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CHAPTER 1

INTRODUCTION AND
OVERVIEW OF AUDIT AND
ASSURANCE

Prepared by:
Daniella Juric
RMIT University

LEARNING OBJECTIVES
After studying this chapter you should be able to:
1. Define an assurance engagement
2. Differentiate between different types of assurance services
3. Differentiate between different levels of assurance
4. Verify different audit opinions
5. Differentiate between the different role of the preparer and the auditor, and
discuss the different firms that provide assurance services
6. Justify the demand for audit and assurance services
7. Discuss the different regulators and regulations surrounding the
assurance process
8. Verify the audit expectation gap.
AUDITING AND ASSURANCE
DEFINED
An assurance engagement is defined as en
engagement in which an assurance practitioner
expresses a conclusion designed to enhance the
degree of confidence of the intended users other
than the responsible party about the outcome of
the evaluation or measurement of a subject matter
against criteria.
AUDITING AND ASSURANCE
DEFINED
intended users - the people for whom the auditor prepares
their report.
Example: shareholders, creditors, employees
responsible party - the person or organisation responsible
for preparing the financial statements. Example: company
management
subject matter that which the auditor is expressing a
conclusion on. Example: financial reports
criteria the rules or principles by which the subject matter
is being evaluated. Example: Accounting standards and
interpretations and Corporations laws

DIFFERENT ASSURANCE SERVICES
THE MOST COMMON ASSURANCE SERVICES ARE:
1. FINANCIAL REPORT AUDITS
an engagement designed to express an opinion
about whether the report is prepared in all material
respects in accordance with a financial reporting
framework (ASA 200, para. 11; ISA 200, para 11.

DIFFERENT ASSURANCE SERVICES
LIMITATIONS OF AN AUDIT:
There is no guarantee that the financial report is free from error or
fraud.
The nature of audit procedures and processes are required to be
performed within a reasonable period and at a reasonable cost.
(ASA 200, ISA 200)
Judgement is required in the process of preparation of the
financial statements.

DIFFERENT ASSURANCE SERVICES
2. COMPLIANCE AUDIT
Involves gathering evidence to ascertain whether rules,
policies, procedures, laws and regulations have been
followed.
A tax audit is an example of a compliance audit.
3. PERFORMANCE AUDIT
Refers to the economy, efficiency and effectiveness of
an organisations activities.
Usually done by internal auditors or can be outsourced to
external auditors.
DIFFERENT ASSURANCE SERVICES
4. COMPREHENSIVE AUDIT
Combines elements of financial report audit,
compliance audit and performance audit.
Often occur in the public sector.
5. INTERNAL AUDIT
Provides assurance about various aspects of an
organisations activities.
Often contain elements of performance audits, compliance
audits, internal control assessments and reviews.
DIFFERENT ASSURANCE SERVICES
6. CORPORATE SOCIAL RESPONSIBILITY (CSR)
ASSURANCE
Includes voluntary reporting about environmental,
employee and social subject matter.
Incorporates both financial and non-financial
information.
Auditor must consider environmental issues on their
clients financial reports (AGS 1036) even if reports
do not include any disclosures.
DIFFERENT LEVELS OF
ASSURANCE
AUDITORS MAY PROVIDE VARYING LEVELS OF
ASSURANCE WHEN CONDUCTING ASSURANCE
ENGAGEMENTS.
1. Reasonable assurance
2. Limited assurance
3. No assurance
DIFFERENT LEVELS OF
ASSURANCE
LEVEL OF
ASSURANCE

EXAMPLE

THE
ASSURANCE
EXPRESSION
REASONABLE
Highest level of
assurance but not
absolute assurance on
the reliability of the
subject matter
Financial
Statement Audit
The auditor has conducted sufficient tests
and obtained appropriate and sufficient
evidence to conclude positively that the
information that is assured is (or is not)
reliable
Positive
LIMITED
Moderate assurance
on the reliability of the
subject matter
Review of a
companys half-
year financial
report
Auditor has done adequate work to report
whether or not anything came to their
attention that would lead them to believe
that the information that is assured is not
true and fair.
Negative
NO ASSURANCE

Agreed-upon
procedures
engagement
The auditor does not report an opinion
merely report on the findings and the facts
of their findings. The client determines the
nature, timing and extent of evidence
gathered and then draws their own
conclusions about these findings
No Assurance
given






Also known as an
UNQUALIFIED
OPINION or
clean opinion
as in a clean bill
of health

Financial report is
true and fair,
presents fairly the
financial position
of the company,
information
complies with AAS
and Corp Act








