REVIEW QUESTIONS

1.12 Explain the difference between a financial report audit and an assurance
engagement.
- An assurance engagement (or service) is defined as ‘an engagement in which an
assurance practitioner aims to obtain sufficient appropriate evidence in order to
express a conclusion designed to enhance the degree of confidence of the intended
users other than the responsible party about the outcome of the measurement or
evaluation of an underlying subject matter against criteria.

- A financial report audit is one type of assurance engagement

- Financial report audits: an engagement designed to express an opinion
about whether the report is prepared in all material respects in accordance with a
financial reporting framework.

1.13 Who are the three parties relevant to an assurance engagement in the financial
reporting context? Explain why each party is interested in the result of an audit.

The assurance practitioner is an auditor working in public practice providing

assurance on financial reports of publicly listed companies, or other entities.
- The assurance practitioner (or auditor) is interested in the result of an audit
because they are providing the audit service. If the audit is not of the required
standard, the auditor’s reputation will suffer.

Intended users are the people for whom the assurance provider prepares their report
(e.g. the shareholders).
- Intended users are interested in the result of an audit because they will rely on
the audit when making their decisions about the entity. If the audit opinion (or
report) provides assurance that the subject matter is in accordance with the
criteria (e.g. true and fair) then the user is likely to place more reliance on the
subject matter than if the audit opinion (or report) states that there was not
enough evidence, or that serious problems were found during the audit.
The responsible party is the person or organisation (e.g. a company) responsible for
the preparation of the subject matter (e.g. the financial reports).
- They are interested in the result of an audit because they will use the report from
the assurance practitioner (or auditor) to make improvements. They are also
interested in receiving a positive report so that their interested users will place
more reliance on the reports.

1.14 An assurance engagement involves evaluation or measurement of subject matter

against criteria. What criteria are used in a financial report audit?

An auditor evaluates the contents of a financial report against the standards and laws
that apply to that type of financial report. Listed public companies must abide by the
Corporations Act, the Australian Accounting Standards (AASB) and the listing rules of
the ASX. Certain companies must also abide by additional specific legislation,
depending on their industry or legal status. In addition, if a company is listed in another
country, foreign exchange listing rules and laws could apply to the financial report.

Auditing standards control the way an audit is conducted, they are not the criteria
against which the financial report is evaluated.

1.17 What is an ‘emphasis of matter’ paragraph? When do you think an auditor would
use it?
As defined in ASA 706 (ASA 706 (5)):
Emphasis of Matter paragraph means a paragraph included in the auditor’s report that
refers to a matter appropriately presented or disclosed in the financial report that, in the
auditor’s judgement, is of such importance that it is fundamental to users’ understanding
of the financial report.

The emphasis of matter paragraph is included in the audit report immediately after the
opinion paragraph.
An emphasis of matter paragraph draws the attention of the reader to an issue that the
auditor believes has been adequately and accurately explained in a note to the financial
report. The purpose of the paragraph is to ensure that the reader pays appropriate
attention to the issue when reading the financial report. The audit report remains
unqualified and the user of the financial report can still rely on the information contained
in the financial report (ASA 706; ISA 706).

The emphasis of matter paragraph is not used when the entity has not disclosed the
issue in its report. The auditor can use an ‘other matter’ paragraph to introduce another
matter that the auditor believes should be disclosed.

The usual circumstance which would warrant an Emphasis of Matter paragraph in the
auditor’s report is the existence of a significant uncertainty, the resolution of which may
materially affect the financial report.

From ASA 706:

A1. Examples of circumstances where the auditor may consider it necessary to include
an Emphasis of Matter paragraph are:
- An uncertainty relating to the future outcome of exceptional litigation or regulatory
action.
- Early application (where permitted) of a new accounting standard (for example, a new
Australian Accounting Standard) that has a pervasive effect on the financial report in
advance of its effective date.
- A major catastrophe that has had, or continues to have, a significant effect on the
entity’s financial position.

ASA 706 stresses that the inclusion of an Emphasis of Matter paragraph in the auditor’s
report does not affect the auditor’s opinion. An emphasis of matter can be included
in an unqualified auditor’s report or a qualified auditor’s report (see example in
ASA 706).

