Chapter 1 - Concept of and Need for Assurance

Question 1

Assurance has two big classifications - name them and provide examples

Answer 1

1. Audit of financial statements
   + ve pinion - the f/s are true and fair
2. Other Assurance Engagements
   -ve opinion - nothing came to our attention that caused us to believe that what we reviewed was misstated.
   Internal Control Review
   Corporate Governance Practices
   Financial Statements Review
   PFI (Prospective Financial Information) e.g. budgets, cashflows, forecasts

Question 2

Assurance - definition

Answer 2

Assurance could be described as an assurance firm’s satisfaction as to the reliability of an assertion being made by one party for the use of another party. This assurance is expressed in an “assurance report” with a negative or positive conclusion given.

Question 3

Assurance engagement - definition

Answer 3

An assurance engagement is one in which a practitioner expresses a conclusion designed to enhance the degree of confidence of the intended users other than the responsible party about the outcome of the evaluation or measurement of a subject matter against criteria.

Independently verifying to give comfort to general public

The key elements of an assurance engagement are as follows:

1. Three party relationship
   (i) The practitioner - gives assurance e.g. auditor
   (ii) The intended users - who the report goes to e.g. member/shareholders
   (iii) The responsible party (for preparing subject matter and criteria) e.g. director
2. A subject matter (financial statements / internal controls / corporate governance etc)
3. Suitable criteria
   e.g. F/S= In an audit IFRS/IAS/Companies Act
   e.g. IC = Client Doc Controls
   e.g. CG = UK code of CG
4. Sufficient (enough) appropriate(supports subject matter) evidence to support the assurance opinion
5. A written report providing an opinion on the subject matter

Question 4

What are the key elements of an assurance engagement? (5)

Answer 4

The key elements of an assurance engagement are as follows:

1. Three party relationship
   (i) The practitioner - gives assurance e.g. auditor
   (ii) The intended users - who the report goes to e.g. member/shareholders
   (iii) The responsible party (for preparing subject matter and criteria) e.g. director
2. A subject matter (financial statements / internal controls / corporate governance etc)
3. Suitable criteria (my benchmark e.g. companies act 2006, IFRS)
4. Sufficient (ENOUGH) appropriate (RIGHT TYPE) evidence to support the assurance opinion
5. A written report providing an opinion on the subject matter

Question 5

Two types of assurance engagement?

Answer 5

1. Reasonable Assurance
   - High
   - Sufficient and appropriate
   - Very intrusive
   - AEIOU = Analytic procedures, Enquiry, Inspection, Observation, Recalculation
   - Fraud and error stands a reasonable chance of detection
   - Assertive Positive/UnModified Opinion e.g. The financial statements show a true and fair view in all material respects
   - High Risk for auditor
   - If FS are not true and fair this is an unmodified opinion
2. Limited Assurance
   - Low
   - Sufficient and appropriate
   - Less intrusive
   - AE = Analytic procedures, Enquiry
   - Negative Opinion /Modified Opinion e.g. Nothing has come to our attention that make us believe that the subject matter is misstated
   - Low Risk for auditor

Note: It is not practical to give absolute assurance (ie 100%) assurance

Question 6

Can you ever give an absolute assurance?

Answer 6

It is not practical to give absolute assurance (ie 100%) assurance

Absolute assurance is impractical due to factors like:
- Sampling limitations: Auditors don’t test every transaction. A sampling approach is used.
- Reliance on internal controls: Controls may have inherent weaknesses. e.g. accounting system limitations and also client staff members may collude in fraud which can then be deliberately hidden from the auditor or misrepresent matters to them for the same purpose.
- Nature of the financial statements
. The fact that most audit evidence is persuasive rather than conclusive.
. The fact that some items in the subject matter may be estimates and are therefore uncertain.
It is impossible to conclude absolutely that judgemental estimates are correct.
- Quality of auditor judgements: The fact that assurance provision can be subjective and professional judgements have to be made (for example, about what aspects of the subject matter are the most important, how much evidence to obtain, etc).

