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Chap 1 Overview

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Chap 1 Overview

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Page 3

CHAPTER 1
Assurance and auditing: an overview

LEARNING OBJECTIVES (LO)

1.1 Understand the framework for assurance engagements and the
types of assurance engagements that can be provided.
1.2 Define auditing and appreciate the fundamental principles
underlying an audit.
1.3 Appreciate the attributes of accounting information and
understand the reasons giving rise to demand for assurance and
resulting benefits.
1.4 Explain the concept of the expectation gap, especially in the areas
of auditor’s report messages, corporate failures, fraud and
communicating different levels of assurance, and appreciate the
relationships between the auditor, the client and the public.
1.5 Appreciate the role of auditing standards and their authority under
the Corporations Act 2001.
1.6 Obtain an overview of other applications of the assurance function,
including compliance engagements, performance engagements,
comprehensive engagements, internal auditing and forensic
auditing, as well as of providing assurance on subject matter other
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

than historical ﬁnancial information.

ASA 102 Compliance with Ethical Requirements when

Performing Audits, Reviews and Other Assurance
Engagements

ASA 200/ISA 200 Overall Objectives of the Independent Auditor and

the Conduct of an Audit in Accordance with
Australian (International) Auditing Standards

ASA 220/ISA 220 Quality Control for an Audit of a Financial Report

and Other Historical Financial Information

ASAE 3000/ISAE 3000 Assurance Engagements Other than Audits or

Reviews of Historical Financial Information

APES 210 Conformity with Auditing and Assurance Standards

AUASB Foreword to AUASB Pronouncements

AUASB/IAASB AUASB Glossary/Glossary of Terms

AUASB/IAASB Framework for Assurance

Engagements/International Framework for
Assurance Engagements

IAASB Preface to the International Standards on Quality

Control, Auditing, Review, Other Assurance and
Related Services

Page 4
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

These reports can take a number of forms, including ﬁnancial reports, which are
prepared in accordance with accounting standards in order to provide
information on the ﬁnancial position and performance of an entity, and
environmental reports, which are prepared in accordance with environmental
standards to provide information on the environmental performance of an entity.
A primary function of the auditing and assurance profession is to provide
independent and expert opinions on these reports based on an examination of
the evidence underlying the information reported, in order to improve the
credibility of these reports.

Auditors usually bring two major types of expertise to an audit. One of these is
an expertise on the subject matter of the underlying report. For example, if the
audit is of a financial report, this requires expertise on the accounting standards
and regulations that underpin the financial report. Students will have started to
develop this expertise by undertaking the financial accounting subjects
contained in an accounting degree, and will further develop it in practice.

The second major type of expertise is auditing and assurance expertise. This
involves, ﬁrstly, understanding the auditing and assurance services profession
(Chapters 1 –3 ). Further, for any particular engagement, it involves
appropriately planning and assessing risk, including developing an
understanding of the reporting entity and of the industry and environment in
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

which it operates, assessing the major risks of misstatement in the underlying

report (Chapters 4 –7 ), collecting audit evidence so that the risk of
misstatement is reduced to an acceptably low level (Chapters 8 –10 ) and
eﬀectively communicating the ﬁndings (Chapters 11 –12 ). This book
explains this process and helps to develop this expertise.

The auditor has developed the audit process and their own expertise and
reputation in the area of auditing ﬁnancial reports. However, this process and
expertise can be applied to areas other than ﬁnancial reports, such as providing

Figure 1.1 outlines the way the text works through the various stages of the
audit process in a logical manner. Each step in the process builds on the steps
that precede it. This framework is expanded upon in each chapter of the text.

Page 5
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

FIGURE 1.1 Flowchart of overall auditing and assurance framework

LO 1.1 The framework for assurance engagements and

the types of assurance engagements

Framework for assurance engagements

In many situations in today’s society, people who are responsible for a specific task (called
responsible parties or managers) need to account for their performance with respect to that
task. There may be many groups who will rely on this accounting for performance as an aid
to their decision making. These groups may be either resource providers or third parties to
the process (other users). There are many examples of such relationships, including:

shareholders relying on financial reports produced by a company’s management

government agencies relying on reports produced by entities to account for environmental
considerations
parents relying on information produced by schools or contained on websites, when
deciding where to send their children.

In order for users to be able to judge the performance of the responsible party, they may
ask the responsible party to provide them with a report of how the resources under their
care have been used in achieving the aims of the relationship. However, it is recognised that
the report by the responsible party is potentially biased, as the responsible party may have
an incentive to prepare a report that reflects their own performance in the best possible
light. Thus, before the report is made available to the user, the credibility of the report is
enhanced by having someone who is both independent and expert (called the auditor or
assurance service provider) examine that the underlying subject matter of the report is
prepared and presented in accordance with an agreed reporting framework (called suitable
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

criteria ) and provide an assessment (the audit or assurance report) that accompanies the
report prepared by the responsible party.

The International Framework for Assurance Engagements, issued by the International

Auditing and Assurance Standards Board (IAASB) (and in Australia by the Australian
Auditing and Assurance Standards Board (AUASB) as the Framework for Assurance
Engagements), covers both audits and reviews of historical financial information and all
other assurance engagements. This initiative therefore recognises the increasing demand
for assurance over a wide range of subject matter.

FIGURE 1.2 The parties to an assurance engagement

Source: ASAE 3000 Appendix 1/ISAE 3000 Appendix 1. (c) 2018 Auditing and Assurance Standards Board
(AUASB). The text, graphics and layout of this publication are protected by Australian copyright law and the
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

comparable law of other countries. No part of the publication may be reproduced, stored or transmitted in any
form or by any means without the prior written permission of the AUASB except as permitted by law. For
reproduction or publication permission should be sought in writing from the Auditing and Assurance Standards
Board. Requests in the ﬁrst instance should be addressed to the Technical Director, Auditing and Assurance
Standards Board, PO Box 204, Collins Street West, Melbourne, Victoria, 8007.

The following five elements of an assurance engagement are identified (paragraph 26 of

the assurance framework):

1. Three-party relationship
Assurance practitioner (auditor) This is the individual(s) undertaking the
assurance engagement. In Australia this would normally be a member of a
Gay, Grant E., and Roger Simnett. Auditing and Assurance Services in Australia, McGraw-Hill Australia, 2018. ProQuest Ebook Central,
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recognised accounting body (CPA Australia, Chartered Accountants Australia and
New Zealand (Chartered Accountants ANZ) or the Institute of Public Accountants
(IPA)), and one who is bound by the profession’s code of ethics.
Responsible party This is the person or persons responsible for the underlying
subject matter. For example, the board of directors (responsible party) is
responsible for the financial position and performance of the entity, which is
communicated by a financial report. In many attestation engagements, the
responsible party may also be the measurer or evaluator and the engaging
party . Where the financial report is the subject matter information, management
is designated as the measurer/evaluator.
Intended users These are the persons expected to use the assurance practitioner’s
report. Often the intended users will be the addressees of the report by the
assurance practitioner, although there will be circumstances where there will be
other identified users.

Page 7

2. Underlying subject matter The underlying subject matter of an assurance

engagement can take many forms, such as:
financial position and performance (for example, historical or prospective financial
information)
non-financial performance (for example, information aimed at efficiency and
effectiveness of use of resources or level of carbon emissions)
physical characteristics (for example, capacity of a facility)
systems and processes (for example, internal controls)
behaviour (for example, corporate governance, compliance with regulation, human
resource practices).
Thus, the definition of assurance engagements is very broad in its coverage and
includes both existing assurance engagements and newly evolving assurance
engagements. The framework also draws a distinction between the underlying subject
matter (such as the underlying financial position and performance of an entity) and
the report on the subject matter, which is called subject matter information (such as
the statements of financial position and income statements).
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

3. Criteria Suitable criteria are the standards or benchmarks used to measure and
evaluate the underlying subject matter of an assurance engagement. Criteria are
important in the reporting of a conclusion by an assurance practitioner, as they
establish and convey to the intended user the basis on which the conclusion has been
formed. For example, the criteria used for preparing a financial report may be Page 8
International Financial Reporting Standards. The auditor then assesses
whether the financial report is prepared in accordance with these criteria. Without
this frame of reference any conclusion is open to individual interpretation and
misunderstanding.

