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Auditing : A Practical Approach, Canadian Edition Solution Manual

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    Solutions Manual to accompany Auditing: a practical approach by Robyn Moroney Fiona Campbell Jane Hamilton Valerie Warren

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    Chapter 1 – Introduction and overview of audit and assurance SOLUTIONS TO REVIEW QUESTIONS REVIEW QUESTION 1.1 LO 1 According to the CICA Handbook , an assurance engagement is an engagement where a practitioner issues a written report and concludes on a subject matter for which the accountable party is responsible. Therefore, a prerequisite for an assurance engagement is the existence of an accountability relationship , where one party is answerable to another for the subject matter (s. 5025.0304). In the financial reporting context ‘assurance’ relates to the audit or review of an entity’s financial statements. An audit provides reasonable assurance about the fair presentation of the financial statements, and a review provides limited assurance. The audit contains a positive expression of opinion (e.g. ‘in our opinion the financial statements are in accordance with (the Act) including giving a true and fair view…), while the review contains a negative expression of opinion (e.g., ‘we have not become aware of any matter that makes us believe that…the financial statements are not in accordance with Canadian GAAP .. including giving a true and fair view..’). An auditor may also perform agreed upon procedures for a client, but these do not provide any assurance. The client determines the nature, timing and extent of procedures and no opinion is provided to a third-party user. The assurance practitioner is an auditor working in public practice providing assurance on financial statements of publicly listed companies, or other entities. Intended users are the people for whom the assurance provider prepares their report (e.g., the shareholders). The responsible party is the person or organization (e.g., a company) responsible for the preparation of the subject matter (e.g., the financial statements). An assurer must have the knowledge and expertise to assess the truth and fairness of the information being presented by the preparers. Auditors of financial statements need to be trained accountants with detailed knowledge about the complex technical accounting and disclosure issues required to assess the choices made by the financial statement preparers. When undertaking an audit, the auditor should use professional scepticism, professional judgement and due care.

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    Auditors should be independent of the client. Independent auditors have no incentives to aid the entity in presenting their 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). A user needs to believe that the auditor is acting independently. This means that not only should auditors be independent (i.e., not have any undue personal or financial incentive to protect the client), auditors should avoid doing anything that would cause a reasonable person to doubt their independence. REVIEW QUESTION 1.2 LO 2 The arguments in favour of audit firms providing other services to their audit clients relate to the benefits to be derived by all parties. The audit firm has very detailed knowledge about the client and can use that knowledge to recommend actions or products that would suit the client’s needs. In some cases, the auditor could identify a potential problem that the client had not identified. To the extent that the audit firm uses its knowledge to provide better advice than could be provided by an external consultant, the client will benefit. Shareholders of the client and other interested parties will benefit from improvements to the client’s business. Finally, the auditors will benefit from additional revenue which can be used to subsidise the audit firm’s investments in knowledge and systems, and streamline the audit. The main disadvantages of audit firms providing services to their audit clients relate to potential adverse effects on the auditor’s independence. The auditor could be unwilling to provide services which would reduce their audit fees or cause the client to seek another auditor. The auditor could be unwilling to criticise something to the client which was provided by their consulting division. The auditor could be ‘blind’ to potential adverse impacts on the client’s accounting systems from products and services provided by their consulting division. Even if the consulting provided unquestionable benefits to the client, the relationship between the audit firm and the client could become ‘too cosy’, and discourage the client from considering other auditors. Finally, the auditor could be reluctant to qualify the audit report for fear of losing lucrative fees from consulting services. If this occurs, the audit is less valuable because the auditor is less independent.

