Lecture slide ,chapter 6, Overview of the audit of financial reports

1. Chapter 6
Overview of the audit of
financial reports
Prepared by Dr Phil Saj
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2. Learning objectives
1. Discuss the legal and professional issues in appointing
independent auditors.
2. State the statutory and other duties of the independent
auditor.
3. Indicate the current auditing standards and their major
concepts.
4. Describe the auditor’s relationship with the
shareholders, audit committee and other important
groups.
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3. Learning objectives
5. Explain the interrelationship between management's
and the auditor’s responsibilities.
6. Describe the benefits and limitations of audits of
financial statements.
7. Appreciate the overall audit process.
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4. The appointment of an
independent auditor
The Corporations Act 2001 governs the appointment of
the independent auditor. Important issues include:
The basic principles of auditor appointment as
well as the applicable statutory provisions.
Registration of auditors.
Removal and resignation of auditors.
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5. Principles of the appointment
of auditors
Directors of public and large proprietary companies are
required to appoint an auditor.
The duration of the first appointment is only until the
first annual general meeting, during which the
members appoint an auditor (s. 327).
An auditor holds office until his or her death,
removal or resignation (s. 327).
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6. The removal and resignation
of auditors
An auditor may be removed from office only by
resolution of the company at a general meeting, for
which special notice under s. 329 has been given.
When a company receives special notice of a resolution
to remove an auditor, it must send a copy of the notice
to the auditor and lodge a copy with ASIC as soon as
possible.
The auditor is then given 7 days to make representation
in writing, with copies of the representation being sent
to all members entitled to attend the meeting.
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7. The removal and resignation
of auditors
The auditor also has the right to be heard at the
meeting.
Where an auditor is removed from office at a general
meeting, the company may appoint another auditor at
that meeting (or at an adjourned meeting) by a
resolution passed by at least a three-quarter majority.
These provisions regarding the removal of an auditor
have the effect of strengthening the auditor’s
independence.
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8. The removal and resignation
of auditors
The auditor can therefore qualify the accounts or argue
an accounting position without the potential threat of
immediate dismissal by the directors.
An auditor must apply to ASIC for consent to resign,
stating the reasons.
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9. Registration of auditors
The Corporations Act sets out criteria for registration as
a registered company auditor:
Professional membership;
Education;
Experience;
Capability; and
Fit and proper person test.
s. 1279 of the Corporations Act
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10. Duties of an independent auditor
When an auditor accepts an appointment, he or she
enters into a contractual relationship with the company
The audit engagement letter, agreed to and signed by
the auditor and the client, details some of the duties of
an auditor for a company
See ASA 210 Terms of Audit Engagements
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11. Duties of an independent
auditor
There are express or implied terms in such contracts that
the auditor will:
exercise a reasonable degree of care and skill;
be independent of the company;
report to members his or her opinion, as to whether the
financial statements are properly drawn up so as to give
a true and fair view of the company’s financial position,
in accordance with the Corporations Act and applicable
accounting standards; and
comply with auditing standards and the ethical standards.
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12. The audit opinion
The auditor must express an opinion on ‘whether the
financial report is prepared, in all material respects, in
accordance with the applicable financial reporting
framework.’
The opinions expressed in an auditor’s report must be
in accordance with ASA 700 (ISA 700) The Auditor’s
Report on a General Purpose Financial Report.
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13. The audit opinion
The audit opinion can be either unmodified or modified
(qualified) in some way.
According to ASA 705 Modifications to the Opinion in
the Independent Auditor’s Report, modifications are
expressed as:
a qualified opinion;
an adverse opinion; or
a disclaimer of opinion.
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14. Emphasis of matter or other
matter in the audit report
The auditor may find it necessary to draw the attention of
users to certain matters.
These are addressed in ASA 706 Emphasis of Matter
Paragraphs and Other Matter Paragraphs in the
Independent Auditor’s Report.
