Overview

Module 1 presented you with the “big picture” – the legal and professional context in which the audit process takes place, the significance of independence, quality control and legal liability to ensure that the auditor exercises due skill and care in the conduct of their audit engagement and different types of audit opinions that can be expressed. Now it is time to begin learning about the audit process by identifying the different phases of an audit, significance of the audit evidence, process used by the auditor to test assertions that management make in the financial reports being audited and sampling and overview of the risk response phase of the audit.

Remember, and this is a very individual choice, if you have not already done so, to think about the value you might derive from taking some time to review some of the contributions for Task 1(a) as a way to see examples or illustrations of some of the principles and terminology you learned in Module 1 and even what you may cover in Module 2. It is a valuable resource to access if you want to. This will extend to the DF contributions for Task 2 as well for thinking about why risk assessment varies so much across different audit clients. The point of asking each of you to share your work for these assessment tasks on the DF is so that resources YOU create are usable & available for learning.

This second module focuses on the first of the 3 main phases of the auditing process – Risk assessment. Have a quick look at Figure 3.1 in your text and try the following ordering activity to make sure you are aware of what the 3 main phases are called:

This risk assessment phase (ASA 315) considers the risks that each client carries for you as the auditor. These risks are identified and evaluated so you can tailor your audit strategy to minimise those risks (ASA 300). This entails your taking a lot of care to understand your client – the way they conduct and organise their business, the industry and economic environment in which they operate. You will learn about fraud (ASA 240) and going concern (ASA 570) risk factors to be on the lookout for as you learn about the client’s corporate governance and information technology structures. You will learn how these risks are incorporated into the audit risk model to help you determine the most important areas to focus your audit effort (these important areas are based on your professional judgement about what is “material” – ASA 320). You will build on the financial statement analysis skills and knowledge (ASA 520) you bring from pre-requisite units. You will be introduced to the range of procedures auditors use, types of evidence gathered (ASA 500) and how they document this work in their work papers (ASA 230). It is important to understand that the persuasiveness of the evidence varies and it will be considered in its totality to support any conclusions reached. The auditor tests assertions that management make in the reports being audited and may require assistance from experts (ASA 620) and other auditors (ASA 600, 610). You will further review prior accounting knowledge as you are introduced to tests of controls and tests of transactions and balances so that the concepts of sampling can be introduced (ASA 530). Since it is not necessary to test everything to provide reasonable assurance, it is important to understand the sampling principles that ensure the right type and quantity of evidence is obtained to support the conclusions and opinion that you finally express. The response to these risks (ASA 300, 330) involves the execution (performing) of various tests (procedures) to gather evidence and determination of your opinion to be expressed (ASA 700) will be covered in Modules 3 and 4.

Diagrammatic View of the Unit

You will find a copy of this diagram at the beginning of each chapter of your text. The relevant section of the diagram being covered in that chapter will be shown. You might find it a useful study aide to annotate the diagram with the relevant modules, readings and Lakeside cases that are applicable. This should provide a fairly complete roadmap for you of the material you need to cover to put you in the best position to attempt the activities designed to develop your application of the knowledge – it is this ability to apply what you have learned that be the focus of your final examination. This will only be used and highlighted for each Module – see Figure 1.1 in Module 1 Overview.

Chapter 3: Risk assessment I

Background readings

Bibliographic detail for each reading is provided below. Remember that making the effort to read each reference will improve your ability to understand and apply the principles and activities that follow.

Both these readings allow you to reflect on how the decision to take on a new client (client acceptance) and reasons that lead to negligence actions against auditors provides the initial information that feeds into your risk assessment for that client – a nice bridge between Modules 1 and 2.

Text reading

Here is a VERY brief overview which in no way intends to be a substitute for making your own summary/notes. My recommendation is that you makes notes for each chapter objective, compare yours to those at the end of each chapter, including key terms that you should be making notes about and any standards that are referred to. This is the technical auditing language you need to develop an understanding of auditing. You are encouraged to develop and use your own glossary to compare with the one in the text and your Auditing and Assurance Handbook.

So at this point you are moving from the lessons learned, set out in the background readings which you will later apply in the Lakeside case, to illustrate how those lessons can be implemented using the principles and standards that the profession has in place to guard against due skill and care not being exercised in the performance of audit and assurance services. You may even find it beneficial to read through each of the CLOUD 9 case boxes in the relevant chapters for each Module BEFORE you read through the text chapter in detail … this will expose you to similar issues for another audit client that are explored and presented in your Text (to compare and contrast with the Lakeside Company case study).

