Auditing Assertions PDF

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Auditing Notes Auditing Assertions Related standards – 

ASA 315 – Identifying and assessing the risk of material misstatement.

Auditing assertions are claims made by an organisation’s management regarding its financial statements. These assertions form a theoretical basis for external auditors to develop a set of auditing procedures.

The auditor uses these assertions to assess risks by considering the different types of potential misstatements that may occur and then designing audit procedures that address these risks. Assertions essentially deal with recognition and measurement of the various elements of the financial report and related disclosures. ASA 315 has 3 categories of assertions, classes of transactions and events, account balances, and presentation and disclosure. Assertions can be split up into 3 categories

1. Assertions about classes of transactions and events for the period under audit a. Occurrence – transactions and events that have been recorded have occurred and pertain to the entity b. Completeness – All transactions and events that should have been recorded have been recorded. c. Accuracy – Amounts and other data relating to recorded transaction and events have been recorded appropriately. d. Cut-off – Transactions and events have been recorded in the correct accounting period. e. Classification – transactions and events have been recorded in the proper accounts.

2. Assertions about account balances at the period end a. Existence – Assets, liabilities and equity interests exist b. Rights and obligations – the entity holds or controls the rights to assets and liabilities are the obligations of the entity. c. Completeness – All assets, liabilities and equity interests that should have been recorded have been recorded.

d. Valuation and allocation – Assets, liabilities and equity interests are included in the financial report at appropriate amounts and any resulting valuation adjustments are appropriately recorded.

3. Assertions about presentation and disclosure a. Occurrence and rights and obligations – disclosed events, transactions and other matters have occurred and pertain to the entity. b. Completeness – All disclosures that should have been included in the financial report have been included. c. Classification and understandability – financial information is appropriately presented and described, and disclosures are clearly expressed. d. Accuracy and valuation – Financial and other information is disclosed fairly and at appropriate amounts.

Role of the auditor in relation to auditing assertions 1. Obtain evidence that supports each of the assertions for every material component of the financial report (Account balance, class of transactions or a disclosure).

2. Categories of assertions provide a framework for developing specific audit objectives for each material account balance, class of transactions or disclosure.

Auditing procedures An audit procedure are actions that an auditor takes in acquiring evidence. Procedures are not evidence themselves but means of acquiring evidence. ASA 500.5 defines audit evidence as all of the information used by the auditor in arriving at the conclusions on which the auditor’s opinion is based.

Audit procedures 

Inspection – Involves the examination of documents, records, or tangible assets. The reliability of inspection of records or documents depends on their nature and source and on the effectiveness of internal control over their processing. ASA 500 requires the need to inspect original documents over photocopies. The inspection of tangible assets provides reliable audit evidence concerning their existence but not necessarily their valuation, completeness, or ownership.

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Observation – Involves the auditors observing the behaviour of operating personnel and the functioning of the business in operation. These observations are made from the perspective of their effects on accounting and their implications for auditing, such as evidence of control activities being carried out.

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External confirmation – type of enquiry by which an auditor normally obtains written statements from outside parties such as banks, solicitors, or debtors on information that they are qualified to give. Independent party questioned must be reliable and knowledgeable about a subject of interest to the auditor

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Recalculation – the arithmetical accuracy of the many calculations required in the processing of data can be proven by recalculating the results. Examples of this include additions of ledger account balances, depreciation or amortisation calculations and inventory extension and additions.

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Re-performance – the auditor may independently execute procedures or controls that were originally performed as part of the entity’s internal control.

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Analytical procedures – based on their dual nature of business transactions and the interrelationship between the variables of business operations. They involve the investigation of fluctuations in relationships to ascertain whether there are inconsistencies in relation to other relevant information or variations from predicted amounts.

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Enquiry – auditor must ask questions during examination. The question and answer process includes interviewing and obtaining written statements from management and employees. Explanations of significant variations in accounting data are frequently obtained from employees. However, the auditor cannot rely on unsupported answers, but must obtain support for the reasonableness of the answer given. One formal application of the procedure of enquiry is the use of an internal control questionnaire to gain information about the prescribed control activities.

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Vouching

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Tracing Examples

Financial report assertion Existence

Illustrative audit objectives

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Rights and obligations

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Inventories in financial statements physically exist Inventories represent items held for sale I the normal course of business The company has legal title or similar rights of ownership to the inventories

Examples of audit procedures/evidence 

Stocktake, select from inventory records, and count physical stock.

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Check shipping documents (bill of lading) for ownership of goods in

 Completeness

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Valuation and allocation

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Inventories exclude items billed to customers or owned by others Inventory quantities as per the accounting records include all products, material and supplies owned by the company that are on hand. Inventory quantities include all products, materials and supplies owned by the company that are in transit or stored at outside locations. Inventories are properly stated at the lower of cost and net realisable value. Slow-moving, excess, defective and obsolete items included in inventories are properly identified and valued.

