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Lecture Week 1

Chapter 1

Framework: Assurance Engagement

Preparer Preparer can be anyone who prepares financial
statements on a subject matter (e.g. a CFO or CEO
or management).

Subject Matter The subject matter is prepared to be used by the

user, and they need to assess the reliability of the
subject matter.

Practitioner And so they appoint an assurance service

provider, a practitioner, who would have
experience in the subject matter and would be
completely independent of the entity.

Users Users want a level of confidence on the subject

matter. The practitioner would evaluate the
subject matter to see if it complies with the
relevant criteria (i.e. accounting standards).

Assurance Report Practitioner will then collect evidence that

the criteria is being met and based on this
evidence they will provide an assurance report
which is provided to the user (not the preparer)
and this can be used for decision making.

Levels of assurance Two types of levels of assurance,

Direct no claims by client but simply giving an
Attest to verify a claim made by the client that
has been measured

Level of confidence The report can have 3 different levels of

limited Have undertaken some procedures and
nothing has come to the auditors attention that
there are misstatements/errors. It is a negative
way of assuring user and emphasizing that only
some (not detailed) procedures have been
undertaken. This is not possible in final year
reports but can be used as a review
engagement for interim reports.

reasonable found in any annual report and the

message is that users are reasonably assured.
Includes complying with all auditing standards,
have undertaken auditing on a risk come risk
basis, tests undertaken and minimized risk of
failing auditing to a very low extent and can
reasonably assure users that financial statements
are true and fair in their presentation and comply
with accounting standards. This is the only
satisfactory level for an audit engagement.

absolute 100% guarantee of no misstatement,

fraud, etc. (this is not possible as most financial
reporting is based on fair values and so is not
100% accurate, or if checking a sample you cant
be certain there is no error in the whole
population, and it is not expected that an auditor
can detect some fraud)

el of confidence
Preparer e User

Assurance Attest


Subject Practitione
matter r
Assurance Engagement - An
engagement in which a 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.

Non-Assurance Engagement for an advisory service - includes

an agreed upon procedure engagement in which tests and
procedures are undertaken and the findings are presented to client.

Auditing - To obtain reasonable assurance about whether the

financial reports as a whole is free from material misstatement,
whether due to fraud or error, thereby enabling the auditor to
express an opinion on whether the financial report is prepared, in all
material respects, in accordance with an applicable financial
reporting framework; and to report on the financial report, and
communicate as required by the ASAs, in accordance with the
auditors findings (ASA 200)

Ethical Principles (APES110 code of ethics ):
integrity Section 110
objectivity (independent, unbiased) Section 120
professional competence and due care Section 130
confidentiality Section 140
professional behavior Section 150

Fundamental Auditing Principles:

quality control
rigour and skepticism
professional judgment
documentation of engagement
communication (with management, BOD, audit committee,
association (e.g. with illegal businesses)

Audit Expectation Gap

The gap between perceived audit performance by society
and societys expectations of auditors. There are often
unreasonable expectations by society of an auditors performance.
Part of the reason of the gap is due to a deficiency in standards to
what is required as opposed to what is expected (reasonableness
gap). There is a difference between the auditors duty and standards
and this is due to deficient performance by auditors in failing to
meet standards.
Unreasonable expectations gap between what society expects
auditors to achieve and what they can reasonably be expected to
Deficient Standards gap between duties that can reasonably be
expected of auditors and auditors existing duties as defined by law
and professional promulgations,
Deficient Performance gap between the expected standard of
performance of auditors existing duties and the perceived
performance of auditors
Lecture Week 2

Chapter 3

American Accounting Association Model (AAA)

1. Determine the facts
2. Define the ethical issues
3. Identify the major principles, rules and values
4. Specify the alternatives
5. Compare values and alternatives
6. Assess the consequences
7. Make your decisions

Threats & Safeguards

Section 200.3
Threats fall into one or more of the following categories:
(a) Self-interest;
(b) Self-review;
(c) Advocacy; e.g. firm promoting shares in an audit client
(d) Familiarity; and
(e) Intimidation

Section 200.9
Safeguards that may eliminate or reduce threats to an Acceptable Level fall into two
broad categories:
(a) Safeguards created by the profession, legislation or regulation;
education and training
continuing professional development
professional standards
regulatory monitoring and disciplinary process
(b) Safeguards in the work environment
discuss with supervisor
dispose off the interest
do not accept the engagement
get an independent review of the work
removing the person from the engagement
separate teams: assurance and non-assurance
no involvement in any decision-making capacity for the client

Section 210 Accepting a new client, requires evaluating a new client to determine
if there are any threats under Section 200.3 and apply any safeguards if needed under
Section 200.9

Section 240 Fees and other remuneration should be

commensurate with service provided and must not quote too low
fees (avoid low-balling where quote low fees then later attempt to
recoup fees by increasing fees), make client aware of how they are
being charged and should enter into a fee arrangement that may
compromise auditor independence.

