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that provides services to user entities that are part of those entities’ information systems
relevant to financial reporting.
12.2.6 Service Organisation’s System – the policies and procedures designed, implemented
and maintained by the service organisation to provide user entities with the services covered
by the service auditor’s report.
12.2.7 SubService Organisation – A service organisation used by another service
organisation to perform some of the services provided to user entities that are part of those
user entities’ information systems relevant to financial reporting.
12.2.8 User Auditor – An auditor who audits and reports on the financial statements of a user
entity.
12.2.9 User Entity – An entity that uses a service organisation and whose financial statements
are being audited.
12.3. Obtaining an understanding of the service provided by a service organisation,
including control
12.3.1 When obtaining an understanding of the user entity in accordance with ISA 315 the user
auditor shall obtain an understanding of how a user entity uses the services of a service
organisation in the user entity’s operations, including:
The nature of the services provided by the service organisation and the significance of
those services to the user entity, including the effect thereof on the user entity’s internal
control;
The nature and materiality of the transactions processed or accounts or financial reporting
processes affected by the service organisation;
The degree of interaction between the activities of the service organisation and those of the
user entity; and
The nature of the relationship between the user entity and the service organisation,
including the relevant contractual terms for the activities undertaken by the service
organisation.
Nature of services provided
12.3.2 Information on the nature of services provided by a service organisation may be
available from a wide variety of sources, such as:
User manuals.
System overviews.
Technical manuals.
The contract or service level agreement between the user entity and the service
organisation.
Reports by service organisations, internal auditors or regulatory authorities on controls of
the service organisation.
Reports by the service auditor, including management letters, if available.
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12.3.3 Knowledge obtained through the user auditor’s experience with the service organisation
on other audit engagements may also be helpful in obtaining an understanding of the nature of
the services provided by the service organisation. This may be particularly helpful if the
controls at the service organisation over those services are highly standardised.
12.3.4 Examples of service organisation services that are relevant to the audit include:
Maintenance of the user entity’s accounting records.
Management of assets.
Initiating, recording or processing transactions as agent of the user entity.
Materiality
12.3.5 In certain situations, the transactions processed and the accounts affected by the
service organisation may not appear to be material to the user entity’s financial statements, but
the nature of the transactions processed may be significant and the user auditor may
determine that an understanding of those controls is necessary in the circumstances.
Degree of interaction
12.3.6 The significance of the controls of the service organisation to those of the user entity
depends on the degree of interaction between its activities and those of the user entity. The
degree of interaction refers to the extent to which a user entity is able to and elects to
implement effective controls over the processing performed by the service organisation.
12.3.7 For example, a high degree of interaction exists between the activities of the user entity
and those at the service organisation when the user entity authorises transactions and the
service organisation processes and does the accounting for those transactions. In these
circumstances, it may be practicable for the user entity to implement effective controls over
those transactions. On the other hand, when the service organisation initiates or initially
records, processes, and does the accounting for the entity’s transactions, there is a lower
degree of interaction between the two organisations. In these circumstances, the user entity
may be unable to, or may elect not to, implement effective controls over transactions at the
user entity and may rely on controls at the service organisation.
Contract or service level agreement
12.3.8 The contract or service level agreement between the user entity and the service
organisation may provide for matters such as:
The information to be provided to the user entity and responsibilities for initiating
transactions relating to the activities undertaken by the service organisation;
The application of requirements of regulatory bodies concerning the form of records to be
maintained, or access to them;
The indemnification, if any, to be provided to the user entity in the event of performance
failure;
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Whether the service organisation will provide a report on its controls and, if so, whether
such report would be a type 1 or type 2 report;
Whether the user auditor has rights of access to the accounting records of the user entity
maintained by the service organisation and other information necessary for the conduct of
the audit; and
Whether the agreement allows for direct communication between the user auditor and the
service auditor.
Considerations specific to smaller entities
12.3.9 Smaller entities may use external bookkeeping services ranging from the processing of
certain transactions (for example, payment of payroll taxes) and maintenance of their
accounting records to the preparation of their financial statements. The use of such a service
organisation for the preparation of its financial statements does not relieve management of the
smaller entity and, where appropriate, those charged with governance of their responsibilities
for the financial statements.
Understanding of internal control as required by ISA 315
12.3.10 When obtaining an understanding of internal control relevant to audit in accordance
with ISA 315, the user auditor shall evaluate the design and implementation of relevant
controls at the user entity that relate to the services provided by the service organisation,
including those that are applied to the transactions processed by the service organisation.
12.3.11 The user entity may establish controls over the service organisations services that
may be tested by the user auditor and may enable the user auditor to conclude that the user
entity’s controls are operating effectively for some or all of the related assertions, regardless
of the controls in place at the service organisation.
12.3.12 If the user entity, for example, uses a service organisation to process its payroll
transactions, the user entity may establish controls over the submission and receipt of payroll
information that could prevent or detect misstatements. These controls may include:
Comparing the data submitted to the service organisation with reports of information
received from the service organisation after the data has been processed.
Re-computing a sample of the payroll amounts for clerical accuracy and reviewing the total
amount of the payroll for reasonableness.
12.3.13 In this situation, the user auditor may perform tests of the user entity’s controls over
payroll processing that would provide a basis to conclude that the user entity’s controls are
operating effectively for the assertions relevant to payroll transactions.
12.3.14 As noted in ISA 315, in respect of some risks, the user auditor may judge that it is not
possible or practicable to obtain sufficient appropriate audit evidence only from substantive
procedures. Such risks may relate to the inaccurate or incomplete recording of routine or
significant classes of transactions and account balances, the characteristics of which often
permit highly automated processing with little of no manual intervention.
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12.3.15 Such automated processing may be particularly present when the user entity uses
service organisations. In such cases, the user entity’s controls over such risks are relevant to
the audit and the user auditor is required to obtain an understanding of, and to evaluate, such
controls.
Sufficient understanding
12.3.16 The user auditor shall determine whether a sufficient understanding of the nature and
significance of the services provided by the service organisation and their affect on the user
entity’s internal control relevant to the audit has been obtained to provide a basis for the
identification and assessment of risks of material misstatement.
12.3.17 If the user auditor is unable to obtain a sufficient understanding from the user entity,
the user auditor shall obtain that understanding from one or more of the following procedures:
Obtaining a type 1 or type 2 report, if available;
Contacting the service organisation, through the user entity, to obtain specific information;
Visiting the service organisation and performing procedures that will provide the necessary
information about the relevant controls at the service organisation; or
Using another auditor to perform procedures that will provide the necessary information
about the relevant controls at the service organisation. (The guidance in ISA 600 will be
useful in this regard, as it relates to understanding another auditor, involvement in the work
of another auditor in planning the nature, extent and timing of such work, and in evaluating
the sufficiency and appropriateness of the audit evidence obtained.)
12.3.18 The user auditor’s decision as to which procedure, individually or in combination to
undertake, in order to obtain the information necessary to provide a basis for the identification
and assessment of the risks of material misstatement in relation to the user entity’s use of the
service organisation, may be influenced by such matters as:
The size of both the user entity and the service organisation;
The complexity of the transactions at the user entity and the complexity of the services
provided by the service organisation;
The location of the service organisation.
Whether the procedure(s) is expected to effectively provide the user auditor with sufficient
appropriate audit evidence; and
The nature of the relationship between the user entity and the service organisation.
Using a type 1 or type 2 report to support the user auditor’s understanding of the
service organisation
12.3.19 In determining the sufficiency and appropriateness of the audit evidence provided by a
type 1 or type 2 report, the user auditor shall be satisfied as to:
The service auditor’s professional competence and independence from the service
organisation; and
The adequacy of the standards under which the type 1 or type 2 report was issued, for
example may be issued under International Standard on Assurance Engagements (ISAE)
3402
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12.3.20 If the auditor plans to use a type 1 or a type 2 report as audit evidence to support the
user’s understanding about the design and implementation of controls at the service
organisation, the user auditor shall:
Evaluate whether the description and design of controls at the service organisation is at a
date or for a period that is appropriate for the user auditor’s purposes;
Evaluate the sufficiency and appropriateness of the evidence provided by the report for the
understanding of the user entity’s internal control relevant to the audit;
Determine whether complementary user entity controls identified by the service
organisation are relevant to the user entity and, if so, obtain an understanding of whether
the user entity has designed and implemented such controls.
12.3.21 The availability of a type 1 report or type 2 report will generally depend on whether the
contract between a service organisation and a user entity includes the provision of such a
report by the service organisation.
12.3.22 The user auditor may make inquiries about the service auditor to the service auditor’s
professional organisation or other practitioners and inquire whether the service auditor is
subject to regulatory oversight. The service auditor may be practicing in a jurisdiction where
different standards are followed in respect of reports on controls at a service organisation, and
the user auditor may obtain information about the standards used by the service auditor from
the standard setting organisation.
12.3.23 A type 1 or type 2 report, along with information about the user entity, may assist the
user auditor in obtaining an understanding of:
The aspects of controls at the service organisation that may affect the processing of the
user entity’s transactions, including the use of subservice organisations.
The flow of significant transactions through the service organisation to determine the points
in the transaction flow where material misstatements in the user entity’s financial
statements could occur;
The control objectives at the service organisation that are relevant to the user entity’s
financial statements assertions; and
Whether controls at the service organisation are suitably designed and implemented to
prevent or detect processing errors that could result in material misstatements in the user
entity’s financial statements.
12.3.24 It should be noted that a type 1 report will never provide any evidence of the operating
effectiveness of the relevant controls.
Type 1 or type 2 report outside reporting period
12.3.25 A type 1 or type 2 report that is as of a date or for a period that is outside of the
reporting period of a user entity may assist the user auditor in obtaining a preliminary
understanding of the controls implemented at the service organisation if the report is
supplemented by additional current information from other sources.
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12.3.26 If the service organisation’s description of controls is as of a date or for a period that
precedes the beginning of the period under audit, the user auditor may perform procedures to
update the information in a type 1 or type 2 report such as:
Discussing the changes at the service organisation with user entity personnel who could be
in a position of know of such changes;
Reviewing current documentation and correspondence issued by the service organisation;
or
Discussing the changes with service organisation personnel.
12.4. Responding to the assessed risks of material misstatement
12.4.1 In responding to the assessed risks in accordance with ISA 330, the user auditor shall:
Determine whether sufficient appropriate audit evidence concerning the relevant financial
statement assertions is available from records held at the user entity; and, if not,
Perform further audit procedures to obtain sufficient appropriate audit evidence or use
another auditor to perform those procedures at the service organisation on the user
auditor’s behalf.
12.4.2 Whether the use of a service organisation increases a user entity’s risk of material
misstatement depends on the nature of services provided and controls over those services; in
some cases, the use of a service organisation may decrease a user entity’s risk of material
misstatement, particularly if the user entity itself does not possess the expertise necessary to
undertake particular activities, such as initiating, processing, and recording transactions, or
does not have adequate resources (for example, an IT system)
12.4.3 When the service organisation maintains material elements of the accounting records of
the user entity, direct access to those records may be necessary in order for the user auditor to
obtain sufficient appropriate evidence relating to the operations of controls over those records
or to substantiate transactions and balances recorded in them, or both. Such access may
involve either physical inspection of records at the service organisation’s premises or
interrogation of records maintained electronically from the user entity or another location, or
both. When direct access is achieved electronically, the user auditor may thereby obtain
evidence as to the adequacy of controls operated by the service organisation over the
completeness and integrity of the user entity’s data for which the service organisation is
responsible.
