BBAC3054

Advanced Audit and Assurance

WELCO
Week 1 (i):
INTRODUCTION
Auditor is an independent person to auditing company
•The auditing profession is currently
operating in a very dynamic environment
•Numerous forces are affecting the
responsibilities and activities of the auditing
profession
It is therefore both an interesting and
challenging time to be studying auditing.

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Forces Affecting the auditing profession

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Legal and professional framework

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The need for audit....

• The audit of financial statements increases the

reliability of information for users
• reduces the cost of capital for user entities.
• Reduces risk… increases confidence, trust and to
make informed decisions
• Generates a stable source of revenue for the public
accounting firms.

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 However critics have claimed that, current


audits failed to meet user expectations regarding:

Overstated or understated
Because no 100% check only
Intentionally act random selects

1.The detection of fraud

  

2.Treatment of financial distress

3.Treatment of risks, uncertainties, and estimates

Corporate failures, scandals, increase in risk and



globalisation …….
are reasons why assurance services must be regulated…
and cannot be relied upon to regulate itself.

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 Responded by:
•Issuing standards and
guidelines to address
each of these issues

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Recent years;
•Auditing profession has
expanded their services into
areas beyond the traditional
audit of historical financial
statements.

Non audit services ？

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Reasons:
• 1) increase in demand for information of a wide
variety of nature
• 2) strengths and qualities of the profession in terms
of skills and objectivity
• 3) “seems suitable” for such services

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 THE DEMAND FOR AUDITING

• Why do organizations request an audit?

• It allows contracting to take place in an agency
relationship Agency theory

Check if agent use money correctly

e （ shareholder ） agent （ director ）

Provide money but not involve business

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Why do entities require an audit

• This is because of the economic relationships that exists within an

entity, between the entity and other parties that have vested
interest in the company.
• The birth of modern accounting and auditing occurred during the
industrial revolution, when corporations needed to raise capital to
finance expansions
• Corporations issued shares and bonds to the public and borrowed
funds from financial institutions.
• The growth of modern corporation led to the presence of
absentee owners and the use of professional managers.

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Conflict of interest
• Agency relationship between owner and manager,
produces natural conflict of interest
• Due to information issues
• Means manager has more information about the true
financial position and results of the operations than the
absentee owners.
• Manager may not act in the best interest of the owner
• Eg. Manager may spend entity funds to provide excessive
personal benefits or manipulate the reported earnings in
order to a larger bonus
• The need for a monitoring system
• Cost-effective monitoring system

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Information Risk unclear information

Audit have responsibility for this risk

• Auditing has significant risk on information risk.
• Information risk reflects the possibility that the information upon
which the business decision was made was inaccurate.
• A likely cause of the information risk is the possibility of inaccurate
financial statements.
• As society becomes more complex, decision makers are more
likely to receive unreliable information.

When the information risk is weak then information risk will increase

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Causes of Information Risk
 Remoteness of information
When information is obtained from others,likelihood of it
being intentionally or unintentionally misstated increases
 Voluminous data (Huge data)
As organizations become larger, so does the volume of their
exchange transactions. This increases the likelihood that
İmproperly recorded information is included in the records

 Complex exchange transactions (Foreign Transaction)

Different currency
 Biases and motives of the provider (Manipulation)
Information is provided by someone whose goals are inconsistent
with those of the decision maker, the information may be biased
in favor of the provider.
Reducing Information Risk
 User verifies information independent
The user may go to the business premises to examine
records and obtain information about the reliability of the
statements

 User shares information risk with management

If users rely on inaccurate financial statements and as a result
incur a financial loss, they may have basis for a lawsuit
against management. But users may not be able to collect on losses

 Audited financial statements are provided

The most common way for users to obtain reliable information
İs to have an independent audit
How does auditing differs from accounting?
• In terms of objectives and procedures:

Accounting Auditing
Is a process that Does not create
creates financial accounting information
statements but enhances the
credibility of F/Ss

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In an audit of Financial statements:..revision

• The auditor gathers audit evidence and evaluates the

accounting records and supporting documents
Relevant  reliability Cut off, obligation, completeness…
• The auditor evaluates whether the Management Assertions
contained in the F/Ss correspond with the generally
accepted principles
• An auditor of financial statements must possess accounting
knowledge as well as expertise to accumulate and evaluate
evidence whilst an accountant does not need to know
auditing.

