AUD 689 – Topic 8 “Completing the Audit” – Comprehensive Study Notes

Page 1

• Course: AUD 689 – Audit and Assurance Services

• Topic: Completing the Audit

• Introduces the final, critical phase of the audit engagement, where the auditor synthesizes all gathered evidence to form an opinion on the financial statements.

Page 2 — Learning Objectives

• Understand & perform reviews for:

  • Contingent Liabilities — Obligations whose existence depends on uncertain future events.

  • Commitments — Firm agreements for future transactions.

  • Subsequent Events — Events occurring between the financial statement date and the audit report date, or facts discovered thereafter, that may require adjustment or disclosure.

• Conduct the Final Evaluation of Audit Evidence addressing all significant aspects of the financial statements:

  • Going concern — Assessing the entity's ability to continue as a going concern for the foreseeable future.

  • Opening balances & comparative figures — Ensuring consistency and correctness of prior period data.

  • Analytical procedures — Performing an overall review of financial information for consistency and reasonableness.

  • Accounting estimates — Evaluating the reasonableness of management's judgments.

  • Related-party transactions — Identifying and properly disclosing transactions with parties that can exert significant influence.

• Communicate significant findings and observations with Those Charged With Governance (TCWG), such as the audit committee or board of directors.

• Draft the Independent Auditor’s Report based on the audit findings and determine Key Audit Matters (KAM).

Page 3 — Four Phases of an Audit

1. Client Acceptance & Retention — This initial phase involves evaluating the integrity of management, assessing the auditor's independence from the client, and formalizing the engagement through an engagement letter that outlines the scope and terms of the audit.

2. Planning — Developing a comprehensive audit strategy and scope, including understanding the client's business, identifying risks, and determining the nature, timing, and extent of audit procedures.

3. Performing Audit Tests (Fieldwork) — Executing the planned audit procedures to gather sufficient appropriate audit evidence. This involves testing internal controls and performing substantive procedures on financial statement accounts.

4. Reporting Findings — The culmination of the audit, where the auditor forms and expresses an opinion on the financial statements and communicates key findings to appropriate parties.

Page 4 — Audit-Risk Framework in Practice

• Fundamental model: The Audit Risk (AR) model, $AR = IR \times CR \times DR$, where:

  • Inherent Risk (IR): The susceptibility of an assertion to a misstatement, assuming that there are no related internal controls.

  • Control Risk (CR): The risk that a misstatement that could occur in an assertion and that could be material, individually or in aggregate, will not be prevented, or detected and corrected, on a timely basis by the entity's internal control.

  • Detection Risk (DR): The risk that the auditor will not detect a material misstatement that exists in an assertion.

• Flow:

  • Planning ➔ Risk Assessment ➔ Preliminary evaluation of the accounting and internal-control (IC) system. The auditor identifies and assesses risks of material misstatement at both the financial statement and assertion levels.

  • Decision node: “Rely on IC?” — Based on the preliminary evaluation, the auditor decides whether to rely on the entity's internal controls to reduce substantive testing.

  • Yes / good IC ➔ Reduced substantive testing. If internal controls are strong and effectively designed and operated, the auditor can place more reliance on them, leading to less extensive substantive testing of account balances.

  • No / bad IC ➔ Increased substantive testing. If internal controls are weak or ineffective, the auditor cannot rely on them to prevent or detect misstatements, thereby requiring more extensive and detailed substantive testing.

• Completion culminates in the audit report, where the auditor provides assurance based on the gathered evidence.

Page 5 — Importance of Completion Stage

• The auditor comprehensively reviews:

  • All evidence gathered throughout the audit engagement. This involves cross-referencing findings, ensuring completeness, and resolving any outstanding issues.

  • The final version of the financial statements to ensure they are consistent with the auditor's understanding and adhere to the applicable financial reporting framework.

• Objective: To enable the auditor to form and support an independent audit opinion on whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework.

• ISA 220 (Quality Control for an Audit of Financial Statements) explicitly requires that all work performed during the audit must be reviewed as part of the firm's quality control procedures. This review ensures that sufficient appropriate audit evidence has been obtained to support every significant assertion in the financial statements and that the audit documentation is complete and accurate.

Page 6 — Definition of Contingent Liability

• A potential future obligation to an outside party for an unknown amount, stemming from past activities or transactions. Its existence is uncertain.

• Exists only if future uncertain events occur (or fail to occur) beyond the entity's direct control. These events could be positive (e.g., winning a lawsuit) or negative (e.g., losing a lawsuit).

• Risk: The primary audit risk associated with contingent liabilities is the potential for incomplete or improper disclosure in the financial statements, which could mislead users.

Page 7 — Accounting Distinction

• Provision = A recognized liability in the statement of financial position (balance sheet). It represents a present obligation arising from past events, where an outflow of resources embodying economic benefits is probable, and a reliable estimate can be made.

• Contingent liability = Not recognized as a liability on the balance sheet; it is merely disclosed in the notes to the financial statements. This is because its existence or amount is either not probable, or cannot be reliably measured.

• FRS 137 (Provisions, Contingent Liabilities and Contingent Assets): This standard explicitly prohibits the recognition of contingent liabilities on the balance sheet because their existence depends on uncertain future events. Therefore, only disclosure in the financial statement notes is allowed, provided it is not considered remote.

