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CHAPTER 1

INTRODUCTION ANDOVERVIEW OF AUDIT AND

ASSURANCE

Prepared by:Daniella Juric

RMIT University


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LEARNING OBJECTIVES

After studying this chapter you should be able to:1. Define an assurance engagement

2. Differentiate between different types of assurance services

3. Differentiate between different levels of assurance4. Verify different audit opinions

5. Differentiate between the different role of the preparer and the auditor, and

discuss the different firms that provide assurance services

6. Justify the demand for audit and assurance services

7. Discuss the different regulators and regulations surrounding the

assurance process

8. Verify the audit expectation gap.


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AUDITING AND ASSURANCE

DEFINED

An assurance engagement is defined as en

engagement in which an assurance practitioner

expresses a conclusion designed to enhance the

degree of confidence of the intended users other

than the responsible partyabout the outcome of

the evaluation or measurement of a subject matter

against criteria.


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AUDITING AND ASSURANCE

DEFINED

intended users - the people for whom the auditor prepares

their report.

Example: shareholders, creditors, employees

responsible party - the person or organisation responsiblefor preparing the financial statements. Example: company

management

subject matter that which the auditor is expressing a

conclusion on. Example: financial reports criteria the rules or principles by which the subject matter

is being evaluated. Example: Accounting standards and

interpretations and Corporations laws


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DIFFERENT ASSURANCE SERVICES

LIMITATIONS OF AN AUDIT:

There is no guarantee that the financial report is free from error or

fraud.

The nature of audit procedures and processes are required to beperformed within a reasonable period and at a reasonable cost.

(ASA 200, ISA 200)

Judgement is required in the process of preparation of the

financial statements.


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2. COMPLIANCE AUDIT

Involves gathering evidence to ascertain whether rules,

policies, procedures, laws and regulations have been

followed. A tax audit is an example of a compliance audit.

3. PERFORMANCE AUDIT

Refers to the economy, efficiency and effectiveness of

an organisations activities.

Usually done by internal auditors or can be outsourced to

external auditors.


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4. COMPREHENSIVE AUDIT

Combines elements of financial report audit,

compliance audit and performance audit.

Often occur in the public sector.

5. INTERNAL AUDIT

Provides assurance about various aspects of an

organisations activities.

Often contain elements of performance audits, compliance

audits, internal control assessments and reviews.


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6. CORPORATE SOCIAL RESPONSIBILITY (CSR)

ASSURANCE

Includes voluntary reporting about environmental,

employee and social subject matter.

Incorporates both financial and non-financial

information.

Auditor must consider environmental issues on theirclients financial reports (AGS 1036) even if reports

do not include any disclosures.


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DIFFERENT LEVELS OF

ASSURANCE

AUDITORS MAY PROVIDE VARYING LEVELS OF

ASSURANCE WHEN CONDUCTING ASSURANCE

ENGAGEMENTS.

1. Reasonable assurance

2. Limited assurance

3. No assurance


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DIFFERENT LEVELS OF

ASSURANCELEVEL OFASSURANCE

EXAMPLE THEASSURANCE

EXPRESSION

REASONABLE

Highest level of

assurance but not

absolute assurance onthe reliability of the

subject matter

Financial

Statement Audit

The auditor has conducted sufficient tests

and obtained appropriate and sufficient

evidence to conclude positively that the

information that is assured is (or is not)

reliable

Positive

LIMITED

Moderate assurance

on the reliability of the

subject matter

Review of a

companys half-

year financial

report

Auditor has done adequate work to report

whether or not anything came to their

attention that would lead them to believe

that the information that is assured is not

true and fair.

Negative

NO ASSURANCE Agreed-uponprocedures

engagement

The auditor does not report an opinion

merely report on the findings and the facts

of their findings. The client determines the

nature, timing and extent of evidence

gathered and then draws their own

conclusions about these findings

No Assurance

given


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Also known as an

UNQUALIFIED

OPINION or

clean opinionas in a clean bill

of health

Financial report is

true and fair,

presents fairly the

financial position

of the company,

information

complies with AAS

and Corp Act

Modifications

that do not

affect the

auditors opinion Emphasis of

matter

Modifications

that affect the

auditors opinion

QualifiedOpinion

Adverse

opinion

Disclaimer of

Opinion

DIFFERENT AUDIT OPINIONS

UNMODIFIED MODIFIED


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Audit opinions are contained in audit reports providedby the auditor.

