Auditing, Print and Interactive E-Text

About the authors ix Preface x Chapter 1 Introduction and overview of audit and assurance 1 Audit process in focus 4 1.1 Auditing and assurance defined 4 1.2 Different assurance services 4 1.2.1 Financial report audits 4 1.2.2 Compliance audits 5 1.2.3 Performance audits 6 1.2.4 Comprehensive audits 6 1.2.5 Internal audits 6 1.2.6 Corporate social responsibility (CSR) assurance 7 1.3 Different levels of assurance 10 1.3.1 Reasonable assurance 10 1.3.2 Limited assurance 14 1.3.3 No assurance 16 1.4 Different audit opinions 16 1.5 Preparers and auditors 17 1.5.1 Preparer responsibility 17 1.5.2 Auditor responsibility 18 1.5.3 Assurance providers 19 1.6 Demand for audit and assurance services 20 1.6.1 Financial report users 20 1.6.2 Sources of demand for audit and assurance services 20 1.6.3 Theoretical frameworks 21 1.6.4 Demand in a voluntary setting 22 1.7 The role of regulators and regulations 23 1.7.1 Regulators 23 1.7.2 Regulation 26 1.8 The audit expectation gap 28 Summary 30 Key terms 30 Multiple-choice questions 31 Review questions 32 Professional application questions 33 Case study — Crest Outfitters 36 Research question 38 Further reading 38 Solutions to multiple-choice questions 38 Endnotes 38 Acknowledgements 39 Chapter 2 Ethics, legal liability and client acceptance 40 Audit process in focus 42 2.1 The fundamental principles of professional ethics 42 2.1.1 Integrity 42 2.1.2 Objectivity 42 2.1.3 Professional competence and due care 43 2.1.4 Confidentiality 43 2.1.5 Professional behaviour 43 2.2 Independence 44 2.2.1 Threats to independence 44 2.2.2 Threat identification and safeguards to independence 45 2.3 The auditor’s relationships with others 47 2.3.1 Auditors and shareholders 47 2.3.2 Auditors and the board of directors 47 2.3.3 Auditors and the audit committee 48 2.3.4 Auditors and internal auditors 49 2.4 Legal liability 50 2.4.1 Legal liability to clients 50 2.4.2 Contributory negligence 52 2.4.3 Legal liability to third parties 53 2.4.4 Avoidance of litigation 54 2.5 Client acceptance and continuance decisions 55 Summary 59 Key terms 59 Multiple-choice questions 60 Review questions 61 Professional application questions 62 Case study — Crest Outfitters 66 Research question 67 Further reading 67 Solutions to multiple-choice questions 67 Endnotes 67 Acknowledgements 68 Chapter 3 Risk assessment I 69 Audit process in focus 71 3.1 Phases of an audit 71 3.1.1 Risk assessment phase 72 3.1.2 Risk response phase 73 3.1.3 Concluding and reporting on an audit 73 3.2 Gaining an understanding of the entity and of the financial reporting framework 73 3.2.1 Entity level 74 3.2.2 Industry level 76 3.2.3 Economy level 77 3.3 Fraud risk 77 3.3.1 Incentives and pressures to commit a fraud 78 3.3.2 Opportunities to perpetrate a fraud 79 3.3.3 Attitudes and rationalisation to justify a fraud 79 3.4 Going concern 79 3.4.1 Going concern risk — indicators 80 3.4.2 Going concern risk — mitigating factors 80 3.5 Corporate governance 81 3.6 Information technology 85 3.7 Closing procedures 86 Summary 88 Key terms 88 Multiple-choice questions 89 Review questions 90 Professional application questions 90 Case study — Crest Outfitters 95 Research question 98 Further reading 99 Solutions to multiple-choice questions 99 Endnotes 99 Chapter 4 Risk assessment II 100 Audit process in focus 102 4.1 Audit risk 102 4.1.1 The audit risk model and its components 103 4.2 Materiality 106 4.2.1 Qualitative and quantitative materiality 106 4.2.2 Setting materiality 106 4.3 Audit strategy 107 4.4 Client approaches to measuring performance 109 4.4.1 Profitability 110 4.4.2 Liquidity 110 4.5 Analytical procedures 111 4.5.1 Comparisons 111 4.5.2 Trend analysis 111 4.5.3 Common-size analysis 112 4.5.4 Ratio analysis 113 4.5.5 Other analytical procedures 115 4.5.6 Factors to consider when conducting analytical procedures 116 Summary 118 Key terms 118 Multiple-choice questions 119 Review questions 120 Professional application questions 121 Case study — Crest Outfitters 126 Research question 130 Solutions to multiple-choice questions 130 Endnotes 130 Chapter 5 Audit evidence 131 Audit process in focus 133 5.1 Assertions 133 5.2 Types of audit evidence 135 5.2.1 Sufficient appropriate audit evidence 135 5.2.2 External confirmations 136 5.2.3 Documentary evidence 138 5.2.4 Representations 138 5.2.5 Verbal evidence 144 5.2.6 Computational evidence 144 5.2.7 Physical evidence 144 5.2.8 Electronic evidence 144 5.2.9 Data analytics 145 5.3 Persuasiveness of audit evidence 146 5.3.1 Internally generated evidence 146 5.3.2 Externally