Auditing

SYNOPSIS OF INTERNATIONAL STANDARDS ON AUDITING
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TABLE OF CONTENT
S.No Chapter Page No.
Syllabus of Module D Examination 01
01 International Federation of Accountant (IFAC) 22
02 Introduction to Auditing 26
03 ISA 200: Objective and General Principles Governing an Audit 53
04 ISA 210: Terms of Audit Engagements 59
05 ISA 220: Quality Control for Audits 64
06 ISA 230: Audit Documentation 73
07 ISA 240: Fraud and Error 80
08 ISA 300: Planning 87
09 ISA 315: Understanding the entity and its environment 96
10 ISA 320: Audit Materiality 105
11 ISA 500: Audit Evidence 109
12 ISA 505: External Confirmation 119
13 ISA 520: Analytical Procedures 125
14 ISA 530: Audit Sampling 130
15 ISA 550: Related Parties 143
16 ISA 560: Subsequent Events 148
17 ISA 580: Management Representation 154
18 ISA 600: Using the work of another auditor 161
19 ISA 610: Considering the work of Internal Audit 166
20 ISA 620: Using the work of an Expert 172
21 ISA 700: Auditor’s Report 177
22 ISA 701: Modification to the auditor’s report 183
23 ISRE 2410: Review of Interim Financial Information 191
24 Legal Provisions relating to Auditors 197

Synopsis of International Standards on Auditing
INTERMEDIATE EXAMINATION – MODULE D PAPER D 11

AUDITING
OBJECTIVE:
The purpose of the syllabus is to give students theoretical and to a limited extent,
technical knowledge and skills of auditing and review of historical financial information.
It will provide a foundation for acquiring intensive knowledge required for professional
competence.
The syllabus will ensure that candidates are able to understand the nature of auditing and
review services and are familiar with the intellectual and procedural bases for performing
them.
INDICATIVE GRID
SECTION SYLLABUS CONTENTS WEIGHTAGE
A General concepts & principles of audit 25
B Performance of audit 35
C Audit conclusions and reporting 20
D Specific areas 20
TOTAL 100
Note:
The weightages given above are for guidance purposes only and some deviations in
setting of papers could be expected.
CONTENTS:
A. General concepts and principles of audit
· Objective and general principal governing an audit
· Responsibility for the financial statements
· Auditor’s responsibility to consider fraud and errors
· Introduction to International Federation of Accountants
From Desk of Yawer Zakaria Page No 1

· Introduction to international auditing and assurance standard setting body

· Legal consideration relating to appointment and removal of auditor
· Acceptance and continuance of audit client including requirement of Code
of Ethics issued by ICAP
· Audit engagements
B. Performance of audit
· Planning an audit
· Assessment of audit risk
· Audit materiality
· Audit evidence
· Audit sampling
· Substantive procedures
· Test of controls
· Analytical procedures
· Documentation
C. Audit conclusions and reporting
· Nature of different audit opinions (Students will only be expected to
understand the form and implications of audit qualifications)
· Form of audit reports under the Companies Ordinance, 1984
D. Specific areas
· External confirmation
· Subsequent events
· Management representation
· Consideration of related parties
· Using the work of another auditor, internal auditor and expert
· Review of interim financial statements by the independent auditor
Candidates are expected to respond examination questions with reference to international
and local pronouncements issued by any relevant standard setting body. The standards
related to syllabus outline are prescribed as under:
ISA-200 ISA-210 ISA-220 ISA-230 ISA-240 ISA-300

ISA-700 ISA-701 ISRE-2410

Institute of Chartered Accountants of Pakistan has a practice to publish periodically the
bound volumes of updated auditing pronouncements. All pronouncements related to the
areas covered in the syllabus and published in such bound volumes are deemed
applicable for examination purposes (irrespective of their date of applicability date in
practice) unless ICAP specifically notifies that the same will not be adopted. However,
pronouncements and revisions published by ICAP within less than six months from the
date of examination shall not be tested.
Note:
Reference to ISAs shall be deemed to have been changed whenever the same is replaced
by another standard.

EXAMINER’S COMMENTS:
SPRING 2004:
General:
On an overall basis the performance of the students can be termed as below average. It
appears that students normally restrict themselves to plain reading of ISAs and do not try
to grasp the underlying concepts. Students are advised to read the question carefully and
try to understand what is being asked from them. In professional exams you can not
expect to get passing marks after writing mostly irrelevant things.
Question-wise comments are as under:
Question 1:
(a) It was a routine question at this level that was not well answered by the students
in general. Most of the students did not define truth and fairness separately.
(b) It was a basic question that was well answered by the students.
Question 2:
(a) It was not an ISA based question. Although students managed to write the basic
points but many students also wrote irrelevant points. Certain students mentioned
those points which are normally considered during the audit and not at the client
screening level.
(b) A simple ISA based question in which most of the students managed to score
passing marks. Some students wrote few points which are not the basic contents
and are not necessarily there in the engagement letter e.g. provision of other
services etc.
Question 3:
(a) The students in general managed to write the correct answer.
(b) The performance of the students was average in this part. Although the students
knew the basic procedure but very few of them covered all the aspects.
Question 4:
(a) It was a simple ISA based question that was well answered in most of the cases.
(b) Most of the students managed to get passing marks in this part, as it was a routine
question.
Question 5:
(a) The students in general failed to answer this question correctly. Many students
instead of writing about qualified and unqualified report scenarios gave examples

of expert's works like actuarial valuation, fixed assets revaluation etc. which was
not asked in the question.
(b) Many students wrote the correct answer. However, certain students instead of
writing about the reports/opinions of an expert wrote about different types of
opinions of an external auditor.
Question 6:
(a) It was a simple question and most of the students managed to get passing marks in
it.
(b) The performance of the candidates was above average in this part.
Question 7:
(a) It was a simple question however, hardly few students managed to get some
marks in it. Instead of writing about existence and condition of stock almost
everyone wrote all the assertions. Students should understand that physical
verification has nothing to do with presentation and disclosure assertion. As the
concept was lacking therefore, many students failed to get any mark in this
question.
(b) Most of the students hardly managed to get passing marks in this question. Much
more was desired to be written.
Question 8:
(a) The question required a clear concept of the test of controls as per the relevant
ISA. Quite a number of candidates failed to give the right answer as they seemed
confused this concept with the walk-through tests and consequently lost marks.
(b) This was a question which required the candidates to apply their knowledge and
understanding. However, generally the students did not score good marks in this
question partly because the students seemed to rely more heavily on their memory
and reproduced internal control procedures on payments to parties instead of the
procedures to check duplicate payments and also because they did not read the
question clearly enough to understand the requirement.
(c) This question also required a general understanding of the relevant ISA but a
large majority of the students failed to get the requirements right. They spent lot
of time in writing about the effects of CIS and hardly anything was mentioned on
the effects of CIS on audit. However, students who had clearly grasped the
requirement of the question were able to score good marks.
Question 9:
(a) This was a very good question requiring the application of the knowledge gained
through the ISAs. Some of the students gave very pertinent answers. Some of the

students who although knew the relevant ISA failed to earn marks because they
did not conclude e.g. they reproduced the guidance contained in the relevant ISA
and did not sum up the scenario. The scenario based questions always test the
application of knowledge rather than the memory of the students. However, quite
a number of students did apply their knowledge and gained good marks.
(b) The response for this question was also not very encouraging as candidates wrote
assertions against procedures without really giving a serious thought about them.
However as it was an objective type of question students were able to get around
40% to 50% marks.
Question 10:
A very good scenario based question testing the application of the guidance contained in
the relevant ISAs. From the answers it appeared that the students started writing answers
without understanding the requirement of the question e.g. students wasted their valuable
time in discussing suggestions under the circumstances, which were not quite required.
The question specifically required suggestions which related to the financial statements.
Similarly, as per the requirement of the question, students should have explained their
opinion instead of just giving the type of opinion resulting in their losing valuable marks.

AUTUMN 2004:
General:
Overall the performance of the students was not satisfactory. Students normally prepare
for routine ISA based questions and their performance is poor in questions which require
proper understanding of the concepts. In certain cases it has been observed that the
students try to write everything they know about a topic if they don’t know the correct
and precise answer. This approach is not advisable because the marks are for the correct
answer and the examiner is not supposed to search for the relevant part in so much
irrelevant information. It is advised that students should think for a while before they start
to answer any particular question. The communication skills are also at times not up to
the mark.
Question 1:
(a) It was a routine question which was well answered by most of the students. Some
students stated that only Companies Ordinance, 1984 determines the scope of
audit and forgot to mention ISA, IAS, ICAP’s and other local bodies
pronouncement and the terms of audit engagement.
(b) This part was not properly attempted. Majority of candidates just answered that
reasonable assurance means the financial statements are free from material
misstatements. They failed to state that reasonable assurance is a high but not
absolute assurance, expressed positively that the information subject to audit is
free from material misstatement.
(c) This was again an ISA based simple question. The students mostly scored good
marks in it
Question 2:
(a) The students mostly failed to explain the concept of uncertainty. Many students
just wrote about going concern without properly understanding the question.
(b) This question was very poorly attempted. The students were required to define the
agreed upon procedures or give its main characteristics, which are as follows:
- The procedures are of an audit nature
- They are agreed upon between the auditor, the entity being audited and any
appropriate third party.
- The auditor is required to report on factual findings and report is restricted to
interested parties only, as being unaware of the reasons, others may
misinterpret it.
Very few students gave the correct answer. Many students wrote about the engagement
letter of an audit which was not asked. Many others did not attempt or gave irrelevant
answers

Question 3:
(a) The students in general managed to write the correct answer and secured good
marks.
(b) Almost all the students got full marks in this part.
Question 4:
(a) In this part many students failed to point out whether it is an adjusting or non-
adjusting event. Some students discussed only the disagreement with management
and tried to avoid commenting on adjustability or disclosure requirement. The
question was not well answered by most of the students.
(b) This part was again not attempted well by the students. The students generally
failed to identify that as the loss is covered by insurance, it needs no adjustment,
however, it may need disclosure if the event is considered significant in the
overall content. Many students did not discuss the requirement of adjustment or
disclosure properly. However, many students managed to write auditor’s duties
correctly. It appears that the situation was not properly understood by most of the
students and they failed to distinguish whether the event took place before or after
the issuance of audit report.
(c) Many students wrote the correct answer that it was not an adjusting event but
failed to give the reason i.e. because the condition did not exist at the balance
sheet date
Question 5:
It was a simple question but students in general could not get good marks in it. Many
students gave irrelevant information. Majority of the students discussed the weak internal
controls in a small business but did not discuss their impact on the audit.
Question 6:
This question simply required internal control procedures in respect of (a) Purchase
ordering and, (b) Dispatch and invoice preparation for sales.
Some of the candidates could not understand the requirement of the question and resented
the answer in the following manner:
They prepare the audit program along with audit objectives and listed down the audit
procedures in respect of verification of purchase ordering and dispatch and invoice
preparation for sales system.
Some candidates narrated the whole system in respect of purchase ordering and dispatch
and invoice preparation for sales.
Some candidates prepared the flow chart of whole system in respect of purchase ordering
and Dispatch and invoice preparation for sales.
Some students discussed the whole purchase and sales system including payments,
receipts etc., which was not required.

Question 7:
(a) It was a simple question which was partly well answered by most of the students.
However, very few of them could point out that the auditor needs to find out or
discuss the reasons why the client does not wish to send confirmation and assess
whether there are valid grounds for such request.
(b) Most of the students wrote the correct answer. However, certain students
confused positive confirmation with negative confirmation. Accordingly, such
students also gave wrong answers for the subsequent parts.
(c) The students in general managed to get passing marks.
(d) The students on an overall basis wrote the correct answer. However, they did not
discuss all the relevant points.
Question 8:
(a) Most of the students got full marks in this part.
(b) Some candidates were confused and answered part (b) in response to part (c) and
vice versa. Some candidates answered part (b) properly but also included answer
of part (b) in the answer of part (c).
Majority of candidates did not list down complete factors in both the parts.
Question 9:
This is a very simple question. The question required the understanding of general and
application EDP controls along with two examples of each control. The question was not
properly handled and candidates gave answers in haphazard manner and in general
language. Such as:
Few candidates described the EDP environment
Some candidates simply stated that general controls are general while applications are
specific controls
Some candidates gave irrelevant examples or gave no examples at all.
It was evident that candidates did not have sufficient and precise knowledge about the
subject matter.
Question 10:
(a) It was a simple ISA based question and most of the students managed to get very
good marks in this part.
(b) Majority of the students managed to identify the correct situation but many of
them failed to describe the reasons completely

SPRING 2005:
General:
It was an encouraging sign that students appeared to be well prepared in Auditing being
the core subject of their profession. Further improvement, however, is needed in
following areas;
Avoid writing unnecessary/unasked details
Write answers in logical order
Express clearly
Question wise comments are as under;
Question 1:
(a) Very few students knew the exact definition of the term ‘governance’, that is, act
of supervision, direction and control.
(b) A large number of students restricted their answers to the definition of
‘professional skepticism’, while the question was specifically on the importance
of the concept for conduct of an audit.
(c) The concept of level of assurance is an important area and a professional
accountant is supposed to be well versed with the level of assurance he gives in
various types of engagement. Students mostly gave too generalized answers. They
are advised to revisit the Standards, as they are expected to be exact in this
respect.
Question 2:
(a) Provisions of law relating to appointment of first auditor was asked and almost
every student had complete knowledge of the same.
(b) At large, candidates lost valuable marks, as they described the preliminary
assessment of internal audit function, which is done at the planning stage, while
the question required the evaluation of specific work of internal audit.
Question 3:
(a) Students had good understanding of the areas relating to planning.
(b) Similar to part (a) students knew the sources from where knowledge of industry
and entity is obtained.
Question 4:
(a) Very few answered it to the point and un-necessarily wrote definitions of
sampling and non-sampling risk, while the question was on procedures for
reducing the said risks.

(b) Definition and projection of ‘anomalous error’ were well known to almost every
student.
Question 5:
(a) Management representation letter is one of the important documents with regard
to audit. Every professional accountant should know the precise and specific use
of the said letter. It was apparent from the answers given by the students that very
few knew the basic contents of the letter as given in the Standard, like, approval
of financial statements and matters where other audit evidence is not expected to
be available.
(b) ‘Point forward’ or ‘point for next year audit’ is a general concept, well attempted
by the candidates.
(c) Majority could not clearly explain the purpose of cut off test, i.e. to ensure that
transactions pertaining to a certain period are recorded in that period only.
Question 6:
(a) Candidates were required to give their opinion in the given situation, whether
change in the scope of engagement from audit to review could be made. Majority
answered it correctly but could not explain the basis of their opinion or discuss the
relevant portion of the International Standard on Auditing.
(b) Students understood the question but were unable to give comprehensive answer
as to the type of opinion the auditor will give on the basis of his judgment of
materiality of the effect. Many were of the view that failure to reverse a provision
is not as important as the failure to make a provision, which is not always true.
Question 7:
Students were able to state the uses of working paper, matters which affect the contents
of working papers and differences between permanent and current audit files, and secured
good marks.
Question 8:
Question was aimed to test the understanding of certain risk inherent with the CIS
environment, like, non-existence of transaction trail, complexity of application system,
concentration of controls into CIS system, risk of error due to concentration of controls,
lack of documentation in automated processing of transactions and machine readable
Question 9:
The audit programs prepared by the candidates were of very poor quality. Very few
could describe the tests and procedures to ensure existence, obligation and valuation of
balance, and appropriateness of disclosure.
Question 10:
The question called for evaluation of specific work of an expert, while majority of the
students wrote unnecessary details of planning stage evaluation.

AUTUMN 2005:
General:
The paper had a combination of test on theoretical knowledge and practical application.
As expected, candidates did well on the theoretical part but seemed confused while
applying their knowledge on real world examples. Although it is little early at this stage
but students are advised to try their best to visualize the practical applications of rules,
regulations and standards they learn.
Question wise comments are as under;
Question 1:
(a) Very few students knew the prescribed steps required to be followed under the
Code of Ethics when a practicing member accepts an audit engagement in place
of another member whose audit was in process when removed. A large number of
students wrote about client screening process, which is not an ethical requirement.
(b) Only a few candidates knew the provisions of law dealing with vacancy of the
office of the auditor because of disqualification subsequent to appointment. Quite
a number, without any apparent reason, reproduced the provisions related to
disclosure and disposal of investments in client’s equity, at the time of
appointment.
(c) The ethical requirements governing an audit are well known to majority.
However, when it came to explanation, most candidates mixed up the components
of ethical requirements.
Question 2:
(a) This question is another example where students responded without looking at the
given facts. Respective responsibilities of management and auditor were asked in
case unmodified audit report was issued inspite of the fact that financial
statements contained material misstatements. Instead, many students wrote the
course of action left with the management and auditors and could not secure any
marks.
(b) The principal qualitative characteristics which are necessary to give true and fair
view are understandability, relevance, reliability and comparability. Most students
concentrated on the issue of disclosure requirements and could not mention the
characteristics.
Question 3:
(a) Students had good understanding of the audit assertions which are addressed by a
certain procedure and most of them answered the question correctly.
(b) Students had very little idea of contents of direct bank confirmation. They gave
answers based on general understanding and missed many points.

Question 4:
(a) This was a simple question, which required listing of inherent limitations of
Internal control system due to which, frauds and errors cannot be eliminated
altogether. Majority secured good marks in this part.
(b) Very few students wrote to-the-point answers. Some students mixed up internal
controls with audit verification steps. Few preferred to write general activities
rather than those specific with ‘trade debts’. Some found no difference between
control activities and other components of internal control system.
Question 5:
Candidates had good knowledge about the procedure an auditor of consolidated financial
statements of holding company should perform while using the work of the auditor of
subsidiary company. However the answers were un-necessarily lengthy, which were
inappropriate with the marks allocated to this question.
Question 6:
(a) This question required steps to be taken in case analytical procedures identify
relationships which are inconsistent with those established through other available
evidence. A good number performed well, however, few of them mentioned
definition, types and uses of analytical procedure which were not required.
(b) This was also an easy question and attempted well by majority of the students. It
was evident that they had given due attention to the newly applicable Auditing
Standard dealing with internal control system.
(c) This was also a students’ favourite theoretical question on scope and objectives of
internal audit and was answered well.
Question 7:
(a) A number of students did guess work in replying the question and could only
identify one condition, that is, the weakness of accounting and internal control
systems. Some submitted needless paragraphs on management’s non co-operation
and disagreements as condition that indicates existence of misstatements and
errors. Some other conditions are:
- Going concern and liquidity issues
- Significant changes in key personnel
- Complex transactions
- Huge transaction with related parties.
(b) It was a very easy question and majority obtained good marks.
(c) A good number of students knew about other forms of documenting
management’s representations such as

A summary of the oral representation written by the auditor.

A letter from the auditor outlining the auditor’s understanding of management’s
representations duly acknowledged and confirmed by management.
Relevant minutes of meeting of the board of directors or similar body or a signed
copy of the financial statements.
Question 8:
(a) Limitation of scope of auditor’s work is an oft-repeated area. Students were
required to list some of the circumstances which may lead to limitation of scope.
Some of these are as follows:
When terms of engagement specify that the auditor will not carry out a necessary
audit procedure.
Entity can impose such limitation by not co-operating with the auditor in
performing necessary audit procedures.
When auditor is practically unable to perform his necessary audit procedures.
When entity’s records are inadequate for audit purposes.
(b) Most students had a perception that in all cases of uncertainty other than going
concern, only emphasis of matter paragraph is included in auditors report. They
were unaware that in case of multiple uncertainties or uncertainty which is
material and pervasive the auditors may go to the extent of issuing a disclaimer of
opinion.
(c) Capability to analyze a situation comprehensively was found lacking. Students
should have considered the modification of reports at different levels of
materiality and its effects on financial statements as a whole.

SPRING 2006:
General:
Overall, the performance of the candidates in this paper was better. The paper was set in
such a way as to cover a large area of the syllabus. Hence, the students with lack of
adequate coverage of the syllabus could not do well.
Question 1:
(a) This part was set to test the knowledge of the candidates about the international
bodies IFAC and IAASB and their roles. IFAC, being the leader of the worldwide
accounting profession, is responsible for developing, promoting and maintaining
global professional standards and contributes to the efficient functioning of
international economy by speaking out on public interest issues where
professional expertise is most relevant. IAASB, on the other hand, is responsible
for developing and issuing standards on auditing, related services and quality
control. Students had a surface knowledge of such roles.
(b) This part was designed to test the candidates’ knowledge about the applicability
of the ISAs in Pakistan. It was disappointing to note that none of the candidates
were able to give a complete answer to this part. ICAP, being a member of IFAC
and regulator of accountancy profession in Pakistan, has adopted most of the
ISAs. It is mandatory for every practicing member to follow ISAs while
performing audit of a limited company. The format of audit report used in
Pakistan also contains a phrase that the audit is performed in accordance with the
auditing standards as applicable in Pakistan. Very few candidates mentioned the
above points.
Question 2:
This was one of the easiest questions set in the paper and generally the performance of
the candidates was satisfactory. However, in Part (a), in case of Company D, the students
failed to appreciate that the time frame of filling out casual vacancy by directors has
elapsed and authority to appoint auditors then rested with SECP. Part (b) of this question
was well performed by majority with some exceptions where students related auditors’
term with directors term.
Question 3:
This question had three parts. Part (a) and (b) related to preliminary engagement activities
which are carried out for recurring audits and mainly relate to matters like continuance of
client, ethical issues etc. A number of students described planning activities including
assessment of internal control, prior years issues and issues relating to nature, timing and
extent of audit procedures etc. which is not done at this stage.
Question 4:
The performance of the candidates in part (a) was mostly unsatisfactory. In this part,
candidates were required to enumerate the procedures normally undertaken by the
principal auditor while using the work of other auditor and to specify why the principal

auditor does not need to perform all the above referred procedures if the other auditor is
an affiliated firm. The main reason is that in case of an existing relationship, periodic
inter-firm reviews, tests of operating policies and procedures, etc. are routinely carried
out. Therefore such steps may not be required to be performed again. Most candidates
mentioned the audit procedures but failed to specify the difference when the other auditor
is an affiliated firm.
Part (b) was satisfactorily attempted by most candidates. However, very few could
mention all the information required to be documented by the principal auditor and
hence, could not gain full marks in this part.
Question 5:
It was required to identify circumstances where manual controls are preferred over
automated controls. Instead many candidates listed the various manual and automated
controls. Some answered the question with reference to audit risk related to both types of
controls which was not required.
Question 6:
(a) Management representation is an oft-repeated topic but still students often fail to
answer with specified reference to International Standards.
(b) A number of students had no idea of verification of fair value of securities, thus, a
confused response emerged on paper gaining very few marks.
(c) Those who had no knowledge of verification of fair value of listed securities,
obviously could not do any thing in this part. But most surprisingly those who
were able to describe alternate procedures in Part (b) stated that the auditor in
given case had no other alternate available to verify fair values and was supposed
to qualify the audit report.
Question 7:
Completely ignoring the marks allocated to the question, a number of candidates replied
the answer in affirmative without offering any reasons. Some of the candidates correctly
mentioned that working papers are necessary as they assist in planning and performance
as well as supervision and review of the audit work. However, very few mentioned that
working papers also provide evidence that the audit has been performed in accordance
with the requirements of the ISAs and are necessary to support the audit opinion. A few
candidates even expressed that working papers were not required as it was a one time
engagement.
Question 8:
This question on the topic of audit evidence was very easy. Except a few candidates who
did not mention all the five factors, the majority gained full marks.
Question 9:
This question was set to test the candidates’ knowledge about negative and positive
confirmations. In part (a), most of the candidates had a ‘field day’ on this question and

were able to identify the weaknesses of negative confirmation correctly. However, very
few candidates mentioned that negative confirmations are less reliable than positive
confirmations. As a result, they were unable to gain full marks in this part. In part (b) the
candidates correctly identified that negative confirmations will be the right course of
action in this situation but very few were able to enumerate the circumstances when
negative confirmations may be sent.
Question 10:
The question was attempted satisfactorily by majority of the candidates. The only
shortcoming was that many were not able to correlate the right audit procedure with the
right assertion. Some preferred to ignore assertions altogether and just stated the audit
procedure and ended up losing crucial marks. Others listed down all the assertions first
and all audit procedures thereafter. This also resulted in loss of marks as the requirement
was to relate each suggested procedure with audit assertions. Some submitted the
procedure for verification of ‘asset subject to finance lease’ instead of ‘liability’.
Part (b) was a straight forward question and everybody was able to provide accurate and
correct answer. As a result, almost everybody got full marks.
Question 11:
By and large, this question was attempted well by a majority of the candidates who, in
turn, managed to score high marks in this question. The question was designed to test the
knowledge of candidates regarding the ISA related to ‘Subsequent Events’. It was
observed that most of the candidates did very well in describing the audit procedures but
very few were able to mention that such audit procedures are normally performed as near
as practicable, to the date of the auditor’s report.
Question 12:
This question was directed towards identifying the important matters that are considered
after the decision to modify the audit report on the basis of an expert’s opinion has been
taken. Many students ignored this and unnecessarily described the procedure that are
performed before taking any such decision.
Question 13:
This question dealing with the auditor’s report was, on an average, handled well by the
candidates. Nearly every candidate was able to identify that a liability / provision was
required to be made under the circumstances, however, very few mentioned that an
emphasis of matter paragraph was not appropriate under the given circumstances. Almost
everybody was unanimous that it was a case of disagreement with management. Most of
them were able to state that either an adverse or a qualified opinion was appropriate,
however, they did not mention that adverse opinion was suited where the financial effect
of the matter was material and pervasive.

AUTUMN 2006:
General:
Overall approach of the paper setter was to test a large portion of the syllabus by way of
straight forward requirements. Nevertheless, few questions also tested practical
application of knowledge. Generally the performance was good, however as in the past,
even good answers contained irrelevant portions which were not required. There is a
general tendency in many students to produce as much information as they know even if
only a part of it has been asked for. The students are advised to cut this tendency, if they
really want to succeed in the examinations.
Question 1:
Legal provisions regarding appointment of statutory auditor is a topic regularly asked and
was attempted fairly by most students. The general deficiencies noted in the answers
were as follows:
The time lapse after which an ex-employee can become an external auditor was not
mentioned.
There were many examinees who said that a private limited company having paid up
capital less than rupees three million can appoint, even a body corporate, as its auditors.
There was a general misconception that an ex-employee of a director also needs a time
lapse of three years for appointment as an external auditor.
Very few students knew that if shares are held by the minor son of a person, he cannot
accept appointment as an external auditor. There is no such restriction if the son has
attained the age of majority
Question 2:
Most of the students did well in this straight forward question. However, those who
hadn’t studied the relevant text, relied on guess work specially in answering part (b) and
described the dictionary meaning of the word ‘monitoring’.
Question 3:
(a) Generally the students didn’t seem to have studied this area. Most of them
answered using their general understanding of IFAC and couldn’t secure good
marks.
(b) In-depth understanding of importance of financial reporting framework at client
acceptance level was lacking. An auditor is not supposed to accept an assurance
engagement unless management has adopted a reporting framework that serves as
a suitable criteria for preparation and evaluation of financial statements. Some of
the students could not understand the question and tried to explain the importance
of International Accounting Standards.

