Week 9 – Substantive Testing 3 – Using the Work of Others, Fraud
Component Auditor & Principal Auditor
Companies have complex structures and principal auditor cannot often perform whole audit – thus component auditors are used.
Component Auditor – requested by group engagement team and performs work on financial info related to a component for group audit.
o Where an entity has subsidiaries in other countries/location, different auditors may be used instead of principal auditor – these auditors may not be from the same firm as principal auditor
Group Auditor – responsible for direction, supervision and performance of group audit engagement
Component auditor and their work shall not be referred to in audit report unless required by law.
Acceptance and continuation – group auditor must reject/resign from audit if group engagement team is unable to be involved in work of component auditors to the extent necessary to obtain sufficient appropriate audit evidence.
http://www.comlaw.gov.au/Details/F2009L04097
Must establish the following before engaging component auditors:
o Is component auditor independent? Does he/she understand and will he/she comply with ethical requirements relevant to group audit?
o Professional competence
o Whether group engagement team will be able to be involved in work of component auditor to extent necessary to obtain sufficient appropriate audit evidence (ie will component auditor be an interference for principal auditor in obtaining evidence) o Whether component auditor operates in regulatory environment that actively
oversees auditors. –‘ awareness of the regulatory environment may assist the group engagement team in evaluating the independence and competence of the component auditor.’ – (A36 ASA 600)
If work of component auditor is insufficient, group auditor will determine what additional procedures are to be performed.
If component auditor issues/intends to issue a ‘modified’ auditor’s report, the group engagement partner shall consider nature & significant of modification and whether modification is required to group audit report.
When part of the entity or group is audited by a component auditor, the principal auditor is responsible for the opinion on the primary financial report
Principal auditor must be satisfied that component auditor is independent and competent and that their work provides satisfactory evidence to support principal auditor’s opinion.
Experts
Auditor’s may employ experts (land valuers, actuaries, lawyers) to help them audit financial statements where specialist non-accounting/auditing knowledge is required (valuation of assets, complex financial issues, condition of inventory)
Considerations when deciding to use auditor’s expert – nature, significance and complexity of matter; risk of material misstatement; availability of alternative sources of audit evidence.
Internal expert – employed by audit firm for common areas – lawyers
External experts – not employed by audit firm
When selecting an expert, auditor should evaluate if he/she has necessary competence, capabilities and objectivity for the auditor’s purpose
Competence of expert – personal experience, discussion, qualification, licence to practice
Agreement between Auditor and Expert:
o Nature, scope and objectives of expert’s work
o Respective roles & responsibilities of auditor and expert
o Nature, timing and extent of communication between auditor & expert (reports etc) o Confidentiality requirements
Auditor must evaluate expert’s work/conclusions – are conclusions & assumptions reasonable? Is source of data correct and relevant?
Reporting requirements – if unmodified opinion is issued, auditor shall not refer to work of auditor’s expert unless required by law
Types of Experts/Specialists
o Industry specialists – people who have unique organisational/operating
characteristics that raise special accounting/auditing considerations – assigned to particular industries
o Functional specialists – designated for areas of taxation, management advisory services, computer info systems and statistical and other mathematical applications o Technical specialists – may be internal/external – experts in another profession
(actuary/engineer)
o Management’s expert – someone possessing expertise in a field other than accounting/auditing whose work is used in preparing financial report o Auditor’s expert – work is used by auditor to assist in obtaining sufficient
appropriate audit evidence Internal Audit
Internal audit:
o Monitoring of internal controls
o Examination of financial and operating information o Review of operating activities
o Review compliance with laws and regulations o Risk management
o Review of corporate governance
Considerations in using work of internal auditors by external auditors o Objectivity
o Technical competence o Due professional care
o Effective communication between internal auditors and external auditors
o Adequacy of work – external auditor shall evaluate and perform audit procedures on internal auditor’s work to determine adequacy for external auditor’s purposes Fraud – ASA 240
