AUDIT AND ASSURANCE PART A - 1

INTRODUCTION TO ASSURANCE

Assurance Engagements
The practitioner examines the subject matter made available by the responsible party,
matches it to the suitable criteria using evidence and reports to the intended users.
Elements of an assurance engagement
1. An assurance engagement will require a three-party relationship comprising of:
a) The intended user who is the person who requires the assurance report.
b) The responsible party, which is the organisation responsible for preparing the
subject matter to be reviewed.
c) The practitioner (i.e. an accountant) who is the professional who will review
the subject matter and provide the assurance.
2. Suitable subject matter. The subject matter is the data which the responsible party
has prepared and which requires verification.
3. Thirdly this subject matter is then evaluated or assessed against suitable criteria in
order for it to be assessed and an opinion provided.
4. Fourth, the practitioner must ensure that they have gathered sufficient appropriate
evidence in order to give the required level of assurance.
5. Last, an assurance report provides the opinion which is given by the practitioner to
the intended user

Types of assurance assignments

Reasonable assurance Limited assurance

An Assurance engagement in which the An assurance engagement in which the

Practitioner reduces engagement risk to an
acceptably low level in the circumstances of
the engagement as the basis for the
practitioner’s conclusion
Example: External Audit Example
High level of assurance but NOT
absolute or 100%
A high but not absolute level of assurance
is provided, this is known as reasonable
assurance.
More testing (Analytical tests, test of
controls and
substantive testing)
practitioner reduces engagement risk to a
level that is acceptable in the
circumstances of the engagement but
where that risk is greater than for a
reasonable assurance
engagement
Review of financial statements
Moderate level of assurance
The practitioner gathers sufficient evidence
to be satisfied that the subject matter is
plausible; in this case
negative assurance is given whereby the
practitioner confirms that nothing has come
to their attention which indicates that the
subject matter contains material
misstatements.
Lesser testing-focus on obvious errors only
(Analytical testing and Enquiry)
No going concern review

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Going concern review carried out

Positive conclusion- Wording:
‘in our opinion the financial statements give
(or do not give) a true and fair view of the
state of the company’s affairs’.
The procedures undertaken are not nearly
as comprehensive as those in an audit, with
procedures such as analytical review and
enquiry used extensively. In addition, the
practitioner does not need to comply with
ISAs as these only relate to external audits
Negative conclusion-Wording:
“nothing has come to light to suggest errors
or problems exist’'

The assurance is therefore given on the

absence of any indication to the contrary.
Review engagements are often undertaken
as an alternative to an audit, and involve a
practitioner reviewing financial data, such
as six-monthly figures.
This would involve the practitioner
undertaking procedures to state whether
anything has come to their attention which
causes the practitioner to believe that the
financial data is not in accordance with the
financial reporting framework

Assignments were no assurance is given

1. Agreed-upon procedures: A report on factual findings is given but no assurance
expressed. Users must judge for themselves and drawn their own conclusions
2. Compilation engagement: Users of the compiled information gain benefit from the
accountant’s involvement but no assurance is expressed. It is used to collect, classify
and summarise financial information. It means to present data in a manageable and
understandable form.

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External audit
ISA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with International Standards on Auditing states the purpose of an external audit
engagement is to ‘enhance the degree of confidence of intended users in the financial
statements.’
This is achieved by the auditor expressing an opinion on whether the financial statements:
• Give a true and fair view (or present fairly in all material respects).
• Are prepared, in all material respects, in accordance with an applicable financial
reporting framework.
It is a review and assessment of the financial records to form an overall conclusion as to
whether:
The financial statements have been prepared using acceptable accounting policies,
which have been consistently applied.
The financial statements comply with all the relevant regulations and statutory
requirements.
Adequate disclosure of all material matters relevant to the proper presentation of
financial information has been made.

