Unformatted text preview: ANS1 A:
The audit expectation gap arises as a fundamental difference between what the general public expects
from auditing and what a financial audit actually involves. In some cases, this gap isn’t the result of a lack
of auditing knowledge, but more from what the public wishes auditors would do. In either of these
cases, there’s a gap between expectation and reality.
The problem with this gap is that it leads to concern about the auditing process in general. One of the
most common expectations businesses have is that the auditing process will uncover financial
irregularities or instances of fraud in their statements. But this isn’t necessarily the role of an audit,
which comes with its own limitations. As a result, a business owner might be unhappy that the audit isn’t
as far-reaching or comprehensive as expected. The partner is not correct in suggesting that the expectation gap only relates to unreasonable
expectations of users. A good definition of the expectation gap was provided by Porter in 1993. She
described it as ‘the audit expectation-performance gap’. This indicates that the gap has two major
components: (a) a gap between what society expects auditors to achieve and what they can be
reasonably be expected to accomplish (‘reasonableness gap’) (b) a gap between what society can
reasonably expect auditors to accomplish and what they are perceived to achieve (‘performance gap’).
The performance gap is further comprised of deficient performance and deficient standards. The partner
is focusing on the first part of the gap. This has been the main component that the profession has
focused on in responding to the expectation gap issue. The main measures have been directed at
education of the public to dispel their unreasonable expectations. The problem is the expectation gap
has not been resolved which suggests that measures taken thus far have not worked and perhaps more
consideration should be given to the second component of the expectation gap. ANS1B:
The emergence of professional service firms in recent years has resulted from a growing demand from
businesses for specialist advice to help them achieve business advantage in an increasingly competitive
market place.
Much of this advice is requested from audit firms, first because auditors are trained to understand the
dynamics of a business from an external perspective and also because independent viewpoint can often
shed light on problems that may appear intractable from within an organisation.
Non-audit services provided by auditors to their clients fall into three categories:
1. Services required by legislation or contract to be undertaken by the auditors of the business. These
include: regulatory returns e.g. to the Prudential Regulation Authority legal requirements to report on matters such as share issues for non-cash consideration,
expenditure for grant application purposes, etc contractual requirements, for example to report to lenders or vendors on net assets, covenant
requirements, etc. 2. Services that it is most efficient for the auditors to provide because of their existing knowledge of the
business, or because the information required is a by-product of the audit process. These include: services such as those listed in category (1) above that the auditors are not required by law to
undertake, but where the information largely derives from the audited financial records tax compliance, where much of the information derives from the audited financial records 'short form' or other reports in acquisition or reorganisation situations where completion is
necessary in a very short time. 3. Services that could be provided by a number of firms. In this case, the fact that the firm is the auditor
is incidental and it would generally only be chosen because, for example, it had won a tender process.
Examples of such services include: management consultancy tax advice human resources consultancy. The argument against general prohibition
We believe that unnecessarily restricting the provision of non-audit services would have an unintended,
adverse effect on the underlying quality of the audit through restrictions in knowledge and skills:
Knowledge
The cumulative knowledge on which auditors depend would be greatly reduced, actually resulting in a
poorer understanding of the business and a lower likelihood of key issues being identified. When they
are less familiar with the business of a company, auditors would be likely to find out about such issues
only later in the process, resulting in an increased likelihood of undetected misstatements.
Skills
An effective audit often requires experience far beyond the traditional auditing skill set. Auditors need to
be able to draw on the knowledge and experience of colleagues who are expert in key risk areas:
taxation, treasury operations, information systems, regulatory compliance, financial management, due
diligence, actuarial assessments, fraud and business processes. By inhibiting such exchanges within a
firm, a rigorous separation of audit and non-audit services would be likely to lead to a deterioration in
audit quality.
Quality of recruits Ultimately, there would be no reason for specialist divisions within an audit firm to accept the constraint
of being unable to accept work from clients of their auditor colleagues. It follows that there would be a
gradual move to establish themselves as entirely separate entities. The remaining audit-only firms would
not attract the brightest graduates who enter a profession they perceive as opening the door to a broad
range of subsequent careers. The quality of audit judgements would do down and more frauds would go
undetected as the brightest and the best are needed to detect the fraudsters who are becoming cleverer
and more determined.
Dependence on client
As noted above, non-audit service prohibitions would make firms smaller. This, perversely, would mean
that bigger clients would actually create a proportionately bigger intimidation threat because they would
form a larger part of the firm's income.
Quality of business' own systems
The general quality of IT and accounting systems, which business depends on to deliver the information
that management base decisions on, would suffer as a company's auditors are often in the best position
to advise clients on systems. Business would thus be increasingly denied a vital source of people with the
relevant wider skills which a multi functional audit firm develops.
Speed of reporting
Reliable financial information on which the markets rely would be subject to delay where external
advisers had to be consulted by the auditors. This would mean that current attempts by certain
regulators to reduce filing periods would be frustrated as two professional firms would need to be
involved at the same time which in many cases would be unrealistic.
