This article appeared in Summer 2011 edition of SMSF Magazine:

Is there a sensible solution for auditing SMSFs while meeting the practicality of following every audit standard?

Sharif Eldebs, Senior Manager - Superannuation Audit

It is a requirement each year for a SMSF to engage an auditor to perform a financial and compliance audit. The ATO regularly express concerns over the quality of SMSF financial statement audits. Their focus has bee on auditors displaying a lack of understanding of Australian Auditing Standards and / or documentation.

In 2006 the Australian Government introduced a statutory requirement for auditing standards to be legally enforceable under Section 336 of the Corporations Act 2001 for financial audits. This placed Australia in an unusual position, as France is the only other Western country to adopt such an approach. Although auditors were already required to comply with auditing standards, the potential implications and risks of non-compliance were significantly increased.

SMSF auditors are required to sign off that they have conducted their audit with Australian Auditing Standards. There are 40 auditing standards and 500 requirements to comply with. Considering the average cost of an audit is $600, which equates to approximately 3 to 4 hours to complete a financial as well as a compliance audit - the obvious challenge is how to complete a financial audit which truly complies with Australian Auditing Standards.

It is possible however, with some clever implementation, for a SMSF auditor to successfully apply the auditing standards and meet the efficiency standard needed to keep costs to a minimum for clients. Here are some suggestions on how to do this.

Clarity for efficiency

In October 2009 the Auditing and Assurance Standards Board (AUASB) revised and redrafted Australian Auditing Standards in Clarity format. As a result a new standard was introduced, ASA 101 Preamble to Australian Auditing Standards, which fortunately states, when a requirement is not applicable there is no requirement for the auditor to document the reason(s) why the requirement was not performed. For example, in most cases, ASA 508 Enquiry Regarding Litigations and Claims and ASA 500 Going Concern would not be relevant for most SMSF audits, as SMSF assets are rarely involved in legal matters, and are rarely subject to going concern issues, except for defined benefit funds. Therefore, the SMSF auditor does not need to document the reasons why these standards are not required. Hence, this should save time and significantly reduce the documentation required for SMSF audits.

Apply auditing standards at the Administrator level as opposed to fund level

The reality is most controls are set at the SMSF Administrator level. Most SMSF trustees will initially engage an SMSF Administrator to prepare their financial statements and income tax return. The Administrator will then engage a SMSF auditor to audit their funds. In practice the majority of SMSF trustees will have little say or knowledge of who conducts their annual audit. Auditors can save a lot of time by applying auditing standards at the administrator level as opposed to the fund level. For example, ASA 300 Planning an Audit of a Financial Report requires the auditor to perform preliminary engagement activities, including evaluation of their own compliance with ethical requirements, establish and document an overall audit strategy to reduce audit risk, and direct the audit engagement team to execute the audit. It would be more beneficial to apply this standard at the Administrator level as this where most of the fund's controls are. Secondly, it would also be far more efficient as you would not need to prepare a plan for each audit. Therefore, the SMSF auditor would be absolutely right to take advantage of the efficiencies of applying auditing standards at the Administrator level.

Below are other auditing standards the SMSF auditor could apply at the administrator level:

• ASA 200 Objective and General Principles Governing an Audit of a Financial Report
• ASA 220 Quality Control for Audits of Historical Financial Information
• ASA 240 The Auditor's Responsibility to Consider Fraud in an Audit of a Financial Report
• ASA 250 Consideration of Laws and Regulations in an Audit of a Financial Report
• ASA 260 Communication of Audit Matters with Those Charged with Governance
• ASA 315 Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement

Although some auditing standards can be applied at the administrator level other standards do need to be applied to the individual fund being audited. For example, ASA 230 Audit Documentation requires auditors to set up the file in such a way that another auditor, without any previous audit experience can understand the audit procedures performed, and the audit conclusion reached. Clearly this would have to be preformed for each individual fund. Other procedures that could be considered at fund level are:

• ASA 210 Terms of Engagement
• ASA 320 Materiality and Audit Adjustments
• ASA 505 External Confirmations
• ASA 510 Initial Engagement
• ASA 520 Analytical Procedures
• ASA 545 Auditing Fair Value Measurements and Disclosures
• ASA 560 Subsequent Events

Some requirements will need to be applied at the Administrator and fund level. ASA 220 requires the auditor to form an opinion on its compliance with the independence requirements contained in APES 110. The auditor will need to assess whether it satisfies the independence requirements at administrator level, which is particularly important if the Administrator is part of the same audit firm, and whether it is independent of the fund itself. The auditor may conclude they satisfy the independence criteria for the administrator, but don't satisfy the independence requirement of the fund because the trustee is family related. Therefore, the assessment is applied at both levels to satisfy the requirement.

Use a Risk Based Approach

A risk based approach involves gaining an understanding of the risks of an entity and gaining an understanding of how these risks affect the financial statements, and assessing the financial governance arrangement and controls. This is commonly referred to as audit risk, which is defined as the risk of issuing inappropriate opinion on a client's financial statements, for example, issuing an unqualified opinion on financial statements that have been materially misstated. Once the level of audit risk has been identified, the amount of audit work performed can then be varied to match.

The alternative to a risk based approach is to use the same programme (usually based on an extensive checklist) to demonstrate compliance with auditing standards. This approach is less efficient and does not promote thinking, that is "less tick, more think" should be an auditors mantra!

