Lecture slide, chapter 1, An Overview of Auditing

1. Chapter 1
An Overview of Auditing
Prepared by Dr Phil Saj
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2. Learning objectives
1. Explain what an audit is, what it provides, and why
it is demanded
2. Describe how assurance relates to auditing
3. Discuss the importance of the profession, case law
and regulation to auditing
4. Explain the importance of national and
international auditing standards
5. Evaluate whether audits meet the demands of
users.
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3. What is an audit?
“A systematic process of objectively obtaining
and evaluating evidence regarding assertions
made about economic actions and events to
ascertain the degree of correspondence
between those assertions and established
criteria and communicating the results to
interested users”
American Accounting Association (1973)
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4. What is an audit?
systematic process
objectively obtaining and evaluating evidence
regarding assertions made about economic
actions and events
ascertain the degree of correspondence
between those assertions and established
criteria
communicate the results to interested users
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5. The objectives of an auditor
To obtain reasonable assurance about whether
or not the financial report is free from material
misstatement.
To express an opinion about whether the financial
report is prepared in all material respects in
accordance with an applicable financial reporting
framework.
To report that opinion. ASA 200.11
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6. The financial reporting and
auditing framework
In preparing the financial report, management
asserts that it is a true and fair record
The audit process to obtain evidence to validate
management’s assertions
Independent audit report to express an opinion as
to whether the financial report is true and fair
Financial report users can use the information
with reasonable assurance that it is free from
material misstatement
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7. The demand for audits
Agency theory
Information hypothesis
Insurance hypothesis
Regulation
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8. Agency theory
A principal contracts an agent to work on their
behalf
Each party is motivated by self interest
Information asymmetry arises
An independent audit reduces the incentives for
problems
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9. The agency relationship
Provision of
capital
Obtain audit
ManagersInvestors
Provide
financial
report
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10. Information hypothesis
Investors demand quality information in assessing
the risks and returns of their investments
Audits improve the quality of information in
financial reports
Reduces information risk and leads to improved
decision making
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11. Insurance hypothesis
“the ability to shift financial responsibility for
reported data to an auditor lowers the expected
loss from litigation or related settlements to
managers, creditors who might demand an audit
to show they are being prudent to insure against
losses” Wallace (1980)
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12. Insurance hypothesis
Interested parties:
Investors and creditors demand an audit to
be prudent and insure against losses
Regulators to insulate themselves from
criticism by directing blame to auditors
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13. Regulation
Annual audits required by:
Companies, registered schemes & disclosing
entities (excludes small proprietary companies)
Commonwealth and state government
departments, statutory authorities, government
companies and business undertakings,
municipalities
Not-for-profit organisations
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14. Providers of audits
Financial audits are provided by independent auditors
Must be registered with ASIC to be able to perform
audits on reporting entities
Criteria set out in s.1280 Corporations Act
Educational qualifications
Work experience
Good character (fit and proper person)
Member of ICAA or CPA Australia
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15. Assurance
In the Framework for Assurance Engagements an
assurance engagement is defined as:
“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 an evaluation or measurement of a
subject matter against criteria” (paragraph 8)
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16. Assurance engagements
May be financial or non-financial
The level of assurance will vary according to the
particular engagement (according to the amount
of evidence collected)
Audits of annual financial reports imply a
reasonable (or high) level of assurance
In comparison (for example) half-yearly reviews
imply a moderate (or low) level of assurance
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17. The relationship between auditing
and assurance
Financial
Report Audit
Assurance
Engagement
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18. The auditing environment
Co-regulation
The
accounting
profession
Case law Statute
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19. The accounting profession
Professional bodies
Institute of Chartered Accountants in Australia
CPA Australia
National Institute of Accountants
Practice entities
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20. The accounting profession
Professional accounting bodies’ are involved in
the development of audit practice by:
Developing standards of practice,
professional education and rules of conduct
Ensuring professional conduct and self-
regulation
Maintaining standards of qualifications
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21. Case law
Early cases associated with detection of fraud
Change of focus resulting from increased
complexity, increasing size of businesses and
separation of owners from managers
Greater emphasis on ‘reasonable skill and care’
Concept of ‘reasonable assurance’
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22. Case law
Pacific Acceptance case (1970)
Concept of ‘reasonable care and skill’ called for
changed standards to meet changed business
conditions.
