Introduction and Overview of Audit and Assurance

Question 1

What is Auditing?

Answer 1

The verification of information by someone other than the person providing the information. Our role in this class is external auditors working in an audit firm verifying information.

Question 2

We verify the information by:

Answer 2

re-calculating, observing, researching, our own knowledge, tracing to source documents, and vouching.

Question 3

Auditing adhere to

Answer 3

Canadian Auditing Standards (CAS), CAS are based on international auditing standards.

Question 4

There are many types of audits:

Answer 4

Compliance audits, environmental audits, forensic audits, internal audits (Focus on Financial statement audit)

Question 5

Internal Audits and External Audits.

Answer 5

Done by people within the company and Done by independent people outside the company.

Question 6

5 Elements 1. Three Parties

Answer 6

a. practitioner - (us-the external auditor)
b. Responsible party (Management of the company we are auditing)
c. User (shareholders)

Question 7

5 Elements 2. Subject Matter

Answer 7

3. Criteria - IFRS, ASPE, NPO and PSAB
4. Sufficient Appropriate Evidence - our role is not to audit every transaction but to audit enough transactions to get reasonable assurance.
5. Conclusion - The final audit report which indicates whether the financial statements are accurate or not.

Question 8

Statutory Audits

Answer 8

Companies that are required to have an annual audit.

Question 9

Voluntary Audit

Answer 9

Companies that choose to have an audit done.
Reasons for a voluntary audit:
1) To gain additional financing from the bank.
2) Two companies are merging
3) A company is acquiring another company.

Question 10

Corporate Governance and Audit

Answer 10

Corporate Governance structure of a pubco
shareholders
Executives (CEO/CFO)
Management
Employees

Question 11

Other users of external financial statement audit

Answer 11

Shareholders

Question 12

Agency Risk and Audits

Answer 12

Agency risk is the risk that management within the company will do things that benefit themselves rather than the actual owners of the company which are shareholders.

Auditors are hired by the audit committee of the board of directors to represent the shareholders.

We are there to have the shareholder’s back by verifying the financial statements are accurate and thereby reducing agency risks.

Question 13

Role of the auditor

Answer 13

1) To be independent in appearance and fact
2) To be objective
4) To exercise professional judgment.
5) To reduce the expectations gap
6) To reduce information risk.

Question 14

Public Perception of an Auditor

Answer 14

1. Auditor gets absolute assurance.
2. Audit finds all errors.
3. Auditor works for the executives.
4. Auditor prepares the F/S

Question 15

Reality of an Auditor

Answer 15

1. Auditor gets reasonable assurance.
2. Auditor finds material errors.
3. Auditors work for the shareholders.
4. The auditor verifies the F/S but does not prepare them.

Question 16

Who Conducts Audits?

Answer 16

Only public accounting firms can perform external audits and only designated individuals (CPAs) sign off on an audit other accountants can conduct other services such as:
tax services
Consulting services
Compilation of Financial Statements

Question 17

Different Levels of Assurance

Answer 17

Question 18

Audit Reports- The conclusion of the Audit

Answer 18

Unmodified Opinion - Is a clean audit opinion; the auditor concludes that the financial statements are fairly presented.

Emphasis of matter - What results when an auditor issues an unmodified audit opinion when there is a significant issue that is adequately disclosed and there is a need to draw the attention of the user to it in the audit report.

Qualified opinion - an “except for” opinion provided where there is a material scope limitation or a material (significant) mistatement not pervasive to the overall financial statements.

Adverse Opinion - Opinion provided when the auditor concludes that there is a pervasive material misstatement in the financial statements.

disclaimer of opinion - Opinion provided when the impact of a scope limitation is so extreme than an auditor is unable to obrain sufficient appropriate evidence to base an opinion.

Question 19

Financial Statement Users

Answer 19

Investors
In the case of a company, investors generally read the financial statements to determine whether they should invest in or buy, hold, or sell shares in the entity being reported on. They are interested in the return on their investment and are concerned that the entity will remain a going concern into the foreseeable future. Investors may also be interested in the capacity of the entity to pay a dividend. Prospective investors read financial statements to determine whether they should buy shares in the entity.

Suppliers
Suppliers may read the financial statements to determine whether the entity can pay them for goods supplied. They are also interested in whether the entity is likely to remain a going concern (that is, it is likely to continue to be a customer of the supplier) and continue to be able to pay its debts as and when they fall due.

Customers
If customers rely on the entity for their business, they may read the financial statements to determine whether the entity is likely to remain a going concern.

