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CONTENTS
Acknowledgements xiv Index of legal cases xv Preface xvi
1 Why are auditors needed? 1
Learning objectives 1
Opening remarks 2
Introduction to basic principles through a simple case 3 Case study 1.1: Andrew and James, Parts 1-4 3 Justification of audit 7
Case study 1.1: Andrew and Jones, Part 4 8
Introduction to truth and fairness in accounting 11 Basic audit framework 14
Some initial ideas on an extended role for audit 14
Assurance services 19
Summary of principles 19
Definition of an audit of financial and other information 21 The Auditors' Code: The Fundamental Principles of
Independent Auditing 22
Summary 25
Key points of the chapter 25
References 26
Further reading 26
Self-assessment questions (solutions available to students) 27 Self-assessment questions (solutions available to tutors) 27
2 An overview of the postulates and concepts of auditing 28
Learning objectives 28
The importance of theory and concepts in underpinning auditing practice 29
The postulates of auditing 31
The concepts of auditing: credibility, process, communication, performance 32
Introduction to the audit expectations gap 46
The layers of regulation and control 48
Summary 52
Key points of the chapter 53
References 54
Further reading 55
Self-assessment questions (solutions available to students) 55 Self-assessment questions (solutions available to tutors) 55
3 The meaning and importance of auditor independence: factors affecting
independence and measures to attain it 56
Learning objectives 56
Introduction 57
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Independence and the role of audit 57 Definitions of independence 60
Practitioner and profession independence 61
Conflict, power of auditor and client and effect on perceived independence 66
General principles of the IFAC code 73
Ethical standards (ESs) issued by APB 74
Other pronouncements on auditor independence 95
Summary 98
Key points of the chapter 98 References 101
Further reading 101
Self-assessment questions (solutions available to students) 101 Self-assessment questions (solutions available to tutors) 102
4 Audit regulation 104
Learning objectives 104
The need for regulation 105
Companies Act 1989 107
Overview of the UK regulatory system in force until 2003 109 Monitoring audit firms' standards 111
Present regulatory system 112
Financial Reporting Council (FRC) 114
The Professional Oversight Board (POB) 114
Accountancy Investigation and Discipline Board (AIDB) 116 Auditing Practices Board (APB) 116
Accounting Standards Board (ASB) 120
Financial Reporting Review Panel (FRRP) 120
Audit monitoring 121
Report of the Co-ordinating Group on Audit and Accounting
Issues (CGAA) 122
Further regulation of auditing by the law and accounting profession 124
The statutory and practical relationships 124
Rules on appointment, removal and resignation of the auditor 127
Case study 4.1: Rosedale Cosmetics plc, Parts 1-6 128
Private companies 138
Summary 139
Key points of the chapter 139 References 141
Further reading 141
Suggested solutions to tasks 141
Self-assessment questions (solutions available to students) 143 Self-assessment questions (solutions available to tutors) 144 Appendix 4.1: Summary of some of the requirements of the 1989 Companies Act 145
Appendix 4.2: Relevant sections of the Companies Act 1985 147
5 The risk-based approach to audit: audit judgement 166
Learning objectives 166
Why is a risk-based approach to audit an aid to the auditor? 167
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The components of audit risk 173 Case study 5.1: Edengrove Limited 173
Case study 5.2: Kemback Limited, Parts 1 and 2 181, 184 Engagement risk and independence in fact risk 186.
Business risk approach to audit 186
Business risk and inherent risk approaches: similarities and dissimilarities 190
The business risk approach and smaller clients and smaller audit firms 193 Analytical review as a risk analysis tool 194.
