ACCT 3708 (Lecture 1 note)

a) Managers
- Run the company (e.g. CEO, CFO)
- They act as the AGENTS of the owner, where they are supposed to run
the company for the owners benefit (the managers are paid to do so)
- Issue FINANCIAL STATEMENTS to owners to allow owners to determine
how the company is performing
- INFORMATION ASYMMETRY: However, managers might lie about the
company performance for personal gain (fraud) or they might
misrepresent company performance because they do not know how well it
is going (incompetence )
b) Owners
- E.g. shareholders
- They own the company
- Managers (AGENT)help them to run the company (sometimes the
managers also can be shareholders and hence, there is no separation
solution for agency problem)
- Owners determine how the company is performing through financial
statements issued by the managers
- These FINANCIAL STATEMENTS are used by owners to reward or punish
managers and make decisions whether to invest in company
- INFORMATION ASYMMETRY: Owners have no way to determine if the
financial statements are true and fair because the managers might lie
about the company performance for personal gain (e.g. the owners cannot
just walk into the Macquarie Bank to get the financial statements, they
rely on the managers)
- OWNERS RESPONSE: Owners know that financial statements might be
wrong due to fraud or error but they cannot distinguish between good and
bad companies or good and bad managers as they are not the one who
manage the company, they also dont know how the employees work
(hardworking or lazy), thats why they cant distinguish. So, they will
respond by under rewarding good managers (e.g. less bonus) !! Or
undervaluing () the *share price of good companies (when
they undervalue, they might not invest the company because they think
that it might not earn money, then the company cant raise funds) due to
the possibility of information not being quite real
(a) & (b) Basically, both parties lose from INFORMATION ASYMMETRY as good
managers cannot prove that they are good and so the owners under reward
the good managers because they think that good performance may not be
real and the owners cannot tell which companies are good investments and
so they might undervalue the share price of good companies and not invest
in the company.
- These are called the AGENCY COSTS ()
- There is a net loss to society from agency costs (Investors dont invest
into the company, companies not enough funds to get more resources for
projects, no profit, share price dont go up, very hard to build partnership)

SOLUTION:
Both owners and managers can only benefit from reducing agency costs, which
is by having an independent third party providing ASSURANCE as to
whether the financial statements are true and fair.
c) Third Party
- E.g. Auditor
- Conducts procedures to determine the truth and fairness of the financial
statements
- Issues an opinion on their truth and fairness to the shareholders
- ASSURANCE ENGAGEMENT: An engagement in which an assurance
practitioner aims to obtain sufficient (enough) appropriate (convincing)
evidence in order to express 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.
- Key criteria of Assurance Engagement:
A three party relationship (practitioner, responsible party and intended
users)
An appropriate subject matter
Suitable criteria (accounting standards)
Sufficient appropriate evidence
A written assurance report in a form appropriate to a reasonable
assurance engagement or a limited assurance engagement.
d) Assurance
- ABSOLUTE ASSURANCE: Can never be provided (can never give 100%
guarantee that it is true) because:
Valuation issues (e.g. valuing company assets)
Accounting policy choice and judgements
Contingent () items
- REASONABLE ASSURANCE: high but not absolute level of assurance
(enough for shareholders to rely on)
conclusion is expressed in +ve form (The financial statements are true
and fair)
audit engagement (SUFFICIENT, APPROPRIATE EVIDENCE) provides a
reasonable level of assurance and the opinion is expressed in an audit
report
- LIMITED ASSURANCE: is a lower level of assurance than reasonable
assurance (the actual level of assurance depends upon the nature of the
procedures that are carried out)
conclusion is expressed in a ve form (Nothing has come to our
attention to suggest that the financial statement is not true and fair)
e.g. review engagement provides a limited level of assurance
e) Audit
- Carried out by an independent auditor or audit firm (e.g. PwC/KPMG/EY)
- Auditor appointed by the shareholders at the AGM (Annual General
Meeting) where most of the times they accept the recommendation of the
board of directors

Auditor express their audit opinion on the financial statement to the

shareholders via an auditors report included in the annual report
Auditor has no right to change any aspect of the financial statement
Preparation of financial statement is made by the directors and the
auditors report does not absolve () them of this
Auditors need to
comply with accounting standards
present a true and fair view
means there are free of material errors (no error) in:
dollar amount
disclosures
Material errors arise from:
Legitimate errors
Deliberate misstatement (fraud)
Errors in accounting judgement
If errors are found
auditors will ask the management to change the financial statements
If they wont, the auditor changes the audit report
2 types of basic audit opinions
Unqualified if there is nothing wrong then auditors will issue
unqualified auditor report
Qualified if there is error then auditors will issue qualified auditor
report
Auditors can be sued for breach of contract by the company
Auditors can also be sued for negligence by: a) the Company, b) Third
Parties
Negligence: Any conduct which is careless or unintentional in nature and
entails a breach of any contractual duty or duty of care in tort owed to
another person or persons
Elements the plaintiff must prove to say that the auditor negligence:
A duty was owed to plaintiff by defendant (e.g. owe duty of care as a
professional)
A breach of duty of care (negligence conduct occurred)
Loss or damaged was suffered by plaintiff; and
That a causal relationship existed between breach of duty by defendant
and harm suffered by plaintiff

