Chapter 2 Audit regulation structure of the profession and auditor’sliability | Auditing and Assurance Services in Australia

lOMoAR cPSD| 47206071 Page 35 CHAPTER 2
Audit regulation, structure of the profession and auditor’s liability
LEARNING OBJECTIVES (LO) 2.1
Identify the attributes of professional status and describe to what extent
they exist in public accounting.
2.2Describe the regulation of auditing and its subject matter.
2.3Explain the impacts of internationalisation on auditing.
2.4Outline the characteristics of the professional bodies and accounting
firms engaged in the auditing profession, and describe the internal structure of an audit firm. 2.5
Identify the elements of quality control within audit firms, and explain practice-monitoring programs.
2.6Explain the concepts of reasonable care and skill, and negligence.
2.7Explain the auditor’s legal liability to clients.
2.8Explain the auditor’s liability to third parties.
2.9Describe alternative methods used to limit the auditor’s liability. RELEVANT GUIDANCE ASA 101
Preamble to Australian Auditing Standards ASA 220/ISA 220
Quality Control for an Audit of a Financial Report and
Other Historical Financial Information ASA 501/ISA 501
Audit Evidence—Specific Considerations for
Inventory and Segment Information/Audit Evidence —
Specific Considerations for Selected Items ASQC 1/ISQC 1
Quality Control for Firms that Perform Audits and
Reviews of Financial Reports and Other Financial
Information, Other Assurance Engagements and Related Services Engagements lOMoAR cPSD| 47206071 ASAE 3000/ISAE 3000
Assurance Engagements Other than Audits or Reviews of
Historical Financial Information
Code of Ethics for Professional Accountants APES 110/IFAC
Conformity with Auditing and Assurance Standards APES 210
Quality Control for Firms APES 320
Foreword to AUASB Pronouncements AUASB
Framework for Assurance AUASB/IAASB
Engagements/International Framework for Assurance Engagements
Preface to the International Standards on Quality IAASB
Control, Auditing, Review, Other Assurance and Related Services Page 36 lOMoAR cPSD| 47206071 CHAPTER OUTLINE
The auditor is a member of a time-honoured profession, and the status of the
profession and the responsibilities that accompany this status affect the audit and
assurance function and the structure of the profession. The auditor is subject to
regulations imposed by the profession and by society. The audit and assurance
function is carried out in a complex environment composed of interrelationships
between governmental and professional organisations and individual auditors and
audit firms. These regular and enduring relationships form the structure of the
profession. In addition, the audit environment includes the requirements of
legislation, particularly the Corporations Act 2001, discussed in Chapter 1 ; public
expectations of the audit and the existence of the expectation gap, also discussed in
Chapter 1 ; and the legal liability of an auditor and the impact of common law, discussed in this chapter.
This chapter explains the role of government and professional associations in the
auditing and assurance environment and the relationship between them. It recognises
the impact of globalisation on business and the auditing profession and discusses how
the profession has reacted to the need for
internationalisation. It outlines the characteristics of the types of audit firms that make
up the auditing profession and the services they provide. The internal structure of an
audit firm and the influence of that structure on an auditing practice are also covered.
There is also discussion of the quality control procedures that are essential to ensure
that auditors meet their responsibilities to clients and other users and carry out the
audit in accordance with legislation, the auditing standards and the ethical rules.
Finally, this chapter considers an auditor’s legal liability to clients and third parties. The
concept of reasonable care and skill is explained and the elements necessary for a
claim of negligence to be successful are outlined with reference to legal cases. The
concept of contributory negligence and methods used to limit the auditor’s liability are discussed.
