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Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Introduction: An overview of the current a

Auditing and Assurance

Services in Australia

By Grant Gay and Roger Simnett

Slides prepared by Roger Simnett Copyright © McGraw-Hill 2006

Copyright  2006 McGraw-Hill Australia Pty Ltd

Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett

Part One

The Auditing and Assurance Services

Profession

Chapter 1 Assurance and Auditing:

An Overview

Copyright  2006 McGraw-Hill Australia Pty Ltd

Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett

Introduction: An overview of the current

auditing environment

• 2001-2003 Developments:

– Resultant crisis of confidence in financial system:

 Numerous corporate collapses (Enron, HIH, One.Tel etc)

 Collapse of major auditing firm (Arthur Andersen)

 Auditor value questioned during this period.

An overview of the current auditing

environment

• 2004-2006 Developments:

– The auditing profession has gone from strength to

strength.

– Society’s need for a strong, independent auditing

profession has been recognised.

– There have been many legislative and professional

developments aimed at ensuring (or even increasing) the auditor’s professional competence and independence.

Copyright  2006 McGraw-Hill Australia Pty Ltd

Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett

Overview of the current auditing environment

(Cont.) - some overall developments

• A framework for all assurance services, not just

financial statement audit

• Greater independence in the standard-setting process

• Legislation aimed at improving professional

competence and independence

• Revised auditing standards for financial statement

audits

• Corporate governance and ethics - initiatives

All these issues and others will be covered in this

course

The Assurance Framework

• Many parties provide reports to users as an aid in

• Financial statements are just one type (the most

common type) of report that can be assured

Learning Objective 1:

Copyright  2006 McGraw-Hill Australia Pty Ltd

Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett

The objective of assurance engagement

• Assurance engagement:

‘An engagement in which a practitioner expresses a

conclusion designed to enhance the degree of confidence of the intended users other than the responsible party about the outcome of the evaluation or measurement of a subject

matter against criteria’

• International Framework / AUS 108 para.7

The objective of assurance engagement

Copyright  2006 McGraw-Hill Australia Pty Ltd

Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett

Five elements of assurance engagement

• Sufficient appropriate evidence

• Written assurance report

Why is there value in the assurance

service?

• Independence: users derive value from the knowledge that a member of the profession has no interest in the information other than for its usefulness

• Expertise: assurers must have the competence to

obtain sufficient relevant information to provide a

reasonable basis for their conclusions

Copyright  2006 McGraw-Hill Australia Pty Ltd

Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett

Structure of Assurance Standards and

Pronouncements

Learning Objective 2:

Force of Law Auditing Standards

(1 July 2006)

• For such audits, the Australian Auditing Standards is

now be designated as ASA’s, and will have to same

numbering as the equivalent ISA’s

• For such reviews, the Australian Auditing Standard AUS

902, is now designated as Australian Standard on

Review Engagements ASRE2410, equivalent to the

International Standard on Review Engagements ISRE 2410

The force of law auditing standards apply to all audits and reviews of Corporations Act 2001 financial reports that

commence on or after 1 July 2006, (these would be under the left branch of figure 1.2):

Copyright  2006 McGraw-Hill Australia Pty Ltd

Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett

Reasonable assurance

Copyright  2006 McGraw-Hill Australia Pty Ltd

Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett

Limited assurance

Level of assurance on financial statements

• Reasonable assurance engagements are called audit engagements

• Reasonable assurance = high assurance,

positive expression of opinion

• Limited assurance engagements are called review

engagements

• Limited assurance = moderate assurance,

negative expression of opinion

• There are also engagements that provide no

assurance Agreed-upon procedures engagements, report of factual findings

Copyright  2006 McGraw-Hill Australia Pty Ltd

Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett

Attest v direct reporting

• Audit and review engagements can involve either an attest or a direct reporting engagement

• Attest engagement - auditor issues an opinion on

written assertions made by party responsible for the

Auditing Defined

• A Statement of Basic Auditing Concepts (ASOBAC)

(American Accounting Association) defines auditing as:

– A systematic process of objectively obtaining and

evaluating evidence regarding assertions about economic actions and events to ascertain the degree of

correspondence between those assertions and

established criteria, and communicating the results to

interested users.