Legal Requirement for an Audit

Corporations Act 2001 s301(1): A company, registered scheme or
disclosing entity must have the financial report for a financial year audited
in accordance with Division 3 and obtain an auditors report. this
requirement applies to all Australian companies, except small proprietary
companies.
Auditing Standards s307A: If an individual auditor, or an audit company,
conducts: (a) an audit of the financial report for a financial year; or (b) an
audit or review of the financial report for a half-year; the individual auditor
or audit company must conduct the audit or review in accordance with the
auditing standards.
Australian Auditing Standards:

----- Detailed rules about how to conduct an audit are contained in

Australian Auditing Standards (ASAs)
----- ASAs are legally enforceable (s307A)
----- They are set by the Auditing and Assurance Standards Board (AUASB),
which is a statutory body.
----- Compliance () with ASAs is monitored by ASIC.
ASA 101.9: The auditor shall apply the mandatory ()
components of the Australian Auditing Standards when conducting an
audit or review in accordance with those Standards. The mandatory
components are included in each Auditing Standard under the headings
listed below:
--- (i) Application
--- (ii) Operative Date
--- (iii) Objective(s)
--- (iv) Definition(s)
--- (v) Requirements
ASA 101.10: The auditor shall consider the whole text of an Auditing
Standard to understand, interpret and apply the mandatory components.
The explanatory material is included in each Auditing Standard under the
headings listed below:
--- (i) Application
--- (ii) Introduction
--- (iii) Application and other Explanatory Material
--- (iv) Conformity with International Standards on Auditing
--- (v) Appendices
Explanatory material does not create or extend mandatory components.
Audit opinion s308(1): An auditor who audits the financial report for a
financial year must report to members on whether the auditor of the
opinion that the financial report is in accordance with this Act, including:
--- (a) section 296 (compliance with accounting standards); and
--- (b) section 297 (true and fair view)
If not of that opinion, the auditors report must say why.
International Auditing Standards (ISAs)
----- are issued by the International Auditing and Assurance Standard
Boards (IAASB)
----- these standards are not legally enforceable in Australia
----- All ASAs are based on ISAs they have the same number and
contents, except for some minor differences
Other Standards
----- APES 110 (Australian Code of Ethics for Professional Accountants
----- ASQC1 (Quality Control for Firms that Perform Audits and Reviews of
Financial Reports and Other Financial Information, and Other Assurance
Engagements)
----- Standards on Review Engagements (ASREs): cover review
engagements on historical financial information
----- cover assurance engagements other than audits or reviews of
historical financial information covered by Australian Auditing Standards
or Standards on Review Engagements.

 Other documents: AUASB has released 2 other documents that have no

legal force but are designed to explain concepts.
Corporate Governance
- How a company should be managed?
- Auditing and assurance is one part of corporate governance
- The phrase corporate governance describes the framework of rules,
relationships, systems and processes within and by which authority is
exercised and controlled within corporations. It encompasses the
mechanisms by which companies, and those in control, are held to
account.
The Audit Committee
- All listed companies have an audit committee (a sub-committee of the
board of directors that deals with audit and accounting matters)
- They are the primary link between the board of directors and the external
auditor (talk about audit, about issued saw in the company)(they also deal
with the audit committee such as non executives, independent assist the
exec director and non exec director in decisions)
- Requirements: there is no legal requirement to have an audit committee
but ASC listing rules recommend it.
- The board of listed entity should:
have an audit committee which:
---- (1) has at least 3 members, all of whom are non-executive directors
and a majority whom are independent directors; and
---- (2) is chaired by an independent director, who is not the chair of the
board
- Role: review and make recommendations to the board in relation to:
the adequacy () of the entitys corporate reporting processes
whether the entitys financial statements reflect the understanding of
the committee members of, and otherwise provide a true and fair view of,
the financial position and performance of the entity;
the appropriateness of the accounting judgements or choices exercised
by management in preparing the entitys financial statement.
the appointment or removal of the external auditor
the rotation of the audit engagement partner
the scope and adequacy of the external audit
the independence and performance of the external auditor
any proposal for the external auditor to provide non-audit services and
whether it might compromise the independence of the external auditor