Fraud – intentional act by individuals among mgmt, those charged with governance, employees/3rd parties, involving use of deception to obtain unjust/illegal advantage Fraudulent Financial Reporting – ASA 240.A4
- fake journal entries to manipulate operating results
- inappropriately adjusting assumptions/judgements used to estimate a/c balances - omitting/advancing/delaying recognition of events/transactions
- concealing/not disclosing facts
- engaging in complex transactions structured to misrepresent -altering records
(fraud affecting financial reports – misrepresentation of figures) Misappropriation of Assets – ASA 240.A5
- embezzling/misappropriating receipts - stealing physical assets/intellectual property - paying for goods and services not received - using entity’s assets for personal use (fraud affecting assets – theft)
Objectives of Auditor
o Identify and assess risks of material misstatement due to fraud
o Obtain sufficient appropriate audit evidence of assessed risks of material
misstatement due to fraud thru designing and implementing appropriate responses o Respond appropriately to fraud/suspected fraud identified
Professional Scepticism = an attitude that includes a questioning mind, being alert to conditions which may indicate possible misstatement due to error/fraud, and a critical assessment of audit evidence – ASA200
o Necessary in audit to reduce risks of:
Overlooking unusual circumstances
Over generalising when drawing conclusions from audit observations
Using inappropriate assumptions in determining nature, timing and extent of audit procedures and evaluating those results
Fraud Risk Factors:
Fraudulent Financial Reporting Incentive/pressure to commit fraud
Financial stability/profitability is threatened by economic/entity/industry conditions
Excessive pressure for mgmt to meet requirements of 3rd parties
Info available indicates personal financial position of
mgmt/directors is threatened by entity’s performance
Excessive pressure on mgmt/operating personnel to meet financial targets
Perceived opportunity to commit fraud
Nature of entity’s industry/operations
Monitoring of mgmt is not effective
Complex/unstable org. structure
Deficient internal control components Ability to rationalise fraudulent
action
Failure to support good/supporting bad ethical values
History of violation of financial rules
Excessive interest in maximising earnings/share price
Failure to fix internal control weaknesses
Aggressive tax minimisation
Low morale among snr mgmt
Strained relationship with current/prev auditor Misappropriation of Assets
Incentive/pressure to commit fraud
Known/anticipated future employee layoffs
Recent/anticipated changes to employee compensation/benefit plans
Promotions compensation/other rewards inconsistent with expectations
Perceived opportunity to commit fraud
Large amts of cash on hand/processed
Inventory items that are small in size of high value/in high demand
Easily convertible assets (gold/diamonds)
Inadequate internal controls Ability to rationalise fraudulent
action
Disregard for need for monitoring/reducing risk related to misappropriation of assets
Disregard for internal control
Behaviour indicating displeasure/dissatisfaction with entity/its relationship with employee
Change in behaviour/lifestyle that might indicate assets have been misappropriated
Tolerance of petty theft
Circumstances that Indicate Fraud
o Discrepancies in accounting records
Transactions not recorded in complete/timely manner/improperly recorded
Unsupported/unauthorised transactions/balances
Last minute adjustments that significantly affect financial results o Conflicting/missing evidence
Missing docs/inventory/physical assets
Significant unexplained items/reconciliations
Inconsistent, vague/implausible responses from mgmt/employees o Problematic relationship with mgmt
Denial of access to records/facilities/personnel
Undue time pressure to resolve complex/contentious issues
Intimidation of audit team members
Unusual delays in providing requested docs
Unwillingness to cooperate
o Other factors
Accounting policies appear to be at variance with industry norms
Frequent changes in accounting estimates not result from changes in circumstances
Audit procedures – auditor shall design and perform further audit procedures whose nature, timing and extent are responsive to assessed risks of material misstatement due to fraud at assertion level
Procedures examples
o Perform tests on an unannounced basis
o Substantive analytical procedures on disaggregated data
o For significant year end transactions check role of related parties and sources of financing
o Examine opening balances to determine how underlying assumptions reflected actual outcomes over year
Communication to mgmt – if fraud exists/may exist, communicate matters on a timely basis to appropriate level of mgmt to inform those with primary responsibility for prevention and detection of fraud
Communication to regulators – auditor’s legal responsibilities may override auditor’s duty of confidentiality
Auditors has a duty to report fraud, irrespective of materiality, to an appropriate level of mgmt