Question 4:
Students did well while describing assessment of internal audit at planning stage and
discussed various criteria such as Status in the Organization, Scope of Functions and
Technical Competence etc. However, some of them could not see the difference between
assessment of internal audit function at planning stage and assessment of specific work
performed by the internal auditor. Thus, mixed and confused thoughts were presented by
some of them.
Question 5:
Use of expert’s work was another topic where students performed well. However, a
number of students ignored the simple fact that in the given case, the expert’s objectivity
has been impaired as he was an employee of the client. As a result they did not mention
the steps that the auditor may perform in such a situation and lost easy marks.
Question 6:
(a) Term ‘error’ is an essential concept of audit and most of the students stated the
meaning correctly. Some overlooked the requirement and didn’t give examples in
their answers.
(b) Modern auditing approach gives substantial importance to the possibility of
misstatement in financial statements due to intentional act of the management.
Management overrides controls which are established to reduce the risk of
fraudulent financial reporting. Many students disregarded the requirement of the
question and kept on writing every thing they knew about fraud committed by the
management. They were rewarded only for relevant points related to financial
reporting such as fictitious entries, incorrect estimation, concealment of
information etc.
Question 7:
Materiality is another term repeatedly used in auditing and examiner expects a profound
knowledge about the term and its use. An information is material if its omission or
misstatement could influence the economic decision of the users of financial statements.
Better answers contained a brief description of materiality, its due importance and
relationship with the particular circumstances. Some candidates had an incorrect
understanding that a quantitative threshold is blindly taken as materiality level by the
auditor without considering the qualitative characteristics of the items under
consideration.
Question 8:
(a) This was an easy question. Most of the students were able to mention correctly
that sufficiency is a measure of the quantity of audit evidence where as
appropriateness relates to its quality.
(b) The important matters that an auditor usually considers in determining the extent
of tests of controls to be performed by him are:
· Extent of reliance being placed

· The length of time, in respect of which the reliance is being placed

· Frequency of operation of controls during the period
· Lists of other controls and
· Expected deviation from the control.
Some students started discussing irrelevant things like control environment and risk of
management’s override of controls etc. and wasted lot of time.
Question 9:
(a) The auditor considers a number of factors while using analytical procedures as
substantive procedures and the examinees were required to discuss only one such
factor i.e. preciseness of expectation. However, a number of students failed to
notice the requirement. Consequently, some of them just listed all the factors
whereas others discussed each of the factors and wasted lot of time which affected
their performance in other questions.
(b) Concepts of most students regarding analytical procedures were not clear. At the
end of audit, such procedures are usually carried out to corroborate conclusions
drawn during the audit and to identify a previously unrecognized risk of material
misstatement. Most of the students appeared to believe that auditor’s opinion is
based on such procedures.
Question 10:
Most students did have the knowledge about the topic of external confirmation but were
found unable to apply the same on the given situations. They failed to consider many
aspects such as suppliers’ dependency – case (i), documentation requirement of oral
confirmation – case (ii) and using other means where no response was received – case
(iii).
Question 11:
(a) Most students were able to write down the purpose of performing review of
subsequent events although a large number of them wrote very lengthy answers
which were not required. Moreover, the fact that these procedures should be
performed as near as possible to the date of auditors’ report was missing from
many answers.
(b) Overall performance was good in this part of the question in which the examinees
were required to describe the procedures for review of subsequent events.
However, there were instances where examinees produced unasked details like
types of enquiries and procedures relating to specific matters like going concern
and subsequent losses etc.
Question 12:
(a) Students presented a fairly good knowledge about the topic. However, some of
them mixed up qualified opinion with modified opinion ignoring the fact that all
modified opinions are not qualified opinions. Some wrote samples of audit
opinions gaining no marks.

(b) In many cases it was noted that the students reproduced the contents already given
in the question. Students are once again advised that marks are not awarded on the
basis of length of the answer. Relevance, accuracy and coverage of the topic is
considered while marking the questions.

Chapter 1
International Federation Of Accountant

(IFAC)
Chapter Topic List
1. Introduction
2. Membership
3. Structure
4. Committees
5. International auditing practices committee (IAPC)
6. International auditing and assurance board (IAASB)
7. Objectives of IAASB
8. Application of ISAs
Introduction
This chapter covers the basic theme behind International Federation of Accountants
(IFAC), its formation, its committees, its objective. International auditing and assurance
board (IAASB) has also been covered in this chapter

1. INTRODUCTION:
International Federation of Accountants (IFAC) was formed 1977. The mission of
IF AC is the world wide development and enhancement of an accountancy
profession with harmonize standards, able to provide services of consistently high
quality in the public interest. It is a non-profit, non-government, non-political
international organization of accountancy bodies.
2. MEMBERSHIP:
Membership in IFAC is open to accountancy bodies recognized by law or general
consensus within their countries as substantial national organization of good
standing within the accountancy profession. The membership of IFAC member
bodies comprises more than 2,500,000 accountants in the public and private
practice, education and government service.
The Council, which consists of one representative from each member body of IF
AC elects the members of the Board, establishes the basis of financial
contributions by members and adopts changes to the IF AC Constitution.
3. STRUCTURE:
The Board consists of the President, The Deputy President and representatives
from 15 countries elected by the Council for three-year term. Elections of Board
are held annually in such away that one-third of the members of the Board shall
retire each year. The Board supervises the general IFAC program, the budget and
as appropriate, oversees specific committee projects.
4. COMMITTEES:
The standing technical committees of IFAC are:
· Compliance Committee
· Education Committee
· Ethics Committee
· Financial and management accounting Committee
· Information Technology Committee
· International Auditing Practices Committee
· Public sector Committee
5. INTERNATIONAL AUDITING PRACTICES COMMITTEE

(IAPC):
International Standards on Auditing (ISAs) are issued by the International
Auditing Practices Committee (IAPC) the IAPC is the standing committee of the
Council of International Federation of Accountants. Membership of IFAC

automatically confers membership of the International Accounting Standards

Committee (IASC) based in London. The two organizations re independent of
each other, the former deals with auditing with auditing, the latter with
accounting.
6. INTERNATIONAL AUDITING AND ASSURANCE BOARD

(IAASB):
The International Auditing and Assurance Board (IAASB) functions as an
independent standard-setting body under the auspices of IFAC. The objective of
the IAASB is to serve the public interest by setting high quality auditing and
assurance standards and by facilitating the convergence of international and
national standards, thereby enhancing the quality and uniformity of practice
throughout the world and strengthening public confidence in the global auditing
and assurance profession
7. OBJECTIVES OF IAASB:
The IAASB achieves this objective by:
· Establishing high quality auditing standards and guidance for financial

statement audits that are generally accepted and recognized by investors,
auditors, governments, banking regulators, securities regulators and other
key stakeholders across the world:
· Establishing high quality standards and guidance for other types of
assurance services on both financial and non-financial matters;
· Establishing high quality standards and guidance for other related

services;
· Establishing high quality standards for quality control covering the scope
of services addressed by the IAASB; and
· Publishing other pronouncements on auditing and assurance matters,

thereby advancing public understanding of the roles and responsibility of
professional auditors and assurance service providers
8. APPLICATION OF ISAs:
It is mandatory to follow the International Standards on Auditing (ISAs) in
respect of audit of a limited company as auditor in his audit report as laid down in
the Companies General Provisions (Rules and Forms), 1985 states "We conducted
our audit in accordance with auditing standards as applicable in Pakistan. These
standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free from any material
misstatements". The Auditing Standards as applicable in Pakistan are ISAs as
adopted by the Council of ICAP

Test your knowledge
1. Discuss the role of International Federation of Accountants.

2. Discuss the role of International Auditing and Assurance Standards Board.
3. Briefly discuss the authority attaching to International Standards on Auditing
(ISAs) with respect to audit of a limited company in Pakistan.

Chapter 2
Introduction to auditing
Chapter Topic List
1. Definition of Auditing
2. What auditing is not
3. What auditor can not give absolute assurance
4. Need for audit of financial statement
5. Objective of audit
6. Nature of audit
7. Services provided by auditor
8. Professional clearance letter (PCL)
9. Benefits / detriments of audit
10. Benefits of review
11. Agency theory
12. Scope of audit
13. Kinds of audit
14. General principles of governing audit
15. Audit risk
16. Audit risk model
17. Miscellaneous
Introduction
The reader should thoroughly learn this chapter along with all terminologies used in
this chapter, in order to make firm base for next coming chapters.

1. DEFINITION OF AUDITING:
Auditing is an independent examination of financial statements of entity
conducted to express an opinion whether or not such financial statement five a
true and fair view.
(a) INDEPENDECE:
· Independence is an ethical principle.
· Means that the auditor should not have any such relationship with
client which may affect his opinion (e.g.) Employee, Directors, family
or Blood relationship, spouse
· Independence can be impaired in the following cases:
o Acceptance of Gift (Excessive Hospitality)
o Undue dependence on one client:
Total numbers of clients are 10 and total fee is 10 million and out
of 10 million, 1 client is paying 8 million and rest of 9 are paying
2 million only
NOTE:
In UK, limit of one client fee is limited to 15 % of total client fee
o Loans
o Other Services
(b) EXAMINATION:
· Examination means obtaining evidence in support of Financial
Statement
· Examination involves following steps:
o Developing a general strategy and a detailed approach for conduct
of audit
o Ascertaining the accounting and internal control system
o Evaluating internal controls
o Obtaining audit evidence
o Reviewing the financial statement
· Auditor examines the following things:
o Existence
o Ownership
o Valuation
o Completeness

o Presentation & Disclosure

· Auditor cannot give opinion without obtaining evidence.
(c) FINANCIAL STATEMENT:

· A structured representation of financial information which ordinarily
includes accompanying notes derived from accounting records and
intended to communicate an entity’s economic resources or obligation
at a point in time or the changes therein for a period of time in
accounts with Financial Reporting Framework. The term can refer to
complete set of Financial Statement, but it can also refer to single
Financial Statement (e.g.) Balance Sheet, Income Statement and
related explanatory notes.
· It includes:
o Balance Sheet
o Income Statement
o Statement of Changes in Equity
o Cashflow Statement
o Notes and other explanatory materials
· What is included in audited report / financial statement, what is
excluded, is determined largely by:
o National Legislation
o Accounting Standards
(d) ENTITY:
· Means any organisation
(e) OPINION:
· Means audit report
· If auditors opinion is wrong;
o SECP imposed penalty
o ICAP may cancel the license after giving the warning
o Goodwill will damage
o Auditor may go to bars (jail)
· Financial Statements do not give true and fair view is also a positive
opinion because auditor is positive about accounts.
· Financial Statements are required to be prepared by the management
of the organisation.

The duty of the auditor is to verify and required to express his opinion
· If the auditor is satisfied with financial statement, his opinion will be
as follows:
In our opinion, the financial statement of XYZ Ltd for the year ended
31st Dec 2004 gives true and fair view.
(e) TRUE AND FAIR VIEW:

· Means
o Accounts has been prepared in accordance with IAS
o Accounting policies have been consistently followed
o Accounts are not materially misleading / misstated
· Materiality means significant errors (i.e.) error which makes the
Financial Statement to be misleading (decision of user affects)
· Sometimes error of Rs.1 is considered to be as material
EPS Rs.
2000 10.52
2001 11.59
2002 12.30
2003 13.10
2004 13.02
Till 2003, profit is continuously increasing and if a graph is plotted it
will show upward trend. But in 2004 actual profit was 13.15, which
was shown as 13.02 and if this figure is plotted in a graph it will show
a decreasing trend and it will affect the decision of the user. User will
find that it is possible that in future EPS might further decrease.
CRITERIA FOR MATERIALITY

For Balance Sheet’s Item:
· Less than 5 % of total asset --- Immaterial
· More than 10 % of total asset --- Material
· Between 5% - 10% may be material depending on auditor’s
professional judgement.
For Profit & Loss Account:
· Less than 2 % of Sales --- Immaterial
· More than 5 % of Net Profit after tax --- Immaterial

2. WHAT AUDITING IS NOT?

1) Auditing is not guarantee that financial statements are correct.
2) Auditor does not provide an absolute assurance regarding correctness of
financial statement
3) Audit only provides a reasonable assurance that financial statements are
free from material misstatement.
3. WHY AUDITOR GIVES REASONABLE ASSURANCE / WHAT

AUDITOR CAN NOT GIVE ABSOLUTE ASSURANCE?
An audit carried out in accordance with Auditing Standards is designed to provide
reasonable assurance that financial statements taken as whole are free from
material misstatement. The view given by financial statements itself based on a
combination of facts and judgements, and consequently cannot be described as
“correct” or “absolute” when reporting on financial statements, auditors provide a
level of assurance which is reasonable in that context but cannot b absolute.
Auditor can not provide absolute assurance because of:
1) Inherent Limitation of an audit
a) Audit is carried out on test basis (sampling)
b) Audit Evidence is persuasive (means which provide reasonable
assurance) rather than conclusive (means which provide absolute
assurance)
2) Financial Statement includes some accounts on the basis of estimate and
judgement of management.
For Example:
o Allowance for doubtful debts
o Allowance for inventory obsolescence
o Useful Life of machinery
3) Inherent Limitation of Internal Control.
4) Certain Accounts carry substantial risk (e.g.) Transaction with related
parties.
5) Auditor’s judgements are involved in verification or in deciding the extent
of audit procedure.
6) Audit report does not provide an assurance on future viability of company
(going concern).
7) Objective of audit is not to detect fraud.

4. NEED FOR AUDIT OF FINANCIAL STATEMENT:

Modern Auditing has developed since the concept of a company as a separate
legal entity came into existence in late 19th century.
This led to separation of ownership (shareholders) from control (directors) and a
consequent need to safeguard interest of owners, who in all but the smallest of
business (where the shareholder and directors were one and the same) were not
involved in day to day decision made by the management
The following are the needs for audit.
1) Time, distance and cost make it impracticable for all users of financial
statement even if they are knowledgeable to have direct access to underlying
records and perform themselves verification of financial statement. They
place much reliance on auditor for verification of financial statement.
2) An audit provides a moral check on employees of an entity. When employees
know that their work is to be verified by an independent auditor, they take
care to minimize errors. The chances of fraud are also reduced. Management
knows that their assertions (research) will be subject to verification. They
would therefore be inclined not to deviate substantially from recognized
accounting policies.
3) Section 233 of Companies Ordinance 1984 requires that financial statement
should be audited by an auditor of company
4) An audit requires in depth knowledge of business from view point of owners.
This may enable the auditor to give useful recommendations for improving
operation of client.
5. OBJECTIVE OF AUDIT:
Objective of an audit is the expression of an opinion as to whether the financial
statement gives a true and fair view in accounts with ISA and in compliance with
local statutory requirements.
Expression of an opinion includes:
1) Management is responsible for preparing financial statement. The auditor
expresses his opinion on such financial statement
2) Difference between management and auditor on accounting issues have been
satisfactorily resolved and reflected in auditor report.
3) Correctness of amounts in financial statement are not certified or guaranteed.
4) Absolute assurance is not provided by auditor

5) Reasonable assurance of detecting immaterial errors and irregularities is not

provided.
6) There is an unavoidable error that even some material error may remain
undiscovered
7) Future viability of an entity is not assured.
8) Efficiency and effectiveness with which resources have been used are not
reported.
6. NATURE OF AUDIT:
Audit of financial statement is Assurance Engagement.
According to International Framework for Assurance Engagement,
“An Assurance Engagement 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 outcomes of the
evaluation or measurement of a subject matter against criteria”
In other words, Assurance Engagement means an assignment in which the auditor
expresses an opinion in order to enhance credibility of a subject matter against
criteria.
Elements of an Assurance Engagement:
Following are the elements of an assurance engagement:
1) 3 party relationship involving a practitioner, a responsible party
(management) and intended users
2) Subject Matter (financial statement)
3) Criteria (is benchmark used to evaluate or measure the subject matter [i.e]
IAS/IFRS)
4) Evidence (is the information obtained by practitioner to evaluate whether the
subject matter is free of material misstatement)
5) Written report (contains conclusion that convey the assurance about the
subject matter information).
7. SERVICES PROVIDED BY AUDITOR:

Following are services provided by an auditor:
1) Audit
2) Review

3) Compilation
4) Agreed upon procedures.
5) Management and tax consultancy
Following are services provided by an auditor do not fall in definition of
assurance engagement:
1) Compilation
2) Agreed upon procedures.
3) Management and tax consultancy
Compilation includes:
· Writing up books of accounts
· Extracting trial balance
· Preparing financial statement

DIFFERENCE BETWEEN AUDIT , REVIEW AND COMPILATION
AUDIT REVIEW COMPILATION
Shareholders get high level of Shareholders get moderate level In compilation no assurance is
assurance but not absolute of assurance but not high level provided by the auditor.
assurance assurance
In case of audit, the auditor Review is less than an audit. In

obtains all evidence required. case of review, the auditor does
not obtain all evidence required.
His opinion is based on
-
analytical review (i.e.)
comparison of ratios and trends
and also inquiry from
management
Auditor issues audit report Auditor issues review report Compilation report is given by
which is knows as positive which is knows as negative the auditor, he says, “We have
opinion (i.e.) in our opinion opinion (i.e.) We have received compiled the enclosed financial
financial statement gives true financial statement of ABC Ltd statement from accounting
and fair view. for year ended, based on our records provided to us. We have
review nothing has to our not audited ore reviewed
attention which may cause us to financial statement and therefore
believe that financial statement we do not express an opinion on
give true and fair view. such financial statement”
In Limited company, audit is In Limited company, review is

compulsory compulsory -
Auditor provide high level of

assurance because auditor is:
· Qualified - -
· Independent
· Is not restricted in scope.

LEVEL OF ASSURANCE
Agreed upon
Nature of Service Audit Review Compilation
procedures
High, but not Moderate

Level of assurance No assurance No assurance
absolute assurance
Identification
Positive assurance Negative assurance Factual findings of of
Report provided
on assertions on assertions procedures information
compiled
DIFFERENCE BETWEEN EXTERNAL AND INTERNAL AUDIT
External Audit Internal Audit
Objective of external auditor is to express an Basic objective of internal auditor is to review

opinion on financial statement efficiency of management
Internal auditor review both final and operational

External auditor only review final data
data
External auditor reports to shareholders Internal auditor reports to management
Scope of internal auditor is defined by

Scope of external auditor is defined by law
management
External auditor has to comply with ISA Compliance with ISA is not necessary
Total independent Employee of the company
Mandatory for all limited companies Not mandatory

DIFFERENCE BETWEEN ACCOUNTING AND AUDITING
Accounting Auditing
It is concerned with
· Techniques It is concerned with
· Procedure of recording · Basis for accounting measurement and
assertions
· Classifying
· It is analytical critical and
· Summarizing
investigations.
· Interpreting
· Communication of result
Spade work if done by accountant Finishing touch is given by auditor
Unaudited account records cannot be relied upon Audited accounts can be relied upon
Not mandatory for account to be Chartered Mandatory for auditor of public company to e
Accountant Chartered Accountant.
Accountant is appointed by management Auditor is appointed by shareholders

8. PROFESSIONAL CLEARANCE LETTER (PCL):

Dear Sir,
We have been requested by ABC Ltd to carry out the audit for year ended
31/12/06. You believe that your firm is auditing this client previously, kindly
advice if there are any professional reasons, why the audit should not be accepted
by us.
Regards,
XYZ (Chartered Accountants)
Before sending this letter, the new auditor should take permission from client. If
refused by the client to communicate with the previous auditors, the audit cannot
be accepted.
9. BENEFITS OF AUDIT:
The following are the benefits of audit
1) The users of financial statement get higher assurance that the accounts are
correct.
2) It helps Income tax officer to access correct tax liability of a company.
3) It increases the credibility
4) Dispute between management may be more easily settled.
5) Application to third parties for finance may be enhanced by audited accounts.
6) Audit is likely to involve in-depth examination of business and so enable the
auditor to give advice to management for improving efficiency of business.
7) Frauds and errors can easily be detected.
8) Regularity and vigilance of staff.
9) Improvement of internal control system.
DETRIMENTS OF AUDIT:
The following are the detriments of audit
1) Audit fee (for this reason, few partnership and even fewer sole traders are not
likely to have their accounts audited unless such an audit is required by local
statue)

2) Client’s staff and management in giving time to provide information to

auditor. (Professional auditor should therefore plan his audit carefully to
minimise the disruption which his work will cause)
10. BENEFITS OF REVIEW:

1) Sole proprietor and partnership firm cannot afford audit, therefore they
conduct review.
2) Sole proprietor get assurance that his accountant is not involved in fraud.
3) It helps the company to get loan.
11. AGENCY THEORY:

· Agency relationship occur when one party (the principal) employs another
(the agent) to perform a task on their behalf.
· Agency theory implies that agent should work in best interest of principal
· Auditors are agents of shareholders and in case of conflict of interest they
should consider their duties to the users.
· In absence of agency relationship, the users will not have enough confidence
in audited accounts.
12. SCOPE OF AUDIT:

· Scope of Audit means extent of audit tasks which are determined by an
auditor for conducting audit of company
· If auditor is unable to perform audit procedure which he considers necessary
he cannot issue an unqualified report.
· Scope Limitation may be due to:
o Client’s restriction
o General Circumstances
For Example: When auditor appointment is made after year end and
consequently he is unable to attend physical inventory count.
· Determination of scope of audit depends upon nature of audit
CRITERIA FOR DETERMINING SCOPE OF AUDIT:
The criteria for determining scope of audit of a company are:
(a) STATUTORY REQUIREMENTS:
· Most important factor

· Governs rules and regulation framed by statue of country for

safeguarding interest of shareholders.
· Auditor normally determined scope with requirements of these rules
and regulation.
(b) PROPER PLANNING:
· Audit task should be properly planned and organised to cover all
aspects of entity relevant to financial statement to be audited.
(c) REASONABLE ASSURANCE:
· To form expert opinion by an auditor, he should ensure that
information in accounting records are sufficient for preparation of
financial statement and properly communicated in financial statement
· For assessing the reliability and sufficiency of information in financial
statement, he should undertake following task
o Study and evaluation of accounting system and internal control,
for deciding that whether he can rely upon internal control and to
determine nature, timing and extent of other procedure.
o Test, enquiries and verification procedure of accounting
transaction and account balance.
(d) PROPER COMMUNICATION OF INFORMATION:
· Must determine whether relevant information is properly
communicated by:
o Comparing financial statement with accounting records and
source data to determine whether they summarise the transactions
which are recorded.
o Considering the ascertions made by management in preparing
financial statement, selection and consistent application of
accounting policies and manner in which information has been
classified and adequacy of disclosure.
(e) PROPER EVIDENCE:
· For satisfaction for correctness, adequacy of accounting records and
data contained in financial statement, auditor must seek evidence.
(f) EXTENSION OF WORK:
· If auditor suspects any fraud or error after applying tests, verification
and enquires, he must extend his audit task to confirm or allay his
suspicious.

13. KINDS OF AUDIT:

(1) EXTERNAL AUDIT:
· It is concerned with critical review of representation made in published

financial statement
· It is compulsory for all companies which are registered under

Companies Ordinance 1984, to have their accounts audited.
· This type of audit is conducted at different timing.

(a) Continuous Audit:
· Auditor is required to attend at regular intervals during financial
year.
· This is conducted under following cases:
§ Audited accounts are required immediately after close of
financial year (i.e.) in case of banks
§ Where monthly audited accounts are required throughout
year
§ No satisfactory internal control system in force
§ Concern is large and numerous transactions are to be
checked
(b) Final Audit:
· Commenced at end of accounting year when all account have
been closed and final accounts have been prepared.
· Carried on until audit work for the entire period is completed.
(c) Interim Audit:
· Conducted where the management wants to know the trading
result of business in order to declare interim dividend
· Where audited financial statement are required to be issued soon
after the close of financial statement
(2) COST AUDIT:
· Verification and examination of books of cost account in order to

ensure the proper maintenance of books of cost account in accordance
with cost accounting system employed by company.
(3) GOVERNMENT AUDIT:
· Instrument of financial control.

· Main function is to examine the government accounts under prescribed

government audit rules and inform the government regarding the
findings and suggestions. Then it is responsibility of government to
examine his suggestion and take remedial action.
· It is concerned with audit of:

§ Receipts and expenditure
§ Sanctions
§ Provision of funds
§ Stores and stock
§ Effectiveness of expenditure
§ Elimination of waste
§ Efficiency in utilization of resources.
(4) INTERNAL AUDIT:
· Continuous process of reviewing appraising all business activities
relating to financial accounting and other operations.
· Internal audit department is appointed by management and directly
responsible to management
· Main aim of internal audit is to build up sound and satisfactory internal
control system in organisation and consequently minimize the work of
external audit.
(5) MANAGEMENT AUDIT:
· To examine, review and appraise the various policies of management on
basis of objective standard
· Main aim to reveal shortcomings or irregularities in management
· Suggest ways and means to management for improving operational
profitability and organisation viability
· Helps the management for effective use of resources economically and
increase efficiency at all level.

14. GENERAL PRINCIPLES OF GOVERNING AUDIT:

Three basis principles:
· Compliance of Code of Ethics
· Compliance of Auditing Standards
· Attitude of Professional Skepticism
(A) CODE OF ETHICS:
(1) INDEPENDENCE:
· Ability to act with objectivity and integrity
· Should not have any relationship with client which may affect his
opinion (e.g.) directors, employees.
· Free of conflict of interest in performing professional
responsibilities
· If auditor is independent, shareholders place reliance on his audit
report otherwise not.
· The audit firm should periodically ensure relationship which may
impair independence should not exist with client.
· The auditor should be independent infact and in appearance.
Infact means auditor should be:
o Impartial
o Honest
o Unbiased
Inappearance means auditor should not have following
relationship with client:
o Financial Interest
o Business Relationship
· Independence of auditor may be impaired if:
o Goods / service are purchased by him from client at special
term.
o Investment is made by auditor in client’s business
o Funds are borrowed from client
o Close relatives of auditor hold key position with client
o Auditor is employee of entity

(2) INTEGRITY:
· Means honesty and fair dealing
· Conducting audit without the fear of losing an assignment
· Implies that in performance of audit member should not
knowingly misrepresent facts.
(3) OBJECTIVITY:
· Means that auditor should consider all relevant factors and auditor
should avoid giving comments on those matters which do not
affect financial statement
· There may be a conflict of interest between those who prepare
financial statement and who use financial statement
· Users of financial statement depends upon auditor’s report for
relevance and reliability of financial statement
· Implies that auditor should consider only relevant matters only.
(4) PROFESSIONAL COMPETENCE AND DUE CARE:
· The auditor should be appropriately qualified and should possess
practice license from ICAP.
· The auditor should carry out audit with care and diligence and he
should keep himself updated as regards accounting and auditing
standards.
· They should have necessary expertise, unrestricted access to
records, knowledge and required training in field.
· The auditor should always maintain an awareness of latest
development in field of accounting and auditing.
· Auditor should persist until he has dispelled any reasonable doubt
that may have about existence of material errors and irregularities.
· Involves reasonable care and competence and not extra ordinary
performance.
(5) CONFIDENTIALITY:
· Confidentiality is implied in auditor’s contract
· Auditor should not use client’s confidential information for his
personal benefit or for the benefit of 3rd party.
· Auditor should not disclose any information with consent of
client.
· Client’s information can be disclosed in case of:
o Litigation to protect auditor

o Where auditor deem necessary in public interest

o To sue for fees.
· It is the duty of auditor to disclose client’s information in
following circumstances:
o Suspects of terrorism
o Order of court
o Suspects of drug trafficker
o Under banking, insurance, insolvency and financial services
legislation to regulatory authority if auditor considers that
public funds were not used carefully.
(6) PROFESSIONAL BEHAVIOUR:
· Means that auditor should be polite and courteous in his dealing
with the client and staff.
(7) TECHNICAL STANDARDS:
· Means that auditor should keep himself updated with latest
pronouncement on accounting and auditing.
(C) ATTITUDE OF PROFESSIONAL SKEPTICISM:
· An attitude of professional skepticism means the auditor makes a
critical assessment, with a questioning mind, of the validity of audit
evidence obtained and is alert to audit evidence that contradicts or
brings into question the reliability of documents and responses to
inquiries and other information obtained from management and those
charged with governance.
· The auditor should carryout audit with ethical attitude that auditor
should be alert that financial statement may be misstated due to fraud
and error. The auditor should not assume the management to be honest
nor should he assume the management to be dishonest.

