Define audit- 2mks
An audit is the independent examination of and expression of an opinion on the financial statements of an economic entity by appointed auditor in pursuance of that appointment and in compliance with any relevant statutory obligation
State 5 Important roles of International Financial Reporting Standards 5mks
1. They prescribe the approved method of accounting and disclosure.
2. Where one or more methods of accounting are acceptable, they prescribe one method which is preferred and called the benchmark treatment and the allowed alternative treatment and conditions under which that allowed alternative is applied.
3. They prohibit, discourage and restrict use of methods which will not lead to a true and fair view of the financial statements.
4. They increase comparability of financial statements. Application of appropriate IFRS reduces areas of uncertainty and subjectivity in financial statements.
Differentiate between Auditing and Financial Accounting 2mks
Auditing is a check carried out by an independent auditor to make sure that what a company is saying about its financial statement is true. Auditing therefore adds credibility to the financial statements by ensuring the availability of accurate and reliable financial information Financial accounting entails provision of information about a business or company in form of financial statements which are then made public
Describe the importance of Audited Financial Statements to the different stakeholders of the company
i. Present and potential investors. These risk capital providers and their advisors are concerned with the risk that is inherent in their investment. They need information to help them determine whether they should buy more shares, hold on to the shares they have or sell the shares they have.
ii. Employees. These and their representative groups such as trade unions are interested in information about the stability and profitability of their employers. They are also interested in information which enable them assess the ability of the company to provide adequate remuneration, retirement benefits and employment opportunities.
iii. Lenders. These are interested in information that enables them determine whether their loans and interests arising from the loans will be paid back when due.
iv. Suppliers and other trade creditors. These users are interested in information that enables them determine whether the amounts owing to them will be paid when due. Their interest in the company is of shorter period than lenders while they are dependent upon the continuation of the company as a major customer.
v. Customers. These have interest in information about the continuance of the company especially when they have long term involvement and or are dependent as the company.
vi. Government. The main interest of the government is allocation of resources. It also requires information in order to regulate the activities of the enterprise, determine taxation policies and obtain national income statistics.
vii. Public. A company affects public in a variety of ways. A company may make substantial contribution to the local economy by employing people and obtaining supplies locally.
Financial statements assist the public in information on trends and recent developments of the company in the economy .
Briefly outline the difference between Internal Audit and External audit
|Internal auditing||External Auditing|
The main objective is to advice management on whether organization has sound internal control systems to protect it against loss
Internal auditing is not a legal requirement but corporate governance advises and recommends that a company should have an internal audit department.
It covers all areas of organization i.e. operational as well as financial
It is increasingly risk based. The approach is to assess risks, evaluate systems of control and test operation of the systems and finally make recommendations for improvement
The responsibility is to advise and make recommendations on internal controls and corporate governance
The objective is to provide an opinion as to whether or not the financial statements show a trueand fair view of the company’s State affairs.
It is a legal requirement for limited liability companies and public bodies to have their accounts audited
It has a purely financial focus.
In preparing financial statements which show true and fair view of the company’s financial position and performance, the management openly or implicitly makes certain assertions.
Explain the main assertions
This is the assertion that an asset or liability exists at a given date. It is either true or not true that an asset or liability reflected in the balance sheet was in existence at the balance sheet date.
Rights and obligation
This is the assertion that an asset or liability in financial statements pertains to the entity at a given date i.e. an asset is a right of the entity and a liability a genuine obligation of the entity.
This is the assertion that a transaction or event took place which pertains to the entity during the financial period or that a recorded event or transaction actually took place as recorded and it is a valid transaction pertaining the entity. It is either the transaction took place as recorded or not.
This is the assertion that there are no unrecorded assets, liabilities, transactions or undisclosed items.
This is the assertion that an asset or liability is recorded at an appropriate carrying value
This is the assertion that a transaction or an event is recorded and proper amounts of revenue and expense are allocated to the proper period for proper reporting purposes. Whether a transaction brings into being an asset or liability, revenue or expense depends largely on the capitalization policy of an entity
S T U D Y T E X T
Presentation and disclosure
This is the assertion that an item is disclosed, classified and described in accordance with the applicable financial reporting framework
Kingau Kenya Ltd. was formed on 1 June 2006 in order to export flowers to European markets. The Directors are unsure as to their responsibilities and the nature of their relationship with the external auditors. The audit partner has asked you to visit the client and explain to the directors, the fundamental aspects of the accountability of the directors and their
relationship with the auditor.