Section 260 Gifts

Auditor Independence
Section 290 Independence
Should be independent in appearance(perception of
independence) and of mind (actually be independent) to justify that
you have been objective in completing the audit

Threats to auditor independence:

Auditor employment relationships
Member of the assurance team cannot be employed by
the client.
Two year restriction for a retired/resigned audit
partner to join a client
If one former partner is already working for the
client, the restriction is 5 years
Financial and business relationships, including:
investments in audit clients (Direct and indirect)
loans to and from clients (Financial institutions vs
business relationships (Significant?)
goods and services from clients (Arms-length)
Provision of non-audit services
Fees from clients must be collected promptly (before the issue
of a subsequent audit report). Overdue fees may create a self-
interest threat.
Overdue for more than 2 years may be considered a loan to
the client
When total fees generated from a public listed client represent
a large proportion of the auditors total fees (i.e. more than
15% of the audit firms total fees), real or perceived financial
dependency on that client may create a self-interest or
intimidation threat- apply safeguards.
Audit clients must disclose in the financial report the amount
of fees paid to the auditor, split between audit and non-audit
Lecture Week 3

Chapter 4

representations made by management, that are
embodied in the financial report, as used by the auditor
to consider the different types of potential
misstatements that may occur.

Audit Procedures (or Audit Tests or Audit Effort)

Methods used by the auditor to gather and evaluate
audit evidence
Audit tests can be to test controls or number testing
(i.e. test transactions, account balances, presentations
and analytical procedure)

Audit Evidence information obtained by the auditor in arriving at

the conclusions on which the auditors opinion is biased.

When Risk of Material Misstatement (RMM) then Audit Effort

required until Audit Risk is at a low level

When Risk of Material Misstatement (RMM) then Audit Effort

required until Audit Risk is at a low level

Risk of Material Misstatement can be at:

Overall Financial Reporting Level OR Individual
Assertion Level
(Account Level)

Inherent Risk OR
Control Risk

Income statement items/Transactions (e.g. for sales accounts,
expenses, income, revenue):
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-of transactions have been recorded in the correct
accounting period
Classification transactions and events have been recorded
in the proper accounts

Balance sheet items (at period end):

Existence assets, liabilities and equity interests actually
Rights & Obligations - entity holds or controls the rights to
assets and liabilities are the obligations of the entity
Completeness all assets, liabilities and equity that should
have been recorded has been recorded
Valuation & Allocation assets, liabilities and equity
interests are included in the financial report at appropriate
amounts and any resulting valuation adjustments are
appropriately recorded

Presentation & disclosure items:

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

Audit Procedures
Inspection examination of documents, records or tangible assets
Observation observing the behavior of operating personnel and
the functioning of the business in operation; looking at a process or
procedure being performed by someone else
External confirmation audit evidence obtained as a direct
written response to the auditor from a third party
Recalculation checking mathematical accuracy of documents or
records, proven by recalculating the results.
Re-performance - auditor may independently execute procedures
or controls that were originally performed as part of the entitys
internal controls; e.g. dummy transaction
Analytical Procedures investigation and analysis of fluctuations
and relationships to determine whether there are inconsistencies
with other relevant information or deviations from predicted
amounts; e.g. sales goes down but profit goes down (analyse this)
Enquiry auditor may ask questions and can include interviewing
or obtaining statements from management and employees; e.g.
internal control questionnaire.

Audit Trail
A chain of evidence provided by coding, cross-references and
documentation that connects account balances and other summary
results with original transaction data.

Tracing (e.g. for testing Completeness)

Origin Final

Vouching (e.g. for testing Existence/Occurrence)

Audit Evidence
Evidence must be sufficient (i.e. quantity/sample size must be
enough) and appropriate (i.e. it is reliable and relevant)
Audit Risk Model
Risk that an auditor will give an inappropriate audit opinion when
the financial report is materially misstated
Audit Risk = Risk of material misstatement + Detection Risk
(ASA 200 para A34)

Components of Audit Risk Model:

Inherent risk susceptibility of an assertion to material

misstatement given inherent and environmental characteristics, but
without regard to control procedures; e.g. complexity of underlying

Control Risk function of the effectiveness of the design,

implementation and maintenance of internal control by
management to address identified risks that threaten the
achievement of the entitys objectives relevant to preparation of the
entitys financial report. Internal controls can only reduce but never
eliminate risks of material misstatement - due to possibility of
human error.

Detection Risk Risk that auditors substantive procedures will

lead auditor to conclude no material misstatement exists when, in
fact, one does. During planning phase of audit, a planned
acceptable level of detection risk is determined.

Audit Risk some misstatements will exist but clean bill of health
is given; i.e. a combination of inherent risk, control risk and
detection risk.

Combined Risk Assessment:

Business Risk Risk that an entitys business objectives will not be

attained as a result of external and internal factors, pressures and
forces brought to bear on the entity.

