AUE2601 Studyguide 3rd year revision PDF

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AUE2601/1/2020

AUE2601/1/2020

© 2017 University of South Africa All rights reserved Printed and published by the University of South Africa Muckleneuk, Pretoria AUE2601/1/2020 70705712

AUE2601/1/2020

Contents TOPIC 1:

INTRODUCTION TO AUDITING .......................................................... 1

LEARNING UNIT 1.1: THE AUDITOR .................................................................... 3 LEARNING UNIT 1.2: ASSURANCE AND NON-ASSURANCE ENGAGEMENTS ................................................................. 9 LEARNING UNIT 1.3: AUDITING POSTULATES ................................................. 19 LEARNING UNIT 1.4: THE ACCOUNTING PROFESSION .................................. 21 LEARNING UNIT 1.5: THE FINANCIAL STATEMENT AUDIT ENGAGEMENT ................................................................. 25 TOPIC 2:

REGULATION OF THE AUDITOR .................................................... 32

LEARNING UNIT 2.1: LEARNING UNIT 2.2:

THE AUDITING PROFESSION ACT 26 OF 2005 (APA) ............................................................................... 35 THE COMPANIES ACT 71 OF 2008 (THE AUDITOR) ... 45

LEARNING UNIT 2.3:

ETHICAL PRINCIPLES REGULATING THE PROFESSION ................................................................. 49

LEARNING UNIT 2.4:

QUALITY CONTROL OF AUDIT WORK ......................... 72

TOPIC 3:

GENERAL PRINCIPLES OF ASSURANCE ENGAGEMENTS ......... 75

LEARNING UNIT 3.1:

ASSURANCE ENGAGEMENTS ..................................... 77

LEARNING UNIT 3.2:

INTERNAL CONTROL .................................................... 80

LEARNING UNIT 3.3:

AUDIT EVIDENCE ..........................................................91

LEARNING UNIT 3.4:

RISK ASSESSMENT AND AUDIT PROCEDURES ...... 102

LEARNING UNIT 3.5: LEARNING UNIT 3.6:

MATERIALITY ............................................................... 113 AUDIT RISK .................................................................. 118

LEARNING UNIT 3.7:

AUDIT DOCUMENTATION ........................................... 124

LEARNING UNIT 3.8:

ASSURANCE REPORTS .............................................. 126

TOPIC 4:

THE AUDIT PROCESS .................................................................... 128

LEARNING UNIT 4.1: LEARNING UNIT 4.2:

STAGES OF THE AUDIT PROCESS ............................ 130 THE PRELIMINARY ENGAGEMENT STAGE............... 132

LEARNING UNIT 4.3:

THE PLANNING STAGE ............................................... 136

LEARNING UNIT 4.4:

PUTTING THE AUDIT STRATEGY AND PLAN INTO ACTION ......................................................................... 141

LEARNING UNIT 4.5:

THE EVALUATING, CONCLUDING AND REPORTING STAGE .......................................................................... 146

TOPIC 5:

ENGAGEMENTS TO REVIEW HISTORICAL FINANCIAL STATEMENTS ................................................................................. 150

LEARNING UNIT 5.1:

THE AUDITING PRINCIPLES WITH REGARD TO REVIEW ENGAGEMENTS............................................ 152 iii | P a g e

LEARNING UNIT 5.2:

PRELIMINARY ENGAGEMENT ACTIVITIES ............... 156

LEARNING UNIT 5.3:

PERFORMING THE ENGAGEMENT ............................ 158

LEARNING UNIT 5.4:

CONCLUSION AND REPORTING ................................ 162

iv | P a g e

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TOPIC 1:

INTRODUCTION TO AUDITING

Topic overview The aim of this topic is to explain the theory and philosophy of auditing, assurance and non-assurance engagements, the auditing postulates, the accounting profession and the financial statement audit engagement. This topic is divided into the following learning units: Learning unit

Title

Page

1.1

THE AUDITOR

3

1.1.1

The definition, types and characteristics of auditors

3

1.1.2

The need for auditors

6

1.2

ASSURANCE AND NON-ASSURANCE ENGAGEMENTS

9

1.2.1

Assurance engagements

9

1.2.2

Non-assurance engagements

15

1.2.3

Statutory and non-statutory assurance engagements

16

1.3

AUDITING POSTULATES

18

1.4

THE ACCOUNTING PROFESSION

20

1.4.1

Professional status

20

1.4.2

Accounting bodies in South Africa

20

1.4.3

Pronouncements regulating the auditing profession

22

1.5

THE FINANCIAL STATEMENT AUDIT ENGAGEMENT

24

1.5.1

The overall objectives of the auditor and the conduct of an audit in accordance with ISAs

24

1.5.2

The roles of the various parties

25

1.5.3

Management’s assertions regarding the financial statements

26

1|Page

Learning outcomes Learning unit

In this topic we focus on the following learning outcomes:

