1 TH12 SMSF audit myth busters Matina Moffitt CA Executive Director EY Chartered Accountants Australia and New Zealand is a trading name for the Institute of Chartered
2 Ethical Clearance Letters Are Ethical Clearance Letters Mandatory? Why: The purpose of an ethical clearance letter is to assist the accountant approached for an engagement in making a decision about whether or not to accept the appointment. Applicable code: APES 110 Code of Ethics for Professional Accountants (applicable to members of the professional bodies) has a mandatory requirement for an ethical clearance letter to be sent in respect of audit engagements, including SMSF audits. Specifically paragraph of APES 110 contains the mandatory requirement in respect of audit engagements. It states: A Member in Public Practice who is asked to replace an existing auditor or to accept nomination as a replacement auditor shall: (a) Request the prospective client's permission to communicate with the existing auditor. If such permission is refused the Member shall, in the absence of exceptional circumstances, decline the Audit Engagement or the nomination; and (b) On receipt of permission, request in writing of the existing auditor all information which ought to be available to enable the Member to make a decision as to whether the Audit Engagement or the nomination should be accepted. Obligations of the receiving auditor: Regulation 9 Paragraph 1216 notes that Members must reply to professional correspondence and enquiries expeditiously. In the absence of a response to a request for ethical clearance members should use their professional judgment in deciding whether or not to proceed with an engagement. A sample of an ethical clearance letter is available for members on the Institute s website.
3 Independence Applicable ASAs and SIS legislation: ASA 220 requires the engagement partner to form a conclusion on compliance with the independence requirements applying to the audit engagement which are contained in the Code of Ethics. ASAE 3100 requires compliance with the fundamental ethical principles on compliance engagements, for which the concept of independence is integral. SISA39 and the SISR40 require the auditor to comply with the auditor independence requirements prescribed by the APES 110 Code of Ethics for Professional Accountants. Overall, independence requires both: (a) independence of mind the state of mind that permits the expression of a conclusion without being affected by influences that compromise professional judgment, allowing an individual to act with integrity, and exercise objectivity and professional scepticism; and (b) independence in appearance the avoidance of facts and circumstances that are so significant that a reasonable and informed third party, having knowledge of all relevant information, including safeguards applied, would reasonably conclude a firm s, or a member of the engagement team s, integrity, objectivity or professional scepticism had been compromised. The fourth edition of the Independence guide to assist auditors was issued by the joint professional bodies in January It now includes a specific section on SMSF audits (Section 9). Examples of common independence that arise in practice: Where an individual auditor has significantly prepared the accounts for the SMSF Where the staff reporting is directly to them have prepared the accounts Where a partner within their firm is a member/trustee of that SMSF Where a relative or related party of the auditor is a member/trustee of that SMSF or where the auditor has a close personal relationship or business relationship with a member/trustee of the SMSF.
4 Engagement letter Is an engagement letter required annually? As for all other audits, the auditor needs to communicate with those charged with governance, in this case the trustee. Applicable ASA: ASA 210 requires an auditor to agree on audit engagement terms in writing. Audit should not be commenced until a signed engagement letter is received. The letter should include: Objective and scope of the financial report and compliance with the sections of the SIS ACT which the audit report is based on. Responsibility of the auditor Responsibility of the Trustee/ Trustees Identification of the applicable financial reporting framework and SIS sections. The form of any reports or other communication of results of the engagement. The fact that because of the test nature and other inherent limitations of an audit, together with the inherent limitations of internal control, there is an unavoidable risk that even some material misstatement may remain undiscovered. Unrestricted access to whatever records, documentation and other information is requested in connection with the audit. Frequency: The frequency of the engagement letter is not defined but the auditor should use their professional judgment when a new letter is required. Examples of when an engagement letter may need to be reissued: An indication that the trustees misunderstand the objective and scope of the audit. A change in trustees. A significant change in the nature or size of the SMSF. Significant changes in the SISA, SISR or other regulatory requirements, such as changes to the requirements to be reported on in the approved form auditor s report or ACR. An example of an engagement letter is in Guidance Statement GS009 Appendix 1. Every audit file should contain a current engagement letter, even if it is a copy of last year s
