Using internal auditors and experts

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Using internal auditors and experts

MODULE 3 | 3.6.2 | STUDENT COMPANION

An external auditor can draw on three kinds of help: the entity's internal audit function, an auditor's

expert and information from management's expert. Each needs a different evaluation before it counts as

evidence, and none of them reduces the auditor's sole responsibility for the opinion. In Australia, internal

auditors can't give direct assistance on the external audit.

Three kinds of help, side by side

Internal audit function

ASA 610

Auditor's expert

ASA 620

Management's expert

ASA 500

Who they are

Part of the entity: evaluates the

effectiveness of its governance, risk

management and internal control

Skilled in a field outside accounting and

auditing, such as engineering,

valuation, actuarial science or IT; inside

the audit firm or engaged from outside

Works for the entity, helping

management prepare the financial

statements, such as a valuer of

property

What the auditor

evaluates

Objectivity, competence and a

systematic, disciplined approach

Competence, capabilities and

objectivity; agreed terms of the work;

whether the work is adequate

Competence, capabilities and

objectivity; the work; whether it is

appropriate evidence

At Voltana Two experienced staff, reporting to the

chief financial officer

The external engineer who reviewed

battery failure rates

The property valuer the board engaged

to assess the factory rent

In every case, the auditor keeps sole responsibility for the opinion

Internal audit

Internal audit's work can only be considered if it is relevant to the external audit. The auditor then evaluates the

function as a whole: its organisational status and policies (do they support objectivity?), its competence, and

whether it applies a systematic and disciplined approach, including quality control. If any of the three is

inadequate, none of its work can be used.

ADVANCED AUDIT AND ASSURANCE | M3 | 3.6.2 | STUDENT COMPANION

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Can internal audit's work be used?

1. Objectivity

Status and policies: who it

reports to, no conflicting

duties, free to raise

concerns

Yes

No

2. Competence

Qualifications, experience,

training and resources

Yes

No

3. Systematic

approach

A disciplined method,

including quality control

Yes

No

All three adequate

The auditor may use some of the

function's work

Any one inadequate

None of the function's work can be used

Then use less of it where:

More judgement is involved

The assessed risk is higher, especially

for significant risks

Objectivity or competence is weaker

And reperform some of what is used

Voltana

Competence and approach adequate, but objectivity limited: it reports to the CFO. Linden

Ridge uses the depot stock counts, after reperforming a sample, but not the warranty work, a

significant risk.

Australia

Internal auditors can't give direct

assistance on the external audit

Using the work. The auditor discusses the planned use with internal audit, reads its reports, and performs

procedures on the specific work it uses, including reperforming some of it. Direct assistance, where internal

auditors work under the external auditor's direction on the external audit itself, is allowed by the international

standard but not by the Australian one.

Voltana in one line: the reporting line to the CFO, whose conduct is now in question, limits objectivity, so

Linden Ridge uses only lower-risk work it can check, and recommends that internal audit report directly to the

audit committee in future.

Using an auditor's expert

1. Need?

Decide whether expertise

is needed for sufficient

appropriate evidence

2. Evaluate the

expert

Competence, capabilities

and objectivity, including

any links to the client

3. Understand the

field

Enough to set the work

and evaluate it

4. Agree the terms

In writing where

appropriate: purpose,

scope and objectives;

roles; reporting;

confidentiality

5. Evaluate the work

Findings, assumptions

and methods, and the

source data

At Voltana

An external engineer

reviews battery failure

rates

No connection to Voltana;

experience with this

battery chemistry

Enough grasp of failure

testing to set and question

the work

The work agreed in an

engagement letter

Failure data tested against

Voltana's warranty claims

records

Work not adequate?

Agree further work with the expert, or perform other procedures. If sufficient appropriate

evidence still can't be obtained, consider the effect on the opinion.

An expert inside the firm

Covered by the firm's quality management, but still

evaluated for the task, like Linden Ridge's own IT

specialist

ADVANCED AUDIT AND ASSURANCE | M3 | 3.6.2 | STUDENT COMPANION

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Evaluating an expert's work

Look at Questions to ask

Findings Are they relevant and reasonable, and consistent with the other evidence?

Assumptions and

methods

Are they appropriate for this purpose, and how sensitive is the answer to them?

Source data Is the data the expert used relevant, complete and accurate? At Voltana, the failure data

is tested against the warranty claims records

Management's expert

When information prepared by management's expert is used as audit evidence, the auditor evaluates the

expert's competence, capabilities and objectivity, understands the work, and judges whether it is appropriate

evidence for the assertion concerned. For Voltana's factory lease, the team checks the valuer's qualifications

and independence from the chief executive, reads the valuation's assumptions, and compares its market rent

with rents for similar industrial buildings nearby. Management's expert works for management, so scepticism

needs to be at least as sharp as for any other management information.

