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PowerPoint Presentation Topic 3: Overview of assurance concepts and the auditing process Learning outcome ACC331 Topic 3 / 31 Outline the main steps involved in the audit process Outline the audit risk model Explain the relationship between financial report assertions, audit objectives, procedures and evidence Explain the concept of materiality 3.1 3.2 3.3 3.4 Topic learning outcomes 1 3.5 Describe the general requirements and contents of audit working papers Learning outcome ACC331 Topic 3 / 31 Overview of assurance concepts and the auditing process Learning Outcomes: 3.1 & 3.2 Learning outcome ACC331 Topic 3 / 31 Audit process overview 3.1 3 Step 1 Step 2 Step 3 Assess risks and client potential Perform thorough analysis of company, strategy, environment Assess company risks Step 4 Step 5 Assess controls and other processes in place to address risk Perform analytical procedures Step 6 Step 7 Step 8 Step 9 Test operation of controls where controls reduce the risk of misstatement Assess remaining risk of misstatement Design direct tests of account balances Formulate opinion, review quality of work Learning outcome ACC331 Topic 3 / 31 footer 3 Audit process overview 3.1 4 Step 1 Assess risks and client potential Step 2 Perform thorough analysis of company, strategy, environment Accept client? Step 3 Assess company risks Review broad risks affecting client, assess management integrity, assess long prospects of client Terminate search and engagement Thorough understanding of company, strategies, competitors, financial feasibility, etc, as a base to understand future prospects and expected financial results Assessment of broad risks facing the company and the potential effect of these risks on the company’s financial results No Yes Topics 3 & 4 Learning outcome ACC331 Topic 3 / 31 footer 4 Audit process overview 3.1 5 Step 4 Assess controls and other processes in place to address risk Step 5 Perform analytical procedures Account balances with little or no risk of material misstatement Assess whether the control and other processes are adequate to reduce the risk of a material misstatement occurring in the financial statements Corroborate previous assessment and then determine if risk of financial misstatement is reduced to an acceptable level Account balances with residual risk of material misstatement Topics 4 & 5 Learning outcome ACC331 Topic 3 / 31 footer 5 Audit process overview 3.1 6 Step 6 Test operation of controls where controls reduce the risk of misstatement Step 7 Assess remaining risk of misstatement Step 8 Design direct tests of account balances To reduce the risk of material misstatements occurring in audited financial statements Communicate opinion to client and users Step 9 Formulate opinion, review quality of work To assess/confirm the effectiveness of the controls Topic 6 Topic 7 Topics 8 & 9 Learning outcome ACC331 Topic 3 / 31 footer 6 Financial report assertions 3.2 7 By signing their statement, Directors are making claims about recognition and measurement of the various elements of the financial report Per ASA 315.A128 there are 2 categories of assertions: Classes of transactions Account balances Auditors restate the assertions as specific audit objectives for each material class of transaction, balance or disclosure involvement in the financial report They then design audit procedures that gather evidence to support those objectives Learning outcome ACC331 Topic 3 / 31 . 7 footer Transaction assertions 3.2 8 Occurrence: transactions and events that have been recorded have occurred and pertain to the entity. Completeness: all transactions and events that should have been recorded have been recorded. Accuracy: amounts and other data relating to recorded transactions and events have been recorded appropriately. Cut-off : transactions and events have been recorded in the correct accounting period. Classification: transactions and events have been recorded in the proper accounts. Presentation: transactions and events are appropriately aggregated or disaggregated and clearly described, and related disclosures are relevant and understandable in the context of the requirements of the applicable financial reporting framework. Learning outcome ACC331 Topic 3 / 31 8 footer Existence: assets, liabilities and equity interests exist. Rights and obligations: the entity holds or controls the rights to assets, and liabilities are the obligation of the entity. Completeness: all assets, liabilities and equity interests that should have been recorded have been recorded and all related disclosures that should have been included in the financial reports have been included. Accuracy, valuation and allocation: assets, liability and equity interests are included in the financial report at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded and related disclosures have been appropriately measured and described Presentation: assets, liabilities and equity interests are appropriately aggregated or disaggregated and clearly described, and related disclosures are relevant and understandable in the context of the requirements of the applicable financial reporting framework Account balance assertions 3.2 9 Learning outcome ACC331 Topic 3 / 31 9 footer Assertions to objectives—an example 3.2 10 AssertionIllustrative audit objectives ExistenceInventories included in the balance sheet physically exist. Inventories represent items held for sale in normal course of business. CompletenessInventory quantities as per the accounting records include all products, materials and supplies owned by the company that are on hand. Inventory quantities include all products, materials and supplies owned by the company that are in transit or stored at outside locations. Rights and obligationsThe company has legal