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Chapter 1
Audit
el of confidence
Limited
Reasonabl
Preparer e User
Absolute
Direct
Assurance Attest
Report
evidence
Subject Practitione
evaluate
matter r
Criteria
IndependentExpertise
Assurance Engagement - An
engagement in which a practitioner aims to
obtain sufficient appropriate evidence in
order to express a conclusion designed to enhance the degree of
confidence of the intended users other than the responsible party
about the outcome of the measurement or evaluation of an
underlying subject matter against criteria.
Principles
Ethical Principles (APES110 code of ethics ):
integrity Section 110
objectivity (independent, unbiased) Section 120
professional competence and due care Section 130
confidentiality Section 140
professional behavior Section 150
Chapter 3
Section 200.9
Safeguards that may eliminate or reduce threats to an Acceptable Level fall into two
broad categories:
(a) Safeguards created by the profession, legislation or regulation;
education and training
continuing professional development
professional standards
regulatory monitoring and disciplinary process
(b) Safeguards in the work environment
discuss with supervisor
dispose off the interest
do not accept the engagement
get an independent review of the work
removing the person from the engagement
separate teams: assurance and non-assurance
no involvement in any decision-making capacity for the client
Section 210 Accepting a new client, requires evaluating a new client to determine
if there are any threats under Section 200.3 and apply any safeguards if needed under
Section 200.9
Auditor Independence
Section 290 Independence
Should be independent in appearance(perception of
independence) and of mind (actually be independent) to justify that
you have been objective in completing the audit
Chapter 4
Assertions
representations made by management, that are
embodied in the financial report, as used by the auditor
to consider the different types of potential
misstatements that may occur.
Inherent Risk OR
Control Risk
Assertions
Income statement items/Transactions (e.g. for sales accounts,
expenses, income, revenue):
Occurrence transactions and events that have been
recorded have occurred and pertain to the entity
Completeness all transactions and events that should have
been recorded have been recorded
Accuracy amounts and other data relating to recorded
transactions and events have been recorded appropriately
Cut-of transactions have been recorded in the correct
accounting period
Classification transactions and events have been recorded
in the proper accounts
Audit Procedures
Inspection examination of documents, records or tangible assets
Observation observing the behavior of operating personnel and
the functioning of the business in operation; looking at a process or
procedure being performed by someone else
External confirmation audit evidence obtained as a direct
written response to the auditor from a third party
Recalculation checking mathematical accuracy of documents or
records, proven by recalculating the results.
Re-performance - auditor may independently execute procedures
or controls that were originally performed as part of the entitys
internal controls; e.g. dummy transaction
Analytical Procedures investigation and analysis of fluctuations
and relationships to determine whether there are inconsistencies
with other relevant information or deviations from predicted
amounts; e.g. sales goes down but profit goes down (analyse this)
Enquiry auditor may ask questions and can include interviewing
or obtaining statements from management and employees; e.g.
internal control questionnaire.
Audit Trail
A chain of evidence provided by coding, cross-references and
documentation that connects account balances and other summary
results with original transaction data.
Origin Final
Recording
Audit Evidence
Evidence must be sufficient (i.e. quantity/sample size must be
enough) and appropriate (i.e. it is reliable and relevant)
Audit Risk Model
Risk that an auditor will give an inappropriate audit opinion when
the financial report is materially misstated
Audit Risk = Risk of material misstatement + Detection Risk
(ASA 200 para A34)
Audit Risk some misstatements will exist but clean bill of health
is given; i.e. a combination of inherent risk, control risk and
detection risk.
Chapter 5
Decide:
Should I accept the client?
Should I continue? evaluate client on ongoing basis
Prepare engagement letter
o contact person
o fees structure
o using client internal audit or experts
o if expertise from outsiders are required
Planning:
Understand the client
o External
o Internal
o Financial
o Controls
SWOT analysis
Identify Business Risks
Assess the impact of Business Risk (BR) on financial
statements
o i.e. risk of material misstatement at an,
overall financial report level
assertion level
Determine appropriate audit strategy
Prepare an audit plan
Engagement Letter
Letter that documents and confirms the auditors acceptance of the
appointment,
the objective and scope of the audit
the extent of the auditors responsibilities to the entity
responsibilities of management
identification of the applicable financial reporting
framework
form and contents of any report, and statement that there
may be circumstances in which a report may differ from its
expected form and content
Audit Planning
To develop an efficient and effective audit:
devote attention to important areas
identify areas of potential problems
supervision of staff and review of work, who to contact for
consultations
organize and manage audit
select audit team members and assignment of tasks
coordinate with internal auditors, experts or other third
parties
Determines the scope of the audit
Audit Planning Risk Assessment Process
Analytical Procedures
Trend
Operational performance
Relationships between accounts
Compare with industry averages, competitors, previous year
performance, budgets, etc.