Page 8 — Decision Framework for Obligations

Page 9 — Examples of Contingent Liabilities

• Pending litigation / court cases where the outcome is uncertain.

• Corporate guarantees (e.g., a parent company guaranteeing a subsidiary's loans or obligations) which could become actual liabilities if the principal obligor defaults.

• Actual or potential claims (e.g., product liability claims, environmental damage claims).

• Income-tax disputes with tax authorities where the final assessment is still pending.

• Product warranties offered to customers, which represent a potential future obligation to repair or replace defective products.

• Repurchase agreements on sold receivables, where the seller might be obligated to buy back receivables under certain conditions.

Page 10 — Audit Procedures: Contingent Liabilities

• Read minutes of Board of Directors (BOD), shareholder, and committee meetings to identify discussions and decisions related to potential legal or financial obligations.

• Inquire of management and external lawyers about any existing or potential claims, lawsuits, or other contingent matters. This often involves specific legal confirmation letters.

• Review contracts, loan agreements, leases, and correspondence with third parties for indications of unusual clauses or potential obligations.

• Check income-tax returns and assess any open tax years or disputes that could lead to tax liabilities.

• Inspect documents for any guarantees made by the entity on behalf of other parties.

• Obtain management's list of contingencies and compare it against independent findings, challenging any discrepancies or omissions.

Page 11 — Litigation-Specific Work

• Key: It is crucial to make appropriate inquiries about litigation and claims, as these often involve material amounts and complex legal interpretations.

• Obtain a Legal Confirmation Letter (an example is typically found on relevant audit practice pages, e.g., p. 517 of a textbook) directly from the client's external legal counsel, specifically requesting:

  • A comprehensive list of claims against the company, detailing their nature, current status, and management's assessment of the likely outcome.

  • A list of actions by the company.

  • A list of threatened / impending litigation and other contingent liabilities where the lawyers have knowledge.

Page 12 — Review for Commitments

• Commitment = A binding agreement that fixes future conditions or obligations, regardless of the entity's future earnings or economic conditions defined at the time of the agreement.

• Typical: Long-term contracts to buy specific plant, machinery, or raw materials, or agreements to sell product at a fixed future price. These often involve significant future cash outflows or inflows.

• Usually identified by inquiry during the course of regular revenue and purchasing audits, as well as a review of board minutes and key contracts.

• All significant commitments must be appropriately disclosed in the notes to the financial statements to provide users with a complete picture of the entity's future obligations.

Page 13 — Capital Commitments & Audit Tests

• Capital commitments: Represent significant future capital expenditures (CAPEX), such as commitments for plant construction, large machinery acquisitions, investments in other entities, or significant share purchases. These require substantial financial resources.

• Require approval of the Board of Directors (BOD) or shareholders due to their material impact on future liquidity and strategic direction.

• Procedures:

  • Obtain a comprehensive list of all capital commitments from management.

  • Read BOD and shareholder minutes to identify approvals for major capital expenditures.

  • Inspect underlying agreements (e.g., purchase contracts, construction agreements) to confirm terms, amounts, and dates.

  • Secure management representations specifically confirming the completeness and accuracy of the capital commitments list and related disclosures.

Page 14 — Disclosure of Commitments

• The notes to the financial statements must clearly show:

  • Amounts approved & contracted for and represent legally binding future cash outflows.

  • Amounts approved but not contracted for, which indicates future intentions that are likely to materialize but are not yet legally binding.

• Users care about commitments because they imply significant future cash-outflows (or inflows) that will reduce (or increase) available cash-flow for creditors and investors, impacting liquidity and financial flexibility. They provide insight into future strategic direction.

Page 15 — Review for Subsequent Events (SE)

• ISA 560 (Subsequent Events) outlines audit obligations regarding events occurring after the balance sheet date:

  • Consider the effects of subsequent events on the financial statements and the independent auditor’s report.

  • Ensure proper adjustment or disclosure of these events in the financial statements in accordance with the applicable financial reporting framework.

• SE categories:

  1. Events between the financial statement date (e.g., 31 Dec) and the date of the audit report (when the auditor signs the report).

  2. Facts discovered after the audit-report date but before the financial statements are issued.

• Management must establish and maintain effective policies and procedures to identify subsequent events; the auditor reviews these policies and performs specific tests to ensure all material subsequent events are identified and properly accounted for.

Page 16 — SE Types

• Type I (Adjusting Events): These are conditions that existed at the balance-sheet date but were only identified after that date. They provide additional evidence about conditions that existed at the balance sheet date and therefore require adjustment of the amounts recognized in the financial statements.

• Type II (Non-adjusting Events): These are conditions that arose after the balance-sheet date. While they do not require adjustment of financial statement amounts, they are significant enough to require note disclosure (explaining their nature and financial impact) and possibly pro-forma financial statements if their effect is pervasive, to avoid misleading users. Disclosure helps users understand future implications.

• Reference: Specific examples and detailed scenarios are typically provided in accounting standards or textbooks (e.g., pp. 518-519).

