P7 ACCA

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CHAPTER 1
INTERNATIONAL REGULATORY
ENVIRONMENTS FOR AUDIT AND
ASSURANCE SERVICES
International

regulatory frameworks for audit and

assurance services
Audit committees
Internal control effectiveness
Money laundering
Laws and regulations
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EXAM CONTEXT

This chapter is likely to be important in the exam,

particularly money laundering which was covered in the
pilot paper from both a discussion and practical context.
A question requiring a definition of money laundering and
its impact on a specific engagement was included for 5
marks in the December 2007 exam. Question 5 (b)
asked for the benefits of an audit to a small company for
4 marks this would have been a revision of a related
topic covered on F8 Audit & Assurance.
The technical content of this part of the syllabus is
mainly drawn from your earlier studies. Questions in this
paper are unlikely to ask for straight repetition of this
knowledge, but rather to require explanation or
discussion of the reasons behind the regulations.

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The need for laws, regulations,

standards and other guidance

Corporate scandals, such as Enron and Worldcom in the

USA, and Parmalat in Italy have brought the audit
profession under close scrutiny from investors,
businesses, regulators and others.
Businesses have become more complex and global, and
firms of accountants have expanded their range of
services well beyond traditional assurance and tax
advice. This has led to a great deal of re-examination of
regulatory and standard-setting structures both nationally
and internationally in recent years.

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Enron

One of biggest bankruptcy 2001

One of biggest energy groups with revenues over $ 500
bns and 30,000 employees around the world
1990-1999 stock price was rising steadily to $70. In 2000
went to $90. During 2001 declined less than $1.
Arthur Andersen firms income dependent on Enron
consultancy and other services provided (doubts on
independence and objectivity)
Collapse internationally

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Enron

Financial reporting irregularities 1997-2000. A number of

special-purpose entities (owned by the Group) was
created. Big loans on SPVs. The structure of SPVs was
so complex to avoid be consolidated (auditors did not
find out it).
In this way debt levels of Enron were kept low off
balance sheet debt
Earning overstated

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Worldcom

Start as small telephone company expansion program

through acquisitions of other companies enter in
telecommunication sector (internet)
Filed for bankruptcy in July 2002
Accounting irregularities (misclassification of capital
expenditure)
CEO was charged with fraud and making false statement
in connection with accounting irregularities that led to
WorldComs collapse

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Parmalat

Founded in 1962 in Parma Italy

Focus on milk and diary products
In decade to 2003, Parmalat had experienced
remarkable growth with sales from 845 millions
in 1992 to 1,6 billions in 2002

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Parmalat

Calisto Tanzi Chairman and CEO

1990 Son of Calisto Tanzi bought Parma FC substantial
injection of resources allowed Parma to get very strong
team
Daughter of Calisto Tanzi created Parmatour. Substantial
resources were diverted from Parmalat to Parmatour
Calisto Tanzi prestige / bought television station for the
Parmalat Group
Sponsor of Niki Lauda (F1 pilot)

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Parmalat

Complicated organisational structure including 170 subsidiaries

Substantial funds were moved between these subsidiaries some
of which registered in Cayman Islands
For instance, Bonlat , subsidiary registered in Cayman Islands,
was supposed to held 3.95 billions in Bank of America account
in the New York. In Dec 2003, revealed that Bonlat provided
false documentation about the asset to its auditors, Grant
Thornton.
Accused Grant Thornton that involved in setting up of offshore
companies in Caribbean that allowed Tanzi to manipulate funds
and hide groups true financial position.