Simple Procedures:
Complex Procedures:
ratio analysis
time series modeling
simple comparisons
regression analysis
time series analysis
financial modeling
trend statements
Ratios:
Short Term Liquidity Ratios:
Current Ratio high ratio (benchmark 2:1, assets : liabilities)
indicates entitys ability pay current debt obligations; high
ratio means there are more current assets over current
liabilities
= Current Assets .
Current Liabilities
Quick Asset Ratio same as current ratio but does not
include inventory and can help identify if there is an inventory
account risk
= Liquid Assets .
Current Liabilities
Operating Cash Flow Ratio provides a longer term
measure of entitys ability to meet current liabilities by using
cash flows instead of current assets to meet current liabilities;
higher is better/more able to meet obligations
=.Cash flow from operations
Current Liabilities
Activity Ratios:
Receivables Turnover Ratio indicates how many times
accounts are turned over in a year (can also use days in
receivables ratio how many days it takes to collect sales
revenue); higher ratio is more desirable
Inventory Turnover Ratio indicates how many times
inventory is turned over in a year; if it is low it means
inventory is not selling quickly, and could be misstated or
valued incorrectly
Profitability Ratios:
Gross Profit Ratio provides an indication of companys
product pricing and product mix (inventory account errors can
distort ratio due to COGS)
Net Profit Ratio measure profitability after all expenses are
considered; significant fluctuations of this ratio may indicate
misstatement in expense accounts and auditor may need to
increase their testing of these accounts.
Solvency Ratios:
Debt to Equity Ratio higher the ratio, the higher the
gearing/debt, this can determine against the industry average
whether the entity will be able to acquire more debt in the
future or not (i.e. can be a risk)
Times Interest Earned Ratio higher ratio is better as it
means profits are high, and debt can be paid off (compare
against D/E Ratio, especially if they dont follow the same
trend)
Identify Business Risks
SWOT Analysis
for each weakness and threat are there any possibilities for
the entity to mitigate them and the strategies put in place to
deal with it must be considered.
Assess Risks
Once business risks have been identified, and if these affect
financial statements, then determine whether it afects at a
financial report level or at an assertion level.
Only the risks of material misstatement (RMM), such as inherent
risks, etc., need to be assessed and then responded to, others can
simply be noted for and left as is. These must be assessed to
determine how the business risk afect/impact risk of
material misstatement.
Respond to Risks
Audit
Plan
Response to risk:
- Develop an overall audit strategy that lies along the continuum
below,
Chapter 6
Risk Of Material
Misstatement
Fraud Triangle
If all 3 factors of fraud triangle present then there
is a high risk of fraud.
Red Flags:
Unusual transactions (e.g. lavish lifestyles,
excessive payments, kickbacks to govt.
officials)
Management
Market Pressures (e.g. slowing industry, prevent takeovers)
Unusual pressures (e.g. maintain share prices)
Unsatisfactory records (incl. management slow to provide
documents)
Role in industry (e.g. a leading provider/dominant role)
Earnings Management
Earnings management occurs when judgment in financial reporting
and in structuring transactions is used to alter financial reports to
influence perceptions of stakeholders; distorting statements but not
changing figures
Examples:
big bath charges under the guise of restructuring
intentional violations of accounting standards and other
reporting requirements that are individually immaterial
inappropriate revenue recognition
improper accruals and estimation of liabilities in good times
Related Parties
Auditors are required to specifically assess the risk that related
parties and related party transactions will not be identified, or
appropriately disclosed and/or measured (ASA 550).
evidence from related-parties might not be as reliable
can be a sham (e.g. place a large order before year end to
increase sales)
fraud
Once related parties are identified, disclose this fact for
shareholders to see, they will then decided if action is needed or
not.
