Auditing of Compliance with Financial Reporting Frameworks – the Presentation Assertion
Audit regulators are reporting that financial statement disclosure deficiencies have increased substantially over the past few years. It is crucial for auditors to realise that they need to have a sound understanding of the financial reporting framework applied by the entity and perform thorough audit procedures to determine whether the financial reporting framework has been correctly applied. This does not merely require the completion of a disclosure checklist, but also the verification of recognition and measurement, in terms of the financial reporting framework and reporting responsibilities placed on management.
Common audit deficiencies
Some of the deficiencies in this regard identified in the Independent Regulatory Board for Auditors (IRBA) Inspections Report 2019 include:
- Restatements, where it is not clearly identified that this is a correction of an error, resulting in non-compliance with the disclosure requirements of IAS 8 and IAS 1, in this regard
- Insufficient IFRS 7 (financial instrument) disclosures to achieve the objective of this standard
- Deficiencies in classification within the IFRS 13 (fair value measurement) fair value hierarchy, and the required qualitative disclosures for level 2 and level 3 instruments
- Insufficient disclosures relating to impairment assessments of goodwill and intangible assets
- Directors’ remuneration: disclosures not in compliance with the requirements of the Companies Act, and insufficient audit evidence on file supporting the directors’ remuneration disclosed
- Incorrect classification of current and non-current, particularly the classification of loans to/from related parties as current or non-current assets and/or liabilities, and debt or equity
- Inclusion of non-cash-flow items on the statement of cash flows
- No documented audit evidence on the engagement file to suggest that the statement of cash flow was audited and that transactions reflected on the statement of cash flow represent actual cash flows
- Insufficient audit evidence on the audit file supporting the classification of cash flows as operating, investing or financing activities.
There have been many negative findings regarding verification of compliance with IFRS and IFRS for SMEs in recent times, and a trend in internal monitoring by firms also reflects this weakness. Numerous reportable irregularities and audit failures have also resulted.
Recognition
Recognition of financial statement elements should be tested against the requirements of the financial reporting framework, for example:
- In all cases, revenue recognition should be evaluated for compliance with recognition criteria in the standard.
- Recognition of intangible assets which have been internally generated should be evaluated, taking into account the definitions of research and development costs, respectively.
- It should be verified that impairment responsibilities of management were carried out in terms of the standard and the accounting policy.
Failure to comply should result in a management report item, and determination of the effect on risk of material misstatement.
Measurement
The measurement of financial statement elements should be verified for appropriateness, in terms of the financial reporting framework.
- For assets and liabilities, it is important to address measurement at initial recognition and subsequent measurement.
- Auditors should be particularly careful when encountering estimates. Classes, balances, and disclosures subject to estimates by management should be verified, in compliance with ISA 540. Using the LEAF template ensures that considerations are complete.
- PPE, and intangible asset useful lives and residual values are subject to management estimates, and should be evaluated every year to ensure that the valuation assertion is being satisfied, i.e. that the patterns of obtaining the economic value from the entity’s assets are represented. Comparing useful lives and residual values to industry norms or SARS tables is not in compliance with the standard.
Disclosure
When testing disclosures, in terms of the financial reporting framework, considerations should include verification of:
- Compliance of the accounting policies with the financial reporting framework
- Whether all the required disclosures have been made
- Classification of items, e.g. cost of sales vs. expenses and inventory/PPE
Management responsibility
The verification of compliance with the financial reporting framework further includes an evaluation of whether management fulfilled their responsibilities, including:
• Management’s assessment of going concern
• Management’s assessment of impairment
• Management’s estimates
• Management’s use of experts
Professional skepticism/fraud risk
Management’s incorrect or inappropriate recognition, measurement and disclosures may go undetected, if the auditor does not understand the requirements of the financial reporting framework and, in addition, does not verify this thoroughly, in line with the requirements and the accounting policy.
Auditors who apply adequate levels of professional scepticism around areas of judgment can appropriately challenge management’s estimates and assumptions, as well as properly identify and document their assessment of the risk of material misstatement at the financial statement and assertion levels.
Auditors that exercise appropriate levels of professional competence and due care when performing audits are more likely to ensure that sufficient audit evidence has been gathered to support their audit opinion. A thorough understanding of the business and the motivations of management goes a long way in assessing overall risk of fraud and specific areas subject to fraud risk. This, in conjunction with areas of high estimation risk, results in significant risks where sufficient procedures must be performed on systems and substantive procedures.
In Summary
LEAF stands ready to support you with any difficulties during fieldwork or planning. Make sure the methodology and templates of the firm support these requirements.
References
1. IRBA: Public Inspections Report, 2019
2. IAASB: ISA 315 (Revised 2019), Identifying and Assessing the Risks of Material Misstatement
3. IAASB: ISA 240, The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements
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