15. AUDIT RISK:

· Audit risk is the risk that auditor issues an inappropriate audit opinion when
the financial statement are materially misstated.
· The Auditor should perform in a way to reduce audit risk to an acceptably
low level as it is not possible to eliminate such risk.
· Inherent Risk and Control Risk are entity’s risk assessment and collectively
knows as risk of material misstatement.
· Audit risk can be reduced by assigning to engagement staff with better
knowledge, skills, more close supervision and if required using work of
experts, ad consideration of validity of going concern assumption.
· Three components of audit risk are:
(a) Inherent Risk:
· Inherent Risk is susceptibility of misstatement in account balance or
financial statement as whole.
· Account Balance:
Account Balance refer to specific balance sheet or income statement
(e.g.) Account Receivable, inventories.
Examples:
o Account involving high degree of estimation
§ WIP
§ Intangibles
§ Doubtful accounts
o Complexity of transactions/ other events which requires work of
expert.
§ Provision for pension
§ Revaluation of asset
o Degree of judgement involved in determining account balance.
§ Provision for contingencies
§ Measuring of work completed and estimating cost on
contract account.
o Susceptibility of assets to loss / misappropriation
§ Cash is more susceptible than machinery
o Transactions not subject to ordinary processing
§ Loss by fire
§ Asset revaluation

· Financial Statement:
Examples:
o Integrity of management
o Management experience and knowledge
o Unusual pressure on management
o Factor’s affecting the industry in which the entity operates and
nature of entity’s business
§ High Technology
§ Declining demand of industry products.
§ Frequent changes in product technology and fashions
§ Many business failures.
(b) Control Risk:
· Control risk is risk that entity’s internal control will not prevent,
detect or correct a material misstatement in an account balance.
· Reasons for Control Risk:
Control risk exists because of inherent limitation of system of internal
control.
Inherent limitation of system of internal control:
o Cost v/s benefit relation
o Controls are generally designed for routine transaction rather than
non-routine transaction.
o Human errors due to:
§ Carelessness
§ Distraction
§ Mistakes to judgement
§ Misunderstanding of instructions
o Collusion (means understanding between two person for
fraudulent intentions)
o Override of control by senior member of management
o Control may become obsolete inadequate due to changes in
conditions.
(c) Detection Risk:
· Detection risk is risk that auditor’s substantive procedure will not
detect a material misstatement in an account balance.

· Detection risk relates to extent of substantive procedure. The larger

the sample size selected by auditor, the lower will be detection risk
and vice verse.
· Relationship of Detection Risk with risk of material misstatement:
I.R & C.R = D.R
I.R & C.R = D.R

If risk of material misstatement is high, the auditor will have to reduce
D.R so that the overall audit risk is reduced to an acceptable lower
rate. Conversely if risk of material misstatement is lower, the auditor
may increase D.R and still the audit risk will be reduced to an
acceptable lower level. Accordingly auditor can reduce extent of its
testing.
16. AUDIT RISK MODEL:
1) It is used in preparing audit program and serves as tool to minimize the risk of
issuance of unqualified opinion on financial statement which are materially
misstated and at same time avoid over auditing in low risk area.
2) It is,
A.R = I.R x C.R x D.R
3) Auditor only assesses risk of material misstatement but cannot reduce such
risk. Except where client subsequently implements auditor’s
recommendations on improvement of internal control, the control risk may be
reduced
4) D.R may be controlled to substantial extent, it is not possible to eliminate it if
even 100 % transactions are verified
5) If risk of material misstatement are high and D.R is also high, it is an
indication that auditor has not obtained sufficient appropriate evidence to
form his opinion
6) Minimum amount of substantive procedures have to be applied even if risk of
material misstatement are too low
7) Reducing audit risk to extremely low level may not be feasible as cost
involved in reducing D.R may be high and would exceed value to the users of
financial statement
8) Auditor should consider assessed level of risk of material misstatement in
determining nature, timing and extent of substantive procedure.

17. MISCELLANEOUS:
· Whether auditor can be liable for third party:
The auditor should not be liable for claims by third parties because:
o Auditor owns no duty of care to third parties
o Third parties do not have contractual relationship with auditors as they
have not paid any fee to auditors
The auditors should be held liable against third parties because:
o Credibility of financial statement is reduced
o Investor will have less confidence in the companies and share prices
will be affected
o Financial Institution will not feel comfortable to advance loans to
companies.
· Can auditor perform other services for his client:

Arguments against providing other services:
o Independence is impaired.
o Continuity of staff may be a problem. The same staff may not be
available at all times for a specific client.
o Frequent changes in the audit firm's management.
Arguments for providing other services to an audit client:
o Special expertise is available as the auditor has experience with many
other companies.
o The client can save costs as some of the audit and other services
provided by the auditor may contribute to the purpose of another.
o Small companies may not afford to hire qualified accountants on a
permanent basis.
o The audit firms will get additional business.
o The loss of independence may be compensated if different staff and
partners ate responsible to carry out audit and those responsible to
perform related services.
· Factors which may incline the auditor not to accept nomination:

Following factors may influence the auditor not to accept the nomination
o Inability to serve the client
o Conflict of interest with any existing client
o Undue dependence on one client
o Unusual pressures on management

o Lack of cooperation from management

o Inadequacy of internal controls as reported by previous auditors.
o Non audit services provided by the associate of the audit firm
o Integrity of client.
· Requirements in acceptance of client:

Legal:
o Appointment is valid in accordance with Companies Ordinance 1984
Ethical:
o Independence requirements
o Avoidance of conflict of interest such as advising two clients who are
competitors.
o Ability to serve client
Commercial:
o Adequacy of fees.
· Can former partner in audit firm accept a job with client:

There is no restriction in Companies Ordinance 1984 or in the Code of Ethics,
for a former partner to work for client.
Advantage:
o The auditor already is knowledgeable about the client’s business, its
accounting system, internal control of the management. Consequently
the time required by new employee to get familiar with the company’s
internal control structure is saved.
Disadvantages:
o The former partner is aware of the audit approach, sampling techniques
and areas where the audit firm focuses attentions. The audit firm should
be cautious on such issues.
o The former partner may have developed close relations with the audit
staff. Such relationship may threaten the independence.
o The audit staff being impressed with the former partner may place
excessive reliance on the work and representations made by him.
· Matters relevant as regards audit fee:

o Fees should be mentioned in engagement letter
o Fees should not be charged on percentage or contingency basis.
o Where fee is not agreed before hand the auditor should charge the fee
based on time spent.

o If the auditor faces litigation for unsatisfactory work a suspiciously low

fee is taken into account.
· Restriction in exercising lien over books of accounts for non-payment of

fees:
o An auditor has a particular lien over books and records, i.e., he can
retain those books on which be has performed the work.
o The books and records must have come into auditor's possession
lawfully
o Fee note must have been raised
o Fee is not under dispute
o Lien cannot be exercised on those books which the company has to
maintain by law
· Matters to be considered in providing non-audit services to audit client:

o Compilation services should not be provided to limited companies
o In the compilation report the fact should be clearly mentioned that the
auditor has not audited or reviewed the accounts and accordingly no
opinion is expressed.
o The staffs that have provided compilation services should not be
involved in auditing those accounts.
o If fixed assets have been revalued by the auditor, he should not carry
out audit of those accounts.
o The auditor should consider that audit and non audit services to same
client will not constitute undue dependence on one client due to
excessive remuneration.
· Why adherence to International Standards on Auditing is important:

Adherence to International standards on auditing is necessary for following
reasons:
o To provide reasonable assurance that the audit firm complies with
professions standards and regulatory and legal requirements
o Auditor's report is appropriate
o In the increasing cross border environment, adherence to International
standards on Auditing is necessary for inflow of foreign investment
which depends upon other things, credibility of financial statements.
o Pakistan is a member of IFAC and it is committed to follow
International standards on Auditing.

· How to minimize litigations:

Certain measures that the auditor should adopt to minimize litigation claims
include:
o Obtain sufficient appropriate audit evidence
o Carry our risk assessment procedures
o Discuss with the staff the major risk areas
o Study and evaluate internal controls
o Consider compliance with laws and regulations
o Carry our audit with an attitude to professional skepticism
o Complete disclose checklist
o Verify compliance of accounting standards
· Characteristics of financial statement:

The following are characteristics of financial statement:
o Relevance
o Reliability
o Completeness
o Comparability
o Consistency
o Understandability
o Neutrality
· Is auditor is responsible for detecting immaterial frauds and errors:

The auditor is not responsible for detection and disclosure of immaterial
frauds and errors. In audit report also, the auditor mention that he has planned
and performed the audit to obtain reasonable assurance whether the financial
statement are free from material misstatement.
However, the auditor may be negligent if he detects an immaterial fraud and
does not report it, or carries out audit procedures on immaterial items but the
procedures were carried negligently.

Test your knowledge
1. What is auditing and what are its objects and scope? Differentiate between
accounting and auditing.
2. Describe advantages of having the accounts audited by an independent
professional auditor.
3. What is meant by continuous audit and to what class of business is it especially
applicable? State its advantages and disadvantages.
4. Are all audits the same in purpose and scope? Explain various classes of audit.
5. What is final audit? What is an interim audit? Why is it conducted?
6. What do you mean by audit risk? What are the components of audit risk.
7. Name the code of ethics? Describe independence.
8. What do you mean by Assurance Engagement? Elements of Assurance
Engagement.
9. What are the services provided by auditor.
10. Difference between review and audit.
11. Why auditor can not give absolute assurance.

Chapter 3
ISA 200: Objective and General

Principles Governing an Audit
of Financial Statements
Chapter Topic List
1. Objective of an audit of financial statements

2. Ethical requirements
3. Scope and compliance
4. Professional skepticism
5. Audit risk
6. Financial reporting framework
7. Miscellaneous
Introduction
This chapter covers ISA 200: Objective and General Principles Governing an Audit of
Financial Statements. The Standard describes management’s responsibility for financial
statements and the overall objective and scope of the audit of financial statement of an
entity by an independent auditor.

1. OBJECTIVE OF AN AUDIT OF FINANCIAL STATEMENTS:

The objective of an audit of financial statements is to enable the auditor to express
an opinion whether the financial statements are prepared:
· In all material respects.
· In accordance with an applicable financial reporting framework.
2. ETHICAL REQUIRMENTS:
· The auditor should comply with relevant ethical requirements relating to audit
engagement.
· IFAC Code of Ethics:
o Professional Behaviour
o Objectivity
o Professional Competence and Due Care Confidentiality
o Integrity
3. SCOPE AND COMPLIANCE:

· The term "scope of an audit" refers to:
"The audit procedures that, in the auditor's judgment and based on the ISAs,
are deemed appropriate in the circumstances to achieve the objective of the
audit."
· The auditors may be required to comply with other professional, legal or

regulatory requirements in addition to the ISAs.
· The ISAs do not override the local laws and regulations that govern an audit
of financial statements.
· In the event that those laws and regulations differ from the ISAs, an audit
conducted in accordance with the local laws and regulations will not
automatically comply with ISAs.
· The auditor should not represent compliance with ISA unless the auditor has
complied fully with all of the ISA relevant to the audit.
4. PROFESSIONAL SKEPTICISM:
· The auditor should plan and perform an audit with an attitude of professional
skepticism recognizing the fact that circumstances may exist that cause the
financial statements to be materially misstated.
· An attitude of professional skepticism means

"The auditor makes a critical assessment, with a questioning mind, of the

validity of audit evidence obtained and is alert to audit evidence that
contradicts or brings into question the reliability of documents and responses
to inquiries and other information obtained from management and those
charged with governance."
· When making inquiries and performing other audit procedures, the auditor is
not satisfied with less-than-persuasive audit evidence based on a belief that
management and those charged with governance are honest and have
integrity.
5. AUDIT RISK:
· The risk that the auditor expresses an inappropriate audit opinion when the
financial statements are materially misstated is known as "audit risk."
· The auditor should plan and perform the audit to reduce audit risk to an
acceptably low level that is consistent with the objective of an audit.
· The auditor reduces audit risk by designing and performing audit procedures
to obtain sufficient appropriate audit evidence to be able to draw reasonable
conclusions on which to base an audit opinion.
· Detection risk:
Detection risk cannot be reduced to zero because:
o The auditor usually does not examine all of a class of transactions,
account balance, or disclosure
o The possibility that an auditor might select an inappropriate audit
procedure
o The possibility that an auditor misapply an appropriate audit
procedure
o The possibility that an auditor misinterpret the audit results.
The above factors can be addressed through:
o Adequate planning
o Proper assignment of personnel to the engagement team
o The application of professional skepticism,
o Supervision and review of the audit work performed.
· There is an inverse relationship. The greater the risk of material misstatement

the less the detection risk that can be accepted. Conversely, the less risk of
material misstatement, the greater the detection risk that can be accepted.

· Risks at financial statement level:

Risk at financial statement level may be due to the following:
o Weak Control Environment
o Decling Business Trend
o Management Overrides & collusion
Risk at financial statement Level can be reduced by:
o Maintaining Professional Skepticism
o Assigning more professional staff and there with special skills and
using experts providing more supervision
o More qualified staff to the auditing engagement
Control Environment:
"Control Environment means the function of BOD, audit committee &
management including their attitude, awareness & action as regard internal
control & its importance in the entity"
Elements of Control Environment:
o Communication and enforcement of integrity and ethical values.
o Commitment to competence
o Participation by directors
o Management philosophy and operating style.
o Organizational Structure
o Assignment of authority and responsibility
o Human resources policies and practices.
· Risks at account balance:

Risk at account balance may be due to the following:
o Complex calculation
o Accounting Estimate
o Technological Development
Risk at account balance can be reduced by:

o Increase the sample size
o Increase audit procedure
o Extent the substantive procedure

6. FINANCIAL REPORTING FRAMEWORK:

· The auditor should determine whether the financial reporting framework
(IFRS) adopted by management in preparing the financial statements is
acceptable.
· The auditor determines the following while accepting the financial reporting
framework adopted by management
o The nature of the entity
o The objective of the financial statements
· When the auditor concludes that the financial reporting framework adopted
by management is not acceptable then:
o The auditor considers the implications in relation to engagement
acceptance
o The auditor considers the implications in relation to the auditor's report.
7. MISCELLANEOUS:
· Entities face a variety of business risks due to:
o The nature of their operations and industry
o The regulatory environment in which they operate
o Their size and complexity.
· Management is responsible for

o Identifying the financial reporting framework to use in the preparation and
presentation of the financial statements.
o Preparing and presenting the financial statements in accordance with that
applicable financial reporting framework.
o Designing, implementing and maintaining internal control relevant to the
preparation and presentation of financial statements
o Selecting and applying appropriate accounting policies
o Making accounting estimates.

Test your knowledge
1. What are the IFAC code of ethics.

2. What do you mean by professional skepticism.
3. Name the risk faced by the entity.
4. What the management is responsible regarding financial statement.

Chapter 4
ISA 210: Terms of Audit Engagements

Chapter Topic List
1. Objective of audit engagement

2. Audit engagement letter to whom sent
3. Contents of audit engagement letter
4. Separate engagement letter
5. Audit of components
6. Recurring audit
7. Change in engagement letter
Introduction
This chapter covers ISA 210: Terms of Audit Engagements. An auditor's engagement
letter to the client is designed to document and confirm the auditor's acceptance of the
appointment, the scope of the auditor's work, and the extent of the auditor's
responsibilities and the form of any reports. The Standard describes the principal
contents of an engagement letter.

1. OBJECTIVE OF AUDIT ENGAGEMENT:

· Engagement letter is a letter sent by an auditor to his client, after the receipt
of communication regarding his appointment, but preferably before the
commencement of engagement, spelling out the extent of his responsibilities
in order to avoid any misunderstanding with respect to his engagement and
documents and confirming the acceptance of appointment, the objective and
scope of audit, the extent of responsibilities and the form of reports to be
made to the client.
· The main objectives of an engagement letter are:

o Define clearly the extent of auditor's responsibilities and to minimize the
possibility of any misunderstanding between the client and the auditor.
o Provides written confirmation of the auditor's acceptance of his
appointment, the scope of audit and form of his report.
o Client becomes aware that the discovery of fraud is not the main aim of
the audit.
o Client becomes informed about the other professional services that the
auditor can provide.
o Scope of special or additional work is also determined.
o Basis of computation of fees are brought to the knowledge of client.
2. AUDIT ENGAGEMENT LETTER TO WHOM SENT:

· Audit Engagement letter should be send to the following:
o Engagement letter should be sent to all new clients soon after the
appointment as auditor and, in any event, before the commencement of the
first audit engagement.
o Engagement letter may also be sent to existing clients, to whom no such
letter has previously been sent, as soon as suitable opportunity occurs.
o When there is a change in the nature and scope of assignment or there is a
change in job specification, management, size and line of business, data
processing, the communication of such letter assumes greater importance.
o When an auditor of parent company is also the auditor of its subsidiaries, a
separate engagement letter should be sent to each company audited by him
o When there are joint auditors, engagement letter is similar terms be sent
by each auditor when no joint letter is sent.

3. CONTENTS OF AUDIT ENGAGEMENT LETTER:

Principal Contents of audit engagement letter are:
o The objective of the audit of financial statements
o Management's responsibility for the financial statements.
o The applicable financial reporting framework adopted by management in
preparing the financial statements.
o The scope of the audit.
o The fact that there is unavoidable risks that even some material
misstatement may remain undiscovered.
o Unrestricted access to whatever records, documentation and other
information requested in connection with the audit.
o Expectation of receiving from management written confirmation
concerning representations made in connection with the audit.
o Request for the client to confirm the terms of the engagement by
acknowledging receipt of the engagement letter.
o Basis on which fees are computed and any billing arrangements.
o Description of any other letters or reports the auditor expects to issue to
the client.
4. SEPARATE ENGAGEMENT LETTER:

The auditor may decide not to send a new engagement letter each period.
However, the following factors may make it appropriate to send a new letter:
o Any indication that the client misunderstands the objective and scope of
the audit.
o Any revised or special terms of the engagement.
o A recent change of senior management, board of directors or ownership.
o A significant change in nature or size of the client’s business.
o Legal requirements.
o A change in the financial reporting framework adopted by management in
preparing the financial statements.
5. AUDIT OF COMPONENTS:
The following are the factors which influence the decision whether to send a
separate engagement letter to the component (subsidiary, branch, division) when
the auditor of a parent entity is also the auditor of component.
o Who appoints the auditor of the component

o Whether a separate auditor's report is to be issued on the component

o Legal requirements.
o The extent of any work performed by other auditors.
o Degree of ownership by parent.
o Degree of independence of the component's management.
6. RECURRING AUDIT
· The auditor should consider the following on recurring audits:
o Whether circumstances require the terms of the engagement to be revised
o Whether there is a need to remind the client of the existing terms of the
engagement.
7. CHANGE IN ENGAGEMENT LETTER:

· An auditor should consider the appropriateness of doing so when he is
requested to change the engagement from audit (high level assurance) to
related services (lower level assurance) before the completion of the
engagement.
· Reasons for Change:

A request from client to auditor to change the engagement may be due to:
o Change in circumstances
o Misunderstanding of scope of audit or related services
o Restriction on the scope of the engagement, whether imposed by
management or caused by circumstances.
The first two requests would ordinarily be considered a reasonable basis for
change in the engagement. In case of third request, it would not be considered
reasonable because the change relates to information that is incorrect,
incomplete or otherwise unsatisfactory.
· Where the terms of the engagement are changed, the auditor and the client
should agree on the new terms
· The auditor should undertake the following steps when the auditor is unable
to agree to a change of the engagement and is not permitted to continue the
original engagement.
o The auditor should withdraw.
o The auditor should consider whether there is any legal or contractual
obligations, to report the circumstances necessitating the withdrawal to
other parties, such as the board of directors or shareholders.

Test your knowledge
1. What are the primary purposes of an engagement letter?

2. What are the objectives of an engagement letter?
3. What are the contents which engagement letter would normally cover
4. Identify the steps that are involved in accepting an audit engagement
5. Can engagement letter be change. What are the reasons?
6. What are the factors that may make it appropriate to send a new letter.

Chapter 5
ISA 220: Quality Control for Audits

Chapter Topic List
1. Definitions
2. Meaning of quality control
3. Objectives of quality control
4. Duties / functions of engagement teams
5. Responsibilities of engagement partner
6. Matters to be considered before audit acceptance
7. Control procedures
8. Quality control policies
9. Engagement quality control review
10. Miscellaneous
Introduction
This chapter covers ISA 220: Quality control for audits. Controlling the quality of audit
work is essential in maintaining the high standards of the profession. This Standard
distinguishes between controls on individual audits and general quality controls
adopted by an audit firm. While recognizing the interrelationship of the two types of
controls, general quality controls "augment and facilitate" controls on individual audit
but do not replace them. Controls over delegation of work to assistants on an individual
audit in order to comply with the basic auditing principles are addressed, and practical
assistance is provided to an audit firm in controlling the general quality of their
practice.

1. DEFINITIONS:
· Engagement partner:
The partner or other person in the firm who:
o Is responsible for the audit engagement and its performance
o Is responsible for the auditor’s report that is issued on behalf of the firm
o Where required, has the appropriate authority from a professional, legal or
regulatory body.
· Engagement quality control review:

Process designed to provide an objective evaluation, before the auditor’s
report is issued, of the significant judgments the engagement team made and
the conclusions they reached in formulating the auditor’s report.
· Monitoring:
Process comprising following designed to enable the firm to obtain
reasonable assurance that its system of quality control is operating
effectively:
o An ongoing consideration
o Evaluation of the firm’s system of quality control.
2. MEANING OF QUALITY CONTROL:

Quality Control refers to all measures undertaking by an audit practice which are
designed to assist in achieving a high quality of audit and of the audit report
issued and wherever considered necessary to improve quality. In other words
quality control is the mean by which a firm obtains reasonable assurance that its
expression of audit opinion always reflects observance of approved auditing
standards, any statutory or contractual requirement and any professional standards
set by the firm itself.
3. OBJECTIVES OF QUALITY CONTROL:

The following are the objectives of quality control:
o Quality control promotes observance of the professional standards relevant
to the work of an auditor.
o How overall quality of the work carried out within the firm can best be
monitored and maintained.
o It provides reasonable assurance that all audits carried out by the firm are
performed in accordance with approved auditing standards.
o It provides evidence to third parties that proper steps have been taken to
achieve a high standard of auditing.

o It reduces the audit risk by ensuring that an opinion on the financial

statements is properly arrived at and worked.
o The firm must have sufficient direction, supervision and review of work at
all levels to provide reasonable assurance that the work performed meets
appropriate standards of quality.
4. DUTIES / FUNCTIONS OF ENGAGEMENT TEAMS:

The following are the duties/functions of engagement teams:
o Implement quality control procedures that are applicable to the audit
engagement
o Provide the firm with relevant information to enable the functioning of
that part of the firm’s system of quality control relating to independence
o Are entitled to rely on the firm’s systems unless information provided by
the firm or other parties suggests otherwise.
5. RESPONSIBILITIES OF ENGAGEMENT PARTNER:

Responsibilities of engagement partner include:
o Overall quality on each engagement
o Review whether the audit complies with professional standards and
regulatory and legal requirements
o Review that the firm's quality control policies and procedures have been
complied with.
o Issue appropriate audit reports
o Consider whether members of engagement team have complied with
ethical requirements
o Take appropriate action if engagement team members have not complied
with independence requirements
o Identity and evaluate circumstances and relationships that create threats to
independence.
o Consider appropriate procedures regarding acceptance and continuation of
client
o Direction, supervision and review
o For listed companies, appointment of engagement quality control
reviewer, engagement quality control review is to be arranged before
issuance of audit report and discussion of significant matters arising
during audit engagement or during engagement quality control review
with engagement quality control reviewer

6. MATTERS TO BE CONSIDERED BEFORE AUDIT

ACCEPTANCE:
· The following matters to be considered before audit acceptance:
o The integrity of management
o Ability to serve the client
o Ethical Requirement
· The proposed chartered accountant communicate for following reasons before

accepting the audit:
o Communication with previous auditor enables a chartered accountant in
practice to ascertain whether the circumstances in which a change in
appointment is proposed are such that the appointment can properly be
accepted and also whether there is a wish to undertake the engagement.
o Communication with previous auditor helps to preserve the harmonious
relationships which should exist between all chartered accountants in
practice on whom clients rely for professional advice and assistance.
o Communication with previous auditor serves to protect a chartered
accountant in practice from accepting an appointment in circumstances
where al the pertinent facts are not known.
o Communication with previous auditor serves to protect the minority
proprietors of a business who may not be fully informed of the
circumstances in which the change is proposed.
o Communication with previous auditor serves to protect the interests of the
existing chartered accountant in practice when the proposed change arise
from, or is an attempt to interfere with the conscientious exercise of the
existing accountant's duty to act as an independent professional.
· The following are the matters the proposed auditor should consider as regards
communication with existing auditor:
o Ascertain if the prospective client has advised the existing accountant of
the proposed change and has given permission, preferably in writing to
discuss the client's affairs fully and freely with the proposed chartered
accountant in practice.
o When satisfied with the reply received from prospective client, request
permission to communicate with the existing chartered accountant. If such
permission is refused, the proposed chartered accountant in practice
should decline the appointment.
o On receipt of permission, ask the existing accountant, preferably in
writing:
§ To provide information on any professional reasons which should

be known before deciding whether or not to accept the appointment

and. if there are such matters; and
§ To provide all the necessary details to be able to come to a decision.
o The existing accountant, on receipt of the communication referred to
above should:
§ Reply, preferably in writing, advising whether there are any
professional reasons why the proposed chartered accountant in
practice should not accept the appointment.
§ If there are any such reasons or other matters which should be
disclosed, ensure that the client has given permission to give details
of this information to the proposed chartered accountant in practice.
If permission is not granted the existing accountant should report
that fact to the proposed chartered accountant in practice.
o On receipt of permission from the client disclose all information needed
by the proposed chartered accountant in practice to be able to decide
whether or not to accept the appointment and discuss freely with the
proposed chartered accountant in practice all matters relevant to the
appointment of which the latter should be aware.
· The following of action should be taken by the proposed auditor course if the
proposed auditor does not receive, within reasonable time, reply from the
existing auditor:
o If the proposed chartered accountant in practice does not receive, within a
reasonable time, a reply from the existing accountant and there is no
reason to believe that there are any exceptional circumstances surrounding
the proposed change, the proposed chartered accountant in practice should
endeavour to communicate with the existing accountant by some other
means. If unable to obtain a satisfactory outcome in this way, the proposed
chartered accountant in practice should send a further letter, stating that
there is an assumption that there is no professional reason why the
appointment should not be accepted and that there is an intention to do so.
7. CONTROL PROCEDURES:
· Direction involves:
o Their responsibilities
o The nature of the entity's business
o Risk-related issues
o Problems that may arise
o The detailed approach to the performance of the engagement.
· Supervision involves:

o Tracking the progress of the audit engagement

o Considering the capabilities and competence of individual members of the
engagement team
o Addressing significant issues arising during the audit engagement.
o Identifying matters for consultation
· Review:
Review means worked performed by less experienced team members must be
reviewed by experienced team member
Review includes:
o The work has been performed in accordance with professional standards
and regulatory and legal requirements.
o Significant matters have been resolved and reflected in audit report.
o There is a need to revise the nature, timing and extent of work performed
o The work performed is appropriately documented
o Sufficient and appropriate evidence has been obtained.
o The objectives of the engagement procedures have been achieved.
8. QUALITY CONTROL POLICIES:

The policies of quality control are listed below:
· Professional Requirements:
The Personnel in the firm should adhere to the principle of independences,
integrity, objectivity, confidentiality and professional behaviour.
· Skills and Competence:
The firm should be staffed by personnel who have attained and maintained
the technical standards and professional competence required to enable to
fulfil their responsibilities with due care.
· Assignment:
Audit work is to be assigned to personnel who have the degree of technical
training and proficiency required in the circumstances.
· Delegation:
There should be sufficient direction, supervision and review at all levels to
provide reasonable assurance that the work performed meets appropriate
standards of quality.
· Consultation:
Whenever necessary, consultation within or outside the firm is to occur with
those who have appropriate expertise.

