UNSW Business School
School of Accounting, Auditing and Taxation
ACCT5908 Auditing and Assurance Services
Term 3 - 2022
Topic 1
Overview of the Audit Function and the
Importance of Ethical Judgment
Course Overview
2
Demand for Assurance
• Demand arises because users are not in a position to
establish the credibility of the information they are presented
with.
• This demand may be due to:
• Conflict of interest – managers may present biased
information, as they are evaluated on the information.
• Consequence – information provided forms the basis of
many user’s decisions.
• Complexity – many users do not have the expertise required
to determine the quality of information presented.
• Remoteness – the separation of owners from management
prevents users from assessing information quality.
3
Hypotheses explaining demand for
Assurance
• Agency theory (stewardship hypothesis)
• Information hypothesis
• Insurance hypothesis
4
Other benefits of assurance
An assurance service may also result in one or both of the
following:
• Recommendations by the assurance provider to improve the
efficiency and effectiveness of operations, and/or
• A positive influence on the behaviour of people whose activities
are being assured.
5
What is an assurance engagement?
“Assurance engagement means an engagement in which a
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”
• Audits of historical financial statements (the subject matter)
are a type of assurance.
• Examples of other ‘subject matter’ include
• Greenhouse gas emission statements
• Corporate Social Responsibility reporting
• Sustainability reports
• Cyber security statements
• Health and aged care representations
6
Five elements of assurance engagement
• Three party relationship:
• Assurance practitioner
• Responsible party
• Intended user
• Underlying subject matter
• Criteria
• Sufficient appropriate evidence
• A written assurance report
7
Focus of assurance work
• Assurance can be of assistance in improving the efficiency
and effectiveness of any agency relationship characterised by
information asymmetry.
• The most recognizable form of assurance is the audit of
historical financial statements (this is the primary focus of the
course).
8
Importance of Audit Quality
• Audits play a critical role in the smooth and efficient operation
of society.
• Audit quality continues to be tested and questioned around
the world.
• Audit quality is hard to define and measure
• We know when audit quality is absent, but most of we do not know
when audit quality is present.
• How do we know that a quality audit has been done?
9
Auditors responsibilities under the
Corporations Act 2001
• Management is responsible for the preparation and
presentation of appropriate accounts. Accounts are to be
accompanied by a report of an independent auditor appointed
by the shareholders.
10
Auditors’ responsibilities under the
Corporations Act 2001
• Auditors are responsible for reporting to company members
on the directors’ financial report presented at the Annual
General Meeting.
• They say whether the financial report:
- Is in accordance with the law, including compliance with
accounting standards.
- Provides a true and fair view.
• Clarifying management and auditor responsibilities has been
a focus of attention for a long time.
• There is still widespread misunderstanding.
11
Why is there value in the assurance
service?
• Independence
• Users derive value from the knowledge that the assurance
provider has no interest in the information other than for its
usefulness.
• Expertise
• Assurers must have the competence to obtain sufficient relevant
information to provide a reasonable basis for their conclusions.
• Requires professional judgment and professional scepticism.
• Trust and Confidence
• Stakeholders must have trust and confidence in the practitioner's
independence and expertise.
12
Auditor independence
• Independence is a key characteristic of an audit or assurance
service provider.
• In order for auditors to add credibility to financial reports or
other subject matter, they need to remain independent.
• Independence is one of the fundamental ethical virtues or
principles required by the ethical codes (APES110).
13
Independence: Ethical Requirements
• Test for independence is a reasonable person test: Would a
reasonable person having access to all facts consider that the
auditor was independent?
• Ethical rules emphasize both:
• Perceived independence (independence in appearance) – how
others will view the auditor.
• Actual independence (independence of mind) – state of mind of
the auditor. Whether the auditor can actually eliminate bias and
personal interest from his or her decisions and not succumb to
any undue pressures or influences. Related to integrity,
objectivity and strength of character.
14
Threats to independence
15
Self Interest Threat
Self Interest threat occurs when a firm or person
could benefit from a financial, or other self
interest in the client
– Equity or loans to the client
– Fee dependence on the client
– Business relationships with the client
– Contingent audit fees
– Possibility of future employment with the client
16
Self Review Threat
A self review threat occurs when
– The auditor audits work that they have previously
done for the client
• For example, the firm auditing the client’s accounts after the
firm helped to prepare them.
– The auditor was an employee of the client
• This only applies to senior auditors (partners/managers) who
were senior employees at the client and had the ability to
influence the financial statements or accounting system.
17
Advocacy Threat
Advocacy threat occurs when a firm or individual
auditor undertakes activities to promote a client’s
position or interests.