generated evidence held by the client 146 5.3.3 Externally generated evidence sent directly to the auditor 146 5.4 Using the work of an expert 147 5.4.1 Assessing the need to use an expert 147 5.4.2 Determining the scope of the work to be carried out 147 5.4.3 Assessing the capability of the expert 147 5.4.4 Assessing the objectivity of the expert 147 5.4.5 Assessing the expert’s report 148 5.4.6 Responsibility for the conclusion 148 5.5 Using the work of another auditor 148 5.6 Evidence gathering procedures 149 Summary 151 Key terms 151 Multiple-choice questions 153 Review questions 154 Professional application questions 155 Case study — Crest Outfitters 159 Solutions to multiple-choice questions 160 Endnotes 160 Acknowledgements 160 Chapter 6 Gaining an understanding of the client’s system of internal controls 161 Audit process in focus 163 6.1 Internal control defined 163 6.2 Objectives of internal controls 164 6.3 System of internal control 165 6.3.1 The control environment 165 6.3.2 The entity’s risk assessment process 168 6.3.3 The entity’s process to monitor the system of internal control 169 6.3.4 Information systems and communication 170 6.3.5 Control activities 171 6.3.6 Internal controls in less complex entities 173 6.4 Transaction-level internal controls 173 6.4.1 Example transaction flows — sales process 174 6.4.2 Example transaction flows — cost of sales process 174 6.5 Documenting internal controls 176 6.6 Identifying strengths and weaknesses in a system of internal controls 180 6.7 Management letters 180 Summary 184 Key terms 184 Multiple-choice questions 185 Review questions 186 Professional application questions 186 Case study — Crest Outfitters 191 Research question 194 Solutions to multiple-choice questions 194 Endnotes 194 Acknowledgements 194 Chapter 7 Sampling and overview of the risk response phase of the audit 195 Audit process in focus 197 7.1 Audit sampling 197 7.2 Sampling and non-sampling risk 199 7.2.1 Sampling risk and tests of controls 199 7.2.2 Sampling risk and substantive procedures 200 7.2.3 Non-sampling risk 201 7.3 Statistical and non-statistical sampling 202 7.4 Sampling methods 202 7.4.1 Random selection 202 7.4.2 Systematic selection 202 7.4.3 Haphazard selection 203 7.4.4 Block selection 203 7.4.5 Judgemental selection 203 7.4.6 Factors to consider when selecting a sample 204 7.5 Factors that influence the sample size — testing controls 205 7.6 Factors that influence the sample size — substantive testing 206 7.7 Evaluating sample test results 208 7.8 Tests of controls and substantive procedures 209 7.8.1 Tests of controls 209 7.8.2 Substantive procedures 210 7.9 Nature, timing and extent of audit testing 211 7.9.1 Nature of audit testing 211 7.9.2 Timing of audit testing 212 7.9.3 Extent of audit testing 212 7.10 Drawing conclusions 213 7.11 Documentation — audit working papers 214 7.11.1 Permanent file 214 7.11.2 Current file 215 Summary 220 Key terms 221 Multiple-choice questions 222 Review questions 223 Professional application questions 224 Case study — Crest Outfitters 228 Research question 229 Solutions to multiple-choice questions 229 Endnotes 229 Acknowledgements 229 Chapter 8 Execution of the audit —testing of controls 230 Audit process in focus 232 8.1 Types of controls 232 8.1.1 Prevent and detect controls 233 8.1.2 Manual and automated controls 236 8.2 Techniques for testing controls 238 8.2.1 Enquiry 238 8.2.2 Observation 239 8.2.3 Inspection of physical evidence 239 8.2.4 Re-performance 239 8.3 Selecting and designing tests of controls 239 8.3.1 Which controls should be selected for testing? 239 8.3.2 How much testing does the auditor need to do? 239 8.4 Results of the auditor’s testing 244 8.5 Documenting conclusions 245 Summary 248 Key terms 248 Multiple-choice questions 249 Review questions 250 Professional application questions 250 Case study — Crest Outfitters 254 Research question 256 Solutions to multiple-choice questions 256 Endnotes 256 Chapter 9 Execution of the audit —performing substantive procedures 258 Audit process in focus 260 9.1 Overview of substantive procedures 260 9.1.1 Substantive procedures and assertions 260 9.1.2 Definition of substantive procedures 262 9.2 Relationship between risk assessment and the nature, timing and extent of substantive procedures 263 9.2.1 Timing of substantive procedures 264 9.3 Substantive audit procedures 265 9.3.1 Tests of details 265 9.3.2 Key item testing 266 9.3.3 Analytical procedures 267 9.3.4 Types of analytical procedures 267 9.3.5 Performing substantive testing using computers 268 9.4 Levels of evidence 269 9.4.1 Persuasive 