About the authors ix
Preface x
Chapter 1 Introduction and overview of audit and assurance 1
Audit process in focus 4
1.1 Auditing and assurance defined 4
1.2 Different assurance services 4
1.2.1 Financial report audits 4
1.2.2 Compliance audits 5
1.2.3 Performance audits 6
1.2.4 Comprehensive audits 6
1.2.5 Internal audits 6
1.2.6 Corporate social responsibility (CSR) assurance 7
1.3 Different levels of assurance 10
1.3.1 Reasonable assurance 10
1.3.2 Limited assurance 14
1.3.3 No assurance 16
1.4 Different audit opinions 16
1.5 Preparers and auditors 17
1.5.1 Preparer responsibility 17
1.5.2 Auditor responsibility 18
1.5.3 Assurance providers 19
1.6 Demand for audit and assurance services 20
1.6.1 Financial report users 20
1.6.2 Sources of demand for audit and assurance services 20
1.6.3 Theoretical frameworks 21
1.6.4 Demand in a voluntary setting 22
1.7 The role of regulators and regulations 23
1.7.1 Regulators 23
1.7.2 Regulation 26
1.8 The audit expectation gap 28
Summary 30
Key terms 30
Multiple-choice questions 31
Review questions 32
Professional application questions 33
Case study — Crest Outfitters 36
Research question 38
Further reading 38
Solutions to multiple-choice questions 38
Endnotes 38
Acknowledgements 39
Chapter 2 Ethics, legal liability and client acceptance 40
Audit process in focus 42
2.1 The fundamental principles of professional ethics 42
2.1.1 Integrity 42
2.1.2 Objectivity 42
2.1.3 Professional competence and due care 43
2.1.4 Confidentiality 43
2.1.5 Professional behaviour 43
2.2 Independence 44
2.2.1 Threats to independence 44
2.2.2 Threat identification and safeguards to independence 45
2.3 The auditor’s relationships with others 47
2.3.1 Auditors and shareholders 47
2.3.2 Auditors and the board of directors 47
2.3.3 Auditors and the audit committee 48
2.3.4 Auditors and internal auditors 49
2.4 Legal liability 50
2.4.1 Legal liability to clients 50
2.4.2 Contributory negligence 52
2.4.3 Legal liability to third parties 53
2.4.4 Avoidance of litigation 54
2.5 Client acceptance and continuance decisions 55
Summary 59
Key terms 59
Multiple-choice questions 60
Review questions 61
Professional application questions 62
Case study — Crest Outfitters 66
Research question 67
Further reading 67
Solutions to multiple-choice questions 67
Endnotes 67
Acknowledgements 68
Chapter 3 Risk assessment I 69
Audit process in focus 71
3.1 Phases of an audit 71
3.1.1 Risk assessment phase 72
3.1.2 Risk response phase 73
3.1.3 Concluding and reporting on an audit 73
3.2 Gaining an understanding of the entity and of the financial reporting framework 73
3.2.1 Entity level 74
3.2.2 Industry level 76
3.2.3 Economy level 77
3.3 Fraud risk 77
3.3.1 Incentives and pressures to commit a fraud 78
3.3.2 Opportunities to perpetrate a fraud 79
3.3.3 Attitudes and rationalisation to justify a fraud 79
3.4 Going concern 79
3.4.1 Going concern risk — indicators 80
3.4.2 Going concern risk — mitigating factors 80
3.5 Corporate governance 81
3.6 Information technology 85
3.7 Closing procedures 86
Summary 88
Key terms 88
Multiple-choice questions 89
Review questions 90
Professional application questions 90
Case study — Crest Outfitters 95
Research question 98
Further reading 99
Solutions to multiple-choice questions 99
Endnotes 99
Chapter 4 Risk assessment II 100
Audit process in focus 102
4.1 Audit risk 102
4.1.1 The audit risk model and its components 103
4.2 Materiality 106
4.2.1 Qualitative and quantitative materiality 106
4.2.2 Setting materiality 106
4.3 Audit strategy 107
4.4 Client approaches to measuring performance 109
4.4.1 Profitability 110
4.4.2 Liquidity 110
4.5 Analytical procedures 111
4.5.1 Comparisons 111
4.5.2 Trend analysis 111
4.5.3 Common-size analysis 112
4.5.4 Ratio analysis 113
4.5.5 Other analytical procedures 115
4.5.6 Factors to consider when conducting analytical procedures 116
Summary 118
Key terms 118
Multiple-choice questions 119
Review questions 120
Professional application questions 121
Case study — Crest Outfitters 126
Research question 130
Solutions to multiple-choice questions 130
Endnotes 130
Chapter 5 Audit evidence 131
Audit process in focus 133
5.1 Assertions 133
5.2 Types of audit evidence 135
5.2.1 Sufficient appropriate audit evidence 135
5.2.2 External confirmations 136
5.2.3 Documentary evidence 138
5.2.4 Representations 138
5.2.5 Verbal evidence 144
5.2.6 Computational evidence 144
5.2.7 Physical evidence 144
5.2.8 Electronic evidence 144
5.2.9 Data analytics 145
5.3 Persuasiveness of audit evidence 146
5.3.1 Internally generated evidence 146
5.3.2 Externally generated evidence held by the client 146