5 Reminder: The Trustees are required to appoint the auditor at least 45 days prior to the date the SMSF annual return is due to be lodged. Planning: Do I need an audit strategy and audit plan? Applicable standard: Under ASA300, the auditor is required to establish an audit strategy. As stated in ASA300: Establishing the overall audit strategy for the audit of a small entity need not be a complex or time consuming exercise; it varies according to the size of the entity and the complexity of the audit. Matters that may be considered in developing the overall audit strategy and the detailed audit plan as detailed in the appendix to ASA 300 include: Scope of the audit including the reporting framework needs to be established at the planning stage. For SMSFs the scope includes both the financial statements and the compliance audit. Considerations of reliance to be placed on the work of other auditors such as auditors of custodians or use of experts in investment valuations and pension liabilities. The reporting objectives, timing of the audit and communications required. The auditor needs to know the statutory deadlines and any other requirements by the client. The direction of the audit. This includes planning materiality, changes to accounting standards, changes to legislation and identification of areas of high risk. It can be as simple as rolling forward priors year and assessing and including any changes in the last 12 months. Planning is a continual and iterative process throughout the audit. Do I need to consider internal controls if adopting substantive approach? Applicable standard: ASA 260 requires the auditor to communicate any weaknesses identified in the internal controls in a letter to the trustees. This is the same requirement as for all other audits where weaknesses are detailed in a management letter that has the observation and a recommendation for improvement.
6 For SMSF audits, internal controls are not typically present, and even where implemented by the trustee, they are not generally relied upon by the auditor. The audit of a SMSF is typically done a substantive one. For the SMSFs the auditor needs to go through the above process, and appropriately document all considerations even if the auditor knows that he will adopt a substantive approach. In some circumstances internal control reliance may be appropriate, in particular in the area of investments where the Trustee may use a third party provider. Bank Confirmation A bank confirmation can be a useful tool to assist auditors in confirming year end balances, existence of covenants and/or other deposits or accounts. Should auditors be obtaining bank audit certificates as a matter of course? A bank confirmation is not mandatory when auditing cash balances. The decision as to whether or not to obtain a bank audit certificate should be based on the circumstances of each individual SMSF. Guidance Statement GS 016 Bank Confirmation Requests sets out the considerations for obtaining a bank confirmation. It provides guidance on the enquiry and confirmation methods for obtaining audit evidence regarding an entity s bank accounts and transactions. Paragraph 13 indicates that where banking activities are significant, complex, or unusual and may impact on the assertions or disclosures regarding the banking activities the auditor would ordinarily request a bank confirmation. Some examples of when an auditor may deem it necessary to seek a bank confirmation include: an SMSF that is a new client and very little is known about the client s transactions The SMSF has recently purchased/sold a property and confirmation of large transactions is required including settlement amounts, legal costs etc. The SMSF client has provided incomplete audit documentation such as missing bank statements and the auditor is unable to confirm the year end cash balance Paragraph 14 states that an auditor may decide not to request a bank confirmation where an SMSF s banking activities are simple and straightforward, the assessed risk of material misstatement of bank related account balances and disclosures is low and alternate methods or procedures can be used to obtain sufficient appropriate audit evidence in respect of banking activities. Each circumstance and fund is different. It is therefore up to the individual auditor to exercise their professional judgment and carefully consider the circumstances of their client.
