File: Chapter 01 Discussion problems and case studies
[QUESTION 01]
You are an auditor with O’Brien and Associates and have been approached to undertake the audit of the
financial report of Lithgow Ltd for the year ended 30 June 2024. Lithgow is a listed company that
produces and sells office furniture throughout Australia and New Zealand. Explain the five elements of
this assurance engagement.
[TYPE Short Answer]
[ANS]
The five elements of this assurance engagement are as follows:
1. A “three-party relationship” is required for an assurance engagement as follows:
Responsible party—Lithgow’s directors are responsible for the underlying subject matter and are
therefore the responsible party.
Practitioner—O’Brien & Associates will conduct the assurance (audit) engagement and is therefore the
practitioner (auditor).
Intended users—Lithgow’s shareholders are the main intended users of the assurance report.
2. An “underlying subject matter”, which is what the practitioner is expressing an opinion on. Therefore,
Lithgow’s financial report is the underlying subject matter.
3. “Suitable criteria”, which are the benchmarks used to evaluate or measure the subject matter. As
Lithgow Ltd is a publicly listed company, the financial report will need to be prepared in accordance with
AASB accounting standards, the Corporations Act 2001 and ASX listing requirements and so they are the
suitable criteria.
4. “Sufficient appropriate evidence”, which would need to be obtained from Lithgow’s financial records,
the directors, management and external sources, that Lithgow’s financial report complies with AASB
accounting standards, the Corporations Act 2001 and ASX listing requirements.
5. The practitioner needs to provide a “written assurance report” that conveys the assurance obtained
about the subject matter information. O’Brien and Associates will therefore be required to provide an
auditor’s report in accordance with ASAs and the Corporations Act 2001.
[TAGS]
Learning Objective: 1.1 Understand the framework for assurance engagements and the types of
assurance engagements that can be provided
Topic: The framework for assurance engagements and the types of assurance engagements
Difficulty: Easy
Blooms: Comprehension
[QUESTION 02]
You have recently joined the audit firm of Albert & Chan as an audit graduate. At your first staff training
session, the staff training manager comments that underlying all assurance engagements is the need to
exercise professional judgment and professional scepticism. Discuss the importance of professional
judgment and professional scepticism under the assurance framework.
[TYPE Essay]
[ANS]
ASA 200.16 (ISA 200.16) requires that the auditor exercise professional judgment in the planning and
performance of the audit of a financial report. This is because the interpretation of relevant ethical
requirements and Australian auditing standards cannot be made without the application of relevant
training, knowledge and experience in making informed decisions about the courses of action that are
appropriate based on the facts and circumstances of the assurance engagement. For example,
judgments need to be made about materiality; audit risk; the nature, timing and extent of audit
procedures required to obtain sufficient appropriate audit evidence; evaluating evidence; and drawing
conclusions based on the evidence obtained.
ASA 200.15/ISA 200.15 requires that the auditor also plan and perform the assurance engagement with
professional scepticism, which is an attitude that includes a questioning mind, being alert to conditions
that may indicate possible misstatement due to error or fraud, and a critical assessment of audit
evidence.
[TAGS]
Learning Objective: 1.1 Understand the framework for assurance engagements and the types of
assurance engagements that can be provided
Topic: The framework for assurance engagements and the types of assurance engagements
Difficulty: Easy
Blooms: Comprehension
[QUESTION 03]
You are an audit partner with Ainsworth & Willis and your client, Sportswear Ltd, has requested that
you:
(a) Provide an oral report to Sportswear’s bank on the truth and fairness of the half-yearly financial
report that Sportswear has submitted to its bank in support of its loan application.
(b) Prepare a report giving a written opinion addressed to and for use by management indicating
whether the half-yearly management accounts give a true and fair view in accordance with Australian
Accounting Standards.
Explain whether each of these engagements is an assurance engagement.
[TYPE Short Answer]
[ANS]
(a) No—This is not an assurance engagement, as the report is oral, and a written report is required as a
necessary element of an assurance engagement.
(b) No—This is not an assurance engagement, as there are only two parties to the engagement, auditors
and management, who is also the intended user, and three parties are required as a necessary element
of an assurance engagement.
[TAGS]
Learning Objective: 1.1 Understand the framework for assurance engagements and the types of
assurance engagements that can be provided
Topic: The framework for assurance engagements and the types of assurance engagements
Difficulty: Easy
Blooms: Comprehension
[QUESTION 04]
Dawn Ltd, an electrical engineering firm with offices throughout Australia, has requested its auditor,
Craig & Associates, to undertake the following three engagements and report on the results of their
work:
(a) Check whether the annual schedule of bonuses paid to senior management has been calculated
correctly by checking the figures used in the calculations to the company’s audited accounting records.