Lenders
Lenders may read the financial statements to determine whether the entity can pay the interest and principal on their loans as and when they fall due.

Employees
Employees may read the financial statements to determine whether the entity can pay their wages or salaries and other benefits (for example, vacation pay). They may also be interested in assessing the future stability and profitability of the entity, as this affects their job security.

Governments
Governments may read the financial statements to determine whether the entity is complying with regulations and paying a fair amount of taxation given its reported earnings and to gain a better understanding of the entity’s activities. An entity in receipt of government grants may provide a copy of its financial statements when applying for a grant and when reporting on how grant funds have been spent.

The General Public
The general public may read the financial statements to determine whether they should associate with the entity (for example, as a future employee, customer, or supplier) and to gain a better understanding of the entity, what it does, and its plans for the future.

Question 20

Information Risk and Causes

Answer 20

Remoteness
Most financial statement users do not have access to the entity under review. This makes it difficult to determine whether the information contained in the financial statements is a fair presentation of the entity and its activities for the relevant period.

Complexity
Most financial statement users do not have the accounting and legal knowledge to enable them to assess the complex accounting and disclosure choices being made by the entity.

Competing Incentives
Management has an incentive to disclose the information contained in the financial statements in a way that helps them achieve their own objectives—for example, to present their performance in the best possible light. Users may find it difficult to identify when management is presenting biased information.

Reliability
Financial statement users are concerned with the reliability of the information contained in the financial statements. As they use that information to make decisions that have real consequences (financial and otherwise, such as assessing the future viability of the company), it is very important that users are able to rely on the facts contained in the financial statements.
An independent third-party review of the information contained in the financial statements by a team of auditors, who have the knowledge and expertise to assess the fair presentation of the information being presented by the preparers, aids users with all of these issues. Auditors have access to entity records, so they are not remote. They are trained accountants and have detailed knowledge about the complex technical accounting and disclosure issues required to assess the choices made by the financial statement preparers. Independent auditors have no incentives to aid the entity in presenting its results in the best possible light. They are concerned with ensuring that the information contained in the financial statements is reliable and free from any significant (material) misstatements (error or fraud).

Cloud 9 Integrated Case

Question 21

Theoretical Frameworks

Answer 21

Agency Theory
When an individual is an owner-manager of their own business, there are no competing incentives. The owner (principal) and manager (agent) are one. When an owner hires a manager to run the business on their behalf, potential conflicts arise. The manager has the incentive to provide favorable results. If there is one owner, they can easily monitor the activities of the manager. When there are several owners (such as shareholders of a large company), it is difficult for the owners to monitor the activities of the management. Agency theory tells us that, due to the remoteness of the owners from the entity, the complexity of items included in the financial statements, and competing incentives between the owners and managers, the owners (principals) have an incentive to hire an auditor (incur a monitoring cost) to assess the fair presentation of the information contained in the financial statements prepared by their managers (agents).

Information Hypothesis
Financial statement users require access to high-quality information to make a variety of decisions. That information is used to determine whether to hold or sell shares in the entity, whether to lend money to the entity, what rate of interest to charge the entity on money lent, and so on. The greater the perceived quality of the information contained in the financial statements, the more likely it will be relied upon by the users of that information. The information hypothesis tells us that, due to the demand for reliable, high-quality information, various user groups, including shareholders, banks, and other lenders, will demand that financial statements be audited to aid their decision-making.

Insurance Hypothesis
Investors take on a risk when buying shares. If the entity fails, investors could lose the money invested. According to the insurance hypothesis, an audit is one way for investors to insure against at least part of their loss should the company they invest in fail. As auditors are required to take out professional indemnity insurance policies, they are seen as having “deep pockets” (that is, access to money), should an investor be able to prove that audit failure was to blame, at least in part, for a loss. The insurance hypothesis tells us that investors will demand that financial statements be audited as a way of insuring against some of their losses should their investments fail.

Question 22

Different Assurance Services

Answer 22

A financial statement audit is an audit that provides reasonable assurance about whether the financial statements are prepared in all material respects in accordance with the financial reporting framework

listed entity is an entity whose shares or debt are listed on a stock exchange

fair presentation the consistent and faithful application of accounting standards when preparing financial statements

a compliance audit is an audit to determine whether the entity has conformed to regulations, rules, or processes.

