This article provides some insight into the matters that need to be considered by auditors when engaged to provide the external audit service to a client operating in a specialised industry. In the Advanced Audit and Assurance (AAA) exam, question scenarios may be based on audit clients operating in a specialised industry, so candidates need to be aware of the matters which auditors need to consider, especially when planning the audit.
What is a specialised industry?
Perhaps it is easiest to start by explaining that a specialised industry is not necessarily rare or even unusual. Examples of specialised industries include:
- banking and insurance
- agriculture, and
- oil extraction
What makes these industries specialised is that they are likely either to have specific financial reporting standards applicable to them, or to have distinct accounting policies which have been developed to account for specialised transactions and balances which are based on the normally-applied financial reporting standards. For instance, IAS® 41, Agriculture is clearly relevant specifically to the agriculture sector and IFRS®, 7 Financial Instruments: Disclosure will need specific application by companies operating in the banking sector. Some specialised industries will required specific application of accounting standards, for example, valuation of extracted oil in line with IAS 2 Inventories, or the valuation of apple trees (an example of bearer plants) under IAS 16 Property, Plant and Equipment.
Prior to accepting an audit engagement involving a specialist industry, there are a number of relevant auditing standards which the audit firm needs to pay close attention.
- IESBA International Code of Ethics for Professional Accountants (the Code) requires, amongst any acceptance of a new client being in line with ethical principles, that the auditor should have an appropriate understanding of the nature and complexity of the client’s business, as well as knowledge of relevant industrial regulatory or reporting requirements. 1
- ISA 220 (Revised) Quality Management for an Audit of Financial Statements requires the auditor to assess whether there are sufficient and appropriate resources to perform the engagement and that there is the ‘appropriate competence and capabilities’. 2
Larger audit firms are likely to meet the competence requirement for almost any type of industry – they will either already possess necessary skill and competence through having existing clients in the particular industry, or have the resource available to bring in experts and/or provide any necessary staff training. Smaller firms may have to carefully consider their competence to take on an audit client in a specialised industry if they have not previously worked with an audit client in the same industry. However, regardless of size, audit firms may choose to specialise themselves in the audit of clients in a particular market or sector, for example a smaller firm may specialise in the audit of clients in the farming sector, or in not-for-profit organisations, so it should not be assumed that just because an audit firm is small, it would not meet the competence requirement.
The audit firm should also ensure that there is adequate documentation to demonstrate that competence has been considered, and the steps that have been taken to improve competence where necessary, for example through appropriate staff training.
Identification of the risk of material misstatement in a specialised industry should be approached in the same was as in any other audit – by obtaining appropriate understanding of the business and its environment. Assuming that staff have the necessary competence, as discussed above, this should not be problematical.
To assist audit team members assigned to a specialised industry client, the audit firm is likely to have additional resources available. There may be briefing notes or internal technical guidance on how financial reporting standards should be applied within the sector. For example, in the audit of banking sector clients, an audit firm may produce guidance on the specific application of IFRS® Standards relating to the range of financial instruments typically held by banks. Audit staff can then refer to this guidance when performing the audit, particularly when identifying risks of material misstatement.
It is also important to remember that while there may be specific risks of material misstatement relating to the industry-specific balances and transactions, there must also be appropriate consideration of the “normal” balances and transactions. For instance, in the audit of a bank, there will be plenty of risks to consider other than those relating to bank-specific transactions and balances, for example the depreciation of properties, recognition of provisions and impairment of goodwill would all still be relevant. These 'normal' types of risk must not be forgotten, just because the client operates in a specialised industry.
Reliance on experts
Linked to the previous matters, competence, audit planning and the specialised nature of some transactions and balances, the auditor may plan to use an auditor’s expert to obtain audit evidence. This is quite likely in a specialised industry as despite being competent to perform the engagement, the audit firm may not have the necessary specific expertise in some areas. For instance, in the audit of a bank, specialists may be brought into value complex financial instruments or actuaries to review a defined benefit pension scheme.
In this situation, the audit firm must adhere to the requirements and principles of ISA 620, Using the Work of an Auditor’s Expert which deals with matters including the evaluation of the objectivity, competence and capabilities of the auditor’s expert, determining and communicating the scope and objectives of their work, and assessing their findings. It is particularly important that the auditor evaluates the relevance and adequacy of the expert’s findings or conclusions. There is a danger of over-reliance on the expert’s work; the fact that the audit is of a specialised nature does not mean that the auditor can pass all responsibility over to an expert. For instance, the auditor must consider whether the expert’s findings are consistent with the auditor’s understanding of the client and with the conclusions of other audit procedures. Any inconsistencies must be investigated.
Many students find exam questions which feature more ‘unusual’ or specialised industries with concern. However, the scenario will provide adequate information to be able to answer the requirements. Consider whether there are any specialised or unusual rules (such as those stated earlier in this article) which may affect the planning stage or affect the audit evidence which is provided. For example, agricultural products or specialised machinery or inventories may require the use of an expert to assess their value. Reviewing the large assets of a mining company to assess whether they exist or whether the ships of a maritime business are floating or in dry dock awaiting repair. Students should apply their basic auditing knowledge to the specific scenario, so even if you have never audited a chemical company, the same rules regarding the valuation of inventories will apply. Remember, apply the knowledge to the specific scenario as no credit is given for listing generic audit processes without reference to the scenario.
The audit of a client in a specialised industry can pose some challenges to the audit firm. However, with proper consideration of competence, and by providing staff with additional support and guidance, these audits should not necessarily be more complex or challenging to plan and perform. Using experts can provide high quality audit evidence in specialist situations, but the auditor must be careful to fully evaluate the findings of the auditor’s expert and not to over-rely on their work. For audit staff, working on this type of engagement can be very rewarding, providing exposure to sometimes unusual businesses.
Written by a member of the Advanced Audit and Assurance examining team
(1). IESBA International Code of Ethics for Professional Accountants, para.320.3 A4
(2). ISA 220 (Revised) Quality Management for an Audit of Financial Statements, para.26