AC 4342 Auditing Introduction to assurance and financial statement auditing Discussion Question: Messier Q1-13, 14 1 References HKICPA Members’ Handbook Amended Preface to the Hong Kong Quality Control, Auditing, Review, Other Assurance, and Related Services Pronouncements Hong Kong Framework for Assurance Engagements Reference Messier: Ch 1 2 CILOs and TLAs CILOs 1 Describe the auditing profession, the regulatory, legal and reporting framework of auditing. Recognize the basic principles, objectives and ethical requirements of audit and assurance services.
Identify the audit process from client acceptance, design of audit procedures and express an appropriate audit conclusion based on the audit evidence obtained. Assess risks and threats to an audit of financial statements through analytical and critical thinking. Communicate effectively in writing and verbally. v v 2 3 4 5 v 3 Specific learning outcomes Understand the major concepts of auditing – why, what, how & limitations Differentiate the types of services offered by public practitioners assurance and nonassurance services
Describe the 3 fundamental concepts in conducting a F/S audit ( Materiality, Evidence, Audit risk ) 4 CILOs and TLAs TLAs 1 Lectures, in-class activities and assignments, designed to assist students’ understanding and learning of auditing principles, objectives, legal and ethical requirements of audit and assurance services. Lectures, in-class activities and assignments, designed to assist students to understand and perform audit tests on financial statement account balances and formulate appropriate audit reports. v 2 5 The Study of Auditing
The study of auditing is different from other accounting courses that you have taken because … OTHER COURSES Rules, techniques and computations to prepare and analyse financial information AUDITING Analytical and logical skills Much more conceptual in nature 6 The Demand for Auditing and Assurance The development of the corporate form of business and the expanding world economy over the last 200 years have given rise to an explosion in the demand for assurance provided by auditors. 7 Why auditing is required ? Regulatory requirements
Companies formed under Hong Kong Companies Ordinance Issuance of new shares Economic demand (theoretical framework / agency theory) 8 Principals and Agents A public company is a company that sells its stocks or bonds to the public, giving the public a valid interest in the proper use, or stewardship, over the company’s resources. Agents Principals 9 Economic Demand Agency relationship occurs when one party, the principal, employs another party, the agent to perform a task on his behalf Agency theory – Separation of ownership & control Conflict of interests between
Agents (managers) – increase personal benefits Principals (shareholders / stockholders) – increase in the financial returns from investment => Managers put their own interests as top priority Information asymmetry =>Auditing helps to reduce the information risk, thus increase creditability to information reported (F/S prepared ) by managers 10 The Role of Auditing 11 Auditing – a general def’n Extracted from American Accounting Association Committee on Basic Auditing Concepts (1973)
Is a systematic process Of objectively obtaining and evaluating evidence Regarding assertions about economic events To ascertain the degree of correspondence between those assertions and established criteria And communicating the results to interested users 12 Fundamental Concepts in Conducting a F/S Audit Materiality Audit Risk Evidence 13 Evidence Regarding Management Assertions Evidence that assists the auditor in evaluating management’s financial statement assertions consists of the underlying accounting data and any additional information available to the auditor, whether originating from the client or externally.
Relevance – Is the information related to the specific assertion being tested? Reliability – Can the information be relied upon to signal the true state of the specific assertion being tested? 14 Summary of management assertions by category Classes of transactions & events for the period under audit Account balances at period end Presentation and disclosures Occurrence /Existence Rights and obligations Completeness Accuracy / Valuation and allocation Cutoff Classification Transactions and events that have been recorded have occurred and pertain to the entity.
Assets, liabilities, and equity interests exist. Disclosed events, transactions, and other matters have occurred and pertain to the entity. (Occurrence and rights and obligations) The entity holds or controls the rights to assets, and liabilities are the obligations of the entity. All transactions and events that should have been recorded have been recorded. Amounts and other data relating to recorded transactions and events have been recorded appropriately. All assets, liabilities and equity interests that should have been recorded have been recorded.
Assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded. All disclosures that should have been included in the financial statements have been included. (Completeness) Financial and other information are disclosed fairly and at appropriate amounts. (Accuracy and Valuation) Transactions and events have been recorded in the correct accounting period. Transactions and events have been recorded in the proper accounts.
