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AUDIT AND ASSURANCE CASE STUDY QUESTIONS

The first article in this series of two on Paper P7 case study questions discussed question style, what to look for in the requirements, how higher­level skills are tested, and the meaning of professional marks within a question requirement. This second article goes through part of a typical Section A case study question, applying the recommended approach described in the previous article. This approach comprises four stages. STAGE 1 – UNDERSTANDING THE REQUIREMENT The first thing to do is to read and fully understand the question requirement. Here is the requirement we will be looking at in this article: 'Prepare a report, to be used by a partner in your firm, in which you identify and evaluate the professional, ethical, and other issues raised in deciding whether to accept the appointment as provider of an assurance opinion as requested by Petsupply Co.' (12 marks) Note: this requirement includes two professional marks. Having read the requirement, break it down. You are asked to do two things: identify, ie state from the information provided evaluate, ie discuss from a critical point of view. The requirement asks you to consider 'professional, ethical, and other issues'. This could cover a wide range of considerations, such as: ethics: independence, competence, conflicts of interest, confidentiality, assessing integrity professional issues: the risk profile of the work requested, the fee – and whether it is sufficient to compensate for high risk, availability of staff, managing client expectations, logistical matters such as timing, legal and regulatory matters – such as money laundering, and (in some cases) obtaining professional clearance other issues: whether the work 'fits' with the commercial strategy of the audit firm, the potential knock­on effect of taking on the work – such as the impact on other clients, or on other work performed for this client. You are asked to produce a report, so remember that the professional marks available will be awarded for using the correct format, the use of professional business language, and for presenting your comments as a logical flow culminating in a conclusion. From reading the requirement, you know that the question scenario will be based on a potential assurance assignment and will be broadly based around acceptance issues. STAGE 2 – READING THE SCENARIO When reading through the detail of the scenario, you should now be alert to information relevant to this requirement. Highlight important points that you think are relevant to the scenario and remember to focus on issues that could affect your acceptance of a potential assurance assignment.

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Kapil Dhaka

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Stefani Indarto

This study developed and tested a model that describes how auditors evaluate the relevant risks and how auditors adapt to these risks when they decided to accept their clients. Client acceptance model developed by the auditor is intended for auditors to evaluate the risk associated with business clients, including the financial condition of the internal control structure of the client and the client's prospects and business continuity. This evaluation is then used to determine the risks that would be faced by the auditor if the auditor will accept the audit assignment for a client company or reject consideration of profitability or letigasi possibility in the future. Participants or respondents in this study are the Under Graduate final semester accounting students who enrolled in the Accounting Department of Soegijapranata Catholic University in Semarang. There were 345 students. The method of data analysis used in this study is SEM (Structural Equation Modeling), which will be...

bekhruz alikulov

Our case study focuses on developing the student's understanding of the auditor's evaluation of prospective audit clients. A comprehensive evaluation is uniquely important since the client acceptance decision can be the chief contributor to auditor business risk (engagement risk). Even so, guidance in the area of client acceptance is general in nature and not as extensive or prescriptive as other significant auditing promulgation. This student case study provides practical evaluation criteria for client acceptance that can also be used by accounting professionals to benchmark their client acceptance evaluation process. This student case study can be used in the accounting classroom as a descriptive benchmark of the evaluation of a prospective client. STUDENT ENGAGEMENT USING A CASE STUDY his case can be implemented in the advanced auditing course as a take home problem or as an in-class discussion. We recommend motivating the topic of client acceptance by asking students if more revenue from a potential new audit client engagement is always a good thing. The answer is seemingly simple-'yes, of course more revenue is better than less revenue.' We suggest posing the following set of questions to students: Put yourself in the place of an audit partner of a mid-size accounting firm who is under pressure to bring in new client work to grow the CPA practice and increase revenue. Is more business always a good thing? Why or why not? According to professional guidance, what are the evaluation criteria you need to consider before taking on a new audit client or new client work? Of course, the answer to these questions is not simple. Our Case Analysis and Discussion follows.

Studies in Business and Economics

mayar mohamed

Prashastya Research Journal

Navneet Kulkarni

This study is an attempt to show the issues faced by the auditors-practicing Chartered Accountants. Study is made within Belagavi city. The objective of the study resembles the topic of this paper-to find out the issues faces by the auditors and to understand those issues. The Primary data is collected in the form of questionnaire and oral interview. Secondary data is collected through CA Institute and references for audit theory. Comparison and analyses are made through charts and tables to understand the issues faced by auditors in Belagavi City. There are various facets of the study which explores the practical issues and has no thematic solution in the theory of auditing and any statute. Theoretically speaking, the Indian system of auditing is an excellent system which is carried out by professionals and it is very hard for the client organization/firm to find any loophole in it. But, does not have solutions to basic problems faced by the auditors which are discussed in this study. Yet, this study aims at just pointing out the persistent issues in the profession of auditing. Considering the issues, respondents, that are practicing auditors, have given solutions and are stated in the article.

European Journal of Accounting, Finance & Business

Sergiu Soimu

Department of accountancy, the malawi polytechnic

john chilima , DICKSON FYOP

Internal audit function plays a major role in achieving organizational goals. Internal audit functions need to be operated effectively in order to add value to the organisation. Internal auditors help in identifying risks and inefficiencies in organisation and recommend controls to mitigate those risks. The study aimed to assess factors that would contribute to an effective internal audit function in Malawian commercial banks. The objectives were to assess the extent of internal auditor’s competency; to examine the extent of internal auditor’s independence and objectivity and to identify the level of improvement in the financial performance of commercial banks operating in Malawi. The study adopted descriptive design. It targeted 40 personnel from all the commercial banks by selecting 4 people from each bank. The main focus was 2 individuals from the internal audit function; 1 from risk department; and 1 from management. Purposive sampling was employed and questionnaires were used. The study revealed that there is a high correlation between the factors assessed and effectiveness of an internal audit function. The study also found that the function doesn’t only satisfy the legal need to have internal audit function in commercial banks but it also adds value.

arash tahriri

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Audit case studies: lessons from real-world audit failures and success stories

If you’re an auditor, you’ve probably achieved your fair share of success stories – perhaps ...

By Nana Obeng & Tom Edwards & Yasmin Wilks

If you’re an auditor, you’ve probably achieved your fair share of success stories – perhaps you’ve witnessed a few failures too.

As the saying goes, we learn from our mistakes, and audit case studies, both failures and successes serve as valuable insight. Real-life audit examples provide us with lessons on what to do and what to avoid, enabling organisations to improve their audit processes. 

Ready to discover some real-world examples? Here’s our pick of a few high-profile cases…

When things go wrong

(1) enron corporation.

The Enron scandal and the subsequent collapse of the Enron Corporation serves as a stark reminder of audit failure and corporate misconduct. Possibly the most high-profile scandal ever unearthed, the Sarbanes-Oxley Act (SOX) of 2002 was passed as a result of scandals such as this, WorldCom, Tyco, and Global Crossing.

Enron's auditor Arthur Andersen was heavily criticised for failing to detect fraudulent financial reporting. And lots of lessons can be learned from this example.

Firstly, Enron’s case highlights the importance of auditors maintaining independence from the companies they audit to ensure unbiased assessments. But it also reminds us of the importance of whistle-blower protection – where there are safeguards in place, organisations will encourage openness and provide the confidence for individuals discovering financial irregularities to expose them. And Enron finally emphasises how crucial regulatory oversight is in holding auditors accountable and preventing corporate fraud.

(2) Toshiba

We’ve all heard of Toshiba , a renowned multinational conglomerate, manufacturing a wide variety of consumer and business products. Despite the company’s famous success, this chapter of their story is not one of their finest.

In July 2015, Toshiba experienced an internal audit failure that spotlighted the gap between good corporate governance structure and its practical implementation. It led to Toshiba Corp’s president, Hisao Tanaka, and his two predecessors quitting after investigators found that the company had inflated earnings by $1.2 billion between 2009 and 2014.

Regardless of a sound governance structure, the organisation suffered from a massive financial scandal, highlighting the importance of proactive internal auditing to identify and prevent financial irregularities.

(3) Ernst & Young

Even the largest professional services companies are sometimes at the centre of an audit scandal. And in the case of Ernst & Young , these kinds of scenarios serve as a reminder of the importance of a robust auditing process for even the biggest of players.

EY was fined $11.8 million for audit failures in 2016. USA regulator SEC found that EY’s audit team repeatedly failed to detect fraudulent activity for more than four consecutive years. Additionally, it was reported that EY’s team failed to take effective measures in minimising known recurring tax-related problems.

This case emphasises the critical role auditors play in scrutinising high-risk areas and addressing known deficiencies. And underscores the importance of due diligence and thoroughness in audits.

(4) WorldCom

The WorldCom scandal is another example of a colossal audit failure. Arthur Andersen, the same auditor implicated in the Enron scandal, failed to detect a massive accounting fraud at WorldCom.

What can we learn from this tale? Well, attentive auditing is essential, and auditors need to exercise a blend of vigilance and scepticism when assessing financial statements. This example also points to ethical responsibility, underscoring auditors’ moral and ethical duty to report financial irregularities.

Like Enron, WorldCom’s case was instrumental in regulatory reforms, like the Sarbanes-Oxley Act which increased corporate accountability.

Getting it right

(1) apple inc.

Tech giant Apple is widely recognised for its financial transparency and internal controls. Their financial audits consistently reflect strong performance and accountability. Key takeaways from Apple's success include their transparency – Apple publishes detailed financial statements and reports that are easily accessible to the public, building trust with investors and stakeholders. They also have a set of robust internal controls and processes in place, minimising the risk of financial mismanagement or fraud.

The organisation’s MD Tim Cook says , “We do the right thing, even when it’s not easy.”

(2) Microsoft

Microsoft's another great example of a business with transparency and accountability at its core. The tech leader has consistently demonstrated exemplary corporate governance and financial reporting .

Their success highlights several valuable lessons, including the significance of disclosure. Microsoft provides comprehensive financial disclosures, offering investors a clear picture of their financial health. And they’ve also got their finger on the pulse when it comes to  risk management , with practices in place that have been instrumental in ensuring long-term financial stability.

