Day: December 23, 2022

  • When doing a Risk Assessment on a client, what does an auditor look at?

    When doing a Risk Assessment on a client, what does an auditor look at?

    Because risk is such a significant component of an audit, it is of the utmost significance that auditors approach risk evaluation with the utmost caution.

    The auditor is tasked with several overall objectives, one of which is to identify the risks that a company faces (both business risk and the risk of material misstatement) and then minimise these risks to an acceptable level.

    In light of this difficulty, the objective of ISA 330, entitled The Auditor’s Responses to Assessed Risks, is to address the responsibilities that an auditor must face when developing and putting into practice audit procedures tailored to respond specifically to the risk of material misstatement.

    ISA 330 and ISA 315, “Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and its Environment,” have a substantial amount of interaction.

    The auditor’s methodology/approach in planning and carrying out further audit procedures is referred to as being “responsive to the assessed risk of material misstatement.”

    There are generally two fundamental methods of obtaining audit evidence to help reduce audit risk:

    1. Substantive Testing (or Tests of Detail); and
    2. Tests of Control (or Compliance Testing).

    ISA 330 defines substantive testing and tests of control as follows:

    ‘Substantive procedures: an audit procedure designed to detect material misstatements at the assertion level. Substantive procedures comprise:

    1. Tests of details (of classes of transactions, account balances, and disclosures); and
    2. Substantive Analytical Procedures.

    Tests of controls: an audit procedure designed to evaluate the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the assertion level.’

    The auditor could think that doing tests of control is not an effective way [especially for SME clients] to acquire sufficient and appropriate audit evidence to address the levels of risk. As a result, they would think that a more substantive approach would be needed. These concepts illustrate that audit procedures must be responsive to the assessed levels of risk.

    Risk at the Assertion Level

    When referring to what management has asserted [stated] to be true, the term “assertion” should be used.

    As an instance, management will declare (at the assertion level of the financial statement) that all transactions that should have been documented have been recorded.

    As a result, management will make an assertion, and it will be the auditor’s responsibility to provide audit evidence that substantiates this assertion.

    As part of their risk assessment, the auditor will identify important areas (transactions, balances, and disclosures) that are prone to the risk of material misstatement.

    Hence, the auditor will look at both the “inherent” and the “control” risks.

    Inherent Risk

    The possibility that the account or section being audited has been materially misstated due to fraud or error without considering the related internal controls is known as the “inherent risk.”

    In assessing inherent risk, these are some of the factors that the auditor needs to consider:

    • The complexity of determining the account amount (especially if the amount is estimated);
    • History (have there been past errors discovered);
    • The circumstances of the entity’s business and the environment in which it operates; and
    • Management’s overall risk awareness.

    Control Risk

    The control risk is the risk that the internal control environment in a particular part of the accounting system will not prevent, detect and correct a material misstatement.

    As a result, the auditor shall consider the inherent risk and control risk at the financial statement assertions level and then evaluates the probability that the financial statements include a material misstatement.

    In some cases, the assessed levels of risk might be such that the auditor decides it is appropriate to obtain more persuasive audit evidence in areas where the assessed levels of risk are so high (for example, cash in a cash-based business such as a restaurant).

    Significant risks are those that need extra attention from the auditor.

    The following are signs that risk could be considered significant:

    1. Risk of fraud.
    2. A significant degree of subjectivity in the financial information.
    3. Unusual transactions.
    4. Significant transactions are undertaken with a related party.
    5. The transactions undertaken are complex.

    Responses to the Assessed Risks

    The objective of ISA 330 is:

    ‘to obtain sufficient, appropriate audit evidence regarding the assessed risks of material misstatement, through designing and implementing appropriate responses to these risks.’

    Responses can include exercising professional scepticism, using auditor’s experts, deploying extra or alternative employees with suitable levels of experience and competence to meet the assessed levels of risk, and using more unexpected audit processes by the auditor.

    Tests of Control

    Tests of control are what the auditor does to determine how well the entity’s control environment works.

    For example, the auditor might watch the sales invoice processing cycle to see if the controls over the entity’s sales processing can find and fix [identifying and correcting] mistakes quickly.

    The auditor can also do tests of control if they think that just doing tests of substantive won’t be enough to provide enough audit evidence at the assertion level.

