The responses below are provided on a general basis and should not be taken as a substitute for professional judgement. They do not constitute any professional advice. Professional advice from an accountant, auditor, consultant or other advisor should be sought where appropriate. ISCA and its staff make no representations or warranties of any kind, express or implied, in relation to the responses and disclaim all liabilities for any claim, loss or damage of any kind, howsoever arising, in connection with the responses, including any use of or reliance on them.
We were asked to accept an appointment to act as auditors for a potential client. Hence, we sent a request to the preceding auditor to obtain professional clearance. However, we did not receive any reply. Based on a telephone conversation with an ex-staff of the firm, we understand that the audit firm has been dissolved six months ago. What are the next appropriate procedures that we can take before we can accept the appointment to act as auditors?
Section 210.10 of the Accounting and Corporate Regulatory Authority (ACRA) Code of Professional Conduct and Ethics for Public Accountants and Accounting Entities states that a public accountant who is asked to replace another public accountant should determine whether there are any reasons, professional or other, for not accepting the engagement, such as circumstances that threaten compliance with the fundamental principles. For example, there may be a threat to professional competence and due care if a public accountant accepts the engagement before knowing all the pertinent facts.
Paragraph 210.16 further states that if the proposed accountant is unable to communicate with the existing accountant, the proposed accountant should try to obtain information about any possible threats by other means such as through inquiries of third parties or background investigations on senior management or those charged with governance of the client. Paragraph 210.17 goes on to state that where threats cannot be eliminated or reduced to an acceptable level through the application of safeguards, a public accountant should, unless there is satisfaction as to necessary facts by other means, decline the engagement.
Hence, your firm should try to obtain information about any possible threats by other means such as through inquiries of third parties or background investigations on senior management or those charged with governance of the client since communication with the existing accountant is not possible. If the possible threats cannot be eliminated or reduced to an acceptable level, your firm should consider declining the engagement.
Under the current audit exemption criterion, an exempt private company (“EPC”) with turnover < S$5 million is exempt from audit. For an EPC which has a subsidiary or subsidiaries (i.e. a group), do we consider the turnover at company level or group level for this purpose?
The criterion of S$5 million is based on the company level turnover. Section 205C (1) of the Singapore Companies Act refers to the revenue of the exempt private company, without making special provisions for holding companies.
There are 2 types of companies that do not need to be audited:
- Exempt Private Company (EPC) with annual revenue of up to $5 million or less;
- A dormant EPC that does not have any accounting transactions (no business activities).
However, my understanding is that all dormant companies and not just dormant EPC, are exempted from audit. As such, I would appreciate if you could clarify on the 2nd condition above.
It is correct that all dormant companies are exempted from audits, regardless of whether they are EPCs or not.
You may wish to note that Section 205B(1) of the Singapore Companies Act allows a dormant company to be exempted from audit requirements if:
- it has been dormant from the time of its formation; or
- it has been dormant since the end of the previous financial year.
However, Section 205B(6) provides that members who hold not less than 5% of the company’s issued share capital can still require a dormant company to obtain an audit of its accounts.
Are there are any other regulations or code, other than those specified in SSA 210 paragraph A24, that might prohibit a practitioner from including a “restriction of the auditor’s liability” clause in the audit client engagement letter?
Based on SSA 210 Agreeing the Terms of Audit Engagements paragraph A24, when relevant, any restriction of the auditor’s liability could be made in the audit engagement letter, when such possibility exists. We are not aware of any other regulations or codes which prohibit the inclusion of such clauses in the engagement letter. However, as each restriction of liability clause is unique in itself, much like the engagements for which the engagement letters are drafted for, you are strongly advised to seek professional legal advice before including the restriction of the auditor’s liability in the engagement letters, especially whether the clause would be enforceable in the Courts of Law in Singapore.
SSA 230 Audit Documentation paragraph 15 states that after the assembly of the final audit file has been completed, the auditor shall not delete or discard audit documentation of any nature before the end of its retention period.
SSA 230 paragraph A23 further states that SSQC 1 Quality Control for Firms that Perform Audits and Reviews of Financial Statements, and Other Assurance and Related Services Engagements (or national requirements that are at least as demanding) requires firms to establish policies and procedures for the retention of engagement documentation. The retention period for audit engagements ordinarily is no shorter than five years from the date of the auditor’s report, or, if later, the date of the group auditor’s report.
If an auditor encounters a suspected fraud in the course of an audit engagement, does the auditor have to withdraw from the engagement? Does the auditor have the option to continue with the engagement and issue a modified opinion?
The Singapore Companies Act (the Act) does not appear to dictate whether the auditor – who encounters a suspected fraud in the course of an audit engagement – is required to withdraw or continue with the engagement. The Act does, however, set out the legal obligations of the auditor in the event that he has reason to believe that a fraudulent activity has been committed by a public company or subsidiary of a public company, in paragraphs 9A to 9C of Section 207. We would also like to draw your attention to Section 207(9) of the Act which states that the auditor of a company is required to report to the Registrar of Companies if he is satisfied that there has been a breach or non-observance of any of the provisions of this Act.
Additionally, the auditor would need to consider the implications of fraud on the audit engagement and risk of material misstatements before determining if he would continue with the engagement. Paragraphs 35 to 37 of SSA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements provide guidance for the auditor where there have been indications of fraud.
Further, paragraph A54 of SSA 240 also provides several “examples of exceptional circumstances that may arise and that may bring into question the auditor’s ability to continue performing the audit”.
Hence, the auditor would need to assess his position after considering the guidance above to determine if it is appropriate to withdraw from the audit engagement.
When the auditor decides to continue with the audit engagement after giving due consideration to the above, if the auditor concludes that based on the audit evidence obtained, the financial statements as a whole are not free from material misstatement, or is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a whole are free from material misstatement, the auditor shall modify the opinion in the auditor’s report in accordance with SSA 705 Modifications to the Independent Auditor’s Report.
I am a service provider in the midst of helping my client appoint an auditor for my client’s Singapore company with a foreign company as shareholder. The auditor requested to meet the beneficial owner of the foreign company in person for an interview, claiming that this is one of the requirements imposed on the audit firm. May I know whether the auditor has such a right to request to meet the beneficial owner? We have performed our own Know Your Client (KYC) on the beneficial owner. Is it sufficient for us to give an undertaking to the auditor that we have conducted KYC on the beneficial owner?
Auditors are required under SSA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment to identify and assess the risks of material misstatement, whether due to fraud or error, through understanding the entity and its environment, thereby providing a basis for designing and implementing responses to the assessed risks of material misstatement.
One of the risk assessment procedures identified in SSA 315 paragraph 6(a) include inquiries of management, and of others within the entity which in the auditor’s judgment may have information that is likely to assist in identifying risks of material misstatement due to fraud or error.
Furthermore, it was indicated in SSA 315 paragraph 14(a) that an auditor should obtain an understanding of the control environment and as part of obtaining an understanding of the control environment, the auditor shall evaluate whether management, with the oversight of those charged with governance, has created and maintained a culture of honesty and ethical behaviour.
Hence, obtaining an understanding of the client is an important part of audit. If the auditor deems it necessary to enhance his understanding of the client, the auditor may request for a meeting with the beneficiary owner of the foreign company although the beneficiary owner has the discretion to decide whether he wishes to meet the auditor or not.
Furthermore, an audit engagement should be regarded as a separate engagement from that of the services rendered by the service provider. As such, the auditor would be expected to exercise professional scepticism and perform his own KYC process, based on his professional judgment, instead of merely placing reliance on the undertaking from your company in respect of the KYC performed by your company.
The definition of performance materiality is as described in SSA 320 Materiality in Planning and Performing an Audit paragraph 9. It means the amount or amounts set by the auditor at less than materiality for the financial statements as a whole to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole. If applicable, performance materiality also refers to the amount or amounts set by the auditor at less than the materiality level or levels for particular classes of transactions, account balances or disclosures. It is determined for purposes of assessing the risks of material misstatement and determining the nature, timing and extent of further audit procedures (paragraph 11).
Applying the above:
- Performance materiality is determined for each financial statements caption (e.g. cash, fixed assets, revenue, etc) and will be different as it depends on the risk of each caption.
- Performance materiality must be lower than the overall materiality.
- Generally, performance materiality is determined at the planning phase. However, as SSA 320 states that performance materiality is determined for the purposes of assessing the risks of material misstatements and determining the nature, timing and extent of further audit procedures, it could also be determined at a later phase as long as it is determined before the audit procedures are conducted.
Additionally, you may also refer to the ICPAS publication – Practical Guidance 3 on “Materiality for Audit of Separate Financial Statements of Small Companies” – which can be found on the ISCA Centre for Auditing and Assurance (ISCA_QAGuide_Dec10_Resized1018.pdf). The publication provides practical guidance on establishing materiality during the phase of an audit.
According to paragraphs A3-A4 of SSA 320 Materiality in Planning and Performing an Audit, determining materiality involves the exercise of professional judgment. A percentage is often applied to a chosen benchmark as a starting point in determining materiality for the financial statements as a whole. Some examples of benchmarks that may be appropriate, depending on the circumstances of the entity, include categories of reported income such as profit before tax, total revenue, gross profit and total expenses, total equity or net asset value. Profit before tax from continuing operations is often used for profit-oriented entities. When profit before tax from continuing operations is volatile, other benchmarks may be more appropriate, such as gross profit or total revenues.
SSA 320 paragraph A7 also explains the relationship between the percentage and the chosen benchmark whereby a percentage applied to profit before tax from continuing operations will normally be higher than a percentage applied to total revenue. For example, the auditor may consider five percent of profit before tax from continuing operations to be appropriate for a profit-oriented entity in a manufacturing industry, while the auditor may consider one percent of total revenue or total expenses to be appropriate for a not-for-profit entity. Higher or lower percentages, however, may be deemed appropriate depending on the circumstances.
As determination of the benchmark and the percentage to be applied to the benchmark is mainly based on judgement of the auditor, the materiality formula applied to each entity may be tailored according to the facts and circumstances of the entity.
You may also wish to refer to the table under paragraph 8 in the ISCA publication – Practical Guidance 3 on “Materiality for Audit of Separate Financial Statements of Small Companies” – for an indication of the suggested percentages to be used for benchmarks such as profit before tax and turnover/total assets. Please refer to the Practical Guidance in ISCA_QAGuide_Dec10_Resized1018.pdf for more details.
Can the audit team obtain a confirmation of inventory balance at year-end and skip the observation of inventory count?
The answer is a definite No. The main objectives in observation of inventory count are (i) to obtain evidence of the existence and condition of the inventory and the security of its storage (ii) to observe how the client company conducts the inventory count (iii) to test the accuracy of the counting, and (iv) to obtain information for checking at later stages, such as last goods-received and despatched documents.