Modifications
that do not
affect the
auditors opinion
Emphasis of
matter
Modifications
that affect the
auditors opinion
Qualified
Opinion
Adverse
opinion
Disclaimer of
Opinion
DIFFERENT AUDIT OPINIONS
UNMODIFIED MODIFIED
DIFFERENT AUDIT OPINIONS
Audit opinions are contained in audit reports provided
by the auditor.
An unmodified audit report contains an unqualified or
clean opinion. Refer Figure 1.1 p. 12.
All other reports are modified opinions.
A report can be an unqualified modified report when an
emphasis of matter is added.
An emphasis of matter is used so that the reader can pay
appropriate attention to the issue raised, but does not
change the auditors opinion (ASA 706, ISA 706)

DIFFERENT AUDIT OPINIONS



Auditors Judgement about the
Pervasiveness of the Effects or Possible
Effects on the Financial Report
Nature of Matter Giving Rise to the
Modification


Material but Not
Pervasive
Material and
Pervasive

Financial report is materially
misstated


Qualified opinion

Adverse opinion


Inability to obtain sufficient
appropriate audit
evidence


Qualified opinion


Disclaimer of Opinion

DIFFERENT AUDIT OPINIONS
Other modified reports are qualified (ASA 705). A
qualified opinion is given when there are reservations
about the truth and fairness of the financial statements.
Can include a qualified or except for opinion. This is
when issue(s) are material but not pervasive.
Adverse opinion would arise when financial report is
misstated and is material and pervasive.
Disclaimer of opinion would arise when there is an
inability to obtain sufficient appropriate audit evidence
and is material and pervasive.

PREPARERS AND AUDITORS
It is the responsibility of those charged with governance
to prepare the financial statements. The information should
include the following attributes: PREPARERS responsibility
1. Relevant: has an impact on the decisions made by users regarding
the performance of the entity.
2. Reliable: Information is free from material misstatements (errors or
fraud.)
3. Comparable: information needs to be comparable through time.
Comparable against the same entity over time and against other
entities.
4. Understandable: Users need to be able to interpret the information
presented in order to make decisions.
5. True and fair: requires the consistent and faithful application of an
applicable framework when preparing report.
PREPARERS AND AUDITORS
AUDITOR ALSO HAS RESPONSIBILITIES RELATING TO THE
AUDIT. AUDITOR RESPONSIBILITIES
1. Professional scepticism : maintaining
independent of the entity and having a questioning mind
to thoroughly investigate all evidence presented.
2. Professional judgement: use of judgement based on level
of expertise , knowledge and training obtained
by the auditor.
3. Due care: being diligent, applying standards and
documenting each stage of the audit process.
PREPARERS AND AUDITORS
Assurance services are provided by accounting and
consulting firms.
There are three tiers of assurance providers in Australia.
First tier comprises of the Big 4, which includes Deloitte,
Ernst & Young, KPMG and PWC
Mid tier comprises of firms with significant presence and
most have international affiliations.
Next tier made up of regional and local accounting firms.
DEMAND FOR AUDIT AND
ASSURANCE SERVICES
The users of the financial statements are not limited to
the shareholders or owners of the business.
Other users can include:
Investors: can include current or potential investors.
Decisions include to buy, hold or sell stake in the
organisation.
Suppliers: may want to assess whether the entity can pay
them back for goods supplied.
Customers: may look into going concern if it is to rely on
the entity for goods.
DEMAND FOR AUDIT AND
ASSURANCE SERVICES
Lenders: to assess whether loan repayments can be
made as and when they fall due.
Employees: to assess whether they can pay entitlements,
and stability may be assessed for job security.
Governments: whether the entity is complying with
regulations and paying appropriate taxes.
General public: whether they should associate with the
entity (future employee, customer or supplier,) what it
does and plans to do in future.
SOURCES OF DEMAND FOR AUDIT &
ASSURANCE SERVICES
REASONS WHY USERS DEMAND FINANCIAL REPORTS
INCLUDE:
1. Remoteness : users do not have access to information
themselves.
2. Complexity : users do not have knowledge to be able to
make disclosure choices.
3. Competing incentives: users may find it difficult to identify
when the incentives of management have been over-
represented.
4. Reliability: as decisions are being made based on
information presented, it is important that it be reliable.
THEORETICAL FRAMEWORKS
THE DEMAND FOR AUDIT CAN BE EXPLAINED BY THE
FOLLOWING THREE THEORIES:
1. AGENCY THEORY: Due to the remoteness of the owners from the
entity, the owners have an incentive to hire an auditor to assess
information provided by management.
2. INFORMATION HYPOTHESIS: Due to the need for
reliable information, users will demand that information be
audited to aid in decision making.
3. INSURANCE HYPOTHESIS: Investors demand audited
financial statements to insure against potential losses.
DEMAND IN A VOLUNTARY
SETTING
It is becoming more common to voluntarily disclose CSR
information in various forms.
This is as stakeholders are demanding information
regarding the entitys impact on the environment and
actions taken to reduce their impact.
Entities are not required to have CSR disclosures
assured.
These services are provided to meet user demands for
high-quality, reliable information and to demonstrate a
high level of corporate social responsibility.
THE ROLE OF REGULATORS AND
REGULATIONS
THERE ARE A NUMBER OF REGULATORS THAT IMPACT THE
AUDIT PROCESS. THEY INCLUDE:
1. FINANCIAL REPORTING COUNCIL (FRC)
oversees the process used for setting accounting and auditing
standards. Also monitors and reports on auditor
independence.
2. AUDITING AND ASSURANCE STANDARDS BOARD (AUASB)
Responsible for the formulation of auditing standards.
AUASB redesigned auditing standards to bring in line with
international standards.
Responsible for issuing ASRE, ASAE and GS standards and
statements.
THE ROLE OF REGULATORS AND
REGULATIONS
3. INTERNATIONAL AUDITING AND ASSURANCE STANDARDS
BOARD
Develop and issue International Standards on Auditing (ISAs).
Operates under the auspices of International Federation of
Accountants (IFAC).
4. ACCOUNTING PROFESSIONAL AND ETHICAL STANDARDS
BOARD (APESB)
Established as an independent body by CPA Australia and
ICAA to issue professional and ethical standards.
APES standards are mandatory for all members of CPA
Australia, ICAA and NIA.
THE ROLE OF REGULATORS AND
REGULATIONS
5. AUSTRALIAN SECURITIES AND INVESTMENTS COMMISSION
(ASIC)
Government body that administers the ASIC Act and much of
Corporations Act.
Plays a role in overseeing of the audit function.
6. AUSTRALIAN SECURITIES EXCHANGE (ASX)
Formed in 1987 after merging of six state based exchanges.
Provide additional obligations for entities wishing to list on
the exchange.
THE ROLE OF REGULATORS AND
REGULATIONS
7. COMPANIES AUDITORS AND LIQUIDATORS DISCIPLINARY
BOARD (CALDB)
Responds to ASIC and APRA regarding breaches of
Corporations Act or ASIC Act.
Board may cancel or suspend auditor, may give warning or ask
for undertaking to improve conduct.
8. PROFESSIONAL BODIES (INCLUDING CPA AUSTRALIA,
INSTITUTE OF CHARTERED ACCOUNTANTS IN AUSTRALIA &
NATIONAL INSTITUTE OF ACCOUNTANTS)
Include professionals in public practice, industry, academia
and government.
Requires further post-graduate study and minimum work
experience periods to join as members.
REGULATION
CORPORATIONS ACT
Provides guidance on conducting audit of financial
reports.
This includes that certain accounts need to be
audited (s. 301,) the audit report stating whether it is
true and fair & in accordance with accounting
standards (s. 307,) standards must be applied (s.
307A,) retention of audit working papers (s. 307B,)
and independence declaration (s. 307C.)
REGULATION
CLERP 9
Significant changes brought about from 1 July 2004
including auditing standards having force of law.
Other changes include:
Disclosure of non-audit services provided by auditor.
Enhanced independence and employment requirements.
Auditor rotation based on not exceeding being auditor for
more than five out of the last seven years.