Judgement in accounting and auditing and its relationship to risk 195 Management of the audit process 197
Case study 5.3: Hughes Electronics Limited 199
Case study 5.4: County Hotel Limited, Parts 1 and 2 203
Summary 211
Key points of the chapter 211
References 213
Further reading 213
Suggested solutions to tasks 214
Self-assessment questions (solutions available to students) 216 Case study 5.5: Cosmetics company: Fine Faces plc 217 Self-assessment questions (solutions available to tutors) 219
6 The search for evidence explained 221
Learning objectives 221
The audit defined as a search for evidence to enable an opinion to be formed 222
Forming conclusions on the basis of evidence: The exercise of judgement 224
Reliability of audit evidence (grades of audit evidence) 227 Case study 6.1: Ridgewalk ple 232
The business risk approach to gathering audit evidence 234 The stages of the audit process and the evidential requirements
at each stage 237
Limited assurance and compilation engagements and agreed upon procedures 237
Conclusion 242
Summary 242
Key points of the chapter 242
Reference 243
Further reading 244
Self-assessment questions (solutions available to students) 244 Self-assessment questions (solutions available to tutors) 245
7 Systems work: basic ideas 1 247
Learning objectives 247
Introduction 248
Note on auditing in a computer environment 248 Note on business approach to audit 250
Layers of regulation and control expanded 251 Note on nature of controls 251
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Case study 7.1: High Quality Limited (small independent supermarket) 263
Case study 7.2: Company in the financial services sector: Caiplie Financial Services 265
Accounting and quality assurance/control systems 266 General controls 267
Case study 7.3: Cash received system: Horton Limited 272 A word about collusion 281
Summary 288
Key points of the chapter 289 References 290
Further reading 290
Self-assessment questions (solutions available to students) 290 Self-assessment questions (solutions available to tutors) 291
8 Systems work: basic ideas 2 292
Learning objectives 292 Introduction 293
Application controls 293
Data capture/input controls 294
Processing controls 301
Output controls 304
Database systems 304
E-commerce 306
Audit approaches to systems and controls 312
Summary 332
Key points of the chapter 332
Further reading 334
Self-assessment questions (solutions available to students) 334 Self-assessment questions (solutions available to tutors) 334
9 Testing and evaluation of systems 336
Learning objectives 336
Introduction 337
Sales and debtors system 337
Case study 9.1: Broomfield plc: sales and debtors system 337
Payroll system 340
Case study 9.2: Wages payroll: Troston plc 340
Purchases and creditors system 342
Case study 9.3: Broomfield plc: part of purchases and trade creditors system 342
General and application controls in a sales system 345
Case study 9.4: Burbage Limited 345
Compliance testing (tests of control) 347
Evaluation of systems and audit conclusions 355
Summary 357
Key points of the chapter 357
Reference 357
Further reading 357
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Self-assessment questions (solutions available to students) 358 Self-assessment questions (solutions available to tutors) 358
10 Substantive testing, computer-assisted audit techniques and
audit programmes 360 Learning objectives 360 Introduction 361
Substantive testing data (transactions and balances) 361
Case study 10.1: Powerbase plc: the substantive audit programme for purchases 362
The use of audit software 366
Directional testing 374
Substantive audit programmes for wages 376
Substantive audit programmes for cash 377
The management letter (communication of audit matters to
those charged with governance) 377
Audit management with the computer 382
Summary 385
Key points of the chapter 385
Reference 387
Further reading 387
Self-assessment questions (solutions available to students) 387 Self-assessment questions (solutions available to tutors) 388
Appendix 10.1: substantive audit programme for production wages: Troston plc 389
Appendix 10.2: substantive audit programme for cash/bank: County Hotel Limited 392
11 Sampling and materiality 396
Learning objectives 396 Introduction 397
What is sampling? 397
Designing and selecting the sample for testing 398
Case study 11.1: An example of judgemental sampling:
Broomfield plc 399
Sample selection methodology 401
Evaluation of test results 404
Monetary unit sampling (MUS) 406
Comparative advantages of statistical and non-statistical sampling 407 Alternative statistical sampling methods 408
Materiality 409
Summary 419
Key points of the chapter 419
References 421
Further reading 421
Self-assessment questions (solutions available to students) 421 Self-assessment questions (solutions available to tutors) 422
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12 Final work: general principles, analytical review of financial statements,
fixed assets and debtors 423
Learning objectives 423 Introduction 424
Pre-final work 424
Balance sheet date work 425
Bridging work between conclusion of interim work and the balance sheet date 427
Analytical procedures 427
Case study 12.1: Kothari Limited: analytical review 430 Case study 12.2: Art Aid Limited: analytical review 436 Detailed final audit work: general matters 440 Tangible fixed assets and depreciation 447
Case study 12.3: Pykestone plc: fixed assets 447
Trade debtors and sales 462
Case study 12.4: Sterndale plc: ageing statement 466
