&

Auditing
Assurance
Services(M)
Semester 1 2019

UNIVERSITY OF ADELAIDE
Semester 1: 2019 - Lecture 1
BUSINESS SCHOOL Introduction to Auditing
Dr Phil Saj PhD CPA
University of Adelaide 2

Overview of Lecture 1
1: Definition of an audit.
(And what does an audit provide?)
2: Overview of an audit.
AUDITING
3: Reasons for an audit. DEFINED
4:The legal and professional context.
5: The concept of assurance.

University of Adelaide 3 University of Adelaide 4

1: Auditing Defined Auditing Defined

(American Accounting Association, 1973, cited in Leung et al., 2019, p.3)

■ systematic process
“ A systematic process of objectively obtaining
■ objectively obtain and evaluate evidence
and evaluating evidence regarding assertions
■ about assertions concerning economic
about economic actions and events to actions and events
ascertain the degree of correspondence ■ ascertain the degree of correspondence
between those assertions and established between those assertions and established
criteria
criteria and communicating the results to
interested users.”
■ communicate the results to interested users
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 Systematic process Objectively obtain and evaluate
evidence
■ Four phases of an audit
■ Client acceptance/ continuance ■ Objective
■ free from bias
■ Plan the audit
■ auditor must be independent
■ Perform audit tests
■ exercise professional judgement
■ Complete the audit and report
■ exercise professional scepticism
■ Prescribed and guided by: ■ Obtain evidence by applying accepted
■ auditing standards, procedures and processes (audit tests)
■ the code of ethics and
■ legislation ■ Draw conclusions based on what the
evidence suggests
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Auditor Independence Professional Scepticism

“...the state of mind that permits the ￭ “An attitude that includes a questioning
provision of an opinion without being mind and a critical assessment of audit
affected by influences that compromise evidence. The auditor should not assume
professional judgment, allowing the that management is either honest nor
individual to act with integrity, and dishonest.”
http://www.accountingconcern.com/accounting-dictionary/professional-skepticism/
exercise objectivity and professional [accessed July 17 2013]

scepticism.” [APES 1110.2]

Sales increased Leases have been

Professional Judgement
by 10% this year correctly classified
“…the application of relevant training,
knowledge and experience, within the
Plant and Trade
equipment Show me the creditors are context provided by auditing, accounting and
is valued valued at
at $50m
evidence $6m ethical standards, in making informed
decisions about the courses of action that are
The discount rate used appropriate in the circumstances of an audit
The current ratio is 1.4 in determining NPV of
cash flows was 4% engagement.”
AUASB Glossary

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 Professional Judgement
■ the application of relevant training knowledge
and experience
■ within the context provided by auditing,
accounting and ethical standards
■ making informed decisions about courses of
action
■ in the circumstances of an audit engagement
Audit evidence
“Information used by the auditor in arriving
at the conclusions on which the auditor’s
opinion is based. Audit evidence includes
both information contained in the
accounting records underlying the financial
report and other information.” [AUASB Glossary]

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Lecture Illustration: Audit Evidence Audit Evidence

Extract from Income Statement of Ace Pty Ltd at 30/6/2017
$ $ $
Sales
Ledger Account (ABC Ltd)
ABC Ltd Tax Invoice No. 00231
6,000 Date: June 24 2017 (copy 2)
12,000 Sales Accounts Receivable
18,000 36,000 Deliver To:
To: XYZ Ltd
6,000 6,000
Interest received 1,000 Account Customer Salesperson
Other Income 2,000 Order No. J.L.
241
Total Income 39,000 4537
Sales Journal (ABC Ltd)
COGS 18,000 Code Description Qty Price Total
Date Description Debit Credit
Finance Expense 2,000
Depreciation Expense 1,500 24/6 Accounts Rec $6,000 34 TV 10 $600 $6,000
Other Expenses 500
Total Expenses 22,000 Sales $6,000
Delivery Instructions: Amount $6,000
To record a credit sale of 10 TVs
Ship on June 24 2017 Due
Profit (Loss) 17,000
University of Adelaide 15 University of Adelaide 16

