Understanding auditor | responsibilinesAssurance anc auditing: Integral to the economy "The overnng objective ofthis textbook isto build a foundation with which to analyse cunent professional ‘sues and adapt audit approaches to business and economic complexities, Through studying this chapter, you wil be able to Lo Deine the conoepte of assurance, ining ravew engagements, and eudting 2° Describe the special role of aust, urich provide reasonable assurance, in meeting he demands of sociely for and ia nancial reporting and the ole of reviwe, which provide ited assurance, 3°» Describe how the pubic accounting profession has changed this decade, the infuanoes that have ‘caused those chenges and how those chenges afisct the nature ofthe ait and review processes, 4 _Distnguich the diferenses among assurance services inducing review senibes andl audit senices and Uesctibe the oe of eral carroin nancial epertng itegty. 5 Describe the reuierrents for professionals eniorng the pubic accounting pcleesion gereraly and the assurance profession more speciicaly where professional judgement and scepticism is vial for a ually product 6 Describe the unious roles of internal, extemal and pubic sactor assurance providers in imprewrg the relatilty of infomation and the processes that lead to the recoding and presentation of infomation (both inarciel anc operation. deny te important professional and regulary bodlos that alfect he nature end quelty of auc and _assurerice sences as well as tha scope of services proved, eats Cleeinais ee eae ech Ga auecuaeeCHAPTER ‘The capital markets depend on accurate, reliable and objective (neutral) data that portray the economic BAM Aa: ape: nature ofan en's business and In turn provide & base wo judge cutent progress towards age objectives tf the market does not recsve reliable data ttvestrs lose confidence in the eystem, make poor decisions and may loco great deal of money, ultimately, the sytem may fal. tis a complex process. But the complexity goes further. Accounting transactions are becoming increasingly complicated a8 comparies engage in more elborate structures as well as in tansactions that ate cicut to measure, Further, complexity can ony increase, as mes: companies and regulators recognise, because we are becoming a global ecenomy and accounting is moving towards global hrrnonisation 'AS a profession, we ace in a period of change in which aasurance providers and accountants are called upon ta make professional judgements thet bes: rfect the economies of transactions of cument states of economic holdings. Puble accounting fms need prolessonal statt who make consistent judgements across a wide variety of companies, counties and types of tabsactons, Thus, profesional judgement and processes with which to make such judgements consistently across both the beeaath of fm, a8 well as time, ae tcl to the future success ofeach pubile accountng fim, For assurance provides, his judgement has o be aceompanid by professional scepticism, which encowages a ctca ance and avokds accoptance of presented evidence without question, This textbook is designed to fecitae student understanding of contemporary professional change and the importance of developing a proces ot making professional judgements within this cantar Throughout this textbook, we wil ele: to a conceptual famewerk for making professional judgements. We term that process the Aude and Review Opinion Fomudaton Proces a prove an overview ofthat process the diagram above. The nature of he process vais depending on whether an i suit of review ofa financial repo i conducted. This i 9 since the ume and fon requed to engage with ‘Box IV Obtaining substantive evidence about account assertion, 8 much less fr a review compared tan aud. However, the step depicted nthe clagram on p. 2a valid n both conten ET 1a The folowing excorpls from an Age entice desorbe a mer fraud at Socets Génsree (a Fench company) eri he Nations Ausvalia Barkin stata. Itthe French dig deep enough, they may end up in ‘Austalen barking tery Tre best quid o fing the Noe in Socio Ganda that ‘was percited by Keviel's losing bels thal sheremarkets would ‘se, and inked by the bank tsof when i clscovered the Postion, and eo inom just as global markets wee tenking ceria hs week But there axe mary sia, chit of wrich i that Ker ‘crourwenied SooGen's intemal contol. cst tke NAB ho ofvaves tader Jarre Kenvie drove & SUS. blion (BAB till) truck through are Austen, and SocGen chaimnan (Dario! Govton end Bank of France govaino’ Crsten Noyer can find them on Natoral Avsrela Berk's websile, ‘The foreign exchange rads that cost NAB S360 mition in 2004 a'e chickenteed compared with SocGan's los, which carly days of is csaster, SooGen isin Geriek Bouton says intemal contals have been tgniened end Keniel and Hs immediate supervisors stood coan, bs he ago appareity beliowes thatthe bark isa vito a hi-and-un ~ fal Keri 2 retatvely nor trader, has single-handedly deoa'ved al the bank's systems wih an ‘extenccnarly sopisicalog wob offeke transactions, ina separate statement, the bank offered tat the debect was an soled and exceptional auc ‘One hopes not ia way: better to cisoover that SocGen's systems fled than to beleve thoy wore sole and so easly bypassed. We need to know, that’ fer sure, and the two reports prepared in the wake of the NABIs ferign exchange ‘debacle n 2006 are atl wod-cass buen forthe job. ‘Oneisby the prucentialrequlter inthis court, APPA, andthe ole, commessioned byNABits, iby PrcewetrrouseCooner, Both ae forensicwatks, end both iderity ety that te losses were caused by ogue wading. intatedinpursutot rots, magredrepestedyinaniernptto recouplosses, andmethodicaly and melculouslyconcealed. But beoihthengoontoinvestigatehow tne suoteruge could ave ‘succeeded, and ther conclusions the sane: protection against rogue ade events the product of excellence in three erecting areas: governance, Cutire and iskemanagementoantos. Pu summed up NAB!S shartcamings on that gl Font ‘mest eucencily,stalng ints repor that poor supervision had ‘enabled the rogue curency traders to reutnely excaec ther ‘racing lent (he bari’ value-e-k cetng was breached repeetodly, withthe knowledge ol superiors), tatintenal contol sans were inadequate fa creshourlag inthe system of “Tis ace Gemonstates the chetonge facing Inestorein companies and theincreesed expectations theyhavelor acters twensure that thay have efebe ifermation. Auctoss at NAB and Société Générale hac to lraw the clan's inlemal conto’ syst, ‘heyhadto enero that al trades had been property counted for, and nly, thay needed to esse that al secures were propery valved, Ina market where e2cuitos may bo tod to kes that ere uncertain, 6s was the case for US eubpime meotages, sucha vakuzionisdiffut. Yelthe aril states mejor points ‘ratwe wildevelop inihs tedock usar damand forreliable Inforration corinues to expand beyond that of ance report Cala, a particular, users re becoming more conoemed thal irtemsl contol ystems are dasigredto prevent tau, andi trey {alta dso hen to dlect aud ona tina basis, 1 Audiors ee operating wih complex computer systams, Intercornected across the werld, n which deosions ate ‘often made in seoonds, reporting trades was a key weakness that ho traders exotakod, ard that a saves of inemal warning signs were either ignored, Cor ostin the system, ght un 2s fer as tne boars au commits, ‘Overigying kal PG sei, was @ cul that focuses excessively 1 gocd nev, end profs, NAB'S board smely ‘was retinforned of irparart issues’, he reper conchxcod, NAB accopled the rings, anc cleaned up its act aconng oan APRA template tha ora time set hocing ‘eta cepkal ageinsl assets, esticng ourency racing end ‘benching is itenal isk capital assessrent fori, APRA also ‘oversaw cull changes that included wholesale renewal of the board and senior management. ‘Allthat fr $960 milion? No. Al that because a bericol he standing of NAB should neve bein the positon where losses, ‘are generate that way. Ezacily the same principe appies to ‘SocGen, even more so, arguably, night ofthe fact that he rich bark wes ane ofthe fou maga-payers n equity ‘eriatves, alongs ENPP, Deteche and Goldman Sachs. ‘Confidencein the deruaivos market vas akeady al a radi below SocGan's revelation. Te sooner tre bank ang is pie regueter get cn wth a ful sulonsy and overhau, te batter. 2. Aucdtors need to undessand inkenal cntols anc, in some, iuisctotions, provide assurance to owners and olher uses ‘hat those contis ao woreng Decisions about he valuation of many assets and abit ‘are increasingly dificut as FRS has moved valuation tonards afar value basis 2 Treatictshstvaes theimportancedtthe +--+ assurance profession toa sucvesstul economy. Althe same time, ti thealficut task that assurance rovdarstace. shows howenuchthe prolessionhas evoked over the past decade, fen hetine when ucts of Historca-based financial report, otter complementediby a wide arayo paper documents, were the nom.enapter >> ‘The focus ofthis textbook is on the audit and review of financial reports for companies. However the importance of internal auditing and public sector audlting that facus on broader aspects of risks, ‘opetations, and govemance are recognised, a6 fs the growing importance of assurance on sustainability ‘and other types of non-financial reporting in the private sector. Review engagements provide less ‘assurance than an audit, but are being increasingly used in Auswaia. They oan be used m provision of ‘assurance on half-year financial reports and, uncer recent changes in federal and state-based legislation, for financial reports of some companies limited by guarantee and in some states for incorporated ‘associations. As such, this textbook, while remaining primary focused on statutory auditing. ‘incorporates material on review engagements wherever relevant. In viewing the process for conducting an auditor review in the above diagram, the objective isto reach Box V. In Box V @ decision is mate unequivocally about the truth and faimess of an organtsation's financial report in the case ofan audit ane about whether anylhing has come to the aueltor's attention to, cause Gout about truth and faimess in the case ofa review. But, making these decisions is not enough fora public accounting fim vo succeed. The assurance provider must max a decision that caries a very low risk of boing in oor. For example, an audit opinion where the auelitor says the financial report {eit presented wien, in fact, tis not fairy presented, often will lead to lawsuits or regulatory action, This s true too for a review conclusion whore the assurance provider states that nothing has come to his tor er attention to create doubt that the financial or other type of repo is fly presented in all material respects in accordance with accounting standards. fh order to minimiss that risk, the assurance provider is influenced by three factors that form an underlying basis for the audit ot review opinion formulation process (1) professional regulation and exandards, (2) ethical conduct and (2) legal implications, ‘To minimis risk, the assuranos provider pays a great deal of attention to client selection. Assurance Droviders are not requited to pesform auelts or reviews for any entity that asks; Le. It fs the public accounting fms cholce whether ta provide that service. Thus, most fms have detsiled procedures (Box D tohlp them make decisions so that they are not associated with clants where menagement integrity 8 ‘in question or whete a company might ctherwtse present the publc accounting fm with nnecessanly high tsk (eg. client fnancial fei, regulatory action against the client) in the cess of an audit ‘engagement, once a client is accepted (oc the frm decides to retain @ continuing client}, the auditor must be sure to thoroughly understand the clent’s business (or update prior knowledge in the case of a continuing client, its industry, ts competition, end its management and governance processes to determine the Ukellcod that fancial accounts might be in enor and where cfticel accounting estimates are going to he made (Bax 1). The auditor will also gain an understanding of the client's intemal conttot processes, which depending on the audit strategy may range from a minimal to a thorough undescanding, and will gether information about activities that may affect account balances ‘and estimates (Box I). Much of what most people think of as aualting (Le. the tasting of account Dalances) occurs in Box 1V, which includes substantive tess of account balances. It is important 10 recognize that although direct teting of account balances is very important, i is only ane past of a ‘thorough audit. The factors identified in Boxes I through TI will influence greatly the amount of testing to ‘be performed in Box IV. Finally, the auctor will make a decision about (a) whether enough evidence has ‘been gathered to support an audit oF review opinion and (h) what type of opinion shoul be issued (Box ‘The processes for review engagements difer from those described here in that the testing consists, primary of enquires of management and analytics! procedures (generally ratio analysis) and so whileaudits provide ‘ressonable assurance’ as to the suth and fsimess of the financial report, a review ‘engagement provides only limited assurance ‘We vill follow the audit and review opinion fomnulation framework tbroughout the textbook. The ceaily chapters focus on understanding the profession and the demands made of individual assurance professionals, Audit fallures oocur because the auditor did not understand the cent 's business, changes in the industry or the clients intemal processes. Ths textbook examines these issues thoroughly before ‘advancing to subsequent phases ofthe audit and review opinion formulation process i later chepters, legislative actions, the eoancmy in which the bani perfomed today without an in-depih undestancing of the ‘competion. Decl testing of account balenaes alone would nt ‘bark’s nancial stuctre, the quay of is loan porto, be sufcient to develop a foundation for an ave opis, Increased globalisation of accounting and auditing Accounting standards in Austtalia ate set by the Australian Accounting Standaxdls Boaxd (AASB), The nature of accounting standaris and the demand for aecounting-rlated information have changed in the last deca in five signiteant ways: |. Giobsl harmonisation’ There is @ trend towards Global harmonisation of accounting standards wath ‘ntemational accounting standards. Austiaia adopted IFRS - Intemational Financial Reporting Standars ~ in 2006 and many countries around the world, especially within Asia, use IFRS. Within ie foreseeable future, the US is scheduled to adopt IFRS and the International Accounting: els Board (ASH) wll set that country’s accounting standards too. 2. Expanded accountability: The demand for accountablity has grown beyond financial statements to ‘assurance on emissions and other aspects of sustainability. There is a glowing movement for integrated reporting that combines both financial and sustainability reporting in one document, 3 Serting audit standards: While auditing standasds in Austalia are set by the Auditing anc Assurance Standards Board (AUASE), the tend is to harmonise auditing and assurance standards on @ global basis, based on the slandards of the International Auditing and Assurance Standards Board (/AAS3), a body under the International Federation of Accountants (FAC). Mote detaied reporting: There is demand for more current information then that revealed in current ‘annual financial reports. In Austalia, the Ausialian Securities and Investments Commission (ASIC) - has endorsed on 2 voluntary basis tho use of Standard Business Reporting (SBR) for fing fnanctal statoments using XBRI.