The observation of inventory count is to enable the auditor to check whether the inventory count procedures (provided by the management) are properly followed, and to conduct test counts to check that the procedures and internal controls over stocktake are satisfactory. Without attending the inventory count, the auditor would not be able to determine the existence, completeness and accuracy of the count records, in particular the high value items.
As far as possible, the management and the auditor should plan ahead for inventory count to be performed as at year-end date. In the event the management is unable to schedule inventory count as at year-end date, the auditor should highlight to the management that roll-forward /backward procedures on inventory quantities test counted during the physical inventory count to the financial year end position, need to be performed by the management. The auditor should then audit this information provided by management.
The auditor first need to know the costing method adopted by the company, whether the company is using first in first out (FIFO) or weighted average cost (WAC) to account for the cost of inventory.
FIFO method assumes that the items of inventory that were purchased or produced first are sold first and consequently the items remaining in inventory at the end of the period are those most recently purchased or produced. WAC method determines the cost of each item from the WAC of similar items at the beginning of a period and the cost of similar items purchased or produced during the period.
In performing unit cost testing for inventories under the FIFO cost formula, other than test checking the inventory items movement are in FIFO manner, the auditor needs to vouch to respective supplier invoices for the unit cost stated in the inventory list. If there are discrepancies in the samples tested for unit cost, the auditor needs to consider projecting the misstatement to the population to obtain a broad view of the scale of misstatement instead of disregarding it as immaterial without proper investigation into the reason for misstatement.
For testing inventories under WAC formula, the auditor should request for the detailed movements of inventories for the selected samples and verify to the relevant supporting documents such as the supplier invoices (for purchases) and sales invoices (for sales) and perform re-computation of the WAC for those items selected. Often, companies rely on their inventory systems to calculate the WAC of inventories. Unless the integrity of the inventory system has been tested and verified, the auditor should not rely solely on the WA costing generated by the inventory system and deem it appropriate.
If there are no subsequent year-end sales for the samples selected for testing of net realisable value, can the auditor consider tracing to current year’s sales or consider replacing the samples without subsequent year-end sales to complete the testing?
When there is a long time lapse from year-end to the audit report date, tracing to current year’s sales may not be appropriate as the sample itself may suggest existence of slow moving inventory. The auditor can choose an appropriate replacement sample to replace the original sample. This does not mean that no work need to be performed on the original sample. The original sample where there are no subsequent sales are exceptions noted and needs to be investigated, and with the disposition properly documented.
The auditor will need to perform further work to analyse whether there is any risk of stock obsolescence other than the original sample, by reviewing the company’s inventory aging list and discussing with management (preferably the sales manager or sales director) and assess the reasonableness of their assessment. After considering all this, the auditor must make sure that all the work performed and discussion made are properly documented and referenced to indicate work has been done.
What are some of the practical considerations to auditors when assessing the adequacy and reasonableness of inventories write-down and allowance for inventory obsolescence estimated by management in addressing the valuation assertion?
As part of the audit planning and risk assessment procedures, the auditor is required to gain an understanding of the industry developments and changes in economic environment affecting the inventories held by the company. The demand by customer is usually correlated to the prevailing economic conditions and may be significantly affected during an economic downturn especially if the demand for the product is elastic.
The nature of inventories is also an important factor for the auditor to consider in assessing adequacy and reasonableness of the allowance for inventory obsolescence. Perishable products like fresh fruits and vegetables which have a relatively short shelf life and electronic products such as computers and mobile phones in a fast changing technological environment are subject to a higher risk of obsolescence. On the other hand, generic items like spare parts of equipment generally have longer shelf life and a lower risk of obsolescence if they are properly stored and handled with care provided that the equipment continues to be used in the market.
Special arrangement with suppliers, if any, could also mitigate the risk of inventory obsolescence. An example would be items purchased from holding company which can be returned unconditionally if unsold.
The auditor should also keep a look out for the condition of the inventories during the inventory count. Signs of inventory obsolescence include discoloured, dented, dusty, rusty or expired goods and should be brought to the attention of management for appropriate follow-up actions to be taken. The auditor however should be mindful that observation of the physical inventory usually only provide limited evidence on the valuation assertion.
If management has an internal provisioning policy for slow moving and obsolete inventories i.e. relies on inventory aging report to provide for obsolete inventory, can the auditor then place reliance on management representation without corroborative work performed?
By simply relying on management representation is not sufficient work done. The auditor is required to review and check the reasonableness of the company’s internal provisioning policy.
The auditor should corroborate audit evidence by checking the accuracy of the inventories aging report, on a sample basis for each aging brackets and check that the underlying data provided by management are captured accurately before evaluating management’s assumptions on the provision.
Additionally, if provision is made for inventories that are over 180 days by the management. Why 180 days? Management may explain “the assumption is based on sales trend and inventory turnover days for the past years”. Merely documenting management’s representation is not sufficient work done. Auditor should corroborate management’s representation by performing review on the past year’s sales trend and inventory turnover days to conclude on the reasonableness of management’s assumption.
How does the auditor review and assess a company’s functional currency? Will it suffice for the auditor to rely on the management’s representations without challenging the appropriateness of the functional currency determined by the management?
Purely relying on the management’s representation without further work done is not acceptable. The auditor needs to understand the company’s business and its operations. The planning meeting with the management is a good time for the auditor to get an update on the changes to the company’s operations, key customers or suppliers and other relevant details. Management may verbally conclude that the company’s operations are the same as last year’s and that there are no significant changes to customers or suppliers from the prior year. The auditor will have to document the understanding obtained in the notes to the planning meeting, and corroborate it with the work done during the audit field work.
The review of functional currency can be done in conjunction with the audit of profit and loss items, for example, review of the sales and purchases invoices files to check if transactions denominated in currencies other than the determined functional currency correspond to the weighted or composition represented by the management. The auditor can also perform analytical review of the currency denomination of the receivables and payables to identify inconsistency with the substantive testing performed for sales, purchases and expenses. For example, if the results of the substantive testing procedures performed for sales, purchases and expenses indicate that the company transacts mainly in SGD, it would be unusual if the receivables and payables are denominated in currencies other than SGD. The auditor should then make further enquiry, seek further clarification and perform additional audit procedures to conclude whether the unusual finding makes business sense and can be corroborated.
How often should an auditor review the management’s assessment of functional currency? Under what circumstances would a company have a change in functional currency issue? How should the auditor document and address the issue?
Regardless of how thorough the auditor had performed the assessment in prior years, the auditor is required to demonstrate that adequate work has been performed in every audit to conclude that the functional currency determined by the management is still appropriate.
The functional currency can be changed only if there is a change to the underlying transactions, events or circumstances of the company. An example would be a Singapore-incorporated company which used to import from its parent company in China and sold its products locally decided to manufacture the product in Singapore and also not rely on the parent company for funding by retaining its operating receipts in Singapore and not remitting it back to China. In this example, RMB was the functional currency of the company in prior years. This may not be the case in the current financial year from the date the company ceased to import from its parent company in China and commenced manufacturing of the products in Singapore.
The auditor has to sight to the agreement for the effective date of termination of import from the parent company. Depending on whether the management intends to lease or build a manufacturing plant, the auditor should check for existence of the manufacturing plant by verifying to lease agreement or building contract. If the management intends to build a manufacturing plant, the change of functional currency may not be immediate. The auditor needs to identify when the company commences manufacturing the product in Singapore by asking the right questions and requesting for appropriate supporting documents to substantiate the change in functional currency.
PBSE review helps to identify events occurring after the balance sheet date which may have an implication on the financial statements, and it is the auditor’s responsibility to perform such review as stated in paragraph 6 of SSA 560 Subsequent Events. An example illustrating the importance of PBSE review would be the disposal of a building after year-end at a price significantly below its net book value. Through the enquiry with the management on significant events that occurred after the balance sheet date and review of directors’ meeting minutes, the audit team was made aware of such events and had requested that an impairment charge be provided for in the financial statements under audit. Had the PBSE review not been performed, the auditor would not have been aware of the subsequent sale and would have proceeded to issue a clean report on the financial statements which did not include this significant impairment provision.
Another example which illustrates the importance of PBSE review relates to review of credit notes issued after year-end. The audit team, in the course of the review of credit notes issued after year-end, had identified a credit note issued to a customer for a substantial amount which was unusual. Through further enquiry with the management, the audit team discovered that the credit note issued relates to sales discount provided to a distributor for meeting the sales target for the financial year. It was then that the audit team realised that the management had not made any provision for such liability as at balance sheet date. Further procedures were subsequently performed by the audit team to assess the pervasiveness of the issue and to evaluate the need for adjustments in the financial statements.
Not necessarily. However, some common PBSE audit procedures include:
• inquiry of management or those charged with governance;
• review of subsequent management accounts of the company;
• review of subsequent minutes of directors’ and shareholders’ meetings;
• review of credit notes issued after year-end;
• review of journal entries made subsequent to the date of financial statements;
• review of legal correspondences and update of legal replies (if applicable) until the date of audit report;
• review of subsequent payments;
• review of significant contracts and agreements signed after year-end;
• review of unpaid suppliers’ invoices and correspondences with suppliers; and
• search for unrecorded liabilities
When deciding on the types and extent of PBSE audit procedures, auditors need to consider their understanding of the company and the risks assessed. Generally, more extensive PBSE audit procedures are expected to be performed in the audit of a company with messy records or which lacks a clear reporting line and ownership of accounting function. Also, a specific risk identified in the audit may require more extensive or specific audit procedures to be performed.
Other PBSE audit procedures which may be performed include but are not limited to the review of subsequent utilisation of warranty provision, and review of correspondences with suppliers, customers and other relevant parties in cases of disputes. For example, in the audit of a manufacturing or trading company where goods sold are covered by warranty, a review of subsequent utilisation of warranty provision may be performed to assess that the warranty provision is adequate but not excessive.
If the interval between audit fieldwork and the date of audit report is short, is a post-balance sheet events (PBSE) review still required to be performed?
Yes, audit teams need to perform sufficient PBSE audit procedures to cover the period between the audit fieldwork and the date of the auditor’s report, regardless of the length of the interval. However, the extent of the PBSE audit procedures performed varies depending on the length of the interval. For illustrative purposes, an audit team has completed the audit fieldwork on 7 February 2012 but the audit report cannot be issued until the receipt of a significant outstanding amount from a customer subsequently on 21 February 2012. In addition to the followup on the documentation of the subsequent receipt received, the audit team needs to perform PBSE audit procedures to address the 14-day lapse between the completion date of the audit fieldwork and the date of the audit report, 21 February 2012. Given the relatively short interval, the amount of work is not expected to be as extensive as that for a one-month or longer interval. Judgement needs to be exercised by the public accountant and manager with significant experience when determining the nature, timing and extent of PBSE audit procedures, taking into account their understanding of the company and the risks assessed.
