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SOLUTION MANUAL
to accompany

MODERN AUDITING
&
ASSURANCE SERVICES
5th edition
Prepared by
Philomena Leung, Paul Coram, Barry Cooper and
Peter Richardson

© John Wiley & Sons Australia, Ltd 2011

Solution Manual to accompany Modern Auditing and Assurance Services 5e

Chapter 2 Governance and the Auditor
Review questions
2
...
It comprises the corporate
governance concept of conformance and accountability; and the strategic direction
concept of performance and value creation of an organisation or enterprise
...

The conformance aspect, primarily based on corporate governance best practice,
addresses issues such as:







The roles of the chairman of the board and the top management, i
...
, the Chief
Executive Officer of the organisation to ensure accountability and independence;
The composition, skills base, remuneration, and training of the board, and its
committees such as the roles of the non-executive directors, audit, nomination and
remuneration committees;
The adequacy and reasonableness of compensation schemes for executives;
Internal control structures, risk management, and the role of internal audit;
The financial reporting and disclosure regime; and
The independence of the audit function and the reporting mechanisms
...
As the conformance aspect is also concerned with the
historical matters, it also corresponds with the underlying concept in the International
Assurance Framework dealt with in Chapter 1
...
Depending on the jurisdiction in
which the organisation is based, the external auditors may also be required to ensure the
organisation and the board of directors have complied with all relevant legislation and
regulations
...
The recent development in corporate governance, such as the CLERP 9 Act 2004,
the ASX Corporate Governance Principles, and guidelines concerning non-executive
directors and audit committees, are all aimed to ensure the effectiveness of accountability
processes
...
The performance aspect

© John Wiley & Sons Australia, Ltd 2011

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Auditing and assurance services include those assurance services which deal with
historical financial information
...
Moreover, the identification of risks, and the
assessing of risk management processes, overlap the corporate governance and strategic
areas of the organisation
...
12

What is meant by earnings management? How do you think the concept of
earnings management might have influenced the auditor’s role in the audit of
financial statements?

Earning management occurs when the management manipulates financial statements and
transactions in order to influence the public’s perceptions about the economic
performance of the entity
...

Incentives for earnings management are inherent in the management structure and
culture
...
In extreme cases,
earnings management can amount to fraud
...
The
auditor’s role has changed quite significantly, with increasing audit resources and
techniques in place to focus on detecting earnings management practices
...

ASA240 also recommends auditors to carry out a greater number of procedures to
enhance the prospects of detecting material financial misstatements resulting from fraud
and earnings management practices
...
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Solution Manual to accompany Modern Auditing and Assurance Services 5e

2
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The ANAO audits the activities and performance of government agencies,
authorities and companies
...
The performance
audits are aimed at examining the economy, efficiency and effectiveness of the
operations of government entities
...
ANAO is
the audit office for the Parliament and the Commonwealth agencies and statutory bodies
...
Employees of the
ANAO carry out various audit functions under the guidance, authorisation and charter of
the A-G, who is essentially the head of ANAO
...


2
...

Internal auditors can assist the board of directors of an organisation in the following
ways:
 As internal auditors are directly reporting to the Audit Committee, the Audit
Committee can advise the board of the level of compliance and performance in
relation to each director’s portfolio of responsibilities,
 Independently review operations or programs to ascertain whether they are
being carried out consistently with the board’s objectives and policies,
 Assisting the board to improve on governance policy’s setting and operations
by providing recommendations,

© John Wiley & Sons Australia, Ltd 2011

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Providing evidence-based information regarding the effectiveness of internal
controls and risk management policies and processes,
Giving assurance on financial and management reports
...
Independence is achieved through
organisational status and objectivity
...

 The chief internal audit executive has direct communication with the board of
directors or its audit committee
...


2
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 Plan the audit
...

 Report findings to management
...

The principal differences between an operational audit and a financial report audit are:
Phase

Operational Audit

Initial
Reporting
Post-reporting

Select auditee
To management
Perform follow up

2
...


The accountability framework consists of the auditor-general being the independent
auditor who undertakes the audit and reporting function on all Government departments,
agencies and entities
...


© John Wiley & Sons Australia, Ltd 2011

2
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Often a
committee is set up to review public finance expenditures, agency budgets or certain
actions taken by the Government
...

These committees are known for maintaining the accountability of the public sector:
 Public Accounts Committee,
 Senate Estimate Committee
 Joint Committee of Public Accounts and Audits (JCPAA)
As the Parliament’s watchdog, JCPAA has the power to:
 Examine the accounts of the receipts and expenditure,
 Examine the financial affairs,
 Examine all reports of the auditor-general laid before the houses of Parliament,
 Report to both houses matters relate to accounts, statements or reports which
the committee feels should be brought to the Parliament’s attention,
 Report desirable alternations/recommendations into the management and
maintenance of public accounts,
 Inquire into matters raised by the auditor-general and referred matters to the
committee by either house of Parliament,
 Recommend to either house of appropriate actions to be taken on matters
raised
...
18

What are the duties and powers of the Australian auditor-general?

The auditor-general (in both state and Commonwealth spheres) is an independent officer
of parliament who audits and reports to parliament on the activities and performance of
government agencies, authorities, companies and their controlled entities
...
The
auditor-general is responsible for financial statement audits of government-controlled
entities
...


2
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Another is the standard of probity and propriety (ethics)
of public officials
...


© John Wiley & Sons Australia, Ltd 2011

2
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Propriety: to ensure that management decision and actions are appropriate in
regard to the stewardship of public moneys
...
20 Define and illustrate the meaning of economy, efficiency, and effectiveness in
the performance audit of the public transport system
...

 “Efficiency” means the use of resources such that output is optimised for any
given set of resource inputs, or input is minimised for any given quantity and
quality of output
...

