ACCT 356

ADVANCED AUDITING
Week 2

The Act of Auditing

Rob Vosslamber
rob.vosslamber@canterbury.ac.nz

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 Today
Menu
1. Admin (and hello!)
2. So, what is an audit again?
3. Auditing accy estimates
4. Use of auditor experts

Readings
On Learn

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 1. Admin

News

1. Last week
2. Course outline
3. Tut this week
4. Group assignment

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 What is an audit?

Based on what you know and what you studied

in ACCT 346, do you agree with the
following view? Why or why not?

“Auditing today is clearly the most

controversial aspect of the accountant’s
work.”
(Matthews, 2006)

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 2. What is an audit?
1. Provide a one-sentence definition of “audit”.
2. Why are there auditors?
3. Who benefits from the audit?

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 The context of audit
Create a diagram that indicates the relationship between the financial
statements and all these elements:

The audited company (auditee)

TCWG (Those Charged with Governance)
Management
Shareholders
Other stakeholders
Other F/S users (ie non-shareholders)
Board Committees
The auditor
IAASB
XRB
FMA

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 10. “For purposes of the ISAs (NZ), the following terms have the meanings
attributed below:

(a) Those charged with governance – The person(s) or organisation(s) (e.g.,

a corporate trustee) with responsibility for overseeing the strategic direction of
the entity and obligations related to the accountability of the entity. This
includes overseeing the financial reporting process. For some entities, those
charged with governance may include management personnel, for example,
executive members of a governance board of a private or public sector entity,
or an owner-manager. For discussion of the diversity of governance structures,
see paragraphs A1–A8.

(b) Management – The person(s) with executive responsibility for the

conduct of the entity’s operations. For some entities, management includes
some or all of those charged with governance, for example, executive
members of a governance board, or an owner-manager.”
(ISA(NZ)260, para. 10)
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 Provide at least four distinct reasons why
we have audits of financial statements.

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 Audit Utopia?
King Josiah (r. 640-609 BC)
commanded that the temple be
rebuilt with donated funds, saying,
“Let them use these funds for buying
timber and quarried stone to repair the
house. But no accounting shall be asked
from them for the money that is
delivered into their hand, for they deal
honestly.”
(II Kings 22)

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 “The origin of auditing goes back to times scarcely
less remote than that of accounting … Whenever
the advance of civilization brought about the
necessity of one man being entrusted to some
extent with the property of another, the advisability
of some kind of check upon the fidelity of the
former would become apparent.”
(Mautz & Sharaf, 1961)

Auditing (like accy) is a social function that requires the

ideas of:
 The distinction between the individual and the group
 Some concept of property

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 We may have an idea (or ideas!) of why we audit,
but what actually is an audit for?
(Provide at least four distinct reasons why we have audits of financial
statements.)

(Refer to van Peursen and Pratt – on Learn)

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 So, why audit?
Context of audit:
a) Growth and development of commerce
b) Separation of ownership and control
c) Human fallibility
d) Nature of financial reporting

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 (a) Growth of commerce
Littleton’s prerequisites for bookkeeping: writing,
arithmetic, private property, money, commerce,
credit, capital
(see A C Littleton (1933) Accounting Evolution to 1900, p. 13).

Results in:
Increasing complexity
Increasing distance
◦ Geographical
◦ Temporal
◦ Personal (delegation)
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 (b) Separation of ownership and control
(agency relationship):

Owner
delegates accounts

Agent

Third parties

Leads to conflicts of interests, remoteness, and

complexity, power imbalances, info asymmetry
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 (c) Human fallibility

Independent verification is needed due to:

record-keeping errors
asset misappropriation
fraud

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 (d) Nature of financial reporting
The objective of general purpose financial reporting is to
provide financial information about the reporting entity that
is useful to existing and potential investors, lenders and other
creditors in making decision relating to providing resources
to the entity.
(IASB Conceptual Framework, 2018)

Stewardship
Decision-making

The purpose of an audit is to enhance the degree of

confidence of intended users in the financial statements
(ISA (NZ) 200, para. 3)

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 But is this what auditors actually do?

Review historical audit reports

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 Theories of auditing
Traditional view
An enhancer of the value of accounting
information.
Eg OED:  2. Official examination of accounts with verification by
reference to witnesses and vouchers. (Accounts were originally oral:
cf.; Luke xvi. 2–7.)

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 Private interest theory (eg agency theory)

A way to safeguard private interests

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 Public interest theory

A way to protect and promote the public

interest

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 Critical theory

A way to enrich the auditors, or others? or

redistribute power?

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 So, what is an audit?

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 Today
Menu
1. Admin (and hello!)
2. So, what is an audit again?
3. Auditing accy estimates
4. Use of auditor experts

Readings
On Learn

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 3. Auditing accounting estimates

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 Key word

Judgement!!
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 Why are estimates such a big deal?

