Please answer this assignment, it has got some questions of Auditing. It has got 4 questions relating to audting Tests of controls, tests of trascations and balances, and internal controls.

Question 1 (6 marks) Content assessed: Topic 5 You are the auditor of Medicorp Ltd (Medicorp). Medicorp is a public company listed on the Australian Securities Exchange. It started as a small company conducting medical research, and now has some patented products that it produces and sells to hospitals, mainly in New South Wales. Because of the runaway success of its most recent product - a drug that is effective against avian flu - Medicorp has moved some of its production to China in order to cut costs and sell more easily into its growing Asian markets. Medicorp has an audit committee, composed of a majority of non-executive directors, which meets four times a year. Day-to-day running of the company is still very much in the hands of its original founders, who met while doing postgraduate research at a leading medical school. As part of their remuneration, the key management personnel are given options in the company which can be exercised if certain criteria relating to the company's performance are met. You are now auditing the fixed assets system for the Australian operation of Medicorp. The company maintains a computerised asset register administered by each division. You have held a discussion with Medicorp staff and noted the following procedures. 1. To obtain a new asset, a purchase requisition is prepared by the divisional manager. 2. The requisition is sent to head office where it is checked by the purchasing officer and a purchase order prepared. 3. Assets less than $500 are expensed immediately; assets from $501 upwards are capitalised. Purchases of more than $5,000 are approved by the financial accountant; purchases of more than $20,000 are approved by the board. 4. One copy of the purchase order is sent to the supplier; the other two copies are sent to the central store at head office. 5. When the asset is received into the central store, a clerk checks that the details match the original purchase order. The clerk then issues the asset with a computer-generated barcode. The barcode number is also written onto the supplier invoice and purchase order. 6. The supplier invoice and one copy of the purchase order are then stapled together and passed to accounts payable for payment. 7. The asset is then sent to the division that requested it, together with a copy of the purchase order. The divisional manager then inputs the details into the asset register using the barcode and other documentation. 8. For disposals and write-offs, a disposal or write-off form is prepared by the divisional manager and sent to head office for approval. A copy of the form is retained at head office. The original is returned to the divisional manager for action and to update the asset register. 9. The fixed asset system calculates depreciation automatically using the data input by divisional managers. Required a) Identify four internal control activities that the auditor might rely on in the conduct of the audit. b) Suggest two improvements that could be made to the internal control environment at Medicorp. Question 2 (6 marks) Content assessed: Topic 6 Funtastic Ltd (Funtastic) provides pay-TV services to customers in regional and rural New South Wales. To subscribe to Funtastic, customers call a hotline number, select the package they require and provide a credit card number to allow automatic payment of the monthly fee. Approximately 300 new subscribers sign up each month. There are no contracts, and payment is accepted only via credit card. There is no hardcopy documentation generated in relation to the sales hotline: staff enter the customers details directly into the computer, which then generates the relevant journal entries and postings to the ledger. From your discussions with management, you believe that this system has not changed since you tested it during last year's audit, when you place a high level of reliance on the controls and found only one minor deviation. Required Outline how the information provided would affect the nature, timing and extent of tests of controls. Question 3 (12 marks) Content assessed: Topic 6 You have been assigned to the audit of Moroney Ltd, a large manufacturing company. The audit strategy indicates that a 'lower assessed level of control risk' strategy has been adopted. Key controls on which the team intends to rely for the revenue cycle are as follows: 1. All sales orders are taken over the phone. At the time the sale is taken the customer service officer checks that the customer is an approved customer and that the sale will not result in the customer exceeding their credit limit. 2. All sales must be followed up by a written sales order (in triplicate) before goods are shipped from the warehouse. 3. On receipt of the sales order, one copy is matched to the computer records and the customer order is flagged as 'OK to proceed' within the system. A second copy is sent to the debors clerk and a third copy is forwarded to the warehouse. Required For each of the controls identified above: a) Indicate the purpose of the control (i.e. what is the control designed to prevent or detect?); b) Indicate the balance and assertion which this control will have an effect on in the financial report; and c) Provide an example of one procedure which could be used to test the control. Please present your answer in the following table: Purpose of Balance and Example of control assertion procedure 1 2 3 Question 4 (8 marks) Content assessed: Topic 7 You are the senior accountant working on the audit of Dynasty Ltd (Dynasty) for the year ended 30 June 2010. While assessing the risk of material misstatement, you note that Dynasty appears to have a significant debt-recovery problem. The majority of Dynasty's debtors are outstanding for more than 60 days. Dynasty's current bad debt provision is calculated as 1% of the debtors balance at month end. Required a) Describe the analytical procedures you would perform in order to form a view on whether a 1% bad debt provision is reasonable. b) Assume that your analysis in a) above revealed that in the previous two financial years (2008 & 2009), Dynasty wrote off $378,000 and $423,500 worth of debtors, respectively. In those years, sales were $3,450,000 and 45,650,000, respectively. Given this information, describe the additional substantive procedures you will carry out at year end in order to obtain sufficient appropriate audit evidence regarding the following assertions in relation to the debtors balance. i) Valuation & allocation ii) Existence Question 5 (8 marks) Content assessed: Topic 7 You are the auditor of Amazing Pty Ltd (Amazing) and you have determined the necessary data fields from the payroll transactions file (PTF) and the payroll master file (PMF) to perform some CAATs. From the PTF, the following data fields are relevant. 1. Employee number 2. Employee name 3. Date of payment 4. Gross amount of payment per payroll transaction 5. Net amount of payment (i.e. what went into the bank) 6. Income tax paid on the transaction 7. Superannuation paid on the transaction 8. Location or business unit of employee From the PMF, the following data fields are relevant. 9. Employee number 10. Employee name 11. Employee address 12. Employee home telephone number 13. Employee bank account number 14. Employee date of birth 15. Employee joining date to the company 16. Employee leaving date from the company 17. Employee tax file number You have requested and obtained the payroll transactions for the year ending 30 June 2010 and the PMF as at 30 June 2010. Required Using the data obtained from the client, suggest CAATs to perform the following substantive tests of detail: a) Testing the classification of payroll costs and related liabilities; and b) Testing the cut-off of payroll costs. Include the fields to be used, and any calculations required. Rationale Assessing topics 5,6 & 7 in general this assignment has been specifically designed to assessment your ability to: 1. Understand the key elements of the internal control structure 2. Identify factors impacting the auditors assessment of the sufficiency and appropriateness of the evidence gathered by tests of controls. 