ACCA Articles

Another Audit Q&A with Steve

I have seen lots of questions posted on AccountancyStudents these last few weeks about ACCA paper F8 and have received a number of emails asking me questions about this paper.  AccountancyStudents are dedicated to ensuring students pass their exams, so I thought it would benefit every student of F8 to put some of the questions I have been asked in an article so others can benefit.

The key problem that students seem to have with audit papers is the fact that when they attempt a question, their answer never seems to mirror that of the model answer.  In auditing papers it is often the case that a question/scenario can cover a wide range of answers and therefore just because a student’s answer does not mirror that of the model answer does not mean it would result in a fail. As long as you justify the reasoning for your answer then you should not go far wrong.  Remember the model answers are much longer than what would be expected from you in the exam, so do not think you would be expected to produce answers the same length and quality as those in the model answers.

Can I pass F8 if I do not work in Audit?
Of course you can.  Some students do not work in management accounting but can pass a management accounting paper.  Most students do not work in practice but get through F8.  If you do not work in practice or have never had exposure to audit, you might wish to consider whether to do P7 (Advanced Audit and Assurance) as an option paper but as F8 is not an option, you have no choice but to do the paper, but it is very much passable.  The key is getting a good and broad knowledge and good understanding of the syllabus.

Who is the examiner?
The examiner for F8 is Alan Lewin.  The examiner for P7 is Lisa Weaver. You are advised to read all articles written by them in Student Accountant.  For paper F8 you are encouraged to read Alan Lewin’s article in the October edition of Student Accountant as that highlights some of the most common errors found in paper F8.

What is the key to passing F8
Auditing is very much based on judgements. In real life those judgements have to be substantiated by reasoned argument.  For example if the auditor considers that the risk of material misstatement due to revenue recognition is not appropriate, then the auditor is required to support this decision with justification given that revenue recognition is a key audit area (turnover/income is often the largest figure in a set of financial statements).

The same rationale occurs in auditing exams.  If you are asked to make a conclusion on an issue, for example whether an audit report should be qualified (modified), unqualified (unmodified), adverse or disclaimed, then you must give the reasons why you have arrived at that decision.  Simply saying it should be unqualified without any rationale behind your answer will gain you little (if any) marks.

Tailoring your answers to the scenario is also a crucial factor.  If you simply write everything you know about ISA 500 (Audit Evidence) without tailoring that answer to the scenario you are giving it away that you have simply rote-learnt the answer.  Every student in the world can rote learn accounting standards and auditing standards and know them back-to-front and inside out.  The key is not actually rote learning them, but applying the standards and your knowledge to the scenario set.

As accounting standards are tested in F7 I don’t have to know them in F8 – right?
Definitely not right.  The whole audit process is concerned with ensuring the financial statements give a true and fair view.  If an auditor does not know their accounting standards then how can they audit that particular client?  In a recent reply to a student’s query, I cited an ‘available-for-sale’ financial asset and the provisions of IAS 39 (Financial Instruments: Recognition and Measurement).  If the auditor did not know the provisions of IAS 39 and the fact that IAS 39 states that an available-for-sale financial asset must be recognised at fair value, then how can the auditor then understand that ISA 545 (Auditing Fair Value Measurements and Disclosures) or ISA 620 (Using the Work of an Expert) kicks in?  In fact how could the auditor know that such an asset would need to be valued at fair value if they were not required to know about accounting standards?

Knowledge of accounting standards in an auditing paper is as paramount as knowing about the auditing standards so make sure that your knowledge of F7 is not neglected in F8 or that knowledge acquired in P2 neglected in P7.

Do I have to learn the contents of the auditors’ report?
It is highly unlikely (in fact I would say very, very unlikely) that you would be asked to re-produce an auditor’s report.  I would say that you should know the contents of the auditors’ report and how it is structured (the order it follows).  You should also be aware of issues such as the ‘Bannerman’ paragraph in respect of the auditor’s duty to third parties as you could be asked a question on this. 

What is absolutely crucial is that you know when to issue an unqualified opinion, a qualified opinion, an adverse opinion and a disclaimer.  You should also know what the effect of those opinions has on the client.

When are substantive tests and tests of controls relevant?
This is a very common question.  Substantive testing is the detailed ‘ticking and flicking’ testing.  Tests of controls are testing the internal controls.  Wherever possible, the auditor would like to place reliance on a client’s internal controls as this results in less detailed substantive testing, but if these prove ineffective, or tests of controls are deemed inappropriate then substantive testing must be performed. 

