Tax planning is the arrangement of one’s affairs in such a manner that the tax planner may either reduce the incident of tax wholly or reduce it to maximum possible extent as may be permissible within the framework of the taxation laws. It does not amount to evasion of tax. It is an act of prudence and farsightedness on the part of the taxpayer who is entitle to reduce the burden of his tax liability to the maximum possible extent under the existing law. Tax planning ensures not only accruals of tax benefit within the four corners of law, but it also ensures that the tax obligations are properly discharged to avoid penal provision.

The first and foremost characteristic of tax planning is that it results in the reduction in tax liability of an individual which ensure that an individual has more disposable income which can be used by the individual for consumption or for making investments which can come in handy in future.

Another feature of tax planning is that one needs to plan in advance regarding how to make sure that tax liability is reduced to the maximum, possibly by investing in tax saving instruments right from start of the financial year. If a taxpayer is thinking that he/she can reduce tax liability by doing tax planning the night before the last date for filing income tax returns, then he/she will be in for disappointment.

Another feature of tax planning is that effective tax planning can be done only by investing in tax saving instruments which can be through tax exemptions, rebates, allowances and other reliefs or benefits permitted under the Law.

Tax planning is one thing which has to be made every year and unlike other investments like real estate or shares where one has to review the investment after 2 or 3 years.

Lastly, tax planning is dynamic in nature because every year you have to modify your tax plan according to rules framed by the government as the government keeps changing tax laws which in turn keep the tax planner on toes as he or she has to change his or her investment in tax saving instruments accordingly.
(3 marks for explanation of tax planning)
(2 marks for any two features of tax planning)

Intended objectives of Tax Planning

• Reduction of Tax Liability: A taxpayer can save the maximum amount of tax, by properly arranging his/her operations as per the requirements of the law, within the framework of the statute.
• Minimization of Litigation: There is a war-like situation between the taxpayers and tax authorities as the taxpayer wants the tax liability to be minimum while the authorities attempt to extract the maximum. So, a proper tax planning aims at conforming to the provisions of the tax law, in such a way that incidence of litigation is minimized.
• Productive Investment: One of the major objectives of tax planning is to channel taxable income to different investment plans. It aims at the optimum utilization of resources for productive causes and relieving the taxpayer from tax liability.
• Healthy Growth of Economy: The growth and development of the economy greatly depend on the growth of its citizens. Tax planning measures involve generating more money that flows freely and results in the sound progress of the economy.
• Economic Stability: Proper tax planning brings economic stability by various techniques such as mobilizing resources for national projects or availing ways for investments which are productive in nature.
• Employment generation: Tax planning creates employment opportunities in different ways. Firstly, efficient tax planning requires some sort of expertise that creates job opportunities in the form of advisory services. Secondly, amount saved through tax planning is generally invested in commencement of new business or the expansion of existing business. This creates new employment opportunities.                                            (Any 5 points for 5 marks)

Time Variable
When investors expect tax rates to decrease or remain constant over time, one desirable goal is to postpone the moment of taxation as further in the future as possible. Even when tax rates are expected to rise a little, one could benefit from delaying the recognition of income due to the concept of time value of money. However, if one expects a sharp increase in tax rates, acceleration of the recognition of income becomes rewarding.

Due to the decline in the present value of money, the further into the future that the money is received or paid out, the effect of a tax on income will be less if it occurs further in the future. Likewise, a tax deduction is more valuable if taken sooner rather than later, assuming that tax rates remain unchanged during the relevant time frame. Thus, taxes can be lowered by both postponing taxation of income items to later tax years and accelerating tax deductions to earlier tax years.

Also rules of taxation pertaining to taxpayers vary with respect to time. One set of rules may apply for the first five years and a different set will apply thereafter. Thus, a tax benefit available in one year may disappear in the next just as a statutory restriction causing a tax problem this year may be lifted in the future.

