‘Clarity’ has arrived for auditors

Following on from a continued wave of improvements to Accounting Standards, the International Auditing and Assurance Standards Board (IAASB) embarked on the ‘clarity’ project.

It undertook a ‘clarity’ programme to enhance the users’ understanding of its International Auditing Standards (ISAs). Tied to the ideals of harmonisation internationally, the Australian Auditing and Assurance Standards Board (AUASB) followed suit by revising and redrafting the Australian Auditing Standards (ASAs) in ‘clarity format’.

The most obvious change in the international standards has been the replacement of the term ‘should’ with ‘shall’ when describing black-letter requirements that place obligations upon auditors. While 'should' had a gentlemen's agreement feel about it, there is no room for discretion when the change to ‘shall’ is considered.

Here in Australia, this significant change was adopted into Australian Auditing Standards (ASAs) back in 2006 when the standards obtained ‘force of law’. The main impact for both auditors and companies alike of this latest redrafting and revision will therefore be through ‘elevations’ from the old standards from guidance only notes to mandatory procedures (shalls) and through enhanced clarifications. This article aims to highlight the main enhancements.

The revised and redrafted ASAs are effective for audits of financial statements commencing for reporting periods beginning on or after 1 January 2010 (essentially December 2010 year ends).

ASA 260 Communication with Those Charged with Governance

The standard aims to promote effective two-way communication between the auditor and those charged with governance. Note that those charged with governance has now been extended to include persons who act with both management and governance responsibilities.

Specific matters, which must be communicated to you by your auditors, include:

• Their views on significant qualitative aspects of the your accounting practices
• Any significant difficulties encountered during the audit
• Any significant matters communicated to management (where management is separate from those charged with governance)
• All written representations requested from management (where management is separate from those charged with governance)
• Any other matters the auditor considers significant to the oversight of the financial reporting process.

Paragraph 17 now requires that the auditor of a listed entity has to communicate to those charged with governance total fees charged by the auditor’s firm (including network firms) for audit and non-audit services for the period covered by the financial report. Fees are to be allocated to appropriate categories to assist those charged with governance in assessing the auditor’s independence.

ASA 265 Communicating Deficiencies in Internal Control to Those Charged with Governance and Management

This is a new standard which is designed to address the way in which auditors report control deficiencies to those charged with governance. Whilst the standard introduces requirements for the auditor to communicate in writing, to those charged with governance, and where appropriate, management, all significant deficiencies in internal control and their potential effects, this should not represent a significant change from current best practice procedures of communicating in management letters where controls have failed or do not exist.

The major difference you will notice is that the term ‘material weakness’ has been replaced with ‘significant deficiency’. Paragraph six defines a ‘significant deficiency’ as a deficiency or combination of deficiencies in internal control that, in the auditor’s professional judgement, is of sufficient importance to merit the attention of those charged with governance.

ASA 540 (revised and redrafted) Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures

The revised Auditing Standard introduces new risk assessment procedures that were not contained in the existing Auditing Standards. For example, paragraph eight requires the auditor to understand the requirements of the applicable financial reporting framework, how management identifies transactions and events that may give rise to accounting estimates, and how management makes accounting estimates (including assessing the effect of estimation uncertainty).

For any accounting estimates that give rise to significant risks of misstatement, paragraph 15 requires the auditor to evaluate:

• How management has considered alternative assumptions or outcomes
• Whether management’s assumptions are reasonable
• Where relevant to the reasonableness of management’s assumptions, or the application of the financial reporting framework, management’s intent to carry out courses of action and its ability to do so.

The ASA emphasises the importance for the auditor to adopt a higher degree of professional scepticism where accounting estimates, fair value estimates, and related disclosures are concerned, with particular emphasis placed on management bias.

ASA 550 (revised and redrafted) Related Parties

Auditing related party transactions has always been difficult due to their subjective nature. This revised and redrafted standard recognises that risks of material misstatement are higher when related parties are involved.

Paragraph 14 requires the auditor to obtain an understanding of the internal controls, if any, that management has established to: identify, account for and disclose related party transactions; authorise and approve significant transactions and arrangements with related parties; and authorise and approve significant transactions and arrangements outside the normal course of business.

The standard requires that where controls are not present in this area, the auditor may be required to report the fact to those charged with governance.

In addition, the updated standard requires the auditor to challenge any management assertion that transactions with related parties are on an arm’s length basis.

Remember, it is important to note that the Standard applies regardless of whether your company is required to disclose related party transactions in the financial report.

ASA 600 (revised and redrafted) Special Considerations - Audits of a Group Financial Report (including the Work of Component Auditors)

This revised ASA covers a wider scope than the previous standard and sets out new requirements in respect of the relationship between the group engagement team and the component auditors. It will affect audit firms who are not the auditor for the entire group.

The following areas are likely to require additional thought and documentation by the auditor:

• Consideration of whether the engagement is a group audit within the scope of ASA 600 (revised and redrafted).
• Establishing an overall group audit strategy and group audit plan.
• Scoping the group audit, including determining significant components in the group.
• Gaining an understanding of the group-wide internal control environment and the consolidation process.
• Determining materiality and performance materiality for the group and its components.
• Obtaining an understanding of the competency of any component auditors involved in the work.

Clear communication between group and component auditors will be paramount, remembering that audit firms do not need to be the same firm worldwide.

ASA 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report

This standard does not lay down specific circumstances when an ‘emphasis of matter’ paragraph or an ‘other matter’ paragraph is required, only general principles governing the use of these in the auditor’s report.

Emphasis of matter paragraphs are no longer included in the definition of a modified opinion.

Furthermore, ASA 706 withdraws the previous restriction of emphasis of matter paragraphs to the five specific circumstances permitted previously under ASA 701, i.e.:

• Significant uncertainty re going concern
• Significant uncertainty – other
• Additional disclosures
• Inconsistent other information
• Subsequent event resulting in a new auditor’s report on a revised financial report.

Now emphasis of matter or other matter paragraphs are to be included wherever the auditor believes it is necessary. A significant uncertainty, the resolution of which may materially affect the financial report, would continue to warrant an emphasis of matter.