Case study 12.5: Sterndale plc: analytical review of sales and debtors 467 Summary 478
Key points of the chapter 478
Further reading 481
Self-assessment questions (solutions available to students) 481 Self-assessment questions (solutions available to tutors) 482
13 Final work: specific problems related to stocks, long-term contracts and
trade creditors 483
Learning objectives 483
Introduction 484
Stocks and work in progress 484
Analytical procedures 489
Case study 13.1: Billbrook Limited: analysis of stock, Parts 1 and 2 489, 490 Case study 13.2: Greenburn Limited: stocktaking instructions 496
Case study 13.3: Spancarr plc: stock valuation, Parts 1, 2 and 3 502, 504, 507 Valuation of long-term contracts 511
Case study 13.4: Graves Limited: long-term contracts 511
Trade creditors and purchases 517
Analytical procedures 520
Summary 527
Key points of the chapter 527
Further reading 529
Self-assessment questions (solutions available to students) 529 Self-assessment questions (solutions available to tutors) 530
14 Final review: post-balance sheet period, provisions, contingencies,
letter of representation 532
Learning objectives 532 Introduction 533
Post-balance sheet events 533
Provisions, contingent liabilities and contingent assets 539 Going concern 547
Audit work to detect post-balance sheet events and contingencies 547
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Management letter of representation 550
Audit documentation and role of final review 554 Summary 558
Key points of the chapter 558 Further reading 560
Self-assessment questions (solutions available to students) 560 Self-assessment questions (solutions available to tutors) 561
15 Assurance engagements and internal audit 563
Learning objectives 563 Introduction 564
Assurance engagements 564
Case study 15.1: Protecting the environment in an area of scenic beauty 575 Case study 15.2: Gilling Limited 578
Internal audit 582
Case study 15.3: Greenburn Limited: fleet of vans 583
Auditing in the public sector 585
Case study 15.4: Photocopy costs in an educational institution 586
Case study 15.5: Barnton plc 587
How to make the internal audit function effective 589
Reliance on internal audit by the external auditor 591
Outsourcing of internal audit work 594
Case study 15.6: Internal audit at Troston plc 595 Summary 597
Key points of the chapter 597
Further reading 599
Self-assessment questions (solutions available to students) 599 Self-assessment questions (solutions available to tutors) 601
16 The auditor's report 603
Learning objectives 603 Introduction 604
The unqualified report 604 The qualified audit report 615
Disclaimer of responsibility 624
Reasons for the introduction of the expanded audit report 626
Reporting on corporate governance issues 628
Electronic publication of auditors' reports 634 Summary 635
Key points of the chapter 636
Further reading 637
Self-assessment questions (solutions available to students) 638 Self-assessment questions (solutions available to tutors) 639 Appendix 16.1 641
17 Fraud and going concern 644
Learning objectives 644 Introduction to fraud 645 Responsibility for fraud detection 646 Recent debates relating to fraud 657
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Case law relating to fraud 659
Consideration of law and regulations 660 Introduction to going concern 663
Directors' and auditors' responsibilities for going concern 663 Reporting on going concern 669 Summary 671
Key points of the chapter 671 Further reading 674
Self-assessment questions (solutions available to students) 674 Self-assessment questions (solutions available to tutors) 675
18 The audit expectations gap and corporate governance 677
Learning objectives 677
The audit expectations gap 678
The causes of the audit expectations gap, possible developments and solutions 679
Corporate governance 692
Summary 704
Key points of the chapter 704
References 705
Further reading 706
Self-assessment questions (solutions available to students) 706 Self-assessment questions (solutions available to tutors) 707
19 The auditor and liability under the law 709
Learning objectives 709 Introduction 710
Criminal liability 710 Civil liability 711 Case law 712
Auditing standards 727
Professional conduct 727
Potential ways of reducing auditor liability 728
Summary 733
Key points of the chapter 733
References 736
Further reading 736
Self-assessment questions (solutions available to students) 737 Self-assessment questions (solutions available to tutors) 738
20 Criticisms and developments in auditing 739
Learning objectives 739
Introduction 740
Regulation of auditing 740
Independence 748
The critics' view of the way forward 752 Response to criticisms 754
The Audit Agenda: Next Steps 760 Auditing into the twenty-first century 761 Auditor liability 763
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The audit society 771 Summary 784
Key points of the chapter 785 References 787
Further reading 790
Self-assessment questions (solutions available to students) 790 Self-assessment questions (solutions available to tutors) 790
21 Examination hints and final remarks 791
Learning objectives 791 Introduction 792
General examination hints 792 Auditing as an examination subject 794 Final remarks 795
Index 797
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INDEX OF LEGAL CASES
723
724
ADT Ltd. vs Binder Hamlyn (1996) B.C.C, 808. Andrew and Others vs Kounnis Freeman (1999) 2 B.C.L.C. 641 Anns vs Merton London Borough Council (1978) A.C. 728. AWA Ltd. vs Daniels t/a Deloitte Haskins and Sells (1992)