– Promoting a clients shares or debt securities
– Acting as an advocate for the client in
• Litigation
• Disputes with third parties
18
Familiarity Threat
Familiarity threat occurs when there is a close
relationship between the auditor and the client,
such that the auditor is or is perceived to be too
sympathetic to the client’s interests
– Immediate family members as employees or directors
– Former partner being a director or senior employee of
the client
– Acceptance of excessive gifts from the client
19
Intimidation Threat
Intimidation threat occurs when an auditor may be
deterred from acting objectively by actual or perceived
threats from the client.
– A Firm being threatened with dismissal from a Client
Engagement.
– An Audit Client indicating that it will not award a planned non-
assurance contract to the Firm if the Firm continues to disagree
with the client‘s accounting treatment for a particular transaction.
– A Firm being threatened with litigation by the client.
– A Firm being pressured to reduce inappropriately the extent of
work performed in order to reduce fees.
20
Safeguards
• Safeguards fall into two broad categories. For an auditor
these are:
• Safeguards created by the profession, legislation or regulation –
education, professional standards, monitoring and disciplinary
processes, and inspections and reviews.
• Safeguards within the work environment (firm wide engagement
specific) – independence and quality control policies and
procedures.
• The safeguards are aimed at reducing or resolving
circumstances that pose threats to independence.
21
Rotation of audit personnel / audit firms
• There are different requirements for different types of entities
• Principles based approach.
• Additional specific rules for listed / public interest entities.
• Listed entities
• Audit partners can only serve for a maximum of 5 years before having
to ‘cool off’
• Other Public Interest Entities
• Audit partners can only serve for a maximum of 7 years before having
to ‘cool off’.
• No requirement in Australia for rotation of audit firms.
• But this is a requirement does exist in other jurisdictions.
• Some clients require firm rotation.
• There is debate on how these requirements impact audit quality.
22
Fee determination
• Audit fees should be commensurate with the service provided.
Thus, they should reflect the time taken to audit and the
knowledge, skills and expertise required.
• An auditor should not enter into fee arrangements that may
comprise their independence.
• Fees for a period should not be dependent on fees from the
provision of future audits or other services.
• When total fees generated from a client represent a large
proportion of the auditor’s total fees, real or perceived
financial dependency on that client may create a self-interest
or intimidation threat.
23
Independence - Legislative requirements:
Corporations Act 2001.
• Section 307C: Independence declaration.
• Auditors must give directors a written declaration of their
independence and this is to be included in the directors’ report.
• Section 324CA: Conflict of interest
• Auditor must take reasonable steps to ensure conflict of interest
situations cease to exist as soon as possible. Conflict of interest
is where members of audit team are not capable of exercising
objective and impartial judgment, as judged by a reasonable
person.
24
Independence - Legislative requirements:
Corporations Act 2001.
• Section 300(1)(ca): Former auditors
• Directors’ report is to include names of each officer of client who
was a former partner or director of current auditor.
• Section 324CI: Member of audit firm
• Cannot become director, company secretary or member of
senior management of a client until two years after ceasing to be
with audit firm.
• Section 324DA: Rotation of audit partners
• Lead or review partner for five successive years cannot play a
significant role in the audit of that entity for at least another two
successive years.
25
Independence - Legislative requirements:
Corporations Act 2001.
• Section 300(11)(B): Non-audit services
• Boards of all listed companies are required to provide a
statement in their annual report that identifies all non-audit
services provided by an audit firm, the fee for each service and
an explanation of why provision of the service did not impair
independence.
26
Auditors’ appointment
• s327B: Shareholders are responsible for the appointment of
auditor
• Auditor is in breach of independence requirements if, while
auditing at a time that a s324CH(1) relationship exists, the
auditor is aware of relationship and does not take all reasonable
steps to discontinue the audit.
• s324CH(1) Relationships include
• Auditor or immediate family member cannot be an officer or audit
critical member (influencing financial report) of client.
• Auditor cannot provide remuneration to officer or audit critical
employee for acting as a consultant.
• Auditor cannot have an investment in client.
• Auditor cannot owe money to a client (unless a housing or
commercial loan on normal terms and conditions).
27
Auditors’ removal and resignation
• Removal: Difficult to remove an auditor.
• Section 329: Requires a resolution of company at a general
meeting of which special notice has been given. Auditor
entitled to make written representation and speak at general
meeting. A copy of notice must be sent to ASIC.
• Resignation (s329(9)): Auditor can resign. Must have written
consent from ASIC if a public company. Application outlines
reason and ASIC must approve the reason. Designed to
ensure independence and integrity of audit function is
maintained.
