AUE2601 EXAM PACK. This is a com0lete and an all-inclusive guide to AUE2601 - Auditing Theory And Practice
The need for Auditing Services
Jackson & Stent Chapter 1
ISA 200 – Objectives and general principles governing an audit
ISA 610
International Framework for Assurance Engagements
Extern...
Exam = 2 hours, consisting of :
70% - questions at Level 1 (knowledge and comprehension)
30% - questions at Level 2 (application)
INTRODUCTION TO AUDITING THEORY & AUDIT PRACTICE
PART A – INTRODUCTION TO AUDITING THEORY
Study Topic 2 (text book pg 1/2)
2.1 The need for Auditing Services
Jackson & Stent Chapter 1
ISA 200 – Objectives and general principles governing an audit
ISA 610
International Framework for Assurance Engagements
External auditors – express an independent opinion if the AFS’s of a company fairly present the financial position and
results of the company’s operations. NOT an employee of the company. Basically enhances the degree of confidence
which users of the financial statements will have of the information they received from the financial statements.
Internal auditors – perform independent assignments on behalf of senior management of the company – normally to
evaluate the efficiency, economy and effectiveness of the company’s internal control systems and business activities.
Enhances management’s degree of confidence that the company’s systems are functioning as intended. Employee of
the company, but should be independent of the department, division or subsidiary which they are auditing.
Government auditors – evaluate and investigate the financial affairs of government departments and report their
findings to senior government therefore increasing the degree of confidence which they have in their departments.
Employee of the government, but must be independent of the government department they are auditing.
Forensic auditors – concentrate on investigating and gathering evidence where there has been alleged financial
mismanagement, theft or fraud. Work independent of the entity under investigation and increases the degree of
confidence the investigating body has in the evidence which is presented.
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Special purpose auditors – specialise in a particular field such as environmental auditors and VAT auditors. Enhance
the confidence people have in the “correctness” of the information that is being presented.
MUST BE INDEPENDENT OF THE ENTITY BEING AUDITED.
Auditor required to observe the fundamental ethical principles of :
· integrity (straightforward, honest, moral)
· objectivity (impartial, fair, non-biased and non-prejudicial)
· professional competence and due care – maintaining professional knowledge and skill at the required level and
performing work diligently
· professional behavior – comply with laws and regulations and avoid action which discredits the profession
· confidentiality – respecting the confidentiality of client information.
Financial reporting system is the entire process by which the management of a business entity compiles and
discloses financial information concerning their financial position and the results of the entity’s operations.
All this information is communicated to external parties in the entities financial statement at the end of each accounting
period and the financial reporting process must address the needs of users of the financial information (investors,
lenders, suppliers and employees). Information must be understandable, relevant, and reliable and prepared on a basis
that is comparable with that used by other business entities.
Objective of financial statements = to provide information about the financial position, performance and changes in
financial position of an enterprise that is useful to a wide range of users in making economic decisions. (From the
conceptual accounting framework in the International Standard – IAS).
Auditing vs. accounting :
Management responsibility to prepare the financial statements in accordance to International Financial Reporting
Standards (IFRS’s) and also to :
· maintain an appropriate accounting system and
· design and implement adequate internal controls to ensure the reliability and integrity of the accounting system
Accounting = the series of tasks and records of an entity by which transactions are processed as a means of
maintaining financial records.
Auditing = examining audit evidence to find sufficient evidential matter to support the comments of
management contained in the financial statements, in order to express an opinion in the auditor’s report as to
whether or not the financial statements fairly present the affairs of the entity in accordance with International
Financial Reporting Standards and the relevant statutory requirements.
AUDITOR THEREFORE EXPRESSES AN OPINION ON MANAGEMENT’S FINANCIAL STATEMENTS.
Engagement of auditing can either be because of statutory requirements (e.g. companies) or on a voluntary basis :
Statutory audits – audits required in terms of an Act – e.g. Companies Act which state that all companies must be
audited on an annual basis. These acts normally spell out the statutory duties and responsibilities of the auditor.
Non-statutory audits – audits that are requested by clients but are not obligatory in terms of legislation – e.g. if
member wants audit of a CC.
Either engaged for :
Audits – auditing engagements
Related services – review engagements or engagements where agreed-upon procedures are carried out and
compilation engagements.
Objective of :
Audit engagement – to enable the auditor to express an opinion as to whether the financials statement are prepared
(in all material respects) in accordance with an applicable financial reporting framework
Review engagement – to enable the auditor to state whether or not anything has come to the auditor's attention that
causes the auditor to believe that the financial statements are not prepared (in all material respects) in accordance with
an identified financial reporting framework. A review engagement is conducted on the basis of procedures that do not
provide all the evidence that would be required in an audit.
Agreed-upon-procedures engagement – for the auditor to carry out procedures of an audit nature to which the auditor
rd
and the entity and any appropriate 3 parties have agreed and to report on the factual findings
Compilation engagement – to use accounting expertise as opposed to auditing expertise to collect, classify and
summarise financial information.
OBJECTIVE OF A FINANCIAL AUDIT (AUDIT OF FINANCIAL STATEMENTS) – to provide users of the financial
statements of companies with a high degree of assurance about the creditability of the assertions made by the
management of the company in its financial statements. The assurance is in the form of an expression of an
opinion in the auditor’s report as to whether or not the financial statements are a fair presentation of the
company’s operating activities.
