WHAT EXACTLY IS AN AUDIT ALL
ABOUT?
- if the audit opinion and the
auditor's report is signed that
must mean that management is
doing a good job at managing the
organization
- audits are some way that we
check whether management are
telling the truth in the financial
statements
And all of this comes from the invention
of the factory and the steam engine
which resulted in something called
mass production. Now the industrial
revolution which is where we really saw
factories and the steam engine and
mass production come about. The
industrial revolution meant that we
moved away from cottage industry.
Cottage industry was I made one thing, I
sold one thing, and it was only just me
and a small number of people but mass
production meant that companies
needed more money to be able to buy
the equipment and the machines that
went into production lines.
So where were they going to get the
Money? Well, they could go to a bank
and apply for some money or they could
try and get some shareholders to invest
but how do we know whether a
company is a good investment? How do
I know if managers who run the
company when they report back to their
shareholders are telling the truth and if
management might say “Trust me, trust
me, I'm a good guy. Of course, I'm telling
you the truth” so that is where audits
were born.
Audits were really born out of
this idea of building trust.
WHAT THE MODERN DEFINITION OF AN
AUDIT IS?
- ASA stands for our Australian
Auditing Standards
-The auditing standards are our guide.
They tell us what we should be doing
on the audit and they are legally
enforceable under the corporations’
act.
BREAKDOWN OF AUDIT
The purpose of an audit is to
enhance the degree of confidence of
intended users in the financial report.
This is achieved by the expression of an
opinion by the auditor on whether the
financial report is prepared in all
material respects in accordance with the
applicable financial reporting
framework.
 to enhance the degree of confidence
- if we have information that is more
reliable. When they say confidence,
they're really meaning we're looking
for information that is more reliable,
that we know is more accurate for
decision making.
 intended users of the financial report
- intended users are typically our
shareholders but a bank might order
an audit report. So, anybody, the
people who pay commission the
audit report those are our intended
users.
 financial report - we learn it in
accounting standards
 the expression of an opinion -
opinion is really going to be our
output
 whether the financial report is
prepared in material respect in
accordance with the applicable
financial reporting framework - so,
the applicable financial reporting
framework is essentially your
accounting standards. Financial
report has a couple of different parts
– income statement, balance sheet,
our statement of cash flows,
statement of changes of equity, our
notes to the accounts, director's
declarations, the audit report. The
financial report is prepared in
accordance with our double AASBs.
Now, when we have our opinion an
important thing to remember is that the
opinion is not a guarantee. We are not
guaranteeing the quality of
management,
we are not guaranteeing the quality of
the investment or the company. We're
simply saying that what they're
reporting in the financial statements is
truthful and fair in accordance with the
accounting standards.
So, theoretically, you could be doing a
really terrible job as managers,
management could be running the
company into the ground but as long as
they're truthful about that, we're going to
give them an audit opinion that says
they're telling the truth. So, this is an
important misconception, that an audit
is some sort of guarantee. It's definitely
not.
AUDITS ARE PART OF CORPORATE
GOVERNANCE
Corporate Governance - describes the
framework of rules, relationships,
systems, and processes within and by
which authority is exercised and
controlled. It's really all about making
sure that there's accountability.
Remember that accountability is of
management of the company, and also
the board of directors.
CORPORATE GOVERNANCE
STRUCTURES ARE MULTI-PARTY
When we think about corporate
governance, we have the entity. An
entity is essentially managed by
management. So, management are
there looking after the entity. Now, who
really owns the entity? Typically for
publicly listed companies, it's our
shareholders. So, our shareholders
employ management. Our shareholders
also have the board of directors. We
also have regulators which provide
regulations on the board and provide
regulations on management. There are
also the auditors and what they're really
doing is they're saying we're keeping an
eye on management on behalf of the
shareholders.
So, everybody is working
together as part of this corporate
governance framework and it requires
all of the parties to work together.
