Audit & Assurance exam Flashcards
(36 cards)
Distinguish between reasonable assurance and limited assurance
Reasonable assurance engagements aim at reducing risk to an acceptably low level as a basis for a positive conclusion (reasonable assurance means a high but not absolute level of assurance).
Limited assurance engagements aim at reducing risk to a level that is acceptable in the circumstances but where that risk is greater than for a reasonable assurance engagement as the basis for a negative conclusion.
Why is there a demand for audits?
Agency theory
Information hypothesis
Insurance hypothesis
Regulation
Steps in accepting an audit engagement
CLIENT EVALUATION
Evaluate integrity of management
Identify special circumstances and unusual
risks
ETHICAL AND LEGAL CONSIDERATIONS
- Evaluate independence
- Assess competence to perform audit
- Determine ability to use due care
ENGAGEMENT
Prepare engagement letter
Internal control system
Five components:
Control environment Risk assessment processes Information system Control activities Monitoring of controls.
What is an audit?
“A systematic process of objectively obtaining and evaluating evidence regarding assertions made 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)
The audit expectation gap
“the difference between what auditors actually do when they conduct an audit and what shareholders and others think auditor’s do, or should do, in conducting the audit”
Report of HIH Royal Commission
What is governance?
The exercise of economic and administrative authority to manage an entity’s affairs.
Concerned with processes by which decisions are made and implemented, so that the entity’s affairs are conducted properly and in accordance with the laws and other applicable regulations.
Applicable to all entities.
The auditor and governance
Overall objective of the auditor:
“ …to obtain reasonable assurance about whether
the financial report as a whole is free from
material misstatement, whether due to fraud or
error…” (ASA200.11)
The effectiveness of the assurance engagement is a function of the auditor’s relationship with the entity’s management and the governance body.
Internal auditing
Internal audit encompasses examination and evaluation of:
Adequacy and effectiveness of governance and internal control structure.
The quality of performance.
The procedures of risk identification and management
Mechanisms to ensure regulatory compliance.
Supplements the work of independent auditors.
Internal auditors should:
Review the reliability and integrity of financial and operating information
Review the systems established to ensure compliance with policies, plans, procedures, laws and regulations
Assess risks within and outside the business
Review the means of minimising risks
Appraise the economy and efficiency of resources
Review operations or programs.
Operational auditing:
Five Phases:
- Preliminary preparation – gain a comprehensive understanding of the organisation
- Field survey – identify problem areas and sensitive issues
- Program development – step-by-step program
- Audit application – detailed review
- Reporting and follow-up – with senior management and the audit committee.
What are the two major components of the audit expectation gap?
The two major components are the reasonableness gap and the performance gap. The reasonableness gap is the gap between what society expects auditors to achieve and what they can be reasonably expected to accomplish. Whereas the performance gap is the gap between what society can reasonably expect auditors to accomplish and what they are perceived to achieve. The performance gap comprises deficient performance and deficient standards.
There were a number of major corporate collapses in the early 2000s. What was the main Australian regulatory response to these problems?
The main regulatory response was through the implementation of the Corporate Law Economic Reform Program (CLERP) 9 in 2004. Some main changes of CLERP 9 were to expand the requirements on independence for auditors and also the creation of the Financial Reporting Council, which had a significant effect on the role of the accounting profession in the regulatory landscape. No longer would the accounting profession in Australia be responsible for the setting of auditing standards.
Why is it impossible for an auditor to provide absolute assurance regarding subject matter on which they express their opinion?
It is impossible for the auditor to provide absolute assurance because there are so many judgements in the audit process. The auditor makes a judgement about the risks of material misstatement and then designs procedures accordingly. These procedures use sampling (discussed later in the text) which will always provide some sort of error rate. Even if there was no constraint on cost or time the auditor could not provide absolute assurance because he or she may misinterpret evidence and because there are so many account balances that are the product of significant professional judgement.
Types of threats:
Self-interest threats may occur as a result of financial or other interests of a professional accountant, or of an immediate or close family member.
Self-review threats may occur when a previous judgement needs to be re-evaluated by the professional accountant responsible for that judgement.