3. Test controls in the revenues, receivables and receipts system. 4. Undertake substantive tests of balances and transactions on the key cycles with reference to the financial report assertions 5. Describe and understand the use of computer-assisted audit techniques in substantive testing. Marking criteria Marks awarded for this assessment task will be based on the degree to which students: Comply with the required aspects of each question; Reasonably adhere to the overall word limit for the assessment task. ACC331 Auditing & Assurance Services FACULTY OF BUSINESS Study Guide 201160 *ACC331* Auditing & Assurance Services ACC331 Study Guide Faculty of Business Written and compiled by Warwick Baines Educational designer Linda Ward Produced by Division of Learning and Teaching Services, Charles Sturt University, Albury Bathurst - Wagga Wagga, New South Wales, Australia. First Published Reprinted January 2010 May 2010, September 2010, December 2010, May 2011 Printed at Charles Sturt University Charles Sturt University Previously published material in this book is copied on behalf of Charles Sturt University pursuant to Part VB of the Commonwealth Copyright Act 1968. ii Contents Page Facilitating your learning 1 Topic 1 The role of auditing and ethical decision making 3 Topic 2 Legal liability of auditors 10 Topic 3 Overview of assurance concepts and the audit process 14 Topic 4 Audit planning 21 Topic 5 Internal controls and risk assessment 26 Topic 6 Tests of controls 30 Topic 7 Tests of transactions and balances 33 Topic 8 Audit sampling 37 Topic 9 Completing the audit 41 Topic 10 Reporting obligations 44 iii iv Facilitating your learning The objectives of this Study Guide are to facilitate your progress through each of the topics in the subject and to ensure that you have acquired the requisite understanding and knowledge of the concepts and techniques presented in each of these topics. These notes are not intended to summarise the text nor repeat information contained in the text. Instead, they should be used as a guide for your learning. It is important that you use them as such and not as a substitute for the essential reading. Your ability to apply the knowledge gained from study of this subject is tested in the self-test exercises, which prepare you for completing the assessments. These exercises are also an excellent tool for reviewing the concepts learned in preparation for the final examination. As far as possible, the material has been presented in the same order as the text. In a few places however you will need to read material out of sequence. You should not find that this causes a problem in terms of assumed knowledge within the text. For each topic, the Study Guide contains: 1. Essential reading - specific references for all the essential reading of the topic. The essential readings are from the set text and the readings at the back of Study Guide. Complete all readings in the order suggested in the Study Guide. 2. Objectives - the purpose of the learning objectives is to clearly identify the concepts and procedures you should have mastered having read the required readings and attempted the learning activities. Note that these may differ from the textbook chapter objectives so it is imperative that you follow the objectives in the study guide. 3. Commentary - this presents an overview of the topic and highlights the essential issues, concepts and techniques you must ensure that you have grasped before you attempt relevant assessment questions. The Commentary complements the essential reading and is not a substitute for it. 4. Self-test exercises - a selection of questions, practical exercises, and case studies from the prescribed text and other sources, designed to help you assess your understanding of the material. Solutions are available on CSU Interact. 5. References - a bibliographical listing of the resources used in writing and compiling the Commentary, many of which may prove useful in completing the assessments. 1 ACC331 Study Guide Learning activities The guidance provided in the Study Guide takes the form of a series of learning activities, which should help to ensure that you understand the content of the topic. The learning activities are presented as follows: Objective check Indicates the topic objective subsequently addressed. Use this check to ensure you have covered the key aspects of the topic. Read Prompts you to engage with specific text reading and other essential reading material. Listen Tailored short audio tutorials covering key concepts of the subject. Accessible through CSU Interact. Forum activity Allows you to interact with other students and teaching staff to share ideas and/or ask questions. Accessible through CSU Interact. Self-test exercises Includes a selection of multiple choice and review questions, practical exercises and case studies, for you to \"self-test\" your understanding of the topic material. Solutions accessible through CSU Interact. 2 ACC331 Study Guide Topic 1 The role of auditing and ethical decision making Essential reading Chapter 1 pp. 1-20 & pp. 28-37 Gay, G. E., & Simnett, R. (2007). Auditing and assurance services in Australia (3rd revised ed.). Sydney: McGraw-Hill. pp. 1-18 & pp. 25-32 Gay, G. E., & Simnett, R. (2010). Auditing and assurance services in Australia (4th ed.). Sydney: McGraw-Hill. Chapter 2 pp. 52-60 Gay, G. E., & Simnett, R. (2007). Auditing and assurance services in Australia (3rd revised ed.). Sydney: McGraw-Hill. pp. 53-61 Gay, G. E., & Simnett, R. (2010). Auditing and assurance services in Australia (4th ed.). Sydney: McGraw-Hill. Chapter 3 pp. 84-89 & pp. 100-109 Gay, G. E., & Simnett, R. (2007). Auditing and assurance services in Australia (3rd revised ed.). Sydney: McGraw-Hill. pp. 90-97 & pp. 111-120 Gay, G. E., & Simnett, R. (2010). Auditing and assurance services in Australia (4th ed.). Sydney: McGraw-Hill. Objectives At the completion of this topic you should be able to: 1. outline the nature of and need for assurance services; 2. distinguish the role of audits from accounting; 3. understand the relationship between the auditor, the client and the public and evaluate the impact of this relationship on the expectation gap; 4. explain the impact that the regulatory bodies have on the nature and quality of assurance services provided to the public; 5. apply the ethical rulings of the accounting bodies using sound ethical decision-making techniques; Commentary The key objectives of the subject are to help you understand why audits are performed and to provide you with an overview of how an audit is undertaken. The subject begins with several topics focused on the regulatory, ethical and legal 3 ACC331 Study Guide framework of auditing before moving onto the preparation, execution and completion of a financial statement audit. The subject finishes with a brief overview of other assurance services currently available. This first topic addresses the need for assurance services, differentiates auditing from accounting, outlines the relational and regulatory context in which auditors operate and demonstrates the practical application of sound ethical principles. NATURE OF AND NEED FOR ASSURANCE SERVICES 1.1 The fundamental purpose of an assurance service; is to provide users with confidence that some action which is reported to have been performed or to have occurred did actually occur. It is a broad concept that encompasses a whole range of different services. Often these services are differentiated by the level of assurance they provide to the users requesting the service. Your textbook outlines the key elements common to all assurance engagements and then gives an overview of the main types of engagements. Read Gay & Simnett (2007), pp. 3-15 Gay & Simnett (2010), pp. 2-12 Forum activity Log on and provide your thoughts on the following: At this very early stage of the subject how important do you think the assurance role really is? WHAT IS AUDITING? 