    Financial statement risk, which is the risk that the financial statements contain a material misstatement, and detection risk, which is the risk that the auditor’s procedures won’t catch [fail to detect] a material misstatement, are opposites (the lower the financial statement risk, the higher the detection risk becomes and vice versa).

    For recurring audits, tests of controls will have been done in previous audits, and there will be evidence in the audit files from previous years about how well those controls work.

    In some jurisdictions, rules say that detailed tests of control can only be done every third audit. But the auditor’s risk assessment should decide how often control tests should be done. Usually, these are the things to think about:

    • The risk of material misstatement;
    • The general operating effectiveness of the internal controls;
    • The extent of reliance on internal control;
    • The effectiveness of general IT-related internal controls; and
    • The application of internal control by the entity.

    The above list is not exhaustive, and the auditor may think other factors should also be considered when deciding how long it should pass before detailed control tests are performed.

    No matter what procedures are performed, ISA 330 says that the auditor must do substantive procedures on important areas, such as:

    • Agreeing on the financial statements to the underlying accounting records.
    • Examining material journal entries.
    • Examine other adjustments that have been made in preparing the financial statements.

    Documentation

    The auditor should make sure that proper records have been kept for the following things:

    • The discussion among the audit engagement team relating to the susceptibility of the financial statements to material misstatement (including any significant decisions reached).
    • Key elements of understanding the entity and the environment in which it works. Also, the sources of the information gathered and the methods used to assess the risks [risk assessment procedures].
    • The identified and assessed risks of material misstatement.
    • Significant risks that have been identified together with an evaluation of the related controls.
    • Overall responses to address the risks of material misstatement.
    • The nature, timing and extent of further audit procedures linked to the assessed risks at the assertion level.
    • Documented conclusions where the auditor has relied on the evidence concerning the effectiveness of controls from previous audits and how these conclusions are appropriate.
    Our website's articles, templates, and material are solely for you to look over. Although we make every effort to keep the information up to date and accurate, we make no representations or warranties of any kind, either express or implied, regarding the website or the information, articles, templates, or related graphics that are contained on the website in terms of its completeness, accuracy, reliability, suitability, or availability. Therefore, any reliance on such information is strictly at your own risk.

    Keep in touch with us so that you can receive timely updates |

    要获得即时更新，请与我们保持联系

    1. Website ✍️ https://www.ccs-co.com/ 2. Telegram ✍️ http://bit.ly/YourAuditor 3. Facebook ✍

    4. Blog ✍ https://lnkd.in/e-Pu8_G 5. Google ✍ https://lnkd.in/ehZE6mxy

    6. LinkedIn ✍ https://www.linkedin.com/company/74734209/admin/

    14
  • What is the concept of ‘Materiality’, and how is it applied in an Audit?

    What is the concept of ‘Materiality’, and how is it applied in an Audit?

    The word “materiality” basically means how important or significant something is in relation to the financial statements as a whole.

    ISA 320 Materiality in Planning and Performing an Audit says [defines] the following about the term:

    ‘A matter is material if its omission or misstatement would reasonably influence the economic decisions of users taken on the basis of the financial statements.’

    This definition basically says that whether something is “material” or not depends on how big the item is or how important the error or omission on the financial statements is.

    The main objective of the external audit is for the auditor to express an opinion on whether or not the financial statements show a true and fair view of the business (or present fairly in all material respects).

    This level of assurance is high but not absolute.

    This is because the auditor can’t test every single transaction or event that goes into a reporting entity’s financial statements.

    In addition to this limitation, there is also a degree of estimation in financial statements. Because of this, it is generally accepted in the business world that financial statements will never be 100% accurate in every way.

    Example

    A manufacturing company is in the business of manufacturing coffee powder.

    At the end of the year, several containers with different ingredients go into making coffee powder.

    These containers must be valued to be included in the reporting entity’s closing inventory valuation.

    All of these kinds of products will be called “work-in-progress,” and work-in-progress will always contain a degree of estimation in relation to the actual cost of the product still in production at year-end, together with estimations of overhead absorption (both fixed and variable) such as factory heat and light and direct labour costs.

    Most of the time, these valuations are done by management based on their “best estimates.”