Explain to the directors of Kingau Kenya Ltd.
a. The need for an audit
The need for an audit. These are the requirements of the Companies Act Cap 486.
• To prove the true and fair view of the companies state of affairs as at a given date.
• To find out whether the company has kept proper books of account.
• To write a report to be used by stakeholders.
• To provide advice to management on areas of internal weaknesses.
• Detection of errors and frauds
b. Procedures for the appointment of an auditor of a public company under the Companies Act.
i) Upon registration of a company (30 days after) the Board of Directors or the Registrar of Companies appoints an auditor.
ii) He can also be appointed at the AGM. If this approach is used the outgoing auditor must be given a 28 days notice.
iii) Automatic reappointment. This occurs if there is no resolution to remove the existing auditor, if the existing auditor has not given in writing a notice to resign and if he has not committed an act to disqualify automatic re-appointment.
iv) Casual vacancies may arise and should be filled by the directors of the company except if he resigned in which case it is filled by shareholders Casual vacancies arise if the auditor dies becomes incapacitated or he resigns.
c. Directors responsibilities in relation to the accounting function of the Company.
Safeguarding the company assets an preventing fraud and error
• Selecting suitable accounting policies and applying them consistently
• Ensuring that the company keeps proper accounting records as per the Companies Act.
• Delivering to the government agency, court or stock exchange a copy of the company’s auditor financial statements within the specified period after year-end.
• Stating whether applicable accounting standards have been followed subject to any material departure disclosed and explained in the financial statements.
• Prepare the financial statements on a going concern basis unless it is appropriate to presume that the company will continue operations.
• Setting up an internal control system to enable all the above responsibilities to be carried out as required.
d. Auditors’ statutory responsibilities in relation to the audit of the company’s financial statements.
The auditor should make a report to members on accounts examined by them and laid before company in AGM. It must contain statements as to matters mentioned in the 7th schedule. They include:
• Whether or not they have obtained all information and explanations which to the best of their knowledge and belief were necessary for the audit.
• Whether in their opinion proper books of account have been kept and proper returns adequate for the purpose of the audit have been received from branches not visited.
• Whether the profit and loss account and balance sheet are in agreement with the books of account and returns.
Explain 7 rights entitled to the Auditor of certain organisation
• Right to access at all times the accounting records of the company. These records included shareholders register, memorandum of association, minutes of meetings and returns from branches of the company.
• Right to receive notice of general meetings, attend and speak during the general meetings.
• Right to require from officers and employees of the company any information and explanations deemed necessary for the purpose of the audit. This includes all information from client’s books, vouchers and management representations.
• Right to require that subsidiaries and their auditors provide such information and explanations as deemed necessary for the audit of the holding company.
• Right to remuneration. The auditor should be paid audit fees when due and be reimbursed audit expenses incurred in connection with the audit.
• Right to legal and technical advice. An auditor has right to use work of an expert to get technical knowledge on areas he may require such.
• Right to send representations to shareholders in case there are attempts by the directors to dismiss him. The auditor also has the right to receive a twenty eight day notice of the meeting where his dismissal will be discussed and he can speak or read his representations at that meeting.
Your firm has been approached by the directors of Abyss Ltd. a newly formed sacco to undertake the audit for its first complete financial year ended 31 December 1999 Your manager has assigned you the responsibility for leading the team. You have had various discussions with the directors about the timetable and the respective responsibilities of management and the auditor. You have drafted a letter of engagement and have sent it to the managing director for approval and acceptance but the management has not yet responded to your letter.
a) Explain why a letter of engagement is sent before any new audit appointment is accepted.
b) Set out the main contents of a letter of engagement.
c) Itemize the actions you would take in response to the non-reply by the management to your draft engagement letter.
d) State when it might be necessary to re-draft an engagement letter and have it reaffirmed by the client’s management.
a. Why the letter of engagement is sent before any new audit appointment is accepted.
It is the purpose of a letter of engagement to dearly define the extent of the auditor’s responsibilities and so minimize the possibility of any misunderstanding between the auditor and the client.
It provides a written confirmation of the auditor’s acceptance-of the appointment, the scope of the audit, form of his report and scope of non audit services. If a letter of engagement is not sent to clients both new and existing, there is scope for argument about the precise extent of the respective obligations of the clients and its auditors and directors.
b. Contents of a letter of engagement.