This planning technique is most effective when the taxation of the income can be deferred without differing the related cash flow from the income. In the same manner, greater tax savings will result if one is able to accelerate the deductions without altering the timing of the related cash payments.                                     (2.5 marks)

Jurisdiction or Location Variable
Another method to reduce income tax bill is to ensure that an additional income will be attributed to a family member (in case of individuals) or subsidiary (in case of corporations) with the lowest marginal tax rates. Such behaviour is especially profitable in countries with progressive income tax system and also in case of multinationals. We distinguish between two subtypes of such schemes: those that are purely under the jurisdiction of one tax authority (domestic transactions) and those that have an international scope (international transactions). Tax authorities around the world try to enforce the Substance-Over-Form and Business-Purpose Doctrines when dealing with the contracts between related parties (Scholes et al. 2005). They are much less concerned when contracts are written between parties with opposite interests as in those cases the use of arms-length prices is usually a rule.

All citizens and residents, including companies incorporated in Ghana are subject to income tax provided the income is accrued in, derived from or brought into Ghana. In Ghana the rate of corporate income tax differs depending on where the entity is located or the type of industry in which the company is operating. For example, within the Ghana Tax Jurisdiction companies located in the Free Zone Areas have different rules. Manufacturing Companies in Accra/Tema, Regional capital and other areas enjoy location incentives. Agro-based companies established in Ghana enjoy tax holidays and companies producing cocoa by-products from cocoa waste have different tax rates depending on where they are located.

In summary, tax plays an important role in location decisions, principally in three ways: the fiscal burden, the administrative burden, and long-term stability and predictability.                                     (2.5 marks)

Character or Activity variable
The third type of tax planning activities includes transactions which convert one type of income into another. In many countries “ordinary income” (like wages, dividends, interests etc) is taxed more heavily than capital gains. Sometimes the distinction has been made between “active income” and “passive income”. In the next two sections we analyze one relatively widespread scheme in Estonia that relies on differential taxation of dividends vis-à-vis compensation for work.

Every income item is characterized as either ordinary income or capital gain. Ordinary income is generated from sale of goods or performance of services in regular course of business. Income generated by investments (interest, dividends, royalties, and rents) is ordinary. Capital gains are generated by the sale or exchange of capital assets

Most business income is characterized as ordinary income and taxed at the rates applicable to the taxpayer earning the income. Several tax characters may provide for taxation at a lower rate. For example, individual taxpayers earning interest on Treasury bill issued by the Government of Ghana are exempted from tax. In addition, Banks’ lending to the agricultural sector have different rate from lending to other sectors of the economy.

When income is taxed at a preferential rate, the before-tax return earned may be lower than the returned earned on income subject to a higher tax rate. The reduction in pre-tax return inherent in tax-favoured investments is often referred to as an implicit tax. Implicit taxes arise in many jurisdictions in which preferential tax treatment is granted to certain activities but not to others. For instance, most tax laws encourage the acquisition of business property by allowing accelerated depreciation of asset costs over recovery lives much shorter than the assets economic lives. This situation leads to tax benefits decreasing the after-tax cost of purchasing assets relative to leasing comparable property. As a result, the cost of leasing may decline to induce business to continue to rent rather than buy assets.                          (2.5 marks)

Entity Variable
Different entities, such as sole proprietorships, partnerships, limited liability companies and corporations, are taxed at different rates, so choosing the right entity may minimize taxes. For instance, corporations do not pay employment tax, so if a taxpayer organizes his business as a corporation, he can receive part of his income as a dividend, which is not subject to employment taxes.

This focuses essentially on individuals and companies as the two types of taxpaying entities involved in business and investment transactions. Given the progressive nature of income tax rates in Ghana, the marginal tax rate applying to each taxpaying entity will depend on that entity’s particular circumstances. As a result, the tax rates are bound to differ among these organizations. Entity variable tax planning therefore takes advantage of these rates differentials to improve NPV. Entity variable refers to planning opportunities that shift income to an entity, which is subject to a lower marginal rate of tax or a shift of deductions to an entity subject to higher marginal tax rate.

An individual beginning a business or investing in another person’s business must carefully weigh the tax benefits and costs of different organizational forms against the non-tax costs or benefits of these entities before the business or investment is undertaken.