4. Sufficient appropriate evidence The engagement process for an assurance

engagement is a systematic methodology requiring specialised knowledge, a skill

5. A written assurance report The assurance practitioner presents a written conclusion

that provides a level of assurance about the underlying subject matter.

Independence and expertise: professional

judgment and professional scepticism
The assurance practitioner will seek to obtain sufficient appropriate evidence as the basis
for the provision of the level of assurance. In conjunction with the nature and form of the
underlying subject matter, criteria and procedures, the reliability of the evidence itself can
impact on the overall sufficiency and appropriateness of the evidence available.

There are a number of characteristics that make it appropriate for the profession to provide
assurance on a range of underlying subject matter. As mentioned earlier, the profession is
leveraging off its reputation as a high-quality professional provider of assurance services.
In particular, it is the independence and expertise of the assurance practitioner that are
sought after.

Users derive value from the knowledge that the assurance provider has no interest in the
information other than to enhance its credibility. Assurance independence is an absence of
interests that create an unacceptable risk of material bias with respect to the quality or
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

content of information that is the subject of an assurance engagement. Independence

remains the cornerstone on which the assurance function is based, and will be discussed in
more detail in Chapter 3 .

The exercise of professional judgment permeates the notion of professional service. An

assurance service engagement requires the exercise of professional judgment (ASA
200.16/ISA 200.16), which involves the application of relevant training, knowledge and
experience in making informed decisions about the courses of action that are appropriate in
the circumstances of the assurance engagement. The auditor should also plan and perform
the assurance engagement with professional scepticism , which is an attitude that
Gay, Grant E., and Roger Simnett. Auditing and Assurance Services in Australia, McGraw-Hill Australia, 2018. ProQuest Ebook Central,
http://ebookcentral.proquest.com/lib/adelaide/detail.action?docID=5729228.
Created from adelaide on 2021-03-14 21:58:39.
includes a questioning mind, being alert to conditions that may indicate possible
misstatement due to error or fraud, and a critical assessment of audit evidence (ASA
200.15/ISA 200.15). The provision of a professional service requires the assurance
practitioner to offer only those services that they have the competence to complete, to
exercise due care in the performance of the service, to adequately plan and supervise the
performance of the service and to obtain sufficient relevant information to provide a
reasonable basis for conclusions or recommendations. Consideration must also be given to
the appropriateness of measurement criteria and to the need to communicate the
engagement results. Users can obtain assurance from the service only if they are aware of
the assurance practitioner’s involvement.

It could be argued that professional reputation is the critical factor that adds value to the
assurance services offered by the professional accountant. As a profession, we need to
protect or even improve the profession’s brand name, thus enhancing the value of the
assurance services. A further advantage to having members of the accounting profession
provide assurance is that accountants are subject to many professional quality Page 9
controls and disciplining mechanisms, and this should provide assurance to users
about the quality of the inputs to and processes of our services, and therefore the quality of
the final report, the output. It is through this process that assurance services add value.

Whether the accounting profession is successful in becoming the most appropriate group
for providing assurance in a wide range of areas will depend on a number of factors,
including whether society sees accountants as experts in the underlying subject matter of
the assurance engagement. Financial report auditors are expert in the subject matter of
accounting information prepared in accordance with accounting standards, and have
developed processes and a reputation as high-quality assurance providers. Whether this
reputation easily transfers to other areas—such as providing assurance on environmental
reports (or, as argued in Huggins et al., 2011, greenhouse gas reports), and possibly as a
high-cost provider given the necessity of having high-level ethical standards and quality
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

controls in place associated with being a member of the accounting profession—will be the
test of success.

Types of assurance engagements

Reasonable, limited and agreed-upon procedures
engagements

Reasonable A reduction in Suﬃcient appropriate The

assurance assurance evidence is obtained as practitioner’s
engagement engagement part of a systematic conclusion is
risk to an engagement process that expressed in a
acceptably includes: form that
low level obtaining an conveys the
under the understanding of the practitioner’s
engagement
circumstances circumstances opinion on the
of the assessing risks outcome of the
engagement. responding to assessed assessment of
risks the underlying
performing further subject matter
procedures using a against the
combination of inspection, criteria.
observation, conﬁrmation,
recalculation, re-
performance, analytical
procedures and enquiry
(such further procedures
involve substantive
procedures, including,
where applicable,
obtaining corroborating
information, and tests,
depending on the nature
of the underlying subject
matter, of the operating
eﬀectiveness of controls)
evaluating the evidence
obtained.
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

Limited A reduction in Suﬃcient appropriate The

assurance assurance evidence is obtained as practitioner’s
engagement engagement part of a systematic conclusion is
risk to a level engagement process that expressed in a
that is includes obtaining an form that
acceptable understanding of the conveys
under the underlying subject matter whether, based
circumstances and other engagement on procedures
of the circumstances, but in which performed and
engagement procedures are deliberately evidence
Gay, Grant E., and Roger Simnett. Auditing and Assurance Services in Australia, McGraw-Hill Australia, 2018. ProQuest Ebook Central,
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but where limited relative to a obtained, any
that risk is reasonable assurance matter has
greater than engagement. come to the
for a auditor’s
reasonable attention to
assurance persuade them
engagement. that the
information has
been materially
misstated.

FIGURE 1.3 Differences between reasonable assurance and limited assurance engagements
Source: Australian Auditing and Assurance Standards Board (April 2010), Framework for Assurance
Engagements, Appendix 1. (c) 2018 Auditing and Assurance Standards Board (AUASB). The text, graphics and
layout of this publication are protected by Australian copyright law and the comparable law of other countries.
No part of the publication may be reproduced, stored or transmitted in any form or by any means without the
prior written permission of the AUASB except as permitted by law. For reproduction or publication permission
should be sought in writing from the Auditing and Assurance Standards Board. Requests in the ﬁrst instance
should be addressed to the Technical Director, Auditing and Assurance Standards Board, PO Box 204, Collins
Street West, Melbourne, Victoria, 8007.

It is also possible to provide a third type of engagement, termed a related services enga
gement , which covers in particular an agreed-upon procedures engagement .
While this type of engagement involves the use of assurance techniques such as evidence-
collection procedures, it does not involve an attempt to communicate a level of assurance.
A significant difference of this type of engagement from an assurance engagement is that
the auditor does not have the discretion to undertake evidence-collection procedures
outside those that have been agreed upon. The auditor therefore only issues a report of fact
ual findings to the parties that have agreed to the procedures being performed, in which
no conclusion is communicated and which therefore expresses no assurance. However, it
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

provides the user with information to meet a particular need, from which the user can draw
conclusions and derive their own level of assurance as a result of the auditor’s procedures.

The assurance framework (paragraph 17) states that the framework, and therefore all
assurance pronouncements, does not cover agreed-upon procedures engagements, the
compilation of financial information engagements, management consulting services, or the
preparation of tax returns where there is no conclusion conveying a level of assurance. An
auditor who undertakes such engagements is required to apply procedures and an
appropriate level of professional skill and care. This may involve having due regard to

Page 10

Attestation and direct engagements

It is also necessary to distinguish between an attestation engagement and a direct eng
agement . An attestation engagement requires a party other than the auditor to measure
or evaluate the underlying subject matter against the criteria (paragraph 12 of the assurance
framework). The audit of a general-purpose financial report is an example of an attestation
engagement. A direct engagement requires the auditor to directly measure or evaluate the
underlying subject matter against the criteria. For example, an auditor’s report could be
issued on the adequacy of internal control. Where management does not measure or
evaluate the adequacy of internal control, and therefore the auditor is required to report
directly on its adequacy, the engagement is classed as a direct engagement. If, however,
management has measured or evaluated the adequacy of internal control and the auditor is
required to attest to this statement, it is an attestation engagement.

Audit and assurance engagements are supported by a detailed infrastructure of standards

and pronouncements issued by the Australian Auditing and Assurance Standards Board
(AUASB). Following a policy of convergence in Australia with international Page 11
standards, this infrastructure is similar to the structure of the standards and
pronouncements issued by the International Auditing and Assurance Standards Board
(IAASB), which is responsible for setting auditing and assurance standards at the
international level. For audits undertaken in Australia under the Corporations Act 2001, the
auditing standards have legal authority and failure to observe these standards may expose a
member to investigation and disciplinary action from the Australian Securities and
Investments Commission (ASIC). The AUASB and the IAASB will be discussed in more
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

detail in Chapter 2 , as will the structure and the role of auditing and assurance
standards.

