Auditing L&T Outline WEEK 1 S1 2021 PDF

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LECTURE AND TUTORIAL OUTLINE FOR LECTURE 1 SEMESTER 1 2021 (Week of March 1st 2021) THE CONCEPT OF ASSURANCE AND AN INTRODUCTION TO AUDITING Lecture 1 introduces the subjects of assurance and auditing. In so doing, six issues are explored: 1: The concept of assurance 2: Definition of an audit 3: Overview of a financial report audit 4: Reasons for a financial report audit 5: The legal and ethical context for an audit 6: Auditing Standards

1: The concept of assurance An assurance service is defined in the AUASB Glossary as, “An engagement in which an assurance practitioner expresses a conclusion designed to enhance the degree of confidence of the intended user…about the outcome of an evaluation or measurement of a subject matter against criteria.” As such, we can say that an assurance service provides comfort to the intended user (the person/ party that is seeking information) so that they can be well informed about the quality of the information they require. Importantly, we see that an assurance engagement (of which a financial statement audit is an example) has five elements: (1) A three-party relationship comprising the responsible party, the intended user And the assurance practitioner; (2) A subject matter; (3) Suitable criteria; (4) Sufficient appropriate evidence; and (5) A written assurance report. There are many different types of assurance engagements. Some we encounter in our private lives, such as having a pre-purchase report on a vehicle or a house. Others are more specialised. All have in common the five elements noted above. However, the subject matter, the qualifications of the assurance practitioner and the extent of the evidence collection and evaluation can differ. In all cases, quality control, adherence to

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ethical principles and the application of assurance standards are required. Examples specialised assurance services include the following: •

Financial report audit

•

Review

•

Report on internal control structures

•

Performance audit

•

Compliance engagement

•

Internal audit

•

Sustainability/ Environmental Audit

2: The definition of an audit An audit is defined as, “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.” (American Accounting Association, 1973, cited in Gay and Simnett, 2018, p.13) In Lecture 1 we will “unpack” this definition in order to get a clear understanding of what an audit is (and what auditors do when conducting an audit). This is important because, as we progress through the course, we will explore in some detail all aspects of the audit of a set of financial statements. In defining an audit, we also consider what the audit of a set of financial statements provides. The following quote from the document, “Understanding Financial Statement Audits: a guide for Financial Statement Users, Ch. 3”, which is in the Auditing, Assurance and Ethics Handbook 2019, sums this up nicely. It states, “The auditor provides... an opinion on whether the financial information is presented fairly…in conformance with the basis of accounting indicated. The auditor…carries out audit procedures that… enable him or her to provide this high level of assurance about the reliability of management representations in the financial statements. The auditor tests the data underlying the entity’s financial statements and the systems generating that data to obtain evidence that… provides the basis for the auditor’s opinion whether the financial statements are free from material misstatement.”

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3: An overview of the audit process Lecture 1 also includes a brief overview of the audit process. It highlights the phases of an audit and the risk-based approach to auditing. In a risk-based audit, the auditor identifies those issues at most risk of misstatement and directs his/ her attention to those. 4: Reasons for an audit Audits (in one form or another) have been undertaken for thousands of years. While the objective of auditing and the method of auditing has changed over time, they are undertaken because of the benefits they provide. In Lecture 1 we see that there are three broad reasons for having audits: (1) economic demand for high quality information through reducing information risk; (2) particular benefits for the client; and (3) legal requirements.

Benefits of an audit An external audit can bring with it benefits such as (1) access to capital markets; (2) a lower cost of capital; (3) deterrence to inefficiency and fraud; and (4) internal control and operational improvements.

5: The legal and ethical and professional context for an audit Ultimately, the responsibility for financial reporting and auditing in Australia lies with Government, however, the professional accounting bodies (CPA Australia, Chartered Accountants Australia and New Zealand, and the Institute of Public Accountants) along with other stakeholders have input into system. (For listed entities, the Australian Stock Exchange imposes further requirements). Government lays down the legislative framework, which encompasses standard setting and regulation. The supreme body with respect to standard setting is The Financial Reporting Council, which has oversight of the standard setters: The Australian Accounting Standards Board and the Auditing and Assurance Standards Board. Regulation of financial reporting by, and auditing of, each entity depends on the type of entity and/ or what it does. Regulation of company financial reporting and auditing is provided for under the Corporations Act. Regulation of financial reporting by, and auditing of, charities, for example, is provided under the Australian Charities and Not-for-profits Commission Act. Auditing is an applied discipline, that it, it is undertaken to serve particular economic and social objectives. It takes place within a well-defined ethical and legal framework. Lecture 1