An Emphasis of Matter Paragraph is included in
the auditor’s report where it is necessary to draw
the attention of users to a matter, or matters, that
are presented or disclosed in the financial report that
are of fundamental importance to users’
understanding of the financial report.
of the financial report. 1414

15. Emphasis of matter or other
matter in the audit report
An Other Matter Paragraph is included in the
auditor’s report where it is necessary to draw the
attention of users to a matter, or matters, other than
those disclosed in the financial report, that are
relevant to users’ understanding of the audit, the
auditor’s responsibilities or the audit report.
The inclusion of an Emphasis of Matter Paragraph or an
Other Matter Paragraph does not modify the audit
opinion.
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16. Duty to report
Auditor has a statutory duty to report to members on
the company's financial statements.
The auditor must notify ASIC if there are reasonable
grounds to suspect a contravention of the Corporations
Act.
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17. Auditing standards
Auditors reply on a codified set of auditing standards
prepared by the Auditing and Assurance Standards
Board (AUSASB).
Uniformity with international auditing standards.
Standards indicate the minimum level of care required
in performing an audit.
Ultimately the courts determine whether the level
of care provided is adequate.
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18. Standards on Review
Engagements
ASRE 2400
ASRE2405
ASRE 2410*
Standards on Assurance
Engagements
ASAE 3000-3600
Australian Auditing
Standards
ASA100-800*
ASA 805
ASA 810
AUASB Glossary
ASQC1 Quality Control for Firms that Perform Audits and Reviews of Financial Reports
and Other Financial Information, Other Assurance Engagements and Related Services*
Forward to AUASB Pronouncements
STRUCTURE OF PRONOUNCEMENTS ISSUED BY THE AUASB
Audits and reviews of
historical financial information
Assurance engagements other than audits
and reviews of historical financial information
Guidance Statements, other guidance and AUASB Bulletins
Auditing standards
*Made under
s.336
of the
Corporations
Act
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19. Auditing standards
Clarity standards introduced in October 2009.
Structure:
Mandatory components
Application
Operative date
Objectives
Definition
Requirements
Explanatory material
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20. Introduction
ASQC1
ASA 100s (3)
Auditing standards
Planning
ASA 300s (4)
Responsibilities
ASA 200s (8)
Internal
Control
ASA 400s (2)
Audit Conclusions
And Reporting
ASA 700s (5)
Specialised
Areas
ASA 800s (3)
Using the
Work of Others
ASA 600s (3)
Audit Evidence
ASA 500s (12)
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21. Independent auditor
relationships
In a financial statement audit, the auditor maintains
professional relationships with four important
groups:
the shareholders;
the board of directors and audit committee;
the internal auditors; and
management.
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22. The shareholders
Shareholders rely on the audited financial statements
for assurance that management has properly
discharged its stewardship responsibility.
The auditor, therefore, has an important responsibility
to shareholders of the company.
In theory, the directors’ powers to appoint the auditor
are limited; in practice, the shareholders of the
company generally accept the recommendations of the
directors.
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23. The board of directors
The board of directors of an entity is responsible for
seeing that the entity operates in the best interests of
the shareholders.
The auditor’s relationship with the directors largely
depends on the composition of the board and works
best when the majority are outside or non-executive
directors.
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24. The audit committee
The Australian Stock Exchange now requires all listed
companies in the Top 300 to have an audit committee
Audit committees have an important role in corporate
governance.
The Audit Committees: Best Practice Guide was
developed by the AUASB to assist companies in
setting up audit committees.
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25. The audit committee
The main objectives of an appropriately established
and effective audit committee usually include the
following:
assisting the board of directors in discharging its
responsibility to exercise due care, diligence and
skill in relation to the entity’s reporting of financial
information, accounting policies, internal control
system and risk management system.
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26. The audit committee
Improve the credibility and objectivity of the
accountability process (including financial reporting).
Provide a formal forum for communication between the
board of directors and senior financial management.
Improve the effectiveness.
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27. Internal auditors
From the perspective of the independent auditor,
internal auditing is a component of the entity’s control
environment.
