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The following topics are covered in this

Introduction chapter:
• Definition of assurance
to assurance • Types of assurance engagement
• External audit engagements
• Review engagements

1.1 WHAT IS ASSURANCE?

LEARNING SUMMARY
After studying this section you should be able to:
• explain the nature of audit and other assurance engagements
• explain the five elements of an assurance engagement.

Definition of an assurance engagement

DEFINITION An assurance engagement is one in which a
practitioner expresses a conclusion designed to enhance the
degree of confidence of the intended users other than the
responsible party about the outcome of the evaluation or
measurement of a subject matter against criteria.

Practitioner
3 Party
Intended user
Involvement Responsible party

E.g. financial statements, other financial

Subject Matter data, systems
Remember the five
key elements of an
E.g. accounting standards, assurance
Suitable Criteria UK Corporate Governance Code engagement. These
are fundamental to
your understanding
and are commonly
Evidence Sufficient and appropriate tested.

Written
Assurance Expressing a conclusion or opinion
Report

KEY POINT Assurance services include the audit of financial

statements, risk assessment reviews, systems reliability reports
A question can focus
and value for money audits in public sector organisations etc.
specifically on the
three parties
The three party relationship: involved in an
external audit
assignment. These
Responsible would be:
Practitioner Intended User
Party • Practitioner – the
auditors
• Intended user –
shareholders
Depends on the • Responsible
Assurance firm Usually the directors party -directors
assignment

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1.2 TYPES OF ASSURANCE
ENGAGEMENT
LEARNING SUMMARY
After studying this section you should be able to:
• explain the levels of assurance provided by an external audit and other
review engagements
• describe the types of assurance engagement.

Limited and reasonable assurance

Limited assurance Reasonable assurance

Moderate/lower level of High but not absolute level of You must be

assurance assurance comfortable with
limited assurance
versus reasonable
assurance and
negative opinion
Conclusion expressed negatively Opinion expressed positively versus positive
opinion.

E.g. engagement to examine a

E.g. audit of financial statements
forecast

‘Nothing has come to our

attention which causes us to ‘In our opinion, the financial
believe that these assumptions statements show a true and fair
do not provide a reasonable view.’
basis for the forecast.’

KEY POINT The confidence inspired by a reasonable assurance

report is designed to be greater than that inspired by a limited
assurance report.

• There are more regulations/ standards governing a reasonable

assurance assignment.
• The procedures carries out in a reasonable assurance assignment
will be more thorough.
• The evidence gathered in a reasonable assurance assignment will
need to be of a higher quality.

1.3 EXTERNAL AUDIT

ENGAGEMENTS
LEARNING SUMMARY
After studying this section you should be able to:
• identify and describe the objectives and general principles of external
audit engagements
• describe the limitations of external audits.

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Objectives of an external audit engagement
ISA 200 Overall objectives of the independent auditor and the conduct of an
audit in accordance with International Standards on Auditing states: the
objectives of an auditor are to:
• Obtain reasonable assurance about whether the financial statements
as a whole are free from material misstatement, whether due to fraud
or error.
• Express an opinion on whether the financial statements are prepared,
in all material respects, in accordance with an applicable financial
reporting framework.
• Report on the financial statements, and communicate as required by
ISAs, in accordance with the auditor’s findings.

KEY POINT An external audit is an example of a reasonable

assurance engagement.

The need for external audit:

• Shareholders provide the finance for a company and may or may not
be involved in the day to day running of the company.
• Directors manage the company on behalf of the shareholders in order
to achieve the objectives of that company.
• The directors must prepare financial statements to provide
information on performance and financial position to shareholders.
• The directors have various incentives to manipulate the financial
statements and show a different level of performance.
• Hence the need for an independent review of the financial statements
to ensure they give a true and fair view – the external audit.

KEY POINT In most developed countries, publicly quoted

companies and large companies are required by law to produce
annual financial statements and have them audited by an external
auditor.