1.21 Explain the difference between the IAASB and the AUASB.
The AUASB is the Auditing and Assurance Standards Board of Australia.
“The Auditing and Assurance Standards Board (AUASB) is an independent, statutory
agency of the Australian Government, responsible for developing, issuing and
maintaining auditing and assurance standards.
The mission of the AUASB is to develop, in the public interest, high-quality auditing and
assurance standards and related guidance, as a means to enhance the relevance,
reliability and timeliness of information provided to users of auditing and assurance
services.”
(http://www.auasb.gov.au/About-the-AUASB.aspx)

The AUASB also works with other standard setters around the world, including the
IAASB.
The IAASB sets international auditing standards, focusing on audit, quality control,
review, other assurance, and related services engagements. It was established by the
IFAC Board (International Federation of Accountants) to function as an independent
standard setting body under the auspices of IFAC and subject to the oversight of the
Public Interest Oversight Board (PIOC).
(http://www.ifac.org/auditing-assurance/about-iaasb/terms-reference)

1.22 Explain the ‘audit expectation gap’. What causes the gap?
The audit expectation gap occurs when there is a difference between the expectations
of assurance providers and those of the users of the financial reports. If a gap exists, it
means that the users’ beliefs do not align with what the auditor’s performance in the
audit. A gap usually occurs when the users of financial reports want more than the
auditor provides.
The users could be unrealistic in their views. Some examples of unrealistic expectations
are:
 the auditor provides complete assurance
 the auditor guarantees the future viability of the entity
 an unmodified audit opinion means that the accounts are completely accurate
 if any fraud exists, the auditor would definitely find it
 the auditor has checked every transaction.

In reality, the auditor:

 provides reasonable assurance only,
 does not guarantee the future viability of the entity,
 provides an unmodified opinion when the auditor believes there are not material
misstatements in the financial report
 does not guarantee that no fraud exists, although the auditor will take reasonable
steps to try to uncover any fraud,
 tests only a sample of transactions.

The standards under which auditors operate could be deficient. Users’ expectations
could be reasonable, but beyond what current standards require. This suggests that
audit standards could be improved and strengthened in order to meet user expectations
in the future.

In addition, it is possible that some auditors do not give users what they require
because the auditors are not following the standards. In these cases, the auditors are
potentially liable to be sued or face prosecution.
PROFESSIONAL APPLICATION QUESTIONS
1.23 AUDIT REPORTS
Find a copy of a recent audit report and a review report for an Australian company listed
on the ASX.
Required
(a) Explain the relevance of the paragraphs ‘Directors’ responsibility for the
financial report’ and ‘Auditor’s responsibility’ in the audit report to the audit
expectation gap.
These paragraphs highlight to readers that the directors of the company and the
auditors have separate and distinct responsibilities.
- The directors are responsible for maintaining the accounting systems and
preparing the reports, and the auditors are responsible for conducting an audit of
these reports by evaluating their contents against the criteria of the accounting
standards and relevant legislation.
- The auditor’s responsibilities do not include preparing the reports and the
auditor must use judgement when choosing procedures and evaluating the
evidence.

(b) Find the lines in the audit report that express the auditor’s opinion – is it an
unqualified or modified audit opinion?
The paragraph is headed ‘Auditor’s opinion’. It states that in the auditor’s opinion the
reports are consistent with the relevant legislation including giving a true and fair view of
the financial position and performance of the company. This means that the opinion is
unqualified and unmodified.

(c) Find the lines in the review report that express the auditor’s conclusion – is it
an audit opinion? Is it a positive or negative statement?
The auditor expresses a conclusion, not an opinion, in the review report. It is not an
opinion because they did not conduct an audit. The statement is a negative one – ‘we
have not become aware… is not in accordance’.
(d) Make a list of the other differences between the audit report and the review
report.
Other differences include:
Interim report refers to AASB 134 on interim reporting, reference to IFRS in audit relates
to adoption of those standards in the annual report.
Audit report refers to audit of remuneration (the company does not make these
disclosures in half-yearly report)
Close reading of the description of the work done by the auditor will reveal that the
procedures used for the interim report review are less comprehensive than those done
for the full year audit (also see reference to ASRE 2410 in interim review). This is the
main difference between the reports and why the audit report contains an opinion and
the review report expresses a conclusion.