Completing the audit In this topic

transit 

Stocktake, select from physical stock, count, and check against inventory records.

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Compare subsequent sales price to cost.

1. 2. 3. 4. 5.

Auditing contingent liabilities Events that arise after the balance date Obtaining a representation letter from management Evaluating all our audit evidence Assessing going concern

Auditing contingent liabilities

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Recorded on the balance sheet. Examples include o Warranties o Lawsuits o Disagreements with ATO o Guaranteeing the debt/loan of another entity

What standards apply?   

ASA 500 Audit evidence ASA 502 – Audit evidence – specific considerations for litigation and claims ASA 540 Auditing accounting estimates, including fair value accounting estimates, and related disclosures

Events arising after the balance date What is a subsequent event – AASB 110 – Events after the reporting date • From the Definitions of AASB 110 Events after the reporting period are those events, favourable and unfavourable, that occur between the end of the reporting period and the date when the financial statements are authorised for issue. Two types of events can be identified: (a) those that provide evidence of conditions that existed at the end of the reporting period (adjusting events after the reporting period); and (b) those that are indicative of conditions that arose after the reporting period (non-adjusting events after the reporting period). • It is management’s responsibility to identify subsequent events

Examples –   

Customer who owes funds (AR) is placed into voluntary administration Announcing a joint voluntary administration Announcing a joint venture in the future

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Purchasing a major asset Deciding to sell off or close part of the entitys operations Commencing or progress in a lawsuit Destruction of a major asset.

What auditing standard applies ASA 560 – Subsequent events The auditor must determine whether subsequent events are appropriately adjusted, recorded, and/or disclosed in the financial report.

Assessing the risk of going concern AASBB 101 presentation of financial statements

Completion of Audit Audit opinions What is in this topic? 1. 2. 3. 4. 5.

Collating our audit findings Negotiating adjustments with the client Preparing the audit opinion Determining the key audit matters Preparing the management letter

Collating out audit findings ASA 450 Evaluation of misstatements identified during the audit What are included in misstatements? 

Misstatement means a difference between the reported amount, classification, presentation, or disclosure of a financial statement report item and the amount, classification, presentation, or disclosure that is required for the item to be in accordance with the applicable financial reporting framework (which is the audited amount) (Para. 4a)

During the audit, we must:

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“accumulate misstatements identified during the audit, other than those that are clearly trivial.” (Para 5)

We must evaluate the misstatements individually and in aggregate form.

Summary list of misstatements  

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A record of all misstatements identified during the audit Many names, depending on the audit firm o Summary of unadjusted misstatements o Schedule of audit differences Individual firms have their own classification systems for misstatements – options include o Type – factual, judgement or projected o Type – amount, classification, presentation, disclosure o Material – quantitatively material, qualitatively material.

Negotiating the audit ASA 450 instructs the auditor to  

Request management correct the misstatements (450.8) If they refuse – consider this when preparing their opinion (450.9)

The audit negotiation process The audit negotiation process Adjustments will be more easily accepted by Adjustments are more likely to be argued over the client when: when:  They are based on clear mistakes/errors  They are based on projections with  They are based on projections with small samples large samples  They are based on a difference of  An independent expert verifies the opinion in an accounting estimate auditor’s judgement or opinion about  They are for disclosures that require an issue. judgment on how much to disclose  Where the audit committee is effective  There is a dominant CEO/CFO. in providing oversight  Whether a similar misstatement was made in previous years and adjusted. Factors that may affect the auditor-client negotiation process  

Why is an audit needed? Does the CFO or FC support the auditor’s judgement?

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The negotiation tactics used Whether the auditor is at the beginning or end of their 5-year rotation (level of trust) Whether it is the first year a firm audits a client The quality of the auditor client relationship Whether non-audit services are also provided by the auditor The experience of both the audit partner and the client’s main negotiator Whether anyone on the audit committee used to work at the audit firm.

Preparing the audit opinion (ASA 700, 705, and 706) Organisation of the standards   

Standards about opinion – 700, 705 Disclosures – 706 Disclosures related to audit process – 701

ASA 700 1. We must form an opinion (Para 10) 2. The information we must use to prepare our opinion (para 10-13) a. Do we have sufficient appropriate evidence? (ASA 500) b. Are any uncorrected misstatements material? c. Is the financial report overall free from material misstatement? d. Are disclosures appropriate? ASA 700: Forming an opinion and reporting on a financial report requires auditors to form an opinion under Para. 10. The information we must use to prepare our opinion under this standard includes 1. 2. 3. 4.

Sufficient appropriate evidence (defined by ASA 500) Are any uncorrected misstatements material? Is the financial report overall free from material misstatement? And Are disclosures appropriate.