28
Right of access to records and
reasonable fees
• Section 310: Auditing has right of access at all reasonable
times to the accounting and other records and registers, and
an entitlement to require from any officer of the company such
information and explanations as required for the purposes of
audit.
• Section 331: Auditor is entitled to receive reasonable fees and
expenses for the work carried out.
• Collectively, all these provisions assist an auditor to maintain
actual and perceived independence and create a suitable
environment for an audit process that is free from undue
influence and obstruction.
29
Ethical principles
• An ethical disposition underpins the value of an assurance
service.
• An ethical disposition is more than just independence and is relevant to
all professional accountants.
APES110
Code of Ethics for Professional Accountants (Including Independence
Standards)
Consistent with the IESBA Code
Often referred to as ‘The Code’
30
Accounting bodies’ codes of ethics
• APES 110 sets out the ethical pronouncements for
professional accountants (not just auditors).
• APES 110 consists of four sections:
• Part 1: General Application of the Code
• Part 2: Members in Business
• Part 3: Members in Public Practice
• Part 4: Independence Requirements
• Auditing standards, which in Australia have the ‘Force of Law’
require compliance with ethical standards.
31
Purpose of the code of ethics
• Code of ethics: formal, systematic statement of rules,
principles, regulations or laws developed by a community to
promote its well-being and punish undermining behaviour.
• The code therefore:
• Makes explicit the values implicitly required.
• Indicates how members should act towards one another.
• Provides an objective basis for sanctions.
Ethics are principally attitudes of mind rather than compliance with
written rules of conduct..
32
Ethical codes and disciplinary rules
• The establishment of ethical codes and disciplinary rules does
not necessarily create an ethical culture or ensure the moral
integrity of employees.
• Accounts are expected to comply with the spirit as well as the
letter of the rules.
33
Fundamental ethical principles
• Contained in national and international codes of ethics:
• Integrity
• Objectivity
• Professional competence and due care
• Confidentiality
• Professional behaviour
34
Applying Ethics
• Sound ethical practice requires;
• Knowledge of the basic principles on which moral values and
rules are based.
• Competence in decision making skills.
• Ability to choose appropriate policies and decision processes in
different situations.
• Key factors to be considered in ethical conflict resolution are:
• relevant facts.
• ethical issues involved.
• fundamental principles related to the matter in question.
• established internal procedures.
• alternate courses of action.
35
Ethical decision making models
• There are different ethical decision making models with many
common features.
• An example is the American Accounting Association’s Ethical
Decision Making Model.
36
Ethical decision making model
37
Why is there value in the assurance
service?
• Independence
• Users derive value from the knowledge that the assurance
provider has no interest in the information other than for its
usefulness.
• Expertise
• Assurers must have the competence to obtain sufficient relevant
information to provide a reasonable basis for their conclusions.
• Requires professional judgment and professional scepticism.
38
Expertise: Professional judgment and
professional scepticism
• Professional Judgment
• Involves the application of relevant training, knowledge and
experience in making informed decisions bout appropriate
courses of action.
• Professional Scepticism
• An attitude that includes a questioning mind, being alert to
conditions indicating possible misstatement and critically
assessing audit evidence.
39
Virtues of an auditor
A distinguishing mark of the accountancy profession is its
acceptance to act in the public interest, defined as ‘the
collective well-being of the community of people that the
members serve’
• Auditors (and indeed all accountants) may have to prioritise
public interest over commercial / profit orientations.
40
Types of assurance engagements
• Reasonable assurance engagements are commonly called
‘audit engagements’.
• Limited assurance engagements are commonly called
‘review engagements’.
• There are also engagements that provide no assurance:
• Agreed-upon procedures engagements where the auditor
reports their findings and doesn’t provide assurance.
41
Audit firms
• There are three levels of audit firms in Australia:
• International (including the Big Four and other firms that are
members of Forum of Firms).
• National firms
• Regional or local firms
• The largest international firms are known as the ‘Big Four’. They
are: PWC, EY, KPMG, Deloitte
• The Big Four are the most visible and public face of auditing,
especially for large listed clients.
• Mid-Tier Firms (e.g., Pitcher Partners, Grant Thornton) are also
active in the large client audit market.
• Small to Medium Practices (SMP) conduct the majority of audits
in Australia, but mostly for smaller clients.
42
Other services
• While audit and assurance services form a significant part of a
public accounting firm’s client base and revenue stream, most
firms also offer other advisory / consulting services:
• Tax services
• Management services
• Internal audit
• Accounting services
• Insolvency services
43
Internal structure of an audit firm
44
Audit and Assurance Services
• Our focus, unless otherwise noted, will be on audits of
historical financial statements.
