CPA Australia, with the assistance of PwC partner Valerie Clifford, has developed these tips to assist members conducting audits when economic conditions are uncertain.
This is not an exhaustive list and auditors should refer to the auditing standards applicable in their jurisdiction. For matters not covered by the tips auditors are expected to use professional judgement appropriate to the audit. The tips are generally applicable to all audits of financial reports, including self-managed superannuation funds.
Risk of material misstatement
The risks of material misstatement in financial reports are significantly higher for entities experiencing difficulties in times of uncertainty.
Communicating with clients
It's important to advise your client as soon as possible that the risks of material misstatement are higher than in previous years. This is due to the economic conditions and the difficulties that client may be experiencing.
You may need to change aspects of the audit of the client's financial report, including:
- overall decisions regarding client continuance
- staffing of the audit and the extent of supervision of employees
- the nature, timing and extent of audit procedures.
You should also advise those charged with the governance of the client (see also ISA 260/ASA 260 Communication with those Charged with Governance) when you become aware of the following:
- a material weakness in the design or implementation of internal controls which may give rise to a possible material misstatement in the financial report
- you have doubts about your client's ability to continue as a going concern.
Planning the overall audit strategy is more important during difficult conditions because of the increased risks.
When planning the audit, it is important that you:
- consult and plan early
- think unconventionally so all possible issues are considered
- thoroughly understand the client's business and its viability
- challenge the business model
- consider assigning more experienced employees to the audit and have greater partner involvement
- consider performing substantive procedures closer to, or at, period end — particularly in critical audit areas.
Training your audit staff
Some audit employees may not have sufficient experience of auditing clients in financial difficulty. Accordingly, they may need training to learn what should be done differently in this particular situation.
Knowledge sharing and subject matter experts
Given the increased risks, your audit team should discuss any potentially difficult or contentious matters among themselves and with other professionals or experts within or outside your firm.
When planning the audit, you should consider what would cause the financial report to be materially misstated. If your audit client is experiencing tough conditions, there may be circumstances that affect your determination of materiality, such as:
- net income may be nominal during tough times or significantly different from previous periods
- misstatements that may exist in balances representing opening equity may contribute to a material misstatement during tough times
- the expectations of users of the financial report including what they would consider to be material misstatement, may differ significantly from previous periods
- your own assessment of the risks that may lead to material misstatements in the financial report.
Your overall assessment of materiality remains based on your professional judgement, but it should include qualitative and quantitative considerations.
Areas of increased risk include:
- management bias — with or without fraudulent intent:
- the natural temptation to bias judgements and disclosures toward the most favourable end
- management using a difficult period as an opportunity to overestimate certain balances, such as write-down of assets
- fraud, which can occur because:
- financial stability or profitability is threatened
- there is excessive pressure on management
- employee resources have been reduced in critical risk management areas
- managers may seek to override controls
- asset measurements and valuations. Evaluating the assumptions and data used by management should be a major focus of your response to the increased risk of material misstatement associated with fair value measurements and accounting estimates.
Given these and other risks, you may need to reassess:
- the nature, extent and timing of risk assessment procedures
- the effectiveness of the internal controls designed to prevent or detect and correct material misstatements
- risks that require special audit consideration (estimates and disclosures)
- whether further audit procedures as well as those that are usually performed are required. For example, do the present tests of controls and substantive procedures take account of the higher risk of material misstatement?
- your response to the possibility of fraud, such as maintaining your professional scepticism, focus the engagement team's discussion on the possibility of material misstatements due to fraud and understand the business rationale for significant transactions.
The critical issues that you need to consider in assessing going concern are:
- the appropriateness of management's assumption that the firm is a going concern
- the disclosure of any material uncertainties about the entity's ability to continue as a going concern
- the appropriateness of management's assumption that the entity is a going concern, even if the financial reporting framework used in the preparation of the financial report does not include an explicit requirement for management to make that assumption
- the actual period for which management is assessing the entity's ability to continue as a going concern
- entities that have not previously needed to prepare a detailed analysis in support of the going concern assumption may need to give the matter further consideration. You and the entity should benefit from early discussions regarding the need to give this matter further consideration.
The following are some final pearls of wisdom for auditors to consider with clients having trouble:
- think unconventionally
- maintain your professional scepticism
- reassess risks and identify the most significant client exposures
- consult early and regularly with those charged with governance, also with management, audit committees and experts
- raise awareness — make sure partners, employees and clients understand the potential ramifications of a client going through tough times (formal training may be necessary)
- keep informed — monitor the guidance issued by standard setters and regulators.
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