ACCA

LECTURE
NOTES

INTRODUCTORY

PAPER AA
Mr. Duc Tran©

AUDIT AND ASSURANCE


CHAPTER 1
AUDIT AND OTHER ASSURANCE ENGAGEMENTS
What we learn in this chapter includes:



Identify and describe the objective and general principles of external audit engagements



Explain the nature and development of audit and other assurance engagements



Discuss the concepts of accountability, stewardship and agency



Discuss the concepts of materiality, true and fair presentation and reasonable assurance



Explain reporting as a means of communication to different stakeholders



Explain the level of assurance provided by audit and other review assignments



Describe the limitations of statutory audits.

1. Why audit and auditor is needed?
1.1.

Connecting background

In order to understand why we need audit and ultimately auditors, we have to go back to financial
accounting and revise some basics.
In financial accounting we discussed Users of financial statements and we called them users of financial
statements because they need financial information of the organisation to make decisions. Users include:
(1) Owners
(2) Management
(3) Creditors
(4) Bankers
(5) Government
(6) Employees
(7) Customers

(8) Competitors
(9) Investors
As the decisions of the users financial statements depend on the information provided by the set of
financial statements then the probability of making correct decision is linked up with the accuracy of the
information as well.
1.2.

Who is responsible for accurate financial statements

It is the responsibility of the management to provided users of financial statements with relevant and
reliable financial information in form of true and fair financial statements. But this is where things get odd.
Presenting financial statements with true and fair view means that financial statement presents the same
financial position and financial performance of the company which actually is. And if the financial position
and performance portrayed by financial statements is not in line with reality then it means financial
statements are not reliable and any decisions made on such information can be wrong as well.

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1.3.

Why management can’t be trusted?

Now the obvious question is why even having management in place financial statements can be wrong?
Well this is really simple. If business is making losses and as management is duty bound to produce true
and fair financial statements, they will publish financial statements containing the true picture of the
business i.e. to produce financial statements that shows the weak position and loss making performance of
the business. But by presenting this true state of business there are chances that management may lose

their jobs as shareholders may decide to remove the directors (management). To avoid this from
happening, if they have no other way to stop the losses and also to save their own stake, they will
intentionally make such financial statements which shows that business is fine and is in profit which in fact
not what reality is.
Accountability is the quality or state of being accountable, that is, being required or expected to justify
actions and decisions. It suggests an obligation or willingness to accept responsibility for one's actions.
Stewardship refers to the duties and obligations of a person who manages another person's property.
Agents are people employed or used to provide a particular service. In the case of a company, the people
being used to provide the service of managing the business also have the second role of being people in
their own right trying to maximise their personal wealth.
1.4.

How auditor fits into the equation?

As discussed above, shareholders cannot rely solely on management to provide true and fair financial
statements. They need such person who not only knows how to prepare financial statements but also
checks the financial statements of the company for them and provide opinion regarding the truth and
fairness of financial information independent of management.
The name of this “superman” is Auditor who will state his opinion in front of all the users by auditing the
financial statements.
Putting all this stuff in technical language then it can be said this way: As auditor expresses his opinion after
examining financial information underlying financial statements, so it means he has taken great care while
forming up an opinion. Also, as he is experienced, users can rely on his opinion i.e. his opinion provides
assurance to the users of financial statements whether they are good or not.

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Because of this assurance, creditability of the financial statements increases.
For the same reason the activities undertaken by auditor which involves examining financial information
are named as Assurance engagements.

2. Assurance engagements
2.1.

Definition

An engagement in which a practitioner expresses a conclusion designed to enhance the degree of
confidence of the intended users other than the responsible party about the outcome of the evaluation or
measurement of a subject matter against criteria. The outcome of the evaluation or measurement of a
subject matter is the information that results from applying the criteria.
Under the International Framework for Assurance Engagements there are two types of assurance
engagement a practitioner is permitted to perform:


A reasonable assurance engagement and;



A limited assurance engagement.

Reasonable assurance engagement is an engagement in which high level of assurance is provided.
Limited assurance engagement is an engagement in which moderate level of assurance is provided but is of
lesser degree as compared to reasonable assurance.
2.2.