An example of the importance of high-quality auditing and its contribution to well-

functioning markets is contained in Auditing in the global news 1.1 .

Why is audit quality important?

Auditors play a critical role in ensuring that Australian investors can be
confident and informed when making investment decisions. High-quality
audits support the quality of financial reports and enable investors to rely on
the auditor’s independent assessment of financial reports.

Audit quality relates to matters that affect the auditor’s ability to achieve an
audit’s fundamental objective: to obtain reasonable assurance that the
financial report as a whole is free of material misstatement. Auditors must
ensure any deficiencies detected are addressed or communicated through
the auditor’s report.

Note: This view is consistent with the objective of the audit, as outlined in
paragraph 11 of Auditing Standard ASA 200 Overall Objectives of the
Independent Auditor and the Conduct of an Audit in Accordance with
Australian Auditing Standards.

Audit quality can be inﬂuenced by such factors as:

an audit ﬁrm’s culture and focus on audit quality, professional scepticism

and consultation
the auditor’s understanding of the business and the risks affecting the
financial report
the internal and external experience and expertise applied in audits
(including recruitment and training, the use of experts, and specialist
industry knowledge)
how effectively audit engagements are supervised and reviewed (including
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

audit ﬁrm quality reviews)

the audit firm’s system of accountability of engagement partners and others
in the firm for audit quality (e.g. impact on remuneration for poor internal
quality review findings).

Source: © Australian Securities & Investments Commission. Reproduced with permission. ‘Audit quality

—the role of directors and audit committees’, Information Sheet 196 (INFO 196), reissued 23 June
2017, http://asic.gov.au/regulatory-resources/ﬁnancial-reporting-and-audit/auditors/audit-quality-th
e-role-of-directors-and-audit-committees/.

4. Users derive value from the assurance report due to the fact that the
assurer:
is independent of the underlying subject matter

has the required expertise, applying professional judgment and

professional scepticism.
5. There are three major types of engagements provided by the auditing
and assurance profession:
reasonable assurance engagement (audit) involves a reduction in
assurance engagement risk to an acceptably low level in the
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

circumstances of the engagement as a basis for the practitioner’s

conclusion
limited assurance engagement (review) involves a reduction in
assurance engagement risk to a level that is acceptable in the
circumstances—but where the remaining risk is greater than with a
reasonable assurance engagement
agreed-upon procedures involves a report of factual ﬁndings, where
no level of assurance is expressed.
6. Auditing pronouncements are applicable to all assurance
engagements, but not to ‘other service’ engagements, such as

Interestingly, auditing, or the audit of financial reports, is no longer defined in the

AUASB/IAASB Glossary. In ASA 200.11 (ISA 200.11), the objectives of the auditor in
undertaking an audit of a financial report are stated as:

(a) To obtain reasonable assurance about whether the financial report as a whole is
free from material misstatement, whether due to fraud or error, thereby enabling the
auditor to express an opinion on whether the financial report is prepared, in all
material respects, in accordance with an applicable financial reporting framework;
and
(b) To report on the financial report, and communicate as required by the Australian
Auditing Standards (ASAs), in accordance with the auditor’s findings.

This definition also underlines the relationship between assurance and audit. Page 13
Assurance covers the range of underlying subject matter information, both financial
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

and non-financial, while the term audit is used to refer to a subset of assurance
engagements, where the subject matter is financial information prepared in accordance
with an applicable financial reporting framework.

While these objectives describe the expected outcomes, they do not describe what an audit
entails, or the process of auditing . A useful definition is that developed by the
American Accounting Association (AAA) in A Statement of Basic Auditing Concepts
(ASOBAC) (1973). It defines auditing as:

The important parts of this definition are:

Systematic process Audits are structured activities that follow a logical sequence.
Objectivity This is a quality of the methods by which information is obtained and also a
quality of the person doing the audit. Essentially it means freedom from bias.
Obtaining and evaluating evidence This is a matter of examining the underlying
support for assertions or representations.
Assertions about economic actions and events An assertion is essentially a proposition
that can be proved or disproved. They are used by the auditor to consider the different
types of potential misstatements that may occur.
Degree of correspondence . . . established criteria This means that an audit establishes
the conformity of assertions with specified criteria.
Communicating results To be useful, the results of the audit need to be communicated
to interested parties by either oral or written means.

This broad definition reflects the essential nature of all assurance engagements as
investigative processes sufficient to encompass the many different purposes for which an
assurance service might be conducted. An example of how this systematic process is
operationalised, which is explained in more detail in Parts 2 and 3 of this book, is
contained in Global example 1.1 .
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

Assume that the auditor, while undertaking the audit of a statement of

financial position, sees as one of the line items in the statement of financial
position an inventory of $1 million. The entity being audited should be able to
provide the auditor with the specific quantity and valuation for each type of
inventory item comprising the $1 million balance. The objective of the auditor
when undertaking the audit of inventory is to determine whether this line
item is materially misstated. As we will outline later in this book, the auditor
uses a risk-based assertion-based methodology in undertaking the audit. In
Chapter 4 we outline the assertions that are contained in account
balances and related disclosures at period end (inventory is an account
balance at year end). The assertions that management is implicitly making by
recording an inventory balance of $1 million in the statement of financial
position are that:

inventory of $1 million exists (existence )

the entity has the rights of ownership of this inventory (rights and obliga
tions )
all inventory that should have been recorded has been recorded (compl
eteness )
inventory has been recorded in the ﬁnancial report at the Page 14
appropriate value, and any resulting valuation adjustments (such as
obsolescence) have been correctly recorded (accuracy, valuation and allo
cation )
inventory has been recorded in the proper accounts (classiﬁcation )
inventory is clearly described and related disclosures are relevant and
understandable (presentation ).
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

The auditor then uses a risk-based methodology to identify the risks of

misstatement and relates these through to the assertions outlined above.
The different types of risks that are considered by the auditors are outlined
in Chapters 5 –7 . For example, consider that the auditor has identified
that the major risk is that the entity may wish to overstate profit. They will
achieve this by overstating inventory, which will understate the cost of goods
sold (if goods are in inventory, they are not sold). The auditor will assess how
the entity is likely to achieve this overstatement, and will concentrate their
audit attention on the related assertions.

The function of auditing as an activity should be viewed as part of the general proposition
that the subject matter information (such as a financial report) is generally of more value to
the various groups that use it if it has been examined and reported upon by an independent
third party. The quality of that information is enhanced by the added credibility given
through the audit function. This ultimately impacts on the process of resource allocation,
with the added credibility given to the subject matter information enhancing the
effectiveness of communication within the economic system.

The subject matter information of the audit can take many forms, for example, the financial
report of a private or public entity, a report on an entity’s carbon emissions, compliance
with prescribed rules or regulations, the cost of a government program or the efficiency or
effectiveness with which resources have been used. When it covers subject matter other
than historical financial information, it is normally referred to as an assurance engagement,
rather than an audit. The nature of the audit process and the criteria used by an auditor to
form and express an opinion depend upon the objectives of the engagement.

Fundamental principles underlying an audit

Fundamental principles encompass the high ideals of professional conduct and the
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

essential qualities underpinning every audit, and should accord with the assurance
framework discussed earlier. Conceptually, fundamental principles should:

underpin the objective(s) of an audit, and help drive the conduct of the auditor in using
professional judgment to meet the professional requirements of the auditing standards
be easily understood both by auditors and other readers of auditing standards
be universally applicable to all audits
entrench the expectations that auditors are expected to accept and abide by.

Page 15

Fundamental principles of professional ethics

The auditor is required to comply with relevant ethical requirements relating to audit
engagements (ASA 200.14/ISA 200.14). This is supported by ASA 220 (ISA 220), which
outlines quality control standards for audits of historical financial information. The five
fundamental principles of ethical requirements contained in ASA 102.A3 (ISA 220.A4) are
those outlined below. They are also the same as those discussed in the national and
international codes of ethics, which are covered in more detail in Chapter 3 .