Page 17 — Detailed Examples

• Type I:

  • A customer filing for bankruptcy after year-end but due to financial difficulties that existed before the balance sheet date, confirming the uncollectibility of an existing receivable. This requires adjusting the allowance for doubtful accounts.

  • Post-year-end sales of inventory at prices below cost, revealing that the Net Realizable Value (NRV) of inventory was lower than cost at year-end. This requires adjusting inventory to the lower of cost or NRV.

• Type II:

  • Acquisition or disposal of a major business on $14\,\text{Feb}\,2018$ for $RM95{,}000{,}000$ cash. This is a new condition arising after year-end, which impacts future operations but not the prior year's financial position.

  • Issuance of shares or bonds, significant purchases of assets, destruction of a major production plant by fire (if it occurred post-year-end), or major litigation arising post-year-end.

Page 18 — Auditor’s SE Time-Line

31 Dec — Balance-sheet date
1 Feb — Fieldwork ends / report signed
15 Feb — FS delivered

• Segment 1 = subsequent-event period (BS date ➔ report date). This is the period during which the auditor actively searches for material subsequent events.

• Segment 2 = post-audit period (report date ➔ FS issuance). During this period, the auditor has no active responsibility to search for SEs, but acts if they become aware of any material facts.

• Segment 3 = after issuance (after the financial statements have been issued to the public). The auditor's obligations continue, though the actions required differ.

Page 19 — Responsibilities in Period 1 & 2

• Period 1 (Balance Sheet Date to Audit Report Date): The auditor must perform specific audit procedures designed to search for all material subsequent events. If identified, these events must be properly adjusted in the financial statements (Type I) or adequately disclosed (Type II).

• Period 2 (Audit Report Date to Financial Statement Issuance Date): The auditor has no active search duty for subsequent events. However, if the auditor becomes aware of a material fact that existed at the audit report date (or occurred thereafter) and would have affected the audit report had it been known earlier:

  • They must discuss the matter with management and, where appropriate, with TCWG.

  • Independently determine if the financial statements need amendment.

  • Take appropriate action, which may involve informing management to amend the financial statements or issuing a revised audit report. If management amends the FS, the auditor typically performs additional audit procedures and issues a new or re-dated audit report.

Page 20 — Actions if Facts Arise After Report Date

• If management amends financial statements (typically in Period 2 or 3):

  • The auditor performs necessary extra audit work on the amendments and re-dates the audit report not earlier than the date the amended financial statements are approved by management/TCWG. Alternatively, the auditor may dual-date the report to reflect the additional work (e.g., February 1, 20XX, except for Note X as of March 15, 20XX).

• If management refuses to amend financial statements when required (typically in Period 2):

  • The auditor issues a qualified or adverse opinion (if the original report has not been issued yet), or takes steps to prevent reliance on the original report (e.g., notifying management, TCWG, and regulatory authorities if the report has already been issued).

• Period 3 (after issuance): Similar obligations arise if material facts are discovered. The auditor may need to:

  • Investigate the matter and consult with legal counsel.

  • Request management to issue revised financial statements and a new audit report. This may involve re-issuance of the financial statements with an Emphasis of Matter Paragraph (EMP) or Other Matter Paragraph (OMP) and taking steps to alert all recipients of the prior financial statements that they should no longer be relied upon. If management refuses, the auditor must inform TCWG and potentially regulatory authorities.

Page 21 — SE Audit Procedures

• Evaluate management’s established processes for identifying subsequent events to ensure their policies are robust.

• Read minutes of the Board of Directors, audit committee, and other significant sub-committees for discussions about new significant events or issues.

• Review relevant interim financial statements, budgets, cash-flow forecasts, and management reports prepared after the balance sheet date for any unusual trends or significant transactions.

• Inquire of the entity’s lawyers about any new or ongoing litigation or claims that have arisen or been resolved since year-end.

• Discuss with management about any new commitments (e.g., major capital outlays), significant borrowings, disposals of major assets, mergers and acquisitions (M&A), equity issuances, or events causing significant damage (e.g., natural disasters).

• Obtain a management representation letter, specifically covering subsequent events, confirming that all material subsequent events have been identified, properly accounted for, and disclosed.

Page 22 — Going Concern (GC) Concept

• ISA 570 (Going Concern) requires the auditor to:

  • Assess the appropriateness of management’s use of the going concern assumption at both the planning stage and during the final review phase of the audit.

  • Obtain sufficient appropriate audit evidence regarding the appropriateness of management’s use of the going concern assumption.

• GC assumption: The fundamental accounting premise that an entity will continue in operation for the foreseeable future, usually considered to be at least 12 months beyond the year-end balance sheet date. This means the entity has no intention or necessity to liquidate or curtail the scale of its operations.

• Under the going concern basis, assets and liabilities are recorded on the assumption that the entity will be able to realize its assets and settle its liabilities in the normal course of business, rather than at liquidation values.

Page 23 — Auditor GC Responsibilities & Operating Indicators

• The auditor’s primary responsibility is to evaluate the appropriateness of management’s use of the going concern assumption in the preparation of the financial statements.

• Identify material uncertainties that may cast significant doubt on the entity's ability to continue as a going concern, and ensure these uncertainties are adequately disclosed in the financial statements.

