I am a service provider in the midst of helping my client appoint an auditor for my client’s Singapore company with a foreign company as shareholder. The auditor requested to meet the beneficial owner of the foreign company in person for an interview, claiming that this is one of the requirements imposed on the audit firm. May I know whether the auditor has such a right to request to meet the beneficial owner?
We have performed our own Know Your Client (KYC) on the beneficial owner. Is it sufficient for us to give an undertaking to the auditor that we have conducted KYC on the beneficial owner?
Auditors are required under SSA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment to identify and assess the risks of material misstatement, whether due to fraud or error, through understanding the entity and its environment, thereby providing a basis for designing and implementing responses to the assessed risks of material misstatement.
One of the risk assessment procedures identified in SSA 315 paragraph 6(a) include inquiries of management, and of others within the entity which in the auditor’s judgment may have information that is likely to assist in identifying risks of material misstatement due to fraud or error.
Furthermore, it was indicated in SSA 315 paragraph 14(a) that an auditor should obtain an understanding of the control environment and as part of obtaining an understanding of the control environment, the auditor shall evaluate whether management, with the oversight of those charged with governance, has created and maintained a culture of honesty and ethical behaviour.
Hence, obtaining an understanding of the client is an important part of audit. If the auditor deems it necessary to enhance his understanding of the client, the auditor may request for a meeting with the beneficiary owner of the foreign company although the beneficiary owner has the discretion to decide whether he wishes to meet the auditor or not.
Furthermore, an audit engagement should be regarded as a separate engagement from that of the services rendered by the service provider. As such, the auditor would be expected to exercise professional scepticism and perform his own KYC process, based on his professional judgment, instead of merely placing reliance on the undertaking from your company in respect of the KYC performed by your company.
The definition of performance materiality is as described in SSA 320 Materiality in Planning and Performing an Audit paragraph 9. It means the amount or amounts set by the auditor at less than materiality for the financial statements as a whole to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole. If applicable, performance materiality also refers to the amount or amounts set by the auditor at less than the materiality level or levels for particular classes of transactions, account balances or disclosures. It is determined for purposes of assessing the risks of material misstatement and determining the nature, timing and extent of further audit procedures (paragraph 11).
Applying the above:
- Performance materiality is determined for each financial statements caption (e.g. cash, fixed assets, revenue, etc) and will be different as it depends on the risk of each caption.
- Performance materiality must be lower than the overall materiality.
- Generally, performance materiality is determined at the planning phase. However, as SSA 320 states that performance materiality is determined for the purposes of assessing the risks of material misstatements and determining the nature, timing and extent of further audit procedures, it could also be determined at a later phase as long as it is determined before the audit procedures are conducted.
Additionally, you may also refer to the ICPAS publication – Practical Guidance 3 on “Materiality for Audit of Separate Financial Statements of Small Companies” – which can be found on the ICPAS Centre for Auditing and Assurance (ICPAS_QAGuide_Dec10_Resized1018.pdf). The publication provides practical guidance on establishing materiality during the phase of an audit.
According to paragraphs A3-A4 of SSA 320 Materiality in Planning and Performing an Audit, determining materiality involves the exercise of professional judgment. A percentage is often applied to a chosen benchmark as a starting point in determining materiality for the financial statements as a whole. Some examples of benchmarks that may be appropriate, depending on the circumstances of the entity, include categories of reported income such as profit before tax, total revenue, gross profit and total expenses, total equity or net asset value. Profit before tax from continuing operations is often used for profit-oriented entities. When profit before tax from continuing operations is volatile, other benchmarks may be more appropriate, such as gross profit or total revenues.
SSA 320 paragraph A7 also explains the relationship between the percentage and the chosen benchmark whereby a percentage applied to profit before tax from continuing operations will normally be higher than a percentage applied to total revenue. For example, the auditor may consider five percent of profit before tax from continuing operations to be appropriate for a profit-oriented entity in a manufacturing industry, while the auditor may consider one percent of total revenue or total expenses to be appropriate for a not-for-profit entity. Higher or lower percentages, however, may be deemed appropriate depending on the circumstances.
As determination of the benchmark and the percentage to be applied to the benchmark is mainly based on judgement of the auditor, the materiality formula applied to each entity may be tailored according to the facts and circumstances of the entity.
You may also wish to refer to the table under paragraph 8 in the ICPAS publication – Practical Guidance 3 on “Materiality for Audit of Separate Financial Statements of Small Companies” – for an indication of the suggested percentages to be used for benchmarks such as profit before tax and turnover/total assets. Please refer to the Practical Guidance in ICPAS_QAGuide_Dec10_Resized1018.pdf for more details.