What Circumstances Meet the Condition that the Auditor is Unable to Obtain Sufficient Appropriate Audit Evidence ?

The auditor’s inability to obtain sufficient appropriate audit evidence (also referred to as a limitation on the scope of the audit) may arise from :

1. Circumstances beyond the control of the entity;
2. Circumstances relating to the nature or timing or the auditor’s work; or
3. Limitations imposed by management

An inability to perform a specific procedures does not constitute a limitation on the scope of the audit if the auditor is able to obtain sufficient appropriate audit evidence by performing alternative procedures.

Examples of circumstances beyond the control of the entity include when :

1. The entity’s accounting records have been destroyed
2. The accounting records of a significant component have been seized indefinitely by governmental authorities

Examples of circumstances relating to the nature of timing of the auditor’s work include when :

1. The entity is required to use the equity method of accounting for an associated entity, and the auditor is unable to obtain sufficient appropriate audit evidence about the latter’s financial information to evaluate whether the equity method has been appropriately applied
2. The timing of the auditor’s appointment is such that the auditor is unable to observe the counting of the physical inventories
3. The auditor determines that performing substantive procedures alone is not sufficient, but the entity’s controls are not effective

Examples of an inability to obtain sufficient appropriate audit evidence arising from a limitation on the scope of the audit imposed by management include when :

1. Management prevents the auditor from observing the counting of the physical inventory
2. Management prevents the auditor from requesting external confirmation of specific account balances.

Source : IAS 705 – Modifications to the Opinion in the Independent Auditor’s Report paragraphs A8 - A12

Audit of leases, the audit objectives and audit program to be prepared while auditing the lessee obligation

For accounting and financial reporting purposes, an entity as the lessee has two alternatives in classifying a lease : (1) Operating Lease, (2) Finance Lease. The proper classification of a lease is determined by the circumstances surrounding the leasing transaction. According to IAS 17 : Leases, whether a lease is a finance lease or not will have to be judged based on the substance of the transaction, rather than on its mere form. If substantially all of the benefits and risks of ownership have been transferred to the lessee, the lease should be classified as a finance lease. Besides, IAS 17 also stipulates that substantially all of the risks or benefits of ownership are deemed to have been transferred if a lease transaction meets any one of criteria as prescribed in para. 10 and para. 11 of IAS 17.

While conducting an audit of lease transaction, the auditor shall take notes of the following principal objectives :

• Determine that all finance leases are recorded in the balance sheet with appropriate classification of the leased asset and the obligation
• Ascertain that depreciation expenses and interest expense relating to finance leases and rent expense on operating leases have been calculated and reported properly in the income statement
• Ascertain that footnote disclosure of finance lease and operating lease obligations are adequate and are in compliance with the disclosure requirements of IAS 17

The auditing procedures related to lessee obligations consist principally of a careful examination and study of the lease documents to determine the substance of the transaction and the proper accounting treatment. During the examination of the lease agreements, the auditor normally prepares a summary of the terms and provisions of each lease for his or her permanent file working papers documentation.

Then, how the auditor should prepare his or her audit program in relation with the audit of lease transaction ?

An audit program for lease obligations would include the following steps :

• Examine lease agreements and prepare a summary of key terms and pertinent data for the permanent file
• Determine that leases have been properly classified as either finance leases or operating leases using the criteria of IAS 17
• For capitalized leases, check the present value computations and determine the appropriateness of the discount rate used
• Determine that lease payments and expenses included in the accounts are in agreement with the provisions of the lease contracts
• Determine that executory costs to be paid by the lessee (property taxes, insurance, etc.) have been properly accrued and included in expenses
• Determine that any additional contingent rents payable have been accrued (such contingent rents may result from escalation clauses, gross receipts, provisions, etc.)
• Ascertain that footnote and balance sheet disclosures are in accordance with IAS 17

Source : Accountants’ Handbook – Lee.J.Seidler and D.R.Carmichael

For further reference, read also :

• The right way to classify a lease
• How is the treatment of land and buildings lease transaction ?
• Effect of operating and finance leases on lessee financial statements and key financial ratios

Audit Documentation Requirement

Auditors support the conclusions in their reports with the audit documentation, also referred to as working papers or work papers. Audit documentation also facilitates the planning, performance, and supervision of the engagement and provides the basis for the review of the quality of the work by providing the reviewer with written documentation of the evidence supporting the auditor’s significant conclusions.

The auditor shall prepare audit documentation on a timely basis, which must be sufficient to enable an experienced auditor (an individual who has practical audit experience, and a reasonable understanding of (i) audit processes, (ii) ISAs and applicable legal and regulatory requirements. (iii) the business environment in which the entity operates, and (iv) auditing and financial reporting issues relevant to the entity’s industry), having no previous connection with the audit, to understand :

(a) the nature, timing and extent of the audit procedures performed to comply with the ISAs and applicable legal and regulatory requirements;

(b) the results of the audit procedures performed, and the audit evidence obtained; and

(c) significant matters arising during the audit, the conclusions reached thereon, and significant professional judgments made in reaching those conclusions.

In documenting the nature, timing and extent of audit procedures performed, the auditor shall record :

(a) the identifying characteristics of the specific items or maters tested;

(b) who performed the audit work and the date such work was completed; and

(c) who reviewed the audit work performed and the date and extent of such review.

ISA 230 Audit Documentation, para. 14-16 regulates the assembly of the final audit file. The auditor shall assemble the audit documentation in the audit file and complete the administrative process of assembling the final audit file on a timely basis after the date of the auditor’s report. After the assembly of the final audit file has been completed, the auditor shall not delete or discard audit documentation of any nature before the end of its retention period.

Audit documentation may be recorded on paper or on electronic or other media. Examples of audit documentation include audit programs, analyses, issues memoranda, summaries of significant matters, letters of confirmation and representation, checklist and also correspondence (including e-mail) concerning significant matters.

International Standard on Quality Control (ISQC) 1 requires firms to establish policies and procedures for the timely completion of the assembly of audit files. An appropriate time limit within which to complete the assembly of the final audit file is ordinarily not more than 60 days after the date of the auditor’s report.

The completion of the assembly of the final audit file after the date of the auditor’s report is an administrative process that does not involve the performance of new audit procedures or the drawing of new conclusions. Changes may, however, be made to the audit documentation during the final assembly process if they are administrative in nature. Example of such changes include :

• Deleting or discarding superseded documentation
• Sorting, collating and cross-referencing working papers
• Signing off on completion checklist relating to the file assembly process
• Documenting audit evidence that the auditor has obtained, discussed and agreed with the relevant members of the engagement team before the date of the auditor’s report.

ISQC 1 also requires firms to establish policies and procedures for the retention of engagement documentation. The retention period for audit engagements ordinarily is no shorter than 5 (five) years from the date of the auditor’s report, or, if later, the date of the group auditor’s report.

While PCAOB in its Auditing Standard No. 3 Audit Documentation requires the auditor to retain audit documentation for seven years from the date the auditor grants permission to use the auditor’s report in connection with the issuance of the company’s financial statements (report release date), unless a longer period of time is required by law. If a report is not issued in connection with an engagement, then the audit documentation must be retained for seven years from the date that fieldwork was substantially completed. If the auditor was unable to complete the engagement, then the audit documentation must be retained for seven years from the date the engagement ceased. Read further

“The skill of an accountant can always be ascertained by an inspection of his working papers.” – Robert H. Montgomery, Montgomery’s Auditing, 1912