planning and risk · copyright 2003 mcgraw-hill australia pty ltd ppts t/a auditing and assurance...

Copyright 2003 McGraw-Hill Australia Pty Ltd

PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett

Slides prepared by Roger Simnett 1

PART TWO:

Planning and Risk




CHAPTER 5

OVERVIEW OF ELEMENTS OF THE FINANCIAL

REPPORT AUDIT PROCESS




ACCOUNTING AND AUDITING

CONTRASTED

ACCOUNTING AUDITING

Responsib ility of management Responsib ility of auditor

Measure and record

accounting data in accordance

with accounting standards

Obtain sufficient appropriate audit

evidence about the propriety and

accuracy of the accounting data in

accordance with auditing standards

Prepare the financial report in

accordance with the identified

financial reporting framework

Provide an audit opinion on whether

the financial report is presented

fairly in accordance with the

identified financial reporting

framework

Distribute the financial report,

including the audit report, to

the owners of the entityFig. 5.1 Relationship

between accounting and

auditing (p.177)




AREAS OF AUDIT

INTEREST • Accountable activity of the entity

Collection of original accounting data

Allocation and reclassification of accounting data

Presentation of results

• Organisation of the entity

External relationships

Internal organisational structure




FINANCIAL REPORT

ASSERTIONS

• Existence

• Occurrence

• Completeness

• Rights and obligations

• Valuation

• Measurement

• Presentation and disclosure




ASSERTIONS AND OBJECTIVES FOR INVENTORY

Example 5.1 Assertions and objectives for the account balance of inventory of

a manufacturing company (p. 183)

Financial report Illustrative audit objectives

assertion

Existence n Inventories included in statement of financial position physically exist.

n Inventories represent items held for sale in normal course of business.

Completeness n Inventory includes all products, materials and supplies owned by the

company that are on hand, in transit or stored at outside locations.

Rights and n The company has legal title of ownership to the inventories.

obligations

Valuation n Inventories are properly stated at cost (except when net realisable value

is lower).

n Slow-moving, defective and obsolete items included in inventories are

properly identified and valued.

Measurement n Inventory is recorded at the correct amount in the correct period.

Presentation and n Inventories are properly classified as current assets with major

disclosure categories and their bases of valuation adequately disclosed.

Note: Assertion of Occurrence relates to transactions related to inventory, not the balance




AUDIT EVIDENCE

Audit evidence

Underlying accounting data

Books or original entry

General and subsidiary ledgers

Related accounting manuals

Worksheets supporting cost allocations, computation and reconciliations, etc.

+

Corroborating information

Documents, such as cheques,

Confirmations and other written

Information from inquiry,

Other information developed or obtained by the auditor

invoices, contracts and minutes

representations

observations and inspection

Fig. 5.2 The audit

equation (p. 184)




EXAMPLE OF A CASH

PURCHASE TRANSACTION

Business

entity

(client)

Cash

Business

entity

(supplier) Inventory

Fig. 5.3 A cash purchase

transaction (p.184)




AUDIT PROCEDURES

• Inspection

• Observation

• Inquiry

• Confirmation

• Computation

• Analytical procedures




Transactions traced from initial entry in system to intermediate records, where transactions become components of subtotals, and ultimately to disposition in final records, where subtotals are summarised for presentation in financial report.

Direction of tracing can be modified: auditor can trace from point of initiation of transaction to final recording (assertion of completeness), or trace from final record back to point of initiation (assertion of existence).

THE AUDIT TRAIL




SELECTING AUDIT

PROCEDURES

Influenced by the following factors:

• Auditor’s assessment of inherent risk

• Nature of the internal control structure and assessment of control risk

• Materiality of particular component of financial report

• Experience gained from previous audits

• Results of other audit procedures

• Source and reliability of information available




Sufficiency — quantity of audit evidence necessary to provide the auditor with a reasonable basis for an opinion on the financial report.

Appropriateness — quality of audit evidence. Two dimensions:

• Relevance — relates to the financial report assertion of interest.

• Reliability — influenced by its source and nature.

SUFFICIENT APPROPRIATE AUDIT

EVIDENCE




RELIABILITY OF AUDIT EVIDENCE

• Evidence from sources outside an entity is more reliable than evidence obtained solely from within an entity.

• Evidence generated internally is more reliable when the internal control structure is effective.

• Evidence obtained directly by the auditor is more reliable than evidence obtained from the client.

• Evidence in the form of documents or written representations is more reliable than oral representations.




AUDIT RISK AT THE FINANCIAL

REPORT LEVEL

Audit risk is the risk that the auditor will give an inappropriate audit opinion when the financial report is materially misstated.

• Before issuing an opinion on the financial

report, the auditor needs to reduce audit risk sufficiently to make the opinion reliable.




• The auditor reduces audit risk by performing audit procedures until there is sufficient appropriate evidence for each assertion of each significant transaction class or account balance to provide reasonable assurance that the financial reports are not materially misstated.

