Year-Round Monitoring Review Promotion
Engaging an external independent monitor reviewer is one of the best ways to identify audit deficiencies. While the HKSQC 1 only requires cyclical reviews of no more than 3 years, your Practice has the responsibility to ensure that the extent of reviews is adequate to maintain and improve overall audit quality. In this month, we are offering year-round monitoring review packages so that your ongoing audit engagements are reviewed periodically to maintain a high standard of audit quality. Prices for a completed file monitoring review are reduced to as low as HK$11,000 per audit file.
Learn more about our September 2022 monitoring review packages here.
Sharing of Inspection Findings & Case Studies
We have consolidated the inspection findings from the 80 inspection engagements that we have provided consultancy services. In September, we will be sharing with you on a daily basis of case studies and practice review findings that were previously identified by regulators in real inspection cases. By sharing our knowledge and experience, we aim to raise awareness of these common issues and help you to elevate your overall audit quality.
Finding #1: Audit Confirmations (Sep 8, 2022)
“The trade receivables increased over 400% from last year. However, no audit confirmation requests were arranged for significant trade receivables. Given that external confirmations are able to provide more persuasive audit evidence, the Practice should consider performing external confirmation procedures as required by HKSA 505.
In addition, the audit documentation showed that audit team had only checked selected trade receivable balances to the internally generated invoices and subsequent bank statements, which did not show details of the payees. Given the significance of the trade receivables, the Practice should have obtained further evidence (for example, bank advices with details of the payees) to confirm that the trade receivables were settled by the relevant customer.”
What can we learn from Finding #1?
When an account balance is material and significant to the financial statements, auditors are expected to perform more audit procedures to ascertain the existence of the balance. Even when the balance has been subsequently settled, and that alternative procedures can be performed by checking to sales invoices, auditors are expected to send audit confirmations, which provides higher level of assurance that substantive tests of details.
When documenting the source documents that were checked, it is inadequate to simply add an audit mark next to the settled balances. Be sure to also document details of the debtors and payees, and third-party generated source documents, such as bank advices, and document the dates and amounts of payments, and bank advice numbers, where applicable.
Finding #2: Recurring Qualified Audit Opinion (Sep 9, 2022)
“Recurring qualified audit opinion
The Practice accepted the appointment as auditor of Client D in 2013 and issued recurring qualified opinions for three consecutive years from 2015 to 2017 due to the inability to attend inventories counts.
In carrying out the acceptance and continuance procedures, despite the scope limitation, there was no evidence to show that the Practice had made efforts to resolve the issue or given adequate consideration to the impact of the recurring audit qualification on its ability to act as its auditor before accepting the appointment and reappointment. The practitioner advised that he had made requests to attend inventory counts and believed the problem causing the scope limitation could be resolved before accepting the reappointment. However, no such documentary evidence could be provided.
The Practice was reminded that Chapter C of Section 400.52 of the Code of Ethics provides that, in deciding whether to accept appointment or reappointment as auditor, the practice should consider whether the envisaged limitation is so significant that the need to issue a qualification of opinion exists and if so, the practice would normally not accept appointment or reappointment as auditor. The Practice should endeavour to obtain sufficient, relevant and reliable audit evidence to enable it to express an unqualified opinion.”
What can we learn from Finding #2?
The auditor should always consider prior period’s audit opinion when performing client acceptance, or engagement reappointment procedures. The effect of prior period’s audit opinion on the upcoming current year’s audit should be considered. When the basis of qualification of prior year’s audit is expected to re-occur in the current year’s audit, the auditor should document what additional procedures have been performed to try to resolve the issue, and that there are actual steps taken to minimize the effect of the same problem taking place in the current year’s audit. Such documentation can be prepared and completed prior to acceptance / re-acceptance of the engagement.
In this example, there was a limitation of scope on the attendance of stock count procedures. The auditor could have discussed with management on the reasons behind the absence of stock count, and whether a periodic / interim stock count can be performed. Evidence of such discussion may include the distribution of stock count procedures, policy manual on inventory management, performing walkthrough on inventory cycles, and email correspondence of such discussion taking place.
Auditors are also reminded to consider the impact of the opening balances, especially when it was not possible to ascertain the accuracy or completeness of the comparative figures, and thus consider when a modified opinion should be issued on the opening balance, even when the issue has been resolved in the current year.
Finding #3: Accounting Treatment for Revenues & Cut-off Test
“Revenue recognition
Client C was a travel agent and was mainly engaged in arranging sales and purchase of tickets for flights and hotels. According to its financial statements, Client C’s sales and costs of sales amounted to HK$102M and HK$99M respectively. A gross profit margin of around 2.9% was earned.