· Acceptance & Continuance of client:

An evaluation of prospective clients and a review, on an on going basis of
existing clients is to be conducted. In making a decision accept or retain a
client, the firms’ independence and ability to serve the client properly and the
integrity of the client’s management are to considered.
· Monitoring:
The continued adequacy and operational effectiveness of quality control
policies and procedures should be monitored.
9. ENGAGEMENT QUALITY CONTROL REVIEW:

· Engagement quality control review is mandatory for listed companies only
· Engagement quality control reviewer may be a partner of the firm or outsider
· Engagement quality control review is performed before issuance of audit
report
· It is the responsibility of engagement partner to appoint engagement quality
control reviewer
· General Qualities of firm's Q.C policies and procedure
o Relevant
o Adequate
o Operating Effectively
o Complied with in practice.
· Matters to be reviewed by Q.C Reviewer:

o An engagement quality control review for audits of financial statements of
listed entities includes
o Independence Requirement
o Risks identified by engagement team and the responses to those risks,
o Significant Judgments involved
o Whether appropriate consultation was made where required
o Disposition of frauds found during audit
o The matters to be communicated to management and those charged with
governance
o Adequate Documentation
o The appropriateness of auditor’s report.

10. MISCELLANEOUS:
· Continuance of client relationship includes:
o Consideration of significant matters that have arisen during the current or
previous audit engagement.
o Their implications for continuing the relationship
· The appropriate capabilities and competence include the following:
o Practical experience with similar audit engagements.
o An understanding of professional standards & regulatory and legal
requirements.
o Appropriate technical knowledge.
o Knowledge of relevant industries in which the client operates.
o Ability to apply professional judgment.
o An understanding of the firm's quality control policies and procedures.
· Where differences of opinion arise within the engagement team or between
the engagement partner and the engagement quality control reviewer, the
engagement team should follow the firm's policies and procedures for dealing
with differences of opinion.

Test your knowledge
1. What do you understand by quality control? What are its objectives?

2. What are different quality control policies? Explain briefly.
3. What are the responsibilities of engagement partner & engagement team.
4. What are the matters that should be consider before accepting audit.
5. What do you mean by Engagement Quality Control review?

Chapter 6
ISA 230: Audit Documentation

Chapter Topic List
1. Definition
2. Objective of audit documentation
3. Contents of audit documentation
4. Factors affecting audit documentation
5. Retention
6. Assembly and modification
7. Working papers and their contents
8. Miscellaneous
Introduction
This chapter covers ISA 230: Audit Documentation. Guidance is provided on the
general form and content of working papers as well as specific examples of working
appears normally prepared or obtained by the auditor. Ownership and custody of
working paper is also discussed.

1. DEFINITION:
· Audit Documentation means:
o The Record of audit procedures performed
o Relevant audit evidence obtained
o Conclusions the auditor reached
2. OBJECTIVE OF AUDIT DOCUMENTATION:

The auditor should prepare on timely basis audit documentation that provides:
o A sufficient and appropriate record of the basis for auditor's report.
o Evidence that the audit was performed in a/c with ISA and applicable legal
and regulatory requirements.
o Assisting the audit team to plan and perform the audit
o Assisting the audit team to in directing, supervising and reviewing.
o Enabling the audit team to be accountable for its work.
o Retaining a record of significant matters for future audit.
o Enabling an experienced auditor to conduct Q.C Review and Inspection.
o Enabling an experienced auditor to conduct external inspection in a/c
applicable legal and regulatory requirements.
3. CONTENTS OF AUDIT DOCUMENTATION:

· Audit Documentation includes:
o Audit Programs
o Analyses
o Issue memoranda
o Summaries of Significant Matters
o Letter of Confirmation and representation
o Checklists
o Correspondence concerning significant matters.
o Abstracts or copies of the entity's records.
4. FACTORS AFFECTING AUDIT DOCUMENTATION:

The form and content of working papers are affected by matters such as the
following:
o Nature of audit procedure to be performed.
o The identified risk of material misstatement

o Judgment required in performing the work and evaluating the results.

o Significance of audit evidence obtained
o Mature and extent of exceptions identified
o Need to document a conclusion
o Need for Direction, Supervision and Review
o Nature & Complexity of business
o Form of Auditor's Report
o Audit Methodology and tools used
5. RETENTION:
· The auditor could prepare and retain summary of significant matters in
Completion Memorandum. It facilitates effective & efficient Review and
Inspection.
· ISQC 1 specifies the retention period for audit engagement documentation for
not shorter than 5 years from date of auditor's report, but 10 years a/c with
230(6) of Companies Ordinance 1984.
6. ASSEMBLY AND MODIFICATION:

· The auditor should completed assembly of final audit file 60 days after the
date of auditor's report. It is an appropriate time limit
· After the assembly of the final audit file has been completed, the auditor
should not delete or discard audit documentation before the end of retention
period.
· When auditor finds it necessary to modify existing audit documentation or
add new audit documentation after the assembly of final audit file, the auditor
should document:
o When and by whom they were made
o The specific reasons for making them
o Their effect, if any on the auditor's conclusions.
· When exceptional circumstances arise after the date of auditor's report that
require the auditor to perform new or additional audit procedures, the auditor
should documents
o The circumstances encountered
o The new or additional procedures performed, audit evidence obtained and
conclusion reached.
o When and by whom the resulting changes to audit documentation were
made.

7. WORKING PAPERS AND THEIR CONTENTS:

· Working papers should be sufficiently complete and detailed. If through the
study of working papers alone another auditor who has no previous
experience with the client is able to understand the work performed and to
determine the bases of significant conclusions drawn, it is considered that
working papers are sufficiently complete.
· Working papers should be:

o Clear
o Concise
o Complete
o Neat
o Well indexed
o Informative
· Working papers should be so organized and indexed that any information

required at a subsequent date may be instantly obtained from the working
paper files.
· In case of recurring audits, working paper files are classified as:

o Permanent audit files
o Current audit files
PERMANENT FILE:
Permanent files are used to accumulate information of continuing importance
to succeeding audits, and are updated every year. Instead of obtaining certain
documents for each year's working paper file, the auditor places them in a
separate file as part of each year's audit evidence. Obviously each year, the
contents of the permanent file will be updated where necessary.
Usual contents of permanent file are:
§ Legal status of the entity, e.g., limited company, partnership or sole
proprietorship
§ Holding. subsidiary and associated companies
§ Extracts from legal documents e.g., memorandum of association,
article of association, or partnership deed.
§ Organization chart
§ Loan agreements
§ Joint Auditors
§ Related parties

§ Key ratios
CURRENT AUDIT FILE:
Current audit files contain working papers relating to a single accounting
period.
Usual contents of current audit file are:
§ Audit planning documentation
§ Evidence of inherent and control risk assessment.
§ Audit programme
§ Post closing trial balance
§ Final adjusting entries
§ Documentation relating to finalization and completion of audit
§ Planning and time control information.
§ Details of meeting with client
8. MISCELLANEOUS:
· Audit Documentation may be recorded on paper and on electronic or other
media
· The auditor should prepare the audit documentation so that the experienced
auditor understands the following matters having no previous connection with
audit.
o The nature, timing and extent of audit procedure
o The results of audit procedure
o Significant matters arising during the audit conclusion reached.
· The auditor should document discussions of significant matters with
management and others on a timely basis.
· In documenting the nature, timing and extent of audit procedure performed,
the auditor should record:
o Who performed the audit work and date such work was completed
o Who reviewed the audit work performed and the date and extent of such
review.
· Following factors should be considered regarding retention of working papers

stored on electric media.
o Confidentiality:
Access to the working papers should be restricted in accordance with
firm’s policy

o Back ups:
Reliable back ups should be maintained for working papers.
o Easy access:
Appropriate index should be maintained for instant retrieve of the
information.
o Physical protection:
Adequate safeguards are required against damage of the records.
o Protection against unauthorized changes:
Passwords should be issued to safeguard against unauthorized changes.
· Possible consequence of maintaining inadequate working paper are:

o Supervision of the audit will be difficult
o Non compliance of documentation of the overall audit plan
o Non compliance of documentation of:
§ Understanding of the entity's accounting and control system.
§ Assessment of control risk
o It will be difficult to review that:
§ The work has been performed in accordance with the audit program
§ Matters discussed with entity and their responses will not be
evidenced
§ Inappropriate audit opinion may be given.
§ Difficult to defend in case of litigation
§ Ineffective and inefficient audit

Test your knowledge
1. What do you mean by Audit Documentation? What are the objectives of audit
documentation.
2. What are the matters that affect audit documentation.
3. For how much period audit documentation will be retained.
4. Can audit documentation be modified. If yes then what should be documented
when modification is made.
5. What do you mean by working papers. Name the contents of working papers.

Chapter 7
ISA 240: Fraud & Error

Chapter Topic List
1. Definition
2. Responsibility for Prevention
3. Responsibility for Detection
4. Reporting responsibilities
5. Indication that fraud/errors and risk of material misstatement exist
6. Assessment of risk of material misstatement
7. Miscellaneous
Introduction
This chapter covers ISA 240: Frauds & Error. The Standard defines fraud and error,
and indicates that the responsibility for the prevention of fraud and error rests with
management. The auditor should plan the audit so that there is a reasonable expectation
of detecting material misstatements resulting from fraud and error. Suggested
procedures are provided which should be considered when the auditor has an indication
that fraud or error may exist.

1. DEFINITIONS:
· The term “error” refers to an unintentional misstatement in financial
statements, including the omission of an amount or a disclosure
· The term “fraud” refers to an intentional act involving the use of deception to
obtain an unjust or illegal advantage.
2. RESPONSIBILITY FOR PREVENTION:

· The primary responsibility for the prevention of fraud rests with both those
charged with governance of the entity and with management.
Responsibility of management include:
o Safeguarding of assets.
o Preparation of reliable financial statements giving a true and fair view.
o Operation of an effective internal control system
o Ensuring compliance with laws and regulations.
o Establishing an internal audit department.
· The objective of an audit is to express and opinion whether or not the

accounts are free of material misstatements. The auditor should therefore be
alert that frauds and errors may cause the financial statements not reflecting a
true and fair view.
3. RESPONSIBILITY FOR DETECTION:

· The primary responsibility for the detection of fraud rests with both those
charged with governance of the entity and with management.
· As regards auditor's responsibility for detection of fraud and errors, following

matters should be considered.
o Auditor is expected to perform tests to provide reasonable assurance that:
§ Effect of fraud is reflected in financial statements.
§ Errors discovered have been corrected
o Subsequent discovery of a material misstatement in financial statements
does not necessarily mean that the auditor was negligent. The court would
consider whether appropriate audit procedures were applied with due care
and diligence and the auditor's report was based on the results of tests.
o The risk that audit procedures will not detect a material misstatement
resulting from fraud is greater than that of arising from errors because:
§ Auditing practices followed do not require the auditor to verify the
authenticity of original documents.

§ Many audit procedures are effective to detect errors but not forgery
and collusion.
o Unless there are reasons to suspect a fraud, the auditor is entitled to accept
management assertions as true, and records and documents as genuine.
o At the same time, the auditor should plan and perform the audit with an
attitude of professional skepticism recognizing that conditions may
indicate that fraud or error may exist.
o This follows that audit procedures should be designed of giving the
auditor reasonable expectation of detecting fraud and errors.
o The auditor should not perform the audit with, a pre - conceived notion
that the management is dishonest, nor assume that management's integrity
is beyond doubt.
o Internal control system howsoever, strong cannot provide an absolute
assurance that frauds and errors will not be prevented and detected on a
timely basis because of certain inherent limitations of internal controls.
4. REPORTING RESPONSIBILITIES:
· As soon as fraud is suspected or discovered, or an error is identified, the
auditor should communicate the fact to management. (Unless fraud by senior
management, including directors, is suspected, in which case the auditor
would normally seek legal advice).
· Where the fraud or error has material effect on financial statements, the
auditor should express a qualified or adverse opinion if.
o Effect of fraud is not reflected in, financial statements: or
o Errors discovered have not been corrected
· Where despite a fraud or irregularity, the auditor concludes that true and fair
view of financial statements is not impaired he need not qualify his report.
5. INDICATION THAT FRAUD/ERRORS AND RISK OF

MATERIAL MISSTATEMENT EXIST:
· The following are the procedures that indicate that fraud of error may exist
o When the auditor's suspicions are aroused that a fraud or error exists
which may materially affect financial statements, the auditor should
modify or extend audit procedures. .
o If performance of modified and additional procedures confirms the
auditor's suspicion, be should consider nature and cause of fraud or error
and:
§ Determine that the effect of fraud is reflected in financial statements.

§ Determine that the errors identified have been corrected

o Discuss the matter with senior management (unless fraud by senior
management is suspected).
o Consider the reliability or other audit evidence obtained. If fraud by senior
management is suspected, the reliability of management representations
will be questionable.
o Determine implication of fraud considering the relationship of the
perpetration (be guilty of doing) to specific control procedures.
· Following are some of the indications where risk of irregularities may exist:
o Continuous failure to correct major weaknesses in internal control
o Frequent changes in legal advisors and auditors
o High staff turnover in finance department
o Unusual transactions
o Inadequate accounting records
o Inadequate documentation
o Inadequate working capital
· The following are the conditions or events that may indicate the risk of
existence of material misstatement.
o Discrepancies in accounting record
o Transactions recorded incorrectly as to account, amount or period.
o Missing evidences
o Unauthorized transactions
o Last minute adjustments
o Unauthorized access to records
o Over - writing on documents
o Unusual rations and trends
o Restrictions in scope imposed by management
o Unusual delays by management-in providing responses to queries
o Failure to accept auditor's recommendations to rectify weaknesses in the
accounting and internal control system
6. ASSESSMENT OF RISK OF MATERIAL MISSTATEMENT:

· The following matters should be considered in assessing risk of material
misstatement
o Identification of risk throughout the process of obtaining understanding of

the entity and its environment including internal controls.

o Consider what can go wrong if controls are not effective
o Consider whether risks are significant that could result in the misstatement
of financial statements
o Consider likelihood that the risks may result in misstatement of financial
statements.
The auditor should also consider whether the risk of material misstatement
has pervasive effect or account balance effect For example risk due to weak
control environment or integrity of management may have pervasive effect.
Conversely, an unauthorized access to warehouse may have an effect only on
the existence of inventories.
7. MISCELLANEOUS:
· The following are the auditor’s duties as regards immaterial fraud:
o The auditor is not responsible for not detecting immaterial fraud, unless he
has carried out examination on immaterial items and the procedures are
not satisfactory.
o If the auditor has detected a fraud which is not material, he should
immediately report it to Management so that management may investigate
the matter.
o If the management does not take any action, it is possible that the
management is also a party to such fraud. In such case the auditor should
report the fraud to audit committee.
· Chances of fraud increase due to:

o Ineffective controls
o Poor design of internal control system
o Non compliance of the internal controls
o Inherent risk
o Inexperienced and incompetent management
o Dishonest management
o Circumstances that may lead management to manipulate the accounts
o Unusual transactions
o Non availability of audit evidence
· Members of the engagement team should discuss the susceptibility of the

entity’s financial statements to material misstatement due to fraud.
· The auditor should make inquiries of management, internal audit, and others

within the entity as appropriate, to determine whether they have knowledge of

any actual, suspected or alleged fraud affecting the entity.
· The auditor should make those charged with governance and management
aware, as soon as practicable, and at the appropriate level of responsibility, of
material weaknesses in the design or implementation of internal control to
prevent and detect fraud which may have come to the auditor’s attention.
· The auditor should document communications about fraud made to

management, those charged with governance, regulators and others.
· If, as a result of a misstatement resulting from fraud or suspected fraud, the

auditor encounters exceptional circumstances that bring into question the
auditor’s ability to continue performing the audit the auditor should:
o Consider the professional and legal responsibilities applicable in the
circumstances, including whether there is a requirement for the auditor to
report to the person or persons who made the audit appointment or, in
some cases, to regulatory authorities;
o Consider the possibility of withdrawing from the engagement; and
o If the auditor withdraws:
§ Discuss with the appropriate level of management and those charged
with governance the auditor’s withdrawal from the engagement and
the reasons for the withdrawal; and
§ Consider whether there is a professional or legal requirement to report
to the person or persons who made the audit appointment or, in some
cases, to regulatory authorities, the auditor’s withdrawal from the
engagement and the reasons for the withdrawal.

Test your knowledge
6. What are the responsibilities for prevention of frauds of management.

7. What are the responsibilities for detection of frauds of auditor.
8. What are the factors which indicate that fraud or error exist.
9. What are the duties of auditor for immaterial fraud.

Chapter 8
ISA 300: Planning

Chapter Topic List
1. Definition of audit planning

2. Objective of planning
3. Components of planning
4. Panning the audit
5. Preliminary activities for current and initial audit
6. Overall audit strategy
7. Knowledge about client's business
8. Audit program
9. Audit plan
10. Documentation
Introduction
This chapter covers ISA 300: Planning. The guidance applies to the planning process of
the audit of both financial statements and other financial information. It is framed in the
context of recurring audits, identifies key elements in the planning process and provides
practical examples of items which should be considered when planning an audit.
Adequate audit planning helps to ensure that appropriate attention is devoted to
important areas of the audit, that potential problems are promptly identified, and that
the work is completed expeditiously. Planning also assists in proper utilization of
assistants and in coordination of work done by other auditors and experts.

1. DEFINITION OF AUDIT PLANNING:

Audit planning means that the action to be taken by auditor in respect of any
particular field of verification and reporting should be so designed that it may
enable an auditor to conduct an audit more effectively. Therefore an audit
planning should cover preparation required for each individual audit, its
integration with other related activities or actions and the estimated time-span for
the completion of task.
Audit planning can be defined as:
“Audit should be planned adequately regardless of the size of the enterprise
concerned, and the work during performance be controlled and recorded in order
to carry out the audit effectively and efficiently and best use may be made of the
firms resource available”.
2. OBJECTIVE OF PLANNING:
· Adequate planning helps the auditor in:
o Developing appropriate attention to important areas of the audit
o Potential problems are identified and resolved on a timely basis
o Audit engagement is properly organized and managed
o Proper assignment of work
o Engaging the assignment in effective and efficient manner.
· The nature and extent of planning depends on

o Size of the entity
o Complexity of the entity
o The auditor's previous experience with the entity
o Changes occurred during the current audit.
3. COMPONENTS OF PLANNING:
· There are two types of audit planning:
o Overall audit plan (to develop a general strategy):
Restricted Substantive Procedures:
If controls are strong, than the auditor select a small sample size and
perform restricted substantive procedure.
Expanded Substantive Procedures:
If controls are week, than the auditor select a large sample size and
perform expanded substantive procedure.

o Audit Program (to develop a specific strategy)

Audit programs are specific (e.g.) one audit program for cash and bank
balance another audit program for work in process and another for fixed
assets etc.
§ Substantive Procedures
§ Test of Controls
· Difference between Expanded & Restricted Substantive Procedures:
Expanded Substantive Restricted Substantive

Procedures Procedures
Control risk is planned at high Controls risk is planned at

level Moderate or low level
The extent of obtaining

In depth understanding of
understanding of accounting and
accounting and internal control
internal controls system is
system
restricted
Minimum tests of controls Extended tests of controls
Large sample size for Small sample size for

substantive procedures substantive procedures
4. PLANNING THE AUDIT:

· Planning the audit will involve following steps:
o Study previous year's working papers
o Update your knowledge regarding:
§ General level of economic activity
§ Stability of operations
§ Financial performance
§ Products and services
o Update the accounting system and internal control system.
o Set out materiality level.
o Assess inherent risk
o Review interim accounts
o Review budgets and forecasts for next year. The review may identity

going concern problem if any

o Consider new accounting and auditing pronouncements affecting the
client's business
o Carryout analytical procedures to enhance your understanding of the
business and identify potential problems.
· Possible sources of obtaining information for the purpose of planning the

audit:
o Prior year's working papers
o Predecessor auditor's working papers
o Articles and memorandum of association
o Minutes of directors and shareholders
o Tour the factory and offices of client
o Discussion of audit matters with internal auditor
o Inquires from management
o Discussions with client's lawyers
· Audit planning memorandum sets out general strategy. It is necessary that not
only audit be properly planned, but evidence should also be placed on the file
that adequate planning has been carried out. .
The form and contents of audit planning memorandum will vary for each
client but they would generally include the following matters:
o Problems experienced in previous years' audit
o Client's use of computer system
o Staffing requirements
o Consideration of use of the work of an expert or another auditor
o Identification of locations to be examined.
o Intended audit approach
o Agreement on dates to perform test of controls
o Assistance to be obtained by the client.
o Certificates and letter of representation to be obtained from the client
o Time budgets
o Analytical reviews
o Knowledge of the business
o Accounting and internal control systems
o Audit risk

5. PRELIMINARY ACTIVITIES FOR CURRENT AND INITIAL

AUDIT:
· Current Audit:
The auditor should perform the following activities at the beginning of the
current audit engagement:
o Perform procedures regarding the continuance of the client relationship
o Evaluate compliance with ethical requirements, including independence
o Establish an understanding of the terms of the engagement
· Initial Audit:
The auditor should perform the following activities before accepting the new
audit engagement:
o Evaluate firm's ability to serve the client.
o Inquire about the integrity of prospective client.
o Request the management permission to communicate with the predecessor
auditor.
o Communicate with the predecessor auditor as regards disagreement on
accounting policies, disclosures, and application of accounting policies
and predecessor's understanding of the reasons for the change in auditors.
o Consider disparities between the prospective client's reasons for removal
of auditors and the preceding auditor's replies.
o Evaluate firm's independence.
o Ensure that acceptance of the client will not violate code of ethics.
o Consider conflict of interest problems.
o Inquire whether there are any third parties whom we know will rely on our
reports for lending decisions.
o Consider level of fee to be charged.
o If fees are due to predecessor auditor, the job can still be accepted but the
new firm should help in settling fee of the previous auditors.
o Obtain a copy of the notice that has been sent for a resolution at a
company's annual general meeting appointing the firm as auditors.
o Inquire whether a copy of such notice has been sent to the retiring auditor
and to members.
o Ensure compliance of the Companies Ordinance 1984 regarding
representation from retiring auditor.
o Send a letter of engagement to the directors.

6. OVERALL AUDIT STRATEGY:

· The auditor before planning audit testing must plan an overall strategy. He
should develop and document an overall audit plan describing the expected
scope and conduct of audit. The auditor should consider the following matters
in developing an overall plan / overall audit strategy:
o Reporting framework
o Industry specific reporting requirements
o Group structure
o Reporting dates
o Terms of engagement and statutory responsibilities
o Nature and timing of reports required to be submitted under the
engagement.
o Accounting policies adopted and changes therein
o Identification of significant audit areas
o Setting of materiality levels
o Circumstances requiring special attention
o Degree of reliance to be placed on accounting systems and internal control
o Nature and extent of evidence obtained
o Work of internal auditor and utilization and reliance thereon
o Involvement of experts
· The auditor may need to modify the overall audit strategy and audit plan in
following cases:
o As a result of unexpected events
o Changes in conditions
o Changes in audit evidence obtained from the results of audit procedures
7. KNOWLEDGE ABOUT CLIENT'S BUSINESS

Knowledge about the nature of business of the client plays an important role in
the planning of audit procedures and their application. The auditor should collect
and accord all essential information about the past and present business
operations of the enterprise. The auditor should, therefore, obtain knowledge
about:
o Annual accounts to shareholders
o Minutes of shareholders, directors and committees
o Internal financial reports
o Previous year's working papers

o Discussions with client's management and staff

o Client's policy, accounting and management manual
o Government policies and their impact on client's business
o Visits to clients premises and plant facilities
8. AUDIT PROGRAM:
· In order to draw up a well designed and satisfactory audit program, the
auditor should include the following items in audit program:
o Name of the client
o Audit commencement date
o Duration of Audit
o Accounting System of the client
o System of Internal Control
o Previous Auditors Reports
o Examination of:
§ Cash book and petty cash book
§ Sales and sales returns books
§ Purchase and purchase returns books
§ Bills receivable and bills payable books
§ Ledger accounts and other books
§ Statutory books and registers being maintained by the company
The audit program should not be very rigid it must be capable of being
reviewed in view of changing circumstances.
· Audit programs help in:
o Planning the audit
o Supervision and review
o Work is done expeditiously
· Audit Programs are of two types:
o Audit programs for substantive procedures are prepared in order to obtain
evidence as to the amount in financial statement.
Objective of Substantive procedure is to detect a material misstatement in
financial statement.
Substantive procedures are of two types
§ Tests of details
§ Substantive analytical procedures

o Audit program for Test of Control is prepared to obtain evidence as

regards operation and compliance of entities internal control
Objective of Test of Control is to detect deviation from entities control
procedures.
9. AUDIT PLAN:
The auditor should develop an audit plan for the audit in order to reduce audit risk
to an acceptably low level. The audit plan is more detailed than the overall audit
strategy and includes
Audit Plan includes:
o Description of nature, timing and extent of planned risk assessment
procedures
o Description of nature, timing and extent of planned further audit
procedures at the assertion level
o Description of such other audit procedures requited to be carried out for
the engagement
10. DOCUMENTATION:
· The auditor should document the overall audit strategy and the audit plan,
including any significant changes made during the audit engagement.
· The auditor's documentation of any significant changes includes:
o The reasons for the significant changes
o The auditor's response to the events
o The auditor's response to the conditions
o The auditor's response to the results of audit procedures that resulted in
such changes

Test your knowledge
1. What do you mean by audit planning? What are the objectives of audit planning.
2. What are the components of planning?
3. What are the steps involve in planning the audit?
4. What are the preliminary activities for current and initial audit.
5. What matters are included in overall audit strategy.
6. How knowledge of client’s business can be obtained.
7. What are the types of audit program.
8. What matters should be included in audit plan.