Elements of assurance engagement – fundamentals


According to International Framework on Assurance Engagements, there are five elements of any
assurance engagement as follows (refer to CREST – Criteria, Report, Evidence, Subject matter and Three
party relationship)
(1) A three party relationship involving practitioner (auditor), a responsible part (client) and intended
users (users of financial statements)
(2) Subject matter against which assurance is required by the intended users
(3) Criteria which will be used by the practitioner to assess the subject matter
(4) Gathering of sufficient appropriate evidence based on which practitioner will express his opinion
regarding subject matter
(5) Expression of an opinion which will be done by the practitioner through written report
Intended users are the person, persons or class of persons for whom the practitioner prepares the
assurance report.
The responsible party is the person (or persons) responsible for the subject matter (in a direct reporting
engagement) or subject matter information of the assurance engagement.
The practitioner is the individual providing professional services that will review the subject matter and
provide the assurance.

3. Audit engagements
Audit is an examination of financial information to enable an auditor to express his opinion as to whether
the financial statements give true and fair view in accordance with identified financial reporting framework.

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3.1.

Financial information vs. financial statements


Financial information simply means two things:
(1) Accounting records which are all such documents, ledgers, accounts and everything that is part of
accounting cycle and is part of financial statements.
(2) Other information includes all such information that does not form part of financial statements but
provides valuable data that helps auditor during engagement. For example, minutes of meeting, bank
reconciliation etc.
Financial statements in auditing as well have the same meanings as meant under IAS 1 according to which a
complete set of financial statements comprises:
(1) A statement of financial position as at the end of the period;
(2) A statement of comprehensive income for the period;
(3) A statement of changes in equity for the period;
(4) A statement of cash flows for the period;
(5) Notes, comprising a summary of significant accounting policies and other explanatory information
Why not examine financial statements directly bypassing the financial information?
According to the definition auditor examines financial information and express his opinion on financial
statements. Some of you might be thinking that why not examine financial statements straight and express
an opinion. The reason is auditor cannot examine financial statements on their own as they are too
summarised to be examined and also they bear just totals for everything and provides no detailed
information that enables the auditor to check whether accounting is done correctly or not.
Therefore, he has to refer back to the financial information underlying such financial statements. And if he
examines the basis on which financial statements are prepared i.e. financial information then financial
statements will automatically be checked for accuracy.
3.2.

What is true and fair?

The financial statements will be TRUE if they are in accordance with actual state of affairs of the business
and nothing is against facts.
The financial statements are set to be FAIR when they are free from any bias of responsible party (client) as
bias of any kind can distort the view of the business in financial statements.

Therefore, true and fair view simply means the projection of the business as it really is in reality on ground
as the facts and figures in the financial statements are in line with reality and also the financial information
in financial statements is not distorted or affected by any bias and prejudice.
3.3.

When financial statements do not give true and fair view

Financial statements will not give true and fair view if they contain material misstatement. Misstatement
arises when there is a difference between what has been done in the financial statements and what should
have been done in accordance with an applicable financial reporting framework.
These differences can arise because of unintentional or intentional actions. We classify them as errors
(unintentional) and fraud (intentional).

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However, not all misstatements are material misstatements and thus not every misstatement can distort
the view of financial statements. Material misstatements are such misstatements that cause such distortion
in financial statements that they ultimately affect the decision of the users of such financial statement.
Therefore, if an error or collection of errors have not affected or not capable of affecting decisions of the
users then such misstatements are not material.
Now what is material and what is not material that is determined by the auditor by exercising his
professional judgement. Exercising of professional judgement means the application of relevant
knowledge, training and the experience that auditor has acquired, related to given circumstances, to reach
reasonable conclusions in context of auditing, accounting and ethical standards.
3.4.

Why examination is needed? – Audit evidence


Auditor must have the evidence to back his opinion. Auditor does not express anything on his own or
without any reason. Through examination of financial information he gathers the evidence which helps him
to reach conclusions and on the basis of such conclusions he makes up and expresses his opinion.
In the absence of any evidence he will not be in a position to express any opinion.
3.5.

Financial reporting framework – criteria

In order to assess the financial information, auditor needs a benchmark with which he can compare it and
decide whether everything is done properly or not. This involves international and local standards related
to accounting, taxation etc. Auditor examines the financial statements using such criteria and then
expresses his opinion. These criteria are called Framework.
In our context the applicable financial reporting framework is International Accounting Standards (IASs) and
International Financial Reporting Standards (IFRSs). However we can have local rules, regulations and
standards as well that differ from country to country. Such rules, regulations and standards will also form
part of applicable financial reporting framework.

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3.6.

Auditor’s report – expression of opinion

When the auditor is satisfied that sufficient appropriate audit evidence has been obtained then he
expresses his opinion in written form in auditor’s report.