Integrity An auditor should be straightforward and honest in all professional and

business relationships.
Objectivity An auditor should not allow prejudices or bias, conflicts of interest or undue
influence of others to override professional or business judgment.
Professional competence and due care An auditor has a continuing duty to maintain
their professional knowledge and skill at the level required to ensure that a client or
employer receives the advantage of competent professional service based on current
developments in practice, legislation and techniques. An auditor should act diligently and
in accordance with applicable technical and professional standards in all professional and
business relationships.
Confidentiality An auditor should respect the confidentiality of information acquired as
a result of professional or business relationships and should not disclose any such
information to third parties without proper and specific authority unless there is a legal or
professional right or duty to disclose. Confidential information acquired as a result of
professional and business relationships should not be used for the personal advantage of
the assurance practitioner or third parties.
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

Professional behaviour An auditor should comply with relevant laws and regulations
and should avoid any action that discredits the profession.

Fundamental principles underlying the objective

of an audit
There have been several notable attempts to provide a conceptual basis from which
auditing could proceed and, while each makes a contribution, no comprehensive
framework has yet been formulated. In many respects, the lack of progress on this front
Gay, Grant E., and Roger Simnett. Auditing and Assurance Services in Australia, McGraw-Hill Australia, 2018. ProQuest Ebook Central,
http://ebookcentral.proquest.com/lib/adelaide/detail.action?docID=5729228.
Created from adelaide on 2021-03-14 21:58:39.
reflects the mix of theoretical and policy issues that have influenced supporting disciplines
such as accounting.

Given that auditing standards adopted internationally and in Australia are reportedly
principles based, it has always been a concern that these principles have not been properly
enunciated. To address this concern, in 2005 the IAASB and AUASB released for
discussion a draft consultation paper in which they outlined fundamental principles
underlying an audit. Although this discussion paper is not an authoritative document, and
these fundamental principles are not contained in auditing standards, it is generally agreed
that the following is a comprehensive list of such principles.

Knowledge The auditor should possess a sufficient understanding of the entity and its
environment to appropriately plan and perform the audit, interpret audit findings and
report on the financial report.
Responsibility The auditor should take responsibility for the auditor’s opinion,
maintaining an adequate level of involvement in the audit engagement, properly
supervising any assistants and evaluating the work of experts or others upon whom
reliance is placed.
Quality control The auditor should follow quality control procedures, including
consultation with others as necessary, that support the issuance of an auditor’s report that
is appropriate in the circumstances.
Rigour and scepticism The auditor should plan and perform an audit with thoroughness
and with an attitude of professional scepticism, critically assessing with a questioning
mind the validity and reliability of evidence, and recognising circumstances that may
cause the financial report to be materially misstated.
Professional judgment The auditor should exercise professional judgment, within the
bounds of the fundamental principles and the applicable professional requirements, in
discharging the auditor’s responsibilities.
Evidence The auditor should obtain sufficient appropriate evidence to constitute Page 16
a reasonable basis for expressing an opinion on the financial report.
Documentation The auditor should document matters that are important in providing
evidence to support the auditor’s opinion.
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Communication The auditor should communicate significant matters affecting the

entity’s financial report to management, to those charged with governance and, while
respecting the confidentiality of information, to others, where compliance with local laws
and regulations requires additional communication in the broader public interest.
Association The auditor should not be associated with or allow the use of the auditor’s
name or their report to be associated with information known by the auditor to be
misleading, unless the auditor reports on the information and how it is misleading.
Reporting The auditor should report to those who have appointed the auditor to the
engagement. The auditor’s report should contain a clear expression of opinion in writing
and set out all information necessary for a proper understanding of the opinion and its
basis.

professional behaviour.
5. The fundamental principles underlying the objective of an audit are:
knowledge
responsibility
quality control
rigour and scepticism
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professional judgment
evidence
documentation
communication
association
reporting.

Page 17

Attributes of accounting information

The fundamental objective of financial reporting in its broadest sense is defined in the
Australian Accounting Standards Board (AASB)/International Accounting Standards
Board (IASB) Framework for the Preparation and Presentation of Financial
Statements/Conceptual Framework for Financial Reporting. This framework identifies the
objective of financial reports as the provision of information useful to a wide range of users
for making economic decisions. In meeting this objective, general-purpose financial
reports also represent the means by which management and governing bodies meet their
accountability obligations to report to users by providing information about the
performance, the financial position and the financing and investing activities of the entity.

The functions served by financial reporting comprise economic decision making, control
and accountability. The potential users of financial reports include current and potential
investors, creditors, employees and their representatives, customers, the government and
the public. Some of these users do not have direct access to accounting information nor do
they have the power to demand it. In those circumstances, such users rely on general-
purpose financial reports for information relevant to their needs.

To enable the financial reporting system to meet the fundamental objectives of financial
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reporting, the information should possess the following interrelated fundamental and
enhancing characteristics, as identified in the framework.

Fundamental characteristics

For the information to be useful, it must have the fundamental qualitative characteristics of
relevance and faithful representation.

Relevance This requires that the information provided must be capable of making a
difference in the decision making of report users by assisting them to make and evaluate
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decisions about the allocation of scarce resources and to assess the accountability of the
preparers of these reports. The information needs to have predictive value, confirmatory
value, or both. The information in a financial report is directed to assist them in
predicting the outcomes of past, present or future events (predictive value), or confirming
or correcting past evaluations (confirmatory value). One of the important aspects of
auditing is the determination of the degree of correspondence between assertions about
economic actions and events and established criteria. In terms of general-purpose
financial reporting, the established criteria are those directed towards the provision of
relevant information. In that context, accounting standards represent a financial reporting
framework directed toward providing relevant financial information.
Faithful representation This is the extent to which the information presented to users
represents, without bias or undue error, the underlying transactions and events that have
occurred. This requires the information to be complete, neutral and free from error. The
information needs to have a complete depiction of all the necessary descriptions and
explanations for understanding the phenomenon. The information should be neutral and
not designed to lead users to conclusions that serve particular needs, desires or
preconceptions of report preparers. Faithful representation also requires the information
to be free from error, meaning the descriptions and reporting processes should contain no
errors or omissions.

Enhancing characteristics

The usefulness of relevant and faithfully represented information is enhanced by the

enhancing characteristics—comparability, verifiability, timeliness and understandability.

Comparability means the information can be compared with similar information about
other entities, and with similar information about the same entity for other periods.
Verifiability means that different knowledgeable and independent observers could reach
consensus that a particular depiction is a faithful representation.
Timeliness means having information available to decision makers in a timely Page 18
fashion so that it is capable of influencing their decisions.
Understandability means classifying, characterising and presenting information clearly
and concisely.
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Demand for assurance

The attributes of information (relevance, faithful representation, comparability,
verifiability, timeliness and understandability) provide a basis for the demand for
assurance. Users of assurance services require some assurance as to the quality of
information in terms of those attributes. The role of auditing (and assurance) is seen as
being especially important to faithful representation and relevance. With regard to financial
report audits, the role of the auditor is to be satisfied that the general-purpose financial
report represents what it purports to represent without bias, and that the contents are

Conflict of interest The user (for example, the owner) may perceive an actual or
potential conflict with the preparer (management). Management could have an incentive
to present biased information in a financial report because these reports are a means to
convey information about management’s performance. This conflict creates uncertainty
as to the objectivity of the information preparer. An independent, third-party examination
will reduce the possibility of bias and enhance the credibility of the information.
Consequence When a user is contemplating using information to make decisions of
consequence, the quality of that information is of direct concern.
Complexity The underlying subject matter and the process by which the data (for
example, transactions) is converted into information (for example, financial reports) is
complex and, as it becomes more complex, the possibility of error is increased. The
average user of that information does not possess the required level of expertise to judge
the quality of information.
Remoteness The separation of owner and manager, and therefore the user and the
preparer, whether due to physical, legal or time and cost constraints, prevents the user
from assessing the quality of the information.

These four conditions have given rise to the following three hypotheses to explain the
demand for auditing (Wallace, 1980); these hypotheses could equally be used to understand
the demand for assurance.

1. Agency theory (stewardship hypothesis) In an agency relationship, investors, as

principals in the relationship, entrust their resources to managers, who act as their agents
or as stewards of the resources. However, in this relationship a potential conflict of
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interest arises (management should be trying to maximise returns to investors but has an
incentive to consume or reallocate resources for its own benefit). In an attempt to monitor
their activities, managers are asked to account for the level and performance of resources
under their control by producing periodic financial reports. Because of the potential
conflict of interest outlined above, the complexity of the financial reporting process and
the remoteness of the investors from the managers, the financial reports may be biased.
The use of an agreed-upon reporting framework, generally accepted accounting
principles (GAAP), is one attempt to reduce the bias, and getting assurance on these
reports from an expert who is independent of management also increases the confidence
in the information that is communicated. This is shown in Figure 1.4 .

