Solutions Manual - 1.2 Chapter 1: Auditing and Governance Chapter ...

Solutions Manual For Audit and assurance 2 nd Edition by Philomena Leung Paul Coram Barry Cooper Kirsty Redgen Dominic Canestrari-Soh 1 / 4

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Chapter 1: Auditing and Governance

Chapter 1: Auditing and Governance

Review questions 1.11Describe the nature of an audit.An auditor sets out to achieve enhanced credibility of information disclosed to increase reliability for the users of the financial statements. A definition from the Committee on

Basic Auditing is as follows:

An audit is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users.

1.12What does an independent auditor do during a financial report audit?The auditor will provide a written opinion to the shareholders of a company as to the truth and fairness of the financial report prepared by management. This includes ensuring that the financial report is free from material error and is prepared in accordance with relevant accounting standards and corporate law; in Australia, this means compliance with the Corporations Act and Australian Financial Reporting Standards.The auditor performs audit procedures, generally performing tests on samples of the company’s transactions and balances, to provide sufficient and appropriate evidence upon which to rely in forming the audit opinion. Where the company has an effective internal control system that prevents, detects and corrects potential accounting and reporting errors, the auditor may choose to rely on those internal controls and reduce the amount of detailed testing performed. Where there are no effective internal controls in place, the auditor will perform extensive tests of the company’s transactions and balances.Once the audit work is completed the evidence is assessed and judgments are made as to the possibility of the financial report containing material errors. If the auditor believes that the financial report contains material errors the management will be requested to make any necessary amendments to the report. If management refuse to amend the report the auditor will consider the need to modify the audit opinion to highlight the errors to the users of the financial report.© John Wiley & Sons Australia, Ltd 2023 2 / 4

1.3 Solutions manual to accompany Audit and assurance 2e by Leung et al.

1.13Explain how agency theory results in a demand for auditing.In an agency relationship, investors (as principals) entrust their resources to managers (as agents). The agent’s self-interest is expected to diverge from the principals’ interest, giving rise to agency costs. A consequence of this agency problem is that investors will ‘price protect’ themselves on the assumption that managers are acting for themselves. It is therefore a rational response that there is a demand for a financial statement audit to verify the assertions made by management.

1.14 What are the current implications of the audit expectation gap? Can it be reduced?The current implications of the audit expectation gap are the same as it has always been. A difference in expectations about what users think they are getting and what they are actually getting is going to be a problem – particularly for a service like auditing that is difficult to observe. There are three important areas where differences

in perceptions occur and they are as follows:

1.Reporting on internal control. Reporting on internal control has not been taken on in the Australian environment – unlike in the US with Sarbanes-Oxley. In fact, the most recent iteration of the audit report actually includes a specific disclaimer on the issue of reporting on internal control.

2.Detection of fraud. This has been an area where auditors have expanded their responsibilities in recent years through the development of ASA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of a Financial Report (ISA 240). However, it is still not seen as the core objective of an audit and the only responsibility that still exists in relation to fraud is material fraud. As stated

by the Chairman of the FRC, Jeff Lucy:

“I would say there is, in fact, now a clear market expectation to this effect – that is, that auditors are bloodhounds not just watchdogs. Simply put, the market expects auditors to pick up instances of fraud”.

3.Evaluation of going concern. Current auditors’ responsibilities include a consideration of going concern. However, they make no positive assurance about what they do in this regard. Despite not commenting on this issue, the fact is that users think auditors are guaranteeing the ongoing financial viability of a firm, which is not currently true.Reducing the gap has traditionally focused on educating users about what an audit is actually designed to provide. However, this has not been particularly successful, and therefore, in the future, more substantive changes on what auditors do and provide to users would seem the main way that a reduction in the expectation gap could occur.© John Wiley & Sons Australia, Ltd 2023 3 / 4

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Chapter 1: Auditing and Governance

1.15 What are the suggestions to address the audit expectation gap?

The ACCA defines the audit expectation gap to include three gaps: (1) knowledge

gap; (2) performance gap; and (3) evolution gap.The ACCA refers that the knowledge gap is the difference between what the public thinks auditors do and what auditors actually do. This recognises that sometimes the public has a misunderstanding about what auditors are responsible for. The performance gap focuses on areas where auditors do not do what auditing standards or regulations require due to insufficient focus on quality, complexity of certain auditing standards, or differences in interpretation of auditing standards or regulatory requirements. The evolution gap exists in the areas of the audit where there is a need for evolution, taking into account the general public’s demand, technological advances and how the overall audit processes can be enhanced to add more value.ACCA recommends that there is an urgent need for audit to evolve and to listen to the public’s legitimate concerns about audit. Closing the expectation gap in audit will support a more constructive discussion about how audits can evolve to meet society’s expectations.In October 2021, CAANZ, together with ACCA, CPA Canada, and the AASB Canada published a report which advocates a holistic approach to narrow the expectation gap on fraud and going concern.

The main recommendations of the CAANZ report include:

• encouraging forensic specialists to be involved in risk assessment where a high risk is identified, but allowing auditors to still apply their professional judgement when determining how to respond to identified fraud risks, as mandatory use of forensic specialists may widen the expectation gap • encouraging the IASB and the IAASB to explore additional going concern disclosures as supplements for the ‘current binary approach to disclosing material uncertainty about going concern’ • suggesting that the IAASB, along with national standard setters, determine if the auditing standards could be ‘enhanced’ in such a way as to assist audit practitioners to apply professional scepticism rather than introducing an additional ‘suspicious’ mindset.

1.16 List and explain the elements of an assurance engagement.Assurance is a broad term to describe any situation where information is prepared by one party and then attested to its accuracy by another party. Assurance engagements can relate to a broad set of potential engagements that may be financial or non- financial, and the level of assurance provided can vary according to the particular engagement. It is important to understand that in all assurance engagements (regardless of the subject matter and level of assurance provided), the practitioner must apply professional judgement and professional scepticism.© John Wiley & Sons Australia, Ltd 2023

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