“Trust in the LORD with all your heart and lean not on your

own understanding; in all your ways submit to him, and he will

make your paths straight.” Proverbs 3:5-6
 Chapter 1

An Overview of Auditing
This chapter will give answers to:
• What is an audit?

• What does an audit provide?

• Why is there a demand for audits?

• Who provides audits?

What is an auditing?
According to ASA (Australia Standard of Auditing) 200 Overall
Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with Australian Auditing Standards (ISA – International
Standard on Auditing 200):
“the objective of a financial report audit is for the auditor to express an
opinion about whether the financial report is prepared in all material
respects in accordance with an applicable financial reporting
framework”
• That opinion is on whether the financial report is presented fairly, in
all material respects, or gives a true and fair view in accordance with
the framework.
According to Mautz and Sharaf:
… the purpose of an audit still seems to be to provide certain interested
parties with an attestation of the reliability of certain information supplied
by those entrusted with the property of others.

the Committee on Basic Auditing Concepts of the American Accounting

Association which defines auditing as:
• A systematic process of objectively obtaining and evaluating evidence
regarding assertions about economic actions and events to ascertain the
degree of correspondence between those assertions and established
criteria and communicating the results to interested users
In summary:
• The auditor is setting out to achieve enhanced credibility of
information disclosed to increase reliability for the users of the
financial statements.
• Accounting is a representation of the economic situation of an entity
for a period, which managers are required to represent to users.
These representations by managers are known as assertions about
the economic actions and events of the entity.
• The auditor's task is to obtain evidence to validate these assertions
and ensure economic events are appropriately communicated to
users.
Question???????
Why organisations are prepared to pay to have an external party audit
their accounts to provide assurance on the information disclosed?
What does auditor provide?
Auditor's Responsibility
• The auditor's responsibility is to express an opinion on the financial report.
• The auditor's report shall state that the audit was conducted in accordance
with Australian auditing standards.
• An audit should be described. This includes stating that the auditor has
performed procedures to obtain evidence about the amounts and
disclosures in the financial report. The procedures will vary dependent on
the auditor's assessment of the risks of material misstatement.
• The auditor's report shall state that the auditor believes that sufficient and
appropriate audit evidence has been obtained to form an opinion.
Why there is a demand for audit
• Does audit exist because of regulatory mandate?
• Would a demand for audit exist without regulatory mandate?
Three theories which propose reasons why demand for audits
might exist without regulatory mandate:

• agency theory
• information hypothesis
• insurance hypothesis.
Agency Theory
• … a contract under which one or more persons engage another
person to perform some service on their behalf which involves
delegating some decision-making authority to the agent.
Information Hypothesis
• the audit improves the quality of information, which provides
benefits through the reduction of risk, improvements of decisions,
and the increase in profits.
• Investors will demand this information because it is useful for
decision making and will assist them in assessing the risks and returns
associated with their investments.
• overlap between the information hypothesis and agency theory.
The same Information that is useful in monitoring an agent's
performance is also useful for making investment decisions

• However, the focus of the agency demand for auditing is more

related to the stewardship role of accounting — which is more an
examination of what has happened. The focus of the information
hypothesis is more towards the decision usefulness role
of accounting.
Insurance Hypothesis
• The ability to shift financial responsibility for reported data to an
auditor lowers the expected loss from litigation or related settlements
to managers, creditors, and other professionals involved in the
securities market. As potential litigation awards increase, this
insurance demand for an audit from managers and professional
participants in financial activities can be expected to grow (Wallace,
1980)
Regulation
In the Australian environment, all of the following bodies are required
to have an annual audit:
• companies, registered schemes and disclosing entities (except small
proprietary companies)
• commonwealth and state government departments, statutory
authorities, government companies and business undertakings, and
municipalities
• not-for-profit organisations, including educational institutions.
Who provide audits?
• External auditor, also known as independent auditor
• Either individual practitioners or members of public accounting firms
What is an assurance?
Assurance engagement
• An audit is an assurance engagement. But assurance is broader than
auditing of financial reports.