Remember our auditors have to
follow audit standards those are actually
set by our regulators. As part of the
board of directors is a subset of the
board called the audit committee. The
audit committee is comprised of only
independent directors. Those are non-
executive directors, people who are not
CEOs and according to the good
corporate governance guides, they're
responsible for the oversight of the
financial reporting process. So, that's all
of our reporting from internal data out to
external parties.
COMMON FOR AUDIT COMMITTEES TO
DO
 They have to make sure that the
reporting process and internal
controls are adequate.
 They have to look at accounting
judgments. Are we making the
correct
accounting policy choice under the
requirements of the AASBs?
 the audit committee is responsible
for negotiating with the auditor.
What's the audit going to be about,
how long is it going to take, what's
the fee going to be, and;
 Finally, they also receive reports
from internal auditors. Internal
auditors work within firms,
especially, large firms they'll often
be whole departments of internal
auditors, checking accounting and
operational information throughout
the year. As the external auditors
we’ll also be talking with the internal
auditors but they have to report to
someone independent. Audit
committee takes the independent
audit reports of the internal auditors
as well. These are the people who
are really responsible for financial
reporting and it's important that our
audit committee members have
accounting skills, financial reporting
skills, understanding of audits as
well so they can work well with us.
WHY DO WE HAVE AUDITS?
To any publicly listed company
they will say we have to have audits
because the law requires us to do so but
if you go back right to the early 1900s
there's some research that indicates
that there were certain reasons why
people actually got audits or why
entities got orders. That was typically to
have a lower cost of capital.
 Companies provide information to
users to help them make this
business decisions.
 When it comes to those decisions,
they make decisions about their
investment and that includes if they
will buy more shares or hold the
shares or sell. Remember our
investors have a limited resource
and that limited resource is cash.
So, they need to decide on a regular
basis -- where to allocate or invest.
So, companies provide those sorts
of users with all sorts of
information.
 To know if they're telling the truth, the
users want the report to be checked
by having an independent expert
examine it for credibility and that's a
really important part of the audit.
 The audit is about improving the
credibility of information prepared by
management because of course
management are going to tell
whatever they think the shareholders
want to hear this is sort of like
parenting in a way. The auditor is
there to keep management in check
to make sure that they're telling the
truth to shareholders so that
shareholders can make the most
appropriate decision. Shareholders
want is optimal decision making and
that optimal decision making comes
when they have accurate and
complete information.
Audits are so important within our
society, it helps keep those financial
markets flowing and information
accurate for decision making.
WHY DO WE HAVE ASSURANCE?
 Conflict of Interest: managers may
present biased information as they
are also evaluated on the
information.
 Consequences: information
provided to users have
consequences if we make a sub-
optimal decision. We don't want
sub-optimal decision-making
because we have inaccurate
information.
 Complexity: accounting information
is also now more complex. Average
shareholder, the mom and dad
shareholder, can't unpack that
complexity potentially your fund
managers and more sophisticated
investors can but they're complex so
we want subject matter experts doing
it, and;
 Remoteness: there's a big distance
between the users and managers of
the firm and the intermediaries, the
board, so, therefore we need to make
sure that we have our audit report to
help bridge that gap of information
because there is that remoteness
WHAT EXACTLY IS THE OUTPUT OF AN
AUDIT?
The audit report is the main part.
A subset of the report is the opinion but
generally a lot of auditors will use those
terms interchangeably.
Different types of opinions: two
categories…
1. Unqualified Opinion. that actually
means that you're giving the financial
statements a big check that they're
telling the truth -- everything is true
and fair and meets the accounting
standards. Unqualified is the positive
message that most companies are
looking for. They're saying they're
telling the truth.
2. Modified Opinions. Ordered opinions
that become modified and modified
really breaks down into different
levels of severity.
 1) Qualified - if things are not
quite right but small and
contained, we have a qualified
opinion.