1.2 Although there are a number of different assurance services our focus for this subject is on just one type of assurance servicethe financial statement audit. It is important therefore to understand what is meant by the term 'audit'. There are numerous published definitions of auditing available but somewhat unhelpfully the Australian Auditing Standards' glossary no longer defines 'auditing' or even 'the audit of financial statements'. Although the glossary of the International Auditing Standards does define auditing, this definition is rather limited because it only focuses on the objective of the auditing rather than also including an outline of the process involved to achieve that objective. Your textbook cites the American Accounting Association (AAA) definition because it covers both the process and the objective. It then goes on to discuss the fundamental principles upon which an effective audit should be based. 4 ACC331 Study Guide Read Gay & Simnett (2007), pp. 14-19 Gay & Simnett (2010), pp. 12-16 The distinction between auditing and accounting This is a point where many people get confused, particularly in relation to financial statement auditing, so let's look at the distinction. Accounting is 'the recording, classifying and summarising of economic events in a logical manner for the purpose of providing financial information for decision making (Arens et al., 2007, p. 14). Auditing: 'a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users' (AAA cited in Gay and Simnett 2007, p. 16). Essentially, what we have is a two stage process. Firstly; the accountant 'accounts' for the economic events in accordance with some established criteria and in doing so makes a number of assertions about that information. The auditor then checks the accountant's assertions against the established criteria to determine the degree of correspondence. The auditor will then produce a report which communicates their findings and in doing so lends credibility to the information produced. The confusion arises because both the auditor and the accountant are required to have knowledge of the established criteria by which the economic events must be summarised and accordingly, auditors should have at least as good a knowledge of accounting as accountants do. However an auditor is also required to have additional skills and knowledge to enable them to perform an audit. For example: the auditor must also know how to collect and assess evidence, and determine an appropriate opinion to be communicated to users. To further assist in your understanding of the distinction, your textbook briefly discusses some of the attributes of useful accounting information. Read Gay & Simnett (2007), pp. 19-20 Gay & Simnett (2010), pp. 16-18 THE AUDITOR-CLIENT-PUBLIC RELATIONSHIP 1.3 The most commonly cited objective of financial reporting is to provide useful information to users such as investors and creditors so that rational investment, credit and similar decisions may be made. Management is responsible for preparing financial information which is an accurate and fair presentation of the financial 5 ACC331 Study Guide position of the organisation. External auditors perform audit procedures to provide assurance to outside parties that the financial information is presented fairly. However as your textbook outlines, the auditor-client-public relationship is 'complicated and delicate' (Gay & Simnett, 2007, p. 28). This in turn has led to significant differences in expectations between the three parties. Your textbook discusses the reasons for the gaps in expectations as well outlining some of the areas where the expectation gap appears to be the greatest. Read Gay & Simnett (2007), pp. 28-34 Gay & Simnett (2010), pp. 25-32 Forum activity Log on and provide your thoughts on the following: Whose responsibility is it to narrow the audit expectation gap? THE IMPACT OF REGULATION 1.4 Changes in the prevailing social, political and economic climate can lead to changes in the philosophies regarding what the responsibilities of assurance service providers should be and how these duties should be carried out. To illustrate; the spate of corporate collapses in the early part of this decade resulted in numerous calls for improvements in the auditing function as many investors searched for a reason for the corporate collapse and for ways in which they could be prevented in the future. A number of professional bodies exist to ensure that assurance services are performed competently and in the public interest. These consist of self regulatory professional bodies, such as the Institute of Chartered Accountants in Australia (ICAA) and CPA Australia, and governmental regularity agencies. Your textbook provides a comprehensive overview in a section of Chapter 2. Read Gay & Simnett (2007), pp. 52-60 Gay & Simnett (2010), pp. 53-61 6 ACC331 Study Guide The role of auditing standards You will have noted in the above reading that the Auditing and Assurance Standards Board (AUASB) issue auditing standards that govern the conduct of all audits in Australia. As a result of recent changes to the Corporations Act 2001 these standards now have legal backingpreviously only members of the main professional bodies were expected to comply with the auditing standards. By now you should have obtained the most recent copy of an auditing and assurance handbook compiled by either the ICAA or CPA Australia. They are almost identical and there is no need to acquire both. We will be referring to particular auditing standards throughout the subject so it is important that you first understand the role they play in regulating the auditing profession. Read Gay & Simnett (2007), pp. 34-37 Gay & Simnett (2010), pp. 32-35 Listen Audio File 1 'The role of auditing'. APPLYING AN ETHICAL FRAMEWORK 1.5 It soon becomes clear that the regulatory framework will not always guarantee the most appropriate or just outcome for users of financial information. This is because those responsible for ensuring that financial information is true and fair either break the rules, or in some situations the issues as presented are not easily solved by reference to the regulatory framework. Ethics, which is concerned with what is right and wrong, can play a key role in restoring the confidence users have in the financial information as presented. The two major Australian accounting bodies, the ICAA and CPA Australia, jointly issued APES 110 'Code of Ethics for Professional Accountants'. It is included in both handbooks and compliance is mandatory for all members. Not only do codes of ethics reinforce the requirement on those that are bound by them to comply with the law but they also provide principles and frameworks with which to resolve issues that have no clear regulatory solution. It must be acknowledged however that simply 'establishing codes of ethics and disciplinary rules does not necessarily create an ethical culture in an organisation or business, nor does it ensure the moral integrity of its individual members' (Gay & Simnett 2007, p.83). Ultimately this will depend on an individuals own values. Read Gay & Simnett (2007), pp. 84-86 Gay & Simnett (2010), pp. 90-93 7 ACC331 Study Guide Forum activity Log on and provide your thoughts on the following: 'Based on the corporate collapses that they've been involved in, auditors are generally unethical people.' Discuss. If ethics is ultimately about your own values can it be taught and/or mandated? Applying ethics Sound ethical decision-making requires knowledge of the rules, competence in decision-making and an ability to choose appropriate policies and procedures in different situations. To assist with ethical decision-making a number of authors have developed ethical decision models. These models adapt aspects of various modern ethical theories into a practical step-by-step method of decision making. The models are extremely useful as they ensure that you have considered all aspects of an ethical decision in making a decision. This does not mean they must be used in all situations rather that they provide a good background or framework by which ethical decisions can be made. Your textbook outlines three ethical decision models. It would be extremely useful to understand at least one of these models and be able to apply them to an ethical decision. Read Gay & Simnett (2007), pp. 87-89 Gay & Simnett (2010), pp. 94-97 Audit independence One of the most important ethical values for an auditor is independence. This is because the credibility of the audit report relies on the independence of its preparer. Given the delicate nature of the auditor-client-public relationship, as previously discussed, auditors are under constant independence pressures. In order to protect the independence of the auditor, the Corporations Act contains a number of important provisions. These are further supported by APES 110 and United States legislation such as the Sarbanes-Oxley Act of 2002. Read Gay & Simnett (2007), pp. 100-109 Gay & Simnett (2010), pp. 111-120 Listen Audio File 2 'Ethics'. 