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International Regulatory framework

The international regulatory framework for
audit
and
assurance
services
encompasses:
Pronouncements by IFAC which is the
worldwide organisation for accounting
profession
Internal controls - implications for auditors

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International standard setting

International Standards on Auditing are produced by the

International Auditing and Assurance Standards Board
(IAASB), a technical standing committee of the
International Federation of Accountants (IFAC).
The mission of IFAC as set out in its constitution: 'The
development and enhancement of an accountancy
profession with harmonised standards able to provide
services of consistently high quality in the public interest'.
Much of pronouncements and principles are embodied in
the law of many jurisdictions.
For example in the UK, auditor must be a member of
recognised supervisory body and audits should be carried
out in accordance with International Standards of Auditing
(ISAs)
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Overview of UK standard setting

Standards of Auditing in the UK are issued

by the UK Auditing Practices Board, part
of the Financial Reporting Council, based
on the international ones with additional
UK-specific guidance where desirable.

The APB has not yet adopted the IAASB's

IAPSs, ISREs, ISAEs or ISRSs.

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Public oversight internationally

In February 2005 the Public Interest Oversight Board

was launched to exercise oversight for all of IFACs
'public interest activities' including its standard-setting
bodies such as the IAASB. Its work involves:
Monitoring the standard-setting boards
Overseeing the nomination process for
membership of these boards
Co-operation with national oversight authorities.
The objective of the international PIOB is to increase the
confidence of investors and others that the public
interest activities of IFAC are properly responsive to the
public interest.

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Other examples of public oversight

In the UK, the Professional Oversight Board

(POB) of the FRC, is a regulatory body whose aim
is to provide assurance that the professional
accountancy bodies in the UK are properly setting
standards and enforcing discipline for their
members in accordance with UK-specific
companies legislation and other statutory
requirements.

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Other examples of public oversight

In the USA, the Public Company Accounting Board (PCAOB)

is a private sector body created by the Sarbanes-Oxley Act,
2002.
Its aim is to oversee the auditors of public companies. Its
stated purpose is to protect the interests of investors and
further the public interest in the preparation of informative,
fair and independent audit reports.
Its powers include setting auditing, quality control, ethics,
independence and other standards relating to the
preparation of audit reports by issuers. It also has the
authority to regulate the non-audit services that audit firms
can offer this power was awarded to it as a result of the
Enron and Worldcom scandals.

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Audit committees
Combined

Code provisions

The board would establish an audit committee of at least three

members. The main role and responsibilities should be set out
in written terms of reference and should include:
(a) To monitor the integrity of the financial statements of the
company, reviewing significant financial reporting issues and
judgments contained in them
(b) To review the company's internal financial controls and,
unless expressly addressed by a separate board risk
committee composed of independent directors or by the board
itself, the company's control and risk management systems
(c) To monitor and review the effectiveness of the company's
internal audit function.
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Audit committees
(d) To make recommendations to the board for it to put
to the shareholders for their approval in general
meeting in relation to the appointment of the external
auditor and to approve the remuneration and terms
of engagement of the external auditors
(e) To monitor and review the external auditor's
independence, objectivity and effectiveness, taking
into consideration relevant UK professional and
regulatory requirements regarding audit and nonaudit services offered by the auditors

The audit committee should be provided with

sufficient resources to undertake its duties.
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Advantages and disadvantages

Advantages
Increased confidence in credibility of reporting
Frees executive directors to manage
Offers the external auditors a direct link with
non-executive directors
Creates culture opposed to fraud
Disadvantages
Selecting suitable independent non-executive
directors can be difficult
Cost of audit committee
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Link between non executive

directors and external auditors

Discuss prior the audit matters such as:

Scope of audit
Role of internal auditors
Audit fees
And after the audit:
Control environment and weaknesses identified
Any differences of opinion between the auditors and the
management and how these have been resolved
Significant adjustments made

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Internal control effectiveness

Internal control is a key part of good corporate
governance. Directors are responsible for
maintaining a system of control that will contribute
to
Safeguarding the company's assets
Helping to prevent and detect fraud
Safeguarding the shareholders' investment

Good internal control helps the business to run

efficiently. A control system reduces identified risks
to the business. It also helps to ensure reliability of
reporting and compliance with laws.

