BHMH2123

Introduction to Auditing 1

& Taxation

LECTURE 7
AN OVERVIEW OF AUDITING
& AUDIT REPORTS

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 Nature of Auditing [審計]

Auditing is the accumulation and evaluation of evidence

[評核證據] about recorded information to determine and
report on the degree of correspondence between the
recorded information and established criteria
[既定的標準] during accounting period.

Auditing should be done by a competent, independent

person [有技能及獨立人士].
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 Understand objectives and responsibilities
for the audit

• Management is responsible for the financial

statements and for internal control.
• The Sarbanes–Oxley Act increases
management’s responsibility for the financial
statements. The Sarbanes-Oxley Act provides
for criminal penalties for anyone who
knowingly falsely certifies the statements.
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Understand objectives and responsibilities for
the audit (cont’d)
• Auditor’s responsibility is to discover whether there are
any material misstatements presented on financial
statements that affect the users’ economic decision
making.
• Auditors need to distinguish whether there are, with
reasonable assurance and professional skepticism:
– Material vs. immaterial misstatements
– Errors vs. fraud
– Fraud resulting from fraudulent financial reporting vs.
misappropriation of assets 4

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 Objective of an audit
• The objective of an audit of financial statements is to
enable the auditor to express an opinion whether the
financial statements are prepared in a true and fair view,
in all material respects, in accordance with an identified
financial reporting framework
• True implies mathematical accuracy of the financial
statements in that they "add up" and agree with the
numbers in the underlying records.
• Fair implies a broader view of the statements in that they
contain no distortions, and is akin to "reasonableness" in
the eyes of the law - accounts could be mathematically
correct but still be misleading (e.g "window dressing"). 5

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 Objective of an Audit
Opinion
• An audit involves an expression of opinion and is
designed to provide reasonable assurance that the
financial statements taken as whole are free from
material misstatements
In all material respects
• The auditor needs to consider whether the effect
of identified uncorrected misstatements, both
individually and in the aggregate, is material to the
financial statements taken as a whole 6

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 Objective of an Audit
True and fair view
• It is a statutory requirement in Hong Kong and every
Hong Kong incorporated company should have
annual financial statements giving a true and fair
view
An identified financial reporting framework
• In Hong Kong, an identified financial reporting
framework is GAAP in HK, including HKFRSs, and
HK Companies Ordinance
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Steps to Develop Audit Objectives

Understand objectives and

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responsibilities for the audit.

Divide financial statements into

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cycles.

Know management assertions

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about accounts.
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 Steps to Develop Audit Objectives

Know general audit objectives for

4 classes of transactions and account
balances.
Know specific audit objectives for
5 classes of transactions and account
balances.

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 Types of Audits and auditors

Types of Auditors Types of Audit

Financial statement audits
Independent auditors
(statutory/external audits)
Internal or management
Internal auditors
audits
Compliance audits
Government auditors
(e.g. tax audits)

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 Internal Audit [內部審計]

Evaluate computerized payroll system

Example
for efficiency and effectiveness
Number of records processed, costs of
Information
the department, and number of errors
Established Company standards for efficiency and
Criteria effectiveness in payroll department
Available Error reports, payroll records, and
Evidence payroll processing costs 11

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 Compliance Audit [符合審計]

Determine whether bank requirements

Example
for loan continuation have been met

Information Company records

Established
Loan agreement provisions
Criteria
Available Financial statements and
Evidence calculations by the auditor 12

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Statutory/External (Financial Statement) Audit
[財務報表審計]

Annual audit of Boeing’s

Example
financial statements

Information Boeing's financial statements

Established Generally accepted accounting

Criteria principles
Available Documents, records, and outside
Evidence sources of evidence 13

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 Why is auditing needed:
Economic demand for financial statement audits
Required by Companies Ordinance
• To express the opinion on the truth and fairness of the
financial statements
Used as a monitoring mechanism
• To act as a major disciplinary force on corporate governance
and to safeguard the best interest of relevant parties e.g.
creditors and shareholders due to the agency theory
Enhance investors’ confidence
• To provide reliable accounting information for their decision-
making 14

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 Some primary auditing concepts relate to
auditing function

• Audit evidence (discuss further in lecture 10)

• Materiality (discuss further in lecture 11)
• Due audit care
• Fair presentation
• Ethical conduct & Independence (discuss further in
lecture 8)

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 Due audit care
• Relate to how the prudent auditor performs the audit
• A prudent auditor who represents the average of his
profession
• The legal concept of a prudent man provides a useful
guide for auditors
• But it is an imperfect criterion for it cannot cover all
aspects of due audit care

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 Due audit care (cont’d)

• A prudent auditor will:-

– keep abreast of professional development
– be responsive to unusual events and unfamiliar
circumstances
– supervise his assistants properly
– clear any doubt concerning material items
– play special attention to any unusual audit risk

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 Fair presentation
• Auditors oblige to exercise due audit care to ensure
the financial statements
– comply with accounting standards & company law
provisions; and
– provide a clear picture of the entity's financial
status
• Auditor’s judgment is needed because mere
compliance will not necessarily produce fair
presentation of financial statements
• Auditors should report any doubts or deficiencies

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 Auditors’ professional liability

• Criminal liability
– Aware of unlawful events during the audit
process e.g. theft of company resources;
production of false financial statements
• Civil liability under the common law
– Negligence

