BACT 311

The Audit Process: Final Review of Audit of Financial Statements

OBJECTIVES
When you have studied this lesson you should be able to:
 Explain the review procedures in relation to opening balances and comparative figures
 Review other information for its impact on the opinion on the financial statements
 Understand the impact of subsequent events on the view conveyed by the financial
statements
 Critically evaluate issues surrounding the going concern basis

CONTENTS
1) Events after the balance sheet date
2) Comparatives
3) Related parties
4) The implications of published un audited information
5) Going Concern
6) Subsequent Events / Events after the balance sheet

INSTRUCTIONS
Assigned Reading
International Financial Reporting Standards (IFRS)
International standards on auditing (ISA)

6.0 The Final Review of the Financial Statements

The work we have considered so far has shown that the auditor first gathers facts about the
enterprise and the environment it operates in. The next stage was the gathering of audit evidence
about individual items and groups of items which together form the accounts. We then find that
the auditor is in a position of knowing that he has sufficient evidence to substantiate the detail of
the accounts. He then needs to form an opinion as to whether the accounts as a whole contain
certain qualities and this is when a final review is carried out.
This is a stage of the audit carried out by senior members of the audit team using the financial
statements. This is further to the analytical review procedures carried out as part of substantive
tests. The aims of this review are:

i. To provide audit evidence by determining if the financial statements provide

information that is internally consistent with other information in the possession of the
auditor and
ii. Also to determine if the financial statements have been prepared using acceptable
accounting policies, they comply with IFRS and other requirements and that there is
adequate disclosure of all relevant matters.

I would stress however, the following two issues:

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i. Qualities of the auditor who performs this review: this auditor must have:

a) An ability to distinguish between non-material, material and fundamental items;

b) An ability to assess the accuracy and completeness of information gathered in
the audit;
c) Must possess skill, imagination and good judgement particularly on professional
and economic issues;
d) An ability to recognise apparent inconsistencies and abnormalities which might
indicate areas where errors, omissions, frauds, irregularities have occurred which
might not have been revealed by the routine audit procedures and;
e) An ability to assess whether or not an audit opinion is possible.

ii. The qualities required of the final accounts: the final accounts must possess certain qualities
and these are:

a) Use of acceptable accounting policies, appropriate to the business and

consistently applied;
b) They must show the results of operations in the profit and loss account, state of
affairs in the balance sheet, changes in the financial position in the statement of
source and application of funds and all other information included in the
financial statement should be compatible with each other and with the auditor's
knowledge of the enterprise;
c) All appropriate matters should be adequately disclosed and information
contained in the accounts should be suitably classified and presented;
d) There must be compliance with statutory requirements;
e) There must be compliance with other relevant regulations;
f) There must be compliance with Kenya Accounting Standards.

The final review may reveal:

a) All is well or
b) Further audit evidence is required in some areas or
c) That it may be desirable to make amendments to the accounts and
d) That a qualified report may be required.

The review stage is very important in modern auditing as current auditing opinion is moving more
towards a consideration of the view given to users by financial statements. The detail is still
important but the view given must be true in detail and fair in totality.
.

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6.1 Going Concern Considerations

IAS 1 Presentation of Financial Statements recognizes the going concern assumption as one of the
fundamental assumptions that underlie the periodic financial statements of enterprises. The
meaning of going concern can be said to be that the financial statements assume that the enterprise
will continue in operational existence for the foreseeable future, or put another way the financial
statements assume no intention or necessity to liquidate or curtail significantly the scale of
operation or put more simply that the enterprise can meet its financial obligations as they fall due.
The going concern idea is very well established in accounting and there is an authoritative
document, ISA 570 Going Concern, The student is advised to read it in detail. The points to note
however are:

i. The importance of the principle

ii. The auditor's duty
iii. Indications of the inapplicability of the principle
iv. Counter indications
v. Audit procedures
vi. The impact on audit reports in practice.

6.11 The importance of the principle:

We will probably understand better how important this principle is if we consider the implications
of abandoning it. The effects of abandoning the principle include among others the following:

a) Fixed assets would need to be valued at realisable values and not depreciated
cost.
b) Fixed assets would have to be classified as current assets as they would have no
future benefits to the organization.
c) Stock would have to be regarded at lower of cost or forced sale net realisable
value.
d) Prepayments and intangible assets may have no future benefits.
e) New liabilities may appear such as redundancy pay, leave pay and closure costs.
f) Long-term liabilities may crystallize and become immediately payable hence
they cannot be classified as long-term liabilities.
g) The departure from the assumption, the reasons for this departure and its effect
need to be explained in the accounts in accordance with IAS 1.
6.12 The auditor's duty
The auditor has a duty to express an opinion on the truth and fairness and compliance with
legislation, of the accounts. The valuation basis adopted in preparing the accounts assumes that
the company is a going concern in accordance with IAS 1. Therefore, for the auditor to form an
opinion he should consider whether he has reasonable grounds for accepting the applicability of
the going concern assumption. It follows therefore; he must carry out sufficient work to ensure
that this assumption is justified. He therefore looks for evidence that the company is likely to

