Auditing and Professional Practice

Fundamental Principles of an Audit

Discuss about the Auditing and Professional Practice.
 

1. The Auditing standard of Australia AUS 202 states that the purpose of an Audit of financial report is to facilitate the auditor to express an opinion on the financial statement prepared on the basis of established financial reporting framework. For the purpose of performing the audit objectively and efficiently the standard has prescribed general principles of an Audit. It is mandatory for Auditor to act in accordance with the ethical requirement of CPA Australia and ICAA (Gray and Manson 2007). The fundamental principle of Audit prescribed by the standard are:

• Independence;
• Integrity;
• Objectivity;
• Competence and due care;
• Confidentiality;
• Professional behavior;
• Technical standards.

An Auditor is required to encounter a number of threats while rendering professional services these threats may result in the non compliance of fundamental principles (Dogui and Herasâ€ÂSaizarbitoria 2014). The threat for noncompliance with fundamental principle may come from the following:

• Self Interest: The threat of self interest may arise due to financial or other interests. The self interest obscures the professional judgment and objectivity of the auditor.
• Self Review: The threat of self review arises when an Auditor is required to review or revaluate the judgment earlier made by him. It arises because of biases and prejudices of the auditor.
• Advocacy: The threat of Advocacy arises when the auditor promotes an opinion or position to such an extent that it compromises professional independence.
• Familiarity: The threat may arise from familiarity due to close relationship with client. It may compromise the auditor’s professional integrity.
• Intimidation: The threat of Intimidation may arise when the auditor is prevented from acting objectively. 

In the given case the Bolt Ltd has asked its auditor to analyze the potential accusation of steel pty ltd and to prepare a report on it. The Auditor was performing his duty but after reviewing a draft report the CFO has asked the Auditor to focus on sales and profitability and to avoid the analysis of cash flow. The fundamental principle includes independence but in the given case it can be seen that CFO is providing direction or judgment about the analysis to be made thus hampering the independence of the auditor. As the auditor is unable to analyze the situation independently this will affect competency with which an auditor functions. Therefore violation of one fundamental principle of independence will further lead to the violation of another principle of competence and due care. The objectivity principle requires the auditor to perform the work in such a manner that the quality of the work is not compromised. The suggestion of the CFO if followed will not only be violation of independence but it will also hamper the quality of work performed thus principle of objectivity is also violated.

In the given case the threat to violation of fundamental principle is from self interest of the auditor. In order to protect the audit engagement the auditor may compromise on the quality of the analysis. The fundamental principle is at risk due to intimidation. In the given case the auditor was deterred from performing his task effectively thus violating the fundamental principles.

In conclusion it can be said that the discussion with the CFO indicates that there is a threat to the fundamental principles of independence, objectivity and competence. This threat to the fundamental principles arises from self interest and intimidation faced by the auditor.

Threats to Fundamental Principles

2. (A) In a business a manager or an executive is always engaged in making decision. The decision made by them affects various stake holders therefore it is very important that an ethical decision making process is followed.  The American Accounting Association (AAA) Model puts forward an effective framework within which an ethical decision can be made (Craft 2013). The AAA model was developed from a report written by Langenderfer and Rockness in 1990 which has suggested seven logical steps for an ethical decision making (Thomas 2012). These steps are outlined below:

• The first step is to establish the facts or particulars of the case. In this step the process of decision making begins and therefore it is important to ensure that there is no vagueness about what is under consideration.
• The second step forms identification of ethical issue. This requires examination of the details of the case and determining the ethical matter that are at stake.
• The third step is to identify the norms, principles and values related to the case. This involves putting the decision making process in the context of social, ethical and professional behavior.
• The fourth step is to identify the alternative course of action. In this step every possible outcomes are considered whether appropriate or inappropriate.
• The fifth step is to identify the best course of action. In this step after considering all the option the best option is chosen. At this stage it will be possible to ascertain whether the outcome of the option is in accordance with the ethical principles.
• In the sixth step the consequences of the outcomes are determined so that implication of each outcome becomes clear in order to make the final decision.
• . At the seventh step the decision is taken.

