The Importance of independence for external auditors

The Importance of independence for outside analyseorsThe word of freedom is defined as freedom from situations and relationships which make it prob adequate that a reasonable and informed third fellowship would conclude that objectivity either is impaired or could be impaired.(Anon, www.europeanlawyer.co.uk) OnlineThere ar 2 types of independence, that be independence of mind and independence in appearanceIndependence of mindThe state of mind that permits the port of a conclusion without beingness affected by kneads that compromise professional judgment, thereby, bothowing an individual to act with integrity, and deed objectivity and professional scepticism.(ACCA, www.accaglobal.com) OnlineIndependence in appearanceThe avoidance of facts and circumstances that be so operative that a reasonable and informed third party, having knowledge of all relevant information, including safeguards applied, would reasonably conclude a firms, or a member of the assurance groups, integ rity, objectivity or professional scepticism had been compromised.(CIMA, www2.cimaglobal.com) Online point 1(b)It is authorised for external listeners to be independent beca work external scrutinizeors act on behalf of the owners of the clientele, modal(prenominal)ly the shargonh darkeneder, and report on the fiscal statements prepared by counsel for the benefit of shareholders. If the external scrutinizeors are non independent of their shareholder, for example, if they hold shares in the companies that they scrutinise, their ability to form an objective opinion on the monetary statements allow for be impaired.In addition, external studyors must be also be seen to be independent be endeavour if they are non, the owners of the contrast will not have confidence in the audit reports that the audits issue. This is wherefore it is auditors independent is so important because to pr solution march on s evokedals such as those of Enrons and Parmalats case, and and so forthF or example in the case of Phar-Mor, Inc one of the top 10 belatedly discount drug store chains in the United States and declared bankrupt in the division 1995. Phar-Mor, Inc declared bankrupt because the superior society add to the frauds and ability to cover it up for so long. Listed below the summarized of the factors contributing to the fraudFamiliarity threatPhar-Mor, Inc knowledge of audit procedure an objectives. Phar-Mors fraud group was made up a several former auditors, including at least one former auditor who had worked for Coopers on the Phar-Mor audit. The fraud team indicated that one reason they were successful in hiding the fraud from the auditors was because they knew what the auditors were looking for.Self-interest threatThe Phar-Mor had pecuniary interest in financial account, potential self-interest threat whitethorn reach. Such the fraud in the Phar-Mor case includeOverstating record and recording consigned scrutinize as owned inventoryRecording tax income from receipts from vendors under certain promotion and exclusivity agreements when received rather than over the life of the agreementsUnderstating the amount of depends collectible by holding disbursement checksRecording revenues and receivables from vendors at budgeted rather than factual amounts(Severson and Julie, V., http//www.allbusiness.com) OnlineIntegrityThe principle imposes an pledge on all professional retrieveants to be straightforward and honest in professional and business relationships. In the case of Phar-Mor, the Phor-Mor did not perform honest in professional and business relationships. The Phar-Mor provide misstatement of margins, inventories, and earnings in reports to focussing and in general ledger and financial statements (to cover up other(a)wise misstatements), and diversion of assets to committed companies via manually written checks (nature of disbursements falsified when recorded in books and records).(Severson and Julie, V., http//www.a llbusiness.com) Online distrust 1(c) (i)From the case above, a member of the audit team has possible financial interest in the client, potential self interest threat whitethorn occur and the gift rise to Roslan possible self-interest.Form my point of view, it seems less real in terms of threats because the depose fund is indirect investment in the client. However, if the ownership in the client augments resulting in a pregnant proportion of Roslans fund to be invested in the client, then the threat may be significant. Moreover Roslan is an audit partner who audit in the investment comp either.Safeguard or action to be slayn is since the threat may not be so significant, it may not be necessary to get Roslan to stir off the financial interest. However, it would be better to remove or re-assign Roslan from the audit assurance engagement.QUESTION 1 (c) (ii) For the case above, Sofia Ali has been allown extended gift and hospitality by client that is in the form of a discount to purchase on new car by a sales manager. This may give arise to possible self interest and familiarity threats. The threats may be significant because of the extent of gift and hospitality that is audit staff is offered discount. However, the threats may not be significant if the gift and hospitality is within clients normal commercial terms, that is client offer to other customers.Safeguard or actions to be taken is the audit staff, Sofia Ali should adduce to policies of audit firm prohibiting or getting permission before accepting the gifts and hospitality from senior personnel.QUESTION 2 (a)ISA 500 Audit Evidence requires auditors to retain sufficient, remove audit tell to be able to draw reasonable conclusions on which to base the audit opinion. Sufficiency and appropriateness are interrelated and don to audit curtilage obtained from both tests of assure and essential procedures.