Microsoft carries out consistent and regular financial audits , to maintain trust and transparency with all of their stakeholders.

(3) Johnson & Johnson

Johnson & Johnson's another example of a profound commitment to transparency . The healthcare multinational is renowned for its sense of responsibility when it comes to ethical conduct.

Key takeaways include their strong ethical leadership – an essential asset for fostering a culture of compliance and accountability.

They also boast hardy compliance programs , proving that investing in this area can help detect and prevent financial misconduct. Stakeholder communication is another factor in Johnson & Johnson’s audit success, and open comms are encouraged to build trust and confidence.

What can we learn from all these case studies? The need for thoroughness, vigilance, transparency, ethical leadership, and continual improvement in auditing are essential. They emphasise the importance of not just having a good corporate governance structure, but also ensuring its effective implementation. And by learning from both successes and failures, we can strive to build a corporate environment that prioritises (financial) integrity and compliance with relevant regulatory, legal, and industry standards – and, of course foster trust and prevent costly failures.

Are you  looking for high-calibre talent  with the skills to protect you from audit mishaps?  Let’s chat  about your needs. Or perhaps you’re an  audit professional  looking to help companies grow their audit capabilities? If you’re looking to progress your career and safeguard an exciting, growing business,  get in touch , or check out our  latest roles . 

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Auditing and Assurance: A Case Studies Approach, 7th edition

Auditing and Assurance: A Case Studies Approach , 7th edition, provides challenging, practical cases for auditing and assurance students at both undergraduate and postgraduate level

Publisher: LexisNexis

Now in its 7th edition, Auditing and Assurance: A Case Studies Approach provides a challenging and practical methodology for auditing and assurance students at both undergraduate and postgraduate level.

Written by experts in the field, this book provides an overall contextual model to understanding the key elements of the audit process. Each chapter contains real life case studies which are designed to assist self-learning and improved application skills.

This text is a valuable resource for any students or practitioners working in the field of auditing and assurance. It is also useful for candidates undertaking the Audit and Assurance (AAA) Module in the Chartered Accountants (CA) Program and CPA Australia’s CPA Program.

• Key revisions to the auditing standards (ISAs/ASAs), most significantly in the areas of audit reporting, disclosures and assertions
• Commentary on recent developments in practice, including corporate governance and data analytics
• New and updated case studies and exam preparation
• Updated online learning materials for students and lecturers
• Audit Planning, Understanding the Entity and Risk Assessment
• Internal Control and Fraud Risk
• Auditor’s Procedure in Response to Assessed Risks
• IT Systems: Internal Control and Audit Evidence
• Audit Conclusions and Reporting Introduction
• Other Types of Audit, Review and Assurance Engagements
• Quality Control, Ethical Requirements, Independence, Corporate Governance and Litigation
• Assignments
• Practice Examinations

Featured Authors

Kevin frohbus.

Kevin Frohbus is the Audit Technical Director of Crowe Horwath Australasia. In this role, Kevin is responsible for audit and accounting technical consultation, thought leadership and quality control. He provides advice to clients in both the public and private sectors on a range of issues, including professional standards and regulatory requirements.

Nonna Martinov-Bennie

Nonna Martinov-Bennie is Professor of Accounting and Director of the International Governance and Performance (IGAP) Research Centre in the Faculty of Business and Economics at Macquarie University. Prior to this, she held positions at the University of New South Wales and The University of Sydney. Before academia, Nonna was a Senior Audit Manager with Deloitte Touche Tohmatsu managing audit teams for major corporate audit clients.

Internal audit: A case study of impact and quality of an internal control audit

Corresponding Author

Leif Christensen

• [email protected]
• orcid.org/0000-0002-9341-7168

Department of Accounting, Copenhagen Business School, Frederiksberg, Denmark

Correspondence

Leif Christensen, Department of Accounting, Copenhagen Business School, Solbjerg Plads 3, 2000 Frederiksberg, Denmark.

Email: [email protected]

Traditionally, when companies needed assistance regarding internal controls, they turned to an external auditor (EA). However, now, due to an ongoing tightening of legal requirements and practices regarding the independence of EAs, this assistance has been restricted. As an alternative, companies are increasingly requesting internal audits to deliver this support. Even though internal audit function (IAF) are an important player in internal control, however, there is little academic knowledge about their impact. Based on a single-case study in a large financial institution, this paper explores to what extent and how IAF affect internal controls. Furthermore, it assesses whether IAF add value to the company. The results suggest that the management letter process, including a step-by-step settlement of interactions, leads to a joint problem solving, an acceptance of all IAF's recommendations and a value-adding outcome improving the level of internal controls.

1 INTRODUCTION

In recent decades, there has been growing pressure on companies to improve internal controls—a development in which a number of events and stakeholders have joined forces. Increasing regulatory pressure, along with the economic consequences of ineffective internal controls, has been documented since the introduction of Sarbanes–Oxley (Ashbaugh-Skaife et al.,  2009 ). The financial crisis amplified this pressure by introducing a myriad of disclosure requirements which are dependent on effective internal controls regarding compliance and reporting (Van der Stede,  2011 ). Most recently, and due to procedural weaknesses and ineffective internal controls, a number of large money-laundering cases have led to new regulatory requirements (Yeoh,  2020 ). Responding to the risk of not complying with these and other regulatory requirements, companies are motivated to use best practice guidelines and frameworks (Sarens & Christopher,  2010 ). Furthermore, there is a managerial desire to have well-controlled business processes (Sarens et al.,  2009 ).

Traditionally, when companies needed assistance regarding internal controls, they turned to external auditor (EA) (Power,  2009 ). However, since Sarbanes–Oxley, the regulatory requirements governing the independence of EAs have been tightened, imposing restrictions on companies' use of EAs as advisers (Abbott et al.,  2007 ). As an alternative, companies with an internal audit function (IAF) might utilise this resource; it seems that IAF has played a key role in providing advice and assurance about the quality of internal controls (Maijoor,  2000 ; Spira & Page,  2003 ) and that this importance has grown in recent years (Oussii & Boulila Taktak,  2018 ).

Even though it seems that IAF are an important player, it generally does not have a well-defined role in relation to internal control (Arena & Sarens,  2015 ). Regarding internal controls we know that a competent and independent IAF decreases internal control deficiencies (Mazza & Azzali,  2015 ). Furthermore, competences can be proxied by number of severe internal control weaknesses detected by IAF (Oussii & Boulila Taktak,  2018 ) and effectiveness can be measured by the recommendation implementation rate (Turetken et al.,  2020 ). However, considering IAF's importance, it is surprising that there is little academic knowledge about their impact on internal controls (Bame-Aldred et al.,  2012 ; Roussy et al.,  2020 ). To improve this knowledge, the aim of this paper is to explore to what extent and how IAF affect internal controls. Further, the paper analyses whether this impact adds value to the company.

Recognising that IAFs vary in quality in terms of both independence and professional qualifications (Arena & Jeppesen,  2010 ), a single-case study (Yin,  2009 ) has been performed of an IAF in a large Danish financial institution (the Group) governed by detailed regulatory EU-based requirements. 1 The IAF studied is, according to the audit agreement governed by the audit committee, responsible for the internal control audit, including the related management letter reporting. To allow for comparison with other companies, the case study includes a contextual description of boundaries, role and qualifications. An important element of the context is the interaction between IAF and client, which is part of the management letter process. This process is a step-by-step interaction in which each step is settled before the next interaction occurs. One of the steps is an interaction on IAF's observations, which are assessed internal control weaknesses. The remainder of the management letter process involves interactions aimed at mitigating these weaknesses and reporting the result to management.

Responding to the research question, the analysis includes management letters for the period 2008–2017. The result of the analysis contributes with a detailed understanding of how IAF, through the management letter process, impacts the internal control system in a financial institution (Bame-Aldred et al.,  2012 ; Roussy et al.,  2020 ). Beyond adding to the limited knowledge of IAF's impact on changes to internal controls this study provides details about the quality assessment of internal audits (Trotman & Duncan,  2018 ).

The paper is organised as follows: Section  2 contains a description of the method. Section  3 presents the theoretical outline and conceptual framework. In Section  4 , ‘Audit in the Group’, the management letter process and the interaction between IAF and client is illustrated and explained, and the contextual features are described. Section  5 and 6 present the findings regarding the research question, and in Section  7 , the case study is discussed and concluded.

Because little is known about IAF's impact on internal controls, a single-case study is used to explore the phenomenon in detail. This method is appropriate given that the focus is on a real-life situation with a variety of data sources (Yin,  2009 ). Looking at the elements of the research question, the ‘extent’ of the impact is assessed primarily through an analysis of the management letters. This analysis is also used as a basis for gaining a general understanding of the management letter process. The main part of the case study, investigation into ‘how’ IAF affect internal controls, is based on a qualitative analysis of the interactions involved in the management letter process.

The data sources used include interviews of IAF and client staff, observations in meetings and archival documents, the management letters themselves and IAFs' supporting memos and working papers. Access was also granted to the annual customer satisfaction survey, through which IAF is evaluated by the client. The Group considers the information assessed and analysed to be confidential. The confidentiality agreement allowed me free access to information on the Group's premises. Further, I was placed in IAF, where I collected data alongside IAF and had immediate access to the staff. According to the terms of the confidentiality agreement, I was not allowed to remove information from the premises without approval from the head of IAF. To honour the confidentiality requirement, and to obtain sufficient evidence that the observations and quotes used in the paper would fairly represent the informants' attitudes, we agreed that the relevant sections of the paper should be reviewed by the informants. In addition, the Head of IAF reviewed the entirety of Section  4 (‘Audit in the Group’) and Section  6 (‘How does IAF affect internal controls?’).

The Group did not allow the use of a voice recorder. Instead, notes were taken during each interview, and memos were produced immediately after the meetings. Furthermore, we agreed that informal follow-up meetings could be arranged if required. Because I was located in the IAF department and close to both first- and second-line staff, the opportunity to go back to the interviewees was repeatedly taken, not only to clarify issues but also to expand the interviews and thereby obtain more information and a deeper understanding. The informal nature of the meetings resulted in interviews of more than 30 persons. The main informants were six IAF staff and five client representatives. The case study was initiated in June 2013 and finalised in November 2018.