(@ hypertext language). Voluntary sustainability reporting is also becoming ‘mote frequent in Ausuala. Both of these phenomena are referred to as appropriate throucinout this textbook, Increased 1s reporting: Thete is more demand for rik-besed information about companies, Auitors must be prepared to audit in this broader environment. This textbook discusses Australian and intemational auditing standards, I also explores ihe importance of isk analysis to every auc,| | ' ‘The aucitors tasks both difficult and crucially important ‘The auditor must gather independent evidence to gain ‘assurance that financial reporting is reliable, The auditor must determine that management as properly spplied AASB accounting standards. The standards for professional auditors aie high and 99 are the pubilo’s expectations of auditors and ‘thes assurance providers ‘the external audit profession performs a unique task, Tt does not create the financial reports or other basic data; generally it is precluded from designing the IT internal control systems for an ‘audit client; and it must develop opinions on financial reports based on sampling ancl auett analysis. It is profession rife with risks and potential conflicts. Its value is affirmed when the public has ‘confidence in its objectivity and the accuracy of its reports. When it falls, much of the falal stem fails, This chapter defines the bond nature of audit and assurance services, discusses the ‘domand for such services, identifies the providers of such services and focuses on Uke audit of on ‘organisation's financial report. ‘A Tree-matket economy ean exist only If there is sharing of accurate, reliable information among, parties that have a vested interest in the fnancial performance and future prospects of a ‘organisation, The market is further strengthened ifthe data are transparent and neutral ~ that is, the data do not favour one party over another. The reported data must reflect the economies of transactions and the current economie condition of assels controlled and obligations owed, Tneteasingly, the market also wants to knav that the resources entrusted to the organisation lave ‘been used appropriately that is, management Is not inditectly taking! money fram the shareholders though manipulation of share options, misuse of corporate assets for personal purposes oF outright fraud commitied through presenting misleading and inaccurate financial results, Investors are tired of financial reporting failures and want assurance that those kinds of problems are not happentng it companies in witch they invest, Thus, the auditor must understand how organisations ate governed nel the Key information that boards utilise to ensure that organisations are managed propety. ‘The audit funtion must: Perform tests on an organisation's records to determine thal they are accurate = Interpret accounting standards and other authoritative pronouncements to ensure that financial reporis are fairly presented, © Make judgements about the faimess of complex accounting processes such as inventory ‘valuation, other asset impairments and the appropriate market valuation of securities. © Doall this ina totally objective, unbiased and professionally seeptical manner: ‘This textbook addresses the unique challenges that accountants and autltors face every day. Auditors are lke a ood referee in a sporting, event in that hardly anyone ever notices them when they do their job correctly, However, if the audit or review process falls, investors, creditors and ‘employees are harmed and everyone notices. This textbook is designed to help you develop the sills needed to excel in performing this very important societal function. carter 4Part 1 AUDITING DEFINED ‘The word audit or auditing is used generically in all types of engagements where assurance is lemanded, The Academy Awards, the Logies, the weekly draws of Tattslatto and the AFL's Brownlow Medal count are all examples of where assurance of the integrity of the result is demanded and often the process of providing this assurance is termed an audit, However, in the framework on which the auditing standards depend ancl in the context of finanetal reports, the ‘wor ‘audit’ is reserved for only one type of assurance provision, that relating to the provision of ‘reasonable assurance’ as to the falmess (or truth and fairness) of historical nancial information generally presented in the form of an anmual report. inanelal report auditing has been desined as a: systematic process of abjectively ablaining and evaluating evidence regarding ‘assertions about economic actions an events to ascertain the degree of correspondence Duetneen those assertions and esiablished criteria an commusticating Uhe results to linorested ners! Financial report aueiting, in its broadest context, is the process of attesting to assertions about economic actions and events. It is therefore frequently referred to as an attestation serviee. Attestation is a three-part process: gathering evidence about assertions, evaluating that evidence against objective criteria and communicating the conclusion reached to interested parlies. We adopt this broad approach for describing a financial auc, Financial report audits involve a very rigorous process, explained in detail In this vextbook. Jt is important. to understand that a less rigorous process, kino ‘engagement’ and designed to provide ‘inited assurance’ can be applied to financial reports als. In Australia, the lal-year or interim reports for disclosing entities can, under the Corporations Act 2001, be either audited or reviewed by the company’s auctor? but the end of financial period annual report ean, under the same Act, only be auclited. Technically, under the IAASB framework adopted in Ausivalia, the term auditor should be applied only to auditing of financial report engagements and uke term assurance provider to reviews, However, in Australia, tis the disclosing entity’s auditor who conducts the half-year financial report review, if review rather than audit is chesen, As such, henceforth this textbook tends to refer to ‘anditors’ rather than the more clumsy ‘auditors or assuranee providers’. Many of the procedures involved in an audit are applicable also to review engagements. The chapters that follow highlight the procedures and outcomes involved! in an audit and «llferences in those procedures ancl outcomes when a review engagement isinvalved. ‘There are a variety of parties involved in the production and use of audited or reviewed ‘nancial reports. The board of directors tas oversight responsiblity over management and engages tte auditor to aucit or review (as appropriate) the financial report and prepare au independent opinion on, in the ease of an audit, the fairness (truth and falmess if an engagement under the Corporations Act) of the financial report and, in Uke case of a review, whether anything has come { the autor’ attention to create doubt about the fairness (or truth anv falress) of the financiat report.’ Assurance Is often provided on nor-financial information too and these soris of ‘engagements are disenssed later in this chapter. Idting Cots Crestiee Repet af the Crate Ds Stine Cees Te eve 7, ne)Regardless of whether the financial report is audited or reviewed, management has responsibilities for (a) managing the organisation, (b) safeguarding the assets entrusted to it and (©) preparing financial statements and notes that portray the economic condition of the company and the results of iis activities over a period of time, The financial statements and notes, together with the Director's Statement and aucltor’s report, constitute the financial report land this report {8 provided to third parties who (a) have invested or might invest in the company, (b) lend resources to the organisation or (¢) otherwise have a vested interest in the organisation, Aucltors gather evidence to determine whether the fnanelal report is fairy presented in accordance with accounting standards and prepare an Indopendent opinion that is shated with third-party users, management and the board of directors. ‘The audit or review adds value only ifthe auditor © has expertise in both obtaining and evaluating evidence regarding the fairness of the financial statements © isindependent of management and the third partes © is knowledgeable about company risks and financial reporting stanlards. ‘That Is, the essence of quality audits or reviews les in te competence and independence of the auditor, [fan auelitor is competent but not fearless in reporting the audit outcome, audits (or reviews) are not valuable. If an auditor is fearless in reporting, but incompetence leads to ‘inappropriate reporting, then again the value of audits (or reviews) is lost, ta the detriment of the capital market At a general level, audit or review engagements are a process of (1) gathering evidence to allest to assertions (usually made by management, to the effect that, for instance, assets on the balance sheet actually exist, but also by other parties), (2) evaluating those assertions against objective criteria (e.g, accounting standards) and (3) commumicating the auditor's conclusion to inverested parties (usually outside parties such as users of nancial reports, but also to ‘management and regulators). \y evidence Auditors gather evidence that the client's processes are working correctly, the financial data are properly recorded and properly adjusted {0 market value when appropriate, and the financial report is fairly presented. Thus, an auctor is part investigator, part evaluator of the quality of aueit or review evidence, and part analyser of the persuasiveness and sufficiency of evidence that has been gathered, Unlike lawyers charged to unashamedly protect the interests of their clients, fuditors must gather and evaluate evidence in an unbiased manner. Thus, the auditor must be systematic and objective in obiaining and evaluating evidence and adopt an attitude of professional scepticism, aluating assertions Atils most generic level, an assertion is a positive statement about an action, event, condition or performance over a specified period of time. For unbiased arid clear communication, there must be criteria whereby Independent observers can assess whether such assertions are appropriate Accounting standards provide eviteria for nancial report audits or reviews, Criteria exist also for evaluating the design and operation of internal conivols. Internal auditors may refer to management's poticles and procedures in determining a department's complianee with company naeren 1 >>AM policies, A taxation officer will refer to the Tax Act to determine if taxable income is correctly computed, The Intemational Accounting Standards Board (ASB) anc ‘of @ compary, Thus, a challenge for autos fs 0 assess consequent the AASB have moved to a conceptual model that curen matket vale of assets ard labilies, as opposed to only ‘emonasises far mart valves to pray he economic actly _verying the cost of assets and abi, ‘When management prepares financial reports, it asserts implicitly that the statements and notes are fairly presented in accordance with accounting standards. Accounting standards become the criteria by which Taimness' of a financial report presentation is judged. However, accounting students know that interpreting authoritative pronouncements ean be difficult. The auditor's task is to consider whether the accounting standards and generally accepted accounting principles have been applied. appropriately by management to portray the reality of the ‘economic activity of the company in a transparent way. ‘The assertions by management embodied in the financial report provide directions for the design of the audit. For example, by showing inventory valued in the nancial report at $25 rnllion, ‘management is asserting that the inventory exists, is complete, is owned and is properly valued atthe lower of cost and net realisable value. The auditor thus needs to gather objective evidence to test each of hese assertions. Olten, bul not alivays, during the process of auditing te auditor wil examine the ‘quality of internal controls over financial reporting, which can also add to the value interent in the purchase of auditing services. There is some global convergence on internal control standards, as, many regulatory agencies around the world have adopted regulatory requirements sinilar to the US Sarbanes-Oxley Aet of 2002, That Act requires management to report on internal control and for managements assertions in relation to those internal controls to be audited in what has become known asan ‘integrated audit. Australian auditing standards do not require auditors to report publicly on internal controls over financial reporting. The frameworks developed by AS/NZS ISO 31000 Feisk Management ~ Principles and Guidelines (2009) and/or the Committee of Sponsoring Organizations (COSO) are frequently used to evaluate controls, i this evaluation does take place. Communicating results lo users Communication of aul results to directors, management and interested third parties completes the ‘audit or review process: To minimise misunderstancings, this communication usually follows prescribed format by leary outlining the nature ofthe work performed and the conchsions reached. A finanefal report audit results in an auditar’s opinion directed to the shareholders of the cient organisation. A review engagement results in