2) Adverse - if the something is
not quite right on a much
larger scale then we have the
adverse opinion.
Two reasons why we might modify the
audit opinion for a client?
1) We disagree with management
about something. that could be a
number or a disclosure we disagree with
them and it's important but it's not show
stopper super super huge
2) Scope limitation and a scope
limitation is when we don't have
sufficient and appropriate audit
evidence.
If you have option one all right a
disagreement with management or
option two and it's relatively self-
contained, we're going to give a
qualified opinion.
If we go with option one
disagreement with management but it's
big or there's lots of it, we give an
adverse opinion.
If we have a scope limitation and it's
quite large then we're going to give a
disclaimer of opinion.
Qualified is a bit of a first level, basic
level of modification, and adverse and
disclaimer these two really are the same
thing for different options. Adverse is for
problem one and disclaimer is for
problem number.
Emphasis of Matter Paragraph - it is
something that can be added to any of
the opinions and that's generally if they
want to flag other information to the
attention of the shareholder.
DO AUDITS HAVE VALUE?
A client often think that an audit
doesn't have a lot of value because it's a
regulatory process but to shareholders
an audit will have value because it helps
them make sure that they've got
accurate credible information for their
decision making.
Three Hypotheses Explaining Demand
for Assurance (3 Main Theories)
1) Agency Theory. where managers
are self-interested and they might
not be truthful.
2) Information Hypothesis. that is
that shareholders want accurate
information for their decision
making.
3) Insurance Hypothesis. about the
process of litigation and that says
well if something goes wrong the
auditors don't do their job
correctly, and I lose my
investment well then, I can
actually go ahead and try and sue
the auditor as a shareholder to try
and recoup some of my financial
losses.

WHAT DOES THE PROFESSION SAY
ABOUT AUDITS?
 Auditors are independent
objective. That's what the
standard says, that's what the
profession says, that's what we
pride ourselves on being
independent and objective.
 Auditors have significant
expertise and produce a high-
quality audit. We have our
expertise in accounting
standards, we have our expertise
in our auditing standards, and the
application of both.
There's lots of information out there
and then lots of also research that
shows that audits do have value.
Shareholders
recognize we have value and that audits
are generally of high quality. The
auditing standards set the basic level at
which our audits should be performed
so the profession itself will tell you they
have value and that's not surprising
because they're self-interest.
WHAT DRIVES THESE DIFFERENT
OPINIONS?
Opinions where the profession says that
audits are great and the journalists are
saying audits might not be so high
quality because they're not independent
what drives these different opinions? It's
something called the auditor's
expectation gap. It's a bit like those
memes of what people think I do at my
job versus what I should be doing at my
job versus what I actually do at my job.
So, 1) we have a gap between what the
public thinks auditors do, 2) what the
standards instruct the auditors to do, 3)
what the auditors actually do, and 4)
public perceptions of performance. So,
there is definitely a big gap between
what auditors actually do and public
perceptions of audit performance. And
sometimes there's an unreasonable
expectation gap. Sometimes there's this
perception that auditors should be doing
something in particular and what we're
actually doing is we're doing what the
standards say so. The standards tell us
to do one thing and we do it then this
gap is really small but if we don't follow
what the standards say to do if we fail
to do what the standards say we should
do, we end up with a performance gap.
WHAT EXACTLY ARE OUR AUDITOR’S
LEGAL OBLIGATIONS?
 A management is responsible for
the preparation and fair
representation of the accounts.
They have to tell the truth and follow
the standards in preparing their
financial report.
 Auditors are responsible for the
auditor's report so we can't adjust
the financial statements.

. to make sure that we keep
THE ETHICS OF AUDIT
If we have ethics and as a
profession if we have ethics then it's
more likely that we are trustworthy and
that trustworthiness means that when
we give an opinion people rely on it, they
trust it and they can go forward with
confidence in using that information.
