Suggest some measures to improve effectiveness of management letter Auditing Help

1. The letter should be issued immediately after interim audit.
2. If the letter sets out weaknesses in the operation of controls, give some examples of non-compliance.
3. The letter should give constructive recommendations. The tone of the letter should not give impression to staff that they are being criticized.
4. Response of management, as to their agreement with recommendations, should be set out in the letter. Preferably, the dates from which. the recommendations will be complied with be agreed.

The language should be clear, and concise.
The letter should be double checked for accuracy.
While making recommendations, cost vs benefit consideration recommendations be considered.

Discuss business risks and financial statement risks for following matters:

(1) Non-compliance of health and safety regulations.
(2) Centralized controls.
(3) High staff turnover.
(4) Cash flow problems.

(1) Noncompliance of health and safety regulation

Business risk
Fines and penalties, cancelation of license.
Financial statement risk
Contingent or actual liabilities, impairment of license.

(2) Centralized controls

Business risk
Inefficiencies as management cannot take prompt action.
Financial statement risk
Management override of controls. If errors are not rectified,
financial statements may be misstated.

(3) High staff turnover

Business risk
Poor human resource management and inefficiencies
Excessive training period.
Financial statement risk
Errors may occur in training period.

(4) Cash flow problems

Business risk
Liquidity problems
Financial statement risk
Going concern.

Give some examples of inherent risk at financial statement level.

In listed company there is unusual pressure on management to show better profitability, solvency and liquidity.
Volatile market
Different regions, economic and political instability.

How would you update internal control questionnaire prepared last year.

l. Study last year’s questionnaire.
2. Obtain procedures manual form client.
3. Note changes from previous year.
4. Inquire from the client changes since previous year.
5. Perform walk through test to confirm your understanding of the changes.

Sea View Limited is a manufacturing company. Behroze & Co., Chartered Accountants are their auditors. The audit of fmancial statements of the Company for the year ended November 30,2008 is in progress. Sami, the senior in charge on the audit has received the first draft of the financial statements from Kamil, the CFO of the Company. The abridged financial information of the Company for the year ended November 30, 2008 is as follows:


Sami had a meeting with the CFO of the Company which revealed the following matters:

(i) The Company’s sales have suffered on account of depressed economic conditions in the country;
(ii) The Company has introduced a new product ‘Cherry’ during the year in place of ‘Merry’ and incurred substantial cost in the acquisition of property, plant and equipment; and
(iii) This year’s physical verification of stocks had not been carried out on November 30 on the plea that the relevant staff was on leave. The stock check will now be carried out on December 15, 2008.


Given the above data and circumstances, identify the following:

a) the risks that may result in material misstatements ill the financial statements; and
(b) the implications of the risks identified along with audit procedures that would be most suitable to mitigate those risks. (lCAP Winter 2008)

Risk of entering fictitious sales invoices

Overstatement of sales
Audit procedures

– Agree sales invoices with dispatch notes
– Verify sales returns in the subsequent period.

Risk of incorrect cl assification of revenue expenditure as capital expenditure

Understatement of expenses
Audit procedures
Detail test of additions

Risk of unrecorded impairment loss

Overstatement of property, plant and equipment, overstatement of profits.
Audit procedures
Compare carrying· value with recoverable amount

Risk of recording fictitious trade debts

Overstatement of debtors
Audit procedures
– Circularize debtors
– Check subsequent collections.

Risk of incorrect inventory count

Incorrect inventory valuation
Audit procedures
Work back inventory to ascertain balance at year end

Risk of unrecorded impairment of intangible assets

Overstatement of intangible assets
Audit procedures
Compare carrying value with recoverable amount.

Discuss some possible risks of non-compliance of following Standards
IAS 2 Inventories
IAS 8 Accounting policies, changes in accounting estimates and errors
IAS 12 Income taxes
IAS 16 Property, plant and equipment
IAS 17 Leases
IAS. 18 Revenues
IAS 20 Government grants
IAS 23 Borrowing costs
lAS 32 Financial Instruments: Presentation
lAS 36 Impairment
IAS 37 Provisions, Contingent liabilities and Contingent assets
IAS 38 Intangible assets
IFRS 2 Share-based payments
IFRS 7 Financial instruments disclosures
IFRS 8 Operating segments.