(b) Conduct detailed analytical procedures and enquiries of management as to whether the half-yearly
financial report lodged with ASIC presents a true and fair view, and whether it has been prepared in
accordance with Australian Accounting Standards.
(c) Conduct whatever tests are deemed necessary to determine whether its annual financial report
presents a true and fair view, and whether it has been prepared in accordance with Australian
Accounting Standards.
For each engagement, explain whether the engagement is an audit, review or agreed-upon-procedures
engagement and the level of assurance provided.
[TYPE Short Answer]
[ANS]
(a) This engagement is an agreed-upon-procedures engagement, as the client is deciding on the
procedures to be undertaken when checking the calculations. No assurance is provided, but rather a
statement of factual findings would be provided, and the client could deduce their own assurance from
it, as they are the ones that decided on what needs to be done.
(b) This engagement is a review engagement, as analytical procedures and enquiries only are being
carried out. Therefore, only a limited level of assurance will be provided.
(c) This engagement is an audit, as a full range of tests are being carried out and the auditor is deciding
on what testing is to be done. Therefore, a reasonable level of assurance would be provided.
[TAGS]
Learning Objective: 1.1 Understand the framework for assurance engagements and the types of
assurance engagements that can be provided
Topic: The framework for assurance engagements and the types of assurance engagements
Difficulty: Medium
Blooms: Application
[QUESTION 05]
Your audit firm, Henderson, Williams & Associates (HWA), is the auditor of Apple Juice Ltd (AJL). As a
fruit juice producer, AJL is subject to strict quality control requirements imposed by legislation, which
require all fruit juice producers to submit an annual report from an appropriately qualified auditor on
compliance with a range of quality control requirements. AJL has approached you as its auditor
requesting that you undertake the work.
AJL has to pay the fee for the quality audit, but the auditor must send their report directly to the
Australian Food Safety Commission (AFSC). The quality requirements cover areas such as raw materials,
manufacturing processes, plant and equipment, and production personnel. Jason McKenzie, AJL’s chief
financial officer, has advised the AFSC that HWA is AJL’s nominated audit firm for the next quality audit.
It is now 21 May 2024 and you have received the quality requirements schedule from the AFSC. This
schedule outlines the specific procedures the auditor is to perform, together with space for the results
of these procedures and a final statement by the auditor certifying that the entity has complied with the
quality requirements of the legislation. The schedule must be completed and returned by 14 July 2024.
Indicate the type of engagement that this represents, the level of assurance provided, the type of report
that the auditor is able to provide and whether it is possible to meet the requirements of the AFSC.
[TYPE Short Answer]
[ANS]
Because the procedures that HWA will perform are stipulated in the schedule, this will be an agreedupon-procedures engagement. No assurance will be provided. A report of factual findings will be issued.
HWA cannot provide the auditor’s statement requested, even if they conducted an audit rather than an
agreed-upon-procedures engagement, as it is not possible to provide certification (as certification
implies absolute assurance). The highest level of assurance possible by an auditor is reasonable
assurance when an audit is conducted.
[TAGS]
Learning Objective: 1.1 Understand the framework for assurance engagements and the types of
assurance engagements that can be provided
Topic: The framework for assurance engagements and the types of assurance engagements
Difficulty: Medium
Blooms: Application
[QUESTION 06]
You are the audit manager of your client, International Services Ltd (ISL), which acquired the small
proprietary company, Regional Pty Ltd (Regional), on 30 June 2024. The agreed price of the acquisition
was $5 million, on the condition that ISL is satisfied with the financial records of Regional. As Regional is
a small proprietary company, it has not prepared statutory financial reports or undergone an audit since
its incorporation in 2020. However, Regional has agreed to allow your firm, which is the auditor of ISL, to
access its books and records.The CEO of ISL, Sally Rogers, has requested that your firm provide
assurance on the following three items:
(a) the management accounts for the year ended 30 June 2023
(b) all transactions occurring from the date negotiations commenced until the settlement date, to
ensure that all transactions were within the normal course of operations
(c) the financial report prepared at the acquisition date of 30 June 2024.
To clarify your responsibilities, you requested that ISL indicate the level of assurance that they require
for each item. Sally replied that the financial report as at acquisition date is very important, as are the
transactions since negotiations commenced, but that she is willing to have less work done on the
previous year’s management accounts.
Indicate the type of engagement that will most likely be undertaken for each of the three tasks and the
level of assurance to be provided. Explain your selections.