1.26 CORPORATE SUSTAINABILITY REPORTING ASSURANCE LO2, 3, 5

Find an example of a recent corporate sustainability assurance report for a large
company and any audit or review of that report by an auditor
Required
(a) Who wrote the assurance report?
Ernst & Young
(b) What level of assurance is provided?
Ernst & Young identify in the first main paragraph of the report that they have carried
out a ‘limited assurance engagement in order to state that nothing has come to our
attention that causes us to believe that:
· NAB has not presented its material sustainability issues and that the associated
disclosures are not complete in its 2014 Annual Review, and
· The Performance Metrics and Disclosures as detailed below, have not been
reported and presented fairly, in all material respects, in accordance with the
criteria.’
Ernst & Young explain at the end of the first page (Assurance Practitioner’s
Responsibility) that have not sought to gather all the evidence that would be required
if they were providing a reasonable level of assurance. This statement is designed to
warn the reader that there is a lower level of assurance provided than for a
financial statement audit, and that the auditor has not done as much, or the type of,
work as would be done for a higher level of assurance (such as that provided in a
financial statement audit). Ernst & Young explain the type of work they did do in the
section ‘Work performed’.
Note the wording of their conclusion, including the use of the words ‘nothing’ and
‘not’:

1.29 CORPORATE SUSTAINABILITY REPORTING ASSURANCE LO2, 3, 5

Climate Balance Pty Ltd is a consulting firm specialising in sustainability and climate
change issues. It offers sustainability report assurance services to a variety of
organisations, including listed companies. It is not a registered company auditor and
does not provide company audits.
Required
Why would a listed company obtain sustainability assurance services from a
consulting firm and its company audits from a chartered accounting firm?

As discussed in detail in chapter 2 of the text, there are potential conflicts of interest if
an audit firm also performs other work for a client. For example, an accounting firm
could provide consulting services on installation of a computer system, and then be
engaged to audit the client’s accounting records that were produced by that system.
There is potential for the auditor to miss mistakes in the accounting reports through
either ignorance (not realising there was a fundamental error in the system that affected
the accuracy of the accounting reports) or bias (deciding not to pursue an issue that
potentially was caused by the accounting firm’s consulting work not being sufficiently
rigorous).

Sustainability reporting (preparation of the report or assurance) would not create a

conflict of interest in most cases because the information being provided in the
sustainability report is not integral to the financial report being assured.
However, companies could prefer to engage another consulting firm to prepare or
assure a sustainability report because the other firm could be an expert in that type of
service, or a greater expert than the audit firm engaged to do the financial report
assurance.

1.32 EXPECTATIONS GAP

MaxSecurity Limited (MaxSecurity) has been an audit client of Smith & Associates
(S&A) for the past 15 years. MaxSecurity is based in Wollongong, where it
manufactures high-tech armour-plated personnel carriers. MaxSecurity often has to go
through a competitive market tender process to win large government contracts. Its
main product, the small but powerful Terrain Master, is highly specialised and
MaxSecurity does business only with nations that have a recognised, democratically
elected government.
MaxSecurity maintains a highly secure environment because of the sensitive and
confidential nature of its vehicle designs and its clients.
Clarke Field has been the engagement partner on the MaxSecurity audit for the last five
years. Clarke is a specialist in auditing clients in the defence industry and intends to
remain as review partner when the audit is rotated next year to a new partner (Sally
Woodrow, who is to be promoted to partner to enable her to sign-off on the audit).
The board of MaxSecurity is considering issuing half-yearly financial reports in addition
to its full-year financial reports and has approached the audit partner, Clarke Field, to
discuss the possibility of engaging the firm to discuss the audit implications. Clarke
suggests that S&A could review the half-yearly financial reports.
MaxSecurity’s end of financial year is 30 June.
Source: Adapted from the CA Program’s Audit & assurance exam, May 2008.
Required
Discuss the expectations gap that could exist for the audit of MaxSecurity.
Consider the existence of any special interests of the users of MaxSecurity’s
financial reports.
The expectations gap is the difference between the expectations of financial report
users and the auditor’s performance.
Special users for MaxSecurity could include:
 Government agencies, including Department of Foreign Affairs and Trade,
who would be interested in the purchases by foreign governments and
individuals of this type of security vehicle.
 Competing companies and/or governments who would be interested in
sensitive information about the construction of the vehicles and the identity of
the purchasers.
 Wollongong local government and NSW State Government, who would be
interested in the financial viability of the business and its impact on local
employment and economic activity
 Suppliers of technological equipment – it is possible that the Terrain Master
uses specialised components. These suppliers would be interested in the
financial viability of the business and the likelihood of its timely payment for
goods purchased on credit. Such equipment could be made to specialised order
with limited alternative customers. The suppliers would have large investments to
support eh manufacture of these specialised components.
 Other potential customers
 Usual relationships would exist with lenders, shareholders, employees.

