Part A: Audit Framework and Regulation

Ch.1 Audit and Other Assurance

Engagements
1 The purpose of external audit engagements
1.1 Objective of External Audit
 The objective of an audit of financial statements is to enable the auditor to express an opinion
on whether the financial statements are prepared, in all material respects, in accordance with
an applicable financial reporting framework. An audit of financial statements is an example of an
assurance engagement.
 The external auditors, even if they advise the directors, solely report to the shareholders.

1.1.1 Statutory and non-statutory Audits

a) Statutory Audits
 In most countries, audits are required under national statute for many undertakings, including
limited liability companies. Other organisations and entities requiring a statutory audit may
include charities, investment businesses and trade unions.
 Advantages include:
1) There is an impartial view provided by the auditors.
2) The company also enjoys the benefits of professional accountants reviewing the
accounts and system as part of the audit.
3) Recommendations can also be made in relation to accounting and control systems and
the possibility that auditors might detect fraud and error.

b) Non-statutory Audits
 They are performed by independent auditors because the company's owners, proprietors,
members, trustees, professional and governing bodies or other interested parties want them,
rather than because the law requires them.
 Advantages, for example for a partnership, are:
1) It can provide a means of settling accounts between the partners.
2) Where audited accounts are available this may make the accounts more acceptable to
the taxation authorities when it comes to agreeing an individual partner's liability to
tax.
3) The sale of the business or the negotiation of loan or overdraft facilities may be
facilitated if the firm is able to produce audited accounts.
4) An audit on behalf of a 'sleeping partner' is useful since generally such a person will
have few other means of checking the accounts of the business or confirming the share
of profits due to them.
Part A: Audit Framework and Regulation

2 Accountability, Stewardship and Agency

 Assignment: Google the Enron scandal, Parmalat, Xerox and Lehman Brothers scandals.

2.1 Accountability
 This is the quality or state of being accountable; that is, being required or expected to justify
actions and decisions. It suggests an obligation or willingness to accept responsibility for one's
actions.
 The directors are accountable for the shareholder’s investment of which the shareholders
expect a good return which the directors are in a position to affect since they manage the
company.

2.2 Stewardship
 This refers to the duties and obligations of a person who manages another person's property.

2.3 Agency
 In the case of a company, the manager/ director is the agent of the shareholder (principal) and
they therefore have the fiduciary duty to maximize the shareholder wealth.

3 Assurance Engagement
 This is one which a practitioner (external auditor) aims to obtain sufficient appropriate
evidence in order to express a conclusion designed to enhance the degree of confidence of the
intended users (shareholder) other than the responsible party (manager) about the outcome of
the measurement or evaluation of an underlying subject matter against criteria.
Definitions
1) Intended users are 'the individual(s) or organisation(s), or group(s) thereof that the
practitioner expects will use the assurance report'
2) The responsible party is 'the party responsible for the underlying subject matter'
3) The practitioner is 'the individual conducting the engagement (usually the engagement
partner or other members of the engagement team, or as applicable, the firm'

3.1 Elements of an Assurance Engagement

An assurance engagement will include the following:
 A three party relationship. These are the intended user, the responsible party and the
practitioner.
 A subject matter. This is the data to be evaluated that has been prepared by the responsible
party. It could be
1) Financial performance (e.g. historical financial information),
2) Non-financial performance (e.g. key performance indicators),
3) Processes (e.g. internal control) and
4) Behaviour (e.g. compliance with laws and regulations).
Part A: Audit Framework and Regulation

 Suitable criteria. The subject matter is evaluated or measured against criteria in order to reach
an opinion.
 Evidence. Sufficient appropriate evidence needs to be gathered to support the required level of
assurance.
 An assurance report. A written report containing the practitioner's opinion is issued to the
intended user, in the form appropriate to a reasonable assurance engagement or a limited
assurance engagement.

NB:

To remember these elements we can use the mnemonic CREST:

Criteria

Report

Evidence

Subject matter

Three party relationships

3.2 Objectives of an Assurance Engagement

 The objective of an assurance engagement will depend on the level of assurance given.
1) Reasonable Assurance Engagement
 Here, a high, but not absolute, level of assurance is given.
 The objective of a reasonable assurance engagement is a reduction in assurance engagement
risk to an acceptably low level in the circumstances of the engagement as the basis for the
assurance practitioner's conclusion. The conclusion would usually be expressed in a positive
form.
 A significant amount of testing and evaluation is required to support the conclusion.
 An example of a reasonable assurance engagement is an audit.

2) Limited Assurance
 This is a lower level of assurance. The nature, timing and extent of the procedures carried out
by the practitioner in a limited assurance engagement would be limited compared with what is
required in a reasonable assurance engagement. Nevertheless, the procedures performed
should be planned to obtain a level of assurance which is meaningful, in the practitioner's
professional judgement.
 This would usually be expressed in a negative form of words.
 For both reasonable and assurance engagements, the revised ISAE requires the practitioner to
provide a summary of the procedures undertaken within the assurance report.
 An example of a limited assurance engagement is a review of financial statements.
Part A: Audit Framework and Regulation

4 Types of assurance services

4.1 Other Assurance Engagements

 In some cases, stakeholders may find that they receive sufficient assurance about an issue from
a less detailed engagement, for example, a review. A review can provide a cost-efficient
alternative to an audit where an audit is not required by law, and would provide limited
assurance.
 The objective of a review engagement is to obtain limited assurance about whether the subject
matter information is free from material misstatement.

5 Assurance and Reports

5.1 Truth & Fairness/Fair Presentation

 The audit opinion is not an opinion of absolute correctness but rather is an opinion of whether
the financial statements reflect a true and fair view.
 True: Information is factual and conforms with reality. In addition, the information conforms
with required standards and law. The financial statements have been correctly extracted from
the books and records.
 Fair: Information is free from discrimination and bias and in compliance with expected
standards and rules. The accounts should reflect the commercial substance of the company's
underlying transactions.
 An audit gives the reader reasonable assurance on the truth and fairness of the financial
statements, which is a high, but not absolute, level of assurance. The auditor's report does not
guarantee that the financial statements are correct, but that they are true and fair within a
reasonable margin of error. One of the reasons that an auditor does not give absolute assurance
is because of the inherent limitations of audit.
Part A: Audit Framework and Regulation

5.2 Limitations of Audit and Materiality

 Materiality is an expression of the relative significance or importance of a particular

matter in the context of the financial statements as a whole. A matter is material if its
omission or misstatement would reasonably be expected to influence the economic
decisions of users taken on the basis of the financial statements. Materiality depends
on the size of the item or error judged in the particular circumstances of its omission
or misstatement.