Chapter 1 - Reintroduction to audit and assurance

Question 1

What is an assurance engagement?

Answer 1

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.

Question 2

What elements are essential for an assurance engagement? Outline the suitable mnemonic and briefly expand on each point and why it is important where relevant

Answer 2

CREST

• Criteria - The benchmarks or standards used to evaluate or measure the subject matter to ensure that the subject matter is evaluated consistently and objectively.
• Report - The final written opinion or conclusion issued by the practitioner to communicate the level of assurance provided (reasonable or limited) and outlines the findings, scope, and any issues identified
• Evidence - Sufficient, appropriate evidence must be gathered to support the assurance opinion to enable the practitioner to reach a conclusion with confidence. This evidence may include documents, records, or other relevant data obtained during the engagement.
• Subject matter - The information or data being evaluated, which can be financial (like financial statements) or non-financial (like compliance with regulations).
• Three party relationship - There must be three distinct parties involved in the engagement: Practitioner (e.g., auditor or assurance professional), Responsible Party (e.g., management, responsible for preparing the subject matter), and Intended Users (e.g., shareholders, stakeholders, or regulators).

Question 3

What are the two types of assurance engagements? Breifly describe each, including the objective, evidence sought and outcome of the engagement and give suitable examples

Answer 3

There are two types of assurance engagement conducted by practitioners:

1. Reasonable assurance engagement:
   Objective: To provide a high level of assurance that the subject matter (e.g., financial statements) is free from material misstatement.
   Evidence sought: The practitioner collects sufficient and appropriate evidence through rigorous procedures, such as tests of controls, substantive testing, and analytical procedures.
   Outcome: The auditor provides a positive opinion, stating that, in their opinion, the subject matter complies with the applicable criteria (e.g., that the financial statements present a true and fair view in all material respects).
   Example: An external audit of financial statements.
2. Limited assurance engagement:
   Objective: To provide a moderate level of assurance, which is lower than that in reasonable assurance engagements.
   Evidence sought: The practitioner gathers less extensive evidence compared to a reasonable assurance engagement, using procedures such as inquiry, limited testing, and analytical review.
   Outcome: The auditor provides a negative opinion, typically expressed in the form of “nothing has come to our attention” that indicates any material issues.
   Example: A review engagement of interim financial statements.

Question 4

Can absolute assurance be given? Why? (5)

Answer 4

No, absolute assurance cannot be given in an assurance engagement. This is because of several inherent limitations that make it impossible to eliminate all risks of material misstatement:

• Sampling Risk: Auditors typically examine a sample of transactions, not all of them.
• Limitations of Internal Controls: Even well-designed internal controls may not detect or prevent all errors or fraud.
• Use of Judgments: Auditors and assurance practitioners must exercise professional judgment, especially when evaluating estimates, complex transactions, or uncertain situations.
• Management Override and Fraud Risk: Fraudulent activities, especially involving management collusion, may go undetected.
• Complexity of Subject Matter: Some areas of assurance, such as sustainability or compliance, involve subjective criteria that add complexity and uncertainty.

Question 5

Who are the main stakeholders that benefit from assurance engagements? Briefly explain each

Answer 5

• Shareholders (Investors)
• Directors (Management)
• Customers and Suppliers
• Lenders and Banks
• Employees
• Society (General Public and Third Parties)

Question 6

How do shareholders (investors) benefit from assurance engagements? (3)

Answer 6

• Enhances the credibility of the information being reported, allowing shareholders to trust that the financial statements fairly represent the company’s financial position.
• Provides reliable information that helps shareholders hold management accountable for their actions and decisions (stewardship).
• Draws attention to any deficiencies, errors, or misstatements in the financial statements, which could influence shareholders’ investment decisions and corporate oversight.

Question 7

How do directors (management) benefit from assurance engagements? (4)

Answer 7

• Reduces the risk of management bias, errors, or fraudulent activities by offering an independent review of the financial reporting process.
• Enhances the reliability of information used for strategic business decisions.
• Provides valuable insights through the management letter, which offers constructive advice on improving internal controls, risk management, and organizational efficiency.
• Helps directors deter potential fraudulent practices by increasing transparency.

Question 8

How do customers and suppliers benefit from assurance engagements?

Answer 8

• The accuracy and reliability of audited financial statements can impact decisions to trade or partner with the company: An audit provides customers and suppliers with the confidence to transact with the company, knowing that its financial position has been verified by independent professionals.

Question 9

How do lenders and banks benefit from assurance engagements? (3)

Answer 9

• Lenders and banks value the assurance that comes from having the business scrutinized by professional auditors.
• Assurance enhances confidence in the company’s financial health, making it easier for the company to raise finance during negotiations.
• By providing transparency, assurance helps banks and lenders better assess risk and determine appropriate lending terms.

Question 10

How do employees benefit from assurance engagements? (2)

Answer 10

• Provide employees with greater confidence about job security, particularly if the audited financial statements show a stable financial position.
• Enhance trust in bonuses or performance-based compensation if linked to profits, ensuring that reported figures are accurate.

Question 11

How does society (general public and third parties) benefit from assurance engagements? (2)

Answer 11

• Help ensure that high-quality, reliable information circulates in the financial markets, thereby improving the company’s reputation and contributing to public trust.
• Provides additional assurance to third parties, such as taxation authorities or regulators, regarding the accuracy and reliability of the company’s financial statements.

Question 12

What are the two overall objectives of an audit of financial statements?

Answer 12

The two overall objectives of an audit of financial statements, as outlined in ISA 200, are:
* To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error
* To express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework

Question 13

Outline the audit threshold for companies in the UK, including the exceptions

Answer 13

In the UK, the audit threshold determines which companies are required by law to have their financial statements audited. The rules are primarily governed by the Companies Act 2006.

A company can be exempt from a statutory audit if it meets two out of the following three criteria for two consecutive financial years:
* Turnover: Not more than £10.2 million
* Total Assets: Not more than £5.1 million (measured as the value of total assets on the balance sheet)
* Number of Employees: Not more than 50 employees

However, even if a company qualifies as small, it may still be required to have an audit under certain circumstances, including:
* Public Interest Entities (PIEs): Companies such as listed companies, banks, insurance companies, and other regulated entities must always have an audit.
* Parent Companies in a Group: If the company is part of a group that exceeds the small group threshold, it may still require an audit. Many subsidiary companies are exempt from an audit irrespective of their size as long as the parent company guarantees the liabilities of the subsidiary.
* Charities: Charities with gross income over £1 million (or £250,000 if assets exceed £3.26 million) require an audit under UK charity law.
* Specific Regulatory or Shareholder Requirements: Some companies may require an audit if it is stipulated in their articles of association, or if shareholders (holding at least 10% of voting rights) request one.

Question 14

What are two categories of assurance engagements with regards to the work carried out?

Answer 14

• Audit engagements
• Other assurance engagements

Question 15

For audit engagements, detail the following:
* A brief description
* Procedures undertaken during the engagement
* Type of assurance given

Answer 15

Question 16

For other assurance engagements, detail the following:
* A brief description
* Procedures undertaken during the engagement
* Type of assurance given

Answer 16