5.3.3 Externally generated evidence sent directly to the auditor 146
5.4 Using the work of an expert 147
5.4.1 Assessing the need to use an expert 147
5.4.2 Determining the scope of the work to be carried out 147
5.4.3 Assessing the capability of the expert 147
5.4.4 Assessing the objectivity of the expert 147
5.4.5 Assessing the expert’s report 148
5.4.6 Responsibility for the conclusion 148
5.5 Using the work of another auditor 148
5.6 Evidence gathering procedures 149
Summary 151
Key terms 151
Multiple-choice questions 153
Review questions 154
Professional application questions 155
Case study — Crest Outfitters 159
Solutions to multiple-choice questions 160
Endnotes 160
Acknowledgements 160
Chapter 6 Gaining an understanding of the client’s system of internal controls 161
Audit process in focus 163
6.1 Internal control defined 163
6.2 Objectives of internal controls 164
6.3 System of internal control 165
6.3.1 The control environment 165
6.3.2 The entity’s risk assessment process 168
6.3.3 The entity’s process to monitor the system of internal control 169
6.3.4 Information systems and communication 170
6.3.5 Control activities 171
6.3.6 Internal controls in less complex entities 173
6.4 Transaction-level internal controls 173
6.4.1 Example transaction flows — sales process 174
6.4.2 Example transaction flows — cost of sales process 174
6.5 Documenting internal controls 176
6.6 Identifying strengths and weaknesses in a system of internal controls 180
6.7 Management letters 180
Summary 184
Key terms 184
Multiple-choice questions 185
Review questions 186
Professional application questions 186
Case study — Crest Outfitters 191
Research question 194
Solutions to multiple-choice questions 194
Endnotes 194
Acknowledgements 194
Chapter 7 Sampling and overview of the risk response phase of the audit 195
Audit process in focus 197
7.1 Audit sampling 197
7.2 Sampling and non-sampling risk 199
7.2.1 Sampling risk and tests of controls 199
7.2.2 Sampling risk and substantive procedures 200
7.2.3 Non-sampling risk 201
7.3 Statistical and non-statistical sampling 202
7.4 Sampling methods 202
7.4.1 Random selection 202
7.4.2 Systematic selection 202
7.4.3 Haphazard selection 203
7.4.4 Block selection 203
7.4.5 Judgemental selection 203
7.4.6 Factors to consider when selecting a sample 204
7.5 Factors that influence the sample size — testing controls 205
7.6 Factors that influence the sample size — substantive testing 206
7.7 Evaluating sample test results 208
7.8 Tests of controls and substantive procedures 209
7.8.1 Tests of controls 209
7.8.2 Substantive procedures 210
7.9 Nature, timing and extent of audit testing 211
7.9.1 Nature of audit testing 211
7.9.2 Timing of audit testing 212
7.9.3 Extent of audit testing 212
7.10 Drawing conclusions 213
7.11 Documentation — audit working papers 214
7.11.1 Permanent file 214
7.11.2 Current file 215
Summary 220
Key terms 221
Multiple-choice questions 222
Review questions 223
Professional application questions 224
Case study — Crest Outfitters 228
Research question 229
Solutions to multiple-choice questions 229
Endnotes 229
Acknowledgements 229
Chapter 8 Execution of the audit —testing of controls 230
Audit process in focus 232
8.1 Types of controls 232
8.1.1 Prevent and detect controls 233
8.1.2 Manual and automated controls 236
8.2 Techniques for testing controls 238
8.2.1 Enquiry 238
8.2.2 Observation 239
8.2.3 Inspection of physical evidence 239
8.2.4 Re-performance 239
8.3 Selecting and designing tests of controls 239
8.3.1 Which controls should be selected for testing? 239
8.3.2 How much testing does the auditor need to do? 239
8.4 Results of the auditor’s testing 244
8.5 Documenting conclusions 245
Summary 248
Key terms 248
Multiple-choice questions 249
Review questions 250
Professional application questions 250
Case study — Crest Outfitters 254
Research question 256
Solutions to multiple-choice questions 256
Endnotes 256
Chapter 9 Execution of the audit —performing substantive procedures 258
Audit process in focus 260
9.1 Overview of substantive procedures 260
9.1.1 Substantive procedures and assertions 260
9.1.2 Definition of substantive procedures 262
9.2 Relationship between risk assessment and the nature, timing and extent of substantive procedures 263
9.2.1 Timing of substantive procedures 264
9.3 Substantive audit procedures 265
9.3.1 Tests of details 265
9.3.2 Key item testing 266
9.3.3 Analytical procedures 267
9.3.4 Types of analytical procedures 267
9.3.5 Performing substantive testing using computers 268
9.4 Levels of evidence 269
9.4.1 Persuasive 269