Is it necessary to perform the post-balance sheet events (PBSE) audit procedure to address the time lapse between the date of the audit report and the date of issuance of the financial statements?
According to SSA 560 Subsequent Events paragraph 10, the auditor has no obligation to perform any audit procedures after the date of the auditor’s report. However, if a material matter becomes known to the auditor before the financial statements are issued that may cause the auditor to amend the auditor’s report, then the auditor is required to discuss the matter with management and/or those charged with governance and determine whether the financial statements need amendment either in terms of disclosure or/and adjustment.
The extent of the PBSE audit procedure to be performed on the interval is an area requiring significant judgement. It is explained in SSA 210 Agreeing the Terms of Audit Engagements that the terms of the audit engagement include the agreement of management to inform the auditor of facts that may affect the financial statements, of which management may become aware during the period from the date of the auditor’s report to the date the financial statements are issued. Hence, at the minimum, the auditor is expected to make an enquiry with the management.
Additional PBSE audit procedures will be necessary in circumstances where the auditor determines that the financial statements need to be amended and a new audit report at a later date is to be issued on the amended financial statements.
For certain companies in the freight-forwarding business, transactions making up each specific accounts receivable balance are voluminous and individually insignificant. Furthermore, the auditor is always unable to obtain replies from all the circularised balances. Can the auditor perform alternative audit procedures on certain key transactions within the circularised accounts receivable balances for the non-replies?
Rule number one on sampling is “No cherry picking.” The above is an example of “samples on samples” which is unacceptable. In order for the auditor to draw a conclusion on the population from which the sample is selected, the use of sampling methodology requires that the entire sample items chosen be tested without exceptions. If there are exceptions, every exception should be investigated and satisfactorily resolved before the results of the audit procedures can be considered as sufficient to provide the relevant and reliable audit evidence necessary to address the assertions intended by the audit procedures.
For illustrative purposes, based on the sample selection planning template in the Audit Manual for Small Companies, eight debtors’ balances were selected for external confirmation. The auditor is required to corroborate all the eight balances selected either by way of confirmation replies or where there are no replies, by way of alternative procedures. For replies with differences, such differences should be investigated and satisfactorily resolved. For each non-reply, alternative audit procedures should be carried out to obtain relevant and reliable audit evidence on the unconfirmed account balance in its entirety.
For most of the small and medium-sized enterprises (SMEs), the audit usually commences four to five months after year-end. As alternative procedures can be easily performed to verify the accounts receivable (AR) balances, is it still necessary to circularise AR?
At first glance, this notion appears reasonable. Currently, the use of external confirmation is not mandated by any SSAs. However, SSA 330 The Auditor’s Responses to Assessed Risks paragraph 19 specifically requires the auditor to consider whether external confirmation procedures are to be performed as substantive audit procedures. As auditors, we need to design and perform audit procedures that are appropriate in the circumstances for the purpose of obtaining sufficient appropriate audit evidence. Reliability of the audit evidence is one of the key considerations in the process. Audit evidence in the form of external confirmation received directly by the auditor from a confirming party is considered the most reliable and appropriate evidence to address both the existence and completeness assertions for AR. In view of the integral relationship between AR and revenue which carries a presumed risk of fraud, the use of external confirmation procedures is typically expected when auditing AR balances. The expectation is further illustrated in the Audit Practice Bulletin No 1 of 2010 on External Confirmation issued by Accounting and Corporate Regulatory Authority (ACRA) which states that “ACRA expects auditors to continue to use confirmations as a means of obtaining audit evidence to ascertain the existence and/or completeness of assets and liabilities.”
In rare circumstances, should the auditor determine not to perform external confirmation procedures, the factors considered and the rationale for decision should be included in the audit working paper. The documentation should include the nature, timing and extent of alternative audit procedures performed. For example, in the audit of a freight-forwarding company, based on the auditor’s understanding of the industry and prior years’ audit experience, the response rate from AR circularisation is poor and therefore, the use of confirmation would not be effective. In such an instance, the auditor performs alternative audit procedures on the transactions making up the AR balance to subsequent receipts or delivery note with customer’s acknowledgement on goods received. To further check that the AR is genuine, the auditor should perform checks through search engines, such as Google or Yahoo, to check the registered address of the AR is the same as the address indicated on the invoice or perform an ROC search on the AR business profile, that is, ACRA’s website.
Would it make sense to allow the client to send out the accounts receivable (AR) confirmation request letters to speed up the confirmation process?
The auditor is required to maintain control over external confirmation requests, which include, inter alia, the sending or delivery of the requests to the confirming party. By allowing the client to send out the AR confirmation request letters, the auditor loses control of the confirmation process. Worse, the act will increase the risk that the confirmation requests or replies are intercepted and altered during the process.
To speed up the confirmation process, one suggestion is to send confirmation requests as soon as the year-end accounts are closed. By doing so, the debtors are likely to respond as the balances are current and information is readily available. If replies are not received within two to three weeks from the date of request, the auditor can follow up by sending a reminder on the confirmation request or calling the debtors.
In cases where the auditor is required to issue an audit opinion shortly after the balance sheet date to meet the tight reporting deadline of the audit client, the auditor may consider performing circularisation at an interim date prior to the balance sheet date. Thereafter, the auditor needs to perform audit procedures to validate the movements during the intervening period between the interim date and the balance sheet date.
If the auditor receives accounts receivable (AR) replies via fax or email, can the auditor accept the replies received without performing additional audit procedures?
In recent years, technology has advanced tremendously. The fax confirmation replies may be sent from a residential address of the Chief Executive Officer of the company under audit, who is trying to manipulate the revenue and profit of the company. Similarly, an email confirmation reply may also come from a non-existent customer’s email account created by a Finance Manager trying to cover up a potential scam of siphoning cash from the company under audit. The auditor needs to apply an appropriate level of professional scepticism regarding such confirmations received.
Generally, it is hard to establish the proof of origin for confirmations received by fax and email. In view of the susceptibility of email and fax confirmations to fraud, further audit procedures should be performed to verify these confirmations. The auditor should check the accuracy of the mailing address or fax number of the intended confirming parties and call the intended confirming parties directly regarding the confirmed balances. Of course, the audit work performed in addressing the reliability of replies prior to placing reliance needs to be documented properly as evidence of work done.
Knowing that management’s words should not be taken at face value, how should the auditor address the issue of a material debt that is long overdue?
It is management’s responsibility to assess the recoverability of the outstanding receivables while the auditor’s responsibility is to evaluate the management’s assessment. As part of the evaluation, the auditor should inquire into the basis of management’s assessment and corroborate the representations by management on the recoverability of outstanding receivables.
Where such evidence is not available, the auditor should independently evaluate the credit-worthiness of the customer and the ability to repay the outstanding amount. Such evaluation may include reviewing subsequent receipts and correspondences with the debtor, independently examining past payment patterns, or reviewing the debtor’s financial statements or credit rating report purchased from a reputable credit rating agency. Professional judgement is required when determining the nature and extent of additional audit procedures, taking into consideration the availability of information needed in the respective audit procedures.
In a scenario where the debtor is a publicly-listed corporation, there would be readily available financial information which the auditor can use to assess the ability of the debtor to repay the debt. However, in a contractual agreement setting out the repayment terms of the outstanding debts entered into between the company being audited and the debtor, the auditor should review the agreement and follow up with the management on the repayments.
For a local trading company, are sales invoices adequate evidence to support check that the customers have received the goods? How will the auditors ascertain that the sales transactions recognised have occurred and are genuine?
Sales invoices are internally generated documents by the company and by themselves, will not provide sufficient evidence that the goods have been delivered to the buyers. To ascertain that the sales transactions recognised have occurred and are genuine, auditors should obtain evidence of customers’ acknowledgement of receipts of goods, which are usually indicated in the delivery orders. For some companies, sales invoices, instead of delivery orders, may be used for customers’ acknowledgement of goods received. The acknowledgement of receipt of goods by customers on sales invoices may provide reliable evidence of the occurrence of the sales. In addition to the details, the dates of acknowledgement by the customers indicated on the delivery orders or sales invoices must be checked to make sure the sales transactions have been recorded in the correct accounting period.
In the case of overseas sales, it is unlikely that the customers will acknowledge goods received on the delivery orders issued by the company. How should the auditors check the occurrence of such sales?
For overseas sales, the company usually transports the goods to a destination designated by the customers by sea or air freight. Delivery documents such as bills of lading (BOL) and airway bills (AWB) issued by the shipper and cargo airlines respectively will provide the auditor with reliable evidence of these sales. BOL and AWB usually contain the following details relating to (i) the details of the goods that are loaded onto the vessel or aircraft to the consignee, (ii) the name and address of the consignee and (iii) the acknowledgement of goods for shipment signed by the shipper or cargo airlines. For samples selected, auditors should trace the details of the sales invoices to BOL or AWB to confirm the occurrence of sales to overseas customers.
Smaller companies may not have the practice of issuing delivery orders and/or requiring the customers to sign as evidence of receipts on the delivery orders or invoices. What should the auditors do?
Under the Singapore Companies Act, the directors and managers of the company are required to keep proper accounting and other records which will sufficiently explain the transactions and financial position of the company. It is therefore the management’s responsibility to provide the auditors with the necessary documents to support the sales transactions that are recorded in the books.
In such circumstances, the auditors should highlight to the management their responsibility to maintain proper accounting and other records, and the possible legal consequences for non-compliance. The auditor should ask if management can provide other relevant documents which can support the sales transactions. Where the management is unable to provide further documentation, auditors may consider requesting for external confirmations from the customers to confirm the sales transactions during the year.
If the auditor has exhausted all possible solutions with the management and is still unable to establish the occurrence of sales, the auditor will need to consider the implication to the overall financial statements. If the auditor has exhausted all avenues available to verify that the goods have been delivered, the auditors should assess the materiality and pervasiveness of the matter in determining the need to modify the audit report and the type of modified report.
For retail sales, goods are generally sold using cash terms at the point of sales (POS). The POS system is usually used to capture the receipts of payments from customers detailing the goods that have been sold. Can the auditors simply test the sales by reconciling the daily sales captured in the POS system with the general ledger without performing further audit procedures?
The answer is no. Sales report generated from the POS system is an internally generated document that is inadequate as evidence on the receipt of goods by the customers. To verify the occurrence of sales, the auditors should trace the sales recorded in the POS system to the payments received.