The research approach is qualitative with a positivistic spirit (Power & Gendron,  2015 ). This classification is also supported by the researcher's cultural memory, which is based on years of audit experience (Daoust & Malsch,  2019 ), including a taken-for-granted assumption that work in general, this case study included, can be replicated to verify observations and conclusions.

2.1 Review—management letters

To clarify the extent of the impact, a detailed analysis was made of management letters covering the period 2008–2017. On an annual basis, 30–35 management letters are prepared, each with two to five recommendations. For the period analysed, a total of 821 recommendations were reported.

The management letter reporting in the Group consists of two sections: an audit memo and a management summary. Together, these sections fulfil the definition of a management letter (Manson et al.,  2001 ). An important element in the management letter is the classification of recommendations (Hellman,  2006 ). The Group uses a prioritisation based on three categories (1, 2 and 3). This is comparable with American Institute of Certified Public Accountants (AICPA,  2008 ) classifications: ‘material weakness’ (1), ‘significant deficiency’ (2) and ‘deficiency’ (3). Furthermore, a long-form audit report (LFAR) addressed to the board of directors is closely linked to the management letter process, as it summarises the result of the audit.

To classify the information by criteria other than level of priority, a coding of the wording of the observations, risk evaluations and recommendations was performed (Brinkmann & Kvale,  2015 ). Based on this coding, a number of classifications were derived, inspired by a study of management letters (Manson et al.,  2001 ). If the observation or the risk evaluation included a reference that could be related to ‘legal’, ‘regulatory’ or ‘internal policy’ issues, it was classified accordingly. If no such reference was included, the recommendation was considered to be based on the auditor's professional judgement and was classified as ‘audit’.

2.2 Management letter process

To explore the nature of the interactions illustrated in Figure  2 , responsive interviews (Rubin & Rubin,  2011 ) based on a number of main questions (Appendix  A ) were conducted with IAF and client staff. To support the dialogue and keep the conversations focused, the overview of the management letter process (Figure  2 ) and the combined IAF–client interaction model (Figure  1 ) were used. Furthermore, 10 recommendations were selected to provide detailed input to the assessment of the audit and business value of the IAF–client interaction and to the assessment of the quality dimension of the management letter process.

3 THEORETICAL OUTLINE AND CONCEPTUAL FRAMEWORK

The interaction between EA and client has been the subject of studies since 1991, when issues regarding the audit opinion on the financial statement were analysed by Antle and Nalebuff. Following this study, several other papers have focused on the interactions between EA and client regarding the audit of financial reporting; these include studies by Gibbins et al. ( 2001 ) and Beattie et al. ( 2004 ). The conceptual models described in these papers have been updated in subsequent studies by Salterio ( 2012 ) and Fearnley et al. ( 2011 ). These models focus on the interaction between EA and the client; in this, they differ from the present study, in which IAF performs the internal control audit. However, the nature of the IAF, including their independence from the executive board, is similar to that of an EA, and the quality of the work seems to be at the same level (Bame-Aldred et al.,  2012 ; Stefaniak et al.,  2012 ). Consequently, the conceptual models of Salterio ( 2012 ) and Fearnley et al. ( 2011 ) are useful to guide the data collection and organise the observations supporting an analysis of IAF's impact on the company's internal controls. Derived from these studies, Figure  1 presents the model used in this paper.

Overall, the model is used to describe the behaviour (5) of IAF and the client when interacting regarding an issue (4) related to the management letter process (Figure  2 ). The output (6), which is a decision on the implementation of new controls or the improvement of existing ones, is classified as either a client, a joint or an IAF product. Furthermore, a number of contextual features—regulatory (1), general (2) and IAF/client (3)—affect the interaction between IAF and the client.

3.1 Interaction

The interaction begins with an ‘issue’ (4), which can be a recommendation or, later in the management letter process, a draft management summary or the LFAR. The nature of the behaviour exhibited in the interaction by both IAF and client (5) ranges from ‘permissive’ through ‘argumentative’ to ‘insisting’. ‘Insisting’ behaviour can be illustrated by a situation in which the IAF, due to professional responsibilities or legal requirements, have thresholds which cannot be exceeded. In contrast to ‘insisting’, ‘permissive’ behaviour is seen in situations in which one of the parties simply accepts the arguments of the other. A third type of situation, in which the behaviour of the parties is more mixed, or in which they try to find some middle ground, should also be anticipated (Kulset & Stuart,  2018 ; Murnighan & Bazerman,  1990 ). This intermediate style of interaction between ‘permissive’ and ‘insisting’ has been labelled ‘argumentative’. According to Beattie et al. ( 2000 ), interactions can range from an ‘exchange of information’ through ‘discussion’ to ‘negotiation’. Of these classifications, only ‘negotiation’ is clearly defined in the literature. These classifications are used to describe the combined behaviour of IAF and the client. The type of behaviour exhibited can also be viewed as a result of the interaction strategy chosen by IAF and the client. According to McCracken et al. ( 2011 ) an overall distributive interaction strategy can be either ‘contending’, ‘compromising’ or ‘conceding’. As an alternative, an integrative interaction strategy is focused on a joint problem solving, where the output both preserves IAF's objective and allows the client to feel that they have achieved their own objectives.

The output of the interaction (6) can be classified as either a client product, a joint product or an IAF product (Salterio,  2012 ). For a number of years, the annual report has been considered a joint product (Antle & Nalebuff,  1991 ).

The combined IAF–client interaction model addresses the output from an interaction perspective but does not consider the quality dimension. To access this dimension, the internal audit quality framework developed by Trotman and Duncan ( 2018 ) was utilised. This framework includes an assessment of five quality dimensions: ‘context’, ‘inputs’, ‘processes’, ‘outputs’ and ‘outcomes’. Even though the definitions differ, the combined IAF–client interaction model and the management letter process (Figure  2 ) provide input to the quality assessment of all dimensions except ‘outcomes’, which includes an assessment of ‘value-add’. An indication of a value-adding ‘outcome’ is acceptance of IAF's recommendations. This assessment of quality, based on considerations of specific dimensions, is distant from the value-adding concepts previously promoted by the big audit firms (Power,  2000 ).

3.2 Contextual features

Contextual features (1), (2) and (3) are categories of factors that in varying degrees affect the core interaction. Examples of these, derived from the initial studies of the factors (Beattie et al.,  2004 ; Gibbins et al.,  2001 ) and subsequent, related papers by the same authors, have been added in a ‘bullet’ format.

The regulatory/legal context (1) has been analysed by Fearnley et al. ( 2011 ), who compare their results with those of the initial study by Beattie et al. ( 2004 ). The ‘risk of being caught’ has risen in the period between these two studies, and this has shifted the behaviour of the client (5) from insisting towards passive acceptance. One example is the impact of the Sarbanes–Oxley Act, through which auditors have been mandated more power, which has resulted in a move from a permissive to a more insisting style of behaviour (Brown & Wright,  2008 ).

Regarding the general interaction context (2), the ‘tone from the top’ (Lail et al.,  2015 ) could be a policy by the board of directors on ‘no surprises’, which tends to make the parties more co-operative (Fearnley et al.,  2011 ). Again, one example is the Sarbanes–Oxley Act, which dictates that the auditor needs assurance in order to certify the internal controls. On the other hand, the cost of controls for complying with auditors' recommendations can be high (Carney,  2006 ). In such a situation, the preferences of the parties could differ.

The audit/client context (3) has been analysed in a number of studies. The development of this feature is analysed by Fearnley et al. ( 2011 ), who, in comparing with an early study by Beattie et al. ( 2000 ), finds that the impact of the audit/client context has diminished relative to that of the regulatory/legal context. A different result is reported in a study on the effect of past client relationship, which concludes that the impact of the audit/client context is significant (Brown-Liburd & Wright,  2011 ). The focus on ‘length of relationship’ is inspired by an interest in antecedents to present interactions (Salterio,  2012 ). For example, the behaviour chosen when dealing with a significant audit difference has been analysed in combination with the result of previous interactions (Hatfield et al.,  2010 ). The study indicates that the magnitude of the audit difference influences the nature of the auditor's interaction, moving it in the direction of being more insisting. There is, however, also a pull in the opposite direction because client concessions from prior interactions could have the same impact.

4 AUDIT IN THE GROUP

4.1 interaction between iaf and client.

The result of an internal control audit is reported in a management letter (Manson et al.,  2001 ). Although the management letter is formally prepared by the IAF, it is also the result of a process involving a number of interactions between IAF and the client. Because the Group had no existing description of the management letter process, an overview description was prepared, and handshake symbols were inserted where interaction between IAF and the client was identified; see Figure  2 :

The description is based on a review of the management letters supported by interviews of IAF staff responsible for the individual steps of the process. There are three documents prepared as part of the management letter process, an audit memo, the management summary and the LFAR.

4.1.1 Audit memo

The most detailed document in the management letter process is the audit memo, which describes the result of the internal control audit, focusing on the identified weaknesses. The main purpose is to communicate the result of the audit, mainly to the staff responsible for the reviewed processes. Appendix  A to the audit memo includes the following headings in a table format: observation, risk evaluation, recommendation and local management's comments. A prioritisation (1–3) of the observations is also included. The first interaction in the management letter process is a meeting between the IAF manager and client staff in which the observations are presented and adjusted if necessary. The overall aim is to establish an objective description of the observations. Figure  2 refers to this interaction as ‘meeting about initial observations’.

The next step for the IAF is to prepare a description of the potential risk and a recommendation for mitigating the weakness. The second interaction is a meeting about the recommendation, in which the primary objective is to ensure that the improvements of internal controls will mitigate the risks identified.

When the above steps have been finalised, a draft report with observations, risk evaluation and recommendations is sent to local management. The main objective is for the local management to prepare comments upon the observations including a description of specific actions that will mitigate the risks and deadlines for implementation. The third interaction is a meeting between local management and IAF in which the draft audit memo is presented. In addition to agreeing on the description of the observations, actions, deadlines and so on, the prioritisation of the observations is another important issue, because all Priority 1 and some Priority 2 observations are included in the LFAR, which is forwarded to the Financial Supervisory Authorities (FSA). After the local management and IAF have agreed, the audit memo is finalised and signed by both parties.