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continue trading for at least the next 12 months from the balance sheet date or 6 months from the
date of the audit report or more practically, he looks for evidence that there is no indication to the
contrary. He must however take account of significant events which are likely to occur even
later.
In the event that the auditor considers that the company is not a going concern, he should advise
the directors accordingly and ensure that the accounts are prepared on a market value or a break-up
basis. If the directors refuse to comply then the auditor will have to qualify the accounts as a
whole to the effect they are not true and fair. It is not possible for the auditor to rely on an
assessment of the going concern position at the balance sheet date alone because the accounts
usually only become public knowledge much later after the balance sheet date. It therefore
becomes necessary to take into account events taking place after the year end and before the AGM
which may affect the company as a going concern.

6.13 Indications of inapplicability of going concern

Insolvency, unfortunately, is a growth industry as the economy suffers a down turn and therefore
for a majority of enterprises in Kenya, the abandonment of the going concern assumption is no
longer a remote possibility. Consequently, on all audits the auditor must consider whether or not
his client is a going concern. ISA 570 gives numerous indications of going concern inapplicability.

6.14 Counter-indications
That the auditor has found indications of going concern non-applicability does not of itself justify
immediate conclusion that the entity is not a going concern. He must also seek for counter-
indications or mitigating factors. This may include the following:
a) Ability to raise cash by selling assets
b) Ability to obtain new sources of finance for example leasing, factoring debts,
hiring plant.
c) Opportunities of rearranging debt repayments or conversion of long term debt
into equity.
d) The possibility of a rights issue.
e) Support from other group companies or from associated companies.
f) The possibility of making alternative trading arrangements.

6.15 The auditors procedures

In forming an opinion on the going concern position of a company, the auditor should:
a) Investigate the company, its background, its plans for the future, review of cash
flows and financing plans;
b) At every stage of the audit search for and evaluate evidence for and against the
going concern applicability;
c) If he is in doubt, and the directors have formulated plans for the continuation of
the company, he should evaluate these plans, ensuring that:

1. All parts of the plan are consistent with each other;

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2. If the plans are contingent on the response of third parties then he should
seek third parties written confirmations;
3. Ascertain that the plans are specific rather than general;
4. Review the supporting evidence for the plans if available for
reasonableness;
5. Seriously consider any professional advice obtained by the directors;
6. Consider any potential support from other group companies by looking at
any contractual obligations, directors intentions and the ability of the group
company to give the support.
d) Consider whether he has sufficient evidence to form an opinion on the
applicability of the going concern assumption.

6.16 Audit Reports

In the vast majority of cases, the going concern assumption is appropriate and if applied no
mention need be made in the auditor's report.
In rare incidences, notes to the accounts may make reference to the going concern assumption.
This may include references to continued favourable trading or availability of finance. It may be
that the going concern assumption is not in doubt, but for a full understanding of the accounts there
is need for amplification of these notes. In such cases, the auditor may use an emphasis of matter
which is not a qualification and is allowed in ISA 700
When the auditor has complete doubt about the going concern assumption he may be required to
qualify his report and this is a highly charged area for the auditor because an expression in his
audit report that a company is not a going concern may in itself bring about the closure of the
company. The auditor should therefore:

a) Not refrain from expressing a qualified opinion even though this may lead to
receivership or liquidation;
b) The auditor should consider materiality, if the adjustments required on
abandoning the going concern assumption are not material, then no qualification
should be given;
c) If the auditor concludes that there is doubt then he should consider the
consequences for the figures in the accounts. For example, he should obtain an
estimate of the necessary provision against stock or the redundancy payments.
In practice because of the difficulties involved in making adjustments to the accounts and
producing them on a break up basis, accounts in most cases in Kenya are produced on the going
concern assumption and qualified by the auditor on the grounds that the going concern assumption
may not be appropriate.

6.20 Subsequent Events

Definition

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IAS 10 Events After the Balance Sheet Date prescribes the accounting for, and disclosure of,
events after the balance sheet date.
Events after the balance sheet date are those events that occur between the balance sheet date
and the date when the financial statements are authorized for issue.
Events After the Balance Sheet Date may be classified into two categories:
 Adjusting events and
 Non-adjusting events.

An entity adjusts the amounts recognised in the financial statements to reflect adjusting events
after the balance sheet date.