8 ACC331 Study Guide Conclusion This topic has introduced you to the nature of auditing and the unique pressures it faces in its relationships with clients and the public. The next topic focuses on the legal implications of those relationships. Self-test exercises You should now attempt the following self-test exercises and ensure that you have met all five learning objectives for this topic. 2007 Topic learning objectives 1-2 1 3 4 4 5 5 Type of question Review Review Case study Discussion problem Discussion problem Case study Case study Number 1.2 1.13 1.28 1.32 2.23 3.20 3.30 2010 Pages Number Pages 42 44 46 47 78 134 138-139 1.2 1.12 1.33 2.8 2.19 3.21 3.32 41 44 47 82 83 142 146 References Arens, A., Best, P., Shailer, G., Fiedler, B., Elder, R., & Beasley, M. (2007). Auditing and assurance services in Australia: An integrated approach (7th ed.). Sydney: Pearson. 9 ACC331 Study Guide Topic 2 Legal liability of auditors Essential reading Chapter 4 pp. 142-170 Gay, G. E., & Simnett, R. (2007). Auditing and assurance services in Australia (3rd Revised Ed.). Sydney: McGraw-Hill. pp. 150-181 Gay, G. E., & Simnett, R. (2010). Auditing and assurance services in Australia (4th ed.). Sydney: McGraw-Hill. Objectives At the completion of this topic you should be able to: 1. explain the concept of reasonable care and skill and define negligence and assess their impact on an auditor's legal liability to clients; 2. describe the concept of contributory negligence; 3. indicate to what extent a duty of care may be owed to third parties; 4. analyse the arguments for and against limiting liability; and 5. explain the auditor's duties in regard to the prevention, detection and reporting of fraud. Commentary While most audits are conducted properly, accounting practices still spend a significant amount on professional liability insurance and legal costs. It is therefore important that auditors use due professional care to minimise such costs. Further even when due professional care is used; investors, clients and other users may still bring an action against auditors. In this topic, we discuss the legal environment and concepts related to auditors. Key court decisions are reviewed and their impact on the profession is discussed. AN AUDITOR'S LIABILITY TO CLIENTS 2.1 In order to prove that an audit has been negligently performed the plaintiff must show that the auditor failed to exercise 'due care'. In determining what constitutes 'due care' you need to consider this from both a professional and legal viewpoint. From a professional viewpoint, this requires adherence to the professional standards. From a legal position you need to consider case law. Your textbook examines in some detail the major cases involving auditors that have shaped the legal understanding of negligence. 10 ACC331 Study Guide Read Gay & Simnett (2007), pp. 142-149 Gay & Simnett (2010), pp. 150-159 CONTRIBUTORY NEGLIGENCE 2.2 An important development in the area of breach of contract by auditors is contributory negligence. This exists where a plaintiff fails to exercise the required standard of care, thus contributing to its own loss. Prior to the AWA case this defence was unsuccessful. Read Gay & Simnett (2007), pp. 149-151 Gay & Simnett (2010), pp. 159-161 LIABILITY TO THIRD PARTIES 2.3 In most cases, the auditor does not know explicitly who will be using the financial statements but is aware that third parties will be using them. Over the years a number of cases have considered the auditor's liability in relation to persons other than the immediate client. The decisions in these cases have given rise to various tests for establishing such a third party liabilitysome have made it easier to establish third party liability than others. In rough chronological order the tests are as follows: 1. Special relationship A duty is owed to any third party to whom the auditor shows accounts, or knows the client is going to show accounts, so as to induce some action. Key cases: Candler (dissenting judgement of Lord Denning) Hedley Byrne MLC v Evatt Shaddock and Associates 2. Reasonable foreseeability A duty is owed to a specific third party of whom they were not aware but who was part of a class of persons of whom they should have been aware. Key cases: Scott Group JEB Fasteners Twomax 11 ACC331 Study Guide 3. Proximity In answering the question of whether there was sufficient proximity between the auditor and the third party you need to examine whether the statement made by the auditor was meant to induce the third party to undertake specific actions. Key cases: Caparo AGC Columbia Coffee (wider interpretation but overturned in Esanda case) Esanda Therefore in the current situation it would be difficult to establish that audits of general purpose financial reports were ever intended to induce third parties to undertake a specific course of action. This does not necessarily mean auditors are having an easier time in avoiding liabilityprivity letters, consumer and criminal law are other important avenues open to non-clients who believe an auditor should be subject to some form of sanction for their actions or inaction. Your textbook examines in more detail the above key cases that have established the tests for establishing third party liability as well as providing a brief outline of the avenues outside of case law. Read Gay & Simnett (2007), pp. 151-161 Gay & Simnett (2010), pp. 161-173 LIMITATION OF LIABILITY 2.4 Given the damages awarded against auditors and the consequent rise in professional indemnity insurance for auditors, it is not surprising that the auditing profession has been seeking some sort of 'cap' on the damages which can be awarded by the courts. Your textbook sets out in detail the historical and current status or the arguments for and against Read Gay & Simnett (2007), pp. 162-166 Gay & Simnett (2010), pp. 173-177 Listen Audio File 3 'Legal liability'. 12 ACC331 Study Guide FRAUD 2.5 One interesting matter that is disclosed by a review of the cases is that it is not part of an auditor's duty to detect fraud or to conduct the audit in a way aimed specifically at detecting fraud, unless that is the term of the engagement. However, once fraud is detected in the course of an audit there is a duty to warn management. Further, if an auditor's suspicion is aroused, then the auditor has a duty to fully investigate the matter, even if further audit procedures are needed and to advise the directors. Read Gay & Simnett (2007), pp. 166-170 Gay & Simnett (2010), pp. 177-181 Conclusion This topic has provided the legal framework within which auditors relate to their clients and third parties. Now that we've established the regulatory, ethical and legal framework of auditing we're ready to undertake an overview of the audit process itself. Self-test exercises You should now attempt the following self-test exercises and ensure that you have met all five learning objectives for this topic. 