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Chapter 1 Assurance and auditing: an overview Learning objectives

1.1 Understand the framework for assurance engagements and the structure of assurance standards and pronouncements. 1.2 Define auditing and appreciate the fundamental principles underlying an audit. 1.3 Appreciate the attributes of accounting information. 1.4 Understand the reasons giving rise to demand for assurance and appreciate the relationship between the auditor, the client and the public. 1.5 Appreciate the evolution of the audit function. 1.6 Explain the concept of the expectation gap, especially in the areas of auditor’s report messages, corporate failures, fraud and communicating different levels of assurance. 1.7 Appreciate the role of auditing standards and the audit commitments under the Corporations Act 2001. 1.8 Obtain an overview of other applications of the assurance function, including compliance auditing, performance auditing, comprehensive auditing, internal auditing and forensic auditing, as well as providing assurance on subject matter other than historical financial information.

Major chapter sections The framework for assurance engagements Auditing defined Attributes of accounting information Demand for assurance Evolution of the audit function The expectation gap The role of auditing standards Other applications of the assurance function

Lecture plan When students arrive at the first lecture, they usually have little understanding of what assurance and auditing entail. We find that the first class is very important for capturing students' attention and stimulating their interest in the subject. (Generally, they have also not read Chapter 1 before the first class.) There is so much that has happened recently that it is important to summarise what is currently happening in the financial system, especially with the global financial crisis, and the auditor’s role. This provides you with an opportunity to emphasise how important the auditing and assurance profession is currently perceived to be with regard to the role it plays in society, to cover the auditing profession’s response to the crisis of confidence in the financial system and to set the scene for what students can expect during the course. Learning objective 1.1: The framework for assurance engagements With increasing demand for assurance to cover a wide range of subject matters, the International Auditing and Assurance Standards Board (IAASB) released a framework for assurance engagements. This framework covers both audits and reviews of historical financial information, and other assurance engagements. This framework provides independent and expert auditors with criteria against which to examine reports. This section helps students understand the fundamentals of auditing before tackling the course. It also shows how the framework relates to both financial report audits and other assurance services. The section:  provides an explanation of assurance engagement and its five elements  outlines the need for the members of the profession to be independent; that is, without interests that may create risks of material bias with respect to the quality or content of

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information, and to exercise professional judgement and professional scepticism to maintain the quality of assurance services. [Use slides 1-5 to 1-10] Structure of assurance standards and pronouncements To help students gain a deeper understanding of assurance, this section looks at the structure of assurance standards and pronouncements. Provided in the slides is a diagrammatic depiction of the structure of assurance standards and pronouncements in Australia and internationally, which can be found on page 8 of the textbook (figure 1.2). This section also reviews the two different types of assurance: reasonable assurance engagements (an audit) and limited assurance engagements (a review). This synopsis of audits and reviews will be useful for students to compare and contrast. Additionally, this section outlines the difference between attest and direct reporting. [Use slides 1-10 to 1-16] Learning objective 1.2: Auditing defined We have used and expanded on the definition in A Statement of Basic Auditing Concepts (ASOBAC) here because it captures nicely the major components of the audit process (outlined on slide 17), rather than simply stating the objective. Students should be encouraged to compare this definition with the one contained in the Auditing and Assurance Standards Board (AUASB) glossary/ISA Glossary of Terms. It should be pointed out that these definitions are similar, although the profession’s definition is more technical and does not use the word assertion (recognising that there are direct-reporting as well as assertion-based engagements). [Use slides 1-17 and 1-18] Fundamental principles underlying an audit To understand the evolution of auditing as a discipline, it is important for students to understand the principles that have dictated such developments. Students, who may well be the future of the auditing profession, are expected to be instilled with these principles and adhere to them when working in the profession. The section will examine the:  fundamental principles of professional ethics  fundamental principles underlying the objective of an audit. [Use slides 1-19 to 1-21] Learning objective 1.3: Attributes of accounting information If students are to thoroughly understand the audit process as it relates to accounting information, it is crucial for them to appreciate the role of accounting information and the process of communication through financial reports. This section highlights the essential characteristics of information that enable objective financial reporting:  relevance  reliability  comparability  true and fair presentation. [Use slide 1-22] Learning objective 1.4: Demand for assurance

