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Audit matters of governance interest ordinarily include

 Material weaknesses in internal control

 Non-compliance with laws and regulations

 Fraud involving management

 Questions regarding management integrity

 The general approach and overall scope of the audit

 The selection of, or changes in, significant accounting policies and practices that have a material effect on the financial statements

 The potential effect on the financial statements of any significant risk and exposures, such as pending litigation, that requires disclosure in the financial statements

 Significant audit adjustments that could materially affect the financial statements

 Material uncertainties relating to the entity’s ability to continue as a going concern

 Disagreement with management about matters that could be significant to the entity’s financial statements or the auditor’s report

 Expected modifications to the auditor’s report.

 Unadjusted/uncorrected misstatements aggregated by the auditor during the audit which management considers immaterial, both individually and in aggregate, to the financial statements taken as a whole.

 Any other matters agreed upon in the terms of the engagement.

The two formal means of communicating audit matters are:

 The letter of Engagement and

 The Management Letter, letter of weakness, internal control Memorandum or Constructive Service letter.

Matters relating to accounting system and the system of internal control such as any material weaknesses in accounting and internal control and the auditor’s views on the company’s accounting policies and financial reporting(commonly referred to as reportable conditions) are communicated through a Management Letter, the subject matter of ISA 265.

ISA 260 Communicating with those charged with governance

Auditor communicates with those charged with governance to provide useful feedback about the audit. Those charged with governance may be the Board of directors or the audit committee (a subcommittee of the board).

The objectives of the auditor in respect of ISA 260 are to:

(a) communicate clearly with those charged with governance the responsibilities of the auditor in relation to the financial statement audit, and an overview of the planned scope and timing of the audit;

190 (b) obtain from those charged with governance information relevant to the audit;

(c) provide those charged with governance with timely observations arising from the audit that are significant and relevant to their responsibility to oversee the financial reporting process; and

(d) promote effective two-way communication between the auditor and those charged with governance.

Matters to be communicated

1. The Auditor’s Responsibilities in Relation to the Financial Statement Audit: The auditor shall communicate with those charged with governance his responsibilities in relation to the financial statement audit, including that:

(a) He is responsible for forming and expressing an opinion on the financial statements that have been prepared by management with the oversight of those charged with governance; and

(b) The audit of the financial statements does not relieve management or those charged with governance of their responsibilities.

2. Planned Scope and Timing of the Audit: The auditor shall communicate with those charged with governance an overview of the planned scope and timing of the audit, which includes communicating about the significant risks identified by the auditor.

3. Significant Findings from the Audit: These are management letter points usually communicated along with deficiencies in internal control per ISA 265.

The auditor communicates

(a) His views about significant qualitative aspects of the entity’s accounting practices, including accounting policies, accounting estimates and financial statement disclosures.

(b) Significant difficulties, if any, encountered during the audit;

(c) Unless all of those charged with governance are involved in managing the entity:

(i) Significant matters arising during the audit that were discussed, or subject to correspondence, with management; and

(ii) Written representations the auditor is requesting;

(d) Circumstances that affect the form and content of the auditor’s report, if any; and

(e) Any other significant matters arising during the audit that, in the auditor’s professional judgment, are relevant to the oversight of the financial reporting process.

4. Auditor Independence: In the case of listed entities, the auditor shall communicate with those charged with governance (in writing),a statement that the engagement team and others in the firm as appropriate, the firm and, when applicable, network firms have complied with relevant ethical requirements regarding independence; and

(i) All relationships and other matters between the firm, network firms, and the entity that, in the auditor’s professional judgment, may reasonably be thought to bear on independence. For example, total fees charged during the period covered by the financial statements for audit and non-audit services provided by the firm and network firms to the entity and components controlled by the entity; and

(ii) The related safeguards that have been applied to eliminate identified threats to independence or reduce them to an acceptable level.

191 Establishing the communication process

The communication with those charged with governance may be provided either in writing or orally. It could take place as a discussion between the auditor and an appropriate level of management e.g. the audit committee for a larger company.

Where oral communication would not be adequate, ISA 260 requires that communication is in writing, in the form of a letter or report. If communication is oral then the matters communicated, to whom and when must be documented.

Communication must be made on a timely basis. The appropriate timing will vary depending on the matter to be communicated. Communication in respect of planning matters will be likely to be made early in the engagement. Any significant difficulties encountered during the audit should be communicated as soon as practicable, especially if they are likely to lead to a modified opinion.

