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AUDITING
Week 7
9.21 Assertions
In planning the audit of a clients liabilities, an auditor derived the following specific
objectives from managements financial statement assertions:
1. Liabilities are not valued below the amount expected to be paid in accordance with an
applicable accounting standard.
2. The total of the schedule of purchase ledger balances agrees to the balance on the
purchase ledger control account.
3. All liabilities represent obligating events occurring before the year end.
4. Current liabilities include all amounts owed by the company that fall due within 12
months of the year end.
5. All liabilities that were settled before the year end have been excluded from the balance
sheet.
6. Liabilities have been properly classified in the balance sheet.
7. All finance lease obligations have been included in liabilities.
8. Details of any mortgages in relation to bank loans have been disclosed in the notes of the
financial report.
9. Provisions for staff annual leave have been correctly calculated.
10. Long-term liabilities have been discounted to present value where the discounting
amount is material.
Required
For each specific audit objective (items 1-10), identify the management
assertion from which it was derived.
Assertions from ASA 500.
1.
Valuation and allocation
2.
Accuracy and valuation and allocation
3.
Rights and obligations
4.
Completeness
5.
Existence
6.
Classification and understandability of disclosure
7.
Completeness
8.
Presentation and disclosure assertions particularly in relation to completeness
9.
Accuracy and valuation and allocation
10.
Valuation and allocation.
9.22

Obtaining an understanding

You are an audit senior at the accounting firm of Court & Partners in Sydney. The firm has
recently won the audit of a small manufacturing firm located in Bankstown and you have
been given the job. The audit partner in the planning meeting tells you not to worry about the
controls because the firm is quite small, and based on his experience of firms of this size,
controls are mostly poor and it is not even worth looking at them.

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Comment on the audit partner's advice.
It may be true that for most companies of this size controls are poor, however the auditor still
has an obligation to obtain an understanding of the internal controls. ASA 315 requires the
auditor to obtain an understanding of internal control relevant to the audit.
Therefore no matter what the preconceptions of the audit partner this is a requirement for all
audits and must be followed. If the audit has been performed before and the conclusion is that
controls are very poor then less work will be undertaken in obtaining this understanding.
However, in this situation the audit is being performed for the first time so the review should
be undertaken properly and completely as required by the auditing standards.
Outline any special considerations in evaluating and relying on controls in small firms.
Smaller firms are less likely to have many of the formal controls that would be expected in
larger entities. In particular, the overriding requirement for segregation of duties is difficult to
implement for many small entities. These problems can be countered by developing a culture
that emphasises integrity, ethical values and competence. However, from an audit point of
view it is very difficult to be able to rely on controls in this type of environment.
ErgoOffice Ltd manufactures office furniture. It employs 250 staff at its single factory and its
turnover last year was $40 million.
You are an audit senior with a firm of accountants which has held appointment as external
auditor to ErgoOffice for a number of years. However, you have not previously been involved
with the audit. You are currently reviewing the audit file before planning the audit for the
financial year ending 30 June 2015. Last year there were no major audit problems and
inherent risk was assessed as relatively low and the control environment was considered
satisfactory.
The description of the purchases system as updated in last years audit file reads as follows.
Requisitioning
Department heads have authority to issue requisitions for non-capital purchases up to $5000.
Stock requisitions are automatically issued by the computer when predetermined reorder
levels are reached.
Ordering
All requisitions pass through the purchasing office which checks the authority of the
requisitioner, identifies suitable suppliers and obtains quotes where necessary. The purchasing
office then opens up an order against the supplier which is recorded in the supplier master file
on the computer. The computer assigns an order number. A copy of the order is printed out
and sent to the supplier.
Goods inward
Deliveries are accepted only at the centralised goods inwards dock. The goods inward clerk
accesses the order on the computer and checks that the goods are in agreement with the order
and are in good condition. The goods inward clerk then updates the computer record of the
order with receiving information.