How this chapter fits into the overall auditing and assurance profession is illustrated in
Figure 2.1 , which is an expansion of part of the overall flowchart provided in Chapter 1 . lOMoAR cPSD| 47206071 lOMoAR cPSD| 47206071
FIGURE 2.1 Flowchart of auditing and assurance profession lOMoAR cPSD| 47206071 Page 37
LO 2.1 Professional status of the auditor
The status of a profession can be determined by the extent to which the professional
group exhibits certain attributes which distinguishes it from those that are
nonprofessional. Greenwood (1957) indicates that all professions seem to possess five
elements: systematic theory; professional authority and expertise; community sanction;
regulative codes; and a culture. Systematic theory
One significant difference between a professional and a non-professional occupation is
the underlying body of theory that supports the work of the professional. Although
nonprofessional work may require procedural skill, that skill does not rest on a body of
systematic theory. The underlying theory of the auditing profession consists of auditing
theory and accounting theory. Knowledge of systematic theory can best be achieved
through formal education in an academic environment. Today, therefore, a tertiary
education is considered a prerequisite for people entering the auditing profession. They
are then required to complete the education program of one of the three accounting
bodies (Chartered Accountants Program, CPA Program or IPA Program) and also undertake
continuing professional development throughout their auditing career.
Professional authority and expertise
Expertise in the systematic theory of auditing and accounting is the basis for the auditor’s
work in these areas. Professionals have authority within the area of their expertise
because their clients lack the requisite theoretical knowledge. However, professionals
only have authority if society confers that authority upon them. Community sanction
Professionals normally attempt to formalise their authority by gaining community
approval of certain powers and privileges. First and foremost among the powers for which
professions strive is control over admissions to the profession. To be a registered company
auditor a person must, among other things, be a member of one of the accounting bodies lOMoAR cPSD| 47206071
(discussed later in this chapter) or other prescribed bodies, each of which controls
admission to their own organisation.
Another privilege that professions strive for is relative immunity from community
judgment on technical matters. Although professions are responsible to the community
for their actions, it is generally accepted that a professional’s performance should be
judged by standards established by the profession itself. Prior to the CLERP 9 legislative
amendments, made as part of the Corporate Law Economic Reform Program, discussed in
Chapter 3 , the setting of auditing and assurance standards was undertaken by the
accounting bodies through the Australian Accounting Research Foundation (AARF). While
auditing standards are now set by the Auditing and Assurance Standards Board (AUASB),
which is an independent statutory body, the profession contributes heavily to the process,
with a majority of AUASB members being members of the profession, and members of
the profession also contributing to the consultation/development process for auditing
standards, as discussed later in this chapter.
Among the powers and privileges for which professions strive, privileged communication
stands out as perhaps the ultimate criterion of professionalism. Professional performance
is facilitated if the client feels free to volunteer information which otherwise might not be
divulged. Privileged information is a right granted by the community to protect the client
from legal encroachment on confidential communications with a professional. Although
the professions of medicine and law have generally been granted this privilege, legal
privilege between auditor and client does not exist. However, because an auditor will
have access to information that a client would not normally make available to external
parties, the ethical rules of the accounting bodies (discussed in Chapter 3 ) prohibit
auditors from disclosing such information to a third party without specific authority from
the client or unless there is a legal or professional duty to disclose, such as under section
311 of the Corporations Act 2001. Page 38 Regulative codes
The powers and privileges granted to a profession by the community effectively constitute
a monopoly. In Australia, registered company auditors have been granted a monopoly on
rendering external auditors’ opinions on the financial reports of companies. Since any
monopoly is subject to abuse, a profession must take steps to assure the community that lOMoAR cPSD| 47206071
the profession will discipline its members. Professions therefore establish regulative codes.
Regulation of the auditing profession is directed at two areas: technical and ethical.
Auditing standards govern the technical work of the auditor while the ethical rules govern the auditor’s behaviour. A culture
Another distinguishing feature of a profession is a well-established culture that applies to
the professional group. Sociologists call this a subculture. A subculture contains specific
behavioural prescriptions and proscriptions. For example, auditors are expected to behave
in a way that is in accord with APES 110 Code of Ethics for Professional Accountants,
including exhibiting integrity, independence, objectivity, confidentiality and public
interest. New members of the profession must learn what is expected of them or they will
not be accepted as colleagues by their associates. QUICK REVIEW
1. Auditing is a profession.
2. The auditing profession is regulated largely by the auditing and assurance
standards and its own ethical rules.
