Auditing Ch 2 Audit Concets, Role and History

Mike Pratt, Karen van Peursem, Mukesh Garg, Auditing Theory & Practice, 1st Australasian Edition.
© 2023 Cengage Australia Pty Ltd.

All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Chapter 2
Audit concepts, role
and history
Mike Pratt, Karen van Peursem, Mukesh Garg, Auditing Theory & Practice, 1st Australasian Edition. © 2023 Cengage Australia Pty Ltd.
Learnings objectives
After studying the material in this chapter, you should be
able to:
• explain the purpose and elements of a conceptual
framework for audit
• explain the role of the external auditor.
Conceptual framework for audit
Credibility through process for auditors
• Audit risk
• Audit risk is the concern that the auditor may express an inappropriate opinion on the
financial statements.
• Audit evidence
• The auditor’s ability to express an opinion on the truth and fairness of financial
statements will depend upon the accumulation of sufficient, relevant and reliable
evidence.
• Audit materiality
• Materiality is a fundamental concept of auditing that will influence the nature, extent
and timing of the audit work carried out.’
Cost–benefit of obtaining further audit evidence
Interactions between audit evidence,
materiality and risk
Credibility through disclosure
‘Communication’ is fundamental to audit. So, for example, without an audit
opinion about the accounts’ compliance with GAAP, the discoveries made by the
auditor have no meaning.
Typically, the auditor may communicate as to:
• the negotiation of audit contracts and fees
• decisions about the scope, level of assurance and intended user of the opinion
• obtaining access to the client’s documents and records
• what comprises the client’s responsibility and what is expected of the auditor
• how to improve the client’s processes or systems
• situations in which the auditor must share their findings.
Credibility through accountability
To fulfil their responsibilities, the assurance professional must also be
held to account. We agree with Flint (1988) that the effort made to
achieve audit goals would be in vain if there were no mechanisms to
ensure that professionals are held to account. That is, to be trustworthy,
auditors are accountable to those in their company and their profession,
to their client, and to other stakeholders who rely on the audit opinion.
• To the firm
• To the profession
• To the client
• To the public.
The role of the external auditor
People rely on auditors’ opinions to make financial decisions, and
businesses rely on the public’s trust in those statements to attract
investors.
A role is the sum of cultural and behavioural patterns associated
with a particular status within a society … [it consists of] attitudes,
values and behaviour ascribed by society to any and all persons
occupying this status. (Davidson, 1975)
Role senders
• Those who influence auditors’ behaviour are referred to as role senders. As Davidson
(1975) states, role senders can have legal, contractual or cooperative relationships with
the auditor (see Figure 2.9 Role of the auditor: Formal and informal role senders).
Role conflict: The expectation gap
Because of these different interests, the auditor’s role shifts, and auditors may
come into conflict with certain of their stakeholders at different times and in
different circumstances.
The audit expectation gap may arise from a number of sources, some of which
can be explained from audit theory:
• Principal board members may expect auditors to monitor manager-agents closely.
• Economic players may seek a fast turnaround and quick response to market conditions so that they
can make buy/sell decisions.
• Stakeholders may expect the auditors to provide insurance for their losses.
• Social accountability advocates may expect auditors to identify social inequities.
• External stakeholders may expect the auditor to discover all fraud or errors.
The audit expectation gap
Sources that may contribute to the audit

expectation gap
Fraud detection
Management fraud involves either the misappropriation of an organisation’s assets (such as
stealing equipment) or the manipulation of accounting information (such as overstating asset
valuation).
• In Australia, the Corporations Act 2001 (s 1308) states that a person commits an offence if a document is required
under or for the purposes of this Act; or is lodged with or submitted to the Australian Securities and Investments
Commission (ASIC); and the person makes, or authorises the making of, a statement in the document; or omits, or
authorises the omission of, a matter or thing from the document; and the person knows that the document is
materially false or misleading because of the statement or omission.
• In New Zealand, the Companies Act 1993 (as amended to 2017) states that anyone who ‘knowingly makes a
materially false or misleading statement in any document … required by the Act will be criminally liable’ (s 377,
1(a)). Therefore, an auditor commits an offence if they make a false disclosure, or fail to disclose matters of which
they have knowledge and which should be disclosed in the audit report.
Predicting company failure
Company failure as an audit began after securities regulations in the 1930s brought
the professional accountant/auditor more firmly into the role of regulating markets.
Portrayed in the accounting standards as a going concern issue, predicting company
failure is a unique task for auditors who are not usually called upon to predict future
events (see Figure 2.12 Auditors can be called upon to predict a going concern
issue).
Detecting and reporting illegal acts
Traditionally, the auditor has not had a duty to discover or disclose illegal acts by the client
when not specifically contracted to do so.
ASA 250 and ISA NZ 250 point out that management’s (and the governing board’s) responsibility is to comply
with the law. Nonetheless, they do distinguish between laws and regulations that have a direct, material effect
on the financial statements and those that affect the likely continuance of the client. As to the first:
• The provisions of those laws and regulations generally recognised to have a direct effect on the
determination of material amounts and disclosures in the financial statements such as tax and pension laws
and regulations. (ASA 250, para 6(a))
For these matters, the auditor should obtain sufficient appropriate evidence, as would be
expected for any potentially material amount on the financial statements.
Role conflict: Expectation gap positions
It may be better to withdraw from an engagement – even if there has been
significant time spent – should they run the risk of being associated with illegal
or fraudulent acts. Table 2.2 shows expectation gap positions

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Mike Pratt, Karen van Peursem, Mukesh Garg, Auditing Theory & Practice, 1st Australasian Edition.

© 2023 Cengage Australia Pty Ltd.

Sources that may contribute to the audit

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