Tax costs decrease (and cash flows increase) when income is generated by an entity subject to a low tax rate.                (2.5 marks)

Trading in Ghana is having presence in Ghana, doing business in Ghana and making profits in Ghana. Trading in Ghana is taxable in Ghana while trading with Ghana is not having presence in Ghana and not doing business in Ghana. Trading with Ghana is not taxable in Ghana.

Tax implication of XYZ Park Co contract for fuel depot in Ghana are as follows:

• Production and Fabrication works – $500,000.
  This work is to be carried out outside Ghana. Therefore, permanent establishment cannot be established in Ghana. The income therefore not liable to tax in Ghana.

Installation Work and related service $200,000 and GH¢2,400,000 respectively.

• Installation site is in Ghana. This will serve as a permanent establishment for the performance of the work in Ghana.
• Related services will also be performed in Ghana and therefore will constitute a permanent establishment for XYZ Park in Ghana.
• If there is double tax agreement (i.e. tax treaty) between Ghana and the country of residence of XYZ Park, Ghana tax will apply to both the installation works and related service and appropriate relief provided.                 (4 points @ 1.5 marks each = 6 marks)

i) The Comparable Uncontrolled Price (CUP) method
The CUP method compares the price for property, goods or services transferred in a controlled transaction to the price charged for property or services transferred in a comparable uncontrolled transaction in comparable circumstances. An uncontrolled price is the price agreed between independent parties for the transfer of property, goods or services. If the transfer is in all material respects comparable to the transfer between related parties, the price becomes a comparable uncontrolled price.
There are two possible types of comparison which are:

• Internal comparable uncontrolled price where the price to the controlled transaction is compared to the price charged in a comparable transaction between one of the parties to the transaction and an independent person and;
• External comparable uncontrolled price where the price to the controlled transaction is compared to the price of a comparable transaction between independent parties, both of whom are unrelated to the parties to the controlled transaction

The use of an internal comparable uncontrolled price is preferred because relatively the circumstances of the controlled transaction are likely to reflect more closely those of the uncontrolled transaction.                (2 marks)

ii) Resale Price (RP) method
The resale price method is based on the price at which a product that has been purchased from a related party is resold to an independent person. This resale price is reduced by the resale price margin representing the amount out of which the reseller would seek to cover its selling and other operating expenses and, in the light of the functions performed (taking into account assets used and risks assumed), make an appropriate profit. What is left after subtracting the resale price margin can be regarded, after adjustment for other costs associated with the purchase of the product (e.g. customs duties) as an arm’s length price of the previous transfer of property between the related parties.

The resale price method will be most useful where the reseller contributes little to the value of the product ultimately on-sold on an arm’s length basis. This is because reliable comparables are more likely to be found. The method will be most reliable if the reseller on-sells within a short time because the more time that lapses, the greater the risks assumed in relation to changes in the market, in rates of exchanges, etc. This, and similar issues, will become significant if there are significant variances between such business practices carried out by the tested party, and those carried out by parties identified as comparables. If there are significant differences that, at arm’s length, are likely to impact upon the return to resellers, it will be necessary to make comparability adjustments.             (2 marks)

iii) Cost Plus (CP) method
The CP method uses the costs incurred by the supplier of property, goods or services in a controlled transaction. An appropriate CP mark-up is added to this cost, to make an appropriate profit in the light of the functions performed taking into account assets used, risks assumed and the market conditions. What is arrived at after adding the cost plus mark-up to the above costs may be regarded as an arm’s length price of the controlled transaction.

The CP method starts by computing the cost of providing the goods or services and adds an appropriate mark-up. In contrast, the Resale Price method starts from the final selling price and subtracts an appropriate gross margin to arrive at a purchase price. The CP method will use margins computed after direct and indirect costs of production, while a net margin method will use margins computed after operating expenses of the person as well.          (2 marks)

iv) Transactional Profit Split (PS) method
The (PS) method identifies the aggregate profit to be split for the related parties from a controlled transaction(s) and then splits those profits between the related parties based on an economically valid basis. The combined profits to be split are the profits combined earned by the associated enterprises from the controlled transaction under review.