In the given case of Luke and Zane the AAA model can be used for ethical decision making the seven steps are given below:

1. Facts of the case: In the given case Luke and Zane are two senior Auditors in atop audit firm. They work in a highly competitive environment and both are aspirant for the post of Audit Supervisor. In case of a particular job Zane was replaced and Luke was bought in for that assignment. After taking on the assignment Luke discovered that the main reason for replacing Zane was not that was provided but the true reason for replacement was that the client has made a complained against Luke to the Audit Manager. The client made the allegation that Zane was late at work and has failed to address various issues regarding. The Luke after verifying the work has found that Zane has performed an excellent work and suspected that the audit manger was misled by the client because of may be personal problem, between Zane and the client.
2. Ethical Issue Involved: In this case the decision of Luke to use the hard work made by Zane in bringing out the issues which otherwise would have been overlooked by him is an ethical issue. It is an ethical issue because on successfully resolving these issues may help him in obtaining promotion by getting good review from customers.
3. Norms: An Auditor is required to follow the ethical principles and professional behavior while conduction Audit.
4. Alternative Action: The alternative course of action is that Luke can acknowledge the hard work made by Zane and should also inform the Audit Manager about the possibility that he has been misled by the client.
5. Best Course of Action: If the principles of Auditing and ethical behavior is considered then it is best for Luke to inform the manager. As it is in accordance with the basic principles and ethical behavior.
6. Consequences: If Luke considers decides to take credit of work done by Zane then he may probably receive a good review and promotion. If Luke decides to take up the matter with Manager then probably the client’s intention to violate the basic principle of Independence could be bought to the notice of Audit Manager.
7. Decision: keeping the Principles and ethical code in mind it is advised that Luke should inform Audit Manager about the work done by Zane. Further he should also inform about his doubt to the manager. 

B) The Mary Guy in 1990 has developed a list of ten core values for making ethical decisions (Shapiro et al. 2014).  These values are:

• Caring;
• Honesty;
• Accountability;
• Promise keeping;
• Pursuit of excellence;
• Loyalty;
• Fairness;
• Integrity;
• Respect for other; and
• Responsible citizenship.

Apart from the ten core values Gury also suggested five rules that integrate the values and help in ethical decision making (Lauesen 2012). They are:

• The first rule is considering the well being of others, including those are not participating. This rule puts emphasis on respect and caring for others.
• The Second rule is that actions should be as a member of a community and not just an individual. This rule emphasizes the core values of integrity, reliability, respect for others and responsible citizenship.
• The third rule is obeying the law by following the principles of integrity and responsible citizenship.
• The fourth rule is to question the basis of taking a decision. This will help to put emphasis on all values.
• Lastly in rule Five it is important to respect the other people’s custom but own ethics should not be compromised. It puts the emphasis on fairness, integrity, accountability and respect of others.

The decision to inform the manager about the work done by Zane is in accordance with core value of outlined by Mary Guy. Further the decision is in accordance with the rules outlined by her therefore it can be concluded the decision taken will remain the same.

There are two important key assertions at risks in relations to the accounts payable are as follows

1. Searching for unrecorded accounts payable: According to Johnstone et al. (2013) the understatement in liabilities are usually at relatively high risk in relation to the completeness of assertions to search for the unrecorded accounts payable. One of the significant aspects in relation to the accounts payable are that the time frame from the balance sheet till the date of completion of fieldwork is estimated to assess the most important test in auditing for accounts payable. During the process of conducting the research for unrecorded accounts payable, the auditor is under obligations to search and select the transactions over pre-determined amount of dollar while inspecting for the supporting documentations of vendors invoice for all such transactions. The area of test which the auditor undertakes to perform the discovery of unrecorded accounts payable is primarily dependent on two important  criteria which are as follows
2. Assessing the degree of control risks
3. The materiality of potential accounts payable balance in the financial statements.

If the degree of assessed level of control risk for the completeness and valuation assertions is low, then the auditor may review low number of cash disbursement transactions for a determined period after the date of balance sheet, so that the length of review period is shortened up in order to exclude or reduce reconciliation of vendor’s invoice on monthly basis by undermining the records of clients.

