LECTURE AND TUTORIAL OUTLINE FOR LECTURE 1
SEMESTER 2 2020 (Week of July 27th 2020)
THE CONCEPT OF ASSURANCE AND AN INTRODUCTION TO AUDITING
Lecture 1 introduces the subjects of assurance and auditing. In so doing, five issues are
explored:
1: The concept of assurance
2: Definition of an audit
3: Overview of a financial report audit
4: Reasons for a financial report audit
5: The legal and ethical context for an audit
1: The concept of assurance
An assurance service is defined in the AUASB Glossary as,
“An engagement in which an assurance practitioner expresses a conclusion
designed to enhance the degree of confidence of the intended user…about the
outcome of an evaluation or measurement of a subject matter against criteria.”
As such, we can say that an assurance service provides comfort to the intended user (the
person/ party that is seeking information) so that they can be well informed about the
quality of the information they require.
Importantly, we see that an assurance engagement (of which a financial statement audit is
an example) has five elements:
(1) A three party relationship comprising the responsible party, the intended user
And the assurance practitioner;
(2) A subject matter;
(3) Suitable criteria;
(4) Sufficient appropriate evidence; and
(5) A written assurance report.
There are many different types of assurance engagements. Some we encounter in our
private lives, such as having a pre-purchase report on a vehicle or a house. Others are
more specialised. All have in common the five elements noted above. However, the
subject matter, the qualifications of the assurance practitioner and the extent of the
evidence collection and evaluation can differ. In all cases, quality control, adherence to
ethical principles and the application of assurance standards are required. Examples
specialised assurance services include the following:
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•
Financial report audit
•
Review
•
Report on internal control structures
•
Performance audit
•
Compliance engagement
•
Internal audit
•
Sustainability/ Environmental Audit
2: The definition of an audit
An audit is defined as,
“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.” (American Accounting Association,
1973, cited in Gay and Simnett, 2018, p.13)
In Lecture 1 we will “unpack” this definition in order to get a clear understanding of what an
audit is (and what auditors do when conducting an audit). This is important because, as we
progress through the course, we will explore in some detail all aspects of the audit of a set
of financial statements.
In defining an audit, we also consider what the audit of a set of financial statements
provides. The following quote from the document, “Understanding Financial Statement
Audits: a guide for Financial Statement Users, Ch. 3”, which is in the Auditing, Assurance
and Ethics Handbook 2019, sums this up nicely. It states,
“The auditor provides... an opinion on whether the financial information is
presented fairly…in conformance with the basis of accounting indicated. The
auditor…carries out audit procedures that… enable him or her to provide this high
level of assurance about the reliability of management representations in the
financial statements. The auditor tests the data underlying the entity’s financial
statements and the systems generating that data to obtain evidence that…
provides the basis for the auditor’s opinion whether the financial statements are
free from material misstatement.”
3: An overview of the audit process
Lecture 1 also includes a brief overview of the audit process. It highlights the phases of an
audit and the risk based approach to auditing. In a risk based audit, the auditor identifies
those issues at most risk of misstatement and directs his/ her attention to those.
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4: Reasons for an audit
Audits (in one form or another) have been undertaken for thousands of years. While the
objective of auditing and the method of auditing has changed over time, they are
undertaken because of the benefits they provide. In Lecture 1 we see that there are three
broad reasons for having audits: (1) economic demand for high quality information through
reducing information risk; (2) particular benefits for the client; and (3) legal requirements.
Benefits of an audit
An external audit can bring with it benefits such as (1) access to capital markets; (2) a
lower cost of capital; (3) deterrence to inefficiency and fraud; and (4) internal control and
operational improvements.
5: The legal and ethical and professional context for an audit
Ultimately, the responsibility for financial reporting and auditing in Australia lies with
Government, however, the professional accounting bodies (CPA Australia, Chartered
Accountants Australia and New Zealand, and the Institute of Public Accountants) along
with other stakeholders have input into system. (For listed entities, the Australian Stock
Exchange imposes further requirements).
Government lays down the legislative framework, which encompasses standard setting
and regulation. The supreme body with respect to standard setting is The Financial
Reporting Council, which has oversight of the standard setters: The Australian Accounting
Standards Board and the Auditing and Assurance Standards Board.
Regulation of financial reporting by, and auditing of, each entity depends on the type of
entity and/ or what it does. Regulation of company financial reporting and auditing is
provided for under the Corporations Act. Regulation of financial reporting by, and auditing
of, charities, for example, is provided under the Australian Charities and Not-for-profits
Commission Act.