Definition and scope of audit: it should be made dear that an audit involves the examination of and expression of opinion on the financial statements of an enterprise by an appointed
auditor in pursuance of that appointment and in the case of a statutory audit, that the matters to be reported upon are laid down in Companies Act 1962 or any relevant legislation.
Fraud and irregularities: the responsibility of the prevention and detection of errors and frauds rests with the management and this responsibility is fulfilled mainly through the
implementation and continued operation of an adequate internal control system.
A ccounting, Taxation and other services:-the letter should delineate clearly the accountant’s and the client a responsibilities in relation to these services and the day to day book-keeping, the maintenance of all accounting records and the preparation of financial statements.
Fees: mention should be made of fees and the general basis on which fees are computed and rendered.
c. The auditor should ensure that;
P roper accounting records and returns have been kept.
The accounts kept are in agreement with the accounting records and returns. If they are not in agreement the directors should readily provide the auditor with all the explanations and
information he requires.
d. When it might be necessary to re-draft an engagement letter and have it re-affirmed by the client’s management:
When there are new clients who have appointed the auditor
When there is an existing client who has not received it previously in particular statutory audits.
The objectivity of the external auditor may be threatened or appear to be threatened where:
i. There is undue dependence on any audit client or group of clients.
ii. The firm, its partners or staff have any financial interest in an audit client.
iii. There are family or other close personal or business relationships between the firm, its partners or staff and the audit client.
iv. The firm provides other services to audit clients.
a) For each of the four examples given above, explain why the objectivity of the external auditor may be threatened, or appear to be threatened, and why the threat is important.
If the auditor depends, or relies on a particular client or group of connected clients because the firm takes a large part of its fee income from the client, the auditor may be less likely to challenge accounting policies or disclosures proposed by the client, for fear of upsetting them. This typically happens when the firm is small, but the client is large. Where the firm feels that an audit qualification may be necessary, it may be reluctant to issue it for fear of losing the client and the fee income. This applies regardless of whether the fee income is audit fee income or income for other work. The issue is important because if the auditor does not issue a qualified audit report where appropriate, the firm may be sued
for negligence. Where a large client is involved, the firm’s professional indemnity insurance may not cover the claim.
Where a partner or member of staff in a firm (or the firm itself) holds shares in a client, they have an interest in the client’s performance. If the client performs well, the value of the
shares may rise. A qualified audit report is not usually associated with good performance and the firm may therefore be reluctant to issue one where appropriate. This is important for
the reasons noted above.
Even if there is no question of a qualified audit report, there may be a temptation to help the client present the results in the best possible light, instead of presenting a balanced view.
There is also a financial interest where partners, staff or the firm make loans to, or guarantee the borrowings of the client or vice versa. Significantly overdue fees of amounts that are
significant to either auditor or client are akin to loans.
Family or other close personal or business relationships. Where there is family or other close personal or business relationships between client and audit firm, the individuals concerned may try to influence the firm in its dealings with the client in order to protect the family or personal relationship, or the mutual business interest.
If, for example, an audit partner is married to the finance director of a client, it is less likely that the client will receive a qualified audit report than it would be if the relationship did not exist.
This is important in any case but more so where the effect of a qualified (or modified) audit report is likely to result in, say, withdrawal or non-renewal of banking facilities which might
result in the business ceasing to be a going concern. If the firm does not issue a modified audit report in such circumstances, the firm may be exposed to claims of negligence by the bank.
If there are close business relationships between client and auditor, both parties have an interest in each other’s performance and there is therefore a double pressure to present the results in the best possible light and not to issue a qualified audit report.
Many audit firms provide their audit clients with services other than audit services. It is very common for auditors to provide their very small audit clients with accountancy services, for
example. Other services that can be provided include tax, management consulting, IT and human resources advice. Some firms not only provide consulting advice, but also perform IT and other functions for some of their clients.
b) Describe requirements that reduce the threats to auditor objectivity for each of the four
examples given above.
Most of the following are requirements of rules of professional conduct.
(i) Undue dependence
A firm should put in place additional safeguards where the recurring fee income from one client or group exceeds 15% of the gross practice income (10% for clients listed
on a stock exchange or where the public interest is involved). Additional safeguards include supplementary reviews and the rotation of the engagement partner and senior
There are exceptions where a practice is being set up or run down. The rules are also applied to members practicing part-time.
A review mechanism should be triggered within the firm where the gross fee income exceeds 10% (5%) of gross practice income.