An unmodified audit report contains an unqualifiedorclean opinion. Refer Figure 1.1 p. 12.

All other reports are modified opinions.

A report can be an unqualified modified report when anemphasis of matteris added.

An emphasis of matter is used so that the reader can pay

appropriate attention to the issue raised, but does notchange the auditors opinion (ASA 706, ISA 706)


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Auditors Judgement about the

Pervasiveness of the Effects or Possible

Effects on the Financial Report

Nature of Matter Giving Rise to the

Modification

Material but Not

Pervasive

Material and

Pervasive

Financial report is materially

misstated

Qualified opinion

Adverse opinion

Inability to obtain sufficient

appropriate audit

evidence

Qualified opinion

Disclaimer of Opinion


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Other modified reports are qualified (ASA 705). Aqualified opinion is given when there are reservationsabout the truth and fairness of the financial statements.

Can include a qualified or except for opinion. This iswhen issue(s) are material but not pervasive.

Adverseopinion would arise when financial report ismisstatedand is material and pervasive.

Disclaimer of opinion would arise when there is aninability to obtain sufficient appropriate audit evidenceand is material and pervasive.


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PREPARERS AND AUDITORS

It is the responsibility of those charged with governance to prepare the financial statements. The information shouldinclude the following attributes:PREPARERS responsibility

1. Relevant: has an impact on the decisions made by users regardingthe performance of the entity.

2. Reliable: Information is free from material misstatements (errors orfraud.)

3. Comparable: information needs to be comparable through time.Comparable against the same entity over time and against otherentities.

4. Understandable: Users need to be able to interpret the informationpresented in order to make decisions.

5. True and fair: requires the consistent and faithful application of anapplicable framework when preparing report.


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AUDITOR ALSO HAS RESPONSIBILITIES RELATING TO THE

AUDIT. AUDITOR RESPONSIBILITIES

1. Professional scepticism: maintaining

independent of the entity and having a questioning mindto thoroughlyinvestigate all evidence presented.

2. Professional judgement: use of judgement based on level

of expertise, knowledge and training obtained

by the auditor.

3. Due care: being diligent, applying standards and

documenting each stage of the audit process.


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Assurance services are provided by accounting and

consulting firms.

There are three tiers of assurance providers in Australia.

First tier comprises of the Big 4, which includes Deloitte,Ernst & Young, KPMG and PWC

Mid tier comprises of firms with significant presence and

most have international affiliations.

Next tier made up of regional and local accounting firms.


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DEMAND FOR AUDIT AND

ASSURANCE SERVICES

The users of the financial statements are not limited tothe shareholders or owners of the business.

Other users can include:

Investors: can include current or potential investors.Decisions include to buy, hold or sell stake in theorganisation.

Suppliers: may want to assess whether the entity can paythem back for goods supplied.

Customers: may look into going concern if it is to rely onthe entity for goods.


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DEMAND FOR AUDIT AND

ASSURANCE SERVICES

Lenders: to assess whether loan repayments can be

made as and when they fall due.

Employees: to assess whether they can pay entitlements,

and stability may be assessed for job security.

Governments:whether the entity is complying with

regulations and paying appropriate taxes.

General public: whether they should associate with theentity (future employee, customer or supplier,) what it

does and plans to do in future.


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SOURCES OF DEMAND FOR AUDIT &

ASSURANCE SERVICES

REASONS WHY USERS DEMAND FINANCIAL REPORTS

INCLUDE:

1. Remoteness: users do not have access to information

themselves.2. Complexity: users do not have knowledge to be able to

make disclosure choices.

3. Competing incentives: users may find it difficult to identify

when the incentives of management have been over-represented.

4. Reliability: as decisions are being made based on

information presented, it is important that it be reliable.


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THEORETICAL FRAMEWORKS

THE DEMAND FOR AUDIT CAN BE EXPLAINED BY THE

FOLLOWING THREE THEORIES:

1. AGENCY THEORY: Due to the remoteness of the owners from the

entity, the owners have an incentive to hire an auditor to assessinformation provided by management.

2. INFORMATION HYPOTHESIS: Due to the need for

reliable information, users will demand that information be

audited to aid in decision making.

3. INSURANCE HYPOTHESIS: Investors demand audited

financial statements to insure against potential losses.


