BLOCK 1 LECTURE 2 SUPPORT FILE

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BLOCK 1 (LECTURE 2)
Professional skepticism
1. Components – due care
2. Attitude-
a. Questioning mind
b. Critical assessment of evidence gathered
3. Three elements
a. Attributes – qualities of a good auditor
i. Professional competence [ qualification]
ii. Experience [ Skilled / competent/ Callibre]
iii. Regular training and development of the auditor (CPD)
b. Mind set
i. Questioning mind
ii. Being alert in the process of audit
c. Actions
i. Critical assessment of evidence gathered ( Review of the working paper)
ii. Discussion with those charged with governance (TCWG)
Specific areas – to apply professional skepticism
When does auditor apply professional skepticism? – through out

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Topic 4: Auditor responsibility for fraud
Massaging the figures= Window dressing= creative accounting= manipulating the FS to show better
performance [Why the management do so?]
1. Self-interest- better results means better bonuses / salaries
2. Incentive / opportunity– achieving target / management can manipulate the actual results to
achieve targets (normally the last quarter / 4th quarter of the financial year is very risky]
3. Incentive- Listed Company!! – if the company is listed, the management has an outside pressure
to show better results / to boost market value of shares
4. Incentive- Negotiating a loan – if the company is negotiating a loan – there is a high chance of
financial statement been fabricated / being massaged to show better liquidity for securing a
bank loan
Auditor should be skeptical analysing the financial statements ( that is the reason that the auditor
perform risk assessment at the planning stage to identify risky areas within the financial statements)
Risky areas in the financial statement (Inherent risk / risk by default / embedded in the FS)
1. ASSETS- OVERSTATED
a. Tangible
b. Intangible
c. Current assets
2. LIABILITIES – UNDERSTATED
a. Current
b. Non-current liab
3. INCOME – OVERSTATED
a. Sales
b. Other income
c. Exchange gains
4. EXPENSES –UNDERSTATED
a. Depreciation expense
b. Bad debt expense
5. SUBJECTIVE AREAS IN THE FINANCIAL STATEMENT (Estimates of the management /
management estimates are risky / inherently risky)
a. Fair values
b. Depreciation
c. Going concern
d. Provision
6. DISCLOSURES ( Inherently risky)
a. Lack of disclosure
b. Incomplete disclosure
c. Examples
i. Contingent liability
ii. Non-adjusting event
iii. Related party transaction
iv. Operating segments

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Fraudulent financial reporting – in economic downturn
Example:
Parker company is facing difficult trading condition due to an economic recession in the country and it
was necessary to cut price on the products due to economic downturn. The consumer spending is
depressed.
Extracts from the financial statements
Sales $ million 2018 2017
Sales 8 9
Ok its fine, that sales has gone down over the last year because of economic recession by 11%. What if
the sales must have gone down by more than 11% and the management has fabricated or massaged it
to show at minus 11% ?
Sales could be overstated !!
Further, due to economic recession, the consumer spending is depressed – What about inventory in the
warehouse ?
What will happen to the inventory due to economic recession? It will become slow moving – Auditor
should be skeptical about inventory valuation?
Due to economic recession- depressed trading condition? – What about receivables in the balance
sheet?- Receivables could be overstated !! why – if bad debts are not recorded.
If I am going to the audit of Parker company – What are risky areas?
1. Sales – overstated
2. Inventory – overstated
3. Receivable – overstated

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How the auditor should respond to earning management?
 Use of professional scepticism
 Discussion among engagement team
 Planning meeting(ISA-300)- at the stage of the planning there should be a discussion
between the engagement partner and the team, where by the engagement partner
informs the team of the risky areas within the financial statement
 Evaluation of accounting policies
 The audit team should critically evaluate the accounting policies to ensure that the
accounting policies are in line with IAS / IFRS
 Completeness of disclosures
 The audit team should critically evaluate the disclosure required in the FS and should
ensure their completeness / there should not be an omission of a disclosure required
 Communication with TCWG
 If the auditor identify any material misstatement( wrong accounting policy / lack of
disclosure) the auditor should to inform TCWG for rectifying it
 Audit report
 If not rectified by TCWG, the auditor would consider the implication for the audit report
 Other reporting requirements
 Should the auditor inform the regulator? In some countries the auditor has an obligatory
responsibility to inform the regulator of a breach of IAS/ IFRS for e.g. in USA, there is a
regulator known as PCAOB, to whom the matter should be whistle blown.