[TYPE Short Answer]
[ANS]
(a) A review engagement would most probably be undertaken to provide limited assurance on the
management accounts for the ended 30 June 2023. This should be sufficient, as Sally has indicated that
she is willing to have less work done on these management accounts.
(b) An agreed-upon-procedures engagement would be undertaken provided that the client, ISL, specifies
what they mean by transactions “within the normal course of operations”. No assurance would be
provided, but rather a report of factual findings would be issued, and the client could deduce their own
assurance from it, as they are the ones that decided on what needs to be done.
(c) An audit providing a reasonable level of assurance would be required on the financial report at
acquisition date of 30 June 2024, as one would expect that more than a limited level of assurance would
be required on a financial report prepared for acquisition purposes, and you are told that the CEO
considers the financial report at acquisition date to be very important.
[TAGS]
Learning Objective: 1.1 Understand the framework for assurance engagements and the types of
assurance engagements that can be provided
Topic: The framework for assurance engagements and the types of assurance engagements
Difficulty: Hard
Blooms: Analysis
[QUESTION 07]
The American Accounting Association definition of auditing refers to auditing as being a “systematic
process of objectively obtaining and evaluating evidence regarding assertions about economic actions
and events”. Explain what is meant by “systematic process” and “objectively obtaining and evaluating
evidence”.
[TYPE Short Answer]
[ANS]
A systematic process means that financial report audits are structured activities that follow a logical
sequence with appropriate planning documents and programs. Undertaking their task objectively means
that a financial report auditor must be independent, so that the auditor is able to give an unbiased
opinion. This is essential if users are to rely on the auditor’s opinion. Objectively obtaining and
evaluating evidence is a major part of the audit, as a financial report auditor must gather sufficient
appropriate audit evidence by examining the underlying support for assertions or representations
contained in the financial report to come to an opinion as to whether the financial report gives a true
and fair view.
[TAGS]
Learning Objective: 1.2 Define auditing and appreciate the fundamental principles underlying an audit.
Topic: Auditing—definition and fundamental principles
Difficulty: Easy
Blooms: Comprehension
[QUESTION 08]
Rupert Harris, your audit assistant, is unsure about the relationship between the attributes of financial
reporting information and auditing. Explain to Rupert the connection between auditing and preparing
and communicating accounting information.
[TYPE Short Answer]
[ANS]
Financial reports are prepared in accordance with accounting standards to provide information on the
financial position and performance of an entity. This information is useful to a wide range of users for
making economic decisions. Financial reports also represent the means by which management and
governing bodies meet their accounting obligations to report to users. However, the financial reports
prepared by management and governing bodies may be biased, as they have an incentive to prepare
reports that reflect their own performance in the best possible light.
The independent audit of these reports enhances their credibility. The purpose of financial report
auditing is to provide independent and expert opinions as to whether the financial reports are materially
misstated from the basis on which they are prepared (such as accounting standards) based on an
examination of evidence underlying the data reported and communicate that to users through the
auditor’s report.
[TAGS]
Learning Objective: 1.3 Appreciate the attributes of accounting information and understand the reasons
giving rise to demand for assurance and resulting benefits
Topic: Attributes of accounting information and the demand for assurance
Difficulty: Easy
Blooms: Comprehension
[QUESTION 09]
Your staff training manager has indicated that there are three explanatory theories of auditing: agency
theory, the information hypothesis and the insurance hypothesis. Briefly explain each theory.
[TYPE Essay]
[ANS]
Agency theory (stewardship hypothesis) sets out that in an agency relationship, investors, as principals
in the relationship, entrust their resources to managers, who act as their agents or as stewards of the
resources. However, in this relationship a potential conflict of interest arises (management should be
trying to maximise returns to investors but have an incentive to consume or reallocate resources for
their own benefit). In an attempt to monitor their activities, managers are asked to account for the level
and performance of resources under their control by producing periodic financial reports. Because of
the potential conflict of interest, the complexity of the subject matter and the remoteness of the
investors from the managers, the financial reports may be biased, which creates a demand for assurance
to ensure the accountability of managers.
The information hypothesis indicates that an assurance service is a means of improving the quality and
credibility of information. An assurance service is also valued as a means of improving financial and nonfinancial data for internal decision making, detecting errors and motivating employees to exercise more
care in preparing records. Also, the investors benefit through the increased confidence of external users
in the information.
The insurance hypothesis indicates that the demand for assurance arises from those who may suffer loss
when things go wrong. For example, if an organisation goes into liquidation and has no resources to pay
its debts, it may be possible to recover some of the losses from the auditor. As auditors are required to
have insurance against such potential losses, this has given rise to a “deep-pockets” effect in that the
auditor is seen to have a greater ability to pay. As audit firms will be very concerned with maintaining
their reputation, any legal action undertaken against them that may damage this reputation will be
treated very seriously.