• Operating red flags that may indicate going concern issues:

  • Loss of a major market (e.g., due to technological obsolescence), key franchise, or principal supplier, which could severely disrupt operations.

  • Labor difficulties or supply shortages that halt or significantly reduce production.

  • Loss of key management personnel without adequate replacement, potentially impacting operational expertise and strategic direction.

  • Negative operating cash flows over an extended period.

Page 24 — Financial GC Indicators

• Net liabilities or negative equity position, indicating that the entity's liabilities exceed its assets.

• Adverse key financial ratios, such as significantly declining current ratio, debt-to-equity ratio, or profitability margins.

• Large operating losses incurred consistently over several periods, and shrinking gross or net profit margins, indicating unsustainable business operations.

• Inability to pay creditors on due dates, or experiencing legal actions by creditors seeking payment.

• Suppliers switching to cash-on-delivery terms, reflecting a loss of confidence in the entity's ability to pay debts.

• Difficulties in obtaining or renewing financing, or breach of loan covenants with lenders.

• Arrears or discontinuance of dividends, which might signal financial strain or capital preservation efforts.

• Significant capital expenditure commitments without sufficient funding.

Page 25 — Other GC Indicators & Audit Steps (1-2)

• Other significant indicators of going concern risk:

  • Pending lawsuits or regulatory investigations that could result in significant liabilities or operational restrictions.

  • Adverse effects of new legislation, government policy changes, or economic shifts (e.g., a sudden increase in oil prices for a transport company) that negatively impact the business environment.

• Audit Steps:

  1. Evaluate all audit evidence gathered throughout the engagement for any indicators that may cast significant doubt on the entity’s ability to continue as a going concern.

  2. If such doubt exists, the auditor obtains management’s assessment and detailed mitigation plan, which should outline how the entity intends to address the going concern threats. This often includes cash flow forecasts and projected financial performance.

Page 26 — Steps 3 & Reporting

• Step 3: If substantial doubt persists after evaluating management’s plans and obtaining corroborating evidence, the auditor then assesses the sufficiency and appropriateness of the financial statement disclosures regarding the going concern uncertainty. If disclosures are adequate, the auditor adds an Emphasis of Matter paragraph (going-concern specific paragraph) to the audit report to highlight this material uncertainty to users.

Page 27 — Example GC Matrix

Page 28 — GC Audit Procedures (Extended)

1. Analyze cash-flow and profit forecasts provided by management, evaluate the underlying assumptions for reasonableness, and perform sensitivity analyses.

2. Review post-period events for any fresh capital injections, significant share issues, new credit facilities obtained, or asset sales that improve liquidity.

3. Inspect debenture and loan agreements for any breaches of covenants that could lead to immediate repayment demands.

4. Read minutes of BOD and key committee meetings discussing financial difficulties, strategic responses, and management's actions to address the situation.

Page 29 — GC Audit Procedures (cont.) & Conclusion

5. Inquire of legal counsel regarding the status and potential outcomes of any litigation or claims that could impose significant financial obligations.

6. Obtain formal letters of financial support from parent companies or major shareholders, clearly outlining the nature and duration of the support.

7. Secure written representations from management specifically on their plans to address going concern issues, their assessment of the entity's ability to continue as a going concern, and the completeness of relevant disclosures.

• Conclude whether the going concern uncertainty is resolved, mitigated (with appropriate disclosure), or unresolved. This conclusion directly dictates the appropriate type of audit report and opinion.

Page 30 — Reporting Outcomes: GC Resolved or Mitigated

Page 31 — GC Unresolved or Inappropriate

• If uncertainty is adequately disclosed but still unresolved, meaning there is still a material uncertainty, an EMP may suffice to draw users' attention to the note. The opinion can remain unmodified if the financial statements correctly reflect the uncertainty and are not pervasively misleading.

• If financial statements are not properly prepared on the going concern basis (e.g., management used GC assumption when liquidation is imminent, or ignored significant uncertainties), this constitutes a material misstatement:

  • Qualified opinion (if the misstatement is material but not pervasive) — The FS are materially misstated but still provide a reliable basis for economic decisions.

  • Adverse opinion (if the misstatement is material and pervasive) — The FS are so misstated that they do not present fairly the financial position, financial performance, or cash flows.

• If the auditor lacks sufficient appropriate evidence to assess the appropriateness of the going concern assumption or the effectiveness of management's plans (a scope limitation), and the potential effects on the financial statements are material and pervasive, the auditor issues a Disclaimer of Opinion.

Page 32 — Opening Balances (OB)

• ISA 510 (Initial Audit Engagements – Opening Balances) requires the auditor to obtain sufficient appropriate audit evidence that:

  • OB free from material misstatement that could affect the current period's financial statements.

  • OB correctly carried forward from the prior period or, where applicable, re-stated.

  • Appropriate accounting policies are consistently applied to the opening balances, or changes thereto are properly accounted for and adequately disclosed.

• Procedures to test opening balances:

  • Identify the accounting policies applied to the opening balances and verify their consistency with those applied in the current period. Any changes in policy must be reviewed for proper accounting and disclosure.

  • Check the prior period's audit opinion. If a qualified, adverse, or disclaimer opinion was issued, the auditor must understand the issues and take appropriate action in the current audit.