Question 7

What is Reasonable Assurance (5)

Answer 7

• High
• Sufficient and appropriate
• Very intrusive
• AEIOU = Analytic procedures, Enquiry, Inspection, Observation, Recalculation
• Fraud and error stands a reasonable chance of detection
• Assertive Positive/UnModified Opinion e.g. The financial statements show a true and fair view in all material respects
• High Risk for auditor
• If FS are not true and fair this is an unmodified opinion

Question 8

What is Limited Assurance (5)

Answer 8

2. Limited Assurance
   - Low
   - Sufficient and appropriate
   - Less intrusive
   - AE = Analytic procedures, Enquiry
   - Negative Opinion /Modified Opinion e.g. Nothing has come to our attention that make us believe that the subject matter is misstated
   - Low Risk for auditors

Question 9

Differentiate between reasonable and limited assurance

Answer 9

Reasonable assurance provides a positive opinion based on sufficient evidence, while limited assurance offers a negative conclusion with less intrusive evidence.

Question 10

Examples of assurance engagements and who are the regulators (4) What type of assurance engagement are these? (1)

Answer 10

 Bank audits - required by FCA
 Pension scheme audits - required by FCA
 Charity audits - required by charity commission
 Solicitors’ audits - required by SRA

This is a limited assurance engagement

Question 11

Examples of assurance engagements voluntary engagements (6) What type of assurance engagement are these? (1)

Answer 11

 Environmental audits - CSR reports
 Due diligence (where a report is requested on an acquisition target)
 Internal audit - outsourced
 Fraud investigations- outsourced
 Internal control reports - processes or procedures assigned to prevent.detect fraud and error
 Reports on business plans or projections - cashflow forecasts

Different levels of assurance will be given for different assurance engagements. For example, only limited assurance could be given for a report on a business plan as the data contained in that document would be based on forecast figures.

This is a limited assurance engagement

Question 12

When reviewing a cashflow forecast will you give a positive or negative or can it be either opinion?

Answer 12

Different levels of assurance will be given for different assurance engagements. For example, only limited assurance could be given for a report on a business plan as the data contained in that document would be based on forecast figures.

Always negative as it is limited
These are a prediction

Question 13

What are the requirements to undergo a statutory audit?

Answer 13

In the UK, all companies of a certain size must have an audit by law (companies act 2006) - for this current and last financial year

1. An annual turnover/revenue of more than £10.2 million
2. Assets (NCA and CA) worth more than £5.1 million
3. 50 or more employees on average

Question 14

What makes a company exempt from audit?

Answer 14

2 or more of the below - SET BY COMPANIES ACT 2006 - for this current and last financial year

1. An annual turnover/revenue no more than £10.2 million
2. Assets (NCA + CA) worth no more than £5.1 million
3. 50 or fewer employees on average

Question 15

Why might directors manipulate financial statements?

Answer 15

• Have an incentive to manipulate
• Bonuses
• Salary
• Reputation
• Keep job

Question 16

Define True and Fair

Answer 16

No official definition but here is the generally accepted ones

True: Information is factual and conforms with reality, not false. In addition the information conforms with required standards and law. The accounts have been correctly extracted from the books and records.

Fair: Information is free from discrimination and bias in compliance with expected standards and rules. The accounts should reflect the commercial substance of the company’s underlying transactions.

Question 17

What is an RSB? (1) Give an example (1) What are they responsible for ensuring? (2)

Answer 17

Recognised Supervisory Body (RSB)

The Companies Act 2006 requires that auditors are members of a RSB. The ICAEW is an RSB. ICAS (Scotland), CAI (Ireland)

Ensure auditors are competent

The RSB is responsible for ensuring:
- Only Individuals holding an appropriate qualification or Firms controlled by qualified persons can conduct audits
- Those individuals or firms are monitored on a regular basis (CPD - continual professional development)

Question 18

ISA (UK)

Answer 18

International Standards on Auditing

Question 19

What are the two Overall Objectives of the Auditor (2) What rule states this (1)

Answer 19

ISA 200 (UK and Ireland) Overall Objectives of the Independent Auditor states that the auditor should:

(a) Obtain REASONABLE ASSURANCE about whether the financial statements as a whole are free from
material misstatement, whether due to fraud or error.
(b) Report on the financial statements, and communicate as required by the ISAs, in accordance with the auditor’s findings.