2007 Topic learning objectives 1-5 1 3 4 5 2010 Type of question Number Pages Number Pages Review Review Case study Discussion problem Case study 4.1 4.3 4.23 4.30 4.31 171-173 173 176 179-180 180 4.1 4.3 4.30 4.31 4.33 183-184 185 189 189 190 13 ACC331 Study Guide Topic 3 Overview of assurance concepts and the audit process Essential reading Chapter 5 pp. 190-206 & 210-221 Gay, G. E., & Simnett, R. (2007). Auditing and assurance services in Australia (3rd revised ed.). Sydney: McGraw-Hill. pp. 199-213 & 217-229 Gay, G. E., & Simnett, R. (2010). Auditing and assurance services in Australia (4th ed.). Sydney: McGraw-Hill. Objectives At the completion of this topic you should be able to: 1. outline the main steps involved in the audit process; 2. explain the relationship between financial report assertions, audit objectives, procedures and evidence; 3. outline the audit risk model; and 4. describe the general requirement and contents of audit working papers. Commentary This relatively short topic introduces to you some important processes, concept relationships and models that you will be constantly revisiting throughout the rest of the subject as you come to grips with planning, executing and completing an audit. In many ways the topic acts as a basic reference guide for all that topics that follow so it should be extremely helpful to your progress in the subject. THE AUDIT PROCESS 3.1 A broad overview of the audit process is depicted below and on the next page in Figure 3.1. In turn the listed steps will be covered methodically, and in some detail, by subsequent topics so you should have a good look at this flow chart. 14 ACC331 Study Guide Step 1 Step 1 Assess Risks and Client Potential Client Potential [TOPIC 4] Review broad risks affecting client, assess management integrity, assess long term prospects of client. No Accept Client? Terminate Search and Engagement Yes Step 2 Step 2 Knowledge of the business Thorough understanding of company, strategies, competitors, financial feasibility, etc., as a base to understand the broad risks facing the company. [TOPIC 4] Steptep 4 S3 Assess Controls and Other Processes in Place to Address the Risk Risk [TOPIC 5] Assess whether the control and other processes are adequate to reduce the risk of a material misstatement occurring in the financial statements. 15 ACC331 Study Guide Determine Account Balances with Residual Account Balances with Risk of Material Misstatement Residual Risk of Account Account Balances withNo Balances with Little or Risk of Material Misstatement Little or No Risk of Material Misstatement Material Misstatement Step 4 Step 6 Test Operation of Controls Where Controls Reduce the Risk of Misstatement Reduce the Risk of Misstatement 6] [TOPIC Step 5 8 Step Design Direct Tests of Account Balances and Transactions to Reduce the Risk of Material Misstatements Occurring in Audited Financial Statements [TOPICS 7 and 8] Step 6 Formulate Opinion, Review Quality of Work, and Communicate Opinion to Client and Users [TOPICS 9 and 10] Figure 3.1 Overview of audit process [Adapted from: Rittenburg & Schwieger 2000] ASSERTIONS, OBJECTIVES, EVIDENCE AND PROCEDURES 3.2 Financial report assertions are essentially general claims by the company about their financial position and operations. It is worth pointing out that sometimes financial report assertions are known simply as audit assertions. In order for the auditor to be able to attest to an assertion, it is necessary to have objectively determined criteria as a reference against which the assertion may be assessed. Your textbook introduces you to the key financial report assertions then describes, by way of example, how general financial report assertions become specific audit objectives. 16 ACC331 Study Guide Read Gay & Simnett (2007), pp. 190-192 Gay & Simnett (2010), pp. 199-201 Audit procedures Broadly speaking, audit procedures are the actions an auditor takes to acquire evidence to support an audit objective. Hence, as your textbooks stresses they are not evidence, they are the means of acquiring evidence. Audit evidence Audit evidence is information which can be used to support our ultimate opinion. This evidence can come from any number or sources, or be obtained by any means. For example, to check the amount of cash which a clerk holds in a petty cash tin, we could count it ourselves, watch the clerk count it, or ask the clerk how much is there. Obviously, however some forms of evidence are better than others and according to ASA 500.5 audit procedures must be selected in order to provide audit evidence that is sufficient and appropriate. Sufficiency is a measure of the quantity of evidence obtained. In other words we are asking: Is the sample big enough to draw an appropriate conclusion? To be appropriate the evidence must be relevant to our opinion. In other words we are asking how this test helps us achieve our audit objective. For example, a test which checks whether cheques are authorised doesn't tell us anything about whether they have been recorded in the correct accounting period. If our objective is to test the measurement assertion then this test is clearly inappropriate. Read Gay & Simnett (2007), pp. 192-198 Gay & Simnett (2010), pp. 201-208 AUDIT RISK MODEL 3.3 Of course there is always the possibility that the auditor will get it wrong and that the audit evidence gathered through various procedures is either not sufficient or appropriate to address the stated audit objectives. This is due to a combination of factors that are together known as audit risk. Your textbook has an excellent summary and diagram (Figure 5.4, p. 201) outlining the various components of audit risk that you should have a look at now before you go any further. Read Gay & Simnett (2007), pp. 199-202 Gay & Simnett (2010), pp. 208-212 17 ACC331 Study Guide Assessment of audit risk Before undertaking an audit, or even accepting a client, it is important that the auditor undertake an assessment of audit risk so that audit risk can be reduced to an acceptably low levelas close to nil as possible. So how do we do this? The only element the auditor has any control over is detection riskthe risk that their substantive procedures will lead the auditor to conclude no material misstatement exists when, in fact, one does. All the other elements are either uncontrollable (in the case of inherent risk) or controlled by the client (control risk).Therefore the auditor must design the type and levels of audit testing based on their assessment of the inherent risk and control risk found at the client. When using the relative values for risk components the relationship between the components is explained in the acceptable detection risk matrix which is in your textbook but also reproduced below. Auditors' assessment of control risk: High Low High Low Low Medium Medium Low Medium High Low Auditors' assessment of inherent risk: Medium Medium High High Source: Gay & Simnett (2007), p. 202. To illustrate the use of this matrix, let's use an example. In our client CSU Ltd, we have assessed our inherent risk as high and control risk as high. Using the matrix we can determine what level of detection risk is acceptable to give us the minimal audit risk by checking where the columns and rows headed 'high' intersect. The intersection indicates that a low level of detection risk is acceptable. This means we will need to perform extensive substantive testing as part of our audit procedures so that overall audit risk is at an acceptably low level. Although we can also estimate our detection risk as a specific percentage this approach is not used by Australian audit firms so we will not cover it in this subject. Forum activity Log on and provide your thoughts on the following statement: 'If auditors can only control detection risk, there is no point assessing overall audit risk' Business risk Business risk is a relatively new but now widely accepted approach to auditing. It demands that the auditor have a comprehensive understanding of the clients business and industry so that its assessment of audit risk is fully informed. The textbook in this chapter provides a definition and a brief overview of the 18 ACC331 Study Guide relationship between business risk and audit risk. In the next topic we cover the assessment of business risk. Read Gay & Simnett (2007), pp. 204-206 Gay & Simnett (2010), pp. 212-213 WORKING PAPERS 3.4 As crucial as undertaking audit work, is the need to document that work appropriately. Working papers not only record the efficient and appropriate evidence obtained by the auditor to enable them to form their final opinion, but they also act as a valuable planning tool for the next audit. A sound overview of the nature of working papers, along with some basic examples, is provided in the textbook. Read Gay & Simnett (2007), pp. 210-221 Gay & Simnett (2010), pp. 217-229 Listen Audio File 4 'Assurance concepts and the audit process'. Conclusion Now that you have grasped these basic reference tools you're ready to step through the audit process in some detail, beginning with planning an audit. Self-test exercises You should now attempt the following self-test exercises and ensure that you have met all three learning objectives for this topic. 