Financial information is appropriately presented and described, and disclosures are clearly expressed. (Classification and understandability) Materiality Misstatements, including omissions, are considered to be material if they, individually or in the aggregate, could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements. Judgements about materiality are made in light of surrounding circumstances, and are affected by the size or nature of a misstatement, or a combination of both. 16 Audit Risk
Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. The auditor’s report with an unmodified opinion states that the audit provides only reasonable assurance that the financial statements do not contain material misstatements. Reasonable assurance implies some risk that a material misstatement could be present in the financial statements and the auditor will fail to detect it. 17 Overview of the F/S Audit Process 18 ASSURANCE SERVICES Any relationship with auditing ? 19 Assurance engagement is … Assurance engagement is an ngagement in which A practitioner expresses a conclusion designed to enhance the degree of confidence of the intended users other than the responsible party About the outcome of the evaluation or measurement of a subject matter Against criteria 20 Assurance engagement is … Forms of an subject matter Financial performance (eg historical or prospective financial position, financial performance and cash flows) Non-financial performance (eg room occupancy) Physical characteristics (eg capacity of a facility) Systems and processes (eg internal control / IT system )
Behaviour (corporate overnance, compliance with regulations, human resource practices) (HKICPA, Hong Kong Framework for Assurance Engagements) 21 Assurance engagement is … Criteria are the benchmarks used to evaluate or measure the subject matter. Criteria can be Formal eg HKFRS, IFRS (reporting on F/S) International Public Sector Accounting Standards (reporting on internal control) applicable law, regulation or contract (reporting on compliance) Less formal eg internally developed code of conduct an agreed level of performance (such as the number of times a particular committee is expected to meet in a year). HKICPA, Hong Kong Framework for Assurance Engagements) 22 Other assurance services Examples of assurance services provided by auditors other than financial statement audits: Attestation on internal control over financial reporting Review of historical financial statements Newspaper circulation audits (ABC audit) (http://www. hkabc. com. hk) 23 Assurance Report The practitioner provides a written report containing a conclusion that conveys the assurance obtained about the subject matter information _______________ _______________
Positive form of expression of Negative form of expression of the conclusion conclusion “In our opinion, internal control is effective, in all material respects, based on XYZ criteria” “Based on our work described in this report, nothing has come to our attention that causes us to believe that internal control is not effective, in all material respects, based on XYZ criteria” 24 Level of Assurance Why absolute assurance cannot be attained ? Reducing assurance engagement risk to zero is very rarely attainable or cost beneficial because of following factors • The use of selective testing ( ). The inherent limitations of internal control • Evidence available to the practitioner is persuasive rather than conclusive. • Judgment involved in – gathering and evaluating evidence – forming conclusions based on that evidence. 25 Sampling: Inferences Based on Limited Observations Auditors use (1) their knowledge about the transactions and/or (2) a sampling approach to examine the transactions. It would be too costly for the auditor to examine every transaction. 26 Professional Framework HKICPA Members’ Handbook VOLUME I
Professional Accountants Ordinance & By-Laws Professional Ethics & Conduct VOLUME II Financial Reporting Standards VOLUME III Auditing & Assurance Standards 27 Amended Preface to the Hong Kong Quality Control, Auditing, Review, Other Assurance, and Related Services Pronouncements HK Framework for Assurance Engagements HK Standards on Auditing Review Engagements Investment Circular Reporting Engagements Assurance Engagements HKSA HKSRE HKSIR HKSAE HKSRS 28 HK Standards on Related Services Amended Preface to the Hong Kong Quality Control, Auditing, Review, Other Assurance, and Related Services Pronouncements
HKSRS – Guidelines for conducting nonassurance services – Only 2 HKSRS issued so far – HKSRS 4400 – Engagements to Perform Agreed-Upon Procedures Regarding Financial Information Engagements to Compile Financial Statements (Compilation engagements) 29 – HKSRS 4410 – Major Phases of the Audit Client acceptance/continuance and establishing an understanding with the client Preliminary engagement activities Plan the audit Consider internal control Audit business processes and related account (e. g. revenue generation) Complete the audit Evaluate results and issue audit report 30
Issue the Audit Report The auditor’s report is the main product or output of the audit. The audit report with an unmodified (‘clean’) opinion is the most common type of report issued. 31 Issue the Audit Report The title line of the audit report includes the word __________ and usually, the report is addressed to the ____________of the company. The audit report includes introductory paragraph management’s responsibility paragraph auditor’s responsibility paragraph, and auditor’s opinion paragraph.
The audit report is signed and dated. 32 Auditing Demands Logic, Reasoning, and Resourcefulness An auditor needs to understand more than just the accounting concepts and techniques. Auditing is a fundamentally logical process of thinking and reasoning – so use your common sense and reasoning skills! As you learn new auditing concepts, take some time to understand the underlying logic and how the concepts interrelate with other concepts. Being a good auditor sometimes requires imagination and innovation. 33