In our previous discussion, we explored the responsibilities of external auditors under ISA 200 and how the outsourcing of key functions can influence financial statement audits. In this installment, we delve deeper into ISA 402, a crucial standard in the realm of auditing, focusing on its objectives, scope, and key definitions.
Objectives of ISA 402:
The International Standards on Auditing (ISAs) establish a framework for consistent and rigorous auditing practices. When a user entity engages the services of a service organization, ISA 402 outlines specific objectives for the user auditor:
1. Understanding of Services: The first objective is to obtain a comprehensive understanding of the nature and significance of the services provided by the service organization. This understanding is crucial to provide an appropriate basis for identifying and assessing the risks of material misstatement in the user entity’s financial statements.
2. Audit Procedures: The second objective is to design and perform audit procedures that are responsive to the identified risks. These procedures are tailored to ensure the audit effectively addresses the impact of service organization involvement on the financial statement audit.
Key Definitions:
To navigate the complexities of ISA 402, it’s imperative to comprehend key terms within the standard:
1. Complementary User Entity Controls: These are controls that the service organization assumes will be implemented by user entities. These controls are critical for achieving control objectives and should be identified in the description of the service organization’s system.
2. Type 1 Report: This report is comprised of two components:
– A description prepared by the service organization’s management of the service organization’s system, control objectives, and related controls as of a specified date.
– A report by the service auditor that aims to convey reasonable assurance regarding the description, the suitability of control design for achieving specified control objectives, and the service auditor’s opinion on these elements.
3. Type 2 Report: Similar to a Type 1 report, a Type 2 report includes a description of the service organization’s system, control objectives, and related controls. However, it also encompasses their design and operating effectiveness over a specified period. The service auditor’s report provides assurance on these elements.
4. Service Auditor: The service auditor is an auditor engaged by the service organization to provide an assurance report on the controls of the service organization.
5. Service Organization: This refers to a third-party organization or a segment of such an organization that provides services to user entities. These services are relevant to those entities’ information systems concerning financial reporting.
6. Service Organization’s System: This includes the policies and procedures established, implemented, and maintained by the service organization. These policies and procedures are designed to provide user entities with the services covered in the service auditor’s report.
7. Subservice Organization: This term relates to a service organization employed by another service organization to execute some of the services provided to user entities concerning their information systems relevant to financial reporting.
8. User Auditor: The user auditor is responsible for auditing and reporting on the financial statements of a user entity.
9. User Entity: A user entity is an entity that utilizes the services of a service organization and is the subject of the financial statement audit.
What to Anticipate in the Next Episode:
In the upcoming discussion, we will delve into the specific requirements of adopting ISA 402, including the assessment of the risk of material misstatement. We will also provide a more in-depth exploration of the types of reports (Type 1 and Type 2) as specified in the standard. Additionally, we will uncover the application and other explanatory materials that further clarify the intricacies of ISA 402.
As we continue our journey into the world of auditing and financial reporting standards, stay tuned for a comprehensive understanding of how ISA 402 plays a pivotal role in ensuring the integrity and reliability of financial statements within the context of service organizations.
Conclusion:
ISA 402 is a crucial component of the International Standards on Auditing, with clear objectives to guide user auditors in the face of service organization involvement. Understanding the key terms within this standard is vital for auditors and stakeholders alike. In the upcoming discussions, we will explore the practical application of ISA 402 and its significance in maintaining the quality and trustworthiness of financial statements.