- 20 Marks
AA – L2 – Q2 – The Role and Responsibilities of Auditors
Question
The purpose of an external audit and its role are not well understood. You have been asked to write some material for inclusion of your firm’s training materials dealing with these issues in the audit of large companies.
Required:
(a) Draft an explanation dealing with the purpose of an external audit and its role in the audit of large companies, for the inclusion in your firm’s training materials.
(b) The external audit process for the audit of large entities generally involves two or more recognizable stages. One stage involves understanding the business and risk assessment, determining the response to assessed risk, testing of controls as the interim audit. Another stage involves further tests of controls and substantive procedures and audit finalisation procedures. This stage is sometimes known as the final audit.
Describe and explain the main audit procedures and processes that take place during the interim and final audit of a large entity.
Answer
(a) . (i) The external audit has a long history that derives largely from the separation of the ownership and management of assets. Those who own assets wish to ensure that those to whom they have entrusted control are using those assets wisely. This is known as the ‘stewardship’ function.
(ii) The requirement for an independent audit helps to ensure that financial statements are free of bias and manipulation for the benefit of users of financial information.
(iii) Companies are owned by shareholders but they are managed by directors (in very small companies, owners and managers are the same, but many such companies are not subject to statutory audit requirements).
(iv) The requirement for a statutory audit is a public interest issue: the public is invited to invest in enterprises, it is in the interests of the capital markets (and society as a whole) that those investing do so in the knowledge that they will be provided with ‘true and fair’ information about the enterprise. This should result in the efficient allocation of capital as investors are able to make rational decisions on the basis of transparent financial information.
(v) The requirement for an audit can help prevent investors from being defrauded, although there is no guarantee of this because the external audit has inherent limitations. Reducing the possibility of false information being provided by managers to owners is achieved by the requirement for external auditors to be independent of the managers upon whose financial statements they are reporting.
(vi) The purpose of the external audit under International Standards on Auditing is for the auditor to obtain sufficient appropriate audit evidence on which to base the audit opinion. This opinion is to the effect that the financial statements give a ‘true and fair view’ (or ‘present fairly in all material respects’) of the position, performance (and cash flows) of the entity. This opinion is prepared for the benefit of shareholders.
(b). (i) The interim audit generally involves risk assessment, the testing of internal controls, and certain analytical and other substantive procedures. Many of these procedures are often performed concurrently.
(ii) Risk assessment involves gathering information about the business, inquiries, analytical procedures and determining the response to assessed risk. In practice it also involves the determination of materiality and performance materiality.
(iii) Risk assessment also involves evaluating the design of internal controls and determining whether they have been implemented.
(iv) Final audit procedures also involve a review of the financial statements as a whole to ensure that they are internally consistent, and in accordance with the relevant financial reporting framework and the auditor’s knowledge of the business.
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