Fundamental of Auditing For B.

com-II Bzu

Chapter#2 True and Fair view

Assurance Engagements:

Means an engagement 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 a criteria.

OR

Assurance engagement is an engagement performed by a practitioner to enable himself to express an

opinion about the measurement of subject matter against a criteria. Practitioner’s expression of opinion raise the
confidence of the users over the measurement of subject matter subject to the criteria applicable under consideration

So simply we can conclude the definition into following words for your better understanding:

In simple terms, giving assurance means: offering an opinion about specific information so the users of
that information are able to make confident decisions knowing that the risk of the information being 'incorrect'
is reduced.

Examples of Assurance engagements:

In order to understand the concept of Assurance engagement we will take some common practical examples. In
many situations, there are people who need to be assured about something:

● Parents need assurance that schools are suitably educating their children

● Diners need assurance that a restaurant is serving food that is safe to eat

● Shareholders need assurance that the published Financial Statements of a company are not wrong

● Directors need assurance that the systems inside the company they run are working.

Elements of assurance engagement

(a) Three party relationship involving :=> Tripartite

 The practitioner

 The responsible party

 The intended user

(b) Subject matter

(c) A suitable criteria

(d) An engagement process (audit work/appropriate evidence)

(e) A conclusion and report (opinion)

=>The three party relationship: The three party relationship involves:

The practitioner/the assurance provider– the party who forms the opinion on the subject matter and gives the
assurance.

The responsible party – the person preparing/working on the subject matter; (company, government, dept., etc.)
Compiled& composed by Kamran Arshad MPhil (Finance)* Contact# 03023967507
E-mail kamranarshd413@gmail.com
Principal of Almeezan Academy of Education Karor
Fundamental of Auditing For B.com-II Bzu

The intended user– the party who relies on the assurance report. (Investors, public, pressure group)

=>Suitable criteria: Criteria are the standards or benchmarks used to evaluate or measure the subject matter of an
assurance engagement. It is easy to consider criteria for financial statements but in other matters criteria are not
always established.

=>Engagement process The engagement process involves;

Agreeing the terms of the engagement in an engagement letter. A methodology for evidence gathering, and
evaluation and measurement to support a conclusion. A conclusion and a report

=>Conclusion and report: The practitioner’s conclusion and report relates to an assertion by the responsible party.
The assertion is the responsible party’s conclusion about the subject matter based on identified suitable criteria. The
practitioner can either express a conclusion about; the assertion by the responsible party or the subject matter in a
form similar to the assertion made by the responsible party.
Reasonable assurance normally express in the positive form. It is sometimes called positive assurance.
This type of assurance engagement expresses their opinion that reduces the assurance engagement risks to the
acceptable low level for the subject matter that the firm being express on.
For example, an audit on financial statements is an example of the reasonable assurance engagement. Auditors will
express their opinion based on the result of their examination. Those opinions will be based on a positive form

The Review Engagement or Limited Assurance:

The Review Engagement or Limited Assurance is sometimes calling negative engagement. This type of
engagement is different from a reasonable assurance engagement. Normally, this engagement, auditor perform fewer
procedures and review to support a conclusion on the financial statements in terms of whether anything has come to
the auditor attention to indicated that the financial statements are not prepared in accordance with the specific
accounting standard. Review Engagement provides the level of limited assurance to the users of financial statements
as the result of the procedure that auditors use to review the financial statements.
In normal case, the audit opinion in the assurance engagement is the negative opinion, for example,
nothing comes to their attention that the financial statements that they review are not true and fair. However, if the
Review engagement could not obtain sufficient supporting documents to support their opinion, the audit should
express the qualify opinion.
Meaning of True and Fair View:
Let break down into two words: True and Fair;
True mean
The financial statements are free from any kind of material misstatement? No matter the material
misstatements are from error or fraud. The financial statements are true when all kind of errors are taking into
accounts. Financial statements are truly prepared when they are respected and followed the accounting standards and
frameworks that they are used. Yet, maybe there is some part of financial statements are not respect the accounting
standard. In this case, the materiality concept is used to deal with.
In simply true suggests that the financial statements are factually correct and have been prepared according
to applicable reporting framework such as the IFRS and they do not contain any material misstatements that may
mislead the users. Misstatements may result from material errors or omissions of transactions & balances in the
financial statements

Fair view
Means that the financial transactions are treated fairly as they should be and all significant information is
sufficiently disclosed in the financial statements to ensure that the users are not misleading.
Fair view mainly focuses on the ways how the quality of the information in the financial statements is.
For example, financial statements have enough comparative information. Information that should have been
disclosed is disclosed.