Let’s illustrate using an example of a retail shop selling beauty and fragrance products where customers purchase and make payment either in cash, credit cards or NETs (an abbreviation for Network for Electronic Transfers). On a sample basis, the auditors should check the daily sales recorded to payments received by:
(i) vouching to the banked-in slips for cash sales;
(ii) vouching to the daily statements from credit card companies on credit card sales; and
(iii) vouching to the daily statement from NETS on collection on behalf of the company.
Is selecting a sample of five transactions before and after year-end sufficient to address the sales cut-off assertion?
In order to perform a robust cut-off testing, the auditors need to obtain an understanding of the company’s cut-off procedures and assess the risk of material misstatement of revenue arising from any cut-off error. Rather than select a fixed sample number of transactions before and after year-end, the auditors should select adequate samples in the period during which the risk of cut-off is assessed to be high.
When determining the nature and extent of the audit procedures to address cut-off assertion, the following factors should be considered:
1. Risk of cut-off errors
Where the risk of cut-off errors is higher, the cut-off test will need to be more rigorous with more samples being tested and/or period covered extended. Indicators of higher risk of cut-off errors include but are not limited to the following:
i) Delivery orders are not pre-numbered or accounted for on a periodic basis;
ii) Delivery orders are not issued in proper sequence;
iii) Quantity of goods delivered or shipped is not reconciled to the quantity of goods billed;
iv) Management incentives to meet revenue goals is unusually high; and
v) Numerous or individually significant sales transactions occur near the end of the year.
2. Nature of sales
Depending on the nature of sales, the extent or method of testing may vary. For example, for retail sales, auditors may test the sales in the last day before and first day after year-end by tracing to the daily receipts to make sure the sales are recorded in the proper period. For a trading company, it may be more appropriate to extend the period covered to one week or even one month before and after year-end, taking into consideration the risk of cut-off errors, as illustrated earlier. Also, the test will involve vouching to delivery orders or sales invoices acknowledged by the customers.
3. International commercial terms (incoterms) used – for overseas trading sales
For overseas trading sales, incoterms are commonly used to determine when risks and rewards of the ownership are transferred. The auditor should examine the incoterms when performing the sales cut-off test to determine if the company has recorded sales in the correct accounting period during the year-end audit.
Let’s illustrate with a company which ships goods to its customers using the incoterm – Delivered Duty Paid. The occurrence of sales happens only when the freight forwarder delivers the goods to the buyer’s premises as specified by the buyer and after settling the necessary import duties and taxes, assuming no further conditions need to be met. The auditors need to assess the estimated length of time it takes to complete the sales process, which may vary with destinations. If the entire process takes approximately two weeks, the testing period will likely be two weeks or more before the year-end date.
Can the auditors rely on the confirmation received from the executive directors for their audit of the remuneration of directors without performing further audit procedures?
The confirmation of remuneration received from directors addresses the completeness and accuracy of executive directors’ remuneration as at financial year-end. However the confirmation on its own is insufficient evidence that the director has been correctly paid and remuneration correctly recorded. The auditors should verify to the directors’ employment contracts to ascertain the validity of the directors’ remuneration including benefits-in-kind. Smaller companies may not prepare or maintain written employment contracts. In such an instance, the auditor can perform alternative audit procedure to reconcile the directors’ remuneration to the IR8A submitted by the director to the Inland Revenue Authority of Singapore. In addition, a written management letter should be issued to those charged with governance to recommend that the company prepare formal employment contracts for each executive director, setting out clearly all the elements of remuneration including benefits.
Usually for a trading company, the auditor would perform audit procedures on office rental and staff costs. For the other operating expenses, can the auditors simply agree with the stated amount to general ledger and not perform further audit procedures?
It depends. In most audits, the auditor will consider three key factors to determine the extent of audit procedures to be performed. The factors considered include (1) whether the balances are material; (2) whether the balances have a higher risk of misstatement and (3) whether the balances are required to be tested by the SSAs.
For the other operating expenses, the auditors should make sure that all the material operating expenses are tested. In addition, the auditors can make use of analytical review procedures to identify expenses with significant or unusual fluctuations, or where the amount of expenses is not in line with expectations formed at the planning stage as these expenses are likely to have a higher risk of misstatement for testing. The auditor should also pay attention to expenses which by nature are susceptible to misstatement, for instance, travelling and entertainment expenses. Where staff or management are expected to travel frequently in the course of their work, the auditor should select samples and to check that the travelling and entertainment expenses recorded are incurred for business purposes. Last but not least, SSA 501 Audit Evidence – Specific Considerations for Selected Items paragraph 9(c) specifically requires the auditors to review the legal expense account in order to identify potential litigation and claims involving the entity which may give rise to a risk of material misstatement.
Who is responsible for identifying related parties (RPs) and related parties transactions (RPTs)? What are the common audit procedures the auditors can perform to identify and evaluate the completeness of RPs and RPTs?
The management is responsible for providing the auditors with a complete and accurate list of RPs and RPTs and the auditor’s duty is to audit the information provided by the management. SSA 550 Related Parties paragraph 15 specifically requires the auditors to inspect bank and legal confirmations obtained as part of the auditors’ procedures and inspect minutes of meeting of shareholders and those charged with governance (TCWG) for indications of the existence of relationships with RPs or RPTs that management has not previously identified or disclosed to the auditors.
Some other common audit procedures the auditors can perform to identify and evaluate the completeness of RPs and RPTs include:
• Engage with appropriate key management personnel to understand management’s internal procedures for identifying and accounting for RPTs
• Review prior years’ audit documentation for names of known RPs
• Ask predecessor or other auditors of related companies about existing relationship and the extent of management involvement in material transactions
• Inquire of appropriate management personnel as to the affiliation of TCWG with other companies
• Review the nature and extent of business transacted with major customers, suppliers, borrowers and lenders for any unusual or preferential terms for indication of RPTs
• Purchase the business profile of the company from the Accounting and Corporate Regulatory Authority’s website for information on the names of the directors and shareholders to identify RPs
• Obtain the group structure for a subsidiary of a group to identify names of RPs
The auditors should also obtain a written representation from management confirming the identity of the company’s RPs, the relationships and transactions of which they are aware.
What should the auditors do in the event that they have identified previously unidentified or undisclosed related parties (RPs) or related parties transactions (RPTs)?
The auditors should seek to understand from the management and evaluate the underlying circumstances of such transactions, and why such transactions were not identified previously. Auditors should then request the management to identify all such transactions for the auditors’ further evaluation.
The auditors are then required to communicate to the engagement team such information for them to consider the implication to the audit and the need to reassess the risk of material misstatements to the overall financial statements.
When deciding on the types and extent of audit procedures on the newly-identified RPs, auditors need to consider management’s response and the auditors’ reassessed risk. If the non-disclosure by management appears intentional and therefore indicative of a risk of material misstatement due to fraud at the assertion level, the auditors shall design and perform further audit procedures whose nature, timing and extent are responsive to the now significantly higher assessed risks of material misstatement at that assertion level. Further guidance is set out in SSA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements.
Should the auditors regard significant identified RPTs outside the normal course of business as a significant risk?
SSA 550 Related Parties paragraph 18 specifically requires the auditors to treat significant identified RPTs outside the entity’s normal course of business as giving rise to significant risks. The auditors need to understand and evaluate management’s business rationale for having such transactions, that is, through inquiry of management and review of correspondences, signed contracts or agreements. Having obtained the understanding, the auditors should check that the transactions are appropriately authorised, approved, accounted for and disclosed in the financial statements.
Examples of such transactions include:
• Complex equity transactions, such as corporate restructuring or acquisition
• Transactions with offshore entities in jurisdictions with weak corporate laws
• The leasing of premises or the rendering of management services by the entity to another party if no consideration is exchanged
• Sales transactions with unusually large discounts or returns
• Transactions with circular arrangements, for example, sales with a commitment to repurchase
Are auditors required to perform audit procedures to determine whether the transactions entered into with the related parties (RPs) are at arm’s length?
SSA 550 Related Parties paragraph 24 specifically states that if management has made an assertion in the financial statements to the effect that related parties transactions (RPTs) are conducted on terms equivalent to those prevailing for arm’s length transactions, the auditors shall obtain sufficient appropriate audit evidence about the assertion.
The preparation of the financial statements is the responsibility of the management. Where such assertion is made in the financial statements, the management is required to substantiate the assertion by providing support. Such support may include:
• Comparing the terms of the RPTs to those of an identical or similar transaction with one or more unrelated parties
• Engaging an external expert to determine a market value and to confirm market terms and conditions for the transactions
• Comparing the terms of RPTs to known market terms for broadly similar transactions in an open market
The auditors are required to evaluate the management’s support by verifying to the source of the internal or external data supporting the assertion, and testing the data to determine their accuracy, completeness and relevance and where applicable, consider the appropriateness of management’s process for supporting the assertion and evaluate the reasonableness of any significant assumptions on which the assertion is based. In practice, most of the supporting documents can be verified in the course of the auditor’s work.
Can auditors obtain confirmations from the related parties (RPs) for the balances outstanding and the related parties transactions (RPTs) transacted for the financial period without performing further audit procedures to verify the transactions. Is that adequate work done?
The confirmation received from RPs addresses the completeness and accuracy of balances outstanding and transactions with RPs for the financial period. However the confirmation on its own is insufficient evidence that such transactions and balances have been correctly recorded. The auditors would also need to satisfy themselves as to the validity of the purpose, nature and extent of these transactions and balances and their effect on the financial statements.
In the process of obtaining and confirming an understanding of the business purpose of such transactions, the auditors may examine invoices, executed copies of copies of agreements, contracts, or other pertinent documents, for example, shipping documents, and determine whether the transactions have been approved by the board of directors or other appropriate management personnel Where the auditors assessed that the transactions appear unusual and the full effect of the transactions may not be properly accounted for or disclosed in the financial statements, additional procedures may be necessary. The Public Company Accounting Oversight Board AU Section 334 sets out examples of such procedures:
• Confirm transaction terms including guarantees and other significant data, with the other party or parties to the transaction
• Inspect evidence in possession of the other party or parties to the transaction
• Confirm or discuss significant information with intermediaries, such as banks, guarantors, agents, attorneys, to obtain a better understanding of the transaction
• Refer to financial publications, trade journals, credit agencies, and other information sources when there is reason to believe that unfamiliar customers, suppliers, or other business enterprises with which material amounts of business that have been transacted lack substance
• With respect to material uncollected balances, guarantees, and other obligations, obtain information about the financial capability of the other party or parties to the transaction. Such information may be obtained from audited/unaudited financial statements or credit agencies. The auditors should decide on the degree of assurance required and the extent to which available information provides such assurance.