The profit may be the aggregate profit from the transactions or a residual profit intended to represent the profit that cannot readily be assigned to one of the persons. Factors to be taken into account in undertaking a profit split are:

• Whether the profit split is to be undertaken on a particular product line, an aggregation of products, or a whole of entity basis.
• Whether it is necessary to identify the persons in relation to the transaction and the profits of each person so as to determine the profits to be split among them if the person transacted with more than one connected person.
• Whether the accounts of the related persons need to be put on a common basis as to accounting practice and currency and then consolidated in order for the combined profit to be determined.           (2 marks)

v) Transactional Net Margin Method (TNMM)
The TNMM examines the net profit margin relative to an appropriate base such as sales, costs or assets that a person realizes from a controlled transaction or transactions that it is appropriate to aggregate. This is compared with the result achieved by independent persons on a similar transaction(s). The main difference between the transactional net margin method and the profit split method is that the former is a one-sided method” that is applied only to one of the connected persons, whereas the latter is applied to all the relevant connected persons.

The transactional net margin method requires the comparison of net margins obtained in its related party dealings against either:

• The net margins of the person’s dealings with independent persons in comparable circumstances; or
• The net margins earned in comparable dealings between two independent persons.               (2 marks)

There are two types of double taxations: economic double taxation and juridical double taxation.

• Economic double taxation arises when income from the same economic activity is subjected to tax in the hands of different persons. Thus, Economic double taxation refers to the taxation of two different taxpayers with respect to the same income (or capital). Economic double taxation occurs, for example, when income earned by a corporation is taxed both to the corporation and to its shareholders when distributed as a dividend. A typical example usually cited to explain the concept of economic double taxation is the tax imposed on the income of an entity and dividends paid to shareholders. Since the income of the entity and the dividends paid to shareholders is generated from the same economic activity, the imposition of taxes at the corporate level and the shareholder level is viewed as economic double taxation of income.
• Juridical double taxation on the other hand, arises where more than one state imposes similar or comparable taxes on a stream of income of a person within identical periods. Thus, Juridical double taxation refers to circumstances where a taxpayer is subject to tax on the same income (or capital) in more than one jurisdiction. For example, a resident of Ghana who is also considered to be a resident of the United States would be potentially subject to concurrent full taxation in both countries.

The substantial difference between economic and juridical double taxation lies in the fact that whereas in juridical double taxation, the tax is imposed on the same income (tax object) in the hands of the same person (tax subject) by more than one state, in economic double taxation, the income is taxed in the hands of different persons.
Juridical double taxation usually arises due to the following:
 * Source Principles or Rules
 * Residence Principles or Rules
The jurisdiction to impose income tax is based either on the relationship of the income (tax object) to the taxing state (commonly known as the source) or the relationship of the taxpayer (tax subject) to the taxing state based on residence or nationality (commonly known as the residence).

Report
To:       Tax Partner
From: Tax Intern
Date:   July 7, 2020
Subject: Ghanaian Permanent Establishment

a) Ghanaian permanent establishment, according to the Act 896, could be any of the following:

• A place in Ghana where a non-resident person carries on business or that is at the disposal of the person for that purpose.
• A place in Ghana where a person has, is using or is installing substantial equipment or substantial machinery.
• A place in Ghana where a person is engaged in a construction, assembly or installation project for ninety days or more. This includes a place where a person is conducting supervisory activities in relation to that project.
• A place for the provision of services in Ghana.
• A place in Ghana where an agent performs any function on behalf of the business of a non-resident person:
  * including, in the case of an insurance business, the collection of premiums or the insurance of risks situated in Ghana, but
  * excluding a case involving a general agent of independent status with its own legal personality acting in the ordinary course of business.                                            (4 points for one mark each for total of 4 marks)