2007 Topic learning objectives 2 3 3 2 2 2 4 2010 Type of question Number Pages Number Pages Review Review Review Case study Case study Case study Discussion problem 5.1 5.3 5.12 5.21 5.24 5.26 5.32 222-223 224 225 227 228 229 233 5.1 5.3 5.15 5.22 5.24 5.28 5.36 231-232 232-233 234 235 236 238 243 19 ACC331 Study Guide References Rittenberg, L. E., & Schwieger, B. J. (2000). Auditing concepts for a changing environment (3rd ed.). USA: Harcourt College Publishers. 20 ACC331 Study Guide Topic 4 Audit planning Essential reading Chapter 6 pp. 236-276 Gay, G. E., & Simnett, R. (2007). Auditing and assurance services in Australia (3rd revised ed.). Sydney: McGraw-Hill. pp. 245-287 Gay, G. E., & Simnett, R. (2010). Auditing and assurance services in Australia (4th ed.). Sydney: McGraw-Hill. Chapter 7 pp. 313-319 Gay, G. E., & Simnett, R. (2007), Auditing and assurance services in Australia (3rd revised ed.). Sydney: McGraw-Hill. pp. 327-331 Gay, G. E., & Simnett, R. (2010). Auditing and assurance services in Australia (4th ed.). Sydney: McGraw-Hill. Objectives At the completion of this topic you should be able to: 1. explain why the decision to accept a client is important and outline the key steps involved in client acceptance and continuance; 2. understand the knowledge required by an auditor in preparing an audit strategy and audit plan; 3. assess client business risk; and 4. outline the types and uses of analytical procedures and distinguish those that are useful in obtaining an understanding of the client. Commentary This topic really gets the audit process rolling by outlining the steps involved in accepting new clients and continuing with existing ones. The remainder of the topic is concerned with the detailed planning steps that need to be undertaken before audit fieldwork can commence. CLIENT ACCEPTANCE AND CONTINUANCE 4.1 Before agreeing to accept a new client, the auditor is required by the auditing standards to undertake a number of steps to assess the appropriateness of such an engagement. Such steps also need to be in place for periodically reviewing the continuance of existing clients. Your textbook summarises these steps in an excellent diagram. 21 ACC331 Study Guide Read Gay & Simnett (2007), pp. 236-239 Gay & Simnett (2010), pp. 245-249 Agreeing on the nature of the engagement: The engagement letter After accepting an appointment, ASA 210.05 requires the auditor and the entity to agree on the terms of the engagement. The standard requires the auditors to record in writing the terms of the engagement that have been agreed with their client, and to forward a copy of this record to the client. In doing this, the auditor and the client should have a mutual understanding of the nature of the audit services to be performed, the timing of those services, the expected fees and the basis on which they will be invoiced, the responsibilities for the auditor in searching for fraud, the client's responsibilities for preparing information for the audit, and the need for other services to be performed if necessary. A good engagement letter clarifies the responsibilities of both management and the auditor as well as the nature of the engagement and audit report; thereby assisting auditor's to reduce their risk exposure in the event of a misunderstanding of the auditor's responsibilities. Your textbook provides an example of an engagement letter. Read Gay & Simnett (2007), pp. 239-246 Gay & Simnett (2010), pp. 249-258 AUDIT STRATEGY 4.2 You were provided with a diagrammatic overview of the entire audit process in the previous topic. To conduct an audit efficiently and effectively requires adequate planning. Auditing planning has two key aspects, an overall audit strategy and an audit plan. The audit strategy essentially sets the 'big picture' parameters for the conduct of the audit to 'ensure that important and potential risk areas of the audit are given appropriate attention and that problems are identified and dealt with' (Gay & Simnett, 2007, p.243). Guided by the audit strategy, the audit plan fleshes out in detail the nature, timing and extent of the audit procedures required to achieve the audit objectives. You were introduced to the concept of audit objectives and audit plans in the previous topic. Your textbook outlines some important points to consider when developing the audit strategy and the subsequent audit plan. 22 ACC331 Study Guide Read Gay & Simnett (2007), pp. 246-252 Gay & Simnett (2010), pp. 258-264 Knowledge of the client's business Basic common sense and a reading of the audit process overview should have made it clear by now that the planning process really needs to start with obtaining a thorough knowledge of the client's business. This will inform the risk assessments process which will in turn inform the audit strategy and audit plan. Your textbook reinforces why this is important to the audit and the methods that can be used to acquire and analyse that client knowledge. Read Gay & Simnett (2007), pp. 252-258 Gay & Simnett (2010), pp. 265-268 ASSESSING BUSINESS RISK 4.3 By obtaining a thorough understanding of the client's business auditors are able to assess business risk. This term and its relationship to audit risk were introduced to you in the previous topic. As stated above assessing business risk is crucial to informing the overall audit strategy. It should be undertaken early in the audit planning process, particularly after accepting a new engagement, and revisited frequently. Your textbook covers some of the techniques used to assess business risk including SWOT analysis, value-chain approach and PEST analysis. Many of you will probably be aware that these techniques are often used by management consultants and marketers seeing to improve the performance or add value to the organization. Bear in mind that for the purposes of this subject any business assessment technique used must ultimately be effective in assessing business risk. Read Gay & Simnett (2007), pp. 258-266 Gay & Simnett (2010), pp. 268-275 23 ACC331 Study Guide ANALYTICAL PROCEDURES 4.4 Analytical procedures are required by the auditing standards during the planning phase to inform the auditor's risk assessment but they can also be used during the course of the audit. As we move into the execution phase of the audit, in subsequent topics, you will come to understand how analytical procedures can be used as a substantive audit procedure. Your textbook introduces the major types of analytical procedures as well briefly covering how to analyse the findings. You should have at least encountered the most common of these, ratio analysis, in a first year accounting subject. Read Gay & Simnett (2007), pp. 266-276 Gay & Simnett (2010), pp. 275-287 Materiality Like analytical procedures the concept of materiality must also be applied at the planning stage of an audit to assist with audit risk assessment but it is also important for guiding audit procedures during the audit fieldwork. Read Gay & Simnett (2007), pp. 313-319 Gay & Simnett (2010), pp. 327-331 Listen Audio File 5 'Risk Analysis'. 