Materiality (ASA 320) is defined as information, individually or in

aggregate, that if misstated or omitted from a financial report may
adversely affect decisions about the allocation of scarce resources
made by financial report users.
Lecture Week 4

Chapter 5

Should I accept the client?
Should I continue? evaluate client on ongoing basis
Prepare engagement letter
o contact person
o fees structure
o using client internal audit or experts
o if expertise from outsiders are required

Understand the client
o External
o Internal
o Financial
o Controls
SWOT analysis
Identify Business Risks
Assess the impact of Business Risk (BR) on financial
o i.e. risk of material misstatement at an,
overall financial report level
assertion level
Determine appropriate audit strategy
Prepare an audit plan

Engagement Letter
Letter that documents and confirms the auditors acceptance of the
the objective and scope of the audit
the extent of the auditors responsibilities to the entity
responsibilities of management
identification of the applicable financial reporting
form and contents of any report, and statement that there
may be circumstances in which a report may differ from its
expected form and content

Audit Planning
To develop an efficient and effective audit:
devote attention to important areas
identify areas of potential problems
supervision of staff and review of work, who to contact for
organize and manage audit
select audit team members and assignment of tasks
coordinate with internal auditors, experts or other third
Determines the scope of the audit
Audit Planning Risk Assessment Process

Understand Identify Assess Respond to

the entity Risks Risks risks

Understand the entity

o Taxation subsidies, relief from tax, additional taxes
o Import/Export are channels open, scope available to
improve or threats
o Government Incentive
o Environmental Pressure
o Accounting Framework
o Growth prospects
o Competition market share of client, monopolistic
o Barriers to entry easy to join or many restrictions
o Generally accepted norms not legalized but
accepted norm that companies behave in particular
o Capital or Labour Intensive
o Substitute Products competition with substitutes
o Industry developments
External Environment:
o Economic growth
o Currency, stock market volatility
o Fluctuations in prices is the product reasonably
o Interest Rates
o Consumer sentiment
o Availability of finance
o Product lines is risk spread over multiple product
o Location of facilities how many, and where are they
located, overseas (what is happening overseas if there
are any e.g. civil unrest)
o Markets where
o Key customers and suppliers major suppliers and
customers information needs to be known
o Internet (online) platform
o Employment arrangement, union contracts if staff is
main asset there will be union agreements etc.
Financing and Investment:
o Current and future projects how much is invested in
current projects, how much is needed for the future
o Use of financial instrument complexity of valuations
and modeling risks
o Debt and equity structure is it highly geared
o Investments long term or short term
o Accounting policies which assets/liabilities may be
problematic depending on the industry, are standards
clear or are they able to be manipulated
o Unusual or complex transactions
o Foreign currency assets, liabilities or transactions
o Fair Value
o Tone at the top level management overall controls
o Risk assessment procedures how does the entity
assess their own risks
o Internal audit dept. who do they report to
o Data processing system
o Control activities

Analytical Procedures
Operational performance
Relationships between accounts
Compare with industry averages, competitors, previous year
performance, budgets, etc.
Simple Procedures:
Complex Procedures:
ratio analysis
time series modeling
simple comparisons
regression analysis
time series analysis
financial modeling
trend statements

Short Term Liquidity Ratios:
Current Ratio high ratio (benchmark 2:1, assets : liabilities)
indicates entitys ability pay current debt obligations; high
ratio means there are more current assets over current
= Current Assets .
Current Liabilities
Quick Asset Ratio same as current ratio but does not
include inventory and can help identify if there is an inventory
account risk
= Liquid Assets .
Current Liabilities
Operating Cash Flow Ratio provides a longer term
measure of entitys ability to meet current liabilities by using
cash flows instead of current assets to meet current liabilities;
higher is better/more able to meet obligations
=.Cash flow from operations
Current Liabilities
Activity Ratios:
Receivables Turnover Ratio indicates how many times
accounts are turned over in a year (can also use days in
receivables ratio how many days it takes to collect sales
revenue); higher ratio is more desirable
Inventory Turnover Ratio indicates how many times
inventory is turned over in a year; if it is low it means
inventory is not selling quickly, and could be misstated or
valued incorrectly

Profitability Ratios:
Gross Profit Ratio provides an indication of companys
product pricing and product mix (inventory account errors can
distort ratio due to COGS)
Net Profit Ratio measure profitability after all expenses are
considered; significant fluctuations of this ratio may indicate
misstatement in expense accounts and auditor may need to
increase their testing of these accounts.

Solvency Ratios:
Debt to Equity Ratio higher the ratio, the higher the
gearing/debt, this can determine against the industry average
whether the entity will be able to acquire more debt in the
future or not (i.e. can be a risk)
Times Interest Earned Ratio higher ratio is better as it
means profits are high, and debt can be paid off (compare
against D/E Ratio, especially if they dont follow the same
Identify Business Risks
SWOT Analysis

for each weakness and threat are there any possibilities for
the entity to mitigate them and the strategies put in place to
deal with it must be considered.

Business Risk Risk that an entitys business objectives will not be

attained as a result of external and internal factors, pressures and
forces brought to bear on the entity.

Assess Risks
Once business risks have been identified, and if these affect
financial statements, then determine whether it afects at a
financial report level or at an assertion level.
Only the risks of material misstatement (RMM), such as inherent
risks, etc., need to be assessed and then responded to, others can
simply be noted for and left as is. These must be assessed to
determine how the business risk afect/impact risk of
material misstatement.