a review conclusion directed to shareholders, Both repoxts Aelinente the responsibilities of both management and the auditor, summarise the auelit or review process ancl express the auchtors opinion, or conclusion in the case ofa review, onthe financial report, When the auditor las no reservations about management's assertions and there is compliance with accounting standards, the report is referred to as an winger audit seport. Sued a report for an audit is shown in Bxdubit 1.1 and for a review is shown in Une same exhibit. I the auditor had reservations about the fair presentation of the financial report, the audit or review report would be expanded to explain the nature of the auditor's reservations (covered in Chapter 17).Jab, RisenbergJobstore and Geaming 25 ingeey Sues: ‘canberr ACT 0200 ‘Suny Jim Soar Ls 25 Fotos Sweet Seon ACT 0200 "ie hav ad te axon anal pao Sy in ae Lin, whic compas the statement of fnancial postion as at 9 une 2012, the atatement of comprohensive come itement of changes in | ety and staterent of eh owe loc the yoar then en, notes | comprising sommary af significant accounting pices and ater ‘rglanatay information, ae the rete declaration, ‘The decors ofthe company ar respansbi or the prepara the finanlal repr that gives rue anf ew in accordance with ‘Austaon Accounting Stndrds and the Copartins Act 2001 a fot ‘uch internal conto asthe crete detennie is naessary to onaie ‘the preparation of tie fancil report that ite from atrial ‘mistatement, whether duet frau or ener. In Note 2, the ieetors abo sat, in aocrdance with Accounting Standard AASB 101 ‘resentation of Pnanckl Starner tat tho nancial iter ‘comply wth Inemstonal Francial Reporting Stannlz ‘Oursesponsiity isto express an opinin an the Manca epot based ‘on ou at, We conducted our aut in accordance wih Austalan ‘Autting Sndards, Tove standaré eu tht we comply wlth ‘elovant etic! requrements relating ta aut engogements an plan id perf the audit to obtain leasonable assurance abot whether the francil partis to om material missatement ‘An adit involves pefomang procedures to obtain auatexdence sbous {he amounts and cscosures i the financial rap. The procedures selected depend on she autor judgement, nuding the asosament of the ik of matnl missstement ofthe ancl epart. whether duo to aud orn. tn making thse sk assessments, the euktor considers ntem conta lovant othe entity's preparation othe ‘nana repr tha gives a rue and Ji vilw nord to dec. uit ‘procedures tat ae appropriate into czcumstanees, but pot ore pupooo of expressing an opinion an the efsctvaness of the ony’ ‘neal cont. fn audit also includes ereluatng the aporopriateness| of accounting pales sed and the easonabenets of eocoutng ‘estimates made by the diecicts, as wellas evaluating the overs prosentstion othe nancial pon, We beeve tha the aust evidence we have chained i suicient and _apaoprat to provide bess for ous et opinion, cuaeren 1 >> ASSURANCE AND AuDiTinG: IavESRAL ro sue ecouosy Subp, Rttnberg Johnstone and Grama 26 Kgeey Sect CCanberr ACT 0200 [sim in Sax 25 Photovoltaic Sect Sitoon ACT o200 “Wenavevovwed te accompanying 21 December 2012 ancl report of Sunny Jen Soar a. which compries the nalnoe sheet as at 31 Decomber 2012, andthe income satoment, statement of changes in ‘ey and cash ow satoment forthe hal-year ended an that ate 2 ‘desorption of socounting pois other selected expanatory notes, sng tect decree “The ceca of th company ac separ tho ptparaton lhe 531 December 2012 nancial reper in aecordonce with Ausakan ‘Aooounting Standards and the Caporatons Act 2001 and fo sch ‘onto asthe ctectors determine Is necessey to enable the prepaation ofthe 31 Deoomber 2012 nancial epat tat fee fom mates) _mettzment, whether duo to aud or ar. ‘OurYesponsibity ito exores a conluion on tho hal year 2012 financil epor based on our review, We conduct our review in ccotdace with Aung Sanat on Review ngegements ARE 2110 Boviow ofa Financia! Report Pafomed by de ndepenent “Actor ofthe nay, mercer ta sate weet, onthe basis ofthe rooedues dseibed, anything has come to our tention thet causes sto bolove tht the fancal sports not pesentd ay, ina ‘moter respects, aocorance with Australian Accounting Standards fad the Comaretons Act 230, As the audit of Sunny Jen Soar id, -ASRE 240 equies that we comply with the eshica requirements ‘elovant to th aut of tho annual nancial ep. ‘A review of a al-yarfarcialepor- ons of making enquies, ‘tina of peteons wesponstle for fnancil and accounting mates, ‘and appving nail and other view pccodures. A rede is substantia les soope than an avi conducted in accordance with ‘Ausalan Auditing Sandards and consequenty doesnot enable iso ‘obtain assurance that wo would became awate of all inlfeant mates that might be denies man aut. Assotingly, we da not exmese an ait epnion (oor)Paar 199 In conducting or ua, we have comple with the requtements of the Comeratons Act 2001. We confm that Independence decattion requned by the Capperatone Act 2002 ‘whic hae nse give othe drectas of Sunny Jim Soa a, would be | ime same terms ivan io the dueetons as tthe me of his do's reper {nour opinion: 2. the nancial roar of Sunny J Solar La i in accordance withthe (oxporatins Act 2001, noting 4. giving tue and far view af the company’s facial postion a6 1 90 Jone 2012 and af is pefomance fr the year ended on tat de, and 14 complying wth Autatien Accounting Skandal and the Conporations Regulations 2001; nd 1, the financial report asa compos with lntematonal nancial Reporting Stade aecacioaea ia Now 2. sh, Ritnberg, Jomntone and Gramtng 78 Kingsley Suest Canberra ACT 0200 | 27 August 012 | | in ASA 700 Ferg a pn a type of entity's) financial status, ‘Base on cu eviews, which not an suet, nating hes Come to cue tention that causs us ta bsive that tho 31 December 2012 Manca report of Sunny J Soar 1a doesnot give ate and fair vi of te fnanel! poston ofthe company ns at 3 December 202, ano its fancllpefocrance ani cag ows forthe alse ended on that date, in accordance with Austalan Accounting tances athe ‘Camperatone Act 2001, (Avatior's signature) 27 etuary 2013 Jubb, Rinenberg, Johnstone ad Graming 2s Kingeey Steet Canberra ACT 0200 ei Rei a Fi rene 8 Se Aloe Hom AUDITING: A SPECIAL FUNCTION ‘Auditing i a ‘special function’. By attesting to financial reports that deplet a company’s (or other the independent auditor assumes a public responsibility transcending any employment relationship with the client. The independent public accountant performing this special function owes ulimate allegiance to the company’s creditors (or debt holders) and shareholders, as well as to potential investors (i. vo the investing public). This public Interest aspect of the auditor's role has sometimes been described as that of a ‘public watchdog’ funetion that demands complete honouring of the public trust by the auditor. Aucltors serve a number of diverse parties, but the most important isthe public, as represented by investors, lenders, workers and others who make decisions based on financial and operating information about a company or other entity. That function requires the highest level of technical competence, freedom from bis in assessing the faimess of financial presentations, and concern for the integrity of the financial reporting process. Ti essence, auditors should view themselves as guardians of the capital markets. Unfortunately, that guardianship roleAssuenuce ano auDITiuG: InreanaL 40 INE ecoNONY ‘has not always been embraced by the profession in the manner that the public expects. When the ‘responsibilities are not fulfilled to the public's expectations, the repercussions include lawsuits and’ or increased regulation. Se 7 accommo aoe ae ee uk ee eee nee ren herecteanasus uiney cecrcy one eo | coeur ee oe ee ci) connec cn eperene pie Seer erreesnay | rh strmnrer tip mbit aperee malfeasance on Wall Sireet, including the collapse of Leben includes fraud and negligence iy advisers end third perties,’ bres noneee ee ee soltor Cratos Siders, wil visi Austra his woekin aid to Macoff's Po scheme in a bd toreccun some ofthe SUSE ‘stabi partnerstins wih prominent supecannuation funds and billon ($A7B kllon ost inthe wok leoest france soar, is eS ‘There Is tle disagreement that major fallaes occurred in the accounting profession during tite late 1990s and early 2000s. We need not repeat all of thera, as most people are well aware of IH and One.Tel in Australia and Enron and WorldCom in the US, as well as other significant ‘nancial frauds, More recently, there have been failures in not identifying weaknesses in financial Institutions on a timely basis (e.g. Letunan Bros). In the US, the failure to identify the Bemie MadotT ponat scheme* created another set of worldwide headlines, These foilures have had a profound effect on the auditing profession. The fallures go far beyond that of Andersen ~ the largest public accounting frm ever to fail, Some of the problems were arguably as follows: 1. The profession lost track of the imperative to be responsible to the public. 2. Accounting standards came to be viewed as a set of rules that could be interpreted (with very minor boundaries) to suit the reporting objectives of management. 3 A significant portion of top management's remuneration was (and continues to be) in the form of shaves or shave options. Thus, management's incentives are to increase share price — even If ‘operations do not justify an incresse in share price. 4 Auditors were, in essence, perceiving management rather then shereholders as thelr client, ‘Thus auditors had strong motivation to please management. Finding a way to accomplish a management reporting objective too olten resulted in Iucrative consulting contracts for the audit firs 5 The accounting profession had difficulty exercising the judgement required to implement principles-based accounting and auditors had difficulty providing assurance on suet accounting. Because of the diffeulty in writing clear and unambiguous rules for every circumstance or transaction, the trend to prineiples-based accounting is inevitable. ‘the dtm curse of ports ta eto rue ist sth er Lo pay rua cet is tweens 8Parr 139 Uswersranoane ‘Too many accountants felt it was acceptable to apply accounting principles in a manner designed to achieve management objectives. In other words, the mindset was wrong: ICib is not prohibited under the accounting standards, it must be acceptable 7. The auditing profession needed to be more profitable in order to retain partners and managers. In order to be more profitable, many audit rms redueed the amount of audit testing by inappropriately applying # risk-based approach to auditing. 8 Regulators were underfunded and overworked. As such, the regulatory environment provided leas oversight and, coupled with a pro-business attitude, allowed greater flexibility in reporting to take place ‘The public accounting profession has been one of the most highly regarded professions in the country, The new audit professianal must be more than a ‘rules person’. He or she must be able to meet the challenges of professional Judgement, exereise professional scepticism and adhere to standards of professional excellence and ethics. Understanding the unique challenges of the profession ‘As you work your way through this textbook and your course, keep in mind the significant challenges faced by the profession: = Ault procedures must be designed to detect material fraud and assure users thatthe finaricial reports free from material frat © Review procedures aenerally involve only enquiries of management and analytical procedures and provide limited rather than reasonable assurance, but this difference is often not well understood by the pubic ‘Accounting is highly complex ~often, in part, because companies are entering into snereasingly complex transachions and organisational structures, = Computer systems are complex. When used properly, they provide opportities for effective controls, but when not used property, they create adeitional risks. Many companies are global. Many’ audit firms operate in multiple countries but require consistent high-quality audits wherever the audit takes place. © In auditing companies dual listed in the US or with US subsidiaries, Australian auditors must comply with the requirements of the US Sarbanes-Oxley Act 2002. Under that Aet, auditors rust evaltate the quality of internal control over financial reporting in US-listed companies and roust report that evaluation to users ofthe fnancial statements = ‘There is time pressure to get the audit or review done andl to report more quickly than ever before Finally there is a need to generate audit fees sufficient to both (a) attract new people like you to the profession and (b) retain managers and partners, who often operate under heavy stress to fulfil this most important obligation. But clients will resist price changes that they do not believe are warranted and fee cutting by competitors i fe, THE NEED FOR UNBIASED REPORTING Capital markets are built on transparent financial reporting, Financial reports reflect, within the limits of the accounting model, a true and fair view of the organisation's financial results. The financial reports do not favour one user of them aver another. All users are considered important In many cases, the interests of the various users can conflict, Curront shareholders might wantcaprer >> ranagement to use accounting prinelples that result in higher levels of reported net income, but lending institutions generally prefer a conservative approach to valuation and income recognition, Exhibit 1.2 presents an overview of potential financial report users. ‘The auditor must also consider whether a misstatement might be material to a user. The need {or unbiased reporting can easily be seen by examining a situation in which a bank is considering a ‘company’s loan request, In preparing its report, management of the company’ wishes to obtain the Joan and prefers that its auditors agree with its own assessment of its financial accomplishments. ‘The bank relies on the financial report of the company, among other information, to assess the riskiness of the loan (that i, the likelihood that the company will not be able to repay the loar. ant Interest in a timely fashion). If Une loan Js made at a good rate, the bank will prosper and may be able to offer higher savings rates to attract more depositors. The company receiving the loan will be able to expand, hire new workers and inerease the community's workforce. All parties benefit from accurate, unbiased information that portrays economic