1 & 11. Nature, Objective, Scope Of Audit Flashcards
Meaning and definition of auditing
An audit is independent examination of financial information of any entity, whether profit oriented or not, and irrespective of its size or legal form, when such an examination is conducted with a view to expressing an opinion thereon.
The person conducting this task should take care to ensure that financial statements would not mislead anybody. This he can do honestly by satisfying himself that:
1. the accounts have been drawn up with reference to entries in the books of account;
2. the entries in the books of account are adequately supported by sufficient and appropriate evidence;
3. none of the entries in the books of account have been omitted in the process of compilation;
4. the information conveyed by the statements is clear and unambiguous;
5. the financial statement amounts are properly classified, described and disclosed in conformity with accounting standards; and
6. the statement of accounts presents a true and fair picture of the operational results and of the assets and liabilities.
Objective of audit
In conducting an audit of financial statements, objectives of the auditor in accordance with SA-200 “Overall Objectives of the Independent auditor and the conduct of an audit in accordance with Standards on Auditing” are: -
(a) To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework; and
(b) To report on the financial statements, and communicate as required by the SAs, in accordance with the auditor’s findings.
Scope of audit
The following points merit consideration in regard to the scope of audit:
- The audit should be organized to cover adequately all aspects of the enterprise relevant to the financial statements being audited.
- To form an opinion on the financial statements, the auditor should be reasonably satisfied as to whether the information contained in the underlying accounting records and other source data is reliable and sufficient as the basis for the preparation of the financial statements.
- In forming his opinion, the auditor should also decide whether the relevant information is properly disclosed in the financial statements subject to statutory requirements, where applicable.
- The auditor assesses the reliability and sufficiency of the information contained in the underlying accounting records and other source data by:
i) making a study and evaluation of accounting systems and internal controls and
ii) Carrying out such other tests, enquires and other verification procedures. - The auditor determines whether the relevant information is properly disclosed in the financial statements by:
i) Comparing the financial statements with the underlying accounting records and other source data; and
ii) considering the judgments that management has made in preparing the financial statements accordingly,, the auditor assesses the selection and consistent application of accounting policies, the manner in which the information has been classified, and the adequacy of disclosure. - The auditor is not expected to perform duties which are outside the scope of his competence.
- Constraints on the scope of the audit of financial statements which impair the ability to express an unqualified opinion should be set out in his report, and a qualified opinion or disclaimer of opinion should be expressed as appropriate.
Advantages of audit
- Safeguards the financial interest of persons who are not associated with the management of the entity.
- Acts as a moral check on the employees from committing defalcations or embezzlement.
- Helpful in settling liability for taxes, negotiating loans and for determining purchase consideration.
- Useful for settling trade disputes for higher wages or bonus as well as claims in respect of damage suffered by property, by fire or some other calamity.
- Help in settlement of accounts at the time of admission of death of a partner.
- Govt. may require audited and certified statement before it gives any assistance or issues a license for a particular trade.
- Help in detection of wastage of losses, especially those that occur due to the absence of inadequacy of internal checks or internal control measures.
- Ascertains whether the necessary books of account have been properly kept and helps the client in making good any deficiencies or inadequacies in this respect.
- As an appraisal function, audit reviews the existence and operations of various controls in the organizations and reports weaknesses, inadequacies, etc. in them.
Inherent limitations of audit
The auditor is not expected to, and cannot reduce audit risk to zero and cannot therefore obtain absolute assurance that the financial statements are free from material misstatement due to fraud or error.
This is because there are inherent limitations of an audit. The inherent limitations of an audit arise from:
- Nature of financial reporting
Preparation of financial statements involves judgments by management in applying the applicable financial reporting framework.
In addition, many financial statement items involve subjective decisions or a degree of uncertainty and there may be a range of acceptable interpretations that can be made. - Nature of audit procedures
There are practical and legal limitations on the ability of the auditor to obtain audit evidence.
For example,
i) Management may not provide, intentionally or unintentionally, the complete information as requested by the auditor.
ii) Fraud may involve sophisticated and carefully organized schemes designed to conceal it.
iii) An audit is not an official investigation into alleged wrongdoing. - Timeliness of Financial Reporting and the balance between benefit and cost.
The relevance of information decreases over time and the auditor cannot verify each and every matter. Therefore, a balance has to be struck between the reliability of information and cost of obtaining it. - Other Matters that affect the limitations of an audit
i) Occurrence and non-compliance with laws and regulations
ii) Fraud
iii) Existence of related party relationships and transactions.
iv) Future events
Leadership responsibility for quality of audits
As per SA 220 “Quality Control for an Audit o Financial Statements”
- Engagement partner shall take responsibility for overall quality.
- Actions of engagement partner and members emphasize:
a) Importance to audit quality of:
i) Performing work that complies with professional standards and legal and regulatory requirements.
ii) Complying with firm’s quality control policies and procedures.
iii) Issuing auditor’s reports that are appropriate in the circumstances.
iv) Engagement team’s ability to raise concerns without fear of reprisals.
b) Fact that quality is essential in performing audit engagements.
What is independence
There are two interlinked perspectives of independence of auditors, one, independence of mind and two, independence in appearance.
Independence of mind:
The state of mind that permits the provision of an opinion without being affected by influences allowing an individual to act with integrity, and exercise objectivity and professional skepticism.
Independence in appearance:
The avoidance of facts and circumstances that are so significant that a reasonable and informed third party, having knowledge of all relevant information, would reasonably conclude an auditor’s integrity, objectivity or professional skepticism had been compromised.