Types of Audit Evidence About assertions concerning

economic actions and events
￭ Accounting information system
￭ Documentary evidence ■ Financial Statements
■ a set of assertions made by the board
￭ Third party representations
about the entity’s economic performance
￭ Physical evidence and position
￭ Computations ■ that claim to truthfully and fairly depict the
underlying economic reality
￭ Data interrelationships
￭ Client representations
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Ascertain the degree of correspondence Lecture Illustration: Assertions
between those assertions and Extract from Balance Sheet of Ace Ltd at 30/6/2017
established criteria
$m
■ In a financial statement audit, the accounting Cash 205
standards are the established criteria. Receivables 45
Inventory 16
■ Evaluate/ test Other 70
Current assets 336
■ Key questions
■ are the accounting treatments valid? PP&E. 1200
Intangible assets 670
■ are estimates reasonable? Deferred tax assets 100
Other 45
■ are the disclosures appropriate? Non-current assets 2015
Total assets 2351
■ what is material?
University of Adelaide 19 University of Adelaide 20

Lecture Illustration: Assertions Ascertain the degree of correspondence

between those assertions and
￭ Assets
Current Assets established criteria
Inventory…$16,000,000 ■ What accounting treatment has been
￭ In recognising this item, management is asserting: applied?
￭ The inventory exists
■ What is required by the accounting
￭ It is correctly valued
standards?
￭ All inventory is included (the record is complete)
￭ The entity has the right to it (owns the inventory) ■ Example:
￭ Inventory has been properly classified and the ■ Inventory shall be measured at the lower
necessary disclosures have been presented. of cost and NRV (AASB102.9)
￭ The auditor tests these management assertions.
21 University of Adelaide 22

Ascertain the degree of correspondence

between those assertions and established Communicate the results to
criteria (continued) interested users
￭ The audit test (lower of cost and NRV) ■ The audit report
￭ Identify the inventory
■ Written report
￭ Ascertain existence and condition of inventory
￭ Attend stock take - inspect and inquire ■ To members/ shareholders
￭ Ascertain market price ■ Format specified
￭ Client’s price list and/ prices of competitors ■ States the audit opinion (and also includes
￭ Ascertain costs of selling the inventory other information for the reader)
￭ Compare ■ The audit opinion is based on the application
￭ Decide: is the inventory fairly stated, or is an of the auditing standards, the code of ethics,
adjustment required? and any relevant legislation. (see example)
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 Summary: Auditing Defined A Financial Statement Audit
■ systematic process
Financial Members/
■ objectively obtain and evaluate evidence Board Statements Shareholders
■ about assertions concerning economic
actions and events Audit
External Auditor
Report
■ ascertain the degree of correspondence
Determine what is sufficient
between those assertions and established appropriate evidence
criteria (Auditing Standards)

■ communicate the results to interested users Suitable criteria

(Accounting Standards)
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University of Adelaide 25

The Financial Statement Audit

(Hogget, Edwards and Medlin, 2003, p. 15)

“ An independent examination of an entity’s WHAT DOES

financial statements, supporting documentation
and records, in order to form an opinion as to
AN AUDIT
whether the financial reports comply with certain
levels of quality, as specified in the accounting
PROVIDE?
standards, and present a true and fair view of
the entity’s financial performance and position.”

University of Adelaide 27 University of Adelaide 28

The responsibility of the auditor for

auditing the financial report What Does an Audit Provide?
“The auditor provides... an opinion on whether the financial ANSWER
information is presented fairly…in conformance with the basis ■ An audit provides assurance.
of accounting indicated. The auditor…carries out audit
■ Not a guarantee.
procedures that… enable him or her to provide this high level
of assurance about the reliability of management ■ An opinion based on the application
representations in the financial statements. The auditor tests of judgement.
the data underlying the entity’s financial statements and the
systems generating that data to obtain evidence that…
■ Comfort
provides the basis for the auditor’s opinion whether the ■ “What you see is what you get”
financial statements are free from material misstatement.”
(Understanding Financial Statement Audits: a guide for Financial Statement Users, Ch. 3 ) ■ Reduced information risk
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 The Concept of Assurance
“An engagement in which an assurance OVERVIEW
practitioner expresses a conclusion
designed to enhance the degree of
OF AN
confidence of the intended user…about AUDIT
the outcome of an evaluation or
measurement of a subject matter against
criteria.” [ AUASB Glossary]

University of Adelaide 31 University of Adelaide 32

2: Overview of an audit Perform Risk Assessment Procedures

Shareholders
i Perform risk assessment procedures Economic
Governance, Regulators
Management and
ii Assess risk of material misstatement Lenders
Internal Control Employees
General Cash
iii Respond to assess risks Social/
Sales &
Capital Payroll & Market
Collection Personnel
Acquisition
Cultural Activity
Activity Activity
iv Perform further audit procedures Suppliers
Purchases &
Payment
v Evaluate audit evidence Activity
Technology
Community Inventory &
Warehousing
vi Communicate audit findings Industry Activity
Customers
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Assess the Risk of Material

