Opening balances

ISA 510 Initial Engagements – Opening Balances requires that when auditors take on a new client, they must ensure that:

  • opening balances do not contain material misstatements;
  • prior period closing balances have been correctly brought forward or, where appropriate, restated; and
  • appropriate accounting policies have been consistently applied, or changes adequately disclosed.


  • Were the previous financial statements audited?
  • If the previous financial statements were audited, was the opinion modified?
  • If the previous opinion was modified, has the matter been resolved since then?
  • Were any adjustments made as a result of the audit? If so, has the client adjusted their accounting ledgers as well as the financial statements?

If auditors are unable to satisfy themselves with regard to the preceding period, they will have to consider modifying the current audit report.

Audit procedures

Where the prior period was audited by another auditor or unaudited, the auditors will need to perform additional work in order to satisfy themselves regarding the opening position. Such work would include:

  • consulting the client's management
  • reviewing records and accounting and control procedures in the preceding period
  • consulting with the previous auditor and reviewing (with their permission) their working papers and relevant management letters
  • substantive testing of any opening balances where the above procedures are unsatisfactory.

Some evidence of the opening position will also usually be gained from the audit work performed in the current period.


ISA 710 Comparative Information – Corresponding Figures and Comparative Financial Statements requires that comparative figures comply with the identified financial reporting framework and that they are free from material misstatement.

The IASB's Framework for the Preparation and Presentation of Financial Statements and IAS 1 Presentation of Financial Statements both require that financial statements show comparatives.

Two categories of comparatives exist:

  • corresponding figures where preceding period figures are included as an integral part of the current period financial statements; and
  • comparative financial statements where preceding period amounts are included for comparison with the current period.

Corresponding figures

Audit procedures in respect of corresponding figures should be significantly less than for the current period and are limited to ensuring that corresponding figures have been correctly reported and appropriately classified. This involves evaluating whether:

  • accounting policies are consistently applied; and
  • corresponding figures agree to the prior period financial statements.

Comparative financial statements

Sufficient appropriate evidence should be gathered to ensure that comparative financial statements meet the requirements of an applicable financial reporting framework. This involves evaluating whether:

  • accounting policies are consistently applied; and
  • comparative figures agree to the prior period financial statements.

2 Subsequent events review

ISA 560 Subsequent Events details the responsibilities of the auditors with respect to subsequent events and the procedures they can use. As can be seen above auditors are responsible for performing these procedures right up until the day that they sign the audit report. After this date they can relax a little but whilst they no longer have to perform procedures they must act if they are made aware of any significant subsequent events.

Audit procedures

The nature of procedures performed in a subsequent events review depends on many variables, such as the nature of transactions and events and the availability of data and reports. However the following procedures are typical of a subsequent events review:

  • Enquiring into management's procedures/systems for the identification of subsequent events;
  • Inspection of minutes of members' and directors' meetings;
  • Reviewing accounting records including budgets, forecasts and interim information.
  • Enquiring of directors if they are aware of any subsequent events that require reflection in the year-end account;
  • Obtaining, from management, a letter of representation that all subsequent events have been considered in the preparation of the financial statements;
  • Inspection of correspondence with legal advisors;
  • Enquiring of the progress with regards to reported provisions and contingencies; and
  • 'Normal' post reporting period work performed in order to verify year-end balances:
    • checking after date receipts from receivables;
    • inspecting the cash book for payments/receipts that were not accrued for at the year-end; and
    • checking the sales price of inventories.

If, after the financial statements have been issued, management amends the financial statements, the auditor shall:

  • Provide a new auditor's report on the amended financial statements; and
  • Extend the audit procedures described above to the date of the new auditor's report.

3 Going concern

The going concern concept

According to IAS1 financial statements should be prepared on the basis that the company is a going concern unless it is inappropriate to do so.

Going concern is defined in IAS1 as the assumption that the enterprise will continue in operational existence for the foreseeable future.