More generally, there is a requirement for firms to carry professional indemnity insurance to cover professional negligence claims and ACCA monitors practicing firms to ensure that they are complying with, amongst other things, the independence requirements.
Firms are also required to keep up with changes in independence requirements as a condition of being permitted to practice.
(ii) Financial interest
No partner in a firm, or any member of staff working on a particular audit, or any person closely connected with them, should hold any shares in an audit client.
There are exceptions where collective investments are held by third parties, where the individual concerned has no control over the composition of investments.
Where such shares or interests are acquired through marriage or inheritance, for example, the shares should be disposed of at the earliest possible opportunity, provided that the disposal does not involve insider trading. Where shares are held by the auditor because the company’s constitution requires it, the minimum level should be held and the votes attaching to the shares should not be exercised.
There are some exceptions for transactions on normal commercial terms with money lending institutions – a normal mortgage from a bank, for example.
Firms, their partners and staff should not make loans to, or guarantee the borrowings of, any audit client, or vice versa.
(iii) Family or other close personal or business relationships
An officer (such as a director) or employee of an audit client, or a partner or employee of such a person, is prohibited from accepting appointment as auditor of that client.
Problems can also arise if an officer or senior employee of an audit client is closely connected with a partner or senior staff member responsible for the conduct of the audit
(or anyone closely connected with them).
Closely connected persons generally include minor children and spouses. In this case, adult children and their spouses, siblings, and any other relative to whom regular financial assistance is given (or who is otherwise indebted to the partner or employee) are also included.
(iv) Other services
A firm should not participate in the preparation of the accounting records of a company listed on a stock exchange or a public interest company except in relation to the finalization of the statutory accounts (assistance of a mechanical nature) or in an emergency situation.
Where a firm does provide such assistance to a smaller firm, care should be taken not to take on management functions, to ensure that the client accepts responsibility for the accounting records, and to ensure that adequate audit tests are performed and properly recorded.
A firm may advertise for and interview prospective staff for a client and produce a short list and recommendations, but the client must make the final decision.
A firm should not audit a client’s financial statements which include the product of specialist valuations performed by the firm (such as the valuation of intangible assets or pension
funds). Where a firm provides other services to audit clients, it is important that the audit team should be entirely independent of the team providing the other service. One method of achieving this is by setting up internal structures whereby the two teams do not communicate with one another.
Discuss the value of external audit to the following users:
(a) Shareholders who want information about a company’s performance Shareholders are the primary users of the auditor’s report. Its main purpose is to give assurance on the financial statements. This should allow shareholders to place more reliance on the information in the financial statements.
It is important that shareholders understand the nature of the audit opinion, in particular that it is not an absolute guarantee of accuracy, but rather that it gives reasonable assurance that the financial statements are free from material misstatements.
(b) Management who want to reduce risk and improve performance
The main output of the external audit is the auditor’s report, giving assurance on the information in the financial statements. In order to give that opinion, the auditor will have found out about the business, considered the risks it faces, and found out something about its systems and controls.
It is not the objective of the external auditor to advise management on reducing risk and improving performance, but if in the course of performing the audit, the auditor discovers a systems weakness or some other inefficiency, they should report this directly to the company’s management
List down internal control procedures for raw material purchasing system of a large manufacturing Firm
i) The company should have clear division of duties between the various departments i.e. the manufacturing department, stores department and factory department.
ii) A responsible official should be charged with the duty of overseeing purchase of raw materials in the company and should report to the managing director or other appropriate senior level of management.
iii) The company should establish the re-order levels for purchase of all materials used in production. When the re-order level is reached a purchase requisition should be raised and must be authorized by the factory managers. This should then be sent to the purchasing department.
iv) Upon receipt of the purchase requisition, it should be checked to confirm that the transaction is authorized. Another person should prepare a purchase order and submit this together with the purchase requisition for the authorization by purchasing manager.
v) Upon delivery an official from stores department must inspect the goods for quality and quantity. All units received should be recorded in a suitable documentation e.g. a goods received note (GRN) which store’s staff and supplier’s staff should counter sign.
vi) The goods received note and the suppliers invoice should be taken to the accounts department where an independent person should post the entries to the purchases ledger.
vii) Before payments are made to the suppliers, supplier’s statement should be reconciled to the ledger balance.
ISA 400 (Risk Assessments and Internal Control) deals with internal control objectives and internal controls. ISA 500 (Audit Evidence) deals with audit objectives and audit procedures. A proper understanding of internal controls is essential to auditors in order that they understand the business and are able to effectively plan and execute tests of controls and an appropriate level of substantive procedures.