Question 20

What MUST an auditor do in order to adhere to the overall objectives of reasonable assurance and reporting on FS? (4)

Answer 20

In order to do this, the auditor must:
 Comply with relevant ethical requirements
 Plan and perform the audit with professional scepticism – a questioning mind, being alert to conditions which may indicate possible misstatement and maintain critical assessment of audit evidence

COMPETENCE
 Exercise professional judgement – application of relevant training, knowledge and experience in making decisions
 Obtain audit evidence that is both sufficient and appropriate, from which reasonable conclusions may be drawn, on which the auditor’s opinion is then based

Question 21

Stages of an audit (5)

Answer 21

1. Obtaining the engagement
2. Planning
3. Performing procedures
4. Review and completion
5. Reporting

Question 22

What are the benefits of assurance to shareholders?

Answer 22

The key benefit of assurance is the independent, professional verification being given to the users.

Trust the f/s provided - buy or sell shares or remove directors

Question 23

What are the benefits of assurance to third parties?

Answer 23

Technically the assurance report is only addressed to one set of people but it can be used to give confidence to other parties e.g. employees, banks, suppliers, customers in a way that benefits the business, governments

Enhanced Credibility: Assurance provides an independent verification, giving third parties (like investors, banks, and suppliers) confidence in the accuracy of the information, such as financial statements.

Improved Decision-Making: With reliable, assured information, third parties can make more informed decisions, such as assessing creditworthiness or determining investment risks.

Lowered Risk: Assurance reduces the risk of misinformation, which helps third parties avoid decisions based on inaccurate data.

Trust and Transparency: By having an external auditor verify information, companies demonstrate transparency, which can strengthen trust between the company and external stakeholders.

Question 24

What are the benefits of assurance to the board of directors?

Answer 24

The benefits of assurance to the board of directors include:

Improved Accountability: Assurance provides an independent check on management’s financial reporting and controls, helping the board ensure that internal processes are being followed.

Error and Fraud Prevention: Knowing that an external party will review financial data can encourage more accurate and honest reporting by management, reducing the likelihood of errors or fraud.

Enhanced Decision-Making: With reliable information on the company’s performance and financial health, the board can make better strategic and operational decisions.

Risk Management: Assurance services assess potential risks in financial reporting, helping the board identify and address areas that may require additional oversight or control improvements.

Increased Stakeholder Confidence: Assurance strengthens the board’s reputation for effective governance, increasing stakeholder trust and potentially attracting more investors or partners.

By providing these benefits, assurance helps the board fulfill its fiduciary and governance responsibilities effectively.

Question 25

ACID (4)

Answer 25

4 benefits of assurance

Attention to issues
Credibility
Independent verification
Detterent

Question 26

Audit always has 2 outputs, what are they? (2)

Answer 26

1. Auditors report = main purpose = opinion goes to shareholders
   This opinion is either modified or unmodified
2. Management letter = add value = internal controls weaknesses

Question 27

What are the limitations of assurance? (4)

Answer 27

Absolute assurance is impractical due to factors like:
- Testing and Sampling limitations: Auditors don’t test every transaction. A sampling approach is used.

• Reliance on internal controls: Controls may have inherent weaknesses. e.g. accounting system limitations and also client staff members may collude in fraud which can then be deliberately hidden from the auditor or misrepresent matters to them for the same purpose.
• Nature of the financial statements
  . The fact that most audit evidence is persuasive rather than conclusive.
  . The fact that some items in the subject matter may be estimates and are therefore uncertain.
  It is impossible to conclude absolutely that judgemental estimates are correct.
• Quality of auditor judgements: The fact that assurance provision can be subjective and professional judgements have to be made (for example, about what aspects of the subject matter are the most important, how much evidence to obtain, etc).

Question 28

Why is testing and sampling a limitation of assurance?

Answer 28

• Testing and Sampling limitations: Auditors don’t test every transaction. A sampling approach is used.