    The example above showed how a reporting entity would use accounting estimates to create a balance for the financial statements (i.e. work-in-progress, which will be included within current assets).

    In this case, the auditor will follow a certain standard for auditing:

    ISA 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates and Related Disclosures.

    Types of Materiality

    There are two types of materiality:

    • Financial Statement Materiality; and
    • Performance Materiality.

    Financial statement materiality is calculated for the financial statements as a whole (see later), and this calculation is based on the auditor’s experience and judgement.

    Performance materiality is the amount or amounts set by the auditor that are less than materiality for the financial statements as a whole.

    This is done to make it less likely that the total number of uncorrected and undetected mistakes will add up to more than what is considered “material” for the financial statements.

    Thus, performance materiality reduces the probability that the aggregate amount of uncorrected and undetected misstatements exceeds the materiality level for the financial statements.

    The level of performance materiality selected is a matter of professional judgment and is impacted by the auditor’s understanding of the client, including the types and amounts of misstatements found during previous audits of the client; these matters impact the auditor’s expectations regarding misstatements that might be present in the current period. The performance materiality level can be set at different levels for different accounts.

    Example

    An audit senior has determined that the materiality of financial statements for the audit of ABC Corporation is RM65,000.

    Here are some excerpts from the financial statements of ABC Corporation:

    • Turnover – RM7.5 million
    • Trade and other receivables – RM2.6 million
    • Cash at the bank – RM0.75 million
    • Trade payables – RM1.4 million

    Now think about what would happen if the financial statement materiality of RM65,000 was used for all of the above areas.

    There will be several balances or parts of balances that the auditor does not test because they are less than the RM65,000 “materiality level” for financial statements.

    Suppose the auditor only looked at what was important in the financial statements. In that case, the untested items could have misstatements that could add up to material [big] misstatements when added to other misstatements. This is where the idea of how important performance materiality is comes into play.

    So, performance materiality is a lower level of materiality than that set for the financial statements as a whole.

    This lower level of materiality is used during sampling to reduce the risk of small errors [immaterial misstatements] becoming big ones [material] when they are added up.

    ISA 320 adds to the definition of performance materiality by saying that performance materiality:

    ‘also refers to the amount or amounts set by the auditor at less than the materiality level or levels for particular classes of transactions, account balances or disclosures.’

    There are no formulas in ISA 320 that say how performance materiality should be calculated. Instead, the auditor uses his or her own judgement, taking the following things into account:

    • The nature and extent of misstatements that were identified in prior year audits;
    • The auditor’s understanding of the entity and the environment in which it operates; and
    • The result of the auditor’s risk assessment procedures.

    Calculation of financial statement materiality

    Again, it’s up to the auditor’s professional judgement to come up with a materiality level for the financial statements as a whole.

    But over the years, it has become common to put percentages on certain parts of the financial statements and use those numbers to figure out the materiality level of the financial statements.

    For example:

    • ½ to 1% of turnover
    • 1 to 2% of gross assets (non-current + current assets (also known as the statement of financial position/balance sheet total))
    • 5% of profit before tax
    • 2 to 5% of net assets

    Whilst not as common in real-life practice, it is not unheard of for ½ to 1% of gross profit to be included in the above percentage calculations.

    Most audit methods use the “averaging” method to determine financial statement materiality level.

    This is where three elements of the financial statements will be used, percentages applied and then an average worked out to arrive at a financial statement materiality level.

    Example

    Here are some extracts from a client’s financial statements from the planning stage:

    • Turnover – RM27.5 million
    • Profit before income tax – RM2.5 million
    • Non-current assets [NBV] – RM1.2 million
    • Current assets – RM4 million

    Using the averaging method, financial statement materiality at the planning stage can be calculated as follows:

    So, RM504,000/3 = RM168,000, and using the averaging method; this is how important each item is on the financial statement as a whole.

    The auditor could reduce this by a certain percentage to get to a performance materiality level.

    For example, they could reduce the financial statement materiality by 75% to arrive at a performance materiality level.

    However, this is not a rule, and it is up to the auditor to decide how they will reach a performance materiality level.

    Using percentages to determine a financial statement’s materiality level is not prescriptive, and the benchmarks above are only meant as a guide.