Chapter 7
Internal Controls
Purpose of controls are to get information quickly in order to fix risks
and to run operations efficiently and effectively, in order to make
decisions, such as future growth prospects, to comply with
standards, and for financial reporting obligations (ASA 315.A51).
Types of controls:
Internal
Controls
Management Transaction
controls controls
Assertions to be considered:
Occurrence transactions and events that have been
recorded have occurred and pertain to the entity
Completeness all transactions and events that should have
been recorded have been recorded
Accuracy amounts and other data relating to recorded
transactions and events have been recorded appropriately
Cut-of transactions have been recorded in the correct
accounting period
Classification transactions and events have been recorded
in the proper accounts
Auditors requirements
Chapter 8
Testing of controls
Planning the scope of tests of controls:
Nature type of testing (either tests of controls or
substantive tests)
Timing to provide assurance that controls are effective
throughout the year, and not just at year-end, tests must be
done at an interim period
Extent the more the auditor relies on operating
effectiveness of controls, greater the extent of the auditors
controls; determined with reference to audit sampling
techniques
Major Activities
Chapter 9
Substantive Tests
Tests of Balances Tests directed to selected items which
are an aggregate of a number of transactions; i.e. check the
final balance
Tests of Transactions tests of individual transactions,
performed to obtain audit evidence to detect material
misstatements at the assertion level. Involves inspecting
underlying documents, testing flow of transactions through
the system and recalculating for clerical accuracy
Tests of disclosure
Cash, cash receipts and cash payments (p. 405-6 Table 9.1)
Assertions of interest:
Substantive testing:
When doing tests, if risks are high, look at the transactions in
the next month and see if they are reconciled in bank
statement, or can trace transactions back.
When testing controls, these same transactions or events can
be examined to also achieve substantive testing objectives
i.e. dual-purpose tests
Accounts Receivable:
Procedure Assertions that can
be tested
Undertake debtors confirmation procedures Existence, Rights
Review subsequent receipts Existence,
Completeness, Valuation
Review minutes and contracts for evidence of Rights
pledging of receivables, factoring or other liens
Review aged trial balance and undertake follow- Valuation
up procedures for amounts overdue
Test conversion rates for any foreign currency Valuation
accounts receivable
Inventory:
Procedure Assertions that can
be tested
Inspect physical inventory (check from Existence
inventory records to physical stock)
Undertake substantive analytical procedures Completeness,
Existence, Valuation
Inspect physical inventory (check from physical Completeness
stock to inventory records)
Enquire about legal ownership of goods being Rights, Completeness
shipped to entity by inspecting supporting
documentation
Enquire about legal ownership of any goods on Rights
consignment by inspecting supporting
documentation
Undertake tests of pricing Valuation
Accounts Payable, payments and payroll (p. 424-5 Table 9.4; p. 428
Table 9.5)
Accounts Payable:
Procedure Assertions that can
be tested
Confirm with suppliers All
Review of subsequent payments Completeness
Vouch to supporting documentation (e.g. Existence, Obligations
suppliers invoices and monthly statements)
Review for any unmatched receiving reports Completeness
and suppliers invoices (checking none are
missing)
Agree dollar value of accounts payable to Valuation
supporting documents (e.g. suppliers invoices)
Undertake substantive analytical procedures Valuation, Completeness
(e.g. ratios)
Payroll:
Procedure Assertions that can
be tested
Test from supporting documentation (time Completeness
sheets, department records) to payroll journal
Select transactions from payroll listing and Occurrence
agree to supporting documentation (e.g. time
sheets)
Review for unmatched reports and staff records Completeness,
Occurrence
Check that last payroll recorded before balance Cut-off
date, and first payroll records after balance
date, are recorded in the correct period
Verify times, amounts and computation on time Accuracy
sheets to payroll and employment records
Assertions of interest:
existence
rights & obligations
valuation & allocation
o cost depreciation, amortization, impairment
o repairs and maintenance expensed? capitalized?
o revaluation
Audit Procedures:
physical inspection
ratios - see if valuations are correct
documentary evidence
recalculate
Assertions:
Valuation
Existence
Procedures:
Physically examine documentation
seek external confirmation
review minutes of meetings
o is it a short term or long term investment?
inspect market quotations
test clerical accuracy
Assertions:
Completeness
Procedures:
External confirmations banks
Substantive analytical procedures
Recalculation and vouching
Read minutes of meetings, review debt arrangement
Lecture Week 8 AUDIT SAMPLING IS
DEFINITELY IN EXAM!!
