Chapter 1 Elements of assurance

Question 1

1.1 Key elements

Answer 1

An assurance engagement is one in which a practitioner expresses a conclusion designed to enhance the degree of confidence the indeed users other than the responsible party have about the outcome of the evaluation or measurement of a subject matter against criteria.
Key elements
• 3 party involvement – practitioner, intended user and responsible party
• Subject matter – financial statements, systems, and other financial data
• Suitable criteria – accounting standards, UK corporate governance code
• Evidence
• Written report

Question 2

1.2 The 3 party relationship

Answer 2

• Practitioner (auditor, assurance firm)
• Intended user (depends on the assignment)
• Responsible party (usually the directors)

Question 3

1.3 Levels of Assurance

Answer 3

There are two levels of assurance, it is important to determine which level is required.
Limited assurance:
Moderate/ low level of assurance. The conclusion is expressed negatively. An example is an engagement to review interim accounts (half year).
Wording used such as ‘Based on our review, nothing has come to our attention that causes us to believe that the accompanying interim financial information does not give a true and fair view’.
Reasonable assurance:
Hugh but not absolute level of assurance, with the conclusion expressed positively. An example is the audit of financial statements. Wording used such as ‘In our opinion, the financial statements show a true and fair view.’

Question 4

2.1 Types of assurance engagement

Answer 4

• Statutory audit
• Fraud investigations
• Due diligence
• Internal controls assessment
• Business plan/projection reviews
• Environmental audits.

Question 5

2.2 Statutory audit

Answer 5

A common type of engagement is the audit of a company’s financial statements. UK audits are governed by companies act 2006 and international standards on Auditing (ISAs). ISA 200 states the objectives of the auditor are:
- To obtain reasonable assurance that the financial statements are free from material misstatement, whether due to fraud or error
- To express an opinion on if the financial statements are prepared in all material respects, in accordance with an applicable financial reporting framework
Auditors must comply with ethical requirements, plan, and perform the audit with professional scepticism (questioning mind, being alert to misstatement, critical assessment of audit evidence), exercise professional judgement (apply training, knowledge, and experience) and obtain sufficient audit evidence to base their opinion.

Question 6

2.3 Legal requirements

Answer 6

Companies Act 2006 exempts small private limited companies from a mandatory audit if they satisfy 2 of the 3 criteria (periods after 1 Jan 2006):
- No more than 3 employees, turnover does not exceed £10.2m and total assets does not exceed £5.1m.
An auditor must:
- Be a member of a recognised supervisory body (RSB) – ensures individuals are holding an appropriate qualification or are part of a firm controlled by qualified persons
- Not be ineligible – Companies Act 2006 prohibits a person being an auditor if they are an officer or employee of the company or a partner or employee of the above

Question 7

3.1 Why is assurance important

Answer 7

The benefits of assurance are:
- Independent scrutiny of the business by experts
- Added credibility
- By-products/ subsidiary benefits (fraud deterrent)
- Draws attention to issues
- Reduces risk of management bias

Question 8

3.2 Limitations of assurance

Answer 8

The limitations of assurance are:
- Sampling – not 100% of transactions are reviewed
- Inherent limitations of systems that produce the financial info
- Evidence is generally persuasive and not conclusive
- Collusion to defraud
- Financial info includes subjective and judgemental matters
- Use of management representations as evidence may be unavoidable

Question 9

4.1 The Expectations Gap

Answer 9

Many shareholders and the public do not understand the nature of a statutory audit. They rely on the auditor’s report of the companies they own shares in, employed by or trade with. These misunderstandings can cause problems for the auditing profession. Examples of misunderstandings include the perception that:
- Auditors detects all fraud and error
- The audit tests all transactions
- The auditor verifies the accuracy of the financial statements
- The company is guaranteed to continue to trade for the foreseeable future
- The statement of financial position shows the true value of the company