Three parties, subject matter and criteria

Accounting Ahead | Original study resource | accountingahead.com.au

Three parties, subject matter and criteria

MODULE 1 | 1.2.6 | STUDENT COMPANION

Every assurance engagement needs five elements. This lesson covers the first three: a three-party

relationship, an appropriate underlying subject matter, and suitable criteria that are available to the

people relying on the report. Criteria matter more than they look: two honest organisations can measure

exactly the same activity and report very different numbers.

The five elements of an assurance engagement

This lesson The next two lessons

1. A three-party

relationship

Practitioner,

responsible party and

intended users

2. An appropriate

underlying

subject matter

Identifiable,

consistently

measurable and

testable

3. Suitable

criteria

The benchmarks,

available to the

people relying on the

report

4. Sufficient

appropriate

evidence

Enough evidence, of

the right quality, to

support the

conclusion

5. A written

assurance report

Containing the

practitioner's

conclusion

If any element is missing, the work may still be valuable, but it isn't an assurance engagement

The parties

These roles can be held by the same party or by different parties.

Role Who it is

Practitioner The person or firm doing the assurance work and giving the conclusion

Responsible party Whoever is responsible for the underlying subject matter; in a financial statement

audit, normally the board of directors

Intended users The people the report is written for, such as shareholders, lenders and other

providers of capital

Engaging party (sometimes

separate)

Whoever engages the practitioner

Measurer or evaluator

(sometimes separate)

Whoever applies the criteria to the subject matter, such as a company's finance

team

Two limits always apply. The practitioner can never be the responsible party, because nobody can

independently assure their own information. The responsible party can be one of the intended users, but

never the only one, or the report would only tell its preparer what it already knows.

ADVANCED AUDIT AND ASSURANCE | M1 | 1.2.6 | STUDENT COMPANION

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Accounting Ahead | Original study resource | accountingahead.com.au

Restricted use: when a report is written for one user and one purpose, such as a bank's covenant report, the

practitioner may restrict its use to that user, so that others don't rely on it for purposes it wasn't designed for.

Who's who in three engagements

Role Company audit Bank covenant report Second Helping meals

report

Practitioner The auditor An assurance practitioner An assurance practitioner

Responsible party The board of directors The company Second Helping (its board)

Measurer or

evaluator

The finance team,

preparing the statements

The company's finance

team, measuring covenant

compliance

Charity staff, weighing

deliveries and converting

them to meals

Engaging party The company, which

appoints its auditor

The company Second Helping

Intended users Shareholders, lenders and

other providers of capital

The bank (use of the report

can be restricted to it)

Major donors and the

government grant body

An appropriate underlying subject matter

The subject matter is appropriate when it can be identified, when it can be consistently measured or

evaluated against the criteria, and when the resulting information can be put through procedures that produce

sufficient appropriate evidence. Non-financial subject matter is often trickier: it mixes numbers with narrative,

and it rarely has measurement rules as developed as the accounting standards.

Forms the subject matter can take

Form Example (imagined)

Financial performance or position A franchise network's monthly sales

Non-financial performance An internet provider's average time to answer support calls

Physical characteristics The storage capacity of a grain terminal

Systems and processes A hospital's controls over who can change patient billing records

Behaviour A club's compliance with its liquor licence, or the conduct of a board's

governance

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Suitable criteria

Criteria are the benchmarks used to measure or evaluate the subject matter. Established criteria are set by an

authoritative body through a transparent process, such as the accounting standards, or the Greenhouse Gas

Protocol, the most widely used international method for measuring an organisation's emissions. Specifically

developed criteria are designed for the engagement, by the responsible party or sometimes by the practitioner.

Either way, they must be suitable, and available to the people relying on the report: a conclusion means

nothing if the reader doesn't know what yardstick was used.

Second Helping (imagined), a food rescue charity, reports that it delivered 1.2 million meals last year, and its

major donors and a government grant body want the figure assured. The underlying subject matter is the food

redistributed; the subject matter information is the meals figure; the criteria are the charity's own rules for turning

food into meals. It weighs surplus food and counts every 400 g delivered as one meal. Had it chosen 250 g a

meal, the same food would have produced about 1.9 million meals.

Testing the meals count against the five qualities

The rule: every 400 g of food delivered counts as one meal, giving 1.2 million meals. At 250 g a meal, the same food would count as

about 1.9 million: 60% more, without one extra plate served.

Quality The question it asks Testing the meals count

Relevance Do the criteria help users make their

decisions?

Count food delivered to partner agencies, not food collected,

some of which may never leave the warehouse

Completeness Is anything significant left out that could affect

users' conclusions?

Say how spoiled food is treated, rather than quietly dropping it or

counting it anyway

Reliability Would different people, at different times,

measure it consistently?