Respond to Risks


Response to risk:
- Develop an overall audit strategy that lies along the continuum

Purpose of preparing audit plan:

evidence of work performed
evidence of proper planning of work
guidance to inexperienced staff
a means of controlling time spent on the engagement
evidence of consideration of internal control in relation to
proposed audit procedures
assigning and scheduling of audit staff
o coordinating assistance of entity personnel in data
o determining extent of involvement, of experts,
specialists and internal auditors
o establishing and coordinating staffing requirements
Lecture Week 5

Chapter 6

Risk of Material Misstatement

Risk Of Material

Financial Report Assertion

Level Level

Inherent Risk at Inheren Control

financial t Risk Risk
reporting level

Inherent risk susceptibility of an assertion to material

misstatement given inherent and environmental characteristics, but
without regard to control procedures; e.g. complexity of underlying

Factors affecting inherent risk at financial report level:

Integrity of management
Management experience, knowledge and changes during the
Unusual pressure on management (can cause even competent
managers to do the wrong thing)
Nature of the entitys business (the types of transactions they
Factors affecting he industry the entity operates in

Impact of high IR at financial report level:

more experienced staff know the right questions to ask
more skeptical
more testing e.g. larger sample sizes
more use of experts
increased review and supervision
increased consultation with other audit partners, informal
more training to detect fraud
lower performance materiality level more evidence required
to assure that misstatements do not pass this level
more reliance on substantive testing

Inherent Risk at assertion level:

IR greater for some assertions and related classes of
transactions, account balances and disclosures than for others
Auditor must focus on:
o accounts likely to require adjustment
o complexity of underlying transactions
o susceptibility of assets to loss or misappropriation (e.g.
how likely/easy is it for items to be stolen)
o occurrence of unusual and complex transactions
Fraud is defined in ASA 240 as an intentional act among
management, employees, those charged with governance, or third
parties, involving the use of deception to obtain an unjust or illegal
advantage. Can be classified as fraudulent
financial reporting or misappropriation of assets.

Fraud Triangle
If all 3 factors of fraud triangle present then there
is a high risk of fraud.

Red Flags:
Unusual transactions (e.g. lavish lifestyles,
excessive payments, kickbacks to govt.
Market Pressures (e.g. slowing industry, prevent takeovers)
Unusual pressures (e.g. maintain share prices)
Unsatisfactory records (incl. management slow to provide
Role in industry (e.g. a leading provider/dominant role)

Substantive testing then done to determine fraud risk.

Auditors responsibilities (ASA 240):

reasonable assurance that you have gathered evidence that
there is no fraud in financial statements
assess RMM due to fraud
if fraud is detected talk to management, or report to audit
committee or ASIC

Earnings Management
Earnings management occurs when judgment in financial reporting
and in structuring transactions is used to alter financial reports to
influence perceptions of stakeholders; distorting statements but not
changing figures
big bath charges under the guise of restructuring
intentional violations of accounting standards and other
reporting requirements that are individually immaterial
inappropriate revenue recognition
improper accruals and estimation of liabilities in good times

Related Parties
Auditors are required to specifically assess the risk that related
parties and related party transactions will not be identified, or
appropriately disclosed and/or measured (ASA 550).
evidence from related-parties might not be as reliable
can be a sham (e.g. place a large order before year end to
increase sales)
Once related parties are identified, disclose this fact for
shareholders to see, they will then decided if action is needed or

Going Concern Basis

Going concern assumption is viewing the entity as continuing in
business for the foreseeable future without any intention or
necessity to liquidate or otherwise cease its operations (ASA 570).
Requires auditors to assess going concern at planning stage, as it
may affect the appropriateness of presentation of reports. Required
to focus on the next 12mths, until next audit report (p.274-5).
Lecture Week 6

Chapter 7

Internal Controls
Purpose of controls are to get information quickly in order to fix risks
and to run operations efficiently and effectively, in order to make
decisions, such as future growth prospects, to comply with
standards, and for financial reporting obligations (ASA 315.A51).

Types of controls:


Management Transaction
controls controls

Prevent Detect Prevent Detect

controls controls controls controls

Management Controls Controls performed by managers to

mitigate strategic risks to the entity and to promote effectiveness of
decision-making and efficiency of the business.
communicating business objectives and goals throughout the
establishing lines of authority and accountability
monitoring both the external and internal environment for
establishing and enforcing appropriate codes of corporate
defining policies and procedures for dealing with these risks
monitoring performance of key segments of the entity through
performance indicators and benchmarking

Transaction Controls controls that are focused internal risks

within systems and processes and reflect the formal policies and
procedures defined by management; deal primarily with reliability of
accounting information and compliance with rules and regulations.

Design and Implementation:

Design evaluate whether the design is effective in
preventing, detecting and correcting material misstatements.
Implementation only if designs are effective, then check
implementation and if control are consistent and appropriate
and are being used.
Can do substantive test of design and implementation by
putting through a dummy transaction, to see if system really

Assertions to be considered:
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-of transactions have been recorded in the correct
accounting period
Classification transactions and events have been recorded
in the proper accounts

Auditors requirements

Chapter 8

* Testing of controls involves looking at samples, etc. but not

actually doing any procedures, while substantive tests involve doing
the tests *

Testing of controls
Planning the scope of tests of controls:
Nature type of testing (either tests of controls or
substantive tests)
Timing to provide assurance that controls are effective
throughout the year, and not just at year-end, tests must be
done at an interim period
Extent the more the auditor relies on operating
effectiveness of controls, greater the extent of the auditors
controls; determined with reference to audit sampling

Major Activities

Sales Controls Examples:

Proper authorization policy control prevents fictitious
customers from being entered into the system and provides
assurance that every sales transaction has actually occurred
Occurrence is the assertion being tested (can be done by
taking a sample and check for proper approvals, or put
through a dummy transaction and see if approved signature is
Reconciliation of quantities shipped to quantity
billed/Sequence checks of shipping documents identify is all
goods dispatched have been billed/identify all dispatch notes
are accounted for in the invoices Completeness is the
assertion being tested (inspect reconciliations, pick random
sample, or review evidence of staff carrying our sequence)
Monthly statements are sent to customers (all customers)
disputes will be identified. How are disputes followed up and
resolved? Occurrence, accuracy, completeness are the
assertions being tested (observe mailing of monthly
statements, and review evidence of follow-up and client-
customer correspondence).

