Regulators are sharpening their focus on the audit of cash flow statements. Hugh Morgan shares tips on some common areas of weakness and errors for auditors.
Getting the preparation and audit of a statement of cash flows right is important. Users of financial statements expect companies and their auditors to identify and correct material misstatements within the cash flow statement prior to publication, but regulators such as the UK Financial Reporting Council (FRC) repeatedly find that this primary financial statement is not given the necessary amount of input from preparers and auditors.
The FRC has reviewed many cash flow statements over recent years. It shares findings in a thematic briefing on the audit of cash flow statements and a thematic review of cash flow and liquidity disclosures. Both documents offer insights that may help firms to enhance the audit of cash flow statements by avoiding the most common and significant areas of weakness and errors and their root causes.
There are also articles, guidance and other ICAEW resources (see box at the end of this article) to assist preparers and auditors, including a recent webinar from the Audit and Assurance Faculty and the Corporate Reporting Faculty on Tips and common pitfalls in preparing and auditing cash flow statements. This article highlights some practical tips for auditors from this webinar.
Let’s begin by focusing on matters to consider when planning cash flow statement audit work, then move on to consider some ways to strengthen execution.
Planning
When planning a financial statement audit and the audit of the cash flow statement, auditors need to remember that it is a primary statement and how important it is to obtain sufficient and appropriate audit evidence that the cash flow statement is accurately presented.
This includes performing confirmation procedures over cash and cash equivalents or, if necessary, alternative procedures to confirm the right start point and end point for the cash flow statement.
Although some may see the audit of a cash flow statement as an unimportant or mechanical exercise, work on this primary statement should be allocated to a suitably experienced and senior audit team member. Audit of the cash flow statement needs to involve somebody with a good overview of the client’s activities and how these impact the cash flow statement.
Work on this primary statement should be allocated to a suitably experienced and senior audit team member
Planning ahead is vital. As with other aspects of a financial statement audit, the auditor should agree up front with the audited entity that the cash flow statement and supporting working papers will be ready at the same time as the other primary statements and the front-end information. When auditing the cash flow statement, you will need all of this information.
Do not forget that the audit work on the cash flow statement should be linked to the ISA 315 audit risk assessment that the team will perform at the start of the audit. This will ensure that the planned cash flow statement audit work reflects the identified audit risks. It is a link that should not be lost as work on the cash flow statement and the wider audit progress.
The audit needs to identify and obtain an understanding of the purpose of any one-off transactions or non-standard arrangements and consider their impact on the financial statements and the cash flow statement. On group audits, this information is needed for parent cash flow audit work and for any subsidiaries.
The group auditor needs to see the subsidiary cash flow statements. It is vital to understand at the planning stage if there are any one-off transactions or non-standard arrangements.
The group auditor needs to know where there are foreign components and currency transactions, then these can be built into the audit plan, so disclosures that are missing or inconsistent with our knowledge can be spotted.
Execution
The audit team has a collective responsibility to get this right. It’s important to remember that what is happening in the rest of the financial statements is integral to the audit of the cash flow statement. If the cash flow statement is being audited in isolation, there’s a risk that something significant may be missed.
The team member with responsibility for auditing the cash flow statement should ask questions of those responsible for the other financial statements to identify whether the cash and non-cash transactions have been appropriately included or excluded from the cash flow statement and, where appropriate, disclosed in the financial statements.
If the cash flow statement is audited in isolation, there’s a risk that something significant may be missed
If other team members have responsibility for particular areas of the balance sheet, they should consider how various elements of that area should be reflected in the cash flow statement and the related disclosures and communicate these to a team member with responsibility for auditing the cash flow statement.
When auditing the cash flow statement, it’s also important to read the ‘other information’ to check that transactions and arrangements disclosed in the front end – such as those relating to an acquisition or issue of equity, for example – are included in the cash flow statement.
Audit work on cash flow should address the cash flow impact of the significant and other risks we have identified at the planning stage. Because the auditor’s risk assessment should be ongoing, where those risks change or new risks are identified, audit work on the cash flow statement needs to be responsive to those changes, otherwise things may be missed.
If there are unusual transactions or complexities such as hedging derivatives, discontinued operations, or sale and leaseback arrangements, the auditor should be making use of available accounting guidance. If necessary, consult with financial reporting experts, within the firm if this is an option, or by contacting ICAEW’s Technical Advisory Service helpline.
It’s important to keep your eyes and ears open for any developments, such as late changes to the financial statements. Such changes may happen even when the auditor received the cash flow statement on time and has had sufficient time to audit it. The potential for late changes must be factored into audit work on the cash flow statement, to minimise the risk that something may be missed.
An effective stand-back assessment is also vital, and the value of basic sense checks should not be underestimated. The team member with responsibility for auditing the cash flow statement may want to ask, for example, “Does what I am seeing make sense given what I know and what the client team has told me?” and consider whether anything obvious might have been missed. For example, are foreign exchange movements in the primary statements reflected as would be expected, given how exchange rates have moved?
An effective stand-back assessment is vital, and the value of basic sense checks should not be underestimated
As with many matters relating to the audit of the cash flow statement, that stand-back assessment is best conducted by somebody who knows the audited entity and knows what it has been doing.
Root causes and ways to address them
Understanding the root causes behind inadequacies also offers opportunities to enhance cash flow statement audit. Insights on those most commonly identified by the FRC and how firms are successfully addressing these are offered in the recent faculties webinar on cash flow audit and in an earlier Audit & Beyond article on Strengthening the audit of cash flow statements.
Hugh Morgan, Technical Director, RSM UK, and Chair of ICAEW’s Technical and Practical Auditing Committee.
Other ICAEW resources that firms may find useful include:
Tips and common pitfalls in preparing and auditing cash flow statements – a faculties webinar
Statement of cash flows: common pitfalls and tips for reviewers – a Corporate Reporting Faculty helpsheet
