P7 LSBF Class notes September 2017 – June 2018 PDF

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ACCA Paper P(INT)Advanced Audit &AssuranceClass NotesSeptember 2017 – June 2018© Interactive World Wide Ltd, April 2017All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photoc...

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ACCA Paper P7 (INT)

Advanced Audit & Assurance Class Notes September 2017 – June 2018

© Interactive World Wide Ltd, April 2017 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of Interactive World Wide Ltd.

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Contents PAGE INTRODUCTION TO THE PAPER

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CHAPTER 1:

REGULATORY ENVIRONMENT

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CHAPTER 2:

PROFESSIONAL AND ETHICAL CONSIDERATIONS

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CHAPTER 3:

PRACTICE MANAGEMENT

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CHAPTER 4:

ASSIGNMENTS I – THE AUDIT OF FINANCIAL STATEMENTS

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CHAPTER 5:

ASSIGNMENTS II – GROUP AUDITS

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CHAPTER 6:

AUDIT REPORTS AND OTHER REPORTS

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CHAPTER 7:

ASSIGNMENTS III – OTHER ASSIGNMENTS

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CHAPTER 8:

CURRENT ISSUES AND DEVELOPMENTS

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QUESTION BANK

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Introduction to the Paper

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IN TR O D U CT ION T O T HE P A P E R

AIM OF THE PAPER The aim of the paper is to apply relevant knowledge, skills and exercise professional judgement in analysing, evaluating and concluding and reporting on the assurance engagement and other audit and assurance issues in the context of best practice and current developments. In simpler terms, this means a very practical exam, in which students need to look at real situations and identify relevant issues to an auditor (or other assurance provider), and how those issues may be addressed.

OUTLINE OF THE SYLLABUS A.

Regulatory Environment

B.

Professional and Ethical Considerations

C.

Practice Management

D.

Audit of Historical Financial Information

E.

Other Assignments

F.

Reporting

G.

Current Issues and Developments

FORMAT OF THE EXAM PAPER The syllabus is assessed by a three hour and 15 minute paper-based examination. The examination consists of: ●

two compulsory questions, totalling 60 marks (35 + 25), and covering several areas of the syllabus within a single scenario, and

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a choice of two from three questions worth 20 marks each, which are each likely to focus mostly on a single syllabus area. ● 4 Professional Marks, all of which will be in either Q1 or Q2, awarded for a specific format of answer (typically Briefing Notes)

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Chapter 1

Regulatory Environment

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CHA P TE R 1 – R E G ULA T O R Y E N V IR O N ME N T

EXAM QUESTIONS ● Define “Money Laundering”, and explain the auditor’s responsibilities. ● Comment on the need for ethical guidance for accountants on money laundering. (Pilot Paper Q5) ● Explain the auditor’s responsibilities relating to the laws and regulations that apply to a client’s business.

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CHA P TE R 1 – R E G ULA TO R Y E N V IR O N ME N T

INTERNATIONAL REGULATORY FRAMEWORKS

Regulatory framework In each country, regulation comes from a number of sources. Since this is largely a revision area from F8, and is not examined very often on P7, the Notes here are deliberately brief. Regulation is necessary in many industries, and audit/assurance is no exception. So many people rely on the information produced by organisations, and as a result those who give assurance on that information fulfil a vital role. If work was not regulated, there would be too much variety in how work was done, and a major threat to quality control.

Summary of regulators ACCA To be an auditor, you need to be authorised in your country to audit. In the UK (and throughout Europe) this is done by requiring you to be a member of a Recognised Supervisory Body (RSB) and ACCA is one of these. The ACCA ensures auditors are suitably qualified; monitors behaviour, and quality control.

The IAASB The International Audit & Assurance Standards Board sets International Audit Standards (ISA). Many countries have either adopted these in full, or based their own national audit standards very closely on them. The IAASB is part of the International Federation of Accountants (IFAC).

The FRC The Financial Reporting Council in the UK regulates UK financial reporting, including corporate governance. Its various bodies set UK accounting standards and the UK Corporate Governance Code. Most countries have their own version of the FRC.

Public Oversight Board Given recent corporate scandals, there has been a trend for setting up independent bodies to oversee the “experts”. IFAC has an oversight board, but individual countries also have their own (in the UK, this is part of the FRC ). Accountants and auditors used to be self-regulating, but too many failures (eg Enron) have put a stop to this.

Corporate governance Corporate Governance now appears on many of the ACCA exam papers, eg F1, F4, F8 and P1 – with most of the detail on papers P1 and F8. As such, detailed questions in P7 are relatively unlikely. Chapter 1 of the P7 Study Text has a useful reminder of the main areas, which are not repeated here as they should be revision.