Control Policies and procedures and tests of controls for sales


Specific Common Control Tests of Controls

Control Policies and
Objectives Procedures
Occurrence Policy of authorization of Select a sample of sales
All sales credit and terms transactions from sales
recorded Evidence of quantities journal (daily activity
are bona shipped reconciled to report), check for
fide quantities invoiced appropriate authorization
transactions Monthly statements and trace to shipping doc.
for mailed to customers file
merchandis and queries followed up Inspect reconciliation of
e actually shipments to invoices
shipped to Observe mailing of monthly
customers statements, and enquire
about follow-up of queries
Completene Shipping documents Review the evidence of
ss and sales invoices pre- control of accounting for
All sales numbered and numerical sequence of
shipped sequence accounted shipping documents and
have been for sales invoices, or test
invoiced and Quantities shipped numerical sequence
recorded in periodically reconciled Inspect evidence of
accounting to quantities invoiced, clients reconciliations of
records independently of shipments to invoices
shipping and invoicing Observe checking of
departments shipments or inspect
Shipments checked for selected shipments
shipping documents
Accuracy Re-computation and Select a sample of
All comparison of details transactions from the
invoices (quantity, price, terms) sales journal (daily
have been to supporting activity report) and review
recorded documents evidence that comparison
correctly as Monthly statements with supporting
to amount, mailed to customers documentation
and Authorization and undertaken and that
summarized independent follow-up prices traced to approved
correctly of correspondence with list and extensions and
customers footings recomputed
Supervisory review and Observe mailing of
approval of monthly statements
summarization and Review evidence of follow-
posting up of correspondence with
Approval of write-offs customers
of uncollectable Inspect indication of
accounts supervisory review and
Programmed controls approval of
in processing sales to summarization and
identify unusual sales posting
accounts Inspect approval of write-
offs of uncollectable
Test data techniques to
test specific programmed
Cut-of Written procedures Observe or ascertain that
All detailing the last sales written procedures
invoices (and related cost of followed and independent
have been sales) recorded before check carried out.
recorded in balance date, and first Substantive tests will
the correct sale (and related cost likely be required to
period of sales) of next period ensure they are recorded
recorded in next period in the correct periods
Independent check
that written procedures
Classificatio Appropriate account Review approval of and
n codings on sales account codings for sales,
All sales documents including related-party
have been sales
classified in
with written
p. 366-7 for more tests
Lecture Week 7

Chapter 9

Substantive Tests
Tests of Balances Tests directed to selected items which
are an aggregate of a number of transactions; i.e. check the
final balance
Tests of Transactions tests of individual transactions,
performed to obtain audit evidence to detect material
misstatements at the assertion level. Involves inspecting
underlying documents, testing flow of transactions through
the system and recalculating for clerical accuracy
Tests of disclosure

Cash, cash receipts and cash payments (p. 405-6 Table 9.1)

Assertions of interest:

Substantive testing:
When doing tests, if risks are high, look at the transactions in
the next month and see if they are reconciled in bank
statement, or can trace transactions back.
When testing controls, these same transactions or events can
be examined to also achieve substantive testing objectives
i.e. dual-purpose tests

Cash/Bank Balance Substantive testing:

Procedure Assertions that can
be tested
Request and examine bank confirmation All
Undertake tests of bank reconciliations Existence, Completeness
Test conversion rates for any foreign currency Valuation

Cash/Bank Transaction Substantive testing:

Procedure Assertions that can
be tested
Inspect supporting documentation Occurrence, Accuracy
Undertake sequence check (remittance advices Completeness
and cheques) serial number check
Check last cash receipts and cash payments Cut-off
before balance date and first cash receipts and
cash payments after balance date are recorded
in the correct period
Sales, cash receipts & accounts receivable (p. 410 Table 9.2)
Assertions of interest:

Sales Transaction: (similar to

Procedure Assertions that can
be tested
Vouch entries in sales journal to supporting Occurrence
documentation of sale
Test from supporting documentation (invoice, Completeness
delivery note) to sales journal
Verify prices, quantity and computation on sales Accuracy
invoices, prices verified to master price list,
quantity verified to shipping documentation
Review shipping documents at year end to Cut-off
ensure sale is recorded in correct period
Check last sales recorded before and after Cut-off
balance date
Check invoices recorded before and after year Cut-off
- Cut-off is an important assertion that would be misstated in
sales transactions as a management can inflate sales by
getting large orders in current period, only to refund in the next
period, or to get an order in early for a different period

