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Comments from ACCA
March 2008

Executive Summary

ACCA welcomes the opportunity to comment on the proposed International Standard on Auditing ISA 501 (Redrafted) Audit Evidence Regarding Specific Financial Statement Account Balances and Disclosures (proposed ISA 501), issued for comment by the International Auditing and Assurance Standards Board (IAASB) of the International Federation of Accountants.

We recognise that, without revision, it is a difficult task to redraft proposed ISA 501in accordance with the Clarity drafting conventions.

We support the removal of a section dealing with auditing the valuation and disclosure of long-term investments but suggest that more could have been eliminated, or transferred to other ISAs, to recognise that financial reporting and auditing have changed since extant ISA 501 was issued.

We conclude that the redrafting has not achieved its aims because it results in potential confusion over the applicability of proposed ISA 501. We suggest, as a consequence, possible amendments to: the document that governs the application of ISAs, the structure of ISAs in relation to the matters dealt with in proposed ISA 501, and the wording of objectives and requirements.

General Comments

ISA s relevant to the audit

Proposed ISA 501 is unusual because it has sections dealing with unconnected aspects of an audit. This circumstance should be recognised in the Preface to the International Standards on Quality Control, Auditing, Review, Other Assurance and Related Services (the Preface).

Paragraph 13 of the Preface ( Approved December 2006 – effective as of December 15, 2009) provides that: ‘The auditor applies each ISA relevant to the audit. An ISA is relevant when the ISA is in effect and the circumstances addressed by the ISA exist.'

As currently drafted, some sections are not subject to any restriction on scope and proposed ISA 501 is always applicable, therefore, in its entirety. This could have unintended consequences, as auditors might be criticised for failure to comply with an applicable ISA.

We provide further information on this in the section of our response headed Scope and objective that follows immediately.

If the Preface is not amended, we suggest an alternative solution to this problem in the section of our response headed Removal of the requirement and guidance on auditing the valuation and disclosure of long-term investments.

Scope and objective

Extant ISA 501 is a collection of sections of standards and guidance additional to that contained in extant ISA 500 Audit Evidence with respect to certain specific financial statement account balances and other disclosures. The first requirement of each section of extant ISA 501 begins with a condition precedent concerning the materiality of the matter. Although that is not repeated explicitly in subsequent requirements, it remains implicit throughout. We do not believe that the Clarity redrafting has properly recognised this. In the section of our response headed ISAs relevant to the audit we examine the problem of the unintended applicability of proposed ISA 501. In this section we provide further support for that analysis and set out our concerns and recommendations on the scope of proposed ISA 501, which depends on its objectives, requirements and treatments of risks of material misstatement.

In proposed ISA 501, materiality (in effect, whether each section of the ISA is relevant) is not dealt with in the scope and objectives but appears inconsistently in the requirements:

• Inventory – puts materiality (not the risk of material misstatement) as a condition precedent only in the first (and last) requirements
• Litigation and claims – the section contains several requirements that always apply and a requirement that has a materiality condition precedent that is incorrectly coupled with wording that removes the condition. The effect is to require communication with legal counsel in all circumstances, even where litigation and claims are highly unlikely to have a material effect on the financial statements
• Segmental information – incorrectly omits any mention of materiality

While the intention may have been to extend materiality considerations throughout, this has not been achieved. The Clarity redrafting has resulted in extensive revision of extant ISA 501. The Clarity drafting conventions do not allow auditors to interpret requirements, nor do we believe that auditors should be expected to do so. We strongly suggest that for those sections where it is appropriate, the scope, objective and detail of proposed ISA 501 should be amended to reinstate a precondition that applicability depends on there being an assessed risk of material misstatement.

Because proposed ISA 501 has not been formally revised, it remains an uncomfortable mix of requirements relating to identifying and assessing risks and responding to such assessments. This is most evident in the section on litigation and claims, which is least suited to the use of a precondition that applicability depends on there being an assessed risk of material misstatement.

