ISAs – Summaries and Application Guide ISA 200

ISA 200*
OVERALL OBJECTIVES OF THE
INDEPENDENT AUDITOR

LO # LEARNING OBJECTIVE

LO 1 FINANCIAL STATEMENTS, AND FINANCIAL REPORTING FRAMEWORKS

LO 2 PARTIES INVOLVED IN AN AUDIT
LO 3 NATURE AND SCOPE OF AUDIT
LO 4 EVIDENCE, RISK AND PROCEDURES
LO 5 ESSENTIALS FOR PROPER CONDUCT OF AUDIT
LO 6 ISAs AND CODE OF ETHICS
LO 7 SMALLER ENTITY

*(Effective for audits of financial statements for periods beginning on or after December 15, 2009)

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ISAs – Summaries and Application Guide ISA 200

LO 1: FINANCIAL STATEMENTS, AND FINANCIAL REPORTING FRAMEWORKS:

Financial Statements:
Financial statements means structured representation of historical (i.e. past) financial information.

Financial statements may be:

 General Purpose (prepared for wide range of users) or
 Special Purpose (prepared for specific users).

Financial Statements may also be:

 Complete Set of Financial Statements.
 Single Financial Statement or Element.
 Summary Financial Statements.

Types of Financial Statements and How are they audited

1. General purpose financial statements are audited in accordance with ISA 200 – 700 Series.
2. Special purpose financial statements are audited in accordance with ISA 800.
3. Single financial statements are audited in accordance with ISA 805.
4. Summary Financial Statements are audited in accordance with ISA 810.

Framework:
Framework means criteria/basis (i.e. standard rules and regulations) used to prepare financial
statements.

There are many types of frameworks e.g.:

1. General Purpose (for wide range of users), and Special Purpose (for specific users).
2. Fair presentation Framework, and Compliance Framework.

General purpose framework: (to meet needs of wide range of users)

Examples of general purpose framework include:
 IFRS
 IFRS for SMEs
 National Framework (or Financial Reporting Framework of Jurisdiction X) e.g. US GAAP
 XYZ Law of Jurisdiction X

If AFRF is other than IFRS, jurisdiction of framework shall also be referred in opinion.

Exam Tip
Sometimes, a specific user may also accept financial statements prepared under General Purpose
Framework if such framework meets its needs.

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Special purpose framework: (to meet needs of specific users)

Examples of Special Purpose Frameworks:

1. Regulatory Basis:
Such a framework may be established by a regulator, and may be used to prepare financial
statements to meet requirements of regulator.
Note that if Regulator established framework to meet requirements of wide range of users, it
will be a general purpose framework, and NOT special purpose framework.

2. Tax Basis:
Such a framework may be used to prepare financial statements to accompany an entity’s tax
return.

3. Cash Basis:
Such framework may be used to prepare financial statements for creditors.

4. Contractual Basis:
Such a framework may be established by individual parties in the terms of a contract e.g. in
a loan-agreement, or project-grant.

If Special Purpose Framework is used by Management

 Auditor shall include “Emphasis of Matter Paragraph” in his report to explain basis of accounting
i.e. the financial statements are prepared in accordance with a special purpose framework.
 Auditor may also include “Other Matter Paragraph” restrict distribution of report.

Fair Presentation Framework:

Fair presentation framework is a financial reporting framework that requires compliance with
requirements of the framework, and contains acknowledgment that, to achieve fair presentation, it
may be necessary for management:
 To provide disclosures in addition to specific requirements of framework or
 To depart from a requirement of framework

In Fair presentation framework, auditor expresses opinion whether:

 “financial statements give true and fair view in accordance with the framework”, or
 “financial statements are presented fairly, in all material respects, in accordance with the
framework”. (Both phrases are equivalent)

Compliance Framework:
Compliance framework is a financial reporting framework that requires compliance with
requirements of the framework, and does not contain acknowledgements which are contained in
fair presentation framework (regarding additional disclosures or departure from requirements of
framework to achieve fair presentation).

In Compliance framework, auditor expresses opinion whether “financial statements are prepared,
in all material respects, in accordance with the framework”.

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Study Tips
 If in fair presentation framework, financial statements do not achieve fair presentation,
management may include additional disclosures or (in rare case) may depart from a requirement.
 If in compliance framework, financial statements are misleading (in rare case), such AFRF is not
acceptable and auditor shall not accept audit. If deficiencies in compliance framework are
identified during audit, auditor shall request management to change framework and shall agree
new terms.

Applicable Financial Reporting Framework (AFRF):

AFRF is the financial reporting framework adopted by management to prepare financial statements.
AFRF is required to be disclosed in financial statements (to communicate basis of preparation of
financial statements).

A description that financial statements are prepared in accordance with an AFRF is appropriate
only if all requirements of that framework are met. A qualifying or limited language is not allowed
e.g. “Financial statements are in substantial compliance with IFRS”.