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DEMAND IN A VOLUNTARY

SETTING

It is becoming more common to voluntarily disclose CSRinformation in various forms.

This is as stakeholders are demanding information

regarding the entitys impact on the environment andactions taken to reduce their impact.

Entities are not required to have CSR disclosures

assured.

These services are provided to meet user demands forhigh-quality, reliable information and to demonstrate ahigh level of corporate social responsibility.


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THE ROLE OF REGULATORS AND

REGULATIONS

THERE ARE A NUMBER OF REGULATORS THAT IMPACT THEAUDIT PROCESS. THEY INCLUDE:

1. FINANCIAL REPORTING COUNCIL (FRC)

oversees the process used for setting accounting and auditing

standards. Also monitors and reports on auditorindependence.

2. AUDITING AND ASSURANCE STANDARDS BOARD (AUASB)

Responsible for the formulation of auditing standards.

AUASB redesigned auditing standards to bring in line withinternational standards.

Responsible for issuing ASRE, ASAE and GS standards andstatements.


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REGULATIONS

3. INTERNATIONAL AUDITING AND ASSURANCE STANDARDS

BOARD

Develop and issue International Standards on Auditing (ISAs).

Operates under the auspices of International Federation ofAccountants (IFAC).

4. ACCOUNTING PROFESSIONAL AND ETHICAL STANDARDS

BOARD (APESB)

Established as an independent body by CPA Australia andICAA to issue professional and ethical standards.

APES standards are mandatory for all members of CPA

Australia, ICAA and NIA.


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REGULATIONS

5. AUSTRALIAN SECURITIES AND INVESTMENTS COMMISSION

(ASIC)

Government body that administers the ASIC Act and much of

Corporations Act.

Plays a role in overseeing of the audit function.

6. AUSTRALIAN SECURITIES EXCHANGE (ASX)

Formed in 1987 after merging of six state based exchanges.

Provide additional obligations for entities wishing to list onthe exchange.

O O G O S


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REGULATIONS

7. COMPANIES AUDITORS AND LIQUIDATORS DISCIPLINARYBOARD (CALDB)

Responds to ASIC and APRA regarding breaches ofCorporations Act or ASIC Act.

Board may cancel or suspend auditor, may give warning or askfor undertaking to improve conduct.

8. PROFESSIONAL BODIES (INCLUDING CPA AUSTRALIA,INSTITUTE OF CHARTERED ACCOUNTANTS IN AUSTRALIA &NATIONAL INSTITUTE OF ACCOUNTANTS)

Include professionals in public practice, industry, academiaand government.

Requires further post-graduate study and minimum workexperience periods to join as members.


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REGULATION

CORPORATIONS ACT

Provides guidance on conducting audit of financial

reports.

This includes that certain accounts need to be

audited(s. 301,) the audit report stating whether it is

true and fair & in accordance with accounting

standards (s. 307,) standards must be applied (s.

307A,) retention of audit working papers (s. 307B,)

and independence declaration (s. 307C.)


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REGULATION

CLERP 9

Significant changes brought about from 1 July 2004

including auditing standards having force of law.

Other changes include:

Disclosure of non-audit services provided by auditor.

Enhanced independence and employment requirements.

Auditor rotation based on not exceeding being auditor formore than five out of the last seven years.


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Its not fair! This

isnt what auditors

do.Youre supposed to guarantee

the financial report!

We lost all of our

investments because

of your report!!

You should

have

detected the

fraud !

AUDIT EXPECTATION GAP


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AUDIT EXPECTATION GAP

IS THE DIFFERENCE BETWEEN THE EXPECTATIONS OF

ASSURANCE PROVIDERS AND FINANCIAL REPORT OR

OTHER USERS.

Can be caused by unrealistic expectations including: The auditor providing a complete assurance.

The auditor guaranteeing future viability of entity.

An unqualified opinion denotes complete accuracy.

The auditor will find all frauds.

We know these cannot be met by the auditor.


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SUMMARY

After studying this chapter you should be able to:1. Define an assurance engagement

2. Differentiate between different types of assurance services

3. Differentiate between different levels of assurance

4. Verify different audit opinions

5. Differentiate between the different role of the preparer and the auditor, and

discuss the different firms that provide assurance services

6. Justify the demand for audit and assurance services

7. Discuss the different regulators and regulations surrounding the assuranceprocess

8. Verify the audit expectation gap.

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