results, The more accurate the {nancial information provided to the bank, te more positive the overall results of Its decision wall bbe, not merely for the company and the bank but also for society as a whole. ee Management ‘Sharshoiers | of veces, appoint: ofthe autor and make ci Burohae more stares as pt ofa share atfering lnarclal Insioutors | Loan decisions ~ nero ats, ens ana tisk Tonation Authorties | Determine tavable income end tax cve Potential Invests | Buy shes or debentres Regulatory Age Compliance with regulations, need fr alles bargaining Gecsions Buy ort dbbentues Vendors “Asses ret mse ‘Protest employes fom auoions conceming supernanuaton where oe nse | [> | NEED FOR ASSURANCE ‘Why do financial report users need assurance? ‘The need for assurance services arises from several factors: i © Potential bias in providing information; that is, the providing party may want to convey i better impression than real circumstances merit. ® Remoteness between a user and the organisation or trading partner.part 1 > © Complesity of the transactions, information or processing systems such that it is difficult to dletermine thelr proper presentation witout. a review by an independent expert = Risiciness of investments. Investors need to manage thelr risk and thereby minimise financial surprises. All of these issues were at play in the subprime mortgage crisis in the US, which had workdwide implications, including for Australia, The borrowers often did not provide unbiased information, there was remoteness between the Jenders and the subsequent buyers of the mortgages, and the derivative securities were very complex to undersiand. Consequently, various financial report ‘users and others suffered significant lossos. Potential bias in providing information ‘Management Iisa vested interest in providing information that will make management look good ‘Management has inside information that it may or may not want to share with users, For example, ‘management's compensation may be tied to company’ profitability or share price and it may be tempted to ‘bend! accounting standards and generally accopted accounting principles (GAAP) to make its performance look better. There must be an unbiased arbiter to ensure fairness to users. ‘That isthe role ofthe auelt funtion Remoteness of users ‘The internet, coupled with global communication ancl transportation, Nas enabled us to become a alobal society. The advantages are tremendous, but a signiteant disadvantage is that we no longer either know ar interact direetly with many parties. Most users cannot interview management, tour ‘a company’s plant of review its financial records fist hancl instead, Chey must rely on the financial report fo communicate the results of management's performance. Complexity Many business transactions are more complex than they were a decade ago. Third-party users tlepene on managers and auditors to deal with such complexities as financial instruments, derivatives, long-term contracts and other complex transactions to ensure that they are fairly presented and fully disclosed in fnanetal reports Managing risk During the past decade, many fnanelal report users ~ superannuation funds, private investors, venture capitalists and banks ~ lst hillons of dollars because nancial information and, in some inslances, the alt funeton had become unreliable. When audits are not reliable, investors and other users lose a significant source of information that they need to manage risk. In the past decade, a large umber of financial statements. and notes have been found to involve (@) misapplication of accounting standards; (b) outright fraud; (c) aggressive accounting — for example, in developing estimates; and (2) recording sales transactions in the wrong period. Often revelations of these misstatements were followed by precipitous drops in share prices ~ and in a number of cases, bankruptcy for the companies involved and litigation for the audit firms involved.INCREASED DEMAND FOR ACCOUNTABILITY ‘The accounting profession hus undergone a decade of turmoll and change. The factors eading up to the changes inelude: (a) the failure of one of the largest: public accounting firms in the world Andersen); (b) the largest bankruptcy in the history of Australia (HIM Ltd) and the largest bankruptcies in history in the US (Enron, WorldCom) - each of the bankruptcies occurred in companies where financial report mistepresentation had taken place; (¢) millions of dollars in ‘investment and superannuation funcl losses; (d) a sense that auelitors did not remain independent despite being engaged by shareholders rather than by the managers of a company (e) the Increased complexity in accounting brought about by a movement to fair value accounting and the complexity of financial instruments; and (Da question as to whether the public accounting profession could sufficiently govern itself to ensure that it would always act in the public interest. ‘The culmination of these failures Jed in Australia to the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 (CLERP 9) which may be the ‘most important Australian legislation affecting the public accounting profession in our lfetirne * "The Act focused on four critical improvements related to auditing and financial reports: 4 Improved corporate governance 2 audit standard setting moved to a new statutory authority organisation 3 improved independence of the external audit function 4. acknowledgement of greater public expectations of auditors, DEMAND FOR IMPROVED CORPORATE GOVERNANCE, Corporate governance is an oversight structure that ensures that management operates in the best inverests of the shareholders and that there is appropriate accountability to the organisation's stakeholders (owners, workers, regulators, lenders) ‘That structure usually stars with the board of directors. There were two major ertiisms of boards during the past decade: © The board often was not independent of maragement; the board members either Included a majority of management members or were chosen by management and thus were beholden to ‘management. © The independent members of the board did nob assume ownership of the audit function on. Dbehalf of shareholders; they did not take an active role in oversight of the andit or in the decisions to retain or change the audit firm, Since 2008, the Australian Securities Exclange Listing Rules have required the largest 500 Usted ‘companies by marke! capitalisation to establish an independent audit committee as a subcommittee of the board of directors to provide oversight ofboth internal and external audit functions, Many smaller ‘companies voluntarily support audit committees, But corporate governance does not stop with the board and committees. The CLERP 9 Act gave increased protection to whistleblowers within the organisation. ‘The internal and extemal audit professions both play expanded roles in improving corporate ‘governance. The external auditors have a responsibility to discuss with the audit committee the appropriateness of accounting choices made by management. The external auditors also have an. © Clapor 4 teed ty proves «abe 0 ep Corporations Act 200 sas eg eal sled Highs ‘os ton sube wo lhe CLERPOaerens tote Carports Ac © nthe US Sarees Oty At 208, BLS was ys nd as even ere i eas a CLERP cuarer 1 >> ASSURANCE AND AUDITING: [ATESRAL TO THE EcoUGKY ”Part £95 Jnereased responsiblity to search for the existence of material fraud, including the identification of {aud risk factors. An intornal audit funetion js required by many major securities exchanges, but fs not mandated in Australia, Rather, disclosures about internal audit need to be made where the function does exist, Where the function does exist, most intomal audit charters require that there bbe a direct relationship to the chair of the audit commitzee and a responsibility to bring ‘questionable items to that chair. Thus, in terms of the auditing profession, it is elear that the responsitilities have expanded well beyond that of just auditing a company’s financial repors. ‘Auclting is an important component of corporate governance DEMAND FOR SUSTAINABILITY REPORTING 4 Although itis overwhelmingly voluntary in Australia, sted companies expecially are increasingly issuing sustalnabllity reports. In some instances assurance on thase sustainability reports Is provided, not just by members ofthe auditing profession but also by those with other skil sets Ce. environmental engineers). Two major intemational frameworks have come tothe fore in terms of sustainability reporting. The frst, the Global Reporting Inttiative (GRD), isued the third edition of its Guidelines (G3) in 20067 and these remain the version current at the time of wnitng, although ‘work is continuing on guidance on reporting community impacts and human rights and embedding gender diversity. These G8 Guidelines nominate economic, environmental and social as broad | categories under which to report. Within these categories, more specific ‘aspects’ together with aspect-related key performance indicators are included. Bxhibit 1.8 summarises these aspects and the key performance indicators are refered to in the chapters to which they are relevant. 63 includes very litle regarding assurance on sustainabily reports, At paragraph 9.19 i states: 8,19 Policy and current practice with regard to seeking external assurance forthe report. If not Included in the assurance report accompanying the sustainability report, explain the scope an basis of any external assurance proved. Also explain the relationship between the reporting organization and the assurance provider(s)” ‘Another intemational organisation, Accountability, provides deeper guidance on provision of sssurance on sustainability reports. In particular AccountAblity claims tha its AA1000 Assurance Standard (2008) provides a comprehensive way of holding an organisation to account: for Its ‘management, performance and reporting on sustainability issues by evaluating the adherence ofan organisation to the AA1000 AcsountAbilty Principles and the quality of the disclosed information on sustainabllty performance (otrp/Avaw accountability or/images(contensAVBMOS6/AA10CDAS% 202008 pa, viewed 28.10.10) Hi ‘The National Greenhouse anc Energy Reporting Act 2007 ‘The Nationat Greenhouse and Broray Reporting (NGER) Act 2007 came into effect in Australia in 2008 and requires controlling entities to register and report on energy-related information luring the financial year following registration, vith a phased approach over three years from 2009, according to the size of greenhouse gas emissions. Ultimately, this legislation wil affect approximately 700 medium to large entities. Not al wall be listed companies or necessarily even incorporated. The NGHR Act requires controlling entities to register and report to the Australian Department of Climate Change, for eventual public disclosure, the emissions of greenhouse gases produced or consumed energy at or above a specified level within 1 financial year. In short, the NGBR Act initiates measurement and reporting ofthe greenhouse gas emissions and the production and consumption of energy by the largest emitters and it requires also 7 nal patna’ OR Susi Reporting Gute, Ce 208euaprer 1 >> sup AUDITING: INTEGRAL To THE EcoHOWY Bonomi pana Matt presence ‘Conitance [ Inet eoonamie ampacs [anspor ‘Environmental | Mateos Overall = i Employment Water Boalversty Enisins effuents end waste [abourdanagementelaons | Oocupatonal nes ana Tra and elueation ‘Athcompettive behav ual oppomuniy| Product [e responsibilty | Human sights | invesmen: ana procurement ractions | Nor-aserminaton - redo of exogaton and calatvo Cha our owed and compulsory labour [ customer pavacy F commie ‘camption | Pubic policy Sanco Ga Repo wi (i, Sv 9 as Oba 206 that the estimations are transparent, comparable, accurate and complete. The Department of Climate Grange makes the eneray consumption data provided ta it pubic va the intemet some months after its capture, subjet to wltnhelng for reasons of competitive eisadvantage. The fst tranche o information was released in Februar 2010 ane the second in February 2011 In terms of assurance of the information, reporting entities can inate purchase oftheir own voluntary assurance report but, additionally, the Department of Climate Change can mandatorily & require assurance tobe provided by firms that have registered for this process. In August 2010, the Department isued an Audit Determination Honabook which provides guidance on the conduct of greenhouse and energy ude under the NGER Act AUDIT STANDARD SETTING AND AUDITOR INDEPENDENCE, The CLERP 9 Act moved the setting of auditing standards away from the previous co: regulatory arrangement with the professional accounting bodies to a statutory authority, theUuversranoins avorton mespousra4c ties Auditing and Assurance Standards Board (AUASB), This Boatd was given the authority to set auditing standards for all audit and assurence engagements, but, just as importantly, for audits conducted under the Corporations Act 2001 (jee. audits of incorporated entities) the auditing sianderds were given legal backing under that Act. Further, to ensure the independence of the audit firm, the CLERP 9 Act strengtitened the independence of ‘auditors by requiring = mandatory rotation every five years of the partner in charge of the audit engagement = that certain types of consulting work cannot be performed for audit clients increased! oversight of Potential independence conflicts, including potential conflicts that may alfect performance by the Independent auditing firm. “Although there have been calls for differential auditing and assurance standards, with lesser requirements for audits of smaller listed and nonvlisted companies and unincorporated entities, both the IAASB and AUASB have resisted, arguing that resolution of this issue lies in differential accounting standards rather than auditing standards, The AASB introduced a reduced disclose regime (RDR) for smaller entities in 2010. PUBLIC EXPECTATIONS OF AUDITORS “The public expects auditors to (a) find fraud, (o) enforce accounting principles that best portray the spirit of the concepts adopted by the AASB or the IASB and (c) be neutral to users, At the same time, directors, management and the audit commitiee expect cost-effective auclits, Thus, the profession faces dual pressures - one to keep fees dovm and the other to recognise increased ‘responsibilities for an increasingly complex set of audit clients Aithough the recent focus of the aulting profession has been on the audit