4.1.2 Management summary

Using the signed audit memos, IAF prepares a management summary addressed to the executive board. The summary provides an overview of the observations from the audit memos, including prioritisation and a status (open/closed) on the action items from the local management comments. The fourth interaction is a meeting in which the draft management summary is presented to the executive board. At this meeting, the executive board comment on the conclusion, but the main issue is the open action items and a potential prioritisation of these at Group level. After agreement between the executive board and IAF is achieved, the management summary is finalised and signed by both parties.

4.1.3 Long-form audit report

Every quarter, IAF prepares a draft LFAR for the board of directors (audit committee). The LFAR at an overall level describes the audit performed and provides a summary of the results, including all Priority 1 and some Priority 2 observations. There is no specific rule for the selection of Priority 2 observations, but observations related to compliance with FSA regulations are often included in the LFAR. The fifth interaction is a meeting with the same structure as those held with the executive board, but in which the reports presented are the signed management summary and the draft LFAR. Upon agreement, the LFAR is finalised and prepared for the board of directors. Because the audit committee members are also part of the board, the presentation is considered a formality, where the LFAR is signed by the board members and thus formally approved.

4.2 Contextual features

The combined interaction model (Figure  1 ) includes three contextual features that can describe the impact on the IAF–client interaction: ‘regulatory/legal’, ‘general interaction’ and ‘audit/client’.

4.2.1 Regulatory legal context

• Appointment and dismissal of the head of IAF must be made by the board of directors and approved by FSA.
• The budget for IAF must be approved by the board of directors.
• IAF are not allowed to perform any functions other than auditing.
• The audit must comply with generally accepted auditing standards and be performed in accordance with the audit agreement. Specific reference is made to ISA 315.
• EA must perform a sample-based quality review of IAF work and report the result to the board of directors in the LFAR. Specific reference is made to ISA 610. 2

The audit committee has responsibility for ensuring that an audit agreement is entered into between EA and IAF. According to the audit agreement, the internal control audit and the related management reporting are the responsibility of IAF, as is traditional (Arena & Sarens,  2015 ). In contrast, the audit of the financial statement is performed primarily by EA, supported by IAF staff. The co-operation between EA and IAF results in an integrated financial and internal control audit (Kinney et al.,  2013 ). The agreed sharing of the audit in the Group is consistent with the view that IAF have an advantage over EA, because they experience a higher level of identification with the business and know its processes better. IAF have a long-term view, because they do not have to consider the renewal of the assignment and thus are able to provide a less lenient internal control evaluation (Stefaniak et al.,  2012 ).

First-line functions prefer to develop solutions that are reasonably secure—that way they avoid potential problems with IAF, us or FSA at a later stage. (Head of IT security)

4.2.2 General interaction context

Those who are on several financial services boards are more risk-averse. They tend to be very careful not to be exposed to negative audit reports. (Board member)

The issue of being exposed is amplified by the fact that both the internal and external LFAR, addressed to the board of directors, must be forwarded to FSA. If critical matters are included, it should be expected that FSA will request further information, for example, the supporting management letters and minutes from board meetings. These requests are formally addressed to the board of directors. As a consequence of this practice, problems related to internal control identified by IAF and/or FSA are transparent to the audit committee and the board of directors.

I got a very clear message from a board member: ‘We don't want loans that exceed the collateral—none at all’. Needless to say, this gave rise to an internal review and a general clarification of the requirements to the employees. (Client manager)

4.2.3 IAF/client context

Although not a requirement, it is a long-standing local practice that the head of IAF in major Danish financial institutions is a state-authorised auditor. IAF staff members have degrees as state-authorised auditors (20%), master's degrees in auditing (30%), master's degrees in finance (20%) and bachelor's degrees in accounting (30%). Except for the staff with master's degrees in finance, the other members have substantial experience working with a ‘Big 4’ audit firm. These past experiences have an impact on their professional identity as auditors (Daoust & Malsch,  2019 ). Supporting this identity, members of IAF have been active in the Institute of Internal Auditors and the Danish Institute of EA. Furthermore, some members of IAF teach auditing at master's level at Copenhagen Business School.

We have only a very few examples of recommendations from IAF which seem unreasonable. We always ask for—and get—an explanation. In general, the recommendations are reasonable. (Client manager)

If we get a reasonable result (mitigation of risk), there is no need to go further. There is also the future working relation to consider. (IAF manager)

We don't report minor details; it will just irritate the client and we will most likely have trouble getting through with the important issues. I believe that this approach explains why you don't see examples of withdrawn recommendations. (Head of IAF)

The value of the internal control audit, including the identification of weaknesses, also depends on the coordination of the audit (Lin et al.,  2011 ). During the case study, meetings between IAF and EA were observed. These meetings related primarily to detailed planning and sharing of the results of the work performed. The nature of these meetings indicates a joint-audit approach, which can be seen as a way of utilising the combined knowledge and thus improving the overall level of comfort (Sarens et al.,  2009 ). Furthermore, in the year-end LFAR, EA must state whether the work stipulated in the audit agreement has been carried out and whether IAF have performed satisfactorily, including remaining independent from the executive board. In each of the years included in the case study, EA reported that IAF met the regulatory requirements and that the result of the internal control audits supported the planned high control reliance.

5 TO WHAT EXTENT DOES IAF AFFECT INTERNAL CONTROLS?

The review of management letter reporting covering the period 2008–2017 included a total of 821 recommendations. Table  1 presents the recommendations, classified by IAF's prioritisation and divided into implementation of new controls and improvement of existing ones:

The only year with a significantly higher number of recommendations for new controls is 2009—following the financial crisis and an increase in new requirements from FSA (Van der Stede,  2011 ). Apart from 2009, the number of recommendations for new controls is stable at around 20 on an annual basis. The recommendations, classified by nature of requirement, are listed in Table  2 :

Of the recommendations for implementation of new controls, 32% relate to legal and regulatory requirements, 12% to compliance with internal policies and 56% to IAF's professional judgement without reference to any specific requirement.

The review of the management letters also covered management comments, including deadlines for when the risks would be mitigated. There are some examples in which mitigating actions were delayed compared to the initial plan. The main explanation for these delays is that a number of recommendations had been used as input to the implementation of a new system, which might have resulted in a redesign of supporting processes and internal controls. Based on a review of the database of recommendations maintained by IAF, all issues had, however, been closed by the time of the study. In summary, an average of approximately 20 new controls is implemented annually in response to the IAF's recommendations. Besides having a significant impact on the level of internal controls, the acceptance of all recommendations is an indication of a high quality IAF (Trotman & Duncan,  2018 ).

6 HOW DOES IAF AFFECT INTERNAL CONTROLS?

• Meeting about initial observations
• Meeting about recommendations
• Meeting about draft audit memo
• Meeting about draft management summary
• Meeting about draft LFAR

6.1 Meeting about initial observations

The audit typically results in a number of observations, which are documented in Appendix  A to the audit memo. An observation is the most detailed level in the management letter and is the subject of the first interaction between IAF and the client. The objective of this interaction is to arrive at a common understanding of the observations, which are internal control weaknesses identified by IAF as part of the process audit (Figure  2 ). The basis for this agreement is that the IAF manager sends a draft of Appendix  A to the client staff member who has been involved in the audit. If necessary, a meeting is held between the parties to clarify any misunderstandings and prepare any necessary adjustments to the description in order to make it as precise as possible.

If they (IAF) have got a wrong impression of a procedure—they are willing to listen to valid arguments. (Client manager)

If there are different views, it is up to the client to present further documentation to support adjustments. Therefore, the meeting is an argumentative exchange of information supporting, adjusting or rejecting the observation, and the output is a joint product.

6.2 Meeting about recommendations

Regarding the recommendations, it is of less importance how the issue is solved. When we have agreed on an observation, it is up to the client to suggest a solution—as long as it works. But the recommendation should mitigate the risk—otherwise we must try again. We need to close the observation; how it happens is actually of minor importance. (IAF manager)

There is no point in preparing a recommendation if the client has no practical options for implementing an improvement. Then it is better to suggest another solution as long as the risk is mitigated. (Head of IAF)

This practical approach is also illustrated by the way the client handles the recommendation. Because it is the client's responsibility at a later stage to implement a solution, the client staff member often goes back to local management to agree on a solution.

The nature of both the IAF and client side of the interaction can be classified primarily as argumentative. There are, however, indications that IAF could insist if necessary. The statement that ‘the recommendation should mitigate the risk’ indicates the existence of minimum requirements to the solutions. The combined behaviour is, however, still a discussion aimed at describing a recommendation and a solution which can be implemented to fulfil the audit requirements. Therefore, the output of the interaction is a joint product because both parties take part in a co-operative manner.

6.3 Meeting about draft audit memo

The local managers don't mind our recommendations, and they prefer to have well-controlled business processes. If we are reasonable with our recommendations, they comply. However, they do not like priority 1 observations. Being exposed to the board of directors is not seen as a desirable situation. (IAF manager)

It is obvious that priority 1 recommendations can lead to reactions from the board of directors, which may cause unnecessary turmoil in the organisation—a situation we want to avoid for obvious reasons; but in general, the recommendations from IAF are reasonable. (Client manager)

… we might sometimes agree on a priority 2 instead of 1. It is, however, a bargaining situation—if we change priority from 1 to 2, we could perhaps agree to speed up the deadline for implementation. (Head of IAF)

The ‘deadline for implementation’ refers to the final element of Appendix  A , which is the management comment. In this section, local management comments on the observations and recommendations and commits to a deadline. The deadline for mitigating the risk is important, because IAF follows up on the agreed deadlines on an ongoing basis.

The behaviour exhibited by both IAF and the client is classified as argumentative leaning towards insisting, and the combined nature of the interaction is classed as a negotiation. This is mainly due to the potential exposure to the board of directors. When the management comments have been finalised, the audit memo is signed by both parties. Even though the number of Priority 1 recommendations is reduced as a result of the interaction, IAF make the final decision. Therefore, the draft audit memo should be classified as primarily an IAF product.