If the auditor concludes the client’s internal controls are effective and reliance can be placed on them then less substantive testing can be undertaken.  Where internal controls are deemed to be ineffective, or reliance on them cannot be placed then substantive testing must be undertaken.  This is an area of judgement and in exam scenarios you may need to justify why you deem it appropriate to undertake more substantive testing than relying on internal controls or vice-versa.

What is sampling?
Sampling works by extracting a ‘sample’ from a ‘population’ and examining that sample.  For example, in a trade receivables audit, certain receivables will be sampled – but not all of them.  The sample extracted will be subject to certain audit tests and if the outcome of these tests is satisfactory, then reliance can be placed on the entire ‘population’.  In the trade receivables a ‘population’ would be the entire set of balances that make up the total balance on the trade receivables listing. 

If the auditor concludes that there are errors or other factors that render the sample unsatisfactory or the objective of that audit area was not achieved, the auditor should extend their sample accordingly and if this does not achieve the overall audit objective, then the auditor considers the impact on their audit opinion.

What is anomalous error?
An anomalous error is an isolated error that occurs in a sample.  In order to be classed as an ‘anomalous’ error, the auditor has to be satisfied the error is isolated.  In order to achieve this, the auditor will perform additional testing. 

An example of an anomalous error is where an audit client has branches (say in a retail store) and one of the branches inventory counts has an error in the stock valuation formula.  The auditor will need to test that this error has only occurred in that one branch and if it has, then it can be classed as an ‘anomalous’ error. 

Can an auditor qualify an audit report if they find any error?
Remember, the principle behind the audit.  It is to give reasonable assurance that the financial statements are free from ‘material’ misstatement.  If the auditor finds an error that is immaterial, but the client does not wish to correct it, then the auditor should not qualify their report just because of that error.  Only where the financial statements contain a ‘material’ misstatement should the auditor consider a modified or adverse opinion – or even a disclaimer.

What is the difference between a qualified and an adverse audit opinion?
The difference between the two is fundamental.  A qualified report is usually followed by an ‘except for’ paragraph stating that ‘except for’ the matter which qualifies the audit opinion, the financial statements otherwise give a true and fair view. 

An adverse opinion, on the other hand states that the financial statements do not give a true and fair view.  These opinions are quite rare, but do exist.  For example, where a company omits (and refuses) to include a material pension fund deficit on its balance in respect of its defined benefit pension scheme, then this would give rise to an adverse audit opinion.

You have to be careful to understand what constitutes a breach in accounting standard (therefore a possible qualification) and what constitutes the financial statements failing to give a true and fair view, thus an adverse or even a disclaimer of opinion.

Disclaimers are where the auditors conclude that the audit has revealed that the company’s policies, controls and procedures in respect of financial reporting are so unstable that they cannot form an opinion on the financial statements.

Any other tips for the exam?
Yes.  Write clearly!  Auditing papers are main discursive and if the marker cannot read your answers, they are not going to give you the marks.

Also bear in mind these are professional exams.  They attract professional marks – get those marks in the bag.  They could mean the difference between a pass and a fail. 

Where you are given financial data, the examiner has put that in the paper for a reason.  Keep in mind issues such as materiality and do not be afraid to calculate things like ratios and debtor days – it shows you are ‘thinking outside the box’.  If you are asked to consider an issue, think about how material that issue is to the financial statements presented to you in the scenario.

Justify your answer.  If you are asked to ‘comment’ on an issue, make a comment but always back up your answer with a reasoned argument.  It is far too easy to say “this represents a fraud” or “assets are overstated” without supporting your answer with justification.  The examiner is looking for (a) a conclusion and (b) reasons why you have arrived at that conclusion.

Remember, in real life audit the auditors are always required to support their conclusions with reasons. 

Finally, whatever you do in the exam – do not fall into the trap of presenting a ‘rote learned’ answer.  The examiner and the markers will be able to see a rote learned answer.  If you know the auditing standards and have learnt them (which one would expect in a paper such as F8/P7), then apply that knowledge to the scenario set.  Remember, standards such as ISA 500 (Audit Evidence) have six methods of gaining audit evidence: inquiry, observation, analytical review etc.  It is important to understand that not every single method will be appropriate to the scenario set in your exam.

And don’t forget those accounting standards!!

There are other articles which have been written by myself on this subject which can be found in the ‘articles’ and ‘audit’ section of the AccountancyStudents.co.uk website.

Good luck in your exams.

Steve Collings FMAAT ACCA DipIFRS is Audit Manager at Leavitt Walmsley Associates (http://www.lwaltd.com) and a partner in AccountancyStudents.co.uk