• The mere fact that a non-resident has a subsidiary in Ghana is not enough to make the subsidiary a permanent establishment of the parent company. It is important to show that the parent company performs or carries out its business through the subsidiary in Ghana before the subsidiary will be classified as a PE of the parent company. The general understanding of the word “permanent” establishment connotes an element of “continuity” and as such it will be difficult to characterize a one- off transaction as creating a permanent establishment of a non-resident in Ghana.
• Under the income tax law of Ghana, a permanent establishment is treated as an entity which is distinct from its non-resident owner. A Ghanaian permanent establishment is subjected to tax in the same manner as a resident company but a foreign permanent establishment is exempt from tax. The permanent establishment and its owner are treated as persons in a controlled relationship and thus the transactions must satisfy the arm’s length principle. A Ghanaian permanent establishment is expected to withhold tax on payments made, pay taxes on payments received and pay tax by instalments after assessment in the same manner a resident company will do under a similar circumstance. The tax law recognizes a debt owed by an owner to a permanent establishment or a debt owed by permanent establishment to its owner and interest derived or incurred as a result of this debt obligation provided these obligations reflect in the book of accounts maintained by the owner and the permanent establishment.
• Any activity carried out by a permanent establishment is treated as conducted in the course of a single business.
• The Act also provides that when the owner of a permanent establishment employs an individual who is resident in Ghana; makes a sale of trading stock of the same or a similar kind as those sold through the PE and when the owner conducts any other business activity with a person resident in Ghana and the activity is of the same or a similar kind effected through the permanent establishment, the activities of the owner of the PE are treated as conducted by the Ghanaian permanent establishment.
• Any asset held by or employed in an activity of a permanent establishment is an asset of the permanent establishment. An intangible asset created by or through a permanent establishment is an asset of the permanent establishment. However, an intangible asset is recognized as an asset of a Ghanaian permanent establishment if that the asset is exploited in Ghana. A debt obligation incurred in borrowing money which is employed in the activity of a permanent establishment or which is used to acquire an asset which is held or employed in the activities of a permanent establishment is recognized as a liability of the permanent establishment. Any other liability arising directly out of an activity of the permanent establishment is also recognized as a liability of the permanent establishment.                              (5 points @ 2 marks each = 10 marks )

Use of audit software in the audit of revenue and receivables tests of controls.
• Audit software could be used in the performance of computer controls such as sequence checks on pre-numbered documents.

• Audit software could be used to detect the violation of system rules or the presence of an unreasonable item on the master file. Examples of such techniques might include the following:
o Identify (by comparison with sales ledger balance) all those customers who have
o Print a report of customers with no entry in their credit limit field.
o Print a report of all customers whose trade discounts exceed, say, 30%.

• Substantive procedures
Audit software can scrutinise a large volume of data quickly and extract information for the auditor to check/investigate. An example might include the following:
o Performance of the client’s work (an aged analysis of receivables)
o Checking the cast on the transaction making up a balance.
o Calculating keys ratios, e.g. trade receivables collection period.
o Selecting a stratified sample for the direct confirmation of the receivables printing confirmation request.
o Identifying unmatched transactions (e.g. round sum payments on account)
o Listing all credit notes issued after the year-end in excess of a certain amount.
o Listing all accounts with a credit balance in excess of a certain amount.                                        ( 3 principles @ 2 marks=6 marks)

The extent of external auditor’s reliance on the internal auditor’s use of embedded software includes.

• Assessment of internal auditors’ organisational status
• The scope of internal auditor’s work
• Due professional care and competences
• Independence
• The security of the software
• The security of the data extracted for review
• The specific tasks carried out by the software and their relevance to the external audit.

• Money laundering puts large sums of illegal money into the hands of criminals who use such funds on financial and political crises and upheavals.
• Money launderers would often set up Ponzi schemes which entice people to withdraw their savings from the traditional deposit takers and fund managers into their scheme. This tends to undermine the official financial and banking system of the countries in which they operate.
• When they succeed, they introduce large amounts of money into the economy without an immediate corresponding rise in goods and services, resulting in hyperinflation. As a result, weak third world countries may not be able to absorb the shocks and their economies may crumble.
• Money laundering has been found to be a significant source of funds to international terrorist organisations. They use the resources to engage in terrorist activities that lead to wanton destruction of human lives and properties. In countries where money launderers and terrorists gain a strong foothold, they become failed states.
• Money launderers could use their ill-gotten money to finance coups de tat in countries facing hardships or poverty.
(5 point @ 1 mark each = 5 marks)