6.4 Meeting about draft management summary

It is a management decision how to prioritise the resources—and it is clearly not our job to be involved in this process. We accept the decisions and plan our audit accordingly. (Head of IAF)

This is seen as a permissive attitude based on a professional understanding of roles and responsibilities, including potential independence issues. Because the changes to the draft management summary are the result of management decisions, the output is classified as a client product.

6.5 Meeting about draft long-form audit report

It is our document and our professional responsibility. Further, we have been involved in the whole process, and therefore it is not acceptable if the audit committee changes our professional judgment. (Head of IAF)

I see this as an indication that the behaviour of IAF is argumentative, leaning towards insisting, and the meeting should be classified as an exchange of information. A review of draft and final LFARs revealed no substantive changes. This can also be explained by the fact that the audit committee is involved in the management letter process at a rather late stage, when all other parties have agreed on the details. The output is the final LFAR, which is signed by the board of directors. The document is an IAF product, because IAF has both the formal and the actual responsibility.

6.5.1 Outcome of the management letter process

The output from the management letter process and the combined IAF–client interaction model is a joint product defined as a number of accepted audit recommendations. After implementation of these recommendations, the outcome is an improved level of internal control. Assessing the audit and business value of this outcome, I presented the respondents with a number of specific recommendations, asking the client to evaluate the business value and IAF to evaluate the audit value. As part of this assessment, we asked the respondents to consider that the Group is governed by regulatory requirements, which might overrule business-driven considerations.

This is a typical recommendation primarily for the benefit of FSA. The control is performed as expected, but not documented according to requirements from FSA. From a business perspective it makes no difference—but we accept the recommendation and see it as a defence when we have inspections from FSA. (Client manager)

Due to information from network groups, we pay more attention to areas which we know that FSA is aware of. If, for example, another bank has struggled with FSA regarding real estate loans, we use additional resources to ensure that all risks are mitigated. You might say that the audit serves both a traditional audit purpose and at the same time as a kind of defence against FSA. After all, we prefer to have a good reputation and working relations with FSA—it makes things much easier. (Deputy head of IAF)

All the specific recommendations would have been included in the management letters if the audit had been performed in a situation where we didn't have to consider regulatory requirements. The only difference is that two recommendations would most likely not have been included in the LFAR. (Head of IAF)

Both recommendations relate to failure to comply with regulatory requirements. The first recommendation is implementation of a system-based access control aiming at ensuring that employees working in more than one legal entity comply with FSA's requirement for ‘double employment’. The second recommendation ‘… a review of real estate loans to ensure compliance with FSA's loan limits and documentation requirements’, is also commented by a client manager, re above.

This assessment supports the conclusion that recommendations would have been included in the management letters independent of the regulatory requirements and that they add value from an audit perspective.

They are recommendations which FSA would no doubt report—most likely as orders—and with good reason. However, we should have proper internal controls in place in these areas no matter what FSA might say. (Head of IT security)

The recommendation and our mitigation of the risk are totally independent of whether FSA exists or not. The issue is too important from both an audit and a business perspective to be affected by FSA's assessment. (Head of IT security)

Based on these discussions, it seems that all respondents recognise the regulatory requirements. However, the outcome of the management letter process, the improved level of internal control, would have been implemented independently of the regulatory requirements because IAF's recommendations add value from both an audit and a client perspective.

7 DISCUSSION AND CONCLUSION

Based on a single-case study, the management letters from IAF and the supporting process in a large financial institution were analysed. In the case study, IAF is organised, staffed and working in such a way that EA can rely on the work delivered at a level of high control reliance. IAF performs only auditing and is not involved in any other roles. This clear role definition is both supported by regulatory requirements and recognised as agreed local practice. Consequently, IAF complies with general independence and ethical requirements.

As part of the study, a detailed review was conducted of the management letter reporting of the internal control audits for 2008–2017. The review clarified the extent to which IAF impact internal controls. In total, 223 (27%) of the observations resulted in recommendations for implementation of new controls. The remaining 598 (73%) relate to improvements to existing controls, including documentation. All recommendations reported in management letters are implemented, without exception. Based on this analysis, IAF have a significant impact on internal controls and deliver work at a high quality (Trotman & Duncan,  2018 ).

As a basis for the analysis of how IAF affect internal controls, a description of the management letter process was established, including five interactions between IAF and the client (Figure  2 ). To contribute to an understanding of how internal control audits impact internal controls, these interactions were analysed based on the theories of audit–client interaction (Fearnley et al.,  2011 ; Salterio,  2012 ). The results are summarised in Table  3 :

IAF and the client both exhibit mixed behaviour, but their behaviour is predominantly argumentative when making decisions regarding internal control audits. The examples of mixed behaviour are as expected (Murnighan & Bazerman,  1990 ). The mixed behaviour is also supported by IAF as they consider when ‘enough is enough’ with the aim of supporting the long-term relationship (Stefaniak et al.,  2012 ). The combined IAF and client behaviour is primarily an exchange of information in which issues are presented at meetings between IAF and the client and the quality of information decides the output of the interaction. There are, however, two exceptions, namely, the overall prioritisation of the resources required to improve existing controls or implement new ones and the LFAR. The prioritisation of resources is a management responsibility and thus a client product, and IAF fully respect the authority of the executive board. The LFAR, on the other hand, is IAFs' responsibility, being their report to the board of directors, and consequently it is an IAF product.

A key element in the management letter process is the meeting regarding the initial observation, where a common understanding of an internal control weakness is established. The remainder of the management letter process might be considered as interactions aimed at mitigating this weakness and reporting the result to management. Even though IAF's behaviour in these remaining interactions is predominantly argumentative/insisting, the interaction strategy could be seen as integrative, aiming at joint problem solving (McCracken et al.,  2011 ). Supporting this view, the ‘trade-off’, from an IAF perspective, is the prioritisation of the recommendations, whereas their key objective of mitigating the audit risk is not discussed. Mitigation of audit risk is achieved, because the output of the IAF–client interaction is the decision on implementation of new controls or improvement of existing ones, which should be considered a joint product. This joint product and understanding have been established through a step-by-step process in which disagreements are settled before the next step is started. The fact that different levels of employees have agreed the ‘step-by-step’ interactions might explain an unconditional acceptance from the audit committee. Potentially, the audit committee, and therefore also the board of directors, could disagree with the recommendations, but then, they would be in opposition to both IAF and the business decisions taken as part of the management letter process.

This conclusion regarding co-operation is different from that of a study by Hellman ( 2006 ) in which the client was found to be more aggressive towards the auditors and disagreements were reported. However, there is an important contextual difference, because the study by Hellman ( 2006 ) is based on management letters produced in the period 1999–2001, before the requirements regarding audit independence imposed by Sarbanes–Oxley. In that period, the audit approach was focused on delivering ‘added value’ to the client (Power,  2000 ). Furthermore, that study concludes that the audit was considered useful if it supported the hierarchical management control in the company (Hellman,  2006 ). This top-down approach differs significantly from the ‘bottom-up’ audit in the management letter process, in which each interaction is agreed before proceeding to the next level. Also, the recommendations in the management letters in the present case study are based on a strict internal control evaluation.

Even though a strict internal control assessment might be distant from the ‘added value’ approaches promoted by the big audit firms (Power,  2000 ), the internal control audit performed by IAF seems to add value. This conclusion is supported by viewing the result of the case study through the lens of internal audit quality (Trotman & Duncan,  2018 ). The technical skills and experience of IAF match the qualifications seen in big audit firms. Furthermore, it seems that objectivity (Stefaniak et al.,  2012 ) and soft skills are at the same level, which is supported by the annual customer (client) satisfaction surveys. The ‘technical production’ and ‘service interaction’ dimensions, supported by the management letter process and the step-by-step structure and acceptance, seem to be crucial to the classification of the outcome as value-adding. The outcome of this process is an improved level of internal controls that is unconditionally accepted by the client. This is seen as an indication of a valuable outcome adding both significant business and audit value through the mitigation of risk. Mitigation of the audit risk is supported by the annual formal statement from EA accepting the result of the internal control audits and the full integration of it in the remaining part of the audit of the Group's annual report, which is based on a high control reliance. Consequently, the result illustrates a fully integrated financial and internal control audit (Kinney et al.,  2013 ). Furthermore, it seems that the regulatory requirements only have a limited impact, because almost all recommendations would have been implemented independently of the regulatory regime. This result differs from those of previous studies regarding financial reporting in which the risk of being caught has been found to be the most important contextual feature (Fearnley et al.,  2011 ).

This paper contributes with a detailed understanding of how IAF impact the internal controls system in a financial institution (Bame-Aldred et al.,  2012 ; Roussy et al.,  2020 ). It also adds a deeper understanding of the management letter process compared to previous studies. Furthermore, the results suggest that the audit approach documented in the management letter process, including the step-by-step settlement of the interactions, is crucial to an assessment of the outcome as value-adding. This suggestion adds detail to the ‘technical production’ and ‘service interaction’ dimensions included in the ‘Internal Audit Quality Framework’ by Trotman and Duncan ( 2018 ).

Based on a review of management letters covering a period of 10 years, it seems that the auditors continue each year to issue new recommendations for improvements to internal controls. It could be of interest for further research to explore how this is possible. One explanation could be that the systems and procedures after an implementation project is finalised fail to include an ongoing improvement matching contextual changes. An alternative or supplementary explanation might be that system implementations are primarily considered a technology-driven activity that does not include internal control requirements. Furthermore, IAF have indicated that they use additional resources to meet regulatory requirements. It could be of interest for future research to explore the nature and magnitude of the burden and how much additional work this requires beyond what is needed to mitigate the audit risk. Considering mitigation of risk, the case identified an overlap between mitigation of audit and business risk, supporting a joint interest between auditor and client. It could be of interest for further research to analyse the impact of this overlap on internal control audits.

There are some weaknesses in and limitations to the study. The analysis is based on a specific set of interactions between IAF and the client in a major financial institution. The management letter process, including the interactions involved and the co-operation between IAF and EA, might be different in other companies. These limitations notwithstanding, the study contributes to an understanding of the extent to which IAF affect internal controls and how they do so.

ACKNOWLEDGEMENT

There are no funders to report for this submission.

CONFLICT OF INTEREST

No conflict of interest.

ETHICS STATEMENT

I confirm complying with Wiley's Guidelines on Publishing Ethics.