Threats to independence
The code of ethics for professional accountants, prepared by the IFAC identifies five types of threats. These are:
- Self - interest threats - occurs when an aduiting firm, its partner or associate could benefit from a financial interest in an audit client. (5 examples)
- Self - review threats - occurs when during a review of any judgement or conclusion reached in a previous audit or non-audit engagement, or when a member of the audit team was previously a director or senior enployee of the client. (2 examples)
- Advocacy threats - occur when the auditor promotes, or is perceived to promote, a client’s opinion to a point where people may believe that objectivity is getting compromised. (2 examples)
- Familiarity threats - These are self-evident, and occur when auditors form relationship with the client where they end up being too sympathetic to the client’s interests. (4 examples)
- Intinidation threats - occur when auditors are deterred from acting objectively with an adequate degree of professional skepticism. Basically, these could happen because of threat of replacement over disagreements with the application of accounting principles, or pressure to disproportionately reduce work in response to reduced audit fees.
Safeguards to independence
- For the public to have confidence in the quality of audit, it is essential that auditors should always be and appears to be independent of the entities that they are auditing.
- Before taking on any work, an auditor must conscientiously consider whether it involves threats to his independence.
- When such threats exist, the auditor should either desist from the task or put in place safeguards to eliminate them or, at the very least, reduce the threats to an acceptable level.
- If the auditor is unable to fully implement credible and adequate safeguards, then he must not accept the work.
What is professional skepticism
Professional skepticism refers to 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:
1. Audit evidence that contradicts other audit evidence obtained.
2.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 SAs.
- Maintaining professional skepticism throughout the audit is necessary if the auditor is to reduce the risks of:
i) Overlooking unusual circumstances.
ii) Over generalising when drawing conclusions from audit observations.
iii) Using inappropriate assumptions in determining the nature, timing, and extent of the audit procedures and evaluating the results thereof.
Preconditions for audit
As per SA 210 “Agreeing the Terms of Audit Engagements”, preconditions for an audit may be defined as the use by management of an acceptable financial reporting framework in the preparation of the financial statements and the agreement of management and, where appropriate, those charged with governance to the premise on which an audit is conducted.
In order to establish whether the preconditions for an audit are present, the auditor shall:
(a) Determine whether the financial reporting framework is acceptable and
(b) Obtain the agreement of management that it acknowledges and understands its responsibility:
i) For the preparation of the financial statements in accordance with the applicable financial reporting framework including where relevant their fair representation;
ii) For such internal control as management considers necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error; and
(ii) To provide the auditor with:
a) Access to all information of which management is aware that is relevant to the preparation of the financial statements such as records, documentation and other matters;
b) Additional information that the auditor may request from management for the purpose of the audit; and
c) Unrestricted access to persons within the entity from whom the auditor determines it necessary to obtain audit evidence.
Agreement of audit engagement terms
According to SA 210 “Agreeing the Terms of Audit Engagements”, the auditor shall agree the terms of the audit engagement with management or those charged with governance, as appropriate.
The agreed terms of the audit engagement shall be recorded in an audit engagement letter or other suitable form of written agreement and shall include:
a) The objective and scope of the audit of the financial statements
b) The responsibilities of the auditor
c) The responsibilities of management
d) ldentification of the applicable financial reporting framework for the preparation of the financial statements and
e) Reference to the expected form and content of any reports to be issued by the auditor and a statement that there may be circumstances in which a report may differ from its expected form and content.
The audit engagement letter is sent by the auditor to his client.
Recurring audits
Recurring audit is an audit which is performed by an auditor over years.
The auditor may decide not to senda new audit engagement letter or other written agreement each period. However, the following factors may make it appropriate to revise the terms of the audit engagement or to remind the entity of existing terms:
i) Any indication that the entity misunderstands the objective and scope of the audit.
ii) Any revised or special terms of the audit engagement.
iii) A recent change of senior management.
iv) A significant change in ownership.
v) A significant change in nature or size of the entity’s business.
vi) A change in legal or regulatory requirements.
vii) A change in the financial reporting framework adopted in the preparation of the financial statements.
viii) A change in other reporting requirements.
Limitations of scope prior to audit engagement acceptance
If management or those charged with governance impose a limitation on the scope of the auditor’s work in the terms of a proposed audit engagement such that the auditor believes the limitation will result in the auditor disclaiming an opinion on the financial statements, the auditor shall not accept such a limited engagement as an audit engagement, unless required by law or regulation to do so.
Acceptance of change in engagment
An auditor who, before the completion of the engagement, is requested to change the engagement to one which provides a lower level of assurance, should consider the appropriateness of doing so.
A request from the entity for the auditor to change the terms of the audit engagement may result from-
1. A change in circumstances affecting the need for the service.
2. A misunderstanding as to the nature of an audit as originally requested.
3. A restriction on the scope of the audit engagement, whether imposed by management or caused by other circumstances.
If the auditor concludes that there is reasonable justification to change the audit engagement and if the audit work performed to the date of change complied with the SAs, the report to be issued would be appropriate to the revised engagement.
In order to avoid confusion, the report would not include reference to:
a) The original audit engagement or
b) Any procedures that may have been performed in the original audit engagement.
If the terms of the audit engagement are changed, the auditor and management shall agree on and record the new terms of the engagement in an engagement letter or other suitable form of written agreement.
The auditor should not agree to a change of engagement where there is no reasonable justification for doing so.
If the auditor is unable to agree to a change of the terms of the audit engagement and is not permitted by management to continue the original audit engagement, the auditor shall:
a) Withdraw from the audit engagement where possible under applicable law or regulation; and
b) Determine whether there is any obligation, either contractual or otherwise, to report the circumstances to other parties, such as those charged with governance, owners or regulators.