A performance audit is an assessment of the economy, efficiency, and effectiveness of an organization’s operations.

comprehensive audit an audit that encompasses a range of audit and audit-related activities, such as a financial statement audit, performance audit, and compliance audit.

internal audit is an independent service within an entity that generally evaluates and improves risk management, internal control procedures, and elements of the governance process
those charged with governance generally the board of directors, and may include management of an entity, concerned with evaluating and improving risk management, internal control procedures, and elements of the governance process

corporate social responsibility (CSR) a range of activities undertaken voluntarily by a corporation; CSR disclosures include environmental, employee, and social reporting
consulting firms non-audit firms that provide assurance services on non-financial information, such as corporate social responsibility and environmental disclosures

Question 23

Reasonable Assurance

Answer 23

reasonable assurance assurance that provides high but not absolute assurance on the reliability of the subject matter

Question 24

Limited Assurance and Review Engagement

Answer 24

limited assurance is the level of assurance obtained where engagement risk is reduced to an acceptable level and the evidence gathered is at least sufficient for the practitioner to conclude and provide a level of assurance that is likely to enhance the intended users’ confidence about the financial statements

review engagement in which the practitioner does adequate work to provide limited assurance

Question 25

Preparer Responsibility

Answer 25

It is the responsibility of those charged with governance to ensure that the information contained in their financial statements is relevant, reliable, comparable, understandable, and fairly presented. Each of these concepts is now discussed. Relevant The information included in the financial statements should be relevant to the users of that report. Information is relevant if it has an impact on the decisions made by users regarding the performance of the entity. Users require information that helps them evaluate past, present, and future events relating to the entity. They are interested in evaluating past decisions made by management and predicting whether the entity will remain viable (that is, a going concern) into the future. Users can use current information to estimate future share price movements, like dividend payments, and the ability of the entity to meet its immediate obligations. Reliable The information included in the financial statements should be reliable to the users of those statements. Information is reliable when it is free from material misstatements (errors or fraud). If users perceive that the information presented is unreliable, for whatever reason, the financial statements cannot be used to make the types of decisions outlined above. The information must be unbiased; it must not be presented in such a way as to influence the user’s decision-making process. An independent audit of the financial statements is one method of improving the reliability of the financial statements. Comparable The information included in the financial statements should be comparable through time. Users need to be able to trace an entity’s performance to identify any trends that may influence their perception of how well the entity is doing. Users also need to be able to benchmark the performance of the entity against other similar organizations to assess its relative performance. To enable such comparisons, information must be presented consistently across time and across entities. Any changes in accounting policies must be clearly disclosed so that appropriate adjustments can be made. Consistent application of Canadian generally accepted accounting principles by all entities over time aids these comparisons. Understandable The information included in the financial statements should be understandable. Users need to understand the information presented in order to make appropriate decisions. The financial statement disclosures should provide additional details to aid in the interpretation of the accounting information provided and they should be appropriately placed based on their significance. The disclosures must be clear and concise, and phrased in such a way as to impartially inform users to aid their decision-making. Fairly Presented The information included in the financial statements should be fairly presented. “Presented fairly” or “truth and fairness” refers to the consistent and faithful application of the accounting standards or an applicable framework when preparing financial statements. It is the responsibility of the auditor to form an opinion on the fair presentation or the truth and fairness of the financial statements. In doing so, the auditor will assess the accounting policies selected by those charged with the governance of the entity. Specifically, the auditor will evaluate whether those accounting policies are consistent with the financial reporting framework used by the entity. The auditor will also consider the accounting estimates made by management and those charged with governance to determine whether the estimates are reasonable. The auditor will assess the relevance, reliability, comparability, and understandability of the information presented in the financial statements and the adequacy of the disclosures.

Question 26

Auditor Responsibility

Answer 26

When undertaking an audit, the auditor should use professional skepticism, professional judgment, and due care. Each of these concepts is now defined and explained. Professional Scepticism Professional skepticism is an attitude adopted by the auditor when conducting the audit. It means that the auditor remains independent of the entity, its management, and its staff when completing the audit work. In a practical sense, it means that the auditor maintains a questioning mind and thoroughly investigates all evidence presented by the client. The auditor must seek independent evidence to corroborate information provided by the client and must be suspicious when evidence contradicts documents held by the client or inquiries made by client personnel (including management and those charged with governance). It means the auditor should assess evidence critically and remain alert for fraud. Professional Judgement Professional judgment relates to the level of expertise, knowledge, and training that an auditor uses while conducting an audit. An auditor must utilize their judgment throughout the audit. For example, an auditor must determine the reliability of an information source and decide on the sufficiency and appropriateness of evidence gathered, the procedures to be used in testing, and an appropriate sample size. Due Care Due care refers to being diligent while conducting an audit, applying technical and statute-backed standards, and documenting each stage in the audit process.

Question 27

Audit Expectation Gap

Answer 27