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Directors responsibilities

It is the directors responsibility to implement and

maintain an appropriate system of internal controls.
Auditors should not take any executive role in this area.
Instead their responsibility is to review the controls as
part of their audit work and decide whether any reliance
can be placed on them.
The Combined Code recommends that the board of
directors reports on its review of internal controls as part
of the annual report. The statement should be based on
an annual assessment of internal control which should
confirm that the board has considered all significant
aspects of internal control.

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Auditors responsibilities

The guidance states that the auditors should concentrate

on the review carried out by the board. The objective of
the auditors' work is to assess whether the company's
summary of the process that the board has adopted in
reviewing the effectiveness of the system of internal
control is supported by the documentation prepared by
the directors and reflects that process.
The auditors should make appropriate enquiries and
review the statement made by the board in the accounts
and the supporting documentation.

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Auditors may report

The auditors may report by exception if:
The boards summary of the process of
review of internal controls is not supported
The board has not made an appropriate
disclosure if it has failed to conduct an
annual review, or that disclosure made is
not
consistent
with
the
auditors
understanding

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Auditors report
The report should be included in a separate paragraph
below the opinion paragraph. The Bulletin gives the
following example:
Other matter
We have reviewed the board's description of its process
for reviewing the effectiveness of internal control set out
on page x of the annual report. In our opinion the boards
comments concerning ... do not appropriately reflect our
understanding of the process undertaken by the board
because...

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Money Laundering
Definition:
Money laundering is the process by which
criminals attempt to conceal the true
origin and ownership of the proceeds of
their criminal activity, allowing them to
maintain control over the proceeds and,
ultimately, providing a cover for their
sources of income.
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International recommendations

An inter-governmental body, the Financial Action Task Force

on Money Laundering (FATF) was established to set
standards and develop policies to combat money laundering
and terrorist financing.
In 1990, FATF issued recommendations for governments on
how to combat these offences and these recommendations
have now been endorsed by more than 130 countries.
Customer due diligence
Reporting suspicious transactions
International cooperation
Make money laundering criminal offence

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Criminal offences:

Possessing, dealing with or concealing the

proceeds of any crime (proceeds from tax
evasion, bribery)
Attempting and assisting to commit money
laundering
Failure of an individual in the regulated sector to
report a suspicion of money laundering
Doing or disclosing something that may
prejudice an investigation in such activities
(Tipping-off)

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Penalties and risks

Imprisonment
Unlimited fine
Loss of authority to conduct business
Adverse publicity / loss of reputation

DEFENCES:
a report being made to appropriate authority or the
MLRO
that it was the intention to make a report but there was a
reasonable excuse for not having done so
'reasonable excuse' is likely to encompass the fear of
physical violence
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ACCA GUIDANCE
1.
2.

3.

4.

5.
6.

Appoint an MLRO (Money Laundering Reporting Officer) and

implement internal reporting procedures
Establish internal controls and policies appropriate to prevent
money laundering, and make relevant individuals aware of
the procedures
Train individuals to ensure that they are aware of the relevant
legislation, know how to recognise and deal with potential
money laundering, how to report suspicions to the MLRO,
and how to identify clients
Verify the identity of new and existing clients and maintain
evidence of identification (ie customer due diligence
measures)
Establish record keeping system for all transactions
Report suspicions of money laundering to relevant authority

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ACCA GUIDANCE
Appoint an MLRO:
The MLRO should have a suitable level of
seniority and experience.
Individuals should make internal reports of
money laundering to MLRO.
The MLRO must consider whether to report to
relevant authority and document the process.

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ACCA GUIDANCE
Audit firm should establish policies that cover:
client acceptance
gathering 'know your client' (KYC) information
controls over client money and transactions
through the client account
advice and services to clients that could be of
use to a money launderer
internal reporting lines
the role of the MLRO
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Client identification

The requirement to verify the identities of all

clients is mandatory. Verification must be
documented
before
any
work
is
undertaken. Sufficient knowledge of a client
must be maintained to be able to identify
that which is unusual and/or suspicious.

