Auditing

Question 1

Research Carillion case on slides

Question 2

What is an audit?

Answer 2

An investigation or a search for
evidence to enable reasonable assurance to be given on the truth and fairness of financial and other information by a person/persons independent of the preparer and persons likely to gain directly from the use of information

Question 3

What do auditors do generally?

Answer 3

Gather evidence to form an opinion on whether the
accounts give a true and fair view of the company’s financial affairs

Question 4

What three things do auditors do?

Answer 4

• Compliance testing
• Substantive testing
• Analytical reviews

Question 5

What is compliance testing?

Answer 5

Testing of the company’s policies and procedures (internal controls)

Question 6

What is substantive testing?

Answer 6

Detailed testing of selected
individual transactions to
ensure they have been
authorised and accounted
for correctly

Question 7

What are analytical reviews?

Answer 7

Analysing relationships between items to identify unusual fluctuations which
may indicate possible misstatements

Question 8

Why have auditors failed to identify misstatements in
the accounts before corporate collapses?

Answer 8

• Was the evidence not available?
• Did the auditor fail, for whatever reason, to find the evidence?

Question 9

What is the audit expectations gap?

Answer 9

Common understanding:
The gap between what stakeholders expect auditors to provide and what the auditor provides.

In the academic literature:
The gap between what
stakeholders think auditors
do (perceived performance)
and what they think auditors
should do (expectations)

Question 10

What does the audit expectations gap framework by Porter audit show?

Answer 10

The reasons for the difference between society’s expectations of auditors and the perceived performance by auditors

Question 11

What created the reasonableness gap in the Porter framework?

Answer 11

what stakeholders expect of
auditors vs. what auditors can be reasonably expected
to provide

Question 12

When someone critises auditors for not raising fraud, how do they combat this?

Answer 12

Auditing standards say that detecting fraud is the responsibility of management. Auditors test managements information and provide assurance.

Question 13

What does the society think auditors should do? What falls short here?

Answer 13

Act ethically at high levels of integrity.
Auditors performance (performance gap)

Question 14

What is the performance gap?

Answer 14

what stakeholders can reasonably
expect of auditors vs. their perception of what auditors
provide

Question 15

What two gaps lie inside the performance gap and explain each?

Answer 15

• Deficient standards gap: the responsibilities that stakeholders expect auditors to fulfil vs. the auditor’s actual responsibilities under the law and auditing
  standards
• Deficient performance gap: expected standards of
  performance vs. the auditor’s actual performance

Question 16

What are the causes of the audit expectations gap?

Answer 16

• Society’s lack of knowledge and misunderstanding about the audit role and the work of auditors
• Auditing standards not strict enough
• Lack of competence

Question 17

Why is there an argument that auditing standards are not strict enough?

Answer 17

International Standard on Auditing (ISA) 240 suggests that the primary responsibility for the prevention and detection of fraud lies with management. While the auditor seeks to gain reasonable assurance that the financial statements are free from material
misstatement caused by fraud, the inherent limitations of audit may result in such misstatements not being detected

ISA 570 states that it is management’s responsibility
to assess the entity’s ability to continue as a going
concern.

Question 18

What is fraud vs creative accounting?

Answer 18

Fraud is illegal.

Creative accounting is distorting the company’s actual reality.

Question 19

What are exampled of lack of competence when referring to the expectations gap?

Answer 19

• Lack of knowledge; lack of experience; lack of care
• Lack of time; pressure to lower audit fees
• Complexity of modern businesses; some close to being
  unauditable
• Lack of auditor independence

Question 20

Is the auditors expectations gap static?

Answer 20

No, it changes over time

Question 21

Why is the AEG not static?

Answer 21

• Auditor’s duties and standards of performance may change due to action by regulators and/or other powerful stakeholders
• Auditor performance and societal expectations of audit
  evolve with technology and cultural norms
• More clarity and awareness about the auditor’s role may
  narrow existing gaps but also create new expectations

Question 22

What is the paradox of AEG?

Answer 22

• Criticisms of audit in the aftermath of financial scandals is usually accompanied by calls for audit reforms/extensions
• The AEG ultimately benefits the audit profession

Question 23

What is the role of audit and the agency problem?

Answer 23

Via an audit of the financial statements, the audit can monitor managers so that they act in the interests of investors

Question 24

What do the agents want to maximise?

Answer 24

Managers want to maximise their own wealth – pay,
bonuses etc.

Question 25

What do the principals want to maximise?

Answer 25

Maximise their own
wealth - returns on
investment

Question 26

For an audit to be credible, what should be the case?

Answer 26

Auditors should be independent

Question 27

Who can auditors be said to act on behalf of and why?

Answer 27

Auditors act on behalf on the shareholders and report
to them. In UK limited companies, auditors are technically appointed by shareholders at the Annual General Meeting (AGM).

Question 28

In practice however, who determines the appointment of the auditors?

Answer 28

Responsibility is on that of the Audit committee

Question 29

Why should audit be independent?

Answer 29

Provides assurance to the shareholder that the financial statement shows a fair view

Question 30

What are the threats to auditor independence?

Answer 30

• Self-interest threat
• Self-review threat
• Advocacy threat
• Familiarity threat
• Intimidation threat

Question 31

What is a self-interest threat?

Answer 31

The threat that a member could benefit, financially or otherwise, from an interest in, or relationship with, a client or persons associated with the client.

Question 32

What is a self-review threat?

Answer 32

A self-review threat will arise as the external audit team
may be insufficiently questioning of the work performed
by the secondee and may be reluctant to highlight
errors or omissions in the work

Question 33

What is an advocacy threat?

Answer 33

The threat that a member will promote a client’s interests or position to the point that his or her objectivity or independence is compromised.

Question 34

What is a familiarity threat?

Answer 34

The threat that due to a long or close relationship with a client or employer, a professional accountant will be too sympathetic to their interests or too accepting of their work

Question 35

What is an intimidation threat?

Answer 35

Threat exists if the auditor is intimidated by management or its directors to the point that they are deterred from acting objectively.

Question 36

Look at an example of a threat to independence on the slides.

Question 37

Who named the type of audit threats above?

Answer 37

The International Federation of Accountants (IFAC) code of ethics

Question 38

Performing accounting services for a non-listed client is
permitted provided…

Answer 38

…they are routine and mechanical in nature. (involved no judgement)

Question 39

What are safeguards against the threats to auditor independence?

Answer 39

Legislation
Guidance/ethics code/regulator
The firm environment

Question 40

How does legislation safeguard against audit threats?

Answer 40

EU Audit Regulation: all EU public interest entities must
rotate their auditors every 10 years; key audit partners
must rotate after a maximum of seven years

Question 41

How does guidance/ ethics codes safeguard against threats to audit independence?

Answer 41

Business, personal and employment relationships with audit clients.
Provision of non-audit services to audit clients.

Question 42

How does the firm environment safeguard against the threats to auditor independence?

Answer 42

Internal control procedures.
Corporate governance mechanisms – company
directors, the audit committee.