LO 2: PARTIES INVOLVED IN AN AUDIT:

Management and Those Charged With Governance (TCWG):
 Management means persons responsible for conduct of entity’s operations (e.g. CFO, CEO).
 TCWG means persons responsible for Overseeing the strategic direction and Accountability
(e.g. Directors).
 Sometimes, Management and TCWG may be same e.g. in Sole-proprietorship or Partnership.

Responsibilities of Management:
An audit is conducted on the premise that management (and where applicable TCWG) is
responsible:
 For preparation and presentation of financial statements in accordance with AFRF (i.e. to
identify AFRF, prepare and present financial statements in accordance with AFRF, and
describe AFRF in notes)
 For design and implementation of such internal controls which are necessary for
preparation of reliable financial statements;
 To provide auditor with all relevant information, and additional information requested by
auditor, and unrestricted access to persons to obtain evidence.

Responsibilities/ Overall Objective of the Auditor:

The overall objectives of the auditor are:
 To obtain reasonable assurance whether financial statements are free from material
misstatement (whether due to error or fraud), to enable auditor to express opinion whether
financial statements are prepared, in all material respects, in accordance with the AFRF, and
 To report on the financial statements, and
 To communicate as required by the ISAs in accordance with the auditor’s findings
(considering confidentiality principle).

How Reasonable Assurance is Obtained

Reasonable assurance is achieved when auditor obtains sufficient appropriate audit evidence (and
reduces audit risk to appropriate level) by performing procedures as per ISAs, and Code of Ethics. (But
remember that ISAs are objective/evidence-oriented, not procedure-oriented)

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Different Stakeholders:
 Existing or Prospective Shareholders.
 A holding company.
 Lenders.
 Donors.
 Tax Authorities.

Expectation Gap by stakeholders:

Expectation gap means public perception of the role and responsibilities of the external auditor is
different (and is usually higher) from his statutory role and responsibilities.

Some Common Misunderstandings (i.e. Expectation Gap) about Audit:

1. Auditor prepares financial statements.
2. Auditor checks 100% transactions of entity during the accounting period.
3. Auditor provides absolute assurance (i.e. he certifies or guarantees that financial statements
are correct in all respects).
4. Auditor is responsible to detect fraud.
5. Auditor is responsible to express opinion on internal controls.
6. Emphasis of Matter, Other Matter Paragraph, and Material Uncertainty related to Going
Concern Paragraph are modified opinions.

LO 3: NATURE AND SCOPE OF AUDIT:

Scope of Audit:
Scope of audit involves expressing opinion on financial statements. It does not assure future
viability or efficiency/effectiveness of management.

However, local laws may require auditor to provide opinions on other specific matters.

Levels of Assurance:
There are three level of assurance:
1. Limited Assurance.
2. Reasonable Assurance.
3. Absolute Assurance (not provided to clients).

Limited Assurance (also called Moderate Level or Negative Assurance)

It is a moderate level of assurance which is expressed in negative form of conclusion i.e. “nothing
has come to our attention that causes us to believe that financial statements do not give true and
fair view”.

This level of assurance is usually given in review of historical financial statements.

Review of Financial Statements

Review of financial statements is conducted in accordance with ISRE 2400, or ISRE 2410.

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Reasonable Assurance (also called High Level or Positive Assurance)

It is a high, but not absolute, level of assurance which is expressed in positive form of conclusion i.e.
“financial statements give true and fair view in accordance with the framework”.

This level of assurance is usually given in an audit of historical financial statements.

Auditor is responsible to obtain reasonable assurance and express opinion. He does not certify or
guarantee that financial statements are free from all misstatements. Subsequent discovery of
material misstatement does not by itself indicate failure to conduct audit in accordance with ISAs.
There may be some undetected material misstatements even after audit due to inherent
limitations of audit.

Inherent Limitations of Audit:

Following inherent limitations cause most of the audit evidence being persuasive rather than
conclusive:
1. Nature of financial statements (estimates, judgments and uncertainties are involved e.g. in
accounting estimates).

2. Nature of audit procedures (judgments are involved)

a. Management may not provide complete information to auditor.
b. Auditor does not have legal powers (e.g. power to search).
c. Fraud involving collusion and complex techniques, or involving senior management
are harder to detect.

3. Time and Cost limitation (Therefore, auditor plans audit in such a way that he directs its
efforts on risky areas, and uses sampling). However, time and cost are not valid basis to
omit a required audit procedure.

4. Other matters/assertions in which it is difficult to identify misstatements:

a. Transactions with related parties.
b. Non-compliance with laws and regulations
c. Going Concerns Issues

LO 4: EVIDENCE, RISK AND PROCEDURES:

Sufficient Appropriate Audit Evidence:
To obtain reasonable assurance, auditor obtains Sufficient Appropriate audit evidence.
 Sufficiency is a measure of Quantity of evidence (which is affected by risk and quality of
evidence).
 Appropriateness is a measure of Quality of evidence (which is affected by relevance, and
reliability of information).