Chapter 9
ISA 315: Understanding the entity and its

environment and assessing risk
of material misstatement
Chapter Topic List
1. Risk assessment procedures

2. Understanding entity and its environment including its internal control
3. Assessing the risk of material misstatement
4. Communicating weaknesses in internal control
5. Documentation
Introduction
This chapter covers ISA 315: Understanding the entity and its environment and
assessing risk of material misstatement. Management is responsible for maintaining an
adequate accounting system incorporating various internal controls to the extent
appropriate to the size and nature of the business, However, the auditor needs
reasonable assurance that the accounting system is adequate and that all the accounting
information which should be recorded has, in fact, been recorded. Internal controls
normally contribute to such assurance. This Standard describes accounting systems,
elements, objective and limitations of internal control and the audit procedures for the
study and evaluation of internal control.

1. RISK ASSESSMENT PROCEDURES:

· Audit procedures to obtain understanding are called risk assessment
procedures. The objective of risk assessment procedures is to obtain
understanding of the entity and its environment including internal controls
· Risk assessment procedures are:
o Inquires of management and others within the entity
o Analytical procedures
o Observation and inspection
Inquires of management and others within the entity:
Inquiry from Aspect of understanding the entity
Audit committee Control environment

Internal auditor Effectiveness of the internal controls
Accounts department Selection of accounting policies
Lawyers Compliance with laws & regulation
Marketing personnel Marketing strategies
Analytical procedures:
Analytical procedures may be helpful in identifying the existence of unusual
transactions or events, and amounts, ratios, and trends that might indicate
matters that have financial and audit implications. In performing analytical
procedures as risk assessment procedures, the auditor develops expectations
about plausible relationships that are reasonably expected to exist
Observation and Inspection:
Observation and inspection may support inquires of management and others,
and also provide information about the entity and its environment. Such audit
procedures ordinarily include the following:
o Observation of entity activities and operations
o Inspection of documents
o Reading reports prepared by management
o Visits to the entity’s premises and plant facilities
o Tracing transactions through the information system relevant to financial
reporting

· Difference between risk assessment procedures and test of controls:
Risk assessment procedures Test of controls

In risk assessment procedures
In test of control the auditor
evidence is obtained only by
obtains sufficient evidence by
tracing a few transactions
testing operating effectiveness
through the system.
In risk assessment procedures

In tests of controls only
the evidence may be obtained
inquires are not sufficient
only through inquiry.
Risk assessment procedures Tests of controls involve
include inquiry, analytical similar procedures but include
procedures, inspection and re performance of controls by
observation. the auditor
Risk assessment procedures are Tests of controls are performed

applied at beginning of audit. throughout the audit
· Evaluation of entity's risks assessment procedures by external auditor.

o Consider how management identifies business risks relating to financial
reporting
o Consider how the management determines significance and likelihood of
such risk.
o Management actions to manage the risks
o Identify risks of material misstatement which the management could not
identify
o Report weaknesses in the entity's risk management process to those
charged with governance
· Evaluation of entity's risks assessment procedures by internal auditor.

o Obtain understanding of entity's objectives
o Discuss with departmental managers the nature of the risks inn their
departments
o Consider how the management determines significance and likelihood of
such risk
o Assess controls to manage the risks
o Test controls to provide evidence that they operate and provide effective
management of risk
o Make recommendations to departmental manager for improving the

operations.
· The auditor assesses risk of material misstatement by:

o Identifying risks in the process of obtaining understanding of the entity, its
environment including internal controls
o Relating risks identified to what can go wrong at the assertion level
o Considering impact and likelihood of risks.
§ Whether the risk is a fraud or error
§ Whether the transaction is complex
§ Whether the transaction relates to related party
§ Whether the transaction appears to be unusual
§ Whether significant estimates are required in measuring the
transaction
The auditor uses the risk assessment to determine tests of controls and
substantive procedures.
2. UNDERSTANDING ENTITY AND ITS ENVIRONMENT

INCLUDING ITS INTERNAL CONTROL:
The understanding of entity is required to assess the risk of material
misstatement. It involves the following aspects:
o Industry, regulatory and other factors including the applicable financial
reporting framework
o Nature of entity
o Objective, strategies and related business risks that may result in material
misstatement of financial statement
o Measurement and review of entity’s financial performance
CONTROLS IN IT ENVIRONMENT:
Controls in IT environment are classified as:
o General IT controls
o IT application controls
General IT controls:
General IT controls comprise:
§ Organisational controls
§ Procedural controls
§ Built in controls

§ Controls over physical access

§ Software control
IT application controls:
IT application controls can be categorized into:
§ Input controls
§ Processing controls
§ Output controls
INTERNAL CONTROL:
Internal control is the process designed and effected by those charged with
governance, management and other personnel to provide reasonable assurance
about the achievement of entity’s objectives with regards to reliability of financial
reporting, effectiveness and efficiency of operations and compliance with
applicable laws and regulation.
The objective of a system of internal control is to reduce business risks that may
adversely affect the achievement of above objectives.
The components of internal control are:
o Control Environment
o Entity risk assessment procedures
o Accounting system
o Control activities
o Monitoring controls
Control Environment:
"Control Environment means the function of BOD, audit committee &
management including their attitude, awareness & action as regard internal
control & its importance in the entity"
Elements of Control Environment:
o Communication and enforcement of integrity and ethical values.
o Commitment to competence
o Participation by directors
o Management philosophy and operating style.
o Organizational Structure
o Assignment of authority and responsibility
o Human resources policies and practices.

Entity risk assessment procedures:

Auditor’s duties as regards entity’s risk assessment procedures are:
o Obtain understanding as to how does the management:
§ Identify business risk relating to financial statement
§ Estimates impact and likelihood of such risks
o Management’s action to address the risks
o Consider risks that the management has failed to identify.
Accounting System:
The auditor should obtain understanding as to significant class of
transactions, procedures by which the transactions are initiated, recorded,
processed and reported.
The areas to be considered in obtaining understanding of the accounting
system are:
o Significant class of transactions
o Procedures for:
§ Initiating
§ Recording
§ Processing
§ Reporting
o Related accounting records
o Process to prepare financial statement
Control Activities:
Control activities are established to ensure that management policies are
complied with. The areas covered are:
o Authorisation
o Performance review
o Information Processing
o Physical Controls
o Segregation of duties
Monitoring of Controls:
Monitoring of controls involves activities that the entity uses to monitor
internal controls. The task is generally performed by the internal auditor.

Characteristics of Manual and Automated elements of internal control

relevant to auditor’s risk assessment:
The following are the advantages of automated elements of internal control:
o Enhance the timeliness, availability and accuracy of information
o Facilitate the additional analysis of information
o Enhance the ability to monitor the performance
o Reduce the risk that controls will be avoided
o Enhance the ability to achieve effective segregation of duties
The following are the disadvantages of automated elements of internal control:
o Unauthorized changes to data in master files
o Unauthorized changes to system or programs
o Failure to make necessary changes to systems or programs
o Inappropriate manual intervention
o Potential loss of data
o Inability to access data
Manual system may be more suitable where judgement and discretion are
required such as for following circumstances:
o Large, unusual or non-recurring transactions
o Circumstances where errors are difficult to define
o In monitoring the effectiveness of automated controls.
Manual system may be less suitable in following:
o High volume or recurring transactions
o Control activities are adequately designed and automated
3. ASSESSING THE RISK OF MATERIAL MISSTATEMENT:

The auditor should assess risk of materials statements at the financial statement
level and at the assertion level for classes of transactions, account balances and
disclosures.
4. COMMUNICATING WEAKNESSES IN INTERNAL

CONTROLS
The auditor should make management aware, as soon as possible and at a
appropriate level of responsibility, of material weaknesses in the design and

operation of the accounting and internal control systems, which have come to the
auditor's attention.
A material weakness in the accounting and internal control system is a condition
which may result in material misstatement in the financial statements.
Usually, material weaknesses in the accounting and. internal control system are
communicated in writing. In some circumstances it may be appropriate for
certain matters to be raised orally with directors and management. In such cases,
the auditor should circulate the file note to those attending the meeting to provide
a record of the auditor's observations and any responses of the management.
In any report to management, the auditor should explain that the report is not a
comprehensive statement of all weaknesses which exist or of all improvements
which may be made but that it documents only those matters which have come to
the attention as a result of audit procedures performed. Auditors may wish to
refer to audit approach in the report to management, particularly the work
undertaken on the accounting and internal control system, to help management
appreciate the nature, timing and extent of the audit procedures which have
resulted in identification of the matters included in the report.
5. DOCUMENTATION:
The auditor should document the results of risk assessment.
For practical purposes there are three major techniques of documenting the
accounting and internal control system
o Narrative description
o Internal Control Questionnaire (ICQ)
o Flow charts

Test your knowledge
1. What are the risk assessment procedures.

2. Difference between risk assessment procedures and test of controls.
3. What aspects does understanding of entity includes.
4. What are the controls in IT environment.
5. What do you mean by internal control? What are the components of internal
control.
6. What are the techniques of documenting the accounting and internal control
system.

Chapter 10
ISA 320: Audit Materiality

Chapter Topic List
1. Definition
2. Objective of materiality
3. Consideration of materiality
4. Relationship of materiality with audit risk
5. Miscellaneous
Introduction
This chapter covers ISA 320: Materiality. This Standard defines the concept of
materiality. Materiality is defined as the magnitude or nature of a misstatement
including an omission of financial information either individually or in the aggregate
that, in the light of surrounding circumstances, makes it probable that, as a result of the
misstatement, the judgement of a reasonable person relying on the information would
have been influenced or his decision affected. The assessment of materiality is a matter
of the auditor's professional judgment and is considered at both an overall level and in
relation to individual account balances and disclosures.

1. DEFINITION:
Materiality is defined as:
"Information is material if its omission or misstatement could influence the
economic decisions of users taken on the basis of financial statement. Materiality
depends on the size of the item or error judged in the particular circumstances of
its omission or misstatement. Thus, materiality provides a threshold or cut -off
point rather than being primary qualitative characteristics which information
must have if it is to be useful."
2. OBJECTIVE OF MATERIALITY:
The following are the objectives of materiality
o Decide what items to examine
o Whether to use sampling and substantive analytical procedure
o Select audit procedure that in combination can be expected to reduce audit
risk to acceptably low level
3. CONSIDERATION OF MATERIALITY:
· In designing the audit plan, the auditor establishes an acceptable materiality
level so to detect following:
o Amount of Misstatement (Quantitative Misstatement)
o Nature of Misstatement (Qualitative Misstatement):
§ Inadequate or inappropriate description of accounting policy
§ Illegal payment
§ Non-compliance of law and regulation
§ Personal Expenditure of directors charged to company
· The auditor considers materiality at both level:
o Overall financial statement level
o Account Balance
· Materiality should be considered by an auditor when:
o Determining nature, timing and extent of audit procedure
o Evaluating the effect of misstatement
4. RELATIONSHIP OF MATERIALITY WITH AUDIT RISK:

· There is an inverse relationship b/w materiality and level of audit risk (i.e.)
higher the materiality level, the lower the audit risk and vice versa. The
higher the audit risk, the lower needs to be materiality level and vice versa.

· If materiality level is lower, audit risk is increased. The auditor would

compensate this by either:
o Reducing the assessed risk of material misstatement along with carrying
out additional TOC
o Reducing Detection risk by modifying nature, timing and extent of
substantive procedure
· The auditor intentionally set the acceptable materiality level at a lower level
than it is intended to be because:
o To reduce the likelihood of undiscovered misstatements
o To provide the auditor with margin of safety when evaluating the effect of
misstatements
5. MISCELLANEOUS:
· When auditor concludes that the aggregate of material misstatement is
material the auditor needs:
o To consider reducing audit risk by extending audit procedures
o Requesting management to adjust the financial statement (if management
refuse to adjust financial statement then the auditor considers appropriate
modification to his reports)
· The auditor should undertake following steps when aggregate of uncorrected
misstatement approaches the materiality level:
o The auditor would consider whether it is likely that undetected
misstatements, when taken with aggregate uncorrected misstatement could
exceed materiality level
o To consider reducing audit risk by extending audit procedures
o Requesting management to adjust the financial statement
· Aggregate of Uncorrected Misstatement comprises:
o Specific misstatement identified by the auditor including the net effect of
uncorrected misstatement identified during audit or previous periods
o Projected Errors (auditors best estimate of other misstatement which can't
be specifically identified)
· If auditor has identified a material misstatement resulting from error, the
auditor should undertake following steps:
o The auditor should communicate the misstatement to appropriate level of
management on timely basis
o Consider the need to report to choose charged with governance.

Test your knowledge
1. What do you mean by materiality? What are the objectives of materiality.

2. What should the auditor consider in setting materiality level?
3. Relationship between materiality and audit risk.
4. What are the components of aggregate of uncorrected misstatement.

Chapter 11
ISA 500: Audit Evidence

Chapter Topic List
1. Definition
2. Components of audit evidence
3. Source of obtaining audit evidence
4. Qualities of audit evidence
5. Assertions & their objectives
6. Different types of audit procedures
7. Miscellaneous
Introduction
This chapter covers ISA 500: Audit Evidence. Audit evidence is information obtained
by the auditor in arriving at the conclusions upon which an opinion on the financial
information is based. The nature and sources of audit evidence are described as well as
the sufficiency and appropriateness of audit evidence and the methods by which it is
obtained by the auditor in the performance of compliance and substantive procedures.

1. DEFINITION:
The main objective of an examination of the financial statements is to renders
opinion as to the fairness of the financial statements in conformity with the
general accepted accounting principles. In this connection the auditor needs
sufficient competent evidence which he obtains through inspection, observation,
inquiries and confirmation to afford a reasonable basis for an opinion. Thus
evidence is said to be an integral part of auditing. Evidence may represent the
underlying accounting data of the client (for example: journals, ledgers and
reconciliations) or corroborating information (for example: cheques, invoices and
information obtained by inquiry, observation, inspection and physical
examination). ISA 500 defines audit evidence as
"Audit evidence" is all the information used by the auditor in arriving at the
conclusions on which the audit opinion is based
2. COMPONENTS OF AUDIT EVIDENCE:

Audit Evidence includes:
· Information contained in the accounting records

Accounting records generally include:
o Records of initial entries:
§ Cash Book
§ Journal
§ Ledger
§ Purchase Day Book
§ Sales Day Book
o Supporting records:
§ Work sheets and spreadsheets supporting
§ Cost allocations
§ Computations
§ Reconciliations
§ Disclosures
o Payment Vouchers / Supplier's Invoice:
§ Purchase Order
§ GRN
o Receipt Vouchers:
§ GDN
§ Order from customer

· Other information
Other information includes:
o Minutes of meetings
o Confirmations from third parties
o Analysts' reports
o Comparable data about competitors
o Controls manuals
o Information obtained from such audit procedures:
§ Inquiry
§ Observation
§ Inspection
3. SOURCE OF OBTAINING AUDIT EVIDENCE:

· Audit evidence obtained from:
o Audit procedures performed during the course of the audit
o Other sources such as previous audits and a firm's quality control
procedures for client acceptance and continuance
· Reliable audit evidence:

o Bank confirmation
o Bank statement
o Paid cheques
o Deposit slips
o Copies of sales invoices
o Physical count of assets
4. QUALITIES OF AUDIT EVIDENCE:

· Audit Evidence should be:
o Sufficient:
Measure of Quantity of Audit Evidence
Quantity of Audit Evidence needed is affected by:
§ Risk of Misstatement:
Higher the risk, the more Audit Evidence is required
§ Quality of Audit Evidence:
Higher the quality, the less Audit Evidence is required

o Appropriate:
Measure of quality of Audit Evidence
§ Relevant
§ Reliable:
o Generalization about Reliability of Audit Evidence
à Audit evidence is more reliable when it is obtained from
independent sources outside the entity. (For example: bank
confirmation, accounts receivable confirmation and
communication from entity's lawyer)
à Audit evidence that is generated internally is more reliable
when the related controls imposed by the entity are effective.
à Audit evidence obtained directly by the auditor (for example,
observation of the application of a control) is more reliable
than audit evidence obtained indirectly or (for example,
inquiry about the application of a control).
à Audit evidence is more reliable in documentary form (whether
paper, electronic, or other medium) than oral representation
à Audit evidence provided by original documents is more
reliable than audit evidence provided by photocopies or
facsimiles.
o Reliability of audit evidence is influenced by:
à Its source
à Its nature
à Individual Circumstances
· However, merely obtaining more Audit Evidence may not compensate for its
poor quality.
· Audit evidence is generally persuasive rather than conclusive. Persuasive
means any evidence that may cause a person to believe a fact. Conclusive
means decisive and convincing. In many cases the auditor has to rely on
evidence which is only persuasive rather than conclusive. This is because
generally it is difficult to obtain conclusive evidence.
5. ASSERTIONS & THEIR OBJECTIVES:

· The auditor should use assertions for classes of transactions, account
balances, and presentation and disclosures in sufficient detail for:
o Forming a basis for the assessment of risks of material misstatement
o Designing and performance of further audit procedures

· Following are assertions about classes of transactions for the period which are
also termed as Test of Control:
o Occurrence:
Transactions that have been recorded have occurred
o Completeness:
All transactions that should have been recorded have been recorded.
o Accuracy:
Amounts relating to recorded transactions have been recorded
appropriately.
o Cutoff:
Transactions have been recorded in the correct accounting period.
o Classification
Transactions have been recorded in the proper accounts
· Following are the assertions about account balances at the period end for
balance sheet items:
o Existence:
Assets, liabilities, and equity interests exist.
o Rights and obligations:
The entity holds or controls the rights to assets, and liabilities are the
obligation of the entity.
o Completeness:
All assets, liabilities and equity interests that should have been recorded
have been recorded.
o Valuation and allocation:
Assets, liabilities, and equity interests are included in the financial
statements at appropriate amounts.
· Assertions about presentation and disclosure for balance sheet and profit &
loss a/c items:
o Occurrence and rights and obligations:
Disclosed events, transactions, and other matters have occurred and
pertain to the entity.
o Completeness:
All disclosures that should have been included in the financial statements
have been included.
o Classification and understandability:
Financial information is appropriately presented and disclosures are

clearly expressed.
o Accuracy and valuation:
Financial and other information are disclosed fairly and at appropriate
amounts.
6. DIFFERENT TYPES OF AUDIT PROCEDURES:

· The auditor obtains audit evidence to draw reasonable conclusions on which
to base the audit opinion by performing following audit procedures / audit
techniques:
o RISK ASSESSMENT PROCEDURES:
Obtaining an understanding of the following to assess the risks of material
misstatement at the financial statement and assertion levels
§ Entity and its environment
§ Entity's internal control
NOTE:
Risk assessment procedures by themselves do not provide sufficient
appropriate audit evidence however are supplemented by further audit
procedures in the form of tests of controls, when necessary, and
substantive procedures.
o TESTS OF CONTROLS:
Testing the operating effectiveness of controls in preventing, or detecting
and correcting, material misstatements at the assertion level
NOTE:
Tests of controls are necessary in two circumstances.
§ When the auditor's risk assessment includes an expectation of the
operating effectiveness of controls
§ When substantive procedures alone do not provide sufficient
appropriate audit evidence
o SUBSTANTIVE PROCEDURES:
Detect material misstatements at the assertion level and include tests of
details of classes of transactions, account balances and disclosures and
substantive analytical procedures.
NOTE:
Auditor performs substantive procedures in response to assessment of risk
of material misstatement and test of control.
Auditor performs substantive procedures to obtain sufficient appropriate

audit evidence because:

§ Auditor's risk assessment is judgmental and may not identify all risk
of material misstatement
§ There are inherent limitations of internal control.
· In addition to above, the following are also the audit procedures performed by
the auditor to obtain audit evidence:
o INSPECTION OF RECORDS OR DOCUMENTS:
Inspection consists of examining records or documents, whether internal
or external, in paper form, electronic form, or other media.
o INSPECTION OF TANGIBLE ASSETS:
§ Inspection of tangible assets consists of physical examination of the
assets.
§ Inspection of tangible assets may provide reliable audit evidence with
respect to their existence, but not about the entity's rights and
obligations or the valuation of the assets.
o OBSERVATION:
Observation consists of looking at a process or procedure being performed
by others. It verifies existence
Examples include observation of the counting of inventories by the entity's
personnel.
o INQUIRY:
§ Inquiry consists of seeking information of knowledgeable persons
both financial and non-financial, throughout the entity or outside the
entity.
§ It may be oral or written
§ Inquiry does not itself provide sufficient audit evidence and is not
sufficient to test operating effectiveness of internal control.
o CONFIRMATION:
Confirmation, which is a specific type of inquiry, is the process of
obtaining representation of information directly from a third party.
For example:
§ Direct confirmation of receivables by communication with debtors
§ Direct confirmation of agreements & contracts from 3 rd party
o RECALCULATION:
Recalculation consists of checking the mathematical accuracy. It may be

by using CAAT
o REPERFORMANCE:
Reperformance is the auditor's independent execution of procedures or
controls that were originally performed as part of the entity's internal
control, either manually or through the use of CAATs.
It is not applicable in audit procedures but applicable in TOC
o ANALYTICAL PROCEDURES
Analytical procedures consist of evaluations of financial information made
by a study of plausible relationships among both financial and non-
financial data. It is ratio analysis.
The objective of analytical procedure is to identify events at time of risk
assessment at planning
Objectives Insp. Obser. Inquiry Confir. Recal. A. Proc

Existence X X
Ownership X
Completeness X
Valuation X X
Presentation & Disc. X
7. MISCELLANEOUS:
· Following are the limitation of test of details:
o Test of details are based on the results of test of controls. If inappropriate
conclusions are drawn from test of controls, the selection to same size for
test of details may be inappropriate. For example if there is over reliance
on internal control, a smaller sample size will be selected.
o Missing audit trails, for example in IT environment
o The auditor may use inappropriate audit procedure to verify an assertion.
· An audit rarely involves the authentication of documentation, nor is the
auditor trained as or expected to be an expert in such authentication.
However, the auditor considers the reliability of the information to be used as
audit evidence & controls over their preparation, for example, photocopies,
facsimiles.
· When information produced by the entity is used by the auditor to perform
audit procedures, the auditor should obtain audit evidence about

o Accuracy of the information

o Completeness of the information
· The auditor considers the relationship between the cost of obtaining audit
evidence and the usefulness of the information obtained. However, difficulty
or high cost is not a valid reason for omitting an audit procedure for which
there is no alternative.
· In certain circumstances, audit evidence obtained from previous audits may
provide audit evidence where the auditor performs audit procedures to
establish its continuing relevance.
· When the information is in electronic form, the auditor may carry out certain
of the audit procedures using Computer Aided Audit Techniques (CAAT).
Entities may use:
o Electronic commerce:
§ Customers or suppliers are connected with entities via network
(internet)
§ Purchase, cash receipt, and cash disbursement transactions take place
electronically
o Image processing systems:
§ Documents are scanned and converted into electronic images to
facilitate storage and reference
§ The source documents may not be retained after conversion.

Test your knowledge
1. What do you mean by audit evidence? What are the components of audit
evidence
2. What are the reliable sources of obtaining audit evidence
3. What are the qualities of audit evidence
4. What are the objectives of assertions? Name all assertions.
5. What are the different types of audit procedures.
6. What are the audit procedures that the auditor perform when information is in
electronic form.

Chapter 12
ISA 505: External Confirmation

Chapter Topic List
1. Introduction
2. Design of external confirmation request
3. Positive & negative confirmation
4. Management request
5. Reliability
6. External confirmation process
7. External confirmations prior to the year-end
Introduction
This chapter covers ISA 505: External Confirmation. The purpose of this International
Standard on Auditing (ISA) is to establish standards and provide guidance on the
auditor’s use of external confirmations as a means of obtaining audit evidence.

1. INTRODUCTION:
· External confirmation is the process of obtaining and evaluating audit
evidence through a representation of information or an existing condition
directly from a third party in response to a request for information about a
particular item affecting assertions in the financial statements or related
disclosures.
· The auditor should determine whether the use of external confirmations is

necessary to obtain sufficient appropriate audit evidence at the assertions.
In making this determination, the auditor should consider the assessed risk of
material misstatement at the assertion level and how the audit evidence from
other planned audit procedures will reduce the risk of material misstatement
at the assertion level to an acceptably low level.
· External confirmations are frequently used in relation to account balances and

their components, but need not be restricted to these items.
The following are the situations where external confirmations may be used:
o Bank balances and other information from bankers.
o Accounts receivable balances
o Stocks held by third parties at bonded warehouses for processing or on
consignment
o Property title deeds held by lawyers or financiers for safe custody or as
security
o Investments purchased from stockbrokers but not delivered at the balance
sheet date
o Loans from lenders
o Accounts payable balances
2. DESIGN OF EXTERNAL CONFIRMATION REQUEST:

· The auditor should tailor external confirmation requests to the specific audit
objective. When designing the request, the auditor considers the assertions
being addressed and the factors that are likely to affect the reliability of the
confirmations.
The following are the factors which affect the design of the requests
o Form of the external confirmation request
o Prior experience on the audit or similar engagements
o The nature of the information being confirmed
o The intended respondent

3. POSITIVE & NEGATIVE CONFIRMATION:

· The auditor may use positive or negative external confirmation requests or a
combination of both.
· POSITIVE CONFIRMATION:
o A positive external confirmation request asks the respondent to reply to
the auditor in all cases either by indicating the respondent’s agreement
with the given information, or by asking the respondent to fill in
information.
o A response to a positive confirmation request is ordinarily expected to
provide reliable audit evidence.
o There is a risk that a respondent may reply to the confirmation request
without verifying that the information is correct.
The auditor may reduce this risk, however, by using positive confirmation
requests that do not state the amount (or other information) on the
confirmation request, but ask the respondent to fill in the amount or
furnish other information. On the other hand, use of this type of “blank”
confirmation request may result in lower response rates because additional
effort is required of the respondents.
· NEGATIVE CONFIRMATION:
o A negative external confirmation request asks the respondent to reply only
in the event of disagreement with the information provided in the request.
o When no response has been received to a negative confirmation request,
the auditor remains aware that there will be no clear audit evidence that
intended third parties have received the confirmation requests and verified
that the information contained therein is correct.
o The use of negative confirmation requests ordinarily provides less reliable
audit evidence than the use of positive confirmation requests, and the
auditor considers performing other substantive procedures to supplement
the use of negative confirmations.
o Negative confirmation requests may be used to reduce the risk of material
misstatement to an acceptable level when:
§ The assessed risk of material misstatement is lower
§ A large number of small balances is involved
§ A substantial number of errors is not expected
§ The auditor has no reason to believe that respondents will disregard
these requests
· A combination of positive and negative external confirmations may be used.