Auditing is an applied discipline, that it, it is undertaken to serve particular economic and
social objectives. It takes place within a well-defined ethical and legal framework. Lecture 1
introduces that framework. We explore this framework in greater detail in weeks 10 and 11
of the course.
2: LEARNING OBJECTIVES: LECTURE
1: Understand the concept of assurance
2: Explain the five essential elements of an assurance engagement
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3: Define auditing.
4: Become familiar with the main steps in undertaking an audit
5: Understand the reasons for undertaking an audit.
6: Understand the benefits of an audit
7: Appreciate the legal and ethical framework within which an audit takes place
A NOTE ABOUT THE READINGS IN WEEK 1
In week 1 we use five readings in addition to the textbook and the handbook. These
readings are short (one is just one page) but provide essential material on the nature of an
audit and the reasons for undertaking an audit. Some readings cover material that is not
included in the textbook, while some provide a slightly different perspective on material
covered in the textbook. Readings can be accessed through the course web page.
3: REQUIRED READING/ VIEWING
Textbook: Gay, G. and Simnett, R. (2018) Auditing and Assurance in Australia (Seventh
Edition), McGraw-Hill, Sydney, pp. 6-28
Auditing and Assurance Standards Board (AUASB) Pronouncements
(www.auasb.gov.au) AUAS Glossary
Australian Professional and Ethical Standards Board (APESB) Pronouncements
(www.apesb.org.au) APES 110. Glossary
Readings:
Reading 1: Leung, P., Coram, P., Cooper, B. and Richardson, P. (2018) Auditing
and Assurance (First Edition), p. 193, “Benefits of an Audit”. Brisbane, Pearson.
Reading 2: Arens, A., Best, P.J., Shailer, G.E.P., Fiedler, B.A., Elder, and Beasley (2013).
Auditing, Assurance Services and Ethics in Australia: An integrated Approach, 9th edition,
pp. 10-12.
Reading 3: Institute of Chartered Accountants in Australia (2013) Audit and review
requirements for Australian entities.
Reading 4 Understanding Financial Statement Audits – A Guide for Financial Statement
Users, Chapter 1-4.
Reading 5 Wittington and Pany (2012) Principles of Auditing and Other Assurance
Services. McGraw Hill. Pp.142-148.pdf
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Additional Guidance:
Answering Case Study Questions
Film Clips
Film Clip 1: A Few Minutes With… Film1: The importance of an audit.
Film Clip 2: Interview between Lee White and Greg Medcraft. Institute of Chartered
Accountants in Australia
Film Clip 3: Professional Scepticism. Institute of Chartered Accountants of England and
Wales.
4: WEEKLY QUESTIONS (TO BE COMPLETED BY MONDAY AUGUST 3rd)
QUESTION 1
Consider Reading 4, “Understanding Financial Statement Audits: A Guide for Financial
Statement Users”, and answer the following questions:
(i) Why are financial statements needed?
(ii) Why are financial statement audits needed?
(iii) In the process of providing reasonable assurance that the financial statements are
fairly presented, what does an auditor address?
(iv) Does an auditor guarantee the accuracy of the financial statements that he/she
audits?
QUESTION 2
(a) Explain the concept of differential reporting.
(b) Define the following and cite the appropriate sections of the Corporations Act 2001
to support your answer.
(i) Small proprietary limited company;
(ii) Large proprietary limited company.
(c) Using the information in Reading 3 compare the financial reporting and assurance
requirements of a large proprietary limited company with those of a small
proprietary limited company.
QUESTION 3
The textbook, at pp. 7-9, outlines the five elements of an assurance report. Discuss each
of the five elements using the Using examples from the Independent Audit Report on the
2019 Financial Report of Downer Ltd (which can be accessed through the course home
page), answer the following questions:
(a) Who is the responsible party?
(b) What is the subject matter of the audit?
(c) What are the criteria against which the subject matter you identifies in (ii) above are
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evaluated?
(d) What does this audit report tell the reader about the role of Australian
Auditing Standards in the audit?
QUESTION 4 (Exploring audit resources):
Access the website of the Australian Auditing and Assurance Standards Board
(www.auasb.gov.au). From the menu ribbon at the top of the screen, select Publications.
Scroll down and select AUASB Bulletins. Click on the hot link titled, “Professional
Scepticism in an Audit of a Financial Report” (which is dated Aug 12 2012) and, in your
own words, answer the following questions:
(a) What is professional skepticism?