Why is there a need to analyse the construction contracts on an individual basis? Can we not just select one or two samples of contract and just walk them through?
This unfortunately is not adequate work performed. For instance, if a company has 5 contracts and you select the top 2 for your testing, the remaining 3 contracts not selected could be material on a cumulative basis. There is also the danger that profit from any of these 3 contracts offset the losses from the remaining contracts which breaches FRS 11, para 37(c). To elaborate, foreseeable losses may need to be made for loss-making contracts but should the analysis not be done on individual contracts but in totality, there is the possibility that profit arising from the profitable contracts is inadvertently used to offset the loss provision made.
Why do companies need to determine stage of completion for each individual construction contract? Would it not be sufficient to verify invoices acknowledged by the customers or supported by third party certifications to substantiate the revenue recognised? After all, these documents are acknowledged by third parties and therefore, should be reliable.
No, this is not adequate work done. We are talking about project accounting here. What this means is that the “percentage-of-completion (POC) point” determines the revenue, costs, profits and WIP that need to be recognised in the accounts and each of these elements have to be tied back to the POC point and cannot be determined in isolation. For instance, assuming a simple example where the contract value is $6m and the project is 70% completed but the amount of invoices acknowledge by customer and supported by third party certifications is $3m. You should not recognise only $3m as your revenue. Given that the POC determined is 70%, the amount of revenue that you should recognise is $4.2m. If you had not determined the POC, you would erroneously recognise only $3m as your revenue instead of $4.2m. The amount of costs that need to be recognised and the resulting attributable profit and WIP have to be also be computed based on the POC of 70% and accounted for in the financial statements. These elements are correlated.
Recognising percentage-of-completion (POC) in construction contracts is easier said than done. Not all companies use the “proportion of contract costs” method to determine POC. Also, for those that use the “survey of work performed” method or “completion of physical activity” method, companies may not engage external surveyors. Would this tantamount to scope limitation?
If the projects are big, it would be advisable for companies to engage third party surveyors to determine the POC for all material projects as at year-end. The POC for the survey method or physical activity method must be determined by “experts” (who could be engineers, architects or surveyors) who are knowledgeable about the subject matter and has the competence to make that determination. Some companies may not want to incur the costs to hire the experts but that being said, auditors should exercise professional judgment in deciding whether to insist that experts be used, having taken into account of the significance of each projects and the potential impact on the financial statements should incorrect determination of POC been made.
Can auditors rely on the representation of inhouse experts to determine the percentage-of-completion for the management in construction contracts if companies do not engage external experts?
This is a viable alternative to external experts. However, reliance can only be placed by auditors after having satisfied themselves that the in-house personnel has the competence and capability to make the POC determination and more importantly, he is objective in his work. The expert’s objectivity can be quite tricky to corroborate especially if he is an employee of the company. You could, for instance, check that he is registered with a particular association or institute which requires that he complies with the relevant code of ethics and professional conduct. After you are satisfied with the expert’s professional characteristics, you should then obtain an understanding of the expert’s work and ascertain whether his work can be used as your audit evidence. All these are requirements of SSA 500(R) paragraph 8 and must be complied with.
This may not necessarily be so. If this method is adopted, you have to obtain an understanding of the management’s bidding process of each contract and their process of revising the estimated total contract costs as the contract progresses. The numerator i.e. total contract costs incurred may be easier for the management to determine because they are based on actual amount incurred and should be supported by relevant documents. However, the denominator i.e. estimated total contract costs requires exercise of judgment by the management because it requires consideration of factors like overruns, delays, over/under-budgeting, changes in market conditions, etc. especially for the bigger projects.
If the management do have processes in place to review and revise their estimated total contract costs, can auditors just document as such and pass further work?
This would not be adequate. Auditors have to corroborate management’s processes and representations. This can be done by verifying the major components in the estimated total contract costs which may include, but not limited to, verifying quotation from suppliers to support materials costs, ascertaining the reasonableness of the basis and estimated amount of labour costs by reviewing payroll records and files, review the appropriateness of overheads allocation.
It was mentioned that determination of foreseeable losses is highly subjective due to the need to consider various factors. How can this determination be audited?
To identify foreseeable losses, management has to first ascertain the estimated total contract costs. Foreseeable loss is the product of estimated total contract costs in excess of total contract revenue. We have discussed this in our previous question as to how these estimates can be corroborated so it shall not be repeated here. It would be useful to again emphasise the additional factors that need to be considered when determining the appropriateness of the estimated total contract costs and the resulting foreseeable loss. Auditors are required to analyse and discuss, among others, these matters with the management: delays, cost overruns, penalty clauses, liquidated damages clauses. It is crucial that auditors read the contracts to “sift out” any clauses that affect elements of revenue, total costs and loss provisions.
For projects fully completed in a particular financial year, does it mean that auditors do not need to worry about performing all the aforementioned audit procedures?
Only certain procedures may not be required anymore, for example, there may no longer be the need to corroborate estimated total contract costs as all costs should have been incurred and any loss realised. However, other procedures to confirm completion of projects are required for instance, sighting Certificate of Release acknowledged by customer, TOP, Certificate of Completion by architects and/or quantity surveyor or customer acknowledged project hand-over documents. In addition, do perform post balance sheet events review work to make sure that total contract costs have been captured and any loss has been accrued for in the financial year under audit.
If the management’s records are incomplete or not in proper order such that the auditors’ ability to perform the required audit procedures is hampered, what can be done?
There is no one correct answer to this question. Auditors have to consider the extent of scope limitation and whether alternative audit procedures could be performed. If in doubt, it pays to consult with other practitioners. Suffice to say that if the scope limitation, in the auditors’ professional judgment, has significant impact on the financial statements, they should seriously consider issuing a modified opinion. That being said, it would be wise for the auditors to obtain concurrence from another experienced practitioner just to make sure that the type of audit opinion issued is appropriate. Complete and robust documentation to justify the type of opinion issued shall be prepared and filed. Any modified opinion should not be taken lightly. Thereafter, the auditor should also find out whether the company will make improvements to their accounting and financial reporting function to address incomplete and improper record-keeping and if not, he should consider whether it is worth keeping the client.
For the response letters sent out by banks to auditors to confirm balances, are there any guidelines currently to indicate that the response letters must be duly signed by an officer of the banks before they can be accepted as audit evidence?
SSA 505 External Confirmations and Audit Guidance Statement (AGS) 6 Bank Reports for Audit Purposes do not specifically state whether the response letter to a request for bank confirmation needs to be signed by an authorized officer of the bank. Therefore, auditors need to exercise professional judgement to determine whether the response letter can be considered sufficient appropriate audit evidence.
In exercising that professional judgement, auditors have to bear in mind the objective of the procedure, which is to design and perform external confirmation procedures to obtain relevant and reliable audit evidence (SSA 505 paragraph 5). Auditors are required to assess the reliability of the responses to confirmation requests. If there are inconsistencies in audit evidence obtained from various sources or if the auditors have doubts over the reliability of the information, modifications or additional audit procedures have to be performed to resolve such inconsistencies or doubts (SSA 500 Audit Evidence paragraph 11). For example, the auditors may have to consider contacting the confirming party to verify the source and contents of the confirmation response (SSA 505 paragraph A14).
Hence, after considering the above, some auditors may insist on the bank confirmation to be signed by an authorized officer of the bank, whilst others may accept as sufficient appropriate audit evidence a bank confirmation which states “This is a computer generated statement. No signature is required”. Nevertheless, in all cases, the bank confirmation must be an original copy and be received by the auditors directly from the bank.
With reference to clarified SSA 505 on external confirmations, I would like to enquire if third party debtor confirmations are currently mandatory under Singapore auditing standards.
Although obtaining external confirmations is not a mandatory procedure to be performed, SSA 500 Audit Evidence paragraph A31 highlights that audit evidence is more reliable when it is obtained from independent sources outside the entity. The auditor should perform alternative audit procedures where no response is received to a positive external confirmation request.
I am currently working on a first year audit of a new client whose financial statements of the previous financial year are not audited. I understand that I should state in the auditor’s report that the corresponding figures are unaudited. Although the company has no opening stock and other opening balances can be verified as part of current year’s audit, the accumulated retained earnings brought forward still cannot be verified and will always have effect on future balance sheet. How should the audit opinion be expressed in this case?
As you have rightly pointed out, SSA 710 Comparative Information – Corresponding Figures and Comparative Financial Statements paragraph 14 states that if the prior period financial statements were not audited, the auditor shall state in an Other Matter paragraph in the auditor’s report that the corresponding figures are unaudited. Such a statement does not, however, relieve the auditor of the requirement to obtain sufficient appropriate audit evidence that the opening balances do not contain misstatements that materially affect the current period’s financial statements.
Hence, it is the auditor’s responsibility to obtain sufficient audit evidence about whether opening balances contain misstatements that materially affect the current period’s financial statements.
In accordance with SSA 510 Initial Audit Engagements – Opening Balance paragraphs 10 and 11, if the auditor is unable to obtain sufficient appropriate audit evidence regarding the opening balances, the auditor shall express a qualified opinion or disclaim an opinion on the financial statements, as appropriate, in accordance with SSA 705 Modifications to the Opinion in the Independent Auditor’s Report. If the auditor concludes that the opening balances contain a misstatement that materially affects the current period’s financial statements, and the effect of the misstatement is not appropriately accounted for or not adequately presented or disclosed, the auditor shall express a qualified opinion or an adverse opinion, as appropriate, in accordance with SSA 705. SSA 705 paragraphs 7 to 10 further discuss the different types of modification to the auditor’s opinion.
You may also wish to refer to SSA 510 paragraphs 6 and A3 to A7 which provide guidance on the nature and extent of procedures necessary to obtain sufficient appropriate audit evidence regarding opening balances.
Hence, the audit opinion to be expressed depends on the audit evidence obtained by the auditor and the impact on the financial statements.
Do SSA 300 and SSA 510 state that the incoming auditors should rely on the working papers of the predecessor auditors to ascertain the opening balances are fairly stated?
SSA 510 Initial Audit Engagements – Opening Balances provides that the auditor shall obtain sufficient appropriate audit evidence about whether the opening balances contain misstatements that materially affect the current period’s financial statements.
Paragraph 6(c) of SSA 510 states some of the procedures that the auditor may perform in order to obtain sufficient appropriate audit evidence on the opening balances and these include where the prior year financial statements were audited, reviewing the predecessor auditor’s working papers to obtain evidence regarding the opening balances. Paragraph A4 further states that whether such a review provides sufficient appropriate audit evidence is influenced by the professional competence and independence of the predecessor auditor.