For example, in respect of a public transport system, the meaning of economy, efficiency
and effectiveness can be illustrated as follows:
Economy





Efficiency





Effectiveness






Acquisitions of rolling-stock that meets safety,
environment and performance requirements (such as
low emission vehicles, achieving required passenger
capacity, safety devices and low maintenance costs),
Improvements in infrastructure that meet the
appropriate time-frame, budgetary measures and
occupational/passenger health and safety,
Staffing requirement is sufficient to maintain high
level of public safety and minimise fare evasion
...

Trams, buses and trains arrive on-time, or within the
limit allow for late/early arrival,
Fare evasion is kept to a minimum standard,
Passenger capacity is fulfilled,
Customer complaints are kept to minimum

© John Wiley & Sons Australia, Ltd 2011

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21
Establishing an effective internal audit department
Required
Explain the key considerations of the matters you will discuss with the chair of the
audit committee
...
The scope of internal auditing should encompass the examination and evaluation of (a)
the adequacy and effectiveness of the organisation’s governance and internal control
structure, (b) the quality of performance in carrying out assigned responsibilities, (c)
the procedures of risk identification and management, and (d) the mechanisms to
ensure regulatory compliance
...
The role of internal auditors should:
• review the reliability and integrity of financial and operating information and the
means used to identify, measure, classify and report such information
• review the systems established to ensure compliance with those policies, plans,
procedures, laws and regulations that could have a significant impact on operations
and reports, and determine whether the organisation is in compliance
• assess risks within the business operations and those from outside the business which
may affect the ongoing wellbeing of the organisation as a whole
• review the means of minimising risks and help management with risk management
processes
• appraise the economy and efficiency with which resources are employed
• review operations or programs to ascertain whether they are being carried out as
planned, and whether results are consistent with established objectives and goals
3
...

There is usually a close relationship between internal auditors and an entity’s outside
independent auditors
...
One of the
responsibilities of the chief audit executive is to coordinate the work of internal auditors
with the work of the external auditor
...
ASA 610 Considering the Work of Internal Audit (ISA 610)
establishes standards and provides guidance to external auditors on obtaining an
understanding of the activities of internal auditing and its effect on audit risk
...
8

Chapter 2: Governance and the auditor

2
...
Refer
to specific examples — choose some large companies and access information from
their websites
...
The main objectives of an effective audit committee
include the following:
• assisting the directors to discharge their responsibilities with due care, diligence and
skill; in particular, the audit committee is concerned with:
– financial statements and financial information
– the appropriateness of accounting policies used
– adequacy of financial management policies and procedures
– adequacy and monitoring of internal control structures
– proper risk management plans and processes
– business practices
– protection of assets, including intellectual property
– compliance with relevant laws, regulations, standards and best practice guidelines
...

Students can access annual reports of companies where the objectives and performance of
audit committees are reported
...
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Solution Manual to accompany Modern Auditing and Assurance Services 5e

Case studies
2
...

Explain the importance of the audit committee charter
...
The IIA professional statement include the following matters in the charter:
The audit committee should report to the board on the following matters:
– assessment of whether external reporting is consistent with information and
knowledge available to them and whether it is adequate for shareholders
– assessment of the reporting processes
– procedures for the selection and appointment of the external auditor and the
rotation of the audit partner
– recommendations for the appointment or removal of an auditor
– assessment of the performance and independence of the external auditor, with
special consideration if there is the provision of non-audit services
– assessment of the performance and objectivity of the internal audit function
– the results of its review of risk management and internal compliance and control
systems
...
24 Madoff’s scheme
Required
Evaluate the case from an audit point of view, highlighting possible risks for an
investor and a fund manager who might be attracted to such a scheme
...
Moreover there must be dividends from the investments and
details of the investors must be recorded with details of the funds that were paid into their
accounts
...
Presumably,
all these were fake
...

The possible risks for an investor who invests in such funds include:
 Market risks where the investments are unsound and loss are accrued;
 Financial risks where the returns of the investments are concealed from the
investors;

© John Wiley & Sons Australia, Ltd 2011

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The possible risks for a fund manager include:
 Investment risks where the fund manager commits to a phony investment;
 Loss of reputation for the fund manager who invests in a phony scheme;
 Loss of money in respect to inability to repay investors
...
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Solution Manual to accompany Modern Auditing and Assurance Services 5e

Research Question
2
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The management of the company is preparing for a major cut in
operations and retrenchments
...

As the organisation have lost a significant amount of investments, audit
committee should identify potential impairments or write-offs that should be done
so that the investments will be properly reflected in the financial statements
...

As there are a lot of risks that could affect the organisation, audit committee
should identify and analyse a broader range of risks and devise a risk management
plan and processes that could properly respond to those risks
...

Audit committee should ensure that all material information relating to the
organisation to be disclosed
...


2
...
Write a synopsis of the efficiency and
effectiveness of the ANAO’s business continuity management plan
...
12

Chapter 2: Governance and the auditor

• improved efficiency and effectiveness of business-as-usual operations;
• the ability to use negative events as opportunities to improve business processes;
• identifying key interdependencies that may not have otherwise been apparent; and
• building resilience that facilitates managing and recovering from a business disruption
event
...

 BCM plan should be subject to systematic review
...

 A structured and regular system of performance monitoring of the BCM
...
The reporting includes the status of the business continuity
plan and follow-up of post incident reviews from any exercises that have been
conducted or any incidents that have occurred during the period
...
Some examples of review
triggers are changes to the entity’s outcomes and outputs, machinery-ofgovernment changes, major changes to personnel or technology, a change in
physical location, or following a test, exercise or an actual business disruption that
has highlighted deficiencies
...


© John Wiley & Sons Australia, Ltd 2011

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