[TAGS]
Learning Objective: 1.3 Appreciate the attributes of accounting information and understand the reasons
giving rise to demand for assurance and resulting benefits
Topic: Attributes of accounting information and the demand for assurance
Difficulty: Easy
Blooms: Comprehension
[QUESTION 10]
Reliability Insurance Ltd is a large well-established insurance company that provides life, property and
public liability insurance. Reliability Insurance has included the following information in its notes to the
financial report for the year ended 30 June 2024:
(a) The results of the independent actuary’s report undertaken in 2021 on the adequacy of its selfinsurance reserves.
(b) A contingent liability of $15 million for the outcome of a class action lawsuit lodged for unspecified
damages against an insurance client for product defects that resulted in serious injury to users of the
product and to which litigants are still being added.
Explain which attributes of accounting information the auditor would be concerned about in these two
scenarios.
[TYPE Short Answer]
[ANS]
(a) The auditor would be concerned about the relevance of the information, as the actuary’s report is
three years old and therefore is out of date and not relevant to an assessment of the current position of
the insurance reserves.
(b) The auditor would be concerned with the faithful representation of the information. The damages
are unspecified and additional litigants are still being added, so it would be very difficult to put an
accurate figure on the likely contingent liability.
[TAGS]
Learning Objective: 1.3 Appreciate the attributes of accounting information and understand the reasons
giving rise to demand for assurance and resulting benefits
Topic: Attributes of accounting information and the demand for assurance
Difficulty: Medium
Blooms: Application
[QUESTION 11]
The Australian Securities and Investments Commission (ASIC) Audit Inspection Program has found that
in some of the key audit areas reviewed, auditors did not obtain sufficient appropriate audit evidence,
exercise sufficient professional scepticism or otherwise comply with auditing standards in at least one
significant audit area. Explain which element of the audit expectation gap, if any, this result supports.
[TYPE Short Answer]
[ANS]
Auditors not complying with auditing standards is an example of the performance gap, the deficient
performance element of the expectation gap.
[TAGS]
Learning Objective: 1.4 Explain the concept of the expectation gap, especially in the areas of auditor’s
report messages, corporate failures, fraud and communicating different levels of assurance, and
appreciate the relationships between the auditor, the client and the public
Topic: Auditor–client–public relationship and the expectation gap
Difficulty: Easy
Blooms: Application
[QUESTION 12]
Robert Ainsworth is considering investing in Ocean Ltd, a large manufacturing company with its head
office in Melbourne. Robert has reviewed Ocean’s most recent audited financial report, which shows a
net profit of $300,000 and a net asset position of $600,000. The auditor’s report is unmodified, stating
that in the auditor’s opinion the financial report gives a true and fair view. As a result, Robert is now
feeling confident about his proposed investment in Ocean, as he believes that the auditor’s report
provides absolute assurance about the accuracy of the financial report, including the profit figure of
$300,000, and that there is no chance of the company going bankrupt. Furthermore, he is aware of the
various management frauds that have occurred in some companies in recent years and is comforted by
the fact that the unmodified auditor’s report indicates that no frauds have occurred within Ocean.
Advise Robert whether his conclusions about Ocean are reasonable based on the audited financial
report, explaining the reasons for your opinion.
[TYPE Short Answer]
[ANS]
It is unreasonable for Robert to expect absolute assurance from an audit. This is due to the inherent
limitations of the audit process, such as the need to apply professional judgment in determining the
nature, timing and scope of tests, the use of sampling procedures to collect audit evidence, the
persuasive rather than conclusive nature of much of the available evidence and the inherent limitations
of internal control. Rather, an audit provides a reasonable level of assurance that, in the auditor’s
opinion, there are no material misstatements in the financial report.
Furthermore, while an entity’s financial report is normally prepared based on the assumption that it is a
going concern, and the auditor tests the reasonableness of this assumption, it is unreasonable to
assume that this guarantees that the entity will continue in existence. Bankruptcy can occur due to
unexpected circumstances occurring after the auditor’s report has been issued.
Also, while the auditor obtains sufficient appropriate audit evidence that there is a reasonable
expectation that there are no material misstatements in the financial report due to fraud or error, it is
unreasonable to expect that this means that immaterial frauds or errors have not occurred.
Furthermore, due to the nature and sophistication of frauds, and the inherent limitations of the audit
process, it is also possible that even a material fraud will not be uncovered.