4. Importance of auditor’s opinion
As we discussed before that auditor is someone who is not only skillful and experienced but also
independent from management. Therefore his opinion attaches credibility and thus his opinion provides an
assurance of a certain degree to the users of financial statements. The credibility of the auditor and the
assurance provided increases the confidence of the users in the financial statements as they feel safer
while relying on the financial statements.
4.1.

Relating the levels of assurance with types of assurance engagements

The level of assurance (in other words confidence) provided, depends on the types of assurance
engagement. In audit engagement level of assurance provided by the auditor is of reasonable nature, not
absolute nature.
The assurance given by auditors is governed by the fact that auditors use judgement in deciding what audit
procedures to use and what conclusions to draw, and also by the limitations of every audit. These are
illustrated in the following diagram.

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But this does not mean that reasonable level of assurance is no assurance at all! Absolute assurance is at
the very extreme i.e. the highest level of assurance whereas reasonable assurance is high level assurance
but not of the level of absoluteness or exactness.
We studied earlier that there are two types of assurance engagements:


Reasonable assurance engagement




Limited assurance engagement

As we discussed that audit provides reasonable assurance therefore audit engagement is basically a
reasonable assurance engagement.
Another type of assurance engagement which provides limited or moderate level of assurance is called
Review engagement.
Have a look at the following figure to understand the relation between types of assurances and level of
assurances each type provides.

4.2.

Absolute assurance vs. Reasonable assurance vs. Limited assurance

We understood that auditor cannot provide absolute assurance because of inherent limitations of audit.
But the reason behind the differing level of assurance under audit and review engagements is not related
to inherent limitations.
Under audit engagement auditor examines the financial information extensively. And because of this
rigorous examination auditor obtains audit evidence of such amount and such quality which enables the
auditor to express an opinion in positive form of expression which in turn provides reasonable assurance.
Whereas under review, reviewer does examine the financial information but not that extensively as done
under audit and as a result not all the evidence is gathered that would be required under an audit to

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express an opinion in positive form. But the evidence collected under a review does enable an auditor to

express an opinion in a negative form of expression.
Negative assurance
Negative assurance is when an auditor gives an assurance that nothing has come to his attention which
indicates that the financial statements have not been prepared according to the framework. In other
words, he gives his assurance in the absence of any evidence to the contrary.
An external audit can be distinguished from other engagements in the following ways.
(a) External audit engagement: the auditor provides a high, but not absolute, level of assurance that the
information audited is free of material misstatement. This is expressed positively in the audit report as
reasonable assurance.
(b) Review engagement: the auditor provides a limited level of assurance that the information subject to
review is free of material misstatement. This is expressed in the form of negative assurance.


An attestation engagement: This is where the underlying subject matter has not been
measured or evaluated by the practitioner, and the practitioner concludes whether or not the
subject matter information is free from material misstatement. A good example of an
attestation engagement is the review of a sustainability report, which has been prepared by
management. In this case, management measures and evaluates the extent to which the
company has achieved its sustainability targets, and the practitioner provides a conclusion as to
whether the measurement and evaluation is free from material misstatement (based on
materiality, and does not assure the result). Another example is the review of a cash flows
forecast report. And at the conclusion of attest engagement, practitioner will issue a report in
which he may word his opinion as follows: In our opinion, the responsible party’s assertion that
forecasts has been prepared on best estimate basis, is fair.



A direct engagement: This is where the underlying subject matter has been measured and
evaluated by the practitioner, and the practitioner then presents conclusions on the reported
outcome in the assurance report. An example of this is when the practitioner is engaged to

carry out a review of the effectiveness of a company’s system of internal controls. The
practitioner would evaluate the internal controls, and then issue an assurance report explaining
the outcome of the review. This means the practitioner will give recommendation (to
overcome weaknesses) for each section.

Other syllabus may mention agreed-upon procedures (e.g. verifying the date of joining, calculating the
number of years of service and presenting the details to the company) and compilation engagement
(e.g. preparation of prospectus).