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    REVIEW QUESTION 1.3 LO 3 An auditor evaluates the contents of a financial statement against the standards and laws that apply to that type of financial statement. According to CAS 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Canadian Auditing Standards , the objective of a financial statement audit is for the auditor to express an opinion about whether the financial statements are prepared in all material respects in accordance with a financial reporting framework (CAS 200, para. 11). Within a Canadian context, this means that the financial statements have been prepared in accordance with Canadian generally accepted accounting principles (GAAP) and any relevant legislation, such as the Canada Business Corporations Act. Listed public companies must abide by the appropriate Corporations Act, the Canadian Institute of Chartered Accountants (CICA) Accounting Standards Board (AcSB), the Canadian Securities Administrators (CSA), and the listing rules of the public stock exchange (for instance, the TSX – Toronto Stock Exchange) and report their financial statements using IFRS. Certain companies must also abide by additional specific legislation, depending on their industry or legal status. In addition, if a company is listed in another country, foreign exchange listing rules and laws could apply to the financial statement. Private companies in Canada may report their financial statements using IFRS or Accounting Standards for Private Enterprises. Auditing standards control the way an audit is conducted, they are not the criteria against which the financial statement is evaluated. REVIEW QUESTION 1.4 LO 2 An operational audit (performance audit) is an assessment of the economy, efficiency and effectiveness of an organization’s operations. It can be conducted internally (by internal audit) or externally (by an audit firm) and across the entire organization or for part of an organization. Management may request an operational audit (performance audit) of its own company (or part thereof) in order to assess the economy, efficiency and effectiveness of the organization. Ideally, the audit would identify issues that need to be addressed in order to increase the performance of the division or company. For example, the audit could examine a logistics department. It would assess the cost of running the department, the number of deliveries per input (such as labour hours, vehicle hours, etc), and indicators of delivery on time to the correct address.

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    An operational audit (performance audit) could be conducted on a government department or agency as part of the process of accountability to the public. Stakeholders of government entities are usually seen to be more interested in economy, efficiency and effectiveness than in profit, or surplus. Operational (performance) auditing can expose poor practices, or even corruption, in an organization. Operational (performance) auditing can provide information on the implementation of government policies. Regular operational (performance) auditing of government entities can help build trust between the government and the citizens. REVIEW QUESTION 1.5 LO 2 Internal auditors are employees of the company, and therefore cannot be completely independent of the company. However, it is possible to increase the independence of the internal audit department through means such as funding, terms of reference, and lines of reporting. A well-funded internal audit department can investigate more issues and spend more time on each investigation, potentially increasing the chance of discovering fraud and other problems. An internal audit department with a small budget is likely to have fewer staff and less qualified staff (because they will be lower paid), and will have to make compromises on the issues to be investigated. An internal audit department with wide terms of reference has the freedom to pursue the issues which the audit staff believe are most important or create the most risk for the organization. A department with narrow terms of reference could be limited to investigating only certain matters, or must seek the approval of higher levels of management before commencing any investigation. If the internal audit department reports to the CFO it is possible that the CFO will prevent some issues from reaching other members of the management team, or the board of directors. Often, the problems will be within the CFO’s department, creating a conflict of interest for the CFO when deciding whether to report the issue more widely. An internal audit department that reports directly to the audit committee is outside the normal lines of management and reporting. The audit committee is part of the board of directors. Therefore, reporting to the audit committee increases the chance that the highest level of the organization is aware of the problems and will approve the investigation. The audit committee also deals with the external auditor. If the internal auditor reports directly to the audit committee it can communicate the issues to the external auditor and ask them to consider them, where relevant, as part of the financial statement audit. Not all companies have an audit committee. Where the audit committee does not exist, the internal auditor could report directly to the full board of directors.

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    REVIEW QUESTION 1.6 LO 4 As defined in CAS 706 (CAS 706 (5)): Emphasis of Matter paragraph means a paragraph included in the auditor’s report that refers to a matter appropriately presented or disclosed in the financial statements that, in the auditor’s judgement, is of such importance that it is fundamental to users’ understanding of the financial statements. The emphasis of matter paragraph is included in the audit report immediately after the opinion paragraph. An emphasis of matter paragraph draws the attention of the reader to an issue that the auditor believes has been adequately and accurately explained in a note to the financial statements. The purpose of the paragraph is to ensure that the reader pays appropriate attention to the issue when reading the financial statements. The audit report remains unqualified and the user of the financial statements can still rely on the information contained in the financial statements (CAS 706; ISA 706). The emphasis of matter paragraph is not used when the entity has not disclosed the issue in its report. The auditor can use an ‘other matter’ paragraph to introduce another matter that the auditor believes should be disclosed. The usual circumstance which would warrant an Emphasis of Matter paragraph in the auditor’s report is the existence of a significant uncertainty, the resolution of which may materially affect the financial statements. From CAS 706: A1. Examples of circumstances where the auditor may consider it necessary to include an Emphasis of Matter paragraph are: - An uncertainty relating to the future outcome of exceptional litigation or regulatory action. - Early application (where permitted) of a new accounting standard (for example, a new Canadian generally accepted accounting principle) that has a pervasive effect on the financial statements in advance of its effective date. - A major catastrophe that has had, or continues to have, a significant effect on the entity’s financial position. CAS 706 stresses that the inclusion of an Emphasis of Matter paragraph in the auditor’s report does not affect the auditor’s opinion. An emphasis of matter can be included in an unqualified auditor’s report or a qualified auditor’s report (see example in CAS 706).