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Important Terms
True and Fair presentation
Financial statements are produced by management which give a true and fair view of the
entity’s results. The auditor in reviewing these financial statements gives an opinion on the
truth and fairness of them.
Although there is no definition in the International Standards on Auditing of true and fair it is
generally considered to have the following meaning:
True – Information is factual and conforms with reality in that there are no factual errors. In
addition it is assumed that to be true it must comply with accounting standards and any
relevant legislation. Lastly true includes data being correctly transferred from accounting
records to the financial statements.
Fair – Information is clear, impartial and unbiased, and also reflects plainly the commercial
substance of the transactions of the entity.
Those charged with governance – The person(s) with responsibility for overseeing the
strategic direction of the entity and obligations related to the accountability of the entity. This
includes overseeing the financial reporting process.
Management – The person(s) with executive responsibility for the conduct of the entity’s
operations.
In some cases, all of those charged with governance are involved in managing the entity, for
example, a small business where a single owner manages the entity and no one else has a
governance role
Engagement partner – The partner in the firm who is responsible for the audit engagement
and its performance, and for the auditor’s report that is issued on behalf of the firm, and who
has the appropriate authority from a professional, legal or regulatory body.
Professional judgment – The application of relevant training, knowledge and experience,
within the context provided by auditing, accounting and ethical standards, in making
informed decisions about the courses of action that are appropriate in the circumstances of
the audit engagement.
Professional skepticism – An attitude that includes a questioning mind, being alert to
conditions which may indicate possible misstatement due to error or fraud, and a critical
assessment of audit evidence. Professional skepticism includes being alert to, for example:
 Audit evidence that contradicts other audit evidence obtained.
 Information that brings into question the reliability of documents and responses to
inquiries to be used as audit evidence.
 Conditions that may indicate possible fraud.
 Circumstances that suggest the need for audit procedures in addition to those
required by the ISAs.

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Benefit of an audit
 Higher quality information which is more reliable, improving the reputation of the
market.
 Independent scrutiny and verification may be valuable to management.
 Reduces the risk of management bias and fraud and error by acting as a deterrent.
An audit may also detect bias, fraud and error.
 Enhances the credibility of the financial statements, e.g. for tax authorities or
lenders.
 Deficiencies in the internal control system may be highlighted by the auditor.
Inherent Limitations of audit/ Reasons why absolute assurance cannot be given
1. Sampling – it is not practical for an auditor to test 100% of transactions and so they
have to apply sampling methodologies in selecting balances/transactions to test.
Therefore, there could be an error in an item not selected for testing by the auditor.
2. Subjectivity – financial statements include judgmental and subjective areas and
therefore the auditor is required to use their judgment in assessing whether the
financial statements are true and fair.
3. Inherent limitations of internal control systems – an internal control system is
operated by people and hence is liable to human error. In addition, there is the
possibility of controls override by management and of collusion and fraud. It is
impossible to remove all of these inherent limitations and as the auditor relies on the
internal control systems, this can reduce the usefulness of the audit.
4. Evidence is persuasive not conclusive – the opinion is based on audit evidence
gathered; however, while this evidence can indicate possible issues affecting the
audit opinion, evidence involves estimates and judgments and hence does not give a
definite conclusion.
5. Even if everything reported on was examined and found to be satisfactory, there may
be other items which should have been included– the completeness problem.
6. Auditors plan their work to detect material errors and frauds only – so small frauds
(or large frauds split into many small amounts) may go unnoticed.

An external audit has a number of other issues which reduce its usefulness
1. Audit report format – the format of the opinion is determined by International
Standards on Auditing. However, the terminology used is not usually understood by
non-accountants. This means that users may not actually understand the audit
opinion given.
2. Historic information – the audit report is often issued some time after the year end,
and so the financial information can be quite different to the current position. In the
current marketplace where companies’ financial positions can change quite quickly,
the audit opinion may no longer be relevant as it is out of date.
3. Auditors need to understand their clients in great depth if they are to understand
how fraud could be carried out and hidden. However, auditors cannot become too
close to their clients or their independence will be called into question.
4. Where auditors spot errors or fraud, their primary legal responsibility is to report this
to management. Any external reporting is hampered by rules on confidentiality.

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Expectation Gap
It is the gap between the expectation of users of assurance reports, particularly audit
reports under the Companies Act, and the firm’s legal responsibilities
Such expectation gaps include:

Expectations of Users Firm’s Auditor’s Legal Responsibilities

Belief that Auditor is responsible to prepare In reality, it is the management’s

the financial statements
Belief that the Auditor’s principal duty is to
detect fraud
Perception that Auditors reviews all the
entity’s transactions
Perception that the audit report is ‘correct’
responsibility
Auditor’s duty is to report that the financial
statements are free of material
misstatements arising from fraud and error
An audit is conducted on a Test basis
Auditors provide reasonable assurance
giving a True & Fair view

TEXY BOOK REFERENCE

1. Chapter 1

QUESTIONS

1. QUIZ IN THE CLASS

2. PYQ – MAR/JUN 2016, JUNE 2015

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