269 9.4.2 Corroborative 270 9.4.3 Minimal 271 9.4.4 General 271 9.5 Evaluating and documenting substantive analytical procedures results 272 9.5.1 Evaluating errors identified in testing 272 9.5.2 Concluding and documenting the results of substantive procedures 273 Summary 275 Key terms 275 Multiple-choice questions 276 Review questions 277 Professional application questions 277 Case study — Crest Outfitters 281 Research question 283 Solutions to multiple-choice questions 283 Endnotes 283 Chapter 10 Substantive testing and balance sheet accounts 284 Audit process in focus 286 10.1 Relationship between risk assessment and substantive procedures 286 10.1.1 Extent of substantive procedures 286 10.1.2 Timing of substantive procedures 286 10.1.3 Matters to consider when designing substantive procedures 288 10.2 Substantive testing of cash 289 10.2.1 Principal objectives in auditing cash 289 10.2.2 Processes affecting cash 290 10.2.3 Illustrative procedures for auditing cash 291 10.3 Substantive testing of trade receivables 292 10.3.1 Principal objectives in auditing trade receivables 293 10.3.2 Processes affecting trade receivables 293 10.3.3 Illustrative procedures for auditing trade receivables 293 10.4 Substantive testing of inventory 297 10.4.1 Principal objectives in auditing inventory 298 10.4.2 Processes affecting inventory 298 10.4.3 Illustrative procedures for auditing inventory 300 10.5 Substantive testing of property, plant and equipment 302 10.5.1 Principal objectives in auditing property, plant and equipment 303 10.5.2 Processes affecting property, plant and equipment 304 10.5.3 Illustrative procedures for auditing property, plant and equipment 305 10.6 Substantive testing of payables 306 10.6.1 Principal objectives in auditing payables 307 10.6.2 Processes affecting payables 307 10.6.3 Illustrative procedures for auditing payables 308 10.7 Special considerations for auditing other balance sheet accounts 309 10.8 Assessing the results of substantive procedures 310 Summary 311 Key terms 312 Multiple-choice questions 312 Review questions 313 Professional application questions 314 Case study — Crest Outfitters 322 Research question 323 Solutions to multiple-choice questions 323 Endnotes 323 Acknowledgements 324 Chapter 11 Substantive testing and income statement accounts 325 Audit process in focus 327 11.1 Relationship between risk assessment and substantive procedures 327 11.1.1 Differences between auditing income statement and balance sheet accounts 327 11.1.2 Extent of substantive procedures 328 11.1.3 Timing of substantive procedures 328 11.2 Substantive testing of revenue 328 11.2.1 Principal objectives in auditing revenue 329 11.2.2 Processes affecting sales revenue 330 11.2.3 Illustrative procedures for auditing revenue 331 11.3 Substantive testing of cost of sales and other significant expenses 333 11.3.1 Principal objectives in auditing costs and expenses 334 11.3.2 Processes affecting costs and expenses 334 11.3.3 Illustrative procedures for auditing costs and expenses 335 11.4 Assessing the results of substantive procedures 336 Summary 338 Key terms 338 Multiple-choice questions 339 Review questions 340 Professional application questions 341 Case study — Crest Outfitters 348 Solutions to multiple-choice questions 349 Endnotes 350 Acknowledgements 350 Chapter 12 Completing and reporting on the audit 351 Audit process in focus 354 12.1 Engagement wrap-up 354 12.1.1 Sufficient appropriate audit evidence 356 12.1.2 Evaluating audit evidence 356 12.2 Going concern 357 12.3 Subsequent events 358 12.3.1 Type 1 subsequent events —adjusting events 358 12.3.2 Type 2 subsequent events —non-adjusting events 359 12.3.3 Procedures used when conducting a subsequent events review 359 12.4 Misstatements 361 12.4.1 Current-year misstatements 362 12.4.2 Prior-year misstatements 362 12.4.3 Qualitative considerations 363 12.5 Evaluating the conclusions and forming an opinion 363 12.6 Components of the audit report 364 12.7 Modifications to the audit report 365 12.7.1 Emphasis of matter 366 12.7.2 Limitation of scope 366 12.7.3 Disagreement with those charged with governance 367 12.8 Corporations Act 2001 breaches 367 12.9 Management representation and communication with those charged with governance 368 12.9.1 Audit matters of governance interest to be communicated 368 12.9.2 Documentation considerations 369 Summary 370 Key terms 371 Multiple-choice questions 371 Review questions 372 Professional application questions 373 Case study — Crest Outfitters 377 Research question 380 Solutions to multiple-choice questions 381 Endnotes 381 Index 382