Chapter 01 Assurance Services

Question 1

LO. 01
Relationship between shareholders and directors/management?

Answer 1

Following concepts explain the nature of the relationship of directors/management with shareholders:
1. Stewardship: the practice of managing another person’s property. The directors have a stewardship role. They look after the assets of the company and manage them on behalf of shareholders.
2. Agent: an individual who acts on behalf of the principal. In a company, Directors are agents and shareholders are principals, i.e., directors act according to instructions and in the best interest of shareholders.
3. Accountability: As agents of the shareholders, directors are accountable to shareholders. Directors show their accountability to shareholders by preparing annual financial statements and presenting them to the shareholders for their decision-making.

Question 2

LO. 01
Advantages of Audit/Assurance Engagement?

Answer 2

1. It increases the credibility of financial statements, as most of the misstatements are identified.
2. Auditor identifies deficiencies in the entity’s internal control system and gives recommendations to management to improve it.
3. It confirms that management is performing its statutory and non-statutory duties.
4. It assists in the sale or purchase of a business.
5. It assists in the grant of loans by banks.

Question 3

LO. 02
Elements of Assurance Engagement?

Answer 3

1. Three-party relationship:
   > Intended users (the parties who require subject matter and assurance reports e.g. shareholders, bankers).
   >Responsible party (the party which is responsible for preparation of subject matter i.e. directors, management), and >Practitioner (the professional who verifies subject matter and provides assurance on it i.e. auditor in an audit)
2. A subject matter: Subject matter is the information prepared by the responsible party, and is verified by the practitioner eg. Historical financial statements, or Cashflowforecast
3. A Suitable Criteria: Criteria means framework/basis (e.g. IFRS) which is used by the responsible party to prepare subject matter (e.g. financial statements), and used by the practitioner to evaluate the subject. Suitable means it should be selected appropriately.
4. Evidence Evidence: is the information used by the practitioner in arriving at the conclusion on which his report is based. Evidence should be Sufficient and Appropriate.
5. Written Assurance Report: It is a report written in standard format (as per ISAs or as per local Laws) which includes the conclusion of the practitioner. It is provided by practitioners to intended users.

If any of the above elements is missing, engagement will be called non-assuranceengagement.

Question 4

LO. 03
Levels of Assurance that can be provided?

Answer 4

Assurance means confidence. There are three levels of assurance depending on the extent of work i.e.
1. Limited Assurance (also called Moderate Level or Negative Assurance): It is a moderate level of assurance, expressed in a negative form of conclusion i.e. “Based on our review, nothing has come to our attention that causes us to believe that these financial statements do not give a true and fair view of the financial position of ABC Limited as at December 31. 20X1, and it’s financial performance and cash flows for the year then ended, in accordance with IFRS.” This level of assurance is usually given in a review of historical financial statements or a review of cash flow forecasts.
2. Reasonable Assurance (also called High Level or Positive Assurance) It is a high, but not absolute, level of assurance expressed in a positive form of conclusion i.e. “In our opinion, financial statements give true and fair view of financial position of ABC Limited at December 31, 20X1 and its financial performance and cash flow for the year then ended in accordance with IFRS.” This level of assurance is usually given in an audit of historical financial statements. Reasonable assurance means the auditor does not certify or guarantee that financial statements are free from all misstatements. There may still be some undetected misstatements even after the audit due to inherent limitationsofthe audit.

Question 5

Lo. 03
Why absolute assurance can not be provided?

Answer 5

Absolute Assurance: Absolute assurance means certification or guarantee that financial statements are free from all misstatements. The auditor cannot provide absolute assurance because most of the audit evidence is persuasive rather than conclusive due to inherent limitations of audit:
1. Nature of financial statements: (estimates, judgments, and uncertainties are involved e.g. in accounting estimates).
2. Nature of audit procedures: a) Management may not provide complete information to the auditor.
b) Auditor does not have legal powers (e.g. power to search).
c) Fraud involving collusion and complex techniques, or involving senior management are harder to detect.
3) Time and Cost limitation (Therefore, the auditor plans the audit in such a way that he directs its efforts on risky areas, and uses sampling).
4) There are always some inherent limitations in the client’s internal control system.
5) Company’s staff may not be available to answer the auditor’s questions or to provide him with documents.
6) Many of the audit procedures are based on the auditor’s judgment, which may be faulty.