• The Australian auditing standards define an assurance engagement as

‘an engagement in which an assurance practitioner expresses a
conclusion designed to enhance the degree of confidence of the
intended users other than the responsible party about the outcome
of the evaluation or measurement of a subject matter against criteria
The Auditing Environment
• Accounting Profession
• The first professional society of accountants—Scotland in 1854; England in
1870; Australia in 1884
• In England, accountants were first used for bankruptcies
• According to Watts and Zimmerman one judge in 1875 remarked:
“The whole affairs in bankruptcy have been handed over to an ignorant set of
men called accountants, which was one of the greatest abuses ever introduced
into the law”.
Accounting bodies have been instrumental in the
development of audit practice over the years by:
• developing standards of practice through research and issuance of
standards, professional education, and the establishment of rules of
conduct for members
• ensuring professional conduct and effective self-regulation of quality
of service
• maintaining standards of qualifications through accredited courses,
examinations and practical experience for accountants seeking to
become members.
s. 88B of the Corporations Act defines ‘qualified
accountant’ as follows:
• For the purposes of this Act, a qualified accountant is a person
covered by a declaration in force under subsection (2).
• ASIC may, in writing, declare that all members of a specified
professional body, or all persons in a specified class of members of a
specified professional body, are qualified accountants for the
purposes of this Act.
• ASIC – (Australia Security and Investment Commission) may, in
writing, vary or revoke a declaration made under subsection (2).
Professional Bodies
• Institute of Chartered Accountants in Australia (ICAA)
• CPA Australia
• The Institute of Public Accountants (IPA)
Practice Entities
• The ‘Big Four’
• Deloitte
• Ernst & Young
• KPMG
• PricewaterhouseCoopers
Case Law
• Laws passed based on earlier cases
Regulation and other
oversight
Corporate Law Economic Reform Program (Audit Reform
and Corporate Disclosure) Act 2004 (also known as CLERP 9
Act)

Changes in regards to audit independence:

1. Non-audit services—
2. Audit partner rotation
3. Auditor working for client

Changes in regards to audit quality

1. The role of the Financial Reporting Council (FRC)
1. Australian Auditing and Assurance Standards Board (AUASB)
2. Annual General Meeting (AGM)
 Australian Securities and Investments Commission (ASIC)

ASIC is accountable to the Australian Parliament through the Attorney-General. Its

objectives (s. 1(2)) are:
• to maintain, facilitate and improve the performance of companies, the securities
markets and the futures markets
• to promote the informed and confident participation of investors and consumers
in the financial system
• to achieve uniformity of administration of the Corporations Act throughout
Australia
• to administer the laws that confer functions and powers on it effectively and with
a minimum of procedural requirements
• to receive, process and store — efficiently and quickly — the information given to
ASIC under the laws
• to ensure that the documents are available for public access
• to take action to enforce and give effect to national scheme law.
The Companies Auditors and Liquidators Disciplinary Board
(CALDB)

• A statutory body established in 1990 under the ASIC Act

The Australian Securities Exchange (ASX)

• ASX is a public company, operating as the main national stock

exchange for equities, derivatives and fixed interest securities

• It facilitates capital raisings for unlisted companies, uses

advanced computer systems for trading (CHESS), settlement and
capital matching
• Also provides comprehensive market data and information to a
range of users

• ASX makes or adopts Listing Rules in the interests of the public

• The Listing Rules provide prerequisites for the admission and

continuation of listing and supplement the disclosure
requirements of the Corporations Act
Auditing Standards
• Who sets auditing standards in Australia?

• The process was originally controlled by the accounting profession through

the Australian Accounting Research Foundation (AARF) founded in 1966
• Implementation of CLERP 9 Act changes this
• It’ now under the control of Auditing and Assurance Standards Board
(AUASB), and it has the force of law under the Corporations Act, s. 336
Does the audit meet the
demands of users?
Who are the users of audits?
The audit expectation gap
• According to Porter (1993): It is ‘the audit expectation – performance
gap’.
• The gap has two major components:
• 1. a gap between what society expects auditors to achieve and what they can
be reasonably expected to accomplish (‘reasonableness gap’)
• 2. a gap between what society can reasonably expect auditors to accomplish
and what they are perceived to achieve (‘performance gap’). The
performance gap comprises deficient performance and deficient standards.