45
Regulation of auditing in Australia
46
The Auditing and Assurance Standards
Board (AUASB)
The AUASB was reconsitituted as an independent statutory body
on 1 July 2004 and is responsible for the development of
auditing and assurance services standards.
• The board consists of 10 members appointed by the FRC, and a
chair appointed by the relevant minister.
• Responsibility for the final approval of auditing and assurance
standards lies with parliament.
• The AUASB has a long standing policy of convergence and
harmonisation with International Standards on Auditing (ISAs).
47
Regulation of auditing
• The Australian Securities and Investments Commission
(ASIC) – The administering authority for the
Corporations Act 2001.
• ASIC conducts inspections of the four largest firms
and other national and networked firms that audit
many listed entities.
• Risk based selection of audits to inspect.
48
Professional Bodies Inspection Program
• Professional Accounting Bodies (e.g., Institute of Chartered
Accountants Australia and New Zealand, CPA Australia) also
conduct inspections of their members who are Registered
Company Auditors (who often audit smaller entities).
49
Who can be an ‘auditor’?
Anyone!
• There is nothing stopping anyone conducting an audit,
BUT
• Legislation and other requirements may specify an auditor with certain
licenses and or memberships and/or qualifications. (e.g., be a Registered
Company Auditor).
• Members of professional bodies must follow regulations that may restrict the
ability of their members to conduct an audit.
• Most audits are undertaken with reference to auditing standards which,
directly or indirectly, have certain requirements that will restrict the ability of
most individuals to conduct an audit in accordance with those auditing
standards.
50
Registered company auditor
• In order to become a registered company auditor (RCA) under
s1280 of the Corporations Act 2001, a person must:
• have prescribed academic qualifications (or equivalent).
• have the required competencies and experience.
• be capable of performing the duties of an auditor.
• be a fit and proper person.
51
Regulation of auditing
• The Companies Auditors Disciplinary Board:
• CADB determines whether a registered auditor has failed to
carry out his or her duties properly or is not a fit and proper
person to be registered.
52
What if something goes wrong?
• What are the consequences if an auditor performs a poor
audit?
• Sometimes no consequence!
• Sanction by audit firm and/or ASIC
• Suspension / loss of auditor registration
• Legal sanction.
53
Negligence
Negligence can be defined as any conduct that 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 person.
54
Claims for negligence
• To be successful in a claim for negligence, a plaintiff must
prove that:
• Duty was owed to the plaintiff by the defendant (duty of care).
• A breach of the duty of care (negligent conduct) occurred.
• Loss or damage was suffered by the plaintiff.
• A causal relationship existed between the breach of duty by the
defendant and the harm suffered by the plaintiff.
• Auditor’s defense normally rests on ‘duty of care’.
• Auditor’s owe a duty of care to the client (and members of the
client).
• Does an auditor owe a duty of care to third parties?
55
Liability to third parties
• Did the auditor mean for a third party to undertake a specific
action?
• A general conclusion drawn from case law is that it would be
hard to show that audits on general purpose financial reports
were ever intended to induce third parties to undertake a
specific course of action. (Auditors would strongly argue that
this was never the intention).
But never forget the auditor’s ethical responsibilities and
the virtues of an auditor!
56
Liability to third parties:
Competition and Consumer Act 2010
• Consideration needs to be given to the provisions of the
Commonwealth Competition and Consumer Act and relevant
state Fair Trading Acts:
• Acts prohibit misleading and deceptive conduct.
• It is possible that, in issuing an inappropriate auditor’s report, an
auditor might be guilty of conduct that is misleading or deceptive.
57
Liability to third parties:
ASIC Act
• Under section 50 of the ASIC Act, ASIC may, in the public
interest, take civil action to recover damages or property on
behalf of others who have suffered loss.
• In 2008 ASIC launched action under this section against the
auditors of Westpoint Group.
58
Criminal Liability of auditors
• Auditors can be subject to criminal prosecution.
• It is an offence under Section 989ca of the Corporations Act
to not conduct an audit in accordance with auditing standards.
• Criminal actions against auditors are rare. There has only
ever been one conviction in Australia.
• Robert Evett in 2021.
59
Auditing is a challenging but honorable and rewarding
profession, that comes with considerable public interest
responsibilities.
All members of the business community (and capital market
participants) must interact with the audit profession, so it is
important for all to understand the audit function (even those not
planning to be an auditor).
We hope you enjoy the course.