For example, where the total accounts receivable balance comprises a small
number of large balances and a large number of small balances, the auditor
may decide that it is appropriate to confirm all or a sample of the large
balances with positive confirmation requests and a sample of the small
balances using negative confirmation requests.
4. MANAGEMENT REQUEST:
· When the auditor seeks to confirm certain balances or other information, and
management requests the auditor not to do so, the auditor should consider
whether there are valid grounds for such a request and obtain audit evidence
to support the validity of management’s requests.
If the auditor agrees to management’s request not to seek external
confirmation regarding a particular matter, the auditor should apply
alternative audit procedures to obtain sufficient appropriate audit evidence
regarding that matter.
If the auditor does not accept the validity of management’s request and is
prevented from carrying out the confirmations, there has been a limitation on
the scope of the auditor’s work and the auditor should consider the possible
impact on the auditor’s report.
5. RELIABILITY:
· The reliability of audit evidence provided by a confirmation is affected by the
respondent’s:
o Competence
o Independence
o Authority to respond
o Knowledge of the matter being confirmed
o Objectivity
For this reason, the auditor attempts to ensure, where practicable, that the
confirmation request is directed to an appropriate individual.
· The reliability of the audit evidence obtained by external confirmations

depends upon the following factors:
o Control the auditor exercises over confirmation requests and responses
o The characteristics of the respondents
o Any restrictions included in the response or imposed by management.
· The auditor considers whether there is any indication that external
confirmations received may not be reliable. The auditor considers the
response’s authenticity and performs audit procedures to dismiss any concern.

The auditor may choose to verify the source and contents of a response in a
telephone call to the purported sender. In addition, the auditor requests the
purported sender to mail the original confirmation directly to the auditor.
6. EXTERNAL CONFIRMATION PROCESS:

· When performing confirmation procedures, the auditor should maintain
control over:
o The process of selecting those to whom a request will be sent
o The preparation and sending of confirmation requests
o The responses to those requests
Control is maintained over communications between the intended recipients
and the auditor to minimize the possibility that the results of the confirmation
process will be biased because of the interception and alteration of
confirmation requests or responses.
The auditor ensures that it is the auditor who sends out the confirmation
requests, that the requests are properly addressed, and that it is requested that
all replies are sent directly to the auditor.
· The auditor should perform alternative audit procedures where no response is

received to a positive external confirmation request.
Where no response is received, the auditor ordinarily contacts the recipient of
the request to bring out a response. Where the auditor is unable to obtain a
response, the auditor uses alternative audit procedures.
· When the auditor forms a conclusion that the confirmation process and
alternative audit procedures have not provided sufficient appropriate audit
evidence regarding an assertion, the auditor should perform additional audit
procedures to obtain sufficient appropriate audit evidence.
Based on following evaluation, the auditor determines whether additional
audit procedures are needed to obtain sufficient appropriate audit evidence.
o Reliability of the confirmations and alternative audit procedures
o Nature of any exceptions, including the implications, both quantitative and
qualitative of those exceptions
o Audit evidence provided by other audit procedures
7. EXTERNAL CONFIRMATIONS PRIOR TO THE YEAR-END:

· When the auditor uses confirmation as at a date prior to the balance sheet to
obtain audit evidence to support an assertion, the auditor obtains sufficient
appropriate audit evidence that transactions relevant to the assertion in the
intervening period have not been materially misstated.

Test your knowledge
1. What do you mean by external confirmation.

2. What are the factors which affect the design of the requests
3. What is positive as well as negative confirmation.
4. How reliability of audit evidence provided by a confirmation is affected.
5. What is external confirmation process

Chapter 13
ISA 520: Analytical Procedures

Chapter Topic List
1. Analytical procedure
2. Timing of analytical procedure
3. Objective of analytical procedure
4. Analytical procedures as substantive procedures
Introduction
This chapter covers ISA 520: Analytical Procedures. A description of the nature of
analytical review procedures is provided as well as guidance on the objectives, timing
and extent of reliance to be placed on such procedures in performing an audit. Also
discussed is the auditor's investigation of unusual fluctuations

1. ANALYTICAL PROCEDURE:
· Analytical procedure is an audit procedure which seeks to provide evidence
as to the completeness, accuracy and validity of the information contained in
the accounting records or in the financial statements. This procedure
comprises of systematic study and comparison of financial and non-financial
information, investigation of significant fluctuations and their variances. The
auditor, at the planning stage, should carry out an overall review of the draft
accounts, identifying problem areas and planning audit directions. ISA 520
defines analytical procedures as:
"Analytical procedures" means evaluations of financial information made by
a study or plausible relationships among both financial and non-financial
data.
Analytical procedures include:
o Comparisons of the entity's financial information with prior periods
o Comparisons of the entity's financial information with anticipated results
of the entity, such as budgets or forecasts
o Comparison of the entity's ratio of sales to accounts receivable with
industry averages or with other entities of comparable size in the same
industry
o Relationship among elements of financial information (i.e.) ratio analysis
o Relationship b/w financial information and relevant non-financial
information, such as payroll costs to number of employees
· The following are the audit procedures that are necessary in case the
analytical procedures identify relationship that is inconsistent with other audit
evidence available with the auditor.
o Investigate and inquiry of management
o Corroboration of management's responses
o Consideration of the need to apply other audit procedures, if management
is unable to provide an explanation or if the explanation is not considered
adequate
2. TIMING OF ANALYTICAL PROCEDURE:

· The auditor should apply analytical procedures:
o As risk assessment procedures to obtain an understanding of the entity and
its environment
o In the overall review at the end of the audit
· Auditor applies analytical procedures at 3 stages

o At Beginning à Necessary à As risk assessment procedures to obtain

understanding of entity
o During à No Necessary à As substantive procedures
o At end à Necessary à In the overall review at the end of the audit.
3. OBJECTIVE OF ANALYTICAL PROCEDURE:

Analytical procedures are used for the following purposes:
o As risk assessment procedures:
The auditor should apply analytical procedures as risk assessment
procedures to obtain an understanding of the entity and its environment.
o As substantive procedures:
The auditor should apply analytical procedures as substantive procedures
in reducing the risk of material misstatement at the assertion level to an
acceptably low level
o As an overall review of the financial statements at the end of the audit:
The auditor should apply analytical procedures at or near the end of the
audit when forming an overall conclusion as to whether the financial
statements as a whole are consistent with the auditor's understanding of
the entity.
4. ANALYTICAL PROCEDURES AS SUBSTANTIVE

PROCEDURES:
· When designing and performing analytical procedures as substantive
procedures, the auditor will need to consider the following:
o SUITABILITY OF USING SUBSTANTIVE ANALYTICAL
PROCEDURES:
In determining the suitability of substantive analytical procedures given
the assertions, the auditor considers:
§ The assessment of the risk of material misstatement:
The auditor considers detailed test when risk of material misstatement
is high and will not base audit opinion on substantive analytical
procedures are suitable.
§ Any tests of details directed toward the same assertion:
Substantive analytical procedures may also be considered appropriate
when tests of details are performed on the same assertion.
o RELIABILITY OF DATA:
Reliability of data must be considered in designing substantive analytical

procedures, for this purpose, the auditor considers the following:

§ Source of the information available:
Information source outside the entity is more reliable
§ Comparability of the information available:
Data must be comparable
§ Nature and relevance of the information available:
Whether budgets have been established as results to be expected
rather than as goals to be achieved
§ Controls over the preparation of the information:
For example, controls over the preparation, review and maintenance
of budgets.
When controls over the entity's preparation of information used by the
auditor are effective, the auditor has greater confidence in the
reliability of the information and, therefore, in the results of
substantive analytical procedures.
o WHETHER THE EXPECTATION IS SUFFICIENTLY PRECISE:
The auditor should consider following factors in assessing whether the
expectations are sufficiently precise to identify a material misstatement at
the desired level of assurance:
§ The accuracy with which the expected results of substantive analytical
procedures can be predicted:
§ The degree to which information can be disaggregated:
§ The availability of the information, both financial and non financial
· The auditor considers the amount of difference from expectation that can be
accepted without further investigation in designing and performing
substantive analytical procedures. For Example: If G.P % in 2005 is 20% then
acceptable deviation in G.P % of 2006 could be 20 + - 0.5 %

Test your knowledge
1. What do you mean by analytical procedures. What are the objectives of

analytical procedures.
2. What auditor should consider when designing and performing analytical
procedures as substantive procedures

Chapter 14
ISA 530: Audit Sampling

Chapter Topic List
1. Definitions
2. Sampling and non-sampling risk
3. Means for selecting items for testing
4. Design of sample
5. Stratification
6. Methods of sampling
7. Nature & cause of errors
8. Projection of error
9. Evaluation of sample result
10. Miscellaneous
Introduction
This chapter covers ISA 530: Audit Sampling. The purpose of this International
Standard on Auditing (ISA) is to establish standards and provide guidance on the use of
audit sampling and other means of selecting items for testing when designing audit
procedures to gather audit evidence.

1. DEFINITIONS:
· Audit sampling:
Audit sampling is the application of a compliance or substantive procedure to
less than 100% of the items within an account balance or class of transactions
to enable the auditor to obtain and evaluate evidence of some characteristic of
the balance or class and to form or assist in forming a conclusion concerning
that characteristic.
It is important to recognise that certain testing procedure do not come within
the definition of sampling. Tests performed on 100% of the items within a
population do not involve sampling. Likewise the technique of selecting all
items within a population which have a particular significance (e.g. all items
over a certain amount) does not qualify as sampling with respect to the
portion of the population examined nor with respect to the population as a
whole, since the items were not selected from the total population on a basis
that we expected to be representative. Such items might imply some
characteristic of the remaining portion of the population but would not be the
basis for a valid conclusion about the remaining portion of the population.
ISA 520 defines audit sampling as:
“Audit sampling involves the application of audit procedures to less than
100% of items and such that all sampling units have a chance of selection”.
Certain limitations of sampling are:
o Sample may not be representative of population
o Auditor’s judgment is required in selecting sample size
o Judgments are also required in drawing conclusions from sample results
o The auditor may use inappropriate population of the population may not
be complete.
· Error:
Error means
o Control deviations, when performing tests of control
o Misstatements, when performing tests of details
· Anomalous error:
Anomalous error means an error that arises from an isolated event that has not
recurred other than on specifically identifiable occasions
· Population:
Population means the entire set of data from which a sample is selected
For Example, there are 1000 customers and out of which 50 were send

confirmation, then 1000 will be population, 50 will be sample size and each
customer shall be sample unit.
Population should be:
o Appropriate
o Complete
· Sampling unit:
Sampling unit means the individual items constituting a population
· Statistical & Non- Statistical Sampling:

Statistical sampling means sampling that has the following characteristics
o Random selection of a sample
o Use of probability theory
A sampling approach that does not have any of above characteristics is
considered non-statistical sampling.
The decision whether to use a statistical or non-statistical sampling approach
is a matter for auditor’s judgment for obtaining sufficient appropriate audit
evidence in the particular circumstances.
· Stratification:
Stratification is the process of dividing a population into subpopulations, each
of which have similar characteristics.
· Tolerable error:
Tolerable error means the maximum error in a population that the auditor is
willing to accept.
2. SAMPLING AND NON-SAMPLING RISK:

Sampling Risk:
· Sampling risk arises from the possibility that the auditor's conclusion, based
on sample may be different from the conclusion reached if the entire
population were subjected to the same audit procedure.
There are two types of sampling risk:
o The risk the auditor will conclude:
§ In the case of a test of controls, that controls are more effective than
they actually are
§ In the case of a test of details, that a material error does not exist
when in fact it does
This type of risk affects audit effectiveness and is more likely to lead to an

inappropriate audit opinion.

o The risk the auditor will conclude:
§ In the case of a test of controls, that controls are less effective than
they actually are
§ In the case of a test of details, that a material error exists when in fact
it does not
This type of risk affects audit efficiency as it would usually lead to
additional work.
· Sampling risk might appear at 2 stages:
o Test of Control:
It means evidence obtain by the auditor in order to detect non-compliance
of internal control
§ Risk of Over Reliance
§ Risk of Under Reliance
o Substantive Procedures:
Evidence obtained by the auditor in order to detect material misstatement
in financial statement:
§ Risk of Incorrect Acceptance
§ Risk of Incorrect Rejection
· Sampling risk can be reduced by increasing sample size.
Non-Sampling Risk:
· Three key points in Non-sampling risk:
o Audit evidence is persuasive rather than conclusive
o Auditor has concluded audit evidence incorrectly
o Incorrect Audit Procedure
· Non-sampling risk can be reduced by:
o Proper engagement
o Planning
o Supervision
o Review
3. MEANS FOR SELECTING ITEMS FOR TESTING:

· When designing audit procedures, the auditor should determine following
appropriate means of selecting items for testing:
o Audit sampling

o Selecting all items (100% examination):

100% examination is unlikely in the case of tests of controls; however, it
is more common for tests of details.
100% examination may be appropriate when:
§ Population constitutes a small number of large value items
§ There is a significant risk
§ Other means of testing do not provide sufficient appropriate audit
evidence
§ When the repetitive nature of a calculation makes a 100%
examination cost effective
o Selecting specific items:
The auditor may decide to select specific items based on following factors:
§ Auditor's understanding of the entity
§ Assessed risk of material misstatement
§ Characteristics of the population being tested
The following is the criteria for selection of specific items:
§ High value or key items
§ All items over a certain amount
§ Items to obtain information:
The auditor may examine items to obtain information about following
matters:
à Nature of the entity
à Nature of transactions
à Internal control
§ Items to test control activities.
· The decision as to which approach to use will depend on:
o Circumstances & application of above means may be appropriate in
particular circumstances
o Risk of material misstatement related to the assertion
o Audit efficiency
o Auditor's satisfaction about methods that is effective in providing
sufficient appropriate audit evidence to meet the objectives of the audit
4. DESIGN OF SAMPLE:
In designing an audit sample, the auditor applies judgement in considering:

o Audit objective:
The auditor should first consider the specific audit objectives to be achieved
to enable him to determine the audit procedure or combination of procedures
which is likely to best achieve those objectives.
o Population:
The population is the entire set of data from which the auditor wishes to
sample in order to reach a conclusion. The auditor should determine that the
population from which he draws the sample is appropriate for the specific
audit objective. The auditor should define the sampling unit in order to obtain
an efficient and effective sample to achieve the particular audit objective.
o Risk:
In planning the audit, the auditor uses professional judgement to assess the
level of audit risk that is appropriate.
o Tolerable Error:
Tolerable error is the maximum error in the population that the auditor would
be willing to accept and still concludes that the result from the sample has
achieved his audit objective. Tolerable error is considered during the planning
stage and is related to the auditor's preliminary judgement about materiality.
The smaller the tolerable error, the larger the sample size the auditor will
require.
o Expected Error in Population
If the auditor expects error to be present, he will normally have to examine 'a
larger sample to conclude either that the population value is fairly stated to
within the planned tolerable error or that the planned reliance on a relevant
control is justified. Smaller sample sizes are justified when the population is
expected to be error free. In determining the expected error in a population,
the auditor should consider such matters as error levels identified in previous
audits, changes in client procedures and evidence available from his
evaluation of the system of internal control and from results of analytical
review procedures.
o Stratification:
Stratification is the process of dividing a population into sub-populations, that
it is a group of sampling units, which have similar characteristics (often
monetary value). The strata must be explicitly defined so that each sampling
unit can belong to only on stratum. This procedure reduces the variability of
the items within each stratum. Stratification enables the auditor to direct his
efforts towards the items he considers potentially contain the greater
monetary error.

5. STRATIFICATION:
· Stratification is the process of dividing a population into sub-populations, that
it is a group of sampling units, which have similar characteristics (often
monetary value). The strata must be explicitly defined so that each sampling
unit can belong to only on stratum. This procedure reduces the variability of
the items within each stratum. Stratification enables the auditor to direct his
efforts towards the items he considers potentially contain the greater
monetary error.
· The objective of stratification is to reduce the variability of items within each
stratum and therefore allow sample size to be reduced without a proportional
increase in sampling risk.
· For Example:
Strata No. Amt % No Amt
Less than 1000 2000 500,000 1 20 5000
1000 - 10,000 600 1380,000 10 60 138,000
Over 10,000 20 500,000 100 20 500,000
2620 6880,000 100 5143,000
4% 75 %
Last Column of Amount is projected by an auditor.
6. METHODS OF SAMPLING:
The following are the methods used in sampling
o Random Number:
Use of a computerized random number generator or random number tables
o Systematic Selection:
§ Systematic selection, in which the number of sampling units in the
population is divided by the sample size to give a sampling interval
§ Although the starting point may be determined haphazardly
o Haphazard selection:
§ In which the auditor selects the sample without following a structured
technique.
§ The auditor avoids any conscious bias
§ Haphazard selection is not appropriate when using statistical sampling

o Block selection:
§ Block selection involves selecting a block(s) of bordering items from
within the population.
§ Block selection cannot ordinarily be used in audit sampling because most
populations are structured such that items in a sequence can be expected
to have similar characteristics to each other, but different characteristics
from items elsewhere in the population.
§ This approach is ordinarily used in conjunction with the systematic
method of sample selection and is most efficient when selecting items
using CAATs.
§ For Example:
Sales Cumulative
1 3000 3000
2 20000 23000 20,000
3 4000 27000
12,500
4 5000 32000
5 9000 41000 32,500
6 1000 42000
Total Sales are 500,000 and sample size of 40 (mean 40 invoices are to
check) Now, 500,000/40 = Rs. 12,500
The first selection will be on haphazard basis. 2 & 5 are selected.
7. NATURE & CAUSE OF ERRORS:

· When error has been identified then the auditor should undertake following
things:
o Specific inquiries
o Effect of identified errors on the financial statements
o Effectiveness of internal control
· The auditor should check following to decide whether it an error or not
o Intentional or Unintentional
o Whether error is committed by a junior manager or senior manager has
overridden the error
o It is an isolated event (i.e. anomalous error) or there error is of the
repetitive nature.

8. PROJECTION OF ERROR:
· The auditor should project monetary errors found in the sample to the
population, and should consider the effect of the projected error on the
particular audit objective and on other areas of the audit.
· When an error has been established as an anomalous error, it may be excluded
when projecting sample errors to the population.
· If a class of transactions or account balance has been divided into strata, the
error is projected for each stratum separately.
· Projected errors plus anomalous errors for each stratum are then combined
when considering the possible effect of errors on the total account balance or
class of transactions.
· For Example:
Population 800,000
25 %
Sample 200,000
Error Found 11,000 (1)
Tolerable Error 40,000
If 100 % check then 44,000 (2)
If anomalous error 3000 is present in 11,000 then

11,000 - 3,000 = 8,000 x 4 = 32,000 + 3000 = 35,000 (3)
(1)
In this case, auditor issue unqualified report
(2)
In this case, auditor issue qualified report
(3)
In this case, auditor issue unqualified report
9. EVALUATION OF SAMPLE RESULT:

· If the evaluation of sample results indicates that the assessment of the relevant
characteristic of the population needs to be revised, the auditor may:
o Request management to investigate identified errors
o Modify the nature, timing and extent of further audit procedures 0
Consider the effect on the audit report.
· Having carried out, on each sample item, those audit procedures that are

appropriate to the particular audit objective, the auditor should:

o Analyze any errors detected in the sample:
In analyzing the errors detected in the sample, the auditor should
determine that an item in question is in fact an error. In designing the
sample, the auditor will have defined those conditions that constitute an
error by reference to his audit objectives. For example, in substantive
procedure relating to the recording of accounts receivable, a misposting
between customer accounts does not affect the total accounts receivable.
Therefore, it may be inappropriate to consider this an error in evaluating
the sample results of this particular procedure, even though it may have an
impact on other areas of the audit, such as the assessment of doubtful
accounts. The auditor should also consider the qualitative aspects of the
errors. These include the nature and cause of the error and the possible
impact of the error on other phase of the audit, for example, the amount of
planned reliance on international control procedures.
o Project the errors found in the sample to the population:
The auditor should project the error results of the sample to the population
from which the sample was selected. There are several acceptable methods
of projecting the error results. However, in all cases the method of
projection should be consistent with the method used to select the
sampling unit. When projecting error results, the auditor should keep in
mind the qualitative aspects of the errors found. When the population is
divided into two or more sub-populations (stratification), the projection of
errors is done separately for each sub-population and the results are added
together.
o Assess the sampling risk:
The auditor should consider whether errors in the population might exceed
the tolerable error. To accomplish this, the auditor should compare the
projected population error to the tolerable error and also then compare the
sample results to the evidence obtained from other relevant audit
procedures when forming his conclusions about an account balance, class
of transactions or specific control. The projected population error used for
this comparison should be net of adjustments made by the client. AI;
projected error approaches tolerable error, the risk of incorrect acceptance
or over reliance increases. The auditor should therefore reconsider the
sampling risk and if he determines that the risk is unacceptable, he should
consider extending his audit procedures or performing alternative audit
procedures.
· Following are essential considerations in selection and evaluation of sample
results.
o Population from which the sampling is drawn should be sufficiently large.
In case of small population sample may not only be unnecessary but may
reflect unacceptable deviations.

o Sample should be based upon objective of the audit test.

o Every item in the population should have an equal chance of being
selected.
o Sample should be selected from whole of the population and it should be
representative (i.e.) every item in the population should have an equal
chance of being selected.
o Sample should be spread over the whole of the accounting period. For
example, a sample drawn from last three months may give erroneous
results if the internal controls have broken during this period.
o If the population is of diversified characteristic, stratification is advisable.
o The sample unit should be clearly identified.
o The population from which the sample is drawn, should be appropriate in,
relation to audit objective.
o Sample size should be determined on the basis of sampling risk, the
tolerable error and expected error.
o Errors detected in sample should be analyzed to determine whether an
item is actually an error. The quality of error should also be considered.
o The error results should be projected for whole of the population.
o In using sampling, the auditor should be cautious of the sampling risks,
particularly the risk of incorrect acceptance and over reliance.
10. MISCELLANEOUS:
· If a selected item is not appropriate for the application of the audit procedure,
the audit procedure is ordinarily performed on a replacement item. (For
example check 55, but have reason that 55 is not available, then check 56)
· When auditor is unable to apply the designed audit procedures to a selected
item for instance, documentation relating to that item has been lost. If suitable
alternative audit procedures cannot be performed on that item, the auditor
ordinarily considers that item to be in error.
· The auditor should consider following which assist auditor in defining what
constitutes an error and what population to use:
o Specific objectives
o Combination of audit procedures
· In the context of substantive procedures, audit sampling and other means of

testing may be used to:
o Verify one or more assertions about a financial statement amount (for
example, the existence of accounts receivable)
o Make an independent estimate of some amount (for example, the value of

obsolete inventories)
· Following matters should be documented when sampling is used.

o Objective of test
o Population
o Sample units
o What constitutes an error
o Sample size
o Basis of selection
o Errors found
o Evaluation and conclusion
· Difference b/w test of control & substantive procedures:
Test of Control Substantive Procedures

The objective of substantive
The objective of test of control
procedure is to detect material
is to detect non-compliance of
misstatement in the financial
control procedures
statement
In case of test of control, the In case of substantive

auditor obtains evidence to procedure the auditor is
ensure the operations of internal concerned with amount in
control financial statement
In case of test of control, the
auditor verifies: In case of substantive
Authorization procedures, the auditor verifies
Sequence of Documents the financial statement
Completeness of data assertions mentioned in ISA-
Accuracy of data 500
Segregation of duties

Test your knowledge
1. What do you mean by sampling?

2. What is sampling & non-sampling risk?
3. What auditor should consider when designing the sample?
4. What do you mean by stratification? Objective of stratification
5. What are the methods of sampling?
6. What is projection of errors?
7. What are the objectives of evaluating the sample results?
8. Difference between test of control & substantive procedures?

Chapter 15
ISA 550: Related Parties

Chapter Topic List
1. Definition
2. Audit procedure regarding related parties
3. Responsibilities of management
4. Responsibilities of auditor
5. Existence and disclosure of related parties
6. Indication of unidentified related parties & transaction
Introduction
This chapter covers ISA 550: Related Parties. Discussed are the procedures to be
considered in obtaining sufficient appropriate audit evidence concerning the existence
of transactions with related parties. This Standard is premised on the definition and
disclosure requirements set out in International Accounting Standard (IAS) 24,
"Related Party Disclosures." This ISA provides guidance to assist auditors in
determining whether management of an entity has properly disclosed related party
relationships and transactions with such parties in accordance with the provisions of
IAS 24.

1. DEFINITION:
· Parties are considered to be related when one party can control or exercise
significant control over the operating and financial policies of the other party.
For Example: Holding an subsidiary companies or associated companies
2. AUDIT PROCEDURE REGARDING RELATED PARTIES:

· The auditor should perform audit procedures designed to obtain sufficient
appropriate audit evidence regarding following of related parties and the
effect of related party transactions that are material to the financial
statements:
o Identification
o Disclosure
· The auditor should perform modified, extended or additional audit procedures

that will provide sufficient appropriate audit evidence because of the
uncertainty regarding the completeness of related party transaction in the
following circumstances which
o Increases the risk of misstatement beyond that which would ordinarily be
expected
o Indicates that a material misstatement regarding related parties has
occurred
· Related parties and related parties transactions are significant because:

o Financial reporting framework require separate disclosure
o Related Party transaction may affect the financial statement
o Reliability of Audit Evidence is affected
o Transaction is made for a purpose other than the routine purpose.
3. RESPONSIBILITIES OF MANAGEMENT:
· Management is responsible for the following:
o Identification and disclosure of related party and transactions
o To implement adequate control that the related party transactions are
identified
4. RESPONSIBILITIES OF AUDITOR:
· The following are the responsibilities of auditors regarding related parties &
their transactions.
o The auditor needs to have a sufficient understanding of entity and its

environment to so as to identify the related parties.

o The auditor should review information provided by management and
should be alert for other material related party transactions
o When obtaining an understanding of the entity's internal control, the
auditor should consider the adequacy of control activities over the
authorization and recording of related party transactions
o In examining the identified related party transactions, the auditor should
obtain sufficient appropriate audit evidence as to whether these
transactions have been properly recorded and disclosed.
o The auditor considers performing following procedures because of the
limited availability of appropriate evidence about related parties
transactions:
§ Confirming the terms & amount of transaction with the related party
§ Inspecting information in possession of the related party
§ Confirming information with persons associated with the transaction,
such as banks, lawyers, guarantors and agents.
o The auditor should obtain a written representation from management
concerning:
§ The completeness of related party information
§ The adequacy of related party disclosures
o The auditor should modify the auditor's report appropriately if:
§ Auditor is unable to obtain sufficient appropriate audit evidence
concerning related parties and transactions
§ Auditor concludes that their disclosure in the financial statements is
not adequate.
5. EXISTENCE AND DISCLOSURE OF RELATED PARTIES:

· The auditor should review information provided by management regarding
related parties and should perform the following audit procedures in respect
of the completeness of this information:
o Review prior year working papers
o Review the entity's procedures for identification of related parties
o Inquire from management
o List of major shareholders
o Review minutes of the shareholders meetings or other statutory records
o Inquire from predecessor auditors
o Review tax returns

6. INDICATION OF UNIDENTIFIED RELATED PARTIES &

TRANSACTION:
· Procedures which indicate that unidentified related party exists:
o Transactions which have abnormal terms of trade, such as unusual prices
o Transactions which lack the logical reason for the occurrence
o Transactions processed in an unusual manner
o High turnover from some customers or supplier
· Procedures which indicate that unidentified related transaction exists
o Detailed Test of transaction and balances
o Review of minutes
o Review confirmation from bank and other sources.