As you read each chapter from your text you will be invited to complete a series of activities (questions) to reinforce your ability to apply the material you have been learning about auditing. The idea is, once again, to encourage you to see how the various resources (readings, case, text and standards) you are being asked to use are inter-related and not a series of discrete items to be learned individually.

Text reading

In plainest language, this chapter is about what to look out for as an auditor as you develop your understanding of an audit client in order to make an assessment of how risky the client is to your business as an auditor. In short, how risky is this client to your audit firm?

More so than for Module 1, it is now very important to realise that the detail in your text is contained in your Handbook … get into the habit of recognising this and learning how to use the Handbook you have. This will avoid that sense of needing to memorise things. Each time you see a reference to an ASA, be sure to make a note to follow-up and see what is in that standard (ASA).

This first part of Module 2 covers the risk assessment stage (ASA 300, 315) where an auditor will gain an understanding of their client, evaluate risks, determine an audit strategy and set their planning materiality (ASA 320). Gaining an understanding of your client involves consideration of issues at the broader economic level, the industry level and entity level (operations) (ASA 315). You should find Figures 3.1 and 3.2 very useful overviews of what the Chapter covers. I also expect that you will recognise quite a few risk factors from the background readings you were asked to review in Module 1 … again, think about how your evidence, your knowledge of a client accumulates as your audit work continues. You need to reach a point where your professional judgement is satisfied you have enough (sufficient) of the the right kind (appropriate) of evidence to support your audit opinion.

You will learn about factors that indicate concerns about the potential and existence of fraud (ASA 240), the client’s ability to continue as a going concern (ASA 570) and the extent to which they have corporate governance mechanisms in place to guard against and cover these risks. Part of this is to assess the extent to which the client is reliant on information technology and the care they take within their accounting processing system, especially in relation to closing entries to guard against the temptation to manage earnings results.

Have a look at ASA 570, paragraphs 2-7 and read them carefully (including the footnotes). Then try the following activity which will also reinforce your improving ability to read and link information in the standards to other resources you are being asked to use:

Questions and Activities (Text Chapter 3)

Remember, if you wish to review your comprehension of the content you should feel free to attempt the:

• Multiple Choice Questions, and
• Review Questions presented for each Chapter.

You will find suggested answers to Multiple Choice Questions as you attempt them embedded in your e-text (3rd Edition). You will NOT find suggested answers to the Review Questions provided BECAUSE I expect that you are capable of locating the relevant material in the Chapter … the questions are in the same sequence as the objectives and sections of the Chapter.

You should NOT expect Multiple Choice or Review style questions in your Final Examination – the style of questions will be based on those set out below that are designed to develop your skills at applying the content you have been learning.

You are provided with suggested feedback for each of these questions. Remember it is very important that you attempt to develop an answer for yourself BEFORE you check the suggestion – otherwise you will NOT learn to apply your knowledge. A direct link is provided for the suggested answers. A new window will open for your use; alternatively, there is a word version of all feedback for each Module.

Text Chapter 3: PAQ 3.26

Text Chapter 3: PAQ 3.32

Text Chapter 3: PAQ 3.37

Text Chapter 3: PAQ 3.38

Remember, if you have any questions about the content or the suggested you should come along to one of the scheduled live online support sessions or ask on the Module 2 discussion forum. Always try and be as specific as possible about what is not clear to you so that replies can be most immediately helpful; and you are encouraged to help (answer) each other and not rely solely on staff responding. This is good practice to develop your own understanding.

Chapter 4: Risk assessment II

Background readings

This reading allows you to reflect on how professional judgment is necessary throughout the audit process because VERY LITTLE has specific directives that must be followed … there are MANY choices that need to be made about what needs to be done and how it needs to be done based on the business environment and characteristics unique to each of your clients. This was what you learned about from the decision to take on a new client (client acceptance) and the initial information that feeds into your risk assessment for that client – strengthening that bridge between Modules 1 and 2.

Text reading

Remember, as you read each chapter from your text you will be invited to complete a series of activities (questions) to reinforce your ability to apply the material you have been learning about auditing. The idea is, once again, to encourage you to see how the various resources (readings, case, text and standards) you are being asked to use are inter-related and not a series of discrete items to be learned individually.

In this chapter you discover two new and very important audit terms: audit risk and materiality. In Chapter 3 you learned about what to be on the lookout for; in this Chapter you learn about using what you found out about your client. More specifically, the Chapter exposes you to how to use all the information (this becomes, and is evaluated as evidence) you have been collecting during the engagement acceptance process (ASA 210) and coming to a sound understanding of your client’s business (ASA 315). Specifically you learn how to use the information you have been diligently documenting (ASA 230) to minimise audit risk (ASA 315). This is the risk that an auditor expresses an inappropriate audit opinion when a financial report is materially misstated. Equally, you learn how the information informs your assessment of the three components of audit risk – inherent risk, control risk and detection risk. The combined assessment of inherent and control risk is called the risk of material misstatement, a crucial component of your risk assessment.