The following deficiencies were identified in the audit work on sales:
Accounting treatment and cut-off test
As advised by the practitioner, Client C recognised sales when the services (associated with a ticket sold) had been completed by its suppliers (e.g. airlines and hotels). Based on the circumstances of Client C, it would seem more appropriate that the sales should have been recognised when (i) the booking services were performed by Client C, or (ii) tickets were delivered to and had been accepted by Client C’s customers under HKFRS 15. There was no evidence to show that the Practice had critically assessed the appropriateness of the timing of revenue recognition.
In the sales cut-off test performed, there was no evidence to show that the Practice had checked relevant evidence (e.g. customers’ acknowledgement of tickets) to substantiate the timing when Client C had satisfied its performance obligation for ensuring that the timing of revenue recognition was correct.
Accordingly, the Practice might not be able to appropriately identify cut-off errors from the test“
What can we learn from Finding #3?
Regardless of which financial reporting framework is adopted by the audit clients, the auditor should always assess the appropriateness of how and when revenues are recognized.
“How” refers to whether the revenues and cost of sales are recognized on a net basis, or on gross basis. Often brokers and agents should recognize revenues on a net basis, as a broker or agent only earns commission incomes. When assessing whether the client acts as a principal or agent, the auditor should assess
whether the client has control over the goods or services before it transfers to a customer
Control is signified by whether the client is primarily responsible for fulfilling the promise to provide the services or goods. In this case study, the party primarily responsible for providing the services is the airlines company or the hotels.
Another indicator that control has been obtained by the client is whether the client bears inventory risk. E-tickets and boarding passes are directly issued in Client C’s customers names
whether the client has ability to direct a third party to provide services to its customers on behalf of its customers
In the case study, Client C must go through the third party to change itinerary dates or upgrade services, for example from economy to business class, or from a standard suite to a deluxe suite. Client C cannot change the underlying services without the service provider’s approval.
whether the client can combine or integrate the goods or services
In the case study, Client C issues the E-tickets, or hotel booking confirmations directly to its customers without any further modifications.
All indicators point towards that Client C does not have control over the services and acts as an agent in its revenue transactions and therefore, it should recognize its revenues on a net basis. Its revenue should be HK$3 million instead of HK$102 million.
“When” refers to whether the performance obligations have been fulfilled, or whether the title of ownership and control over the goods have been passed to the buyers.
Control is passed to Client C’s customers when the E-tickets are issued to its customers. Whether its customers eventually board the flights on time, or have further modifications to its services, for example, the use of mileage awards to upgrade to business class or not, are beyond the control of Client C. Besides making this assessment, the auditor is also recommended to check to third-party audit evidence showing the timing when control has been accepted by its customers.
One of the most appropriate sections in documenting these analyses are in the audit planning sections when understanding and evaluating the internal controls relating to revenue recognition, or in the revenue section of audit working paper, for example in the audit notes below the breakdown of revenues.
Finding #4: Scope over Interest in an Associate
Interest in an Associate
Client D had a material interest in an associate of HK$42 million at year end date and shared HK$3.2 million of its profits during the year. The associate was a significant component of the Group. The audit team obtained the audit report on the associate and discussed with the component auditor to understand whether there were significant changes to the business operation and any impact of new accounting standards on the associate.
However, there was no further audit work (e.g. a review of the component working papers and analytical procedures as required by HKSA 600) performed by the audit team to obtain sufficient appropriate audit evidence to support the associate’s financial information included in the consolidated financial statements.
What can we learn from Finding #4?
When auditors are planning a group audit (an audit of more than one component, such as a subsidiary, associate, or joint venture, etc.), the auditor should first assess whether the component of the Group is significant to the Group. The Group’s overall materiality and component materiality is often used as benchmarks to determine whether the key financial statement line items of the component are significant to the Group.
In this case study, the sharing of the associate’s profits were material to the Group, but moreover, the sales and expenses of the associate were very significant when compared to the Group’s materiality. Any material misstatement in the profit or loss of the associate, would potentially lead to a misstatement of the profits and / losses shared with the holding company.
Once the auditor has concluded that the component is significant to the Group, the auditor should then determine the audit scope and planned audit procedures on the component. There are two common methods in auditing an associate that has been determined as significant to the Group.
1) Full Scope Audit, as if you normally audit a single entity, but using a component materiality, or 2) Rely on referral instructions to an external component auditor.
In this case study, the auditor chose the latter option. Normally in a set of referral instructions sent to the component auditor, it should report to the Group’s auditor of any significant risks identified, the materiality and performance materiality used in the audit, any early warning events or significant deficiencies identified. Findings to analytical review and subsequent event review procedures may also be provided within an audit summary memorandum by the component auditor.
After receiving such deliverables from the component auditor, the Group auditor should consider performing additional procedures on the Group’s significant risk areas are required, and document how it has concluded that the procedures performed by the component auditor are adequate to obtain reasonable assurance, and this may include a formal discussion with the engagement partner of the component auditor, with written minutes to document the discussion points, and a site-visit to review the component auditor’s working papers.