The Review Engagement That Wanted to Be an Audit
You are a partner in a small practice. A new client, Marlow & Finch Pty Ltd, is a private company with revenue of $6 million and a bank loan of $2.5 million. The bank has told the directors it requires 'assurance' on the financial report before it will extend the loan. The directors have asked you to perform a 'limited audit' - they want the bank to receive a report that looks like an audit report but at review-level fees. They have provided a draft financial report, a trial balance, and a schedule of fixed assets. They have not prepared a cash flow statement, and the fixed asset schedule has no supporting depreciation calculations. The company's accountant left three months ago and has not been replaced. The directors have offered to provide a management representation letter confirming the financial report is accurate 'in all material respects'. The bank's credit officer has told the directors verbally that a review report will be acceptable.
1. Determine what engagement you can accept, and explain how you would respond to the directors' request for a 'limited audit'.
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You cannot accept a 'limited audit' - no such engagement exists.
There are two relevant engagement types here:
- A review under ASRE 2410 / ASA 2400-style review standards - limited assurance, primarily inquiry and analytical procedures, with a conclusion expressed in the negative form ('nothing has come to our attention...').
- An audit under ASAs - reasonable assurance, with an opinion expressed in the positive form.
A report that 'looks like an audit' but is based on review procedures would be misleading to the bank and would breach the fundamental principle of professional behaviour and integrity. The bank is relying on the form of the report; giving it audit appearance without audit work is exactly the harm the standards exist to prevent.
What to do.
- Clarify the bank's actual requirement in writing. The credit officer's verbal comment is not sufficient. Obtain written confirmation of what the bank will accept. If the bank requires an audit, the engagement is an audit and must be priced and resourced as one.
- Explain the difference to the directors in plain terms - the level of assurance, the procedures performed, the form of conclusion, and the fact that a review will not satisfy a requirement for an audit.
- Assess whether you can perform either engagement. The absence of a qualified accountant, the missing cash flow statement and the unsupported fixed asset schedule are significant. Under ASRE 2410 you would still need the financial report to be prepared in accordance with the applicable framework. A missing cash flow statement is a departure from the framework, and a review conclusion may need to be modified.
- Do not accept the representation letter as a substitute for evidence. A management representation confirming the financial report is 'accurate in all material respects' is not audit or review evidence for the specific balances - it is a fallback, not a procedure. Under ASA 580, representations cannot replace other evidence that should be available.
- Consider client acceptance. A company with no accountant, incomplete records and directors seeking a lower level of assurance than the bank requires is a higher-risk client. Document your assessment under ASA 220 and consider whether the engagement should be declined.
2. Assume the bank confirms in writing that a review is acceptable and you accept the engagement. Identify the procedures you would perform, the problems the financial report presents, and the form of your conclusion.
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Procedures for a review.
A review provides limited assurance through primarily inquiry and analytical procedures:
- Inquiry of management about the accounting records, significant transactions, related parties, subsequent events and any departures from the framework.
- Analytical procedures - compare current and prior period figures, compute ratios (gross margin, receivable days, inventory turnover, interest cover) and investigate unusual movements. For a company with a $2.5 million loan, interest cover and debt covenants are key.
- Obtain the financial report and agree it to the trial balance.
- Review the fixed asset schedule and obtain the depreciation calculations. If they do not exist, ask management to prepare them - you cannot perform a review on a schedule with no depreciation support.
- Obtain the missing cash flow statement. Its absence is a departure from the financial reporting framework.
- Obtain a management representation letter covering the financial report, completeness of information, related parties and subsequent events - but do not treat it as a substitute for the procedures above.
- Consider subsequent events up to the date of the review conclusion.
Problems the financial report presents.
- Missing cash flow statement. A complete financial report under AASB 101 requires one. If management will not prepare it, the financial report is not in accordance with the framework and your conclusion must be modified.
- Unsupported fixed assets. Without depreciation calculations, you cannot conclude on the carrying amount. This is a scope limitation.
- No accountant. The internal record-keeping is weak, which increases the risk that the trial balance itself is unreliable.
Form of conclusion.
A review conclusion is expressed in the negative form: 'Based on our review, which is not an audit, nothing has come to our attention that causes us to believe the financial report does not present fairly...'. If the cash flow statement is missing or the fixed assets cannot be supported, the conclusion must be modified - a qualified conclusion, or an adverse conclusion or disclaimer depending on pervasiveness.
Communication. Report to the directors and, if appropriate, to the bank, that the financial report has deficiencies. Do not let the bank's acceptance of a review be read as acceptance of an incomplete financial report.