Paragraphs A6 and A7 provide other audit procedures the auditor may perform to obtain the necessary audit evidence, e.g. from part of the current period’s audit procedures, examining accounting records and other information underlying the opening balances, confirmations with third parties etc.
Hence, the incoming auditors should perform an independent level of work and not just placed its total reliance on the working papers of the predecessor auditors to ascertain that the opening balances are fairly stated.
With regards to a Statement by Directors as stated below, please advise if it constitutes a qualification opined by the directors. If so, can we as auditors issue a report without any similar qualification or would an emphasis of matter paragraph suffice?
In the opinion of the directors,
(a) the accompanying financial statements are drawn up so as to give a true and fair view of the state of affairs of the Company as at 31 December 2011 and the results, changes in equity and cash flows of the Company for the year ended on that date, and
(b) at the date of this statement, subject to the continued financial support from its holding company, there are reasonable grounds to believe that the Company will be able to pay its debts as and when they fall due.
The auditor will have to first assess whether the going concern assumption is appropriate but a material uncertainty exists. Then the auditor will have to make his judgment whether adequate disclosures have been made in the financial statements. Assuming that the auditor concludes that the going concern assumption is appropriate but material uncertainty exists, paragraph 19 of SSA 570 Going Concern will apply if there are adequate disclosures in the financial statements, and the auditor shall express an unmodified opinion and include an Emphasis of Matter paragraph in the auditor’s report. Conversely, paragraph 20 of SSA 570 will apply if there are inadequate disclosures in the financial statements, and the auditor shall express a qualified opinion or adverse opinion as appropriate.
The inclusion of the “subject to the continued financial support from its holding company” in the Statement by Directors will suggest that this is a significant matter and requires additional disclosure by the directors. Hence, you are advised to evaluate the existing circumstances surrounding the client’s business and whether there are any material uncertainty related to events or conditions that may cast significant doubt on the client’s ability to continue as a going concern in determining the appropriate auditor’s report to be issued.
SSA 600 Special Considerations – Audits of Group Financial Statements (Including the Work of Component Auditors) paragraph 9(a) defines component as “an entity or business activity for which group or component management prepares financial information that should be included in the group financial statements”.
Depending on the entity’s organisation structure or financial reporting system, a component can be a legal entity or one that is organised by function, product, service, or geographic location. We illustrate with an example of a shipping group of companies that consists of subsidiaries and associates involving business activities, namely ship management, ship owning and ship chartering in various regions. In this example, the component of the group may be identified as (a) an individual subsidiary and associate; (b) an individual business activity; (c) an individual business activity by region; (d) a region, or (e) any other grouping, depending on how the financial reporting structure is organised.
SSA 600 Special Considerations – Audits of Group Financial Statements (Including the Work of Component Auditors) states that the group engagement team may consider
(a) applying a percentage (that is, 15%) to a chosen benchmark (for example, group assets, liabilities, cash flows, profits or turnover) to identify individual components that are of financial significance, and (b) identifying a component as likely to include significant risks of material misstatement in the group financial statements due to its specific nature of circumstances. When determining significant component of a group, the following should be considered:
(i) Components with insignificant revenue but many capital assets
We illustrate with an example of a group that has subsidiaries with significant revenue and profit and subsidiaries with insignificant revenue but many capital assets. The group engagement team may consider it appropriate to use two benchmarks, profit before tax and gross assets to identify significant component instead of merely sticking to one benchmark.
(ii) Components that are loss-making companies
When determining whether components with reported losses are financially significant, the group engagement team should inquire about the reason(s) for the losses, and non-recurring charges that affect the quality of earnings. Take an example of a group comprising profitable components and loss-making components – the group engagement team may use revenue or gross profit instead of profit/loss before tax to identify individually financially significant components.
(iii) Components that carry a higher risk of misstatement
When determining such components, the group engagement team would consider the following scenarios which may indicate likely higher risk of material misstatement:
- A component with no obvious business rationale
- A newly-acquired component
- A component with continued reported losses or current year loss
- A component that is carrying out a specific activity of the group (for example, foreign exchange trading or hedging activity)
- Questionable competency of component management or concern that component management does not have the necessary knowledge of the applicable financial reporting framework
- Fraud risk factors of the components are identified that would indicate a risk of material misstatement due to fraud (for example, history of fraud or allegation of fraud)
- Other factors including:
- Excessive pressure from the group for the component to meet certain performance targets
- Significant portion of component management’s remuneration is based on achieving performance targets
- Accounting estimates subject to management bias
- Risks associated with the location of the component (for example, political or economic instability)
Hence, the group engagement team would have to gather sufficient understanding of the group and circumstances to determine significant component which is not merely a mechanical or mathematical exercise.
The group engagement team is responsible for providing the audit opinion on the group financial statements and therefore needs to gather sufficient and appropriate audit evidence to support the opinion on the consolidated financial statements. In order to do so, the group engagement team needs to identify significant components of the group that may expose the group to a higher risk of material misstatement either due to the financial significance of the component or due to the nature of the component’s business. This is because a material misstatement in the financial statements of a component could become a material misstatement in the financial statements of a group.
Prior to accepting a new engagement, the group engagement partner should assess the integrity of the potential client; consider whether he has the competence and expertise to take on the engagement, and whether the firm is in compliance with relevant ethical requirements. Specifically relating to the acceptance of group audit engagement, SSA 600 Special Considerations – Audits of Group Financial Statements (Including the Work of Component Auditors) paragraph 12 requires the group engagement team to obtain an understanding of the group, its components, and the environment to the extent that it is sufficient to identify components that are likely to be significant. Using this information, the group engagement partner then evaluates whether the group engagement team can be involved in the work of those component auditors to obtain sufficient appropriate audit evidence to form a basis for the group audit opinion.
Such understanding can be acquired by way of discussion with the group management, inquiry of the previous auditor, search engines like Google or Yahoo, or purchase of the company’s business profile through the Accounting and Corporate Regulatory Authority (ACRA) website. Through the information gathered, the group engagement team would be able to understand the composition of the group, components that make up the group’s core business activities, group’s consolidation process and group-wide control (if any).
Where certain of the group’s significant components are being audited by the other auditors, the group engagement partner needs to evaluate if his team can have access to these component auditors, their documentation as well as component management. In some circumstances, the group engagement partner may be made aware that they will be denied access to the financial information, management and component auditor of a significant foreign entity of the group. The audit engagement team should consider declining the engagement if the limitation could result in the engagement partner giving a disclaimed opinion on the group financial statements.
Can the group engagement team perform the audit work of foreign components without involving the foreign audit firm? What are the implications to the overall audit?
SSA 600 Special Considerations – Audits of Group Financial Statements (Including the Work of Component Auditors) does not prohibit the group engagement partner to perform the audit work on foreign components. The group engagement partner can decide whether he wants the group engagement team to perform the audit of the component or rely on the work of the component auditor. If the former is concluded, the group engagement partner needs to make sure the firm has the professional expertise and competency to perform the audit, such as an understanding of the culture and practices, and the legal and financial reporting framework of the component’s environment which may affect how the audit is planned and carried out.
We take an example of an audit of a foreign component in China. The tax system in China is complicated and can be difficult for the group engagement team to understand. If the group engagement team does not understand how the tax in China is being computed, this may contribute to a potential risk that the tax element of the foreign component be materially misstated. Further, in the audit of cash and bank balances in China, there are certain banks within certain provinces that do not entertain foreign auditors and the bank confirmation requests have to be made through locally-registered auditors. Consequently, the group engagement team may still consider it necessary to involve another accounting firm that has the required expertise and competency to assist in the audit of certain element(s) of the foreign component.
If it is an insignificant component, what are the audit works the group engagement team can perform?
SSA 600 Special Considerations – Audits of Group Financial Statements (Including the Work of Component Auditors) paragraph 28 specifically states that “for components that are not significant, the group engagement team shall perform analytical review at group level”. The group engagement team would normally perform analytical review procedures on the aggregated financial information of the components that are not significant, to corroborate the group engagement team’s conclusion that there are no significant risks of material misstatement. If there is any significant variance from the comparable information for prior periods, management’s budgets and expectation formed at planning stage, the group engagement team would need to investigate through inquiry with the group management and consider whether further audit procedures are required to gather the necessary audit evidence.
At times, after performing the audit work on the financial information of significant components; the review of the group-wide controls and consolidation process, and the analytical review procedures at the group level, the group engagement partner may conclude that there is still insufficient appropriate audit evidence gathered to form the group audit opinion.
The group engagement team may then select some non-significant components to perform audit work. In the selection of non-significant components, the group engagement team should include an element of unpredictability that may increase the likelihood of identifying material misstatement of the components’ financial information and have it varied on a cyclical basis.
The additional audit work performed on the non-significant component(s) selected involve (a) an audit or review of the non-significant components’ financial information using component materiality; (b) an audit of one or more account balances, classes of transactions or disclosures, or (c) any other appropriate audit procedures. The group engagement team can either perform the audit work themselves or request the component auditor to perform the audit work. Last but not least, the group engagement team must have these properly documented.
Is it compulsory for a component auditor to provide a copy of their audit working papers to the group engagement team? Is allowing the group engagement team access to the audit files sufficient?
SSA 600 Special Considerations – Audits of Group Financial Statements (Including the Work of Component Auditors) paragraph 41 sets out a list of communication that shall be requested by the group engagement team from its component auditors in order to support the group audit’s conclusion and audit opinion.
Paragraph A59 illustrates that in cooperating with the group engagement team, the component auditor, for example, would provide the group engagement team with access to relevant audit documentation if not prohibited by law or regulation.
Hence, unless prohibited by law or regulation, the component auditor would usually provide such access to the group engagement team. It is to be noted that the standard explicitly refers to access to relevant audit documentation but does not state that copies of audit files are to be provided to the group engagement team.
There are no SSAs requirements or relevant regulations that state that a component auditor has to provide access or a copy of its audit files to the group auditor. The audit files are the property of the audit firm, hence the audit firm has the discretion to determine whether or not to provide the group auditor, access to relevant audit documentation and/or provide copies of audit files. Having said that, SSA 600 supports effective communication between the group auditor and the component auditor so that the group auditor can obtain sufficient appropriate audit evidence on which to base the group opinion. If your firm is not comfortable with providing a copy of your audit documentation to the group auditor, you may wish to communicate with the group auditor if providing access to the work papers and discussions is sufficient for their purpose.
Paragraphs 30(c) and 50(b) of SSA 600 (revised) are applicable to significant components of a group audit, i.e. the group auditor reviews the documentation of component auditors.
Would appreciate if you could clarify the above requirements:
1) Is it mandatory to be performed?