    Since no two audits are the same, it may be better to use different ways to calculate the financial statement’s materiality level. Depending on the level of risk, the auditor may decide that the above calculations give a materiality level that is too high. In this case, they may either lower the percentages (based on their past experience and risk assessment) or use a different method to determine the materiality of a financial statement.

    Materiality considerations during the course of the audit

    Materiality, like planning, doesn’t end once it’s been figured out.

    Things could happen during the detailed audit work that would have led the auditor to a different materiality level during the planning phase.

    Because of this, the auditor must always keep in mind that he or she needs to go back to the planning phase and make any changes that are needed based on what was found during the detailed audit work (this links into the concept of planning being an iterative and continuous process).

    Suppose a situation makes the auditor think that a lower financial statement materiality level would have been set during planning. In that case, the auditor must also look at performance materiality and decide if it needs to be changed because of the situation.

    This would be the case where the results of the financial statements are going to change (which would then give rise to a need to revise materiality levels).

    Example

    Here are some extracts from XYZ Corporation’s financial statements for the year that ended on December 31, 2021, along with the materiality levels that were calculated at the planning stage using the averaging method:

    Financial statement materiality:

    = 1.76m / 3

    = RM59,000 (rounded up)

    The performance materiality level is 65% of financial statement materiality, hence

    = (RM59,000—(RM59,000 × 65/100))

    = RM20,650

    During the review of correspondence from the company’s lawyers, the audit senior noticed that the company had been fined for the illegal dumping of toxic waste amounting to $500,000 plus costs of RM100,000.

    The company was taken to court in October 2021, and the fine was paid in February 2022, as ordered by the courts.

    The directors didn’t tell the auditors about this fine at the pre-audit meeting in October 2021, and nothing has been written down about it in the planning.

    The finance director said that he didn’t think it was important to bring this to the attention of the audit firm because it wouldn’t be paid until the next financial year. Because of this, it didn’t have anything to do with the audit of the financial statements for December 31, 2021.

    IAS 10: Events after the Reporting Period [Malaysia: MFRS 110] would be especially important in this case.

    The fact that the company was prosecuted DURING the financial year to 31 December 2021 means that these conditions existed at the end of the year.

    The fine is an adjusting event under IAS 10, so the financial statements for the year ended 31 December 2021 should have taken this fine into account.

    So, it’s wrong that the director put the fine in the next financial year. If the auditor had known about it, it would have caused them to arrive at a different materiality level (and performance materiality level).

    If this fine had been added as IAS 10 required, the profit before income tax would have been RM400,000.

    This is because RM1 million minus RM500,000 minus RM100,000 is RM400,000.

    Finance statement materiality levels would have been:

    = (RM0.82 + RM0.20 + RM0.44) / 3

    = RM49,000 (rounded up).

    Performance materiality would have been:

    = RM49,000 – (RM49,000 × 65/100)

    = RM17,150.

    This scenario highlights a situation where the auditors have discovered an event during the course of the audit of which they were previously unaware and which would have otherwise resulted in a lower financial statement materiality level and a lower performance materiality level.

    Other considerations

    When the auditor detects transactions or events that he or she didn’t know about before, he or she must also decide if the nature, timing, and scope of any further audit procedures should still be done.

    Obviously, if the situation is caused by fraud and/or an error, the auditor should extend the nature, timing and extent of planned further audit procedures.

    Documentation of materiality

    ISA 320 requires the auditor to document various aspects of materiality, including:

    • Materiality calculated for the financial statements as a whole;
    • Materiality level(s) for particular classes of transactions account balances or disclosures(where applicable);
    • Performance materiality; and
    • Revisions made to financial statement and
    • performance materiality as the audit progresses.

    Even if the auditor has found few or no misstatements, that doesn’t mean that the auditors should disregard materiality levels at the completion phase of the audit.

    At the end of the audit, the auditor should check the materiality levels to ensure they still remain appropriate.

    To do this, the auditor should look at the results of the audit procedures performed, and any misstatements found. The auditor should also evaluate these misstatements according to ISA 450 Evaluation of Misstatements Identified During the Audit.

    When these misstatements are getting close to the materiality levels, the auditor should consider whether they need additional audit procedures to lower the risk of material misstatements.