• The audit risk model focuses audit effort on those classes of transactions or balances that are likely to contain material misstatements.

REDUCING AUDIT RISK




Three components:

• Inherent risk: (IR) susceptibility of an assertion to material misstatement given inherent and environmental characteristics, but without regard to prescribed control procedures.

• Control risk: (CR) risk that material misstatement might not be prevented or detected by internal control procedures.

• Detection risk: (DR) risk that auditors’ substantive procedures lead auditor to conclude no material misstatement when there is one.

COMPONENTS OF AUDIT RISK (AR)




AR = f (IR, CR, DR)

THE AUDIT RISK MODEL




GRAPHICAL DEPICTION OF AUDIT

RISK Fig. 5.4 Audit risk,

graphically depicted (p. 192)




• Auditor cannot change inherent risk.

• Auditor cannot directly change control risk. Auditor can obtain evidence to support an assessed level of control risk less than high (expect to rely on internal control) by examining control environment, information system and control procedures and testing their effectiveness.

REDUCING AUDIT RISK I




The level of detection risk is the lever the auditor can pull to reduce audit risk by:

• Appropriate planning, direction, supervision and review

• Decisions on the nature, timing and extent of audit procedures

• Effective performance of procedures and evaluation of results

REDUCING AUDIT RISK II




INTERRELATIONSHIP OF

COMPONENTS OF AUDIT RISK

Exhibit 5.1 The interrelationships of the components of audit risk (p. 193)




Defined:

• Risk that entity’s business objectives will not be obtained as a result of external and internal factors, pressures and forces brought to bear on entity and, ultimately, the risk associated with the entity’s survival and profitability.

• Requires extensive knowledge of client’s business and industry.

• Recent audit methodologies emphasise assessment of strategic business risk.

STRATEGIC BUSINESS RISK




THE RELATIONSHIP OF STRATEGIC

BUSINESS RISK TO THE DETERMINATION

OF AUDIT RISK




• Tests of control

• Substantive tests

TYPES OF AUDIT TESTS




• To obtain evidence about either:

(1) the effectiveness of the design of the policies or procedures in the internal control structure; or

(2) the operating effectiveness of those policies or procedures.

• The tests are designed to provide evidence to support an assessment of control risk at a level below high (indicating reliance on the keys controls).

TESTS OF CONTROL




• To obtain evidence about the validity and the propriety of the accounting treatment of transactions and balances or, conversely, of errors or irregularities therein.

• These tests reduce detection risk.

SUBSTANTIVE TESTS




• Analytical procedures — study and comparison of relationships between accounting data and related information

• Tests of details — obtaining evidence on the items (or details) included in an account balance or class of transactions:

Tests of transactions

Tests of balances

TYPES OF SUBSTANTIVE

TESTS




USING THE WORK OF AN EXPERT

OR ANOTHER AUDITOR

• Given complexity and highly specialised nature of many client operations, auditors often find they are unable to service clients effectively without specialist knowledge.

• Experts can be internal or external to the audit firm.

• Audit firms develop industry specialisations, have knowledge management systems supporting the specialisations and have employees designated as specialists by industry, function or technical area.




ENSURING THAT WORK BY

AN EXPERT IS ADEQUATE

An auditor should:

• Assess skills and competence of expert

• Assess objectivity and independence of expert

• Communicate with expert to confirm terms of engagement and ensure expert understands objective and use of work

• Evaluate work of expert




USING THE WORK OF

ANOTHER AUDITOR

•Audit work may be undertaken by a number of different auditors. (Consider a consolidated entity with subsidiaries in many countries.)

•The principal auditor retains responsibility for the overall audit opinion and must ensure the procedures used by other auditors are appropriate for the principal auditor’s purpose.




ASSESSING THE WORK OF

ANOTHER AUDITOR

AUS 602 indicates that where an auditor

uses the work of another auditor, the

principal auditor should:

• Assess professional competence of other auditor

• Advise other auditor of requirements applicable to engagement

• Advise other auditor of use to be made of work, areas requiring special attention, and timetable.




These are the specific means used to record audit evidence.

Working papers aid in:

• Planning and performing the audit

• Supervising and reviewing the audit work

• Gathering evidence and providing essential support for the auditor’s opinion

Two main divisions:

• Permanent file - store of documents relevant to this audit and future years (e.g. copies of articles of association, continuing contracts)

• Current working paper file - documentary record of evidence gathered and conclusions reached on this audit.

WORKING PAPERS




Includes:

1. Overall audit plan

2. Review of accounting system and related internal controls

3. Audit program, listing the audit procedures undertaken

4. Details of audit testing undertaken

5. Working trial balance - schedule of general ledger accounts

6. Trial balance working paper schedules, including external documents

7. Draft of financial report and audit report

CURRENT WORKING PAPER FILE