Actions when an audit report is to be modified

ISAs 705 and 706 require the auditor to communicate any planned modification to the auditor’s report with those charged with governance. This is to ensure that those charged with governance understand that a modification is to be made and the reasons for it. Early communication also gives those charged with governance an opportunity to provide the auditor with further information and explanation prior to the issuance of the auditor’s report.

ISA 265: Communicating deficiencies in internal control

A deficiency is defined by ISA 265 as wherea control is designed, implemented or operated in such a way that it is unable to prevent, or detect and correct, misstatements in the financial statements on a timely basis, or a control necessary to prevent, or detect and correct, misstatements in the financial statements on a timely basis is missing.

A significant deficiency is one which merits the attention of those charged with governance. ISA 265 requires the auditor to communicate significant deficiencies identified during the audit to those charged with governance in writing on a timely basis; and tocommunicate any other deficiencies to an appropriate level of management

The communication of significant deficiencies must be in writing and is required to cover:

 A description of the deficiencies and an explanation of their potential effects.

 Sufficient information to allow those charged with governance and management to understand the context of the communication, including an explanation that:

a. the purpose of the audit was to express an opinion on the financial statements b. the audit did include consideration of internal controls in order to design

appropriate audit procedures, and not for the purpose of expressing an opinion on the effectiveness of internal control, and

c. the matters being reported are limited to those deficiencies identified during the audit and considered of sufficient importance to be reported.

The auditor will also usually state that such communication has been provided for the purposes of those charged with governance, and that it may not be suitable for other purposes.

192 3.3 The Management Letter

Main Object: To assist those charged with governance in improving the accounting system, the control environment and to highlight any matters that may be relevant to future audit.

Purposes/Advantages

1. To enable the auditor give his assessment of the accounting system, records and controls.

2. To enable the auditor bring to the attention of management areas of system weakness that may give room to material misstatements and errors.

3. To enable the directors and management to deal with and correct matters that could have led to the modification of the report to shareholders.

4. To enable the auditor point out to management areas where they could be more efficient and effective or where economies in the use of resources could result.

5. To enable the auditor communicate matters that may have an impact on future audits.

6. Serves as a good defence for the auditor, in case of litigation, that the weaknesses occasioning loss were brought to the attention of management.

Contents

The Management Letter usually includes the following maters–

i. The overall approach and scope of the audit, including limitations on the scope of the audit

ii. The accounting policies, and any changes to them, that could materially affect the financial statements

iii. Adjustments arising as a result of audit procedures which could materially impact the financial statements

iv. Material events or uncertainties which could jeopardise the going concern status and which require disclosure within the financial statements

v. Disagreements with management over accounting treatments or disclosures ( including details of non-compliance with accounting standards or legislation)

vi. Any expected modifications of the audit report

vii. Material weaknesses discovered in the accounting and internal control systems.

Other relevant matters to be communicated may include:

 Details of any threats to independence and objectivity and of any safeguards adopted

 Explanations of the audit approach used, including materiality concept and its application to the audit process

 A summary of the business risks identified, including the auditor’s assessment of the likelihood of the risks materializing

 A review of the contents of the management’s representation letter

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 Recommendations, where relevant, to help improve the entity’s internal systems and controls.

Format

There is no set format but the report should highlight the following:

a) The weaknesses discovered b) The implications for the company

c) The recommendations/corrective actions needed.

It is common to add a column for management’s response after the ‘implications’.

Note: Management’s response to each of the issues raised is important. The response has to be discussed with them before finalization and submission of report

4.0 Conclusion

An important aspect of the audit is the communication of observed weakness/deficiencies and other matters of governance interest to those charged with governance for corrective action. This is done the management letter.

5.0 Summary

This unit surveyed the requirements of ISA 260 Communicating with those charged with governance and ISA 265 Communicating deficiencies in internal control and highlighted matters to be communicated to those charged with governance. It also described the form and content of a management letter and the benefits derivable therefrom.

6.0 Tutor-marked Assignment

1. Discuss four matters the auditor communicates to those charged with governance.

2. State the main object of a management letter and discuss 5 advantages of a management letter.

7.0 References/further reading

1. Millichamp, A.H & Taylor, J.R (2011). Auditing, 11^th Edition, London: BookPower/ELST 2. ICAN(2014).Advanced Audit and Assurance Study text. UK: Emile Woolf International 3. ACCA Study Text on Advanced Audit and Assurance. UK: BPP Learning Media

4. International Standards on Auditing 260 and 265.

194 UNIT 15: INVESTIGATIONS

Content

1.0 Introduction 2.0 Objectives 3.0 Main Content