A solution to this would be to adopt the same approach as the IAASB proposed in the Exposure Draft of ISA 505 (Revised and Redrafted) External ConfirmationsI , whereby it applies only when the auditor determines that such procedures are an appropriate response to an assessed risk of material misstatement. To achieve this, we suggest that the requirements relating to risk assessment of litigation and claims (in paragraphs 9 and 10) be transferred from proposed ISA 501.

Removal of the requirement and guidance on auditing the valuation and disclosure of long-term investments

We agree with the change in scope of proposed ISA 501, whereby it no longer deals with auditing the valuation and disclosure of long-term investments.

We suggest that proposed ISA 501 could have done more to recognise that financial reporting has changed since extant ISA 501 was issued. The section dealing with segment information now gives undue prominence to this analysis and could be eliminated with almost no impact on audit quality.

In the section of our response headed ISAs relevant to the audit we set out concerns about the applicability of proposed ISA 501. If the Preface is not amended, the problem we identify could be addressed by a combination of deleting sections, transferring material to Application and Other Explanatory Material (A&OEM) sections of other ISAs, or splitting proposed ISA 501 so that it does not include sections that are unconnected.

Changes made to Enhance the Clarity of Proposed ISA 501

Objectives

For the reasons set elsewhere in this response, under the heading Scope and objectives , the objectives of proposed ISA 501 are not appropriate.

In addition to those general comments, we are concerned that objective 3(a) refers to ‘condition of inventory' . The scope paragraph refers to ‘ certain assertions and related considerations' [emphasis added] but without further explanation, we are unsure if this is intended to refer to the use in an objective of a term that is not normally treated as an assertion itself. We would expect ‘condition' to be related to the valuation assertion as it may indicate the age of inventory and the need for provision against cost. We suggest either that the objective need not refer to ‘condition' or that the A&OEM section be used to explain the word's use.

Requirements

For the reasons set elsewhere in this response under the heading Scope and objectives , many of the requirements of proposed ISA 501 are not appropriate.

Because of the overall nature of our suggestions elsewhere in this response, we do not offer further detailed criticism of each individual requirement. The following selected points are made respectively to emphasise an aspect of our general arguments and to highlight one of the common problems we have identified in earlier Clarity responses concerning the precision of drafting.

Paragraph 5

In paragraph 5, the condition precedent for the requirement to ‘perform audit procedures to obtain audit evidence about whether changes in inventory between the count date and the date of the financial statements are properly recorded' is only that ‘the entity's physical inventory count is conducted at a date other than the date of the financial statements'.

This should be rewritten to introduce a materiality test. The wording should also refer to circumstances where none of the count (or counts) are conducted as at the date of the financial statements.

Paragraph 11

The wording about alternative audit procedures in paragraph 11(b) is presumably intended to apply to 11(a) as well as 11(b), so as to give effect to the intention of the wording of paragraph 37 of extant ISA 501.

We do not believe that users will always place this interpretation on the paragraph and, to avoid ambiguity, we suggest that all of the condition precedent be placed at the beginning of the paragraph. Alternatively, the words ‘and the auditor is unable to obtain sufficient appropriate audit evidence by applying alternative audit procedures' could be added to 11(a).

Other Matters

The Explanatory Memorandum forming part of the Exposure Draft invites comments on the following other matters:

• Special considerations in the audit of small entities
• Special considerations in the audit of public sector entities
• Developing nations
• Translation (see below)
• Undue costs

Our response contains comments that are relevant to the above except we have not made a distinction between developing nations and others, as the audit of small entities may be present in both. We have no separate comments on public sector aspects of the proposed standard.

Translation

We are aware of some confusion over the use of the words ‘inquiry' and ‘enquiry' . In ISAs ‘inquiry' is used consistently. We see no reason to change that in proposed ISA 501.

In paragraph 10, unidentified litigation or claims are not restricted by any test of risk.

In our February 2008 response to proposed ISA 505 we supported this approach.

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