Question 29

Why is reliance on internal controls a limitation of assurance?

Answer 29

• Reliance on internal controls: Controls may have inherent weaknesses. e.g. accounting system limitations and also client staff members may COLLUDE IN FRAUD which can then be deliberately hidden from the auditor or misrepresent matters to them for the same purpose.

Question 30

Why is the nature of the financial statements a limitation of assurance?

Answer 30

• Nature of the financial statements
  . The fact that most audit evidence is PERSUASIVE rather than conclusive.
  . The fact that some items in the subject matter may be ESTIMATES and are therefore uncertain.

It is impossible to conclude absolutely that judgemental estimates are correct.

Question 31

Why is the quality of auditor judgements a limitation of assurance?

Answer 31

• Quality of auditor judgements: The fact that assurance provision can be subjective and professional judgements have to be made (for example, about what aspects of the subject matter are the most important, how much evidence to obtain, etc).

Question 32

What is the “expectations gap,” and why is it a concern in auditing?

Answer 32

The expectations gap refers to the difference between what users think auditors do (e.g., providing absolute assurance) and what auditors actually do (e.g., reasonable assurance). This misunderstanding can reduce the perceived value of the audit report.

Question 33

How can auditors work to close the expectations gap? (2)

Answer 33

By issuing engagement letters, setting clear expectations, and improving report content and format. It spells out the work that will be carried out and the limitations of that work

Also we regularly reviewing the format and content of reports (audit and management letter) issued as a result of assurance work.

Engagement letter - spelling out the work that will be carried out and the limitations of that work

These clearly define auditors vs directors roles

Question 34

What is the definition of sustainability in business?

Answer 34

Sustainability is meeting the needs of the present without compromising the ability of future generations to meet their own needs, as defined by the UN Bruntland Commission in 1987.

Question 35

What are the three key areas of sustainability in corporate governance (ESG)?

Answer 35

1. Environmental: Minimising environmental impact and addressing climate change. Environmental footprint
2. Social: Considering the well-being of society, stakeholders, and employees.
3. Governance: Ensuring ethical business practices and long-term, sustainable operations.

Question 36

How does sustainability impact the role of a chartered accountant?

Answer 36

Sustainability influences various aspects of accounting, including

RAGS

Risk Management
Assurance
Governance
Sustainability metrics and targets

integrating responsible practices into decision-making.

Question 37

RAGS (4)

Answer 37

RAGS

Risk Management
Assurance
Governance
Sustainability metrics and targets

Question 38

How does sustainability impact the role of a chartered accountant? - Risk management

Answer 38

• Climate change - significant risks for business
• Accounting and assurance perspective - particular interest in risk
• Reporting

Question 39

How does sustainability impact the role of a chartered accountant? - Assurance

Answer 39

Information around sustainability and ESG - Credibility when disclosed to stakeholders

Question 40

How does sustainability impact the role of a chartered accountant? - Governance

Answer 40

• Stakeholder engagement - depends on reliable info
• Assurance engagements - very useful

Question 41

How does sustainability impact the role of a chartered accountant? - Sustainability metrics and targets

Answer 41

• Effective measurement of ESG performance data and benchmarking - timely publication

Question 42

Relationship between IFRS Foundations, IASB, IFRS Standards and ISSB

Answer 42

IFRS Foundations
IASB ISSB
IFRS Standards

Question 43

What recent developments in sustainability standards should accountants be aware of? (3)

Answer 43

The formation of the International Sustainability Standards Board (ISSB) to create global standards. Sits alongside IASB.

Publications like the FRC Climate Thematic Audit (FRC) and IAASB’s guidance on climate-related risks in audits.

Required company reporting, eg UK companies are required to report on issues relating to sustainability in the strategic report and the director’s report

Question 44

How might sustainability issues influence the audit process?

Answer 44

Sustainability considerations may affect inherent risk assessments and the relevance of sustainability metrics in audit evidence, impacting the overall assurance approach.

Question 45

Why are sustainability standards becoming more important for businesses?

Answer 45

There is increasing demand from stakeholders for transparency and accountability regarding environmental and social impacts, which can influence a company’s reputation and operational longevity.

