Technical and Professional Capacity of Independent Auditors

Posted on Oct 17, 2024 in Law & Jurisprudence

NTO ENTRENAMIE 210: Technical and Professional Capacity of Independent Auditor

01. First Rule:

“The audit must be performed by persons having adequate technical training and professional capacity as an auditor.”

02. Education and Experience:

This standard recognizes that, however able a person may be in other fields, they cannot meet audit standards without adequate education and experience in the field of auditing.

03. Expertise and Responsibility:

The independent auditor is recognized by the public as a person with expertise in accounting and auditing. This expertise begins with formal education and is further developed through experience. The independent auditor must have adequate training to meet the demands of the profession. The auditor, bearing the ultimate responsibility of their commitment, must have a weighted view of the different degrees of supervision and review of the work performed, as well as the training of their subordinates, who, in turn, must meet the responsibilities inherent in the different stages and functions of their jobs.

220: Independence

Description of the Standard on Independence

01. Second Rule:

“In all matters relating to the work assigned, the auditor(s) must maintain an independent mental attitude.”

02. Impartiality and Objectivity:

This standard requires the auditor to be independent. In addition to being independent in their actions, they should not be negatively predisposed towards the audit client, as this would compromise the impartiality necessary to rely on their findings, regardless of their technical capacity. To be independent, the auditor must be intellectually honest. To be recognized as independent, they must be free of any obligation or interest with the client, its management, or its owners.

SECTION 311: Planning and Supervision

01. First Standard for the Performance of Work:

“The work must be properly planned, and the work of the audit team must be properly supervised.” This section provides guidance to the auditor performing an audit in accordance with generally accepted auditing standards, with regard to the considerations and procedures for planning and supervision, including the preparation of an audit program.

02. Delegation and Responsibility:

The auditor, who has the final responsibility for the audit, may delegate part of the planning and supervision to other team members. For the purposes of this section: (a) “other team” refers to staff of the firm other than the auditor who has the final responsibility for the audit, and (b) the term “auditor” refers to all team members, including the auditor who has the final responsibility for the audit.

Planning

03. Developing an Overall Strategy:

Planning an audit involves developing an overall strategy for the expected conduct and scope of the audit. The nature, extent, and timing of planning vary with the size and complexity of the entity under review, the auditor’s experience, and their knowledge of the business entity. In planning the audit, the auditor should consider, among other things:

• a) Issues related to the business of the entity and the industry in which it operates.
• b) The accounting policies and procedures of the entity.
• c) The methods used by the entity to process significant accounting information, including the use of external services.
• d) The assessed level of control risk.
• e) Preliminary materiality levels.
• f) Accounts in the financial statements that will likely require adjustments.
• g) The conditions that may require extension or modification of audit tests, such as the risk of significant errors or irregularities or the existence of related party transactions.
• h) The nature of the reports that are expected to be issued (for example, a report on financial statements, reports on financial statements to regulators, or special reports, such as those issued in compliance with contractual terms).

Supervision

11. Directing and Monitoring:

Supervision includes directing the efforts of the audit team members in achieving the objectives of the audit and determining whether those objectives were met. Elements of supervision include instructing the audit team members, keeping informed of significant issues identified, reviewing the work performed, and managing differences of opinion among team members.

12. Responsibilities and Procedures:

The other members of the audit team should be informed of their responsibilities and the scope of the procedures they are to execute. They shall be informed of matters that may affect the nature, extent, and timing of the procedures to be carried out.

SECTION 312: Audit Risk and Materiality

01. Guidance on Risk and Materiality:

This section provides guidance on the consideration that the auditor should give to risk and materiality when planning and conducting an audit of financial statements in accordance with generally accepted auditing standards. Audit risk and the recognition of the relative importance of some matters affect the application of generally accepted auditing standards, especially standards relating to the execution of the work and the reports, and are implicit in the auditor’s standard report.

02. Acknowledging Audit Risk:

The existence of audit risk is recognized and is implicit in the auditor’s standard report, which states that there is “reasonable assurance” about whether the financial statements are free of material misstatement. Audit risk is the risk that the auditor may unknowingly fail to appropriately modify their opinion on financial statements that are materially misstated. In addition to audit risk, the auditor is also exposed to the risk of adverse publicity or other events arising in connection with financial statements they have examined and on which they have issued an opinion.

Audit Planning

08. Considering Audit Risk and Materiality:

The auditor must consider audit risk and materiality when:

• a) Planning the audit and designing procedures for it, and
• b) Assessing whether the financial statements taken as a whole are presented fairly in all material respects.

