Understanding the client and its governance
Required:
(a) Make a list of the main factors that will be considered by each audit manager’s group.
(b) Based on the above information, can you conclude that Ajax Ltd complies with Principle 4 of the principles? Explain.
(a)
(i) Entity level
(Refer to text 3.2 and ASA 315.11(b) and A31-A35)
Team will be trying to gain an understanding of:
Complexity of the client’s structure (subsidiaries, locations, investments)
Ownership and relations between owners and other people or entities (related party issues)
Factors to consider include:
Business operations – revenue, products, markets, production, outsourcing, geographic dispersion, segmentation on industry lines, location of facilities and inventories, key customers, suppliers, employment arrangements, research and development activities, transactions with related parties.
Investments – new or planned acquisitions or divestitures, investments in securities and loans, capital investment, non-consolidated entities.
Financing – major subsidiaries, debt, beneficial owners, derivatives.
Financial reporting issues such as principles and practices usually applied, revenue and cost recognition, fair value accounting, foreign currency items, complex transaction accounting,
Changes from prior periods in any of these factors.
(ii) Industry and economic effects
(Refer to text 3.2 and ASA 315.11(a) and A25-A30)
Factors to consider include:
Competitive environment, supplier and customer relationships, technological developments, cyclical or seasonal activities, energy supply and cost, nature of regulation, including accounting practices, specific regulations affecting industry, taxation, government policies, environmental requirements, general economic conditions, interest rates, availability of financing, inflation, currency revaluations.
(b) NOTE: this answer is based on the 3rd edition of the Guidelines as used in your text; the 4th edition was significantly revised in 2019.
Principle 4 of the ASX recommendations refers to safeguarding the integrity in the entity’s financial reporting (see figure 3.4). The ASX recommends that the entity establishes an audit committee which is comprised only of non-executive directors, with a majority of independent directors, and chaired by an independent chair who is not chair of the board. The committee should have at least 3 members, and operate with a formal charter.
The question states that there are four members of the audit committee, who are all independent directors. In addition, the chair of the committee is an independent director. These conditions satisfy the ASX recommendations. We do not know if the audit committee has a formal charter, so we do not know if that condition is satisfied. The question states that the chair of the audit committee (Stella) is also the chair of the board. This means that the company does not fully satisfy the recommendations of the ASX, so we can’t conclude that the entity complies with Principle 4.