Test your knowledge
1. What do you mean by related parties?

2. What are the audit procedures regarding related parties?
3. What are the responsibilities of management & auditor regarding related parties.
4. What are the procedures that indicate the unidentified related parties &
transactions exist?

Chapter 16
ISA 560: Subsequent Events

Chapter Topic List
1. Definition
2. Identification of subsequent events
3. Adjustment or disclosure of events
4. Auditing of component by another auditor
5. Responsibility of auditor:
6. Condition when reissue of f/s is not necessary
Introduction
This chapter covers ISA 560: Subsequent Events. The purpose of this International
auditor’s responsibility regarding subsequent events.

1. DEFINITION:
IAS 10 describes the subsequent events of two types:
· Adjusting Events:
Those events that provide further evidence of conditions that existed the date
of the financial statements
· Non-Adjusting Events:
Those events that are indicative of conditions that arose after the date of the
financial statements.
· Date of F/S:
Date of F/S means on which F/S are prepared and the date of end of latest
period covered by financial statement, which is normally the date of most
recent B/S in F IS subject to audit.
· Date of Approval of financial statement:
Date of Approval of financial statement is the date at which board of directors
approves the F IS for issue.
· Date of Auditor's report:
Date of the auditor's report" is the date selected by the auditor to date the
report on the financial statements.
· Date the financial statements are issued
Date the financial statements are issued is the date that the auditor’s report
and audited financial statements are made available to third parties.
2. IDENTIFICATION OF SUBSEQUENT EVENTS:

To identify the subsequent events the following procedures may be performed:
o Review management's procedures to identify subsequent events
o Review minutes of the meetings of shareholders and those charged with
governance
o Reading the entity's latest available interim financial statements, budgets,
cash flow etc
o Inquiring entity's legal council
o Inquiring of management as to whether any subsequent events have
occurred which might affect the financial statements:
§ Whether new commitments, borrowings or guarantees have been
entered into
§ Whether sales of assets have occurred or are planned
§ Whether the issue of new shares or debentures has been made or is
planned

§ Whether any unusual accounting adjustments have been made or are

considered
3. ADJUSTMENT OR DISCLOSURE OF EVENTS:

· The auditor should perform procedures designed to obtain sufficient
appropriate audit evidence that all events up to the date of the auditor's report
that may require adjustment of, or disclosure in, the financial statements have
been identified.
· When the auditor becomes aware of events which materially affect the
financial statements, the auditor should consider whether such events are
properly accounted for and adequately disclosed in the financial statements.
4. AUDITING OF COMPONENT BY ANOTHER AUDITOR:

When a component, such as a division, branch or subsidiary, is audited by another
auditor, the auditor should consider:
o Other auditor's procedures regarding events after the date of the financial
statements
o The need to inform the other auditor of the planned date of the auditor's
report
5. RESPONSIBILITY OF AUDITOR:
· RESPONSIBILITY OF AUDITOR AFTER DATE OF AUDITOR'S
REPORT BUT BEFORE F/S ARE ISSUED:
o The auditor does not have any responsibility to perform procedures or
make any inquiry regarding the financial statements after the date of the
auditor's report which does not affect financial statement materially.
During this period from the date of the auditor's report to the date the
financial statements are issued, the responsibility to inform the auditor of
facts which may affect the financial statements rests with management.
o When, after the date of the auditor's report but before the-date the financial
statements are issued, the auditor becomes aware of a fact which may
materially affect the financial statements, the auditor should:
§ Consider whether the financial statements need amendment
§ Should discuss the matter with management
§ Should take the action appropriate in the circumstances
· WHEN MANAGEMENT AMENDS THE FINANCIAL STATEMENTS:

When management amends the financial statements, the auditor would:
§ Carry out the procedures necessary in the circumstances

§ Provide management with a new report on the amended financial

statements
§ The new auditor's report would be dated not earlier than the date of
approval of the amended financial statements.
· WHEN MANAGEMENT AMENDS THE FINANCIAL STATEMENTS:

o When management does not amend the financial statements in
circumstances where the auditor believes they need to be amended and the
auditor's report has not been released to the entity, the auditor should
express a qualified opinion or an adverse opinion.
o When management does not amend the financial statements in
circumstances where the auditor believes they need to be amended and the
auditor's report has been released to the entity, the auditor should do:
§ Inform those charged with governance of the entity not to issue
financial statement and the audit report
If F/S and auditor's report are released despite the auditor's notice then the
auditor would take appropriate steps to prevent the reliance on the
auditor's report (this would depends on auditors legal right and
obligations and the recommendations of the auditor's lawyer)
· FACTS DISCOVERED AFTER THE F/S HAVE BEEN ISSUED:

o After the financial statements have been issued, the auditor has no
obligation to make any inquiry regarding such financial statements.
o When, after the financial statements have been issued, the auditor becomes
aware of a fact which existed at the date of the auditor's report and which
if known at that date, may have caused the auditor to modify the auditor's
report, the auditor should:
§ Consider whether the financial statements need revision
§ Discuss the matter with management
§ Take the action appropriate in the circumstances.
· WHEN THE MANAGEMENT REVISE AND REISSUE F/S:

o When management revises and reissue the financial statements, the auditor
would:
§ Carry out the audit procedures necessary in the circumstances
§ Review the steps taken by management to inform that all those person
who are in receipt of previously issue F/S
§ Issue a new report on the revised financial statements:
à The new auditor's report should include an emphasis of a matter
paragraph stating the reason for the revision of the previously

issued financial statements and to the earlier report issued by the

auditor.
à The new auditor's report would be dated not earlier than the date
of approval of the revised financial statements
· WHEN THE MANAGEMENT DOES NOT REVISE AND REISSUE F/S:

o When management does not revise F IS and does not take the necessary
steps to inform all those person who are in receipt of the previously issued
financial statements together with the auditor's report, then the auditor
would:
§ Notify those persons responsible for the overall direction of the entity
§ The auditor would take necessary action which would depend on the
auditor's legal rights and obligations and the recommendations of the
auditor's lawyers.
6. CONDITION WHEN REISSUE OF F/S IS NOT NECESSARY:

If the next issue of F/S is about to happen then the auditor might consider not re-
issuing F/S provided that the adequate disclosures has been made in the F/S
whose issue is about to happen.

Test your knowledge
1. What are the procedures for identifying the subsequent events?

2. What are the responsibilities of auditor regarding subsequent events?
3. What are the conditions when reissue of f/s is not necessary?

Chapter 17
ISA 580: Management Representation

Chapter Topic List
1. Representation as audit evidence

2. Objective of management representation
3. Auditor’s duties as regards management representations
4. Documentation
5. Basic elements of representation letter
6. Refusal of providing representation
7. Specimen of management representation letter
8. Letter to management
Introduction
This chapter covers ISA 580: Management Representation. This Standard provides
guidance to the auditor on using management representations as audit evidence,
procedures the auditor should apply in evaluating and documenting them, and
circumstances in which written representations should be obtained. It indicates that
with regard to representations for material financial statement matters, the auditor
should seek corroborative evidence, evaluate the representations for reasonableness and
consistency with other audit evidence and other representations, and consider whether
the individual making the representation can be expected to be well-informed. It also
notes that representations can be documented in the working papers by summarizing
oral discussions or by obtaining written representation.

1. REPRESENTATION AS AUDIT EVIDENCE:

· The auditor should obtain appropriate representations from management.
· The auditor should obtain evidence that:
o Management acknowledges its responsibility for the fair presentation of
the financial statement.
o Management has approved the financial statements.
· The auditor can obtain acknowledgment in any of the following forms:
o Minutes of the Meetings
o Written representation from management
o Signed Copy of financial statement
· The auditor should obtain written representations from management on
matters material to the financial statements when other sufficient appropriate
audit evidence cannot reasonably be expected to exist.
For Example:
The carrying of an investment for a long term or short term basis (as per IAS
39, the short term held for trading investments should be carried to the market
value. To carry it on long term there is no Audit Evidence to exist)
· The possibility of misunderstandings between the auditor and management is
reduced when oral representations are confirmed by management in writing.
· The auditor should obtain written representation from management that:
o Management acknowledges its responsibility for the design and
implementation of internal control
o Management believes uncorrected misstatements are immaterial.
· The auditor should do following before evaluating and considering
representation by management
o Get the corroborative audit evidence
o Consider that the person making management representation is well
informed
o Evaluate that representations made by management is consistent and
reasonable with other audit evidence.
· Representations by management cannot be a substitute for other audit
evidence that the auditor could reasonably expect to be available.
For example, for the existence of debtors there is expected to be Audit
Evidence like confirmation
· If the auditor is unable to obtain sufficient appropriate audit evidence
regarding a matter which has material effect on the financial statements and

such audit evidence is expected to be available, this will constitute a

limitation in the scope of the audit, even if a representation from management
has been received on the matter.
· If a representation by management is contradicted by other audit evidence, the
auditor should:
o Investigate the circumstances
o Reconsider the reliability of other representations made by management.
2. OBJECTIVE OF MANAGEMENT REPRESENTATION:

· Management representation letter serves following two purposes:
o Provides a formal acknowledgment regarding management responsibility
as regards financial statement
o Serves as evidence where other sufficient appropriate audit evidence
cannot reasonably be expected to exist.
3. AUDITOR’S DUTIES AS REGARDS MANAGEMENT

REPRESENTATIONS:
The following are the responsibility as regards management representation:
o The auditor should corroborate the management representations with other
sources
o Evaluate reasonableness of management representations in the light of
other evidences. If the auditor finds a contradiction, the causes should be
investigated and reliability of other representations should be considered
o Ensure that letter of representation is signed by person whose level of
authority is appropriate to the matters contained in letter of representation,
for example, by the chief executive and finance director
o Even if the letter of representation is received the auditor will still have to
decide whether in the circumstances are sufficient to enable him to issue
an unqualified opinion
o Where other sufficient appropriate evidence is expected to exist and the
auditor is unable to obtain such evidence a mere receipt of letter of
representation would not justify issuance of an unqualified report
o The letter of representation should be obtained every year and filed in
current audit file
As the representation letter forms an audit evidence it should be approved before
the audit report is prepared. In case of unusual time lag between receipt of
representation letter and issuance of audit report, the auditor may need to perform
other audit work or obtain a supplementary letter of representation

4. DOCUMENTATION:
· The auditor would include in audit working papers evidence of management's
representations in the form oral discussions or written representations from
management
· Written representation can take the form of
o Management Representation
o Letter from the auditor of its understanding of management's
representations, duly acknowledged and confirmed by management
o Minutes of meetings
o Signed copy of the financial statements
5. BASIC ELEMENTS OF REPRESENTATION LETTER:

· The following are the basic elements of Management Representation Letter
o It should be addressed to the auditor
o It should contain specified information
o It should be appropriately dated and signed:
§ A management representation letter would be dated the same date as
the auditor's report.
However, in certain circumstances, it may be dated after the date of
the auditor's report
§ A management representation letter would be signed by the members
of management who have primary responsibility (ordinarily the senior
executive officer and the senior financial officer)
In certain circumstances, auditor may wish to obtain representation
letters from other members of management.
6. REFUSAL OF PROVIDING REPRESENTATION:

· If management refuses to provide a representation this constitutes a scope
limitation and auditor should express a qualified opinion or disclaimer of
opinion
· In such circumstances, the auditor would evaluate any reliance placed on
other representations made by management during the course of the audit
· Auditor would consider if the other implications of the refusal may have any
additional effect on the auditor's report.

7. SPECIMEN OF MANAGEMENT REPRESENTAION LETTER:

(Entity Letterhead)
(To Auditor) (Date)
This representation letter is provided in connection with your audit of the

financial statements of ABC Company for the year ended December 31, 19X 1 for
the purpose of expressing an opinion as to whether the financial statements give a
true and fair view of (present fairly, in all material respects) the financial position
of ABC Company as of December 31, 19X 1 and of the results of its operations
and its cash flows for the year then ended in accordance with (indicate applicable
financial reporting framework).
We acknowledge our responsibility for the fair presentation of the financial
statements in accordance with (indicate relevant financial reporting framework).
We confirm, to the best of our knowledge and belief, the following
representations:
Include here representations relevant to the entity. Such representations may
include the following:
o We have made available to you all books of account and supporting
documentation and all minutes of meetings of shareholders and the board
of directors
o We confirm the completeness of the information provided regarding the
identification of related parties
o The financial statements are free of material misstatements, including
omissions.
o We have no plans or intentions that may materially alter the carrying value
or classification of assets and liabilities reflected in the financial
statements
o The Company has satisfactory title to all assets and there are no liens or
encumbrances on the company's assets, except for those that are disclosed
in Note X to the financial statements.
o We have recorded or disclosed, as appropriate, all liabilities, both actual
and contingent and have disclosed in Note X to the financial statements all
guarantees that we have given to third parties.
o Other than . . . described in Note X to the financial statements, there have
been no events subsequent to period end which require adjustment
of or disclosure in the financial statements or Notes thereto.
(Senior Executive Officer)

(Senior Financial Officer)

8. LETTER TO MANAGEMENT:
In many audit firms, it is the normal practice to send at the conclusion of audit or
during the course of audit a letter to management pointing out the areas where
inefficiencies were observed and the suggested constructive advice for
improvement in financial control. Such letter would usually deal with:
o Weaknesses and inefficiencies observed in accounting records
o System break-down where computer is employed
o Extra time involvement due to system weaknesses and failure of adhere to
time schedule as agreed
o Appropriateness or otherwise of accounting policies
o Presentation of financial statements
o Appreciation for co-operation and assistance extended by the client’s staff
and management during the course of audit

Test your knowledge
1. What are objective of management representation?

2. What are auditor’s duties as regards management representations?
3. What are the basic elements of management representation letter?
4. What auditor should do when management refuses to provide a representation?
5. What do you mean by letter to management?

Chapter 18
ISA 600: Using the work of another

auditor
Chapter Topic List
1. Definitions
2. Objective of reliance on other auditor
3. Work of other auditor affecting the audit
4. Acceptance as principal auditor
5. Responsibilities of other auditor
6. Responsibilities of principal auditor
7. Reporting consideration
Introduction
This chapter covers ISA 600: Using the work of other auditor. The purpose of this
International Standard on Auditing (ISA) is to establish standards and provide guidance
when an auditor, reporting on the financial statements of an entity, uses the work of
another auditor on the financial information of one or more components included in the
financial statements of the entity. This ISA does not deal with those instances where
two or more auditors are appointed as joint auditors nor does it deal with the auditor’s
relationship with a predecessor auditor.

1. DEFINITIONS:
· PRINCIPAL AUDITOR:
Principal auditor means the auditor with responsibility for reporting on the
financial statements of an entity when those financial statements include
financial information of one or more components audited by another auditor.
· OTHER AUDITOR:
Other auditor means an auditor, other than the principal auditor, with
responsibility for reporting on the financial information of a component
which is included in the financial statements audited by the principal auditor.
· COMPONENT:
Component means a division, branch, subsidiary, joint venture, associated
company or other entity whose financial information is included in financial
statements audited by the principal auditor.
2. OBJECTIVE OF RELIANCE ON OTHER AUDITOR:

Certain clients of an auditor may have branches, subsidiaries or associated
companies within or outside the country. Some of such branches etc. are audited
by the auditor other than the auditor of the entity. Since the ultimate responsibility
of audit report rests with the auditor signing the report, he should make enquiries
into the work done by other auditors.
The object of such enquiries should be to ensure that:
o Accounting policies are consistently applied throughout the entity
o Financial statements are drafted and information presented as required by
law
o There is sufficient evidence that audit work is performed according to
basic principles
3. WORK OF OTHER AUDITOR AFFECTING THE AUDIT:

When the principal auditor uses the work of another auditor, the principal auditor
should determine how the work of the other auditor will affect the audit.
Examples of the matters where the work of another auditor may affect the audit
o Professional competence of the other auditor
o Independence, integrity, objectivity and technical standards of the other
auditor
Performance of audit by the other auditor
o Finding of the other auditor

4. ACCEPTANCE AS PRINCIPAL AUDITOR:

The auditor should consider the following when accepting the engagement as
principal auditor:
o Whether the auditor’s own participation is sufficient to be able to act as
the principal auditor
o The materiality of the portion of the financial statements which the
principal auditor audits
o The principal auditor’s degree of knowledge regarding the business of the
components
o The risk of material misstatements in the financial statements of the
components audited by the other auditor
o The performance of additional procedures regarding the components
audited by the other auditor resulting in the principal auditor having
significant participation in such audit
5. RESPONSIBILITIES OF OTHER AUDITOR:

ISA 600 requires the other auditor to cooperate with the principal auditor. In
particular, the other auditor should advise the principal auditor of significant
matters that he considers should be brought to the attention of the principal
auditor.
6. RESPONSIBILITIES OF PRINCIPAL AUDITOR:

The following are the responsibilities of principal auditor set out in ISA 600:
o Advise the other auditor of the independence requirements
o Advise the other auditor of the use which is to be made of the other
auditor's work
o Advise the other auditor of the relevant accounting and auditing and
reporting requirements
It is not necessary to apply above procedures when they are affiliated
firms the principal auditor and the other auditor may have a continuing,
formal relationship (e.g.) KPMG and E & Y
o Consider professional competence of the other auditor
o Obtain sufficient appropriate audit evidence for the adequacy of the work
performed by the other auditor
o The principal auditor might discuss with the other auditor the audit
procedures applied, review a written summary of the other auditor’s
procedures or review working papers of the other auditor.
o Consider significant findings of the other auditor
o The principal auditor would document the following in audit working

papers:
§ Components whose financial information was audited by other
auditors
§ Their significance to the financial statements of the entity as a whole
§ The names of the other auditors
§ Any conclusions reached that individual components are immaterial.
§ The procedures performed and the conclusions reached.
7. REPORTING CONSIDERATION:
· When the principal auditor concludes that the work of the other auditor
cannot be used and the principal auditor has not been able to perform
sufficient additional procedures regarding the financial information of the
component audited by the other auditor, the principal auditor should express a
qualified opinion or disclaimer of opinion because there is a limitation in the
scope of the audit.
· If the other auditor issues, or intends to issue, a modified auditor’s report, the
principal auditor would consider whether the subject of the modification is of
such a nature and significance that a modification of the principal auditor’s
report is required.
· Where the local regulations allow the principal auditor to base the audit
opinion on the financial statements taken as a whole, solely upon the report of
the other auditor regarding a component the report should, in both the scope
and opinion paragraph, clearly indicate the degree of responsibility and the
proportions of the financial statements examined by each auditor. This may
be stated in percentages, total assets, total revenue, or other appropriate
criteria. Such reference does not represent an audit qualification, but only
indicates respective responsibilities of the two auditors.

Test your knowledge
1. What are the objectives of reliance on other auditor?

2. How the work of other auditor affect the audit?
3. What the auditor should consider the when accepting the engagement as principal
auditor?
4. What are the responsibilities of other auditor & principal auditor?

Chapter 19
ISA 610: Considering the work of internal

audit
Chapter Topic List
1. Definition of internal auditing

2. Objectives of internal auditing
3. Responsibilities of internal audit
4. Internal v/s External auditor
5. Scope and work of internal auditor
6. Outsourcing of internal audit
7. Co-ordination
8. Reliance on work of internal auditor
Introduction
This chapter covers ISA 610: Considering the work of internal audit. The purpose of
this International Standard on Auditing (ISA) is to establish standards and provide
guidance to external auditors in considering the work of internal auditing. This ISA
does not deal with instances when personnel from internal auditing assist the external
auditor in carrying out external audit procedures. The procedures noted in this ISA need
only be applied to internal auditing activities which are relevant to the audit of the
financial statements.

1. DEFINITION OF INTERNAL AUDITING:

Internal audit is concerned with the evaluation of work carried out by the
employees of other departments of an organization and reports to the
management regarding the adequacy, soundness, effectiveness and weakness
prevailing through the organization. The management takes an appropriate
remedial action on departmental weaknesses as reported by the internal audit. ISA
610 defines internal auditing as:
“Internal auditing means an appraisal activity established within an entity as a
service to the entity. Its functions include, amongst other things, monitoring
internal control”
2. OBJECTIVES OF INTERNAL AUDITING:

The objectives of internal audit comprise the appraising, reviewing and reporting
on:
o The extent of compliance with established policies, plans and procedures
o The soundness, adequacy and application of accounting, financial and
other relevant control
o The extent to which the assets and interests of the organisation are
properly accounted for and safeguarded from losses of all kinds
o The application of proper authorizations within the delegated authorities
given by the various levels of management
o The reliability of accounting and other data developed within the
organization and proper co-ordination between departments
o The quality of performance in carrying out assigned responsibilities being
appraised at the appropriate level of management
3. RESPONSIBILITIES OF INTERNAL AUDIT:

The responsibilities of an Internal Audit in an organization should be clearly
established by management policy. The related authority should provide the
internal access to allot the organization's records, properties and personnel
matters. The internal audit should be free to review and appraise policies, plans,
procedures and records.
The internal audit responsibilities are:
o To inform and advise management
o To co-ordinate activities with others so as to best achieve audit objective
and the objective of the organization
o In performing functions the internal audit has no direct responsibility for
any activities which it has reviewed.

4. INTERNAL V/S EXTERNAL AUDITOR:

· While the external auditor has sole responsibility for the audit opinion
expressed and for determining the nature, timing and extent of external audit
procedures, certain parts of internal auditing work may be useful to the
external auditor.
· Similarities of Internal and External Auditor:
o Both require some degree of objectivity.
o Both require audit evidence.
o Both use sampling.
o Both place large degree by' emphasis on internal control.
o Both require to issue report.
o Both must adhere to professional standards.
o Both require to document their work through use of working papers.
· External Auditor's Relation with Internal Auditor:

o Review organization and independence of the internal auditor
o Review goals and plans of the internal auditor including nature and extent
of work
o Review the degree of integration of the internal auditor's work with that of
the external auditor
o Review with the internal auditor, his evaluation of the company's internal
control
o Follow-up significant recommendations for improvement of accounting
and internal control practices by the company's internal auditors
o Review compliance by management and staff with company's policies.
5. SCOPE AND WORK OF INTERNAL AUDITOR:

· ISA 610 determines the following as usual activities in scope of internal
auditing:
o Monitoring of internal control
o Examination of financial and operating information
o Review of the economy, efficiency and effectiveness of operations of an
entity
o Review of compliance with laws, regulations
6. OUTSOURCING OF INTERNAL AUDIT:

· In recent year, the trend of outsourcing internal audit by companies to

professional firms has increased.

· The advantages are:
o More independence than enjoyed by the internal audit department.
o More qualified staff could be available
o Payment can be made on the basis of time spent rather than commitment
of fixed costs of internal audit department.
· Disadvantages include:
o Audit firm's staff may not have same intimate knowledge of the business
as possessed entity's staff.
o Audit firm's fee may be too expensive
o Staff of the professional firm cannot be controlled by the company same
way as internal staff.
7. CO-ORDINATION:
Co-ordination with internal auditor involves:
o Frequent meetings with internal auditor
o Access to internal auditor's programme and working papers
o Exchange of audit reports and management letters.
Effective coordination requires advance planning between the two auditors. Such
joint planning is facilitated by understanding and recognition by each audit group
of the other's primary role and responsibilities.
8. RELIANCE ON WORK OF INTERNAL AUDITOR:

· The external auditor should obtain a sufficient understanding of internal audit
activities to identify and assess the risks of material misstatement of the
financial statements and to design and perform further audit procedures.
The external auditor should perform an assessment of the internal audit
function when internal auditing is relevant to the external auditor’s risk
assessment.
The criteria for reliance on general work of internal auditor are:
o Organizational status:
§ Internal auditor should report to highest authority
§ Internal auditor should be free to communicate with external auditor
§ Internal auditor should not be involved in any operating
responsibilities
o Scope of function
o Skill and competence

o Due professional care:

§ Work of assistant is reviewed
§ Work of assistant is supervised
§ Internal auditing should be properly planned
§ Finding of internal auditor are adequately documented.
· When the external auditor intends to use specific work of internal auditing,
the external auditor should evaluate and perform audit procedures on that
work to confirm its adequacy for the external auditor’s purposes.
The criteria for reliance on specific work of internal auditor are:
o The work is performed by persons having adequate technical training and
proficiency as internal auditors and the work of assistants is properly
supervised, reviewed and documented
o Sufficient appropriate audit evidence is obtained to be able to draw
reasonable conclusions
o Conclusions reached are appropriate in the circumstances and any reports
prepared are consistent with the results of the work performed
o Any exceptions or unusual matters disclosed by internal auditing are
properly resolved.

Test your knowledge
1. What do you mean by internal auditing? What are objectives of internal auditing?
2. What are the responsibilities of internal audit?
3. How the external auditor rely on the work of internal auditor?
4. What co-ordination involves?
5. What is scope of internal audit?
6. What do you mean by outsourcing of internal audit

Chapter 20
ISA 620: Using the work of an expert

Chapter Topic List
1. Introduction
2. Need to use the work of expert
3. Competence & objectivity of expert
4. Auditor’s duties as regards work of expert
5. Auditor’s report with reference to expert
Introduction
This chapter covers ISA 620: Using the work of expert. The purpose of this
International Standard on Auditing (ISA) is to establish standards and provide guidance
on using the work of an expert as audit evidence.

1. INTRODUCTION:
· Expert means a person or firm possessing special skill, knowledge and
experience in a particular field other than accounting and auditing.
· When using the work of an expert, the auditor should obtain sufficient
appropriate audit evidence that such work is adequate for the purposes of the
audit. When the auditor uses the work of the expert employed by him, he
would need to apply relevant procedures to the employee's work and findings
but will not ordinarily need to assess for each engagement the employer's
skills and competence.
2. NEED TO USE THE WORK OF EXPERT:

· The work of experts may be available to the auditor in the form of reports,
opinions, valuations and statements such as the following:
o Valuations of assets
o Determination of quantities or physical conditions of assets
o Determination of amount using specialized techniques or methods
o Measurement work completed and in progress
o Legal opinions concerning interpretation of agreements, statutes and
regulations
· The decision of the auditor regarding the extent of the use of expert's work
will be decided in the light of the following criteria:
o Materiality of the financial statement
o Risk of misstatement
o Quantity and quality of other audit evidence available
3. COMPETENCE & OBJECTIVITY OF EXPERT:

· The auditor before using the work of an expert must assess:
o Professional competence of such expert:
It involves the consideration of:
§ Professional membership of professional body
§ Experience and reputation
· When the auditor is doubtful about the competency or objective of the expert,
he should discuss any reservation with the management to decide the extent
of accepting of expert's works as audit evidence. Otherwise the auditor should
undertake additional procedure to obtain audit evidence.