In the first circumstance, the auditor should consider audit risk and materiality to obtain sufficient competent evidential matter. In the second circumstance, this enables them to properly evaluate the financial statements.

Considerations at the Financial Statement Level

09. Limiting Audit Risk:

The auditor should plan the audit so that audit risk is limited to a low level that is, in their professional judgment, appropriate for expressing an opinion on the financial statements. Audit risk can be assessed quantitatively or non-quantitatively.

10. Preliminary Materiality Levels:

Section 311, “Planning and Supervision,” requires the auditor to consider, among other things, their preliminary judgment about materiality levels for the purposes of the audit. This judgment may or may not be quantified.

Considerations at the Individual Account Balance or Class of Transactions Level

17. Inverse Relationship Between Audit Risk and Materiality:

The auditor recognizes that there is an inverse relationship between audit risk and materiality. For example, the risk that an account balance or class of transactions may be materially misstated by an extremely large amount might be very low, but the risk that it may be materially misstated by an extremely small amount could be very high. This would require the auditor to perform one or more of the following: (a) select a more effective audit procedure, (b) perform the audit procedures closer to the balance sheet date, or (c) increase the extent of a particular audit procedure.

Evaluation of Audit Findings

27. Assessing Fair Presentation:

In assessing whether the financial statements are presented fairly in all material respects, the auditor should aggregate uncorrected misstatements to consider whether, in relation to individual amounts, subtotals, or totals in the financial statements, these misstatements materially misstate the financial statements taken as a whole.

326: Evidential Matter

01. Third Standard for the Execution of Work:

“Sufficient competent evidential matter is to be obtained through inspection, observation, inquiries, and confirmations to afford a reasonable basis for an opinion regarding the financial statements under examination.”

02. Obtaining and Evaluating Evidence:

Much of the independent auditor’s work in forming their opinion on the financial statements consists of obtaining and evaluating evidential matter relevant to the assertions in those financial statements. The validity of that evidence for audit purposes is a matter of the auditor’s professional judgment. In this respect, audit evidence differs from legal evidence, which is subject to rigid rules.

329: Analytical Procedures

01. Guidance on Analytical Procedures:

This section provides guidance for the use of analytical procedures, which are required in the planning and review phases of all audits.

02. Evaluations of Financial Information:

Analytical procedures are an important part of the audit process and consist of evaluations of financial information made by a study of plausible relationships among both financial and non-financial data. A basic premise underlying the application of analytical procedures is that plausible relationships among data are expected to exist in the absence of known conditions to the contrary. Specific conditions that can cause variations in these relationships include, for example, unusual transactions or events, accounting changes, business changes, random fluctuations, or misstatements.

03. Understanding Financial Relationships:

Understanding financial relationships is essential in planning and evaluating the results of analytical procedures and usually requires knowledge of the client and the industry in which it operates.

Analytical Procedures Used in Planning the Audit

06. Purpose of Analytical Procedures in Planning:

The purpose of applying analytical procedures in planning the audit is to assist the auditor in planning the nature, timing, and extent of audit procedures that will be used to obtain evidential matter for specific account balances or classes of transactions. To accomplish this, the analytical procedures used in planning the audit should focus on:

• a) Enhancing the auditor’s understanding of the client’s business and the transactions and events that have occurred since the last audit date, and
• b) Identifying areas that may represent specific risks relevant to the audit.

Therefore, the objective of these procedures is to identify such things as the existence of unusual transactions and events and amounts, ratios, and trends that might indicate matters that have financial statement and audit planning ramifications.

07. Use of Aggregate Data:

The analytical procedures used in planning the audit generally use data aggregated at a high level. In addition, the sophistication, extent, and timing of the procedures, which are a matter of the auditor’s professional judgment, may vary widely depending on the size and complexity of the client.

08. Consideration of Non-Financial Information:

Although the analytical procedures used in planning the audit often use only financial information, non-financial information is sometimes also relevant. For example, the number of employees, square footage of selling space, volume of production, and similar information can be helpful in fulfilling the purpose of these procedures.

Analytical Procedures Used as Substantive Tests

09. Reliance on Substantive Tests:

The auditor’s reliance on substantive tests to achieve an audit objective related to a particular assertion may be derived from tests of details, from analytical procedures, or from a combination of both. The decision about which procedures to use to achieve a particular audit objective is based on the auditor’s judgment about the expected efficiency and effectiveness of the available procedures.

