Chapter 1 – Assurance and Auditing an Overview The Framework for Assurance Engagements * The framework defines an assurance engagement as ‘an engagement in which an assurance 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 * The following five elements of assurance engagement are identified 1.
Three party relationships – between the practitioner (auditor), responsible party, intended user 2. Subject matter – financial position and performance, non-financial performance, physical characteristics, systems and processes, behavior 3. Subject criteria – criteria are the standards or benchmarks used to measure and evaluate the subject matter of an assurance engagement 4.
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Sufficient appropriate evidence – the engagement process fr an assurance engagement is a systematic methodology requiring specialized knowledge, a skill base and techniques for evidence gathering and evaluation to support a conclusion, irrespective of the nature of the engagement subject matter 5. A written assurance report – the practitioner draws a written conclusion that provides a level of assurance about the subject matter * The definition of assurance services is very broad in its coverage and includes both existing assurance services and newly evolving assurance services Independence Users derive knowledge that the assurance provider has no interest in the information other than its usefulness * Assurance independence is an absence of interests that create an unacceptable risk of material bias with respect to the quality or content of information that is the subject of an assurance engagement Expertise: Professional Judgment and Professional Skepticism * An assurance engagement requires the exercise of professional judgment (ASA 200. 6), which involves the application of relevant training, knowledge and experience in making informed decisions about the courses of action that are appropriate in the circumstances of the assurance engagement * The auditor should also plan and perform the assurance engagement with professional skepticism, which is an attitude that includes a question mind, being alert to conditions that may indicate possible misstatement due to error or fraud, and a critical assessment of udit evidence (ASA 200. 15) * It could be argued that professional reputation is the critical factor that adds value to the assurance services offered by the professional accountant The Structure of Assurance Standards and Pronouncements The Australian code of ethics APES 110, and the standard on quality control procedures for audit firms APES 320 are applicable to all assurance firms and engagements * The standards set by AUASB are divided between assurance standards and other AUASB standards * The assurance standards are governed by the framework for assurance engagement which provides a general framework for all assurance services, and defines and describes the elements of an assurance engagement * Under the assurance framework, the standards are split into three groups, comprising those relating to audits of historical financial information, to reviews of historical financial information, and to other assurance engagements * There is currently ASAE 3000, which contains requirements for all assurance engagements other than those on historical financial information * Standards have also been developed for some specific assurance engagements, such as standards for compliance engagements (ASAE 3100; no international equivalent) and for performance engagements (ASAE 3500) * When an auditor is undertaking other assurance services engagements, they should also refer to these standards; ASAE 3000. 7 outlines that these standards provide helpful guidance to assurance practitioners * The objective of a limited assurance engagement is a reduction in assurance engagement risk to an acceptably low level, and this is associated with a positively expressed assurance opinion * The objective of a limited assurance engagement is a reduction in assurance engagement risk to a level that is acceptable in the circumstances and this is associated with a negatively expressed assurance opinion, such as that nothing has come to the auditor’s attention to persuade them that the information has been materially misstated * A significant difference between a related services engagement and an assurance engagement is that the auditor does not have the discretion to undertake evidence collection procedures outside those that have been agreed upon * The auditor therefore only issues a report of factual findings to the parties that have agreed to the procedures being performed, in which no conclusion is communicated and which therefore expresses no assurance * An assertion based assurance engagement requires the auditor to issue an opinion on written assertions made y others * A direct reporting assurance engagement requires the auditor to provide assurance on the accountability matter on which the responsible party has not made a written assertion Auditing Defined * ASA 200. 1 provides the objectives of the auditor in undertaking an audit of a financial report * The definition developed by the American Accounting Association is ‘ 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’ * The quality of information is enhanced by the added credibility given through the audit function Fundamental Principles Underlying an Audit * Fundamental principles were described as encompassing the high ideals of professional conduct and the essential qualities underpinning every ISA audit * Conceptually, fundamental principles should: 1. Underpin the objectives of an audit, and help drive the conduct of the auditor in using professional judgment to meet the professional requirements o the auditing standards 2.
