Auditing : A Practical Approach, Canadian Edition Solution Manual

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Solutions Manualto accompanyAuditing: a practicalapproachbyRobyn MoroneyFiona CampbellJane HamiltonValerie Warren

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Chapter 1 – Introduction and overview of audit and assuranceSOLUTIONS TO REVIEW QUESTIONSREVIEW QUESTION 1.1LO 1According to theCICA Handbook, anassurance engagementis an engagementwhere a practitioner issues a written report and concludes on a subject matter forwhich the accountable party is responsible. Therefore, a prerequisite for anassuranceengagementistheexistenceofanaccountability 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 anentity’s financial statements.Anauditprovidesreasonableassuranceaboutthefairpresentationofthefinancial statements, and a review provides limited assurance. The audit containsa positive expression of opinion (e.g. ‘in our opinion the financial statementsarein accordance with (the Act) including giving a true and fair view…), while thereview contains a negative expression of opinion (e.g., ‘we havenotbecomeaware of any matter that makes us believe that…the financial statements arenotin accordance with Canadian GAAP .. including giving a true and fair view..’).An auditor may also perform agreed upon procedures for a client, but these donot provide any assurance. The client determines the nature, timing and extent ofprocedures and no opinion is provided to a third-party user.Theassurance practitioneris an auditor working in public practice providingassurance on financial statements of publicly listed companies, or other entities.Intendedusersare the people for whom the assurance provider prepares theirreport(e.g.,theshareholders).Theresponsiblepartyisthepersonororganization (e.g., a company) responsible for the preparation of the subjectmatter (e.g., the financial statements).An assurer must have the knowledge and expertise to assess the truth andfairness of the information being presented by the preparers. Auditors of financialstatements need to be trained accountants with detailed knowledge about thecomplex technicalaccountinganddisclosureissuesrequiredtoassessthechoices made by the financial statement preparers. When undertaking an audit,the auditor should use professional scepticism, professional judgement and duecare.

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Auditors should be independent of the client. Independent auditors have noincentives to aid the entity in presenting their results in the best possible light.They are concerned with ensuring that the information contained in the financialstatements 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 anyundue personal or financial incentive to protect the client), auditors should avoiddoinganythingthatwouldcauseareasonablepersontodoubttheirindependence.REVIEW QUESTION 1.2LO 2The arguments in favour of audit firms providing other services to their auditclients relate to the benefits to be derived by all parties. The audit firm has verydetailed knowledge about the client and can use that knowledge to recommendactions or products that would suit the client’s needs. In some cases, the auditorcould identify a potential problem that the client had not identified. To the extentthat the audit firm uses its knowledge to provide better advice than could beprovided by an external consultant, the client will benefit. Shareholders of theclient and other interested parties will benefit from improvements to the client’sbusiness. Finally, the auditors will benefit from additional revenue which can beused to subsidise the audit firm’s investments in knowledge and systems, andstreamline the audit.The main disadvantages of audit firms providing services to their audit clientsrelate to potential adverse effects on the auditor’s independence. The auditorcould be unwilling to provide services which would reduce their audit fees orcause the client to seek another auditor. The auditor could be unwilling to criticisesomething to the client which was provided by their consulting division. Theauditor could be ‘blind’ to potential adverse impacts on the client’s accountingsystems from products and services provided by their consulting division. Even ifthe consulting provided unquestionable benefits to the client, the relationshipbetween the audit firm and the client could become ‘too cosy’, and discouragethe client from considering other auditors. Finally, the auditor could be reluctantto 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 1.3LO 3An auditor evaluates the contents of a financial statement against the standardsand laws that apply to that type of financial statement. According to CAS 200Overall Objectives of the Independent Auditor and the Conduct of an Audit inAccordancewithCanadianAuditingStandards,theobjectiveofafinancialstatement audit is for the auditor to express an opinion about whether thefinancial statements are prepared in all material respects in accordance with afinancial reporting framework (CAS 200, para. 11). Within a Canadian context,this means that the financial statements have been prepared in accordance withCanadian generally accepted accounting principles (GAAP) and any relevantlegislation,suchastheCanadaBusinessCorporationsAct.ListedpubliccompaniesmustabidebytheappropriateCorporationsAct,theCanadianInstitute of Chartered Accountants (CICA) Accounting Standards Board (AcSB),the Canadian Securities Administrators (CSA), and the listing rules of the publicstock exchange (for instance, the TSX – Toronto Stock Exchange) and reporttheir financial statements using IFRS. Certain companies must also abide byadditional specific legislation, depending on their industry or legal status.Inaddition, if a company is listed in another country, foreign exchange listing rulesand laws could apply to the financial statement. Private companies in Canadamay report their financial statements using IFRS or Accounting Standards forPrivate Enterprises.Auditing standards control the way an audit is conducted, they are not the criteriaagainst which the financial statement is evaluated.REVIEW QUESTION 1.4LO 2An operational audit (performance audit) is an assessment of the economy,efficiency and effectiveness of an organization’s operations. It can be conductedinternally (by internal audit) or externally (by an audit firm) and across the entireorganization or for part of an organization.Management may request an operational audit (performance audit) of its owncompany(orpartthereof)inordertoassesstheeconomy,efficiencyandeffectiveness of the organization. Ideally, the audit would identify issues thatneed to be addressed in order to increase the performance of the division orcompany. For example, the audit could examine a logistics department. It wouldassess 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 tothe correct address.

