The Audit Framework

Question 1

Relationships between principal (owners), agent (directors) and auditors

Principal to Agent:
Agent to Auditor:
Auditor will: (5)
Management involves fixing: (3)
Manager is accountable to owners:

Answer 1

Principal to Agent

• Principal provides capital and hires agent to manage it

Agent to Auditor

• Agent hires auditor and pays auditor to reduce principal’s information risk

Auditor to Principal

Auditor will:

• gather evidence
• evaluate fairness
• issue audit opinion
• add credibility
• reduce information risk

Management involves fixing:

• Information asymmetry
• Conflicts of interest
• Information risk for principal

Manager is accountable to owners:
Provides financial reports

Question 2

Auditing - definition

A systematic process of:

The process done?
Why?
What they do at the end.

Answer 2

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.

Question 3

Assurance Services definition

An engagement in which _______________ expresses a ______________: (2)

Answer 3

An engagement in which practitioner expresses a conclusion:

• designed to enhance the degree of confidence of the intended users other than the responsible party
• about the outcome of the evaluation or measurement of a subject matter against criteria.

Question 4

Auditing & Assurance Compared

Engaged by?
Nature of Work?
Quality of Evidence?
Reporting?

Answer 4

Engaged by

Audit:

• Directors on behalf of Shareholders

Assurance:

• Interested Party

Nature of Work

Audit:

• Strict Guidelines

Assurance:

• Variable

Quality of Evidence

Audit:

• Stringent

Assurance:

• Usually less detailed

Reporting

Audit:

• To Shareholders

Assurance:

• To interested party

Question 5

Audit Engagement

Four basic aims. To evaluate:

1. Whether ______________ _____________ & accompanying notes are in accordance with ___________ ___________.
2. The __________________ & ____________________ of internal control systems over _____________ __________.
3. The possibility of ______ occurring within the organisations.
4. The ___________ that the ______________ will ___________

Answer 5

Four basic aims. To evaluate:

1. Whether financial statements & accompanying notes are in accordance with specified criteria.
2. The effectiveness & appropriateness of internal control systems over financial reporting.
3. The possibility of fraud occurring within the organisations.
4. The likelihood that the organisation will continue

Question 6

Fundamental Concepts: Audit Risk
What is it?
What does the auditors standard report state? (2)

Answer 6

Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.

The auditor’s standard report states that the audit provides only reasonable assurance that the financial statements do not contain material misstatements.

Reasonable assurance implies some risk that a material misstatement could be present in the financial statements and the auditor will fail to detect it.

Question 7

Fundamental Concepts: Materiality

_____________ or _______________ of items are material if they could, individually or collectively, influence the ____________ ____________ of users taken on the basis of the financial statements.

Materiality depends on the ______ and ____________ of the ___________ or __________________ judged in the surrounding __________________.

That is, the ______ or ______________ of the item, or a ______________ of both, could be the ______________ factor.

Try do without gap fill prompts

Answer 7

Omissions or misstatements of items are material if they could, individually or collectively, influence the economic decisions of users taken on the basis of the financial statements.

Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances.

That is, the size or nature of the item, or a combination of both, could be the determining factor.

Question 8

Fundamental Concepts: Evidence

Evidence that assists the auditor in evaluating management’s financial statement assertions consists of: (2)

The auditor will be concerned with: (2)

Answer 8

Evidence that assists the auditor in evaluating management’s financial statement assertions consists of:

• The underlying accounting data
• And any other corroborating information available to the auditor.

The auditor will be concerned with:

• Relevance
• Reliability

Question 9

Fundamental Concepts: Management Assertions

Financial statements issued by management contain ____________ and ____________ assertions. E.g. (3 with description)

Answer 9

Financial statements issued by management contain explicit and implicit assertions. E.g.

Transactions (E)
Management asserts that transactions related to inventory actually occurred.

Account Balances (I)
Management asserts that the entity owns the inventory represented in the inventory account.

Presentation & Disclosure (I)
Management asserts that the financial statements properly classify and present the inventory.