• Ghana has joined other well-meaning countries in the fight against money laundering and terrorism financing.
• Ghana has subscribed to the world anti-money laundering and terrorism financing organisation and is implementing the 48 FAFT recommendations.
• Ghana is also a member of GIABA the West African organisation fighting against money laundering and terrorism financing.
• Ghana has entered into a treaty with other countries for collaboration in the arrest, prosecution and confiscation of assets illegally acquired by money launderers. The proceeds from sale are shared among collaborating countries.
• Ghana has passed the anti-money laundering law and anti-money laundering regulation, all in the fight against money laundering.
• Many organisations are in the forefront in the fight against money laundering in Ghana, including EOCO, the Financial Intelligence Centre, and other Security Agencies such as Ghana Immigration Service and Interpol.
(Any 5 points @ 1 mark each = 5 marks)

In the public sector, audit mandates or expectations may expand circumstances relevant for reporting by public sector auditors in an Emphasis of Matter paragraph. When considering reporting in an Emphasis of Matter paragraph, the examples provided below must be considered:
• Legislative actions on programs or the budget;
• Contradictive laws, regulations or directives with a significant effect on the entity;
• Fraud, abuse or losses;
• Significant transactions;
• Significant internal control deficiencies;
• Questionable business practices;
• Transactions entered into without due regard for the economy;
• Prior period restatements;
• Environmental issues;
• Corporate social responsibility issues;
• Ethical issues (proper behaviour by public officials); or
• Ineffective and uneconomical use of public assets.
(Any 1 point @ 1 mark each = 10 marks)

Economy; minimising the cost of resources used for an activity, having regard to appropriate quality. It is concerned with the availability of resources 1. In due time 2. Inappropriate quantity and quality 3. At the best price.

Efficiency; Getting the most from the available resources, resources have been put to optimal use or whether similar results could be achieved with fewer resources. It is concerned with 1. relationship between resource employed, 2. condition given and results achieved, quality and quality 3. and timing of outputs and outcomes.

Effectiveness; Effectiveness is concerned with, 1. Meeting the objective set and achieving the intended results 2. It is a goal attainment concept 3. Also involved with ascertaining whether the impacts observed are the result of policy or other circumstance.                         (3 principles @ 2 marks=6 marks)

Information to be documented in Performance Audit for enhancement of audit work may include;
• Background knowledge and information of the entity; name address, what it does, organisation structure, senior management personnel and their qualification, history, objectives, strategies etc. This will help the auditor to understand the nature of the work and facilitate his work.
• Audit objectives and sub-audit objectives. What the auditor wants to achieve and the level of achievements
• Audit scope, the area of the audit and the likely time of coverage
• Audit criteria; what the audit should be
• Audit methodology; the approach to be used for the audit.
• Activity plan covering staff requirement expertise, external expertise needed.
• The estimated cost of the audit
• Key projects timeframe, milestones and control points

The claim was an event after the balance sheet date. Suppose the accident occurred before the year-end of 30 September 2018. In that case, the claim gives additional evidence of a year-end condition and thus meets the definition of an adjusting post balance sheet event. In this case the matter appears to have been properly disclosed in the notes to the financial statements per IAS 10: Events After the Balance Sheet Date and IAS 37: Provisions, Contingent Liabilities and Contingent Assets. A provision would only be necessary if the claim was probable to succeed and there is sufficient appropriate evidence that this is not the case. There is, therefore, no material misstatement and (inability to obtain sufficient appropriate audit evidence).

Therefore the audit manager is correct to propose an unmodified opinion.

However, the audit report doesn’t need to contain an emphasis of matter paragraph.
ISA 705: Modifications to the Independent Auditor’s Report states that an emphasis of matter paragraph should be used to highlight a matter where there is significant uncertainty.

Uncertainties usually are only regarded as significant if they involve a level of concern about the company’s going concern status or would have an unusually significant effect on the financial statements. This is not the case here, as there is enough cash to pay the damages in the unlikely event that the claim goes against Toys Co Ltd. This appears to be a one-off situation with a low risk of the estimate being subject to change, and thus there is no significant uncertainty.