24 ACC331 Study Guide Conclusion The planning stage is a crucial first step in undertaking an audit because it sets the tone for the conduct of the audit. We've seen that an effective assessment of audit risk is crucial for ensuring a well planned audit. As we move into the execution phase of the audit the assessment of risk continues to be a major concern. Self-test exercises You should now attempt the following self-test exercises and ensure that you have met all four learning objectives for this topic. 2007 Topic learning objectives 1 4 2 3 2 3 4 4 4 2010 Type of question Number Pages Number Pages Review Review Review Review Case study Case study Case study Review Case study 6.1 6.3 6.8 6.14 6.21 6.26 6.29 7.8 7.24 277-278 279 280 280 282 284-285 287 321 328-329 6.1 6.3 6.8 6.14 6.21 6.26 6.29 7.12 7.27 289-290 291 292 292 294 296-297 298-299 337 348-349 25 ACC331 Study Guide Topic 5 Internal controls and risk assessment Essential reading Chapter 8 pp. 336-370 Gay, G. E., & Simnett, R. (2007). Auditing and assurance services in Australia (3rd revised ed.). Sydney: McGraw-Hill. pp. 353-391 Gay, G. E., & Simnett, R. (2010). Auditing and assurance services in Australia (4th ed.). Sydney: McGraw-Hill. Objectives At the completion of this topic you should be able to: 1. define key internal control concepts and explain the audit logic of assessing control risk; 2. describe the general objectives of internal control; 3. understand the key elements of the internal control structure; 4. explain how the auditor undertakes an assessment of control risk and how this assessment impacts upon audit procedures; and 5. distinguish between key controls and identify those controls that affect the auditor's assessment of control risk in a computerised system. Commentary An organisation's internal controls are integral to its effective governance. Internal controls exist at different levels of the organisation. For example, at the strategic level there may be a well designed capital investment process, at the operational level there may be a well designed supply chain management system and at the accounting system level there may be a system of authorising transactions. As part of controlling audit risk and designing an effective and efficient audit, the auditor needs to assess control risk. But before this can be achieved the auditor must have a thorough understanding of how a client's internal controls actually operate. 26 ACC331 Study Guide AUDIT STRATEGY AND INTERNAL CONTROL 5.1 The audit risk model and detection risk matrix introduced in Topic 3 clearly demonstrates the significant impact a client's internal control process has on the conduct of an audit. Poorly performing internal control processes, for example, increases the level of control risk and forces the auditor to adjust their audit strategy and program accordingly. It is also worth noting that, because of its inherent limitations, even internal control that is working well can only reduce the level of control risk to low but cannot eliminate it. Read Gay & Simnett (2007), pp. 336-339 Gay & Simnett (2010), pp. 353-357 OBJECTIVES OF INTERNAL CONTROL 5.2 Topic 3 outlined how financial report assertions about a company's financial position and operations are restated by the auditor as specific audit objectives to be met. In a similar vein key internal control objectives, established by company management, can be restated by the auditor as specific control objectives. This then enables the auditor to assess whether the particular control is working effectively. Read Gay & Simnett (2007), pp. 339-342 Gay & Simnett (2010), pp. 357-360 UNDERSTANDING THE INTERNAL CONTROL STRUCTURE 5.3 In order to arrive at any assessment as to the effectiveness of an internal control structure and hence determine the level of control risk and the audit strategy to be pursued, it is of paramount importance that the auditor obtain a comprehensive understanding of that structure. Read Gay & Simnett (2007), pp. 342-355 Gay & Simnett (2010), pp. 360-374 27 ACC331 Study Guide Documenting the understanding The documentation of the auditor's understanding of the internal control structure commonly includes internal control questionnaires and checklists, narrative memoranda and flow charts. Some comprehensive examples are provided in your textbook. Although you will need to understand the methods used to document an auditor's understanding of the internal control structure you will not be required to reproduce such documentation in this subject. Read Gay & Simnett (2007), pp. 355-359 Gay & Simnett (2010), pp. 374-377 (but including Fig. 8.5 on p. 378) CONTROL RISK ASSESSMENT 5.4 As discussed previously control risk is the risk that the client's procedures will not prevent or detect material misstatements in the financial statements on a timely basis. Once an auditor has obtained an understanding of the internal control structure they should have identified and evaluated the controls which are likely to exist in the company and can therefore assess control risk. This assessment will then in turn impact upon the extent of tests of controls which is covered in the next topic. Read Gay & Simnett (2007), pp. 359-362 Gay & Simnett (2010), pp. 377-381 Listen Audio File 6 'Understanding and assessing internal control'. INTERNAL CONTROL STRUCTURE AND CIS 5.5 Controls are used to assist in preventing, detecting and correcting potential errors and/or fraudulent activities. In a computerised environment, major business risks may include things such as the potential corruption of data by allowing users to download and manipulate information from a central database and then uploading that information back to the database. In considering the internal control structure that involves a computerised system, the auditing profession has distinguished controls into various categories, such as: 28 user control and IT controls general controls versus application controls programmed versus manual controls ACC331 Study Guide Your textbook provides a thorough coverage discussion of these categories with particular focus on general and application controls. It is important that you have an understanding of the key types of general and application controls. Read Gay & Simnett (2007), pp. 362-370 Gay & Simnett (2010), pp. 381-391 Conclusion Once an assessment of the client's internal control environment has been undertaken the auditor is now in a position to test those controls upon which they are seeking to rely. This is covered in the next topic. Self-test exercises You should now attempt the following self-test exercises and ensure that you have met all five learning objectives for this topic. 2007 Topic learning objectives 1-4 1-2 3 4 5 2010 Type of question Number Pages Number Pages Review Discussion problem Case study Case study Discussion problem 8.1 8.12 8.13 8.20 8.22 378-379 381 381 384-385 385 8.1 8.17 8.19 8.25 8.28 399-400 404 404 407 416 29 ACC331 Study Guide Topic 6 Tests of controls Essential reading Gay, G. E., & Simnett, R. (2007). Auditing and assurance services in Australia (3rd revised ed.). Sydney: McGraw-Hill. Chapter 9 pp. 396-415 & 428-432 Gay, G. E., & Simnett, R. (2010). Auditing and assurance services in Australia (4th ed.). Sydney: McGraw-Hill. pp. 419-441 & 454-458 Objectives At the completion of this topic you should be able to: 1. identify factors impacting the auditors assessment of the sufficiency and appropriateness of the evidence gathered by tests of controls; 2. describe the audit procedures for testing controls in the revenues, receivables and receipts system; and 3. understand the audit approaches to testing controls through the computer. Commentary Once the auditor has completed their review of the client's internal control structure and assessed the control risk they are in a position to undertake tests of the controls upon which they are seeking reliance. SUFFICIENCY AND APPROPRIATENESS OF EVIDENCE 6.1 In undertaking tests of controls it is important that the auditor regularly assesses the sufficiency and appropriateness of the audit evidence gathered to support the assessed level of control risk. Remember that