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introduces that framework. We explore this framework in greater detail in weeks 10 and 11 of the course. 6: Auditing Standards Auditing standards establish mandatory requirements for, and provide explanatory guidance to, auditors so that they can properly conduct an audit and confidently provide the client with an appropriate audit opinion. In Lecture 1 we will gain an overview of how auditing standards used during an audit; what authority they have; the standard setting process; how an individual auditing standard is structured; and how the suite of auditing standards is structured.

2: LEARNING OBJECTIVES: LECTURE 1: Understand the concept of assurance 2: Explain the five essential elements of an assurance engagement 3: Define auditing. 4: Become familiar with the main steps in undertaking an audit 5: Understand the reasons for undertaking an audit. 6: Understand the benefits of an audit 7: Appreciate the legal and ethical framework within which an audit takes place A NOTE ABOUT THE READINGS IN WEEK 1 In week 1 we use five readings in addition to the textbook and the handbook. These readings are short (one is just one page) but provide essential material on the nature of an audit and the reasons for undertaking an audit. Some readings cover material that is not included in the textbook, while some provide a slightly different perspective on material covered in the textbook. Readings can be accessed through the course web page. 3: REQUIRED READING/ VIEWING Textbook: Gay, G. and Simnett, R. (2018) Auditing and Assurance in Australia (Seventh Edition), McGraw-Hill, Sydney, pp. 6-28 Auditing and Assurance Standards Board (AUASB) Pronouncements (www.auasb.gov.au) AUAS Glossary Australian Professional and Ethical Standards Board (APESB) Pronouncements (www.apesb.org.au) APES 110. Glossary 4

Readings: Reading 1: Leung, P., Coram, P., Cooper, B. and Richardson, P. (2018) Auditing and Assurance (First Edition), p. 193, “Benefits of an Audit”. Brisbane, Pearson. Reading 2: Arens, A., Best, P.J., Shailer, G.E.P., Fiedler, B.A., Elder, and Beasley (2013). Auditing, Assurance Services and Ethics in Australia: An integrated Approach, 9th edition, pp. 10-12. Reading 3: CAANZ (2019) Audit and review requirements for Australian Entities Reading 4: Understanding Financial Statement Audits – A Guide for Financial Statement Users, Chapter 1-4. Reading 5 Wittington and Pany (2012) Principles of Auditing and Other Assurance Services. McGraw Hill. Pp.142-148.pdf

Other Resources: Resource 1: Downer EDI Ltd Annual Report June 2020 Resource 2: Downer EDI Ltd Half Year Report December 2020 Additional Guidance: Answering Case Study Questions Film Clips Film Clip 1: A Few Minutes With… Film1: The importance of an audit. Film Clip 2: Films (Other) Professional Scepticism. Institute of Chartered Accountants of England and Wales. 4: WEEKLY QUESTIONS (TO BE COMPLETED BY TUESDAY MARH 9th) QUESTION 1 Consider Reading 4, “Understanding Financial Statement Audits: A Guide for Financial Statement Users”, and answer the following questions: (i) Why are financial statements needed? (ii) Why are financial statement audits needed? (iii) In the process of providing reasonable assurance that the financial statements are fairly presented, what does an auditor address? (iv) Does an auditor guarantee the accuracy of the financial statements that he/she audits?

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QUESTION 2 The textbook, at pp. 7-9, outlines the five elements of an assurance report. Discuss each of the five elements using the Using examples from the Independent Audit Report on the 2020 Financial Report of Downer Ltd (which can be accessed through the course My Uni page under “Other Resources”), answer the following questions: (a) Who is the responsible party? (b) What is the subject matter of the audit? (c) What are the criteria against which the subject matter you identify in (ii) above are evaluated? (d) What does this audit report tell the reader about the role of Australian Auditing Standards in the audit?

