Past Test Questions Flashcards
- Describe the nature of an audit
An audit is 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.
Explain the purpose of a financial statement audit in terms of its scope, users, and level of assurance.
- A financial statement audit obtains evidence to validate management’s assertions about economic actions and events against selected criteria and communicates that to the users
- A financial statement audit is the audit of financial statements for a specific period
- The intended users are the shareholders and selected others.
- A financial statement audit provides reasonable assurance that the financial statements are free from material misstatement, are credible and can be relied upon.
- Describe the nature and purpose of an assurance engagement.
- broad term
- any situation where information is prepared by one party
- then attested to its accuracy by another party. Purpose of an assurance engagement = express conclusion intended to increase the confidence of intended users.
- Assurance engagements include:
- audit (usually relates to a financial statement audit)
- include assurance on other financial and non-financial information.
- E.gs. environmental audits, compliance audits, review engagement.
The level of assurance provided can vary: according to the type of engagement
e.g. a review engagement such as an interim financial statement audit provides limited assurance whereas an audit provides reasonable assurance the financial statements are free from material mis-statement.
elements of an assurance engagement.
- A three-way relationship
- Subject matter of an assurance engagement
- Suitable criteria based on…
- Evidence gathering
A three-way relationship
- A responsible party (e.g., directors), an intended user (e.g., a shareholder), and an assurance practitioner (the auditor)
Subject matter of an assurance engagement
- Historical financial information, performance related, physical system or processes, behaviour e.g., corporate governance
Suitable criteria based on…
- Relevance, completeness, reliability, neutrality and understandability
- E.g., financial reporting framework and accounting standards to determine the outcome of the audit
Evidence gathering
- A conclusion or assurance report e.g., audit report
Explain how agency theory results in a demand for auditing.
In an agency relationship, investors (as principals) entrust their resources to managers (as agents). The assumption is that managers act in their own self-interest and not the principals’ interest, giving rise to agency costs. Consequently, investors will ‘price protect’ themselves on the assumption that managers are acting for themselves. They will demand a financial statement audit to monitor the actions of managers, verify the assertions made by management and that they have acted appropriately so reduce the risk of business failure
Explain the role of auditing and assurance standards in the auditing profession within Aotearoa New Zealand.
Audit and assurance standards provide minimum guidance for auditors to help determine the extent of steps and procedures that should be applied to fulfil the objective of the audit or assurance engagement. They are the criteria or yardsticks against which the quality of audit or assurance results are evaluated.
six (6) phases of the audit process.
- Phase I: Perform risk assessment procedures
- Phase 2: Assess the risk of material misstatement
- Phase 3: Respond to assessed risks
- Phase 4: Perform further audit procedures
- Phase 5: Evaluate audit evidence
- Phase 6: Communicate audit findings
Phase I: Perform risk assessment procedures
Identify financial statement assertions, understand the entity and its environment, make decisions about materiality, perform analytical procedures, identify risks of material mis-statement including understanding the internal control system
Phase 2: Assess the risk of material misstatement
Determine size of mis-statements, and likelihood of mis-statement and significant inherent risks
Phase 3: Respond to assessed risks
Includes audit staffing, nature, timing, and extent of audit tests
Phase 4: Perform further audit procedures
Includes tests of controls and substantive tests, quantitative methods to use
Phase 5: Evaluate audit evidence
Appropriate evidence is gathered and evaluated including journals, ledgers, source documentation
Phase 6: Communicate audit findings
Communication via audit report opinion to intended users of the report and to other parties including the audit committee
Describe the steps involved in the audit planning process.
- Planning starts with an understanding of the entity and its environment.
- Planning also involves setting materiality levels,
- assessing audit risk and its components,
- obtaining an understanding of the internal control structure and then
- developing a preliminary audit strategy for significant assertions. Auditors should also perform analytical procedures as part of the planning process as well as consider the risk of fraud.
- Analyse how the scope of the auditing environment has changed in the last 30 years.
The auditing environment has changed in the last 30 years through:
- Changes in the NZ economy and increased privatisation of services such as rail and telecommunications in New Zealand resulting in bigger organisations that have less regulation of their economic activities
- economic crisis (removal of trade barriers (tariffs), labour market restrictions and overseas ownership) and
- Corporate collapses related to accounting mis-statements, internal controls and apparent failure of auditors
Describe the nature of ‘corporate governance’.
Governance is the exercise of economic and administrative authority necessary to manage entities affairs. Governance is concerned with the process by which decisions are made and implemented so that the entity’s affairs are conducted properly and in accordance with the laws and regulations.
three corporate governance issues that impact the external auditor’s roles.
Corporate governance issues include:
risk management
internal control
earnings management.
Risk management
Risk management is the culture, process and system established to manage opportunities and minimise or control risks. Risk management is a broad concept and is not only confined to health and safety and includes business continuity, corporate governance, and fraud.
Internal controls
Internal controls are the policies and procedures an organisation puts in place to ensure business is operated in an orderly manner and to prevent and detect fraud, error, misappropriation of assets and non-compliance with policies and procedures.
Earnings management
- Earnings management is when management manipulates financial statements and transactions to influence the public perception about the financial performance of the entity. Earnings management techniques include use of accruals, revenue recognition, restructuring charges, estimation of liabilities, delaying sales, and manipulation of research and development write-offs.
