Learning Outcome

HI-6026 Auditing, Assurance

and Compliance

Revision Lecture
 Learning Outcome

Topic Lecture
Audit Risk, Materiality and 4,6,7
Audit Strategy

Analytical Procedures 5
Going Concerns 6 & 11
Internal Control Weakness and 7
Test of Control
Substantive Test (Assertions 8
and Audit Procedures)
Subsequent Event 10
Audit Opinion 11

5 cases for each 12 marks

 Learning Outcome

Analytical
Procedures
 Analytical procedures Learning Outcome

• Analytical procedures involve the use of ratios, trend analysis and

operating statistics for comparison with internal and external data.
• Can be used at all stages of the audit: e.g. in planning stage, as a
form of evidence or as part of a final review.
• At this stage we concentrate on the use of analytical procedures in
planning the audit.
 Learning
Analytical procedures most commonly used Outcome
in planning

• Comparison of current balances in the financial report with

balances of previous periods and budgeted amounts (simple
comparisons).

• Computation of ratios and percentage relationships for

comparison with previous years, budgets and industry averages
(ratio analysis).

• Significant variations from expectations indicate areas requiring

investigation.
 Ratio analysis Learning Outcome

• At the planning stage the auditor is undertaking ratio analysis on

unaudited financial information, thus any ratios not in accordance
with the auditor’s expectations will indicate areas requiring
significant audit attention.
• These ratios may be compared to:
– industry data:
• average ratios in industries listed on the ASX
– internal data:
• previous years
• budgets or forecasts
• segment or division data.
 Ratio analysis Learning Outcome

• At the planning stage the auditor is undertaking ratio analysis on

unaudited financial information, thus any ratios not in accordance
with the auditor’s expectations will indicate areas requiring
significant audit attention.
• These ratios may be compared to:
– industry data:
• average ratios in industries listed on the ASX
– internal data:
• previous years
• budgets or forecasts
• segment or division data.
 Learningstage
Ratios commonly used at the planning Outcome

1. Short-term liquidity:
– current ratio (current assets to current liabilities)
– quick asset ratio (liquid assets to current liabilities)
– operating cash flow ratio (cash flow from operations to current
liabilities).
2. Activity:
– receivables turnover/days in receivables (net sales to average
accounts receivable/365 days to receivables turnover)
– inventory turnover/days in inventory (cost of goods sold to
average inventory/365 days to inventory turnover).

Continued
 Learning
Ratios commonly used at the planning stage Outcome
(continued)

3. Profitability:
– gross profit and net profit ratio (gross profit or net
profit to net sales)
– return on total assets (net profit before interest and taxes to total
assets)
– return on shareholders’ equity (net profit to ordinary shareholders’
equity).
4. Solvency:
– debt to equity ratio (total liabilities to shareholders’ equity)
– times interest earned (net profit before interest and taxes to annual
interest expense).
 Learning Outcome

Subsequent
Event
 Learning Outcome
The date of the auditor’s report

• Important because it establishes the date of the auditor’s

responsibility for knowledge of events that should be reflected in
the financial report.
• Auditor’s report should be dated when it is actually signed and no
earlier than the date of directors’ declaration.
• Ensures financial report was completed and formally accepted by
officers of the company prior to the auditor expressing an opinion.

11
 Learning
Summary of types of subsequent eventsOutcome

12
 Learning Outcome
The nature of completion and review procedures

13
 Adjusting events Learning Outcome

• Events, both favourable and unfavourable, that provide

evidence of, or further elucidate, conditions that existed
at balance date.
• Financial effect of such events needs to be taken into
account, therefore they require adjustment to the
figures contained in the statement of financial position
and/or the income statement.

14
 Examples of adjusting events
Learning Outcome

• Subsequent collection of a material account receivable that has

been treated as uncollectable at balance date.
• A legal determination, subsequent to balance date, that
establishes that a claim was in existence, but of an uncertain
amount, at balance date.
• Legislation after balance date that retrospectively changes the
company income tax rate applying to financial period ended on or
prior to balance date.
• Ascertainment subsequent to balance date of selling prices for
inventory items, where those prices were previously uncertain.

15
 Non-adjusting events Learning Outcome

• Do not relate to a condition that existed at balance date.

• Include both favourable and unfavourable events that
create new conditions, as distinct from any condition
that might have existed at balance date.
• If material, disclose in the notes to the accounts.