Type of assurance
provided

Typical form of conclusion
provided

Reasonable

Positive

Limited

Negative

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Examples
- Statutory external audit
- Review of interim financial statements
- Review of internal control system
- Review of cash flow forecasts


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CHAPTER 2
STATUTORY AUDIT AND REGULATION
What we learn in this chapter includes:



Describe the regulatory environment within which statutory audits take place



Discuss the reasons and mechanisms for the regulation of auditors



Explain the statutory regulations governing the appointment, removal and resignation of auditors



Discuss the types of opinion provided in statutory audits



State the objectives and principle activities of statutory audit and assess its value (e.g. in assisting
management to reduce risk and improve performance)




Describe the limitations of statutory audits



Explain the development and status of International Standards on Auditing



Explain the relationship between International Standards on Auditing and national standards

1. Objective of statutory audits and the audit opinion
1.1.
The statutory audit opinion
Objective of statutory audit: most companies are required to have an external audit by law, but some small
companies are exempted. The outcome of the audit is the audit report.
1.2.
Small company audit exemption
Abolition of statutory audit for small companies:
User
Shareholders

For abolition
+ Cost - benefit may not be matched
(Cost may be greater than benefit).

Against abolition
- Benefit for shareholders of unquoted/ unlisted
companies.
- For listed companies, it brings benefit.

- Easier to raise fund, to become bigger because
statutory audit bring more confidence to investors.

Bankers and
Lenders

+ Wondering if banks rely on audited
FS or unaudited ones.

- Banks feel more comfortable to offer borrowings to
companies that have FS to be audited.
- Some banks require audited FS before offering any
finances.

Other payables

+ Limited reliance in practice because
creditors usually rely on relationship
and historical payment records.

- New creditors base their assessment on audited FS.
- Historical payment records cannot be a strong
evidence of current liquidity strength.

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Taxation

authorities

+ Little evidence whether reliance
placed on audited FS.

- Taxation authorities may first review audited FS to
draft up corporate tax.
- Audited FS means more transparency in corporate
governance.

Employees

+ Employees may rarely base on
audited FS to negotiate salary and
benefit.
+ System review and management
consultancy review may bring more
benefit with similar or less cost than
audit.

- Audited FS may be a reliable source for employees to
deal with management about wage.

Management

1.3.

- Independent review and check on accounting system
may be more useful for management.


Auditor rights and duties

RIGHTS
Access to records

A right of access at all times to the books, accounts and vouchers of the
company (in whatever form they are held)
Information and
A right to require from the company's officers such information and
explanations
explanations as they think necessary for the performance of their duties as
auditors
Attendance at/notices of A right to attend any general meetings of the company and to receive all
general meetings
notices of and other communications relating to such meetings which any
member of the company is entitled to receive
Attendance at/notices of
A right to be heard at general meetings which they attend on any part of the
general meetings
business that concerns them as auditors
Rights in relation to
A right to receive a copy of any written resolution proposed
written resolutions
DUTIES
Compliance with
Whether the financial statements have been prepared in accordance
legislation
with the relevant legislation
Truth and fairness of
Whether the balance sheet shows a true and fair view of the

accounts
company's affairs at the end of the period and the profit and loss
account (and cash flow statement) show a true and fair view of the
results for the period
Adequate accounting
Whether adequate accounting records have been kept and returns
records and returns
adequate for the audit received from branches not visited by the
auditor
Agreement of accounts to Whether the accounts are in agreement with the accounting records
records
and returns
Consistency of other
Whether the information in the directors' report is consistent with the
information
financial statements
Directors' benefits
Whether disclosure of directors' benefits has been made in
accordance with the Companies Act 2006

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2. Appointment, removal and resignation of auditors
AUDITOR APPOINTMENT (UK)
Directors
Can appoint auditor:
(a) Before company's first period for appointing auditors

(b) Following a period during which the company did not have an auditors (as
exempt), at any time before the next period for appointing auditors
(c) To fill a casual vacancy
Members
Can appoint auditor by ordinary resolution:
(a) During a period for appointing auditors
(b) If company should have appointed auditor during a period for appointing auditors
but failed to do so
(c) If directors failed to do so
Secretary of State
Can appoint auditors if no auditors are appointed per above
 Shareholders normally appoint the external auditors of a company.
RESIGNATION OF AUDITORS (UK)
1. Resignation procedures
Auditors deposit written notice together with statement of circumstances relevant to
members/creditors. A statement of circumstances must always be submitted for a
quoted/listed company. Both notice of resignation and statement of circumstances
must be sent to regulatory authority.
2. Notice of resignation
3. Statement of
circumstances
4. Convening/Summons of
general meeting

5. Statement prior to
general meeting
6. Other rights of auditors

Sent by company to regulatory authority.
Sent by:

(a) Auditors to regulatory authority
(b) Company to everyone entitled to receive a copy of accounts
Auditors can require directors to call an extraordinary general meeting to discuss
circumstances of resignation.
Directors must send out notice for meeting within 21 days of having received
requisition by auditors.
Auditors may require company to circulate (different) statement of circumstances to
everyone entitled to notice of meeting (note 3).
Can receive all notices that relate to:
(a) A general meeting at which their term of office would have expired (after their
resignation)
(b) A general meeting where casual vacancy caused by their resignation to be filled
(when new auditors appointed)
Can speak at these meetings on any matter which concerns them as auditors

 It differs from Written representations (you will study later).