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It is worthwhile spending a reasonable amount of time during the first lecture discussing why there is a demand for assurance beyond the legal requirements. It is important that students have a basic understanding of the agency relationship that leads to auditing. [Use slides 1-23 to 1-25] Other benefits of Assurance This recognises that there are other benefits resulting from an assurance engagement in addition to increasing users’ confidence in reported information. These include recommendations to improve efficiency and effectiveness and a positive influence on the behaviour of people with audited entities. [Use slide 1-26] The auditor–client–public relationship Students should be introduced to the relationship between the auditor, the client and the public. [Use slide 1-27] Learning objective 1.5: Evolution of the audit function Time availability will determine how much time you spend here. Some lecturers like to devote some time to tracing how the objectives of auditing, and auditing approaches, have evolved over time. One thing that is potentially beneficial is that we provide an example of the business risk approach, so that the students gain an early overview of the audit approach that underpins the approach outlined in the textbook, auditing standards and auditing practice. [Use slides 1-28 to 1-32] Learning objective 1.6: The expectation gap Exposing students to the expectation gaps that can occur and the areas in which expectation gaps commonly occur at an early stage of the course usually encourages them to be more critical in their thinking as they proceed through the course. [Use slides 1-33 to 1-35] Learning objective 1.7: The role of auditing standards Students should be introduced to the various auditing standards and guidance standards: auditing standards (ASAs/ISAs); Auditing Guidance Statements (AGSs); and Guidance Statements (GSs). Under the Corporations Act 2001, Australian Auditing Standards have legislative backing. The implications of this should be discussed. [Use slides 1-36 to 1-38] Audits under the Corporations Act 2001 The emphasis in most auditing and assurance courses is on audits undertaken in accordance with the Corporations Act 2001 (which is arguably the most comprehensive assurance service, and one from which techniques gained can be applied to all assurance services). It is therefore worthwhile drawing students’ attention to this and other applications of the assurance function, including compliance audits, performance audits, comprehensive audits, internal audits and forensic audits, which will be covered later in the course. [Use slides 1-39 to 1-40] Learning objective 1.8: Other applications of the assurance function The uses of audit evidence-gathering methods are not confined to an expression of opinion on financial reports. This section takes the students through their other uses. These include commentaries on:  compliance audits

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   

performance audits comprehensive audits internal audits forensic audits.

These assurance services are discussed in more detail later in the course, so this should be no more than a very brief introduction. [Use slides 1-41 and 1-42] Summary We provide a summary slide of the main learning takeaways in this chapter. [Use slide 1-43]

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SOLUTIONS Chapter 1: Assurance and auditing: an overview REVIEW QUESTIONS

1.1

(a) C Audit is one level of assurance that can be offered. Under the assurance framework, assurance can be at two levels: reasonable (sometimes referred to as audit) and limited (sometimes referred to as review). (b) D For the objectives of the assurance engagement, both A and B may be considered suitable criteria.

1.2

(a) B Systematic process refers to audits being properly planned and structured, following a logical sequence. (b) B Representing their client in matters identified by regulators is not a fundamental principle underlying an audit.

1.3

(a) C Timeliness is not an attribute identified in the Framework for the Preparation and Presentation of Financial Statements. (b) C Management is responsible for the preparation of the financial report, including disclosures made in the accompanying notes.

1.4

(a) A One of the major incentives for audit is to correct potential biases in reporting by management. (b) D The aim of undertaking an assurance engagement is to increase the level of assurance for users of the engagement.

1.5

(a) B Auditors currently use a business risk approach that requires the auditor to understand items that affect the business and may flow through into the financial report. (b) D Auditors initially followed a statement of financial position approach then changed to transactions cycle approach then changed to a financial risk approach before finally adopting a business risk approach.

1.6

(a) C As following Australian auditing standards is mandatory for auditors, it is reasonable for users to believe that auditors have done so. (b) A The e x pe c t a t i o ng a p ha s be e na t t r i bu t e dt oan umbe rofd i ffe r e ntc a u s e s ,i n c l u di ng mi s un de r s t a nd i n go ft h ea ud i tf unc t i o nb yn o na u di t or s .

1.7

(a) B Th ea u di t o ri se x pe c t e dt oc o mpl ywi t ht h er e q u i r e me nt sc o nt a i n e di nt heASAsi na l lb ut r a r ea nde x c e pt i ona lc i r c ums t a nc e s ,a ndGSsp r o vi degui d a nc eon l yonpr oc e dur a l ,e nt i t yori ndu s t r y s pe c i fici s s u e s . (b) D Under the Corporations Act 2001, directors are required to prepare the financial report and auditors are required to report an opinion as to whether the financial report is in accordance with the law, including compliance with accounting standards, and gives a true and fair view.

1.8

(a) D

The activities of forensic auditors are most commonly associated with fraud.

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(b) A Internal auditors often undertake performance or operational audits of the economy, efficiency and effectiveness of the entity.

1.9

1.10

According to ASA 200.A3 (ISA 200.A3), management and, where appropriate, those charged with governance are responsible for: 

the identification of the applicable financial reporting framework, within the context of any relevant laws or regulations



the preparation and presentation of the financial report in accordance with that framework



an adequate description of that framework in the financial report.