7 Independent Valuations Background: SMSF's assets must be valued at market value for the purposes of preparing financial accounts and statements. The tax office has published Valuation guidelines for self managed superannuation funds to assist Trustees to comply with this requirement. The new regulation has made this requirement an operating standard, which gives the ATO the power to enforce compliance. A person who intentionally or recklessly contravenes this standard is guilty of an offence punishable on conviction by a fine not exceeding 100 penalty units (one penalty unit currently equals $170). The tax office will generally accept a determination of an asset's value, as long as: it does not conflict with this guide or Market valuation for tax purposes guide there is no evidence that a different value was used for the corresponding capital gains tax event it was based on objective and supportable data. If the tax office concludes that the most appropriate valuation method has not been used for any of the assets, it will not be accepted and the most appropriate valuation method will be applied to determine an amended value. In addition the market valuation of assets is required to confirm that the SMSF has complied with relevant super laws as follows: acquiring assets between SMSFs and related parties investments made and maintained on an arm's length basis disposing of certain collectables and personal use assets to a related party of the fund determining an SMSF's in house assets as a percentage of all assets in the fund determining the value of assets that support a member's super pension. When to undertake an external valuation for financial report purposes: The ATO expects Trustees to consider the value of the assets in their fund each year. This does not mean that an external valuation for all assets each year. For example, assets such as real property may not need an annual valuation unless a significant event occurred that may change its value since it was last valued, for example, natural disaster, market volatility, changes in the character of the asset.
8 The use of a qualified independent valuer should be undertaken if either: an asset represents a significant proportion of the fund's value the nature of the asset indicates that the valuation is likely to be complex. In all other cases the person who conducts the valuation must base their valuation on objective and supportable data. Depending on the situation, a valuation may be undertaken by a: registered valuer professional valuation service provider member of a recognised professional valuation body person without formal valuation qualifications but who has specific experience or knowledge in a particular area e.g. real estate agent. We recommend the use of a qualified independent valuer where the value of the asset represents a significant proportion of the fund's value or the nature of the asset indicates that the valuation is likely to be complex. It is not the auditor s responsibility to complete valuations for a trustee. But the practical considerations are: Understands the trustee s rationale for selecting a particular valuation method and exercising professional judgment in assessing whether the method is appropriate based on the nature of the asset and investment markets. In situations where the auditor is unable to form an opinion in assessing whether the valuation is accurate and reasonable, the auditor should consider modification of the auditor s report, taking into account materiality and the risk of material misstatement. Experts As discussed in the previous sections, there are occasions when the fund may use experts and the fund auditor may rely on information provided by the expert. Experts include valuers for real estate and other asset valuations and actuaries for actuarial reports for pension paying funds. ASA 620 provides guidance for when using the work of an expert. The auditor needs to consider the following factors: The competence of the expert. Does the expert have the appropriate qualifications and experience in their field, The objectivity of the expert, The scope of the work and whether there were any restrictions, limitations or lack of data needed for the work performed. Also consider the relationship, if any, between the expert and the fund or related parties of the fund, and The appropriateness of the work performed including the assumptions used and the results of the expert s work in the context of the auditor s overall knowledge of the fund. For example when real estate is valued using assumptions about vacancy rates and rental income, are these assumptions consistent with the fund s experience.
9 The above considerations and conclusion thereon need to be documented by the auditor. ASAE3402 / GS007 Using service organisations for investment management services. This standard sets out the obligations of the auditor of the investment management service and the auditor of the investor. This is particularly important for the auditors of SMSFs who often invest via an investment management service such as a wrap account or separately managed account. Where the investment is significant to the fund and there is a risk of material error if the controls of the service entity are not maintained then the auditor of the SMSF must get a report on the controls of the entity or implement alternative procedures to ensure the balances are correct. When assessing controls and the appropriateness of the service providers audit reports, the SMSF auditor should consider who the provider of the service is and assess under ASA620 (as discussed above). Where this information is not available the fund auditor is unable to rely on the investment and tax reports produced by the service organisation. This will result in the auditor using other information to audit around the service organisation where possible. Alternatively the auditor will qualify the audit due the limitation of scope as a significant investment could not be effectively audited. Actuarial certificates When is an actuarial certificate required? There is no need to obtain an actuarial certificate