Ch # 1 Concept and need for Audit and Assurance Flashcards
Definition and objective of audit
An audit is an official examination of the accounts of an entity by an auditor.
Main objective of an audit is to enable an auditor to convey an opinion as to whether or not the financial
statements of an entity are prepared according to an applicable financial reporting framework
Financial statements (F/S)
A structured representation of historical financial information, including disclosures, intended to
communicate an entity’s economic resources or obligations at a point in time, or the changes therein for a
period of time, in accordance with a financial reporting framework.
As per IAS-1 F/S have the following components:
▪ Statement of Financial Position (Balance Sheet)
▪ Statement of Profit or Loss and other comprehensive income
▪ Statement of Changes in Equity
▪ Cash Flow Statement
▪ Notes to the Financial Statements
▪ Comparative information prescribed by the standard
Applicable financial reporting framework (AFRF)
The AFRF adopted by management and, where appropriate, TCWG in the preparation of F/S that is
acceptable in view of the nature of entity and objective of F/S, or that is required by law or regulation. The
AFRF is decided by legislative or regulatory environment within each individual country, and accounting
standards (e.g. IFRS).
Concepts of accountability, stewardship and agency
▪ The directors have a stewardship role.
▪ They look after the assets of the company and manage them on behalf of the shareholders.
▪ Relationship between shareholders and the board of directors (BOD) is also an application of the
principle of agency.
▪ The agent has a legal duty to act in the best interests of the principal
▪ As agents for shareholders, the BOD should be accountable to the shareholders.
▪ To show their accountability, it is a general principle of company law that the directors are required to
prepare annual F/S, which are presented to shareholders for their approval.
The audit report: independence, materiality and true and fair
The key features of the audit report are as follows:
▪ Auditors producing the report are independent from the directors producing the F/S.
▪ The report gives an opinion on whether the financial statements “give a true and fair view”, or
“present fairly” the position and results of the entity in all material respects.
Independence of the auditor
Independence of the auditor
▪ External auditor must be independent from the directors
▪ If he is not independent, his opinion is likely to be influenced by the directors.
True and fair view (fair presentation)
▪ The term ‘true’ implies free from error,
▪ The term ‘fair’ implies that there is no undue bias in the F/S or the way in which they have been
presented.
▪ The phrases ‘true and fair view’ and ‘present fairly’ indicate that a judgement is being given that F/S
can be relied upon and have been properly prepared in accordance with an appropriate AFRF.
Materiality concept
▪ The auditor reports in accordance with the concept of materiality.
▪ He gives an opinion on whether the F/S present fairly in all material respects the financial position and
performance of the entity.
▪ Information is material if, on the basis of the F/S, it could influence the economic decisions of users
should it be omitted or misstated.
▪ The auditor will not aim to examine every number in the F/S. He will concentrate his efforts on the
more significant items in the financial statements.
Advantages of statutory audits:
▪ Increases the credibility of published financial statements.
▪ Confirms to management that they have performed their statutory duties correctly.
▪ Provides assurance to management that they have complied with non statutory requirements
▪ Provides feedback on the effectiveness of internal controls.
▪ Where internal controls are weak or inadequate, the auditor will give recommendations for
improvement. This will assist management in reducing risk and improving performance of the
company.
Inherent Limitations of an Audit
▪ The cost of an audit can be very high.
▪ Disruption caused to a company’s staff during the audit
▪ Some items in the subject matter might be estimates whose truth and fairness will not be known with
certainty until some point in the future. This means the assurance opinion is ultimately subjective and
judgmental.
▪ Most fraud will include an attempt to deliberately conceal the truth or misrepresent information.
▪ Auditor routinely uses sampling rather than tests every item.
▪ Irrespective of how strong a client’s systems are, they will always incorporate some degree of inherent
limitations.
▪ Audit evidence is persuasive rather than conclusive.
Meaning of Assurance
Meaning of Assurance
▪ ‘Assurance’ means confidence.
▪ In an assurance engagement, an ‘assurance firm’ is engaged by one party to give an opinion on a piece
of information that has been prepared by another party.
▪ The opinion is an expression of assurance about the information that has been reviewed.
▪ It gives assurance to the party that hired the assurance firm.
Levels of assurance
Levels of assurance
Assurance falls into one of two categories:
▪ Reasonable Assurance – A high (but not absolute) level of assurance provided by the practitioner’s
conclusion expressed in a positive form.
E.g. “In our opinion the F/S are true and fair”. (i.e. Audit)
▪ Limited Assurance – A moderate level of assurance provided by the practitioner’s conclusion
expressed in a negative form. It is necessary in the situations where the accountant/auditor cannot
obtain sufficient evidence to provide positive assurance
E.g. “Based on our review, nothing has come to our attention that causes us to believe that the
accompanying F/S do not give a true and fair view”. (i.e. Review)
Assurance provided by audit
Assurance provided by audit
▪ Provides a high, but not absolute, level of assurance
▪ Absolute assurance is not provided as there are some inherent limitations of an audit
Elements of an Assurance Engagement
Elements of an Assurance Engagement
Assurance Engagement
An engagement in which a practitioner aims to obtain sufficient appropriate evidence in order to express
a conclusion designed to enhance the degree of confidence of the intended users other than the
responsible party about the subject matter information (that is, the outcome of the measurement or
evaluation of an underlying subject matter against criteria)
- Concept and need for audit & assurance
- Concept and need for audit & assurance
An assurance engagement will consist of the following 5 elements:
1) A three party relationship:
▪ Practitioner (e.g. audit firm)
▪ Responsible party (e.g. directors and management)
▪ Intended users: (e.g. shareholders)
2) Subject matter:
This is the data such as the financial statements that have been prepared by the responsible party for
the practitioner to evaluate.
3) Suitable criteria:
Rules against which the subject matter is evaluated in order to reach an opinion. In a statutory audit
this would be the AFRF.
4) Evidence:
Information used by the practitioner in arriving at the conclusion on which their opinion is based. This
must be sufficient and appropriate.
5) Assurance report:
The report containing the practitioner’s opinion. This is issued to intended user after the collection of
evidence.