1. Assessing the reports obtained from the unmatched vendors invoice:

All the goods and services which the entity received prior to the end of financial year under the indications of issuance report must include accounts payable at the end of the accounting period. It is the duty of the auditor to obtain from the clients those files for all the reports which has been received as unmatched with the invoice of the vendors. The auditor on the other hand should then inspect the receiving reports which are issued at the end of the accounting year in relation to the invoice of the vendors to determine if it has been included in accounts payable. In addition to these, if the client has not received the related invoice of vendors report, then the auditor must inspect to the clients purchase order or prior to the vendors invoice for identical items. The auditor on the event of unmatched reports could consider calling the vendor to determine the amount of obligations. 

For each of the assertions there has been one substantive test in order to obtain sufficient audit evidence which are follows

1. Testing of client’s bank reconciliation statement: The significant objective of determining the clients banks reconciliation statement is to substantiate the balance in conformity with the bank agreement with the help of clients cash accounting records (Waller et al 2013). The objective of the auditor is to obtain the reasonable assurance that the process of reconciliations items is necessary in determining the difference caused by the deposits during the transit process, outstanding cheques and other reconciling items. The auditor also needs determine that the items in the process of reconciliations should be authentic complete and must be treated accordingly.

The extent of analyzing the client’s reconciliations significantly varies depending upon the level of control risk. The auditor should recall three assessments to evaluate the level of risk such as low medium or high. A probable procedure for a client reconciliations are as follows;

1. Comparing the amounts on the reconciliations with the sum totals in the bank statement, ledger balances along with the cash receipts and cash payments records, which consists of drawing up the comparison of the balance statement of bank in contrast to the amount confirmed by the bank (Srivastava and Kogan 2012).
2. Testing and determining the clerical accuracy of the reconciliation process.
   
   Vouching of other Reconciliation Items in Order to Support the Process of Documentations.

1. Considering the call for to investigate the outstanding cheques or other reconciling items which are yet to be cleared.
2. Confirmation of bank balance: The auditor usually complies with the year ending cash balances through direct correspondence procedures with the entire bank with which the clients previously had accounts during that period. The process of confirmation procedure acts as a evidence that cash balance in the statement of financial determines the position of balance at the current date which is owned by the entity and it is not limited or committed (Badertscher et al. 2013). Audit evidence during the bank procedure of confirmations is provided by the AGS 1002 ‘Bank Confirmation requests’ requests a bank to endow with self-regulating confirmation of the review of clients account balance. In addition to this, the information and the balances held by the bank on behalf of the clients also consist of instruments on treasury managements, securities and other vital documents. Under the audit procedures, there are two standard confirmation requests forms on banks has been created in compliance with the Australian bankers associations and are recommended for the use of auditors.
3. Bank confirmations: The information obtained under this confirmation is related to the usual banking activities which are used to confirm the cash balance.

Treasury operations: The information to be long-established or requested under the audit evidence verification is related to the treasury operations and utilization of treasury management instructions. 

Reference

Badertscher, B., Jorgensen, B., Katz, S. and Kinney, W., 2013. Litigation risk and audit pricing: The role of public equity. Unpublished working paper, University of Notre Dame, University of Colorado Boulder, Columbia University, and University of Texas at Austin.

Craft, J.L., 2013. A review of the empirical ethical decision-making literature: 2004–2011. Journal of Business Ethics, 117(2), pp.221-259.

Dogui, K., Boiral, O. and Herasâ€ÂSaizarbitoria, I., 2014. Audit fees and auditor independence: The case of ISO 14001 certification. International Journal of Auditing, 18(1), pp.14-26.

Gray, I. and Manson, S., 2007. The audit process: principles, practice and cases. Cengage learning EMEA.

Johnstone, K., Gramling, A. and Rittenberg, L.E., 2013. Auditing: A Risk-Based Approach to Conducting a Quality Audit. Cengage Learning.

Lauesen, L.M., 2012. Ethical Decision Making. Multidisciplinary Journal for Applied Ethics.

Shapiro, J.P., Stefkovich, J.A. and Gutierrez, K.J., 2014. Ethical decision making. Handbook of Ethical Educational Leadership, p.210.

Srivastava, R.P. and Kogan, A., 2012. Assurance on XBRL instance document: A conceptual framework of assertions. International Journal of Accounting Information Systems, 11(3), pp.261-273.

Thomas, S., 2012. Ethics and accounting education. Issues in Accounting Education, 27(2), pp.399-418.

Waller, W.S., 2013. Auditors' assessments of inherent and control risk in field settings. Accounting Review, pp.783-803.