Adjusting events are those that provide evidence of conditions that existed at the balance sheet
date (e.g. the settlement of a court case after the balance sheet date that confirms that the entity
had a present obligation at the balance sheet date; the bankruptcy of a customer that occurs after
the balance sheet date usually confirms that a loss existed at the balance sheet date on a
receivable).
An entity does not adjust the amounts recognized in the financial statements to reflect non-
adjusting events after the balance sheet date.

Non-adjusting events are those that are indicative of conditions that arose after the balance
sheet date (e.g. a decline in the market value of investments between the balance sheet date and
the date when the financial statements are authorized for issue).
For each material category of non adjusting event after the balance sheet date, an entity discloses
the nature of the event and an estimate of its financial effect.

Dividends declared after the balance sheet dates are not recognized as a liability at the balance
sheet date.

Financial statements are not prepared on a going concern basis if management determines after
the balance sheet date either that it intends to liquidate the entity or to cease trading, or that it has
no realistic alternative but to do so.

The financial statements disclose the date when the financial statements were authorized for
issue, and who gave that authorization.

6.21 Auditors Procedures

The relevant authority on post balance sheet events is ISA. The preparation of profit and loss
account and balance sheet will always involve the consideration of events which have or will occur
after the balance sheet date. The reason being there are numerous transactions in progress at the
balance sheet date whose outcome is uncertain and therefore events subsequent to the balance sheet
date which have occurred or are expected to occur need to be examined to determine the
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appropriate values of assets and liabilities. Examples abound such as the collectability of debts, the
net realisable value of old stocks, the outcome of litigation. Even the value of fixed assets is a
function of their expected future useful life.
Since the directors in preparing the accounts will invariably use post balance sheet events, the
auditor must obtain evidence that all post balance sheet events have been considered and where
appropriate used and balance sheet values correctly incorporate post balance sheet events.

The questions that arise are concerned with what subsequent events should be taken into account
and how should they be treated in the accounts

Principles
i. Financial statements should be prepared on the basis of conditions existing at the
balance sheet date.
ii. A material post balance sheet event requires changes in the amounts to be included in
the financial statements where:
a) It is an adjusting event or
b) It indicates that application of the going concern assumption to whole or a
material part of the company is not appropriate.
iii. A material post balance sheet event should be disclosed where:
a) It is a non-adjusting event of such materiality and its non disclosure would affect
the ability of the users of financial statements to reach a proper understanding of the
financial position or

b) It is the reversal or maturity after the year end of a transaction entered into before
the year end, the substance of which is primarily to alter the appearance of the
company's balance sheet.
iv. In respect of each post balance sheet event which is required to be disclosed under
paragraph (iii) above, the following information should be stated by way of note in the
financial statement:
a) The nature of the event and
b) An estimate of the financial effect or a statement that is not practicable to make
such as estimate.
v. The estimate of the financial effect should be disclosed before taking account of
taxation and the taxation implication should be explained where necessary for a proper
understanding of the financial position.
vi. The date on which the financial statement is approved by the board of directors should
be disclosed in the financial statements.

Post balance sheet events occupy a very important place in auditing and therefore there is usually a
program of work that is carried out in this area. This includes:
i. A routine examination of such events such as collection of debts, sale of stocks,
payment of creditors, resolution of pending litigation;

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ii. A comparison of significant ratios before and after the year end, seeking explanations
for any material differences as they may indicate the presence of adjusting or non-
adjusting events or have going concern implications.
iii. Examination of all material provisions and contingent liabilities at the latest feasible
date prior to signing of the accounts to determine whether any additional evidence
exists that may affect original estimates used.
iv. Review of director’s minutes looking for any major new contract or losses of
customers or losses of major contracts, capital expenditure commitments, and changes
in accounting policy, new borrowing or share issues, extra-ordinary or abnormal
transactions, changes in market conditions or products.
v. Discussions with the management, a review of management accounts, review of profit
forecasts and cash flow projections, review of non-risk areas and
vi. Review of relevant external information e.g. reports in newspapers. This review must
be as near as possible to the date of signing the audit report.

It should be noted that

i. The auditor must always date his audit report. This date should be as close as possible
to the date of approval of the financial statement by the directors but must be after that
date. ISA 700 requires that the date the directors approve their accounts must be
disclosed.
ii. Special situation. These are relatively rare circumstances but possible:

a) If the auditor becomes aware between the date of his report and the AGM when
the accounts will be presented, of information which would change his report
then he should:

1. Discuss the matter with the directors who may wish to amend the accounts
2. Consider taking legal advice
3. Consider making a statement at the AGM as he is allowed to by the
Companies Act.

b) If the directors wish to amend the accounts between the date of the report and the
posting to the members, the auditor should

1. Consider if the proposed amendment requires a change in his report

2. Re date his report
3. Review post balance sheet events up to the re dating.

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