3. Confidentiality is an important requirement for the auditing profession.
LO 2.2 Regulation of auditing and of the subject matter of audits Regulation of auditing
Our society is so complex that there is a whole set of organisations whose function is to
organise and supervise other organisations. The organisations of this type that are of
concern to the auditing profession include both government agencies and professional
associations that regulate auditing as indicated in Figure 2.2 . (In addition, there are
similar agencies that regulate the subject matter of audits, which we will discuss separately below.) lOMoAR cPSD| 47206071 lOMoAR cPSD| 47206071 Financial Reporting Council
The Financial Reporting Council (FRC) is a statutory body established under section 225(1)
of the Australian Securities and Investments Commission Act 2001. The FRC was
established during 1999 as a peak body with responsibility for the broad oversight of the
accounting standard-setting process for the private, public and not-for-profit sectors. As a
result of the CLERP 9 amendments, the FRC’s role has been significantly expanded to
include broad oversight of the auditing standard-setting process and monitoring of auditor independence.
Specific matters for which the FRC is responsible include:
overseeing the operations of the Australian Accounting Standards Board (AASB) and the
Australian Auditing and Assurance Standards Board (AUASB), including appointing their
members, other than the chairs, who are appointed by the Treasurer monitoring the
development of international accounting and auditing standards and accounting and
auditing standards that apply in major international financial centres furthering the
development of a single set of accounting and auditing standards Page 39 for worldwide
use with appropriate regard to international developments monitoring the operation of
Australian accounting and auditing standards to assess their continued relevance and
effectiveness in achieving their objectives monitoring auditors’ independence
monitoring the effectiveness of the consultative arrangements used by the AASB and AUASB
seeking contributions towards the costs of the Australian accounting and
auditing standard-setting process monitoring and periodically reviewing the level
of funding, and the funding arrangements, for the AASB and AUASB.
The legislation expressly limits the FRC’s ability to become involved in the technical
deliberations of the AASB and AUASB. As a result, the FRC does not have the power to
direct the AASB or AUASB in relation to the development, or making, of a particular
standard, or to veto a standard formulated or recommended by the AASB or AUASB. This
provision is designed to ensure the independence of the AASB and AUASB.
Auditing and Assurance Standards Board Page 40
As a result of the CLERP 9 amendments, the AUASB was reconstituted and established as
an independent statutory body on 1 July 2004. The AUASB is responsible for developing lOMoAR cPSD| 47206071
and maintaining auditing and assurance standards and other publications, and consists of
11 members, including the chair. The members of the AUASB are appointed by the FRC
and the chair is appointed by the Treasurer. Membership currently includes auditing
practitioners from the private and public sectors and non-auditors from academia and
other stakeholder groups. The members are supported by the full-time technical staff of
the AUASB. Responsibility for final approval of auditing and assurance standards now lies
with the Parliament, as these are now disallowable legal instruments, following the CLERP
9 amendments. Auditors are required to follow these standards and therefore they are an
important influence on the way in which members of the profession perceive and
discharge their audit responsibilities.
The AUASB has developed a strategy document for 2017 to 2021 which sets out its vision,
mission and strategic objectives (see Auditing in the global news 2.1 ). For the first time
the AUASB’s strategy document has been aligned with that of the AASB and the strategy
documents of the two boards have been issued together, illustrating that the two boards
are working closely together to better achieve the desired outcomes. In order to achieve
their strategic objectives, the AASB and AUASB have both indicated that they will use
collaboration, communication, research and education as enablers. lOMoAR cPSD| 47206071
2.1 Auditing in the global news ... lOMoAR cPSD| 47206071 lOMoAR cPSD| 47206071
AUASB strategy, 2017–2021 AUASB Vision
Contribute to stakeholder confidence in the Australian economy, including its capital
markets, and enhanced credibility in external reporting through independent auditing and assurance. AUASB Mission
Develop, issue and maintain in the public interest, high quality Australian auditing
and assurance standards and guidance that meet user needs and enhance audit and
assurance consistency and quality. Contribute to the development of a single set of
auditing and assurance standards and guidance for world-wide use.