As an independent unit within the entity, the internal
auditor examines, evaluates and monitors the
adequacy and effectiveness of the internal control
structure.
ASA 610 Considering the Work of Internal Audit
requires the independent auditor to assess the work of
the internal auditor for the purpose of planning the audit
and developing an effective audit approach.
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28. Management
During the course of an audit, there is extensive
interaction between the auditor and management.
The typical approach of the auditor towards
management’s assertions may be characterised by
professional scepticism.
This means the auditor should neither disbelieve
management’s assertions nor thoughtlessly accept
them without concern for their truthfulness.
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29. Management
The auditor should also consider ASA 580 Written
Representations when considering management
representations during an audit.
As stated in ASA 580.14, representations by
management cannot be a substitute for other audit
evidence that the auditor could reasonably expect to be
available.
Auditors should ensure that they do not rely on
management representations for the sake of
convenience when alternative evidence is
available.
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30. Management and auditor -
responsibilities
The Corporations Act (s. 294) stipulates that directors
must make a declaration which states that:
the financial statements and notes comply
with accounting standards;
the financial statements and notes give a true
and fair view;
the financial statements comply with the
Corporations Act; and
there are reasonable grounds to believe that the
company will be able to pay its debts as and
when they fall due.
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31. Relationship between accounting
and auditing
FINANCIAL REPORTING
ACCOUNTING
(Guided by accounting standards.
Responsibility of management.)
AUDITING
(Guided by auditing standards.
Responsibility of auditor.)
Distribute the annual report, including
financial statements and the auditor’s
report to shareholders.
Prepare the financial reports and other
reports in accordance with the identified
financial reporting framework.
Verify that financial information has been
presented fairly in accordance with an
identified financial reporting framework.
Obtain and evaluate evidence concerning
the financial reports.
Express an opinion in the auditor’s
report.
Deliver the auditor’s report to the entity.
Classify and summarise recorded data.
Measure and record transaction data.
Analyse events and transactions.
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32. Benefits of an audit
Access to capital markets — public companies must
satisfy statutory audit requirements in accordance with
the Corporations Act.
A lower cost of capital - potential creditors may offer
lower interest rates and potential investors may be
willing to accept a lower rate of return on their
investment.
Audited financial statements improve an entity’s
credibility and therefore reduce risks for investors and
creditors.
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33. Benefits of an audit
Deterrent to inefficiency and fraud - financial
statement audits can be expected to have a favourable
effect on employee efficiency and honesty.
Knowledge that an independent audit is to be
performed is likely to result in fewer errors in the
accounting process and reduce the likelihood of
employee misappropriation of assets.
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34. Benefits of an audit
Control and operational improvements
The independent auditor can suggest how
controls could be improved and how greater
operating efficiencies within the entity’s
organisation may be achieved.
Weaknesses in controls and suggestions for
improvement are usually outlined in the
management letter (discussed later).
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35. Limitations of an audit
Time lapse - A common criticism of the audit function is
that the lapse of time between balance date and the
presentation of the audit report may be up to 4 months.
The Corporate Law Reform Act 1994, provides
investors with more up-to-date information about
a company by requiring the ongoing or continual
disclosure of relevant information.
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36. Limitations of an audit
Audit testing on a selective sample - risk that the
sample drawn from the population may not be
representative of the sample (sampling risk).
Assessment of materiality - requires a high degree of
professional judgement and requires quantitative and
qualitative considerations.
No universally agreed upon guidelines.
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37. Limitations of an audit
Highly specialised areas - auditors may be required to
form a professional opinion in highly specialised areas
or areas that are not dealt adequately with in
accounting or auditing standards e.g. Valuation of
intangible assets, and environment-related accounting
items.
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38. Limitations of an audit
Report format limitations
The audit report and the body of the financial
statements are subject to interpretation.
The standard format of the audit report may not
reflect fully the complexities involved in the audit
process and the decision of the audit opinion.
Despite these limitations, an audit of the financial
statements adds credibility to the financial
information
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