Be easily understood both by auditors and other readers of auditing standards 3. Be universally applicable to all audits 4. Entrench the expectations that auditors are expected to accept and abide by Fundamental Principles of Professional Ethics * Integrity – an auditor should be straightforward and honest in all professional and business relationships * Objectivity – an auditor should not allow prejudices or bias, conflict of interest or undue influence of others to override professional or business judgment * Professional competence and due care – an auditor has a continuing duty to maintain their professional knowledge and skill at the level required to ensure that a lient or employer receives the advantage of competent professional service based on current developments in practice, legislation and techniques * Confidentiality – an auditor should respect the confidentiality of information acquired as a result of professional or business relationship and should not disclose any such information to third parties without proper and specific authority * Professional behaviour – an auditor should comply with relevant laws and regulations and should avoid any action that discredits the profession * The auditor is required to comply with relevant ethical requirements relating to audit engagements (ASA 200. 4) Fundamental Principles Underlying the Objective of an Audit * Knowledge – the auditor should possess a sufficient understanding of the entity and its environment to appropriately plan and perform the audit, interpret audit findings and report on the financial report * Responsibility – the auditor should take responsibility for the audit opinion, maintaining an adequate level of involvement in the audit engagement, properly supervising any assistants, while evaluating the work of exports or others upon whom reliance is placed * Quality control – the auditor should follow quality control procedures, including consultation with others as necessary, that support the issuance of an audit report that is appropriate in the circumstances * Rigor and skepticism – the auditor should plan and perform an audit with thoroughness and with an attitude of professional skepticism * Professional judgment – the auditor should exercise professional judgment, within the bounds of the fundamental principles and the applicable professional requirements, in discharging the auditor’s responsibilities * Evidence – the auditor should obtain sufficient appropriate evidence to constitute a reasonable basis for expressing an opinion on the financial report * Documentation – the auditor should document matters that are important in providing evidence to support the audit opinion * Communication – the auditor should communicate significant matters affecting the entity’s financial report to management, those charged with governance, and, while respecting the confidentiality of information * Association – the auditor should not be associated with or allow the use of the auditor’s name or their report to be associated with information known by the auditor to be misleading, unless the auditor reports on the information and how it is misleading * Reporting – the auditor should report to those who have appointed the auditor to the engagement Attributes of Accounting Information IASB framework identifies the objective of financial reports as the provision of information useful to a wide range of users for making economic decisions * The characteristics that are identified in the framework include the following: 1. Relevance – this requires that the information provided must be useful in assisting financial report users to make and evaluate decisions about the allocation of scarce resources to assess the accountability of the preparers of these reports 2. Reliability – the reliability of financial information is the extent to which the information presented to users represents, without bias or undue error, the underlying transactions and events that have occurred 3.
Comparability – the usefulness of information requires that its representation in a financial report results in users being able to compare aspects of an entity at one time and over time, and between entities at one time and over time 4. True and Fair Representation – the application of the qualitative characteristics and of appropriate accounting standards will normally result in financial reports that convey a true and fair view Demand for Assurance * The need for independent financial report audit arises because of the following conditions: 1. Conflict of interest – the user may perceive an actual or potential conflict with the preparer (management) 2.
Consequence – when a user is contemplating using information to make decisions of consequence, the quality of that information is of direct concern 3. Complexity – the subject matter and the process by which the data is converted into information is complex and, as it becomes more complex, the possibility of error is increased 4. Remoteness – the separation of owner and manager, and therefore the user and preparer, whether due to physical, legal or time and cost constraints, prevents the user from assessing the quality of information Hypothesis Regarding Demand for Auditing * Agency theory – the use of agreed upon reporting framework, is one attempt to reduce the bias, and getting assurance on these reports from an xpert who is independent of management also increases the confidence in the information that is communicated * Information Hypothesis – an assurance service is a means of improving the quality of information * Insurance hypothesis – the insurance hypothesis states that demand for assurance occurs from those who may suffer loss when things go wrong Other Benefits of Assurance * An audit assurance service may also result in one or both of the following: 1. Recommendations by the assurance provider to improve the efficiency and effectiveness of operations 2. a positive influence on the behavior of people whose activities are being assured Current Approach to Auditing * In the late 1990s the financial risk approach was modified to give greater consideration to the strategic or business risks facing the client which is known as the business risk approach * The business risk approach is the approach currently reflected in the auditing standards The Auditor Client Public Relationship Auditors have entities as clients but owners or other members of the public use their reports * Being selected and paid by the clients on whom they report makes total independence difficult to achieve * Ethical rules and professional standards guide individual auditors in resolving the conflicts that inevitably arise The Expectation Gap * Differences which have been identified between the expectations of auditors and financial report users concerning the role and responsibilities of auditors is known as the expectation gap * The following to components of the expectations gap can be identified: 1. The reasonableness gap: the gap between what society expects auditors to achieve and what they can reasonably be expected to accomplish 2.