AUASB Strategic Objectives
1. Develop, issue and maintain high quality Australian auditing and assurance
standards and guidance that meet the needs of external report users. Use IAASB
Standards—where they exist, modified as necessary—or develop Australian-specific standards and guidance.
2. With the AASB, play a leading role in reshaping the Australian external reporting
framework by working with regulators to develop objective criteria on: who
prepares external reports (including financial reports) the nature and extent of
assurance required on external reports. 3.
Actively influence international auditing and assurance standards and
guidance by demonstrating thought leadership and enhancing key international relationships.
4. Attain significant levels of key stakeholder engagement, through collaboration, partnership and outreach.
5. Influence initiatives to develop assurance standards and guidance that meet user
needs for external reporting beyond financial reporting.
6. Monitor and respond to emerging issues impacting the development of auditing
and assurance standards and guidance, including changing technologies.
7. Develop guidance and education initiatives, or promote development by others, to
enhance consistent application of auditing and assurance standards and guidance. lOMoAR cPSD| 47206071
Source: Australian Accounting Standards Board and Auditing and Assurance Standards Page 41 Board (2017)
AASB and AUASB Strategy, 2017-2021. http://www.auasb.gov.au/admin/file/co ntent102/c3/AASB-
AUASB_Strategy_2017-2021.pdf. Accessed 15 December 2017. (c) 2018 Auditing and Assurance Standards
Board (AUASB). The text, graphics and layout of this publication are protected by Australian copyright law and
the comparable law of other countries. No part of the publication may be reproduced, stored or transmitted in
any form or by any means without the prior written permission of the AUASB except as permitted by law. For
reproduction or publication permission should be sought in writing from the Auditing and Assurance Standards
Board. Requests in the first instance should be addressed to the Technical Director, Auditing and Assurance
Standards Board, PO Box 204, Collins Street West, Melbourne, Victoria, 8007.
The AUASB has a longstanding policy of convergence and harmonisation with
International Standards on Auditing (ISAs). In 2003, the AUASB issued its current policy on
harmonisation and convergence of Australian Auditing Standards (ASAs) with ISAs, which
states that the AUASB endeavours to ensure that the Australian Auditing and Assurance Standards:
are issued to cover the topics addressed in ISAs comply with those standards.
The AUASB has used ISAs as the basis for its corresponding ASAs. It is the policy of the
AUASB to aim to ensure that compliance with ASAs will also constitute compliance with
ISAs. Where it is necessary to cover specific Australian industry or regulatory
requirements not addressed in an ISA, the AUASB has indicated that it will include
additional paragraphs designated as ‘Aus’, with appropriate detailed explanation or
references by way of footnotes or appendices to the corresponding ASA. The AUASB has
indicated that in certain circumstances substantive amendments may be made to the
mandatory basic principles and essential procedures of an ISA to reflect additional
Australian professional auditing requirements or in order for it to conform to Australian
legislative and regulatory requirements.
Irrespective of the source of a standard, the document will have been through an
extensive process of development. This process is considered essential to ensure that all
interested parties are given sufficient opportunity to express their views and that the
standards, practices and guidelines developed are technically appropriate, relevant and logical.
Following full consideration of the views expressed on an exposure draft, a final auditing
standard is prepared and approved by the board. As a result of the CLERP 9 amendments,
it is now not until the document is formally approved by the Parliament that the extensive lOMoAR cPSD| 47206071
process of development is complete (that period normally being one to three years) and
the document achieves the status of an auditing standard and therefore an authoritative
statement on the conduct of an audit.
