The Auditor and the Books - Part 2
Maintaining Accounting Records and Financial Statement
Preparation
The Companies Act in Section 90 only prohibits
the engagement partner from the maintenance of any of the company's financial
records. There is no specific provision that the engagement partner may not
prepare the financial statements. However as Regulation 25 of the Companies
Regulations state that accounting records includes any document that would
facilitate the preparation of financial statements it can be concluded that by
maintaining the accounting records to a degree that would require no more (or
every few) adjustments to comply financial reporting standards the financial
statements would be considered to be included in the definition of accounting
records. An auditor cannot create records or systems and
then audit them with independence. Providing an audit client with accounting
and bookkeeping services, such as preparing accounting records or financial
statements, creates a self-review threat when the firm subsequently audits the
financial statements. The audit process, however, necessitates dialogue between
the firm and management of the audit client, which may involve: the application
of accounting standards or policies and financial statement disclosure
requirements, the appropriateness of financial and accounting control and the
methods used in determining the stated amounts of assets and liabilities, or
proposing adjusting journal entries. These activities are considered to be a
normal part of the audit process and do not, generally, create threats to
independence.
An underlying principle is that maintenance of
the records is a management function for which management must be responsible,
even though a client may ask the auditor for assistance. As a practical matter,
this principle can limit the extent to which an auditor can provide bookkeeping
services without applying appropriate safeguards. This principle that should be
applied are: An auditor should not:
- Prepares or change a journal entry, determine or change an account code
or a classification for a transaction or prepare or change another accounting
record without obtaining the approval of management of the entity and
- Prepares a source document or originating data, or makes a change to
such a document or data.
The degree of self-review threat arising from
the preparation of, or changes to, journal entries is also influenced by the
complexity of the entries. If the entries are complex, in addition to obtaining
the approval of management, it may be necessary for the auditor to consult with
another professional accountant for a second opinion. As noted, auditors cannot
prepare, or make changes to, source documents or originating data. There is
nothing in the independence rules to prevent an auditor from providing typing
services, such as, for example, typing cheques for signature by the client. The
distinction is that it is the client's signature on the cheque and not its
initial preparation that makes the cheque an official document.
A similar analysis can be applied to the
question of the auditor providing bookkeeping services. If an auditor takes
source documents that originate from other sources independent of the auditor,
such as suppliers, customers or the client itself, and simply records those
documents in the books, this does not pose an independence problem. Therefore,
an auditor can provide basic bookkeeping services as long as management takes
full responsibility for the accounting records being audited and, if any
threats to independence do arise, they are reduced to an acceptable level.
How can this position be reconciled with the
rule that an auditor who prepares adjusting journal entries must have the
client approve the entries as an indication of management's taking
responsibility for them? The difference is that, in the case of the journal
entries, the auditor often derives or calculates the content of the entry
rather than simply recording the entry in the accounting records. For example,
the auditor might prepare an entry for amortization and actually calculate the
amount. In this case, it is important to make sure the client agrees with, and
takes responsibility for, the entry by, for example, the auditor obtaining the
client's signature to denote approval.
In summary, audit firms must exercise judgment in
assessing their independence when offering services involving bookkeeping and
preparation of journal entries. Such services can create a self-review threat
that requires adequate safeguards for protecting independence. Where a
self-review threat is considered serious, the auditor and or the client should
consider hiring a contract bookkeeper or establishing a clear separation
between the audit personnel and bookkeeping personnel.
The new independence rules do not prohibit
providing advice on accounting policies and issues, the treatment of particular
financial statement items or the wording of notes to the financial statements.
The auditors of entities that are not reporting issuers may also prepare the
financial statements and draft notes to the financial statements. The basic
principle remains, however, that an entity's management must make the
decisions.
Because financial statements are the
representations of management, and management has to accept responsibility for
them, an auditor must be satisfied that small entity management has sufficient
understanding of the financial statements and underlying entries to be able to
accept this responsibility. This can be accomplished by reviewing the financial
statements with management and discussing the management representation letter
with them. The engagement letter also can be a useful vehicle for reminding
small entity management of their responsibility for the financial statements.
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