of financial reports, the ance services is much broader. In this section, we discuss the broader nature of assurance services that might be performed by auditors. concept of asst WHAT IS ASSURANCE? “Assurance services are independent professional sorvices that improve the quality of information, or its context, for decision makers, Assurance isa broad concept Itincludes assurance over information, contained in financial reports. It also includes information about the context ofa provess, such as the sthipment of goods by a web-based firm or how the company handles retuned goods. Assurance services are designed to improve the quality of decision-making by improving confidence in theCHAPTER 1 >> Assuaalce awe AUDITING: INTEGRAL To THE Econom Information on which decisions are based, the process by which that information is developed, ara the context in which the information is presented to users. Example services ate shown in Exhibit 14. ‘The field of assurance services is much broader than traditional audits of financial reports. Assurance services depict: = wider spectrum of services amore diverse group of users = potential users with needs broader than audited financial reports isk Asoassment | Tho quality of prooecses implemented hy an eganisatont dently, asses and manage tiie ‘ustnessFofomance | The process to enti, measure and communicate aerpative menses of 7 easement perfomance; axsurencs onthe eccuracy ofthe pcomence maasuents ised by 4 ancient 4 {normation System | ‘The quelty of controls bul mo information aysem processes io ensue system secu. 1 Retsiity ‘aly, tnainas and accuracy. Assuancason te acatayo ancl another 7 information proved lectoicly to user on census bas q Suetaabiny “onary of dslouco naon eaben ena ey podieen ad Pesfomanes consent satiated nomaton thes iced vestry” mandated tor insince under Ausale's Natal Greenhouse ane! Boy Rep cx 200 Blecronc Commerce | Provide asuance to vanous panicpants eg. consume, reales, cle card issues, ection data inetchange (EDD users, nebork service prods, ofa vendors in ‘@ectonic commerce thatthe systems and cok in use are designed and unctionng in cordance wa accept cena or neg and secu Hldeare Pas Provide assurance to eets and thee fomies that spocfid goals regarding care forthe ‘Adery ae Deng mt by various caregivers. "This sevice focuses on eer pero who want ov independently in their own homes and thos indals who cae forthe lel (eg. so an daughters) ut might ve ata distance epart rom the edt ecause of the recent emphasis on gaining back the public trust of audits, the development of ] these extended services has been slow. ‘The two largest growth areas in the assurance arena have been in the risk assessment area and in businéss performance analysis. Many of the larger public accounting firms have developed these services and provide them through a group that also provides intemal aut outsourcing. The Big 4 firms (Deloitte, Est & Young, pwe ane KPMG) have marketed the business under the broad label of Bnterprise Risk Management Services and in some cases the risk management services wil include an outsourced internal audit ou Assurance vs. attestation vs. aucit vs. review Sometimes the terms assurance, atiestation and audit ate used interchangeably. However, in the context of assurance services, although related, they differ on wo fundamental dimensions: 1. existence of an outside third party that relies on the audita’s opinion 2 nature of services provided. aee ‘or to external users, Assurance services include both attestation ancl audit services and can be provided on financial information or on other information such as the quality of business | processes, the reliability of computer systems or the accuracy of performance dala. Attestation services are a subset of assurance services and alevays Involve a report that goes to a third party For example, the auclitor might provide a report to third parties about the quality of a compary’s internal contro] processes. The narrowest service is the audit or review of a company's financial report, An audit or review of a financial report is a subset of the other services that an auditor can provide, Audits are designed to provide a reasonable level of assurance and reviews are designed to provide limited assurance. An overview of the Unree diferent levels of services is shown in Bxhibit 15, | a h ‘The approach used in performing audits and to some extent reviews of financial reports applies equally wel to other types of assurances, The difference isin the subject-area knowiedge required and the specifie evidence that will need to be gathered to provide the assurance. Thus, the concepts covered in this textbook can be easily generalised to other types of assurance services ‘beyond finaneal report audits or reviews. (psn nut not reused May nec rept only to pay questing the asurence andor oti partes ‘Cleneraly can be aud oreo natu ‘Broad, can mache: * business processes + contol processes + ik analysis + onfnancal performance data nancial siermatin ‘Attestation Service | Indapendent Auditor's Reports used by ‘hid pat a prof thelr decison aking process ‘Ait of financial report ena esto Hoan Infoation tat provides easonable assurance asto the fies (or truth ana fess) othe fnanctlntrmaion ‘Tid patio re primary users o the avait option ‘Audi Secice ‘oviow of nance repo that provides tes surance. In Asta, ths ype of senice i typiesy provide for hall year repr of sted companies Roviow Service | ‘Thi partes te primary users the | | review condusion Not all assurance services are provided by the external auditor. For example, where the function exists, internal auditors often provide a wide variety of assurance services for their organisation including: 1 the effectiveness of a company’s process for identifying and managing risk A * the quality ofan organisation's governance processes the effectiveness and elliciency of an organisation's control processescarrer 1 >> Assurances awp auarrine: INTEGRAL TO THE EcoNONY = the effectiveness and efficiency of operations, with suggestions for operational improvements ‘compliance of company operations with company policies andor regulatory policies. Characteristics of assurance services. All types of assurance serviees involve three critieal components: = information or a process on witich the assurance service is provided = a.user or a group of users who derive value from the assurance services provided 4 an assurance service provider, Items on which assurance is provided ‘The items on which assurance is provided can range from financial reports to computer system integrity to quality of products and services sold via the internet to compliance with regulatory ‘requirements. The assurance can be on information or processes, The adequacy af a process is just 4s important to most users as the information that goes into the process. Examples of assurance services that have been performed by auditing firs include: * the adequacy of the process for the Australlan government's “Bulkling the Education Revolution’ school hallsMibeavies, or the Home Insulation Program designed to create stimulns spending to ameliorate the effects of the global financial crisis, = the quality of controls in a computer system as it affects outside users of tha: syster, Attributes needed to perform assurance services ‘Assurance creates confidence by reducing information risk ~ the risk that the information is not reliable. Investors or other users make better decisions when they have reliable information. The attributes of individuals providing assurance services are the same - whether for nancial reports ‘or other areas identified above, such as information systems security. Those attributes are: = subject-matter Imowledge, such as information system knowledge © independence + knowledge of agreed-upon criteria to evaluate quality of presentation, such as standards for internal control, or agreed-upon standards between the auditor and the user of the service = expertise in the process of gathering and evaluating evidence related to the subject-matter: Meeting the expectations of diverse groups requires considerable expertise. Because of the Increasing complexity of the business environment, the demands made on the professional auditor hhave certainly increased. Beyond required auditing and accounting skills, today’s auctor must understand the clients business and industry; identify problems and propose solutions; understand economic and politcal conditions; understand and utilise computer technology; communicate effectively with management, users and colleagues; and identify elements of business risk. Working oe ont Ge eratePart 1 >> Unpenstanotne. AuDrToR @esrousrBrLtTiEs ‘ in auditing oF review engagement roles requires the ability to exercise professional judgement, a particularly in a context of an ability to exercise professionel scepticism whereby a questioning i rmindset is maintained, 4] ACCOUNTING AND AUDITING EXPERTISE ‘Te complexity of today's eneonment demands th the audlor be fly versed in the technical Tapects of aotountng ad audiing standards, In addon, the autor must ave a sound i conceptual understanding of the basle elements tderlying financial reporting. This conceptual 4 understanding is necessary to address the ever-increasing infusion of new types of transactions | hal contact for which accountng pronouncements ay nok exit. AB an example a he downside | “ox ausocited wih this notion the auding profession was crldcaed reenly because mary 1 financial instruments recorded in connection with the US subprime housing markets and packaged tna old around the word, incudng in Ausra, wese not property shawn at orket value Final, the aur mst fly understand the fundamental concepts of suing. Developing an trenianding of aude coneeps enables the aur to adapt to changing extnome suallons or | plan ferent ut approaches fr cen in dering inde foe facing irks. INTERNAL CONTROL EXPERTISE, ‘The auditor must understand how deficiencies in intemal control will most likely affect the recording and disclosure of transactions and adjust audit procedures to search for errors in account balances. If relying on the internal controls, the auelitor must be able to analyse the organisation's controls to determine if there are weaknesses that should be reported to the rectors, the audit committee or management. KNOWLEDGE OF BUSINESS AND ITS RISKS Most a ums we is apprcach to performing als Bete et, sme fins use abs A appeach Te fundamental prose behind the business rk approach hat Ue autor must tndettand the bade ery ofthe een’ busines in order to deny sent lk alfecing that cnc For enmple, an auditor ofa bal should have substantial knowlege about the business | ceovony nthe aren aerve hth bak, capital sre, the types ofl it hs made and 3 i foth inorder to determine the HelDood (atthe ane wi be repaid andthe Dank il uve Ina / finder fashion, an underaing ofthe srteies used by mangement wil ait the autor in valeting preliminary frail vents and pinpointing areas needing woe atention UND) ERSTANDING ACCOUNTING SYS" 1M COMPLEXITY a ‘Today"s companies ate actively involved in e-commerce and electronic data interchange (EDD. As ‘an example, most pay cheques are deposited directly into bank accounts and debit or credit cards are used for many transactions. Most financial assets exist as digital images in computer systems. ‘Traditional paper documents are disappearing Systems are increasingly integrated across companies. Auditors must be prepared to address the audit challenges posed by electronic systems jn which traditional source documents do not existAssunance anp aupiTiN ‘There ae three primary providers of assurance services the public aecounting profession (ie, external aulitors) = the internal audit profession * the public sector audit profession, ‘Within each sector there are a wide variety of providers. For example, internal audit services are performed by both internal eudit departments housed in an organisation as well as by external auditors performing intemal audit work fora client ‘THE PUBLIC ACCOUNTING PROFESSION ‘The public accounting profession ranges from sole-practitioner firms to lange multinational professional services firms such as the Big 4, Many of the national and local firms provide a variety of services to both audit and non-audit clients. The large public accounting firms may provide ‘many of the same consulting-lype services — but they are restricted in the type of services they cam provide for audit clients and need to be especially careful in providing certain services for listed audit clients. For example, all of the Big 4 firms provide significant internal audit services, restricted under the profession's ethical standards to companies that are not audit clients. The dollar value of the internal audit work can often rival that of the external aualt work for a company. Organisation and size of public accounting firms. ‘The organisational structure of accounting firms varies dramatically. For example, most of the Big, 4 firms operate under one firm name across al countries, often with global accounting and auditing practices. In most cases, however, firms are organised as a partnership or limited liability company within each country, depending on what is permitted legally. The individual partnerships then belong to a global partnership under the fim’s broad name, ¢g. Deloitte Some fins practise internationally through an affiliation with a network of firms. For example, ‘a number of regional or local firms belong to an affiliation of such fms under the name of Moore Stephens. In some cases, itis not clear to the user what the relationship is to a parent fm. For example, when the Parmalat scandal hit in Italy in 2009, there was a lawsuit against Grant ‘Thomnton lialia, a member firm of Grant Thornton International The Italian firm was immediately "Kicked out’ of the intemational firm because the international firm did not want to assume any liability for the work performed by its Italian mémber.