title or similar rights or ownership to the inventories Inventories exclude items billed to customers or owned by others. Accuracy, valuation and allocationInventories are properly stated at cost (except when net realisable value is lower). Slow-moving, excess, defective and obsolete items included in inventories are properly identified and valued. Learning outcome ACC331 Topic 3 / 31 10 footer Audit procedures 3.2 11 Therefore, once audit objectives have been established…. audit procedures are used to obtain audit evidence so that…. audit objectives can be met as per ASA 500.A14-25 common audit procedures are: Inspection Observation Inquiry Confirmation Recalculation Re-performance Analytical procedures Learning outcome ACC331 Topic 3 / 31 11 footer Transactions can be traced from: initial entry in the system to… intermediate records (where the transactions become components of subtotals) to… the final records (where subtotals are summarised) for… presentation in the financial report. The audit trail 3.2 12 Learning outcome ACC331 Topic 3 / 31 12 footer Direction of tracing Direction of the tracing can be modified. An auditor can trace from: point of initiation of transaction to final recording (assertion of completeness), OR trace from final record back to point of initiation (assertion of existence or occurrence). Accounting records Source documents Existence (of account balance components) Occurrence (of transactions in accting records) Completeness (of account balance components) or Completeness (of transactions in accounting records) 3.2 13 Learning outcome ACC331 Topic 3 / 31 Assertions to objectives to procedures 3.2 14 Accuracy, valuation and allocation Learning outcome ACC331 Topic 3 / 31 14 footer Audit evidence 3.2 15 Audit evidence is needed to support audit objectives to support our final opinion It needs to be sufficient and appropriate Sufficiency: quantity of audit evidence necessary to provide the auditor with a reasonable basis for an opinion on the financial report Appropriateness: quality of audit evidence. There two dimensions: Relevance — evidence relates to the financial report assertion of interest Reliability — influenced by the source and nature of the evidence. Learning outcome ACC331 Topic 3 / 31 footer 15 Reliability of audit evidence 3.2 16 Evidence from sources outside an entity is more reliable than evidence obtained solely from within the entity. Evidence obtained directly by the auditor is more reliable than evidence obtained from the client. Evidence in the form of documents or written representations is more reliable than oral representations. Evidence provided by original documents is more reliable than evidence provided by photocopies or facsimiles. We can generalise the following (ASA 500.A31):… Learning outcome ACC331 Topic 3 / 31 footer 16 Overview of assurance concepts and the auditing process Learning Outcome: 3.3 Learning outcome ACC331 Topic 3 / 31 Audit risk is the risk that the auditor will give an inappropriate audit opinion when the financial report is materially misstated. Before issuing an opinion on the financial report, the auditor needs to reduce audit risk to an acceptable level to ensure the opinion is reliable. Overview of the audit risk model 3.3 18 Learning outcome ACC331 Topic 3 / 31 footer 18 An auditor reduces audit risk by performing audit procedures until... there is sufficient and appropriate evidence for each assertion of... each significant transaction class or account balance to... provide reasonable assurance that... the financial reports are not materially misstated. Reducing audit risk 3.3 19 Learning outcome ACC331 Topic 3 / 31 footer 19 The audit risk model focuses audit effort on those classes of transactions or balances (and the particular assertions) that are likely to contain material misstatements. As outlined in ASA 200.A39-46 there are three components: Inherent risk (IR): Susceptibility of an assertion to material misstatement given inherent and environmental characteristics, but without regard to prescribed control procedures. Control risk (CR): Risk that material misstatement might not be prevented or detected by internal control procedures. Detection risk (DR): Risk that auditors’ substantive procedures will lead auditor to conclude no material misstatement exists when, in fact, they do. Components of audit risk 3.3 20 Learning outcome ACC331 Topic 3 / 31 footer 20 Audit risk (in a funky diagram) 3.3 21 Auditors can’t change this Auditors can’t change this either! But can obtain evidence to support an assessed level This is where the auditor can reduce audit risk Learning outcome ACC331 Topic 3 / 31 Auditors cannot change inherent risk. Auditors cannot directly change control risk. An auditor can obtain evidence to support an assessed level of control risk less than high (expect to rely on internal control) by examining control environment, risk assessment process, information system, control activities and monitoring of controls, and testing their effectiveness. The level of detection risk is the lever an auditor can pull to reduce audit risk by: Appropriate planning, direction, supervision and review Decisions on the nature, timing and extent of audit procedures Effective performance of procedures and evaluation of results footer 21 The link between audit risk components 3.3 22 Need to make an assessment If High, NO need to test controls Will rely on substantive tests …of transactions and balances instead Make sure this is practical TEST! Learning outcome ACC331 Topic 3 / 31 To assess control risk as high, auditor must expect that substantive procedures alone will provide sufficient appropriate evidence. Areas where substantive procedures alone may not provide sufficient appropriate evidence include routine recording of significant classes of transactions