Question

1       Discuss what the procedures outlined in ISQC 1 Acceptance and Continuance of Client Relationships should ensure in respect of audit and assurance engagements.    

2.      Define what is meant by objectivity in the IFAC Code of Ethics 2018 and explain how independence in appearance is established.                                 

3.      Explain why internal controls can never be considered to be fool-proof by highlighting four key limitations.                                                                       

4.      Explore the idea of a material misstatement in the context of audit and explain what may influence the auditors’ judgement regarding whether a misstatement is considered to be material.                                                                          

5.    Explain what is meant by sufficient appropriate audit evidence.                   

Answer 1

Answer to Q no.1:-

The procedures outlined in ISQC 1 Acceptance and Continuance of Client Relationships should ensure in respect of audit and assurance engagements:-

The firm shall establish policies and procedures for the acceptance and continuance of client relationships and specific engagements, designed to provide the firm with reasonable assurance that it will only undertake or continue relationships and engagements where the firm:

(a) Is competent to perform the engagement and has the capabilities, including time and resources, to do so;

(b) Can comply with relevant ethical requirements; and

(c) Has considered the integrity of the client, and does not have information that would lead it to conclude that the client lacks integrity

Such policies and procedures shall require:

(a) The firm to obtain such information as it considers necessary in the circumstances before accepting an engagement with a new client, when deciding whether to continue an existing engagement, and when considering acceptance of a new engagement with an existing client.

(b) If a potential conflict of interest is identified in accepting an engagement from a new or an existing client, the firm to determine whether it is appropriate to accept the engagement.

(c) If issues have been identified, and the firm decides to accept or continue the client relationship or a specific engagement, the firm to document how the issues were resolved.

The firm shall establish policies and procedures on continuing an engagement and the client relationship, addressing the circumstances where the firm obtains information that would have caused it to decline the engagement had that information been available earlier. Such policies and procedures shall include consideration of:

(a) The professional and legal responsibilities that apply to the circumstances, including whether there is a requirement for the firm to report to the person or persons who made the appointment or, in some cases, to regulatory authorities; and

(b) The possibility of withdrawing from the engagement or from both the engagement and the client relationship.

Answer to Q no.2:-

Meaning of objectivity in the IFAC Code of Ethics 2018 and independence in appearance is established:-

The principle of objectivity imposes an obligation on all professional accountants not to compromise their professional or business judgment because of bias, conflict of interest or the undue influence of others. A professional accountant may be exposed to situations that may impair objectivity. It is impracticable to define and prescribe all such situations. Relationships that bias or unduly influence the professional judgment of the professional accountant should be avoided.

Independence in Appearance :-The avoidance of facts and circumstances that are so significant that a reasonable and informed third party, having knowledge of all relevant information, including safeguards applied, would reasonably conclude a firm’s, or a member of the assurance team’s, integrity, objectivity or professional skepticism had been compromised.

There are many threats to audit independence including:-

1. Self-interest (or the presence of financial interest)
2. Familiarity and complacency
3. Social bonding
4. Economic bonds
5. Management and employment
6. Litigation

Auditors are required to self-assess their independence with every audit they perform. Often times, such self-assessments are perfunctory and there could be situations where contractors are very aware of threats to an auditor's independence. One contractor brought up the fact that it employed a close relative of an auditor assigned to perform an audit. While the auditor may have been independent in mind, she certainly was not independent in appearance.

Answer to Q no.3:-

Why internal controls can never be considered to be fool-proof by highlighting four key limitations:-

Internal controls can never be considered as absolutely effective because. their effectiveness is limited by the competency and dependability of employees.

Limitations :-

• A good internal control system cannot turn a poor manager into a good one.
• The system can only provide reasonable assurance regarding the achievement of objectives - all internal control systems are at risk from mistakes or errors.
• Internal control systems can be by-passed by collusion and management override.
• Controls are only designed to cope with routine transactions and events.
• There are resource constraints in provision of internal control systems, limiting their effectiveness.

In other words, it is good corporate governance to establish the system, risks within the company will be minimised, but those risks can never be entirely eliminated.

Answer to Q no.4:-

The idea of a material misstatement in the context of audit and explain what may influence the auditors’ judgement regarding whether a misstatement is considered to be material :-

According to ISA 450, the objectives of the auditor are to evaluate:

• The effect of identified misstatements on the audit, and
• The effect of uncorrected misstatements, if any, on the financial statements

A misstatement occurs when something has not been treated correctly in the financial statements, meaning that the applicable financial reporting framework, namely IFRS, has not been properly applied. Examples of misstatement, which can arise due to error or fraud, could include:

• An incorrect amount has been recognised – for example, an asset is not valued in accordance with the relevant IFRS requirement.
• An item is classified incorrectly – for example, finance cost is included within cost of sales in the statement of profit or loss.
• Presentation is not appropriate – for example, the results of discontinued operations are not separately presented.
• Disclosure is not correct or misleading disclosure has been included as a result of management bias – for example, a contingent liability disclosure is missing or inadequately described in the notes to the financial statements.

Answer to Q no.5 :-

Sufficient appropriate audit evidence:-

It is the responsibility of the auditor to obtain reasonable assurance by conducting audit engagement and expressing his opinion in the audit report. This expression of opinion results in reasonable assurance which is conveyed to users of financial statements via audit report. However, to form audit opinion, auditor is required to stay objective and he cannot express an opinion on his own and by his own free will rather his opinion must be based upon evidence i.e. audit evidence (as it is collected as a result of application of audit procedures during audit engagement thus called audit evidence) and it should be that sufficient and appropriate that a reasonable assurance can be drawn on the basis of such evidence by the auditor.

The term, which is a combination of two, “sufficient appropriate” requires auditor to obtain audit evidence which is sufficient enough and also so appropriate that it can back up the conclusions reached and opinions formed by the auditor.

Sufficiency is the measure of quantity of audit evidence i.e. the amount of evidence obtained must be enough that it can be used and considered by the auditor. The quantity of audit evidence required depends on the assessment of risk conducted by the auditor. If the risk of material misstatement is high then higher quantity of audit evidence is required to establish (confirm) by the application of audit procedures.

Appropriateness on the other hand is the measure of quality of audit evidence. Audit evidence is said to be appropriate if it is relevant and reliable in the given set of circumstances. However, the appropriateness of audit evidence is affected by the time, source and the circumstances under which such evidence is obtained.

However, the two features of evidence are NOT independent and isolated rather they are closely interrelated. A quality audit evidence, even if it is in small quantity, might be enough in some situation i.e. higher the quality lesser the amount of evidence required, however, a large quantity of audit evidence cannot be a substitute for inappropriateness of audit evidence i.e. poor quality of audit evidence cannot be rectified by merely increasing the amount of evidence.

Sufficient appropriate audit evidence is obtained by applying appropriate audit procedures keeping the risk assessment in consideration. It is up to the auditor to decide whether a certain audit procedure is appropriate enough to obtain sufficient appropriate evidence in a particular situation. Sufficient appropriate audit evidence is said to have been obtained if the audit risk is reduced by the auditor (through application of audit procedures) to such level that enables the auditor to draw reasonable inferences on which ultimately auditor’s opinion will be based.