Nature and extent of audit evidence
12.4.4 In determining the nature and extent of audit evidence to be obtained in relation to
balances representing assets held or transactions undertaken by a service organisation on
behalf of the user entity, the following procedures may be considered by the auditor:
Inspecting records and documents held by the user entity: the reliability of the source of the
evidence is determined by the nature and extent of the accounting records and supporting
documentation retained by the user entity. In some cases the user entity may not maintain
independent records or documentation of specific transactions undertaken on its behalf.
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Inspecting records and documents held by the service organisation: the user auditor’s
access to the records of the service organisation may be established as part of the
contractual arrangements between the user entity and the service organisation. The user
auditor may also use another auditor, on its behalf to gain access to the user entity’s
records maintained by the service organisation.
Obtaining confirmations of balances and transactions from the service organisation: where
the user entity maintains independent records of balances and transactions, confirmation
from the service organisation corroborating the user entity’s records may constitute reliable
audit evidence concerning the existence of the transactions and assets concerned. For
example, where multiple service organisations are used, such as an investment manager
and a custodian, and these service organisations maintain independent records, the user
auditor may confirm balances with these organisations in order to compare this information
with the independent records of the user entity.
If the user entity does not maintain independent records, information obtained in
confirmations from the service organisation is merely a statement of what is reflected in the
records maintained by the service organisation. Therefore, such confirmations do not,
taken alone, constitute reliable audit evidence. In these circumstances, the user auditor
may consider whether an alternative source of independent evidence can be identified.
Performing analytical procedures on the records maintained by the user entity or on the
reports received from the service organisation: the effectiveness of analytical procedures is
likely to vary by assertion and will be affected by the extent and detail of information
available.
Use of another auditor
12.4.5 Another auditor may perform procedures that are substantive in nature for the benefit of
user auditors. Such an engagement may involve the performance, by another auditor, of
procedures agreed upon by the user entity and its user auditor and by the service organisation
and its service auditor. The findings resulting from the procedures performed by another
auditor are reviewed by the user auditor to determine whether they constitute sufficient
appropriate audit evidence.
12.4.6 In addition there may be requirements imposed by governmental authorities or through
contractual arrangements whereby a service auditor performs designated procedures that are
substantive in nature. The results of the application of the required procedures to balances and
transactions may be used by user auditors as part of the evidence necessary to support their
audit opinions. In these circumstances, it may be useful for the user auditor and the service
auditor to agree, prior to the performance of the procedures, to the audit documentation or
access to audit documentation that will be provided to the user auditor.
12.4.7 In certain circumstances, in particular where the user entity outsources some or all of its
finance function to a service organisation, the user auditor may face a situation where a
significant portion of the audit evidence resides at the service organisation. Substantive
procedures may need to be performed at the service organisation by the user auditor or
another auditor on its behalf. A service auditor may provide a type 2 report and, in addition,
may perform substantive procedures on behalf of the user auditor.
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12.4.8 The involvement of another auditor does not alter the user auditor’s responsibility to
obtain sufficient appropriate audit evidence to afford a reasonable basis to support the user
auditor’s opinion. Accordingly, the user auditor’s consideration of whether sufficient appropriate
audit evidence has been obtained and whether the auditor needs to perform further
substantive procedures includes user auditor’s involvement with, or evidence of, the direction,
supervision and performance of the substantive procedures performed by another auditor.
Tests of controls
12.4.9 When the user auditor’s risk assessment includes an expectation that controls at the
service organisation are operating effectively, the user auditor shall obtain audit evidence
about the operating effectiveness of those controls (as required by ISA 330) from one or more
of the following procedures:
Obtaining a type 2 report if available.
Performing appropriate tests of controls at the service organisation; or
Using another auditor to perform tests of controls at the service organisation on behalf of
the user auditor.
12.4.10 Tests of the operating effectiveness of controls are required where the user auditor
intends to rely on the operating effectiveness of those controls at the service organisation in
determining the nature, timing and extent of substantive procedures or where substantive
procedures alone will not provide sufficient appropriate audit evidence at the assertion level.
12.4.11 If a type 2 report is not available, the user auditor may contact the service organisation
through the user entity, to request that a service auditor be engaged to provide a type 2 report
that includes tests of the operating effectiveness of the relevant controls or the user auditor
may use another auditor to perform procedures at the service organisation that test the
operating effectiveness of those controls. A user auditor may also visit the service organisation
and perform tests of relevant controls if the service organisation agrees to it. The user auditor’s
risk assessments are based on the combined evidence provided by the work of another auditor
and the user auditor’s own procedures.
Using a type 2 report as audit evidence that controls at the service organisation are
operating effectively
12.4.12 A type 2 report may be intended to satisfy the needs of several different user auditors;
therefore tests of controls and results described in the service auditor’s report may not be
relevant to assertions that are significant in the user entity’s financial statements. The relevant
tests of controls and results are evaluated to determine that the service auditor’s report
provides sufficient appropriate audit evidence about the effectiveness of the controls to support
the user auditor’s risk assessment. If, in accordance with the paragraph above, the user auditor
plans to use a type 2 report as audit evidence that controls at the service organisation are
operating effectively, the user auditor shall determine whether the service auditor’s report
provides sufficient appropriate audit evidence about the effectiveness of the controls to support
the user auditor’s risk assessment by:
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Evaluating whether the description, design and operating effectiveness of controls at the
service organisation is at a date or for a period that is appropriate for the user auditor’s
purposes;
Determining whether complementary user entity controls identified by the service
organisation are relevant to the user entity and, if so, obtaining an understanding of
whether the user entity has designed and implemented such controls, and if so, testing
their operating effectiveness;
Evaluating the adequacy of the time period covered by the tests of controls and the time
elapsed since the performance of the tests of controls;
Evaluating whether the tests of controls performed by the service auditor and the results
thereof, as described in the service auditor’s report, are relevant to the assertions in the
user entity’s financial statements and provide sufficient appropriate evidence to support the
user auditor’s risk assessment;
The time period covered by the tests of controls and the time elapsed since the
performance of the tests of controls;
The scope of the service auditor’s work and the services and processes covered, the
controls tested and tests that were performed, and the way in which tested controls relate
to the user entity’s controls; and
The results of the tests of controls and the service auditor’s opinion on the operating
effectiveness of the controls.
12.4.13 For certain assertions, the shorter the period covered by a specific test and the longer
the time elapsed since the performance of the test, the less audit evidence the test may
provide.
12.4.14 In comparing the period covered by the type 2 report to the user entity’s financial
reporting period, the user auditor may conclude that the type 2 report offers less audit
evidence if there is little overlap between the period covered by the type 2 report and the
period for which the user auditor intends to rely on the report. When this is the case, a type 2
report covering a preceding or subsequent period may provide additional audit evidence. In
other cases, the user auditor may determine it is necessary to perform, or use another auditor
to perform, tests of controls at the service organization in order to obtain sufficient appropriate
audit evidence about the operating effectiveness of those controls.
12.4.15 It may be necessary for the auditor to obtain additional evidence about significant
changes to the relevant controls at the service organisation outside of the period covered by
the type 2 report or determine additional audit procedures to be performed. Relevant factors in
determining what additional evidence outside of the period covered by service auditor’s report
may include:
The significance of the risks of material misstatement at the assertion level;
The specific controls that were tested during the interim period; and significant changes to
them since they were tested, including changes in the information system, processes and
personnel;
The degree to which audit evidence about the operating effectiveness of those controls was
obtained.
The length of the remaining period;
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The extent to which the user auditor intends to reduce further substantive procedures
based on the reliance on controls; and
The effectiveness of the control environment and monitoring of controls at the user entity.
12.4.16 Additional audit evidence may be obtained, for example, by extending tests of controls
over the remaining period or testing the user entity’s monitoring of controls. If the service
auditor’s report is completely outside the user entity’s reporting period, the user auditor will be
unable to rely on such tests for the user auditor to conclude that the user entity’s controls are
operating effectively, because they do not provide current evidence of the effectiveness of the
controls, unless other procedures are performed.
Complementary user entity controls
12.4.17 In certain circumstances, a service provided by the service organisation may be
designed with the assumption that certain controls will be implemented by the user entity. For
example, the service may be designed with the assumption that the user entity will have
controls in place for authorising the transactions before they are sent to the service
organisation for processing. In such a situation, the service organisation’s description of
controls may include a description of those complementary user entity controls. The user
auditor considers whether those complementary user entity controls are relevant to the service
provided to the user entity.
12.4.18 If the auditor believes that the service auditor’s report may not provide sufficient
appropriate audit evidence, for example, if the service auditor’s report does not contain a
description of the service auditor’s tests of controls and results thereon, the user auditor may
supplement the understanding of the service auditor’s procedures and conclusions by
contacting the service organisation, through the user entity, to request a discussion with the
service auditor about the scope and results of the service auditor’s work. Also, if the user
auditor believes it is necessary, the user auditor may contact the service organisation, through
the user entity, to request the service auditor perform procedures at the service organisation.
Alternatively, the user auditor, or another auditor, at the request of the user auditor, may
perform such procedures.
12.4.19 The service auditor’s type 2 report identifies results of tests, including exceptions, and
other information that could affect the user auditor’s conclusions. Exceptions noted by the
service auditor or a modified opinion in the service auditor’s type 2 report do not automatically
mean that the service auditor’s report will not be useful for the audit of the user entity’s
financial statements in assessing the risks of material misstatement.
12.4.20 Rather, the exceptions and the matter giving rise to a modified opinion in the service
auditor’s type 2 report are considered in the user auditor’s assessment of the testing of
controls performed by the service auditor. In considering the exceptions and matters giving rise
to a modified opinion, the user auditor may discuss such matters with the service auditor. Such
communication is dependent upon the user entity contacting the service organisation and
obtaining the service organisation’s approval for the communication to take place.
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12.5. Type 1 and type 2 reports that exclude the services of a subservice organisation
12.5.1 If the user auditor plans to use a type 1 or type 2 report that excludes the services
provided by a subservice organisation and those services are relevant to the audit of the user
entity’s financial statements, the user auditor shall apply the requirements of ISA 402 with
respect to the services provided by the subservice organisation.
12.5.2 The nature and extent of work to be performed by the user auditor regarding the
services provided by a subservice organisation depend on the nature and significance of those
services to the user entity and the relevance of those services to the audit.
12.5.3 If a service organization uses a subservice organization, the service auditor’s report
may either include or exclude the subservice organization’s relevant control objectives and
related controls in the service organization’s description of its system and in the scope of the
service auditor’s engagement. These two methods of reporting are known as the inclusive
method and the carve-out method, respectively. If the type 1 or type 2 report excludes the
controls at a subservice organization, and the services provided by the subservice organization
are relevant to the audit of the user entity’s financial statements, the user auditor is required to
apply the requirements of ISA 402 in respect of the subservice organization. The nature and
extent of work to be performed by the user auditor regarding the services provided by a
subservice organization depend on the nature and significance of those services to the user
entity and the relevance of those services to the audit.
12.6. Fraud, non-compliance with laws and regulations and uncorrected misstatements
in relation to activities at the service organisation
12.6.1 The user auditor shall inquire of management of the user entity whether the service
organisation has reported to the user entity, or whether the user entity is otherwise aware of
any fraud, non-compliance with laws and regulations or uncorrected misstatements affecting
the financial statements of the user entity.
12.6.2 The user auditor shall evaluate how such matters affect the nature, timing and extent of
the user auditor’s further audit procedures, including the effect on the user auditor’s
conclusions and user auditor’s report. In certain circumstances, the user auditor may require
additional information to perform the evaluation, and may request the user entity to contact the
service organisation to obtain the necessary information.
12.6.3 A service organisation may be required under the terms of the contract with user
entities to disclose to affected user entities any fraud, non-compliance with laws and
regulations or uncorrected misstatements attributable to the service organisation’s
management or employees.
