You are the manager responsible for the audit of CGL, a public interest entity, for the year ended 31 December 2018. Your firm was appointed as auditors of CGL in September 2017. The audit work has been completed, and you are reviewing the working papers in order to draft a report to those charged with governance. The statement of financial position (balance sheet) shows total assets of GH¢ 78 million (2017 – GH¢ 66 million). The main business activity of CGL is the manufacture of farm machinery.
During the audit of property, plant and equipment it was discovered that controls over capital expenditure transactions had deteriorated during the year. Authorisation had not been granted for the purchase of office equipment with a cost of GH¢ 225,000. No material errors in the financial statements were revealed by audit procedures performed on property, plant and equipment.
An internally generated brand name has been included in the statement of financial position (balance sheet) at a fair value of GH¢10 million. Audit working papers show that the matter was discussed with the financial controller, who stated that the GH¢ 10 million represents the present value of future cash flows estimated to be generated by the brand name. The member of the audit team who completed the work programme on intangible assets has noted that this treatment appears to be in breach of IAS 38 Intangible Assets, and that the management refuses to derecognise the asset.
Problems were experienced in the audit of inventories. Due to an oversight by the internal auditors of Charged with Governance Limited (CGL), the external audit team did not receive a copy of inventory counting procedures prior to attending the count. This caused a delay at the beginning of the inventory count, when the audit team had to quickly familiarise themselves with the procedures. In addition, on the final audit, when the audit senior requested documentation to support the final inventory valuation, it took two weeks for the information to be received because the accountant who had prepared the schedules had mislaid them.
Required:
a) Identify FIVE (5) purposes of including ‘findings from the audit’ (management letter points) in a report to those charged with governance. (5 marks)
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Purposes of including findings from audit
- A report to those charged with governance is produced to communicate matters relating to the external audit to those who are ultimately responsible for the financial statements.
- ISA 260 Communication of Audit Matters with those charged with governance requires the auditor to communicate many matters, including independence and other ethical issues, the audit approach and scope, the details of management representations, and the findings of the audit. The findings of the audit are commonly referred to as management letter points.
- By communicating these matters, the auditor is confident that there is written documentation outlining all significant matters raised during the audit process, and that such matters have been formally notified to the highest level of management of the client.
- For the management, the report should ensure that they fully understand the scope and results of the audit service which has been provided, and is likely to provide constructive comments to help them to fulfil their duties in relation to the financial statements and accounting systems and controls more effectively.
- The report will also help include, where relevant, any actions that management has indicated they will take in relation to recommendations made by the auditors.
b) From the information provided above, identify the matters which should be included as ‘findings from the audit’ in your report to those charged with governance, and explain the reason for their inclusion. (15 marks)
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- Control weakness
ISA 260 contains guidance on the type of issues that should be communicated. One of the matters identified is a control weakness in the capital expenditure transaction cycle. The assets for which no authorisation was obtained amount to 0·3% of total assets (225,000/78 million x 100%), which is clearly immaterial. However, regardless of materiality, the auditor should ensure that the weakness is brought to the attention of the management, with a clear indication of the implication of the weakness, and recommendations as to how the control weakness should be eliminated.
The auditor is providing information to help those charged with governance improve the internal systems and controls and ultimately reduce business risk. In this case there is a high risk of fraud, as the lack of authorisation for purchase of office equipment could allow expenditure on assets not used for bona fide business purposes. - Disagreement with accounting treatment of brand
Audit procedures have revealed a breach of IAS 38 Intangible Assets, in which internally generated brand names are specifically prohibited from being recognised. Charged with Governance Limited (CGL) has recognised an internally generated brand name which is material to the statement of financial position (balance sheet) as it represents 12·8% of total assets (10/78 x 100%). The statement of financial position (balance sheet) therefore contains a material misstatement.
The report to those charged with governance should clearly explain the rules on recognition of internally generated brand names, to ensure that the management has all relevant technical facts available. In the report the auditors should request that the financial statements be corrected, and clarify that if the brand is not derecognised, then the audit opinion will be qualified on the grounds of a material disagreement – an ‘except for’ opinion would be provided. Once the breach of IAS 38 is made clear to the management in the report, they then have the opportunity to discuss the matter and decide whether to amend the financial statements, thereby avoiding a qualified audit opinion. - Audit inefficiencies
Documentation relating to inventories was not always made readily available to the auditors. This seems to be due to poor administration by the client rather than a deliberate attempt to conceal information. The report should contain a brief description of the problems encountered by the audit team. The management should be made aware that significant delay to the receipt of necessary paperwork can cause inefficiencies in the audit process. This may seem a relatively trivial issue, but it could lead to an increase in audit fee. Management should react to these comments by ensuring as far as possible that all requested documentation is made available to the auditors in a timely fashion.