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There is just one area that is important enough to get a brief mention in these notes:

Audit Committees Audit Committees have been a requirement for US listed companies since the 1970s, and are also part of the UK Corporate Governance Code. Audit Committees are a sub-committee of the Board of Directors, and are typically made up only of Independent Non-Executive Directors. Their main roles are: ● To oversee the company’s financial reporting, internal control systems, and risk management processes. ● To help appoint and monitor the performance of the internal audit function. ● To improve the independence of internal audit (eg by considering the benefits of outsourcing it). ● To act as the main contact point for external auditors, to improve their independence. ● To suggest a firm of external auditors. ● To monitor the quality of both internal and external audit work. If the independence of audit committee members is in question (e.g. the company is a family company where NEDs lack independence in general), then the value of the audit committee will be reduced

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CHA P TE R 1 – R E G ULA TO R Y E N V IR O N ME N T

MONEY LAUNDERING AND THE AUDITOR Definition The process by which criminals attempt to hide the true source of their funds in an attempt to make it look like their funds have come from legitimate sources. In many countries, the definition is even broader, and possessing or transferring the proceeds of ANY crime can be money laundering. For example, breaching health and safety regulations in order to save money makes the company a money launderer – it possesses the cost savings, and these were saved by committing a crime.

3 stages of money laundering The money launderer has a number of problems: ● They are holding the proceeds of a crime in cash, which increases the risk of being caught with it ● Spending, or depositing, large amounts of cash which was earned illegally would draw unwanted attention and questions of where the money came from ● The money is too closely associated with the initial crime So, the criminal needs to get rid of the cash as soon as possible, do something to make the cash look legitimate (i.e. “clean”), and then get the cash back so it can be spent and enjoyed without questions being asked. This is done in 3 stages :

Placing This is getting rid of the cash in exchange for something else. In many ways, the most dangerous bit of the process, because this is where the risk of questions being asked is at its greatest. In some ways, “placing” is the start of the second stage in that it is the first transaction of the many that will be called “layering” (see below). Placing involves the money entering the financial system, but it needs to be done carefully and preferably in small amounts so as to avoid raising suspicion. Possible methods would be: ● Changing it into a different currency, using small foreign exchange brokers rather than a bank ● Placing bets with it ● Take the currency to a country where fewer questions tend to be asked ● Put it into a company and claim it is cash sales

Layering If you put money into a company on Monday, and then paid yourself a bonus on Tuesday, it would not take much for an investigator to link the two things together. Layering involves moving the money around by switching countries, buying and selling investments, and generally trying to create a trail that is as long and difficult to follow as possible.

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Integration This is the point at which the laundered believes that it is safe to get the cash back, because the layering trail is long enough that it would be difficult to track back to the beginning. The laundered now aims to get the money paid to them, so that they can spend it on the luxuries the desire.

Audit responsibilities In the past, it was felt that too often auditors and accountants were failing to notice (or maybe failing to look!) that their clients had unexplainable funds, or that some of their business transactions had no obvious business logic. Over the past 20 years, and particularly since 2000, there has been an international attempt to tighten laws on money laundering, and to force professionals (especially accountants) to do more. This has been led by the Financial Action Task Force (FATF) on Money Laundering, which has around 30 of the leading Economies of the World as members. ACCA has issued Technical Fact Sheet 145 to provide guidance to audit firms. The main obligations are: ● To make sure you know who your client really is, and to confirm where they get their money from (“Customer Due Diligence”). ● To report any suspicions of money laundering to the relevant authority (in the UK, the National Crime Agency (NCA). ● Not to tip off a client when you have suspicions. Any failure to do the above can result in prison – so this needs to be taken very seriously! Accountancy firms are required to have detailed procedures in place to show that they are following the rules. Poor quality policies and procedures can lead to firms being fined.

Practical things for audit firms to do ● Appoint an MLRO (Money Laundering Reporting Officer) whose job is to make sure all other ML processes are in place in the Firm, and to decide whether suspicions raised by staff should be reported externally to NCA. The MLRO is likely to be a partner. ● Have Know Your Client (KYC) procedures – the better you know your client, the easier it is to spot odd transactions and behaviour. ● Check the identity of all new clients ( eg by checking passports of directors, Companies House searches on the company itself, its directors and who owns it). ● Train all relevant staff in ML processes, and in how to spot suspicious transactions.

Suspicious transactions ● Transactions that pass through several companies or countries, especially when there is no obvious reason for doing so. ● Multiple small transactions of a similar nature, rather than one large individual transaction.

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CHA P TE R 1 – R E G ULA TO R Y E N V IR O N ME N T

● The creation of complicated groups of companies when a simpler solution appears to exist. ● The creation of a new company that is never actually used to trade. Cash-based businesses have always been a favourite for money launderers, as they can pass their illegal funds through the company and claim that it is sales revenue. Because it is cash, there may be very little (if any) proof of where it came from.