Nature of the Assertion

12. Effectiveness of Analytical Procedures:

Analytical procedures may be effective and efficient tests for assertions in which potential misstatements would not be apparent from an examination of the detailed evidence or in which detailed evidence is not readily available.

Plausibility and Predictability of the Relationship

13. Understanding the Reasons for Relationships:

It is important that the auditor understand the reasons that make relationships plausible because, in certain circumstances, data may appear to be related when they are not, which could lead the auditor to erroneous conclusions. In addition, the presence of an unexpected relationship may provide important evidence when properly investigated.

14. Predictability and Confidence:

The more predictable the relationships are, the greater the reliance that can be placed on the procedures. The desired level of assurance to be obtained from analytical procedures affects the extent to which the relationships need to be predictable.

Availability and Reliability of Data

15. Availability of Data:

For some assertions, data may not be readily available to develop expectations. For example, to test the completeness assertion, expected sales for some entities might be developed based on production statistics or square footage of selling space.

16. Assessing Data Reliability:

The auditor’s reliance on analytical procedures is based on the consistency of the recorded amounts with expectations developed from data derived from other sources. The auditor should assess the reliability of the data by considering the source of the data and the conditions under which it was obtained. The following factors influence the auditor’s consideration of the reliability of data for purposes of achieving audit objectives:

• Whether the information was obtained from independent sources outside the entity or from sources within the entity.
• Whether sources within the entity were independent of those who are responsible for the amount being audited.
• Whether the data was developed under a reliable system with adequate controls.
• Whether the data was subjected to audit testing in the current or prior year.
• Whether expectations were developed using data from a variety of sources.

SECTION 336: Using the Work of a Specialist

01. Guidance on Using Specialists:

The purpose of this section is to provide guidance to the auditor who uses the work of a specialist in performing an audit of financial statements in accordance with generally accepted auditing standards. A specialist is a person (or firm) possessing special skill or knowledge in a particular field other than accounting or auditing.

02. Examples of Specialists:

Specialists covered by this standard include, but are not limited to, actuaries, appraisers, attorneys, engineers, environmental consultants, and geologists. This standard also applies to attorneys engaged in other than the practice of law (for example, to provide services to clients in connection with litigation, claims, or assessments).

03. Applicability of Guidance:

The guidance in this section applies when:

• a) Management engages or employs a specialist and the auditor uses the specialist’s work as evidential matter.
• b) Management engages a specialist employed by the auditor’s firm to provide advisory services, and the auditor uses the specialist’s work as evidential matter.
• c) The auditor engages a specialist and uses the specialist’s work as evidential matter in performing substantive tests to evaluate the assertions in the financial statements.

The auditor should consider the effect on their independence when using the work of a specialist employed by the auditor’s firm.

Decision to Use the Work of a Specialist

06. Auditor’s Knowledge and Expertise:

The auditor’s education and experience qualify them to have expertise in business matters generally; however, the auditor is not expected to have the expertise of a person trained for or qualified to engage in the practice of another profession or occupation. When a matter requiring special skill or knowledge arises, the auditor may decide to use the work of a specialist.

Qualifications and Work of a Specialist

08. Assessing Reputation and Experience:

The auditor should consider the following when assessing the specialist’s reputation and experience to determine whether the specialist possesses the necessary skill and knowledge:

• a) The specialist’s professional certification, license, or other recognition of their expertise in the field.
• The specialist’s reputation and standing in the views of their peers and others familiar with their capability or performance.
• c) The specialist’s experience in the type of work under consideration.

Specialist’s Relationship with the Client

10. Objectivity of the Specialist:

The auditor should assess the specialist’s relationship with the client, including circumstances that might impair the specialist’s objectivity.

11. Independence and Reliability:

When the specialist is unrelated to the client, the specialist’s work will usually provide the auditor with greater assurance of reliability. However, the work of a specialist who is related to the client may be acceptable in some circumstances.

Using the Work of a Specialist

12. Reasonableness and Appropriateness of Methods:

The reasonableness and appropriateness of methods or assumptions used and their application are the responsibility of the specialist. The auditor should:

• a) Obtain an understanding of the methods or assumptions used by the specialist.
• b) Make appropriate tests of data provided to the specialist by the client, taking into account the auditor’s assessment of control risk.
• c) Evaluate whether the specialist’s findings support the related assertions in the financial statements.