Who is the client, who controls, purpose of business

relationship, nature of client, clients sources of funds

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Typical identification procedures

For an individual - obtaining official documents,

with a photograph, which establish the client's
full name and permanent address (eg a driving
license or passport supported by a recent utility
bill).
For an entity - obtaining from the Registrar of
Companies a certificate of incorporation, the
registered address and a list of shareholders
and directors

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Offences for firms

It is an offence not to comply with the above

obligations, designed to assist members in
detecting and preventing their organisations
being used for money laundering purposes.
All partners within a practice (and directors in a
firm) are potentially liable on a joint and several
basis for breaches of the firm's obligations. All
individuals are liable in respect of breaches of
their individual obligations.

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Exercise 1.1
Required:
Why is there a need for ethical guidance
for accountants in respect of money
laundering?

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Answer 1.1

In many countries the legal requirements are onerous

and the penalties for non-compliance are severe (for
example, in the UK auditors risk long prison sentences if
they commit an offence). Give guidance to act in
accordance with law requirements.
Money laundering is widely defined and it is not always
obvious that an offence has been committed.
Without the guidance in issue accountants may be used
unintentionally to launder criminal funds.
In many countries the law creates a conflict between the
ethical duty of confidentiality to the client and the legal
duty to report money laundering offences. The guidance
helps to clarify the members' professional duty to report
offences.

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Professional duty of confidence

Accounting professionals (ACCA members) are not in

breach of any professional duty of confidence if they
report in good faith any money laundering knowledge or
suspicions to the appropriate authority.
This protection applies even if suspicions prove later to
be groundless, provided they were made in good faith.
Disclosure without reasonable grounds for knowledge or
suspicions will increase the risk to be in breach of
confidentiality.

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EXERCISE 1.2

Give five examples of businesses which

would be more susceptible to money
laundering than others.

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ANSWER 1.2

Any cash based businesses would be particularly

suitable for criminals to launder money,
particularly ones where the origins of the cash
cannot be easily proven and where services are
provided rather than goods sold, for example:
Casinos
Bookmakers
Private banking
Money transfer services

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MONEY LAUNDERING RISK

INDICATIONS

Transactions routed through several jurisdictions

Secrecy over transactions
Excessive use of wire transfers
Pattern that after a deposit, the same (or nearly the
same) amount is wired to another financial institution
Large currency instrument transactions
Repeated deposits or withdrawals just below the
monitoring threshold on the same day
High value deposits or withdrawals not characteristic of
the type of account

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Exercise 1.3

You are the audit manager of Loft Co a chain of nightclubs.

During the course of the audit Mr Roy, an employee of the
company, informed you that a substantial cash deposit was
paid into companys bank account and a month later, the
same amount was paid by direct transfer into a bank
account in the name of Evissa, a company based overseas.
The employee informed you that Mr Fox the managing
director of Loft Co had instructed him not to record the
transaction as it had nothing to do with Loft Cos business.

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Answer 1.3
The transaction raises suspicion of money laundering for the
following reasons.
It has been stated that the purpose of transaction has
nothing to do with Loft Cos business. This could be a sign
of an attempt to legitimise the proceeds of a crime through
Loft Co by concealing the illegal source of the cash.
The amount of transaction is substantial for Loft Co. An
unusually large transaction should alert the auditor for the
possibility of money laundering, especially as it does no
seem to relate to the business of Loft Co.

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Answer 1.3

The cash amount paid into Loft Cos bank account is the
same as the amount paid to Evissa. This could be an
attempt by Mr Fox to make the cash appear legitimate by
moving through several companies and jurisdictions.
Mr Roy was instructed not to record the transaction in the
accounting records of Loft Co. Increased secreacy over
transactions is another indicator of money laundering.
The suspicious transaction should be reported to
firms MLRO.