Some commonly risks encountered regarding non compliance of IFRS are:

IAS 2 Inventories
– Inventories may have been valued using marginal costing.
– Where inventory items are not ordinarily interchangeable, the cost may have been assigned using FIFO or average.
– Use of LIFO for external reporting purposes.
– Stage of completion of work in process.

IAS 8 Accounting policies, changes in accounting estimates and errors
– Changes in accounting estimates may have been treated as changes in accounting policies.
– Correction of retained earnings as a result of change in accounting estimate.

IAS 12 Income taxes
– Deferred tax may have been calculated on permanent difference.
– Taxable temporary difference may have been treated as deductible temporary difference.
– Deferred tax on revaluation may not have been appropriated between expense and revaluation surplus.
– Deferred tax liability not recognized for all taxable temporary differences.
– Deferred tax asset not recognized for deductible temporary differences.
– Deferred tax asset recognized although it is not expected that future taxable profits will be available against which the deductible difference can be utilized.
– Deferred tax asset not recognized for the carry forward of unused tax losses to the extent that it is probable that future taxable profit will be available against which the unused tax losses can be utilized.
– Deferred tax relating t 0 revaluation charged as expenses.

IAS 16 Property, plant and equipment
– Incorrect allocation between capital and revenue expenditure.
– Exchange of fixed assets may have been incorrectly recorded.
– Cost of self-constructed assets incorrectly accounted for.
– Inappropriate treatment of revaluation of assets.
– Impairment loss may have been omitted.
– Incorrect treatment of dismantling cost.
– IAS 16 requires that the cost of property, plant and equipment, should include the cost of dismantling and restoration of asset, i.e., decommissioning costs if an obligation exists to incur such cost at the end of the life of asset and a corresponding provision should be recognized at present value.
– Inspection cost not capitalized and not depreciated over the period to the next inspection.
– Training costs necessary to operate a non-current assets capitalized. IAS 16, paragraph 19 (c) prohibits capitalization of these costs.
– Non-current assets “sold” under sale and re purchase agreement may be recognized as sale of property, though in substance it is mode of financing.
– Selective revaluation of non-current assets, entire class of asset is not revalued.

IAS 17 Leases
– Finance lease may have been treated as operating leases.
– Incorrect treatment of guaranteed unguaranteed residual values.
– Gains on sale and lease back transactions arising from finance lease may have been taken to income.

IAS 18 Revenues
– Revenues may be recognized too early or too late.

IAS 20 Government grants
– Grant received from the government is taken to income and not deferred.

IAS 23 Borrowing costs
– Incorrect computation of capitalization of borrowing costs.
– Capitalization may continue even after the asset is ready for intended use.

IAS 32 Financial Instruments: Presentation
– Split between liability and equity components may not have been made in case of convertible debentures. Also, the debt is may not have been stated by discounting potential cash outflow to present value.
– In case of convertible debentures, finance charges not calculated using effective interest rate method.

IAS 36 Impairment
– Assets not reported at lower of carrying value and recoverable amount.
– Inappropriate discount rate used.
– Incorrect identification of cash generating unit.
– Incorrect allocation of goodwill to cash-generating units.

IAS 37 Provisions, Contingent liabilities and Contingent assets
– Provision may have been made for future operating losses.
– Provision may have been treated a contingent liability.
– Contingent gains may have been recognized as income.
– Cash outflow is probable and the amount can be estimated reliably, but a provision is not recognized.
– Contingent liability is not disclosed when cash outflow is possible.
– Provision may not have been made in case an obligation exists for restoration of site.
– Legal fees relating to claims may not have been accrued.

IAS 38 Intangible assets
– Internally generated brands are capitalized.
– Training costs capitalized as intangible asset.
– Development costs capitalized although the criteria set out in

IAS 38 is not met.
– IFRS 2 Share based payments
– Expense has been calculated without grving consideration to performance conditions attached to the share option.
– Fair value used to calculate the expense may be different from fair value at the grant date.
– IFRS 7 Financial instruments disclosures
– Derivative financial instruments not recognized.
– Derivatives should be recognized as financial asset or a financial liability. This will depend on whether the terms of the derivative contract are favorable or unfavorable at balance sheet date.

IFRS 8 Operating segments.
– In case of listed companies, performance and noncurrent assets of various segments may not be disclosed.

Posted on November 3, 2015 in Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment

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