  • If a predecessor auditor existed, consider requesting access to their working papers and communicating with them to understand the prior period's audit. This can provide valuable insights into the opening balances.

  • Assess the materiality of opening balances relative to the current period's financial statements. Even small errors in prior periods can become material if carried forward and accumulate.

Page 33 — Comparative Figures

• ISA 710 (Comparative Information – Corresponding Figures and Comparative Financial Statements) mandates that comparative figures presented must materially comply with the applicable financial reporting framework.

• FRS 101 (Presentation of Financial Statements) explicitly requires the disclosure of prior-period figures for all amounts presented in the current period's financial statements (balance sheet, income statement, cash flow statement, and statement of changes in equity).

• If the presentation or classification of items in the current period's financial statements changes (e.g., due to a change in accounting policy or re-classification of an account), the comparative figures must be re-classified to ensure consistency, unless it is impracticable to do so. If impracticable, the reasons for not re-classifying and the nature of any adjustment that would have been made must be disclosed.

Page 34 — Analytical Procedures (AP) Purposes

1. Planning — Used to understand the client's business and industry, identify potential risk areas, and set the scope and focus of the audit. This helps in tailoring the audit approach.

2. Substantive — Employed as substantive procedures to reduce detection risk. By identifying unusual fluctuations or relationships, analytical procedures can highlight areas where material misstatements may exist.

3. Completion — Performed at or near the end of the audit as an overall review of the financial statements to ensure consistency with the auditor’s understanding of the entity and to identify any material misstatements or inconsistencies not detected previously.

• ISA 520 (Analytical Procedures) specifically mandates the performance of analytical procedures at or near the audit completion phase.

Page 35 — AP Example & Follow-Up

• Example: Testing the gross-profit margin of the client against industry averages or prior period margins. A significant deviation could signal misstatements in revenue or cost of goods old.

• If analytical procedures corroborate account-level tests (e.g., confirming the reasonableness of receivables balances based on sales trends), it reinforces the audit conclusions and provides additional persuasive evidence.

• Significant unexpected fluctuations or relationships identified during analytical procedures ➔ the auditor must investigate these deviations thoroughly and obtain sufficient appropriate audit evidence to explain and resolve them. This investigation may involve performing additional substantive tests or inquiring of management.

Page 36 — Accounting Estimates & ISA 540

• Common accounting estimates, which inherently involve management judgment and estimation uncertainty:

  • Allowance for doubtful accounts (receivables) and inventory obsolescence. These require judgment about future collectibility or salability.

  • Depreciation / amortisation of assets. Requires estimates of useful lives and residual values.

  • Accrued revenue and expenses. Requires estimation of amounts relating to services performed or goods received but not yet invoiced.

  • Deferred tax assets and liabilities. Requires judgment about future taxable profits and tax rates.

  • Lawsuit provisions. Requires estimation of probability and amount of future outflow for pending litigation.

  • Warranty provisions. Requires estimation of future warranty claims based on historical data or product defect rates.

• Complexity varies greatly: for example, estimating a simple rental accrual is less complex than estimating provisions for slow-moving inventory (which requires judgment about market demand and pricing) or complex financial instruments.

• ISA 540 (Auditing Accounting Estimates and Related Disclosures) outlines the auditor's responsibilities for obtaining sufficient appropriate audit evidence about whether accounting estimates and related disclosures in the financial statements are reasonable in the context of the applicable financial reporting framework.

Page 37 — Audit Procedures: Estimates

• Evaluate management’s estimation process, including the data and assumptions used (e.g., assessing the reasonableness of receivable ageing analysis, reviewing the company’s provisioning policy for expected credit losses).

• Re-perform calculations to independently verify the accuracy of the accounting estimate.

• Compare the current period’s estimates with prior periods’ actual outcomes (e.g., comparing last year's warranty provision to actual claims paid) to assess the reliability of management’s past estimation process.

• Review subsequent events for evidence that supports or contradicts the accounting estimate (e.g., a customer bankruptcy post-year-end confirms an impairment on a receivable estimated at year-end, or an inventory fire damage post-year-end confirms a write-down for obsolescence).

Page 38 — Related-Party Transactions (RPT) Definition

• A deal or arrangement between two or more parties that have a pre-existing special relationship, allowing one party to influence the other, or where they are subject to common control. Examples include a major shareholder renovating a company office or a transaction between a parent and its subsidiary.

• RPTs carry a higher risk of material misstatement due to the potential for non-arm's length terms (terms that would not prevail in transactions between independent parties) and opportunities for fraud.

Page 39 — RPT Examples & Transaction Types

• Relationships can include: Parent-subsidiary entities, entities under common control (e.g., two subsidiaries of the same parent), joint ventures, associates, key management personnel (including directors and their close family members), and employee trusts.

• Transaction types that can occur between related parties:

  • Sales and purchases of goods or property (e.g., intercompany sales).

  • Rendering or receiving of services (e.g., management fees, shared IT services).

  • Leasing arrangements (e.g., property leased from a director).

  • Licensing agreements for intellectual property.

  • Financing activities (e.g., loans at non-market rates, capital contributions, equity transactions).

  • Guarantees or pledges of collateral.