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An operational audit (performance audit) could be conducted on a governmentdepartment or agency as part of the process of accountability to the public.Stakeholders of government entities are usually seen to be more interested ineconomy, efficiency and effectiveness than in profit, or surplus. Operational(performance) auditing can expose poor practices, or even corruption, in anorganization. Operational (performance) auditing can provide information on theimplementationofgovernmentpolicies.Regularoperational(performance)auditing of government entities can help build trust between the government andthe citizens.REVIEW QUESTION 1.5LO 2Internalauditorsareemployeesofthecompany,andthereforecannotbecompletely independent of the company. However, it is possible to increase theindependence 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 spendmore time on each investigation, potentially increasing the chance of discoveringfraud and other problems. An internal audit department with a small budget islikely 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 topursue the issues which the audit staff believe are most important or create themost risk for the organization. A department with narrow terms of reference couldbe limited to investigating only certain matters, or must seek the approval ofhigher levels of management before commencing any investigation.If the internal audit department reports to the CFO it is possible that the CFO willprevent some issues from reaching other members of the management team, orthe 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 theissue more widely. An internal audit department that reports directly to the auditcommittee is outside the normal lines of management and reporting. The auditcommittee is part of the board of directors. Therefore, reporting to the auditcommittee increases the chance that the highest level of the organization isaware of the problems and will approve the investigation. The audit committeealso deals with the external auditor. If the internal auditor reports directly to theaudit committee it can communicate the issues to the external auditor and askthem to consider them, where relevant, as part of the financial statement audit.Not all companies have an audit committee. Where the audit committee does notexist, the internal auditor could report directly to the full board of directors.

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REVIEW QUESTION 1.6LO 4As defined in CAS 706 (CAS 706 (5)):Emphasis of Matter paragraph means a paragraph included in the auditor’sreport that refers to a matter appropriately presented or disclosed in the financialstatements that, in the auditor’s judgement, is of such importance that it isfundamental to users’ understanding of the financial statements.The emphasis of matter paragraph is included in the audit report immediatelyafter the opinion paragraph.An emphasis of matter paragraph draws the attention of the reader to an issuethat the auditor believes has been adequately and accurately explained in a noteto the financial statements. The purpose of the paragraph is to ensure that thereaderpaysappropriateattentiontotheissuewhenreadingthefinancialstatements. The audit report remains unqualified and the user of the financialstatements 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 disclosedthe issue in its report. The auditor can use an ‘other matter’ paragraph tointroduce another matter that the auditor believes should be disclosed.The usual circumstance which would warrant an Emphasis of Matter paragraphin the auditor’s report is the existence of a significant uncertainty, the resolutionof which may materially affect the financial statements.From CAS 706:A1. Examples of circumstances where the auditor may consider it necessary toinclude an Emphasis of Matter paragraph are:-Anuncertaintyrelatingtothefutureoutcomeofexceptionallitigationorregulatory action.- Early application (where permitted) of a new accounting standard (for example,a new Canadian generally accepted accounting principle) that has a pervasiveeffect on the financial statements in advance of its effective date.- A major catastrophe that has had, or continues to have, a significant effect onthe entity’s financial position.CAS 706 stresses that the inclusion of an Emphasis of Matter paragraph in theauditor’s report does not affect the auditor’s opinion. An emphasis of matter canbe included in an unqualified auditor’s report or a qualified auditor’s report (seeexample in CAS 706).