Accounts Receivable:
Procedure Assertions that can
be tested
Undertake debtors confirmation procedures Existence, Rights
Review subsequent receipts Existence,
Completeness, Valuation
Review minutes and contracts for evidence of Rights
pledging of receivables, factoring or other liens
Review aged trial balance and undertake follow- Valuation
up procedures for amounts overdue
Test conversion rates for any foreign currency Valuation
accounts receivable

External Confirmation Procedures

Positive Form once debtor has been selected, auditor must
obtain evidence and ask debtor whether they agree with the
amount owed (with follow up if no response, or use alternative
procedures such as checking invoices or receipts).
Negative Form requests debtor to respond only if they disagree
with amount shown. If debtor responds with difference:
o check if timing difference
o check if there is an error by reviewing
supporting documentation
o check if its because of discount, goods returned
or sales difference
Purchases & Inventory (p. 420-1 Table 9.3)

Procedure Assertions that can
be tested
Inspect physical inventory (check from Existence
inventory records to physical stock)
Undertake substantive analytical procedures Completeness,
Existence, Valuation
Inspect physical inventory (check from physical Completeness
stock to inventory records)
Enquire about legal ownership of goods being Rights, Completeness
shipped to entity by inspecting supporting
Enquire about legal ownership of any goods on Rights
consignment by inspecting supporting
Undertake tests of pricing Valuation

Observe physical inventory (look for obsolete or Valuation

damaged items)
Review purchase documents for shipping terms Completeness
for inventory in transit
Scan inventory records to identify any obsolete, Valuation
excess or slow-moving inventory
Confirm stock held at other locations Existence, Completeness

Check subsequent sales prices and compare Valuation

with inventory valuation
Review and ensure that costs assigned to Valuation
inventory are in accordance with an acceptable
accounting method.

Accounts Payable, payments and payroll (p. 424-5 Table 9.4; p. 428
Table 9.5)

Accounts Payable:
Procedure Assertions that can
be tested
Confirm with suppliers All
Review of subsequent payments Completeness
Vouch to supporting documentation (e.g. Existence, Obligations
suppliers invoices and monthly statements)
Review for any unmatched receiving reports Completeness
and suppliers invoices (checking none are
Agree dollar value of accounts payable to Valuation
supporting documents (e.g. suppliers invoices)
Undertake substantive analytical procedures Valuation, Completeness
(e.g. ratios)
Procedure Assertions that can
be tested
Test from supporting documentation (time Completeness
sheets, department records) to payroll journal
Select transactions from payroll listing and Occurrence
agree to supporting documentation (e.g. time
Review for unmatched reports and staff records Completeness,
Check that last payroll recorded before balance Cut-off
date, and first payroll records after balance
date, are recorded in the correct period
Verify times, amounts and computation on time Accuracy
sheets to payroll and employment records

Property, Plant and Equipment (p. 430 Table 9.6)

Assertions of interest:
rights & obligations
valuation & allocation
o cost depreciation, amortization, impairment
o repairs and maintenance expensed? capitalized?
o revaluation

Audit Procedures:
physical inspection
ratios - see if valuations are correct
documentary evidence

Investments (p. 433 Table 9.7)


Physically examine documentation
seek external confirmation
review minutes of meetings
o is it a short term or long term investment?
inspect market quotations
test clerical accuracy

Non-current liabilities and owners equity (p. 436Table 9.8)


External confirmations banks
Substantive analytical procedures
Recalculation and vouching
Read minutes of meetings, review debt arrangement

Chapter 10

Audit Sampling
Means of gathering audit evidence:
100% testing/examination of evidence this is not a sampling
method as you are checking everything and not just a sample
Selecting specific items (i.e. only certain sub-group, e.g. high
risk items) this is not a sampling method as items will not
necessarily be representative of the population
Audit sampling

Sampling Risk probability that the auditor has reached an

incorrect conclusion because the audit sample may not be accurate
in representing the entire population, and so a different conclusion
would have been reached if the entire population were used; it can
be reduced to an acceptably low level but never eliminated.

Non-sampling Risk arises from factors, other than sample size,

that cause an auditor to reach an incorrect conclusion, such as
possibility that,
o auditor will fail to recognize misstatements included in
examined items
o auditor applied procedures that are not effective in
achieving a specific objective

Steps in Audit Sampling:

1. Sample Size
2. Sample Selection how do I choose, e.g. random selection
3. Undertake tests are there any errors?
4. Evaluate findings if there was an error, why was it there?
What could be the magnitude of the error?
5. Project errors to the population
6. Conclude what is the tolerable limit for error? i.e. will I
accept it or conclude that it is materially misstated and the
client needs to adjust it.

Sampling Techniques:
Attribute Sampling sampling approaches to tests of controls
Dollar-unit sampling sampling approaches to substantive
tests (e.g.