Chapter 10
Audit Sampling
Means of gathering audit evidence:
100% testing/examination of evidence this is not a sampling
method as you are checking everything and not just a sample
Selecting specific items (i.e. only certain sub-group, e.g. high
risk items) this is not a sampling method as items will not
necessarily be representative of the population
Audit sampling
Sampling Techniques:
Attribute Sampling sampling approaches to tests of controls
Dollar-unit sampling sampling approaches to substantive
tests (e.g.
Characteristics of interest:
For tests of controls find rate of deviation (i.e. error found
but do not use the word error in exam, use rate of
deviation)
For substantive tests find monetary misstatement (e.g.
error/misstatement of $10,000)
Planning and Design of audit sample:
Objectives Assertion being tested? (ASA 530)
Population What is the population from which the sample
derived?
Should Stratification be used? Divide population in sub-
populations based on a criteria to allow auditor to focus on
key areas
Define a sampling unit (e.g. one sample item, each
transaction, each balance or each dollar?)
What would constitute an error?
Sample Size:
Sample size is afected by the degree of sampling risk
the auditor is willing to take to reduce risk, use a larger
sample size (ASA 530)
Factors that influence sample size for tests of controls:
o Control risk assessment if control risk assessment is
low (i.e. rely on controls), then the sample size is larger
as we want to test the controls sufficiently to ensure we
can rely on them
o Tolerable rate of deviation how many deviations
am I willing to tolerate (i.e. maximum limit or error)?
Keep on testing until the deviations are less than the
limit larger tolerable limit, the larger the sample size
o Expected rate of deviation expecting there to be
errors, but not beyond the expected rate of deviation.
Higher expected rate, larger the sample size
o Auditors desired level of assurance higher level
of assurance, the larger the sample size
o Number of units in the population population size
does not affect sample size
Factors that influence sample size for substantive testing:
o Risk of material misstatement RMM is high, then
sample size is larger
o Tolerable misstatement higher tolerance, then
sample size is smaller
o Expected misstatement if expect to find more
misstatements, then larger sample size
o Auditors desired level of assurance higher level
of assurance, the larger the sample size
o Number of units in the population population size
does not affect sample size
o Stratification use of stratification results in smaller
sample size
Selection of Sample:
Sample items are selected so that sample can be expected to
be representative of the population (ASA 530)
Sampling Techniques:
o Random Selection no bias, random selection of
sample units; use a automated generator
o Systematic Selection units are selected from a
population at regular intervals; start point is randomly
selected can be a useful technique when wishing to
focus on a particular time period
Sample interval = No. of items in population
Sample Size
Then select starting sample unit randomly
within sample interval, and continue to add
sample interval to random start and identify items
to be sampled (e.g. SI = 2, then 1,3,5..)
o Haphazard Selection permitted by auditor standards
but not accepted as there could be bias in selection
(even subconsciously)
Unacceptable sample selection methods:
o Block selection auditor selects all items of a
specified type processed on a particular day, week or
month, or otherwise stored in a block.
o Judgmental selection based on sample item
characteristics; auditor applies judgment in the selection
of the units to be tested; not representative of the
population (e.g. on picking those with a high risk of
error) (ASA 500.A55)
Performing the procedure and evaluating the results:
Auditor performs the required audit procedures on the items
selected
Evaluates the sample results considers both the nature and
cause of any misstatement or deviations identified and their
possible effect on the audit objective and other areas of audit
(ASA 520.12-13)
o determine whether preliminary assessment of relevant
characteristic of the population ought to be accepted or
rejected determined based on whether the tolerable
rate of deviation or tolerable misstatement has been
exceeded.
o Rejection would lead auditor to conclude that:
preliminary assessment of control risk cannot be
accepted (for tests of controls)
relevant account balance or class of transactions
is materially misstated (for substantive
procedures)
Project misstatement of sample onto population:
Projected Misstatements = sample misstatements x
population size
sample size
REMEMB
ER THIS
FORMULA
; IT WILL
NOT BE
GIVEN IN
EXAM!