Level

1.1 The auditor

•

Describe the various roles of auditors

1

1.2 Assurance and nonassurance engagements

•

Describe assurance and other engagements

1

1.3 Auditing postulates

•

Explain and discuss the auditing postulates

1

1.4 The accounting profession

•

Describe the accounting profession

1

1.5 The financial statement audit engagement

•

Explain the financial statement audit engagement

1

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LEARNING UNIT 1.1:

THE AUDITOR

Introduction Auditing firms are often engaged to verify the vote count at major events, such as the Idols competition. Why do you think that the organisers arrange for these firms to audit the results of such competitions? The organisers require an independent verification by a reputable profession which is perceived by the public and contestants as being independent and technically competent. They also want assurance that the results are accurate and that no “fixing” of the results has taken place. An auditing firm can therefore add credibility. The auditing firm can also add value by making recommendations to ensure the smooth running of the event and avoidance of problems. We are certain that you will find the concepts and techniques covered in this study guide and related references useful. However, our experience is that students often fall into the trap of memorising definitions, objectives, rules and techniques without first understanding what an auditor does and what an audit of an entity actually entails. In this study unit, auditing theory is explained by defining an auditor, describing the different types and characteristics of auditors and explaining the fundamental ethical principles and the need for auditors.

1.1.1

The definition, types and characteristics of auditors

In the workplace there are various types of auditors and differences in the types of audits they perform. One thing that they all have in common is that the auditor is independent and provides assurance. 1.1.1.1

What is an auditor?

Study • •

Jackson & Stent (2016:1/2) SAICA Student Handbook, Volume 2A(1), ISA 200: Overall objectives of the independent auditor and the conduct of an audit in accordance with International Standards on Auditing (ISA 200: par 3 and 13[d])

Note the following in the study resources above: • • •

the definition of an auditor the meaning of the auditor “giving assurance” the purpose of an audit of financial statements

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1.1.1.2

Types, characteristics and classification of auditors

Study •

Jackson & Stent (2016:1/2–1/4)

Although this module focuses mainly on the independent external audit function, this learning unit also discusses the internal auditing function and other kinds of auditing services. Note the following in the study resource above: • •

the different types of auditors and the duties they perform characteristics of auditors

Activity 1 Required Name the different types of auditors and describe the objectives of each type of audit.

Feedback on activity 1 Reference: Jackson & Stent (2016:1/2–1/4) See the reference in the prescribed textbook above regarding the types and objectives of the different types of auditors. The focus of this module will be on the external auditor. External auditors express an opinion about the financial statements. However, you are required to understand the differences between the different types of auditors, for example the differences between internal and external auditors (see the table below). Table 1: Differences between internal and external auditors The following are important principles that distinguish internal auditors from external auditors (see Jackson & Stent 2016:1/2–1/4): Internal auditors • Perform independent assignments on behalf of the board of directors. • Provide independent information about the company’s operations. • Are contracted by the company they are working with. In some cases the internal audit function is in-house and the internal auditors are employees of the company.

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External auditors • Perform an attestation function (audit or review engagements). • Provide an independent opinion on the financial information examined. • Work for an independent audit firm.

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• •

•

Report to management (including the audit committee). Function independently in the organisation, but remain part of the organisation. Obtain a mandate from management/the audit committee.

•

Report to the shareholders.

•

Function independently from the organisation.

•

Obtain a mandate through legislation.

As mentioned in the prescribed textbook, the different types of auditors have one characteristic in common, namely “independence”. If the person performing the audit cannot be independent of the entity that is being audited, then the result on the audited entity is not necessarily a valid audit. Note that when internal auditors are part of the organisation, they should still maintain independence of the specific department that is being audited. 1.1.1.3

Independence and fundamental ethical principles

Study • • •

Jackson & Stent (2016:1/10–1/11) SAICA Student Handbook, Volume 2A(2): International Framework for Assurance Engagements (Framework: par 6) SAICA Student Handbook, Volume 2B: Code of Professional Conduct, Part 1 (section 110.1 A1 and 400.5)

Independence is the characteristic that is common to all the assurance engagements, but it is not the only essential characteristic. The International Federation of Accountants (IFAC) lays down the fundamental ethical principles (characteristics) that all auditors, as professional accountants, are required to observe. The South African Institute for Chartered Accountants (SAICA) has adopted the IFAC code in its entirety. Note the following in the study resources above: •

fundamental ethical principles that all professional accountants are required to observe

Activity 2 David Prince has just started his academic studies in Auditing and is asked to comment on whether and how the following scenario could influence the ethical principles an external auditor should comply with. While the external auditor was performing his audit he was unable to confirm that the vehicles owned by the company were actually registered in the company’s name, but decided not to mention the matter to the shareholders in his report and accepted the inclusion of the vehicles in the financial statements. The external auditor also documented that there was a serious threat to the going concern of the business, because the business had lost 60% of its tenders for new contracts. However, he decided not to mention the matter to the shareholders of the company in his report. He was also aware that his father-in-law held shares in the company being audited, and over dinner one evening he commented that it would be in his father-in-law’s best interest to urgently dispose of his shareholding in the company. 5|Page

Required List and discuss the fundamental ethical principles that the external auditor has not complied with according to the SAICA Code of Professional Conduct.