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REMOVAL OF AUDITORS (UK)
1. Notice of removal
Sent to auditors by directors within 28 days, and meeting must be convened
2. Representations
Auditors can require company to state in notice that representations have been made
and send copy to members
3. If resolution passed
(a) Company must notify regulatory authority

(removal procedures)
(b) Auditors must deposit statement of circumstances at company's registered office
within 14 days of ceasing to hold office. Statement must be sent to regulatory
authority.
4. Auditor rights

Can receive notice of and speak at:
(a) General meeting at which their term of office would have expired
(b) General meeting where casual vacancy caused by their removal is to be filled

 Why removal is decided by company but statement of circumstances is prepared by auditors???
SUMMARY:
1. Procedures

RESIGNATION (by auditors)
Auditors deposit written notice &
statement of circumstances

REMOVAL (by company)
Company deposit written resolution
Auditors deposit statement of
circumstances
(a) Written notice sent by company to
regulatory authority
(b) Statement of circumstances sent by
auditors to regulatory authority and by
company to everyone entitled to
receive a copy of accounts

2. Authority and

related persons

(a) Written notice sent by company to
regulatory authority
(b) Statement of circumstances sent by
auditors to regulatory authority and by
company to everyone entitled to
receive a copy of accounts

3. Important time

Directors must send out notice for
meeting within 21 days of having
received requisition by auditors

Notice of removal sent to auditor
within 28 days
Auditors must deposit statement of
circumstances within 14 days of ceasing
to hold office

4. Auditor rights

Can receive notice of and speak at:
(a) General meeting at which their term
of office would have expired
(b) General meeting where casual
vacancy caused by their resignation is
to be filled


Can receive notice of and speak at:
(a) General meeting at which their term
of office would have expired
(b) General meeting where casual
vacancy caused by their removal is to
be filled

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WORKING PROCEDURES OF THE IAASB

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CHAPTER 3
CORPORATE GOVERNANCE
What we learn in this chapter includes:



Discuss the objective, relevance and importance of corporate governance



Discuss the need for auditors to communicate with those charged with governance




Discuss the provisions of international codes of corporate governance (such as OECD) that are most
relevant to auditors



Describe good corporate governance requirements relating to directors’ responsibilities (e.g. for risk
management and internal control) and the reporting responsibilities of auditors



Analyse the structure and roles of audit committees and discuss their drawbacks and limitations



Explain the importance of internal control and risk management



Compare the responsibilities of management and auditors for the design and operation of systems and
controls

1. Corporate governance is the system by which companies are directed and controlled. The Cadbury
Report identified the following:
 Directors: responsible for corporate governance
 Shareholders: linked to the directors by the financial statements
 Other relevant parties: such as employees, customers and suppliers
At usual, the shareholders only have an opportunity to find out about the management of the company at

the AGM (Annual General Meeting).
Day to day business is run by directors; shareholders only review performance once or twice a year.
Corporate governance is important because it ensures that stakeholders with a relevant interest in the
company's business are fully taken into account. It is important that directors manage the company in the
best way for the shareholders, employees and other parties.
1.1. The OECD Principles of Corporate Governance:
The OECD set out the rights of shareholders, the importance of disclosure and transparency and the
responsibilities of the board of directors.
I.

II.

The corporate governance framework should promote transparent and efficient markets, be consistent
with the rule of law and clearly articulate the division of responsibilities among different supervisory,
regulatory and enforcement authorities.
The corporate governance framework should protect shareholders' rights.

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III.

The corporate governance framework should ensure the equitable treatment of all shareholders,
including minority and foreign shareholders. All shareholders should have the opportunity to obtain
effective redress for violation of their rights.
IV. The corporate governance framework should recognize the rights of stakeholders established by law or
through mutual agreements and encourage active co-operation between corporations and stakeholders
in creating wealth, jobs and the sustainability of financially sound enterprises.

V.