AUTHOR CONTRIBUTION

The author confirms sole responsibility for the following: study conception and design, data collection, analysis and interpretation of results and manuscript preparation.

• 1 An important objective of the regulatory requirements is to support independence from the client and in particular the executive functions. The term ‘client’ is consistently used by IAF, and by, for example, Arena and Jeppesen ( 2010 ), when referring to the executive functions.
• 2 The references to ISA 315 and 610 are also included in the description of the relation between internal and external audit in ‘The internal audit function in banks’ (Bank for International Settlements [BIS],  2012 ).
• 3 ‘Auditor's professional judgment’ is also used by International Federation of Accountants (IFAC,  2009 ) as a guideline for ranking findings.

Appendix A: INTERVIEW GUIDE

As part of the introduction to the first employee interview, I made a brief presentation of the project and the research question. This included an introduction to the overview of the management letter process (Figure  1 ) and the combined IAF–client interaction model (Figure  2 ). After the introduction, the discussion began. Depending on the area, the interview focused on either ‘how?’ or ‘why?’ questions:

A.1 Main ‘how?’ questions

• Based on the description of the management letter process, where do you see yourself?
• What is your role in the process (or interaction)?
• How would you describe your working relationship with IAF (or the client)?
• Could you give examples of how you interact with IAF (or the client)?
• I have established a scale describing the behaviour of IAF (or the client)—see Figure  2 . Where do you see IAF (or the client)?
• The part of the process you are involved in—what is the outcome?
• Do you have an impact on the outcome, and could you give some examples?
• I have established a scale describing the outcome, which you can see in Figure  2 . How would you classify the outcome?

A.2 Main ‘why?’ questions

• I have established three categories of contextual features (Figure  2 ). Do you think that any of these have an impact on your co-operation with IAF in the management letter process?
• As part of the ‘how?’ questions, I asked about the working relationship with IAF. Do you think that this has an impact?
• In your view, what is the impact of the board (i.e., the ‘tone from the top’) and the behaviour of the management in general?
• Can you provide examples of how the board or management has intervened in the process or has otherwise had an indirect impact?
• In your view, what is the impact of FSA?
• Can you provide examples of how FSA has intervened in the process or has otherwise had an indirect impact?
• Which one (management or FSA) do you consider to be the most important, and why?
• Regarding the specific meeting—are there examples in which the agreement reached on one issue could have an impact on the rest of the issues to be discussed?

Leif Christensen is an assistant professor, PhD in Accounting at Copenhagen Business School (CBS). Leif's research is in the areas of auditing and management controls. Prior to joining CBS, he worked as a state-authorized auditor, including 15 years as a PwC partner. His research has been published in leading journals such as Qualitative Research in Accounting & Management and Accounting, Auditing & Accountability Journal .

Open Research

Data availability statement.

The data that support the findings of this study are available from the corresponding author upon reasonable request.

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AA Practice Questions

Aa chapter 1 questions – what is assurance, aa chapter 2 questions – corporate governance, aa chapter 3 questions – auditors’ rights, appointment, removal, resignation and regulation, aa chapter 4 questions – professional ethics, aa chapter 5 questions – the auditor’s report, aa chapter 6 questions – audit opinions: unmodified/modified, aa chapter 7 questions – the stages of an audit – appointment, aa chapter 8 questions – the stages of an audit – after appointment, aa chapter 9 questions – audit risk, aa chapter 10 questions – audit evidence, aa chapter 11 questions – audit sampling, aa chapter 12 questions – internal control, aa chapter 13 questions – accounting systems, aa chapter 14 questions – computer system controls, aa chapter 15 questions – computer assisted audit techniques, aa chapter 16 questions – the final audit – the assertions revisited, aa chapter 17 questions – the audit of receivables, aa chapter 18 questions – trade payables, aa chapter 19 questions – accruals and prepayments, aa chapter 20 questions – inventory, aa chapter 21 questions – bank and of cash, aa chapter 22 questions – non-current assets, aa chapter 23 questions – using the work of others, aa chapter 24 questions – audit documentation and quality control, aa chapter 25 questions – fraud and error, aa chapter 26 questions – subsequent events, aa chapter 27 questions – contingent assets and liabilities, aa chapter 28 questions – written representations.

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What you will learn in AA

The Audit and Assurance syllabus is essentially divided into six areas. The syllabus starts with the nature, purpose and scope of assurance engagements, including the statutory audit, its regulatory environment, and introduces governance and professional ethics relating to audit and assurance.

It then leads into planning the audit and performing risk assessment.

The syllabus then covers a range of areas relating to an audit of financial statements including the scope of internal control and the role and function of internal audit. These include, evaluating internal controls, audit evidence, and a review of the financial statements.

In addition to final review procedures, the syllabus concentrates on reporting, including the form and content of the independent auditor’s report.

Finally, the syllabus contains outcomes relating to the demonstration of appropriate digital and employability skills in preparing for and taking the AA examination. This includes being able to interact with different question item types, manage information presented in digital format and being able to use the relevant functionality and technology to prepare and present response options in a professional manner. 

These skills are specifically developed by practicing and preparing for the AA exam, using the learning support content for computer-based exams available via the practice platform and the ACCA website and will need to be demonstrated during the live exam.

On successful completion of this exam, candidates should be able to:

A. Explain the concept of audit and assurance and the functions of audit, corporate governance, including ethics and professional conduct.

B. Demonstrate how the auditor obtains and accepts audit engagements, obtains an understanding of the entity and its environment, assesses the risk of material misstatement (whether arising from fraud or other irregularities) and plans an audit of financial statements

C. Describe and evaluate internal controls, techniques and audit tests, including IT systems to identify and communicate control risks and their potential consequences, making appropriate recommendations. Describe the scope, role and function of internal audit.

D. Identify and describe the work and evidence obtained by the auditor and others required to meet the objectives of audit engagements and the application of the International Standards on Auditing (ISAs)

E. Explain how consideration of subsequent events and the going concern principle can inform the conclusions from audit work and are reflected in different types of auditor’s report, written representations and the final review and report.

F. Demonstrate employability and technology skills

More information about the Practical Experience Requirement can be viewed here:

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Case Studies

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A collaborative effort of the Anti-Fraud Collaboration, these case studies are educational tools for all members of the financial reporting supply chain, as well as students. Participants in case study teachings start with a hypothetical scenario about a fictional company dealing with a fraud. Guided by an instructor, they then discuss what could have been done to address the situation.

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The CAQ, in connection with the Auditing Section of the AAA, established a program designed to facilitate accounting and auditing academics’ ability to obtain access to audit firm personnel to participate in their research projects.

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Publications 04.05.21

Fraud and Emerging Tech: Artificial Intelligence and Machine Learning

Comment Letter 02.01.21

IAASB: Discussion Paper, Fraud and Going Concern in an Audit of Financial Statements

Publications 01.12.21

Mitigating the Risk of Common Fraud Schemes

Policymakers across the globe increasingly recognize the vital role of audit committees and their importance to audit quality. In close collaboration with partner organizations, the CAQ is actively engaged in policy developments related to audit committees.

Newsletter 03.24.23

Audit Committee Insights | March 2023

Publications 03.22.23

Audit Quality Reports Analysis: A Year in Review

Video 02.28.23

Audit Committee Effectiveness: A Webinar Series

Audit Committee members are an essential component to the health of our financial reporting ecosystem and capital markets. While our economy is constantly evolving, so is the role of audit committee members. Policymakers, investors, and other leaders across the globe increasingly recognize the vital role of audit committees and their importance to audit quality. In close collaboration with partner organizations, the CAQ is actively engaged in developments that impact audit committees and provides valuable resources, current policy information, and tools to support audit committees with their responsibilities.

Auditors are highly skilled at adapting and problem solving, without sacrificing the audit quality on which our capital markets and investors depend. It is no surprise that under unprecedented circumstances, long-term investments in training and technology enabled the profession to quickly transition to remote work. Many factors lead to a quality audit, but a combination of auditor expertise and independence coupled with constant innovation and technology bolsters the level of trust and confidence in company financial statements and forms the basis of audit quality—and, therefore, value to capital markets.

2021 Audit Committee Transparency Barometer

Auditor Independence: A Cornerstone of Audit Quality

How Audits Support Capital Markets

The CAQ has been at the forefront of the movement to develop quantitative and qualitative metrics regarding the audit—commonly referred to as audit quality indicators (AQIs)—that could be used to better inform audit committees about key matters that may contribute to the quality of an audit.

Publications 11.30.22

2022 Audit Committee Transparency Barometer

Engaging constructively with policymakers and key stakeholders, the CAQ and its members have made substantial and practical contributions to ongoing efforts to enhance information presented in the auditor’s report to investors and other users.

Newsletter 01.07.21

Public Policy and Technical Alert, December 2020

Alert 12.07.20

Public Policy and Technical Alert, November 2020

Auditors play a key role as independent gatekeepers in the financial reporting ecosystem that underpins confidence in capital markets. Auditors build trust and confidence in information through the assurance services they provide. The auditing profession has steadily developed, systemized, and strengthened this trust and confidence-building role in providing assurance related to company financial statements and internal control over financial reporting. While auditors will continue the essential work of auditing historical financial statements, they can also bring their ability to enhance trust and confidence in other types of data and information issued by companies.

The Role of Auditors in Company-Prepared ESG Information: A Deeper Dive on Assurance

The Role of Auditors in Company-Prepared Cybersecurity Information: Present and Future

The Role of Auditors in Non-GAAP Financial Measures and Key Performance Indicators: Present and Future

Lending trust and credibility to ESG information.

Comment Letter 06.17.22

SEC Proposed Rule: The Enhancement and Standardization of Climate-Related Disclosures for Investors

Video 03.07.22

ESG Reporting 101: What is ESG assurance and why does it matter?

CAQ Commentary on SEC Climate-Related Disclosure Proposal

Alert 12.07.21

Audit Planning Alert for Auditors of Brokers and Dealers

Alert 08.27.19

CAQ ALERT #2019-01 – PCAOB REPORT ON 2018 INSPECTIONS OF BROKERS AND DEALERS

Alert 08.22.18

CAQ Alert #2018-04 – Broker’s and Dealer’s Use of a Service Organization

The Annual CAQ Symposium brings together practice leaders and audit research scholars for a discussion of important issues and an exploration of how research can inform those issues. On the pages for each event, find videos, summaries, and panel participants.