The report. An unmodified auditor's report doesn't mention an expert unless the law requires it. A reference is

allowed only where it helps explain a modified opinion, and then the report makes clear that it doesn't reduce the

auditor's responsibility.

ADVANCED AUDIT AND ASSURANCE | M3 | 3.6.2 | STUDENT COMPANION

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Practice questions

MODULE 3 | 3.6.2 | TRY THESE BEFORE THE WORKED ANSWERS

Question 1 - Can Fretwell's internal audit be used?

Fretwell Music Ltd (imagined) sells instruments, sheet music and lessons through 64 stores. Its external auditor

would like to use internal audit's store visits, which include stock counts and checks on cash handling.

Reporting line: the head of internal audit reports to the audit committee, which approves the annual plan and

her appointment and pay; day-to-day administration runs through the CFO. Staff: the head is a chartered

accountant with 14 years' experience; of three auditors, two are part-way through professional qualifications, and

one joined last year from store operations, where he managed the Victorian stores. Methods: a written audit

manual; all working papers reviewed by the head; an external quality assessment two years ago found the

function generally conforms with internal auditing standards; store visits are announced a week ahead. Evaluate

whether, and how, the external auditor can use internal audit's work.

ADVANCED AUDIT AND ASSURANCE | M3 | 3.6.2 | STUDENT COMPANION

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Question 2 - Terms for an auditor's expert

Ellerby Family Investments Pty Ltd (imagined) holds shares, property and a collection of about 40 Australian

paintings, carried at valuation at about $9 million. Its auditor will engage an independent art valuer, as an

auditor's expert, to value the collection at 30 June. Draft the key terms of the agreement with the valuer.

Question 3 - A management's expert

Glenmora Property Ltd (imagined) owns a business park of six industrial buildings, carried at fair value as

investment property at $84 million. Management engaged a valuer from a national firm; the valuation is dated 31

May, and the valuer's firm also manages the leasing of two of the buildings for a fee. How would you evaluate

the valuer and the valuation?

ADVANCED AUDIT AND ASSURANCE | M3 | 3.6.2 | STUDENT COMPANION

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Worked answers

MODULE 3 | 3.6.2 | WORKED ANSWERS - ATTEMPT THE QUESTIONS FIRST

Question 1 - Fretwell Music (suggested)

Gate Evaluation

Objectivity Generally supported: the head reports to the audit committee, which approves the plan and her

appointment and pay (administration through the CFO is common). But the former manager of

the Victorian stores would be reviewing his own past work, so his visits to those stores aren't

used

Competence Adequate: an experienced, qualified head, and developing staff whose work she reviews

Systematic approach Adequate: a manual, review of every file and a recent external quality assessment; but

announcing visits a week ahead weakens the stock counts

Conclusion. Some work can be used, but less where judgement or risk is higher, such as slow-moving stock

or any significant risk. Discuss it with the head, read the reports, and reperform a sample: attend some visits

and recount items.

No direct assistance. In Australia, internal auditors can't perform procedures for the external audit under the

external auditor's direction.

Question 2 - Key terms with the art valuer

Term What it should say

Nature, scope and

objectives

Value each painting at fair value at 30 June; which works are covered; inspect each one;

report any doubts about condition or authenticity

Roles and responsibilities The valuer inspects the works and uses market evidence such as auction results; the audit

team tests management's list of works, purchase records and proof of ownership

Communication and

reporting

Timetable and meetings; a written report giving each value, the method, the sales evidence

used and any works not inspected

Confidentiality Client information, including where the works are kept, stays confidential and secure

In writing An engagement letter suits an external valuer and a material balance. Also agree: no links

to the family or past dealings in these works; a fee not tied to the values; deadlines

Question 3 - Glenmora's valuer

Competence and capabilities. Qualifications and membership (such as a Certified Practising Valuer),

experience with industrial property in that market, and enough resources.

Objectivity. The valuer works for management, and the leasing fees add a self-interest threat. Ask about all

fees, how the valuer was appointed, any links to directors, and any fee tied to the value.

Understand the work. The terms and any limits management set; the method (income capitalisation,

discounted cash flow or sales comparison); key assumptions such as capitalisation rates, market rents and

vacancies; the valuation standards followed.

Evaluate it as evidence. Test the rent roll against signed leases; compare rates and rents with market data

and recent sales; consider changes between 31 May and 30 June; check the amount and the disclosures. If

doubts remain, engage the auditor's own valuation expert.

ADVANCED AUDIT AND ASSURANCE | M3 | 3.6.2 | WORKED ANSWERS

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