I want to encourage you to pay particular attention to Figures 4.1 through to 4.4 because you will build on these in later chapters as your knowledge of the audit process grows. I also want to point out a way to make these Figures more accurate and clear … it is a simple task to highlight your comprehension of what you are reading and we will be sure to talk about it in support sessions. I will use Figure 4.1 as an example.

When you read the description for Figure 4.1 (not the diagram, but the text description) pay special attention to what level of audit risk that is being set for a high risk client. When you have identified the level of audit risk that is set for a high risk client, I encourage you to annotate the (blank) Audit Risk box on the Figure with that level. It is very important to get this definition of audit risk clear in your mind … it is NOT the ordinary meaning/understanding that you attach to “risk” :).

Try this matching activity to see how you go … BUT remember to be guided by the definition of audit risk, NOT trying to memorise this activity!

Next you will develop your understanding of which information is material, and why (ASA 320). Information is material if it impacts the decision-making process of users of the financial report. Evaluating audit risk and materiality together enables you to determine the most appropriate audit strategy to adopt (ASA 300, 330). This is your risk assessment taking shape to indicate the scope, timing and direction of the audit. Evaluating the results of your risk assessment procedures effectively helps you focus the nature, timing and extent to which you will gather remaining evidence from testing controls and/or substantive procedures (ASA 330). You will also learn about a variety of analytical procedures that underpin a range of information that is crucial to your risk assessment for a client (ASA 315).

Questions and Activities (Text Chapter 4)

Remember, if you wish to review your comprehension of the content you should feel free to attempt the:

• Multiple Choice Questions, and
• Review Questions presented for each Chapter.

It remains very important that you attempt to develop an answer for yourself BEFORE you check the suggestion – otherwise you will NOT learn to apply your knowledge. A direct link is provided for the suggested answers. A new window will open for your use; alternatively, there will be a word version of all feedback for each Module.

Text Chapter 4: PAQ 4.33

Text Chapter 4: PAQ 4.36

Text Chapter 4: PAQ 4.37

Remember, if you have any questions about the content or the suggested you should come along to one of the scheduled live online support sessions or ask on the Module 2 discussion forum. Always try and be as specific as possible about what is not clear to you so that replies can be most immediately helpful; and you are encouraged to help (answer) each other and not rely solely on staff responding. This is good practice to develop your own understanding.

The Lakeside Company case

Just a quick reminder that the objective of you reading any Lakeside cases prescribed is to develop a sense of how a public accounting firm positions itself, professionally and ethically, to ensure it conducts an audit engagement with due skill and care for each audit client.

As you continue learning about your new audit client be mindful that you are building on what you have already found out (learned) about Lakeside … you are accumulating your sufficient and appropriate audit evidence and continuing to see how that is documented in your audit working paper files. These “new” terms: sufficient, appropriate, evidence, documentation, working papers will mean a lot more once you study Chapter 5 and explore exhibits in other Lakeside cases you will be directed to at that point. For now, just appreciate they are audit terms you will learn more about – of course, if you are keen, use your Glossary (text or Handbook) to check their meaning.

Case 3: Audit Risk and Analytical Procedures (4 pages)

In this Case you will get to know how A&C build on and use the background information collected during their client acceptance decision (Cases 1 and 2) to undertake the preliminary risk assessment phase of the audit process. Now that you have accepted Lakeside as a new client, try to think about how you are now using the greater access you have been given to the previous auditor, client records and client staff and premises to corroborate what you have been told by various parties in earlier cases. Accordingly, do not be afraid to review any of the earlier Cases, especially 1 and 2. Also think about how some of the issues raised in your Background Readings are being illustrated by the case as well.

An important feature of Case 3 is the extensive range of Exhibits (3.1–3.8) provided to support your risk assessment. The important thing to be aware of at this point is that you are being exposed to some of the ways an auditor documents their work. Another way to think about this is the way an auditor records the different ways they go about gathering their audit evidence. The following matching activity will provide some examples for you to review. This is something of a preview for what is coming in Chapter 5 of your text.