Page 19
To try to align the interests of managers with those of shareholders, maximising
shareholder wealth, a common practice in today’s environment is for managers to be
rewarded through schemes such as bonuses based on profit and share option schemes. As
rewards may be influenced by the financial information that they produce, management
again may have incentives to bias the financial reports. This provides even further
demand for assurance in today’s society.
2. Information hypothesis An assurance service is a means of improving the quality of
information. For example, investors require information to make an assessment of
expected returns and risks associated with their investment. An assurance service is also
valued as a means of improving financial and non-financial data for internal decision
making, detecting errors and motivating employees to exercise more care in preparing
records.
The information hypothesis also states that investors benefit through the increased
confidence of external users of the information. For example, a study by Blackwell et al.
(1998) showed that for private companies seeking funds from lending institutions, the
costs incurred in audit fees were more than recompensed by the increased savings
associated with lower interest rates when compared with the interest rates charged to
similar companies that were not audited.
3. Insurance hypothesis The insurance hypothesis states that demand for assurance
occurs from those who may suffer loss when things go wrong. For example, if an
organisation goes into liquidation and has no resources to pay its debts, it may be possible
to recover some of the losses from the auditor (the circumstances in which this is possible
are discussed in Chapter 2 ). As auditors are required to have insurance against such
potential losses, this has given rise to a ‘deep-pockets’ effect in that the auditor is seen to
have a greater ability to pay. As audit firms will be very concerned with maintaining their
reputation, any legal action undertaken against them that may damage this reputation will
be treated very seriously.
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There is overlap between these hypotheses, in particular between the agency theory and the
information hypothesis. When providing evidence on stewardship and monitoring, the
assurance provider is also providing information of a particular type to aid the decision-
making process of principals to the contract. While the information hypothesis may be the
major reason for many of the assurance services other than financial report auditing, the
insurance hypothesis will be less likely to explain all these engagements. While this
hypothesis was originally derived to explain demand for financial report audits, it may also
be applied to other specific assurance services, such as expert opinions given in takeover

Beneﬁts of assurance
These characteristics of the demand for assurance result in the following potential benefits
of audit and assurance. For listed companies, one of the major potential benefits is that the
increased relevance and reliability of the assured information means that providers of
capital (shareholders and debt holders) will be able to invest in an entity with Page 20

greater confidence as a result of reduced information risk. This should then result
in a reduced cost of capital for the entity. Auditing should also result in financial
intermediaries such as financial analysts making more accurate and informed
recommendations. Both of these benefits should result in an improved allocation of
investment resources over the range of investment opportunities, and increased confidence
when dealing with audited entities.

An assurance service may also result in one or both of the following benefits:

recommendations by the assurance provider to improve the efficiency and effectiveness

of operations
a positive influence on the behaviour of people whose activities are being assured.

Recommendations usually cite some deficiencies in the activities assured and suggest
possible improvements in performance. Recommendations may contain both an
explanation of the causes of problems and the solution to those problems, or they may
merely identify problems and suggest investigation. For example, auditors conducting a
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

financial report audit typically make recommendations to their clients regarding risks faced
by the organisation and potential improvements to internal control systems.

Auditing and assurance textbooks usually list the positive effect on employees audited as
one of the many benefits of an assurance service. Only recently, however, has research
been conducted to support what assurors have long assumed to be true from their own
experience. In laboratory simulations of the audit process it was found that people whose
activities were assured conformed to established procedures more readily when told that
their work would be subject to an assurance service than did others whose work had not
been previously assured. This performance prevailed even though more efficient
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alternatives were available. Thus, an assurance service has a beneficial effect on the
behaviour of employees.

QUICK REVIEW
1. The accounting attributes of relevance, faithful representation,
comparability, verifiability, timeliness and understandability provide the
basis for the audit function.
2. For general-purpose financial reports, accounting standards represent
a financial reporting framework directed towards providing relevant
financial information, and play a role in providing measurement
techniques to be used in the preparation of reliable information.
3. The four conditions that result in a need for financial report audits are
conflicts of interest, the importance of the decision, the complexity of
the underlying subject matter and the remoteness of users from
managers.
4. The following three hypotheses, which incorporate these conditions,
have been used to explain the demand for financial report audits:
agency theory (stewardship hypothesis)
information hypothesis
insurance hypothesis.
5. The generation of information (and thus assurance) will be a major
determinant of demand for many types of assurance engagements
other than financial report audits, while the insurance hypothesis is
unlikely to explain demand for assurance provided at something other
than the audit level.
6. An assurance service may also result in recommendations to improve
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the eﬃciency and eﬀectiveness of operations and can positively

inﬂuence the behaviour of people whose activities are being assured.

The expectation gap

It is appropriate at this point to recognise that differences have been identified between the
expectations of auditors and financial report users concerning the role and responsibilities
of auditors.

Porter (1993, p. 50) defines the expectation gap as ‘the gap between society’s
expectations of auditors and auditors’ performance, as perceived by society’. The following
two components of the expectation gap can be identified:
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1. the reasonableness gap: the gap between what society expects auditors to achieve and
what they can reasonably be expected to accomplish
2. the performance gap: the gap between what society can reasonably expect auditors to
accomplish and what they are perceived to achieve. This may be further subdivided
into:
deficient standards: the gap between the duties that can reasonably be expected of
auditors and auditors’ existing duties as defined by law and professional
promulgations

FIGURE 1.5 Structure of the gap between audit expectations and audit performance
Source: Adapted from Porter (1993, p. 50).

The expectation gap has also been the basis of the recent amendments to the auditor’s
report, with the prior auditor reporting format seen as contributing to the expectation gap
by creating an information gap and a communications gap. The recent reporting initiatives
for improving the auditor’s report will be discussed in more detail in Chapter 12 . The
IAASB (2011), in their discussion of the expectation gap, identified the concept of an infor
mation gap , a gap between the information that is needed to make informed investment
decisions and what is available to financial report users through the entity’s audited
financial report or other publicly available information.
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This has led to a consideration of how best this information gap can be narrowed by Page 22
providing this type of additional information to users. Users recognise that the
information available to them, including an entity’s audited financial report and the
auditor’s report, is only a part of the wider information set. By design, through the
established financial reporting frameworks and relevant laws and regulations, this smaller
subset of the available information is intended to provide users with a relatively concise
summary of information relevant for their decision making. This is illustrated in
Figure 1.6 .

It also has been suggested that the expectation gap results, in part, from the manner in
which auditors communicate their findings to users of financial reports, which some have
entitled a communications gap (Mock et al., 2013). This reflects differences between
what users desire and understand and what, and how, it is communicated by the assurance
provider. For example, because the standard auditor’s report uses generic language to
describe the auditor’s work effort, users do not get a complete picture about the extent of
the auditor’s procedures on a particular audit and therefore are left with a gap between
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what is actually done and what they perceive is done in connection with the audit.

The debate about the audit expectation gap consistently centres on a number of perennial
issues. Three major expectation gap issues are:

1. early warning by auditors of corporate failure

2. the auditor’s responsibility for the detection and reporting of fraud
3. the auditor’s ability to communicate different levels of assurance.

A common misperception of the audit process is that external auditors should provide the
general public with early warning of corporate failures. While an entity’s financial report is
normally prepared based on the assumption that it is a going concern, this does not
necessarily mean that the entity will continue in existence. The dilemma faced by the
auditors is the requirement to state any unresolved doubts about the entity’s future versus
the risk that any such comments may generate a self-fulfilling prophecy by Page 23
undermining the confidence of the entity’s owners and creditors. Nevertheless, if
facts and circumstances raise doubts about the viability of the entity, those doubts must be
dispelled or disclosed. These concerns about this expectation gap continue even today, as
outlined in Auditing in the global news 1.2 , examining the auditor’s response in
issuing Emphasis of Matter reports associated with going concern issues.
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Auditors of Australian listed entities issue increasing number of

Emphasis of Matter reports associated with going concern issues
[An observed decline for Australian listed entities from 2005–2013] in the
ratio of standard unmodiﬁed auditors’ reports is mainly attributable to the
increase in unmodiﬁed auditors’ reports with Emphasis of Matter paragraphs
[EoMs], rising from 13.0% in 2005 to 18.4% in 2008, maintaining at over 20%
across 2009–2012 and then jumping to 32.3% in 2013 …

The majority of the EoMs are associated with going concern issues. For the
period 2005–2007, 80% to 90% of EoMs are due to going concern-related
uncertainty; increasing to over 90% after 2008, and further increasing to
over 95% after 2012.