Respond to Assessed Risks
Misstatement
■ Develop an audit strategy and program
Business Risk
■ Staffing
Risk of material Risk of material
■ Nature of audit tests
misstatement due to misstatement due to
inherent risk factors failure of internal ■ Timing of audit tests
controls
■ Extent of audit tests
Accounts at risk of material
misstatement
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Perform Further Audit Procedures Evaluate Audit Evidence
￭ Additional Risk Assessment Procedures
■ Results of tests
￭ Audit Tests
￭ Test the effectiveness of internal controls. ￭ Knowledge gained while undertaking the
￭ Test the validity of accounting audit
treatments and disclosures. ￭ Management responses
￭ Application of audit procedures
￭ Criteria (Accounting Standards)
￭ Based on sufficient appropriate evidence

University of Adelaide 38

Communicate the Findings

REASONS
￭ Audit Opinion
FOR AN
￭ Audit report
AUDIT
￭ Other communications

University of Adelaide 40

3: Reasons For an Audit The economic demand for

financial statement audits
■ The economic demand for audits
■ Monitor an agency relationship
■ The benefits of an audit
■ Reduce information risk
■ Statutory requirements

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 The Agency Relationship The Agency Relationship

Provision of
■ Principal and agent capital

■ Different interests/ horizons Investors Managers

■ Information asymmetry

Provide financial
Obtain audit
reports

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Information Risk Causes of information risk

■ Remoteness of information
“The risk that information on
■ Biases and motives of the provider
which a business decision is
made is inaccurate” ■ Voluminous data
[Arens et al., 2013, p.10]
■ Complexity of exchange transactions

University of Adelaide 45 University of Adelaide 46

Remoteness of information Biases and motives of the provider

■ Only management/ board have direct
■ A financial report, is to some extent,
access to accounting and other
a report on the performance of
information.
management and/ or the board.
■ Other parties make decisions based on
information about the entity. ■ Inconsistent objectives.

■ They are reliant on management and ■ Wanting to appear as well-performed

unable to directly assess the quality as possible.
of the information.
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 Voluminous information Complexity of exchange transactions

■ Large organisations with many

■ Hybrid financial instruments
transactions.
■ Cross-jurisdictional transactions
■ Possibility of error.

■ Aggregate of many small errors. ■ Taxation issues

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The benefits of an external audit Obtain access to capital markets

■ Obtain access to capital markets.

■ Requirements of Corporations Act
■ Have a lower cost of capital for public companies

■ A deterrent to inefficiency and fraud ■ ASX requirement for listed companies

■ Control and operational improvements ■ Investor protection

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Lower cost of capital Lender

■ Rate of interest charged by lender is Borrower A Borrower B

proportional to risk. Financial Statements Financial Statements
xxxxxx xIndependent
xxx x xxx x xxx x
Auditors xxxxxx x xxx x xxx x xxx x
■ Lender faces information risk when xxxxxx x xxx xxxReport
xxxxx xx xxxxxx x xxx xxx xxxxx xx
evaluating information supplied by xxx xxxxxxx x xxxxxx
xxx x xxxx x xxx
xx xxxxxx x xxxx xxx x xxx x xxxx xxx xx xx
xxxxxx
xxxxxxx xxxx xxx
xxxxxxx
xx xxxxx
x xx xx xxx
borrower. xxx x xxxx xxxx
xxxx
xxxxxxx xxx xxxx xx x xx
xxxxx xxxxx xxxxx xx x xxxx
xxxx xxxxx xxxxx x xxx xx xxxx
xxxxxxx
xxx xxx xxxx xx x xxx
x xxxx xxxx
■ Audit reduces information risk to lender xx xxx x xxxx
xxxxx x xxx xx xx xxxxx xxx x
xxxx xxx xx xxx x xxxx xxx

and therefore interest rate charged. Signed……Date: xx/xx/xxxx

xxxx xxx xx xxx x xxxx xxx

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Risk/ Return Trade-Off for a Lender Deterrent to inefficiency
and fraud

Required ■ People take greater care if they know

Return there work will be checked.