Page 40 — Responsibilities for RPT

• Management: Primarily responsible for designing, implementing, and maintaining systems to identify, properly account for, and disclose related-party relationships and transactions in accordance with the applicable financial reporting framework. They must ensure RPTs are recorded transparently.

• Auditor (ISA 550 – Related Parties): The auditor's responsibilities include:

  • Obtaining an understanding of the entity's related-party relationships and transactions sufficient to identify the risks of material misstatement (whether due to fraud or error) associated with RPTs.

  • Obtaining sufficient appropriate audit evidence about whether related-party relationships and transactions have been appropriately identified, accounted for, and disclosed in the financial statements.

  • Verifying eliminations of intercompany transactions in consolidated financial statements.

  • Looking for unusual transaction significant terms or indications of fraud (e.g., transactions outside the normal course of business, complex transactions, or transactions with unidentified related parties).

Page 41 — Audit Procedures: RPT

• Review prior period working papers for a list of known related parties.

• Examine minutes of BOD, shareholder, and significant committee meetings, as well as organizational charts, to identify new related parties or unusual transactions. Interview management (and potentially TCWG) about the entity’s related parties and the nature of transactions with them.

• Confirm terms, amounts, and settlement conditions directly with the related party, where feasible and appropriate.

• Inspect supporting documents for RPTs to ensure they are properly authorized, recorded, and reflect the true nature of the transaction.

• Obtain a written representation from management confirming the completeness of the list of related parties, the identification of all related-party transactions, and the adequacy of all related disclosures in the financial statements.

Page 42 — Management Representation Letter (MRL)

• ISA 580 (Written Representations) requires the auditor to obtain written representations from management (and, where appropriate, TCWG). While oral representations are part of the audit process, written representations provide formal, documented confirmation of management's responsibilities and certain matters critical to the audit.

• Purposes:

  1. Acknowledge management’s ultimate responsibility for the preparation and fair presentation of the financial statements in accordance with the applicable financial reporting framework, and for maintaining internal control.

  2. Provide audit evidence regarding key aspects where other objective evidence may not exist (e.g., future intentions, completeness of information provided to the auditor).

  3. Document oral representations made by management during the audit, reducing the risk of misunderstanding.

• The MRL must be dated the same day (or as close as practicable) as the auditor's report, as it covers events up to that date.

• Refusal by management to provide an MRL constitutes a scope limitation, which is a significant impediment to obtaining sufficient appropriate audit evidence. This typically leads to a Qualified opinion or, if pervasive, a Disclaimer of Opinion, as the auditor cannot form an opinion on the financial statements as a whole.

Page 43 — Other Completion Documents

• Management Letter: This is a separate communication, usually issued after the audit report, detailing internal-control weaknesses identified during the audit and providing recommendations for improvement. It is a value-added service but is not part of the audit opinion. Management’s responses and action plans are typically obtained before the audit report is signed.

• Disclosure/Outstanding Checklists: These are systematic tools (often proprietary, like those used by PwC or KPMG) used to ensure that all required disclosures under the applicable financial reporting framework and relevant laws/regulations are complete and accurately presented in the financial statements. They help prevent omissions and ensure compliance.

• Working Papers retention: Audit working papers, which document all audit procedures performed, evidence obtained, and conclusions reached, must be retained for a minimum period (e.g., at least 7 years as per professional standards or local regulations). This includes all documents forming the basis for the audit opinion, even those that might initially appear contradictory, as long as they contribute to the audit trail.

Page 44 — Communication With TCWG (ISA 260)

Objectives:

1. To explain the auditor’s responsibilities, the planned scope, and the timing of the audit, ensuring TCWG understand the audit process and its limitations.

2. To obtain information from TCWG that is relevant to the audit, such as their understanding of risks, fraud suspicions, or significant judgments made by management.

3. To provide timely observations arising from the audit that are significant and relevant to TCWG’s oversight responsibilities (e.g., significant deficiencies in internal control, significant accounting policies, uncorrected misstatements).

4. To foster constructive two-way communication between the auditor and TCWG, which is essential for audit quality and effective governance.

Page 45–46 — TCWG vs Management

• Those Charged With Governance (TCWG): This group has oversight responsibilities for the strategic direction of the entity and accountability of the entity, including overseeing the financial reporting process. This typically includes the board of directors, the audit committee, or equivalent governing bodies.

• Management: Responsible for the day-to-day operations of the entity, which includes the preparation of the financial statements, implementation, and maintenance of internal control.

• In small entities, the roles of TCWG and management may overlap (e.g., a sole proprietor, or a small board that is also involved in daily operations). The auditor must still identify who performs which functions for effective communication.

Page 47 — Reporting Standards

• ISA 700 (Forming an Opinion and Reporting on Financial Statements): This standard provides guidance on forming an opinion on the financial statements, the structure, and the content of the auditor’s report when an unmodified opinion is issued.

• ISA 701 (Communicating Key Audit Matters in the Independent Auditor’s Report): This standard addresses the auditor’s responsibility to communicate Key Audit Matters (KAM) in the auditor’s report. It aims to enhance the communicative value of the report by providing greater transparency about the audit.

• ISA 705 (Modifications to the Opinion in the Independent Auditor’s Report): This standard defines the circumstances under which the auditor is required to modify their opinion (i.e., issue a qualified, adverse, or disclaimer of opinion) and describes the form and content of such a modified report.