tests of controls must be undertaken if the control risk has been assessed as anything other than high. The interrelationship between assertions, objectives, procedures and evidence has been previously outlined. Your textbook now fleshes out those relationships in a little more detail. Of particular note is the relationship between tests of controls and audit assertions. Read Gay & Simnett (2007), pp. 396-403 Gay & Simnett (2010), pp. 419-428 30 ACC331 Study Guide Forum activity Log on and provide your thoughts on the following: How do tests of controls relate to particular audit assertions? TESTING CONTROLS OF THE REVENUE SYSTEM 6.2 In any company's accounting information system, the revenue, receivables and receipts cycle is one of the busiest, often involving large volume and repetitive transactions. As a result it is a cycle that readily lends itself to the controls based audit approach. It is quite useful for you to understand how the controls based audit approach is applied in practice and to see how the interrelationships, such as those between assertions, objectives and procedures, are not just theoretical constructs. Your textbook has comprehensive coverage of testing the controls of the revenue system. It steps you through the entire process from understanding the cycle and its controls through to assessing the effectiveness of those controls and their impact on the rest of the audit. Read Gay & Simnett (2007), pp. 404-415 Gay & Simnett (2010), pp. 429-441 TESTING CONTROLS IN CLIENT COMPUTER PROGRAMS 6.3 There are several approaches that can assist an auditor in testing controls that you should become familiar with. Read Gay & Simnett (2007), pp. 428-432 Gay & Simnett (2010), pp. 454-458 Listen Audio File 7 'Tests of control'. Forum activity Log on and provide your thoughts on the following: What specific test of control do you think is most effective and why? 31 ACC331 Study Guide Conclusion You can see that undertaking appropriate tests of controls is vital to achieving the auditor's objectives. Of equal importance and working in conjunction with tests of controls are substantive tests of transactions and balances covered in the next topic. Self-test exercises You should now attempt the following self-test exercises and ensure that you have met all three learning objectives for this topic. 2007 Topic learning objectives 1 2 1 2 3 32 2010 Type of question Number Pages Number Pages Review Review Review Case study Case study 9.1 9.2 9.7 9.21 9.30 434 434-435 437 439-440 447 9.1 9.2 9.6 9.25 9.34 460-461 461-462 465 467 447 ACC331 Study Guide Topic 7 Tests of transactions and balances Essential reading Chapter 10 pp. 450-496 Gay, G. E., & Simnett, R. (2007). Auditing and assurance services in Australia (3rd revised ed.). Sydney: McGraw-Hill. pp. 477-529 Gay, G. E., & Simnett, R. (2010). Auditing and assurance services in Australia (4th ed.). Sydney: McGraw-Hill. Objectives At the completion of this topic you should be able to: 1. distinguish between tests of controls and substantive tests and between substantive tests of transactions and substantive tests of balances; 2. identify the financial report assertions associated with tests of balances and tests of transactions; 3. undertake substantive tests of balances and substantive tests of transactions on the key cycles with reference to the financial report assertions; and 4. describe and understand the use of computer-assisted audit techniques in substantive testing; Commentary No matter how strong an audit client's internal controls auditors will always need to undertake substantive tests in addition to tests of control, because ultimately the monetary value of balances and transactions needs to be substantiated. This topic begins by establishing the crucial difference between tests of control and substantive tests of transactions and balances, followed by an application of some substantive tests to some selected financial report components. 33 ACC331 Study Guide DISTINGUISHING BETWEEN TESTS 7.1 It is interesting that the word 'substantive' has been used to distinguish tests of transactions and balances from tests of controls. It does not mean that the latter are unimportant but simply that tests of balances and transactions are used to measure (or substantiate) monetary error in accounting records whereas tests of controls relate only to the assessment of controls. It is worth noting however that undertaking just one procedure can often achieve the set objective for both tests of controls and substantive tests of transactions. Even substantive tests of transactions and substantive tests of balances can on occasion share a similar relationship. It is vital that you understand these key distinctions before you continue. Read Gay & Simnett (2007), pp. 450-454 Gay & Simnett (2010), pp. 477-481 7.2 FINANCIAL REPORT ASSERTIONS AND SUBSTANTIVE AUDIT PROCEDURES The concept of financial report assertions and their impact on shaping audit objectives, strategies and procedures (or tests) was introduced several topics ago. Here we revisit them and outline which type of substantive procedure each assertion is more strongly related to. A thorough understanding of these assertions and their relationships will greatly assist you in formulating your own audit procedures. Read Gay & Simnett (2007), pp. 454-458 Gay & Simnett (2010), pp. 482-485 UNDERTAKING SUBSTANTIVE TESTS ON THE KEY CYCLES 7.3 Now that you have a firm grasp on the nature of the financial report assertions you're in a position to undertake substantive tests of balances and transactions on the key cycles found in most audit clients. The key cycles generally involve a key balance sheet account (or category of accounts) and its associated income or cash flow statement accounts. Grouping audit procedures (both control and substantive) by cycle is common among audit firms because this is generally the way clients organise their operations. Although the names of accounts and combinations can vary from client to client the key cycles as outlined in your textbook are: 34 ACC331 Study Guide cash, cash receipts and cash payments sales, cash receipts and accounts receivable purchases and inventories accounts payable and payments non-current assets investments and intangibles non-current liabilities Your textbook provides a comprehensive coverage of each of the above cycles, with each of the detailed tables showing the clear and logical relationship from financial report assertion to specific audit objective to common substantive audit procedure. An important thing to bear in mind is that although your textbook applies all the financial report assertions to every cycle, certain assertions are considered more crucial to some cycles than others. This is driven by what is most likely to be the cause of misstatement for that particular account or cycle. For example it is more likely that an asset will be reported to exist when it doesn't (violation of the existence assertion) than not reporting an asset that actually does exist (violation of the completeness assertion). This is because, as a general rule, the more assets on a balance sheet the better and so audit clients will be more likely to overstate assets than to understate them. The reverse is the case for liabilities so when auditing cycles that involve liabilities; completeness will generally be a more important assertion than existencei.e. is the list of liabilities complete? Okay its time for you to step through the key audit cycles and familiarise yourself with their related major substantive tests of balances and transactions. Although you should be aware of each of the cycles listed, for the purposes of assessment in this subject they do gradually decline in level of importance. The last few pages of this block of reading is different in that it simply highlights some unique aspects of testing account balances in the income statement. Read Gay & Simnett (2007), pp. 458-493 Gay & Simnett (2010), pp. 485-525 COMPUTER ASSISTED SUBSTANTIVE TESTING 7.4 As with testing controls, computer software can greatly assist an auditor in undertaking s