■ Likely of fraud reduces where

likelihood of detection increases.
Audit Report No Audit Report

Expected Risk
University of Adelaide 56

Control and operational Statutory requirements for

improvements financial statement audits
■ Corporations Act
■ Auditor gains good understanding of ■ Public interest entity
the client’s business. ■ Proprietary companies
■ Large
■ Understands client’s industry. ■ Small
■ Companies limited by guarantee
■ Can suggest improvements.
■ Other Acts
■ Especially internal control matters. ■ ACNC Act
■ State Associations Incorporation Acts
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Audit and Review Requirements

(Corporations Act 2001) Users of Audited Financial Reports
Entity Type FR Required Audit/ Review Conditions
Current
Public Interest Entity
shareholders
Disclosing, Public Yes s292(1) A s30(1) RCA s324BA Future
Co. Reg. Scheme Management shareholders
Proprietary Company
Large Yes s292(1) A unless exempted RCA unless
s301(1) approved s324BD
Audited
Small If directed s292(2) If directed s301(2) RCA unless Employees Government
financial report
approved s324BD
Company Limited by Guarantee
Rev. > $1m. Yes s292(1) A s30(1) RCA s324BA
Rev>$250,000 Yes s292(1) A if requested A: RCA Bankers Public
otherwise R s301(3) R: other s324BE
Rev < 250,000 If directed s292(3) A or R if directed A: RCA Creditors
R: other s324BE

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 4: The Ethical, Professional and Legal
Framework within which Audits are
THE ETHICAL, Conducted
￭ Fundamental ethical principles
PROFESSIONAL ￭ Auditor independence
￭ Professional judgement
AND ￭ Professional scepticism
LEGAL FRAMEWORK ￭ Membership of a professional body
￭ Code of ethics
￭ Legal requirements
University of Adelaide 61

Fundamental Principles APESB Pronouncements

Code of Ethics for Professional Accountants
Underlying an Audit (‘APES 100’ series)
Professional standards applicable to all
￭ Integrity members (‘APES 200’ series)

￭ Objectivity Professional standards applicable to members

in public practice (‘APES 300’ series)

￭ Professional competence and Professional standards applicable to members

in business (‘APES 400’ series)
due care
Guidance Statements – Members in Public Practice
￭ Confidentiality Guidance Statements- Members in Business

￭ Professional behaviour Guidance Statement-All Members

Australian Auditing Standards

Legislative Framework
ASQC1 Quality Control
Corporations Act
ASA 100-199 Introductory Matters
Registration of Auditors
ASA 200-299 General Principles and Responsibilities
Audit Requirements for Companies
ASA 300-499 Risk Assessment and Response
Regulation of Auditing
to Assessed Risks

ASIC Act ASA 500-599 Auditing Evidence

Authority for FRC and ASIC ASA 600-699 Using the Work of Others

Role of FRC ASA 700-799 Audit Conclusions and Reporting

AUASB and Auditing Standards ASA 800-899 Specialised Areas

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 The Ethical, Legal and Professional
Framework within which Audits are
Conducted THE
Society/ The Economy
CONCEPT OF
Ethical Framework Legal Framework
Membership of a Professional Body ASSURANCE
Application of auditing standards
through exercising professional
judgement

University of Adelaide 68

5: The Concept of Assurance An Assurance Engagement

“An engagement in which an assurance Responsible Subject

Intended user
practitioner expresses a conclusion party Matter

designed to enhance the degree of Assurance

Assurance provider
confidence of the intended user…about Report

the outcome of an evaluation or Sufficient

appropriate evidence
measurement of a subject matter against
criteria.” [ AUASB Glossary] Suitable criteria
70
University of Adelaide 69

Assurance engagement: A Financial Statement Audit

is an Assurance Engagement
five essential elements
Responsible Subject Matter
Intended user
■ Three party relationship. party (Financial
(Board) Statements) (Shareholders)
■ Subject matter
Assurance provider Audit
■ Sufficient appropriate evidence (External Auditor) Report

■ Suitable criteria Determine what is sufficient

appropriate evidence
(Auditing Standards)
■ A written assurance report
Suitable criteria
(Accounting Standards)
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 LEVELS OF ASSURANCE Levels of Assurance
and Evidence Accumulated
High
(Audit)

Level of Limited
Assurance (Review)

Attained
Reasonable
Limited Significant Extensive
(Review) (Audit)

Amount of Evidence Accumulated

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Review or a Limited Assurance

Engagement Summary of Lecture 1
“an assurance engagement where the assurance 1: Definition of an audit.
practitioner’s objective is a reduction in (And what does an audit provide?)
assurance engagement risk to a level that is
acceptable in the circumstances of the assurance 2: Overview of an audit.
engagement, but where that risk is greater than
for a reasonable assurance engagement, as the 3: Reasons for an audit.
basis for a negative form of expression of the 4:The legal and professional context.
assurance practitioner’s conclusion. A limited
assurance engagement is commonly referred to 5: The concept of assurance.
as a review.” (AUASB Glossary)
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