CAQ Symposium 2022

Video 10.28.21

What’s happening in ESG reporting & assurance today? Top 5 Takeaways from CAQ Symposium 2021

CAQ Symposium 2021

The CAQ creates educational videos that can be used in the classroom or as training resources. Available videos include a “Video Vignettes” series that provides a view into the types of conversations that take place during an audit. Videos also include classroom-ready excerpts derived from an expert panel at a CAQ event.

Publications 01.17.23

2023 Profession Outlook

Publications 03.07.22

Demonstrating the Value of Public Company Auditors

Statement 11.03.21

Statement of Support for the International Sustainability Standards Board (ISSB)

Strong fraud deterrence and detection requires all participants in the financial reporting ecosystem to exercise extreme vigilance. In a heightened risk environment regulators, internal and external auditors, audit committees, and public company management must work together to effectively detect and deter fraud.

Since its inception, the CAQ has sought to improve audit quality by increasing engagement between auditors and the academic community by fostering independent research related to the public company auditing profession.

Audit firms, standard-setters, regulators and the CAQ are developing a growing number of resources to help auditors, investors, management and audit committees understand the impact of the COVID-19 pandemic on financial reporting and oversight, and the CAQ is working to curate and distill that information for you.

COVID-19 11.09.20

Anti-Fraud Resources

COVID-19 10.06.20

Auditing Profession Resources

COVID-19 06.19.20

Audit Committee Resources

Cybersecurity threats are complex and an evolving issue with serious implications for public companies, their boards, investors, and other stakeholders, making it critical that the public company auditing profession does their part to support companies, boards, and others in addressing such threats.

Publications 06.27.22

Audit Partner Pulse Survey, Q2 2022

Comment Letter 05.09.22

SEC: Cybersecurity Risk Management, Strategy, Governance, and Incident Disclosure

Bold Ambition

Accounting+

Video 10.19.21

Profession in Focus: Diversity in Focus with Elena Richards

The CAQ is a prominent voice in the discussion about effective financial disclosures. Convening key investor and financial groups, the CAQ has developed concrete recommendations on ways to facilitate investors’ access to meaningful information.

Comment Letter 11.25.19

SEC: Update of Statistical Disclosures for Bank and Savings and Loan Registrants

Comment Letter 07.29.19

SEC: Amendments to Financial Disclosures about Acquired and Disposed Businesses

Video 11.20.18

Audit Committee Reporting – Leslie Murphy

Emerging technologies are altering the financial reporting environment substantially, and this change is accelerating. For auditors and others in financial reporting, the CAQ provides insights on the benefits and risks of technology developments.

Publications 05.16.19

Emerging Technologies, Risk, and the Auditor’s Focus: A Resource for Auditors, Audit Committees, and Management

Publications 01.12.20

Fraud and Emerging Tech: Robotic Process Automation

Video 04.09.19

Evolution in Auditing

The CAQ is dedicated to enhancing investor confidence by supporting the public company auditing profession every day to improve audit quality and enhance auditor independence, creating a solid foundation of financial reporting that benefits investors in the United States.

2020 Audit Committee Transparency Barometer

Audit In Action

The CAQ has engaged on the issue of fair value (or mark-to-market) accounting, regarding both its usage broadly in the markets and in the context of auditing fair value measurements.

Alert 03.02.18

Public Policy and Technical Alert, February 2018

Publications 03.12.09

CAQ Testimony: “Mark-to-Market Accounting: Practices and Implications”

Meeting Highlights 06.12.97

June 1997 IPTF Joint Meeting Highlights

Are you purpose-driven? Are you a natural problem solver with an unquenchable curiosity? Are you fascinated by the inner workings of companies and financial markets? Then a career in audit may be right for you.

Video 10.05.20

Profession in Focus: A Conversation with EY’s Ken Bouyer on Inclusiveness Recruiting

Making It Balance

Robust internal control over financial reporting (ICFR) is a keystone of investor confidence. The CAQ has advanced the discussion around ICFR and produced a range of resources on the issue.

Perspectives on Management Review Controls: Challenges and Solutions

Alert 05.01.20

Public Policy and Technical Alert, April 2020

Alert 02.07.20

PUBLIC POLICY AND TECHNICAL ALERT, JANUARY 2020

In an increasingly interconnected global economy, market participants are considering whether it is possible or desirable to move toward a more uniform global “language” for financial reporting. As the discussion has taken place around International Financial Reporting Standards (IFRS), the CAQ has been an active voice.

The CAQ has been outspoken against policy provisions that would interfere with the independence of the accounting and auditing standard-setting processes.

The CAQ works to increase investor trust in the capital markets by promoting and developing high-quality performance from the public company auditing profession. A cornerstone of our strong U.S. capital markets is the trust investors place on audited financial statements when making critical decisions. Our resources provide information for investors on developments in the auditing profession, oversight and governance of public companies, and leading practices in the field of audit.

Publications 12.08.21

Value of the Audit

The CAQ has been a leading voice on the issue of mandatory audit firm rotation, which has significant implications for investors, audit committees, public company auditors, and the markets.

Comment Letter 12.14.11

PCAOB: Concept Release on Auditor Independence and Audit Firm Rotation

Comment Letter 02.14.14

ISS: Consultation Document on Auditor Ratification

Keeping CAQ members and stakeholders informed on significant public policy and accounting matters.

The CAQ and the public company auditing profession are dedicated to supporting valuable independent academic research that can have important, real-world impact on audit quality and the future of auditing.

The panel discussion videos are short excerpts from a CAQ event where practitioners and a leading academic provide perspectives on various issues related to the auditors’ risk assessment of a company. Included are the panelist bios and free short descriptions of each video excerpt.

Video 01.09.18

How Auditors Approach Risk Assessments

Video 01.08.18

How Materiality Impacts the Auditor’s Risk Assessment

Video 01.07.18

Consideration of Risks in Multilocation Audits

The CAQ has been at the forefront of the discussion around the role of the public company auditor and whether it should evolve to meet the changing information needs of investors.

Publications 03.09.23

The Role of the Auditor in Climate-Related Information

Publications 11.16.22

Audit Partner Pulse Survey, Fall 2022

The enactment of the Sarbanes-Oxley Act (SOX) of 2002, a law aimed at fostering more reliable financial reporting and enhancing audit quality, was a watershed moment for investors, public company auditors, and the markets. The CAQ has worked to create understanding of the impact of this important law. It has opposed efforts to weaken SOX section 404(b), which provides investors with important assurance by the independent auditor regarding management’s representations about the effectiveness of their company’s internal control over financial reporting (ICFR).

Video 08.01.19

Profession in Focus: Accelerated Filers, ICFR Audits, and Investor Protection

SEC: Amendments to the Accelerated Filer and Large Accelerated Filer Definitions

Publications 05.09.19

Guide to Internal Control Over Financial Reporting

Stay updated on the latest CAQ news.

Since 2008, the CAQ has organized and participated in panel discussions at the Annual Meeting of the American Accounting Association (AAA).

Video 10.09.20

CAQ at the AAA – August 2020

CAQ Panel at the 2020 AAA Auditing Section Midyear Meeting: Leveraging New and Old Media to Promote Degrees in Accounting

Video 08.12.19

CAQ Panel at The 2019 AAA Annual Meeting: Sustaining a Strong System of Quality Control to Enhance Audit Quality

The Sarbanes-Oxley Act of 2002 (SOX) was a watershed moment for investors, public company auditors, and capital markets. It established more reliable corporate reporting and auditor independence rules that enable stakeholders to trust the information provided by public companies. Two decades later, the U.S. is now widely recognized as the gold standard for auditor independence and thousands of high-quality audits are completed each year.

Video 08.08.22

Pop-Up Conversation with Rep. Brad Sherman (D-Calif.) and Mark Baer of Crowe

Video 07.27.22

SOX: The Evolution of Corporate Reporting

Our capital markets are an important engine for driving and maintaining our economic and societal well-being. These markets operate on information, and audited financial statements have long been a critical element of this information dynamic for their accuracy, transparency, and reliability. As investors make decisions, they depend on the information they receive from public company management. As a result, investors need—and in fact have long sought—an independent third party to provide assurance on the information provided by company management. Independence underpins the very credibility of the audit and, ultimately, its value to capital markets. It is also one reason why audit quality in the US has never been higher.

Publications 10.20.22

Auditor Independence

How Do Auditors Maintain Independence?

Audit in Action: The Role of the Audit Committee

The CAQ has engaged on the issue of effectively enhancing transparency in the audit, endeavoring to facilitate access to meaningful information for financial statement users and other constituencies.

Video 02.05.19

Critical Audit Matters: Audit Committee Perspectives

Video 02.13.18

Key Updates on Audit Committee Transparency and Investor Confidence

Alert 10.11.17

CAQ Alert #2017-04 – Select Auditing Considerations for the 2017 Audit Cycle

The vignettes provide insights into the types of conversations that occur between audit team members, as well as between auditors and preparers. The discussions captured in the videos can also be used in other teaching situations, as they highlight communications and interviewing techniques, professional skepticism, and how to navigate conversations on difficult and sensitive issues.

Video 04.13.17

Vignette 3: Auditing Is a People Business

Video 02.17.17

Vignette 2: Evaluating Root Cause and Severity of a Control Deficiency

Video 08.16.16

Vignette 1: Evaluating Management Review Controls over a Goodwill Impairment Estimate

The latest news and resources from the CAQ.

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• Subsequent events
• Study resources
• Audit and Assurance (AA)
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Students of financial reporting and auditing papers will have to gain an understanding of how subsequent events (also known as ‘events after the reporting period’) affect the financial statements of an entity. This article will consider the financial reporting aspects concerning subsequent events using a case study type scenario, and will then discuss the auditing requirements that candidates of Paper F8, Audit and Assurance need to be aware of.

Financial reporting considerations

In almost all circumstances, financial statements will not be finalised until a period of time has elapsed between the year-end date and the date on which the financial statements are (expected to be) issued. Therefore, regard has to be given to events that occur between the reporting date and the date on which the financial statements are (expected to be) authorised for issue.

