ACC707 ASSIGMENT 1 Weight 10% Due Date:20th October 2022

Question
1. How does an audit or review enhance the quality of financial reports? Does an audit
ensure a fair presentation of a company’s financial report or that internal control
systems are free of deficiencies? Explain. (200 words) - 10 marks
➢ Solution
The audit or review enhances the quality of financial reports because the user has
the assurance that an independent, qualified professional has examined the
financial report and has rendered a positive opinion (or negative [nothing has
come to my attention….] review conclusion) on its truth and fairness (fairness for
a non-statutory audit). The independence and expertise of the auditor serves as a
quality control function to overcome the potential bias of management in
presenting the financial report in a manner that most flatters an assessment of
management’s performance. The audit or review is designed to add credibility to
the financial report.
An audit or review does not necessarily ensure the truth and fairness of the
presentation of a company’s financial report although it does dramatically increase
the likelihood that there are no material misstatements in the company’s financial
statements and notes thereto. The caveats about fairness exist for two reasons:
a. Fairness is judged within a framework of Accounting Standards. Some question
whether Accounting Standards without fail result in the fairest possible
presentations when there are significant changes in market values of investments
or assets. For example, accounting standards based on IFRS require financial
institutions to move from using historical cost to market values for all investments
in securities because the IASB (and AASB) believes that market value presents a
better picture of economic reality than does historical cost. However, in illiquid
markets, discerning appropriate market value can be very difficult.
b. Although designed to detect material fraud, it might be possible that a well-
executed audit may still fail to detect even material fraud, especially if management
is involved in covering it up.
2. Who is the most important user of an audit report on a company’s financial report:
company management, the company’s shareholders or the company’s creditors? Briefly
explain your rationale and indicate how auditors should resolve potential conflicts in the
needs of the three parties. (300 words) – 15 marks
Solution
All three of these parties are important users of both audit and review reports.
Arguments can be made for each group as follows:
 Shareholders: They are owners of the organization and thus they represent the
group to which management is ultimately accountable (i.e., management serves
only per the wishes of shareholders). Owners as a group depend on an independent
audit to inform them of the stewardship and overall performance of management.
Shareholders are also represented through the Board of Directors whom they elect
to represent their best interests.

Creditors: They invest capital in the organization in the form of short- or long-term
loans. Creditors are concerned with the safety of their loans and look to audited
reports to provide information on the status of the organization’s financial position
and its earning power to assess the relative safety of their loans or their decision
to grant credit to an organization.

Management: Members of management are interested in seeing that the financial

report shows their performance, and if possible, to do so in a way that is most
favorable to them. Many members of management now have bonus (salary)
agreements tied to reported profits. Additionally, management may have share
options or share investments that are significantly affected by the reported profits
of the company.
Of the three groups, management is more often quite short-term oriented in its
perspective (although certainly not all members of management fall into this
group). Often, management may be interested in achieving short-term objectives
and in applying accounting principles and judgements that are aggressive and seek
to maximize reported income.
Creditors, on the other hand, are more concerned with the safety of their loans and
would prefer a conservative approach to accounting that might understate assets
and revenue and thus provide a cushion for safety. Investors are generally more
long-term oriented (although this is less true with the majority of share ownership
now residing in mutual funds) and are generally more interested in the quality of
reported earnings and assets (i.e., they do not desire any over – or under –
statement; rather, they want the most accurate information on which to make
decisions).
The auditors resolve potential conflicts by:
➢ Understanding the economic substance of transactions
➢ Determining how the economic substance guides the accounting choices
➢ Ensuring the accounting follows the Australian Accounting Standards Board’s
(AASB) Accounting Standards.
Unbiased reporting implies that the auditor always favors appropriate accounting
over the desires of individual users.
 3) Why is ethical behavior by auditors required to justify the public’s trust in the
profession? (50-100 words)- 5 Marks
Solution
➢ Auditors add value to the financial markets by providing an independent
assessment of the reliability of the client’s financial report. That independent
assessment is only valued by the public to the extent that the auditors providing it
have acted, and are perceived to have acted, with the highest level of integrity and
ethics.

4) Why is independence considered the most important characteristic of an auditor?

(50-100words) – 5 marks
Solution
➢ Without independence, the work product of public accountant would be worthless.
Public accountants are expected to judge the truth and fairness of the information
to which they are attesting. If public accountants were not independent, the users
of the financial reports would have no reason to believe the truth and fairness of
the financial report any more than if the report had not been audited.

Discussion and Research Question

5) What are the major threats to auditor independence? Explain why each item
represents a threat to auditor independence. (200 words) – 15 Marks
Solution
Threat to Independence
Auditors are expected to provide an unbiased and professional opinion on the work that
they audit.
There are the five things that can potentially compromise the independence of auditors:

1. Self-Interest Threat
A self-interest threat exists if the auditor holds a direct or indirect financial interest in the
company or depends on the client for a major fee that is outstanding. For example, the
audit team is preparing to conduct its 2020 audit for ABC Company. However, the audit
team has not received its audit fees from ABC Company for its 2019 audit.
Issue: The audit team might be tempted to issue a favorable report so that the company is
able to secure a loan to settle the fees outstanding for their 2019 audit.

2. Self-Review Threat
➢ A self-review threat exists if the auditor is auditing his own work or work that is done by
others in the same firm. Example, the auditor prepares the financial statements for ABC
Company while also serving as the auditor for ABC Company.
Issue: By having the auditor review his or her own work, the auditor cannot be expected
to form an unbiased opinion on the financial statements.
 3. Advocacy Threat
➢ An advocacy threat exists if the auditor is involved in promoting the client, to the point
where their objectivity is potentially compromised. For example, the auditor is assisting in
selling ABC Company while also serving as the auditor for the company.
Issue: The auditor may issue a favorable report to increase the sale price of ABC Company.

4. Familiarity Threat
➢ A familiarity threat exists if the auditor is too personally close to or familiar with
employees, officers, or directors of the client company. For example, ABC Company has
been audited by the same auditor for over 10 years and the auditor regularly plays golf
with the CEO and CFO of ABC Company.
Issue: The auditor may have become too familiar with the client and, thus, lack objectivity
in their work.

5. Intimidation Threat
➢ An intimidation threat exists if the auditor is intimidated by management or its directors to
the point that they are deterred from acting objectively. For example, ABC Company is
unhappy with the conclusion of the audit report and threatens to switch auditors next year.
ABC Company is the biggest client of the auditor.
Issue: The auditor’s independence may be compromised, as ABC Company is their biggest
client and they, quite naturally, do not want to lose such a client. Therefore, the auditor
may issue a report that appeases ABC Com