Annual Audit Manual

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5027 Understand the applicable financial reporting framework, and the entity’s accounting policies
Sep-2022

In This Section

Understand the applicable financial reporting framework, and the entity’s accounting policies

Understand the applicable financial reporting framework, and the entity’s accounting policies

CAS Requirement

The auditor shall perform risk assessment procedures to obtain an understanding of (CAS 315.19):

b) The applicable financial reporting framework, and the entity’s accounting policies and the reasons for any changes thereto; and

The auditor shall evaluate whether the entity’s accounting policies are appropriate and consistent with the applicable financial reporting framework (CAS 315.20).

CAS Guidance

Matters that the auditor may consider when obtaining an understanding of the entity’s applicable financial reporting framework, and how it applies in the context of the nature and circumstances of the entity and its environment may include (CAS 315.A82):

  • The entity’s financial reporting practices in terms of the applicable financial reporting framework, such as:

    • Accounting principles and industry-specific practices, including for industry-specific significant classes of transactions, account balances and related disclosures in the financial statements (for example, loans and investments for banks, or research and development for pharmaceuticals)

    • Revenue recognition

    • Accounting for financial instruments, including related credit losses

    • Foreign currency assets, liabilities and transactions

    • Accounting for unusual or complex transactions including those in controversial or emerging areas (for example, accounting for cryptocurrency)

  • An understanding of the entity’s selection and application of accounting policies, including any changes thereto as well as the reasons therefore, may encompass such matters as:

    • The methods the entity uses to recognize, measure, present and disclose significant and unusual transactions.

    • The effect of significant accounting policies in controversial or emerging areas for which there is a lack of authoritative guidance or consensus.

    • Changes in the environment, such as changes in the applicable financial reporting framework or tax reforms that may necessitate a change in the entity’s accounting policies.

    • Financial reporting standards and laws and regulations that are new to the entity and when and how the entity will adopt, or comply with, such requirements.

Obtaining an understanding of the entity and its environment may assist the auditor in considering where changes in the entity’s financial reporting (e.g., from prior periods) may be expected (CAS 315.A83).

Example:

If the entity has had a significant business combination during the period, the auditor would likely expect changes in classes of transactions, account balances and disclosures associated with that business combination. Alternatively, if there were no significant changes in the financial reporting framework during the period the auditor’s understanding may help confirm that the understanding obtained in the prior period remains applicable.

Considerations specific to public sector entities
The applicable financial reporting framework in a public sector entity is determined by the legislative and regulatory frameworks relevant to each jurisdiction or within each geographical area. Matters that may be considered in the entity’s application of the applicable financial reporting requirements, and how it applies in the context of the nature and circumstances of the entity and its environment, include whether the entity applies a full accrual basis of accounting or a cash basis of accounting in accordance with the International Public Sector Accounting Standards, or a hybrid (CAS 315.A84).

OAG Guidance

In addition to the matters raised in the CAS guidance, consider additional matters when obtaining or updating our understanding such as:

  • Whether accounting policies are appropriate for the business and consistent with the applicable financial reporting framework and accounting policies used in the relevant industry.

  • Whether accounting policies are appropriate when changes in the entity’s financial reporting framework have occurred or are expected to occur.

  • What information management may be using to assess the appropriateness of accounting policies and how we can use that information to inform our understanding, e.g., through Board or management papers setting out the basis of selection of accounting policies.

  • Whether there is adequate disclosure of material matters and whether disclosures are relevant and understandable in the context of the requirements of the applicable financial reporting framework.

Our understanding of the entity and its environment obtained early in the audit assists us in understanding whether the entity’s accounting policies are appropriate and consistent with the applicable financial reporting framework, including any new or emerging requirements of the applicable financial reporting framework. Our understanding of the entity’s application of the relevant financial reporting framework in the context of the nature and circumstances of the entity forms the basis for our procedures to identify and assess risks of material misstatement.

Example:

If a change is made in the applicable financial reporting framework, such as to the definition of a business, we would likely expect changes in the entity’s accounting policies, such as updates for the introduction of new requirements and updates to the characteristics of a business. For entities which complete multiple and/or significant acquisitions during the period, understanding the entity’s accounting policies relating to business combinations in the context of the changes in the applicable financial reporting framework may lead us to assess the inherent risk factor related to change as higher (i.e., moderate or high) for the completeness, accuracy, and presentation and disclosure assertions of the risk "Transactions are not appropriately identified, accounted for and recorded as a business combination (as opposed to an asset acquisition)" within the business combinations FSLI.
Related Guidance

Financial reporting frameworks typically include specific guidance related to accounting estimates. See OAG Audit 7072 for detailed guidance on understanding the requirements of financial reporting frameworks related to estimates.