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    REVIEW QUESTION 1.7 LO 6 The users of the financial statements issued by a large listed public company include shareholders, customers, suppliers, employees, lenders, competitors, and government agencies. They need information which will help them evaluate the future financial performance of the company (including profitability, liquidity and solvency), whether the company has overseas operations and the nature of their activities in those countries (to evaluate exposure to foreign exchange risk, risk to the company of a change in economic conditions in those countries, and whether it is apparently supporting countries with dictators), likely lack of compliance with various laws and regulations, whether the company (and its industry) need government support. Investors are concerned with the value of their investment, employees with their job security, customers with whether the company is likely to remain in business long enough to honour warranties, suppliers with whether they will be paid, lenders with the risk to their loans, competitors with the health of their rivals, and government agencies will be interested in taxes, tariffs, industry support, and economic growth. Users of a sporting team’s financial statements are likely to be interested in the financial condition and performance of the team (its solvency) and whether it is investing in physical facilities, player payments, etc. They might be interested in whether the sporting team supports local businesses and community groups. Although sports teams are often companies limited by guarantee and have members, the members are usually unable to trade their interest in the team. Therefore, users of a sporting team’s financial statements are not concerned about profitability for its own sake, but whether it helps the team pay its players and expand its facilities. Creditors and lenders will be interested in the likelihood that they will be repaid. Government will be interested with sporting and community concerns.

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    REVIEW QUESTION 1.8 LO 6 In addition to the auditing standards (CAS), the Canadian Auditing and Assurance Standards Board (AASB) issues Canadian Standards on Assurance Engagements (CSAE). The IAASB provides an equivalent set of ISAE. CSAE 3000 (ISAE 3000) establishes requirements and provides explanatory guidance for undertaking and reporting on assurance engagements other than audits or reviews of historical financial information covered by Canadian Auditing and Assurance Standards or Standards on Review Engagements. For example, assurance engagements regarding: • Environmental, social and sustainability reports; • Information systems, internal control, and corporate governance processes; and • Compliance with grant conditions, contracts and regulations. In addition, the IAASB is currently undertaking a project on the Assurance of Greenhouse Gas Emissions (GHG). The IAASB believes that with the increasing attention given to the link between GHGs and climate change, many entities are quantifying their GHG emissions for internal management purposes, and an increasing number are also preparing a GHG statement: • As part of a regulatory disclosure regime; • As part of an emissions trading scheme; or • To inform investors and others on a voluntary basis. Voluntary disclosures may be, for example, published as a stand alone document; included as part of a broader sustainability report or in an entity's annual report; or made to support inclusion in a "carbon register." The IAASB states that the focus of this project is on an entity's GHG statement, it does not include requirements or guidance on assuring emissions offsets. The ISAE will also likely be of assistance to financial statement auditors when considering the carrying value of emission trading rights in a financial statement audit. It is the intent of the Accounting and Assurance Standards Board (AASB) to adopt this standard. (see http://www.ifac.org/IAASB/ProjectHistory.php?ProjID=0081 for further information) The AccountAbility organization also provides guidance for sustainability assurance. AccountAbility issues AA1000AS (2008), which is an assurance standard for management, performance and reporting on sustainability issues by evaluating the adherence of an organization to the AccountAbility Principles. (see http://www.accountability.org/ for further information).