9.4.2 Corroborative 270
9.4.3 Minimal 271
9.4.4 General 271
9.5 Evaluating and documenting substantive analytical procedures results 272
9.5.1 Evaluating errors identified in testing 272
9.5.2 Concluding and documenting the results of substantive procedures 273
Summary 275
Key terms 275
Multiple-choice questions 276
Review questions 277
Professional application questions 277
Case study — Crest Outfitters 281
Research question 283
Solutions to multiple-choice questions 283
Endnotes 283
Chapter 10 Substantive testing and balance sheet accounts 284
Audit process in focus 286
10.1 Relationship between risk assessment and substantive procedures 286
10.1.1 Extent of substantive procedures 286
10.1.2 Timing of substantive procedures 286
10.1.3 Matters to consider when designing substantive procedures 288
10.2 Substantive testing of cash 289
10.2.1 Principal objectives in auditing cash 289
10.2.2 Processes affecting cash 290
10.2.3 Illustrative procedures for auditing cash 291
10.3 Substantive testing of trade receivables 292
10.3.1 Principal objectives in auditing trade receivables 293
10.3.2 Processes affecting trade receivables 293
10.3.3 Illustrative procedures for auditing trade receivables 293
10.4 Substantive testing of inventory 297
10.4.1 Principal objectives in auditing inventory 298
10.4.2 Processes affecting inventory 298
10.4.3 Illustrative procedures for auditing inventory 300
10.5 Substantive testing of property, plant and equipment 302
10.5.1 Principal objectives in auditing property, plant and equipment 303
10.5.2 Processes affecting property, plant and equipment 304
10.5.3 Illustrative procedures for auditing property, plant and equipment 305
10.6 Substantive testing of payables 306
10.6.1 Principal objectives in auditing payables 307
10.6.2 Processes affecting payables 307
10.6.3 Illustrative procedures for auditing payables 308
10.7 Special considerations for auditing other balance sheet accounts 309
10.8 Assessing the results of substantive procedures 310
Summary 311
Key terms 312
Multiple-choice questions 312
Review questions 313
Professional application questions 314
Case study — Crest Outfitters 322
Research question 323
Solutions to multiple-choice questions 323
Endnotes 323
Acknowledgements 324
Chapter 11 Substantive testing and income statement accounts 325
Audit process in focus 327
11.1 Relationship between risk assessment and substantive procedures 327
11.1.1 Differences between auditing income statement and balance sheet accounts 327
11.1.2 Extent of substantive procedures 328
11.1.3 Timing of substantive procedures 328
11.2 Substantive testing of revenue 328
11.2.1 Principal objectives in auditing revenue 329
11.2.2 Processes affecting sales revenue 330
11.2.3 Illustrative procedures for auditing revenue 331
11.3 Substantive testing of cost of sales and other significant expenses 333
11.3.1 Principal objectives in auditing costs and expenses 334
11.3.2 Processes affecting costs and expenses 334
11.3.3 Illustrative procedures for auditing costs and expenses 335
11.4 Assessing the results of substantive procedures 336
Summary 338
Key terms 338
Multiple-choice questions 339
Review questions 340
Professional application questions 341
Case study — Crest Outfitters 348
Solutions to multiple-choice questions 349
Endnotes 350
Acknowledgements 350
Chapter 12 Completing and reporting on the audit 351
Audit process in focus 354
12.1 Engagement wrap-up 354
12.1.1 Sufficient appropriate audit evidence 356
12.1.2 Evaluating audit evidence 356
12.2 Going concern 357
12.3 Subsequent events 358
12.3.1 Type 1 subsequent events —adjusting events 358
12.3.2 Type 2 subsequent events —non-adjusting events 359
12.3.3 Procedures used when conducting a subsequent events review 359
12.4 Misstatements 361
12.4.1 Current-year misstatements 362
12.4.2 Prior-year misstatements 362
12.4.3 Qualitative considerations 363
12.5 Evaluating the conclusions and forming an opinion 363
12.6 Components of the audit report 364
12.7 Modifications to the audit report 365
12.7.1 Emphasis of matter 366
12.7.2 Limitation of scope 366
12.7.3 Disagreement with those charged with governance 367
12.8 Corporations Act 2001 breaches 367
12.9 Management representation and communication with those charged with governance 368
12.9.1 Audit matters of governance interest to be communicated 368
12.9.2 Documentation considerations 369
Summary 370
Key terms 371
Multiple-choice questions 371
Review questions 372
Professional application questions 373
Case study — Crest Outfitters 377
Research question 380
Solutions to multiple-choice questions 381
Endnotes 381
Index 382