The corporate governance framework should ensure that timely and accurate disclosure is made on all
material matters regarding the corporation, including the financial situation, performance, ownership,
and governance of the company.
VI. The corporate governance framework should ensure the strategic guidance of the company, the
effective monitoring of management by the board, and the board's accountability to the company and
the shareholders.
 Brief of Principles of Corporate Governance:
a) Promote transparent and efficient markets
b) Protect shareholders’ rights, including minority and foreign shareholders
c) Recognize the rights of stakeholders
d) Ensure timely and accurate disclosure that is material for decision of FS’ users
e) Ensure the strategic guidance for internal control to solve any agency problems
 In order to obtain the best of the advantages and avoid the worst disadvantages, countries may take a
hybrid approach and make some elements of corporate governance mandatory (compulsory) and
some voluntary  the Combined Code
1.2. The Combined Code on Corporate Governance:
This contains detailed guidance for UK companies on good corporate governance, regarding board
composition, remuneration, accountability & audit, and relations with shareholders.
The Board
+ Balance between Executive Directors (ED) and Non-executive Directors (NEDs) (half – half).
+ Board members must have adequate knowledge and expertise in order to run the business.
+ No one can override the business (by having unfettered powers of decisions.
+ Removal and re-election of directors must be submitted at AGM or EGM.
+ Must have audit committee (AC) and this committee has right to talk at AGM or EGM.
+ AC must have right to join any meeting of board members.
+ At least one member of IAC has expertise in accounting and auditing.
+ AC members should be independent from BoD.
+ There is clear division of responsibility between the chairman and the chief executive.

+ Directors are responsible for monitoring the effectiveness of systems and controls. Directors are also
responsible for determining whether to have an internal audit department to assist them in monitoring in the
first place.
Remuneration
+ No directors should be involved in deciding his or her remuneration.
+ Remuneration for should attract & motivate directors, but should avoid pay so high than suitable level.
+ Remuneration should be linked with his/ her performance.
+ Package for directors should be set up transparently and formally.

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Accountability and audit
+The board should present a balanced and understandable assessment of the company's position and
prospects.
+ The board should maintain a sound system of internal control to safeguard shareholders’ investment and
the company's assets.
+ The board should apply internal control principles and maintain an appropriate relationship with the
company's auditors.
Relations with shareholders
+ The board should use AGM to communicate with investors and to encourage their participation.
+ The board has the responsibility for ensuring that satisfactory dialogue with shareholders takes place. The
board should make any material disclosures, may be through EGM.
+ Using Annual Report, not Financial Statements only
Institutional shareholders
+ Institutional shareholders should enter into a dialogue with companies based on the mutual understanding
of objectives.
+ Institutional shareholders have a responsibility to make considered use of their votes.


2. Audit committee
2.1. Cadbury Report

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2.2. Combined Code

Annual report: the annual report should explain to shareholders how, if the auditor provides non-audit services,
auditor independence & objectivity is safeguarded.
Drawbacks of audit committees





Perception of EDs: AC controls them and implies the doubt about EDs’ competence or ethics.
Costs – benefit: costs may be higher than benefit.
It’s not easy to select competent and experienced NEDs for AC.
Procedure set by AC may discourage auditors to find out any issues in company.

3. Internal control effectiveness
Directors are responsible for setting up internal control. And they are also responsible for reviewing it
regularly to ensure that it still meets its objectives.
Internal control helps to protect company’s assets, prevent and detect fraud and protect shareholders’
investment. Part of setting up an internal control system will involve assessing the risks facing the business.
The Combined Code also recommends that the board of directors reports on its review of internal controls

as part of the annual report.
The auditors should review the statements made concerning internal control in the annual report to ensure
that they appear true and are not in conflict with the audited financial statements.

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4. Communication with those charged with governance
‘Those charged with governance’ is defined by ISA 260 as ‘the person(s) or organization(s) with
responsibility for overseeing the strategic direction of the entity and obligations related to the
accountability of the entity’.
‘Management’ is defined by ISA 260 as ‘the person(s) with executive responsibility for the conduct of the
entity’s operations’.
Matters to be communicated by auditors to those charged with governance:





The auditor’s responsibilities in relation to the financial statement audit.
Planned scope and timing of the audit.
Significant findings from the audit.
Auditor independence.

The auditor shall communicate with those charged with governance the form, timing and expected general
content of communications. The auditor shall communicate with those charged with governance on a
timely basis.