Effect of the Specialist’s Work on the Auditor’s Report

13. Sufficient Competent Evidential Matter:

If the auditor concludes that the specialist’s findings support the related assertions in the financial statements, the auditor may reasonably conclude that sufficient competent evidential matter has been obtained. If there is a material difference between the specialist’s findings and the assertions in the financial statements, the auditor should apply additional procedures.

Reference to a Specialist in the Auditor’s Report

15. Avoiding Misinterpretation:

Except as discussed in paragraph 16, the auditor should not refer to the work of a specialist in the auditor’s report. Such a reference might be misconstrued as a qualification of the auditor’s opinion or a division of responsibility, neither of which is intended.

SECTION 339: Working Papers

01. Preparing and Maintaining Working Papers:

The auditor should prepare and maintain working papers, the form and content of which should be designed to meet the circumstances of the particular audit engagement. The information contained in working papers constitutes the principal record of the work performed by the auditor and the conclusions reached concerning significant matters. This section does not modify other auditing standards that require specific documentation, including:

• The letter of audit inquiry to the client’s attorney required by Section 337
• The written representations of management required by Section 333
• The notation in the working papers required by Section 325
• The written audit program or set of written audit programs required by Section 311

However, it is not intended to imply that the auditor is precluded from supporting their report by other means in addition to working papers.

Purpose and Nature of Working Papers

02. Primary Uses of Working Papers:

Working papers are used primarily to:

• a) Provide the principal support for the auditor’s report, including evidence of the auditor’s basis for a conclusion about the achievement of the overall objectives of the audit, and
• b) Aid the auditor in the conduct and supervision of the audit.

03. Records of Procedures and Conclusions:

Working papers are the records kept by the auditor of the procedures applied, the tests performed, the information obtained, and the pertinent conclusions reached in the course of the audit.

04. Factors Affecting Working Paper Content:

Factors affecting the auditor’s judgment about the quantity, type, and content of working papers for a particular audit include:

• a) The nature of the engagement
• b) The form of the auditor’s report
• c) The nature of the financial statements, schedules, or other information on which the auditor is reporting
• d) The nature and condition of the client’s records
• e) The degree of reliance on internal control
• f) The needs in the particular circumstances for supervision and review of the work performed

Content of Working Papers

05. Sufficiency of Working Papers:

The quantity, type, and content of working papers will vary with the circumstances (see paragraph 04), but working papers should be sufficient to show that the accounting records agree or reconcile with the financial statements or other information being reported on and that the applicable auditing standards of fieldwork have been observed. Working papers should normally include documentation showing that:

• a) The work was adequately planned and supervised, indicating observance of the first standard of fieldwork
• b) The system of internal control was studied and evaluated to the extent necessary
• c) The audit evidence obtained, the auditing procedures applied, and the testing performed have provided sufficient competent evidential matter to afford a reasonable basis for an opinion regarding the financial statements under examination

Ownership and Custody of Working Papers

06. Ownership of Working Papers:

Working papers are the property of the auditor.

07. Client Use of Working Papers:

The auditor may, at their discretion, make available to their client working papers or information contained in the working papers.

08. Safeguarding Working Papers:

The auditor should adopt reasonable procedures for safe custody of their working papers and should retain them for a period of time sufficient to meet the needs of their practice and to satisfy any pertinent legal requirements of records retention.

SECTION 410: Adherence to Generally Accepted Accounting Principles

01. First Standard of Reporting:

“The report shall state whether the financial statements are presented in accordance with generally accepted accounting principles.”

02. Interpretation of “Generally Accepted Accounting Principles”:

The term “generally accepted accounting principles” as used in reporting standards includes not only accounting principles and practices but also the methods of applying those principles and practices.

SECTION 420: Consistency of Application of Generally Accepted Accounting Principles

Changes in Accounting Principle

01. Definition of Change in Accounting Principle:

A change in accounting principle results from the adoption of a generally accepted accounting principle different from the one used previously. A change in accounting principle includes, for example, a change in the method of inventory pricing from FIFO to LIFO or a change in the method of depreciation from the straight-line method to an accelerated method for all fixed assets of a particular type or for all newly acquired fixed assets of a particular type.

Change in Reporting Entity

02. Changes Requiring Recognition:

Changes in reporting entities that require recognition in the auditor’s opinion include:

• a) The presentation of consolidated or combined financial statements in place of statements of individual companies
• b) Changes in the specific subsidiaries comprising the group of companies for which consolidated financial statements are presented
• c) Changes in the companies included in combined financial statements
• d) Changes in the methods of accounting for subsidiaries or other investments in common stock or in the equity method, such as a change from the cost method to the equity method

Correction of an Error in Principle

05. Treatment of Correction:

A change from an accounting principle that is not generally accepted to one that is generally accepted is a correction of an error. Although the change should be treated like a correction of an error, the change requires an explanatory paragraph in the auditor’s report.