Learning Objective 3:

Copyright  2006 McGraw-Hill Australia Pty Ltd

Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett

Auditing Defined (Cont.)

• The important parts of this definition:

– Systematic process — audits are structured activities;

– Objectivity — freedom from bias;

– Obtaining and evaluating evidence — allows the auditor to determine the support for assertions or representations;

– Assertions about economic actions and events —

describes the subject matter of an audit;

– Degree of correspondence…established criteria — the purpose of the audit is to determine conformity with some specified criteria; and

– Communicating results — the results must be

communicated to interested parties.

Fundamental Principles Underlying an

Audit

• In 2005 the International and Australian Auditing

Standards Boards released a draft consultation paper in which they outlined possible fundamental principles

underlying an audit These principles should:

– underpin the objective(s) of an audit, and help drive the conduct of the auditor in using professional judgment to meet the professional requirements of the auditing

standards;

– be easily understood both by auditors and other readers

of auditing standards;

– be universally applicable to all audits; and

– entrench the expectations that auditors are expected to accept and abide by.

Learning Objective 4:

Copyright  2006 McGraw-Hill Australia Pty Ltd

Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett

Draft ethical principles

Draft auditing principles

Copyright  2006 McGraw-Hill Australia Pty Ltd

Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett

Attributes of Accounting Information

• From AASB/IASB framework:

Demand for Assurance

• Demand arises because users are not in a position to establish the credibility of the information they are

presented with This may be due to:

– Conflict of interest — managers may present biased

information as they are also evaluated on the information; – Consequence — information provided forms the basis of many users’ decisions;

– Complexity — many users do not have the expertise

required to determine the quality of information presented; and

– Remoteness — the separation of owners from

management prevents users from assessing information quality.

Learning Objective 6:

Copyright  2006 McGraw-Hill Australia Pty Ltd

Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett

Hypotheses relating to demand assurance

1 Agency theory (stewardship hypothesis);

2 Information hypothesis; and

3 Insurance hypothesis

Agency theory

Copyright  2006 McGraw-Hill Australia Pty Ltd

Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett

History of the Audit Function

• Audits have been performed since at least the thirteenth century

• Until the early 1900s, audits focused on the company’s solvency and the detection of fraud and error

• Audits from early 1900s to 1940s: added objectives of verification of financial report accuracy and attestation

to financial report credibility

• Since the 1940s: the overall objective of auditing has been the expression of an opinion as to whether the

financial report is materially misstated

Learning Objective 7:

Audit approaches since the 1940s

• These have evolved over time:

– Balance-sheet approach — this involved the auditor

auditing the assets and liabilities with little emphasis on profit and loss account items.

– Transactions cycle approach — this emphasised the

review of controls which operated within each transaction cycle and provided for limited testing of balance sheet items.

Copyright  2006 McGraw-Hill Australia Pty Ltd

Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett

More recent audit approaches

• Financial risk analysis approach — the auditor

considers relative financial risk and materiality in

planning the audit, such that audit work is concentrated

in areas where there is a higher risk of misstatement

• Business risk approach (current audit approach) — as well as financial risk, the auditor considers business

strategy, associated business risks, and management’s plans to respond to changes in the business

environment

The Auditor-Client-Public Relationship

• The auditor’s primary reporting responsibility is to

resource providers of the client entity, however the

client entity usually engages the auditor and pays the auditor’s fees

• The auditor also discusses the audit findings with

management prior to releasing information to the

resource providers

• In order to combat pressures on independence and

objectivity, the auditing profession has issued a series

of ethical rulings and professional standards to guide the auditor in the conduct of his/her duties

Learning Objective 8:

Copyright  2006 McGraw-Hill Australia Pty Ltd

Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett

The Expectation Gap

• This is defined as: ‘the gap between society’s

expectations of auditors and auditors’ performance as perceived by society.’