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12.7. Communication of deficiencies in internal control identified during the audit.
12.7.1 The user auditor is required to communicate in writing significant deficiencies in internal
control identified during the audit to both management and those charged with governance on
a timely basis. The user auditor is also required to communicate to management at an
appropriate level of management on a timely basis other deficiencies in internal control
identified during the audit that, in the user auditor’s professional judgment, are of sufficient
importance to merit management’s attention. Matters that the user auditor may identify during
the audit and may communicate to management and those charged with governance of the
user entity include:
Any monitoring of controls that could be implemented by the user entity, including those
identified as a result of obtaining a type 1 or type 2 report;
Instances where complementary user entity controls are noted in the type 1 or type 2
report and are not implemented at the user entity; and
Controls that may be needed at the service organisation that do not appear to have been
implemented or that are not specifically covered by a type 2 report.
12.8. Reporting by the user auditor
12.8.1 The user auditor shall modify the opinion in the user auditor’s report in accordance with
ISA 705 if the user auditor is unable to obtain sufficient appropriate audit evidence regarding
the services provided by the service organisation relevant to the user entity’s financial
statements.
12.8.2 The user auditor shall not refer to the work of a service auditor in the user auditor’s
report containing an unqualified opinion unless required by law or regulation to do so. If such
reference is required by law or regulation, the user auditor’s report shall indicate that the
reference does not diminish the user auditor’s responsibility for the audit opinion. The user
auditor may need the consent of the service auditor before making this reference.
12.8.3 If reference to the work of a service auditor is relevant to an understanding of a
modification to the user auditor’s opinion, the user auditor’s report shall indicate that such
reference does not diminish the user auditor’s responsibility for that opinion.
Limitation of scope
12.8.4 When the user auditor is unable to obtain sufficient appropriate audit evidence
regarding the services provided by the service organisation relevant to the audit of the user
entity’s financial statements, a limitation of scope of the audit exists. This may be the case
when:
The user auditor is unable to obtain a sufficient understanding of the services provided by
the service organisation and does not have a basis for the identification and assessment of
the risks of material misstatement;
A user auditor’s risk assessment includes an expectation that controls at the service
organisation are operating effectively and the user auditor is unable to obtain sufficient
appropriate audit evidence about the operating effectiveness of those controls; or
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Sufficient appropriate audit evidence is only available from records held at the service
organisation, and the user auditor is unable to obtain direct access to these records.
12.8.5 Whether the user auditor expresses a qualified opinion or disclaims an opinion depends
on the user auditor’s conclusion as to whether the possible effects on the financial statements
are material or pervasive.
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13. AUDIT EVIDENCE (INCORPORATING ISA 500, 501 and 505)
13.1. Definition and objectives
13.1.1 ISA 500 defines Audit Evidence as “Information used by the auditor in arriving at the
conclusions on which the auditor’s opinion is based. Audit evidence includes both information
contained in the accounting records underlying the financial statements and other information”.
13.1.2 The objective of an auditor is to design and perform audit procedures in such a way as
to enable the auditor to obtain sufficient appropriate audit evidence to be able to draw
reasonable conclusions on which to base the auditor’s opinion.
13.1.3 The engagement team is not expected to address all information that may exist as they
may use sampling approaches and other means of selecting items for testing. The team may
find it necessary to rely on evidence that is persuasive rather than conclusive.
13.1.4 Audit evidence should be evaluated by its characteristics which include:
Sufficiency.
Appropriateness.
13.2. Sufficient and appropriate evidence
13.2.1 Sufficiency is the measure of the quantity of audit evidence needed to form the audit
opinion. The judgement on what is sufficient will be influenced by:
The risk of material misstatement (the greater the risk, the more evidence is likely to be
required).
The quality i.e relevance and reliability of the evidence available.
13.2.2 Appropriateness is the measure of the quality of audit evidence. When designing and
performing audit procedures, the auditor shall consider the relevance and reliability of the
information to be used as audit evidence.
13.2.3 Relevance - The relevance of audit evidence has to be considered in relation to the
objective of forming an opinion and reporting on the financial statements.
Tests of controls
13.2.4 When assessing the relevance of audit evidence relating to tests of controls to support
the assessed level of control risk, the engagement team should consider the following aspects:
Design
13.2.5 Whether the accounting and internal control system is capable of preventing or
detecting material misstatements.
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Operation
13.2.6 Whether the controls exist and have operated effectively throughout the relevant
accounting period.
Substantive procedures
13.2.7 When assessing the relevance of audit evidence obtained from substantive procedures,
the engagement team should assess certain assertions which are embodied in the financial
statements. Audit evidence, in relation to an item, is usually obtained regarding each financial
statement assertion e.g. evidence regarding one assertion (for example, existence of
inventory) will not compensate for the failure to obtain audit evidence regarding another
assertion (for example, valuation of inventory).
13.2.8 Reliability - The reliability of audit evidence is influenced by its source and by its nature
and is dependent on the individual circumstances under which it is obtained.
Independent external evidence (e.g. independent third party confirmations or from an
examination of external documents) is more reliable than internal evidence.
Internally generated information is more reliable when related controls imposed by the
entity are effective.
Documentary evidence is more reliable than oral evidence.
Evidence obtained directly by the firm (such as observation of the application of a control,
or physical inspection) is more reliable than audit evidence obtained indirectly or by
inference.
Internal evidence may be more reliable if it is obtained:
• From a reliable senior official;
• From an employee with no financial interest in the entity; or
• From a number of different personnel.
Original documents are more reliable than copies.
13.2.9 The engagement team would ordinarily obtain more assurance from consistent audit
evidence obtained from different sources or of a different nature than from items of audit
evidence considered individually.
13.2.10 The engagement team should therefore consider whether the conclusions from
different types of audit tests are consistent with one another. When different sources of audit
evidence appear to contradict each other, the reliability of each remains in doubt until further
work has been done to resolve the inconsistency. However, when the individual sources of
evidence relating to a particular matter are all consistent, then the cumulative degree of
assurance obtained is higher than that obtained from individual sources.
13.2.11 The engagement team may take into account the relationship between the cost of
obtaining evidence and the usefulness of the information obtained, but the cost and degree of
difficulty in obtaining evidence is not in itself a valid basis for omitting a necessary audit
procedure.
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Reliability of Information produced by a management’s expert
13.2.12 If the information to be used as audit evidence has been prepared using the work of a
management’s expert, the auditor shall, to the extent necessary, having regard to the
significance of that expert’s work for the auditor’s purposes:
Evaluate the competence, capabilities and objectivity of that expert;
Obtain an understanding of the work of that expert: and
Evaluate the appropriateness of that expert’s work as audit evidence for the relevant
assertion.
13.2.13 When using information produced by the entity, the auditor shall evaluate whether the
information is sufficiently reliable for the auditor’s purposes, including as necessary in the
circumstances:
Obtaining audit evidence about the accuracy and completeness of the information; and
Evaluating whether the information is sufficiently precise and detailed for the auditor’s
purposes.
13.3. Inconsistency or doubt
13.3.1 If audit evidence obtained from one source is inconsistent with that obtained from
another or the auditor has doubts over the reliability of information to be used as audit
evidence, the auditor shall determine what modifications or additions to audit procedures are
necessary to resolve the matter, and shall consider the effect of the matter, if any, on other
aspects of the audit.
13.4. Use of assertions in obtaining audit evidence
13.4.1 The auditor should use assertions for classes of transactions, account balances, and
presentation and disclosures in sufficient detail to form a basis for the assessment of risks of
material misstatement and the design and performance of further audit procedures”.
13.4.2 Assertions used by the auditor to consider the different types of potential misstatements
that may occur fall into the following three categories and may take the following forms:
Assertions about classes of transactions and events
Occurrence (O) - a transaction or event took place which pertains to the entity during the
relevant period.
Completeness (C) - there are no unrecorded assets, liabilities, transactions or events or
undisclosed items.
Accuracy (A) - amounts and other data relating to recorded transactions and events have
been recorded appropriately.
Cut-off (CO) - transactions and events have been recorded in the correct accounting
period.
Classification (CL) - transactions and events have been recorded in the proper accounts.
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a. Assertions about account balances:
Existence (E) - assets or liabilities and equity interests exist at a given date.
Rights and obligations (RO) - the entity holds or controls the rights to assets, and liabilities
are obligations of the entity.
Completeness (C) - all assets, liabilities and equity interests that should have been
recorded have been recorded.
Valuation and allocation (VA) - assets, liabilities and equity interests are recorded in the
financial statements at appropriate amounts and any resulting valuation allocation
adjustments are appropriately recorded.
b. Assertions about presentation and disclosure:
Occurrence and rights and obligations (ORO) - disclosed events, transactions and other
matters have occurred and pertain to the entity.
Completeness (C) - all disclosures that should have been included in the financial
statements have been included.
Classification and understandability (CU) - financial information is appropriately
presented and described, and disclosures are clearly expressed.
Accuracy and valuation (AV) - financial and other information is disclosed fairly and at
appropriate amounts.
13.4.3 Assertions are used in assessing risks by considering the different types of potential
misstatements that may occur, and designing audit procedures that are responsive to the
assessed risks.
13.4.4 The auditor may use the assertions as described above or may express them differently
provided all aspects described above have been covered. The guide to using International
Standards on Auditing in the Audits of Small and Medium Sized entities issued by IFAC has
combined some of the assertions outlined in ISA 315 as follows:
C = Completeness;
E = Existence, which includes occurrence;
A = Accuracy, which includes cut-off, classification and rights and obligations; and
V = Valuation.
13.5. Audit techniques
13.5.1 Inspection of records or documents - This consists of examining records or documents.
Inspection of records and documents provides audit evidence of varying degrees of reliability,
depending on their nature and source and, in the case of internal records and documents, on
the effectiveness of the controls over their production. Examples of where this audit technique
can apply are when verifying expenditure, inspection of documents for evidence of
authorisation, or in verification of documents of ownership such as title deeds for land,
logbooks for motor vehicles etc. Inspection of such documents may not necessarily provide
evidence about ownership or valuation. In addition, inspection of an executed contract may
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provide audit evidence relevant to the entity’s application of accounting policies such as
revenue recognition.
13.5.2 Inspection of inspection of tangible assets - This consists of physical inspection of
assets which may provide reliable audit evidence with respect to their existence, but not
necessarily about the entity’s rights and obligations or valuation of assets. Inspection is usually
done when observing inventory counting.
13.5.3 Observation - Consists of examining a process or procedure being done by others, for
example, observation of the counting of inventories and observation of the performance of
control activities. Although observation provides audit evidence about the performance of a
process or procedure, it is limited to the point in time at which it takes place and by the fact that
the act of being observed may affect how the process or procedure is performed.
13.5.4 External confirmation - This is a specific type of enquiry, and is the process of obtaining
a representation of information or of an existing condition directly from a third party. For
example, confirmation of receivables by communication with debtors. Confirmations are
frequently used in relation to account balances and their components, but need not be
restricted to these items. For example, the auditor may request confirmation of the terms of
agreements or transactions an entity has with third parties; the confirmation request may be
designed to ask if any modifications have been made to the agreement and if so, what the
relevant details are. External confirmations also are used to obtain audit evidence about the
absence of certain conditions, for example, the absence of a “side agreement” that may
influence revenue recognition. See Section 13.8 on “External Confirmations” below for further
guidance on confirmations.
13.5.5 Recalculation - Consists of checking the mathematical accuracy of documents or
records and can be performed through the use of information technology, for example, through
the use of CAATs to check accuracy or summarisation of an entity’s electronic files.