° ‘The organisational hierarchy of public accounting firms has most often taken a pyramidal structure. Partners (or owners) form the top of the pyramid and are responsible for the overall conduct of each audit and other services. Next in the hierarchy are the managers, who review the detailed audit work performed by staf? personnel (the base ofthe pyramid). Seniors are resporsible for overseeing the day- ‘today activities ona speciic audit Staff personnel typically spend wo to four years ata statf level after which they assume increasing supervisory responsibilities as seniors, managers and ultimately partners, Partners and managers are responsible for the mary audit engagements that are being, ‘conducted simultaneously, whereas seniors and staff are usually assigned to only one audtata time, Ams 10 cate of Bie for Pression Acountans The Cote expend deal Cater’ Juda and ea Dedaorlin Pameweds an ssachted Press Sant, tes be noted tht ice ie, Gat Thorton henge hal scr sy atl pata win Gan Tht petto wer ewe rt Tat teeta HAPEER 1 >> te econany 25Part 1 > UMDENErANDING AVOLTOR nESPOHsIRELITIES ‘Although the hierarchical structure will remain for some time in the future, the expectations of those entering the profession have changed significantly. The more prevalent changes are as follows: ‘Audits are performed in teams where each member is expected to contribute to analysing and understanding the business. All auditors are engaged from the very beginning in analysing potential fraud risks associated. withthe clients © Aucitors, at all levels, are expected to understand computer processing and be able to access and andit electronic data. Many public accounting firs have also organised their practices along industry lines to better 1 serve elionts in those industries. These often include categories such as financial services, retails, not-for profit, manufacturing and distribution. The rationale is that an auditor needs to understand the industry as well a5 management does in order to identify (1) risks that the organisation faces : land the conurols the company uses to mitigate those risks, (2) risks of financial report misstatements and (8) opportunities to improve business operations ‘THE INTERNAL AUDIT PROFESSION Internal auditing is defined as: ‘an independent, cbjcetive assurance and consulting activity designed to add value and ianprove an organisation's operations Ic elps an organisation accomplish its objectives by bringing a systematic, alseiphned approach to evaluate al improve the effectiveness of isk management, contol, and governance processes" Internal auditing has emerged as an exciting discipline and an excellent training ground for future management positions, The emphasis on adding value and improving operations squarely aligns internal auditing with shareholders, the beard of directors and management. The scope of Internal auclting is broad ancl includes the evaluation of processes to identify and manage risk; to develop and implement effective controls, including those designed to ensure efficient operations; ‘and to ensure that the governance process is working effectively. Internal auditing, whether itis performed by auditors housed within a company or by auditors that participate in outsourcing functions of a public accounting firm, is increasingly becoming a strong alternative entry point into the auditing profession. The role of internal auditing is enhanced by the encouragement in the ASX Corporate Governance Guidelines and Recommendations (2003, 2007, 2010) to see it as part of risk management and to disclose its characteristics where the function exists. The existence of an effective internal audit function is considered an important part of an organisation’s internal control, Internal auditors may provide both assurance and consulting services. Assurance comes in the form of assuring management and the board of directors about the company’s compliance with policies or regulatory requirements or the effectiveness of processes and operations. Internal audit activities often identify areas where the company ean male significant operating improvements, or reas in which a company is not effectively managing its risk. Internal auelit departments must maintain independence and recognise that they have unique data analysis skills and an ‘independence from operations that can add value to assist management in addressing important problem areas. The internal audit funetion ean analyse and identify potential solutions. However, Parcs Picea Gomer eae recs -flesting Be clarion, ees ~ "tae ter Aor, Star the Pino aera aig‘management is responsible for choosing which salution to implement and must take responsibilty for implesmenting Uhe solution Internal auditing Nas been a leader in assisting onganisations In documenting and evaluating the ‘quality of internal control, An interesting type of internal auditing involves the analysis of company ‘operations, often referred to as an vv, Operational audits are designed to evaluate the effectiveness, economy anc efficiency with which resources are ermplayed ancl can be applied to virtually every facet of an ongonisation’s operations. Operational audits are both challenging andl interesting because the auctor must develop objective criteria to evaluate the effectiveness of an ‘operation, The anelitar mnst become fariliar with best practices across companies as well as within the organisation to develop such criteria, The sudltar then must develop methodology, including the analysis of market data as well as internal information, to evaluate the effectiveness of operations. The auditor will have to thoroughly understand business processes and how various proeesses fi together across the organisation. The eraphasis of an operational audit is on improving ‘operations and the profitabilty of the organisation. ‘The performance of operational audits puts stall auditors in a position to knew more about the organisation and thereby provides a firm {ouration for future career development: HE PUBLIC 0! Public seetar auditors are employed at federal and state levels. The work performed by these auditors ranges from financial audits to performance aucits where the economy, efficiency and effectiveness of various programs are examined. The requirement of accountability has ereated a {demand for more information about government programs and services. Public officals, legislators andl private citizens want and need to know not only whether government funds are being handled properly and in compliance with laws and regulations, but also whether government organisations, programs and services are achieving the purposes for which they were authorised and funded ant whether they are doing so economically and efficiently Public sector auditors perform all the types of audits that internal auditors perform; te major difference is the governmental orientation. Auditors-general place a great deal of emphasis on performance audits. These audits determine (1) whether the entity is acquiring, protecting and using ils resources economically and efficiently; (2) the eauses of inefficiencies or uneconomical practices; (3) whether the entity has complied with laws and regulations; (4) the extent to whielt the desired results or benefits established by the legislature or other autdorising body are being achieved and (5) the effectiveness of organisations, programs, activities or functions. IG PROFE! Auditing 6 « unique profession. It operates as a private enterprise that serves the public Interest but is also intended to improve private company operations. Further, it may take diverse forms, ranging from large, multinational public aecounting firms to small, one-person accounting finsspecialising in tax. It includes both public accounting and intemal auditing. Thus, it is, not ter ‘surprising that a number of regulatory and professional organisations help shape and regulate the nature of services provided by the auditing profession. Because the major focus of this book is on ‘company accounting and financial report audits and reviews, we start with the regulatory bodies that most influence the practice of auditing and reviewing financial reports FINANCIAL Rl ‘The Australian Financial Reporting Cosine! (FRC) i responsible for providing broad oversight of the process for setting accounting and auditing standards as well as monitoring the effectiveness of auditor independence requirements in Australia and giving the relevant government minister reports and aclvice on these matters Ils core objectives in relation to auditing slanclards consist of the following 11 Auditing standards should require the provision of information that: provide Australian auditors with relevant, andl comprehensive guidance in forming an pinion about, and reporting on, whether financial reports comply with the requirements of the Corporations Act 200; and require the preparation af auclitors' reports Ghat are reliable and readily understandable by the users ofthe financial reports to which they relate 2 Accounting and auelting standards should fueltate the Australian economy by having accounting and auditing standards that ate cleerly stated and easy Lo understand. (PORTING COUNCIL (FRC) Im omer to ensure ite independence from standard setting, the FRC does not have powor to ‘izect the AASB ar AUASB in relation to the development, or making, of a partleular standard, oF to veto a standard formulated or recommended by the AASB or AUASB. AUDITING A SURANCE STANDARDS BOARD (AUASB) Consistent with the PRC’ strategie direction to it, standards issued by the AUASB are based on those of the International Auditing and Assurance Standards Board ([AASB), These standards are applicable to the audits of both small and large entities and apply to both the public and private sectors, Currently the AUASB is composed of members appointed by the FRG and a ‘Treasury appointed Chairman. Members may be drawn from public accounting firms, federal and state auditors-general, academia and the legal fraternity. The AVASB is publicly funded through Federal Treasury, with contributions from the professional accounting bodies. The FRG is charged with monitoring the independence of auditors and ethies training for auditors, including at the tertiary Jevel. The Australian Securities and Investments Commission has taken responsibilty for monitoring quality control of anclts, with inspection of work papers, procedures manuals and polley documents,Acsuannce ane aupivine: Turesaat 10 ‘THE AUSTRALIAN SECURITIES AND INVESTMENTS COMMISSION (ASIC) ‘The Australian Securities ond Investments Commission (ASIC) Is responsible for the ‘administration of the Corporations Act and the registration ofall company aueltors, among other Uhings. Any person wishing to have authority to sign an auditor's report where the audit is performed uncler the Corporations Act is required to make an application for registration in ‘writing to ASIC. ASIC must be satisfied that the person meets the requirements for registration, including educational and experience requirements, is eapable of performing the duties of an auditor and otherwise is a fit and proper person. The Companies Audidors and Liquidators Disciplinary Bowel (CALDB), established under the ASIC Act, Is responsible for the discipline of auditors. ASIC maintains surveillance of corporate fixancial reports, conducts aut inspections ‘under powers delegated by the FRC and has the power to Investigate and! conduct hearings of suspected breaches ofthe law by auditors, [fits ofthe opinion that such action is warranted, ASIC ‘can apply to CALDB to have the auditor’ licence suspended or cancelled. In addition, auditors can be subject to the disciplinary processes of the professional accounting bodies, and Itigated against in the courts if duty of care ean be established and a loss resulting from a breach of that duty can be substantiated, THE AUSTRALIAN SECURITIES EXCHANGE (ASX) ‘The Australian Seourities xchange Lid (ASH)" operates asa listed company in its own tight, yet {is par of the regulatory regime within which listed companies disclose their finan information, While it does not have a direct role in the oversight of the audit function, the ASX preseribes the form and nature of corporate disclosures through its sting rules and continnows diselosure regime, ‘backed through the Corporations Ac As such, providing assurance on eomplinnce with laws and regulations ineludes for listed companies the provision of assurance on compliance with ASX listing rules. The ASX isiies Comporate Governance Guidelines for use by listed companies, which have become best practice for many non-listed entities, including not-for-profit entities, ‘One particularly important recent reform is the re-balaneing of responsibliies for monitoring of the capital market in favour of ASIC at the expense of the ASX. The ASX is itself a sted company and, a5 such, it can be argued that it has an inherent conflict of interest since it has historically regulated and monitored the exchange on which it selists. he global fxancal ersis highlighted issues associated with margin lending to directors, share trading by directors during "black out’ periods and other matters, which prompted therefor, Because increasingly Australia’s public accounting firms and companies with US aflliations are alfected by the Sarbanes-Oxley Act 2002, the roles of the Public Company’ Accounting Oversight Board and the Securities and Exchange Conuission are discussed in the next section THE PUBLIC COMPANY ACCOUNTING OVERSIGHT BOARD ‘The Public Company Accounting Oversight Bostd (PCACE) was established by the US Congress fas part of the Sarbanes-Oxley Act of 2002, The PCAOB has full authority to: set auditing standards for audits of listed companies require all firms that audit listed companies to vegister with it © perform quality reviews of all firms that are rexistered with i. ° se Auta Stk cng chapter 17>Sine ccre Stee ee area Peni aren Ah cine at oe Besides setting aualting standards, the PCAOB has responsibilty for registering all firms that practice before it and has broad regulatory authority over those firms. The PCAOB Is responsible for performing quality reviews of all registered firs. ‘THE SECURITIES AND EXCHANGE COMMISSION hange Commission (S20) was established by the US Congress in 1994 to regulate the capital market system. The SEC has oversight responsibilities for the POAOB and for all listed companies that are required to register with it to gain access to the US capital markets ‘The SBC has the authority to establish aecounting standards for companies whose shares are publicly traded, although it has generally delegated this authority to the Financial Accounting Standards Boartl (FASB), However, the SEC has nat shown a reluctance to act when it believed existing accounting standards were being abused by registrants. ‘The Socorities and B INTERNATIONAL AUDITING AND ASSURANCE STANDARDS BOARD ‘The Intornat Stane ASB) 1s a patt of the International Fesleraton of Accountants (IFAC), a global organisation forthe accounting profession that has over 157 members in 123 counties. The