to claim the exempt income if: you want to claim the tax exemption using the segregated assets method, and at all times that pensions were payable during the income year, the SMSF only paid allocated pensions, marketlinked pensions or account based pensions, and no other type of pension. If the market value of the assets supporting an income stream benefit exceeds the member account balance supporting the benefit, the excess amount won't be considered to be segregated current pension assets. If the SMSF pays other types of super income stream benefits and uses the segregated assets method to claim the tax exemption, you will need to obtain a certificate covering all super income stream benefits that the SMSF pays. This includes allocated pensions, market linked pensions and account based pensions. You will need to obtain an actuarial certificate to claim the exemption using the segregated assets method if any of the following apply: your SMSF paid any super income stream benefit other than an allocated pension, market linked pension or an account based pension the market value of a benefit that is an allocated pension, market linked pension or account based pension exceeds the account balance supporting the benefit. SMSF is using the unsegregated assets method, regardless of the type of super pension benefit being paid
10 Investment Strategy Auditor is not required to assess whether the strategy is adequate or appropriate to meet the investment needs of the SMSF. Trustee Responsibility Trustees are required to conduct a review of the fund's investment strategy on a regular basis to ensure that it continues to reflect the purpose and circumstances of the fund and its members; and Trustees are required to consider insurance for fund members as part of the fund's investment strategy These measures are prescribed operating standards for the fund, which means that Trustees must ensure they are complied with at all times. Auditor s procedures: 1. Obtain a copy of the investment strategy and ensure investments are in line with the strategy. 2. Obtain or sight copies of the minutes of the meetings held by the Trustees to evidence the regular review and decisions made in relation to insurance Analytical procedures Do I need to undertake analytical procedures for an SMSF? Analytical procedures can be used as a risk assessment procedure to help identify matters that have a financial report or audit implication and also in obtaining evidence for the financial report assertions and an overall review of the financial statements. Most analytical procedures do not have to be complex or detailed. A common procedure for an SMSF is comparing the movement of the market value of investments held with that of the market overall. In developing your expectations about the relationship between various types of transactions and the current economic conditions will provide the ability to evaluate any unusual or unexpected transactions which may increase the potential risk on material misstatement. However analytical procedures alone will not be sufficient audit evidence when used as a substantive procedure for a significant risk. Additional test of details etc. should be carried out. Finally paragraph 6 of ASA520 states that the auditor shall design and perform analytical procedures near end of the audit that assist the auditor when forming an overall conclusion as to whether the financial report is consistent with the auditor s understanding of the entity.
11 The auditors responsibilities relating to fraud in an Audit of a financial report The term fraud refers to an intentional act by one or more individuals such as the trustees or third parties involving deception to obtain an illegal advantage. Auditors are concerned with fraud that will lead to a material misstatement of the financial statements. General there are two main types of fraud in a SMSFs are misappropriation of assets and manipulation of earnings. There are three conditions that often prove clues of existence of fraud: Pressure immediate needs such as personal or business debts Opportunity due to lack of adequate internal controls which is often present in a SMSF for example authority given to a third party to transact on behalf of the Trustees. Rationalisation the belief that a fraud is not being committed. My money and I will put back in at a later date. Example: The Fund has a property and is let out the property to a relative at a discounts rate, for cash only and no paper work. As auditors there is a need to consider the following: Are there any pressures on the Trustees or third party? Trustees attitude ethical values; one trustee enters into a transaction without approval of the others therefore no oversight; trustees display significant disregard for regulatory authorities. Trustee/audit relationship is the relationship strained between the current or predecessor auditor such as frequent disputes over accounting or compliance matters; unreasonable demands or time constraints; domineering attitude towards the auditor. Remember that fraud is always intentional and involves concealment or misrepresentation to the auditor. Fraud is discovered by looking at patterns, oddities and exceptions and often is in small monetary amounts. A Fraud will not be picked up through substantive procedures alone as it will not identify if a transaction is missing or invalid must understand the entity. Always maintain an attitude of professional skepticism. Which involves making critical assessment validate the audit evidence and remember that the trustees are in a position to override otherwise good internal controls. Under ASA240 states the procedures that the auditor should perform to obtain information for use in identifying the risks of material misstatement due to fraud. Such as enquiries of management regarding: Management s assessment of the risk the financial report may be materially misstatement due to fraud; Management s process of identifying and respond to the risks of fraud in the fund; Managements communication with the charged with governance and managements communication if any with employees if any.