The performance gap: the gap between what society can reasonably expect auditors to accomplish what they are perceived to achieve * The potential causes of the expectation gap are many and varied some of the reasons are pointed out below: 1. The probabilistic nature of auditing 2. The ignorance, naivety, misunderstanding and unreasonable expectations of non-auditors about the audit function 3. The evaluation of audit performance based upon hindsight not available to the auditor at the time the audit was completed 4. The evolutionary development of audit responsibilities, which create response time lags to changing expectations 5. Corporate crisis which lead to new expectations and accountability requirements, and period of high standard setting activities Audit Report Messages ASA 200 provides that the auditor’s opinion helps establish the credibility of the financial information which is different from the users perception that an unqualified audit report indicates that the auditor is guaranteeing that the audited financial report is completely accurate Corporate Failures * The dilemma faced by the auditors is the requirement to state any unresolved doubts about the entity’s future versus the risk that any such comments may generate a self-fulfilling prophecy by undermine the confidence of the entity’s owners and creditors * Trotman points out that the profession could do more in this area, including auditors reporting on non-key financial indicators that can evidence corporate failure and providing commentary on entity’s financial health Earnings Management and Fraud As a result of these concerns and the recent corporate collapses, the profession has recently taken on an increased responsibility for identifying fraud The Role of Auditing Standards Authority of Auditing Standards * As indicated above, the ASA contains the basic principles and essential procedures to be complied with by auditors in the conduct of an audit, together with related guidance * The auditing and assurance standards board of Australia currently develops auditing standards in Australia * These standards prescribe the basic principles and essential procedures that govern the conduct of the auditor * Auditing standards are mandatory for udits conducted under the corporations act and have legal backing * For other audits and assurance engagements there is a mandatory obligation for members of accounting bodes in Australia to comply with the auditing and assurance standards * All auditing standards now contain the following sections: introduction, objective, definitions, requirements, and applications ad other explanatory material * There should be no departures from basic principles, and essential procedures should be undertaken in all except those rare circumstances where it is determined that the audit objects can be more effectively using alternative procedures Other Applications of the Assurance Function Compliance Audits * A compliance audit is an examination of financial information for the purpose of reporting on the legality and control of operations and the probity of those responsible for the administration of funds provided by external parties, including the expression of an opinion on an entity’s compliance with statute, regulations or other directives that govern the activities of the entity Performance Audit Performance auditing is also often referred to as ‘value for money auditing’, ‘operational auditing’, ‘efficiency auditing’, or ‘program results auditing ‘ and is often associated with auditing in the public sector, in various forms, becoming more popular in other areas and is an internal part of many internal audit functions * Performance auditing is a more comprehensive activity designed to analyze organization structure internal systems, work flow and managerial performance Comprehensive Audit * When financial report audits, compliance audits and performance audits are integrated they can be described as a comprehensive audit Internal Audits An internal audit is not a separate type of audit, but one undertaken by a body of audit professionals who are internal to or employees of the audited entity * Seen traditionally as an appraisal activity within an organization for the review of accounting, financial and other operations as a basis for service to management, many internal auditors have today found that they can be of increased value to an organization by participating in the business risk analysis of the organization Forensic Audits * Forensic auditors are employed by companies, government agencies, accounting firms, and consulting and investigative services firms * They are trained in detecting, investigating and deterring fraud and white-collar crime