The auditing standards are applicable to all audits, and for audits undertaken under the
Corporations Act 2001 the standards have legal authority. Failure to observe these
standards may expose a member to investigation and disciplinary action by the Australian
Securities and Investments Commission (ASIC), as discussed below. For other audits and
assurance engagements there is a mandatory obligation, which is found in APES 210
Conformity with Auditing and Assurance Standards, issued by the Accounting Professional
and Ethical Standards Board (APESB), for members of the accounting bodies in Australia to
comply with the auditing and assurance standards.
Each auditing standard is required to state the objective to be achieved in relation to the
subject matter of the standard. The auditor will always be required to achieve the
objective stated in each standard, where the standard is relevant in the circumstances of
the audit. All auditing standards now contain the following sections (ASA 101/Preface to
the International Standards on Quality Control, Auditing, Review, Other Assurance and Related Services):
Introduction: the scope and effective date of the standard
Objective: the objective to be achieved by the auditor
Definitions: the terms that need to be defined within the standard
Requirements: the requirements to be complied with, together with explanatory material
necessary to make the section understandable by an experienced auditor
Application and other explanatory material: material, supplemented in some cases by
appendices, that provides further explanation and guidance supporting proper
application of the auditing standard.
In what are expected to be rare and exceptional circumstances, where the auditor is Page
42 unable to comply with a requirement contained in an auditing standard, the auditor is
required, if possible, to perform appropriate alternative audit procedures, and to
document in the working papers:
the circumstances surrounding their inability to comply
the reasons for their inability to comply lOMoAR cPSD| 47206071
a justification of how alternative audit procedures achieve the objective(s) of the mandatory requirement.
Where the auditor is unable to perform appropriate alternative audit procedures, they are
required to consider the implications for the auditor’s report. (ASA 101; the Preface to the
International Standards on Quality Control, Auditing, Review, Other Assurance and
Related Services contains similar guidance at the international level.)
Accounting Professional and Ethical Standards Board
Until 2006, the accounting bodies maintained control of the setting of ethical standards,
which were promulgated through a joint Code of Professional Conduct (CPC).
In 2006, a body independent of the professional accounting bodies, the Accounting
Professional and Ethical Standards Board (APESB), was formed. The APESB consists of six
members, five of whom are drawn from across the three professional accounting bodies
and an independent chair. APESB standards covering quality control (APES 320), ethical
conduct (APES 110) and compliance with auditing and assurance standards (APES 210)
were issued in May and June 2006 to coincide with the auditing standards obtaining the
force of law with effect from 1 July 2006. Since then a number of additional APESB
standards have been issued, as will be discussed in Chapter 3 .
Standards set by the APESB apply to audits and assurance services carried out by
members of the professional accounting bodies. The fact that the profession has a body of
ethics and quality control procedures helps to boost its reputation. These measures will
be discussed in more detail later in this chapter (quality control) and Chapter 3 (ethics).
Australian Securities and Investments Commission
The Australian Securities and Investments Commission (ASIC) is an independent
Commonwealth government body established by the Australian Securities and
Investments Commission Act 2001. It operates under the direction of three full-time
commissioners, appointed by the Governor-General on the nomination of the Treasurer,
and reports to the Commonwealth Parliament and to the Treasurer. lOMoAR cPSD| 47206071
ASIC began on 1 January 1991 as the Australian Securities Commission, to administer the
Corporations Law. It replaced the National Companies and Securities Commission (NCSC)
and the corporate affairs offices of the states and territories.
In July 1998, it received new consumer protection responsibilities and changed its name
to the Australian Securities and Investments Commission. ASIC enforces company and
financial services laws to protect consumers, investors and creditors. It also regulates and
informs the public about Australian companies, financial markets, financial services
organisations and professionals who deal and advise in investments, superannuation,
insurance, deposit taking and credit.
On 15 July 2001, the Corporations Law was replaced by the Corporations Act 2001 and the
ASIC law was replaced by the Australian Securities and Investments Commission Act 2001.
