Revised of ISA addressing Disclosures in the Audit of Financial Statements

As dropped into my mail inbox by today, July 16, 2015, the IAASB has announced on July 15, 2015 the finalization of Amendments to Auditing Standards to Promote Greater Focus on Financial Statements Disclosures.

It said that the IAASB on July 15, 2015 released its revised International Standards on Auditing (ISAs), Addressing Disclosures in the Audit of Financial Statements. The revisions to the standards aim to focus auditors more explicitly on disclosures throughout the audit process and drive consistency in auditor behavior in applying the requirements of the ISAs.

As a complement to these revisions, IAASB staff has also developed a publication, Addressing Disclosures in the Audit of Financial Statements and Related Conforming Amendments, for auditors that describes financial reporting disclosure trends and their possible implications from an audit perspective and highlights how the ISAs as revised guide the auditor in addressing disclosures. This publication is intended to help the consistent, effective, and proper application of the IASs when addressing disclosures as part of an audit of financial statements, and may be particularly relevant to small and medium practices implementing the changes to the ISAs.

The IAASB firmly believes these changes to the ISAs will enhance audit quality and are capable of being applied proportionately in audits of entities of all sizes, and in all jurisdictions and sectors.

A staff-prepared Basis for Conclusions, which explains the IAASB’s rationale for its decisions, and an At a Glance document, which explains the main changes to the ISAs, are also now available.

The revisions to the standards encompass changes to 10 ISAs and conforming amendments to five other ISAs. They will be effective for audits of financial statements for periods ending on or after December 15, 2016, in line with the effective date for the new and revised Auditor Reporting Standards and ISA 720 (Revised), The Auditor's Responsibilities Relating to Other Information (HRD).

In What Circumstances the Material Misstatements of Financial Statements May Arise ?

ISA 700 requires the auditor, in order to form an opinion on the financial statements, to conclude as to whether reasonable assurance has been obtained about whether the financial statements as a whole are free from material misstatement. This conclusion takes into account the auditor’s evaluation of uncorrected misstatements, if any, on the financial statements in accordance with ISA 450.

ISA 450 defines a  misstatement as a difference between the amount, classification, presentation, or disclosure of a reported financial statement item and the amount, classification, presentation, or disclosure that is required for the item to be in accordance with the applicable financial reporting framework.

Accordingly, a material misstatement of the financial statements may arise in relation to :

1. The appropriateness of the selected accounting policies;
2. The application of the selected accounting policies; or
3. The appropriateness or adequacy of disclosures in the financial statements

Appropriateness of the Selected Accounting Policies

In relation to the appropriateness of the accounting policies management has selected, material misstatements of the financial statements may arise when :

1. The selected accounting policies are not consistent with the applicable financial reporting framework; or
2. The financial statements, including the related notes, do not represent the underlying transactions and events in a manner that achieves fair presentation

Financial reporting frameworks often contain requirements for the accounting for, and disclosure of, changes in accounting policies. Where the entity has changed its selection of significant accounting policies, a material misstatement of the financial statements may arise when the entity has not complied with these requirements.

Application of the Selected Accounting Policies

In relation to the application of the selected accounting policies, material misstatements of the financial statements may arise :

1. When management has not applied the selected accounting policies consistently with the financial reporting framework, including when management has not applied the selected accounting policies consistently between periods or to similar transactions and events (consistency in application); or
2. Due to the method of application of the selected accounting policies (such as an unintentional error in application).

Appropriateness or Adequacy of Disclosures in the Financial Statements

In relation to the appropriateness or adequacy of disclosures in the financial statements, material misstatements of the financial statements may arise when :

1. The financial statements do not include all of the disclosures required by the applicable financial reporting framework;
2. The disclosures in the financial statements are not presented in accordance with the applicable financial reporting framework; or
3. The financial statements do not provide the disclosures necessary to achieve fair presentation.