16
 Examples of non-adjusting events
Learning Outcome

• A fire or flood loss after balance date, not fully covered

by insurance.
• A major currency realignment subsequent to balance
date.
• Raising of additional shares or loan capital after
balance date.
• Mergers and acquisitions after balance date.
• Expropriation, after the balance date, of a significant
overseas investment or asset.

17
 Events between balance date and the dateLearning Outcome
of auditor’s report

The auditor has a responsibility to apply audit procedures

sufficient to enable auditor to determine whether all
material adjusting and non-adjusting events have been
appropriately adjusted for (adjusting) or disclosed (non-
adjusting) in the financial report, up until the date of the
auditor’s report.

18
 Learning Outcome

Substantive Testing
(Assertions and
Audit Procedures)
 Learning Outcome
Types of audit procedures
 Financial report assertions and audit objectives
Learning Outcome
and procedures
Financial report assertions and audit objectives and procedures

• Directors and managers make assertions (embodied in the financial report)

when they present a financial report.
• Auditors use these assertions to identify and assess risks by considering different
types of potential misstatements that may occur and designing audit procedures
in response to risks.
• There are three categories of assertions:
– classes of transactions and events
– account balances
– presentation and disclosure.

21
 Financial report assertions and audit objectives and
Learning Outcome
procedures

Financial report assertions

Assertions about classes of transactions and events for the period under audit:
• 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.

Continued

22
 Financial report assertions and audit objectives and procedures
Learning Outcome

Financial report assertions (continued)

Assertions about account balances at the period end:

• 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.
• Valuation and allocation — assets, liability and equity interests are included in the financial
report at appropriate amounts and any resulting valuation adjustments are appropriately
recorded.

Continued

23
 Financial report assertions and audit objectives and
procedures Learning Outcome

Financial report assertions (continued)

Assertions about presentation and disclosure:
• Occurrence and rights and obligations — disclosed events, transactions and other matters have
occurred and pertain to the entity.
• Completeness — all disclosures that should be included in the financial report have been
included.
• Classification and understandability — financial information is appropriately presented and
described, and disclosures are clearly expressed.
• Accuracy and valuation — financial and other information is disclosed fairly and at appropriate
amounts.

24
 Learning Outcome

Going Concerns
 Learning Outcome
Appropriateness of the going concern basis

• Going concern assumption:

– Entity is viewed as continuing in business for the foreseeable
future without any intention or necessity to liquidate or
otherwise cease its operations (ASA 570.2/ISA 570.2).
• ASA 570.10/ISA 570.10 requires auditors to assess
going concern at planning stage, as imminent business failure
might affect the appropriateness of presentation of financial
report or might motivate management misrepresentations.

Continued
 Learning Outcome
Appropriateness of the going concern basis (continued)

• Early identification helps focus audit effort on appropriate

assertions in the financial report and permits early communication
with management.
• An auditor focuses primarily on anticipated events during the
relevant period, approximately 12 months from the date of the
current audit report to the expected date of the next audit report.
 Learning
Examples of indications of going concern Outcome
problems

• Financial indicators:
– high gearing or fixed-term or reliance on short-term borrowings
– withdrawal of financial creditors, inability to pay creditors or denial of trade
credit by suppliers
– negative operating cash flows or adverse key financial ratios
– lack of sustainable operating profits
– dividend arrears
– difficulty in complying with terms of loan agreements
– inability to obtain necessary financing.

Continued
 Examples of indications of going concernLearning
problemsOutcome
(continued)

• Operating indicators include:

– Management’s intention to cease operations
– loss of key management personnel
– loss of major market, licence or franchise
– prolonged industrial action
– shortages of important supplies
– emergence of highly successful competitors.

Continued
 Examples of indications of going concern problems
Learning Outcome
(continued)

• Other indications:
– non-compliance with capital or statutory requirements
– legal proceedings against the entity
– adverse changes in legislation or government policy
– uninsured or underinsured disasters.
 Mitigating factors Learning Outcome

• Auditor should consider mitigating factors.