• ISA 706 (Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report): This standard provides guidance on when and how to include EMPs and OMPs in the auditor's report when the auditor considers it necessary to draw users' attention to a matter adequately presented or disclosed in the financial statements (EMP) or to a matter other than those presented or disclosed in the financial statements that is relevant to users' understanding of the audit (OMP).

Page 48 — Objectives of Auditor’s Report

(a) To form an independent opinion on the financial statements based on the audit evidence obtained throughout the engagement. The opinion must be robustly supported by sufficient appropriate evidence.
(b) To express that opinion clearly through a written report, describing the basis for the opinion and enhancing user confidence in the financial statements.

Page 49 — Report Classifications

1. Unmodified report with an unmodified opinion (commonly referred to as a standard unqualified report in some jurisdictions). This is issued when the auditor concludes that the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework.

2. Modified reports: These reports deviate from the standard unmodified report and are categorized based on the nature of modification:
   a. Unmodified opinion + EMP/OMP. The auditor expresses an unmodified opinion, but adds an explanatory paragraph to draw attention to a specific matter.
   b. Modified opinions: These are issued when the auditor concludes that the financial statements are materially misstated or there is a material scope limitation. There are three types:
   - Qualified opinion
   - Adverse opinion
   - Disclaimer of opinion

Page 50 — Unmodified (Unqualified) Report

• An unmodified opinion is concluded when the auditor determines that the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework and give a true and fair view (or are presented fairly, in all material respects) of the entity's financial position, financial performance, and cash flows. This is the most common and desired outcome of an audit.

Page 51-53 — EMP & OMP

• Emphasis of Matter Paragraph (EMP):

  • Purpose: Used to highlight a matter already disclosed or presented in the financial statements that, in the auditor’s professional judgment, is of such fundamental importance to users’ understanding that it is appropriate to draw their attention to it. It does not modify the auditor's opinion.

  • Placement: Placed immediately after the opinion paragraph in the auditor’s report.

  • Examples: A significant uncertainty relating to the future outcome of an exceptional lawsuit or regulatory action, a significant subsequent event (Type II) that is adequately disclosed, or a material uncertainty related to the going concern assumption when adequate disclosure is made.

• Other Matter Paragraph (OMP):

  • Purpose: Used to communicate a matter other than those presented or disclosed in the financial statements that, in the auditor’s professional judgment, is relevant to users’ understanding of the audit, the auditor’s responsibilities, or the auditor’s report. It also does not modify the auditor's opinion.

  • Placement: Placed after the opinion paragraph and after any Emphasis of Matter Paragraph.

  • Examples: When the auditor reports on more than one set of financial statements, or when the auditor reports on comparative information, or when reporting on prior period financial statements audited by a predecessor auditor.

Key Distinction: EMP is for matters within the financial statements that need emphasis, while OMP is for matters outside the financial statements but relevant to the audit or report.

Page 54-56 — Modified Opinions

• Modified opinions are issued when the auditor concludes that:

  • The financial statements are materially misstated, or

  • The auditor is unable to obtain sufficient appropriate audit evidence (a scope limitation), and the potential effects of this inability are material.

• Qualified Opinion:

  • Issued when the auditor concludes that the financial statements are materially misstated, but the effects of the misstatement are not pervasive to the financial statements as a whole. This means the specific misstatement is important but does not affect the overall reliability of the financial statements beyond that particular area.

  • Also issued when the auditor is unable to obtain sufficient appropriate audit evidence, and the potential effects on the financial statements of undetected misstatements are material but not pervasive.

  • The report states that, "except for" the matter described, the financial statements are presented fairly.

• Adverse Opinion:

  • Issued when the auditor concludes that the financial statements are materially misstated, and the effects of the misstatement are so pervasive that they render the financial statements misleading or unreliable as a whole. This is the most severe type of modified opinion.

  • The report states that the financial statements do not present fairly, or do not give a true and fair view.

• Disclaimer of Opinion:

  • Issued when the auditor is unable to obtain sufficient appropriate audit evidence to form an opinion on the financial statements, and the potential effects of undetected misstatements on the financial statements are both material and pervasive. This is effectively a statement that the auditor cannot express an opinion.

  • Also issued when the auditor is not independent.

Page 57 — Disclaimer (Detail)

• When a disclaimer of opinion is issued, the auditor explicitly states in the audit report that, due to the inability to obtain sufficient appropriate audit evidence, they are unable to form and express an opinion on the financial statements. This is a crucial distinction as it indicates a severe scope limitation rather than a misstatement by management.

Page 58 — Decision Logic

• The choice of opinion type is based on two key factors:

  • (a) Nature of the matter giving rise to the modification: Is it due to a material misstatement in the financial statements (e.g., non-compliance with accounting standards, inadequate disclosure) or a lack of sufficient appropriate audit evidence (scope limitation)?

  • (b) Pervasiveness: This refers to the widespread impact of the misstatement or scope limitation on the financial statements. A matter is pervasive if, in the auditor’s judgment:

  • It is not confined to specific elements, accounts, or items of the financial statements.