Question 10

Fundamental Concepts: Summary of Assertions by category (6,4,4)

Answer 10

Transactions: These assertions ensure that all transactions are correctly recorded. They include:

• Occurrence: Transactions recorded actually happened.
• Completeness: All transactions that should be recorded are included.
• Authorization: All transactions are properly authorized.
• Accuracy: Amounts and data are correct.
• Cut-off: Transactions are recorded in the correct accounting period.
• Classification: Transactions are properly classified in financial statements.

Account Balances: These assertions ensure that the balances reported are accurate and valid. They include:

• Existence: Assets, liabilities, and equity interests exist.
• Rights & Obligations: The entity holds rights to the assets and obligations to liabilities.
• Completeness: All balances that should be reported are included.
• Valuation & Allocation: Balances are properly valued and allocated.

Presentation & Disclosure: These assertions ensure that financial statements are properly presented and disclosed. They include:

• Occurrence and Rights & Obligations: Disclosed events and transactions have occurred and pertain to the entity.
• Completeness: All disclosures that should be included are.
• Classification & Understandability: Financial information is appropriately presented and easily understood.
• Accuracy & Valuation: Financial information is accurate and properly valued.

Question 11

RECAP: AN AUDITOR’S RESPONSIBILITIES

What does an auditor have the responsbility of?
What is a result of the nature of audit evidence?
What does the auditor have no responsibility to do?

Answer 11

An auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.

Because of the nature of audit evidence and the characteristics of fraud, the auditor is able to obtain reasonable, but not absolute, assurance that material misstatements are detected

The auditor has no responsibility to plan and perform the audit to obtain reasonable assurance that misstatements, whether caused by errors or fraud, that are not material to the financial statements will be detected.

Question 12

Pervasive (5 parts)
What does it mean and how is it different?

Answer 12

• Equity
• Assets
• Liabilities
• Expenses
• Revenues

Pervasive means a misstatement is so serious that it affects the entire financial statements, making them unsuitable for any use. Pervasive misstatements are different from material misstatements because there are no set thresholds to determine the level of pervasiveness.

EALER

Question 13

STANDARD AUDIT REPORT: UNMODIFIED OPINION

How common is it?
Why?

Answer 13

The most common type of audit report issued is the “standard audit report with an unmodified opinion” because management’s assertions about the entity’s financial statements are usually found to conform to the financial reporting framework.

Question 14

An Overview of Audit Reporting (picture)

Different types of opinions, what they mean and where they come from (6)

Answer 14

Immaterial:

Unmodified Opinion: When the issues found are immaterial, the auditor issues an unmodified (or “clean”) opinion, indicating that the financial statements present a true and fair view.

Unmodified with a Matter Paragraph: Even if immaterial issues are present, an auditor might add an explanatory paragraph to highlight certain matters without modifying the opinion itself.

Material:

Qualified Opinion:

Scope Limitation: If there is a limitation in the audit scope (either client-imposed or condition-imposed), meaning the auditor could not obtain sufficient evidence for a particular area, the opinion is qualified.

Departure from Financial Reporting Framework: If the financial statements deviate from applicable accounting standards (but not pervasively), resulting in material misstatements, the opinion is also qualified.

Material and Pervasive:

Disclaimer of Opinion:

Scope Limitation: If the auditor’s inability to obtain sufficient evidence is both material and pervasive, preventing them from forming an opinion, a disclaimer of opinion is issued.

Adverse Opinion:

Departure from Financial Reporting Framework: If the financial statements are both materially and pervasively misstated due to deviations from accounting standards, the auditor issues an adverse opinion, indicating that the financial statements do not present a true and fair view.

Question 15

AUDIT REPORT: EXAMPLE

Content (9)

Answer 15

Content:

• Independent auditor’s report to the members of [XYZ Limited]
• Opinion
• Basis of opinion
• Conclusions relating to the going concern
• Other information
• Opinions on other matters prescribed by the Companies Act 2006
• Matters on which we are required to report by exception
• Responsibilities of directors
• Auditor responsibilities