You are the auditor of a small manufacturing company, Dinko, that pays its staff in cash and by bank transfer and maintains its payroll on a small stand-alone computer.
(a) For the payroll department at Dinko, describe the:
i. Internal control objectives that should be in place.
ii. Internal control environment and internal control procedures that should be in place to achieve the internal control objectives.a)
Control objectives include policies and procedures designed by management to:
• Achieve the orderly and efficient running of the business including adherence to internal policies – this would include the regular, accurate processing and recording of payroll payments.
• Safeguard assets – this would include the physical safeguarding of cash and safeguarding money held in bank accounts by means of other controls.
• Prevent and detect fraud and error – fraud and error would include incorrect payments or deductions from the payroll and payments of incorrect amounts for tax and social insurance, payments for work not performed and payments to dummy employees, for example.
• Achieve accuracy and completeness of the accounting records and timely preparation of reliable financial information; this would include making correct payments and
deductions from the payroll, correct payments for tax and social insurance, and making payments for work performed only (not to dummy employees, for example), in order that quarterly or half-yearly accounts can be prepared (possibly), but in any case in order that annual accounts can be prepared within the time limits for small companies.
(ii) Internal control environment and control procedures
The control environment relates to:
Management’s overall style in encouraging awareness of the need for good controls, for example.
The existence of organizational controls such as review of the payroll by an independent person such as the managing director, and the rotation of payroll duties amongst staff responsible for processing it – this helps achieve all of the objectives set out above.
Segregation of duties and supervisory controls to avoid the misappropriation of cash (or allegations thereof) and to avoid fraudulent collusion to create, for example, dummy employees or to make inflated payments – this prevents the loss of assets and/or inaccurate records.
b) For the payroll charges and payroll balances (including cash) in the financial statements of
i. Describe the external auditor audit objectives.
ii. List the tests of control and substantive procedures that will be applied in order to achieve the audit objectives identified in (b) (i) above
b) Objectives Tests of control and substantive procedures.
i) Existence: of assets and liabilities such as cash on hand and in the bank, and of the liability to pay staff and the associated tax and social insurance liabilities.
Testing controls over the security of cash to ensure that they are operating effectively throughout the relevant period. Performing cash counts, with reconciliations to the records and observing cash payments to staff, ensuring that appropriate signatures are obtained and that unclaimed cash is immediately re-banked.
ii) Occurrence: payroll transactions occurred during the relevant accounting period. Performing cut off tests to ensure that payroll costs incurred during the period have been recorded during the period by examining entries in the payroll just before and after the period end and checking back to source documents, such as time sheets and clock cards.
iii) Completeness: there are no unrecorded assets or liabilities such as those noted under ‘existence’ above or undisclosed items such as payroll liabilities. Performing starters and leavers tests to ensure that staff are not paid before they join the company or after they leave. This involves checking the payroll for two separate periods and examining entries relating to starters and leavers in the intervening period.
Manually checking the accuracy of payroll calculations to ensure that correct payments and deductions are being made in accordance with approved pay rates and approved deduction rates. Reviewing evidence of authorization controls to ensure that the payroll has already been checked.
iv) Measurement: transactions such as payroll payments are recorded at the correct amounts and are recorded in the correct period.As fro completeness, above, and checking to ensure that the payroll has been properly authorized and reviewed. Checking entries relating to hours or time worked in the payroll to source documentation.
v) Presentation and disclosure: an item is disclosed in accordance with accounting standards and legislation. Reviewing the financial statements with the aid of disclosure check list to ensure that disclosure requirements have been met. Reviewing the overall presentation of payroll transactions and balances.
Describe the role of Directors in following
a) Preparation of financial statements
The directors are normally required to prepare the financial statements of the company using the appropriate law of their country and in accordance with the International Accounting Standards (IASs). The auditors are normally required to check or audit those financial statements, again in accordance with the legislation of their country and the International Statements on Auditing.
b) Fraud and error
The directors are responsible for preventing and detecting fraud and error in the financial statements, no matter how immaterial this may be. Auditors are responsible for ensuring that the financial statements show a true and fair view; in other words that the financial statements are materially correct. Auditors are not required to detect immaterial fraud or error.
The directors must ensure that there is adequate disclosure of all matters required by statute or IASs in the financial statements. The auditor will check that disclosure provisions have been complied with, and where certain disclosures have not been made (e.g. ISA 550 regarding related party transactions) provide this information in the audit report.