Change in Principle Inseparable from Change in Estimate

06. Treatment of Inseparable Changes:

The effect of a change in accounting principle may be inseparable from the effect of a change in estimate. When the change in estimate is inseparable from the change in principle, the change should be treated like a change in estimate, which requires disclosure in the financial statements.

Changes Not Affecting Consistency

Change in Accounting Estimate

07. Necessity of Accounting Estimates:

Accounting estimates (such as estimates of useful lives and salvage values of depreciable assets and estimates of warranty costs, uncollectible receivables, and inventory obsolescence) are an integral part of the preparation of financial statements in conformity with generally accepted accounting principles.

Correction of an Error Not Affecting the Accounting Principles Used

09. Correction of Errors:

The correction of an error in previously issued financial statements results from mathematical mistakes, mistakes in the application of accounting principles, or oversight or misuse of facts that existed at the time the financial statements were originally prepared.

Changes in Classifications and Reclassifications

10. Disclosure of Significant Changes:

The classifications used in the current financial statements may differ from the classifications used in the prior year’s financial statements. Significant changes in classification should be indicated and explained in the financial statements or notes thereto.

Adoption of a Principle for New Transactions or Events That Are Materially Different

11. Adoption of New Principles:

Accounting principles are adopted when events or transactions occur for which it is necessary to apply an accounting principle for the first time. This adoption and the amendment or adoption of an accounting principle necessitated by events or transactions that are clearly different in substance are not changes in accounting principles.

Changes Expected to Have a Material Future Effect

12. Disclosure of Future Effects:

If an accounting change has no material effect on the financial statements in the current year but the change is reasonably certain to have a material effect in later years, the change should be disclosed in the notes to the financial statements of the current year.

Disclosure of Changes Not Affecting Consistency

13. Auditor’s Responsibility for Disclosure:

Although the matters discussed in Section 412 and paragraphs 01 and 02 of this Section 413 do not require modification of the independent auditor’s report regarding consistency, the auditor would express a qualified opinion or an adverse opinion if the financial statements do not include adequate disclosure of a change in accounting principle or a change in reporting entity.

Period to Which the Consistency Standard Applies

14. Consistency with Preceding Period:

When the independent auditor reports only on the current period’s financial statements, the auditor should obtain sufficient competent evidential matter to determine whether the accounting principles used in the current period are consistent with those used in the preceding period. (The term “current period” means the most recent year or period of less than one year for which the auditor is issuing a report.)

First-Year Audits

15. Procedures for First-Year Audits:

When the independent auditor has not audited the financial statements of the preceding year of an entity, the auditor should adopt procedures that are practicable and reasonable in the circumstances to obtain assurance that the accounting principles employed in the current year are consistent with those of the preceding year.

SECTION 504: Association with Financial Statements

01. Fourth Standard of Reporting:

“The report shall either contain an expression of opinion regarding the financial statements, taken as a whole, or an assertion to the effect that an opinion cannot be expressed. When an overall opinion cannot be expressed, the reasons therefore should be stated. In all cases where an auditor’s name is associated with financial statements, the report should contain a clear-cut indication of the character of the auditor’s work, if any, and the degree of responsibility the auditor is taking.” The objective of the fourth reporting standard is to prevent misinterpretation of the degree of responsibility the auditor is assuming when their name is associated with financial statements.

SECTION 508: Reports on Audited Financial Statements

01. Applicability of Section:

This section applies to reports issued in connection with audits of financial statements that are intended to present financial position, results of operations, and cash flows in accordance with generally accepted accounting principles. It distinguishes among the types of reports, describes the circumstances in which each type is appropriate, and provides illustrative reports.

02. Exclusions from Section:

This section does not apply to unaudited financial statements, reports on incomplete financial information, or other special reports.

03. Basis for Auditor’s Opinion:

The expression of the auditor’s opinion is based on the auditor’s judgment that the audit has been performed in accordance with generally accepted auditing standards and the resulting audit findings. Generally accepted auditing standards include four standards of reporting. This section is primarily concerned with the fourth standard of reporting (“In all cases where an auditor’s name is associated with financial statements, the report should contain a clear-cut indication of the character of the auditor’s work, if any, and the degree of responsibility the auditor is taking.”).