ACCT 1304 · The Audit Function

Led by Dorothy Edith Rigour Simulacrum

1. Module 4 ○ Open

   The Audit Function

   Led by Dorothy Edith Rigour Simulacrum

   The question

   External audit as the institution that bridges the gap between the preparer (with every incentive to present favourably) and the user (who cannot directly verify). The module covers audit as opinion on truth-and-fairness rather than certification of accuracy, the risk-based approach, materiality (planning vs reporting), the three audit-evidence approaches (controls testing, substantive analytical, tests of detail), the four audit opinions (unqualified, qualified, adverse, disclaimer), the modern extended audit report with Key Audit Matters, the audit-committee relationship, FRC Ethical Standard requirements on independence, the expectation gap between what users think audit does and what it does, and the historical failures (Enron and Andersen, Carillion and KPMG, Patisserie Valerie and Grant Thornton, BHS and PwC) and the resulting Brydon, Kingman, and CMA reforms. The closing exercise reads an audit report.

   Outcome

   The student can describe the risk-based audit approach, identify the four audit opinions and what each means, read an extended auditor's report and extract the Key Audit Matters and materiality disclosure, articulate the auditor-independence requirements, and recognise the expectation gap. (Audit function)

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   Practice scenarios

   Reading the Audit Report

   Rigour Simulacrum gives you the auditor's report from a UK-listed mid-cap company. The opinion is unqualified, but the report runs to nine pages and contains four Key Audit Matters: (1) revenue recognition on long-term contracts, (2) goodwill impairment of the largest acquisition, (3) deferred tax recoverability, and (4) the going-concern conclusion in light of significant covenant headroom pressure. Your job is to interpret what the auditor is signalling.

   Your goals

   • Recognise that an unqualified opinion does *not* mean the auditor was untroubled. The KAMs identify the areas where the auditor's judgement was most heavily exercised — and by implication, where the user should look most closely.
   • Interpret KAM 1 (revenue recognition on long-term contracts): IFRS 15 over-time vs point-in-time judgements; this often involves significant management estimation; the auditor has signalled they devoted considerable work to it. Read the disclosure in the notes for the specific judgements made.
   • Interpret KAM 2 (goodwill impairment): the impairment test depends on cash-flow forecasts and discount rates; small changes in assumptions can produce large changes in the answer. The auditor has signalled this is sensitive. Read the sensitivity disclosures in the notes.
   • Interpret KAM 3 (deferred tax recoverability): the firm has deferred tax assets whose recovery depends on future profits. If forecasts are aggressive, the asset may be impaired. The auditor has signalled scrutiny here.
   • Interpret KAM 4 (going concern): this is the most consequential. Significant covenant headroom pressure means the firm is close to its banking limits. The auditor has concluded going concern is appropriate but flagged it as material. The user should read the going-concern paragraph in the directors' report and the viability statement carefully.
   • Recommend further reading: the relevant notes, the sensitivity analyses, the principal-risks section in the strategic report, and the questions to ask at the AGM.

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