The directors are responsible for ensuring that the company will continue in operational existence for the foreseeable future, and report to the members in the published financial statements if this is unlikely to be the case. The auditor will check the accuracy of the directors’ workings and assumptions and if these are considered incorrect or inappropriate, then the audit report may be modified or qualified to bring the situation to the attention of the members of the company
The Auditors Operational Standard requires the auditor to obtain ‘relevant and reliable audit evidence sufficient to enable him to draw reasonable conclusions therefrom.
a. What is audit evidence? )
Audit evidence consists of any information used by the auditor to enable him to arrive at conclusion necessary for his opinion. Auditing is concerned with the verification of accounting data and with determining the accuracy and reliability of accounting statements and reports
b. Explain the meaning of the following terms;
i) Relevant audit evidence
I t depends on whether it assists the auditor to form an opinion on some aspect of the financial statements. For example evidence that indicates that a recorded asset exists is relevant to audit objectives.
ii) Reliable audit evidence
Reliability of audit evidence can be assessed to some extent on the following presumptions:
• Documentary evidence is more reliable than oral evidence.
• Evidence from outside the enterprise is more reliable than that secured solely from within the enterprise.
• Evidence originated by auditor by such means as analyzing and physical inspection is more reliable than evidence obtained from others.
• Evidence for a figure in accounts is usually obtained from several sources. The cumulative effect of several evidential sources which give a consistent view is greater than that from a single source.
• Original documents are more reliable than photocopies or facsimiles.
c. Explain whether the following types of audit evidence meets the standards of relevancy, reliability and sufficiency as required by the auditor’s operational standards regarding:
• Written confirmation of a trade debtor circularized at year end
• Work-in-progress stocks identified during the annual physical stock count
• Solicitor’s letter confirming pending legal action
Written confirmation of a trade debtor circularize at the year end. Evidence from the enterprise is more reliable than that secured solely from within the enterprise. Though debtor circularization may not be sufficient evidence depending on the circumstances.
Work in progress stocks identified during annual physical stock count. If the auditor was present during the stock take, then as the evidence has originated as a means of analysis and physical inspection by the auditor it is more reliable than if obtained from others. The auditor however needs to refer to other materials and statements so as to collect sufficient evidence.
Solicitors letter confirming pending legal action. It is more reliable evidence than evidence from management. However, it will be sufficient on its own because the solicitor is the one who solely deals with cases.
(a) Explain the purpose of a management representation letter.
a) Management representations are a form of audit evidence. They are contained in a letter, written by the company’s directors and sent to the auditor, just prior to the completion of audit work and before the audit report is signed.
Representations are required for two reasons:
Firstly, so the directors can acknowledge their collective responsibility for the preparation of the financial statements and to confirm that they have approved those statements.
Secondly, to confirm any matters, which are material to the financial statements where representations are crucial to obtaining sufficient and appropriate audit evidence.
In the latter situation, other forms of audit evidence are normally unavailable because knowledge of the facts is confined to management and the matter is one of judgment or opinion.
Obtaining representations does not mean that other evidence does not have to be obtained.
Audit evidence will still be collected and the representation will support that evidence. Any contradiction between sources of evidence should, as always, be investigated.
(b) A suggested format for the letter of representation has been sent by the auditors to the directors of a client company. The directors have stated that they will not sign the letter of representation this year on the grounds that they believe the additional evidence that it provides is not required by the auditor.
Discuss the actions the auditor may take as a result of the decision made by the directors not to sign the letter of representation
The auditor may take the following actions:
Discuss the situation with the directors to try and resolve the issue that the directors have raised. The auditor will need to explain the need for the representation letter again (and note that the signing of the letter was mentioned in the engagement letter).
A scertain exact reasons why the directors will not sign the letter. Consider whether amendments can be made to the letter to incorporate the directors’ concerns that will still provide the auditor with appropriate and sufficient audit evidence. The discussion must clearly explain the fact that if the auditor does not receive sufficient and appropriate audit evidence, then the audit report will have to be modified.
The reason for the audit qualification will be uncertainty regarding the amounts and disclosures in the financial statements.
An ‘except for’ qualification for the material uncertainty is likely, although a disclaimer may be required, especially if the legal claim is thought to require a provision.
Even if the letter is subsequently signed, the auditor must still evaluate the reliability of the evidence. If, in the auditor’s opinion, the letter no longer provides sufficient or reliable evidence, then a qualification may still be required.