Case study:
You are a recently qualified Chartered Certified Accountant in charge of the internal audit department of
ZX, a rapidly expanding company. Turnover has increased by about 20% p.a. for the last five years, to the
current level of $50 million. Net profits are also high, with an acceptable return being provided for the four
shareholders.
The internal audit department was established last year to assist the board of directors in their control of
the company and to prepare for a possible listing on the stock exchange. The Managing Director is keen to
follow the principles of good corporate governance with respect to internal audit. However, he is also
aware that the other board members do not have complete knowledge of corporate governance or
detailed knowledge of International Auditing Standards.
Required:
Write a memo to the board of ZX that:
(a) Explains how the internal audit department can assist the board of directors in fulfilling their obligations
under the principles of good corporate governance.
(10 marks)
(b) Explains the advantages and disadvantages to ZX of an audit committee.

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Answer:
Memo
From: Chief Internal Auditor
To: Board of ZX
Subject: Role of Audit Committee
Date: June 2005

(a) Areas where the internal audit department can assist the directors with the implementation of good
corporate governance in an organization include:
Board reports
Reviewing reports to the board and reports produced by the board to ensure that they do present a
balanced and understandable assessment of the company’s position and prospects. The internal audit
department will have good knowledge of the operations of the company as well as access to accounting
information. The department can effectively ‘audit’ board reports to ensure they are accurate and
understandable.
Internal controls
The board needs to maintain a sound system of internal control. The internal audit department will be able
to review existing controls and recommend improvements to ensure this objective is met.
Application of ISA and IASs
The board needs to have a policy for applying appropriate International Statements on Auditing (ISA) and
International Accounting Standards (IAS) to the organization. Internal audit will certainly be aware of new
auditing standards and will have the technical expertise (especially where internal auditors are
professionally qualified) to identify changes required by accounting standards. Amendments to control
systems for new auditing standards and financial accounting systems for new accounting standards can
therefore be recommended.
Communication with external auditors
Under corporate governance regulations, communications with external auditors will normally be via the
audit committee, although the board must maintain an appropriate relationship with the external auditors.
However, internal and external auditors can also work together to ensure that the internal control system
is sufficient; possibly by external audit delegating work to internal audit, and each auditor reviewing the
work of the other auditor. The board will therefore receive reports from both sets of auditors which will be
accurate because they have been properly checked.
Communication to the board
The internal auditor can also check that appropriate information is provided to the board from the external
auditor. ISA 260 Communications of audit matters with those charged with governance provides a list of
matters which should be communicated to the board and the internal auditor can work with the external
auditor to ensure that this information is provided.


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(b) The advantages of an audit committee include:
Public confidence
Providing increasing public confidence in the creditability and objectivity of published financial information.
This will be particularly important for ZX if listing arrangements go ahead. While an internal audit
department is not normally necessary for incorporated companies, the provision of that department will
provide additional confidence in the accuracy of the financial statements and hopefully make ZX an
attractive investment.
Financial reporting
Supports the directors in fulfilling their financial reporting obligations. The directors have to prepare
financial statements for ZX. The committee can assist by checking the financial statements to ensure that
they comply with appropriate reporting requirements. This is especially important where the board do not
have detailed knowledge of accounting requirements.
Communication
Enhancing the role of ZX’s external auditors by providing an appropriate channel of communication. Use of
the audit committee will enable the external auditor to discuss issues with the financial statements with
the internal auditor, prior to providing a final summary of key points to the board.
‘Friend’ of the Board
The audit committee may also act as a ‘critical friend’ to the board by monitoring the work of the board
and providing helpful guidance, where corporate governance requirements do not appear to be being met.
The audit committee should have detailed knowledge of corporate governance as part of its monitoring
function of the company and can share this with the board that may not have the time to obtain detailed
information.
The disadvantages of an audit committee include:
Lack of understanding of function

As the directors in ZX do not have much knowledge of corporate governance, they may see the additional
involvement of the audit committee as a threat to their authority or taking away some of their
responsibilities. This memo has hopefully outlined the advantages of an audit committee in supporting the
work of the directors, removing this as a problem.
Role of non-executive directors
As the audit committee will be made up mainly from non-executive directors, the board may see this as a
means of decreasing their power and possibly letting other people run the company. Again, the audit
committee must be seen as fulfilling a supporting role for the main board. It will utilize the special
knowledge of account production and internal controls from the external auditor and business nonexecutives to provide appropriate review of information being given to the board.
Cost
The audit committee will increase the expenditure of the company as the non-executive directors will
require some remuneration due to their additional responsibilities. While this cannot be avoided, the

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benefits of the committee in terms of providing assistance to the board and raising the profile of ZX ready
for possible listing must not be forgotten.

