(a) Quality control, ethical and other issues
The first comment made by the audit assistant shows that the audit of the provision in relation to the legal claim has not been properly carried out, and it would seem that there is not sufficient, appropriate audit evidence to conclude that provisions are fairly stated. First, the finance director telling the audit assistant not to approach the company’s legal advisers would appear to be placing a limitation on the evidence which can be obtained. Also, the finance director could have used his seniority to intimidate the audit assistant.
The situation indicates that the finance director may be trying to hide something, and professional scepticism should be exercised. Possibly the finance director knows that the amount which should be provided is much larger than the $10,000, and he is reluctant to recognise a larger liability in the financial statements or that the legal advisers are aware of other provisions which should be included with the financial statements which are currently not being recognised. As the key risk for provisions is understatement, the audit team should not so readily accept the finance director’s assessment that the amount included is complete. The audit team should challenge his statement regarding the adequacy of the provision and ask for written evidence, for example, confirmation from the legal advisers.
It is also concerning that the audit manager told the audit assistant to conclude on the audit work when the planned procedures had not been performed. This does not provide good direction to the audit team and increases audit risk. There could be a material misstatement if the provision is significantly understated, and there is not sufficient evidence on the audit file to currently support the conclusions drawn.
Regarding the second comment made by the audit assistant, it is a requirement of ISA 520 Analytical Procedures that analytical procedures are performed at the overall review stage of the audit. An objective of ISA 520 is that the auditor should design and perform analytical procedures near the end of the audit which assist the auditor when forming their opinion as to whether the financial statements are consistent with the auditor’s understanding of the entity.
It is unlikely that the audit senior’s ‘quick look’ at Bradley Co’s financial statements is adequate to meet the requirements of ISA 520 and audit documentation would seem to be inadequate. Therefore if the audit manager, or another auditor, does not perform a detailed analytical review on Bradley Co’s financial statements as part of the completion of the audit, there is a breach of ISA 520. Failing to perform the final analytical review could mean that further errors are not found, and the auditor will not be able to check that the presentation of the financial statements conforms to the requirements of the applicable financial reporting framework. It is also doubtful whether a full check on the presentation and disclosure in the financial statements has been made. The firm should evidence this through the use of a disclosure checklist.
The lack of final analytical review increases audit risk. Because Bradley Co is a new audit client, it is particularly important that the analytical review is performed as detection risk is higher than for longer-standing audit engagements where the auditor has developed a cumulative knowledge of the audit client.
The fact that the audit manager suggested that a detailed review was not necessary shows a lack of knowledge and understanding of ISA requirements. An audit client being assessed as low risk does not negate the need for analytical review to be performed, which the audit manager should know. Alternatively, the audit manager may have known that analytical review should have been performed, but regardless of this still instructed the audit assistant not to perform the review, maybe due to time pressure. The audit manager should be asked about the reason for his instruction and given further training if necessary.
The manager is not providing proper direction and supervision of the audit assistant, which goes against the principles of ISA 220 Quality Control for an Audit of Financial Statements, and ISQC1 Quality Control for Firms that Perform Audits and Reviews of Financial Statements and other Assurance and Related Services Engagements. Both of these discuss the importance of the audit team having proper direction and supervision as part of ensuring a good quality of audit engagement performance.
The final issue relates to the chairman’s statement. ISA 720 The Auditor’s Responsibilities Relating to Other Information requires that the auditor shall read the other information to identify material inconsistencies, if any, with the audited financial statements.
The audit manager has discussed the chairman’s statement but this does not necessarily mean that the manager has read it for the purpose of identifying potential misstatements, and it might not have been read at all. Even if the manager has read the chairman’s statement, there may not be any audit documentation to show that this has been done or the conclusion of the work. The manager needs to be asked exactly what work has been done, and what documentation exists. As the work performed does not comply with the ISA 720 requirements, then the necessary procedures must be performed before the auditor’s report is issued. This is especially important as the necessary paragraphs will need to be included within the auditor’s report setting out that the other information has been obtained, the responsibility that the auditor has for the other information explained and whether anything needs to be reported in relation to any inconsistencies.
Again, the situation could indicate the audit manager’s lack of knowledge of ISA requirements, or that a short-cut is being taken, probably as a result of time pressure. In either case, the quality of the audit is in jeopardy.

(b) (i) Evaluation of uncorrected misstatements
During the completion stage of the audit, the effect of uncorrected misstatements must be evaluated by the auditor, as required by ISA 450 Evaluation of Misstatements Identified during the Audit. In the event that management refuses to correct some or all of the misstatements communicated by the auditor, ISA 450 requires that the auditor shall obtain an understanding of management’s reasons for not making the corrections and shall take that understanding into account when evaluating whether the financial statements as a whole are free from material misstatement. Therefore a discussion with management is essential in helping the auditor to form an audit opinion.
ISA 450 also requires that the auditor shall communicate with those charged with governance about uncorrected misstatements and the effect that they, individually or in aggregate, may have on the opinion in the auditor’s report.