LAASB defines its objective as: to serve the public interest by setting, high-qnality ating and assurance standards ancl by falitating the convergence of Intemational and national standards, thereby enhancing the quality and uniformity of practice tlwoughout the world and styengthening public confidence inthe global auditing and assurance profession, ‘The IAASD Is interested in harmonising auditing standards around the world and is working closely with US standard setters on selected standards. The LAASB standards are generally consistent ‘with US standards but it wil take many years to achiowe a single set of global auditing standards. ting and Assure COMMITTEE OF SPONSORING ORGANIZATIONS COSO Is the Committee of Sponsoring Organizations of the ‘Treadway Commission. COSO performed the seminal study on fraudulent financial reporting and made a number of recommendations similar to thase enacted in the US Sarbanes-Oaley Act 2002. in 1982, COSO Issued the Internal Control, fulograted Framework, which serves as a framework for evaluating the quality of a company’s internal control system, In 2008, COSO provided additional ‘guidance an implementing internal controls that articulates the basic principles of internal control, COSO continues to publish guidance to assist companies and thelr auditors in implementing and evalustiig internal control and effective enterprise risk management processes, However, increasingly a Standards Australia document, ASNZA ISO 31000 Risk Management ~ Principles and Guidance, 's used in countries other than the US as a risk ment framework for analysing controls and risks, Both frameworks are explained later in this textbook ACCOUNTING STANDARD SETTERS Increasingly, auditors must be aware of global accounting standards as well as standards Wat may apply to audits of partieular organisations, eg. audit standards set by the Austratian PrudentialAssURANCE aap auDETING: INTEGRAL 10 _mitation Authority (APRA) for authorised deposit-taking institutions, insurance companies and superannuation companies. Auditors must also be avrare of accounting starlards set by the AASB, as well as by the International Accounting Standards Board (IASB), which sets the IFRS standards {forthe global practice of accounting. PROFESSIONAL ACCOUNTING BODIES CPA Australia (CPAA) The Institute of Chartered Accauntants in Australia {ICAA) and the Institute of Public Accountants (PA) are the private professional accounting bodies active in Australia, Membership of these bodies is voluntary; their status is derived from regulatory ancl public acceptance that self-regulation by highly trained professionals dedicated to tke public Interest can be effective in meeting third-party users’ needs in relation to credible financial information, ‘These three bodies support a joint body, the Accounting Professional and Ethical Standards Board (APESR), which issues ethical pronouncements for the profession. They also eatry on continuing eduention programs and administer post-degree accreditation through their own prograrns. ‘The professional accounting bodies investigate breaches of the ethical code among theit ‘members, and may impose penalties of fines or suspension and cancellation of membership, However, if a member chooses to resign membership, it is not possible for the accounting bodies to impose penalties. The accounting bodies also covelop standards for, and organise the conduct of, peer reviews of practices. Publle accounting firms must be organised so that both (he individuals in the firm and the firm itself achieve the requited professional standards of independence, technical competence and due professional care. Most firms have developed quality control standards to ensure that the profession's standards are met. Because users are generally not in a position to evaluate the competence or independence of professional accountants, they must rely on the profession's ability to achieve these standards and to police noncompliance. ACCOUNTING PROFESSIONAL AND ETHICAL STANDARDS BOARD (APESB) In January 2006 the Accounting Professional and Ethical Standartis Board (APESB) was formed to issue professional pronouncements on ethics and other matters, APES 110 Code of Ethics for Professional Accouniants is pethaps the most important pronouncement, but others provide requirements and guidance in respect of matters such as forensic accounting services (APES 215), laxation services (APES 220) and valuation services (APES 225) THE INSTITUTE OF INTERNAL AUDITORS ‘The Instituie of internal Auclitors is a voluntary organisation dedicated to enhancing the professionalism and status of the internal auditing profession. With more than 160 000 members located in 165 countries, the HA is responsible for issuing standards and interpretations of thase standards. The IIA has an Australian chapter, formed in 1952, administers the Cevtied Internal cuapten 1 > fee teres fron ee eanPaar 1 > us ‘Auclitor programm and has established a peer review provess to ensure that the practice of internal auditing around the globe is consistent with the professional standards. THE LEGAL SYSTE ‘The legal system acts as an effective quality-control mechanism for the practice of auditing. Third patties may sue public aecounting firms and auditors under statute, contract ane common law for substandard audit work. Although the profession often becomes alarmed when large damages are awarded (0 plaintifis in sults against public accounting firms, the courts help ensure that the profession cloes not fail to meet its responsibilities to third parties. During te past several decades, court cases have led to the codifeation of additional auditing standards for such areas as related party transactions, ‘subsequent events’ affecting the financial report and clatfication of the autor’ report. Summary Efcent operation of the captal markets requres relable francal information, The crusal importance of the fundamental preduct a te ating profession ~ the financial report audit ~ hasbeen reinforced by events ofthe past cenuy. Financ report users need an independent, objective and competent opinion on nancial starmets and notes Recent ures inthe ais profession led to enactnent ofthe CLBRP 9 Act of 04, whieh has changed the east vest of the auing profession. However, despite all hese changes, te pofesion stl operates inthe private stor, antvough ers have eae fori o be taken over by government. The pubic accountng profession i tly a unique profesin in that i eperates in the private sector bt perf a puble sevice Tt can compete for ait engagements in eorapece with oer fn ing quae personnel and it con distinguish its sence by the quay of sas, More than anthing, the fares ofthe pst decade have reiterated the importance ofa sound att funtion ‘Oversight of the public accounting pofesion in terms of aut has sited from the profession ial to the FRC and se. Thus, pubic accounting fm come ver heasy pac scrutiny, The AUASD ses auting standards using the TAASB standards as ba documents and the Australian suing sandards are one of the few sites of auditing standards tohave the force of (long wth France ae Can fr selected aus). fncing la more diverse than public eccotintng. Internal and puble sector auditing provide vahuble services fo rganiation, are broader than public aeounting and expose auditors to twore aspoct of busies, ineuding risk management and operational efitencies "he professional accountant fas been given a postion of public trast The profession Is eared a reputation fo unity trough ts actions, eluding setting sindards aginst which you wl be teasuzed and on which yo wl bl a profesional eateer Ifthe pofesion should ever il to meet user needs, the legal yale ad regulators wll intervene Lo protect the public inerstSELECTED REFER RELEVANT PROFESSIONAL PRONOLI 9 GUIDANCE Reference Intemational Equvalent* _Deseription asa 700 1sa700 Farmiga Opinion ana Repeceg on a Franca Reson ASRE 2810 Ise 2410 avo of Farce part Param by te pent sora ty 18% sting Pts 8X Caporale Governance Count corporate Govemance Pines and Recommends with 2010 Amencnante Commitee ot Spenscing Orgatzatons COS) leera Con, Iga amr Stands AusialaASNZS 60 $1000 so31000 Fe Moragomant- Pines ana Guttance cLERP ‘corporate Law Sooners Rofo Program fut Fm ans Corporate Osco) Ac 2008 hl ems Sas > ge ea ees Ba AS et Acura ec ero ant se ASE ut Sa ND Asda at of Crp Oreo, FESS Acar ocr ant Sas Ban SP kn Pos aan ay, SA ~ lo Sane Pt. SE tan Ge esis Cami, ASX ~Atn Sea aes ASHE Slo et Eames ASB ‘atu asec Sts as, C0 = Coe Srey Cg, ASB = HE secutig Ses od 8, FR — Fre ety Ons, AGB vetnd Aga Aas Sie ea Sse Pc Sera Bes SE — wera aren Si Cnt, AC ewe Fon cl ents FS eo FrencalRerg Se herr Sune a sn, RE sen Sane Rver Eaton, PGR CeapyAahs Dept nd, SEE Seunes a ehgs Coen #5). ee fiew cuestions Note: More questions, including multiple choice questions are available online (LO.2) What isthe ‘special funtion’ that auditors perform? Whofwhat institutions does the publie accounting profession serve in performing this spectalfunetion? (LO 2) Describe the audit opinion formulation process. What are major steps and the outcome of each major step? Deseribe the review conclusion formulation provess. How does it differ from the aut opinion formulation process? (LO 2) The auditors role has evolved over the past decade. How has that role changed regarding (a) the elent ‘environment in which the auditor performs the audit and (b) the expectations and needs of users? (105) How does an auc difer from an assurance service in providing reports to thir parties? Explain in terms of the scope of the activity and the potential users. -5 (LO 1) The term professional judgement is used throughout the chapter. In what ways might an auditor be called ‘upon ta exercise professional juelgement andl professional scepticism in the course of performing an auclit? To ‘what extent does professional judgement rely on principles rather than rules? Bxplain 4-6 (LO2) What tuctors create a need for assurance services? Explain how these factors are important to the publie accounting profession.Paar T 1-10 118 17 (10 4) The faimess of financial statements is judged only by reference to pre-established erteria. What serves as the criteria to judge the faimess of financial statements? Explain why ‘reference to criteria’ is important to the auelit funetion and the results communicated by te audit function. (LO 2) How does complexity affect (1) the demand for auditing services and (2) the performance of alting services? (104) Do users have an interest in intemal controls over financial reporting? In Une US, Section 404 of the ‘Sarbares-Onrloy Act £002 requires management to report on internal control as a supplement to the annul ‘nancial statements and that report needs to have assurance provided on it. Do you think that Australia should adopt such a practice? (LO 1) Who is the most important user of an audit or review report on a company’s financial report: company raanagement, the company’s shareholders or the company’s creditors? Briefly explain your rationale and indicate how auditors should resolve potential conflicts in the needs ofthe three parties. (LO 1, 2) How does an audit or review enhance the quality of financial reports? Does an auelt ensure ‘fir presentation of a company's Briancil report or that internal control systems are free of deficiencies? Explain, (L038) What is corporate governance and why is it important? Explain how an independent and competent audit cominttee improves corporate governance. (103) In what other areas, besides the audit cammitice, did the CLERP 9 Act improve corporate governance? (102, 4) How do assurance services differ rom auclt services? What are the primary drivers ofthe need for assurance services? Does a market for assurance services already exist or do aultors need to develop the market? (LO 5) What areas create opportunities for new assurance services for the next decade? Which service, in your view, has the greatest appeal as you enter the profession? (LO 5) What are the four attributes needed to perform assurance services? Briefly describe each attribute and its Importance, (10 6) In what ways does the practice of internal auditing difer from the practice of public accounting? ‘To whom is the internal auditing function responsible? (10.6) Can a public accounting practice provide intemal audit services to both audit-and non-audit clients? (LO 7) What is public sector auditor? What types of audits does a public sector auditor perform? (LO7) What is the role ofthe accounting profession in setting accounting andl auditing standards? (LO 7) Distinguish between the roles of the AASB, AUASB and the ASIC in (a) setting audit standards, {b) performing quality-control xeviews of member firms andl (c) setting accounting standards. (107) What is COSO? Why is COSO, as a non-regulatory body, important to the auslting profession? (107) Are small public accounting firms that serve only small businesses and other local clients subject to the same auditing and accounting standards as the large international firms? (LO 6) Many public accounting firms are legally formed as networks of accounting firms, Explain what the pluase “network of accounting fms’ means and articulate the services provided by the network to its members. (10 7) In what ways does the legal system serve as a major regulatory body forthe public aceounting profession? Does the cout system have a role in setting elther accounting oF auditing standards? Explain.cussion and r search questions (Users of Financial Reports, LO 2) It as been stated that auditing must be neutral because audited financial reports must serve the needs of a wide variety of users. Ifthe auditor were to favour one group, seh a8 existing shareholders, there might be a bias against another group, such as prospective investors, Dis BROUIRED eee essere eee eee seeae ‘a, What steps has the public accounting profession taken to minimise potential bias towards important users and thereby encourage neutrality in fnaneial reporting and auditing? , Who are the primary users of audited finanefal statements? Ident four user groups you believe are the most Lmporiant, For each one identified, (1) briefly indicate thelr primary use of nancial reports andl (2) indicate how an accounting treatment might benefit one party and potentially act to the detriment of anather user. (Purposes of an Bxternal Audit, LO 1, 2, 4) The Rasmus Company manufactures small gos engines for use on lawnmowers and other power equipraent, Most of its manufacturing has historieally been in Wester Australia, but st has recently opened plants in Asia that account for about 30% of its preduetion, ‘The company’s shares are listed fon the ASK REQUIRED a. Explain the rationale and value of an audit of a listed company to investors, creditors and to the broader community as a whole. , Explain why sound internal controls provide value to Nanci reporting integrity cc. Explain the importance of an audit-commmittee ta the reliability of the financial report and the audit function 28 (Smaller Company and Purpose of an External Audit, LO 1, 2, 4, 6) Quello Golf Distributors Pry Ltd fs a relatively smal, privately held golf distributing company handling several product lines, including Ping, Callaway and Taylor- Made, in Queensland. It sells directly to golf shops, pro shops, etc. but does not sel to the big retailers. It has approximately $8 milion in sales and wants to grow at about 20% per year for the next five years Ibis also thinking ofa takeover or a merger with another gol dstributorship that operates in many of the same areas. REQUIRED a Explain why management might want an independent audit of is fnanetal report, Identity the specific benefits to Quello Golf Distributors, >, What are the factors that Quello might consider in deciding whether to seek an audit from a large national public accounting firm, a national public accounting frm or aJocal frm? cc. Is Quello required to have an aut committee? Bxplain. 