Characteristics of interest:
For tests of controls find rate of deviation (i.e. error found
but do not use the word error in exam, use rate of
For substantive tests find monetary misstatement (e.g.
error/misstatement of $10,000)
Planning and Design of audit sample:
Objectives Assertion being tested? (ASA 530)
Population What is the population from which the sample
Should Stratification be used? Divide population in sub-
populations based on a criteria to allow auditor to focus on
key areas
Define a sampling unit (e.g. one sample item, each
transaction, each balance or each dollar?)
What would constitute an error?
Sample Size:
Sample size is afected by the degree of sampling risk
the auditor is willing to take to reduce risk, use a larger
sample size (ASA 530)
Factors that influence sample size for tests of controls:
o Control risk assessment if control risk assessment is
low (i.e. rely on controls), then the sample size is larger
as we want to test the controls sufficiently to ensure we
can rely on them
o Tolerable rate of deviation how many deviations
am I willing to tolerate (i.e. maximum limit or error)?
Keep on testing until the deviations are less than the
limit larger tolerable limit, the larger the sample size
o Expected rate of deviation expecting there to be
errors, but not beyond the expected rate of deviation.
Higher expected rate, larger the sample size
o Auditors desired level of assurance higher level
of assurance, the larger the sample size
o Number of units in the population population size
does not affect sample size
Factors that influence sample size for substantive testing:
o Risk of material misstatement RMM is high, then
sample size is larger
o Tolerable misstatement higher tolerance, then
sample size is smaller
o Expected misstatement if expect to find more
misstatements, then larger sample size
o Auditors desired level of assurance higher level
of assurance, the larger the sample size
o Number of units in the population population size
does not affect sample size
o Stratification use of stratification results in smaller
sample size

Selection of Sample:
Sample items are selected so that sample can be expected to
be representative of the population (ASA 530)
Sampling Techniques:
o Random Selection no bias, random selection of
sample units; use a automated generator
o Systematic Selection units are selected from a
population at regular intervals; start point is randomly
selected can be a useful technique when wishing to
focus on a particular time period
Sample interval = No. of items in population
Sample Size
Then select starting sample unit randomly
within sample interval, and continue to add
sample interval to random start and identify items
to be sampled (e.g. SI = 2, then 1,3,5..)
o Haphazard Selection permitted by auditor standards
but not accepted as there could be bias in selection
(even subconsciously)
Unacceptable sample selection methods:
o Block selection auditor selects all items of a
specified type processed on a particular day, week or
month, or otherwise stored in a block.
o Judgmental selection based on sample item
characteristics; auditor applies judgment in the selection
of the units to be tested; not representative of the
population (e.g. on picking those with a high risk of
error) (ASA 500.A55)
Performing the procedure and evaluating the results:
Auditor performs the required audit procedures on the items
Evaluates the sample results considers both the nature and
cause of any misstatement or deviations identified and their
possible effect on the audit objective and other areas of audit
(ASA 520.12-13)
o determine whether preliminary assessment of relevant
characteristic of the population ought to be accepted or
rejected determined based on whether the tolerable
rate of deviation or tolerable misstatement has been
o Rejection would lead auditor to conclude that:
preliminary assessment of control risk cannot be
accepted (for tests of controls)
relevant account balance or class of transactions
is materially misstated (for substantive
Project misstatement of sample onto population:
Projected Misstatements = sample misstatements x
population size
sample size

Determining Sample Size (ASA 530.A11)

Control Risk Assessment:
Desired Level of assurance
Tolerable Deviation Rate (TDR) how many times you can
tolerate the controls to fail
Expected number of deviations or expected deviation rate
(EDR) in numbers the amount of errors
TDR = 3% - willing to accept up to 3% deviations
EDR = 1% - expect 1% deviations

Sample Size estimation for attribute sampling:


Reliability factor is found in Reliability Factor Table, using desired

level of assurance and corresponding number of errors (Table will
be given in exam)
higher desired level of assurance will require a larger sample size
(larger numerator); more errors expected to be found, will require
larger sample size
Alternative method for determining sample size is using desired
level of assurance %, tolerable deviation rate %, and
expected deviation rate %
in this case use tables that will be provided in the exam (p.474-5,
Table 10.3 or 10.4) and the sample size is automatically computed
in the table

Evaluation of sample results:

Using sample deviation rate (SDR) as best estimate of population
deviation rate:
SDR = No. of Deviations Found
Sample Size

so, controls are

failing 4.5% of the

4.5% SDR is less

than the 10% TDR,
so control risk
assessment is

Sampling for substantive tests:


Dollar-unit sampling:
Use cumulative total Sampling Interval = Cumulative Total =
Use Sample Size $1,000,000
Compute Sampling Interval (SI) Sample Size
60 Example:
Risk of incorrect acceptance = $16,667
Tolerable Error =
= value allowed to be Therefore, starting at$50,000
randomly selected
incorrect (RS) $14,068 accountAccount
and then add SI =
Balance to$1
(Level of Assurance = value use these dollar-unitsmil
for 60 units (i.e.
that should be correct; so sample size). Expected Error =
100 Risk of incorrect So, $14,068, $30,735, $47,402, $64,069
acceptance) etc. Risk of incorrect
These use the transaction/invoice
acceptance = 5% that
(95% level of

Determine the sample size TM = $50,000 =

Tolerable Misstatement Rate % (TM) = Tolerable Error ($ value)
Account Balance ($ value)$1,000,000
Expected Misstatement Rate % = Expected Error ($)
Account Balance ($)

Use desired level of assurance table (Table 10.3 or 10.4)

Evaluation of Results

Example (cont.):
Dollar value of sample selected = $100,000
Misstatement found in sample = $2,000
Account Balance = $1,000,000

Projected misstatement
= $2,000 x 1,000,000
= $20,000

As projected misstatement is lower than the

tolerable misstatement, the account balance may IN AN EXAM
be considered to be not materially misstated. QUESTION
However projected errors are more than REMEMBER TO
expected! ADD THIS PART IN
If we redo the calculation for sample size with an MISSTATEMENT IS
expected error of $20,000, then the Expected LARGER THAN
Misstatement Rate = 2% and so, sample size = EXPECTED
181 would have been needed (i.e. a larger sample
size should have been used)

Projected misstatements are very close to

tolerable limit

Projected misstatements are more than expected.

