CHAPTER

1
An introduction to auditing and sundry auditing topics
SUGGESTED SOLUTION TO EXERCISE 1.1
1. Reason: The split between ownership and management.
Explanation: In many businesses, the owners (shareholders) do not actually run
(manage) the business; they appoint directors to do this. The directors
are required to report to the shareholders on the company’s
performance. To make sure that management reports fairly, the
shareholders appoint independent auditors to audit the accounting
records. (In the case of a public company, the company must appoint
an auditor in terms of the Companies Act 2008. In the case of a private
company, an audit will be a statutory requirement if the company
meets certain requirements in terms of its public interest score (see
the Companies Regulations 2011 regulations 26 and 28) or if the
company holds assets in a fiduciary capacity exceeding R5 million.
Where a company is not required by law or regulation to have its
annual financial statements audited (i.e. it is not a statutory
requirement), the shareholders or an external third party with an
interest in the company may require an audit.
Reason: Society needs confidence in financial information.
Explanation: Society (the general public) is affected in many ways by financial
information e.g. for paying taxes, making investments, receiving
government services and, if society is to run efficiently and effectively,
the financial information on which government and individuals rely,
must be credible and fair. Independent auditors, whether they are
external or internal or government auditors, contribute significantly
to the quality of this financial information.
Reason: Society requires that those who have responsibility for financial
matters must be accountable.
Explanation: The government is accountable to the public for the manner in which
it spends tax money, directors are accountable to their shareholders
and the public for the manner in which they run their companies e.g.
control pollution, train staff etc. Independent auditors (of any type)
provide a mechanism to evaluate and report on whether the persons
who are financially accountable are acting and reporting
appropriately.
2. Internal auditor: Auditors who perform independent assignments on behalf of senior
management (the audit committee) of the company. The internal
auditor is an employee of the company and can be seen in the wider
sense, as part of the internal/risk response control of the company.
Forensic auditor: A forensic auditor is an auditor who concentrates on investigating and
gathering evidence where there have been allegations of financial
mismanagement, theft or fraud.
Postulates of auditing: The postulates are the foundation on which the discipline (subject) of
auditing is built. They provide a starting point, or basis for thinking
about what auditing actually is.
Professional scepticism: This is an attitude or state of mind which all auditors must exercise. It
means approaching the audit with a questioning mind, not naively
accepting information provided by a client (of any kind) as the truth,
or being ‘led around by the nose’ by the client BUT at the same time
not being rude or discourteous to the client. It also means that the
 auditor should be alert to conditions which may indicate material
misstatement and should remain unconvinced of the truth of a
particular fact until suitable evidence is provided.
Applicable financial reporting framework: The financial reporting framework adopted by management and
where appropriate, those charged with governance in the preparation
of the financial statements, that is acceptable in view of the nature of
the entity and the objective of the financial statements.
3. Limitation 1: The nature of financial reporting.
In the preparation of financial statements, management must apply judgment in applying the relevant reporting
framework which includes making subjective decisions about many account balances. E.g. it is not possible to know
exactly what amounts should be allowed (provided) for say obsolete/impaired inventory.
Limitation 2: The nature of audit procedures.
2.1 The use of testing. As the auditor does not examine every
transaction (as this would be impossible due to Limitation 4
below) he can never be in a position to certify the information
being audited as 100% correct.
2.2 Audit evidence is usually persuasive rather than conclusive.
Unless an auditor is actually present to personally witness a
transaction, decision or internal control he must rely on the
word of others and documentation to ‘persuade’ him that the
transaction, decision or internal control took place. E.g. if the
auditor inspects a sample of purchase orders for authorisation
and finds them all to be correct, he is ‘persuaded’ that all
purchase orders for the year were authorised and that the
authorisation took place prior to the order being placed.
2.3 There are practical and legal limitations on the auditor’s ability
to obtain audit evidence. There is always the possibility that
management may not provide complete information that is
relevant to the preparation of the financial statements and
accordingly the auditor cannot be certain that all relevant
information has been received.
2.4 Audit procedures are not designed specifically to detect fraud,
and by collusion or falsification of documentation and other
means of circumventing controls, fraudulent transactions may
go undetected. The auditor may believe that evidence is valid
when it is not.
Limitation 3: The inherent limitation of internal control and accounting systems.
When performing an audit of financial information the auditor will usually need to place some reliance on the
accounting system and internal controls which produce the information. As internal control systems themselves
are not perfect (e.g. human errors occur), the information which is produced and on which the auditor relies, will
not be perfect.
Limitation 4: Timeliness of financial reporting and the balance between benefit
and cost.
To be of any value the audit opinion must be reported within a reasonable time after the financial year end and
the benefit derived must exceed the cost.
4. Assurance engagement: An assurance engagement is one in which a practitioner ‘expresses a
conclusion’ that provides the user with a level of assurance about a
subject matter which is the responsibility of another party, having
evaluated the subject matter against a suitable set of criteria e.g. an
auditor provides the shareholders with a reasonable (high but not
absolute) level of assurance that the AFS prepared by the directors
are fairly presented in terms of the International Accounting
Standards and IFRSs. Another example would be where the auditor
reviews (but does not carry out a full audit) of the financial
information and provides the user with a limited level (not high) of
assurance.
Non-assurance engagement: In this engagement the professional accountant does not express an
opinion or comment on the subject matter of the engagement. E.g.
the professional accountant is engaged to compile (draw up) a set of
 financial statements for the client, but not audit or review them.
Another example would be where the auditor is engaged to complete
a client’s tax return.
Statutory audit: This is an audit which must be conducted because an Act of
Parliament (statute) requires it e.g. the Companies Act 2008 requires
that all public companies be audited.
Non-statutory audit: This is an audit which is required for some reason other than statute
e.g. a partnership agreement stipulates that an audit of the
partnership’s financial statements must take place.