Cost
Non audit service prohibition would result in an increase in of professional costs in key areas: as regards
the non-audit services, such services can usually be provided at far less cost by auditors who have the
benefit of their cumulative audit knowledge; as regards the audit service, the need for one firm to advise
on and another to audit key issues would inevitably increase costs. We believe this would impact
particularly on businesses which are medium and small sized.
Thus, in summary, we conclude that since such evidence as there is indicates that there is no correlation
between levels of non-audit fees and audit failure, comprehensive safeguards are already applied, and
rigorous separation of non-audit services seems likely to increase the cost and reduce the quality of the
audit, the suggestion should not be pursued. Assuming no undue overall economic dependence results
from the auditor/client relationship and adequate safeguards can be implemented, we believe that
companies themselves should determine whether they use auditors for non-audit services, in
consultation with the profession's guidelines. ANS2:
1. Prior period financial reports can be used to understand the client’s financial performance and
position over several periods. Past periods provide a benchmark for analyzing the current period. For
example, trend analysis can reveal whether the client is growing, becoming more profitable, changing
the mix of products and locations, how cash flows change during the year etc. Detailed analysis can
reveal whether the client is financing its operations through debt or equity, using short or long term
debt, whether it is exposed to foreign currency movements (which it will be because of the imports from
Asia) and how the exchange risk is being managed. The auditor can use the understanding gained from
analyzing past financial reports to assess the risk of misstatement in individual accounts.
2. Anticipated results (forecasts) can reveal where the client foresees risks and understand how the
client plans to handle them. Forecasts can be used to understand what changes the client believes the
future will bring, and how they will impact on the business. Management forecasts and plans can be
analyzed to reveal how growth etc. will be financed.
3. Industry averages provide a benchmark against which to assess the client. Is the client typical of the
industry? How does it vary? Understanding the differences between the client and the other members of
the industry can provide context for judging how the likely future economic conditions will affect the
client, and which accounts are mostly likely to be at risk of material misstatement. ANS3:
The most reliable evidence would be gathered by re-performance of a sample of bank reconciliations.
The auditor could judge if all items were dealt with appropriately. In addition, completed bank
reconciliations can be inspected for evidence of identification of errors and follow-up. The least reliable
evidence would be obtained from observing client staff complete a bank reconciliation or by making
enquiries of the client staff (because these procedures would not provide reliable evidence about the
bank reconciliation performance at earlier periods when different staff were involved The overall
objective of an auditor, in terms of gathering evidence, is described in audit standards, namely; ISA 500
Audit Evidence. "The objective of the auditor is to design and perform audit procedures in such a way to
enable the auditor to obtain sufficient appropriate audit evidence to be able to draw reasonable
conclusions on which to base the auditor's opinion.' •Sufficiency relates to the quantity of evidence.
•Appropriateness relates to the quality and reliability of evidence. There needs to be enough' evidence
to support the auditor's conclusion. What is ‘enough' at the end of the day is a matter of professional
judgement. However, when determining whether they have enough evidence on file the auditor must
consider: •the risk of material misstatement; •the materiality of the item; •the nature of accounting and
internal control systems; •the auditor's knowledge and experience of the business; •the results of
controls tests; •the size of a population being tested; •the size of the sample selected to test; and •the
reliability of the evidence obtained. Auditors will confirm year-end bank balances directly with the bank.
This is a good source of evidence but on its own is not sufficient to give assurance regarding the
completeness and final valuation of bank and cash amounts. The key reason is timing differences. The
client may have received cash amounts or cheques before the end of the year, or may have paid out cheques before the end of the year, that have not yet cleared the bank account. For this reason the
auditor should also perform a bank reconciliation. In combination these two pieces of evidence will be
sufficient to give assurance over the bank balances. Appropriate evidence Appropriateness of evidence
breaks down into two important concepts: •reliability; and •relevance. Auditors should always attempt
to obtain evidence from the most trustworthy and dependable source possible. Evidence is considered
more reliable when it is: •obtained from an independent external source; •generated internally but
subject to effective control; •obtained directly by the auditor; •in documentary form; and •in original
form. Broadly speaking, the more reliable the evidence the less of it the auditor will need. However the
converse is not necessarily true: if evidence is unreliable it will never be appropriate for the audit, no
matter how much is gathered. To be relevant audit evidence has to address the objective/purpose of a
procedure. For example: Attendance at an inventory count provides us with a good example of the
relevance of procedures. During counting the auditor considers the relationship between inventory
records and physical inventories, as follows: •identifying items of physical inventory and tracing them to
inventory records to confirm the completeness of accounting records; and •identifying items on the
inventory record and tracing them to physical inventories to confirm the existence of inventory assets.
