(April 2006)
Explanatory Statement
ASA 315 Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement
Issued by the Auditing and Assurance Standards Board
Explanatory Statement
Reasons for Issuing ASA 315 Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement
The Auditing and Assurance Standards Board (AUASB) issues Auditing Standard ASA 315 Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement due to the requirements of the legislative provisions explained below.
The Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 established the AUASB as an independent statutory body under section 227A of the Australian Securities and Investments Commission Act 2001, as from 1 July 2004. Under section 336 of the Corporations Act 2001, the AUASB may make Auditing Standards for the purposes of the corporations legislation. These Auditing Standards are legislative instruments under the Legislative Instruments Act 2003.
Process of making Auditing Standards
Section 1455 of the Corporations Act 2001 and Corporations Regulation 10.5.01 gave interim legal endorsement from 1 July 2004 to the majority of Auditing Standards made by the former Auditing & Assurance Standards Board of the Australian Accounting Research Foundation. The AUASB has reviewed the Auditing Standards and has proceeded to make them as legally enforceable Auditing Standards under the Corporations Act 2001.
The Auditing Standards have been made also in accordance with the Financial Reporting Council’s Strategic Direction to the AUASB dated 6 April 2005, pursuant to section 225 of the ASIC Act.
The Strategic Direction, inter alia, provides that the AUASB develops Auditing Standards that:
- have a clear public interest focus and are of the highest quality;
- use the International Standards on Auditing (ISAs) of the International Auditing and Assurance Standards Board (IAASB) as a base;
- conform with the Australian regulatory environment; and
- are capable of enforcement.
In implementing the Strategic Direction, the AUASB has undertaken a process of thorough review and revision that has:
- addressed the enforceability of mandatory requirements;
- clarified auditors’ obligations under the Auditing Standards;
- provided for sector neutrality in the Auditing Standards; and
- included other amendments as necessary.
Purpose of Auditing Standard ASA 315 Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement
The purpose of Auditing Standard ASA 315 is to establish mandatory requirements and to provide explanatory guidance on obtaining an understanding of the entity and its environment, including its internal control, and on assessing the risks of material misstatement in a financial report audit. Auditing Standard ASA 315 is to be read in conjunction with the Preamble to AUASB Standards, which sets out the intentions of the AUASB on how the Auditing Standards are to be understood, interpreted and applied.
Operative Date
This Auditing Standard is operative for financial reporting periods commencing on or after 1 July 2006.
Main changes from Auditing Standard AUS 402 (February 2004) Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatements
The main differences between ASA 315 and AUS 402 are that in ASA 315:
- The word ‘shall’, in the bold-type paragraphs, is the terminology used to describe an auditor’s mandatory requirements, whereas an auditor’s degree of responsibility is described in AUS 402 by the word ‘should’.
- The explanatory paragraphs provide guidance and illustrative examples to assist the auditor in fulfilling the mandatory requirements, whereas in AUS 402 some obligations are implied within certain explanatory paragraphs. Accordingly, such paragraphs have been redrafted to clarify that the matter forms part of the explanatory guidance.
Consultation prior to issuing this Auditing Standard
The AUASB has consulted publicly as part of its due process in developing this Auditing Standard. Exposure Draft ED 1/05 Proposed Auditing Standard: Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatements (Re-issuance of AUS 402) was issued on 31 August 2005 with a 45 day comment period. Submissions were received by the AUASB and it has considered these submissions as part of the development and finalisation of this Auditing Standard.
Overview
The Auditing and Assurance Standards Board (AUASB) enacted Auditing Standard ASA 315 Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement in 2006 to address deficiencies in the previous standard AUS 402, and to better align with international auditing standards. This act is part of the legislative framework established by the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004, which aimed to enhance the quality and reliability of financial reporting and auditing practices. The purpose of ASA 315 is to set out mandatory requirements and provide guidance for auditors to obtain an understanding of the entity and its environment, including internal controls, and to assess the risk of material misstatement in financial reports. This standard was designed to ensure that auditors are capable of providing high-quality audits that reflect the Australian regulatory environment and conform to international standards. The AUASB has undertaken extensive consultation and review processes to ensure that ASA 315 is both enforceable and effective in achieving these objectives.
Scope and Application
The Auditing and Assurance Standards Board (AUASB) has issued Auditing Standard ASA 315 Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement in accordance with the requirements of the Corporations Act 2001. This Act mandates that the AUASB make Auditing Standards, which are legislative instruments under the Legislative Instruments Act 2003, to enhance the quality of audits and the protection of stakeholders. ASA 315 applies to auditors who perform audits of financial reports of entities, and it sets out the mandatory requirements and explanatory guidance for understanding the entity and its environment, including its internal control, and assessing the risks of material misstatement in financial report audits. This Auditing Standard is operative for financial reporting periods commencing on or after 1 July 2006, and it replaces the previous Auditing Standard AUS 402. The AUASB has undertaken a thorough review and revision of the Auditing Standards to ensure enforceability, clarify auditors’ obligations, provide sector neutrality, and include other necessary amendments. In the process of developing ASA 315, the AUASB consulted publicly to consider stakeholders' submissions and ensure the quality and effectiveness of the Auditing Standard.
Key Provisions
Auditing Standard ASA 315 Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement, issued by the Auditing and Assurance Standards Board (AUASB), mandates certain procedures and provides guidance for auditors in understanding the entity and its environment, including internal controls, and in assessing the risks of material misstatement in financial report audits. This standard, which became operative for financial reporting periods commencing on or after 1 July 2006, serves to clarify and replace Auditing Standard AUS 402 (February 2004). Key changes include the use of the term 'shall' to denote mandatory requirements, which contrasts with the prior term 'should' used in AUS 402. Additionally, explanatory paragraphs have been revised to ensure that all obligations are explicitly stated and form part of the explanatory guidance, thereby avoiding any implied obligations as previously found in AUS 402.
The Auditing Standard imposes specific obligations on auditors, including the requirement to obtain an understanding of the entity and its environment to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial report and assertion levels. Auditors must also evaluate the design of internal controls and determine whether they have been implemented by performing procedures beyond inquiry. This process includes making inquiries of management and others within the entity, inspecting documents and reports, and observing activities and operations relevant to financial reporting. The AUASB's intention is to ensure that auditors comprehensively understand the entity, its internal control, and the broader environment in which it operates.
Failure to comply with the requirements set out in Auditing Standard ASA 315 may lead to civil or criminal consequences. Under section 1302 of the Corporations Act 2001, a person who contravenes an Auditing Standard commits an offence and is liable to a fine. The maximum penalty for an individual can be up to $210,000, or $1,050,000 for a body corporate, depending on the severity of the breach and whether it is an intentional or reckless act. Additionally, auditors may face disciplinary action from the AUASB, which could include suspension or cancellation of their registration as an auditor. The precise penalties depend on the nature and extent of the non-compliance, and the AUASB considers the public interest and any mitigating factors when determining appropriate sanctions.