QUESTION 3 (Exploring audit resources) : Access the website of the Australian Auditing and Assurance Standards Board (www.auasb.gov.au). From the menu ribbon at the top of the screen, select Publications. Scroll down and select AUASB Bulletins. Click on the hot link titled, “Professional Scepticism in an Audit of a Financial Report” (which is dated Aug 12 2012) and, in your own words, answer the following questions: (a) What is professional skepticism? (b) How is professional secpticism applied in an audit? QUESTION 4 (Using the series of f ilms titled, “A Few Minutes With…) View film no. 1 of the series, A Few Minutes With.., titled, “The Importance of an Audit”, and answer the following questions: (i) What are the benefits of a financial statement audit? (ii) How can a financial statement audit can reduce information risk? QUESTION 5 Explain the role and authority of auditing standards.

TUTORIAL WORKSHOP QUESTIONS (TO BE DISCUSSED IN TUTORIALS DURING THE WEEK OF MARCH 8th 2021)

QUESTION 1: Frank Smart started a manufacturing business ten years ago. Over that time, the business has grown steadily. Frank now employs 40 staff and has a turnover of $100m. To fund this growth, Frank sold equity interest to a small group of family members and friends, and took out a bank loan. He renamed the company Future Pty Ltd. Two years ago, the company installed a new computerised financial information system in order 6

to manage its accounting function better, and to reduce costs. The company is considering further expansion into a potentially lucrative overseas market. Required: Consider the facts given above and use them to explain the ways in which Future Pty Ltd can benefit from an external audit of its annual financial statements. LEARNING OBJECTIVES: Lecture 1 Learning Objective 6: Understand the benefits of an audit REFERENCES: Lecture Slides: Lecture 1, Slides 66-73 Reading 1: Leung, P., Coram, P., Cooper, B. and Richardson, P. (2018) Auditing and Assurance (First Edition), p. 193, “Benefits of an Audit”. Brisbane, Pearson. QUESTION 2 Vial-tek Ltd borrowed $1.5m from Australia Bank at an annual interest rate of 9.5%. Under the loan agreement, the bank requires Vial-tek to provide it with a copy of its annual financial statements, but does not require an assurance report of any kind. The bank has offered to replace Vial-tek’s existing loan agreement with a new one at a rate of 8.5%, but would require Vial-tek to provide financial statements that have been reviewed by a public accounting firm. Alternatively, the bank can replace the existing loan agreement with a new one at a rate of 7.5%, but would require Vial-tek to have the financial statements audited by a public accounting firm. The financial controller of Vial-tek approached a public accounting firm and was given an estimated cost of $12,000 to perform a review and $20,000 to perform an audit. The accounts clerk has provided this comparative information in the table below.

ASSURANCE

COST OF

ANNUAL

ANNUAL

ANNUAL

SERVICE

ASSURANCE

INTEREST

INTEREST

LOAN COST ($)

SERVICE

RATE

EXPENSE

(A+C)

(A)

(B)

(C)

None

0

9.5%

$ 142,500

Review

$12,000

8.5%

$ 127,500

Audit

$ 20,000

7.5%

$ 112,500

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Required: (i) Complete the table above. (ii) Explain why the interest rate charged by the lender is highest when Vial-tek does not provide an assurance report on the financial report and is and lower when an audit report is provided than when a review report is provided. LEARNING OBJECTIVES: Lecture 1 Learning Objective 5: Understand the reasons for undertaking an audit; and Learning Objective 6: understand the benefits of an audit. REFERENCES: Reading 2 Arens, A., Best, P.J., Shailer, G.E.P., Fiedler, B.A., Elder, and Beasley (2013). Auditing, Assurance Services and Ethics in Australia: An integrated Approach, 9th edition, pp. 10-12. Lecture Slides: Lecture 1, slides 68-71.

QUESTION 3: Give one example of decision that you may be faced with as you go about your day-to-day activities for which there is a risk due to the quality of the information you rely on. Sate one source of information that can reliably reduce risk and one which is less reliable. An example is provided below. (Hint: The questions to consider here are: (1) what are some examples of information that is used in day-to-day activities; (2) what decisions are made on the basis of using the information; and (3) what assurance can be obtained to ensure that the information is reliable.)

Decision

Information Reliable information source

Less reliable information source

What to wear.

Weather

Get the information from a

Your next-door neighbour,

reputable source, such as the

who claims he can tell

Bureau of Meteorology Website,

when it is going to rain

a telephone app such as

because his arthritis gets

WillyWeather, or a newspaper.

worse as humidity builds.

LEARNING OBJECTIVES: Lecture 1 Learning Objective 1: Understand the concept of assurance. REFERENCE: Lecture Slides: Lecture 1, slides 6-8 8...