We speculate that the increasing trend in going concern-related auditors’

reports for the period 2011–2013 is attributable to the slowdown in China’s
economic growth, the related impact on commodity prices and prospects in
the resources sector and their impact on the Australian economy. Of speciﬁc
concern is uncertainty about the ability of companies to reﬁnance. The trend
may also be an auditor response to increased scrutiny of auditors by
regulators regarding the applicability of the going concern assumption
during this period.

Source: Carson E, Fargher N. and Zhang Y, (2016) Trends in Auditor Reporting in Australia: A Synthesis
and Opportunities for Research, Australian Accounting Review, Vol.26, No. 3, pp. 226-242.
Reproduced by permission of Copyright Clearance Center.
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Earnings management and fraud

Another area where there appears to be an expectation gap is with regard to the auditor’s
duty to detect and report earnings management and fraud. The general public appears to
have a high expectation that auditors will detect or prevent all fraud. While the auditing
profession has historically not regarded fraud detection as a primary audit objective, as a
result of these concerns and recent corporate collapses, the profession has recently taken on
an increased responsibility for identifying fraud. The current auditing standards now

However, an expectation gap still appears to exist. In their discussion of the expectation
gap in their paper Enhancing the Value of Auditor Reporting: Exploring Options for
Change, the IAASB (2011) stated that: ‘In particular, there continues to be a difference
between public perceptions about the auditor’s ability to detect financial statement fraud
and the auditor’s responsibilities relating to fraud under existing professional standards’. A
part of this is that because of the nature and sophistication of these frauds, the auditors still
disclaim their responsibility for, or the expectation of, finding all material frauds. A more
detailed discussion of the auditor’s responsibility for fraud detection is contained in
Chapter 6 .

Ability to communicate diﬀerent levels of assurance

As outlined earlier, the international assurance framework allows either a reasonable level
of assurance to be issued (audit) or a limited level of assurance to be issued (review). An
auditor’s report and a review report have many consistencies in features. These are
discussed in detail in Chapters 12 and 13 , respectively. The opinion Page 24
paragraph for an auditor’s report (reasonable assurance) is contained in
Exhibit 1.1 . This can be compared with the conclusion paragraph for a review report
(limited assurance), which is contained in Exhibit 1.2 .
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Example auditor’s report, single company—Corporations Act 2001

Opinion
In our opinion:
(a) the financial report of ABC Company Ltd is in accordance with the
Corporations Act 2001, including:
(i) giving a true and fair view of the [company/registered
scheme/disclosing entity]’s financial position as at 30 June 20X1 and of
its performance for the year ended on that date
(ii) complying with Australian Accounting Standards and the Corporations
Regulations 2001
(b) the financial report also complies with International Financial Reporting
Standards as disclosed in Note XX.

INDEPENDENT REVIEW REPORT: CONCLUSION

EXHIBIT 1.2
PARAGRAPH

Example review report, single company—Corporations Act 2001

Conclusion
Based on our review, which is not an audit, we have not become aware of any matter
that makes us believe that the half-year financial report of ABC Company Ltd is not
in accordance with the Corporations Act 2001, including:
(a) giving a true and fair view of the consolidated entity’s financial position as at
30 September 2011 and of its performance for the half-year ended on that date
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(b) complying with Accounting Standard AASB 134 Interim Financial Reporting
and the Corporations Regulations 2001.

An important question is whether the user receives the level of assurance that is intended
by the assurance provider. Using subjects from different backgrounds, Gay et al. (1998)
provided some insight into whether users of review and auditor’s reports understand the
messages conveyed, and whether they are able to distinguish between the two levels of
assurance. While users of financial information recognised that an auditors report with a
positive assurance opinion provided greater assurance than a review report with a statement

Roebuck et al. (2000) researched user responses to changes in some of the factors that
determine the level of assurance, by manipulating, firstly, the underlying subject matter of
the work undertaken (historical (internal control) versus prospective (prospective
information)) and, secondly, the level of work undertaken (higher work level versus
moderate work level). In examining the level of assurance conveyed by the assurance
report, it was found that shareholders did not change their level of assurance on the report
as a result of the description of the work performed by the assurance provider (for which
standard wording suggested for assurance reports and already used for audit and review
reports was used). This demonstrates that at this time the auditing and assurance profession
has problems communicating the level of work performed and that other means of
reporting the level of work should be considered in order to communicate this dimension of
the assurance process accurately to report users. Whether or not recent changes in reporting
requirements contained in the assurance framework have adequately addressed this issue is
a research question that is as yet unanswered.

Page 25

QUICK REVIEW

1. Auditors have entities as clients but owners or other members of the public
use their reports.
2. Auditors and ﬁnancial report users have diﬀerent perceptions of the role
and responsibilities of auditors.
3. The expectation gap, which consists of a reasonableness gap and a
performance gap, is the gap between society’s expectations of auditors
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and auditors’ performance, as perceived by society.

4. The performance gap may be due to deficient standards or deficient
performance.
5. The auditor’s report is seen to contribute to the expectation gap by
creating an information gap and a communications gap.
6. Three major expectation gap issues are: auditors giving early warning of
corporate failure, the auditor’s duty to detect and report fraud, and the
communication of different levels of assurance.

It is the essence of a profession that it should have standards that govern the way in which
an assurance service is provided, and outline what the assurance service provider is
required to do. Codified standards make it clear to third parties that the profession does
have standards that its members should achieve and against which performance can be
measured. Standards also assist an individual auditor by providing a benchmark against
which to assess individual performance. In this regard the auditing standard-setting bodies
seek to improve the quality of auditing practice, and by updating their standards these
bodies can inform individual auditors about changes in the audit function. Codified
standards also provide the courts with an authoritative benchmark against which to
measure an auditor’s performance in the event of an auditor’s work being subject to
litigation.

There is also a series of guidance statements (GSs) which are approved and issued by
the AUASB but do not establish new principles and do not amend existing standards. The
guidance statements provide guidance on procedural matters or on entity- or industry-
specific issues.

Part 2M.3 of the Corporations Act 2001 establishes an accountability process whereby
management is responsible for the preparation and presentation of appropriate financial
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reports, with those financial reports to be accompanied by a report of an independent

auditor appointed by the shareholders. Section 307A of the Corporations Act 2001 gives
legal backing to the auditing standards, as it requires auditors to conduct audits and reviews
of financial reports prepared under Part 2M.3 of the Act in accordance with auditing
standards. For other audits and assurance engagements there is also a mandatory obligation
for members of the accounting bodies in Australia to comply with the auditing and
assurance standards under APES 210 Conformity with Auditing and Assurance Standards,
issued by the Accounting Professional and Ethical Standards Board. The responsibility of

QUICK REVIEW
1. The Australian Auditing and Assurance Standards Board (AUASB)
develops auditing standards in Australia in conformity with
international auditing standards developed by the International
Auditing and Assurance Standards Board (IAASB).
2. These standards prescribe the basic principles and essential
procedures that govern the professional conduct of the auditor. Page 26

3. Auditing standards are mandatory for audits conducted under the

Compliance engagements
A compliance engagement is an examination of financial information for the purpose
of reporting on the legality and control of operations and the probity of those responsible
for the administration of funds provided by external parties, including the expression of an
opinion on an entity’s compliance with statute, regulations or other directives that govern
the activities of the entity.

In Australia, compliance engagements are particularly relevant in government, and the

largest organisation of all is the federal government. Government is truly a big business.
The conventions of the Constitution and parliamentary practice in Australia, supported by
statute, require accountability by government departments for receipts and expenditure.
These departments, as well as statutory authorities, are also responsible for the
administration of complex regulations and are themselves subject to regulations.

The responsibility for the audit of federal government operations rests with the Australian
Auditor-General and, for state government operations, with an appointed state auditor-
general. Essentially, the Auditor-General is required to report to Parliament on compliance
of the government departments with the appropriate financial and legal regulations. The
compliance engagement function also extends to the auditing of sections of some
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

government departments that are concerned with the compliance of private sector entities
and individuals with government regulations. For example, Australian Taxation Office
inspectors are in essence auditors concerned with compliance of the community at large
with government policy. This type of engagement is dealt with further in Chapter 15 .