Question 46

Which three of the following are benefits of assurance work?
A An independent, professional opinion
B Additional confidence given to other related parties
C Testing as a result of sampling is cheaper for the responsible party
D Judgements on estimates can be conclusive
E Assurance may act as a deterrent to error or fraud

Answer 46

Which three of the following are benefits of assurance work?
A An independent, professional opinion
B Additional confidence given to other related parties
E Assurance may act as a deterrent to error or fraud

Question 47

2 Which three of the following describe aspects of the expectations gap with respect to the external audit?
A Users do not understand the meaning of the audit opinion
B Users are not aware of the limitations of the audit process
C Users do not appreciate that reasonable assurance is a low level of assurance
D Users do not understand what the audit process involves

Answer 47

A Users do not understand the meaning of the audit opinion
B Users are not aware of the limitations of the audit process
D Users do not understand what the audit process involves
Reasonable assurance is a high, but not absolute, level of assurance. The other options available represent various aspects of the expectations gap which is the gap between what the assurance provider understands he is doing and what the user of the information believes he is doing. SAMPLE EXAM

Question 48

3 Which two of the following are limitations of the provision of assurance?
A Assurance work is carried out by people independent of the entity
B Sampling is used in assurance work
C Client systems have inherent limitations
D Unqualified staff may be used on assurance engagements
LO 1d
LO 1a

Answer 48

3 Correct answer(s):
B Sampling is used in assurance work
C Client systems have inherent limitations
The answer is not option A as the fact that assurance work is carried out by independent people is a strength of assurance provision. Option D is also incorrect as the use of unqualified staff increases the detection risk of the auditor as opposed to being an inherent limitation of the provision of assurance. Work carried out by less qualified staff should always be supervised, directed and reviewed by more senior personnel.

Question 49

4 In any assurance engagement there are three parties involved: the responsible party, the practitioner and the user.
In respect of given subject matter state which party: determines the suitable criteria?
A User
B Practitioner
C Responsible party
provides an opinion on whether the subject matter complies with the criteria?
D User
E Practitioner
F Responsible party

Answer 49

C Responsible party
It is the responsible party who will determine the suitable criteria (in response to the obligations it has) against which the practitioner will test the subject matter and on which the practitioner will report to the users.
Correct answer(s): E Practitioner
It is the practitioner who will provide the opinion on whether the subject matter complies with the criteria after the evidence has been gathered and evaluated accordingly. The opinion prepared will be issued to the user.

Question 50

6 For each of the following statements, select whether they are true or false.
A statutory audit gives reasonable assurance that the financial statements give a true and fair view. A True
B False
A negative assurance conclusion gives a limited level of assurance.
C True
D False
Reasonable assurance is absolute assurance of the correctness of the subject matter.
E True
F False

Answer 50

A True
The statutory audit provides reasonable assurance through a positively worded assurance conclusion whereas in a non-statutory assurance engagement such as a review engagement, limited assurance is provided with the issue of the negatively worded assurance conclusion. This can be seen in the wording of the two conclusions. The positively worded assurance conclusion includes wording ‘the financial statements give a true and fair view’, whereas the negatively worded assurance conclusion includes the wording ‘nothing has come to our attention’, emphasising the limited nature of the assignment.
Correct answer(s): C True
A negatively worded assurance conclusion includes the wording ‘nothing has come to our attention’, which emphasises the limited nature of the assignment.
Correct answer(s): F False
Reasonable assurance is high assurance provided on the truth and fairness of the subject matter as opposed to absolute assurance of the correctness of the subject matter.

Question 51

8 For each of the following statements relating to the provisions of the Companies Act 2006, select whether they are true or false.
An individual or firm is eligible for appointment as statutory auditor if the individual or firm is a member of a recognised supervisory body and is eligible for appointment under the rules of that body.
A True B False
A person may not act as a statutory auditor of a company if that person is an officer or employee of the company.
C True D False

Answer 51

8 Correct answer(s): A True
The Companies Act 2006 states that a statutory auditor must be a member of a recognised supervisory body.
Correct answer(s):
C True
The Companies Act 2006 states that an officer or employee of the client is ineligible as auditor.