(b) How is professional secpticism applied in an audit?
QUESTION 5 (Using the series of films titled, “A Few Minutes With…)
View film no. 1 of the series, A Few Minutes With.., titled, “The Importance of an Audit”,
and answer the following questions:
(i) What are the benefits of a financial statement audit?
(ii) How can a financial statement audit can reduce information risk?
QUESTION 6
Explain the role and authority of auditing standards.
TUTORIAL WORKSHOP QUESTIONS (TO BE DISCUSSED IN TUTORIALS DURING
THE WEEK OF MARCH 9th 2020)
QUESTION 1: Frank Smart started a manufacturing business ten years ago. Over that
time, the business has grown steadily. Frank now employs 40 staff and has a turnover of
$100m. To fund this growth, Frank sold equity interest to a small group of family members
and friends, and took out a bank loan. He renamed the company Future Pty Ltd. Two
years ago, the company installed a new computerised financial information system in order
to manage its accounting function better, and to reduce costs. The company is considering
further expansion into a potentially lucrative overseas market.
Required: Consider the facts given above and use them to explain the ways in which
Future Pty Ltd can benefit from an external audit of its annual financial statements.
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LEARNING OBJECTIVES: Lecture 1 Learning Objective 8: Understand the reasons for
undertaking an audit; and Learning Objective 9: Understand the benefits of an audit
REFERENCES:
Lecture Slides: Lecture 1, Slides 60-67
Reading 1: Leung, P., Coram, P., Cooper, B. and Richardson, P. (2018) Auditing
and Assurance (First Edition), p. 193, “Benefits of an Audit”. Brisbane, Pearson.
QUESTION 2 Vial-tek Ltd borrowed $1.5m from Australia Bank at an annual interest rate
of 9.5%. Under the loan agreement, the bank requires Vial-tek to provide it with a copy of
its annual financial statements, but does not require an assurance report of any kind. The
bank has offered to replace Vial-tek’s existing loan agreement with a new one at a rate of
8.5%, but would require Vial-tek to provide financial statements that have been reviewed
by a public accounting firm. Alternatively, the bank can replace the existing loan
agreement with a new one at a rate of 7.5%, but would require Vial-tek to have the
financial statements audited by a public accounting firm. The financial controller of Vial-tek
approached a public accounting firm and was given an estimated cost of $12,000 to
perform a review and $20,000 to perform an audit. The accounts clerk has provided this
comparative information in the table below.
ASSURANCE
COST OF
ANNUAL
ANNUAL
ANNUAL
SERVICE
ASSURANCE
INTEREST
INTEREST
LOAN COST ($)
SERVICE
RATE
EXPENSE
None
0
9.5%
$ 142,500
142,500
Review
$12,000
8.5%
$ 127,500
139,500
Audit
$ 20,000
7.5%
$ 112,500
132,500
Required: Explain why the interest rate charged by the lender is highest when Vial-tek
does not provide an assurance report on the financial report and is and lower when an
audit report is provided than when a review report is provided.
LEARNING OBJECTIVES: Lecture 1 Learning Objective 8: Understand the reasons for
undertaking an audit; and Learning Objective 9: understand the benefits of an audit
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REFERENCES:
Reading 2 Arens, A., Best, P.J., Shailer, G.E.P., Fiedler, B.A., Elder, and Beasley (2013).
Auditing, Assurance Services and Ethics in Australia: An integrated Approach, 9th edition,
pp. 10-12.
Lecture Slides: Lecture 1, slides 62-75.
QUESTION 3: Give one example of decision that you may be faced with as you go about
your day-to-day activities for which there is a risk due to the quality of the information you
rely on. Sate one source of information that can reliably reduce risk and one which is less
reliable. An example is provided below.
(Hint: The questions to consider here are: (1) what are some examples of information that
is used in day-to-day activities; (2) what decisions are made on the basis of using the
information; and (3) what assurance can be obtained to ensure that the information is
reliable.)
Decision
Information Reliable information source
Less reliable
information source
What to
Weather
wear.
Get the information from a
Your next door neighbour,
reputable source, such as the
who claims he can tell
Bureau of Meteorology Website,
when it is going to rain
a telephone app such as
because his arthritis gets
WillyWeather, or a newspaper.
worse as humidity builds.
REFERENCES
Lecture Slides: Lecture 1, slides 5-7.
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