13.5.6 Reperformance - This is the auditor’s independent execution of procedures or controls
that were originally performed as part of the entity’s internal control, for example, reperforming
the bank reconciliations, or using CAAT’s for re-performing the ageing of accounts receivable.
13.5.7 Analytical procedures - Consist of evaluations of financial information made by a study
of plausible relationships among both financial and non-financial data. Analytical procedures
also include the investigation of identified fluctuations and relationships that are inconsistent
with other relevant information or deviate significantly from predicted amounts.
13.5.8 Enquiry - This consists of seeking information of knowledgeable persons, both financial
and non-financial, within the entity or outside the entity. Enquiry is an audit procedure that is
used extensively throughout the audit and often is complementary to performing other audit
procedures. Enquiry alone ordinarily does not provide sufficient audit evidence to detect a
material misstatement at the assertion level. Moreover, enquiry alone is not sufficient to test
the operating effectiveness of controls. Enquiries may range from formal written enquiries to
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informal oral enquiries. Evaluating responses to enquiries is an integral part of the enquiry
process.
13.5.9 Responses to enquiries may provide the auditor with information not previously
possessed or with corroborative audit evidence. Alternatively, responses might provide
information that differs significantly from other information that the auditor has obtained, for
example, information regarding the possibility of management override of controls. In some
cases, responses to enquiries provide a basis for the auditor to modify or perform additional
audit procedures.
13.5.10 Although corroboration of evidence obtained through enquiry is often of particular
importance, in the case of enquiries about management intent, the information available to
support management’s intent may be limited. In these cases, understanding management’s
past history of carrying out its stated intentions with respect to assets or liabilities,
management’s stated reasons for choosing a particular course of action, and management’s
ability to pursue a specific course of action may provide relevant information about
management’s intent.
13.5.11 In respect of some matters, the auditor may obtain written representations from
management and where appropriate those charged with governance to confirm responses to
oral enquiries. For example, the auditor ordinarily obtains written representations from
management on material matters when other sufficient appropriate audit evidence cannot
reasonably be expected to exist (see Chapter 22 of this Manual on “Management
Representations”).
13.6. Designing audit procedures for obtaining evidence
13.6.1 Audit evidence is used by the auditor to draw reasonable conclusions on which to base
the audit opinion. The following are the audit procedures that can be used to obtain audit
evidence:
Risk assessment procedures - These are used to obtain an understanding of the entity and
its environment including its internal control, to assess the risks of material misstatement at
the financial statement and assertion levels.
Tests of controls - Test the operating effectiveness of controls in preventing, or detecting
and correcting material misstatements at the assertion level.
Substantive procedures - Detect material misstatements at the assertion level and include
tests of details of classes of transactions, account balances and disclosures, and
substantive analytical procedures.
13.6.2 The engagement team uses a combination of the above audit procedures to obtain
audit evidence.
13.6.3 Risk assessment procedures are performed to provide a satisfactory basis for the
assessment of risks at the financial statement and assertion levels. However, as risk
assessment procedures by themselves do not provide sufficient appropriate audit evidence on
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which to base the audit opinion, they need to be supplemented by further audit procedures in
the form of tests of controls and/or substantive procedures.
13.6.4 Tests of controls are necessary when the engagement team’s risk assessment includes
an expectation of the operating effectiveness of controls, or when substantive procedures
alone do not provide sufficient appropriate audit evidence.
13.6.5 Substantive procedures are performed by the engagement team in response to the
related assessment of risks of material misstatement, which may include the results of tests of
controls. However, as the auditor’s risk assessment is judgmental, it may not identify all risks
of material misstatement. In addition, there are inherent limitations to internal control such as
the risk of management override, the possibility of human error and the effect of systems
changes. Therefore, substantive procedures for material classes of transactions, account
balances, and disclosures are always required to obtain sufficient appropriate audit evidence.
13.6.6 When designing tests of controls and tests of details, the auditor shall determine means
of selecting items for testing that are effective in meeting the purpose of the audit procedure.
13.7. Procedures regarding attendance at physical inventory counting
13.7.1 If inventory is material to the financial statements, the engagement team should obtain
sufficient appropriate audit evidence regarding its existence and condition, by attendance at
the physical inventory counting, unless impracticable to do so. The team’s attendance serves
as a test of control or substantive procedure over inventory depending on the engagement
team’s risk assessment and planned approach. Such attendance enables the engagement
team to:
Evaluate management’s instructions and procedures for recording and controlling the
results of the entity’s physical inventory counting;
Observe the performance of management’s count procedures;
Inspect the inventory;
Perform test counts: and
Perform audit procedures over the entity’s final inventory records to determine whether they
accurately reflect actual inventory count results.
13.7.2 If physical inventory counting is conducted at a date other than the date of the financial
statements, the auditor shall, in addition to the procedures required in the preceding
paragraph, perform audit procedures to obtain audit evidence about whether changes in
inventory between the count date and the date of the financial statements are properly
recorded.
13.7.3 In planning to attend, the engagement team will need to consider the systems of
controlling inventory, the risks involved, the adequacy of the counting instructions (including
arrangements relating to the control of count sheets, work-in-progress and obsolete items and
the movement of inventory), timing and the locations of inventory and whether an expert is
needed.
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13.7.4 The engagement team should take test counts or assess the reasonableness of
procedures for estimating quantities not subject to counts (such as fluids). If weighing
machines are being used, the calibration of such machines should be considered. The
engagement team would also need assurances as to adequate cut-off procedures including
details of the movement of inventory just prior to, during, and after the count so that the
accounting for such movements can be checked at a later date.
13.7.5 When the entity operates a perpetual inventory system which is used to determine the
period-end balance, the engagement team would evaluate whether, through the performance
of additional procedures, the reasons for any significant differences between the physical
count and the perpetual inventory records are understood and the records are properly
adjusted.
13.7.6 The engagement team should perform audit procedures over the final inventory listing
to determine whether it accurately reflects actual inventory counts.
13.7.7 When inventory is situated in several locations, the engagement team will need to
determine which locations are appropriate to attend, considering the materiality and risk of
misstatement of inventory at different locations.
Inventory held by third parties
13.7.8 If inventory under the custody or control of a third party is material to the financial
statements, the auditor shall obtain sufficient appropriate audit evidence regarding the
existence and condition of that inventory by performing one or both of the following:
Request confirmation from the third party as to the quantities and condition of inventory
held on behalf of an entity, taking note of the requirements and guidance in ISA 505 which
deals with external confirmations.
Perform inspection or other audit procedures appropriate in the circumstances.
13.7.9 Where information is obtained that raises doubt about the integrity and objectivity of the
third party, the auditor may consider it appropriate to perform other audit procedures instead
of, or in addition to, confirmation with the third party. Examples of other audit procedures
include:
Attending, or arranging for another auditor to attend, the third party’s physical counting of
inventory, if practicable.
Obtaining another auditor’s report or a service auditor’s report, on the adequacy of the third
party’s internal control for ensuring that inventory is properly counted and adequately
safeguarded.
Inspecting documentation regarding inventory held by third parties, for example, warehouse
receipts, or obtaining confirmation from other parties when such inventory has been
pledged as collateral.
13.7.10 If the engagement team is unable to attend the physical inventory count due to
unforeseen circumstances, a physical count should be taken or observed on an alternative
date and procedures on intervening transactions, where necessary, should be performed.
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13.7.11 If it is impracticable for the engagement team to attend the physical inventory count,
consideration should be given to whether alternative procedures such as documentation of
subsequent sale of specific inventory items acquired prior to the period-end, provide sufficient
appropriate audit evidence regarding the existence and condition of inventory If it is not
possible to do so, the auditor shall modify his opinion in the auditor’s report in accordance with
ISA 705.
A sample format working paper is attached as form F.110 - Inventory count summary sheet in
part I of the manual. Also attached as form F.110 - Attendance at inventory count provides
guidance on detailed steps to be considered when attending an inventory count.
13.8. Procedures regarding external confirmations
13.8.1 The engagement team should determine whether the use of external confirmations is
necessary to obtain sufficient appropriate audit evidence to support certain financial statement
assertions. In making this determination, the engagement team should consider the assessed
risk of material misstatement at the assertion level and how the evidence from other planned
audit procedures will reduce this risk to an acceptably low level for the applicable financial
statement assertions.
13.8.2 External confirmation is the process of obtaining and evaluating audit evidence through
direct communication (in paper form, or by electronic or other medium) from a third party (the
confirming party) in response to a request for information about a particular item affecting
assertions made by management in the financial statements. In deciding to what extent to use
external confirmations, the engagement team considers the characteristics of the environment
in which the entity being audited operates and the practice of potential respondents in dealing
with requests for direct confirmation.
13.8.3 External confirmations are frequently used in relation to obtaining evidence regarding
account balances and their components, but may also be used as a request of external
confirmation of the terms of agreements or transactions an entity has with third parties. The
confirmation request may be designed to ask if any modifications have been made to the
agreement, and if so, what the relevant details are.
13.8.4 Examples of situations where external confirmations may be used include:
Bank balances and other information from bankers.
Accounts receivable balances.
Stocks held by third parties at bonded warehouses for processing or on consignment.
Property title deeds held by lawyers or financiers for safe custody or as security.
Investments purchased from stockbrokers but not delivered at the balance sheet date.
Loans and other borrowings.
Contingent liabilities including off-balance sheet items and legal cases.
Accounts payable balances.
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13.8.5 The auditor shall evaluate whether the results of the external confirmation procedures
provide relevant and reliable audit evidence, or whether further audit evidence is necessary.
Control over external confirmations
13.8.6 When performing confirmation procedures, the engagement team shall maintain control
over the process of selecting those to whom a request will be sent, the preparation and
sending of confirmation requests including follow up requests, and the responses to those
requests. The auditor shall determine the exact information to be confirmed or requested.
13.8.7 Control is maintained over communications between the intended recipients and the
engagement team to minimise the possibility that the results of the confirmation process will be
biased because of the interception and alteration of confirmation requests or responses. The
engagement team should ensure that it is them who send out the confirmation requests, that
the requests are properly addressed, and that it is requested that all replies are sent directly to
the auditor. The engagement team should consider whether replies have come from the
purported senders.
13.8.8 Determining that requests are properly addressed includes testing the validity of some
or all of the addresses on confirmation requests before they are sent out.
Management’s refusal to allow the auditor to send a confirmation request
13.8.9 If management refuses to allow an auditor to send a confirmation request the auditor
shall:
Enquire as to management’s reasons for the refusal, and seek audit evidence as to their
validity and reasonableness:
Evaluate the implication of management’s refusal on the auditor’s assessment of the
relevant risks of material misstatement, including the risk of fraud, and the nature, timing
and extent of other audit procedures; and
Perform alternative audit procedures designed to obtain relevant and reliable audit
evidence.
13.8.10 If the auditor concludes that the management’s refusal to allow the auditor to send a
confirmation request is unreasonable, or the auditor is unable to obtain relevant and reliable
evidence from alternative audit procedures, the auditor shall communicate with those charged
with governance in accordance with ISA 260. The auditor shall also determine the implications
for the audit and the auditor’s opinion in accordance with ISA 705.
13.9. Assertions addressed by external confirmations
13.9.1 ISA 315 requires the use of assertions in assessing risks and designing and performing
audit procedures in response to the assessed risks. ISA 500 categorises the assertions into
those relating to classes of transactions, account balances, and disclosures. While external
confirmations may provide audit evidence regarding these assertions, the ability of an external
confirmation to provide audit evidence relevant to a particular assertion varies.