Calibrated scales on every delivery, not drivers estimating loads

by eye

Neutrality Are the criteria free from bias? A conversion rate from a recognised source, applied every year,

not the most generous rate available

Understandability Are they clear enough that users won't read

them very differently?

Explain what a 'meal' is, rather than just reporting a number of

meals

If the criteria fail: suitable criteria are a precondition for accepting an assurance engagement. If the charity's

criteria were unsuitable and it wouldn't change them, the practitioner shouldn't accept the work as an assurance

engagement, because no conclusion could mean what users would think it meant. More often, the practitioner's

questions improve the criteria, and the charity ends up with a better, more credible measure, disclosed alongside

the figure.

ADVANCED AUDIT AND ASSURANCE | M1 | 1.2.6 | STUDENT COMPANION

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Practice questions

MODULE 1 | 1.2.6 | TRY THESE BEFORE THE WORKED ANSWERS

Question 1 - Who's who?

Engagement (all imagined) Responsible

party

Engaging party Intended users

(a) Crumbworth Bakehouse, a franchisor,

requires each franchisee to provide an assurance

report on the monthly sales that set its royalties.

Hollis Bakeries, a franchisee, engages a

practitioner.

(b) A state sports department engages a

practitioner to report on whether Merrigal Rowing

Club spent its $400,000 boatshed grant in line

with the grant conditions.

(c) Highcrest Air's board asks a practitioner for

assurance on the airline's sustainability report,

which will be published for investors, customers

and community groups.

(d) Quandong Capital, planning to buy Coolabah

Fitness, engages a practitioner to give assurance

on the gym chain's reported membership

numbers.

Question 2 - Appropriate subject matter?

Tumbarra Regional Gallery (imagined) is considering three subject matters for an assurance engagement.

Decide whether each is appropriate, and explain why.

Proposed subject matter Appropriate? Why

(a) The number of visitors last year, counted

by electronic sensors at both entrances

(b) How much visitors loved the new

exhibition

(c) The gallery's compliance with its

child-safety policy for school group visits

ADVANCED AUDIT AND ASSURANCE | M1 | 1.2.6 | STUDENT COMPANION

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Question 3 - Test the pothole criteria

Ardley Shire Council (imagined) reports that 92% of potholes were repaired within five working days. Its criteria:

(1) the clock starts when a works crew logs the pothole in the council's system, not when a resident reports it; (2)

a temporary cold-mix patch counts as a repair; (3) potholes on state-managed roads are excluded, and

after-hours reports aren't logged until staff return; (4) crews record repair dates on paper sheets, typed in once a

week; (5) the report doesn't define a pothole or mention any of these rules. Test the criteria against the five

qualities.

Quality Your assessment

Relevance

Completeness

Reliability

Neutrality

Understandability

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Worked answers

MODULE 1 | 1.2.6 | WORKED ANSWERS - ATTEMPT THE QUESTIONS FIRST

Question 1 - Parties (sample answer)

Engagement Responsible party Engaging party Intended users

(a) Franchise sales Hollis Bakeries (its directors) Hollis Bakeries Crumbworth Bakehouse, the

franchisor

(b) Boatshed grant Merrigal Rowing Club (its

committee)

The state sports

department

The department, and possibly

the club's members

(c) Sustainability report Highcrest Air (its board) Highcrest Air's board Investors, customers and

community groups

(d) Membership

numbers

Coolabah Fitness (its

directors)

Quandong Capital Quandong Capital, and

perhaps its lenders

Question 2 - Tumbarra Regional Gallery (sample answer)

Subject matter Appropriate? Why

(a) Visitor numbers Yes Identifiable and consistently measurable, with evidence available (sensor

logs, calibration checks, reconciliation to ticket sales). Criteria must cover

re-entries

(b) How much visitors

loved it

No, as stated 'Loved' can't be measured consistently. It could become appropriate if

redefined, such as the share of exit-survey ratings of 4 or 5 out of 5

(c) Child-safety

compliance

Yes Behaviour measured against a written policy, with evidence from booking

records, staff screening checks, supervision ratios and incident logs

Question 3 - Ardley Shire Council (sample answer)

Quality Assessment

Relevance Residents care about the time from their report to a proper repair; a crew-logged start and a

temporary patch as the finish make the figure less relevant

Completeness After-hours delays and permanent repairs are left out. Excluding state roads may be

reasonable, but only if disclosed

Reliability Paper sheets typed in weekly invite errors and inconsistency. System timestamps for the

report and the repair would be more reliable

Neutrality Every choice flatters the result: a later start, an earlier finish, helpful exclusions. Neutral

criteria would run from the resident's report to the permanent repair

Understandability With no definition or disclosed rules, readers will assume potholes were fully fixed within five

days of being reported; the criteria must be disclosed

ADVANCED AUDIT AND ASSURANCE | M1 | 1.2.6 | WORKED ANSWERS

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