  • Any consideration involving the 'foreseeable future' involves making a judgement about future events, which are inherently uncertain.
  • Uncertainty increases with time and judgements can only be made on the basis of information available at any point – subsequent events can overturn that judgement.
  • The period that management (and therefore the auditor) is required to consider is usually defined by financial reporting standards. Generally (but not exclusively) the period is a minimum of twelve months from the year-end, with twelve months from the date the financial statements are published being preferred.
  • There may be circumstances in which it is appropriate to look further ahead. This depends on the nature of the business and their associated risks.

UK Syllabus focus

ISA 570 (UK & Ireland) Going Concern requires management to assess going concern for a period of at least one year from the (expected) date of approval of the financial statements (rather than 12 months from the reporting date).

The going concern concept – significance

Whether or not a company can be classed as a going concern affects how its financial statements are prepared.

  • Financial statements are usually prepared on the basis that the reporting entity is a going concern.
  • IAS1 states that 'an entity should prepare its financial statements on a going concern basis, unless
    • the entity is being liquidated or has ceased trading, or
    • the directors have no realistic alternative but to liquidate the entity or to cease trading.'
  • Where the assumption is made that the company will cease trading, the financial statements are prepared using the break-up basis under which:
    • assets are recorded at likely sale values
    • inventory and receivables are likely to require more provisions, and
    • additional liabilities may arise (severance costs for staff, the costs of closing down facilities, etc.).

Directors and Auditors responsibilities

Both directors and auditors of an entity have responsibilities regarding going concern.


  • It is the directors' responsibility to assess the company's ability to continue as a going concern when they are preparing the financial statements.
  • If they are aware of any material uncertainties which may affect this assessment, then IAS 1 requires them to disclose such uncertainties in the financial statements.
  • When the directors are performing their assessment they should take into account a number of relevant factors such as:
    • current and expected profitability
    • debt repayment
    • sources (and potential sources) of financing.


  • ISA 570 Going Concern states that the auditor needs to consider the appropriateness of management's use of the going concern assumption.
  • The auditors need to assess the risk that the company may not be a going concern.
  • The auditor will also need to obtain sufficient appropriate evidence that the company is a going concern.
  • Where there are going concern issues, the auditor needs to ensure that the directors have made sufficient disclosure of such matters in the notes to the financial statements.

Audit procedures

Indicators of going concern problems

Typical indicators and explanations of going concern problems include the following:

  • Net current liabilities (or net liabilities overall!); indicates an inability to meet debts as they fall due.
  • Borrowing facilities not agreed or close to expiry of current agreement; lack of access to cash may make it difficult for a company to manage its operating cycle.
  • Defaulted loan agreements; loans normally become repayable on default, company may find it difficult to repay loan.
  • Unplanned sales of non-current assets; indicates an inability to generate cash from other means and as non-current assets generate income, will cause a decline in income and therefore profits.
  • Missing tax payments; results in fines and penalties, companies normally prioritise tax payments indicating a lack of working capital.
  • Failure to pay staff; indicates a significant lack of working capital.
  • Negative cash flow; indicates overtrading.
  • Inability to obtain credit from suppliers; suggests failure to pay suppliers on time and working capital problems.
  • Major technology changes; inability or insufficient funds to keep up with changes in technology will result in loss of custom and obsolescence of inventory.
  • Legal claims; successful legal claims may result in significant cash payments that can only be settled with liquidation.
  • Loss of key staff; may result inability to trade.
  • Over-reliance on a small number of products, staff , suppliers or customers; loss may result in inability to trade.


Where there is any significant doubt over the future of a company, the directors should include disclosures in the financial statements explaining:

  • the nature of and circumstances surrounding the doubts; and
  • the possible effect on the company.

Where the directors have been unable to assess going concern in the usual way (e.g. for less than one year beyond the date on which they sign the financial statements), this fact should be disclosed.

Where the financial statements are prepared on a basis other than the going concern basis, the basis used should be disclosed.