SUBSTANTI
VE TESTS
SAMPLING
MORE
LIKELY TO
BE IN EXAM!
Dollar-unit sampling:
Example:
Use cumulative total Sampling Interval = Cumulative Total =
Use Sample Size $1,000,000
Compute Sampling Interval (SI) Sample Size
60 Example:
Risk of incorrect acceptance = $16,667
Tolerable Error =
= value allowed to be Therefore, starting at$50,000
randomly selected
incorrect (RS) $14,068 accountAccount
and then add SI =
Balance to$1
(Level of Assurance = value use these dollar-unitsmil
for 60 units (i.e.
that should be correct; so sample size). Expected Error =
100 Risk of incorrect So, $14,068, $30,735, $47,402, $64,069
$500
acceptance) etc. Risk of incorrect
These use the transaction/invoice
acceptance = 5% that
(95% level of
assurance)
Evaluation of Results
Example (cont.):
Dollar value of sample selected = $100,000
Misstatement found in sample = $2,000
Account Balance = $1,000,000
Therefore,
Projected misstatement
= $2,000 x 1,000,000
$100,000
= $20,000
Lecture Week 9
Chapter 11
Directors Declaration
Declare that everything is correct
1. CEO/CFO will make declaration to the Board of Directors
a. Financial Statements comply with all requirements
b. Financial statements and notes provide all relevant info.
c. Financial statements give a true and fair view of the
financial performance of the company
2. Then the Directors will make a declaration
a. Financial statements comply with Corp. Act
b. Financial statements comply with accounting standards
c. Financial statements give a true and fair view of the
financial performance of the company
d. Directors have received a declaration from the CEO/CFO
3. Lastly, the auditors sign the audit report at Date of Audit
Report (this date is important as the auditors responsibility
finishes on the date of audit report once signed and is
considered the date the audit is completed; this date is
generally a period of time after the end of the financial
reporting date period of subsequent events)
Subsequent Events
Management may predict events to occur in the period immediately
after the end of the financial reporting date and so by leaving a
subsequent events period, the auditor is able to check if these
predictions are accurate and can make adjustments to the financialSUBSEQUENT
report if required i.e. adjusting subsequent event, where the EVENTS WILL
event is not as predicted. LIKELY BE IN
EXAM!
Adjusting subsequent event - A subsequent event tells auditors
more about a condition on the financial report and so an adjustment
may be required. This must be made as a journal entry (e.g.
change a provision).
Any major event that occur after the end of the reporting period but
before the Date of Audit Report (i.e. during the subsequent reporting
period) that are unexpected or unrelated to any events in the
financial report, must still be included as a disclosure in the notes
of the financial statement of the event and the amount (amount
if known) and are classified as non-adjusting events.
Evaluate:
impact of individual error on individual account balance
impact of aggregate errors on class of assets/liabilities
impact of aggregate errors on profit position of the company
compare with performance and planning materiality levels set
Examine:
The nature of individual error (isolated, repetitive, deliberate,
lack of controls, judgmental, projected, factual)
are errors qualitatively material?
Chapter 12
OPINION
Unqualified Modified
(clean bill of (ASA 705)
health)
(ASA 700)
Unqualified Opinion
Auditor ensures that the financial statements:
are in accordance with the Corporations Act 2001
give a true and fair view
comply with Australia accounting standards
comply with IFRS
And that the auditor has:
obtained reasonable assurance that financial report as a
whole is free from material misstatement, whether due to
fraud or error
obtained sufficient appropriate evidence
concluded that any uncorrected misstatements are
immaterial, both individually and in aggregate
Modified Opinion
Why there is a problem:
Disagree or Limitation of Scope?
Examples:
misstatements exist (material) - disagree
lack of disclosure - disagree
dont agree with an accounting policy - disagree
you should have consolidated but havent - disagree
access to records not given - Limitation of Scope
inability to audit a major subsidiary - Limitation of Scope
records not proper - Limitation of Scope
Impact of Problem:
Are these issues material or pervasive?
Material affects only certain accounts
Pervasive affects the entire financial statements