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Recording
Purchase invoices are numbered on receipt. The bought ledger clerk checks the invoice
arithmetically and verifies it against the computer record of the order, ensuring that the
records confirm receipt of the goods. These checks are evidenced on the invoice together with
the account coding specified on the order. Receipt of the invoice is also noted on the order
record to prevent accidental acceptance of a duplicate invoice. Invoices are batched daily by
the bought ledger clerk for computer processing and a control sheet is prepared for each batch
listing the total payable. The assistant accountant approves each invoice before passing the
batch to the computer operator.
Payment
At the end of each month the computer prints out cheques for the balance owing to each
supplier together with a remittance advice itemising the make-up of the balance. A copy of
the remittance advice is also printed out in the form of a bought ledger.
The assistant accountant reconciles the total payable with the daily batch control information,
test checks creditors with suppliers statements, approves the copy remittance advices for
payment, has the cheques mechanically signed and passes them directly to the mail room.
You note that your predecessor completed an internal control evaluation checklist and used
the results to justify assessing control risk as low for all purchase and payment transaction
assertions associated with creditors.
Required
(a) Outline the control procedures operating in the purchasing system of
ErgoOffice Ltd.
(b)Comment on the extent to which you can accept your predecessors
assessment of the control environment.
(c) Describe the further work you would plan to undertake to assess
inherent risk and the control environment during the current years
audit.
(a) Requisitioning

There is a limit of $5000 on the authority of department heads to issue

requisitions for non-capital purchases.

The computer automatically generates orders when predetermined reorder

levels are reached.
Ordering
All requisitions are checked for authority by the purchasing office.
Quotes are obtained where necessary from suppliers (although where
necessary not specifically defined).
The computer assigns an order number (presume sequential).

Goods Inward

The goods inward clerk accesses the order on the computer and checks the
goods are in agreement with the order and are in good condition.
Recording

Purchase invoices are numbered on receipt (presume sequential).

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The bought ledger clerk checks the invoice arithmetically, verifies it against
the computer record of the order and the record of delivery. These checks are evidenced
on the invoice together with the account coding.

Receipt of invoice is also noted on order record to prevent acceptance of

duplicate invoice.

A control sheet is prepared for each batch of invoices processed.

The assistant accountant approves each invoice before passing the batch to the
computer operator.

Payment
The assistant accountant reconciles the total payable with the daily batch
control information.

(b) Having the previous years working papers is obviously a great advantage in performing
the work for the current audit. It may be used by the auditor as a starting point so they can
make inquiries as to changes that may have occurred in the system in the current year.
The auditor should also inspect relevant documents in the current year such as:
organisation charts; policy manuals; the chart of accounts; accounting ledgers; journals
and source documents. This will lead to additional inquiries of the client.
(c) Some examples of further work:
Inherent risk
Discussion with management.
Review minutes of directors' meetings.
Review industry publications, newspapers etc.
Control environment
Discussion with management.
Walk through of the accounting system.
10.12 Explain the term materiality in the context of financial reporting.
In relation to financial information, materiality means:
the information which, if omitted, misstated or not disclosed, has
the potential to adversely affect decisions about the allocation of
scarce resources made by users of the financial report or the
discharge of accountability by the management, including the
governing body of the entity. (AASB 1031)
Financial reporting frameworks often discuss the concept of materiality in the context of the
preparation and presentation of a financial report. Although financial reporting frameworks
may discuss materiality in different terms, they generally explain that:
Misstatements, including omissions, are considered to be material if they,
individually or in the aggregate, could reasonably be expected to influence the
economic decisions of users taken on the basis of the financial report;
Judgements about materiality are made in light of surrounding circumstances, and are
affected by the size or nature of a misstatement, or a combination of both; and
Judgements about matters that are material to users of the financial report are based
on a consideration of the common financial information needs of users as a group.

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The possible effect of misstatements on specific individual users, whose needs may
vary widely, is not considered. (ASA320)
In applying this definition, the auditor is required to consider both:
the circumstances pertaining to the entity; and
the information needs of those who will rely on the audited financial report;
when:
(a) Identifying and assessing the risks of material misstatement;
(b) Determining the nature, timing and extent of further audit procedures; and
(c) Evaluating the effect of uncorrected misstatements, if any, on the financial report and in
forming the opinion in the auditors report. (ASA320)
10.13 List and describe the financial statement assertions in relation to
account balances.
Existence that all items include in the balances actually exist
Completeness the financial report includes all balances that exist at the period end
Valuation and allocation amounts in the financial report are correctly valued
Rights and obligations assets included in the financial report represent rights to future
economic benefits for the company and liabilities represent unavoidable future outflows
arising from events that occurred before the period end.
10.14 What is the significance of materiality in relation to the auditors
objectives when obtaining audit evidence?
In assessing the quantitative importance of a misstatement, it is necessary to relate the dollar
amount of the error to the financial report. In planning the audit the auditor generally is
concerned only with misstatements that are quantitatively material; when evaluating audit
evidence the auditor must consider both quantitative and qualitative misstatements.
The following apply in assessing the quantitative importance of a misstatement:
As a general rule, when an amount is equal to or greater than 10% of profit, it is
presumed to be material.
An amount that is equal to or less than 5% of profit may be presumed to not be
material.
For an amount between 5% and 10%, materiality is a matter of judgement.
There are further considerations that refine the above general rules and these are detailed in
AASB 1031.

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10.15 Describe the two main alternative audit strategies that may be
adopted in performing an audit.
ASA 330 describes requirements for auditors to follow in addressing risks identified. The two
main alternative audit strategies are a predominantly substantive approach and a lower
assessed level of control risk approach. A predominantly substantive approach is one where
the majority of audit evidence is obtained by substantive audit procedures that provide direct
evidence as to the fairness of managements financial statement assertions. A lower assessed
level of control risk approach is one that relies on internal controls to support the use of a
reduced level of substantive procedures. This approach requires that the auditor tests internal
controls to verify that control procedures are actually operating as laid down.
10.16 What is the difference between how the auditor uses materiality at
the planning stage and at the final review stage of the audit?
At the planning stage the main focus is to ensure an efficient and effective audit and ensure
that audit attention is devoted to appropriate areas. The auditor will carry out a preliminary
assessment of the risks and establish a level of materiality which will determine the nature,
timing and extent of audit procedures. The level of materiality is a matter of judgement and
may change as the audit progresses.
At the final review stage the auditor will be focussed on specific misstatements that may have
been found during the audit and the extent to which uncorrected errors are material. Where
material errors remain in the financial report the auditor will request that management make
the necessary amendments, if management refuse to change the financial report the auditor
will need to modify the audit opinion. If the misstatements are immaterial then the auditor
will not need to amend the audit opinion.
10.18 What is the difference between a test of control and a substantive
test?
A test of control tests the effectiveness of the internal controls in preventing, detecting and
correcting errors. The auditor must test internal controls before placing reliance on them in
support of the audit opinion. Effective internal controls can reduce the amount of substantive
testing that the auditor needs to perform.
Substantive tests aim to obtain direct evidence about transactions and balances in the
financial report by testing the financial statement assertions. Tests include tests of detail of
transactions and balances and analytical procedures.
10.19 What are the factors that affect the reliability of evidence?

Evidence obtained from an independent source is more reliable than internally

generated evidence
Internally generated evidence is more reliable when internal controls are effective
Evidence obtained directly by the auditor is more reliable than indirect evidence
sourced from the entity
Documentary evidence is more reliable than oral representations

Original documents are more reliable than copies.

10.21 Audit evidence

Corroboratory evidence inspected by an auditor in the course of an audit includes:
1. a letter from a customer directly to the auditor confirming consignment stock held at the
year-end
2. a supplier invoice taken from the companys files
3. a schedule for the calculation of the warranty provision obtained from the companys
files
4. delivery notes, sent with goods, receipted by customers, and held in the companys office
5. a contract for the lease of premises signed by one of the directors and the landlord
6. a goods delivery note signed by the warehouse supervisor to indicate goods were
received
7. inventory count sheets recording inventory held at the year-end
8. a note on the asset register that the life of a piece of equipment is 10 years.
Required
For each item comment on its reliability and relevance as audit evidence.
o Highly reliable and relevant. From a knowledgeable third party, in writing and
received directly by the auditor.
o Somewhat reliable and relevant. From a knowledgeable third party and in writing but
obtained from the client who may have altered the document.
o Low reliability but very relevant in terms of its validity for liabilities. In writing but
prepared by and obtained from the client.
o Reliable and highly relevant to show goods sold. Prepared by and held by the client
but authenticated by a knowledgeable third party in writing.
o Reliable and relevant showing the property lease costs and lease commitments. Legal
document properly signed.
o Reliable and relevant in support of the internal controls being carried out. Third party
document and signed by suitably senior member of staff.
o Somewhat reliable and relevant, showing the quantity of inventory held but not its
value. Prepared and held by the client, its reliability will be determined by the quality of
the inventory count procedures.
o Not very reliable but relevant to the calculation of depreciation. In order for the
information to be more reliable it would need to be checked to some other supporting
information, such as lives of similar assets, a comparison to the companys asset
replacement policy or a review of the age of similar equipment that has been disposed of
in the past.