(ACCA, 2008, pp.119)Sufficiency is the measure of the criterion of audit say. The quantity o f audit evidence required is affected by the aim of fortune in the area being audited. Firstly, it is the level of inherent risk faced by auditors is high. For example, high technology developments in a marketplace which is very competitive can check to departure concern problems and more possibility that the clients monetary Statements will be mis utter. This will lead to an subjoin in the inherent risk and will cause the difficulties for auditors to go bad Financial Statements in a quicksilver(a) industry due to no consistency in Financial Statements and more evidence is needed during the figurening stage. Besides, lack of IT control in a computerized environment may cause the level of control risk faced by auditors is high. This is because more evidence is needed for auditor when auditing the comp all. (ACCA, 2008)Appropriateness is the measure of the quality or reliable of audit evidence and its relevance to the audit field of honor matter. If quality is high, then th e auditor may need less evidence. The quality or reliability of evidence is affected by several factors, such as external sources, evidence directly by auditor, entity, written documentation, and original documents. Original documents are more reliable than photocopies or facsimiles, which can easily be alter by the client.(ACCA, 2008)Testing control is a test for the auditor to determine whether the control is operating effectively throughout the stop under review stage. The auditor must consider the sufficient appropriates audit evidence (such as design and operation) is to support the valueed level of control risk is audit evidence is obtained from tests of control. For example design and operation(ACCA, 2008)The auditor must al expressions carry out substantive procedures on worldly items. The ISA says regardless of the assessed rick of material misstatements, the auditor should design and perform substantive procedures for each material class of transactions, account balan ce and disclose. When obtaining audit evidence from substantive procedures, the auditor must consider the sufficient appropriate audit evidence from such procedures together with any evidence from tests of control to support the audit opinion.(ACCA, 2008, pp.99)In an audit of a financial report, the audit opinion is given on the assertions by way, explicit or otherwise, that are embodied in the financial report. They can be categorized as followsAssertions most classes of transaction and events for the period under auditOne of the examples is occurrence, where a transaction or event took place which pertains to the entity during the period.Assertions about account balances at the period endFor example existence is an asset or a liability exists at a given date, reforms and obligations is an asset or a liability pertains to the entity at a given date, and etc.Assertions about presentation and disclosureAn item is disclosed, classified, and described in union with the applicable f inancial reporting framework.(Shakoor, www.accountancy.com.pk) OnlineThe auditor has a statutory duty to make a report to the entitys members on the truth and directness of the entitys annual accounts. This report must state the auditors opinion on whether the statements have been prepared in accordance with the relevant legislation and whether they give a true and fair view of the profit or passage for the year and state of affairs at the year end. The duty to report on the truth and right of the financial statements is the primary duty associated with the external audit.The assurance given by auditors is governed by the fact that auditors use judgment in deciding what audit procedures to use and what conclusions to draw, and also by the terminus ad quems of every audit. The auditors task is to set whether the accounts show a true and fair view. The auditors are not responsible for establishing whether the accounts are correct in every particular proposition. This is because i t can take a great deal of time and trouble to check the true statement of even a very small transaction and the estimation which means that financial statements can never be completely precise.It is not easy and impossible to examine every single item in the financial reports. Here, as we shall see, auditor provides opinion about the financial statements, but not certificate that the financial statements are correct. Besides, audit procedures are designed to reduce the risk of the misstatements in the financial statements, but not eliminate the error in the financial statements. This is because by providing sufficiently reliable conclusion arriving by way of using the sampling procedures.The sampling risk arises from the possibility that the auditors conclusion, based on a sample, may be different from the conclusion reached if the entire population were subjected to same audit procedure. A sampling risk can be reduced by increasing the sample size for both test of control and sub stantive procedures.(ACCA, 2008, PP.189)QUESTION 2 (b)ConfirmationThis involves seeking confirmation from another source of details in clients invoice records.Example Confirmation from bank balances by referring to the bank statement.(ACCA, 2008, pp.121)Analytical proceduresAnalytical procedures mean the study of trends and ratios in financial and non-financial information. It is used within audit planning to identify risk areas and also as a means of gathering substantive evidence, for example by calculating as estimate of a particular figure based on knowledge of the business and comparing this to the actual figure.Example A similitude of gross profit percentages month by month for a company could be performed and any odd fluctuations investigated as these could indicate errors such as omission of sales, loss of inventory or other errors.(ACCA, 2008, pp.121) observanceObservation means watching a procedure being carried out. It is usually used as a means of gathering evidence a bout the internal controls in a company.Example A appropriate to observe the procedures that are carried out when the post is opened to assess whether controls exist to prevent the misappropriation of cash.