Performance engagements
Performance engagements are also often referred to as ‘value for money auditing’,
‘operational auditing’, ‘efficiency auditing’ or ‘program results auditing’. It is most

A performance engagement is a comprehensive activity designed to analyse organisation

structure, internal systems, work flow and managerial performance. It is usually associated
with issues of efficiency, effectiveness and economy. In short, performance engagements
are intended to provide a measure of an organisation’s achievement of its goals and
objectives.

The products of a performance engagement can range from reports recommending

improvements in efficiency and effectiveness of current operations to general suggestions
about the organisation’s use of resources to provide the greatest long-term benefit to the
entity. Performance engagement reports may contain recommendations for restructuring of
departments or divisions, recommendations for training and replacement of personnel, or
results of cost–value analyses of internal controls of an entity. The performance
engagement has a broad scope and may encompass all major functions of an entity. This
type of engagement is dealt with further in Chapter 15 .

Page 27

Comprehensive engagements
The discussion so far has covered the following engagement types that may be undertaken
as discrete tasks or on an interactive basis:

financial report audit

Collectively, these engagements can be integrated and described as a comprehensive enga

gement . This term is used to describe a broad-scope audit mandate comprising a
combination of elements of the above three types of engagement. In Australia, this
approach is currently more prevalent in public sector auditing, where auditors undertake an
examination for the purpose of expressing an opinion on financial reports, reporting on the
legality and control of operations (including an opinion on an entity’s compliance with
statute, regulations and directives) and reporting on the economy, efficiency and
effectiveness with which the entity has achieved its objectives.

The role of an internal auditor within an entity varies. Internal audits are performed by
employees of organisations functioning in a staff capacity and reporting to a high-level
officer in the organisation. The scope of internal auditing is evolving. Seen traditionally as
an appraisal activity within an organisation for the review of accounting, financial and
other operations as a basis for service to management, many internal auditors have today
found that they can be of increased value to an organisation by participating in the business
risk analysis of the organisation. The role of the internal auditor is discussed further in
Chapter 14 .

Forensic audits
Forensic auditors are employed by companies, government agencies, accounting firms,
and consulting and investigative services firms. They are trained in detecting, investigating
and deterring fraud and white-collar crime. Some examples of situations where forensic
auditors have been involved include:
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analysing financial transactions involving unauthorised transfers of cash between

companies
reconstructing incomplete accounting records to settle an insurance claim over inventory
valuation
proving money-laundering activities by reconstructing cash transactions
investigating and documenting embezzlement, and negotiating insurance settlements.

This type of audit is discussed further in Chapter 13 .

other subject matter. It is also a profession whose members have an established

history and reputational capital that is well known in the community. Moreover, the
profession has strict ethical codes relating to auditor independence and other ethical
considerations, as well as defined investigation and disciplinary procedures. These factors
help to increase public confidence in the competency and legitimacy of the auditing and
assurance profession as assurance providers.

The range of underlying subject matter on which assurance can be, and currently is being,
provided includes future-oriented (prospective) financial information, reports on internal
controls and, more recently, sustainability and carbon emissions reports. The standard for
assurance engagements that operationalises the concepts contained in the assurance
framework is ASAE 3000 (ISAE 3000) Assurance Engagements Other than Audits and
Reviews of Historical Financial Information. This is a general standard; for each of these
subjects there is a more specific standard or guidance that has been or is being developed
by the AUASB or the IAASB. These are covered in Chapters 13 –15 .
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

engaging party
evaluator
existence
expectation gap
forensic audit
fundamental principles
guidance statements (GSs)
information gap
information hypothesis
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

insurance hypothesis
internal audit
limited assurance engagement
measurer
performance engagement
presentation
professional judgment
professional scepticism
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reasonable assurance engagement
related services engagement
report of factual findings
review engagement
rights and obligations
suitable criteria
underlying subject matter
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

Gay, Grant E., and Roger Simnett. Auditing and Assurance Services in Australia, McGraw-Hill Australia, 2018. ProQuest Ebook Central,
http://ebookcentral.proquest.com/lib/adelaide/detail.action?docID=5729228.
Created from adelaide on 2021-03-14 21:58:39.
References and additional readings
American Accounting Association (AAA) (1973) A statement of basic auditing concepts,
Committee on Basic Auditing Concepts, AAA, New York.
Australian Auditing and Assurance Standards Board (AUASB) (2014) Framework for
Assurance Engagements.
Australian Securities and Investments Commission (ASIC) (2017) ‘Audit quality—the role
of directors and audit committees’, Information sheet 196 (INFO 196), reissued 23
June, http://asic.gov.au/regulatory-resources/financial-reporting-and-audit/auditor
s/audit-quality-the-role-of-directors-and-audit-committees/ , accessed 16
December 2017.
Blackwell, D.W., Noland, T.R. and Winters, D.B. (1998) ‘The value of auditor assurance:
evidence from loan pricing’, Journal of Accounting Research, Spring, pp. 57–70.
Carson, E., Fargher, N. and Zhang, Y. (2016) ‘Trends in auditor reporting in Australia: a
synthesis and opportunities for research’, Australian Accounting Review, Vol. 26, No. 3,
pp. 226–42.
Gay, G., Schelluch, P. and Baines, A. (1998) ‘Perceptions of messages conveyed by review
and audit reports’, Accounting Auditing and Accountability, Vol. 11, No. 4, pp. 472–94.
Hasan, M., Maijoor, S., Mock, T.J., Roebuck, P., Simnett, R. and Vanstraelen, A. (2005)
‘The different types of assurance services and levels of assurance provided’,
International Journal of Auditing, Vol. 9, No. 2, pp. 91–102.
Huggins, A., Green, W. and Simnett, R. (2011) ‘The competitive market for assurance
engagements on greenhouse gas information: is there a role for assurers from the
accounting profession?’ Current Issues in Auditing, Vol. 5, No. 2, pp. A1–A12.
International Auditing and Assurance Standards Board (IAASB) (2011) Enhancing the
Value of Auditor Reporting: Exploring Options for Change, www.ifac.org/publication
s-resources/enhancing-value-auditor-reporting-exploring-options-change ,
accessed 16 December 2017.
International Federation of Accountants (IFAC) (2010) ‘IFAC global survey says
international standards crucial to investor and financial stability’, www.ifac.org/news-e
vents/ifac-global-survey-says-international-standards-crucial-investor-and-financi
al-stabili-0 , accessed 16 December 2017.
Mock, T.J., Bédard, J., Coram, P., Davis, S., Espahbodi, R. and Warne, R. (2013) ‘The
audit reporting model: current research synthesis and implications’, Auditing: A
Journal of Practice & Theory, Vol. 32 (Supplement 1), pp. 323–51.
Porter, B.A. (1993) ‘An empirical study of the audit expectation-performance gap’,
Accounting and Business Research, Vol. 24, No. 93, pp. 49–78.
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

Roebuck, P., Simnett, R. and Ho, H.L. (2000) ‘Understanding assurance services reports: a
user perspective’, Accounting and Finance, November, pp. 211–32.
Simnett, R. (2007) ‘A critique of the International Auditing and Assurance Standards
Board’, Australian Accounting Review, July, pp. 28–36.
Simnett, R. and Huggins, A. (2014) ‘Enhancing the auditor’s report: to what extent is there
support for the IAASB’s proposed changes?’, Accounting Horizons, December, pp.
719–48.
Wallace, W.A. (1980) The Economic Role of the Audit in Free and Regulated Markets,
Touche Ross & Co., New York.