Reporting implications

In relation to going concern it is important to understand the following:

  • Financial statements are normally prepared on the going concern basis;
  • Where the going concern basis is used and is appropriate, the auditors do not need to mention the fact in their report;
  • If the auditor believes that the going concern basis used in the financial statements is inappropriate they may have to modify the audit report;
  • If the directors appropriately disclose an uncertainty with regard to going concern the auditor (without modifying their opinion) will refer to this in the audit report in an 'emphasis of matter' paragraph;
  • If the directors prepare the financial statements on another basis (i.e. not going concern) and this is appropriate the auditor will also refer to this in an emphasis of matter paragraph.
  • If the period assessed by management is less than twelve months from the statement of financial position date and management is unwilling to extend the assessment, the auditor may have to modify the audit report, because it may not be possible for the auditor to obtain sufficient appropriate audit evidence regarding the use of the going concern assumption.

4 Written representations

What are written representations?

A written representation is a (written) statement by management provided to the auditor to confirm certain matters or to support other audit evidence (ISA 580 Written Representations). The purpose of obtaining this form of evidence is twofold:

  • to obtain representations that management, and those charged with governance, have fulfilled their responsibility for the preparation of the financial statements, including;
    • preparing the financial statements in accordance with an applicable financial reporting framework;
    • providing the auditor with all relevant information and access to records;
    • recording all transactions and reflecting them in the financial statements.
  • to support other audit evidence relevant to the financial statements if determined necessary by the auditor or required by ISA's.

The latter point may be relevant where the auditor deems that other, more reliable forms of evidence are not available to them. Examples include:

  • plans or intentions that may affect the carrying value of assets or liabilities;
  • confirmation of values where there is a significant degree of estimation or judgement involved, e.g. provisions and contingent liabilities;
  • formal confirmation of the directors' judgement on contentious issues, e.g. the value of assets where there is a risk of impairment; and
  • aspects of laws and regulations that may affect the financial statements, including compliance.

How are written representations obtained?

As the audit progresses, the audit team will assemble a list of those items about which it is appropriate to seek management representations. During completion the auditors will write to the client confirming the issues about which they are seeking representations. The client must formally document, and sign, a response and send it to the auditor.

The representations themselves may take any of the following forms.

  • A letter from the client to the auditors responding to the necessary points. (It is common for the auditor to draft the letter for the client, who simply reproduces it on their own letter-headed paper, approves it and signs it).
  • A letter from the auditors to management setting out the necessary points, which management signs in acknowledgement and returns to the auditors.
  • Minutes of a meeting where representations were made orally, which can be signed by management.

The quality and reliability of written representations

Unfortunately, written representations are internal sources of evidence, and are therefore subject to bias, and tend to focus on contentious areas of the financial statements. They are therefore potentially unreliable forms of audit evidence. They do not, on their own, constitute appropriate evidence.

ISA 580 also clearly states that written representations should only be sought to support other audit evidence. They do not, on their own, constitute sufficient evidence.

It is clear that the quality of written representations is somewhat dubious. However, there are instances where no other, better quality forms of evidence are available to the auditor, particularly where disclosures in the financial statements are restricted to matters of management judgement. Before they can be used the auditor must consider their reliability in terms of:

  • inconsistencies with other forms of evidence; and
  • concerns about the competence, integrity, ethical values or diligence of management;

With inconsistency the auditor will be required to reconsider their initial risk assessment and, perhaps, perform further procedures. If the latter is true (about competence, integrity etc) then the audit must consider whether the engagement can be conducted effectively. If they conclude that it cannot then they should withdraw, where permitted by laws and regulations. If they are not permitted to withdraw they should consider the impact on the audit report. It is likely that this would lead to them disclaiming their opinion.

The last point is also relevant if management refuses to provide written representations.

Additional matters requiring written representation

In addition to the matters identified in the passages above, the following issues may also be documented in a written representation:

  • directors have assessed the risk of fraud and consider it to be low;
  • directors are not aware of any actual, or suspected, instances of fraud;
  • all related parties have been identified and transactions with them disclosed in the financial statements;
  • directors consider the aggregate of all uncorrected misstatements to be immaterial;
  • the directors have considered all subsequent events in preparing the financial statements; and
  • the directors have considered all possible events, matters and contingencies in performing their going concern review.