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REVIEW QUESTION 1.7LO 6The users of the financial statements issued by a large listed public companyinclude shareholders, customers, suppliers, employees, lenders, competitors,and government agencies. They need information which will help them evaluatethe future financial performance of the company (including profitability, liquidityand solvency), whether the company has overseas operations and the nature oftheir activities in those countries (to evaluate exposure to foreign exchange risk,risk to the company of a change in economic conditions in those countries, andwhetheritisapparentlysupportingcountrieswithdictators),likelylackofcompliance with various laws and regulations, whether the company (and itsindustry) need government support. Investors are concerned with the value oftheir investment, employees with their job security, customers with whether thecompany 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 beinterested in taxes, tariffs, industry support, and economic growth.Users of a sporting team’s financial statements are likely to be interested in thefinancial condition and performance of the team (its solvency) and whether it isinvesting in physical facilities, player payments, etc. They might be interested inwhether the sporting team supports local businesses and community groups.Although sports teams are often companies limited by guarantee and havemembers, the members are usually unable to trade their interest in the team.Therefore, users of a sporting team’s financial statements are not concernedabout profitability for its own sake, but whether it helps the team pay its playersand expand its facilities. Creditors and lenders will be interested in the likelihoodthattheywillberepaid.Governmentwillbeinterestedwithsportingandcommunity concerns.

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REVIEW QUESTION 1.8LO 6Inadditiontotheauditingstandards(CAS),theCanadianAuditingandAssurance Standards Board (AASB) issues Canadian Standards on AssuranceEngagements (CSAE). The IAASB provides an equivalent set of ISAE. CSAE3000 (ISAE 3000) establishes requirements and provides explanatory guidancefor undertaking and reporting on assurance engagements other than audits orreviews of historical financial information covered by Canadian Auditing andAssuranceStandards orStandardsonReview Engagements.Forexample,assurance engagements regarding:•Environmental, social and sustainability reports;•Informationsystems,internalcontrol,andcorporategovernanceprocesses; and•Compliance with grant conditions, contracts and regulations.In addition, the IAASB is currently undertaking a project on the Assurance ofGreenhouse Gas Emissions (GHG). The IAASB believes that with the increasingattention given to the link between GHGs and climate change, many entities arequantifying their GHG emissions for internal management purposes, and anincreasing 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 disclosuresmay be, for example, published as a stand alone document; included aspart of a broader sustainability report or in an entity's annual report; ormade to support inclusion in a "carbon register."The IAASB states that the focus of this project is on an entity's GHG statement, itdoes not include requirements or guidance on assuring emissions offsets. TheISAEwillalsolikelybeofassistancetofinancialstatementauditorswhenconsidering the carrying value of emission trading rights in a financial statementaudit. It is the intent of the Accounting and Assurance Standards Board (AASB)to adopt this standard.(seehttp://www.ifac.org/IAASB/ProjectHistory.php?ProjID=0081forfurtherinformation)TheAccountAbilityorganizationalsoprovidesguidanceforsustainabilityassurance.AccountAbility issues AA1000AS (2008), which is an assurancestandard for management, performance and reporting on sustainability issues byevaluating the adherence of an organization to the AccountAbility Principles.(seehttp://www.accountability.org/for further information).