Advocacy threats may occur when a professional accountant promotes a position of opinion to the point that subsequent objectivity may be compromised.
Familiarity threats may occur when, because of a close relationship, a professional accountant becomes too sympathetic to the interests of others.
Intimidation threats may occur when a professional accountant may be deterred from acting objectively by actual or perceived threats.
The cornerstone of the auditing profession:
Describe what is meant by independence in mind and independence in appearance.
The Corporations Act 2001 and Parts 4A & 4B of the Code of Ethics stipulate principles, rules and guidelines in relation to independence.
Section 400.5 – Independence of mind and in appearance
Independence of mind:
State of mind that permits the expression of a conclusion without being affected by influences that compromise professional judgement.
Requires accountant to exercise scepticism and act with integrity and objectivity.
Independence in appearance:
Avoiding situations and facts where a reasonable person would conclude that integrity, objectivity or professional scepticism has been impaired.
hat is a Assurance engagement
The Framework for Assurance Engagements (issued by the AUASB) states that an assurance engagement is:
“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 subject matter of an assurance engagement
Suitable criteria:
Based on relevance, completeness, reliability, neutrality and understandability
Evidence-gathering or engagement process
A conclusion or an assurance report.
Assertion-based engagements:
The assurance practitioner provides an opinion on an assertion made about the subject matter.
Direct reporting engagements:
The assurance practitioner expresses an opinion on subject matter itself absent of any subject matter information.
Benefits of an audit
Access to capital markets — public companies must satisfy statutory audit requirements in accordance with the Corporations Act
A lower cost of capital - potential creditors may offer lower interest rates and potential investors may be willing to accept a lower rate of return on their investment
Audited financial statements improve an entity’s credibility and therefore reduce risks for investors and creditors
Deterrent to inefficiency and fraud – financial report audits can be expected to have a favourable effect on employee efficiency and honesty
Knowledge that an independent audit is to be performed is likely to result in fewer errors in the accounting process and reduce the likelihood of employee misappropriation of assets.
Control and operational improvements – auditor can suggest how controls could be improved and how greater operating efficiencies may be achieved
Weaknesses in controls and suggestions for improvement usually outlined in the management letter.
Limitations of an audit
A time lapse – A common criticism of the audit function is that the lapse of time between end of reporting period and the presentation of the audit report may be up to 4 months
Audit testing on selective samples – risk that the sample drawn from the population may not be representative of the sample (sampling risk)
Assessment of materiality – requires a high degree of professional judgement and requires quantitative and qualitative considerations
Highly specialised areas – auditors may be required to form a professional judgement in highly specialised areas or areas that are not dealt adequately by the accounting or auditing standards
Report format limitations:
The audit report and the body of the financial reports are subject to interpretation
The standard format of the audit report may not reflect fully the complexities involved in the audit process and the decision of the audit opinion
What is meant by reasonable and limited assurance engagements? Give an example for each type.
Reasonable assurance engagement: aims at reducing risk to an acceptable low level of risk as a basis for a positive conclusion (high but not absolute level of assurance). A limited assurance engagement aims at reducing risks to a level that is acceptable in the circumstances but the risk is greater than for a reasonable assurance engagement, as the basis for a negative conclusion.
The assurance engagement can consist of an outcome, a set of criteria and a subject matter, and include all the assurance engagements where ASAs, ASREs and ASAEs apply. A financial statement audit is a reasonable assurance engagement. A sustainability assurance engagement based on a certain set of criteria is an example of limited assurance engagement.
List and explain the elements of an assurance engagement.
An assurance engagement involves three parties: (1) The responsible party – these are responsible for the subject matter, (2) intended user – the person who require assurance on the subject matter, the assurance practitioner, the person who will be providing assurance.
The subject matter is the information that is being reviewed or audited and about which the assurance practitioner will provide an opinion.
Suitable criteria are the criteria around which the subject matter has been prepared and the assurance practitioner will compare the subject matter to the suitable criteria to establish if there are any errors.
Appropriate evidence that the subject matter is free from errors will need to be obtained by the assurance practitioner in order to provide an opinion.
An assurance report is the final element where the assurance practitioner provides a formal opinion to the user.