Question 52

9 Which one of the following best describes the concept of assurance?
Assurance refers to:
A an assurance firm’s high level of satisfaction as to the reliability of an assertion being made by one party for the use of another party
B an assurance firm’s satisfaction as to the reliability of an assertion being made by one party for the use of another party
C a user’s satisfaction as to the reliability of an assertion being made by another party
D an assurance firm’s limited level of satisfaction as to the reliability of an assertion being made by one party for the use of another party

Answer 52

B an assurance firm’s satisfaction as to the reliability of an assertion being made by one party for the use of another party
Assurance refers to an assurance firm’s satisfaction as to the reliability of an assertion being made by one party for the use of another party. This assurance is then expressed in an assurance report with a negative or positive conclusion given as appropriate to that particular engagement.

Question 53

Which three of the following are benefits of an assurance report on financial information? An assurance report:
A enhances the credibility of the information being reported on
B reduces the risk of management bias in the information being reported on
C attests to the correctness of the information being reported on
D draws the attention of the user to deficiencies in the information being reported on

Answer 53

A enhances the credibility of the information being reported on
B reduces the risk of management bias in the information being reported on
D draws the attention of the user to deficiencies in the information being reported on
An assurance report does not ‘attest(s) to the correctness of the information being reported upon’. Even a reasonable assurance engagement (which gives more assurance than a limited assurance engagement) does not provide a guarantee that the information being reported on is correct. Assurance can never be absolute as this statement implies. SAMPLE EXAM

Question 54

The following is an extract from an independent accountant’s unmodified report on a profit forecast:
‘Based on our examination of the evidence supporting the assumptions, nothing has come to our attention which causes us to believe that these assumptions do not provide a reasonable basis for the forecast.’
Which one of the following best describes the type of assurance provided by this statement?
A Positive assurance expressed negatively
B Negative assurance expressed positively
C High level of assurance expressed negatively
D Limited level of assurance expressed negatively

Answer 54

D Limited level of assurance expressed negatively
There are two types of conclusion which can be given: a conclusion expressed in positive terms and a conclusion expressed in negative terms. A conclusion expressed in negative terms is indicated by the phrase ‘nothing has come to our attention’ which indicates the restricted work carried out and hence the fact that the assurance is limited, as opposed to reasonable. Hence this type of assurance is limited level of assurance expressed negatively.

Question 55

n the context of a statutory audit which three of the following are commonly cited examples of misunderstandings that contribute to the expectation gap?
The belief that:
A The auditor’s report certifies the financial statements as correct
B The auditor’s principal duty is to detect fraud
C The auditor is employed by the directors
D The auditor checks all transactions

Answer 55

Correct answer(s):
A The auditor’s report certifies the financial statements as correct
B The auditor’s principal duty is to detect fraud
D The auditor checks all transactions
The expectation gap is the gap between what users of financial statements believe the auditor does and what the auditor actually does. The following three are common manifestations of the expectation gap:
* The auditor’s report certifies the financial statements as correct
* The auditor’s principal duty is to detect fraud
* The auditor checks all transactions
The belief that the auditor is employed by the directors is a common misconception but not a manifestation of the expectation gap. (The company employs the auditor, who is appointed by the shareholders in a general meeting.)

Question 56

14 For each of the following examples, select the level of assurance which would be given. Statutory audit
A Absolute
B Reasonable
Review of financial information
C Reasonable
D Limited
Report on profit and cash flow forecasts
E Reasonable
F Limited

Answer 56

B Reasonable
A statutory audit provides reasonable assurance, which reflects the comprehensiveness of the audit procedures carried out. No assurance engagement, not even a statutory audit, can give absolute assurance.
Correct answer(s): D Limited
A review of financial information gives limited assurance, which is a lower level of assurance than a statutory audit. Its conclusion would be worded negatively.
Correct answer(s): F Limited
A report on profit and cash flow forecasts gives limited assurance. Forecasts are by nature about uncertain future events, and so cannot be made with enough certainty to give a ‘reasonable’ level of assurance.