Auditor should pay due regard to the possibility
of fraud and actively investigate the possibility
of fraud if suspicious circumstances exist.
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23. Regulation
Corporations Act
Responsibility for accounting and auditing
standard settings under government control
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• Regulatory changes focused on reporting issues
• Other issues involved fee dependence and importance of
the auditor in corporate governance
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24. Regulation
Australian Securities and Investment
Commission (ASIC)
Regulates corporate, markets and financial
services sector
Advise on selling of and disclosure of financial
products and services to consumers
Majority of work carried out under Corporations
Act
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25. Regulation
Companies Auditors and Liquidators
Disciplinary Board (CALDB)
Established under ASIC Act
Hears breaches under Corporations Act by
auditors and liquidators
Australian Securities Exchange (AXS)
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26. Regulation of accounting
and auditing
Government
Financial Reporting Council
• Oversee accounting and auditing
standard setting
• Monitor companies’ compliance with
audit-related disclosure requirements
• Advise on continuing steps to enhance
auditor independence
• Monitor disciplinary proceedings of
accounting bodies
Professional
accounting
bodies
Other
stakeholders
ASX
Corporate
Governance
Council
ASIC
CALDB
AASB AUASBSecretariat
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27. The early 2000s- challenges
and changes
Corporate collapses overseas and in Australia
Collapse of Enron led to the Sarbanes-Oxley Act
Collapse of HIH led to a Royal Commission
Ramsay Report
Some recommendations from the HIH Royal
Commission and the Ramsay Report were
incorporated in Corporate Law Economic Reform
Program (CLERP 9)
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28. The early 2000s- challenges
and changes
Major impacts
Role of audit in corporate governance
Auditor independence
Audit quality
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29. Auditor Independence
To conduct the audit without bias and appear to
be objective to those relying on the results of the
audit. Key issues include:
Non-audit services
Audit partner rotation
Auditor working for the client
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30. Audit Quality
Audit quality is that characteristic of auditing
whereby the auditor undertakes his/her work in
both a technically competent manner and ethical
manner, including giving consideration to the
public interest. By conducting the audit in this way,
the auditor can ensure that his/her judgement is
not compromised and that complex issues can be
properly dealt with.
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31. Audit Quality
Role of Financial Reporting Council
Annual general meetings
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32. Auditing Standards
Mandatory requirements and guidance
ASA 101 explains how auditing standard are to
be interpreted and applied
Have “the force of law” for audits undertaken
pursuant to the Corporations Act
The professional bodies require application
Clarity Project (commenced 2004)
International harmonisation
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33. Forward
Framework for Assurance Engagements
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Standards on
Review
Engagements
Glossary
ASQC 1
Assurance No Assurance
Audits and reviews
of historical fin. info
Australian
Auditing
Standards
Standards
on Assurance
Engagements
Standards
on Related
Services
Assurance engagements
other than audits & reviews
of historical fin. info
Engagements other
than audits, reviews
& other assurance
engagements
Guidance Statements
AUASB PRONOUNCEMENTS

34. Does the audit meet demands of
users?
Company
management
Audited
financial
reports
Employees
Bankers
Creditors
Wider public
Government
Future
shareholders
Current
shareholders
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35. Do audits provide good value?
Assessing value can be examined by asking:
How often are they associated with company
failure?
Do auditors get the audit report correct?
How much do they cost?
Do audits provide economic value in the
market?
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36. Audit expectation gap
“the difference between what auditors
actually do when they conduct an audit and
what shareholders and others think auditor's
do, or should do, in conducting the audit”
Report of HIH Royal Commission
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37. Audit expectation gap
Perceived
Performance
of auditors
Society’s
expectation
of auditors
Deficient
performance
Deficient
standards
Unreasonable
expectations
Audit expectation-performance gap
Performance
gap
Reasonableness
gap
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38. Audit expectation gap
Remedies to address unrealistic expectations:
Education of stakeholders about what an
audit provides
Remedies to address deficient standards:
Reporting on internal control
Detection of fraud
Evaluation of going concern
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