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The International Organization for Standardization (ISO) issues quality controlstandards in several areas. The 14000 series addresses various aspects ofenvironmental management. These include the requirements and guidelines forenvironmentalmanagementsystems(EMS).Theyalsoaddressspecificenvironmental aspects, including labelling, performance evaluation, life cycleanalysis, communication and auditing.ISO 19011:2002 provides guidance on the principles of auditing, managing auditprogrammes, conducting quality management system audits and environmentalmanagement system audits, as well as guidance on the competence of qualityand environmental management system auditors.It is applicable to all organizations needing to conduct internal or external auditsof quality and/or environmental management systems or to manage an auditprogramme.The application of ISO 19011 to other types of audits is possible in principleprovided that special consideration is paid to identifying the competence neededby the audit team members in such cases.(Seehttp://www.iso.orgfor further information).REVIEW QUESTION 1.9LO 8Theauditexpectationgapoccurswhenthereisadifferencebetweentheexpectations of assurance providers and financial statement users. The gapoccurs when user beliefs do not align with what an auditor has actually done. Inparticular, 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 areno material (significant) misstatements (errors or fraud) in the financialstatements• the auditor will assess the risk of fraud and conduct tests to try touncover 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 auditingstandards,andmeetingtheminimumstandardsofperformancethatshould be expected of all auditors• peer reviews of audits to ensure that auditing standards have beenapplied correctly• auditing standards being reviewed and updated on a regular basis toenhance the work being done by auditors• education of the public• enhanced reporting to explain what processes have been followed inarriving at an audit (reasonable assurance) or a review (limited assurance)opinion(significantimprovementshavebeenintroducedbystandard-setters improving assurance reporting)• assurance providers reporting accurately the level of assurance beingprovided (reasonable, limited, or none).The audit expectation gap is represented graphically in figure 1.7 of the text.

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REVIEW QUESTION 1.10LO 7ThetwomainbodiesthatregulateauditorsareCanadianSecuritiesAdministrators (CSA) and the Canadian Public Accountability Board (CPAB).CPAB registers auditors for public companies, processes annual statements fromregistered auditors, enforces independence requirements and provides a whistleblowing facility for the reporting of contraventions of the appropriate CorporationsActs. CPAB conducts an audit inspection program to report on audit quality andmake recommendations for continued improvement. CPAB visits a selection offirms annually to gain an understanding of their policies and procedures inrelationtotheirindependence,auditquality,methodologiesandtrainingprograms.TheCPABalsorespondstoallegationsthatanauditorhasbreachedtheappropriate Corporations Act or the standards set out by the Accounting andAssurance Standards Board (AASB). The CPAB, AASOC, and AASB will beinvolved when it is believed an auditor has not carried out their duties properly, isnot a fit and proper person, is subject to disqualification or should not remainregistered for some other reason. In response, they may cancel or suspend theindividual’s registration, give the individual a warning or ask them to make anundertaking to improve their conduct.The inspection process concentrates on an audit firm’s compliance with auditingstandards, and their independence and quality control systems. The processincludes:-reviewingandundertakinglimitedtestingofthefirm’sindependence and quality control systems-interviewingtheleadersoftheauditfirm,humanresourcespersonnel and selected partners and staff-examining the firm’s audit methodology for compliance with auditingstandards-reviewing the conduct ofaspects ofselected audit and reviewengagements.The program finishes with an exit meeting and CPAB sends the audit firm aconfidential report of their findings. CPAB publishes a public report summarisingall their findings.