7 A.C.S.R. 759, (1992) 9 A.C.S.R. 383.
716
730
Bank of Credit and Commerce International (Overseas) Ltd.
(In Liquidation) vs Price Waterhouse (No. 2), (1998) B.C.C. 617, (1998) E.C.C. 410.
736
Barings plc (In Liquidation) vs Cooper & Lybrand (No. 8)
730
Candler vs Crane Christmas & Co. (1951) C.A. (1951) 2K.B. 164,
(1951) 1 All E.R. 426, (1951) 1 T.L.R. 371.
712
Caparo Industries plc vs Dickman and Others (1989) Q.B. 653,
(1989) 2 W.L.R. 316, (1989) 1 All E.R. 798, (1989) 5 B.C.C. 105, (1989) B.C.L.C. 154, (1990) 2 A.C. 605, (1990) 2 W.L.R. 358, (1990) 1 All E.R. 568, (1990) B.C.C. 164, (1990) B.C.L.C. 273. Coulthard & Orrs vs Neville Russell (1998) 1 B.C.L.C. 143, (1998)
B.C.C. 359.
715
736
Donaghue vs Stevenson (1932) S.C. (H.L.) 31.
712
Electra Private Equity Partners vs KPMG Peat Marwick (2001)
1 B.C.L.C. 589.
736
Galoo Ltd. and Others vs Bright Grahame Murray (A Firm) (1994)
2 B.C.L.C. 492, (1994) 1 W.L.R. 1360, (1995) 1 All E.R. 16, (1994) B.C.C. 319.
722
Hedley Byrne & Co. vs Heller and Partners Ltd. (1964) A.C. 465, (1963)
2 All E.R. 575, (1963) 3 W.L.R. 101.
712
660
Irish Woollen Co. Ltd. vs Tyson and Others (1900) 26 Acct. L. R. 13. James McNaughton Paper Group Ltd. vs Hicks Anderson & Co. (1991)
2 W.L.R. 641, (1991) 2 Q.B. 113, (1991) 1 All E.R. 134, (1991) B.C.L.C. 163, (1990) B.C.C. 891.
720
Jarvis plc and Others vs PricewaterhouseCoopers (2000) 2
B.C.L.C. 368.
137
714
JEB Fasteners Ltd. vs Marks Bloom & Co. (1981) 3 All E.R. 289. Morgan Crucible Co. plc vs Hill Samuel Bank Ltd. and Others (1991)
Ch 295, (1991) 1 All E.R. 148, (1991) 2 W.L.R. 655, (1991) B.C.L.C. 178, (1991) B.C.C. 82.
721
re Kingston Cotton Mill Co. (No. 2) (1896) 2 Ch 279.
659
re Thomas Gerrard & Son Ltd. (1967) 2 All E.R. 525, (1967)
3 W.L.R. 84, (1968) Ch 455.
660
Royal Bank of Scotland vs Bannerman Johnstone Maclay and
Others (2002) S.L.T. 181.
725
Sasea Finance Limited (In Liquidation) vs KPMG (2000) 1 B.C.L.C. 236,
(2000) 1 All E.R. 676.
656
Twomax Ltd. and Goode vs Dickson, McFarlane and Robinson (1983)
S.L.T. 98.
715
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