12 Unless the trustees are involved in managing of the fund need as an auditor understand the oversight of management s processes. Inquire of the Trustees whether they have any knowledge of actual, suspected or alleged fraud affecting the fund. Enquiry in conjunction with other risk assessment procedures needs to be used to identify any risk of material misstatement. These enquiries are required to be recorded in writing. Audit Sampling Sampling should be used in SMSF as it provides efficiencies. ASA 530 Audit Sampling requires if sampling is used, the auditor, when designing the sample to consider the purpose of the procedure and the characteristics of the population from which the sample will be drawn and to evaluate whether the results of the sample provide a reasonable basis for concluding on the population. ASA 530 Audit Sampling Determine an appropriate preliminary materiality level Consider audit risks o Do samples need to be increased to compensate for high risks? o Do sample sizes enable material compliance breaches to be identified Sampling methods usually unsophisticated o Every 3rd transaction o All items over $X. Auditor Communication ASA 260 requires the auditor to determine the appropriate persons within the entity's governance structure with whom to communicate, this will normally be the Trustees. Minimum communication required is: Engagement letter Management Letter Contraventions reporting Clearance letter Audit opinion
13 The auditor needs to advise the trustee in writing of all contraventions of SIS noted during the audit, irrespective of their materiality. A clearance letter at the end of the audit is also advisable to ensure that all issues are addressed and advised to the Trustees. Areas that should be considered: Integrity, objectivity and independence Accounting policies Recorded/ unrecorded audit adjustments Going concern Disagreements Integrity/fraud Non compliance with laws and regulations Audit Opinions Whether or not to modify is a decision based on your professional judgement and the facts of each case. Should you need to modify the audit report you will need to apply ASA 705 Modifications to the Opinion in the Independent Auditor s Report and ASA 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor s Report. A modification cannot reduce the scope of the audit. It must either describe a limitation and the financial impact of the limitation or alternatively it is to qualify the report. There are two types of modification: An emphasis of matter is used > Where additional information in the financial statements is drawn attention to > Where there is an event subsequent to year that requires disclosure. A modification which affects the auditors opinion arises when there is an extreme issue arising. This would include scope limitation such as: When the fund is using a management service which does not provide a controls audit report and auditing through the service is not possible. Where there is uncertainty such as a limitation of scope. eg can occur in relation to opening balances when taking on a fund in the first year. Prior to including a limitation of scope in the audit report the auditor should ensure that alternate audit procedures have been used to try to satisfy audit requirements.
14 The qualification should set out the: Reason; and Quantative effect In the audit report we are only required to report material contraventions of SIS. Deciding what is a material contravention is not as straight forward as when faced with a financial statements qualification. This is because monetary considerations are not the only ones that need to be taken into account. In general when a contravention of one of the SIS requirements is found the auditor needs to consider a number of factors, some of which would include: The amount involved The period the fund was in breach How it occurred The frequency of occurrence The effect of the contravention on decisions made by the trustees The impact of the contravention on the members The auditor needs to have documentation to support the audit opinion and that the audit has been conducted in accordance with Auditing Standards and other legal requirements. The ATO in its pronouncements has also indicated that it expects a certain level of audit evidence. ATO Focus and reporting Major concerns are in the areas of: Sole purpose In house assets Borrowing rules Loans to members Early access schemes As these are the areas were SMSFs continue to breach. The message form the ATO is they will review all contraventions this year and do full audits of funds, in particular funds that have been categorise as High Risk. The category is based on the reported breach along with the fund s previous history and prior reportable breaches. The ATO is will complete audits for 3,000 funds in this financial year. 60% will come from ACR reporting the remaining form their internal compliance program. Fund reviews The ATO program of fund reviews is based on an assessment of risk, the risk assessment process uses the findings of auditors reported via auditor contravention reports and independent risk identification processes to select cases. All