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CPAB - Practice Inspections•In accordance with CPAB's mission, they have developed a program ofquality inspections which covers all firms who audit reporting issuers whoissue securities to the public in Canada and are subject to the rules ofprovincial or territorial securities commissions.•Registered firms who audit reporting issuers are subject to inspection byCPAB.Theircurrentpracticeinspectionprogramselectsfirmsforinspection on a cycle ranging from one to three years according to certaincriteria. Annually, CPAB monitors the ongoing effectiveness of its practiceinspection program and publishes a report highlighting inspection findingsfrom the current year as well as trends relating to audit quality.•Aspartoftheirinspectionprocess,CPABhastherighttotakeadisciplinary action against firms or individuals that CPAB has determineddid 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 QUESTIONSPROFESSIONAL APPLICATION 1.1 – Audit reportsLO 2, 3, 4, 5, 8(a)These paragraphs highlight to readers that the directors of the company and theauditors have separate and distinct responsibilities. The directors are responsibleformaintainingtheaccountingsystemsandpreparingthereports,andtheauditors are responsible for conducting an audit of these reports by evaluatingtheir contents against thecriteriaofthe accounting standards andrelevantlegislation. The auditor’s responsibilities do not include preparing the reports andthe auditor must use judgement when choosing procedures and evaluating theevidence.(b)In an independent auditor's report, the paragraph is headed ‘Opinion’. It statesthat in the independent auditor’s opinion the reports are consistent with therelevant standards and legislation including a fair presentation of the financialpositionandperformanceofthecompany.Thismeansthattheopinionisunqualified and unmodified.(c)In a review engagement report, the auditor expresses a conclusion, not anopinion, in the review report. It is not an opinion because they did not conduct anaudit. The statement is a negative one – ‘we havenotbecome aware… isnot, inall material respects, in accordance with ...’.(d)Other differences include:• Audit report indicates that the audit included the financial statements and thenotes to the financial statements, whereas the review engagement report onlyindicates that the financial statements have been reviewed (no reference to thenotes to the financial statements).• Audit report outlines the responsibilities of management and the responsibilitiesof the auditor, whereas the review engagement report makes no reference tothese responsibilities.• Close reading of the description of the work done by the auditor will reveal thatthe procedures used for the review engagement are less comprehensive thanthose done for the audit. This is the main difference between the reports and whythe audit report contains an opinion and the review report expresses a conclusionrather than an opinion.

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PROFESSIONALAPPLICATION1.2–CorporatesustainabilityreportingassuranceLO 2, 3, 5(a)InterPraxis Consulting wrote the report.(b)In the paragraph ‘Introduction’, ‘The Vancity Credit Union has commissionedInterPraxis to provide it with external assurance of its Accountability Report andthe supporting web-based material...’A ‘limited assurance’ conclusion is provided. However, InterPraxis states that intheir opinion the Vancity’s report ‘presents a balanced and fair representation ofits social, economic, and environmental performance’. Therefore, although theassurer provides an ‘opinion’ expressed in a positive form, there is only limitedassurance. This is further shown by the limited scope of work and the limited setof procedures conducted.(c)AA1000AS (2008) is published by the AccountAbility organization, and providesguidanceforsustainabilityassurance.AA1000AS(2008)isanassurancestandard for management, performance and reporting on sustainability issues byevaluating the adherence of an organization to the AccountAbility Principles.(seehttp://www.accountability.org/for further information).(d)The AA1000 Assurance Standard is based on assessment of reports againstthree Assurance Principles:• Materiality: does the sustainability report provide an account covering all theareasofperformancethatstakeholdersneedtojudgetheorganization'ssustainability performance?• Completeness: is the information complete and accurate enough to assess andunderstand the organization's performance in all these areas?• Responsiveness: has the organization responded coherently and consistently tostakeholders' 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 decisionsmade by users regarding the performance of the entity.•Reliability:Informationwillbereliablewhenitisfreefrommaterialmisstatements (errors or fraud).• Comparability: Users need to be able to trace an entity’s performance to identifyany 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 againstother similar organizations to assess its relative performance.• Understandability: Users need to understand the information presented in orderto make appropriate decisions.• Presents fairly: ‘Presented fairly’ refers to the consistent and faithful applicationof accounting standards when preparing the financial statements.Conclusions:•AA1000AS does not require the information to be reliable, but it doesrequireenoughaccuracyforuserstoassessandunderstandtheorganization’s performance in these areas.•AA1000AS does not require the information to be comparable acrossyears and organizations, but does require the organization to respondconsistently to stakeholders’ concerns.•AA1000AS does not require the information to be understandable, butdoesrequiretheorganizationtorespondcoherentlytostakeholders’concerns.•AA1000AS does not require the report to be a fair presentation, but infinancial reporting this is often interpreted as consistent application of thefinancial accounting standards. There are few standards in sustainabilityreporting and those that do exist are not mandatory.

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