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    The International Organization for Standardization (ISO) issues quality control standards in several areas. The 14000 series addresses various aspects of environmental management. These include the requirements and guidelines for environmental management systems (EMS). They also address specific environmental aspects, including labelling, performance evaluation, life cycle analysis, communication and auditing. ISO 19011:2002 provides guidance on the principles of auditing, managing audit programmes, conducting quality management system audits and environmental management system audits, as well as guidance on the competence of quality and environmental management system auditors. It is applicable to all organizations needing to conduct internal or external audits of quality and/or environmental management systems or to manage an audit programme. The application of ISO 19011 to other types of audits is possible in principle provided that special consideration is paid to identifying the competence needed by the audit team members in such cases. (See http://www.iso.org for further information). REVIEW QUESTION 1.9 LO 8 The audit expectation gap occurs when there is a difference between the expectations of assurance providers and financial statement users. The gap occurs when user beliefs do not align with what an auditor has actually done. In particular, the gap is caused by unrealistic user expectations, such as: • the auditor is providing complete assurance • the auditor is guaranteeing the future viability of the entity • an unqualified (clean) audit opinion is an indicator of complete accuracy • the auditor will definitely find any fraud • the auditor has checked all transactions.

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    The reality is that: • an auditor provides reasonable assurance • the audit does not guarantee the future viability of the entity • an unqualified opinion indicates that the auditor believes that there are no material (significant) misstatements (errors or fraud) in the financial statements • the auditor will assess the risk of fraud and conduct tests to try to uncover any fraud, but there is no guarantee that they will find fraud, should it have occurred • the auditor tests a sample of transactions. The audit expectation gap can be reduced by: • auditors performing their duties appropriately, complying with auditing standards, and meeting the minimum standards of performance that should be expected of all auditors • peer reviews of audits to ensure that auditing standards have been applied correctly • auditing standards being reviewed and updated on a regular basis to enhance the work being done by auditors • education of the public • enhanced reporting to explain what processes have been followed in arriving at an audit (reasonable assurance) or a review (limited assurance) opinion (significant improvements have been introduced by standard- setters improving assurance reporting) • assurance providers reporting accurately the level of assurance being provided (reasonable, limited, or none). The audit expectation gap is represented graphically in figure 1.7 of the text.

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    REVIEW QUESTION 1.10 LO 7 The two main bodies that regulate auditors are Canadian Securities Administrators (CSA) and the Canadian Public Accountability Board (CPAB). CPAB registers auditors for public companies, processes annual statements from registered auditors, enforces independence requirements and provides a whistle blowing facility for the reporting of contraventions of the appropriate Corporations Acts. CPAB conducts an audit inspection program to report on audit quality and make recommendations for continued improvement. CPAB visits a selection of firms annually to gain an understanding of their policies and procedures in relation to their independence, audit quality, methodologies and training programs. The CPAB also responds to allegations that an auditor has breached the appropriate Corporations Act or the standards set out by the Accounting and Assurance Standards Board (AASB). The CPAB, AASOC, and AASB will be involved when it is believed an auditor has not carried out their duties properly, is not a fit and proper person, is subject to disqualification or should not remain registered for some other reason. In response, they may cancel or suspend the individual’s registration, give the individual a warning or ask them to make an undertaking to improve their conduct. The inspection process concentrates on an audit firm’s compliance with auditing standards, and their independence and quality control systems. The process includes: - reviewing and undertaking limited testing of the firm’s independence and quality control systems - interviewing the leaders of the audit firm, human resources personnel and selected partners and staff - examining the firm’s audit methodology for compliance with auditing standards - reviewing the conduct of aspects of selected audit and review engagements. The program finishes with an exit meeting and CPAB sends the audit firm a confidential report of their findings. CPAB publishes a public report summarising all their findings.