2) What are the ways to perform the review, i.e. physically visit the component auditor’s office or send the working papers for our review via email/courier,
3) Any alternative procedures that are acceptable under SSA besides reviewing the documentation?
4) Will the use of group audit instructions (per SSA) issued to components auditors replace the review of documentation?
5) What if we are not able to perform the review, say the component auditors do not allow us to review their documentation? Do we issue a qualified opinion or a disclaimer? Any appropriate wording that can be found in SSA?
According to paragraph 18 of SSA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Singapore Standards on Auditing, the auditor shall comply with all SSAs relevant to the audit. An SSA is relevant to the audit when the SSA is in effect and the circumstances addressed by the SSA exist. SSA 600 Special Considerations —Audits of Group Financial Statements (Including the Work of Component Auditors) sets the guidelines when performing group audits, in particular those that involve component auditors. The group engagement auditor shall not represent compliance with SSAs in the auditor’s report unless the auditor has complied with the requirements of all other SSAs relevant to the audit, including SSA 600. In other words, it is mandatory to comply with the requirements of SSA 600.
SSA 600 explains the matters that the group engagement team considers when determining the nature, timing and extent of its involvement in the risk assessment procedures and further audit procedures performed by the component auditors on the financial information of the components. The purpose of this involvement is to obtain sufficient appropriate audit evidence on which to base the audit opinion on the group financial statements.
Paragraphs 30 and 31 of SSA 600 provide guidelines on the group engagement team’s involvement in the work performed by component auditors of a significant component in performing risk assessment and further audit procedures respectively. Paragraph 30 states that the nature, timing and extent of this involvement are affected by the group engagement team’s understanding of the component auditor, but provide the minimum work to be performed, including reviewing the component auditor’s documentation of identified significant risks of material misstatement of the group financial statements. Paragraph A55 further provides other forms of involvement in the work of a component auditor other than those described in paragraph 30 and 31.
Paragraphs 40 and 41 of SSA 600 provide guidelines on communication with the component auditor (i.e. usually in the form of audit instructions that you have mentioned). The group engagement team shall evaluate the component auditor’s communication and determine whether it is necessary to review other relevant parts of the component auditor’s audit documentation. Paragraph A58 further provides that communication between the group engagement team and the component auditor, however, may not necessarily be in writing. For example, the group engagement team may visit the component auditor to discuss identified significant risks or review relevant parts of the component auditor’s audit documentation. Hence, the standard does not stipulate mandatory procedures to be performed. However, documentation requirements as set out in paragraph 50 shall apply.
If the group engagement team concludes that the work of the component auditor is insufficient, the group engagement team shall determine what additional procedures are to be performed, and whether they are to be performed by the component auditor or by the group engagement team.
If the group engagement team is not able to be involved in the work of the component auditor and, therefore, unable to obtain sufficient appropriate audit evidence in relation to that component, the effect of the group engagement team’s inability to obtain sufficient appropriate audit evidence is considered in terms of SSA 705 Modifications to the Opinion in the Independent Auditor’s Report. Paragraphs 7 to 10 of SSA 705 provide guidelines in determining the type of modification to the auditor’s opinion.
You may refer to Appendix 1 in SSA 600 for an example of an auditor’s report containing a qualified (except for) opinion based on the group engagement team’s inability to obtain sufficient appropriate audit evidence in relation to a significant component, but where, in the group engagement team’s judgment, the effect is material but not pervasive.
Can we apply SSA 600 to the audit of a branch when we are reporting on the results of the Singapore incorporated company as a whole?
SSA 600 Special Considerations – Audits of Group Financial Statements (Including the Work of Component Auditors) paragraph 9(a) defines component as an entity or business activity for which group or component management prepares financial information that should be included in the group financial statements. According to SSA 600 paragraph A2, the identification of components is affected by the structure of the group. One of the examples cited in paragraph A2 was that of a head office, with one or more divisions or branches, which could constitute as a component for purposes of group audit under SSA 600. As such, SSA 600 may be applied for the audit of a branch.
What are the group auditor’s responsibilities on the communications and deliverables submitted by the component auditors?
According to paragraph 8(b)(ii) of SSA 600 Special Considerations – Audits of Group Financial Statements (Including the Work of Component Auditors), the group auditor is required to obtain sufficient appropriate audit evidence regarding the financial information of the components and the consolidation process to express an opinion on whether the group financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework.
Where the group engagement team plans to request a component auditor to perform work on the financial information of a component, the group engagement team is required, as stated in paragraph 19, to obtain an understanding of the component auditor, including the component auditor’s professional competence, whether the component auditor understands and complies with the ethical and independence requirements and whether the group engagement team will be able to involved in the work of the component auditor to the extent necessary to obtain sufficient appropriate audit evidence.
Where the financial information of a component has not been prepared in accordance with the same accounting policies applied to the group financial statements, paragraph 35 of SSA 600 requires the group engagement team to evaluate whether the financial information of that component has been appropriately adjusted for purposes of preparing and presenting the group financial statements. Paragraph 36 of SSA 600 also requires the group engagement team to determine whether the financial information identified in the component auditor’s communication is the financial information that is incorporated in the group financial statements.
Hence, as the group engagement team, you should evaluate the quality of the component auditor’s communications and deliverables. If you have any doubts on the reporting made by the component auditors, additional audit procedures should be performed in order to obtain sufficient appropriate audit evidence so as to form an opinion on the group financial statements.
Can the auditor issue a disclaimer of opinion if the auditor is unable to attend the stock-take because the auditor was appointed after the financial year end?
A modified opinion should not be the first solution. The auditor has to consider the extent of scope limitation and whether alternative/ additional audit procedures could be performed.
At first glance, this seems like a limitation of scope. However, the auditor has to consider if alternative/ additional procedures could be performed to ascertain the inventory balance as at year-end. An example of such procedure is observing a current physical stocktake and test checking the roll-back reconciliation to the year-end inventory quantities. The inventory roll-back reconciliation should be prepared by management.
If the auditor is able to obtain sufficient appropriate audit evidence (as mentioned above) regarding the year-end inventory balance, the audit opinion need not be modified. However, if the management is unable to reconcile the current physical inventory count to the year-end inventory quantities or significant time has lapsed since the financial year-end, the auditor may have to modify the auditor’s report as a result of the limitation of scope. To express a qualified opinion or a disclaimer opinion is dependent on the financial impact of the limitation of scope, whether it is material and pervasive to the overall financial statements. It is fair to say that the auditor should have explored/ exhausted all possible solutions with the management, before deciding to issue a modified audit report.
The auditor shall promptly communicate with those charged with governance (TCWG) when he expects to modify the audit opinion. This enables the auditor to give notice to TCWG the intended modification and reasons for modification, seek TCWG’s acknowledgement and for TCWG to explain/ provide further information on the circumstances.
The auditor should also inform TCWG the ramifications of a modified report. Such communication with the management should be adequately minuted with a copy provided to TCWG. An official letter highlighting the reasons for modified opinion, type of opinion and ramifications to directors should be furnished to TCWG. For SMEs, TCWG would be the directors of company.
In conclusion, a modified opinion is never a short cut to completing an audit engagement.
It is always a challenge for the auditor to persuade the client to provide for impairment of accounts receivable because of the potential financial impact on the overall financial statements. Is qualification a solution?
Not necessarily. Upon identifying the potential recoverability issue, the auditor should first engage with the management. For small and medium-sized enterprises (SMEs), management usually consists of one or two key personnel who are very involved in the company’s business operation and know their customers well. Discussion with appropriate management personnel instead of finance personnel will usually provide the auditor with insight on management’s basis of their recoverability assessment. Further audit procedures can then be performed to corroborate management’s assessment.
If the auditor, after performing further audit procedures, is still of the view that impairment is necessary, the auditor should determine the implications to the financial statements. If the auditor concludes that the possible effect on the financial statements is material and management is unwilling to provide for the impairment, qualification is likely to be inevitable. In this scenario, the auditor will need to communicate with those charged with governance on the qualification and the circumstance that leads to the qualification to the audit opinion.
Is SSA 700 paragraph 26 on management’s responsibility for the preparation of the financial statements applicable for a society that is incorporated under the Societies Act or a Management Corporation Strata Title that is registered under the Building Maintenance and Strata Management Act?
As required under paragraph 26 of SSA 700 Forming an Opinion and Reporting on Financial Statements, the auditor’s report shall describe management’s responsibility for the preparation of the financial statements and the description shall include an explanation that management is responsible for such internal control as it determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.
It was further elaborated in paragraph A22 of SSA 700 that, if law or regulation prescribes the responsibilities of management and, where appropriate, those charged with governance in relation to financial reporting, the auditor may determine that the law or regulation includes responsibilities that, in the auditor’s judgment, are equivalent in effect to those set out in SSA 210 Agreeing the Terms of Audit Engagements. For such responsibilities that are equivalent, the auditor may use the wording of the law or regulation to describe them in the engagement letter or other suitable form of written agreement.
A society incorporated under the Societies Act or a Management Corporation Strata Title (MCST) registered under the Building Maintenance and Strata Management Act are governed under the respective Acts and if they do not spell out the responsibilities of management in a society or MCST, you may wish to consider the wordings in paragraph 26 of SSA 700 (i.e. “management is responsible for the preparation of the financial statements in accordance with the applicable financial reporting framework, and for such internal control as it determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error”), since paragraph A22 of SSA 700 states that in other circumstances, including where the auditor decides not to use the wording of law or regulation as incorporated in the engagement letter, the wording of paragraph 26 is used.
According to Accounting and Corporate Regulatory Authority (ACRA), the auditor’s report accompanying the financial statements which are submitted to ACRA for annual returns filing are required to be in the English language. If your client requires an audit opinion in other languages for internal use, you may wish to consider translating the original signed auditor’s report from English to that language instead of signing off another set of auditor’s report and financial statements in the other language. However, if the audit opinion in the other language is required by any overseas authorities for other purposes, you may wish to seek legal advice for any potential implications.
I would like to enquire if we are presenting the statement of comprehensive income using the one-statement approach, then in the independent auditor’s report to the members, do we have to replace the term “profit and loss account” with the term “statement of comprehensive income”?
You may have noticed that the terminology used in Appendix 1B of Audit Guidance Statement (AGS) 1 Sample Independent Auditor’s Reports in the paragraph on “Management’s Responsibility for the Financial Statements” is “profit and loss accounts and balance sheets”. This is consistent with the terminologies used in section 201 of Singapore Companies Act. As the Companies Act has not been amended, we are of the view that you should continue to use the phrase “profit and loss accounts” for the paragraph on “Management’s Responsibility for the Financial Statements” in the auditor’s report.