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 The auditor and fraud and error
• Error
– Unintentional misstatement including omission of an
amount or a disclosure
• Fraud
– Intentional act involving the use of deception to obtain an
unjust or illegal advantages
• Auditor is concerned with misstatements resulting from
– Fraudulent financial reporting (e.g. deception, intentional
misapplication of accounting principles)
– Misstatement of assets (e.g. theft of an entity’s assets)
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 Responsibility for prevention and
detection of fraud and error
 Management and those charged with corporate governance
i.e. the primary responsibility:
 Responsible for prevention and detection of fraud and error
 Creating a culture of honesty and ethical behavior
 Auditor
 not guarantor and an audit does not guarantee detecting
all material misstatements -> due to the difficulties of:
 detection of a material misstatement resulting from
fraud than from error
 detection of a material misstatement resulting from
management fraud than from employee fraud 21

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Three requirements for becoming a CPA in
Hong Kong

Educational requirement

QP programme requirement

Experience requirement
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 Professional designations
Hong Kong
 CPA FCPA
 CPA (Practising) FCPA (Practising)
AUS
 CPA (Aust) FCPA (Aust)
Global qualifications
 ACCA FCCA
 CA FCA
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 Parts of Auditor’s Report [審計報告]
HKSA 700 (Revised)
INDEPENDENT AUDITOR’S REPORT (format)
To the Members of ABC Company
(incorporated in Hong Kong with limited liability)
Report on the Audit of the Financial Statements
• Opinion
• Basis for Opinion
• Key Audit Matters
• Other Information [or another title if appropriate such as
“Information Other than the Financial Statements and
Auditor’s Report Thereon”]
• Responsibilities of Directors and Those Charged with
Governance for the Financial Statements 24

(refer to lecture 9)
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 Parts of Auditor’s Report [審計報告]
HKSA 700 (Revised) cont’d
• Auditor’s Responsibilities for the Audit of the Financial
Statements
Report on Other Legal and Regulatory Requirements

The engagement partner on the audit resulting in this

independent auditor’s report is [name].
XYZ & Co.
Certified Public Accountants (Practising) or Certified Public
Accountants
[Auditor Address]
[Date]
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 Conditions for a standard Auditor’s
Report with Unmodified Opinion

1. Financial statements appropriately disclose the

significant accounting policies selected & applied

2. The applied financial policies are consistent with

the financial reporting framework and the
accounting estimates are reasonable.

3. The information presented in financial

statements is relevant, reliable, comparable and
understandable 26

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 Conditions for a standard Auditor’s
Report with Unmodified Opinion (cont’d)
4. The financial statements with disclosures are
presented in accordance with the financial
reporting framework (e.g. Hong Kong Financial
Reporting Standards HKFRSs).
5. Sufficient appropriate evidences have been
accumulated to conclude that the financial
statements prepared, in all material respects, in
accordance with the applied financial reporting
framework
6. There are no circumstances requiring the
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addition of an explanatory paragraph or
modification of the wording of the report.
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 Emphasis of Matter Paragraph
• Emphasis of Matter Paragraph does not affect the
auditor’s opinion.
• It is not a substitute for:
• The auditor’s expression of a qualified opinion,
an adverse opinion, or a disclaimer of opinion,
or
• The disclosures in the financial statements that
HKFRSs require management to make.

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 Four Categories of Auditor’s Reports

Emphasis of matter
Auditor’s report with
Paragraph
An unmodified opinion
In audit report
[標準無保留意見]
[帶注釋的無保留意見]

Modified opinions Modified opinions

-Qualified opinion -Adverse or disclaimer
[保留意見] [否定意見或拒絕表示意見]
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 Departures from an Unmodified
Opinion

1. Limitation of scope
[審計範圍受限制]

2. Disagreement with management on

accounting or disclosure
[沒有依從會計準則]

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 Modified Opinion[保留意見]

A modified opinion
(except for) report can
result from a limitation on the
scope of the audit or
disagreement with management.

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 Adverse Opinion[否定意見]

It is used only when the auditor believes

that the overall financial statements are
so materially misstated or misleading that
they do not give a true and fair view
in accordance with HKFRSs

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Disclaimer of Opinion [拒絕表示意見]

It is issued when the auditor is unable to obtain

sufficient appropriate audit evidence to provide
a basis for an audit opinion on the
financial statements

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 Materiality [重要性]

Information is material if its

omission or misstatement could
influence the economic decisions
of users taken on the basis of
the financial statements

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 Levels of Materiality [三種不同程度的
重要性]
Amounts are immaterial [不重要]

Amounts are material but do not overshadow

(i.e. pervasive [影 響] the financial statements
as a whole.
Amounts are so material and pervasive [很重要
及有深遠影響] that overall fairness [公允性] of the
statements is in question. 35

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 Relationship of Materiality to Type of
Opinion
Materiality Significance in Terms of Type of
Level Reasonable Users’ Decisions Opinion
Users’ decisions are unlikely
Immaterial to be affected. Unmodified

Users’ decisions are likely

Material to be affected. Qualified

Highly Users’ decisions are likely Disclaimer

material to be significantly affected. or adverse
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 Levels of materiality
• There are three levels of materiality that will affect the decision of
using different audit opinions
Materiality Level Material but not So material and
pervasive to pervasive that
Immaterial affect the fairness of the
Cir- financial financial
statements as a statements as a
cumstances
whole whole is
lead to qualification affected
Limitation of scope Unmodified Qualified “Disclaimer”
opinion or “except for” opinion
Disagreement with unmodified with opinion “Adverse”
management on emphasis of opinion
accounting treatment matter
e.g. policies or paragraph
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disclosures
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 Auditor’s Decision Process

Determine whether any condition exists

requiring a departure from a standard
unmodified report.

Decide the materiality for each condition.

Decide the appropriate type of report.

Write the auditor’s report.

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 End of Lecture 7

Students are reminded to read the

following chapters of AAHK:

Relevant areas of Auditing textbook

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