These include:
– Asset factors—sale of assets, or delayed
replacement
– Debt factors—unused lines of credit, ability
to renew or extend existing loans
– Cost factors—ability to reduce costs
– Equity factors—additional contributions
from owners, subsidiaries or associates.
• See Table 6.3 on page 275 of the textbook.
 Learning Outcome

Internal
Control
Weakness and
Test of Control
 Learning
Components of internal control (IC)Outcome
 Control activities Learning Outcome
• Policies and procedures established by management to
ensure its directives are carried out.
• Can pertain to:
– performance reviews (e.g. comparing actual with budget)
– information processing, in an information technology (IT)
environment comprising general IT controls and application
controls (discussed later this chapter)
– physical controls (e.g. locked storerooms for inventory)
– segregation of duties (the most basic of which is to have
different individuals responsible for handling assets and the
keeping of records relating to those assets).
 Segregation of duties related to aLearning Outcome
transaction

• A transaction may be considered to pass through four

phases:
1. Authorisation—the initial authorisation or approval
for an exchange transaction.
2. Execution—the act that commits the entity to the exchange,
such as placing an order.
3. Custody—the physical act of accepting, delivering
or maintaining the asset.
4. Recording—the entry of the transaction data into
the accounting system.
• Ideally, all four phases should be kept separate.
 Learning Outcome
Monitoring of controls

• Monitoring of controls:
– A process to assess the effectiveness of the performance of
internal control.
– It involves:
• evaluating the design and operation of controls
• taking corrective action where necessary.
• Management may monitor controls through ongoing
activities such as supervisory activities and/or separate
evaluations.
• In many entities internal auditors contribute
to the monitoring process.
 Learning
Steps in the auditor’s consideration of internal Outcome
control
 Understanding internal control and risk assessment
Learning Outcome
Procedure
• The auditor obtains an understanding of internal controls to assess control risk and:
– identify the types of potential misstatements that could occur and the factors that
contribute to the risk that they will occur
– understand the accounting system sufficiently to identify the client documents,
etc., That may be available and ascertain what data will be used in audit tests
– determine an efficient and effective approach to the audit.
• Auditor needs to determine how management identifies business risks, estimates
their significance, assesses their likelihood of occurrence and decides upon actions to
manage them.
• Auditor enquires of management about business risks that management have
identified and considers whether they may result in a material misstatement.
• If auditor identifies a risk of material misstatements that management failed to
identify, they need to consider whether management should have identified it and, if
so, why the process failed.
 Learning Outcome

Audit Opinion
How different types of modifications affect the auditor’s
Learning opinion
Outcome
 Qualified opinion Learning Outcome

• A qualified opinion is expressed when the auditor:

– concludes that misstatements are material but not pervasive to the
financial report
– is unable to obtain sufficient appropriate evidence on which to base the
opinion but concludes that the possible effects on the financial report
could be material but not pervasive (ASA/ISA 705.07).
• The most common types of qualified opinions issued relate to
material departures from a specific accounting standard or
material disagreements over the carrying value of a specific asset
or liability and its potential effect on profit.
 Adverse opinion Learning Outcome

• An adverse opinion should be expressed when the effect of the

misstatements, individually or in the aggregate, are so material and
pervasive that the financial report taken as a whole is, in the
auditor’s opinion, misleading or of little use to the addressee of the
auditor’s report (ASA/ISA 705.08).
• The most common situation in which adverse opinions are issued is
when the accounts are prepared on a going concern basis and the
auditor concludes that it is highly improbable that the entity will
continue as a going concern (ASA/ISA 570.21).
 Disclaimer of opinion Learning Outcome

• A disclaimer of opinion is expressed when the auditor is unable

to obtain sufficient appropriate evidence to form an opinion,
and concludes that the possible effect of undetected
misstatements on the financial report could be both material
and pervasive (ASA/ISA 705.09–10).
• In issuing a disclaimer of opinion the auditor is communicating
that there has been such a limitation on the evidence-
gathering procedures that they are unsure whether the
financial report is reliable.
 Additional communications in the auditor’s
Learningreport:
Outcome
Emphasis of Matter

• In certain limited circumstances it is appropriate for the auditor to

draw attention to or emphasise a matter that is appropriately
presented or disclosed in the financial report and is considered
relevant to users of the auditor’s report, but which, because of its
nature, does not affect the auditor’s opinion.
• The major examples would be when there is a disclosure in the
notes to the financial report that the auditor considers to be
complete and adequate, but important enough to bring to users’
attention.
 Learning
Circumstances giving rise to Emphasis Outcome
of Matter

• ASA/ISA 706.A1 outlines circumstances in which Emphasis of Matter

(EoM) can be issued:
– uncertainty relating to the future outcome of exceptional litigation or
regulatory action
– early application of a new 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.
• Until 2014, approximately 90% of auditor’s reports in Australia containing
EoM paragraphs related to uncertainty regarding going concern status,
with going concern modifications now classed as a separate category of
modification.
 Other Matter paragraph Learning Outcome

• The ability to include an Other Matter (OM) paragraph in the

auditor’s report allows auditor to draw user’s attention to any
other matters, not presented or disclosed in the financial report,
that the auditor believes are sufficiently important to be
highlighted.
• Circumstances giving rise to an OM paragraph are those relevant
to enhancing the user’s understanding of the audit, the auditor’s
responsibilities or the auditor’s report.
 Learning
Circumstances giving rise to a modified opinionOutcome

• The auditor’s opinion should be modified when:

– the auditor concludes, based on the audit evidence obtained, that the
financial report is not free from material misstatements, or
– the auditor is unable to obtain sufficient appropriate evidence to conclude
that the financial report is free of material misstatements (ASA/ISA 705.06).