However, for the rest of the auditor’s report, we are of the view that the terminologies used may be adapted to reflect the terminologies used in the financial statements on which the auditor’s report is providing an opinion. Therefore, if the financial statements use the term “statement of comprehensive income”, the rest of the auditor’s report should also use this term accordingly.
It has been brought to our attention that the auditor’s report issued in Singapore states “Management’s” responsibility. In other jurisdictions like Malaysia, the United Kingdom and Australia, it is stated as “Directors’” responsibility. What is the reason for this difference?
Neither SSA 700 Forming an Opinion and Reporting on Financial Statements nor the Singapore Companies Act expressly imposes the responsibilities on directors only. SSA 700 paragraph 24 specifies that the auditor’s report should describe responsibilities of those in the organization that are responsible for the preparation of the financial statements. The auditor’s report shall use the term that is appropriate in the context of the legal framework in the particular jurisdiction. In some jurisdictions, the appropriate reference may be to those charged with governance. In Singapore, the appropriate reference is determined to be the management of a company.
In Singapore, section 199(1) of the Companies Act states:
Every company and the directors and managers thereof shall cause to be kept such accounting and other records as will sufficiently explain the transactions and financial position of the company and enable true and fair profit and loss accounts and balance-sheets and any documents required to be attached thereto to be prepared from time to time, and shall cause those records to be kept in such manner as to enable them to be conveniently and properly audited.
We are the auditor of a company whose financial statements were not audited in the previous financial period as the company was exempted from audit. I have read SSA 710 on the auditor’s responsibilities relating to comparative information in an audit of financial statements and need help in understanding what are comparative information, corresponding figures and comparative financial statements. Also, do I need to mention this in the audit report?
Comparative information (i.e. prior period amounts and disclosures) can be presented as either (1) corresponding figures or (2) comparative financial statements, depending on the requirements of the applicable financial reporting framework (SSA 710 Comparative Information – Corresponding Figures and Comparative Financial Statements, paragraph 2).
From an audit perspective, the essential difference between the 2 broad approaches is:
(a) For corresponding figures, the auditor’s opinion on the financial statements refers to thecurrent period only, whereas
(b) For comparative financial statements, the auditor’s opinion refers to both current
period and prior period (paragraph 3).
The approach to be adopted is often specified by law or regulation but may also be specified in the terms of the engagement.
Unless required by specific laws and regulations governing the company or specifically included in the engagement
letter that the auditor is required to opine on the prior period financial statements, approach (a) is usually adopted.
In your case, where the prior period was not audited, you would have to state in an Other Matter paragraph in the auditor’s report that the corresponding figures or comparative financial statements were unaudited. However, such a statement does not relieve the auditor of the requirements to obtain sufficient appropriate audit evidence that the opening balances do not contain misstatements that materially affect the current period’s financial statements (SSA 710 paragraphs 14 and 19). You may wish to refer to SSA 510 Initial Audit Engagements – Opening Balances for guidance on the requirements to audit opening balances.
Is SSQC 1 Quality Control for Firms that Perform Audits and Reviews of Financial Statements, and Other Assurance and Related Services Engagements solely applicable for big public accounting firms?
No, this is a misconception. In accordance with SSQC 1, all public accounting firms regardless of size are required to comply with SSQC 1. In time to come, the firms that do not audit public interest- entities (PIEs) may also be subject to review for compliance with SSQC 1 through the practice review programme (PMP). This simply means that the smaller firms will have to implement different policies and procedures to comply with SSQC 1. Embracing the spirit of SSQC 1 is the cornerstone of audit quality and firms should not adopt a ‘one-size-fits-all’ approach.
Would having a Quality Control Manual (QCM) automatically demonstrate the public accounting firms’ compliance with SSQC 1 Quality Control for Firms that Perform Audits and Reviews of Financial Statements, and Other Assurance and Related Services Engagements?
Having a QCM is a good starting point. However, it does not automatically demonstrate that the firms comply with SSQC 1. The firms have to ensure that the quality control policies and procedures in the QCM are effectively adopted and executed with appropriate documentation to demonstrate compliance with SSQC 1. The devil is in the details. More importantly, the QCM should be appropriately customized to suit the operating characteristics, nature and size of each specific firm.
In light of the resource constraints faced by the smaller public accounting firms, they could leverage on the quality control guides issued by the professional bodies or regulators to develop a QCM which is pragmatic but not excessive. In particular, from October 2012, the Institute has issued a series of Practice Guides. These Practice Guides, which include illustrative quality control policies and procedures with various practice aid templates, will help the smaller firms in formulating and documenting the quality controls.
Leadership is an abstract element. How could a public accounting firm’s compliance with this element of SSQC 1 Quality Control for Firms that Perform Audits and Reviews of Financial Statements, and Other Assurance and Related Services Engagements be demonstrated?
Despite the abstract nature of the leadership element, its compliance could be evidenced by the discussion of quality control matters in the minutes of a firm’s internal management meetings. In addition, the firm could incorporate the importance of quality in its mission statement or strategy and also communicate its quality control policies and procedures to the staff when they undergo induction program. With these measures in place, a clear message from the top emphasising quality is visible and can be effectively disseminated to all levels of staff at the firm.
How could a public accounting firm ensures its professional staff comply with the ethical requirements?
The relevant ethical requirements applicable to a public accounting firm are stated in the Code of Professional Conduct and Ethics (the Code) under the Fourth Schedule of the Accountants (Public Accountants) Rules. Regular communication of the ethical requirements under the Code (such as independence and confidentiality) to the firm’s professional staff is crucial to instil the right values and behaviour among the staff. Having said that, the firm should also obtain signed independence confirmation and declaration of confidentiality from its professional staff at least annually, and from its new staff as part of the firm’s orientation program as evidence of such confirmation. A designated senior personnel such as the practitioner himself, has to monitor the results of such confirmation and declaration to ensure that any threats are promptly identified and addressed. If any significant independence threat is identified, the firm should apply appropriate safeguards to reduce the threat to an acceptable level. For instance, for a sole proprietor firm, if the familiarity threat exists due to long association of a senior personnel such as between a practitioner and client, the safeguard review may include, but is not limited to involving a professional public accountant from another firm.
What should be done by a public accounting firm prior to its acceptance of a new client? Is it sufficient to merely discuss with the prospective client over the phone and provide a fee quote?
No, it is clearly not adequate. Firstly, a public accounting firm is required to assess the integrity of a prospective client. Such assessment may include performing background searches by making use of information gathered from discussion with the party who referred the client to the firm, media reports relating to the client, and other relevant and readily available information. Secondly, the firm should ascertain whether it has adequate resources and competence to perform the engagement. Other considerations would be the firm’s compliance with the ethical requirements. Additionally, if the new client is served by another existing public accounting firm, the firm should write to the predecessor to find out whether there are any reasons the appointment by the client should not be accepted, in accordance with the requirements stated in the Code. All the aforementioned evaluation should be properly documented with approval by the firm’s practitioner before the client is accepted.
How could a sole proprietor firm possibly implement Engagement Quality Control (EQC) Review? This is viable in big public accounting firms with multiple partners where they could concur on one another’s engagement report but in a sole proprietor firm, there is only one person and there is no one else with sufficient authority, experience or knowledge within the firm to concur on his engagement report.
It is certainly a common practical issue faced by many sole proprietor firms. To resolve this particular issue, a sole proprietor firm could form alliance with other public accounting firms so as to review one another’s engagement in the capacity of EQC reviewer. Alternatively, the firm may consider engaging external consultants who are existing or retired practitioners to serve as EQC reviewer for the firm’s engagements. The competence, objectivity and independence of the selected EQC reviewer should be properly assessed to ascertain that the EQC reviewer is suitably qualified.
What are the practical solutions for a smaller public accounting firm to implement the SSQC 1 element of monitoring?
There are various measures for a smaller public accounting firm to implement a monitoring programme to ensure that its system of quality control remains relevant and effective. The firm may consider designating suitably qualified external parties such as other firms (but not EQC reviewer) and professional bodies to support its monitoring process. In particular, the firm may enrol in the Institute’s Quality Assurance Review (QAR) Programme which could support the firm in identifying the potential deficiencies of the engagements and recommending specific action plans to improve the quality of the engagements. The QAR Programme could serve as one of the monitoring controls of the firm. In addition, if the firm belongs to a network of firms, it could also engage practitioners from another firm within the network to inspect and review the firm’s selected completed engagements.
Will the benefits outweigh the cost of implementing SSQC 1 Quality Control for Firms that Perform Audits and Reviews of Financial Statements, and Other Assurance and Related Services Engagements?
Yes. In the long run, the benefits of implementing SSQC 1 will far outweigh the cost. Many of the benefits are intangible in nature. For example, effective firm-wide quality control reduces the risks of inappropriate engagement reports issued and therefore reduces the practitioners’ exposure to risk of liability. SSQC 1 implementation serves as a catalyst for the solid foundation of quality on which a firm’s growth and sustainability may be built.
Our existing client has requested us to perform a review of financial information for the 12-month period ended 31 March 2012 for management purpose in accordance with SSRE 2400. The financial year end of the client is 31 December. My question is whether are we prohibited from performing the procedures according to SSRE 2400 and issue a report thereof because we are the statutory auditors and hence, we should apply SSRE 2410 instead?
The principal distinction between SSRE 2400 Engagements to Review Historical Financial Statements and SSRE 2410 Review of Interim Financial Information Performed by the Independent Auditor of the Entity is that SSRE 2400 applies in the case of a review of financial statements performed by a practitioner, who is not the auditor of the entity whereas SSRE 2410 applies in the case of a review of interim financial information by the auditor of the entity.
Through performing the audit of the annual financial statements, the auditor obtains an understanding of the entity and its environment, including its internal control. When the auditor is engaged to review the interim financial information, this understanding is updated through inquiries made in the course of the review, and assists the auditor in focusing the inquiries to be made and the analytical and other review procedures to be applied. Where the practitioner is not the auditor of the entity, the practitioner does not ordinarily have the same understanding of the entity and its environment, including its internal control. Hence, under SSRE 2400, the practitioner needs to carry out different inquiries and procedures to meet the objective of the review.
SSRE 2410 is directed towards a review of interim financial information by an entity’s auditor. However, SSRE 2410 paragraph 3(a) states that SSRE 2410 is to be applied, adapted as necessary in the circumstances, when an entity’s auditor undertakes an engagement to reviewhistorical financial information other than interim financial information of an audit client. In your query, where the review covers 12 months instead of a period shorter than the entity’s financial year, SSRE 2410 would still be the appropriate framework upon which to perform your engagement. You may also wish to refer to footnote 4 in Appendix 4 of SSRE 2410 on the wordings to be used in the auditor’s report in the case of a review of historical financial information instead of interim financial information.