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Topic 5: Auditor responsibility for laws and regulations
Auditor responsibility- Should be ALERT of any instance of non-compliance with laws and regulations
(NOCLAR) and if any found should take appropriate actions.
Laws and regulations – there are many laws and regulations which are applicable to a company
HOWEVER the auditor should only take knowledge about those laws and regulations which have a direct
or indirect effect on the financial statement.
Type A – Laws [Direct effect on FS]
 IAS/ IFRS
Type B – Laws [Indirect effect on FS]
 Health and safety laws- it can cause a provision or contingent liab in the FS
 Environmental laws - it can cause a provision or contingent liab in the FS
Auditor = KOB(Knowledge of business)= relevant laws = direct/ indirect effect on FS
Auditor responsibilities for NOCLAR
1. Obtaining an understanding of the nature of the act and the circumstances in which it has
occurred and further information to evaluate the possible effect on the financial statements
 Nature of act- whether it was an omission or a commission
 Circumstance – Intentional or un-intentional
 Possible effect on the FS – Understatement / overstatement / provision / contingent
liabilities
2. Discussing the matter with management and those charged with governance and obtaining legal
advice in certain circumstances;
 First with the management – Middle management
 Then with TCWG – BOD / Audit committee
 Legal advice – certain circumstances ( what are certain circumstances) – when NOCLAR
has a public interest / for e.g. the hospital is using expired medicines / there is an
environmental breach etc.
 Legal advice is been taken to whistle blow the matter to public/ and you are taking the
legal advice from the professional accountancy body
3. Evaluating the implications of NOCLAR in relation to other aspects of the audit;
 If the auditor identify the NOCLAR / will it affect other aspect of audit? Yes/ how:
1. Client integrity- auditor should re-asses it
2. Impact on the sample size- will the auditor increase the sample size for the
remaining audit
3. Re-assess the need to be more skeptical /re-assess the materiality level

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4. Evaluating the impact of NOCLAR on the audit opinion; and
 If the management fails to rectify the NOCLAR then the auditor should consider its impact
on the audit report
5. Determining whether to report NOCLAR to an appropriate authority outside the entity
 Informed to a regulator ( regulator responsible for laws and regulations)
 Reporting will take precedence over confidentiality
6. Documentation
 The auditor should maintain proper working papers for all NOCLAR identified during the
process of audit and the actions taken

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TOPIC 6: USING THE WORK OF OTHERS
OTHERS – Who others are for an external auditor?
1. ISA-600 –The auditor of the subsidiary ( when you are a parent auditor)

Example:
ABC Co chartered certified accountant is the auditor of the parent company of Plant group. The
plant group comprised of a parent company and six subsidiaries. ABC company is responsible
for the audit of the parent company and three of its subsidiaries whereas the remaining three
subsidiaries are audited by another audit firm.

Plant group ABC Co Another audit firm

Parent company Auditor
S1 Auditor
S2 Auditor
S3 Auditor
S4 Another audit firm
S5 Another audit firm
S6 Another audit firm

What should ABC Co look for in context of another audit firm?

I. Whether the subsidiary to which another audit firm is responsible to perform audit is
significant subsidiary or not?
a. A subsidiary is significant to the group if it contributes 15% or more to the total
profit of the group or it is 15% or more of the total assets of the group
II. If it is a significant subsidiary of the group, then ABC company has to see whether another
audit firm is a related firm or an unrelated firm?
a. Related firm is a firm which is related to ABC company in terms of its size,
reputation, experience etc. (equal firm)
b. Unrelated firm is a firm which is not related to ABC company in terms of size,
reputation or experience ( small firm)
III. If the significant subsidiary is being audit by an un-related firm to ABC company, then
ABC company should check the following before relying on the work of the un-related
firm:
a. Independence
b. Experience in the relevant industry
c. Competence of the teams members involved in the auditor
d. Quality of the working papers developed.

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2. ISA-610- The internal auditor

Before relying on the work of an internal auditor the auditor should ensure:
I. Independence of an internal auditor ( whether he reports to Audit committee or not)
II. Competence of the internal auditor ( qualification of the members of internal audit team)
III. Experience ( since how long they are serving the internal audit dept)
IV. Documentation for the work / how good the documentation is (internal audit report)

3. ISA-620- Expert

Before relying on the work of an expert the auditor should ensure:

I. Independence of an expert
II. Competence of the expert ( certification in the relevant area)
III. Experience ( since how long has he been an expert)
IV. Documentation for his work / how good the documentation is

4. ISA- 402- Service organization

Example: You are an auditor representing ABC & Co a firm of chartered certified accountant, and
you are responsible for the audit of Crow company. Crow company has outsourced its payroll
function to Jack company a service organization.

Before I rely on the work of Jack Company in respect of payroll I will ensure that Jack company
is:
I. Independent of crow company
II. Experience of Jack company / market reputation/ how well it is known in the market / in
the relevant area where the jack company is providing services
III. Documentation of their work/ how well the work relating to payroll was documented
IV. Review the internal control at Jack company (Visit Jack company for it) before I can place
reliance on the payroll data being obtained from Jack company

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