Auditing Principles

Week 8
Question 1
What is a contingent liability? What is the difference between a contingent liability and a provision? Why is it
important for the auditor to test for contingent liabilities?
A contingent liability is a potential obligation to the entity. The accounting treatment of the potential
obligation will be determined by the outcome of an uncertain future event (eg the result of a court case).

Recognition and disclosure will occur if the outcome of the event is likely and the amount of the liability can
be estimated (measured).

In these circumstances, a provision would be required to be included in the financial reports and represents
an amount set aside by an entity as a result of an event which is pending (eg the result of a court case).

If the outcome is at this stage not clear or an amount cannot be identified or measured, the entity is
required to disclose a contingent liability in the notes of the financial reports as per AASB137.
Subsequent events are events that occur after the end of the financial period and before the
financial reports have been published and issued to the shareholders. Such events can give rise
to adjustment of amounts in the financial reports or additional disclosure in the notes to the
financial reports.

Adjusting events require inclusion in the financial reports whereas non-adjusting events focus
on disclosure in the notes (and nothing in the body of the financial reports).
Question 3
Why is it important for an auditor to assess the going concern assumption for an entity as per ASA570? What
are the implications for an entity if the auditor assesses that an entity has questions concerning the ability of
the entity to continue to operate in the next reporting period?
Question 3
The underlying premise of preparing financial reports is that information is needed to make
decisions. If an entity is assessed to be unlikely to continue to operate beyond the next 12 months,
there is no need to provide financial reports for the purposed of making financial decisions.

Eg: The valuation of assets in the financial reports is based on the premise that the entity is a going
concern. The definition of an asset is essentially the ability to use a resource controlled by the entity
to generate income in the future. The value of an asset in the balance is therefore based on whether
it can be used in the future to generate income, it is not based on how much it might be sold for.

If an entity has questions associated with their ability to continue as a going concern, the auditor
must notify ASIC as there are strict rules contained in the Corporations Act 2001 and Federal
Legislation which prohibits an entity from continuing to trade (operate) if the management of that
entity know the entity is unable to meet the
requirements to be assessed as a going concern.

Therefore, the entity must cease trading until corrective measures can be implemented by ASIC
(such as placing the entity into voluntary administration).
Question 4
What is the difference between an unqualified and a modified audit opinion? Give one example of when the
auditor might issue a modified audit report. What signal does the issuing of a modified audit opinion give to
shareholders?
Question 4

If there are no issues with the figures reported, the disclosure of those figures or going
concern issues, this gives rise to an unqualified opinion.

If there are any departures from the Accounting Standards or other mandatory requirements,
this is essentially a breach of the Corporations Law, and will result in a modified opinion.
Depending on the magnitude of this departure, it can range from an “except for” opinion all
the way up to “adverse” if the issue is material and significant and will significantly impact on
the decision making process of the statement user.
Question 6: Arens1 text, page 37 question 1.33
AUDITING STANDARDS ACTIONS OF HARRIS RESULTING IN FAILURE TO COMPLY
1. ASA 220 There is a lack of professional independence. Because of the financial interest in whether the bank loan is
granted, Harris is independent neither in fact nor appearance with respect to this assignment.
2. ASA 210 No reference to an audit engagement letter.
3. ASA 220 It was inappropriate for Harris to hire the two students to conduct the audit. Audit assistants may help in the
conduct of the audit provided that there is proper supervision and review.
4. ASA 220 Harris did not properly supervise nor review the work and judgments of the assistants.
5. ASA 230 There was no documentation of the audit plan, audit procedures and the results of the work conducted.
6. ASA 300 Harris accepted the engagement without considering the availability of competent staff. Knowledge of the
client’s business was not obtained. The audit was not adequately planned and supervised.
7. ASA 315 Harris did not assess risk nor obtain an understanding of the internal control structure. No audit has been
conducted. The work performed was more an accounting service than an audit.
8. ASA 500 Harris acquired no evidence to support the financial statements. Harris merely checked the mathematical
accuracy of the records and summarised the accounts. Standard audit procedures linked to audit objectives
were not performed.
9. ASA 700 Harris’ report made no reference to accounting standards. Because a proper audit was not conducted, the
report should state that no opinion can be expressed as to the fair presentation of the financial statements in
accordance with accounting standards. No reference was made to the Corporations Act 2001.

By not properly planning and conducting the audit, Harris did not obtain a proper understanding of the client
and could not assess consistency of the financial statements with such knowledge.