Auditing Being an auditor
Required:
(a) Write a letterto Kim explaining the concept of reasonable assurance, and how
reasonable assurance is determined. Explain why an auditor cannot offer absolute assurance.
There is a gap between Kim’s expectations and
the level of auditor performance. An auditprovides reasonable assurance, not absolute assurance. The audit enhancesthe reliability and
credibility ofthe information included in a inancial report but is not a guarantee that the financial report is free from error or fraud,
orthatthe company will notfail. Partly, this is because ofthe nature of financial reporting. lt requiresjudgements about accounting
estimates and the choice and application ofvarious accounting methods. There is usually not one ‘right’ answer for a company’s
profit. The auditor cannot guarantee the profit reported bythe company is ‘right’, only1 provide assurance about the appropriateness of
the accounting method se ection and application and the accounting estimates. Anot er reason the assurance is not absolute isthe nature of
the audit process. Auditors cannot review every transaction and account balance so use sampling (which could mean that representative items
are not selected fortesting), some transactions and balances are difficultto gather reliable evidence about, clients can conceal evidence,
and auditors have a limited time frame in which to complete the audit.
(b) Also explain in the letterto Kim the concept of
professional scepticism’ and how it is not the same as assuming that managers are alwaystrying to deceive auditors.
Professional
scepticism is required of an auditor. It is an attitude that requiresthe auditorto remain independent ofthe client and its staff. The
auditor has a questioning mind and thoroughly investigates all evidence presented by their client. This does not mean that they regard the
client as a liar, but that they need to do more than simplytake the client’s word about anything. Usually, there will be confirming
evidence which supports the client’s statements (e.g. copies of contracts, minutes of meetings, etc). Evidence gathered from independent
third parties is generally regarded as more reliable than that gathered from the client. Managers will not alwaystry to deceive auditors,
but auditors must take the responsibility of gathering evidence to verifying managers’ statements. The auditor needsto be alert to the
factthat some managers will try to deceive auditors sometimes.
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2.3 Provision of non-audit servicesto audit clients
Required
(a) Comment on Elise’s beliefthat increasing non-audit service fee revenue from her audit clientwould increase her
reputation in the audit firm.
(rb) Which non-audit services would you advise Elise to avoid trying to sell to Hertenstein Ltd because of
t eir potential ethical issues forthe auditfirm?
(c) Would it make any difference to your answers if Hertenstein Ltd was a proprietary
company, not a listed public company?
(a) It is possible that increasing the profitability ofthe auditfirm would increase Elise’s
reputation within the firm. However, ifthe growth in revenue creates any conflicts of interest or other ethical problems it could damage
Elise’s reputation. See APES 110, s. 290.158 – ifthe provision of non-assurance services creates a threat to the auditor’s
independence, safeguards would need to be applied to eliminate or reduce the threat.
(b) See 290.159 of APES 110 for a guide to which
services to avoid. This section statesthat the auditor should avoid acting as an executive ofthe client company. The auditor should not be
involved in transactions, making decisions aboutthe audit firm’s recommendations, management reporting to directors, or acting as manager
ofthe client within the previoustwo years.
s. 290.161 discusses less significant threats,which should only be offered after careful
consideration because they could create self-review or self-interest threats. These include having custody of a client’s assets,
supervising client employees, and preparing source documents. The section also discusses examples of safeguards, such as making arrangements
so that personnel providing such services do not participate in the audit, and gaining additional advice on the impact of such
services.
(c) Yes. Auditors can provide more non-audit servicesto a proprietary companythan to a listed company.
290.170 The Firm, or
a Network Firm, may provide an Audit Client that is not a Listed Entity with accounting and bookkeeping services, including payroll
services, of a routine or mechanical nature, provided any self-reviewthreat created is reduced to an acceptable level.
Examples of such
services include:
Recording transactions forwhich the Audit Client has determined or approved the appropriate account
classification;
Posting coded transactionsto the Audit Client’s general ledger;
Preparing Financial Statements based on
information in the trial balance; and
Posting the Audit Client approved entriesto the trial balance.
The section continues by
explaining thatthe significance of aqy thre_at created should be evaluated and, ifthe threat is otherthan Clearly lnsignificant,
sa eguar s should be considered an applied as necessary to reduce the threat to an acceptable level.
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3.2 Understanding
the client and its governance
Required
(a) Make a list ofthe main factorsthat will be considered by each audit manager’s
group.
(b) Based on the above information, can you conclude that Ajax Ltd complies with Principle 4 ofthe principles? Explain.
(3)
Entity level
efer to para A23-A27 ofASA315)
Team will be trying to gain an understanding of:
Complexity ofthe client’s
structure (subsidiaries, locations, investments)
Ownership and relations between owners and other people or entities (related party
issues)
Factors to consider include:
Business operations – revenue, products, markets, production, outsourcing, geographic dispersion,
segmentation on industry lines, location of facilities and inventories, key customers, suppliers, employment arrangements, research and
dev elopment activities, transactions with related parties.
lnvestments- new or planned acquisitions or divestitures, investments in
securities and loans, capital investment, non-consolidated entities.
Financing – major subsidiaries, debt, beneficial owners,
derivatives.
Financial reporting issues such as principles and practices usually applied, rev enue and cost recognition, fair v alue
accountinfg, foreign currency items, complextransaction accounting,
Changes rom prior periods in any ofthese factors.
(ii) Industry
and economic effects
(Refer to para A17-A22 ofASA315)
Factors to consider include:
Competitive environment, supplier and customer
relationships, technological developments, cyclical or seasonal activities, energy supply and cost, nature of regulation, including
accounting practices, specific regulations affecting industry, taxation, government policies, environmental requirements, general economic
conditions, interest rates, availability of financing, inflation, currency revaluations.
(b) Principle 4 oftheASX recommendations
refers to safeguarding the integrity in the entity’s financial reporting (see figure 3.4). The ASX recommendsthatthe entity establishes
an audit committee which is comprised only of non-executive directors, with a majority of independent directors, and chaired by an
independent chair who is not chair ofthe board. The committee should have at least 3 members, and operate with a formal charter.
The
question states that there are four members ofthe audit committee,who are all independent directors. In addition, the chair ofthe
committee is an independent director. However, we do not know ifthe chair ofthe committee is also the chair ofthe board, nor ifthe
committee has a formal charter. If both these conditions are satisfied (and the apdpropriate disclosures are made), we could conclude that
the entity complies with Principle 4, but without this information we could not ma e t is conclusion.