15 tax payers are reminded that the ATO is able to cross match and analyse member, fund and corporate tax and investment data to identify areas of misreporting and risk. Extracted from speech by Michael D Ascenzo, Commissioner of Taxation for the SPAA National Conference 23 February 2011, Brisbane ATO Penalty regime With the new penalty legislation coming into effect 1 July 2014, the potential risk of financial penalties being levied against the trustees individually, may lead to auditor s having to face increase pressure not to report breaches to the ATO. Therefore is extremely important that auditors make it clear to the Trustees their reporting obligations: a. The requirement under section 129 of the SIS Act which states that if the auditor forms the opinion that a contravention of the Acts and Regulations has occurred, is occurring or may occur must advise the Trustees. The auditor must also advise APRA at the same time as the trustees if the auditor is of the opinion the contravention may affect the interests of members or beneficiaries. b. Auditing standards require that auditors report compliance breaches to the Trustee even if they are not material and not reported to the ATO. This is done in a form of a management letter. c. Material breaches of any of the sections which the auditor needs to report on within their audit opinion will lead to qualification of the auditor s audit opinion. An auditor s contravention notice ACR may also be required, however the ACR lists the sections and regulations that are reportable to the ATO, it does not include all the sections within the audit report. An example is section 35B. There are seven tests to determine whether a breach is required to be reported. These are discussed below. Breach Reporting to the ATO The ATO released guidelines for auditors and actuaries to assess when a breach should be reported (NAT ). This provides a number of questions to be answered to determine if reporting is required. The ATO have specified breaches which must be reported and the criteria for reporting are: Fund definition test a failure to meet the definition of an SMSF New fund test a fund which is less than 15 months old must have all identified breaches in excess of $2,000 reported Trustee behaviour test a repeat of a breach previously advised to the trustee Trustee behaviour test a failure to resolve a previously advised or reported breach Trustee behaviour test a failure to meet a statutory time period by more than 14 days Financial threshold test did the total value of all contraventions exceed 5% of assets Financial threshold test did the total value of all contraventions exceed $30,000. The penalties that can apply for breaches on specific provisions of the SIS Act range from $850 to $10,200. These penalties not only for new breaches form 1 July 2014 but ones in existence on that date. The breaches with the
16 heaviest penalties are Lending to members (s65), Borrowings (s67), in house asset contravention (s84) and notification of a significant adverse effect on the fund s financial position (s106). Penalty cannot be paid out of the SMSF. Doing so be considered a serious breach. The ATO has advised that these penalties are not automatically applied across the board. The ATO will assess each breach and determine if the fund needs to be audited and penalties applied. The message from the ATO is clear; the trustee should rectify the breach as soon as possible or risk being liable for a penalty. Documentation ASA 230 requires: The auditor shall prepare the audit documentation so as to enable an experienced auditor, having no previous connection with the audit, to understand the audit work performed, the results and audit evidence obtained, and the significant matters identified and conclusions reached thereon This does not mean that the file should contain copies of all documents the auditor has sighted during the audit. It can be achieved by providing appropriate detail such as investment manager, account number distribution statement period and date. For audits of superannuation funds documentation needs to cover both the financial statements audit and the compliance audit. What is sufficient appropriate audit evidence? Sufficiency is the measure of the quantity of audit evidence and is affected by the risk of material misstatement. The higher the risk the more evidence is likely required. Appropriateness is the measure of quality of the evidence, that is, its relevance and its reliability. The higher quality the less evidence may be required In addition the SMSF auditor needs to understand all of the following: Australian Auditing Standards under section 336 of the Corporations Act 2001 and Auditing and Assurance Standards under section 227B of the Australian Securities and Investments Commission Act Superannuation Industry (Supervision) Act and Regulations as they apply to SMSFs Relevant Australian Professional and Ethical standards (APES 110) Accounting standards made by the Australian Accounting Standards Board (AASB).
17 . Disclaimer This presentation represents the opinion of the author(s) and not necessarily those of the Institute of Chartered Accountants in Australia (the Institute) or its members. The contents are for general information only. They are not intended as professional advice for that you should consult a Chartered Accountant or other suitably qualified professional. The Institute expressly disclaims all liability for any loss or damage arising from reliance upon any information in these papers. Chartered Accountants Australia and New Zealand is a trading name for the Institute of Chartered Accountants in