(ACCA, 2008, pp.121) followupInspection means looking at documentation, books and records or assets. This could be done to confirm existence of an asset, to master values or to provide evidence that a control has taken place.Example The inventory of a company at the year-end could be inspected as part of the evidence relating to its value. The inspection would give evidence as to whether the inventory was in good saleable condition.(ACCA, 2008, pp.121)InquiresInquires mean requesting information. This could be from individuals within the company, either viva voce or in written representations, or in formal written requests to third parties.Example A relevant example would be to send a standard confirmation letter to the companys bank(ACCA, 2008, pp.121)QUESTION 3 (a)Audit happe n is the risk of giving an inappropriate opinion on the financial statements. For example, weakness to qualify when the financial statements contain a material error. Audit Risk has three individual components in the formulaAudit Risk = Inherent Risk X Control Risk X maculation Risk(ACCA, 2008)Inherent Risk is the susceptibility of an assertion to a misstatement that could be material individually or when aggregated with misstatements, assuming there were no related internal controls. Inherent risk is also a risk that it is impossible for auditors to manage and transfer away due to the nature of the company and its transaction.(ACCA, 2008)Control Risk is the risk that material misstatement that could occur in an assertion and that could be material, individually or when aggregated with other misstatements, will not be prevented or detected and corrected on a timely posterior by the entitys internal control.(MIA, www.mia.org.my) OnlineDetection Risk is the risk that the auditor wi ll not detect a misstatement that exists in an assertion that could be material, individually or when aggregated with other misstatements. For a given level of audit risk, the acceptable level of detection risk bears an inverse relationship to the assessment of the risk of material misstatement at the assertion level.QUESTION 3 (b)Auditors should obtain an understanding of the entity and its environment, including internal control, sufficient to identity and assess the risks of material misstatement in the financial statements whether due to fraud or error. Then, the auditors able to design and perform except audit procedures.It is essential for auditors to understand the clients environment, including its internal controls because the knowledge of understanding of the clients environment will guide auditors to piss up or maintain a good professional relationship with the client. Listed below are the reasons why auditors need an understanding of the clients environment, including its internal controls.A client may involve in a mercurial sector of economy, which means that the industry has rapidly and is planning further expansion which will require additional resources. This will cause the pedigree obsolete and the obsolete shop may be overstated in the Financial Statements. In such circumstances, there is a risk that creditors will go unpaid and the business will go into liquidation. It is very risky for directors of the company and the auditors if they auditing the company.Todays world is rapidly changing such as technology. It is very competitive with new technology developments in a market because competitive can lead to going concern problems and more possibility that the clients Financial Statements will be misstated. This eventually will increase the inherent risk for the auditors especially in the aspect when the auditors auditing the financial statements. It is also will lead to an increase in the inherent risk and will cause the difficulties fo r auditors to analyze Financial Statements in a volatile industry due to no consistency in Financial Statements.Besides, the managements attitude, whether are they reliable and trustworthy in the business is suspected. This will indicate that the managements integrity is doubtful and mismanagement may be occurred. This in-turn will cause the Financial Statements may be subject to manipulation by existing auditors when they auditing the company as management is bias.Nevertheless, financial aspect will be taking into consideration if the company is facing financial problems. The company would needs a bank loanword to finance the director ambitious plans. However, the loan facilities are scare. The risk for auditors to audit the Financial Statements will increase when the management of the company would use an aggressive accounting tactical manoeuvre to manipulate the Financial Statements.Last but not least, there is a misappropriation to a specialized ascertain for a cash transactio ns or account balances in the. The cash balances may influence the Financial Statements and will cause an increasing risk for auditors to audit Financial Statements and there is a limitation for the auditors to identified completeness of sales and internal controls are insufficient.The aspects of clients environment and internal controls are as followIndustry, regulative and other external factors, including the reporting frameworkNature of the entity, including selection and application of accounting policiesObjectives and strategies and related business risks that might cause material misstatement in the financial statementsMeasurement and review of the entitys financial performanceThe control environmentControl activitiesMonitoring of controls(ACCA, 2008)QUESTION 4 (a)It is important for auditors to observe clients inventory livestock count. This is to support assertions of existence of inventory items that makes up the balance, means that the stock count done by the client st affs are as per the Stock Taking Instruction (STI). All the stocks are properly allocated, check up on that the stock stated in the stock list are actually exist. If do not have such stock exist as per the