Discussion:
Consider how well MaxSecurity’s financial reports would provide the information
that these users would require, given the highly sensitive and confidential nature of
the manufacturing process. Management is responsible for preparing the reports, but
the users may look to the auditors to make sure that the required information is
provided. Also consider how well the audit process would be able to meet the users’
needs for this information
1.33 BEING AN AUDITOR
You have recently graduated from your university course and start work with an audit
firm. You meet an old school friend, Nga, for dinner — you haven’t seen each other for
several years. Nga is surprised that you are now working as an auditor because your
childhood dream was to be a ballet dancer. Unfortunately, your knees were damaged in
a fall and you can no longer dance. The conversation turns to your work and Nga wants
to know how you do your job. Nga cannot understand why an audit is not a
guarantee the company will succeed. Nga also thinks that company managers will lie to
you in order to protect themselves, and as an auditor you would have to assume that
you cannot believe anything a company manager says to you.
Required
(a) Write a letter to Nga explaining the concept of reasonable assurance, and how
reasonable assurance is determined. Explain why an auditor cannot offer
absolute assurance.
There is a gap between Nga’s expectations and the level of auditor performance.
An audit provides reasonable assurance, not absolute assurance. The audit enhances
the reliability and credibility of the information included in a financial report but is not a
guarantee that the financial report is free from error or fraud, or that the company will
not fail. Partly, this is because of the nature of financial reporting. It requires judgements
about accounting estimates and the choice and application of various accounting
methods. There is usually not one ‘right’ answer for a company’s profit. The auditor
cannot guarantee the profit reported by the company is ‘right’, only provide assurance
about the appropriateness of the accounting method selection and application and the
accounting estimates. Another reason the assurance is not absolute is the nature of the
audit process. Auditors cannot review every transaction and account balance, therefore
they use sampling (which could mean that representative items are not selected for
testing). Some transactions and balances are difficult to gather reliable evidence about,
clients can conceal evidence, and auditors have a limited time frame in which to
complete the audit.
(b) Explain in the letter to Nga the concept of ‘professional scepticism’ and how it
is not the same as assuming that managers are always trying to deceive
auditors.
Professional scepticism is required of an auditor. It is an attitude that requires the
auditor to remain independent of the client and its staff. The auditor has a questioning
mind and thoroughly investigates all evidence presented by their client. This does not
mean that they regard the client as a liar, but that they need to do more than simply take
the client’s word about anything. Usually, there will be confirming evidence which
supports the client’s statements (e.g. copies of contracts, minutes of meetings, etc.).
Evidence gathered from independent third parties is generally regarded as more reliable
than that gathered from the client. Managers will not always try to deceive auditors, but
auditors must take the responsibility of gathering evidence to verifying managers’
statements. The auditor needs to be alert to the fact that some managers will try to
deceive auditors sometimes.

1.35 ASIC AND THE CALDB

You are a trainee auditor working for a small audit firm. You completed your accounting
degree at the end of last year and although you have not yet had much experience, you
are concerned at some of the practices and procedures adopted at your audit firm. You
overhear the two partners, Alex and Riley, discussing some problems they are facing
with a particular client. Alex is advising Riley to ‘get the paperwork right’ on the audit,
otherwise they will be in trouble if they get selected for the ASIC inspection program.
Alex is also concerned that ‘the CALDB will be after them’. After the conversation, Riley
comes to you to ask if you, as a recent graduate, know anything about the ASIC
inspection program and the CALDB. Riley confesses that he hasn’t been keeping up to
date.
Required
Write a report to Riley explaining (i) ASIC’s audit inspection program and (ii) the CALDB
and how it operates
Refer to review question 1.20 for a discussion of review of audit quality ASIC and its role
in referring auditors to the CALDB.

Useful articles describing the ASIC inspection program and the role of the CALDB are:
White, L. ‘Audit inspections’, Charter, (May 2008), Volume 79, No. 4, p. 66.
Newman, S. ‘Uncovering the mysteries’, Charter, (February 2008), Volume 79, No. 1,
pp. 62-63.
Newman (2008) reports that ASIC has found evidence that the Big 4 auditors have
higher audit quality than mid-tier audit firms. However, ASIC has found significant
weaknesses in audit documentation during its inspection program at both Big 4 and
mid-tier audit firms. ASIC will use its regulatory powers to refer an auditor to the CALDB
for disciplinary action, where appropriate.