Paragraph 7 of the Framework for Assurance Engagements (International Framework for Assurance Engagements) defines an assurance engagement as ‘an engagement in which an assurance practitioner expresses a conclusion designed to enhance the degree of confidence of the intended users other than the responsible party about the outcome of the evaluation or measurement of a subject matter against criteria’. The framework identifies five elements of an assurance engagement (paragraph 20): 1.

2.

Three-party relationships, comprising: 

assurance practitioner (auditor)—in Australia this would be a member of a recognised accounting body (CPA Australia, The Institute of Chartered Accountants in Australia [ICAA] or the Institute of Public Accountants [IPA]), and one who is bound by the profession’s Code of Ethics



responsible party—the responsible party is the person or persons responsible for the subject matter. For example, management is responsible for the preparation of the financial report or the implementation and operation of internal control



intended user—the intended user is the person or persons expected to use the assurance practitioner’s report. Often the intended user will be the addressee of the report by the assurance practitioner, although there will be circumstances where there will be other identified users.

An appropriate subject matter, which can take many forms, such as: 

financial position and performance



non-financial performance



physical characteristics



systems and processes



behaviour.

3. Suitable criteria, such as the standards or benchmarks used to measure and evaluate the subject matter of an assurance engagement. Criteria are important in the reporting of a conclusion by an assurance practitioner as they establish and convey to the intended user the basis on which the conclusion has been formed. 4 Sufficient appropriate evidence, which should be obtained by the assurance practitioner about whether the subject matter information is free of material misstatement. 5 A written assurance report, which provides a level of assurance about the subject matter based on the conclusions drawn by the assurance practitioner.

1.11

The Glossary in the textbook defines assurance as ‘satisfaction as to the reliability of information provided’. The degree of satisfaction achieved depends on the nature, extent and results of the procedures performed by the auditor and the objectivity of the evidence obtained. Paragraph 11 of the Framework for Assurance Engagements (International Framework for Assurance Engagements ) says that a practitioner can provide two levels of assurance for an assurance engagement: reasonable assurance and limited assurance. For assurance services on historical financial information, a reasonable assurance engagement is commonly termed an audit, and a limited assurance engagement is commonly termed a review. The objective of a reasonable assurance engagement (audit) is reducing assurance engagement risk to an acceptably low level, and this is associated with a positively expressed assurance opinion (such as that the financial information is true and fair). The

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objective of a limited assurance engagement (review) is reducing assurance engagement risk to a level that is acceptable under the circumstances—but where the remaining risk is greater than with a reasonable assurance engagement—and this is associated with a negatively expressed assurance opinion (such as that nothing has come to the auditor’s attention to persuade them that the information has been materially misstated).

1.12

In ASA 200.11 (ISA 200.11), the objectives of the auditor in undertaking an audit of a financial report are: (a) to obtain reasonable assurance about whether the financial report as a whole is free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial report is prepared, in all material respects, in accordance with an applicable financial reporting framework (b) to report on the financial report, and communicate as required by the Australian Auditing Standards (ASAs), in accordance with the auditor’s findings.

1.13

An assurance provider’s opinion is an expression of informed judgment. Financial reports and assurance reports on other subject matters are too imprecise to make a statement of fact, because of the choices available regarding such things as acceptable accounting policies and other criteria. The assurance provider’s opinion is usually based on a subset or a sample of the available evidence, meaning that an opinion cannot be given with 100 per cent certainty.

1.14



Knowledge: The auditor shall possess a sufficient understanding of the entity and its environment to appropriately plan and perform the audit, interpret audit findings, and report on the financial report (many standards, especially ASA 315/ISA 315).



Responsibility: The auditor shall take responsibility for the auditor’s opinion, maintaining an adequate level of involvement in the audit engagement, properly supervising any assistants, and evaluating the work of experts or others upon whom reliance is placed (many standards, especially ASA 200/ISA 200).



Quality control: The auditor shall follow quality control procedures—including consultation with others as necessary—that support the issuance of an auditor’s report that is appropriate in the circumstances (many standards, especially ASA 220/ISA 220).



Rigour and scepticism: The auditor shall plan and perform an audit with thoroughness and with an attitude of professional scepticism, critically assessing with a questioning mind the validity and reliability of evidence, and recognising that circumstances may cause the financial report to be materially misstated (many standards, especially ASA 200/ASA 200).



Professional judgment: The auditor shall exercise professional judgment, within the bounds of the fundamental principles and the applicable professional requirements, in fulfilling the auditor’s responsibilities (many standards, especially ASA 200/ISA 200).



Evidence: The auditor shall obtain sufficient appropriate evidence to afford a reasonable basis for expressing an opinion on the financial report (many standards, especially ASA 500/ISA 500).



Documentation: The auditor shall document matters that are important in providing evidence to support the auditor’s opinion (many standards, especially ASA 230/ISA 230).



Communication: The auditor shall communicat...