Archive for October, 2009

All change (again) on Auditing Standards

Monday, October 26th, 2009

Just this month (October 2009) the Auditing Practices Board issued a whole new set of ISA’s. This was as a result of the IAASB (the international board) issuing their revised ISA’s following their clarification project. These new standards apply for periods beginning on or after 10 December 2010.

What does this mean for your standards? Well, firstly they’ve all been ‘clarified’. That means each standard:

  • has an overall objective clearly stated
  • has separate Requirements & Application sections
  • has the required work prefaced by the word ‘shall’ rather than ‘should’
  • has had other ambiguities in the language taken away

Our UK versions of these standards are slightly different in that they:

  • have extra requirements to bring the standards in line with UK legal requirements included in a grey shaded box
  • do not adopt ISA 700 on Audit Reporting. We have kept our own version but we can still state that our audits have been done in line with the full ISA’s as the requirements of our standard are so similar

The key changes are that 2 new standards have been added and twelve existing standards have been changed, three of these existing standards have had significant changes, according to the APB’s own Staff Paper on the changes.

New Standards

1. ISA 265: communicating deficiencies in internal control to those charged with governance & management

Basically if there’s a control that’s no good in stopping misstatements or if there isn’t a control in place at all then let those responsible for governance know. Also let those responsible for management know. It sounds simple enough but as always there are lots of words to plough through before you come around to the conclusion that you’d probably do that anyway!

2. ISA 450: evaluation of misstatements identified during the audit

It’s both individual and cumulative errors that can be material. No change there then. Interestingly though the standard tells us that we should reassess the materiality level at the end of the audit as our judgement of the figure may have changed.

We should also state a de minimis limit below which we would think any error would be ‘trivial’ and therefore not worth considering even in our cumulative list of individual errors. This limit should be documented.

We should also document all other misstatements regardless of whether they are corrected or not.

This standard links in with the revised standard 320 on Materilaity

Revised Standards with a significant changes

1. 540:Fair Values & Estimates

The idea behind this one is to provide guidance on how to audit areas where management may have been creative with their estimates, including fair value estimates. The changes were driven by the problems of management bias in providing estimates that may have been beneficial to them personally or to their company.

The standard focuses on the auditor using professional scepticism when reviewing these estimates, including looking back at historical estimates and how they have actually turned out in reality.

2. 550: related Parties

The background to these changes is that recent financial scandals have often involved related parties being engaged in inappropriate transactions with companies. The emphasis is on the auditor taking a nmore rigorous approach to identifying both the parties and the types of transactions they are involved in, paying particular care to those transactions outside the entity’s normal business.

3. 600: Group issues

This one looks at the difficulties involved in auditing a group of companies, in particular when you don’t audit all of the subsidiaries. The group auditor will need to consider how involved he can be or needs to be with the auditors of components. He also needs to think about the existence of group-wide controls that may reduce the need to rely on the work of component auditors.

 

All in all there’s a lot to read through, but you can focus your initial reading on the above five areas and then eventually get in to the other nine amended standards and before you know it it will be Christmas 201o. Happy reading…

 

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We all depreciate

Monday, October 26th, 2009

You may have an idea what the word ‘depreciate’ means. It’s used to describe the fall in value of something and it’s that fall in value that we focus on when we use the word. So, for example, if you buy a car you may talk about how much it has ‘depreciated’ over the past 6 months. In other words your focus is on how much value it’s lost in that period.

In preparing financial statements we use the same idea and we focus on the spreading of that fall in value over the time that we use the asset. We allocate the fall in value to each period that we are preparing accounts for and we show that fall as a cost of running the business in that period. This cost is shown in our Profit & Loss Account (or Income & Expenditure Account in the public sector)

Fixed Assets

We depreciate ‘fixed assets’. Fixed assets are those things that we buy with the intention of keeping for the long term, say for example a computer for one of our managers. Some examples of items that are and aren’t fixed assets are as follows:

1. Cash: not a fixed asset as we hold this to spend, not to keep

2. A debtor (a customer who owes us money): not a fixed asset as we are owed this money by a customer and our intention is to receive the money from them as soon as possible.

3. A van: a fixed asset as we own this to use it in our business making deliveries.

4. A building: a fixed asset as we own this to run our business from.

5. A piece of stock (goods for resale): not a fixed asset as our intention is to sell the goods.

So we will depreciate items 3. & 4. in our accounts.

Example

Let’s say we bought a van for £12,000 and we expected it to last 3 years. We expect that it will be worth nothing when we have finished using it at the end of year 3. We have made these estimates based on the fact that we have used a number of similar vans in the past that lasted us 3 years and were worth nothing when we’d finished with them.

We would therefore depreciate the van £4,000 each year (12,000/3). In each year’s Profit & Loss (Income & Expenditure) we would see a charge of £4,000. The same amount each year. If we were preparing monthly accounts, we would see £333.33 (4,000/12) in each month’s accounts.

What?

For the non accountant it may seem strange that we charge the same depreciation each year. ‘Surely it depreciates more in the first year?’ says the non accountant. And if by that we mean ‘Surely it loses more market value in the first year’ then the comment is spot on. But, and here’s the difference in the way we as accountants use the word, we’re not trying to measure how much its market value has fallen. Remember that a fixed asset is something we have to keep and use in our business. Its market value is therefore not relevant to us.

What is more relevant to the accountant is that the business will be able to use the van for as many deliveries in the first year of owning it as they will be able to in the second year and the third year. Therefore the cost of the depreciation needs to be evenly spread across all 3 years. It’s true that the servicing and maintenance may be higher in years two and three, but those additional costs will also be added in to our Profit & Loss Account (Income & Expenditure) in addition to the depreciation.

The normal way of charging depreciation to the Profit & Loss Account (Income & Expenditure) is to spread the depreciation evenly over the period of ownership. This is called ’straight line depreciation’. There are other methods that can be used where the business benefits more from the asset in some periods compared to others, but these are rarely used in practice.

Summary

So there it is, the process of depreciation spreads the cost of a fixed asset through the Profit & Loss Account (Income & Expenditure) evenly over the period that the organisation uses the asset. If you are using management accounts and you are responsible for fixed assets you will see a monthly charge for depreciation of these assets.  

The accountant is more concerned with allocating the cost of the van (or any fixed asset) to the periods over which it is used.

Final points to watch for

Some practical points that may be helpful:

1. Even if you have fixed assets in the department you manage, the depreciation charge may not appear in your management accounts. This will often be the case if you don’t have responsibility for buying fixed assets.

2. Not all fixed assets are depreciated. Investments can be classified as fixed assets and they will not be depreciated. Also, land is never depreciated.

3. You may sometimes hear the term ‘amortisation’ being used. This is like depreciation for ‘intangible fixed assets’. This is a fixed asset that you can’t touch.

An example of this would be where you had bought the legal right to make commemorative mugs for the 2012 Olympics. Let’s say the right to make the mugs lasted from 2010 to 2012 (3 years) and the British Olympic Association had sold you the right to use their logo on your mugs for £300,000. This legal right will benefit our business for 3 years and at the end of this period will be worth nothing. Therefore we should spread the cost of this over 3 years. We could spread it evenly over the three years and charge £100,000 to each of the three years. The legal right is called an intangible fixed asset and the cost of £100,000 charged each year is called amortisation.

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