The amount of audit work an auditor performs is tailored to the level of audit risk. ASA 315 - Indentifying and Assessing the Risks of Material Misstatement through Understanding the Entity and its Environment provides mandatory guidance in relation to auditors' responsibility to identify and assess the risk of material misstatement at the financial report and assertion levels.

The following are examples of what the SMSF auditor should look for to determine audit risk:

• Assess the Administrator's experience in preparing financial statements - Some Administrators have a dedicated team to prepare financial statements; others will use staff sparingly to prepare financial statements. This generally depends on the volume of SMSF financial statements they prepare. The greater the volume the more likely a dedicated team is required, and generally the better the reliability and quality of financial statements prepared.
  
• Use past experience as a guide - If you consistently find the same material errors this should increase your audit risk. For example, an Administrator may consistently calculate the tax provision incorrectly because of their lack of income tax knowledge. Hence, past experience of the Administrator will help determine the level of audit risk.
  
• Assess the Administrator's superannuation software - Administrators that use tailored superannuation software like BGL or Super Mate generally provide more reliable financial statements. Financial statements prepared on non-superannuation applications are more prone to errors. Examples of this are where financial statements have been prepared in MS Word and the net assets have been materially misstated due to a formula error in adding balance sheet items.
  
• Assess the relationships the Administrator has with any other external providers - Strong ethical relationships Administrators have with other service providers should provide the auditor with additional assurance over account balances. For example, some Administrators promote the use of Bank Link, this provides additional third party assurance of the SMSF bank account value at 30 June. Conversely, unethical relationships increase the risk of financial statements being material misstated. For example, an Administrator may use the services of an unscrupulous solicitor to provide mortgage type investments which don't exist. This would increase audit risk and therefore the auditor should separately assess integrity of the external service provider to reduce audit risk.
  
• Assess the type of investment associated with the Administrator - It's always surprising that different Administrators generally administer funds with same type investment structure. For example, you could audit 100 funds from one Administrator where a majority of their funds invest only in direct shares and listed managed funds, then audit 100 funds from another where 80% of their funds invest in closely held unit trusts. The reason for this is generally funds are referred and set up by the same service provider, e.g. a financial planners or Accountants. The existence, valuation, rights and obligations is always easier to validate for listed shares than closely held investment trusts. Therefore, different risks are associated with different Administrators.
  
• New rules and regulations may increase audit risk - The ever changing superannuation environment may also increase audit risk. For example, in the May 2006 budget the government introduced transitional measures to cap non concessional contributions to $1 million dollars prior to 1 July 2007. Prior to this date there was a lot activity to transfer property into SMSFs from related parties before the caps were further reduced the following year. Therefore, trustees may have been motivated to transfer property into the Fund at below market value to avoid exceeding the threshold. Hence, legislation change may lead to increased audit risk.

The key here is to take a step back and consider the risks. So many times auditors dive into the audit and go through the motions of ‘flicking and ticking' and forget about the bigger picture, and miss the key risk areas of the audit, or over-audit areas where the risk of misstatement is minimal. Just spending that little bit of extra time to think about the key risks will save you time and you will be able to perform a more effective audit. Remember, less tick more think!

Inherent Nature of SMSF Financial Statements

Because all trustees are required to be members of their own fund, with the exception of single member funds, this should reduce the risk of fraud and material misstatements as you would only be defrauding yourself or related parties. By there very nature a SMSF will generally have lower inherent risk than other type of entities. This is not to say that fraudulent activity does not occur. There have been examples of family disputes where one member withdraws monies from the fund without the knowledge of other members within the fund.

Compliance audit provides some comfort to the financial statement audit

Having a good understanding of the legal and regulatory framework for superannuation funds will assist the SMSF auditor in completing financial statement audits. The most common compliance breaches for SMSFs are in-house assets and providing financial assistance to related parties via loans. The key items on the balance sheet that need to be investigated are debtors and receivable accounts, regardless of materiality levels, as this where most loans are categorised. Having a good understanding of the compliance law will assist the SMSF auditor to target risk areas and reduce audit time. In most instances the completion of the compliance audit will meet the auditor's responsibility in considering laws and regulations as part of the financial statement audit under ASA 250.

GS009 Auditing Self Managed Superannuation Fund

Guidance Statement 009 is a bit of a "forgotten beast" when it comes to auditing SMSF. It is the only publication that links the application of auditing standards to performing an SMSF audit. This publication provides useful guidance on how to apply the auditing standards, how to use audit assertions for classes of transactions, and account balances and disclosures. This guidance statement is currently being redrafted in clarity format.

Conclusion

The application of 40 auditing standards and 500 requirements may seem daunting. However, there are opportunities to implement well thought out standards that are appropriate and compliant. These processes will focus an audit on the right areas of risk for the specific fund and free the SMSF auditor from any unnecessary burdens. Most importantly, the specialist SMSF auditor will reduce the time it takes to complete an audit without compromising on compliance - and reduce costs for SMSF clients.

For more information, contact the WHK Superannuation Audit team:

Chris Malkin, Principal - Superannuation Audit

Sharif Eldebs, Senoir Manager - Superannuation Audit

Phone: 03 9258 6700

All material contained in this flyer is based on opinions, conclusions and forecasts that are reasonably held at the time this flyer was compiled. WHK Pty Ltd (ABN 84 006 466 351) assumes no obligation to update the material to reflect any changes.

WHK Pty Ltd does not provide any warranty regarding the accuracy and completeness of the information in this flyer. No action should be taken solely on the material contained in this flyer as the information is of a general nature and does not take into account personal circumstances. Before acting on any material contained in this newsletter you should seek professional advice.