What are the auditors responsibility as for communication of audit matters with those charged with governance is concerned?

Link to ISA 260 Original Standard PDF

ISA 260 standard is the property of IAASB and this summary is only for educational purposes. For some sections where summary may not give exact meaning, extracts of the standard are posted here.

ISA 260 definitions

Those charges with governance

ISA 260 defines those charged with governance as the person(s) or organization(s) (for example, a corporate trustee) with responsibility for overseeing the strategic direction of the entity and obligations related to the accountability of the entity. This includes overseeing the financial reporting process. For some entities in some jurisdictions, those charged with governance may include management personnel, for example, executive members of a governance board of a private or public sector entity, or an owner-manager.

ISA 260 Scope

ISA 260 deals with  the auditor’s responsibility to communicate with those charged with governance in an audit of financial statements.

ISA 260 effective date on or after 15 December 2009

ISA 260 Objective

ISA 260 objective are;

• To communicate clearly with those charged with governance the responsibilities of the auditor in relation to the financial statement audit, and an overview of the planned scope and timing of the audit;
• To obtain from those charged with governance information relevant to the audit;
• To provide those charged with governance with timely observations arising from the audit that are significant and relevant to their responsibility to oversee the financial reporting process; and
• To promote effective two-way communication between the auditor and those charged with governance.

ISA 260 Requirements

Those charged with governance

ISA 260 requires auditors to;

• Determine the appropriate person(s) within the entity’s governance structure with whom to communicate.
• In case of communication with sub committee to governing body, for example; audit committee, the auditors shall determine whether the auditor also needs to communicate with the governing body.
• When All of Those Charged with Governance Are Involved in Managing the Entity, then auditor do not need to communicate twice, however auditor shall nonetheless be satisfied that communication with person(s) with management responsibilities adequately informs all of those with whom the auditor would otherwise communicate in their governance capacity

Matters to Be Communicated

ISA 260 require auditor to communicate following;

• The auditor is responsible for expressing opinion and audit does not relive management or those charged with governance of their responsibilities.
• Overview of the planned scope and timing of the audit and significant risks
• Auditor view on significant accounting practices, policies and estimates and their appropriateness.
• Significant difficulty in audit
• Significant matter those discussed with management
• Written representation that auditor is requesting
• Circumstances that affect the form and content of the auditor’s report
• Any other significant matters arising during the audit that, in the auditor’s professional judgment, are relevant to the oversight of the financial reporting process
• Incase of listed companies, communicate that the team, firm and network firms have complied with relevant ethical requirements regarding independence and where there is a risk the related safeguards applied to mitigate that risk. In addition to these fee for audit and non audit services shall be communicated to those charged with governance against relevant categories for them assess the effect of service on independence.

The Communication Process

ISA 260 required auditor to;

• shall communicate with those charged with governance the form, timing and expected general content of communications
• If auditors professional judgement conclude that oral communication with respect to significant risk is not adequate then communicate the same in writing
• Auditor in case of listed entities communicate about the independence as required above.
• Communicate on timely basis
• Audit shall access the adequacy of two way communication with those change with governance and its effect on auditors assessment of risk and ability to gather sufficient appropriate audit evidence

Documentation

Where matters required by this ISA to be communicated are communicated orally, the auditor shall include them in the audit documentation, and when and to whom they were communicated. Where matters have been communicated in writing, the auditor shall retain a copy of the communication as part of the audit documentation

Relevant to ACCA Qualification Paper P7

When considering the reporting ‘outputs’ of an audit of historical financial information, attention is usually focused on the report issued by the auditors to shareholders, which contains the audit opinion. However, there is another important reporting ‘output’ produced as a result of the audit process – the auditor’s communication to those charged with governance. This short article outlines the main features of this communication and summarises the requirements of ISA 260, Communication of Audit Matters With Those Charged With Governance, and the UK equivalent, ISA 260 (UK and Ireland), Communication of Audit Matters With Those Charged With Governance.

Auditors are required by ISA 260 to communicate audit matters of governance interest to those charged with governance. It is important that those charged with governance have an understanding of all significant issues that have arisen from the audit process.

Relevant persons

The first step is to consider to whom the communication should be directed. ISA 260 does not specify this exactly, but states that ‘governance is the term used to describe the role of persons entrusted with the supervision, control and direction of an entity’. This implies that the communication should be with the highest level of management, including the executive and non-executive directors, and the audit committee, where relevant. The identity of the relevant person(s) to whom the communication will be addressed may be clarified in the engagement letter.

Matters to be communicated In the second step, the auditor should consider the type of issues that should be communicated. ISA 260 provides some guidance as to the matters which ordinarily could be incorporated in the communication, including:

• the overall approach and scope of the audit, including any limitations on the scope of the audit
• the accounting policies, and any changes to them, that could materially affect the financial statements
• adjustments arising as a result of audit procedures which could materially impact the financial statements
• material events or uncertainties which could jeopardise the going concern status, and which require disclosure within the financial statements
• disagreements with management over accounting treatments or disclosures
• any expected modifications to the audit report
• material weaknesses discovered in the internal systems and controls.
  

All of the above are referred to as ‘findings from the audit’ (also often called ‘management letter points’).

The reason for communicating such matters is to ensure that the auditors have brought them to the attention of the people responsible for the accounting and financial reporting function of the entity. Those responsible can then discuss the matters and decide any actions that need to be taken in respect of them. For example, if the management of the entity was totally unaware of the matters regarding control weaknesses, it then has the opportunity to implement corrective action. It could also be the case that the management lacks technical knowledge; for example, it may not be appreciated that a specific accounting policy is in breach of acceptable accounting practice. Again, armed with information from the auditor, management can then resolve the problem by deciding on a new accounting policy.

It is important that material errors found in the financial statements are highlighted to management; if they are left uncorrected, the audit opinion will be modified. Management must be made aware of this and given the opportunity to correct the financial statements if necessary, in order to avoid a modified audit report.

Other relevant matters to be communicated The communication to those charged with governance should not just contain findings from the audit, but should cover the range of issues related to the audit, which the auditor may want to raise with management. Such matters may include:

• details of any threats to independence and objectivity, and of any safeguards adopted
• explanations of the audit approach used (for example, the concept of materiality and its application to the audit process)
• a summary of business risks identified, including an assessment of the likelihood of the risks materialising
• a review of the contents of the management’s representation letter
• recommendations, where relevant, to help improve the entity’s internal systems and controls.
  

The timing and form of communication
The auditor should communicate matters to those charged with governance on a timely basis, in order for management to react to the matters raised as soon as possible. Findings from the audit relevant to the accounting and financial reporting function should be communicated before the approval of the financial statements by management. This means that material errors can be corrected by management prior to the audit report being issued, thus avoiding a modification of the report.

ISA 260 discusses the various forms that the communication should take. In most cases, the communication will be in writing, and in the UK and Ireland this is a requirement of the standard. A communication should be issued even if there are no matters that the auditor wishes to bring to the attention of those charged with governance, stating that there are no significant findings from the audit to be communicated.

Outside the UK and Ireland, the communication could be made orally. In this situation, it is important that the auditor has a written record within the audit working papers of the discussion of significant matters with management.

Whichever method is used to formally communicate the matters, oral or written, the process should be seen as a two-way dialogue. Management should have the opportunity to respond to the auditor regarding the matters raised.

Conclusion

The communication with those charged with governance should be viewed as a crucial reporting ‘output’ of the audit. It allows management to be informed of significant matters arising from the audit process, and allows management the chance to respond to the auditor regarding these matters, and to take action to improve the accounting and financial reporting function of the entity.

Written by a member of the Paper P7 examining team