Its not fair! This
isnt what auditors
do.
Youre supposed to guarantee
the financial report!
We lost all of our
investments because
of your report!!
You should
have
detected the
fraud !
AUDIT EXPECTATION GAP
AUDIT EXPECTATION GAP
IS THE DIFFERENCE BETWEEN THE EXPECTATIONS OF
ASSURANCE PROVIDERS AND FINANCIAL REPORT OR
OTHER USERS.
Can be caused by unrealistic expectations including:
The auditor providing a complete assurance.
The auditor guaranteeing future viability of entity.
An unqualified opinion denotes complete accuracy.
The auditor will find all frauds.
We know these cannot be met by the auditor.
AUDIT EXPECTATION GAP
THE EXPECTATION GAP CAN BE REDUCED BY:
Auditors performing their duties appropriately
Undertaking peer reviews of work performed
Reviewing and updating auditing standards.
Educating the public.
Enhanced reporting explaining audit processes and
levels of opinion auditors provide to the entity.
Greater attention to the risk of material fraud
occurring.
SUMMARY
After studying this chapter you should be able to:
1. Define an assurance engagement
2. Differentiate between different types of assurance services
3. Differentiate between different levels of assurance
4. Verify different audit opinions
5. Differentiate between the different role of the preparer and the auditor, and
discuss the different firms that provide assurance services
6. Justify the demand for audit and assurance services
7. Discuss the different regulators and regulations surrounding the assurance
process
8. Verify the audit expectation gap.