Audit and Assurance

Chapter 1


Introduction to the Assurance
Why to have audit
Particularly in larger companies, the
owners of a company and the
management of that company are
distinct. Directors are accountable to
the shareholders in their role as
stewards and agents. Accountable
means being required to justify
actions and decisions.

Agency relationship
One of the primary sources of information about a company is the
financial statements. This contains information that almost all of
the stakeholder groups will find useful. In particular, the
shareholders (the primary stakeholder group) will need reliable
financial statements to appraise the performance of their
shareholding.
The directors are responsible for managing the company in order
to achieve the objectives of that company (normally the
maximization of shareholder wealth). However, directors often
directly benefit from increasing profit director's remuneration
may include bonuses, linked to the level of profits
achieved.
The directors are also responsible for preparing the financial
statements this creates a conflict of interest as the directors
benefit from reporting higher profits. There is therefore a need for
an independent review of these financial statements, i.e.
assurance from an external practitioner to ensure the financial
statements give a true and fair view.
Audit definition
Audit is independent examination and
expression of opinion on the financial
statements whether they are prepared
in all material respects in accordance
with applicable financial reporting
framework.
Independent
Auditor should be independent
from the entity.
Independence of mind
Independence of appearance
Expression of opinion
Expression of opinion on the
financial statements , opinion is
required by the shareholder after
opinion they will be decide whether
to Buy or Sell the shares.
Financial statements
Financial statements are of four types

Statement of financial position (SOFP)
Statement of comprehensive income
Statement of cash flow
Statement of changes in Equity
In all material respect
An item is said to be material if
its omission or misstatement
could influence the economic
decision of users of financial
statements.
Applicable financial reporting framework
IFRS(International financial reporting
standards )
IAS (International accounting
standards )
True and Fair
True: Information is factual and conforms with
reality. In addition the information conforms
with required standard and law.
Fair: Information is free from discrimination
and bias and in compliance with expected
standard and laws.
Assurance engagement
In assurance engagement is one in practitioner
expresses a conclusion designed to enhance the degree
of confidence of intended user about the out come of
the evaluation of subject matter against suitable
criteria and then based on evidence the practitioner
issues a report for the intended users.
It has five components
1) Three way relationship
2) Subject matter
3) Suitable criteria
4) Evidence
5) Assurance report
Three way relationship
A three way relationship involves

A practitioner (the reviewer of the subject
matter who provides the assurance)
Responsible party (i.e. those responsible for
the subject matter)
Intended users (Shareholder)
Subject Matter
Subject matter should be identifiable and capable
of consistent evaluation against suitable criteria.
E.G
Financial Performance (F/s)
Non-financial performance (KPIs)
System and Procedures (Internal controls and IT
system)
Behavior for example (Corporate Governance and
Compliance with law & Regulation)
Suitable criteria
Criteria are the benchmarks used to evaluate or
measure the subject matter.
For example

When reporting on Financial statements ,
International financial reporting standards
When reporting on internal controls , COSO
frame for internal controls
When reporting on Compliance the criteria will
be Applicable law or regulation
Evidence
A practitioner plan and perform an assurance
engagement to obtain sufficient and
appropriate audit evidence whether the
subject matter is free from material
misstatement.
Assurance report
The practitioner provides a written report
containing a conclusion.
For example , in our opinion internal control
are effective based on this criteria. Or Limited
Assurance Nothing came to our attention
.
True and Fair
Review engagement

The objective of a review engagement is
to enable an auditor to give an opinion
whether anything has come to his
attention that would mean the FS were
not properly prepared/true and fair, on
the basis of procedures which would not
constitute an audit.

Review engagement

In a limited assurance assignment, the practitioner:
Gathers sufficient appropriate evidence to be able
to draw limited conclusions.
Concludes that the subject matter, with respect to
identified suitable criteria, is plausible in the
circumstances.
Gives a negatively worded assurance opinion.
Positive assurance /Reasonable assurance
Absolute assurance can not be given because of
limitation of audit.

Reasonable assurance means that in our opinion
financial statements shows True and Fair view or
prepared in all material respect in accordance with
applicable financial reporting framework.
Negative assurance
Nothing has came to attention of auditor
that causes the auditor to believe that
Financial information is not prepared in
all material respect in accordance with
applicable financial reporting framework.
Assurance
services
Assurance Given Purpose
External audit Reasonable
Statutory external
audit
Review Negative
Review of interim
financial
statements
Agreed upon
procedures
None
Examination of specific
head in B/s
Compilation None
Preparation of
financial statements
Statutory Audit
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:
a statutory audit.
Companies that are not required to have a
statutory audit may have an external audit
because the company's shareholders or other
influential stakeholders want one and because
of the benefits of an audit.
Benefits of Statutory Audit
An audit improves the quality and reliability of
information, giving investors faith in and
improving the reputation of the market.
Independent scrutiny and verification may be
valuable to management.
An audit may reduce the risk of management
bias, fraud and error by acting as a deterrent.
An audit enhances the credibility of the financial
statements, e.g. for tax authorities/lenders.
Deficiencies in the internal control system may be
highlighted by the auditor.
Expectation Gap
Some users incorrectly believe that an audit
provides absolute assurance that the audit
opinion is a guarantee the financial
statements are 'correct'.
This and other misconceptions about the role
of an auditor are referred to as the
'expectations gap'.
The greatest level of assurance auditors can
provide is reasonable. The limitations of an
audit mean that it is not possible to provide
'absolute assurance.
Limitation of Audit

1. Auditing is not objective , It is subjective
(judgments have to be made , Risk assessment
Estimates , Judgments)
2. Auditors do not test all transactions and
balances, they test on a sample basis.
3. Audit report has inherent limitation(Standard
format , layman may not understand audit
Jargon)
4. Time lag (period reporting)
5. Assurance may be obtained from the operating
effectiveness of internal controls, which are
inherently limited.
Limitation of Audit
1. A belief that auditors test all transactions
and balances they test on a sample basis.
2. A belief that auditors are required to detect
fraud auditors are required to provide
reasonable assurance that the financial
statements are free from material
misstatement, which may be caused by
fraud.
3. A belief that auditors are responsible for
preparing the financial statements this is
the responsibility of management.
June 2010
(a) Auditors are frequently required to
provide assurance for a range of non-audit
engagements.
Required:
List and explain the elements of an assurance
engagement. (5 marks)

December 2010
(a) Explain the concept of TRUE and FAIR presentation. (4
marks)
Answer
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.

December 2011
Required:

Describe FIVE elements of an unmodified
auditors report. (5 marks)

December 2011
Question:-
Explain the term limited assurance in the context of a
review of a company's cash flow forecast and explain
how this differs from the assurance provided by a
statutory audit.
Answers
A cash flow relates to the future, which is inherently
uncertain, and therefore it would not be possible to
obtain assurance that it is free from material
misstatement. Less reliance can therefore be placed on
the forecast than the financial statements, where the
positive assurance was given.
With limited assurance, limited procedures are
performed often only enquiry and analytical
procedures.