The factory closures constitute a discontinued operation per IFRS 5: Non-Current Assets Held for Sale and Discontinued Operations due to discontinuing a separate major component of the business. It is a major component due to the 10% contribution to revenue in the year to 30 September 2018 and 23% contribution in 2017. In addition, it is a separate business component of the company due to the factories having made only one item, indicating a separate income generating unit.

Under IFRS 5 there must be separate disclosure on the face of the income statement of the post-tax results of the discontinued operation and of any profit or loss resulting from the closures. The revenue and costs of the discontinued operation should be separately disclosed either on the face of the income statement or in the notes to the financial statements. Cash flows relating to the discontinued operation should also be separately disclosed per IAS 7: Cash Flow Statements.

In addition, as Factory Co Ltd is a listed company, IFRS 8: Operating Segments requires separate segmental disclosure of discontinued operations.

Failure to disclose the above information in the financial statements is a material breach of International Accounting Standards. The audit opinion should therefore be qualified on the grounds of disagreement on disclosure requirements of IFRS 5, IAS 7 and IFRS 8. The matter is material but not pervasive, and therefore an ‘except for’ opinion should be issued.
The opinion paragraph should clearly state the reason for the qualification and indicate the financial significance of the matter.

The audit opinion relates only to the financial statements that have been audited. Therefore, the contents of the other information (chairman’s statement and Directors’ Report) are irrelevant when deciding if the financial statements show a true and fair view or are fairly presented.

Emphasis of matter paragraph
An ’emphasis of matter’ paragraph is used to draw the reader’s attention to a matter presented or disclosed in the financial statements, which is fundamental to understanding those financial statements.
When an auditor’s report contains an emphasis of matter paragraph, the opinion is not modified. Therefore, it can only be used where the auditor has obtained sufficient appropriate audit evidence that the matter is not materially misstated in the financial statements. (If the matter is materially misstated, a modified opinion is required.)

Although the opinion is not modified, there is an item in the financial statements, properly presented or disclosed, that the auditor wishes to bring to the attention of users because it is fundamental to an understanding of the financial statements.

Circumstances in which an emphasis of matter paragraph may be necessary
ISA 706 (revised) gives the following examples of circumstances in which an emphasis of matter paragraph may be required:

• Where there is an uncertainty relating to the future outcome of exceptional litigation or regulatory action.
• A significant subsequent event that occurs between the date of the financial statements and the date of the auditor’s report.
• Where the entity has adopted a new IFRS early which has had a pervasive effect on the financial statements.
• To draw attention to a major catastrophe that has had, or continues to have, a significant effect on the entity’s financial position.
• Early application of a new accounting standard that has a pervasive effect on the financial statement

Other matter paragraphs
An ‘other matter’ paragraph is used if the auditor considers it necessary to communicate a matter other than those included in the financial statements that, in his opinion, is relevant to users’ understanding of the audit, the auditor’s responsibilities or the auditor’s report.

Or this is the paragraph that is used to highlight a matter that has not adequately been presented and disclosed in the financial statement but in the auditor’s judgment is fundamental for user’s understanding of the audit, audit work and the auditor’s responsibility.

Circumstances in which other matter paragraph may be necessary
ISA 706 gives the following examples of circumstances in which an ‘other matter’ paragraph may be required:

• Where the auditor is unable to resign from the engagement even though the possible effect of a limitation of scope imposed by management is pervasive (relevant to users’ understanding of the audit). This should be rare in practice.
• Where local law or custom allows the auditor to elaborate on his responsibilities in his report (relevant to users’ understanding of the auditor’s responsibilities or auditor’s report).
• Another example when another matter paragraph might be used is when the prior year financial statements were audited by a previous auditor, or not audited because this is the first-year audit for the current auditor.
• The auditor is reporting on a set of financial statements prepared using different frameworks, e.g. both IFRS and GAAP.