4, Is Quella required to issue a report on the quality of ite internal contral aver financlal reporting when it istes its audited financial report? Explain. 1-29 (Nature of Auditing and the Public Accounting Profession, LO 1,2, 4,7) Do you agree or disagree with the {ollowing statements? Explain your rationale. @ Aprimary purpose of an audit is to ensure that all fraud that might be significant to a user is devected and reported, », ‘There is not an independence problem ina privately held company when the auditor fs to be engaged by the manager because the manager is also the owner.Part : ¢. Inthe US, Sarbanes-Oxley requires mandatary reporting on internal control for listed companies, Tha requirement should be extended to Australian-listed companies. 4G. ‘The expectations of auditors are too high; the expectations simply cannot be met; the public should be better ‘educated on what the auditor does and is capable of doing. ‘e. Consulting by public accounting firms for privately held companies is a value-added proposition and does not ‘impair the independence of the aueit; rather, it enhances the effectiveness ofthe audit because of greater nowledge of the company £ ‘The AUASB greatly enitances the reputation of the public accounting profession because it not only sets stanclardls, but also determines whether firms aualt according to those standards, i. Fairly presented in accordance to accounting standards is not as precise a criterion as one thinks because accounting standards alow a wide varity of choices, e.g. FIFO vs. weighted average, accelerated vs. straight. line depreciation 1h, ‘The aucitor should be forged to state both (a) whether the financial report is prepared in accordance with accounting standards and (b) whether he or she feels that the choices mace by the cient best portray the ‘economic substance of transactions within the accounting standards and GAAP framework, 4, Tax consulting, including preparing the tax return for top management, does not create a confict of interest with the eonduet of the audit, 1-30 (Aualtor Judgement, LO 1, 2) Auditors often refer to the need for ‘professional judgement? REQUIRED.___ ‘4 In examining the auelit opinion formulation process, identify the areas in which auelitor judgement must be made, To what extent does that judgement extend beyand accounting issues? . tis claimed by some that prineiples-based accounting should lead to more consistent audit judgements, Explain the arguments for and against this view. ‘¢. Should a public accounting firm expect that ‘professional jucgements’ made by its staff be, forthe most part, consistent with each other? Ifnot, why not? Ifyes, how are public accounting firms structured to help ensure consistent audit judgements? 41.31 (Understanding the Business, LO 2) It stated in the chapter that understanding a client's business is important to the conduct of an audit, REQUIRED____ a. Explain how an understanding of a business and the business environment would be important to the auditor in evaluating accounts such as: © Inventory . (i) Allowance for impaired receivables Gl) Warranty liability and warranty expenses b. Explain how the understanding of the business may provide value-added services that the aueltor might be able to utilise to assist a client 1-82. implementing an Assurance Service, LO 4) Assume an e-commerce company that sells various products over the internet to consumers (e.g. Amazon.com) wants to develop a certification from an auditor that states the company has (a) effective policies to ensure the following objectives and (b) those policies are implemented in a manner to achieve thaee objectives:Al goods are shipped ina timely fashion. ‘The goods are exactly as advertised, ‘The company stands behind any goods that are damaged in transit. ‘The company fulfils promises made in its creat polices. Credit card and billing information is kept safe and is rot sold to other e-tailers or retailers 2 sees ‘a. Foreach of the assurances (ae), indicate the evidence the auditor would gather in order to provide the assurance desired. ’. How often would the assurances have to be provided in order to meet the objectives sought by both the merchant and consumers? ‘e. What would be the best way to present the assurance, ie, how would a potential user become aware of the assurances provided? 4. Why would a professional accountant be a good provider of such assurances? fe. What are the major attributes of eompanies that might not need such assurances? 1. Who are alternative providers of the above assurances? 1-33 (internal Audit Profession, LO 6) The internal audit profession has grown rapidly in the past decade and has developed its own certification program. Many companies are developing policies to recruit new personnel into Jnternal audit departments, REQUIRED. 1 a. Briefly describe the nature of internal auditing. What does it mean when itis described as an assurance ard consulting activity? How does consulting differ from assurance? >. Briefly explain what the internal auditor's role is regarding risk management and controls. ‘e. What are some of the reasons for pursuing a career in internal auditing? i 4. Can some (all) of internal auditing be outsourced to a public accounting fru? Explain. 1-34 (Regulatory and Professional Organisations, LO 7) Briefly describe the roles and responsibilities ofthe flowing professional organisations in developing and maintaining auditing standards and monitoring the quality ofthe various auditing profession sectors: AUASB uA ASIC ASX FRO TAASB, 41-35 internal Auditing, LO 5, 6) You are aware that most of the higher education frst courses in auditing focus on public accounting rather than internal auditing, Yet your lecturer states that most of the concepts related to an ‘audit approach and evidence gathering are applicable to both internal and external auditing. ‘REQUIRED a. Ifyou decide to start your eareer in internal auditing, how will your first two years of work differ from your ist two years in public accounting? Assume that you are interested in eventually developing your skills as a manager in a lage organisation, Explain why beginning a career in internal auditing would be cormpatible with those objectives.Paer 1-36 (Nature of Audiding and the Public Accounting Profession, LO 1, 2, 8, 4,6) You and a colleague are carrying on a heated discussion. The colleague makes a number of stalemnents about the public accounting profession that you believe are in error. Weleoming an opportunity for rebuttal, you are ready to reply. ‘REQUIRED ‘a, For each of the following colleague statements, develop a brief response indicating erroneous assumptions, sade by the colleague or your agreement with the statements b, Cite relevant evidence in support of your response. Colleague's Statements @ “Auditing neither creates goods nor adds utility to existing goods and therefore does not add value to business. Auditing exists only because it has been legally mandated. Gi) “The failure of the public accounting profession to warn us ofthe problems that existed in the economy is fan example of a profession not adding utility to society.” Gil). “The only reason I would hire an auditor is with the expectation thatthe auditor search for and find any fraud that mighs exist within my company, Searching for [raud should be the primary focus of an audit.” Gv) ‘Auditors cannot legitimately serve the public when they are engaged by the shareholders but thelr day: to-day dealings are with the management of the company belng audited" (%) “The switch to the statutory body, the AUASB, in seting audit standards will enhance the reputation of the profession because the auaitors must actin the puble’s interes.” (f) ‘Auditors cannot add significant value to financial reporis as long as accounting standards allow such liversity in accounting prineiples. How, for example, ean the same auditor issue unqualified opinions on. Identical companies ~ one that uses FIFO and the other weighted average to account for the samme set of, transactions ~ recognising that the reported net income and balanice sheets willbe materially different? How can both be faly presented?” (i) “Aueiting is narrow ~ just nitpicking and challenging the onganisation in an atternpt to find mistakes, I would rather pursue a career where I really understand a company’s business anc! would be in a position, tomake recommendations that would improve it. uli) ‘Auditing would add greater value if it analysed company performance and presented a report on company performance along with the auclited financial report. (2) ‘Ifauditors make recommendations to clients based on weaknesses in the company operations, the auditors ought to make those recommendations public. This would help increase the public rust by providing more accountability by both management and auditors.” () ‘Adding repovts on the quality of internal control will enhance the value of the audit funetian to society” 1.37 Internal Auditing, LO 6) Ramsay Mfg, Ltd has ar active internal audit department that has a major objective to censure compliance with company policies and to identify ways in which an organisation can improve its ‘operational effectiveness. | REQUIRED ‘. Desetibe how an operational aul ight be conducted in the areas noted below, In deseribing the nature of the operational aul, speci | the objectives of such an aucit Gi) the criteria that might be used to determine if the functional area is operating effectively i ii) the types of audit procedures that should be utilised in the conduet of the aud Eiconpten 1 Audit Areas (The treasury function ) Inventory management and contro! Order entry and shipment », Briefly explain how the nature ofthe operational audit differs from a traditional external audit ofa company’s ‘nancial report that might addvess some ofthe same areas 1-38 (Publie Accounting Profession and the Expectations Gap, LO 1, 2)"An audit report too often is viewed as a “cortificate of health” for a company. The most serious consequences stemming from such a misunderstanding are tot the independent auditor ean quickly be portrayed as the force Ut represents all good in ftancial accounting ‘and the guarantar of anything positive anyone wants to feel about-a given company! REQUIRED, Given the above assertion: a Why is public accounting often viewed as a guarantor of results or even as a provider of assurance that, one's investment is of hight quality? b. ‘To what extent i it reasonable to view the auditor as a guarantor ofan organisation's financial quality? Explain, cc. To What extent do you believe that user expectations ofthe public accounting profession appear ta you to be unwarranted? Explain. q 1-39 (AASB, LO 7) Access the AUASB home page at hip svnrw avast. gov a, a. [entity the members ofthe Board and their backgrounds. What is their background in accounting ] or using financial reports? b. Ment te west ecm eng standardised rn exposure fom Men he ature he tant ants he eso ov he Board sung he sana ] 1-40. (AS16107) Acces ASIC ome page at Mee q 2 ene met eee boii the ATS ant pub acount inn Reattin — @) eves iratien cou compl om he ean nepaper nabs b. Games on the nate ofthe acon 1-41. (ASI, 107 Accs the ASIC hate peat stage 2 Henly the nt een report on BIC @ Den sh sue vasa ns opr 1-42, eae Accounting Fins, 10 2,8) Tenge pb aeconng fs no longe rove cern coating sees ors Hover, may aie sceuting fescue voqrosae— Q) soc ences ta tht nowa cene audit inspections. REQUIRED e 1 Log on to the website of one ofthe Big 4 frm and identify the breadth of services that the frm provides to non-audit aliens, . Log on to the website of wo ms in your area and Identify the nature of now audit services provided to clients ¢. Gontrast the breadth ancl nature of services provided by the Big 4 ims vs. the Local firms tat you have examined.Pan Cases 1-43 Public Sector auditing, LO 1,2, 3, 6, 7) On 15 October 2010 the Australian Aucitor General's ‘Report No.12 — Home Insulation Program’ was issued, All phases ofthe program were examined with particular emphasis being ‘given to: ‘program design and implementation b, registration and training of installers payment of rebates 4. the compliance strategy underpinning the program. DISCUSSION ISSUES — Download the report from hipivweanse gov. auldrectorpubications/autrepors/2010-201. cm, ‘& What were the conclusions ofthe investigation into this program? , How would the Office of the Auditor General go about developing evidence to reach the conclusions? ‘e. Why is it important that such programs are audited? 44. Based on the conclusions identified eater, would you consider the work performed on the Home Insulation al Program to be an auclt? Explain why or why not. {nm what substantive ways does it appear that the audit work of the Office of the Auditor General differs from that of the public aecounting profession? 1-44 (Audit Failures LO 2) The Bernard Madof? case in the US occurred in spite of regulation more rigorous than the CLORP 9 legislation in Australia Using newspaper repors, investigate how Mado carried out his ponal scheme and how, even though his fund was audited, he evaded regulatory action until 2008,