Logically, the expectations gap could be narrowed in two ways.
(1) Educating users – The auditor's report as outlined in ISA 700 Forming an opinion and reporting on financial statements includes an explanation of the auditor's responsibilities. It is not clear that any further information would help, and it might even have the effect of bringing the value of the audit into question. One suggestion is that auditors could highlight circumstances where they have had to rely on directors' representations.
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(2) Extending the auditor's responsibilities – Research indicates that extra work by auditors with the inevitable extra costs is likely to make little difference to the detection of fraud because:
Most material frauds involve management
More than half of frauds involve misstated financial reporting but do not include diversion of funds from the company
Management fraud is unlikely to be found in a financial statement audit
Far more is spent on investigating and prosecuting fraud in a company than on its audit.
Suggestions for expanding the auditor's role have included:
Requiring auditors to report to boards and audit committees on the adequacy of controls to prevent and detect fraud
Encouraging the use of targeted forensic fraud reviews (see Chapter 14)
Increasing the requirement to report suspected frauds
Chapter Roundup
Professional accountants may have professional liability under statutory law.
Auditors may have professional liability in the tort of negligence.
The auditor owes a duty of care to the audit client automatically under law.
The auditor only owes a duty of care to parties other than the audit client if one has been established.
Auditors may attempt to limit liability to clients. This may not always be effective in law.
ACCA requires that auditors take out professional indemnity insurance.
Auditor liability is an important practical issue.
Misunderstanding of the auditor's responsibilities in respect of fraud is a major component of the 'expectations gap'.
The 'expectations gap' can be narrowed either by educating the users of audited financial statements, or by extending the auditor's role.
Quick Quiz
1 Define fraud.
2 Draw a table showing the reporting requirements of ISA 240 The auditor's responsibilities relating to fraud in an audit of financial statements.
3 What three matters must an injured party satisfy to the court in an action for negligence?
(1) ...
(2) ...
(3) ...
4 Name four aspects of litigation avoidance.
(1) ...
(2) ...
(3) ...
(4) ...
5 Professional indemnity insurance is insurance against liability arising through any acts of fraud or dishonesty by partners in respect of money held in trust by the firm.
True False
Answers to Quick Quiz
1 Fraud is the use of deception to obtain unjust or illegal financial advantage and intentional misrepresentation by management, employees or third parties.
2 Management If the auditors suspect or detect any fraud (even if immaterial) they should tell management as soon as they can.
Those charged with governance If the auditor has identified fraud involving management, employees with significant roles in internal control, or others, if it results in a material misstatement, they must report it to those charged with governance.
Third parties Auditors may have a statutory duty to report to a regulator. Auditors are advised to take legal advice if reporting externally to the company.
3 (1) A duty of care existed (2) Negligence occurred
(3) The injured party suffered pecuniary loss as a result 4 (1) Client acceptance procedures
(2) Performance of audit work in line with ISAs
(3) Quality control
(4) Disclaimers
5 False. That is fidelity guarantee insurance. Professional indemnity insurance is insurance against civil claims made by clients and third parties arising from work undertaken by the firm.
Now try the questions below from the Practice Question Bank.
Number Level Marks Time
Q4 Examination 15 27 mins
Q5 Examination 20 36 mins
Practice management
P A R T
C
Topic list Syllabus reference 1 P ri nciples and purpose C1 2 Quality control at a firm level C1 3 Quality control on an individual audit C1
Quality control
Introduction
The role performed by auditors represents an activity of significant public interest. Quality independent audit is crucial, both to users and to the audit profession as a whole. Poor audit quality damages the reputation of the firm and may lead to loss of clients and thus fees, as well as an increased risk of litigation and concomitant professional insurance costs.
Although there are specific standards giving guidance on how auditors should perform their work with satisfactory quality, these can never cater for every situation. Two standards deal with quality at a general level. These are ISQC 1 Quality control for firms that perform audits and reviews of financial statements, and other assurance and related services engagements, and ISA 220 Quality control for an audit of financial statements.
Study guide
Intellectual level C1 Quality control
(a) Explain the principles and purpose of quality control of audit and other assurance engagements.
1 (b) Describe the elements of a system of quality control relevant to a given firm. 2 (c) Select and justify quality control procedures that are applicable to a given
audit engagement.
3 (d) Assess whether an engagement has been planned and performed in
accordance with professional standards and whether reports issued are appropriate in the circumstances.
3
Exam guide
Issues relating to quality control can be linked with almost any area of the P7 syllabus, from ethics and auditor liability covered in Part B to any of the specific areas covered in Part D of this Study Text. You could be asked to suggest quality control procedures that a firm should implement in specific
circumstances; to review a firm's procedures and assess their adequacy; or to assess procedures planned or performed, and evidence obtained, for a specific engagement.
1 Principles and purpose
There is no simple definition of audit quality because there is no one 'correct' way to audit. It is often a matter of conducting an audit in line with the spirit as well as the letter of professional guidance.
Audit quality is not defined in law or through regulations, and neither do auditing standards provide a simple definition.
Although each stakeholder in the audit will give a different meaning to audit quality, at its heart it is about delivering an appropriate professional opinion supported by the necessary evidence and judgements.
Many principles contribute to audit quality, including good leadership, experienced judgement, technical competence, ethical values and appropriate client relationships, proper working practices and effective quality control and monitoring review processes.
The standards on audit quality provide guidance to firms on how to achieve these principles.
2 Quality control at a firm level Pilot, 6/09, 12/11, 6/14
The International Standard on Quality Control (ISQC 1) helps audit firms to establish quality standards for their business.
The fact that auditors follow international auditing standards provides a general quality control framework within which audits should be conducted. There are also specific quality control standards.
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