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13.9.2 External confirmation of an account receivable may provide reliable and relevant audit
evidence regarding the existence of the account as at a certain date. Confirmation also
provides audit evidence regarding the operation of cut-off procedures. However, such
confirmation does not ordinarily provide all the necessary audit evidence relating to the
valuation assertion, since it is not practicable to ask the debtor to confirm detailed information
relating to its ability to pay the account.
13.9.3 Similarly, in the case of goods held on consignment, external confirmation is likely to
provide reliable and relevant audit evidence to support the existence and the rights and
obligations assertions, but might not provide audit evidence that supports the valuation
assertion.
13.9.4 The relevance of external confirmations to auditing a particular assertion is also affected
by the objective of the engagement team in selecting information for confirmation. For
example, when auditing the completeness assertion for accounts payable, the engagement
team would need to obtain audit evidence that there is no material unrecorded liability.
Accordingly, sending confirmation requests to an entity’s principal suppliers asking them to
provide copies of their statements of account, or details of amounts owed to the supplier
directly to the firm, even if the records show no amount currently owing to them, will usually be
more effective in detecting unrecorded liabilities than selecting accounts for confirmation based
on the larger amounts recorded in the accounts payable subsidiary ledger. Selecting accounts
for confirmation from the larger accounts recorded in the accounts payable subsidiary ledger is
a weaker test for the Completeness assertions.
13.9.5 The auditor shall evaluate whether the results of the external confirmation procedures
provide relevant and reliable audit evidence, or whether further audit evidence is necessary.
Design of the external confirmation request
13.9.6 The engagement team should tailor external confirmation requests to the specific audit
objective. When designing the request, the engagement team considers the assertions being
addressed and the factors that are likely to affect the reliability of the confirmations. Factors
such as the form of the external confirmation request, prior experience on the audit or similar
engagements, the nature of the information being confirmed, and the intended respondent,
affect the design of the requests because these factors have a direct effect on the reliability of
the audit evidence obtained through external confirmation procedures.
13.9.7 Confirmation requests ordinarily include management’s authorisation to the respondent
to disclose the information to the engagement team. Respondents may be more willing to
respond to a confirmation request containing management’s authorisation, and in some cases
may be unable to respond unless the request contains management’s authorisation. In some
cases a better result may be obtained by having the confirmation request prepared on client
letterhead under the client’s signature.
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Positive and negative confirmations
13.9.8 The engagement team may use positive or negative external confirmation requests or a
combination of both. A positive external confirmation request asks the respondent to reply to
the auditor in all cases, whether in agreement with the information or not. There is a risk,
however, that a respondent may reply to the confirmation request without verifying that the
information is correct. The engagement team may reduce this risk by using positive
confirmation requests that do not state the amount (or other information) on the confirmation
request, but ask the respondent to fill in the amount or furnish other information. On the other
hand, use of this type of “blank” confirmation request may result in lower response rates
because additional effort is required of the respondents.
13.9.9 A negative external confirmation request asks the respondent to reply only in the event
of disagreement with the information provided in the request. However, when no response is
received, the engagement team will have no way of ascertaining whether the intended third
parties have received the confirmation requests. Accordingly, the use of negative confirmation
requests ordinarily provides less persuasive audit evidence than the use of positive
confirmation requests. Accordingly the auditor shall not use negative confirmation requests as
the sole substantive audit procedure to address an assessed risk of material misstatement at
the assertion level unless all of the following are present:
The auditor has assessed the risk of material misstatement as low and has obtained
sufficient appropriate audit evidence regarding the operating effectiveness of controls
relevant to the assertion;
The population of items subject to negative confirmation procedures comprises a large
number of small, homogenous, account balances, transactions or conditions;
A very low exception rate is expected.
The auditor is not aware of circumstances or conditions that would cause recipients of
negative confirmation requests to disregard such requests.
A combination of positive and negative external confirmations may be used. For example,
where the total accounts receivable balance comprises a small number of large balances
and a large number of small balances, the auditor may decide that it is appropriate to
confirm all or a sample of the large balances with positive confirmation requests and a
sample of the small balances using negative confirmation requests.
A sample format working paper is attached as form H.101 - Receivables control sheet in part I
of the manual.
13.9.10 An oral response to an external confirmation does not meet the definition of an
“external confirmation” in ISA 505. However, it does provide audit evidence though not as
persuasive as a written confirmation.
No response
13.9.11 The engagement team should perform alternative procedures where no response is
received to a positive external confirmation request. The alternative audit procedures should
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be such as to provide the evidence about the financial statement assertions that the
confirmation request was intended to provide.
Reliability
13.9.12 If the auditor identifies factors that give rise to doubts about the reliability of the
response to a confirmation request, the auditor shall obtain further audit evidence to resolve
those doubts and evaluate the implications on the assessment of the relevant risks of material
misstatement, including the risk of fraud, and on the related nature, timing and extent of other
audit procedures.
Results
13.9.13 When the engagement team forms a conclusion that the confirmation process and
alternative procedures have not provided sufficient appropriate audit evidence regarding an
assertion, they should undertake additional procedures to obtain sufficient appropriate audit
evidence.
13.9.14 If the auditor has determined that a response to a positive confirmation request is
necessary to obtain sufficient appropriate audit evidence, alternative audit procedures will not
provide the audit evidence that the auditor requires. If the auditor does not receive the
confirmation required in these circumstances, the auditor shall determine the implications for
the audit and the auditor’s opinion in accordance with ISA 705.
13.9.15 The engagement team should evaluate whether the results of the external
confirmation process together with the results from any other procedures performed, provide
sufficient appropriate audit evidence regarding the financial statement assertion being audited.
In conducting this evaluation, the engagement team should consider the guidance provided in
chapter 16 of the Manual on Sampling. The auditor shall investigate exceptions to determine
whether or not they are indicative of misstatements.
13.10. Procedures regarding litigation and claims
13.10.1 The engagement team shall carry out procedures to identify any litigation and claims
involving the entity which may give rise to a risk of material misstatement.
13.10.2 These procedures shall include:
Enquiry of management, and where applicable, others within the entity, including in-house
legal counsel.
Review minutes of meetings of those charged with governance and correspondence
between the entity and its external legal counsel; and
Reviewing legal expense accounts.
13.10.3 When the engagement team assesses a risk of material misstatement regarding
litigation or claims that have been identified or when the team believes they may exist, they
shall , in addition to the procedures required by other ISAs seek direct communication with the
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entity’s external legal counsel. This will assist in obtaining sufficient appropriate audit evidence
as to whether potentially material litigation and claims are known and management’s estimates
of the financial implications, including costs, are reliable. When the engagement team
determines that the risk of material misstatement is a significant risk, they should evaluate the
design of the entity’s related controls and determine whether they have been implemented.
13.10.4 The letter, which should be prepared by management and sent by the engagement
team, should request the entity’s legal counsel to communicate directly with the auditor. If law,
regulation or the respective legal body prohibits the entity’s external legal counsel from
communicating directly with the auditor, the auditor shall perform alternative audit procedures.
When it is considered unlikely that the entity’s legal counsel will respond to a general enquiry,
the letter would ordinarily specify the following:
A list of litigation and claims.
Management’s assessment of the outcome of the litigation or claim and its estimate of the
financial implications, including costs involved.
A request that the entity’s legal counsel confirm the reasonableness of management’s
assessments and provide the auditor with further information if the list is considered by the
entity’s legal counsel to be incomplete or incorrect.
13.10.5 The engagement team should consider the status of legal matters up to the date of the
audit report. In some instances, the team may need to obtain updated information from the
entity’s external legal counsel.
13.10.6 In certain circumstances, the auditor may also judge it necessary to meet with the
entity’s external legal counsel to discuss the likely outcome of litigation or claims. This may be
the case, for example, where :
The auditor determines that there is a significant risk.
The matter is complex
There is a disagreement between management and the entity’s external; legal counsel.
Ordinarily, such meetings require management’s permission and are held with a representative
of management in attendance.
13.10.7 If management refuse to give the engagement team permission to communicate with
the entity’s legal counsel, this would be a scope limitation and should ordinarily lead to a
modified opinion. Where the entity’s legal counsel refuses to respond in an appropriate manner
and the engagement team is unable to obtain sufficient appropriate audit evidence by applying
alternative audit procedures, the team should consider whether there is a scope limitation
which may lead to a modified opinion.
13.10.8 The auditor shall request management and where appropriate, those charged with
governance, to provide written representations that all known actual or possible litigation and
claims whose effect should be considered when preparing the financial statements have been
disclosed to the auditor and accounted for and disclosed in accordance with the applicable
financial reporting framework.
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13.11. Procedures regarding segment information
13.11.1 The auditor shall obtain sufficient appropriate audit evidence regarding the
presentation and disclosure of segment information in accordance with the financial reporting
framework by:
Obtaining an understanding of the methods used by management in determining segment
information, and evaluating whether such methods are likely to result in proper disclosure
and where appropriate testing the application of such methods.
Performing analytical procedures or other audit procedures appropriate in the
circumstances.
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14. INITIAL AUDIT ENGAGEMENTS – OPENING BALANCES (INCORPORATING ISA 510)
14.1. Objectives
14.1.1 In conducting an initial audit engagement, the objective of the auditor with respect to
opening balances is to obtain sufficient appropriate audit evidence about whether:
Opening balances contain misstatements that materially affect the current period’s financial
statements; and
Appropriate accounting policies reflected in the opening balances have been consistently
applied in the current period’s financial statements, or changes thereto are appropriately
accounted for and adequately presented and disclosed in accordance with the applicable
financial reporting framework.
14.2. Definitions
14.2.1 Initial Audit Engagement – An engagement in which either:
• The financial statements for the prior period were not audited; or
• The financial statements for the prior period were audited by a predecessor auditor.
14.2.2 Opening Balances – those account balances that exist at the beginning of the period.
Opening Balances are based upon the closing balances of the prior periods and reflect the
effects of the transactions and events of prior periods and accounting policies applied in the
prior period. Opening balances also include matters requiring disclosure that existed at the
beginning of the period, such as contingencies and commitments.
14.2.3 Predecessor Auditor – the auditor from a different audit firm, who audited the financial
statements of an entity in the prior period and who has been replaced by the current auditor.
14.3. Procedures
14.3.1 The auditor shall read the most recent financial statements, if any, and the predecessor
auditor’s report thereon, if any, for information relevant to opening balances, including
disclosures.
14.3.2 The auditor shall obtain sufficient appropriate audit evidence about whether the opening
balances contain misstatements that materially affect the current period’s financial statements
by:
Determining whether the prior period’s closing balances have been correctly brought
forward to the current period, or when appropriate, have been restated;
Determining whether the opening balances reflect the application of the appropriate
accounting policies; and
Performing one or more of the following:
• Where the prior period financial statements were audited, reviewing the predecessor
auditor’s working papers to obtain evidence regarding the opening balances;
• Evaluating whether audit procedures performed in the current period provide
evidence relevant to the opening balances; or
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• Performing specific audit procedures to obtain evidence regarding the opening
balances.
14.3.3 The nature and extent of audit procedures necessary to obtain sufficient appropriate
audit evidence regarding opening balances depend on such matters as:
The accounting policies followed by the entity.
The nature of the account balances, classes of transactions and disclosures and the risks
of material misstatement in the current period’s financial statements.
The significance of the opening balances relative to the current period’s financial
statements.
Whether the prior period’s financial statements were audited and, if so, whether the
predecessor auditor’s opinion was modified.
14.3.4 If the prior period’s financial statements were audited by a predecessor auditor, the
auditor may be able to obtain sufficient appropriate audit evidence regarding the opening
balances by reviewing the predecessor auditor’s working papers. Whether such a review
provides sufficient appropriate audit evidence is influenced by the professional competence
and independence of the predecessor auditor.
14.3.5 Relevant ethical and professional requirements guide the current auditor’s
communications with the predecessor auditor.
14.3.6 A request for relevant information should be made in writing.
14.3.7 An example of a proforma request from the successor is attached at Appendix I. An
example of a proforma letter from the predecessor (which should be copied to the client)
setting out the basis on which the information is to be provided is attached at Appendix II.
These proformas do not contemplate countersignature; where a predecessor and a successor
proceed in accordance with the basis described in them, their effectiveness is not dependent
on countersignature.
14.3.8 The requesting and granting of access to relevant information can carry risk. In
managing the associated risks a risk management strategy would include:
(in the case of the predecessor) limiting the circumstances in which a duty of care to the
successor or the client may be said to arise;
(in the case of the successor) limiting the circumstances in which a duty of care other than
any accepted in its audit report may be said to arise;
(in the case of the predecessor and the successor) excluding any duty that might otherwise
be said to arise;
(in the case of the predecessor and the successor) limiting the circumstances in which a
duty of care (if any) may be said to be breached.
The risk management procedures adopted will generally include:
the exchange of letters referred to above;
compliance with available guidance on audit reporting;
the approach to information or explanations referred to below; and
focusing on information that is relevant.
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14.3.9 Mindful of the cost and resource involved in a successor looking at information provided
(as well as in a predecessor providing that information), whilst a successor will look to make a
necessary request for information it will also guard against making an unnecessary request for
information. Of course in some cases a request will be unnecessary because the information
requested is irrelevant rather than relevant information: in such a case the predecessor may
challenge the successor’s entitlement to make the request.
Information or explanations additional to the working papers
14.3.10 The predecessor can provide explanations orally or in writing and can request that any
questions be put in writing by the successor, whilst recognising the need for as smooth a
process as possible. Questions should be directed to clarification or
explanation about the audit working papers that have been accessed.
In providing explanations in relation to the audit working papers in response to a request by the
successor, the predecessor should keep in mind:
that its obligation does not extend beyond relevant information;
that explanations should be given a factual or evidential reference point; and
the desirability of an internal written note or record of the request made and
explanation given.
The predecessor may re-emphasise at the beginning of any such discussion with the
successor that any statements made by the predecessor are made in accordance with the
terms of the letter (Appendix II).
Legal professional privilege
14.3.11 Relevant information” may be subject to legal professional privilege. Whether or not
legally privileged information is disclosed to the successor will depend on the circumstances in
which legal privilege arises in respect of that information.
Information may have legally privileged status because the client has asserted, when providing
the information originally to the predecessor, that such “client information” was legally
privileged and that the privilege was not being waived on disclosure to the predecessor. An
example might include legal advice concerning the merits of litigation against the client by a
third party. In any such case, or where the predecessor is uncertain about the legally privileged
status of client information, the predecessor will make enquiries of the client to ascertain
whether it objects to disclosure of that information to the successor, or whether the client
wishes to impose any terms regulating disclosure to the successor.
If the client does not authorise the disclosure to the successor of client information held by the
predecessor on the basis that it is legally privileged, the predecessor considers informing the
successor that certain information is being withheld (without disclosing any details regarding
that information) because the client asserts legal privilege. The matter should then be
addressed between the client and the successor. If the client does not object to client
privileged information being disclosed to the successor, the predecessor should disclose it.
Information may also be relevant but subject to legal professional privilege because legal
privilege is asserted by the predecessor. This may arise where information has been
generated by the predecessor who has, for example, sought legal advice on matters relating to
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the client and the audit. Whether or not such information needs to be disclosed to the
successor will be dependent on the legal position applicable to the particular circumstances
and the predecessor should consider obtaining legal advice on their disclosure obligations.
14.3.12 Both the requests for access and the granting of access need to be timely with a view
to minimising the costs/burden on the predecessor, the successor or the client. There needs to
be a clear understanding about which papers will be provided, by what method and when.
Format
14.3.13 In the case of access to audit working papers, it will be for the predecessor to
determine the format in which they are willing to provide access. This may either be in hard
copy or in electronic form. However, it will wish to do so in a manner that does not put at risk
the confidentiality of its firm’s audit methodologies or of the confidential information of other
clients.
14.3.14 It is reasonable for the successor to make notes of its review in support of its own
documentation requirements.
14.3.15 The predecessor is under no obligation to allow copying of its audit working papers,
but it would be reasonable to allow, as a minimum, the copying of extracts of the books and
records of the client. It would also be reasonable and indeed helpful to allow copying of papers
such as:
breakdown of analyses of financial statement figures; and
documentation of the client’s systems and processes.
Data protection
14.3.16 Data protection laws apply to the personal data of individuals. Relevant information
may contain personal data (for example about employees or about sole traders with whom the
client does business). However, the predecessor may be obliged to provide access to relevant
information by legislation. Care should be taken that Data Protection law (where applicable) is
complied with.
Assets and liabilities
14.3.17 For current assets and liabilities, some audit evidence about opening balances may be
obtained as part of the current period’s audit procedures. For example, the collection
(payment) of opening accounts receivable (accounts payable) during the current period will
provide some audit evidence of their existence, rights and obligations, completeness and
valuation at the beginning of the period. In the case of inventories, however, the current
period’s audit procedures on the closing inventory balance provide little audit evidence
regarding inventory on hand at the beginning of the period. Therefore, additional audit
procedures may be necessary, and one or more of the following may provide sufficient
appropriate audit evidence:
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Observing a current physical inventory count and reconciling it to the opening inventory
quantities.
Performing audit procedures on the valuation of the opening inventory items.
Performing audit procedures on gross profit and cutoff.
14.3.18 For non-current assets and liabilities, such as property plant and equipment,
investments and long-term debt, some audit evidence may be obtained by examining the
accounting records and other information underlying the opening balances. In certain cases,
the auditor may be able to obtain some audit evidence regarding opening balances through
confirmation with third parties, for example, for long-term debt and investments. In other cases,
the auditor may need to carry out additional audit procedures.
Evidence that the opening balances contain misstatements
14.3.19 If the auditor obtains evidence that the opening balances contain misstatements that
could materially affect the current period’s financial statements, the auditor shall perform such
additional audit procedures as are appropriate to determine the effect on the current period’s
financial statements. If the auditor concludes that such misstatements exist in the current
period’s financial statements, the auditor shall communicate the misstatements with the
appropriate level of management and those charged with governance in accordance with ISA
450.
Consistency of accounting policies
14.3.20 The auditor shall obtain sufficient appropriate audit evidence about whether the
accounting policies reflected in the opening balances have been consistently applied in the
current period’s financial statements, and whether changes in the accounting policies have
been appropriately accounted for and adequately presented and disclosed in accordance with
the applicable financial reporting framework.
Relevant information in the predecessor auditor’s report
14.3.21 If the prior period’s financial statements were audited by a predecessor auditor and
there was a modification to the opinion, the auditor shall evaluate the effect of the matter giving
rise to the modification in assessing the risks of material misstatement in the current period’s
financial statements in accordance with ISA 315.
14.4. Audit conclusions and reporting
Opening balances
14.4.1 If the auditor is unable to obtain sufficient audit evidence regarding the opening
balances, the auditor shall express a qualified opinion or disclaim an opinion on the financial
statements as appropriate, in accordance with ISA 705.
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14.4.2 The inability of the auditor to obtain sufficient appropriate audit evidence regarding
opening balances may result in one of the following modifications to the opinion in the auditor’s
report:
A qualified opinion or disclaimer of opinion, as is appropriate in the circumstances; or
Unless prohibited by law or regulation, an opinion which is qualified or disclaimed, as
appropriate, regarding the results of operations, and cash flows, where relevant, and
unmodified regarding financial position.
14.4.3 If the auditor concludes that the opening balances contain a misstatement that
materially affects the current period’s financial statements, and the effect of the misstatement
is not appropriately accounted for or not adequately presented or disclosed, the auditor shall
express a qualified opinion or adverse opinion, as appropriate in accordance with ISA 705.
Consistency of accounting policies
14.4.4 The auditor shall express an qualified opinion or an adverse opinion as appropriate in
accordance with ISA 705 if the auditor concludes that:-
The current period’s accounting policies are not consistently applied in relation to opening
balances in accordance with the applicable financial reporting framework; or
A change in accounting policies is not appropriately accounted for or not adequately
presented or disclosed in accordance with the applicable financial reporting framework.
Modification to the Opinion in the Predecessor Auditor’s Report
14.4.5 If the predecessor auditor’s opinion regarding the prior period’s financial statements
included a modification to the current period’s financial statements, the auditor shall modify the
auditor’s opinion on the current period’s financial statements in accordance with ISA 705 and
ISA 710.
14.4.6 In some situations, a modification to the predecessor auditor’s opinion may not be
relevant and material to the opinion on the current period’s financial statements. This may be
the case where, for example, there was a scope limitation in the prior period, but the matter
giving rise to the scope limitation has been resolved in the current period
Audit programme 6.15 - Trial balance audit programme set out in Part I of the manual provides
audit substantive procedures to be adopted in the audit of opening balances
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Appendix I
Example 1 Letter from the successor auditor requesting access
[Predecessor firm]
[Address]
For the attention of: [Name]
Dear Sirs,
Provision of Information relating to the audit of [audit client]
This firm was duly appointed statutory auditor on [date] to [company] (“the Company”) [and its
subsidiaries as listed in the schedule to this letter (together “the Companies”)].
In accordance with [national regulation] we request for the purposes of our audit work, access
to the following information:
[Set out information necessary at this stage, noting that wherever possible a request framed
simply as a request for “all relevant information held by the predecessor and concerning the
audited entity” or “all relevant information held by the
predecessor in relation to the office of auditor” should be avoided. The successor should strive
to identify the information required, or the type of information required, as precisely as
possible.]
[Where the request is for access to audit working papers and subsequent interim review
working papers, insert where applicable:
[The working papers in respect of your audit report on the financial statements of the
[Company/Companies] relating to [insert period between the beginning of the last financial
statements on which the predecessor reported and the date of cessation of the predecessor’s
appointment].
[Where in your capacity as auditor you conducted a review of interim financial information
subsequent to the audit report referred to above, this request includes a request for access to
the working papers relating to that review also.]
We may also request explanations from you in connection with our consideration of the above
information, and on the same basis.
[We/ the Company will meet reasonable costs that you will incur in giving access/ providing
copies, provided that a maximum amount is agreed first.]
We look forward to receiving your confirmation letter in response to this request, which should
be addressed for the attention of [name of auditor].
Yours faithfully
[Successor]
[Schedule of subsidiaries to which this letter applies in addition to the Company
Company 2 Limited
Company 3 Limited
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Appendix II
Example 2 Letter from predecessor auditor responding to the successor auditor’s
request for access
[Successor firm]
[address]
Dear Sir,
Provision of Information pursuant to audit regulation 3.09 relating to the audit of [audit
client]
We refer to your letter dated [date] following your appointment as statutory auditors of
[company] (“the Company”) [and its subsidiaries listed in the schedule to your letter (together
“the Companies”)].
We confirm we will provide access to the information requested, namely: [This should reflect
the information set out in the successor’s request letter which is necessary at this stage, noting
wherever possible a request framed simply as a request for “all relevant information held by
the predecessor and concerning the audited entity” or “all relevant information held by the
predecessor in relation to the office of auditor” should be avoided. The successor should have
identified the information required, or the type of information required, as precisely as
possible.]
[Where the request is for access to audit working papers and subsequent interim review
working papers if applicable, the following language reflects that set out in the Example 1.