• Before issuing a modified opinion, the auditor should take all

reasonable steps to overcome the issues giving rise to the material
misstatement (disagreements with management) or the issues
causing the auditor to be unable to obtain sufficient appropriate
evidence (limitations on scope).
 Material Misstatement Learning Outcome

• ASA/ISA 450 defines a misstatement as the difference between the

amount, classification, presentation or disclosure of an item
reported by an entity in the financial report and the way that item is
required to be treated in accordance with the applicable financial
reporting framework.
• Therefore, a material misstatement in the financial report may arise
in relation to:
– the appropriateness of the accounting policies selected
– the application of those accounting policies, or
– the appropriateness or adequacy of disclosures in the financial
report (ASA/ISA 705.A3).
 An inability to obtain sufficient appropriate Learning Outcome
audit evidence

• An inability to obtain sufficient appropriate audit evidence (scope

limitation on the auditor’s work) may arise for one of three reasons
(ASA/ISA 705.A8):
– circumstances beyond the control of the entity
– circumstances related to the nature or timing of the auditor’s work, or
– limitations imposed by the entity.
• A limitation on the performance of a particular procedure does not
necessarily constitute a limitation on the scope of the audit if the
auditor is able to obtain sufficient appropriate evidence by
performing alternative procedures.
 Learning Outcome

How to present
answer in the
exam booklet
 Audit Opinion Learning Outcome

Issues/ No/ Client Audit Opinion Justification

(i) Unqualified Audit Given that this issue is material,
the chairman’s report will be
Opinion materially incorrect, but the
financial report itself is correct.
The chairman’s report is other
information, and a material
misstatement in this other
information will result in an
unmodified opinion on the
financial report, but the inclusion
of an Other Matter paragraph in
the auditor’s report
 Subsequent Event Learning Outcome

Issues/ No/ Client Accounting Justification

Treatment
BHP Billiton Type 2 Subsequent The fire on 17 July is a
Event: non-adjusting event, as it
Disclose in the notes to is a new event occurring
the financial report after the reporting date.
 Internal Control Weakness and TestLearning Outcome
of Control

Internal Control Accounts Assertion Test of

Weakness Control
Increase in control risk, Accounts Valuation and Suggest Test of
due to the absence of receivable allocation Controls here
the previous control,
increasing the risk of
bad debts
 Analytical Procedures Learning Outcome

Ratio Explanation Audit Impact

Current Ratio The debt/equity ratio has Audit attention will need to
increased significantly to be directed at confirming the
finance the investment in long-term debt and interest
property plant and charge. However, there is no
equipment, but is still at a indication of any problems
relatively low level, being less relating to debt dependence.
than 1 and meets the loan
covenant requirements. The
times interest earned has
dropped due to the
significant increase in interest
expense of $724 375 related
to the increase in long-term
debt of $7 500 000
 Substantive tests of transactions and balances
Learning Outcome

Issues/ Client/ No. Accounts Assertion Audit procedures/

Audit Steps to
reduce risk
(ii) Provision for bonus / Valuation and
Bonus expense allocation / Accuracy
 Going Concern Audit OpinionLearning Outcome

Going Concern Factors Auditors to assess the appropriateness of going concern Mitigating The reason for assessing the
Factors probability that any company will
continue as a going concern.

Financial Factors • Review after balance date events Assets Factors  The appropriateness of the
Operations Factors • analyse the latest interim financial report, cash flow and profit forecasts Debt Factors presentations of the final report, i.e.
Other Factors • read the minutes of directors meetings for references to financial Cost Factors whether the assets and liabilities
difficulties Other Factors should be valued at fair value or at
• review the terms of venture and loan agreements liquidation values, or
• request information from the entity’s solicitors  May motivate management
• consider the effect of unfilled customer orders misrepresentation to hide the
failure by misstating amounts in the
accounts and financial report (In
addition liquidation increases the
possibility that the auditor will have
to defend the quality of the audit in
court and so will want to be sure
that the audit program and working
papers are water tight.
