Audit the Opening Balances, how far should the Auditor go?

ISA 510 Initial Audit Engagements – Opening Balances para. A3 – A7 underlines the nature and extent of audit procedures necessary to obtain sufficient appropriate audit evidence regarding opening balances which depend on such matters as follows :

(a) the accounting policies followed by the entity

(b) the nature of the account balances, classes of transactions and disclosures and the risks of material misstatement in the current period’s financial statements

(c) the significance of the opening balance relative to the current period’s financial statements

(d) whether the prior period’s financial statements were audited and, if so, whether the predecessor auditor’s opinion was modified

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 paper. Whether such a review provides sufficient appropriate audit evidence is influenced by the professional competence and independence of the predecessor auditor.

Audit evidence about opening balances for current assets and liabilities may be obtained as part of the current period’s audit procedures. For example, the collection (payment) of opening account receivable (account 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 : (1) observing a current physical inventory count and reconciling it to the opening inventory quantities, (2) performing audit procedures on the valuation of the opening inventory items, (3) performing audit procedures on gross profit and cutoff.

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.

So, now can you figure it out how far should the auditor go for the audit of opening balances ?

The Opening Balances

Some questions may arise when we are appointed to replace the former auditor of a company or when the previously financial statements were not audited. What kind of audit procedures have to be conducted by the auditor at the initial audit engagement within this condition ? If the auditor did not apply any audit procedure regarding on the opening balance of the current period’s financial statements, would it be affected to the audit opinion ?

International Standard on Auditing (ISA) 510 Initial Audit Engagements – Opening Balances rules this conditions clearly. This ISA is effective for audits of financial statements for periods beginning on or after December 15, 2009.

Para.3 of this ISA states that in conducting an initial audit engagement (wherein the financial statements for the prior period were not audited, or were audited by a predecessor auditor), the objective of the auditor with respect to opening balance is to obtain sufficient appropriate audit evidence about whether :

(a) opening balances contain misstatements that materially affect the current period’s financial statements; and

(b) 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.

Following are several audit procedures that should be done by the successor auditor regarding the opening balance of financial statements :

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.

2. the auditor shall obtain sufficient appropriate audit evidence about whether the opening balance contain misstatements that materially affect the current period’s financial statements by :

(a) determining whether the prior period’s closing balances have been correctly brought forward to the current period or, when appropriate, have been restated;

(b) determining whether the opening balance reflect the application of appropriate accounting policies, and

(c) performing one or more of the following : (i) where the prior year financial statements were audited, reviewing the predecessor auditor’s working papers to obtain evidence regarding the opening balances, (ii) evaluating whether audit procedures performed in the current period provide evidence relevant to the opening balance, or (iii) performing specific audit procedures to obtain evidence regarding the opening balances.

If the auditor is unable to obtain sufficient appropriate 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.

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 an adverse opinion.

If the auditor concludes that : (a) the current period’s accounting policies are not consistently applied in relation to opening balances in accordance with the applicable financial reporting framework, or (b) a change in accounting policies is not appropriately accounted for or not adequately presented or disclosed in accordance with the applicable financial reporting framework, the auditor shall express a qualified opinion or an adverse opinion (Hrd).

Reference : ISA 510 Initial Audit Engagements – Opening Balances