• There are three components of this expectation gap:

– The reasonableness gap between what society expects auditors to achieve and what they can reasonably be

The gap between audit expectation and

audit performance

Copyright  2006 McGraw-Hill Australia Pty Ltd

Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett

Four major issues in the expectation gap

• The nature and meaning of audit report messages;

• Early warning by auditors of corporate failure;

• Auditor’s responsibility for the detection and reporting of earnings management and fraud; and the

• Auditor’s ability to communicate different levels of

assurance

The Role of Auditing Standards

• Auditing standards (AUSs/ASAs) in Australia are developed

by the Auditing and Assurance Standards Board (AUASB)

• Prescribe the basic principles and essential procedures

which govern the conduct of an auditor.

• For audits conducted under the Corporations Act 2001 the auditing standards must be applied, therefore giving them legal authority.

• Are applicable to all other audits, adapted as necessary

(APS 1.1/APES 410)

• Failure to observe these standards may expose a member

to investigation and disciplinary action from the Australian Securities and Investments Commission (ASIC).

Learning Objective 10:

Copyright  2006 McGraw-Hill Australia Pty Ltd

Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett

Force of Law Auditing Standards

(1 July 2006)

Force of law auditing standards apply to audits and

reviews of financial reports prepared in accordance with the Corporations Law and commencing on or after 1

July 2006:

• For audits, the Australian Auditing Standards are now designated as ASA’s, and have the same numbering as the equivalent ISA’s (there are thirty four ASA’s),

• There are still 10 AUS’s which predominantly relate to frameworks (e.g AUS’s 106, 108, 110) or assurance engagements on other than financial reports prepared

in accordance with the Corporations Act (e.g AUS’s

804, 806, 808, 810, 904)

Force of Law Auditing Standards: ASA’s

ASAs consist of paragraphs that are either mandatory

requirements, identified in bold-type (black lettering); or explanatory guidance, identified in normal-type (grey lettering)

• There has been little change in the detail of the auditing standards in the conversion of AUS’s to ASA’s The

AUASB carefully reviewed the standards in order to

identify any “implied imperatives” (black letter

requirements hidden in the grey lettering)

• The term “shall” (for example, the auditor shall…) is

used to indicate mandatory requirements in ASA’s,

instead of the term “should” which is used to indicate such requirements in AUS’s

Copyright  2006 McGraw-Hill Australia Pty Ltd

Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett

AGSs and AAAs

• Auditing Guidance Standards – provide guidance on procedural matters or industry specific issues, but do not establish new principles or amend existing

standards

• Audit and Assurance Alerts – bring matters of

significant and immediate concern to auditor’s attention

Audits Under the Corporations Act 2001

• Management is responsible for the preparation and

presentation of appropriate accounts Accounts are to

be accompanied by a report of an independent auditor appointed by the shareholders

• The Corporations Act 2001 (ss 292-306) indicates that directors must prepare a financial report (income

statement, balance sheet, statement of changes in

equity cash flow statement, directors’ declaration and other related notes and reports) together with any other information or explanation necessary to give a true and fair view

Learning Objective 11:

Copyright  2006 McGraw-Hill Australia Pty Ltd

Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett

Auditors’ responsibilities under the

Corporations Act 2001

• Auditors are responsible for reporting to company

members on the directors’ financial report that was

presented at the AGM They say whether the financial report:

– is in accordance with the law, including compliance with accounting standards (s 296).

– provides a true and fair view (s 297).

Other Applications of the Assurance

Function

• Evidence-gathering methods of auditing are also employable

in the audit of activities other than financial reports.

• Compliance audit — examination for the purpose of reporting

on legality and control of operations.

• Performance audit — analyses organisation structure,

internal systems, work flow, and managerial performance: efficiency, effectiveness and economy of these items

• Comprehensive audit — usually includes components of

compliance, performance and financial report audits.

• Internal audit — audits performed by employees of the entity

as a part of the entity’s risk management process.

• Forensic audit — associated many times with fraud detection.

Learning Objective 12: