Principles of External Auditing

Brenda Porter is Head of School of Accounting and Law at Victoria University, Wellington New Zealand.Jon Simon is Lecturer in Accounting & Finance at the University of Hull Business School.David Hatherly is Professor of Accounting at the University of Edinburgh Management School.

• About the Authors xi Preface xiiiStructure of the Financial Reporting Council xviiGlossary of Terms xix1 What is Auditing? 11.1 Introduction 11.2 What is an audit? 21.3 Types of audit 31.4 Auditing vs Accounting 81.5 Why are external fi nancial statement audits needed? 81.6 Benefi ts derived from external fi nancial statement audits 111.7 Summary 18Self-review questions 18References 19Additional reading 202 The Development of Auditing and Its Objectives 232.1 Introduction 232.2 Overview of the development of company auditing 232.3 Development of auditing in the period up to 1844 262.4 Development of company auditing 1844–1920s 272.5 Development of company auditing 1920s–1960s 322.6 Development of company auditing 1960s–1990s 362.7 Development of company auditing 1990s–present 392.8 Summary 51Self-review questions 52References 53Additional reading 553 A Framework of Auditing Concepts 573.1 Introduction 573.2 Social purpose, postulates and framework for concepts of auditing 593.3 Concepts relating to the credibility of auditors’ work 603.4 Concepts relating to the audit process 703.5 Concept relating to auditors’ communication: reporting 863.6 Concepts relating to the standard of auditors’ performance 903.7 Summary 94Self-review questions 95References 95Additional reading 984 Threats to, and Safeguarding of, Auditors’ Independence 994.1 Introduction 994.2 Threats to auditors’ independence 1004.3 Steps taken by parliament and regulators to safeguard auditors’ independence 1044.4 Other proposals to strengthen auditors’ independence 1404.5 Role and responsibilities of audit committees 1434.6 Summary 151Self-review questions 152References 153Additional reading 1575 Auditors’ Legal, Regulatory and Professional Responsibilities 1615.1 Introduction 1615.2 Reporting and auditing requirements of companies 1655.3 Appointment, remuneration and removal of company auditors 1815.4 Auditor–client relationship 1895.5 Auditors’ duties and rights 1915.6 Audit fi rms’ transparency reports and governance code 2075.7 Summary 211Self-review questions 212References 213Additional reading 2166 Auditors’ Duties with Respect to Fraud and Non-compliance with Laws and Regulations 2176.1 Introduction 2176.2 Defi nition of fraud 2186.3 Development of auditors’ responsibility to detect and report fraud 2206.4 Auditors’ current responsibilities to detect and report fraud 2296.5 Aggressive earnings management 2416.6 Auditors’ responsibility to detect and report non-compliance with laws and regulations 2426.7 Auditors’ duty of confi dentiality to their clients 2506.8 Summary 253Self-review questions 254References 255Additional reading 257Appendix: Examples of fraud risk factors 2587 Overview of the Audit Process, Audit Evidence, Staffing and Documenting an Audit 2617.1 Introduction 2617.2 Overview of the audit process 2627.3 Clarification of some jargon 2657.4 Audit evidence 2717.5 Staffi ng an audit 2777.6 Documenting an audit 2897.7 Summary 306Self-review questions 307References 309Additional reading 3108 Commencing an Audit: Engagement Procedures, Understanding the Client and Identifying Risks 3118.1 Introduction 3118.2 Pre-engagement investigation 3128.3 Audit engagement letters 3208.4 Understanding the client, its business and its industry and how it evaluates its performance 3258.5 Identifying and assessing risks of material misstatement in the financial statements 3328.6 Analytical procedures 3368.7 Summary 340Self-review questions 341References 342Additional reading 3429 Planning the Audit; Materiality and Audit Risk 3459.1 Introduction 3459.2 Phases of planning an audit 3469.3 Impact of materiality on planning an audit 3509.4 Desired level of audit risk (desired level of assurance) 3629.5 Impact of audit risk on planning the audit 3669.6 Summary 375Self-review questions 377References 377Additional reading 37810 Internal Control and the External Audit 38110.1 Introduction 38110.2 The accounting system 38210.3 Conceptual aspects of internal control 38510.4 Reviewing the accounting system and evaluating its internal controls 40210.5 Developing the audit plan 41110.6 Compliance testing 41510.7 Reporting internal control deficiencies to management 41910.8 Summary 420Self-review questions 421References 422Additional reading 42311 Testing Financial Statement Assertions: Substantive Testing 42511.1 Introduction 42511.2 Significance of substantive testing in the audit process 42611.3 Objectives of, and approaches to, substantive testing 42811.4 Substantive audit procedures 43311.5 Requirements of auditors when misstatements are detected 44111.6 Introduction to substantive testing of inventory and accounts receivable 44311.7 Signifi cant aspects of auditing inventory 44411.8 Signifi cant aspects of auditing accounts receivable 45211.9 Initial engagements 46211.10 Summary 463Self-review questions 463References 464Additional reading 46512 Audit Sampling and Computer Assisted Auditing Techniques (CAATs) 46712.1 Introduction 46712.2 Meaning and importance of sampling in auditing 46812.3 Basic terminology relating to sampling 47012.4 Judgmental sampling vs statistical sampling and sampling methods 47212.5 Designing and selecting samples 47412.6 Judgmental sampling 48112.7 Statistical sampling of attributes and variables, and pps sampling 48212.8 Following up sample results 49012.9 Computer assisted audit techniques 49112.10 Summary 495Self-review questions 496References 497Additional reading 49713 Completion and Review 49913.1 Introduction 49913.2 Review for contingent liabilities and commitments 50113.3 Review for subsequent events 50313.4 (re)Assessment of the going concern assumption 50813.5 Written representations 52013.6 Final review of the fi nancial statements 52713.7 Evaluation of audit evidence gathered and formation of the audit opinion 53013.8 Review of unaudited information 53313.9 Final conference 53713.10 Summary 537Self-review questions 538References 539Additional reading 54014 Auditors’ Reports to Users of Financial Statements and to Management 54314.1 Introduction 54314.2 Auditors’ reporting obligations under the companies act 2006 54414.3 Format and content of audit reports 54914.4 Types of audit opinion 56414.5 Different forms of modifi ed audit opinion 56614.6 Emphasis of matter and other matter paragraphs 57614.7 The audit report – the auditor’s chance to communicate 58014.8 Auditors’ communication with those charged with governance 59014.9 Summary 603Self-review questions 604References 605Additional reading 60915 Legal Liability of Auditors 61115.1 Introduction 61115.2 Overview of auditors’ legal liability 61215.3 Auditors’ contractual liability to their clients 61515.4 Liability to third parties under the common law 62215.5 The effect of out-of-court settlements 66115.6 Summary 663Self-review questions 663References 664Additional reading 666Appendix 1 667Appendix 2 66916 Avoiding and Limiting Auditors’ Liability 67316.1 Introduction 67316.2 Importance of, and responsibility for, quality control of audits 67516.3 The profession’s measures to secure high quality audits 67616.4 Regulators’ measures for securing high quality audits 68916.5 Proposals for limiting auditors’ liability 70816.6 Summary 720Self-review questions 721References 722Additional reading 72517 Corporate Responsibility Reporting and Assurance 72717.1 Introduction 72717.2 Development of corporate responsibility reporting 72917.3 Why do companies publish corporate responsibility reports? 73317.4 Corporate responsibility reporting guidelines 74317.5 Corporate responsibility assurance engagements 74617.6 Why do some companies have their corporate responsibility reports independently assured while others do not? 76317.7 Relevance of corporate responsibility issues to external financial statement audits 76617.8 Summary 772Self-review questions 773References 774Additional reading 777Appendix: Brief descriptions of ‘responsible investment’ indices 77718 The Audit Expectation-Performance Gap and Proposals for Reforming the External Audit Function 78318.1 Introduction 78318.2 The audit expectation-performance gap 78418.3 Overview of proposed reforms following the global financial crisis 79818.4 Enhancing auditors’ reporting responsibilities 79918.5 Audit market concentration and strengthening auditors’ independence 81618.6 Emergence of competition from china 83718.7 Inherent conflicts in the current audit model 83918.8 Summary 841Self-review questions 842References 843Additional reading 849Index 851