IAS 10, Events After the Reporting Period stipulates the accounting and disclosure requirements concerning transactions and events that occur between the reporting date and the (expected) date of approval of the financial statements. Among other things, IAS 10 determines when an event that occurs after the reporting date will result in the financial statements being adjusted, or where such events merely require disclosure within the financial statements.  Such events are referred to in IAS 10 as ‘adjusting’ or ‘non-adjusting’ events.

Students who have studied Paper F3, Financial Accounting will have come across such terminology and it is imperative that they can differentiate between an adjusting and a non-adjusting event. IAS 10 prescribes the definitions of such events as follows:

Adjusting event An event after the reporting period that provides further evidence of conditions that existed at the end of the reporting period, including an event that indicates that the going concern assumption in relation to the whole or part of the enterprise is not appropriate . (1)

Non-adjusting event An event after the reporting period that is indicative of a condition that arose after the end of the reporting period. (1)

Example 1 You are the trainee accountant of Gabriella Enterprises Co and are preparing the financial statements for the year-ended 30 September 2010. The financial statements are expected to be approved in the Annual General Meeting, which is to be held on Monday 29 November 2010. Today’s date is 22 November 2010. You have been made aware of the following matters:

• On 14 October 2010, a material fraud was discovered by the bookkeeper. The payables ledger assistant had been diverting funds into a fictitious supplier bank account, set up by the employee, which had been occurring for the past six months. The employee was immediately dismissed, legal proceedings against the employee have been initiated and the employee’s final wages have been withheld as part‑reimbursement back to the company.
• On 20 September 2010, a customer initiated legal proceedings against the company in relation to a breach of contract. On 29 September 2010, the company’s legal advisers informed the directors that it was unlikely the company would be found liable; therefore no provision has been made in the financial statements, but disclosure as a contingent liability has been made. On 29 October 2010, the court found the company liable on a technicality and is now required to pay damages amounting to a material sum.
• On 19 November 2010, a customer ceased trading due to financial difficulties owing $2,500. As the financial statements are needed for the board meeting on 22 November 2010, you have decided that because the amount is immaterial, no adjustment is required. The auditors have also confirmed that this amount is immaterial to the draft financial statements.

Required: (a) For each of the three events above, you are required to discuss whether the financial statements require amendment.

Answer: When presented with such scenarios, it is important to be alert to the timing of the events in relation to the reporting date and to consider whether the events existed at the year-end, or not. If the conditions did exist at the year-end, the event will become an adjusting event. If the event occurred after the year-end, it will become a non-adjusting event and may simply require disclosure within the financial statements. 

1. Fraud Clearly the fraud committed by the payables ledger clerk has been ongoing during, and beyond the financial year. Fraud, error and other irregularities that occur prior to the year-end date – but which are only discovered after the year-end – are adjusting items, and therefore the financial statements would require amendment to take account of the fraudulent activity up to the year-end. 

2. Legal proceedings At the year-end, the company had made disclosure of a contingent liability. However, subsequent to the year-end (29 October 2010), the court found the company liable for breach of contract. The legal proceedings were issued on 20 September 2010 (some 10 days before the year-end). This is, therefore, evidence of conditions that existed at the year-end. IAS 10 requires the result of a court case after the reporting date to be taken into consideration to determine whether a provision should be recognised in accordance with IAS 37, Provisions, Contingent Liabilities and Contingent Assets at the year-end. In this case, the financial statements will require adjusting because:

• the conditions existed at the year-end
• the recognition criteria for a provision in accordance with IAS 37 have been met.

3. Loss of customer A customer ceasing to trade so soon after the reporting period indicates non-recoverability of a receivable at the reporting date and therefore represents an adjusting event under IAS 10, Events After the Reporting Period . Assets should not be carried in the statement of financial position at any more than their recoverable amount and, therefore, an allowance for receivables should be made.

Auditor’s responsibilities

So far we have considered the financial reporting aspects relating to events after the reporting period. The second part of this article will now consider the auditor’s responsibility in relation to ensuring all events occurring between the reporting date and the (expected) date of the auditor’s report have been adequately taken into consideration, and sufficient appropriate audit evidence has been gathered to achieve the objective. It is important that where students have studied Paper F3, Financial Accounting , knowledge of accounting standards such as IAS 10 is not set aside or forgotten when it comes to papers such as Paper F8, Audit and Assurance . There is a very close relationship between accounting standards and auditing standards.

ISA 560, Subsequent Events outlines the auditor’s responsibility in relation to subsequent events. For the purposes of ISA 560, subsequent events are those events that occur between the reporting date and the date of approval of the financial statements and the signing of the auditor’s report.

The overall objective of ISA 560 is to ensure the auditor performs audit procedures that are designed to obtain sufficient appropriate audit evidence to give reasonable assurance that all events up to the (expected) date of the auditor’s report have been identified, properly accounted for/r disclosed in the financial statements.

ISA 560 also covers events that are discovered by the auditor after the date of the auditor’s report but before the financial statements are issued. 

Audit procedures

In Example 1 above, we identified that fraud and the legal proceedings were adjusting events that gave rise to an adjustment within the financial statements as at 30 September 2010. We also identified that the loss of the customer was also an adjusting event, but as the value of the receivable was considered immaterial, no adjustment was made to the financial statements. Let us expand on the requirement in Example 1 as follows:

Required: (b) Describe the audit procedures that should be performed to obtain sufficient appropriate evidence that the subsequent events have been appropriately treated in the financial statements.

Answer: Candidates who are faced with scenarios such as those in Example 1 should think about the information needed that would prompt an accountant or finance director to go back to the year-end and retrospectively amend the financial statements. You could interpret the question as asking ‘what information would I need in real-life to justify a provision or disclosure within the financial statements before making such provision or disclosure?’ Where candidates have studied Paper F3 and have knowledge of IAS 10, thinking about the provisions contained in this IAS 10 will often lead you into thinking about the audit evidence you would need to satisfy yourself that the requirements in IAS 10 have been met, as well as offering ideas as to how you would go about obtaining this evidence for the audit file.

Fraud Fraud risk factors are covered in ISA 240, The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements . The fact that fraud has occurred at Gabriella Enterprises Co will increase the risk of material misstatement due to fraud.

The audit procedures to be performed to ensure the fraud has been correctly accounted for in the financial statements may include:

• Recalculation of the amounts involved.
• Discussions with management as to how such a fraud occurred and why it took six months’ to discover the fraud (controls should prevent, detect and correct material misstatements on a timely basis).
• Establishing how the bookkeeper discovered the fraud and what controls (if any) contain weaknesses to allow the employee to commit the fraud.  Note that employee fraud usually involves the manipulation of controls, whereas management fraud often involves the overriding of controls.
• Performing substantive procedures on journal entries (particularly those close to, or at, the year-end).
• Confirming directly with suppliers the account activity for the period under audit.
• Reviewing the purchase invoices and being on alert for any ‘doctored’ or ‘copy’ invoices and making enquiries as to their authenticity.
• A review of human resources files for evidence of disciplinary proceedings taken against the employee. This will also confirm compliance with laws and regulations, particularly in relation to employment legislation and the withholding of monies.
• Testing of other controls to identify other weaknesses that may indicate employee or management fraud.
• Obtaining written representations from management concerning the fraud.
• Test checking after-date cash for evidence of reimbursements by the employee, such as the withheld wages/salaries by the entity.
• Discussions with the entity’s legal advisers as to the possibility of reimbursement of the balance of the misappropriated funds.

Legal proceedings

• Obtaining a copy of the court order or other correspondence confirming the company has been found liable to pay compensation to its customer.
• Test checking after-date cash to confirm payment to the customer.
• Ensuring a provision has been recognised as opposed to disclosure as a contingent liability to meet the requirements in IAS 37, Provisions, Contingent Liabilities and Contingent Assets .
• Ensuring the provision is reasonable in relation to the outcome of the court case.
• Obtaining written representation from management to confirm the treatment of the provision.

Loss of customer

• Discuss with management the reason for not adjusting the irrecoverable receivable.
• The auditors have already agreed this amount is immaterial to the financial statements, so this amount would be put on an ‘audit error schedule’. Provided this amount remains immaterial at the completion stage, both individually and when aggregated with other misstatements, the auditor can still express an unmodified opinion.

Financial statements amended after the date of the auditor’s report, but before the financial statements are issued.

Circumstances may arise when the auditor becomes aware of facts that may materially affect the financial statements and, in such situations, the auditor will consider whether the financial statements need amending. The auditor is required to discuss with management how they intend to deal with events that will require the financial statements to be amended after the auditors have signed their report, but before the financial statements are issued.

Where the financial statements are amended, the auditor is required to carry out necessary audit procedures in light of the circumstances giving rise to the amendment. The auditor will also be required to issue a new auditor’s report on the amended financial statements and, therefore, must extend their subsequent events testing up to the (expected) date of the new auditor’s report. The revised auditor’s report must not be dated any earlier than the date of the amended financial statements. In situations where management refuses to make amendments to the financial statements, the auditor must take all steps required to avoid reliance by third parties on the auditor’s report. The auditor should also consider the need to resign from the audit.

Subsequent events are a key examinable area in auditing papers and it is crucial that students have an understanding of the types of audit evidence that the auditor should obtain to confirm that the accounting and disclosure requirements (particularly in IAS 10) have been applied correctly within the financial statements. 

Candidates who simply write ‘obtain a management representation’ cannot expect to pass a question on subsequent events because written representations, on their own, are not a substitute for alternative audit evidence. Where candidates have knowledge of IAS 10 through studying Paper F3, you should not be afraid to think about the accounting requirements in order to help you consider how you will obtain sufficient appropriate audit evidence to achieve the auditing objectives. However, sticking to the question requirement is vital. If you are asked about the types of procedure(s) you should perform in determining whether the accounting treatment has been correctly applied, this is exactly what you must do.

Candidates should take care not to digress into irrelevant areas by writing everything they know about IAS 10, and instead should just answer the question set by the examiner. 

Written by a member of the F8 examining team

Reference (1) IAS 10, Events After the Reporting Date , Paragraph 3.

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