Feedback on activity 2 References: • Jackson & Stent (2016:1/10–1/11) • SAICA Student Handbook, Volume 2B: Code of Professional Conduct, part 1 (section 110.1 A1) Integrity The external auditor has not acted with integrity. Because he failed to confirm whether the vehicles were actually owned by the company and did not report this to the shareholders, he was dishonest. Confidentiality The external auditor should have respected the confidentiality of client information. Chartered accountants are not allowed to disclose confidential information and by advising his father-in-law to dispose of his shareholding he has contravened a fundamental ethical principle. Professional competence and due care Because the external auditor knew that there was a very serious threat to the going concern of the business (there was a threat that the business would not be able to continue trading) and he failed to report this to the company’s shareholders, he did not act with professional competence and due care as required by applicable technical and professional standards when providing professional services. Professional behaviour By being dishonest and not acting with professional competence and due care the external auditor did not comply with the relevant laws and regulations and thus discredits the profession. Note: Objectivity is the fifth fundamental ethical principle. However, it is not applicable to the scenario above.

1.1.2

The need for auditors

Study •

Jackson & Stent (2016:1/5–1/6)

You may ask: “Why do entities require an audit?” Many people answer this question by saying that audits are required by law. However, audits are often used in situations that do not require a compulsory audit. Reliable financial statements are vital for many different parties. These include managers, directors, shareholders, investors, financial institutions (banks), the South African Revenue Service (SARS) and the creditors of the entity. They all require reliable information to make informed decisions. 6|Page

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Why is there a need for auditors? As stated in Jackson & Stent (2016:1/5–1/6), the need for auditors arose out of the natural development of businesses managed by people other than the owners (shareholders). The owners supply the start-up funding for the business and then appoint managers to manage these funds on their behalf. The owners expect the managers to report to them on a regular basis on how the owners' money is being managed. Many owners are not involved in their businesses and do not have the necessary time or money to determine whether the reports they receive from their managers are a fair reflection of the actual state of affairs in the business. This has given rise to the need to appoint an independent person (the external auditor) to evaluate the financial reporting system introduced by management and form an opinion about the fairness of the management's presentation (including the company’s profit/loss) in the annual financial statements. Investors are people who wish to invest money in business entities. To make it attractive for individuals to invest in businesses, the investors and general public need to feel assured that the financial statements supplied by business entities contain reliable financial information. It is the external auditor who supplies this assurance. Note the following in the study resources above: •

The split between ownership and management

The people who own a business are not necessarily the managers of the business. The external auditor is appointed to evaluate the reports of the managers and provide an opinion in his/her report to the owners. •

Confidence in financial information

Auditors inspire confidence of the users by expressing opinions on whether the financial information produced by the business is reliable and credible. •

Accountability

Users require accountability and auditors provide an independent service which assesses and evaluates whether the directors are in fact meeting their responsibilities.

Activity 3 Required Answer the questions, if provided, in section 1.1 of Tutorial Letter 102 and compare your answers with the solutions in section 1.1 of Tutorial Letter 103.

Summary In this learning unit we focused on what an auditor does, the different types of auditors and the need for auditors, which included the objective of an audit.

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Self-assessment After having worked through the learning unit and the references in the prescribed study material, determine if you are able to answer the following questions: 1. 2. 3. 4.

Describe what an auditor does. Explain the different types of auditors. Explain the relationship between the internal and the external auditor. List and explain the fundamental ethical principles that all chartered accountants are required to observe. 5. Explain why there is a need for auditors. 6. Explain the purpose of an audit.

Feedback on self-assessment 1. 2. 3. 4.

Reference: Jackson & Stent 2016:1/2 Reference: Jackson & Stent 2016:1/2–1/3 Reference: Jackson & Stent 2016:1/2–1/3 Reference: SAICA Student Handbook, Volume 2B, Code of Professional Conduct: Part 1 (section 110.1 A1) 5. Reference: Jackson & Stent 2016:1/5–1/6 6. Reference: SAICA Student Handbook, Volume 2A(1) ISA 200: Overall objectives of the independent auditor and the conduct of an audit in accordance with the International Standards on Auditing (ISA 200: par 3)

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LEARNING UNIT 1.2:

ASSURANCE AND NON-ASSURANCE ENGAGEMENTS

Introduction Clients can engage auditors to perform various services. These services can be classified as assurance and non-assurance engagements. In this study unit, auditing theory is explained by discussing assurance and non-assurance engagements according to the auditing pronouncements. We will also deal with the concept of reasonable assurance and explain statutory and nonstatutory engagements. An auditing pronouncement is an official or authoritative statement, for example the International Standards on Auditing (ISA) or the SAICA Code of Professional Conduct. Diagram 1: Types of assurance and non-assurance engagements (based on Jackson & Stent 2012:19/2)

Engagement

Assurance engagement learning unit 1.2.1

Non-assurance engagement learning unit 1.2.2

Audit

Limited assurance/Review

Agreed-upon procedures

Compilation

Reasonable assurance

Moder...