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sophisticated but effective controls. Supervisory controls exercised on a day-to-day basis by the owner-manager may also have a significant beneficial effect as the owner-manager has a personal interest in safeguarding the assets of the entity, measuring its performance and controlling its activities.
.16 The owner-manager occupies a dominant position in a small entity. The owner-manager’s direct control over all decisions, and the ability to intervene personally at any time to ensure an appropriate response to changing circumstances, are often important features of the management of small entities. The exercise of this control can also compensate for otherwise weak internal control procedures. For example, in cases where there is limited segregation of duties in the area of purchasing and cash disbursements, internal control is improved when the owner-manager personally signs all cheques. When the owner manager is not involved, there is a greater risk that employee fraud or error may occur and not be detected.
.17 While a lack of sophistication in internal controls does not, of itself, indicate a high risk of fraud or error, an owner-manager’s dominant position can be abused: management override of controls may have a significant adverse effect on the control environment in any entity, leading to an increased risk of management fraud or material misstatement in the financial report. For example, the owner-manager may direct personnel to make disbursements that they would otherwise not make in the absence of supporting documentation.
.18 The impact of the owner-manager and the potential for management override of internal controls on the audit depend to a great extent on the integrity, attitude, and motives of the owner-manager. As in any other audit, the auditor of a small entity exercises professional scepticism. The auditor neither assumes that the owner-manager is dishonest nor assumes unquestioned honesty. This is an important factor to be considered by the auditor when assessing audit risk, planning the nature and extent of audit work, evaluating audit evidence, and assessing the reliability of management representations.
Commentary on the Application of Auditing and Assurance Standards
.19 The commentary that follows provides guidance on the application of AUSs to the audit of a small entity. This guidance is a supplement to, and not a substitute for, the guidance contained in the relevant AUS and takes account of the special considerations relevant to the audit of small entities. For the specific requirements of AUSs, the auditor refers to the AUS concerned. Where an AUS is, in principle, applicable to the audit of the financial report of small entities and there are no special considerations applicable to the audit of a small entity, no guidance is given in respect of that AUS.
AUS 204: Terms of Audit Engagements
.20 In many cases, owner-managers of small entities are not fully aware of their own responsibilities or those of their auditors. In particular, owner-managers may not appreciate that the financial report is their responsibility, particularly where the owner-manager has outsourced the preparation of the financial report.
.21 One of the purposes of an engagement letter is to communicate clearly the respective responsibilities of the owner-manager and the auditor. The Appendix to AUS 204 provides an example of an audit engagement letter.
.22 Paragraph .06 of AUS 204 states that the auditor may