Example Mr Sowerby is a very successful international drugs dealer, and he has $10million of cash that he wishes to “launder”, so that he can spend it without fear of being questioned as to where he earned it. He builds a gym, and fills it with top of the range equipment, and opens for business. He will probably have to use mostly legitimate money to do this, as attempts to pay contractors and suppliers in cash may be greeted with suspicion. Now the gym is open and has members, he adds fake members to the membership records and pays their fees in cash, using his drugs money. He may have to set up these fake members with addresses of friends, so that if anyone chose to check, they would get the answer Mr Sowerby wants! Notice that he is quite happy to lose some of his money in order to make it legitimate. Before he gets the money as business profits, it will be taxed – but it is worth it, to allow him to spend the remainder. Observations ● Many businesses refuse to accept cash in excess of a certain limit, as they are afraid that any large cash figure accepted may have come from illegal sources. ● Any cash based business is useful for money laundering – casinos and launderettes for example. How could An Auditor Spot This? ● Analytical procedures – comparing the number of members on the register with the amount who actually turn up at the gym, or considering whether the membership numbers are reasonable for the area in which the gym is located. ● Being aware that a gym is a potential money laundering business! Situations that could lead to money laundering offences ● A client under a tax investigation … if problems are found, the evaded tax is the proceeds of crime. ● Client making “facilitation payments” (ie bribes) to help smooth certain transactions (eg paying an official a fee to ensure a contract is won). ● Having clients in political positions makes them “politically exposed persons” (PEP), who have the power to enrich themselves with public money. As such, auditors should treat such clients with extra care, ensuring they fully understand the source of all of their funds.

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The need for ethical guidance Money laundering situations may be complex, so ethical guidance would be useful in the following ways: ● In helping to understand the heavy legal burden. ● In providing a framework of how to address situations not covered by law or previous experience. ● In helping to resolve conflicts between client confidentiality, and the need to report externally. ● In helping to guide an outgoing auditor in what he can say to an incoming auditor as part of the “professional clearance” process. ● In helping to guide auditors working in countries where there are no / limited money laundering laws. ● In helping to understand the interaction between money laundering and the audit report, and other reports to clients and 3rd Parties.

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LAWS AND REGULATIONS AFFECTING CLIENTS (ISA 250)

Responsibility of the auditor Auditors cannot know and understand every law and regulation that affects every client, but they should aim to be aware of those that could materially affect the Financial Statements. By doing this, they are more likely to spot breaches, even if management do not tell them (or are themselves not aware). Where breaches are found, that the auditor considers material: ● Report the breach to management (it is their ultimate responsibility, not the auditor’s, to ensure the company is not breaking laws). ● If the breach involves management, report to the highest level possible ( eg Audit Committee). ● If the breach involves the highest level possible, may need to take legal advice and consider whether the lack of integrity necessitates resignation by the auditor ● Consider the effect of the breach on the accuracy of the Financial Statements as breaches lead to fines (which might require a provision under IAS 37), and serious breaches might threaten a client’s going concern status (which would require disclosure under IAS 1). ● If laws are new, or have been announced but precise detail is yet to be agreed by government, it may be difficult to assess the effect on the company, and may affect the Going Concern assessment. ● In some cases, a breach may have external reporting consequences.

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Chapter 2

Professional and Ethical Considerations

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CHA P TE R 2 – P R O F E S S IO N A L A N D E TH IC A L CO N S ID E R A TIO N S

EXAM QUESTIONS ● Identify the ethical and other professional issues relating to the above situations and state what action, if any, should be taken (Pilot Paper Q5). ● To whom are auditors held liable for poor audit work? ● How can an audit firm restrict their liability?

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CHA P TE R 2 – P R O F E S S IO N A L A N D E T H ICA L C ON S ID E R A T ION S

THE CODE OF ETHICS It is essential that accountants have the public’s trust. As such, ethical behaviour is critical to the reputation of the accountancy profession, and to the value of accountancy and audit work. IFAC have a Code of Ethics, and most accounting bodies (including ACCA) have adopted virtually all of its content.

Fundamental principles These were met at Paper F8, and so no explanations are provided – refer to Chapter 2 of the Study Text if you need a detailed reminder: ● Integrity ● Objectivity ● Professional competence and due care ● Confidentiality ● Professional behaviour.

Why a “Conceptual Framework”, not rules? ● Would be impossible to have rules for every situation ● Rules prevent the use of thought ● As professionals, we should be able to rely on accountants to use professional judgement ● In many cases, there may not be a “right” answer ● Depending on your morals, 2 different people may believe there are 2 very different “right” answers!

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CHA P TE R 2 – P R O F E S S IO N A L A N D E TH IC A L CO N S ID E R A TIO N S

Objectivity It is essential that auditors (and anyone giving an opinion) be, and be seen to be objective.

Threats ● Self-Interest o

undue dependence on a single client

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overdue fees

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gifts and hospitality

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loans to/from client

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contingent fees

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lowballing

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owning shares in client.

● Self-Review o

other services

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preparation of the accounting records being audited.

● Intimidation o

family relationships

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undue dependence on a single client

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financial / business relationship with client

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second opin...