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    CPAB - Practice Inspections • In accordance with CPAB's mission, they have developed a program of quality inspections which covers all firms who audit reporting issuers who issue securities to the public in Canada and are subject to the rules of provincial or territorial securities commissions. • Registered firms who audit reporting issuers are subject to inspection by CPAB. Their current practice inspection program selects firms for inspection on a cycle ranging from one to three years according to certain criteria. Annually, CPAB monitors the ongoing effectiveness of its practice inspection program and publishes a report highlighting inspection findings from the current year as well as trends relating to audit quality. • As part of their inspection process, CPAB has the right to take a disciplinary action against firms or individuals that CPAB has determined did not perform audits in accordance with professional standards. (see http://www.cpab-ccrc.ca/ for further information)

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    SOLUTIONS TO PROFESSIONAL APPLICATION QUESTIONS PROFESSIONAL APPLICATION 1.1 – Audit reports LO 2, 3, 4, 5, 8 (a) These paragraphs highlight to readers that the directors of the company and the auditors have separate and distinct responsibilities. The directors are responsible for maintaining the accounting systems and preparing the reports, and the auditors are responsible for conducting an audit of these reports by evaluating their contents against the criteria of the accounting standards and relevant legislation. The auditor’s responsibilities do not include preparing the reports and the auditor must use judgement when choosing procedures and evaluating the evidence. (b) In an independent auditor's report, the paragraph is headed ‘Opinion’. It states that in the independent auditor’s opinion the reports are consistent with the relevant standards and legislation including a fair presentation of the financial position and performance of the company. This means that the opinion is unqualified and unmodified. (c) In a review engagement report, the auditor expresses a conclusion, not an opinion, in the review report. It is not an opinion because they did not conduct an audit. The statement is a negative one – ‘we have not become aware… is not , in all material respects, in accordance with ...’. (d) Other differences include: • Audit report indicates that the audit included the financial statements and the notes to the financial statements, whereas the review engagement report only indicates that the financial statements have been reviewed (no reference to the notes to the financial statements). • Audit report outlines the responsibilities of management and the responsibilities of the auditor, whereas the review engagement report makes no reference to these responsibilities. • Close reading of the description of the work done by the auditor will reveal that the procedures used for the review engagement are less comprehensive than those done for the audit. This is the main difference between the reports and why the audit report contains an opinion and the review report expresses a conclusion rather than an opinion.

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    PROFESSIONAL APPLICATION 1.2 – Corporate sustainability reporting assurance LO 2, 3, 5 (a) InterPraxis Consulting wrote the report. (b) In the paragraph ‘Introduction’, ‘The Vancity Credit Union has commissioned InterPraxis to provide it with external assurance of its Accountability Report and the supporting web-based material...’ A ‘limited assurance’ conclusion is provided. However, InterPraxis states that in their opinion the Vancity’s report ‘presents a balanced and fair representation of its social, economic, and environmental performance’. Therefore, although the assurer provides an ‘opinion’ expressed in a positive form, there is only limited assurance. This is further shown by the limited scope of work and the limited set of procedures conducted. (c) AA1000AS (2008) is published by the AccountAbility organization, and provides guidance for sustainability assurance. AA1000AS (2008) is an assurance standard for management, performance and reporting on sustainability issues by evaluating the adherence of an organization to the AccountAbility Principles. (see http://www.accountability.org/ for further information). (d) The AA1000 Assurance Standard is based on assessment of reports against three Assurance Principles: • Materiality: does the sustainability report provide an account covering all the areas of performance that stakeholders need to judge the organization's sustainability performance? • Completeness: is the information complete and accurate enough to assess and understand the organization's performance in all these areas? • Responsiveness: has the organization responded coherently and consistently to stakeholders' concerns and interests?

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    From the text discussion of financial reporting: • Relevance: Information will be relevant if it has an impact on the decisions made by users regarding the performance of the entity. • Reliability: Information will be reliable when it is free from material misstatements (errors or fraud). • Comparability: 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. • Understandability: Users need to understand the information presented in order to make appropriate decisions. • Presents fairly: ‘Presented fairly’ refers to the consistent and faithful application of accounting standards when preparing the financial statements. Conclusions: • AA1000AS does not require the information to be reliable, but it does require enough accuracy for users to assess and understand the organization’s performance in these areas. • AA1000AS does not require the information to be comparable across years and organizations, but does require the organization to respond consistently to stakeholders’ concerns. • AA1000AS does not require the information to be understandable, but does require the organization to respond coherently to stakeholders’ concerns. • AA1000AS does not require the report to be a fair presentation, but in financial reporting this is often interpreted as consistent application of the financial accounting standards. There are few standards in sustainability reporting and those that do exist are not mandatory.

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