we are exploring the life of the audit and the audit practice, one key area for consideration is around gaining new audit clients as well as maintaining these clients. This involves the interface between a number of core auditing standards and there is some evidence that students are forgetting about some of these basic ideas in responding to complex problems. Where this is the first year of the audit, the issues arise around the responsibility for the comparative figures and the impact of these on any audit report modifications.
DAA is exploring your understanding of the practice of auditing – both at the client level and also within the firm.
Developments in Audit Practice
Data Analytics and Ethics
A key emerging trend in internal and external audit is the use of data analytics to generate core analysis to highlight anomalies in the integrity of the accounting data. Students should ensure that they have explored the role of data analytics, its strengths and limitations in practice for both internal and external auditors in their wider reading. At the time of writing the IESBA Technology Working Group is exploring the impact of Big Data, Blockchain, Data Analytics etc on the ethics of the auditor which reported in mid 2020. The IESBA issued an ED Proposed Revisions to the Code to Promote the Role and Mindset Expected of Professional Accountants in July 2019 which aims to identify opportunities to emphasize and reinforce the mindset and behavioural characteristics expected of professional accountants in business and in public practice – this is discussed in more depth in the professional judgement section of this review.
Students are reminded that audit reporting is another core area of the syllabus and that it extends more widely than the conventional audit report. The development of the extended audit report in the UK has influenced international audit reports and students should be familiar with this.
There do however remain weaknesses in reporting and the Brydon Review recommends the following areas for improvements:
Create continuity between successive audit reports.
Provide greater transparency over differing estimations, perhaps disclosing graduated findings.
Call out inconsistencies in information made public.
Reference external negative signals and how they have informed the audit.
ISA 720 The Auditor’s Responsibilities relating to Other Information was revised in June 2016 and its impacts are starting to be seen the current cycle of audit reporting. Under ISA 720, the auditor is responsible to ensure that other information included in the audited financial statements is not materially inconsistent with either the financial statements or their understanding of the entities position from their knowledge of the business gained during the audit. This relates to all of the narrative information issued by the reporting entity and covers all of the material issued before the audit report. This supports the ethical requirement that the auditor avoids being knowingly associated with information that is either materially false or misleading. It is particularly focused at the need to make the auditor’s comment on the extended disclosure requirements for directors around risk and viability statements: The standard requires that the auditor specifically reviews and comments upon:
(a) The directors’ confirmation in the annual report that they have carried out a robust assessment of the principal risks facing the entity, including those that would threaten its business model, future performance, solvency or liquidity;
(b) The disclosures in the annual report that describe those risks and explain how they are being managed or mitigated; and
(c) The directors’ explanation in the annual report as to how they have assessed the prospects of the entity, over what period they have done so and why they consider that period to be appropriate, and their statement as to whether they have a reasonable expectation that the entity will be able to continue in operation and meet its liabilities as they fall due over the period of their assessment, including any related disclosures drawing attention to any necessary qualifications or assumptions.
ISA 720 Auditors’ Responsibilities Relating to Other Information 2016
This raises an interesting issue within the idea of the expectation gap as the auditor’s requirement to comment has been operationalized as a statement that the auditors have reviewed the issues detailed above and have nothing material to add or draw attention to.
The Brydon Report (2019) further proposes:
“A Resilience Statement [which] would replace the existing Going Concern and Viability Statements:
The short term reporting component of the Statement would incorporate the existing going concern assessment, but with enhanced transparency, including the disclosure of material uncertainties that could impact on the company as a going concern before any mitigating action has been taken into account.
The medium term component would be a more robust and transparent version of the existing Viability Statement. This component of the Resilience Statement should include stress testing of various scenarios that could threaten the company’s business model, drawing on existing models currently used by the Prudential Regulation Authority for financial services companies.
The long term component would provide an opportunity for directors to set out how they are positioning the business strategically to address the risks of, for example, climate change and other potential existential threats.”
Brydon Report 2019 Assess, Assure and Inform. Improving Audit Quality and Effectiveness.
These suggestions highlight current areas of concern in reporting and students should be familiar with these.
The directors must ensure that the Annual Report, taken as a whole, is fair, balanced and understandable, and provides the necessary information for shareholders to assess the Group’s position, performance, business model and strategy. In an examination context the narrative information around risk reporting or going concern assessment, or other information issued with the financial statements, may not be accurate and students should be prepared to develop an appropriately worded report.
Another key area that the auditor needs to consider is around the disclosure of compliance with corporate governance issues
Sustainability Reporting and Assurance
The UN Sustainable Development Goals are being used as a framework by investors to assess the exposure of companies to risks to their ability to sustainable create value within the organisation. This is linking into the developments of Integrated Reporting and the recent report by the Task force for Climate Based Financial Disclosure. Policy makers within governments and regulators are also looking to these goals to drive the future direction of sustainability in companies. Within this framework the Sustainability Accounting Standards and other sustainable measures are developing and the former were issued at the end of 2018. The 2017 recommendations of the Financial Stability Board (FSB) “Task Force for Climate related disclosures” which seek to establish a framework for an organisations disclosures “that will help financial market participants understand their climate risk”, were widely adopted in the 2018 corporate reports and this is creating a significant market opportunity for sustainability assurance and sustainability consultancy as the standards provide a key framework against which corporate sustainable reporting can be assured
The approach of the professional practice to such an assignment is the same as any other assurance assignment. It consists of initially identifying the subject matter for the engagement, the interested parties who may be using this information and the standards against which the assurance would be carried out must be explored and clarified. This process is essential to clarify the real risk areas in the assurance assignment, to understand the concerns of the company and to understand what assurance is seeking to achieve.
A key idea for the auditor providing assurance against new sustainability standards is the idea of what would render the information useful. In common with all other information for decision making this would reflect the ideas of appropriate standards of relevance, completeness, reliability, neutrality and understandability. This debate mirrors other debates around quality reporting including narrative reporting, risk reporting and KPI reporting whereby there are challenges in ensuring that the information is fairly represented, unbiased, consistent and transparent and the ideas from the FRC in their Cutting the Clutter publication may help this wider issue to be appreciated.
In November 2021 the world attended UN COP 26 where the IFRS Foundation released the prototype standards for global standards on Sustainability Disclosure and Climate Related Disclosure which are setting the agenda for reporting and assurance in this area. Although these are not currently examinable in detail, students should ensure that they understand the benefits and limitations of assurance in this field.