Each of the matters included in the schedule of uncorrected misstatements will be discussed below and the impact on the auditor’s report considered individually and in aggregate.
Share-based payment scheme
The adjustment in relation to the share-based payment scheme is material individually to profit, representing 12% of revenue. It represents less than 1% of total assets and is not material to the statement of financial position.
IFRS® 2 Share-based Payment requires an expense and a corresponding entry to equity to be recognised over the vesting period of a share-based payment scheme, with the amount recognised based on the fair value of equity instruments granted. Management’s argument that no expense should be recognised because the options are unlikely to be exercised is not correct. IFRS 2 would classify the fall in Bradley Co’s share price as a market condition, and these are not relevant to determining whether an expense is recognised or the amount of it.
Therefore management should be requested to make the necessary adjustment to recognise the expense and entry to equity of $300,000. If this is not recognised, the financial statements will contain a material misstatement, with consequences for the auditor’s opinion.
Restructuring provision
The adjustment in relation to the provision is material to profit, representing 2% of revenue. It represents less than 1% of total assets so is not material to the statement of financial position.
The provision appears to have been recognised too early. IAS 37 Provisions, Contingent Liabilities and Contingent Assets requires that for a restructuring provision to be recognised, there must be a present obligation as a result of a past event, and that is only when a detailed formal plan is in place and the entity has started to implement the plan, or announced its main features to those affected. A board decision is insufficient to create a present obligation as a result of a past event. The provision should be recognised in May 20X5 when the announcement to employees was made.
Management should be asked to explain why they have included the provision in the financial statements, for example, there may have been an earlier announcement before 30 April 20X5 of which the auditor is unaware.
In the absence of any such further information, management should be informed that the accounting treatment of the provision is a material misstatement, which if it remains unadjusted will have implications for the auditor’s opinion.
Inventory provision
The additional slow-moving inventory allowance which the auditor considers necessary is not material on an individual basis to either profit or to the statement of profit or loss or the statement of financial position, as it represents only 0·4% of revenue and less than 1% of total assets.
Despite the amount being immaterial, it should not be disregarded, as the auditor should consider the aggregate effect of misstatements on the financial statements. ISA 450 does state that the auditor need not accumulate balances which are ‘clearly trivial’, by which it means that the accumulation of such amounts clearly would not have a material effect on the financial statements. However, at 0·4% of revenue the additional provision is not trivial, so should be discussed with management.
This misstatement is a judgemental misstatement as it arises from the judgements of management concerning an accounting estimate over which the auditor has reached a different conclusion. This is not a breach of financial reporting standards, but a difference in how management and the auditor have estimated an uncertain amount. Management should be asked to confirm the basis on which their estimate was made, and whether they have any reason why the provision should not be increased by the amount recommended by the auditor.
If this amount remains unadjusted by management, it will not on an individual basis impact the auditor’s report.
(ii) Impact on auditor’s report
When considering their opinion, the auditor must conclude whether the financial statements as a whole are free from material misstatement. In order to do this, they must consider whether any remaining uncorrected misstatements are material, either on an individual basis or in aggregate.
Aggregate materiality position
In aggregate, the misstatements have a net effect of $260,000 ($310,000 – $50,000), meaning that if left unadjusted, profit will be overstated by $260,000 and the statement of financial position overstated by the same amount. This is material to profit, at 10·4% of revenue, but is not material to the statement of financial position at less than 1% of total assets.
Impact on auditor’s report
The misstatements in relation to the share-based payment scheme and restructuring provision are individually material to the statement of profit or loss and therefore management should be requested to make this adjustment as the statement of profit or loss is materially misstated if the adjustments are not made by management. According to ISA 705 Modifications to the Opinion in the Independent Auditor’s Report, the auditor shall modify the opinion in the auditor’s report when the auditor concludes that, based on the audit evidence obtained, the financial statements as a whole are not free from material misstatement.
The type of modification depends on the significance of the material misstatement. In this case, these misstatements in aggregate are material to the financial statements, but are unlikely to be considered pervasive even though they relate to a number of balances in the financial statements as they do not represent a substantial proportion of the financial statements. This is supported by the fact that the adjustment is not material to the statement of financial position and it is therefore unlikely that the auditor will conclude that the financial statements as a whole are misleading.
Therefore a qualified opinion should be expressed, with the auditor stating in the opinion that except for the effects of the matters described in the basis for qualified opinion paragraph, the financial statements show a true and fair view. The basis for qualified opinion paragraph should be placed immediately after the opinion paragraph, and should contain a description of the matters giving rise to the qualification This should include a description and quantification of the financial effects of the misstatement.
The remaining uncorrected misstatement in relation to the inventory allowance is, individually, immaterial to the financial statements and although management should be encouraged to amend all misstatements, failure to amend the inventory allowance will have no impact on the auditor’s report. It should be emphasised to management that failure to correct the allowance will have an impact on future periods. If management intends to leave uncorrected misstatements, written confirmation of their immaterial nature should be obtained via a written representation.