THE FUNDAMENTAL PRINCIPLES OF
PROFESSIONAL ETHICS
conceptual framework for professional
ethics and this is for all accountants.
The things that we're required to have
includes factors such as…
 Professional Competence and
Due Care. We need to have the
right skills we need to apply
ourselves when we're doing our
job.
 We need to have integrity that
when things get tough and we
might have to report something a
breach of ethics or breach of
independence then we're willing
to do that for the greater good of
the profession and the general
public.
 We have to be objective. We're
not influenced by outside
information we're always making
our own mind
 Confidentiality. We agree to keep
information that we have access
to confidential. Remember you'll
get access to financial
information way before the
market. So, any information that
we have from our clients we want
confidential and when we sign
our agreement to do an audit, we
actually sign a confidentiality
agreement.
 Professional Behavior. We agree
that we're going to behave in a
professional manner with our
clients and with each other at all
times
 Independence. Independence is
the cornerstone of audit. If we're
not independent they sort of link
together. If I'm not independent
then I can't be objective and then
I probably won't act with integrity.
So, these are really important but
independence is the cornerstone
of audit.
It's the foundation of audit because
if we're not independent and we're
biased people won't trust our opinion
and then our opinion won't have any
value.
AUDITOR INDEPENDENCE
Independence is the cornerstone
of audit. It is important for us to add
credibility, so, in terms of independence
we need to be independent in fact and
in appearance.
It means that I need to be independent,
technically. I shouldn't own shares in a
client, I shouldn't be a customer of a
client that gets a special discount.
Independence in appearance means
that also if I do have some relationships
that those relationships do appear at
arm's length that there is not the
appearance of impropriety that could be
you know I might know the CEO of a big
company from a very long time ago we
probably shouldn't be hanging out all the
time photographing the society pages
together because people might wonder
is the auditor going to be independent it
might appear like the auditor is really
chummy with the CEO of the company.
AUDITOR INDEPENDENCE: ETHICAL
REQUIREMENTS
 The test for independence is a
reasonable person test. Would a
reasonable person accessing all
the facts consider that the auditor
was independent? So, that's why
we have to make sure that we
think about independence in fact
which is the truth and the facts of
the matter plus the appearance of
impropriety. We need to be really
careful there.
 Ethical rules emphasise both
 Independence of Mind
(Actual Independence) in
the code. State of mind that
permits the expression of a
conclusion without being
affected by bias and
personal interest; to allow
us to exercise our
professional judgment
without undue pressure or
influences. We need to have
integrity, we need to be
objective, and if we find
management of doing the
wrong thing we need to say
so.
 Independence in
Appearance (Perceived) the
avoidance of facts and
circumstances that would
lead others to conclude that
our integrity and objectivity
has been compromised.
 Rule about audit partners, they can
only stay on the audit for five years
after that five-year period there's a
risk that the auditor might become
too comfortable might not be as
critical with the client because they've
developed familiarity and rapport in
building that business relationship.
 Remember how I talked about non-
audit services earlier and that
consulting fees can be really large.
Well, the corporations act also
requires companies to disclose fees
paid to the auditor and for non-audit
 services. So, you might see that the
audit is 5 million and you might also
see that they've paid 15 million in
non-audit services that disclosure
helps to keep everybody honest.
THREATS TO INDEPENDENCE
Of course, we have to be
independent but there's also the
possibility that there could be threats to
our independence. Something that
might cause us to be compromised and
therefore we may not be able to be
objective and give the opinion that is of
high quality that the audit standards
require.
 So, a key threat is self-interest the
risk that I might be less than
independent or objective or use
confidential information because I
have some sort of financial interest.
Self-interest could also be that the
client might say to us if you give us
an unqualified audit opinion, I'm going
to give you a whole lot of other
consulting fees, so, there's always the
risk of self-interest.