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Nature of auditing

Purpose:
• To enable auditors to express an opinion
• Subject matter
• Examination of historical F/S Check pass things
Evidence gathering
• Systematic process
independent
• Objectively obtaining and evaluating evidence
• Assertions about economic actions and events
• Degree of correspondence between those assertions and established
criteria
Reporting
Shareholder, banker, investor
• Communicating the results to interested users

Auditor report – independent auditor report

Auditor opinion (unmodified, modified) - Unqualified opinion, Qualified opinion, Adverse
opinion, Disclaimer of opinion 18
AUDITING AND ASSURANCE
SERVICES
• ASSURANCE services are independent professional
services that improve the quality of information, or
its context, for decision makers.
• Examples:
• Risk assessment
• Information system reliability
• Electronic commerce
• Health care performance measurement

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 The nature of assurance services

• Where a professional accountant evaluates or measures a

subject matter that is the responsibility of another party
against criteria, and expresses an opinion which provides the
intended user with a level of assurance about the subject
matter.
• It must exhibit the following elements:
• A) a 3 party relationship
• B) a subject matter……
• Must be identifiable
• Consistent evaluation and measurement
• Subject to procedures and gathering

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 Assurance services:
• C) suitable criteria
Accounting standards or law or regulations
• D) an assurance engagement process
Can be many and varied depending on the subject matter:
• Data i.e. Financial statement or projections
systems and processes i.e. internal control or computer systems
• Behavior i.e. social and environmental or corporate governance
• E) a conclusion…. Level of assurance either high or moderate

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Example of financial statement audit as
assurance service
• Professional accountant: auditor
• Subject matter: financial statements
• Persons responsible: management
• Users: shareholders
• Suitable criteria: accounting standards and law
• Opinion: True and fair
• Level of assurance: high means that the subject matter
materially conforms with the criteria
• Moderate level of assurance :means that the auditor has no
reason to believe that the subject matter does not conform
with the criteria, that is, it is plausible that it does so.

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Limitations of the procedures to conduct an
audit
• Auditors use judgement in deciding Past experience and skills
• Auditing is not a purely objective exercise A = a X A = b √
• Auditors cannot check every item in the records Minimum 2 weeks (small business)
• Limitations of accounting and internal control systems
• Client management or staff might not tell the truth
• Audit evidence indicates what is probable rather than what is certain
• Auditors report months later after the balance sheet date ….. Not up to
date Got adjusting or non adjusting event happens
• Audit report itself is a limitation. It is not informative on all aspects of
audit

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Benefits of audit
• Reassures readers that the accounts have been examined by a knowledgeable,
impartial professional
• Owners are given an independent opinion as to T & F
• Owners have an impression of how their investment has performed in the period
under the responsibility of the directors
• Audited F/S can be used by 3rd parties as they are more confident of the report
• Auditors can play the role of business advisors to help directors to improve the
business by:

1. Management letter
- (Management Letter means a letter prepared by the auditor which discusses findings and
recommendations for improvements in internal control, that were identified during the
audit and were not required to be included in the auditor's report on internal control, and
other management issues.)

2. Discussions during audit

• The existence of audit can help to mitigate against risks

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Limitations of audit

Auditors cannot guarantee:

1.The future viability of the entity Company can operate in next 10 years
2.Management’s effectiveness and efficiency
3.No fraudulent activities had taken place
No fraud, because auditor don’t check everything

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TYPES OF AUDITS

•Financial statements audits 5 component sopl solp…

•Compliance audits Rule and regulation
•Operational audits Company operation - internal control system
•Forensic audits Special focus on fraud

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 US case
Enron case : Fraudulent Financial Reporting
1.Many of its companies were offshore (Special Purpose Entities)
- avoid taxes
- change in transaction currency
- hide overall company losses
- hide significant debts

2. Creative accounting techniques

- To improve reported profits – known as (MTM) marking to market i.e.

recognise sales & earnings on deals a long time before actual revenue
was realized Only can recognize revenue when it transferred
Deposit received, cannot be recognize as revenue, but differ income
- Different revenue recognition method between merchants and agent
3. Huge reported profits drove the share price up
- Allowed executives to trade millions worth of Enron stocks to their
benefit
4.Then share price fell due to the dot.com issue during that period.
-Stuck with massive liabilities and followed by severe liquidity
problems

Pakat with company

5.The audit firm - guilty of destroying the documents relating to
Enron audit

6. Collapse of one of the big “5” A. Andersen

 Consequences
• 4500 employees lost their jobs.
• Investors lost some 60 billion dollars within a few days; for many it meant losing
their old-age security.
• The pension fund for the company's employees was obliterated.
• Citizen’s trust in the American economic system was destroyed.
• Losses on the financial market amounted to the worst stock value loss in peaceful
times.
• Banks were suspected of collusion.
• The auditing firm Arthur Anderson lost its accreditation.
• The rules for company financial reporting were drastically sharpened: 
Sarbanes-Oxley Act(2002).
• Investors' confidence declines