You will also find this Case provides you with an excellent and substantial opportunity to put into practice the financial statement analysis skills you have learned from earlier units studied (you may be more familiar with the term financial ratio analysis … another example of how terminology is adapted as it moves around disciplines and sub-disciplines). The data provided is much more extensive than you are probably used to so it offers excellent development potential for those skills. It is very important (in auditing, this financial statement analysis is an important part of analytical procedures used for risk assessment as per ASA 315) you remain cognisant of the reason for doing the analysis … you are using the numbers/ratios to corroborate what you have found out from various managers and other sources of information during your inquiries and investigations set out in Cases 1-3. Do the numbers make sense in the context of what you know about your client and the industry in which they are operating? Calculating the numbers and ratios means very little without this application. Case 3 Exercise 1 that you are asked to attempt below is especially pertinent to these comments – it will take a while BUT is worth the investment.

Questions and Activities (Lakeside)

It is recommended that you follow the sequence of questions presented. You are being encouraged to explore how the various resources (readings, case, text and standards) you are being asked to use are interrelated and not a series of discrete items to be learned individually.

Lakeside Case 2: Ex 2

Lakeside Case 3: DQ 9

Lakeside Case 1 DQ 3

Lakeside Case 1: Ex 1(a)

Hint: you need to be using the relevant ASA to frame your response here (ASA 240) – there is no need to locate the US standard referred to in the question.

Lakeside Case 3: DQs 3

Lakeside Case 3: DQs 8

Lakeside Case 4: DQ 1

Hint: make sure you use ASA315 which is the Australian equivalent of SAS109

Lakeside Case 5: DQ 6

Lakeside Case 2: DQ 1

Hint: make sure you use ASA320 which is the Australian equivalent of SAS107

Lakeside Case 3: Ex 1

Remember, if you have any questions about the content or the suggested answers you should come along to one of the scheduled live online support sessions or ask on the Module 2 discussion forum. Always try and be as specific as possible about what is not clear to you so that replies can be most immediately helpful; and you are encouraged to help (answer) each other and not rely solely on staff responding. This is good practice to develop your own understanding.

Chapter 5: Audit Evidence

Background readings

There are none for this part of the Module!!

Text reading

Remember, after you read each chapter from your text you will be invited to complete a series of activities (questions) to reinforce your ability to apply the material you have been learning about auditing. The idea is, once again, to encourage you to see how the various resources (readings, case, text and standards) you are being asked to use are inter-related and not a series of discrete items to be learned individually.

In this Chapter you are introduced to the technical auditing terms for procedures you have used in obtaining an understanding of a client’s business and industry and during the risk assessment phase to obtain a variety of evidence to support the opinion they will express. In other words, the technical auditing terminology for audit work you have already been carrying out. In addition, the technical auditing terms for procedures used to gather evidence during the risk response phase of the audit process that is explored in Module 3 are introduced – I point this out so you realise that you have opportunities as the unit progresses to use and learn more about these terms if they seem unclear first time they are introduced to you … be patient and persevere! The timing, nature and extent to which you use procedures to gather particular types of audit evidence, and your ability to use experts and auditors from firms other than your own, are also studied. Specific examples illustrating some of these procedures and types of evidence for the Lakeside Company will be presented later in the Module, and again throughout Module 3.

Questions and Activities (Text Chapter 5)

Remember, if you wish to review your comprehension of the content you should feel free to attempt the:

• Multiple Choice Questions, and
• Review Questions presented for each Chapter.

You are provided with suggested feedback for each of these questions. It is very important that you attempt to develop an answer for yourself BEFORE you check the suggestion – otherwise you will NOT learn to apply your knowledge. A direct link is provided for the suggested answers. A new window will open for your use; alternatively, there will be a word version of all feedback for each Module.

Text Chapter 5: PAQ 5.36

Text Chapter 5: PAQ 5.26

Text Chapter 5: PAQ 5.28

Text Chapter 5: PAQ 5.35

Text Chapter 5: PAQ 5.38

Text Chapter 5: PAQ 5.39

Remember, if you have any questions about the content or the suggested you should come along to one of the scheduled live online support sessions or ask on the Module 2 discussion forum. Always try and be as specific as possible about what is not clear to you so that replies can be most immediately helpful; and you are encouraged to help (answer) each other and not rely solely on staff responding. This is good practice to develop your own understanding.

Chapter 7: Sampling and Overview of the Risk Response Phase

Background readings

As you can see, more practice for you at developing those research skills … this should NOT be onerous for you at this stage of the unit, let alone your degree. There are also some hints available in earlier lessons.

Readings 2.3 – 2.5 provide a glimpse of the impact of sampling methods on the audit process. They are intended to reinforce the key role of professional judgement in the various risk evaluations and assessments you have already learned in Module 1 and Module 2 have on the audit strategy. Think carefully about how important it is to have evidence that supports “reasonable” but not absolute assurance and the consequences of not being able to document your reasons properly (due skill and care) as you read these … remember, things are NEVER as simple and as straightforward as they appear in your text! While it may seem these articles are “old”, the principles covered are long standing ones.