[TAGS]
Learning Objective: 1.4 Explain the concept of the expectation gap, especially in the areas of auditor’s
report messages, corporate failures, fraud and communicating different levels of assurance, and
appreciate the relationships between the auditor, the client and the public
Topic: Auditor–client–public relationship and the expectation gap
Difficulty: Medium
Blooms: Evaluation
[QUESTION 13]
The following statement is representative of the attitude that auditors sometimes encounter with
respect to the value of their work: “A financial report audit is essentially negative and contributes
neither to the gross national product nor to the general wellbeing of society. Auditors do not create;
they merely check what someone else has done.” Identify any aspects of the statement with which you
agree and any with which you disagree.
[TYPE Short Answer]
[ANS]
The statement is true in the sense that the essence of auditing involves checking what someone else has
done.The statement that the financial report audit does not add value is untrue if the auditor has
fulfilled their responsibilities. An independent financial report audit has social value because of the
following:
 Users of financial reports might have greater confidence in the data on which economic decisions
about the entity are based. This will therefore reduce the risks associated with their decisions.
 The increased confidence placed on financial reports will reduce the information risk associated with
the trading of securities, which will serve to promote trade and bring about a movement of
economic resources to those areas where the greatest net benefits are perceived.
 The entity might be able to obtain funds at a lower cost because of the added assurance users have
in the financial report.
 Management and employees of the entity might improve their conduct because they know their
performance will be under scrutiny during the audit.
 The entity’s financial report, accounting system and accounting control might be improved because
of suggestions made by the auditor.
[TAGS]
Learning Objective: 1.4 Explain the concept of the expectation gap, especially in the areas of auditor’s
report messages, corporate failures, fraud and communicating different levels of assurance, and
appreciate the relationships between the auditor, the client and the public
Topic: Auditor–client–public relationship and the expectation gap
Difficulty: Medium
Blooms: Analysis
[QUESTION 14]
You are the audit manager for Wilson, Abbott & Holmes, which has just obtained two new clients:
Astroturf Ltd, a public company, and Regional Golf Club, a not-for-profit entity. Both clients have
requested that you perform an audit on their current year’s financial report. Discuss whether you need
to follow the auditing standards for each engagement and, if so, explain how this would be enforced.
[TYPE Short Answer]
[ANS]
For audits undertaken under the Corporations Act 2001, the auditing standards have legal authority by
virtue of the provisions of the Corporations Act 2001. Failure to observe these standards may expose an
auditor to investigation and disciplinary action from the Australian Securities and Investments
Commission (ASIC).
For other audits, there is a mandatory obligation for members of the accounting bodies in Australia to
comply with the ASAs in accordance with APES 210 Conformity with Auditing and Assurance Standards,
issued by the Australian Professional and Ethical Standards Board (APESB). APES 210 states that the
basic principles and essential procedures in an ASA are mandatory and they must be complied with in
the planning, conduct and reporting of an audit engagement. APES 210 indicates that the standards are
to be applied to all financial report audits and to all audits of other financial and non-financial
information, adapted as necessary. Failure to follow APES 210 would result in disciplinary action against
the auditor by the accounting body of which they are a member.
Therefore, the auditor would need to follow the auditing standards for the audits of both Astroturf Ltd,
a public company, and Regional Golf Club, a not-for-profit entity, although the penalties for noncompliance are more severe under the Corporations Act 2001.
[TAGS]
Learning Objective: 1.5 Appreciate the role of auditing standards and their authority under the
Corporations Act 2001
Topic: Role and authority of auditing standards
Difficulty: Medium
Blooms: Analysis
[QUESTION 15]
Willard & Cohen offer their clients a variety of audit and assurance services, including:
(a) Analysing financial transactions involving unauthorised transfers of cash between companies.
(b) Checking adherence to legislative requirements.
(c) Assessing energy usage patterns and recommendation of energy conservation opportunities based
on detailed testing procedures.
For each of these services, indicate the type of assurance engagement performed.
[TYPE Short Answer]
[ANS]
(a) Analysing financial transactions involving unauthorised transfers of cash between companies is a
forensic audit.
(b) Checking adherence to legislative requirements is a compliance audit.
(c) Assessing energy usage patterns and recommendation of energy conservation opportunities based
on detailed testing procedures is a performance audit.
[TAGS]
Learning Objective: 1.6 Obtain an overview of other applications of the assurance function, including
compliance engagements, performance engagements, comprehensive engagements, internal auditing
and forensic auditing, as well as of providing assurance on subject matter other than historical financial
information
Topic: Other applications of the assurance function
Difficulty: Medium
Blooms: Comprehension