The determination of fair presentation relates to the financial statements taken as a whole. Fair presentation is
determined based on the auditor reporting on the information on the financial position (balance sheet), performanc
(income statement) and any changes in the financial position of the company (cash flow statement).
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ISA 200 – OBJECTIVE AND GENERAL PRINCIPLES GOVERNING AN AUDIT OF FINANCIAL
STATEMENTS
Auditor must comply with relevant ethical requirements relating to audit engagements.
Audit must be conducted in accordance with International Standards on Auditing, but will also have to comply with other
professional, legal or regulatory requirements - ISA’s do not override local laws and regulations.
Auditor should also plan and perform an audit with an attitude of professional skepticism realising that there may be
circumstances resulting in the financial statements being materially misstated.
Auditor conducting an audit in accordance with ISA’s has reasonable assurance that the financial statements taken as a
whole are free from material misstatement (due to fraud or error). Reasonable assurance allows the auditor to conclude
that there are no material misstatements in the financial statements taken as a whole.
Management is responsible for identifying risks to the business however the auditor is only concerned with risks that
may effect the financial statements.
Audit risk = the risk that an auditor may express an inappropriate audit opinion when the financial statements are
materially misstated (risk of material misstatement).
Detection risk = the risk that the auditor will not detect misstatement of the financial statements. The auditor performs
audit procedures to assess the risk of material misstatement and sees to limit detection risk by performing further audit
procedures based on that assessment. Risk is a function of the effectiveness of an audit procedure and its application
by the auditor and can never be reduced to zero because the auditor never examines the full class of transactions,
account balances or disclosure or other factors (e.g. auditor may select an inappropriate audit procedure, misapply an
appropriate audit procedure or misinterpret the audit results.) Can normally be addressed through adequate planning,
proper assignment of personnel of the engagement team, application of professional skepticism and supervision and
review of the audit work performed. Relates to the nature, timing and extent of the auditor’s procedures that are
determined by the auditor to reduce audit risk to an acceptably low level. FOR GIVEN LEVEL OF AUDIT RISK - THE
ACCEPTABLE LEVEL OF DETECTION RISK BEARS AN INVERSE RELATIONSHIP WITH THE RISK OF MATERIAL
MISSTATEMENT AT THE ASSERTION LEVEL, so the greater the risk of material misstatement that the auditor
believes exists, the less the detection risk that can be accepted AND the less risk of material misstatement the auditor
believes exists, the greater the detection risk that can be accepted.
The audit should be planned and preformed to reduce audit risk to an acceptably low level, by designing and performing
audit procedures to obtain sufficient appropriate audit evidence to draw reasonable conclusions on which to base an
audit opinion. Reasonable assurance is obtained when the auditor has reduced audit risk to an acceptably low level.
The auditor is concerned with material misstatements and isn’t responsible for detecting misstatements that are no
material to the financials as a whole. Auditor must consider risk of material misstatements on two levels :
· overall financial statement level – refers to risks of material misstatement relating pervasively to the financial
statements as a whole and that potentially affect many assertions. These risks often relate to the entity’s control
environment (e.g. management’s override of internal controls) but could also be declining economic conditions, but
are mainly relevant due to the risk of material misstatement arising from fraud. Auditor must use knowledge, skill
and ability of personnel assigned significant engagement responsibilities, appropriate levels of supervision and if
there is any event or condition that may cast significant doubt on the entity’s ability to continue as a going concern.
· in relation to classes of transactions, account balances and disclosures and related assertions – assists in
determining the nature, timing and extent of further audit procedures at the assertion level. Auditor must have
sufficient appropriate audit evidence at class of transactions, account balance and disclosure level so that the
auditor at completion of the audit can express an opinion on the financial statements taken as a whole at an
acceptably low level of audit risk (can use a model that expresses the general relationship of the components of
audit risk in mathematical terms to arrive at an appropriate level of detection risk).
Risk of material misstatement at the assertion level consists of :
· inherent risk = susceptibility of an assertion to a misstatement that could be material (either alone or in total with
other misstatements) assuming that there are no related controls. Greater in some assertions and related classes
of transactions, account balances and disclosure (e.g. complex calculations are more likely to be misstated then
simple calculations, and accounts estimates subject to significant measurement uncertainly pose greater risks then
accounts that have relatively routine factual data.) External circumstances giving rise to business risks can also
influence inherent risk (e.g. technological developments can made a product obsolete therefore causing inventory to
be susceptible to overstatement). Factors in the entity and its environment can also influence the inherent ris
related to a specific assertion (e.g. lack of sufficient working capital to continue operations or declining industr
characterised by a large number of business failures.)
· control risk = risk that misstatement could occur in an assertion that could be material, either individually or in total
with other misstatements, and will not be prevented or detected an corrected by the entity’s internal control system.
Some risk will always exist because of the inherent limitations of internal control – and control risk is a function of
the effectiveness of the design and operation of internal control in achieving the entity’s objectives relevant to the
preparation of the financials.
Inherent and control risks are risks of the entity – they exist independently from the audit of financials. The auditor is
required to assess the risk of material misstatement at the assertion level as a basis for further audit procedures, but
that assessment is a judgment rather then a precise measurement of risk. The assessment of the risk of materi
misstatement can be expressed in quantitive terms (e.g. percentages) or in non-quantitive terms.
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