stock list, inquire the management or superior for the explanation.Besides, the auditors should ensure that the condition of the stock are clearly stated during the stock count, such as identify evidence of damaged or slow moving inventory because it is useful for the further evaluation of the inventory. This also wanted to prove that the actual stock record data are as per the stock count.Not only that, observation of stock count is to ensure that all the stocks held in the warehouse are particularly owned by client, that is right and obligations assertion. Any stock held for 3rd party, ensure it is properly separated from the clients stock and inspect the agreement mingled with the 3rd party and client regarding about the stock held.Lastly, the auditors should verify by assert ions of completeness. That is the audit should ensure all sales and purchases are well recorded and all the inventory at year end is included on the statement of financial position.QUESTION 4 (b) (i)As an external auditor, the audit procedures I would take is to find out or enquire whether this box of liquid is still part of the inventory balance, that is inventory record. Besides, I will ensure that the box of liquid in this inventory is written off and not saleable anymore. Lastly, I will also determine whether the sales of the liquid shoe assail are valued at the lower of cost or net realization value, if it is saleable. If the liquid shoe polish still cannot sell, then dispose the liquid shoe polish.QUESTION 4 (b) (ii)As an external auditor, the audit procedures that I would take is I will ensure that clients staff are following instructions during the inventory count. Besides, no pencil is allowed during the inventory count. This is because by using pencil to record down inven tory counted is wake not a good count instruction. Therefore, I will inform the person in billing of count that some staff are using pencils to record down inventory counted to prevent any adjustment easily to be made. Lastly, I will follow up to observe whether the staff are using pen subsequently during the inventory count and observe the condition of the stock properly to ensure it is clearly stated as per during the stock count, as it is useful for the evaluation of the inventory.QUESTION 4 (c)The management of the company is responsible for the identification and reporting of stocks that are worth less than cost to the auditor in a form of a schedule listing all the identified items. The types of inventory that may be worth less than cost include slow-moving, obsolete and damage stocks.Audit procedures for stocks worth less than be are as followsEnquire from management as to how they account for and identify such inventories, including the assumptions they made about the age , conditions and value of the inventories.Inspect sales, marketing and other reports, and review the extent to which inventories which are worth less than costs have been reduced to net realizable value (NRV) in prior years. Analytical procedures may be performed to evaluate the appropriateness of the write down in the current year.Analyse the clients computerized records, if available, to identify goods that are old or slow-moving. The records may also show seconds and damaged goods. Any information produced by the computer administration for management relating to inventories need to be check into. Computer Assisted Auditing Techniques (CAAT) may be used for these purposes.Auditors need to checked the appropriateness of the definition of old and slow-moving given by the management, by making references to competitors products, technology changes and legislation.For high value items the auditors will need to refer to the experts valuation report to note if any material difference s exist.At the inventory count, a note should have been made of any items that appeared to be old, slow-moving or insurance and the count records should be inspected to see if they do show such goods.QUESTION 5The auditors responsibility is to consider the appropriateness of the going concern assumption made by management and whether are there any material uncertainties about the entitys ability to continue as a going concern that need to be disclosed in the financial statements.In obtaining an understanding of the entity, the auditor should consider and stay alert to obtain evidence as to whether any events or conditions and related business risks which may occur and cast significant doubt on the entitys ability to continue as a going concern during the auditing. If such event or conditions were identified, the auditor should perform addition audit procedures to consider their impact to the audit assessments.The auditors should recap managements plan for future actions based on it s going concern assessmentGather sufficient appropriate audit evidence to confirm whether or not a material uncertainty exists. considering the affects of any plans of management and other mitigating factorsSeek written representations from management regarding its plan for future action(ACCA, 2008)The auditor should also inquire management as to its knowledge of events or conditions beyond the period of assessment used by management that may cast significant doubt on the entitys ability to continue as a going concern.The audit procedure that auditor should undertake to realize that may have affected on company going concern issues are as followAnalyse and discuss cash flow, profit and other relevant forecasts with management.Analyse and discuss the entitys latest available interim financial statementReview the term of debentures and loan agreements and determine whether they have been breachedRead minutes of meetings for the reference to financial difficultiesEnquire of entitys la wyer regarding the litigation and claimsConsider the entitys position if unfulfilled customers orderAssess financial ability to provide additional fundsReview events after period end for item affecting the entitys ability to continue as going concern.(ACCA, 2008)