The nature, timing and extent of the audit procedures appropriate to achieve reasonable assurance on the directors’ statement under Item 21.4 or 21.5 of Annexure 1, are a function of the circumstances of each engagement, and will depend on:
- whether the auditor is a new or continuing auditor;
- the proximity of the most recent audited financial report;
- the extent and nature of changes in the entity’s activities and/or industry/industries in which it operates since the issue of the most recent audited financial report; and
- the nature, timing and extent of the audit procedures conducted since the issue of the most recent audited financial report.
Continuity in Auditor
For the continuing auditor where an audited financial report has recently been issued under the Act which includes the directors’ opinion on solvency as part of the directors’ declaration, the audit process may be limited to a consideration of any changes in the entity’s circumstances from the date of the audited financial report. This may involve the auditor:
- enquiring of management/directors as to the basis on which they have formed their opinion on solvency under Item 21.1 of Annexure 1, and evaluating the appropriateness of any new assumptions underlying their opinion;
- updating knowledge of the entity’s business and industry, to evaluate whether there have been any significant changes to the appropriateness of significant assumptions underlying the previous solvency opinion. Particular emphasis may need to be given to any changes in expectations concerning cash flow, trading conditions, financial commitments, financing arrangements etc;
- enquiring as to any changes to the entity’s internal control structure in relation to cash flow and management of debt; and
- applying appropriate analytical review procedures, for example comparing the latest management accounts with budgets and cash flow forecasts.
In the absence of evidence contrary to the representations made by the directors in their Item 21.1 of Annexure 1 statement, and for the auditor to report under Item 21.4 or 21.5 of Annexure 1, ASA 700 states that the auditor shall form an unmodified opinion.
Significant changes in fundamental assumptions and/or conditions, for example changes in the nature of the entity’s business, plans for significant acquisitions and disposals may require application of more extensive audit procedures. Some examples of audit procedures the auditor may consider are provided in paragraph 23(c) of this guidance statement.
Initial Engagement – New Auditor
For an auditor undertaking an initial audit engagement, and/or a situation where there has been a significant time lag since the issue of the latest audited financial report, and less extensive audit procedures applied in relation to forming an audit opinion on the financial report in the current financial period, the nature, timing and extent of the audit procedures may need to be more extensive. This may involve the auditor placing further emphasis on certain areas of the audit, but is not limited to, the following:
- understanding the entity and its environment and assessing the risks of material misstatement under ASA 315 .
- consideration of procedures to obtain information for use in identifying the risks of material misstatement due to fraud under ASA 240 The Auditor’s Responsibilities Relating to Fraud in and Audit of a Financial Report- Appendix 2.
- obtaining sufficient appropriate audit evidence under ASA 500 to support the directors’ statement:
- enquiring of management as to the basis on which they have formed their opinion on solvency and evaluating the appropriateness of the assumptions on which this is based;
- reviewing procedures and controls over cash flows, trading conditions, financial commitments etc that may affect cash flow e.g. collection of debtor days and budgetary forecasts and the ability of the entity to pay its debts as and when they fall due;
- appropriateness of management’s use of the going concern assumption in the preparation of the directors’ statement under ASA 570; and
- obtaining written representations under ASA 580 Written Representations from management based on the assertions made throughout the engagement.
- consideration of subsequent events under ASA 560 that may have the potential to affect the directors’ statement.
In any of the situations described above where the audit procedures create doubt as to the directors’ representations concerning solvency, additional audit procedures may need to be undertaken to enable an opinion to be expressed.
Refer to ASA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment for further guidance on areas the auditor needs to consider when undertaking the audit.