Procedures the auditor should adopt in respect of auditing accounting estimates include:

• Inquire of management how the accounting estimate is made and the data on which it is based.
• Determine whether events occurring up to the date of the auditor’s report (after the reporting period) provide audit evidence regarding the accounting estimate.
• Review the method of measurement used and assess the reasonableness of assumptions made.
• Test the operating effectiveness of the controls over how management made the accounting estimate.
• Develop an expectation of the possible estimate (point estimate) or a range of amounts to evaluate management’s estimate.
• Review the judgments and decisions made by management in the making of accounting estimates to identify whether there are indicators of possible management bias.
• Evaluate overall whether the accounting estimates in the financial statements are either reasonable or misstated.
• Obtain sufficient appropriate audit evidence about whether the disclosures in the financial statements related to accounting estimates and estimation uncertainty are reasonable.
• Obtain written representations from management and, where appropriate, those charged with governance whether they believe significant assumptions used in making accounting estimates are reasonable.
  (Any 5 points @ 1 mark each = 5 marks)

Receivables balance owing from Obey Company Ltd
i) The written representation proposed by management is intended to verify the valuation, existence and rights and obligations of a material receivables balance. However, as management has refused to allow the auditor to circularise the balance and there has been little activity on the account for the past eight months, then there is very little evidence that the auditor has obtained.

• This representation would constitute entity generated evidence, and this is less reliable than auditor generated evidence or evidence from an external source. However, if related control systems operate effectively, then this evidence becomes more reliable. In addition, if the representation is written as opposed to oral, this will increase the reliability as an evidence source.
• Overall this representation is a weak form of evidence, as there were more reliable evidence options available, such as the circularisation, but this was not undertaken.         (2 marks)

ii) To reach a conclusion on the balance, the following procedures should be performed:

• Discuss with management the reasons as to why a circularisation request was refused.
• Review the post year-end period to identify whether any cash has now been received from Obey Company Ltd
• Review correspondence with Obey Company Ltd to assess reasons for the continued non-payment.
• Review board minutes and legal correspondence to assess whether any legal action is being taken to recover the amounts due.
• Discuss with management whether a provision or write down is now required.
• Consider the impact on audit opinion if balance is considered to be materially misstated.                    (3 points for 3 marks)

Warranty provision
i) In this case, the auditor has performed some testing of the provision to obtain auditor-generated evidence. The team has tested the calculations and assumptions. None of this is evidence from an external source.
The very nature of this provision means that it is difficult for the auditor to obtain a significant amount of reliable evidence as to the level of future warranty claims.

Hence the written representation, whilst being an entity generated source of evidence, would still be useful as there are few other alternatives.                    (2 marks)

ii) To reach a conclusion on the balance, the following procedures should be performed:

• Review the post year-end period to compare the level of claims actually made against the amounts provided.
• Review the level of prior year provisions with the amounts claimed to assess the reasonableness of management’s forecasting.
• Review board minutes to assess whether any changes are required to the level of the provision as a result of an increased or decreased level of claims by customers.           (3 points for 3 marks)

Steps to take if written representation on warranty provision is not provided

• ISA 580 Written Representations guides the auditor when written representations are requested from management, but they refuse to provide.
• If management does not provide the requested written representation on the warranty provision, the auditor of Oliso Private Company Limited should discuss the matter with management to understand why they are refusing.
• In addition, the auditor should re-evaluate the integrity of Oliso Private Company Limited’ management and consider the effect that this may have on the reliability of other representations (oral or written) and audit evidence in general.
• The auditor should then take appropriate actions, including determining the possible effect on the audit opinion.
  Impact on the audit report
• As the auditor cannot obtain sufficient appropriate evidence to conclude that the warranty provision is free from material misstatement, a modified audit opinion will be required.
• The warranty provision is material but not pervasive, and therefore a qualified opinion would be appropriate.
• The opinion paragraph will be amended to state ‘except for’ for the lack of evidence on the warranty provision, the financial statements show true and fair view.
• The audit report will require an additional paragraph known as the basis for the qualification paragraph after the opinion paragraph, which will describe the reason for the modification, namely that management refusal to provide a written representation in relation to the warranty provision and hence the reason for the except for opinion.
• The materiality of the warranty provision will be stated in the basis for the opinion paragraph.
  (Any 5 points for 5 marks)