Overall review of evidence

What is the purpose of a final review?

It is the responsibility of the engagement partner to perform a review of audit documentation (including a discussion with the engagement team) in order to satisfy themselves that sufficient appropriate evidence has been obtained to support any conclusions reached and, ultimately, the audit opinion. Considerations include, for example:

  • has work been performed in accordance with professional standards?
  • have the significant risks identified during planning been addressed?
  • are there any critical areas of judgement relating to difficult or contentious matters?
  • are there any significant matters for further consideration?
  • have appropriate consultations taken place or are more needed?
  • have the objectives of the engagement procedures been achieved?
  • does the work documented support the conclusions made?
  • is there a need to revise the nature, timing and extent of procedures?
  • is the evidence sufficient to support an opinion?

Reviews are also significant for a firm's appraisal system and development of staff. Additionally they are an important element of any monitoring system, implemented to identify and rectify deficiencies in a firm's practices that could lead to poor quality work.

Appropriate review procedures are an integral part of an audit and are a requirement of ISA 220 Quality Control for an Audit of Financial Statements.

Evaluation of misstatements

In accordance with ISA 450 Evaluation of Misstatements Identified During the Audit all misstatements should be communicated to management on a timely basis, unless they are clearly trivial. Management should be asked to correct all misstatements identified during the audit. Auditors should try and obtain an understanding of management's reasons for refusing to adjust any of the misstatements. The auditor should determine whether uncorrected misstatements are material in aggregate or individually, and if material should consider the potential impact on their audit report.

Prior to evaluating the significance of uncorrected misstatements the auditor should reassess materiality to confirm whether it remains appropriate to the financial statements. Then the auditor must assess whether uncorrected misstatements are, individually or in aggregate, material. To do this they should consider the size and nature of the misstatements, both in relation to the financial statements as a whole and to particular classes of transaction, account balances and disclosures.

Finally, the auditor should obtain a written representation from management and those charged with governance that they believe the effect of the uncorrected misstatements is immaterial, individually and in aggregate.

Once these procedures have been completed the auditor should then consider the impact of uncorrected misstatements on their reporting. The impact on the audit report is considered in the next chapter. Other reports are considered below.

Other reports

ISA 260 Communication with Those Charged with Governance requires the auditor to make additional communications to managers, directors and those charged with governance at the conclusion of the audit of matters significant to the oversight of the financial reporting process.

One of the matters requiring communication is 'significant findings from the audit.' The existence of errors may indicate that a client's accounting practices or policies contravene financial reporting requirements or that the internal control systems are deficient. Either way these matters should be communicated to the client.

Test your understanding 1: FIXED TEST 3 - Smithson

Smithson Co provides scientific services to a wide range of clients. Typical assignments range from testing food for illegal additives to providing forensic analysis on items used to commit crimes to assist law enforcement officers.

The annual audit is nearly complete. As audit senior you have reported to the engagement partner that Smithson is having some financial difficulties. Income has fallen due to the adverse effect of two high-profile court cases, where Smithson's services to assist the prosecution were found to be in error. Not only did this provide adverse publicity for Smithson, but a number of clients withdrew their contracts. A senior employee then left Smithson, stating lack of investment in new analysis machines was increasing the risk of incorrect information being provided by the company.

A cash flow forecast prepared internally shows Smithson requiring significant additional cash within the next 12 months to maintain even the current level of services.


(a)Define 'going concern' and discuss the auditor's and directors responsibilities in respect of going concern.

(5 marks)

(b)State the audit procedures that may be carried out to try to determine whether or not Smithson Co is a going concern.

(10 marks)

(c)Explain the audit procedures the auditor may take where the auditor has decided that Smithson Co is unlikely to be a going concern.

(5 marks)

Test your understanding 2

ISA 570 Going Concern provides guidance to auditors in respect of ensuring that an entity can continue as a going concern.