Audit evidence may be obtained from different sources e.g.

 During the audit (inside or outside the entity)
 Acceptance and Continuance Procedures
 Previous audits (provided it is still relevant).
 Expert

This concept will be discussed further in ISA 500.

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Audit Risk:
The risk that the auditor expresses an inappropriate opinion when financial statements are
materially misstated. Audit risk is a product of Risk of Material Misstatement and Detection Risk.

Risk of Material Misstatement

The risk that the financial statements contain material misstatements prior to audit.

Risk of material misstatements has two LEVELS:

1. Risk at Financial Statement Level (which affects many assertions)
2. Risk at Assertion Level (which affects specific assertion)

At Assertion level, risk of material misstatement has two components:

1. Inherent Risk (risk due to nature of entity and its transactions e.g. risk of theft in precious
and portable inventory, areas where estimates are applied, risk of change in
technology/fashion, declining industry, lack of working capital to continue operations).
2. Control Risk (risk due to weaknesses in internal control e.g. No approval, reconciliations,
segregation of duties.

Detection Risk:
The risk that the procedures performed by the auditor will not detect a material misstatement in
financial statements (either individually or when aggregated with other misstatements).

Detection risk can be reduced by:

 Adequate planning
 Assignment of competent personnel.
 Application of professional skepticism
 Supervision and review of work performed.

Audit Procedures:
This concept will be discussed in detail in ISA 500.

LO 5: ESSENTIALS FOR PROPER CONDUCT OF AUDIT:

Professional Judgment:
Auditor is required apply professional judgment in planning and performing the audit.

Professional Judgment is the application of Cumulative Audit Knowledge, Experience and Training
(within the context of accounting, auditing, and ethical standards), during an audit to reach an
appropriate course of action or conclusion which is appropriate in the circumstances.

Professional Skepticism:
Auditor is required apply professional sketpcism in planning and performing the audit.

Professional skepticism is an attitude that includes:

 a questioning mind,
 being alert to conditions which indicate possible misstatement (due to error or fraud), and
 critical assessment of audit evidence.

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It means auditor should not believe everything which management tells him. Rather, he should
obtain corroborative evidence and should investigate if there is a conflict.

Independence:
Independence means auditor should be free to perform audit procedures without any bias or
influence. Auditor should be Independent of financial, personal and employment relations with
client.

LO 6: ISAs AND CODE OF ETHICS:

Process of Developing and Issuing a new ISAs:
1. A subject is selected for detailed study.
2. After conducting comprehensive study and research, an exposure draft is produced which is
approved by IAASB and then distributed widely for public comments usually for a period of
120 days or more.
3. Comments and proposed amendments are considered by the IAASB.
4. The new ISA is then published.

Contents of ISAs:
1. Introductory Material, Objectives, Definition.
2. Requirements.
3. Application and Other Explanatory Material (including Appendices).

Auditor shall have understanding of entire text of ISAs (including Application and Other
Explanatory Material.

Auditor is permitted to apply an ISA before its effective date.

Complying with ISAs relevant to Audit:

To obtain reasonable assurance, it is compulsory for auditors to comply with all required
procedures of all ISAs. Auditor shall state compliance with ISAs in audit report only if he has
complied with requirements of all ISAs relevant to audit.

Exceptions to follow requirements of ISA:

A required procedure will not be performed if it is:
 not relevant (because condition does not exist) or
 not practicable.

In following cases, an ISA or its requirement is not relevant:

 If an entity does not have internal audit function, ISA 610 is not relevant.
 If an auditor expresses unmodified opinion, requirements relating to modification in ISA
705 do not apply.
 If no significance deficiencies are identified during audit, requirements relating to
communication with TCWG in ISA 265 do not apply.
 If entity has no segments, requirements relating to segment information in ISA 501 do not
apply.
 If an ISA requires auditor to do something unless prohibited by law or regulation (and law
prohibits it).

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If a procedure is not practicable, auditor shall document:

 reason of departure from required procedure, and
 alternative procedures performed to obtain evidence/assurance.

Conduct of Audit in accordance with Ethical Requirements:

Auditor shall comply with ethical requirements (including independence) of Code of Ethics.

Code of ethics requires auditor to comply with following fundamental principles of ethics:
1. Integrity
2. Objectivity
3. Confidentiality
4. Professional competence and due care
5. Professional behaviour

Complying with local legal or regulatory requirements:

Auditor shall comply with local requirements (if any) in addition to ISAs.

LO 7: SMALLER ENTITY:
Smaller entity means Sole-proprietorship, Partnership or Unlisted entities.
Owner of smaller entity who is involved in management of entity is called “owner-manager”.