 New economy focus on intangible assets

 Growing use of fair value accounting as the preferred
measurement base in accounting standards
 Global Financial Crisis
 Dissatisfaction with auditors’ performance in auditing
estimates

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 Accounting Estimates
“… an approximation of the monetary amount
in the absence of a precise means of
measurement.”
(ISA (NZ) 540 Audit of Accounting Estimates etc., para 7(a))

Examples:
◦ Provision for doubtful accounts
◦ (For further examples, see ISA (NZ) 540,
para. A6, A7)

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 The Warehouse balance sheet

Which balances involve accounting

estimates?

How would you audit these estimates?

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 Accounting Estimates (cont.)

Estimates may be:

◦ Simple vs. complex
◦ Determined on a routine or non-routine basis
◦ May be result of the application of a formula

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 Measurement objective of accounting
estimates varies

Measurement of accounting
estimates depends on nature
of the accounting estimate

Forecast outcome of one or

Value item based on
more transactions, events or
conditions prevalent at
conditions giving rise to need
balance date,
for an estimate,
e.g. fair value of an asset
e.g., provision for warranty
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 Risks
◦ Simple error
◦ Estimation uncertainty
◦ Management bias
◦ Lack of controls over estimation
◦ Fraud
◦ Lack of expertise
◦ Incorrect assumptions

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 Audit of Accounting Estimates
Management is responsible for making such estimates

Uncertainty around outcome of events that have occurred or likely to

occur
Judgment necessary
Potential tool for ‘earnings management’
Risk of material misstatement is increased
Complexity/ lack of expertise

Auditor responsible for obtaining sufficient appropriate evidence

regarding reasonableness of the estimate.

Evidence available often more difficult to obtain and less conclusive

than evidence for other items in the financial statements.

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 Main steps in auditing accounting estimates under ISA(NZ)540 when a risk of material misstatement exists

[ISA(NZ)540 ¶8]

[ISA(NZ)540 ¶9]

[ISA(NZ)540 ¶10]

[ISA(NZ)540 ¶10&11]

[ISA(NZ)540 ¶12]
[ISA(NZ)540 ¶29]
[ISA(NZ)540 ¶13-14]

[ISA(NZ)540 ¶15-17]

[ISA(NZ)540 ¶18-21]

[ISA(NZ)540 ¶22]

[ISA(NZ)540 ¶23]

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(Adapted from Chartered Accountants of Canada CAS540 Implementation Tool for Auditors)
 Audit evidence re estimates
Auditor response (ISA (NZ) 540 paras. 13-14):
a) Review events up to the date of the audit report for
evidence;
b) Test how the estimate was made and the data on which it
was based (including reasonableness of assumptions made);
c) Test effectiveness of controls over how the estimate was
made along with substantive procedures;
d) Develop a point estimate or range to evaluate
management’s point estimate;
e) Consider whether there is a need to consult experts (see also
ISA (NZ) 620: Using the Work of an Auditor’s Expert.

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 Examples
You are auditing the financial statements of Michele Hall
Ltd, Jeweller, and note the following balances:
1. Raw diamonds recorded at a total cost of $1,560,321.

2. Head office building in Wanaka, valued at $5.6 million.

3. Purchased goodwill of Michel van der Halle, the Dutch

subsidiary, purchased 2010, of $750,000.

4. Provision for doubtful debts of $50,000.

5. It is 2020, and NZ has had several weeks of lockdown

due to COVID-19.
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 4. Use of auditor experts
ISA (NZ) 620 Using the Work of an Auditor’s Expert

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 Why?
“If expertise in a field other than accounting or auditing is necessary to
obtain sufficient appropriate audit evidence, the auditor shall determine
whether to use the work of an auditor’s expert (ISA (NZ) 620, para. 7)”

Who?
An individual or organisation possessing expertise in a field other than
auditing or accy, whose work in that field is used by the auditor in
obtaining sufficient appropriate audit evidence… (para. 6)

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 Use of experts
Auditor’s role when an expert used
 Unchanged: The auditor has sole responsibility for the audit opinion
expressed (para. 3)

 Auditor must evaluate the expert’s work (para. 12, 13)

 Audit report shall not refer to the work of the auditor’s expert (para. 14,
15)

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 Examples

Estimates
The preparation of financial statements in conformity with NZ
IFRS requires the directors to make estimates and
assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of
sales and expenses during the reporting period. Actual
results could differ from those estimates. The estimates and
assumptions are reviewed on an ongoing basis. For further
information on areas of estimation and judgement, refer to
the notes to the financial statements, in particular note 19.

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 Example

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 NZOG 2019

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NZOG 2019
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NZOG 2019
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