Compiled& composed by Kamran Arshad MPhil (Finance)* Contact# 03023967507

E-mail kamranarshd413@gmail.com
Principal of Almeezan Academy of Education Karor
Fundamental of Auditing For B.com-II Bzu

In simple words Fair implies that the financial statements present the information faithfully without any
element of bias and they reflect the economic substance of transactions rather than just their legal form.
What is the Materiality Concept?

The materiality concept refers to a situation where the financial information of a company is considered to be
material from the point of view of the preparation of the financial statements if it has the potential to alter the view
or opinion of a reasonable person. In short, all those important financial information that is likely to influence the
judgment of a knowledgeable person should be captured in the preparation of the financial statements of the
company. The materiality concept in accounting is also known as materiality constraint.

The concept of materiality in accounting is very subjective, relative to size and importance. Financial
information might be of material importance to one company but stand immaterial to another company. This aspect
of materiality concept is more noticeable when the comparison between companies which vary in terms of their size
i.e. a large company vis-à-vis a small company. A similar cost may be considered to be the large and material
expense for a small company, but the same may be small and immaterial for a large company because of their large
size and revenue.

As such, it can be said that the main objective of the materiality concept in accounting is to assess whether the
financial information under consideration makes any significant impact on the opinion of the financial statement
users. If the information is not material, then the company does not need to worry about including it in their
financial statements. The financial statement users mentioned here can be auditors, shareholders, investors etc.

In general, thumb rule for materiality of financial information is stated as,

 On the Income statement, a variation of more than 5% of before-tax Profit or more than 0.5% of sales
revenue may be seen as “large enough to matter”

 On the Balance sheet, a variation in the entry of more than 0.5% of total assets or more than 1% of total
equity may be viewed as “large enough to matter” Concept as per GAAP and FASB

Materiality Concept as per GAAP

For GAAP (Generally Accepted Accounting Principles) the primary rule for deciding on materiality is
“Items are material if they could individually or collectively influence the economic decisions of users, taken from
financial statements.”

Materiality Concept as per FASB

On the other hand, for FASB (Financial Accounting Standards Board) the primary rule for deciding on materiality
is-

The magnitude of an omission or misstatement of accounting information that, in the light of surrounding
circumstances, makes it probable that the judgment of a reasonable person relying on the information would
have been changed or influenced by the omission or misstatement.” Concept in let’s understand the Materiality
concept in accounting with the help of a simple example to understand it better.

Let us take the example of a large company that had a building located in the hurricane zone during the
recent natural calamity. The company building has been totally destroyed by the hurricane and after a
gruesome legal battle with the insurance provider, the company has reported an extraordinary loss of
$30,000. Determine the materiality of the event based on the below-given conditions:
Compiled& composed by Kamran Arshad MPhil (Finance)* Contact# 03023967507
E-mail kamranarshd413@gmail.com
Principal of Almeezan Academy of Education Karor
Fundamental of Auditing For B.com-II Bzu

 For company A which is large and generates a net income of $40,000,000

 For company B which is very small and generates a net income of $90,000

a) Now, let us calculate the materiality for company A by dividing the loss of $30,000 by the net income of the
company i.e. $30,000 / $4,000,000 * 100% = 0.08%

By using the above-given data, we will calculate the Materiality of Company A

The materiality of Company A =0.08%

According to the materiality concept, this loss of $30,000 is immaterial for company A because the average financial
statement user would not be concerned with something that is only 0.08% of the total net income.

b) Again, let us calculate the materiality for company B by dividing the loss by the net income of the company i.e.
$30,000 / $90,000 * 100% = 33.34%

Now, we will calculate the Materiality of Company B

The materiality of Company B = 33.33%According to materiality concept, this loss of $30,000 is material for
company B because the average financial statement user would be concerned and might opt out of the business
given that the loss constitutes around 33.33% of the total net income. The above example emphasizes on the
difference in the sizes of the two companies and as such the variation in the behavior of the financial statement users
of the companies.

Compiled& composed by Kamran Arshad MPhil (Finance)* Contact# 03023967507

E-mail kamranarshd413@gmail.com
Principal of Almeezan Academy of Education Karor