  • If it is confined, it represents a substantial proportion of the financial statements.

  • In relation to disclosures, it is fundamental to users’ understanding of the financial statements.

Page 59 — Summary Table

Page 60-62 — Essential Report Contents (ISA 700)

1. Title. The report must have a clear title, such as "Independent Auditor’s Report," to distinguish it from other reports.

2. Addressee. The report must be addressed to those for whom the report is intended, typically the shareholders or Those Charged With Governance (TCWG) of the entity.

3. Introductory Paragraph. Identifies the financial statements that have been audited, including the entity’s name, the period covered, and usually a reference to the summary of significant accounting policies and other explanatory information.

4. Management’s Responsibility for the Financial Statements. This section clearly states that management is responsible for the preparation and fair presentation of the financial statements in accordance with the applicable financial reporting framework, and for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.

5. Auditor’s Responsibility Paragraph & Opinion Basis. This section outlines the auditor’s responsibility to express an opinion on the financial statements based on their audit. It includes a statement that the audit was conducted in accordance with International Standards on Auditing (ISAs) and describes the nature of an audit: planning and performing procedures to obtain reasonable assurance that the financial statements are free from material misstatement.

6. Methodology Statement (Audited per ISA). Explicitly states that the audit was conducted in accordance with International Standards on Auditing (ISAs), which typically implies adherence to ethical requirements, professional skepticism, and professional judgment.

7. Limitations & Any Modifications. This section, if applicable, elaborates on any limitations to the scope of the audit or any factors that led to a modification of the opinion, providing context for the basis of the opinion.

8. Disagreements Described. If there are disagreements with management that led to a modified opinion, the nature and impact of these disagreements are described here.

9. Opinion Paragraph. This is the core of the report, containing the auditor’s concluded opinion on whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework.

10. Other Reporting Responsibilities. Addresses any additional reporting responsibilities required by local laws or regulations beyond the ISAs (e.g., specific legal requirements for public companies).

11. Emphasis of Matter Paragraph (EMP)/Other Matter Paragraph (OMP). Included if the auditor deems it necessary to draw users' attention to a matter adequately presented or disclosed in the financial statements (EMP) or to a matter other than those presented or disclosed in the financial statements that is relevant to users' understanding of the audit (OMP). These are placed after the opinion paragraph.

12. Signature of the Auditor. The report must be signed, typically by the engagement partner and/or the firm name.

13. Date of the Auditor’s Report. The date of the auditor’s report is the date on which the auditor has obtained sufficient appropriate audit evidence on which to base the opinion on the financial statements.

14. Auditor’s Address. The report includes the location (city and country) where the auditor practices.

Page 63 — Key Audit Matters (ISA 701) — Definitions & Objectives

• Key Audit Matters (KAM) are required to be communicated in the auditor's report specifically for listed entities (or when otherwise required by local regulation or deemed appropriate by the auditor).

• KAM = those matters that, in the auditor’s professional judgment, were of most significance in the audit of the financial statements of the current period. These matters are selected from those communicated with TCWG.

• The auditor must:

  • Determine KAM: Identify those matters that required significant auditor attention.

  • Communicate them in the report: Include a specific section in the auditor’s report describing each KAM.

Page 64 — Determining KAM

Consider:

1. Higher-risk or “significant risk” areas per ISA 315 (Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and Its Environment). These are inherently more challenging and require more audit focus.

2. Significant auditor judgments: Matters that involved significant auditor judgment relating to areas in the financial statements that involved significant management judgment, including accounting estimates that have been identified as having high estimation uncertainty (e.g., fair value measurements, impairment assessments).

3. Effects of significant events or transactions during the period: Transactions that had a material effect on the financial statements and required significant audit attention (e.g., major acquisitions, disposals, restructurings, or initial application of new accounting standards).

Page 65 — Communicating Each KAM

For each KAM identified, the auditor describes:

• Why it was significant: Explains the rationale for considering the matter as one of most significance in the audit. This helps users understand the challenges and complexities faced by the auditor.

• How it was addressed in the audit: Provides a summary of the audit procedures performed in response to the KAM. This may include the nature of procedures, key observations, and the outcomes. It demonstrates the depth and focus of the audit work.

• The description must link to underlying financial statement disclosures where relevant but avoid excessive detail that could become cumbersome or could be misinterpreted as a primary disclosure. The purpose is to provide insights into the audit, not to replace management's disclosures.

Page 66-67 — KAM Examples (Goodwill & ECL)

• Example extract often taken from real-world Bank audit reports, showcasing the practical application of KAM reporting:

  • KAM 1: Impairment of goodwill & investments; focus on VIU cash-flow forecasts, WACC discount rate, sensitivity analysis, etc.

  • KAM 2: Expected-credit-losses under MFRS 9 (or IFRS 9); emphasis on staging, model inputs, macroeconomic scenarios; involvement of specialist teams.

• Demonstrates structure: risk area, rationale, and audit response.

Page 68 — End of Topic 8

• The completion phase of an audit integrates all prior audit work, ensuring that the evidence gathered throughout the engagement sufficiently supports the audit opinion, that all financial statement disclosures are adequate, that all identified risks have been appropriately addressed, and that communication with governance and external reporting requirements meet the standards set out by ISAs and