Explain how the concept of earnings management might have influenced the auditor’s role in the audit of financial statements.
The auditor’s role has changed quite significantly, with increasing audit resources and techniques in place to focus on detecting earnings management practices. Auditors are playing a more active role in gaining knowledge of its audit clients’ business risks, which help setting up the most appropriate audit approach.
Earnings management is an issue of judgement and result in financial statement being materially misstated. Auditors provide assurance on financial statement through offering an opinion on the truth and fairness of the financial statement representation. Therefore, auditors should be aware of the possible earnings management techniques and maintain professional scepticism in management judgement.
Discuss the work of the audit committee in enhancing corporate governance and the nature of the relationships between the audit committee and internal and external auditors.
- The audit committee reports to the board of directors and enhances internal accountability and credibility and facilitates the participation of independent directors in the governance process.
- The audit committee oversees the internal audit and external audit functions, but the three functions are intertwined.
- Both the auditors and the audit committee’s roles ensure the integrity of financial reporting.
- The audit committee is involved in monitoring the audit process, audit planning, provides support and fosters the integrity of financial statements, ensures the appropriate resources, support and authority in the entity.
Independence in appearance
Independence in appearance means avoiding situations and facts that are so significant that a reasonable person, knowing all relevant facts and having considered the safeguards in place, would reasonably conclude that a firm’s or a professional accountant’s integrity and objectivity had been impaired.
Independence of mind
Independence of mind relates to the state of mind that permits the expression of a conclusion without being affected by influences that compromise professional judgement. It requires the professional accountant to exercise scepticism and act with integrity and objectivity.
Critically evaluate whether an auditor who meets all the legal, professional and ethical requirements of the auditing profession can be completely objective while conducting an audit.
- Objectivity is a state of mind requiring making judgements without bias, conflict of interest of others or undue influence of others.
- Although there are restrictions imposed under the Code of Ethics these are only guidelines and do not cover all ethical situations an auditor many face. Legal requirements and standards may also not cover everything that could cloud the auditor’s judgement. E.g. it is impossible for an auditor to use professional judgement that is unbiased when they have an economic or financial interest with an audit client.
Critically evaluate whether an auditor can be completely independent when conducting an audit.
Completely independent is not possible
e.g. auditors rely on their clients as a source of income and form close relationships with their clients over time. This will cloud their objectivity and “independence in mind” when undertaking the audit.
- Independence in appearance may result in complying with the Code of Ethics and putting the necessary safeguards in place as outlined in the Code however, this may not be sufficient to maintain integrity and objectivity in undertaking an audit engagement in circumstances that are not directly covered in the Code
“Independence is a static concept”
- Although there are regulations around what independence is it is the spirit of independence which is important rather than mechanically applying the rules.
- One engagement will differ from the other and the amount of independence required will differ
- Standards are updated all the time, the courts will test and bring about new interpretations of independence
- Changes in the business environment may bring about circumstances where the concept of independence may need to be reviewed
- Therefore, independence is not a static concept.
Explain why critical evaluation of ethical issues is important for the auditing profession.
- An understanding of ethical issues and critical thinking are important to become a CA or CPA.
- It assists the auditor to take appropriate action when faced with an ethical dilemma in the auditing profession.
- An auditor should exercise professional scepticism in their role as an auditor and critically evaluate ethical issues that may cloud their judgement as it is important that they act ethically due to the large number of users who rely on their work to assist with decision making.
- The work of auditors is open to public scrutiny and critical evaluation of ethical issues is needed to maintain credibility of the profession, so auditors act in public interest.
Explain the ethical and legal factors need to be considered when deciding whether to accept or continue an audit engagement.
- Evaluate independence and whether there are any circumstances that would compromise the firm’s independence
- Assess competence of the audit team and whether it has the competence and ability to perform the audit in accordance with relevant auditing and ethical standards
- Determine ability of the audit team to take due care. This is the responsibility of the engagement partner and should be declined if this ability cannot be met.
Regulation has had a major influence on the auditor’s role. Critically evaluate this statement in terms of the roles of the XRB, NZ AuASB and professional bodies such as CA ANZ.
- External Reporting Board (XRB) and the NZ AuASB – NZ has adopted international auditing standards. The responsibility to prepare and approve auditing standards in that of the XRB.
- The XRB established the NZ AuASB and delegated authority to the board to develop the standards.
- Professional bodies such as CA ANZ control members of the accounting and audition profession in NZ. Members are bound by CA ANZ rules and professional standards including the Code of Ethics. CA ANZ have been accredited by the FMA to issue licences to “Issuer Auditors”
Discuss the strengths and weaknesses of these regulations on the auditing profession in Aotearoa New Zealand.
Strengths
* More confidence by users of financial reports that they have been through a highly regulated process and can be relied upon for higher quality information to support decision making.
* Safeguards the reputation and credibility of the audit profession.
* Expertise of the CA ANZ in approving auditor licences
* Less risk of corporate collapses and protects interests of society.
Weaknesses
* Many small to medium sized for-profit entities no longer are required to comply with the FRA and may opt out of the audit process - could impact stakeholders in smaller entities.
* Cost to auditors of maintenance of knowledge around accounting and auditing standards. New standards released all the time e.g., Climate Change and Sustainability standards.
* Regulation does not protect against unscrupulous moral or ethical values of auditors.