[The working papers in respect of our audit report on the financial statements of the
[Company/Companies] relating to [insert period specified by the successor, such as the period
between the beginning of the last financial statements on which the predecessor reported and
the date of cessation of the predecessor’s appointment].
[The working papers relating to our review of interim financial information for the period ended
[insert period subsequent to the audit report referred to above, as specified by the successor].]
We understand that you may also request explanations from us in connection with your
consideration of the above information, and on the same basis.
This letter sets out the basis on which the information and explanations (if any) are to be
provided.
Should you request or we provide any supplementary information to that set out above, such
provision will be made on the same basis.
The access is provided to you:
(a) solely in your capacity as duly appointed statutory auditor (as defined by (local legislation);
(b) solely because we are required to give you access to information pursuant to (local
legislation/regulation);
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The provision of access does not and will not alter any responsibility that we may have
accepted or assumed to the [Company/Companies] or the [Company’s/respective Companies’]
members as a body, in accordance with the statutory requirements for audit, for our audit work,
for our audit report or for the opinions we have formed in the course of our work as auditors.
To the fullest extent permitted by law we do not accept or assume responsibility to you or to
anyone else:
(a) as a result of the access given;
(b) for the information to which we provide access;
(c) for any explanation given to you;
(d) in respect of any audit work you may undertake, any audit you may complete, and audit
report you may issue, or any audit opinion you may give.
Where access is provided to audit [and interim review] working papers, those papers were not
created or prepared for, and should not be treated as suitable for, any purpose other than the
statutory audit that was the subject of our audit report [and respectively the interim review we
carried out]. The statutory audit was planned and undertaken solely for the purpose of forming
and giving the audit opinion required by the relevant statutory provision to the persons
contemplated by that statutory provision. [The interim review was planned and undertaken
solely for the purpose of meeting the requirements of the relevant standard.] The statutory
audit [and the interim review] [was/were] not planned or undertaken, and the working papers
were not created prepared, in contemplation of your appointment as statutory auditor or for the
purpose of assisting you in carrying out your appointment as statutory auditor.
Neither you nor anyone else should rely on the information to which access is provided, or any
explanations given in relation to that information. The information cannot in any way serve as a
substitute for the enquiries and procedures that you should undertake and the judgments that
you must make for any purpose in connection with the audit for which you are solely
responsible as the auditor.
If notwithstanding this letter you rely on the information for any purpose and to any degree, you
will do so entirely at your own risk.
[Insert where applicable:]
[We will remove/ have removed from the audit working papers all material in respect of which
legal professional privilege is asserted.]
[Thank you for your confirmation that you/ the Company will meet the reasonable costs that we
will incur in giving access. [As already agreed] these will not exceed *.]
(a) you should refuse to accept an additional engagement, such as to act as an expert witness
or to review the quality of our audit work, where the engagement would involve the use of the
information obtained by you under the (local legislation/regulation);
(b) you should not comment on the quality of our audit work unless required to do so by a legal
or professional obligation;
(c) the information should not be disclosed beyond persons who have a need to access the
information where to do so is a necessary part of your audit work, nor should the information
be disclosed to a third party including the [Company/Companies]
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(although this does not prevent you discussing the information with the [Company/Companies]
where to do so is a necessary part of your audit work, or providing information to any third
party if that is required of you by a legal or professional obligation).
In the event that access to information involves your having access to any intellectual property
of ours or any material in which we have copyright, we do not grant permission to you to use or
exploit that intellectual property or copyright and you must respect the same at all times.
When in this letter we refer to ourselves, we include [any person or organisation associated
with this firm through membership of the HLB International], our [and their] partners, directors,
members, employees and agents. This letter is for the benefit of all those referred to in the
previous sentence and each of them may rely on and enforce in their own right all of the terms
of this letter.
Yours faithfully
[Predecessor]
cc The Company/Companies
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Appendix III
Illustrations of auditors’ reports with modified opinions
Illustration 1:
Circumstances described in Illustration 1 include the following:
The auditor did not observe the counting of the physical inventory at the beginning
of the current period and was unable to obtain sufficient appropriate audit evidence
regarding the opening balances of inventory.
The possible effects of the inability to obtain sufficient appropriate audit evidence
regarding opening balances of inventory are deemed to be material but not
pervasive to the entity’s financial performance and cash flows.
The financial position at year end is fairly presented.
In this particular jurisdiction, law and regulation prohibit the auditor from giving an
opinion which is qualified regarding the financial performance and cash flows and
unmodified regarding financial position.
INDEPENDENT AUDITOR’S REPORT
[Appropriate Addressee]
Report on the financial statements
We have audited the accompanying financial statements of ABC Company, which comprise
the balance sheet as at December 31, 20X1, and the income statement, statement of changes
in equity and cash flow statement for the year then ended, and a
summary of significant accounting policies and other explanatory information.
Management’s responsibility for the financial statements
Management is responsible for the preparation and fair presentation of these financial
statements in accordance with International Financial Reporting Standards 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.
Auditor’s responsibility
Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with International Standards on Auditing. Those
standards require that we comply with ethical requirements and plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free from material
misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and
disclosures in the financial statements. The procedures selected depend on the auditor’s
judgment, including the assessment of the risks of material misstatement of the financial
statements, whether due to fraud or error. In making those risk assessments, the auditor
considers internal control relevant to the entity’s preparation and fair presentation of the
financial statements in order to design audit procedures that are appropriate in the
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circumstances, but not for the purpose of expressing an opinion on the effectiveness of the
entity’s internal control. An audit also includes evaluating the appropriateness of accounting
policies used and the reasonableness of accounting estimates made by management, as well
as evaluating the overall presentation of the financial statements. We believe that the audit
evidence we have obtained is sufficient and appropriate to provide a basis for our qualified
audit opinion.
Basis for qualified opinion
We were appointed as auditors of the company on June 30, 20X1 and thus did not observe the
counting of the physical inventories at the beginning of the year. We were unable to satisfy
ourselves by alternative means concerning inventory quantities held at December 31, 20X0.
Since opening inventories enter into the determination of the financial performance and cash
flows, we were unable to determine whether adjustments might have been necessary in
respect of the profit for the year reported in the income statement and the net cash flows from
operating activities reported in the cash flow statement.
Qualified opinion
In our opinion, except for the possible effects of the matter described in the Basis for Qualified
Opinion paragraph, the financial statements present fairly, in all material respects, (or give a
true and fair view of) the financial position of ABC Company as at December 31, 20X1, and
(of) its financial performance and its cash flows for the year then ended in accordance with
International Financial Reporting Standards.
Other matter
The financial statements of ABC Company for the year ended December 31, 20X0 were
audited by another auditor who expressed an unmodified opinion on those statements on
March 31, 20X1.
Report on other legal and regulatory requirements
[Form and content of this section of the auditor’s report will vary depending on the nature of the
auditor’s other reporting responsibilities.]
[Auditor’s signature]
[Date of the auditor’s report]
[Auditor’s address]
Illustration 2:
Circumstances described in Illustration 2 include the following:
The auditor did not observe the counting of the physical inventory at the beginning
of the current period and was unable to obtain sufficient appropriate audit evidence
regarding the opening balances of inventory.
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The possible effects of the inability to obtain sufficient appropriate audit evidence
regarding opening balances of inventory are deemed to be material but not
pervasive to the entity’s financial performance and cash flows.
The financial position at year end is fairly presented.
An opinion that is qualified regarding the financial performance and cash flows and
unmodified regarding financial position is considered appropriate in the
circumstances.
INDEPENDENT AUDITOR’S REPORT
[Appropriate Addressee]
Report on the financial statements
We have audited the accompanying financial statements of ABC Company, which comprise
the balance sheet as at December 31, 20X1, and the income statement, statement of changes
in equity and cash flow statement for the year then ended, and a
summary of significant accounting policies and other explanatory information.
Management’s responsibility for the financial statements
Management is responsible for the preparation and fair presentation of these financial
statements in accordance with International Financial Reporting Standards 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.
Auditor’s responsibility
Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with International Standards on Auditing. Those
standards require that we comply with ethical requirements and plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and
disclosures in the financial statements. The procedures selected depend on the auditor’s
judgment, including the assessment of the risks of material misstatement of the financial
statements, whether due to fraud or error. In making those risk assessments, the auditor
considers internal control relevant to the entity’s preparation and fair presentation of the
financial statements in order to design audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the effectiveness of the
entity’s internal control. An audit also includes evaluating the appropriateness of accounting
policies used and the reasonableness of accounting estimates made by management, as well
as evaluating the overall presentation of the financial statements. We believe that the audit
evidence we have obtained is sufficient and appropriate to provide a basis for our unmodified
opinion on the financial position and our qualified audit opinion on the financial performance
and cash flows.
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Basis for qualified opinion on the financial performance and cash flows
We were appointed as auditors of the company on June 30, 20X1 and thus did not observe the
counting of the physical inventories at the beginning of the year. We were unable to satisfy
ourselves by alternative means concerning inventory quantities held at December 31, 20X0.
Since opening inventories enter into the determination of the financial performance and cash
flows, we were unable to determine whether adjustments might have been necessary in
respect of the profit for the year reported in the income statement and the net cash flows from
operating activities reported in the cash flow statement.
Qualified opinion on the financial performance and cash flows
In our opinion, except for the possible effects of the matter described in the Basis for Qualified
Opinion paragraph, the Income Statement and Cash Flow Statement present fairly, in all
material respects (or give a true and fair view of) the financial performance and cash flows of
ABC Company for the year ended December 31, 20X1 in accordance with International
Financial Reporting Standards.
Opinion on the financial position
In our opinion, the balance sheet presents fairly, in all material respects (or gives a true and
fair view of) the financial position of ABC Company as at December 31, 20X1 in accordance
with International Financial Reporting Standards.
Other matter
The financial statements of ABC Company for the year ended December 31, 20X0 were
audited by another auditor who expressed an unmodified opinion on those statements on
March 31, 20X1.
Report on other legal and regulatory requirements
[Form and content of this section of the auditor’s report will vary depending on the nature of the
auditor’s other reporting responsibilities.]
[Auditor’s signature]
[Date of the auditor’s report]
[Auditor’s address]
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15. COMPARATIVE INFORMATION - CORRESPONDING FIGURES AND COMPARATIVE
FINANCIAL STATEMENTS (INCORPORATING ISA 710)
15.1. Objective
15.1.1 The objectives of the auditor are:
To obtain sufficient appropriate audit evidence about whether the comparative information
included in the financial statements has been presented, in all material respects, in
accordance with the requirements for comparative information in the applicable financial
reporting framework; and
To report in accordance with the auditor’s reporting responsibilities.
15.2. Definitions
15.2.1 Comparative information – the amounts and disclosures included in the financial
statements in respect of one or more prior periods in accordance with the applicable financial
reporting framework.
15.2.2 Corresponding Figures – Comparative information where amounts and other
disclosures for the prior period are included as an integral part of the current period financial
statements, and are intended to be read only in relation to the amounts and other disclosures
relating to the current period (referred to as “current period figures). The level of detail
presented in the corresponding amounts and disclosures is dictated primarily by its relevance
to the current period figures.
15.2.3 Comparative Financial Statements – Comparative information where amounts and other
disclosures for the prior period are included for comparison with the financial statements of the
current period but, if audited, are referred to in the auditor’s opinion. The level of information
included in those financial statements is comparable with that of the financial statements of the
current period.
15.3. Audit procedures
15.3.1 The auditor shall determine whether the financial statements include the Comparative
Information required by the applicable financial reporting framework, and whether such
information is appropriately classified. For this purpose, the auditor shall evaluate whether:
The comparative information agrees with the amounts and other disclosures presented in
the prior period or, when appropriate, have been restated; and
The accounting policies reflected in the comparative information are consistent with those
applied in the current period or, if there have been changes in accounting policies, whether
those changes have been properly presented and disclosed.