Explain the actions that an auditor should carry out to try and ascertain whether an entity is a going concern.
Real exam question: December 2007

(5 marks)

Test your understanding 3

(a)In accordance with IAS 10, Events after the Reporting Period, define:

(i)'events after the reporting period'

(ii) 'adjusting event'

(iii)'non-adjusting event'

(3 marks)

The date is 3 September 2008. The audit of Brand Co is nearly complete and the financial statements and the audit report are due to be signed next week. However, the following additional information on two material events has just been presented to the auditor. The company's year end was 30 June 2008.

Event 1 – Occurred on 6 July 2008

The filaments in a new type of light bulb have been found to be defective making the light bulb unsafe for use. There have been no sales of this light bulb; it was due to be marketed in the next few weeks. The company's insurers estimate that inventory to the value of $600,000 has been affected. The insurers also estimate that the light bulbs are now only worth $125,000. No claim can be made against the supplier of filaments as this company is in liquidation with no prospect of any amounts being paid to third parties. The insurers will not pay Brand for the fall in value of the inventory as the company was underinsured. All of this inventory was in the finished goods store at the end of the year and no movements of inventory have been recorded post year-end.

Event 2 – Occurred 3 August 2008

Production at the Bask factory was halted for one day when an oil truck reversed into a metal pylon, puncturing the vehicle allowing oil to spread across the factory premises and into a local reservoir. The Environmental Agency is currently considering whether the release of oil was in breach of environmental legislation. The company's insurers have not yet commented on the event.


(b)For each of the two events above:

(i)Explain whether the events are adjusting or non-adjusting according to IAS 10 Events After the Reporting Period.

(4 marks)

(ii) Explain the auditors' responsibility and the audit procedures and actions that should be carried out according to ISA 560 (Redrafted) Subsequent Events.

(9 marks)

(c)Assume that the date is now 15 September 2008, the financial statements and the audit report have just been signed, and the annual general meeting is to take place on 10 October 2009. The Environmental Agency has issued a report stating that Brand Co is in breach of environmental legislation and a fine of $800,000 will now be levied on the company. The amount is material to the financial statements.


Explain the additional audit work the auditor should carry out in respect of this fine.

(4 marks)

(Total: 20 marks)

Test your understanding 4

ISA 580 Written Representations provides guidance on the use of management representations as audit evidence.


(a)List SIX items that could be included in a management representation letter.

Real exam question: June 2008

(3 marks)

(b)List THREE reasons why auditors obtain written representations.

(3 marks)

5 Chapter summary

Test your understanding answers

Test your understanding 1: FIXED TEST 3 - Smithson

THIS IS A FIXED TEST – Please answer the question in full (long form written). Then log on to EN-gage at the following address: Follow the link to 'Fixed Test 3' and answer the questions based on your homework answer.

Once you have answered the questions on EN-gage a model answer will be available for your reference.

Test your understanding 2

Audit work: going concern

  • Review management's plans for future actions based on its going concern assessment.
  • Gather additional sufficient and appropriate audit evidence to confirm or dispel whether or not a material uncertainty exists regarding the going concern concept.
  • Seek written representations from management regarding its plans for future action.
  • Obtain information from company bankers regarding continuance of loan facilities.
  • Review receivables ageing analysis to determine whether there is an increase in days, which may also indicate cashflow problems.

Test your understanding 3


(i)Event after the reporting period: An event, which could be favourable or unfavourable, that occurs between the end of the reporting period and the date that the financial statements are authorised for issue.

(ii) Adjusting event: An event after the reporting period that provides further evidence of conditions that existed at the end of the reporting period, including an event that indicates that the going concern assumption in relation to the whole or part of the enterprise is not appropriate.

(iii)Non-adjusting event: An event after the reporting period that is indicative of a condition that arose after the end of the reporting period.

(b)Event 1

Audit procedures will include:

Event 2

(b)The notification of a fine has taken place after the audit report has been signed.

Audit procedures will include:

Test your understanding 4

Created at 5/24/2012 2:38 PM  by System Account  (GMT) Greenwich Mean Time : Dublin, Edinburgh, Lisbon, London
Last modified at 10/4/2012 11:46 AM  by System Account  (GMT) Greenwich Mean Time : Dublin, Edinburgh, Lisbon, London

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