Remember, after you read each chapter from your text you will be invited to complete a series of activities (questions) to reinforce your ability to apply the material you have been learning about auditing. The idea is, once again, to encourage you to see how the various resources (readings, case, text and standards) you are being asked to use are inter-related and not a series of discrete items to be learned individually.

In this Chapter you learn the principles behind being able to select appropriate items for testing. You will learn how to select a sample that is representative of the entire population of items available for testing and how to consider sampling and non-sampling risk when evaluating the results of applying procedures to your sample (ASA 500, 530). You should be able to distinguish between various statistical and non-statistical sampling methods that are available to auditors. You will also learn about the range of factors that need to be considered in determining sample size for both tests of controls and substantive procedures.

The differences between tests of controls (to assess the effectiveness of the operation of a client’s internal controls across the accounting period being audited) and substantive testing (to gather direct evidence that the financial report is free from material misstatement) is explained. You should be sure that this explanation allows you to understand the significance and meaning of the nature, timing and extent of audit testing for each category of testing. More detailed exploration of how these types of procedures are applied is presented during Module 3.

The final part of Chapter 7 takes you through the principles of documentation, or working papers (ASA 230), on which you record the evidence your procedures generate. This is important because you have been and will be asked to prepare working papers throughout activities in this unit. One thing you will find challenging is that despite common features being identified, it is very unusual for any two working papers to have the same format. You will only come to appreciate this if you complete the prescribed activities. Specific examples will be further illustrated throughout Lakeside Company cases.

Questions and Activities (Text Chapter 7)

Remember, if you wish to review your comprehension of the content you should feel free to attempt the:

• Multiple Choice Questions, and
• Review Questions presented for each Chapter.

You are provided with suggested feedback for each of these questions. It is very important that you attempt to develop an answer for yourself BEFORE you check the suggestion – otherwise you will NOT learn to apply your knowledge. A direct link is provided for the suggested answers. A new window will open for your use; alternatively, there is a word version of all feedback for each Module.

Text Chapter 7: PAQ 7.28

Text Chapter 7: PAQ 7.29

Text Chapter 7: PAQ 7.31

Text Chapter 7: PAQ 7.32

Text Chapter 7: PAQ 7.36

Text Chapter 7: PAQ 7.37

NOT COMPULSORY (OPTIONAL)

But worth a quick look … if you want to “see” sampling in action and think about the terminology you have just been reading about, make the time to quickly read through Cases 10 and 11 of Lakeside. There is no need to be doing any activities, but see how you go appreciating the way the terminology is applied in the case study. Case 10 is an example of testing internal controls (one method called Attribute Sampling … an “attribute” being a feature of the control being tested – for example, seeing an authorisation signature on a document); Case 11 is about substantive testing and is a type of variables sampling called Estimation Sampling. It is used when you want to estimate and account balance within some reasonable bounds. Of course, reading these Cases might also bring back some memories of when you did Statistical Analysis.

Remember, if you have any questions about the content or the suggested you should come along to one of the scheduled live online support sessions or ask on the Module 2 discussion forum. Always try and be as specific as possible about what is not clear to you so that replies can be most immediately helpful; and you are encouraged to help (answer) each other and not rely solely on staff responding. This is good practice to develop your own understanding.

The Lakeside Company case (evidence)

Just a quick reminder that the objective of you reading any Lakeside cases prescribed is to develop a sense of how a public accounting firm positions itself, professionally and ethically, to ensure it conducts an audit engagement with due skill and care for each audit client.

To that end what we need you to do in this final lesson of Module 2 is explore many of the exhibits in Lakeside and try to identify what types of audit procedures and what types of audit evidence they might be illustrating. This will include illustrations of how various working papers document what evidence the auditor is gathering by following their audit programs developed once their strategy is settled.

So have a go at the following Activities and see how you go … all that is required is to refer to the specified Exhibits or pages in Lakeside and see if you can apply what you have been learning (no reading, just looking and thinking ;). You will be reminded of many of these as you move through Module 3.

Time Check?

Now that you have reached a very significant learning milestone, do be sure to check how you feel you are going managing your time in the context of the suggested time frames for working through the Modules? This is your halfway point (or should be … depending a little on how you feel you need to use your Study week (break). Just remember it is important to bear in mind this is NOT a subject that lends itself to cramming for the exam - there is FAR TOO MUCH to cover and draw together.