Benefits and limitations of an audit

BENEFITS LIMITATIONS

Financial statements include

Higher quality information which is
subjective estimates and other
more reliable
judgemental matters
Internal controls may be relied on
Independent scrutiny and
which have their own inherent
verification
limitations
Reduces risk of management bias, Representations from management
fraud and error by acting as a may have to be relied upon as the
deterrent only source of evidence
Note the mnemonics
Enhances the credibility of financial Evidence is often persuasive not above to help you
statements conclusive remember:
Benefits HIRED
Deficiencies in the internal controls Do not test all transactions and Limitations FIRED
can be highlighted balances.

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Expectations gap
DEFINITION Misconceptions about the role of an auditor are
referred to as the expectations gap.

Examples of the expectations gap:

• A belief that auditors test all transactions and balances. Auditors test
on a sample basis. A question may ask
• A belief that auditors will detect all fraud. Auditors are required to you about the
provide reasonable assurance that the financial statements are free differences between
what the public think
from material misstatement, which may be caused by fraud. we do as auditors
• A belief that auditors are responsible for preparing the financial and what we actually
statements. This is the responsibility of management. do.

• A belief that an unmodified auditor’s opinion guarantees the company

is a going concern.

KEY POINT Auditors provide reasonable assurance which is not

absolute assurance. The limitations of audit mean that it is not
possible to provide a 100% guarantee.

1.4 REVIEW ENGAGEMENTS

LEARNING SUMMARY
After studying this section you should be able to:
• describe the general principles of review engagements.
The objective of a review engagement is to enable an auditor to state
whether, on the basis of procedures which do not provide all the evidence
required in an audit, anything has come to the auditor’s attention that
causes the auditor to believe that the financial statements are not prepared
in accordance with the applicable financial reporting framework.

KEY POINT A review engagement is an example of limited

assurance.

A review engagement

Voluntary

Analytical

Make enquiries

Negative
assurance report

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Do you understand?
1 For a statutory audit assignment, list the following:
(i) the three parties involved (ii) the subject matter (iii) the criteria
2 The evidence obtained and the opinion given in a reasonable assurance engagement is
described as sufficient appropriate evidence and a positive opinion.
True or false?
3 Which of the following describes aspects of the expectations gap with respect to the
external audit?
(i) Users are not aware of the limitations of the audit process
(ii) Users do not understand what the audit process involves
(iii) Users do not appreciate that reasonable assurance is a low level of assurance.

low, level of assurance.

(i) and (ii) represent various aspects of the expectations gap. Reasonable assurance is a high, not 3
True 2
statements (iii) The criteria = law and accounting standards.
(i) The three parties = auditor, directors, shareholders (ii) The subject matter = the financial 1

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 Exam style questions

OT Case – practice
You are about to begin the external audit of Amaretto Co. This is the first
year that the company has required an audit and the directors appear to be
unsure about the purpose of an audit. The directors have also indicated that
they expect your firm to check every transaction and detect every fraud and
error in their accounting records. It appears that they believe that is what all
auditors do.

1 Which of the following levels of assurance will be provided by

the independent auditor’s report?
A Absolute assurance
B Reasonable assurance
C Moderate assurance
D Limited assurance

2 Which of the following is NOT one of the five elements of an

assurance engagement?
A Competent staff
B Suitable criteria
C Subject matter
D Written report

3 Which of the following is NOT a benefit of an audit?

A Increased credibility of the financial statements

B Deficiencies in controls may be identified during testing
C Fraud may be detected during the audit
D Sampling is used

4 Which of the following statements is FALSE?

A The auditor will express an opinion as to whether the financial

statements show a true and fair view
B The auditor must be able to obtain sufficient appropriate
evidence to be able to form an opinion
C If the financial statements are found to contain material
misstatements a negative audit opinion will be given
D An audit may not detect all fraud and error in the financial
statements

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5 Which of the following are examples of the expectations gap?

(i) The independent auditor’s report confirms the financial

statements are accurate
(ii) An unmodified opinion means the company is a going concern
(iii) The auditor tests all transactions
(iv) The auditor can be sued for negligence if they issue an
inappropriate opinion

A (i), (ii) and (iii) only

B (i), (ii) and (iv) only
C (i) and (ii) only
D (ii) and (iii) only

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