Source : ISA 705 – Modifications to the Opinion in the Independent Auditor’s Report paragraphs A2 - A7

Responsibilities of Management and The Independent Auditor over the Audited Financial Statements

The fundamental to a financial statement audit is the division of responsibility between management and the independent auditor. The critical distinction is :

• Management is responsible for preparing the financial statements and the contents of the statements are the assertions of management
• The independent auditor is responsible for examining management’s financial statements and expressing an opinion on their fairness

Management’s responsibility for the fairness of the representations in the financial statements carries with it the privilege of determining which disclosures it considers necessary. Although management has the responsibility for the preparation of the financial statements and the accompanying footnotes, the auditor may assist in the preparation of financial statements. For example, he may counsel management as to the applicability of a new accounting principle, and, during the course of the audit, he may propose adjustments to the client’s statements. However, acceptance of his advice and the inclusion of the suggested adjustments in the financial statements do not alter the basic separation of responsibility. Ultimately, management is responsible for all decisions concerning the form and content of the statements.

In the event that management insists on financial statement disclosure that the auditor finds unacceptable, the auditor can either issue an adverse or qualified opinion or withdraw from the engagement.

The auditor’s responsibility is limited to performing the audit investigation and reporting the results in accordance with generally accepted auditing standards. In most cases, any material errors and omissions will be discovered if the audit has been so performed. Yet the possibility always exists that the auditor’s selected evidence will fail to uncover a material error. In this event, the auditor’s best defense is that the audit was performed and the report prepared with due care in accordance with generally accepted auditing standards.

If the auditor were responsible for making certain that all the representations in the statements were correct, it would make him a guarantor or insurer of the reliability of the financial statements. If auditors had that responsibility, evidence requirements and the resulting cost of the audit function would be increased to such an extent that audits would not be economically feasible.

It is usually more difficult for auditors to uncover irregularities (intentional misstatement of financial statements or misappropriation of assets) than errors (unintentional mistakes). This is because of the intended deception associated with irregularities. The auditor’s responsibility for uncovering irregularities deserves special mention.

References :

1)  Auditors Responsibility for Fraud Detection (JofA)

2)  Auditors’ Responsibilities Formalized Under SAS 109 (CPA Journal)

3)  New Fraud Guidance (JofA)

4)  ISA 240 (redrafted) : Auditors and Fraud

5)  IFAC.org Projects

PCAOB Issues Staff Audit Practice Alert on Auditor Considerations of Significant Unusual Transactions

On April 7, 2010, The Public Company Accounting Oversight Board  issued a Staff Audit Practice Alert to remind auditors of public companies about their responsibilities to assess and respond to the risk of material misstatement of the financial statements due to error or fraud posed by significant unusual transactions.

Staff Audit Practice Alert No. 5, Auditor Considerations Regarding Significant Unusual Transactions (Practice Alert No. 5) compiles relevant requirements from existing PCAOB auditing standards regarding significant unusual transactions to assist the auditor in reviews of interim financial information and audits of financial statements.

"The PCAOB’s message to auditors, in this challenging economic environment, has consistently emphasized attention to audit risk and adherence to existing audit requirements," said Martin F. Baumann, Chief Auditor and Director of Professional Standards.

Practice Alert No. 5 complements Staff Audit Practice Alert No. 3, Audit Considerations in the Current Economic Environment, by further addressing risks of material misstatement associated with significant unusual transactions, a risk that the staff believes continues to exist today.

Practice Alert No. 5 compiles existing requirements from PCAOB auditing standards regarding significant unusual transactions and groups them into the following categories:

• Identifying and assessing risks of material misstatement
• Responding to risks of material misstatement
• Consulting others
• Evaluating financial statement presentation and disclosure
• Communicating with audit committees
• Reviewing interim financial information

"Practice Alert No. 5 will assist auditors as they begin their work related to 2010 quarterly reviews and audits of financial statements," said Mr. Baumann.

These alerts are prepared to highlight new, emerging, or otherwise noteworthy circumstances that may affect how auditors conduct audits under the existing requirements of PCAOB standards and relevant laws.

Auditors should determine whether and how to respond to these circumstances based on the specific facts presented. The statements contained in Staff Audit Practice Alerts are not rules of the Board and do not reflect any Board determination or judgment about the conduct of any particular firm, auditor, or any other person.

• Staff Audit Practice Alert No. 5, Auditor Considerations Regarding Significant Unusual Transactions (April 7, 2010)

Source : PCAOB Website

Read also a related article from Journal of Accountancy in here