    Our website's articles, templates, and material are solely for you to look over. Although we make every effort to keep the information up to date and accurate, we make no representations or warranties of any kind, either express or implied, regarding the website or the information, articles, templates, or related graphics that are contained on the website in terms of its completeness, accuracy, reliability, suitability, or availability. Therefore, any reliance on such information is strictly at your own risk.

    Keep in touch with us so that you can receive timely updates |

    要获得即时更新，请与我们保持联系

    1. Website ✍️ https://www.ccs-co.com/ 2. Telegram ✍️ http://bit.ly/YourAuditor 3. Facebook ✍

    4. Blog ✍ https://lnkd.in/e-Pu8_G 5. Google ✍ https://lnkd.in/ehZE6mxy

    6. LinkedIn ✍ https://www.linkedin.com/company/74734209/admin/

    14
  • Salary to Senior Citizens, IRB disallowed Double deduction claim, CCS Successfully defends

    Salary to Senior Citizens, IRB disallowed Double deduction claim, CCS Successfully defends

    In claiming a Double Tax Deduction for remuneration paid to an employee who reaches the age of 60 in the middle of the year, is the remuneration to be prorated to exclude the portion of his remuneration that relates to the period prior to reaching the age of 60?

    Few senior citizen employees of our clients reach the age of 60 in 2020.

    IRB disallowed our client’s claim for a double deduction from the salary of their employees for the months before they turned 60.

    Illustration:

    Financial Year End: 31.12.2020

    Date of Birth of Employee: 1.3.1960

    IRB disallowed our client’s claim for a double deduction from their employee’s salary for January to February 2020 because he hasn’t turned 60.

    IRB only allowed our client’s claim for a double deduction from their employee’s salary for March to December.

    This incident involved a few employees.

    Good news! CCS wins their case, and our client doesn’t have to pay a single cent more to the IRB because of the tax audit.

    The credit goes to everyone on our team.

    支付给60岁的雇员的薪酬，纳税人可以享有双重扣税 (Double Tax Deduction) 的优惠。

    然而，倘若有关员工是在课税年 (Assessment Year) 之间才60岁 （例如：在课税年的9月11日才60岁），那么在他还没有达到60岁前的薪水，在计算双重扣税时是否需要被排除？

    我们的客户有不少年长的雇员，在2020课税年达到60岁。

    然而，这些雇员在达到60岁前的几个月的薪酬，内陆税收局 (IRB) 不允许我们的客户双重扣税。 此项举动，会导致我们的客户必需额外缴付税款 (Addition Tax) 再加上罚款 (Penalty)。

    说明一下：

    财政年度结束：31.12.2020

    雇员的出生日期: 1.3.1960

    由于员工需要在2020年3月1日才达到60岁，因此 2020 年1月及2月份的薪水，IRB 不允许我们的客户双重扣税。

    IRB 只允许我们的客户支付给员工3月至12月的工资，才享有双重扣税的资格。

    这一事件涉及到几个员工，因此影响极大。

    好消息! 在于与 IRB 沟通后，CCS 赢了此案子，我们的客户也因此不需要因税务审计而向IRB多付一分钱 [0 Issues/ Findings]。这要归功于我们团队的每个人。

    References:

    Employment of Senior Citizens, Ex-Convicts, Parolees, Supervised Persons and Ex-Drug Dependants

    Double Tax Deduction: Senior Citizen, Ex-Convict, Parolee, Supervised Person and Ex-Drug Dependants

    LHDN & CTIM

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    Our website's articles, templates, and material are solely for you to look over. Although we make every effort to keep the information up to date and accurate, we make no representations or warranties of any kind, either express or implied, regarding the website or the information, articles, templates, or related graphics that are contained on the website in terms of its completeness, accuracy, reliability, suitability, or availability. Therefore, any reliance on such information is strictly at your own risk.

    Keep in touch with us so that you can receive timely updates |

    要获得即时更新，请与我们保持联系

    1. Website ✍️ https://www.ccs-co.com/ 2. Telegram ✍️ http://bit.ly/YourAuditor 3. Facebook ✍

    4. Blog ✍ https://lnkd.in/e-Pu8_G 5. Google ✍ https://lnkd.in/ehZE6mxy

    6. LinkedIn ✍ https://www.linkedin.com/company/74734209/admin/

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