The new statutes are very similar to the laws that they replaced. The changes made
consist only of changes in terminology and some changes to reflect the new constitutional
underpinnings of the legislation, which is now truly Commonwealth legislation, as the
states have referred their powers to the Commonwealth in relation to registration and
regulation of companies. Section references and numbers have remained essentially unchanged.
The Australian Securities and Investments Commission Act 2001 requires ASIC to:
uphold the law uniformly, effectively and quickly
promote confident and informed participation by investors and consumers in the financial system
make information about companies and other bodies available to the public
improve the performance of the financial system and the entities within it.
ASIC has the power to investigate all perceived serious breaches of the Page 43
Corporations Act 2001, to take action to recover property or damages and to lodge criminal prosecutions.
Following the CLERP 9 amendments, ASIC’s responsibilities have been enhanced. It now
has the following responsibilities concerning oversight of the audit function: lOMoAR cPSD| 47206071 registration of auditors enforcing auditor independence
assessing whether auditors meet the registration requirements concerning practical
experience, education and competency standards post-registration supervision, through
an audit inspection program to ensure audit quality receiving auditors’ annual
statements concerning the nature and complexity of audit work undertaken and
compliance with any conditions of registration
referring matters with respect to the conduct of auditors to the Companies Auditors Disciplinary Board.
Companies Auditors Disciplinary Board
The Companies Auditors Disciplinary Board (CADB) is established under the Australian
Securities and Investments Commission Act 2001. ASIC may make applications to the
board to determine whether auditors have breached the Corporations Act 2001. The
board has the power to impose penalties if it determines that a registered auditor has
failed to carry out duties properly or is not a fit and proper person to be registered.
Penalties may include suspension or cancellation of the auditor’s registration, the
imposition of restrictions on conduct or an admonition.
Matters that may be referred to the CADB include:
failure on the part of an auditor to lodge an annual statement
failure to comply with the conditions of registration
failure to maintain sufficient practical experience, as indicated by a failure to perform
any audit work during a continuous period of five years
failure to perform adequately and properly the duties of an auditor
ceasing to be a fit and proper person to remain registered.
As will be discussed later in this chapter, partners involved in the audits of high-profile
corporate collapses such as Westpoint and Centro had their registered company auditor registrations suspended.
Section 324 of the Corporations Act 2001 provides that a person cannot be appointed as
an auditor of a company unless they are a registered company auditor. Further, section
1280 requires that a person applying for registration must: lOMoAR cPSD| 47206071
be ordinarily resident in Australia
be a member of an approved body
be a graduate of a prescribed university or other prescribed institution in Australia
and have passed a course of study in accountancy and commercial law acceptable to
ASIC have sufficient auditing experience be a fit and proper person.
ASIC Regulatory Guide 180 Auditor Registration provides more detail of what is required
to meet these requirements. For example, to have sufficient auditing experience, an
auditor must have completed at least 3000 hours of work in auditing during the five years
immediately prior to the date of their application, including at least 750 hours spent
supervising audits of companies.
ASIC may approve auditing competency standards on application of any professional body
or accounting firm under section 1280A(1) of the Corporations Act 2001. In November
2004, ASIC approved its first auditing competency standard prepared by CPA Australia and
The Institute of Chartered Accountants in Australia (now Chartered Accountants ANZ). The
competency standard enables auditors to fill out a logbook to demonstrate onthe-job
experience in their audit competency skills and have this certified by a current registered
company auditor. This replaces the previous requirement to meet a specified number of hours.
To meet the educational requirements, auditors will be required to have completed Page 44
a specialist course in auditing, which will be prescribed under the Corporations
Regulations and administered by the professional accounting bodies.
Structure of assurance standards and pronouncements
The structure of the assurance standards and pronouncements issued by the AUASB is
outlined in Figure 2.3 . This is similar to the structure of the standards and
pronouncements issued by the International Auditing and Assurance Standards Board
(IAASB), which is responsible for setting auditing and assurance standards at international level.