John Selwood's Question corner

What should my audit firm be doing, practically, to prepare for the changes applying in ISA 315?

ISA (UK) 315 (Revised) Identifying and Assessing the Risks of Material Misstatement is effective for periods beginning on or after 15 December 2021. In most cases this means that the changes will apply to December 2022 year ends but, as always, do not forget about short accounting periods or the possibility of early adoption.

In other words, its application is imminent!

From the wording of your question, I assume that you have a good understanding of the revised ISA but are looking for some real-world advice. For readers who may not be so far up the learning curve, a brief overview of key changes follows.

There are:

• five new inherent risk factors (subjectivity, complexity, uncertainty, change and susceptibility to misstatement due to management bias or fraud);
• a new concept of ‘spectrum of risk’, which is the degree to which inherent risk varies;
• a requirement for the auditor to obtain sufficient and appropriate audit evidence from risk assessment procedures;
• significantly more requirements on IT, including general IT controls;
• requiring inherent risk and control risk to be assessed separately; and
• a new ‘stand-back’ provision.

In my view, for what it’s worth, the changes that need most focus are:

• how to document the inherent risk assessment using the inherent risk factors; and
• how to determine the right scope for the work on general IT controls.

These changes are going to have a very significant impact on your audit methodology, standard working papers and audit software.

I would expect audit firms that develop their own methodologies to have completed their update by now. However, in my experience 99% of audit firms outsource this and use the resources produced by networks or service providers. The most practical things that these firms could do is:

• scrutinise and understand all of the changes to audit methodologies, working papers and software;
• understand and perhaps decide themselves, if necessary, how these tools can be best used in practice to ensure good compliance with ISAs and an efficient audit approach; and
•  train staff how to use the revised standard working papers and audit software in a consistent way across the firm.

There are additional challenges facing auditors, arising from the revisions to the products provided by service providers. I understand that some publishers and training groups have taken the opportunity to make other changes to their products, beyond those necessary for revised ISAs (of course ISA 240, the fraud standard, has also been revised). Some of the changes I have seen are of more of a housekeeping nature, to tidy and improve parts of the product, or to take into account other upcoming revisions, such as those to ISA 220 on quality management, which applies 12 months later than the changes to ISAs 315 and 240.

Audit firms will have to focus very carefully on implementing these significantly amended audit tools if damaging cost overruns are to be avoided on the first few audits.

Another issue is timing. At the time of writing, some updated working paper packs have been sent to firms. However, it seems clear that it might take a while before all major audit software providers will be ready to roll out their updated products. This means that the window could be very small for firms to prepare properly, train audit teams and be ready to deal with these changes both effectively and efficiently.

As the firm’s audit compliance partner, I’m feeling guilty that I haven’t done anything yet to prepare for the changes in the new ISQMs and I’m getting very anxious about this. Where should I start?

I’ll start by addressing your anxiety. Try to stay calm and remember those wise words on the rear cover of The Hitchhiker’s Guide to the Galaxy: “Don’t panic!”

Unless you are the audit compliance partner (ACP) for one of the UK’s largest audit firms, you still have enough time. I assume that you aren’t auditing listed entities or public interest entities, which would broaden the scope of the changes that you need to prepare for.

First, you need to be prepared to commit some time and resource to your preparations for the new International Standards on Quality Management (ISQMs). This is not something you will be able to polish off on a rainy Tuesday afternoon.

Here are some suggestions to get you started:

• read ISQM 1 and also take a look at the first-time implementation guide from the International Auditing and Assurance Standards Board;
• familiarise yourself with the resources on ICAEW’s ‘Quality management in audit firms hub’;
• watch the three very useful webinars (co-presented by me) that the faculty has produced (these are paid for content); and
• consider obtaining a tool to assist you with the process and documentation of setting quality objectives, risk identification and assessment, developing appropriate responses and ultimately designing your firm’s System of Quality Management. There are a number of good products in the marketplace. You should choose the one that looks right for you.

My suggestions here will not get you to your final destination of developing and documenting everything you need, but they are a good way to start your journey.

The revised ISA 540 has increased my focus on accounting estimates, but I am not always certain what is and is not an accounting estimate. How can I spot accounting estimates and not miss the ones that are most commonly overlooked during audits?

It’s helpful to remind yourself of the definition of an accounting estimate in the International Standard on Auditing (ISA) 540 (Revised) Auditing Accounting Estimates and Related Disclosures.

ISA 540 defines an accounting estimate as: “A monetary amount for which the measurement, in accordance with the requirements of the applicable financial reporting framework, is subject to estimation uncertainty”, where estimation uncertainty is defined as “susceptibility to an inherent lack of precision in measurement”.

It is possible to confuse an accounting estimate and accounting policy, as differentiating between them is not always simple.

Accounting policies are often prescribed by the financial reporting framework or by law or regulation. Regardless of whether they are prescribed or elective, accounting policies represent the measurement bases to be used in reporting matters in the financial statements.

Accounting estimates are the methods chosen to determine the monetary amount of the application of the chosen accounting policies.

You’ll find some helpful examples to illustrate the differences if you visit the faculty’s resource hub for ‘Auditing Accounting Estimates’.

Although it has become increasingly common to see accounting estimates in financial statements, some of these may be easily overlooked by auditors when determining an entity’s population of accounting estimates.

Examples to watch out for include:

• depreciation of tangible fixed assets;
• allowance for doubtful accounts;
• accrued expenses;
• stock obsolescence provision;
• litigation provisions;
• uncertain tax provisions; and
• recoverability of deferred tax assets.

In some industries and economic situations, less common accounting estimates may be relevant, so you may also need to be on the lookout for:

• warranty provisions;
• expected credit loss provisions;
• revenue recognised from long-term contracts;
• impairment of intangible fixed assets or goodwill;
• property held at valuation;
• financial instruments; and
• valuation of pension assets/liabilities.

Another reason why some accounting estimates may not be on your radar and may therefore be overlooked is because they are the result of changes to accounting standards. New accounting standards may introduce a need for new accounting estimates and auditors need to be mindful of this. One example is the International Financial Reporting Standard (IFRS) 9 Financial Instruments, which requires that credit losses on financial assets are measured and recognised using the ‘expected credit loss’ approach.

If you are looking for more insights, practical tips and support to assist with your audit of accounting estimates, you’ll find them through the faculty’s ISA 540 resource hub.