15.3.2 If the auditor becomes aware of a possible material misstatement in the comparative
information while performing the current period audit, the auditor shall perform such additional
audit procedures as are necessary in the circumstances to obtain sufficient appropriate audit
evidence to determine whether a material misstatement exists. If the auditor had audited the
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prior period’s financial statements, the auditor shall also follow the relevant requirements of
ISA 560. If the prior period financial statements are amended, the auditor shall determine that
the comparative information agrees with the amended financial statements.
Written representations
15.3.3 As required by ISA 580 the auditor shall obtain written representations for all the
periods referred to in the auditor’s opinion. The auditor shall also obtain a specific written
representation regarding any restatement made to correct a material misstatement in prior
period financial statements that affect the comparative information.
15.3.4 In the case of comparative financial statements, the written representations are
requested for all periods referred to in the auditor’s opinion because management needs to
reaffirm that the written representations it previously made with respect to the prior period
remain appropriate. In the case of corresponding figures, the written representations are
requested for the financial statements of the current period only because the auditor’s opinion
is on those financial statements, which include the corresponding figures. However, the auditor
requests a specific written representation regarding any restatement made to correct a
material misstatement in the prior period financial statements that affect the comparative
information.
15.4. Audit reporting - corresponding figures
15.4.1 When corresponding figures are presented, the auditor’s opinion shall not refer to the
corresponding figures except in the circumstances described in the paragraphs below. This is
because the auditor’s opinion is on the current period financial statements as a whole,
including the corresponding figures.
15.4.2 If the auditor’s report on the prior period, as previously issued, included a qualified
opinion, a disclaimer of opinion, or an adverse opinion, and the matter which gave rise to the
modification is unresolved, the auditor shall modify the auditor’s opinion on the current period’s
financial statements. In the Basis for Modification paragraph in the auditor’s report, the auditor
shall either:
Refer to both the current period’s figures and the corresponding figures in the description of
the matter giving rise to the modification when the effects or possible effects of the matter
on the current period’s figures are material; or
In other cases, explain that the audit opinion has been modified because of the effects or
possible effects of the unresolved matter on the comparability of the current period’s figures
and the corresponding figures.
Example audit report see Appendix Illustration 1
15.4.3 When the matter which gave rise to the modified opinion in the prior period is resolved
and properly accounted for or disclosed in the financial statements in accordance with the
applicable financial reporting framework, the auditor’s opinion on the current period need not
refer to the previous modification.
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When the auditor’s opinion on the prior period, as previously expressed, was modified, the
unresolved matter that gave rise to the modification may not be relevant to the current period
figures. Nevertheless, a qualified opinion, a disclaimer of opinion, or an adverse opinion ( as
applicable) may be required on the current period’s financial statements because of the effects
or possible effects of the unresolved matter on the comparability of the current and
corresponding figures.
Example audit report see Appendix Illustration 2
Material misstatement
15.4.4 If the auditor obtains audit evidence that a material misstatement exists in the prior
period financial statements on which an unqualified opinion has been previously issued, and
the corresponding figures have not been properly restated or appropriate disclosures have not
been made, the auditor shall express a qualified opinion or an adverse opinion in the auditor’s
report on the current period financial statements, modified with respect to the corresponding
figures included therein.
15.4.5 When the prior period financial statements that are misstated have not been amended
and an auditor’s report has not been reissued, but the corresponding figures have been
restated or appropriate disclosures have been made in the current period financial statements,
the auditor’s report may include an Emphasis of Matter paragraph describing the
circumstances and referring to where relevant disclosures that fully describe the matter that
can be found in the financial statements.
Prior period financial statements audited by a predecessor auditor
15.4.6 If the financial statements of the prior period were audited by a predecessor auditor and
the auditor is not prohibited by law or regulation from referring to the predecessor’s auditor’s
report on the corresponding figures and decides to do so, the auditor shall state in an Other
Matter paragraph in the auditor’s report:
That the financial statements of the prior period were audited by the predecessor auditor;
The type of opinion expressed by the predecessor auditor and, if the opinion was modified,
the reasons therefore; and
The date of that report.
Example audit report see Appendix Illustration 3
Prior period financial statements not audited
15.4.7 If the prior period financial statements were not audited, the auditor shall state in an
Other Matter paragraph in the auditor’s report that the corresponding figures are unaudited.
Such a statement, does not, however, relieve the auditor of the requirement to obtain sufficient
appropriate audit evidence that the opening balances do not contain misstatements that
materially affect the current period’s financial statements in accordance with ISA 510.
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15.5. Audit reporting-comparative financial statements
15.5.1 When comparative financial statements are presented, the auditor’s opinion shall refer
to each period for which financial statements are presented and on which an audit opinion is
expressed.
15.5.2 Because the auditor’s report on comparative financial statements applies to the financial
statements for each of the periods presented, an auditor may express a qualified opinion or an
adverse opinion, disclaim an opinion, or include an Emphasis of Matter paragraph with respect
to one or more periods, while expressing a different auditor’s opinion on the financial
statements of the other period.
Example audit report see Appendix Illustration 4.
15.5.3 When reporting on prior period financial statements in connection with the current
period’s audit, if the auditor’s opinion on such prior period financial statements differs from the
opinion the auditor previously expressed, the auditor shall disclose the substantive reasons for
the different opinion in an Other Matter paragraph in accordance with ISA 706.
15.5.4 When reporting on the prior period financial statements in connection with the current
period’s audit, the opinion expressed on the prior period financial statements may be different
from the opinion previously expressed if the auditor becomes aware of circumstances or
events that materially affect the financial statements of a prior period during the course of the
audit of the current period. In some jurisdictions, the auditor may have additional reporting
responsibilities designed to prevent future reliance on the auditor’s previously issued report on
the prior period financial statements.
Prior period financial statements audited by a predecessor auditor
15.5.5 If the financial statements of the prior period were audited by a predecessor auditor, in
addition to expressing an opinion on the current period’s financial statements, the auditor shall
state in an Other Matter paragraph:
That the financial statements for the prior period were audited by a predecessor auditor;
The type of opinion expressed by the predecessor auditor and, if the opinion was modified,
the reasons therefore; and
The date of that report.
Unless the predecessor’s auditor’s report on the prior period’s financial statements is reissued
with the financial statements.
Material misstatement
15.5.7 If the auditor concludes that a material misstatement exists that affects the prior period
financial statements on which the predecessor auditor has previously reported without
modification, the auditor shall communicate the misstatement with the appropriate level of
management and unless all those charged with governance are involved in managing the
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entity, those charged with governance and request that the predecessor auditor be informed. If
the prior period financial statements are amended, and the predecessor auditor agrees to
issue a new auditor’s report on the amended financial statements of the prior period, the
author shall report only on the current period.
15.5.8 The predecessor auditor may be unable or unwilling to reissue the auditor’s report on
the prior period financial statements. An Other Matter paragraph of the auditor’s report may
indicate that the predecessor auditor reported on the financial statements of the prior period
before amendment. In addition, if the auditor is engaged to audit and obtains sufficient
appropriate audit evidence to be satisfied as to the appropriateness of the amendment, the
auditor’s report may also include the following paragraph:
15.5.9 As part of our audit of the 20X2 financial statements, we also audited the adjustments
described in Note X that were applied to amend the 20X1 financial statements. In our opinion,
such adjustments are appropriate and have been properly applied. We were not engaged to
audit, review or apply any procedures to the 20X1 financial statements of the company other
than with respect to the adjustments and, accordingly, we do not express an opinion or any
other form of assurance on the 2OX1 financial statements taken as a whole.
Prior period financial statements not audited
15.5.10 If the prior period financial statements were not audited, the auditor shall state in an
Other Matter paragraph that the comparative financial statements are unaudited. Such a
statement does not, however, relieve the auditor of the requirement to obtain sufficient
appropriate audit evidence that the opening balances do not contain misstatements that
materially affect the current period’s financial statements in accordance with ISA 510.
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APPENDIX: Illustrations of auditors’ reports
Illustration 1 Corresponding Figures
Report illustrative of the circumstances described as follows:
The auditor’s report on the prior period, as previously issued, included a qualified opinion.
The matter giving rise to the modification is unresolved.
The effects or possible effects of the matter on the current period’s figures are material and
require a modification to the auditor’s opinion regarding the current period figures.
INDEPENDENT AUDITORS' REPORT
..
Basis for Qualified Opinion
As discussed in Note X to the financial statements, no depreciation has been provided in the
financial statements, which constitutes a departure from International Financial Reporting
Standards. This is the result of a decision taken by management at the start of the preceding
financial year and caused us to qualify our audit opinion on the financial statements relating to
that year. Based on the straight-line method of depreciation and annual rates of 5% for the
building and 20% for the equipment, the loss for the year should be increased by xxx in 20X1
and xxx in 20X0, property, plant and equipment should be reduced by accumulated
depreciation of xxx in 20X1 and xxx in 20X0, and the accumulated loss should be increased by
xxx in 20X1 and xxx in 20X0.
Qualified Opinion
In our opinion, except for the effects of the matter described in the Basis for Qualified Opinion
paragraph, the financial statements present fairly, in all material respects, (or give a true and
fair view of) the financial position of ABC Company as at December 31, 20X1, and (of) its
financial performance and its cash flows for the year then ended in accordance with
International Financial Reporting Standards.
.. ....
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Illustration 2 Corresponding figures
Report illustrative of the circumstances described as follows:
The auditor’s report on the prior period, as previously issued, included a qualified opinion.
The matter giving rise to the modification is unresolved.
The effects or possible effects of the matter on the current period’s figures are immaterial
but require a modification to the auditor’s opinion because of the effects or possible effects
of the unresolved matter on the comparability of the current period’s figures and the
corresponding figures.
INDEPENDENT AUDITORS' REPORT
Basis for Qualified Opinion
Because we were appointed auditors of ABC Company during 20X0, we were not able to
observe the counting of the physical inventories at the beginning of that period or satisfy
ourselves concerning those inventory quantities by alternative means. Since opening
inventories affect the determination of the results of operations, we were unable to determine
whether adjustments to the results of operations and opening retained earnings might be
necessary for 20X0. Our audit opinion on the financial statements for the period ended
December 31, 20X0 was modified accordingly. Our opinion on the current period’s financial
statements is also modified because of the possible effect of this matter on the comparability of
the current period’s figures and the corresponding figures.
Qualified Opinion
In our opinion, except for the possible effects on the corresponding figures of the matter
described in the Basis for Qualified Opinion paragraph, the financial statements present fairly,
in all material respects, (or give a true and fair view of) the financial position of ABC Company
as at December 31, 20X1, and (of) its financial performance and its cash flows for the year
then ended in accordance with International Financial Reporting Standards.
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Illustration 3 Corresponding figures
Report illustrative of the circumstances described as follows:
The prior period’s financial statements were audited by a predecessor auditor.
The auditor is not prohibited by law or regulation from referring to the predecessor auditor’s
report on the corresponding figures and decides to do so.
INDEPENDENT AUDITORS' REPORT
Opinion
In our opinion, the financial statements present fairly, in all material respects, (or give a true
and fair view of) the financial position of ABC Company as at December 31, 20X1, and (of) its
financial performance and its cash flows for the year then ended in accordance with
International Financial Reporting Standards.
Other Matter
The financial statements of ABC Company for the year ended December 31, 20X0, were
audited by another auditor who expressed an unmodified opinion on those statements on
March 31, 20X1.
..
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