 Self-review and that's the risk of
checking your own work. So, this
would be like me asking you, the
student to go out and mark your final
exam. Of course, you think you're
going to be doing a good job so there
is always the risk of self-review and
we should try and minimize the risk
that we would do something for the
client some form of consulting then I
would have to check as part of the
audit because I can't be objective
 Familiarity and this are really knowing
people and relationships. This is the
reason why there's that two-year
cooling off period. Familiarity can
mean that we're less willing to blow
the whistle or raise an issue if we find
one. So, familiarity can be family
relationships, husband and wife,
parents, cousins, etc. and that
familiarity could come in all sorts of
different levels. Familiarity can also
be if we know someone for a very
long period of time and that's why we
have the five years of the rotation
because a partner and a CEO or the
executive might become quite
friendly ,and that's expected as part
of building a good business
relationship, but there are concerns
from the regulators that once you get
past five years you may be less
critical of the client because you've
known them for so long
 Advocacy remember our client is
actually the shareholder. So, we can't
advocate on behalf of management. I
can't act as the lawyer on behalf of
the client because really, I need to be
advocating for the shareholder, they
are the ones who we are representing
not anybody else.
 Intimidation this is really typically a
common threat. If you don't give us
an unqualified audit opinion, I'm not
going to provide you with non-audit
services. So, there might be this
interest in the partner we might need
the funds to pay salaries or to keep
the business afloat and so there's
definitely the option of a threat. This
 option around intimidation comes up
even more strongly if you've already
colluded with the client to do
something you weren't supposed to
do. So, if you knew that an
adjustment needed to be made and
the client said look, I promise this is
only a minor thing we're going to fix it
next year. Once you've stepped over
that line management might say but
last year you did something illegal for
us you allowed something through
the corporation’s act said should not
go through the system and so if you
don't help us this time, we're going to
report you to ASIC. So, there's
certainly some risk there for threats.
 So, in terms of looking at the threats
to independence old APES 110,
Section 290 gives us a lot of
examples like we shouldn't prepare
the accounting records and financial
reports because we'd be looking at
and checking our own work. We also
need to make sure that we look at any
financial relationships. We shouldn't
be working with clients and going
back through the code because the
code will have all of the examples
that we need to follow.
There are a lot of different areas
where threats can arise and we need to
be continuously looking out for them. To
protect against threats, we need to have
safeguards. Safeguards fall into two
categories:
1) Those created by the profession,
Legislation, or regulation - so
making sure that everyone's got
the right ethical standards and
training, that the professional
bodies are checking, that we're
independent by doing inspections
through ASIC and by the
accounting firms.
Risk-based if there is more risk, they will
do more inspections around audit
independence.
2) Safeguards within the work
environment. that is individual
firm safeguards and that's things
like doing independence checks
before every single audit that also
includes things like a register of
interests but we need to make
sure that we follow the
corporations act because the
corporations act does require us
to be independent and does
require us to have that
independence declaration as part
of our audit report and audit
opinion. Now, we have to try and
take our safeguards and
implement them to eliminate or
reduce a threat to an acceptable
and reasonable level and that
becomes really difficult because
acceptable and reasonable level is
something ultimately decided by
the audit firm. The audit firm
decides whether a threat is
reduced to an acceptable level
and then later on ASIC do come
and check whether the safeguard
does get it to that level but it's
really hard from within the bubble
of the audit firm to determine
whether your safeguard is
 acceptable and reduces that risk
or that threat to that level that's
reasonable because reasonable
isn't actually defined anywhere.

KEY TAKEAWAYS
 independence really is the
cornerstone of audit. It's critical
for audits and we can't do an
audit without it.
 There are threats to
independence. We've got our five
different threats and we need to
make sure that we can
understand those different
threats
 We also need to know that
safeguards can be implemented
and the code will give us a lot of
examples about what sort of
safeguards, in which sort of
situations.
 We should always continuously
evaluate independence it's not
something that we do once set
and forget it's