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Anti-money laundering program

The basic elements to be considered when designing an

anti-money laundering program include:
dedicated resources
written policies and procedures
comprehensive coverage
timely reporting and resolution of matters
explicit management support
sufficient training and education
regular review/audit of the program.

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Laws and regulations

Companies are subject to laws and
regulation which they must comply.
Examples:
Health and safety law
Employment law
Environmental law
Company law

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Law and regulations

Responsibilities:
Ensure the entitys operations are
conducted in accordance with laws and
MANAGEMENT
MANAGEMENT
regulations
Prevention
and
detection
of
noncompliance
Recognise that noncompliance may
AUDITOR
materially affect the financial statements
AUDITOR
Not responsible for preventing non
compliance and can not detect noncompliance with all laws and regulations as
many of them not affect financial statements
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Difficulties for detection

Reasons why is difficult for auditors not to
detect all non-compliances:
May not affect the financial statements
Non-compliance is ultimately a mater of
legal determination (may be beyond
auditors professional competence)
Testing/sample
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Auditors understanding of laws

The auditor would usually obtain a general
understanding of the laws and regulations
affecting the entity in the following ways:
Use the existing knowledge (and update)
of the entitys industry and business
Discuss / enquire of management

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ISA 250
The auditors responsibilities for considering laws and
regulations as part of their audit is discussed in ISA 250
Consideration of laws and regulations in an audit of
financial statements.
Procedures
Should plan so as to identify any examples of
noncompliance
Evidence
Should obtain sufficient appropriate audit evidence of non
compliance with laws and regulations with a direct effect on
material amounts and disclosures in the FS.
Document findings
Document non-compliance and the results of discussion
with management, those charged with governance and
third parties.
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ISA 250 Audit procedures

The auditor shall perform the following procedures
to help identify instances of non compliances that
may have a material effect on Financial Statements:
Inquiring of management or those charged with
governance as to whether the entity is in
compliance with all applicable laws
Inspecting correspondence with relevant regulatory
authority

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EXAMPLES
The

ISA sets out examples of the type of information that might

come to the auditor's attention that may indicate noncompliance.
Investigation by a government department or payment of fines
Payments for unspecified services or loans to consultants,
related parties, employees or government employees
Services fees that appear excessive in relation to those
normally paid by the entity or in its industry or to the services
actually received
Purchasing at prices significantly above or below market price
Unusual payments in cash
Unusual transactions with companies registered in tax havens
Adverse media comments
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Audit procedures when possible

non-compliance is discovered

When the auditor becomes aware of information

concerning a possible instance of noncompliance, the
auditor should obtain:
an understanding of the nature of the act and the
circumstances in which it has occurred, and
sufficient other information to evaluate the possible
effect on the financial statements.
Any non-compliance with law or regulations should be
documented and discussed with the appropriate level of
management. The auditor should consider the implications
in relation to financial statements (fines, litigation proper
disclosures) and to other aspects of the audit, particularly
the reliability of management representations.

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Reporting non-compliance
Management

Non-compliance should be discussed with those

charged with governance
If those charged with governance are involved, report to
higher level of authority eg audit committee. If not exist or
auditor believes that not be acted upon legal advice
Shareholders
Consider the impact on audit report modified opinion
Third parties
Is there a statutory duty?
Is it in the public interest?
Obtain legal advice
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The auditors report

Disagreement
Where the auditor concludes that the non-compliance
has a material effect on the financial statements, which
has not been amended, he should express a qualified or
adverse opinion.
Limitation on scope
Where adequate information about compliance or
suspected noncompliance cannot be obtained, the
auditor may need to express a qualified opinion or
disclaimer of opinion due to limitation on the scope of the
audit.

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Withdrawal from the engagement

The auditor may conclude that withdrawal

from the engagement is necessary when
the entity does not take the remedial
action that the auditor considers
necessary in the circumstances, even
when the non-compliance is not material
to the financial statements.

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