Audit Evidence Techniques • Inspection of documents and records • Inspection of tangible assets •
Observation • Enquiry • Confirmation • Recalculation • Reperformance • Analytical procedures Ans : b) The auditor would approach discussions with client staff with professional scepticism. This
means that the auditor does not assume the client staff are lying, but the auditor has a questioning
mind, being alert to conditions which may indicate possible errors or fraud. The auditor makes a critical
assessment of any statements by the staff. For example, do the statements make sense given what the
auditor knows about the client and in the context of other evidence gathered? What other evidence
could be obtained to support the statements? How much would the auditor expect the staff to know
about bank reconciliations performed by other staff at other periods? The auditor cannot assume that
staff would lie and not ask them about the audit, but the auditor cannot rely on staff statements alone. A
bank reconciliation is a process in which the sums recorded in a company's bank accounts are compared
and reconciled with the entries in their internal ledgers. This mechanism allows us to identify any
differences, which can then be addressed accordingly, and thus constitutes a genuine and exhaustive
check on the state of the company's accounts. As with any other process within the company,
reconciliations must be audited at least once a year in order to verify their accuracy. In order to begin,
we need a copy of the bank reconciliation of the month we wish to audit, a copy of the corresponding
accounting records, and a copy of the bank statement for the month in question.The fundamental first
step is to begin with a triple check, comparing the balance on the three documents and confirming that
it is correct. If a reconciliation process has been deemed necessary, we can assume that some difference
between the balances given will be found, and this means we will have to check that this difference is
justified and under control.The next step is to review every transaction on the bank account and check
them against general accounting records. To make this task easier, a check-mark can be placed against
each item verified on the printed copies of both documents. It is worth noting that tools do exist to
automate this process, or at least part of it. When this process is complete, attention must be focused on
items, that do not appear on both documents, in order to ensure that they appear correctly on the
reconciliation document, along with a description of what they are. We may find, for example, deposits
on the account that have been processed late, or cheques paid out that have not been redeemed by the bank. Finally, we must check that the sum of the outstanding items from the reconciliation is equal to
the difference between the final balance of the bank account and the final balance in the general
accounting records.If you do your bookkeeping yourself, you should be prepared to reconcile your bank
statements on a fixed schedule (more on that below). If you work with a bookkeeper or online
bookkeeping service, they’ll handle it for you. You only need to reconcile bank statements if you use the
accrual method of accounting. If, on the other hand, you use cash basis accounting, then you record
every transaction at the same time the bank does; there should be no discrepancy between your books
and your bank statement. Not sure which accounting method you’re using? This article on cash vs.
accrual accounting will make it clear. Bank reconciliations may be tedious, but the financial hygiene will
pay off. Here’s why they it’s a great idea to do them. 1. To see your business as it really is : When you
look at your books, you want to know they reflect reality. If your bank account and your books don’t
match up, you could end up spending money you don’t really have—or holding on to the money you
could be investing in your business. 2. To track cash flow : Managing cash flow is a part of managing any
business. Reconciling your bank statements lets you see the relationship between when money enters
your business and when it enters your bank account, and plan how you collect and spend money
accordingly. 3. To detect fraud : Reconciling your bank statements won’t stop fraud, but it will let you
know when it’s happened.For instance, you could pay a vendor by check, but they could tamper with it,
making the amount withdrawn larger, and then cash it. The discrepancy would show up while you
reconcile your bank statement.Or you might share a joint account with your business partner. When they
draw money from your account to pay for a business expense, they could take more than they record on
the books. You’d notice this as soon as you reconcile your bank statement. Hopefully you never lose any
sleep worrying about fraud—but reconciling bank statements is one way you can make sure it isn’t
happening. 4. To detect bank errors : It’s rare, but sometimes the bank will make a mistake. If there’s a
discrepancy in your accounts that you can’t explain any other way, it may be time to speak to someone
at the bank. 5. To stay on top of accounts receivable: If you use the accrual system of accounting, you
might “debit” your cash account when you finish a project and the client says “the cheque is going in the
mail today, I promise!”. Then when you do your bank reconciliation a month later, you realize that
cheque never came, and the money isn’t in your books (even though your bookkeeping shows you got
paid). Bank reconciliations are like a fail-safe for making sure your accounts receivable never get out of
control. And if you’re consistently seeing a discrepancy in accounts receivable between your books and
your bank, you know you have a deeper issue to fix. Ans c) The staff changes impact on the controls testing program because the auditor would require
evidence that the performance of bank reconciliations was similar in different periods. The auditor
would be careful to obtain evidence about the performance of the controls from each period. If there
was any evidence that performance was poor during any sub-period, the auditor would seek to obtain
additional evidence about control performance, or increase the substantive testing. Change Control is
the process that management uses to identify, document and authorize changes to an IT environment. It
minimizes the likelihood of disruptions, unauthorized alterations and errors. The change control
procedures should be designed with the size and complexity of the environment in mind. For example,
applications that are complex, maintained by large IT Staffs or represent high risks require more
formalized and more extensive processes than simple applications maintained by a single IT person. In all
cases there should be clear identification of who is responsible for the ...
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