The sample size was computed taking into
account expected misstatements. Hence, there
might be an unacceptable sampling risk that
might result in actual misstatement being more
than the tolerable limit.
Hence, auditor might reach a decision
immediately- increase sample size before

Always compare the dollar value not the

Stratification projected misstatements need to be done
individually for each sub-category, and not for the population as a
whole, and then add these to get the total projected misstatement
for all categories.

Lecture Week 9
Chapter 11
Directors Declaration
Declare that everything is correct
1. CEO/CFO will make declaration to the Board of Directors
a. Financial Statements comply with all requirements
b. Financial statements and notes provide all relevant info.
c. Financial statements give a true and fair view of the
financial performance of the company
2. Then the Directors will make a declaration
a. Financial statements comply with Corp. Act
b. Financial statements comply with accounting standards
c. Financial statements give a true and fair view of the
financial performance of the company
d. Directors have received a declaration from the CEO/CFO
3. Lastly, the auditors sign the audit report at Date of Audit
Report (this date is important as the auditors responsibility
finishes on the date of audit report once signed and is
considered the date the audit is completed; this date is
generally a period of time after the end of the financial
reporting date period of subsequent events)

Subsequent Events
Management may predict events to occur in the period immediately
after the end of the financial reporting date and so by leaving a
subsequent events period, the auditor is able to check if these
predictions are accurate and can make adjustments to the financialSUBSEQUENT
report if required i.e. adjusting subsequent event, where the EVENTS WILL
event is not as predicted. LIKELY BE IN
Adjusting subsequent event - A subsequent event tells auditors
more about a condition on the financial report and so an adjustment
may be required. This must be made as a journal entry (e.g.
change a provision).

Any major event that occur after the end of the reporting period but
before the Date of Audit Report (i.e. during the subsequent reporting
period) that are unexpected or unrelated to any events in the
financial report, must still be included as a disclosure in the notes
of the financial statement of the event and the amount (amount
if known) and are classified as non-adjusting events.

Balance Audit Report Issued to AGM

Sheet (AR) Date Users

Auditors Mgmt Responsibility Mgmt Responsibility

Responsibility Ignore if event after AR Ignore if event after AR
Undertake Action required if before Action required if before AR, but
procedures to AR, but auditor now auditor now becomes aware,
identify becomes aware ask to recall FS, ensure FS
events Talk to mgmt., ensure amended
FS amended Issue new AR extend
Ensure Issue new AR extend subsequent review procedures
properly subsequent review to new AR date
treated by procedures to new AR Incl. additional paragraph in new
management, date audit report explain why FS
if not, issue Issue modified report if revised and new report issued
modified mgmt. refuse to Issue modified report if mgmt.
Auditor required to accumulate misstatements identified during the
audit, other than those that are clearly trivial (ASA450).

impact of individual error on individual account balance
impact of aggregate errors on class of assets/liabilities
impact of aggregate errors on profit position of the company
compare with performance and planning materiality levels set

The nature of individual error (isolated, repetitive, deliberate,
lack of controls, judgmental, projected, factual)
are errors qualitatively material?

Misstatement of fact fact is misstated, if management refuse to

adjust the report, then auditor can add an other matter
paragraph as a fact is misstated, but emphasis that the financial
statements are still true and fair and it is not related
Material inconsistency - if management refuse to adjust the
report, then auditor can add an other matter paragraph as a fact
is misstated, but emphasis that the financial statements are still
true and fair and it is not related

Chapter 12

Unqualified Modified
(clean bill of (ASA 705)
(ASA 700)

Qualified Disclaimer Adverse

Opinion of Opinion Opinion

Unqualified Opinion
Auditor ensures that the financial statements:
are in accordance with the Corporations Act 2001
give a true and fair view
comply with Australia accounting standards
comply with IFRS
And that the auditor has:
obtained reasonable assurance that financial report as a
whole is free from material misstatement, whether due to
fraud or error
obtained sufficient appropriate evidence
concluded that any uncorrected misstatements are
immaterial, both individually and in aggregate
Modified Opinion
Why there is a problem:
Disagree or Limitation of Scope?
misstatements exist (material) - disagree
lack of disclosure - disagree
dont agree with an accounting policy - disagree
you should have consolidated but havent - disagree
access to records not given - Limitation of Scope
inability to audit a major subsidiary - Limitation of Scope
records not proper - Limitation of Scope

Impact of Problem:
Are these issues material or pervasive?
Material affects only certain accounts
Pervasive affects the entire financial statements

Material but not pervasive (disagreement) = qualified opinion

Material but not pervasive (limitation of scope) = qualified opinion
Material and pervasive (disagreement) = adverse opinion
Material and pervasive (limitation of scope) = disclaimer of opinion

Emphasis of matter (ASA 706)

unqualified opinion but to draw attention to a going concern

Other matter paragraph