Unmodified opinion The opinion clients want 

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“The auditor shall express an unmodified opinion when the auditor concludes that the financial report is prepared, in all material respects, in accordance with the applicable financial reporting framework.” (ASA700.16) Must include: o Sufficient appropriate evidence o Uncorrected misstatements are immaterial o Prepared within the AASBs

Modified audit opinions ASA 705.

What exactly does pervasive mean? 

ASA 705.5: Para 5 –

For the purposes of this auditing standard, the following terms have the meanings attributed below: a. Pervasive – A term used, in the context of misstatements, to describe the effects on the financial report of misstatements of the possible effects on the financial report of the misstatements, if any, that are undetected due to an inability to obtain sufficient appropriate audit evidence. Pervasive effects on the financial report are those that, in the auditor’s judgement: 1. Are not confined to specific elements, accounts, or items of the financial report 2. If so confined, represent or could represent a substantial proportion of the financial report; or 3. In relation to disclosures, are fundamental to users’ understanding of the financial report.

ASA 706 – Emphasis of matter (EoM) and Other matter (OM) paragraphs When the auditor wants to draw attention to some matter that is outside of a modification. The matter is either –  

Already presented/disclosed in the financial statements but the auditor wants to add additional emphasis, or We think it is relevant to the user’s understanding of the audit, auditor’s responsibilities, or the report itself.

ASA 706.6 talks about this definition. It is important to note that neither of these “modify” the auditor’s opinion. Emphasis of matter vs other matter para 

For matters already disclosed in the financial report

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For matters not in the financial report Important to help users understand

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Important to help users understand the financial report Mostly for subsequent events disclosures

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what audit is, and the auditors responsibilities Where other information is contradictory

What about when there is a going concern issue? Two circumstances 1. Where management make appropriate disclosures – Include a material uncertainty paragraph in the audit opinion.

2. Where management do not make appropriate disclosures – Modify the opinion – either qualified or adverse.

Determining the key audit matters – ASA 701 ASA 701 is a new standard which came into effect in Australia in 2019 but has been an international standard since 2015. The UK was an early adopter while the US has a similar standard but use the term critical audit matters.

Why? 

“The purpose of communicating key audit matters is to enhance the communicative value of the auditor’s report by providing greater transparency about the audit that was performed (ASA 701.2).

Management letter What is a management letter?

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ASA 260 communication with those in charged with governance (Those charged with governance) (TCWG)

Significant Findings from the Audit 16. The auditor shall communicate with those charged with governance a) The auditor’s view about significant qualitative aspects of the entitys accounting practices, including accounting policies, accounting estimates and financial reporting disclosures. When applicable, the auditor shall explain to those charged with governance why the auditor considers a significant accounting practice, that is acceptable under the applicable financial reporting framework, not to be most appropriate to the particular circumstances of the entity. b) Significant difficulties, if any, encountered during the audit. c) Unless all of those charged with governance are involved in managing the entity; I. Significant matters, arising during the audit that were discussed, or subject to correspondence, with management and II. Written representations that the auditor is requesting. d) Circumstances that affect the form and content of the auditor’s report, if any; and e) Any other significant matters arising during the audit, tat, in the auditor’s professional judgment, are relevant to the oversight of the financial reporting process. ASA 265 also requires this communication Para. 8: if the auditor has identified one or more deficiencies in internal control, the auditor shall determine, on the basis of the audit work performed, whether, individually or in combination, they constitute significant deficiencies. Para. 9: The auditor shall communicate in writing significant deficiencies in internal control identified during the audit to those charged with governance on a timely basis. Para. 11: The auditor shall include in the written communication of significant deficiencies in internal control: a. a description of the deficiencies and an explanation of their potential effects; and b. Sufficient information to enable those charged with governance and management to understand the context of the communication. In particular, the auditor shall explain that: i. The purpose of the audit was for the auditor to express an opinion on the financial report. ii. the audit included consideration of internal control relevant to the preparation of the financial report in order to design audit procedures that are appropriate in the circumstances but, for the purpose of expressing an opinion on the effectiveness of internal control; or Is this a real letter? 

Yes – but lengthier – often a report

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Many auditors will also give a presentation to TCWG – the audit committee, members of the executive. This is more beneficial as it clears up confusion about the audit and the audit report and explains the terms often thrown by auditors such as a qualified opinion. Some businesses may not know the processes of auditors that well and this process helps clear up any misconception of confusion of the auditing process. What do we hope to achieve with this communication – improvement in internal controls. o Better understanding of the audit process and what the auditor is asking for o Smoother audit next year.

To sum up   

We need to understand what misstatements require adjustment and how to approach management about making those adjustments We need to know how to determine which opinion to give and whether an emphasis of matter, other matter or mat...