Review questions

Framework for assurance engagements

1.1 Explain who is responsible for the preparation and presentation of an entity’s
ﬁnancial report. LO 1.1
1.2 Explain who are the parties to an assurance engagement. LO 1.1
1.3 Discuss what is meant by ‘assurance’ and explain the relationship between
audit and assurances services. LO 1.1

Auditing—deﬁnition and fundamental principles

1.4 According to ASA 200 (ISA 200), what is the objective of the auditor in
undertaking an audit of a ﬁnancial report? LO 1.2
1.5 Describe the fundamental principles underlying the objective of an audit. LO
1.2

Attributes of accounting information and the

demand for assurance
1.6 Explain the two fundamental characteristics required of accounting
information. LO 1.3
1.7 Explain how conflict of interest creates a demand for audit services. LO 1.
3
1.8 Describe who benefits from the services of independent financial report
auditors. LO 1.3

Auditor–client–public relationship and the

expectation gap
1.9 Explain what is meant by the term ‘expectation gap’. LO 1.4
1.10 Explain what is meant by the terms ‘information gap’ and ‘communications
gap’ and how they have contributed to the ‘expectation gap’. LO 1.4

Role and authority of auditing standards

1.11 Explain the role and authority of auditing standards. LO 1.5
Gay, Grant E., and Roger Simnett. Auditing and Assurance Services in Australia, McGraw-Hill Australia, 2018. ProQuest Ebook Central,
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1.12 Do auditors have to comply with auditing standards? Explain. LO 1.5

Other applications of the assurance function

1.13 Provide a brief explanation, and give an example, of each of the following
types of audits:
(a) performance
(b) forensic
(c) compliance. LO 1.6
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

Framework for assurance engagements

1.14 EASY You have recently joined the audit firm of Smith & Singh as an audit
graduate. At your first staff training session, the staff training manager
comments that underlying all assurance engagements is the need
to exercise professional judgment and professional scepticism.
REQUIRED
Discuss the importance of professional judgment and professional
scepticism under the assurance framework. LO 1.1

1.15 MEDIUM Chan & Chow oﬀer their clients a range of professional services,
including:
(a) providing advice on accounting policies and accounting standards

(b) auditing annual ﬁnancial reports

(c) providing assistance to management and the board in Page 31
strengthening internal controls and corporate governance
practices
(d) providing assistance with the establishment and training of internal
audit teams
(e) checking compliance with company policies and legislative
regulations
(f) reviewing half-yearly ﬁnancial reports lodged with ASIC.
REQUIRED
For each of the services listed above, determine whether it is an assurance
engagement, and explain your answer. LO 1.1

1.16 MEDIUM Your audit ﬁrm, Red, Blue & Associates (RBA) is the auditor of
Orange Juice Ltd (OJ). As a fruit juice producer, OJ is subject to strict quality
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

control requirements imposed by legislation, which require all fruit juice

producers to submit an annual report from an appropriately qualified auditor
on compliance with a range of quality control requirements. OJ has
approached you as its auditor requesting that you undertake the work.
OJ has to pay the fee for the quality audit, but the auditor must send their
report directly to the Australian Food Safety Commission (AFSC). The quality
requirements cover areas such as the raw materials, manufacturing
processes, plant and equipment, and production personnel. Peter Fenwick,
OJ’s chief financial officer, has advised the AFSC that RBA is OJ’s nominated
audit firm for the next quality audit. It is now 21 May 2018 and you have
received the quality requirements schedule from the AFSC. This schedule
outlines the specific procedures the auditor is to perform, together with
space for the results of these procedures and a final statement by the
auditor certifying that the entity has complied with the quality requirements
Gay, Grant E., and Roger Simnett. Auditing and Assurance Services in Australia, McGraw-Hill Australia, 2018. ProQuest Ebook Central,
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Created from adelaide on 2021-03-14 21:58:39.
of the legislation. The schedule must be completed and returned by 14 July
2018.
REQUIRED
(a) Indicate the type of engagement that this represents, the level of
assurance provided and the type of report that the auditor is able to
provide.
(b) Indicate whether it is possible to meet the requirements of the
AFSC. LO 1.1

1.17 HARD You are the audit manager of Overseas Explorer Ltd (OEL), which
acquired the small proprietary company Local Pty Ltd (Local) on 30 June
2018. The price of the acquisition was agreed at $5 million, on the condition
that OEL is satisfied with the financial records of Local. As Local is a small
proprietary company, it has not prepared statutory financial reports or
undergone an audit since its incorporation in 2016. However, Local has
agreed to allow your firm, which is the auditor of OEL, to access its books
and records. The CEO of OEL, Wendy Champion, has requested that your
firm provide assurance on the following three items:
(a) the management accounts for the year ended 30 June 2017
(b) all transactions occurring from the date negotiations commenced until
the settlement date, to ensure that all transactions were within the
normal course of operations
(c) the financial report prepared at the acquisition date of 30 June 2018.
In order to clarify your responsibilities, you requested that OEL indicate the
level of assurance that they require for each item. Wendy replied that the
financial report as at acquisition date is very important, as are the
transactions since negotiations commenced, but that she is willing to have
less work done on the previous year’s management accounts.
REQUIRED
Indicate the type of engagement that will most likely be undertaken for each
of the three tasks and the level of assurance to be provided. Explain your
selections. LO 1.1

Auditing—deﬁnition and fundamental principles

1.18 EASY The American Accounting Association deﬁnition of auditing refers to

auditing as being a ‘systematic process of objectively obtaining and
evaluating evidence regarding assertions about economic actions and
events …’
REQUIRED Page 32

Explain what is meant by ‘systematic process’ and ‘objectively obtaining and

evaluating evidence’. LO 1.2

1.20 EASY Auditors are commonly engaged to provide assurance on the

propriety of the balloting process used to determine awards such as
outstanding motion pictures, sporting awards and so on.
REQUIRED
Explain why auditors are chosen for this task. LO 1.3

1.21 MEDIUM Many diﬀerent types of entities undergo audits.

REQUIRED
Provide as many reasons as you can for each of the following types of
entities to undergo an annual audit, and indicate the types of beneﬁts they
would receive from an audit:
(a) Beds for the Homeless, a charity
(b) Winterspoon Ltd, a public company
(c) National Chess Club, a not-for-proﬁt club
(d) Regional Shire Council, a municipal government. LO 1.3

Auditor–client–public relationship and the

expectation gap
1.22 EASY Lindsay Baines is a potential investor in Seascape Ltd (Seascape), a
large manufacturing company. Lindsay has reviewed Seascape’s 2018
audited ﬁnancial report and believes that the auditor’s report provides
absolute assurance that there are no material misstatements in the ﬁnancial
report.
REQUIRED
Advise Lindsay as to whether this is a reasonable expectation, explaining
the reasons for your opinion. LO 1.4

1.24 MEDIUM Susan Prendergast is considering investing in Ocean Voyages

Ltd (OVL), a large cruise ship company. Susan has reviewed OVL’s 2018
audited financial report, which shows a net profit of $500 000 and a net
asset position of $2 million. The auditor’s report is unmodified, stating that
in the auditor’s opinion the financial report gives a true and fair view of the
entity’s financial performance and financial position. As a result, Susan is
now confident about her proposed investment in OVL, as she believes that
the auditor’s report provides absolute assurance about the accuracy of the
financial report, including the healthy profit and net asset figures, and there
is no chance of the company going bankrupt. Further, while she is aware of
the management frauds that have occurred in some companies in Page 33
recent years, she is comforted by the fact that she believes that the
unmodified auditor’s report means that no fraud has occurred within OVL.
REQUIRED
Advise Susan as to whether her conclusions about OVL are reasonable
based on the audited financial report. Provide reasons for your opinion.
LO 1.4

Role and authority of auditing standards

1.25 EASY You are the audit manager for Numbers & Associates, which has just
acquired two new clients: Galaxy Ltd, a public company, and Gold Coast
Copyright © 2018. McGraw-Hill Australia. All rights reserved.

Tennis Club, a not-for-proﬁt entity.

REQUIRED
Discuss whether you need to follow the auditing standards for each
engagement, and if so, explain how this would be enforced. LO 1.5

Other applications of the assurance function

1.26 MEDIUM Gold & Associates (Gold) offers a variety of audit and assurance
services, including:
(a) analysis of financial transactions to identify unauthorised transfers of
cash between companies
Gay, Grant E., and Roger Simnett. Auditing and Assurance Services in Australia, McGraw-Hill Australia, 2018. ProQuest Ebook Central,
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(b) reconstruction of incomplete accounting records to settle insurance
claims
(c) assessment of energy use patterns and recommendation of energy
conservation opportunities
(d) provision of reasonable assurance as to whether financial reports
have been prepared in accordance with applicable accounting
standards
(e) assessment of conformity of employee expense claims with a
company’s policy manual
(f)assisting management in the effective discharge of its responsibilities
by providing independent analysis, appraisals, advice and
recommendations concerning the activities reviewed.
REQUIRED
For each of the services provided by Gold, identify whether an assurance
engagement is being performed, and if so, which type of assurance
engagement (compliance, performance, internal, forensic or financial
report). LO 1.6

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