SUGGESTED SOLUTION TO EXERCISE 1.2

1. Agency theory: This theory, developed by Jensen and Meckling (1976), explains the relationship between business
principles (the shareholders/owners) and their agents (the directors). The shareholders delegate authority to the
directors, who then act on the shareholders’ behalf. Conflict of interest arises between ownership and control,
where those who control the entity (the directors) may not necessarily have the best interest of the shareholders
and other stakeholders at heart.
2. Legitimacy theory: This theory of Dowling and Pfeffer (1975) holds that, for an entity to continue to exist, it must
act in consensus with society’s values, norms and interests. Entities thus have a social responsibility towards, and
should exist in harmony with, its stakeholders.
3. Stakeholder theory: This theory (usually accredited to Freedman, 1984) places focus on the effect that an entity
and its activities have on all of its stakeholders (e.g. employees, society, customers, suppliers etc.) as opposed to
focusing only on its shareholders. In accordance with this theory, an entity is expected to have moral values and
social responsibilities.
4. Ubuntu: Ubuntu is an African philosophy which expresses compassion and humanity. This philosophy manifests
that a corporation has a responsibility to serve not only its shareholders, but also its wider stakeholders.
5. Utilitarian ethics: In lay terms, Utilitarian ethics hold that ethical choices should be based on that which will
produce ‘the greatest good for the greatest number’.

SUGGESTED SOLUTION TO EXERCISE 1.3

1. False The primary objective is to express an opinion on fair presentation of the AFS.
2. False An auditor should be independent, and all members of an audit committee should be independent, non-
executive directors of the company.
3. False The auditor should not only be independent, but should also be seen to be independent.
4. False The auditor gives an opinion, not a certification of fact, on the client's financial statements.
5. False Amounts in the financial statements can never be assumed to be 100% correct as there is a level of
subjectivity and estimation in most amounts reflected in the financial statements.
6. True
7. True
8. False The auditor must comply with the requirements of the International Standards on Auditing.
9. False Unless the directors themselves hold sufficient shares to pass a special resolution. The MOI can only be
altered by the shareholders.
10. False Inquiry consists of seeking relevant information from knowledgeable persons inside or outside the entity.
Inquiries may range from formal written inquiries addressed to third parties to informal oral inquiries
addressed to persons inside the entity.
11. False Testing the systems at the client should be considered regardless of whether fraud is suspected. If the
client has integrated, or sophisticated IT systems that drive large volumes of transactions, the audit of IT
systems should definitely be considered.
12. True

SUGGESTED SOLUTION TO EXERCISE 1.4

(a) The auditor is bound by the profession’s CPC (code of professional conduct). The CPC requires the auditor ‘to
respect the confidentiality of information acquired as a result of professional and business relationships and,
therefore, not disclose any such information to third parties without proper and specific authority, unless there is
a legal or professional right or duty to disclose, nor use the information for the personal advantage of the registered
auditor or third parties’.
(b) 1. Independent in relation to the members of the auditing profession means the ability of the member to:
 1.1 apply objective (not subjective) consideration and unbiased judgement to established facts in
arriving at an opinion or decision.
1.2 adopt an impartial view, free of any influence, interest or relationship which could impair his
independence.
1.3 recognise and respond appropriately to threats, e.g. self-interest threats, intimidation threats,
to his independence both in ‘mind’ and ‘appearance’.
(c) 1. The auditor should ‘not only be independent but be seen to be independent’. This means that even if the
auditor believes that he can act independently (retain an independent mind) in a situation in which he
does not appear to be independent he should decline the engagement, e.g. the auditor may believe that
he can perform the audit of his father’s company independently and may in fact do so! However, because
of the family relationship the auditor will not be seen (perceived) to be independent by users of the audit
opinion provided by the auditor. Users will simply assume that the auditor is not independent (because
it is his father’s company) regardless of how independently he may have acted.
2. Furthermore, if the auditing profession is not perceived to be independent, even though it may be
independent in its actions, its credibility will be undermined.
3. Most importantly, the relationship between Mr Toni and his son will pose a familiarity threat to Mr Toni’s
son as auditor, which may compromise his objectivity as auditor.
(d) The auditor does not perform his/her duties in the interest of his/her client, and is not on anybody’s side; the
auditor must be independent of the client and the party to whom he/she reports so that the opinion given by the
auditor is impartial and free of bias.

SUGGESTED SOLUTION TO EXERCISE 1.6

SUGGESTED SOLUTION TO EXERCISE 1.13

(a)
Mine (Pty) Ltd Craft (Pty) Ltd
Sales income N/A N/A
Service fees N/A N/A
Total turnover 9 155
Non-executive directors N/A N/A
Average employees for the year 82 85
Accounts owed by third parties N/A N/A
Amounts owed to third parties 2 75
Individuals with direct or indirect 10 40
interest in each company’s shares
Total salaries paid to employees N/A N/A
B-BBEE points N/A N/A
Public Interest Score 103 355
(b) Mine (Pty) Ltd will be required to have its annual financial statements audited as the company has a public interest
score of 100 or more, but less than 350 (i.e. 103) and its AFS are internally compiled.
Craft (Pty) Ltd will have to have its annual financial statements audited as its public interest score is equal to or above
350.
(ci) False Public interest score must be calculated annually.
(cii) False The audit must be conducted by a registered auditor.
(ciii) False A company’s PIS indicates its level of public interest and is used to determine whether a company (which is not
required to do so by law or regulation) should have its AFS audited or independently reviewed, which reporting
framework should be applied, and the need for the appointment of a social and ethics committee (for private,
state-owned and unlisted entities).