Common mistakes in writing:


Professional marks for clear memo



Don’t understand best practice for corporate governance




Don’t cover enough bullet points



Don’t understand how to develop ideas from previous points (link between questions a & b)

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CHAPTER 4
PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
What we learn in this chapter includes:



Define and apply the fundamental principles of professional ethics of integrity, objectivity, professional
competence and due care, confidentiality and professional behaviour



Define and apply the conceptual framework



Discuss the sources of, and enforcement mechanisms associated with, ACCA’s Code of ethics and conduct




Discuss the requirements of professional ethics and other requirements in relation to the acceptance of
new audit engagements



Discuss the process by which an auditor obtains an audit engagement



Explain the importance of engagement letters and state their contents

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Introduction
The ACCAs guide to professional ethics set out certain fundamental principles about how its members
should behave. It also recognizes how its members could be subject to certain threats which would
compromise their behavior and suggests ways in which members can safeguard themselves against those
threats.
The guide applies to all members of ACCA and also to all ACCA students. Note that its operation is not
restricted to auditors and covers ACCA members working in industry and commerce.

1. Fundamental principles of professional ethics
1.1. The fundamental principles
The ACCA’s fundamental principles are as follows:



Firstly, integrity, this means that members should be honest, straightforward. If they see something is
amiss, they should say so; they shouldn’t try to conceal it; they shouldn’t turn a blind eye; they
shouldn’t try to be ambiguous; they should state things plainly.



Secondly, objectivity, members should be influenced by the facts and the facts only. They must avoid
bias, conflict of interest and undue influence.



Thirdly, member should exercise professional competence and due care (duty of care). They must keep
themselves up to date with legislation and recent developments. They shouldn’t take on work which
they are not qualified for or for which they have no skills. They must be diligent and careful.



Fourthly, confidentiality. Members, particularly perhaps those who are auditors, have accessed
information which is highly confidential and which is indeed price sensitive. That information must be
held confidentially. Members should not disclose confidential information unless they have a legal or
professional duty to do so. An example of a legal duty to disclose information can arise if a member
thinks that a client or the person they are working for is involved in money laundering. Many countries
have very strong regulations that money laundering suspects should be reported to the authorities.



Finally, members should show professional behavior. They should comply with the law and they should
avoid any actions which discredit the profession. So, for example, when they are trying to advertise
their services they shouldn’t say that other members are bad or poor. They should confine themselves

to promoting what they are good at; they shouldn’t slander other firms.
1.2. Confidentiality
Confidentiality requires members to refrain from disclosing information acquired in the course of
professional work except where:

(a) Disclosure is permitted by law and is authorised by the client or the employer.
(b) Disclosure is required by law (obligatory disclosure: if members know or suspect their client to have
committed money-laundering, treason, drug-trafficking or terrorist offences, they are obliged to
disclose all the information at their disposal to a competent authority).
(c) There is a professional duty or right to disclose (voluntary disclosure). Voluntary disclosure may be
applicable in the following situations:

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 Disclosure is reasonably necessary to protect the member's interests, for example to enable
him to sue for fees or defend an action for, say, negligence.
 Disclosure is authorised by statute.
 Where it is in the public interest to disclose, say where an offence has been committed which is
contrary to the public interest.
 Disclosure is to non-governmental bodies which have statutory powers to compel disclosure.
1.3. Disclosure in the public interest
The ACCA guidance states that there are several factors that the member should take into account
when deciding whether to make disclosure. These are:
 The size of the amounts involved and the extent of likely financial damage
 Whether members of the public are likely to be affected
 The possibility or likelihood of repetition
 The reasons for the client's unwillingness to make disclosures to the authority

 The gravity of the matter
 Relevant legislation, accounting and auditing standards
 Any legal advice obtained
1.4. Non-compliance with laws and regulations (NOCLAR)
Non-compliance refers to acts of omission or commission, intentional or unintentional, committed by the
entity, or by those charged with governance, by management or by other individuals working for or under
the direction of the entity, which are contrary to the prevailing laws or regulations. Non-compliance does
not include personal misconduct unrelated to the business activities of the entity.
The objectives of the auditor when responding to non-compliance or suspected non-compliance
(“NOCLAR”) are:
(a) To comply with the fundamental principles of integrity and professional behaviour;
(b) By alerting management or, where appropriate, those charged with governance of the client, to seek
to:
(i) Enable them to rectify, remediate or mitigate the consequences of the identified or suspected noncompliance; or
(j) Deter the commission of the non-compliance where it has not yet occurred; and
(c) To take such further action
Procedures suggested for the auditor when considering NOCLAR are to:


Obtain an understanding of the NOCALR matter.

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