4. AUDITOR’S DUTIES AS REGARDS WORK OF EXPERT:

· The following are the duties of auditor regards work of expert:
o Assess independence of expert
o Assess competence of expert.
o Consider whether the substance of the expert's findings is properly
reflected in the financial statement
o Study terms of reference for appointment of expert:
§ The objectives and scope of the expert’s work
§ A general outline as to the specific matters the auditor expects the
expert’s report to cover
§ The intended use by the auditor of the expert’s work, including the
possible communication to third parties of the expert’s identity and
extent of involvement
§ The extent of the expert’s access to appropriate records and files
§ Clarification of the expert’s relationship with the entity, if any
§ Confidentiality of the entity’s information
o Assess the work of expert
§ Source data used
§ Understanding & reasonableness of assumptions used.
§ Review or test data used by expert.
· If the results of the expert’s work do not provide sufficient appropriate audit
evidence or if the results are not consistent with other audit evidence, the
auditor should:
o Discuss with the entity and the expert
o Apply additional audit procedures:
§ Engaging another expert; or
§ Modifying the auditor’s report.
5. AUDITOR’S REPORT WITH REFERENCE TO EXPERT:

· When issuing an unmodified auditor’s report, the auditor should not refer to
the work of an expert because such a reference might be misunderstood to be
a qualification of the auditor’s opinion.
· If, as a result of the work of an expert, the auditor decides to issue a modified
auditor’s report (giving explanation of the nature of the modification, and
description of the work of the expert is appropriate in some circumstances)
but the auditor would obtain the permission of the expert before making such
a reference.

If permission is refused and the auditor believes a reference is necessary, the

auditor may need to seek legal advice.

Test your knowledge
1. Is it necessary to use work of expert?

2. What is competence & objectivity of expert?
3. What are the auditor’s duties as regards work of expert?
4. Whether the work expert affects the auditor’s report?

Chapter 21
ISA 700: Auditor’s Report

Chapter Topic List
1. Basic elements of the auditor's report

2. Audit report
3. Miscellaneous
Introduction
This chapter covers ISA 700: Auditor’s Report. The purpose of this International
independent auditor’s report issued as a result of an audit of a complete set of general
purpose financial statements prepared in accordance with a financial reporting
framework that is designed to achieve fair presentation. It also provides guidance on the
matters the auditor considers in forming an opinion on those financial statements. As
described in ISA 200, “Objective and General Principles Governing an Audit of
Financial Statements,” “general purpose financial statements” are financial statements
prepared in accordance with a financial reporting framework that is designed to meet
the common information needs of a wide range of users.

1. BASIC ELEMENTS OF THE AUDITOR'S REPORT:
Title Auditor's Report
Addressee The members of XYZ Co.
We have audited the accompanying

Opening introductory paragraph balance sheet of the XYZ company
identification of the financial as of December 31, 20x7 and the
statement related profit and Loss statement and
cash flows for the year then ended.
These financial statements are the

Opening introductory paragraph responsibility of the entity's
A statement of the responsibility of management. Our responsibility is to
the auditor and the management express an opinion on these financial
statements based on our audit.
We conducted our audit in

accordance with international
standards on auditing. Those
standards require that we plan and
perform audit to obtain reasonable
assurance about whether the financial
statements are free of material
misstatements. An audit includes
examining, on a test basis, evidence
Scope paragraph
supporting the amounts and
disclosures in the financial
statements. An audit also includes
assessing the accounting policies
used and significant estimates made
by the management as well as
evaluating the overall financial
statement presentation. We believe
that our audit provides a reasonable
basis for our opinion.
In our opinion, the financial
statements give a true and fair view
Opinion paragraph of the financial position of the
Company as of December 31, 20x7,

and of the results of its operations

and its cash flows for the accordance
with recognized accounting
standards and comply with relevant
laws.
Date of the report
Auditor's address
Auditor's signatures
2. AUDIT REPORT:
FORM 35A THE COMPANIES ORDINANCE, 1984
AUDITOR'S REPORT TO THE MEMBERS
We have audited the annexed balance sheet of………..as at ………….and the

related * 1 profit and loss account * 2 cash flow statement and statement of
changes in equity together with the notes forming part thereof, for the year then
ended and we state that we have obtained all the information and explanations
which, to the best of our knowledge and belief, were necessary for the purposes of
our audit.
It is the responsibility of the company's management to establish and maintain a
system of internal control, and prepare and present the above said statements in
conformity with the approved accounting standards and the requirements of the
Companies Ordinance, 1984. Our responsibility is to express an opinion on these
statements based on our audit.
We conducted our audit in accordance with the auditing standards as applicable in
Pakistan. These standards require that we plan and perform the audit to obtain
reasonable assurance about whether the above said statements are free of any
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the above said statements. An audit also
includes assessing the accounts policies and significant estimates made by
management, as well, as evaluating the overall presentation of the above said
statements. We believe that our audit provides a reasonable basis for our opinion
and, after due verification, we report that-
(a) in our opinion, proper books of accounts have been kept by the t company
as required by the Companies Ordinance, 1984;
(b) in our opinion-
(i) the balance sheet and profit and loss account together with the notes
thereon have been drawn up in conformity with the Companies
Ordinance, 1984, and are in agreement with the books of accounts and

are further in accordance with accounting policies consistently

applied ............. except for the changes as stated in note(s) ; with
which we concur;
(ii) the expenditure incurred during the year was for the purpose of the
company's business; and
(iii) the business conducted, investments made and the expenditure
incurred during the year were in accordance with the objects of the
company;
(c) in our opinion and to the best of our information and according to the
explanations given to us, the balance sheet, * 1 profit and loss account * 2
cash flow statement and statement of changes in equity, together with the
notes forming part thereof conform with approved accounting standards as
applicable in Pakistan, and, give the information required by the
Companies Ordinance, 1984, in the manner so required and respectively
give a true and fair view of the state of the company's affairs as at
……..and of the * 4 profit/loss, its * 5 cash flows and changes in equity
for the year then' ended; and
(d) in our opinion * 6 Zakat deductible at source under the Zakat and Ushr
Ordinance, 1980 (XVIII of 1980), was deducted by the company and
deposited in the Central Zakat Fund established under Section 7 of that
Ordinance.
Signature
Name(s) of auditor(s)
Date:
Place:
NOTES:
Where applicable:
* 1. Substitute "income and expenditure account",
* 2. Substitute "source and application of funds".
* 3. Where there is no change in the accounting policy (ies) the portion "except
for the changes as stated in note(s)with which we concur" may be omitted.
* 4. Substitute "surplus or deficit".
* 5. Substitute "changes in source and application of funds".
* 6. Where no Zakat is deductible, substitute "no Zakat was deductible at
source under the Zakat and Ushr Ordinance, 1980".

Where any of the matters referred to in the Auditors' Report is answered in the
negative or with a qualification, the report shall 'State the reason for such answers
along with the factual position to the best of the auditor’s information.
3. MISCELLANEOUS:
· The auditor should request management to revise the financial statements. If
the management revises the financial statements, the auditor will issue a new
report which will include an emphasis of a matter paragraph. If the
management does not revise financial statements, the auditor would notify the
Board and audit, committee that action will be taken to prevent reliance on
the auditor's report.
· The auditor should date the report on the financial statements no earlier than
the date on which the auditor has obtained sufficient appropriate audit
evidence on which to base the opinion on the financial statements.

Test your knowledge
1. What are the basic elements of audit report.

2. What auditor should do when the management does not revise financial
statements?

Chapter 22
ISA 701: Modifications to the

independent auditor’s report
Chapter Topic List
1. Circumstances where an opinion other than unqualified is required

2. Qualifications in an audit report
3. Types of opinion
4. Modification
5. Matters that do not affect the auditor’s opinion
6. Matters that do affect the auditor’s opinion
Introduction
This chapter covers ISA 701: Modification to independent auditor’s report. The
purpose of this International Standard on Auditing (ISA) is to establish standards and
provide guidance on the circumstances when the independent auditor’s report should be
modified and the form and the content of the modifications to the auditor’s report in
those circumstances.

1. CIRCUMSTANCES WHERE AN OPINION OTHER THAN

UNQUALIFIED IS REQUIRED:
There are three major categories of circumstances which necessitate a qualified
report:
DEPARTURE FROM INTERNATIONAL AUDITING STANDARDS OR
RELEVANT LAWS AND REGULATIONS:
Since the unqualified standard report states that the accounts have _en prepared in
accordance with International Accounting Standards and comply with local laws
and regulations, it implies that any departure from such standards or local laws
should be noted as "except for" the assertion.
LIMITATION OF SCOPE:
A disclaimer is required when the possible effect of scope limitation is so material
and pervasive that the auditor is unable to express an opinion. However, if
multiple accounts are not affected and the effect on financial statements is not
pervasive, a qualified report is issued.
DISAGREEMENT WITH THE AMOUNTS REPORTED IN THE FINANCIAL
STATEMENTS OR THE MANNER AND EXTENT OF DISCLOSURES:
An adverse opinion is required when the effect of a disagreement is so material
and pervasive that qualification on the report is inadequate. However, if multiple
accounts are not affected and the effect on financial statements is not pervasive, a
qualified report is issued.
2. QUALIFICATIONS IN AN AUDIT REPORT:

The auditor may, however, find it necessary to qualify his report in the following
circumstances:
o Where he has been refused an access to any books, accounts and vouchers
of the company, or where he has been unable to obtain any information or
explanations that he may have required from the directors and officers of
the company
o Where the balance sheet and the profit and loss account on which report is
being given or not, in his opinion, drawn up in conformity with the law
o Where the balance sheet does not exhibit a true and fair view of the state
of the company's affairs, as for example, where he has-failed to verify the
existence of certain assets, where the assets are not properly valued, where
the provision for depreciation is inadequate, where any know loss or
liability has not been provided for, or where an excessive or unjustified
secret reserve exists etc
o Where proper book of account, as required by law, have not been kept by
the company for the period covered by the audited accounts

2. TYPES OF OPINION:
The following are the types of opinion:
UNQUALIFIED OPINION:
An unqualified opinion should be expressed when the auditor concludes that the
financial statements give a true and fair view or are presented fairly, in all
material respects, in accordance with the applicable financial reporting
framework.
QUALIFIED OPINION:
A qualified opinion should be expressed when the auditor concludes that an
unqualified opinion cannot be expressed but that the effect of any disagreement
with management, or limitation on scope is not so material and pervasive as to
require an adverse opinion or a disclaimer of opinion. A qualified opinion should
be expressed as being ‘except for’ the effects of the matter to which the
qualification relates.
DISCLAIMER OF OPINION:
A disclaimer of opinion should be expressed when the possible effect of a
limitation on scope is so material and pervasive that the auditor has not been able
to obtain sufficient appropriate audit evidence and accordingly is unable to
express an opinion on the financial statements.
ADVERSE OPINION:
An adverse opinion should be expressed when the effect of a disagreement is so
material and pervasive to the financial statements that the auditor concludes that a
qualification of the report is not adequate to disclose the misleading or incomplete
nature of the financial statements.

3. MODIFICATION:
· Matters that Do Not Affect the Auditor’s Opinion
o Emphasis of matter
· Matters that Do Affect the Auditor’s Opinion
o Qualified opinion,
o Disclaimer of opinion, or
o Adverse opinion.
MODIFIED REPORT
Opinion is not affected Opinion is affected

[Emphasis of Matter]
· Going Concern
· Significant uncertainty Scope Limitation
· Inconsistency
Qualified (1) Adverse (2)

· Amount
· A/c Policy
· Inadequate
Disclosure
Scope Limitation
[Missing Evidence]
Qualified (1) Disclaimer Opinion (2)
(1) When one account or matter has problem

(2) When more than one accounts or matters have problem

4. MATTERS THAT DO NOT AFFECT THE AUDITOR’S

OPINION:
EMPHASIS OF MATTER:
There are four major reasons for adding a paragraph emphasizing a matter
· Significant uncertainty
· Going concern basis uncertainty
· Amendments required in other information included in annual report
· Material inconsistency between standards and the relevant laws
SIGNIFICANT UNCERTAINTIES:
Certain matters relating to financial statements may not be determinable with any
degree of accuracy (for example major claims against the company the outcome
of which cannot be determined, or tax disputes). In such cases the nature of
uncertainty should be clearly described in the audit report, the uncertainties may
also relate to issues when the auditor cannot decide for or against the client's
conclusion where subjective judgment is involved
GOING CONCERN:
Going concern may be another major cause of uncertainty. There could be doubts
whether or not the entity may continue to be a going concern. The fundamental
assumption in the preparation of financial statement is that the entity is a going
concern. The implication of this concept is that the assets would be realized at or
above carrying values and obligations would be paid off in the ordinary course of
a continuing business. Accordingly, where the circumstances reflect that the
company may become insolvent or has been persistently operating with a net
outflow of cash or is unable to meet its current obligations, the going concern
ability is in question. Obviously, in such cases doubts and uncertainties may arise
as to the' realization of assets at carrying values and the classification of current
assets and current liabilities may be inappropriate.
AUDITOR’S REPORT CONTAINING EMPHASIS OF MATTER:
“Without qualifying our opinion we draw attention to Note X to the financial
statements. The Company is the defendant in a lawsuit alleging infringement of
certain patent rights and claiming royalties and punitive damages. The Company
has filed a counter action, and preliminary hearings and discovery proceedings on
both actions are in progress. The ultimate outcome of the matter cannot presently
be determined, and no provision for any liability that may result has been made in
the financial statements.”

5. MATTERS THAT DO AFFECT THE AUDITOR’S OPINION:

An auditor may not be able to express an unqualified opinion when either of the
following circumstances exist and, in the auditor’s judgment, the effect of the
matter is or may be material to the financial statements:
· There is a limitation on the scope of the auditor’s work
· There is a disagreement with management regarding the acceptability of the
accounting policies selected, the method of their application or the adequacy
of financial statement disclosures.
LIMITATION OF SCOPE:
o A limitation on the scope of the auditor’s work may sometimes be
imposed by the entity (for example, when the terms of the engagement
specify that the auditor will not carry out an audit procedure that the
auditor believes is necessary).
o A scope limitation may be imposed by circumstances (for example, when
the timing of the auditor’s appointment is such that the auditor is unable to
observe the counting of physical inventories).
Limitation of Scope (Qualified Opinion):
We did not observe the counting of the physical inventories as of December 31,
20X1, since that date was prior to the time we were initially engaged as auditors
for the Company. Owing to the nature of the Company’s records, we were unable
to satisfy ourselves as to inventory quantities by other audit procedures.
In our opinion, except for the effects of such adjustments, if any, as might have
been determined to be necessary had we been able to satisfy ourselves as to
physical inventory quantities, the financial statements give a true and fair view of
the financial position of the Company as of December, 31…..and of the results of
its operations and its cash flows for the year then ended and comply with the
Companies Ordinance, 1984.
Limitation of Scope (Disclaimer of Opinion):
We were not able to observe all physical inventories and confirm accounts
receivable due to limitations placed on the scope of our work by the Company.
Because of the significance of the matters discussed in the preceding paragraph,
we do not express an opinion on the financial statements.
DISAGREEMENT WITH MANAGEMENT:
o The auditor may disagree with management about matters such as the
acceptability of accounting policies selected, the method of their
application, or the adequacy of disclosures in the financial statements. If
such disagreements are material to the financial statements, the auditor
should express a qualified or an adverse opinion.

Disagreement with management (Qualified Opinion):

As discussed in Note X to the financial statements, no depreciation has been
provided in the financial statements which practice, in our opinion, is not in
accordance with International Financial Reporting Standards. The provision for
the year ended December 31, 20X1, should be xxx based on the straight-line
method of depreciation using annual rates of 5% for the building and 20% for the
equipment. Accordingly, the fixed assets should be reduced by accumulated
depreciation of xxx and the loss for the year and accumulated deficit should be
increased by xxx and xxx, respectively.
In our opinion, except for the effect on the financial statements of the matter
referred to in the preceding paragraph, the financial statements give a true and fair
view of the financial position of the Company as of December, 31…..and of the
results of its operations and its cash flows for the year then ended and comply
with the Companies Ordinance, 1984.
Disagreement with management (Adverse Opinion):
In our opinion, because of the effects of the matters discussed in the preceding
paragraph(s), the financial statements do not give a true and fair view of (or ‘do
not present fairly, in all material respects,’) the financial position of ABC
Company as of December 20, 19X1, and of its financial performance and its cash
flows for the year then ended in accordance with International Financial
Reporting Standards.”

Test your knowledge
1. Circumstances where an opinion other than unqualified is required?

2. in which circumstances the auditor qualify his report?
3. What are the types of opinion?
4. What are the matters that do affect the auditor’s opinion?

Chapter 23
ISRE 2410: Review of interim financial

information
Chapter Topic List
1. General principles of a review of interim financial information

2. Objective of an engagement to review interim financial information
3. Terms of engagement
4. Procedures for a review of interim financial information
5. Evaluation of misstatements
6. Management representations
7. Auditor’s responsibility for accompanying information
8. Communication
9. Limitation on scope
10. Going concern and significant uncertainties
11. Documentation
Introduction
This chapter covers ISRE 2410: Review of interim financial information. The purpose
of this International Standard on Review Engagements (ISRE) is to establish standards
and provide guidance on the auditor’s professional responsibilities when the auditor
undertakes an engagement to review interim financial information of an audit client,
and on the form and content of the report. The term “auditor” is used throughout this
ISRE, not because the auditor is performing an audit function but because the scope of
this ISRE is limited to a review of interim financial information performed by the
independent auditor of the financial statements of the entity.

1. GENERAL PRINCIPLES OF A REVIEW OF INTERIM

FINANCIAL INFORMATION:
· The auditor should comply with the ethical requirements relevant to the audit
of the annual financial statements of the entity
· The auditor should implement quality control procedures that are applicable
to the individual engagement
· The auditor should plan and perform the review with an attitude of
professional skepticism, recognizing that circumstances may exist that cause
the interim financial information to require a material adjustment for it to be
prepared, in all material respects, in accordance with the applicable financial
reporting framework
2. OBJECTIVE OF AN ENGAGEMENT TO REVIEW INTERIM

FINANCIAL INFORMATION:
· The objective of an engagement to review interim financial information is to
enable the auditor to express a conclusion whether, on the basis of the review,
anything has come to the auditor’s attention that causes the auditor to believe
that the interim financial information is not prepared, in all material respects,
in accordance with an applicable financial reporting framework.
· A review of interim financial information does not provide a basis for
expressing an opinion whether the financial information gives a true and fair
view, or is presented fairly, in all material respects, in accordance with an
applicable financial reporting framework.
3. TERMS OF ENAGAGEMENT:
· The auditor and the client should agree on the terms of the engagement. The
agreed terms of the engagement are ordinarily recorded in an engagement
letter.
4. PROCEDURES FOR A REVIEW OF INTERIM FINANCIAL

INFORMATION:
· Understanding the Entity and its Environment, Including its Internal Control:
The auditor should have an understanding of the entity and its environment,
including its internal control, as it relates to the preparation of both annual
and interim financial information.
· Inquiries, Analytical and Other Review Procedures:
The auditor should make inquiries, primarily of persons responsible for
financial and accounting matters, and perform analytical and other review
procedures to enable the auditor to conclude whether, on the basis of the
procedures performed, anything has come to the auditor’s attention that

causes the auditor to believe that the interim financial information is not
prepared, in all material respects, in accordance with the applicable financial
reporting framework.
· The auditor should obtain evidence that the interim financial information
agrees or reconciles with the underlying accounting records.
· The auditor should inquire whether management has identified all events up
to the date of the review report that may require adjustment to or disclosure in
the interim financial information.
· The auditor should inquire whether management has changed its assessment
of the entity’s ability to continue as a going concern. When, as a result of this
inquiry or other review procedures, the auditor becomes aware of events or
conditions that may cast significant doubt on the entity’s ability to continue as
a going concern, the auditor should:
o Inquire of management as to its plans for future actions based on its going
concern assessment, the feasibility of these plans, and whether
management believes that the outcome of these plans will improve the
situation
o Consider the adequacy of the disclosure about such matters in the interim
financial information.
5. EVALUATION OF MISSTATEMENTS:
The auditor should evaluate, individually and in the aggregate, whether
uncorrected misstatements that have come to the auditor’s attention are material
to the interim financial information.
6. MANAGEMENT REPRESENTATIONS:
The auditor should obtain written representation from management that:
o It acknowledges its responsibility for the design and implementation of
internal control
o The interim financial information is prepared and presented in accordance
with the applicable financial reporting framework
o It has disclosed to the auditor all significant facts relating to any frauds or
suspected frauds known to management that may have affected the entity
o It has disclosed to the auditor the results of its assessment of the risks that
the interim financial information may be materially misstated as a result of
fraud
o It has disclosed to the auditor all significant events that have occurred
subsequent to the balance sheet date and through to the date of the review
report that may require adjustment to or disclosure in the interim financial
information.

7. AUDITOR’S RESPONSIBILITY FOR ACCOMPANYING

INFORMATION:
· The auditor should read the other information that accompanies the interim
financial information to consider whether any such information is materially
inconsistent with the interim financial information
· If a matter comes to the auditor’s attention that causes the auditor to believe
that the other information appears to include a material misstatement of fact,
the auditor should discuss the matter with the entity’s management.
8. COMMUNICATION:
· When, as a result of performing the review of interim financial information, a
matter comes to the auditor’s attention that causes the auditor to believe that it
is necessary to make a material adjustment to the interim financial
information for it to be prepared, in all material respects, in accordance with
the applicable financial reporting framework, the auditor should communicate
this matter as soon as practicable to the appropriate level of management
· When, in the auditor’s judgment, management does not respond appropriately
within a reasonable period of time, the auditor should inform those charged
with governance
· When, in the auditor’s judgment, those charged with governance do not
respond appropriately within a reasonable period of time, the auditor should
consider:
o Whether to modify the report
o The possibility of withdrawing from the engagement
o The possibility of resigning from the appointment to audit the annual
financial statements
9. LIMITATION ON SCOPE:
· When the auditor is unable to complete the review, the auditor should
communicate, in writing, to the appropriate level of management and to those
charged with governance the reason why the review cannot be completed, and
consider whether it is appropriate to issue a report
· If, after accepting the engagement, management imposes a limitation on the
scope of the review, the auditor requests the removal of that limitation.
If management refuses to do so, the auditor is unable to complete the review
and express a conclusion. In such cases, the auditor communicates, in writing,
to the appropriate level of management and those charged with governance
the reason why the review cannot be completed.

10. GOING CONCERN AND SIGNIFICANT UNCERTAINTIES:

· If adequate disclosure is made in the interim financial information, the auditor
should add an emphasis of matter paragraph to the review report to highlight
a material uncertainty relating to an event or condition that may cast
significant doubt on the entity’s ability to continue as a going concern.
· If a material uncertainty that casts significant doubt about the entity’s ability
to continue as a going concern is not adequately disclosed in the interim
financial information, the auditor should express a qualified or adverse
conclusion, as appropriate. The report should include specific reference to the
fact that there is such a material uncertainty.
· The auditor should consider modifying the review report by adding a
paragraph to highlight a significant uncertainty
11. DOCUMENTATION:
The auditor should prepare review documentation that is sufficient and
appropriate to provide a basis for the auditor’s conclusion and to provide
evidence that the review was performed in accordance with International
Standards on Review Engagement and applicable legal and regulatory
requirements

Test your knowledge
1. What are the objectives of an engagement to review interim financial

information?
2. What are the procedures for a review of interim financial information?
3. What is auditor’s responsibility for accompanying information?
4. What is the auditor’s duty regarding documentation of interim financial
information?

Chapter 24
Legal Provisions Relating to Auditors

Chapter Topic List
1. Appointment
2. Commission powers to appoint auditor
3. Remuneration
4. Procedure for change of subsequent auditors/ removal auditors/
appointment of new auditors
5. Removal of auditor
6. Qualification of auditors
7. Disqualifications of auditors
8. Rights of an auditor
9. Duties of an auditor
Introduction
This chapter covers the legal provisions regarding appointment, remuneration, removal
duties, qualification and disqualifications in pursuance to Companies Ordinance 1984.

1. APPOINTMENT:
· First Auditors:
o The first auditors of a company shall be appointed by the directors within
60 days of incorporation of the company
o The first auditors will hold office till the first annual general meeting
o If the directors fail to appoint the first auditors, the members shall appoint
the first auditors
o Where the first auditors are not appointed either by the directors or by the
members within 120 days of incorporation of the company, the Securities
Exchange Commission of Pakistan will appoint the auditor
· Subsequent Auditors:
o At each annual general meeting the company (members) shall appoint the
auditors
o The auditors shall hold office from the conclusion of that meeting till the
conclusion of next annual general meeting
o If no auditors are appointed at annual general meeting, the Securities
Exchange Commission of Pakistan shall appoint an auditor. To exercise
this power the company must give notice to Commission within one week
of these powers having become exercisable
· Casual Vacancy:
o Any casual vacancy shall be filled by directors
o Auditors so appointed shall hold office till next annual general meeting
o If directors do not appoint auditors to fill casual vacancy within 30 days,
Commission may appoint an auditor
2. COMMISSION POWERS TO APPOINT AUDITOR:

The Securities & Exchange Commission of Pakistan may appoint an auditor if the
following situations arise:
o First auditors are not appointed within 120 days from incorporation
o Subsequent auditors are not appointed in annual general meeting
o Casual vacancy is not filled within 30 days
o Auditors appointed are unwilling to act as auditors
To exercise this power, the company must give notice to Commission within one
week of its powers becoming exercisable.
3. REMUNERATION:
· If auditors are appointed by directors, directors shall fix the remuneration.

· If auditors are appointed by commission, commission shall fix remuneration

· In all other cases, the members shall fix the remuneration
4. PROCEDURE FOR CHANGE OF SUBSEQUENT AUDITORS/

REMOVAL AUDITORS/ APPOINTMENT OF NEW
AUDITORS:
New auditors can be appointed in place of retiring auditors if the following
requirements are fulfilled.
o Notice from a member is required for a resolution at the AGM
o The member shall give notice to the company at least 14 days before the
AGM that he intends to propose the appointment of another person as
auditor
o On receipt of the notice the company shall send a copy of such notice to
the:
§ Retiring auditor
§ Members at least seven days before the AGM
o In case of a listed company, notice shall be published at least in one issue
of an English and an Urdu daily newspaper having circulation in the
province where the stock exchange(s) is situate on which the shares of the
company are listed
o The retiring auditor can make representations and the company shall send
a copy of representation to a member or it may be read at AGM.
Provided that the representation cannot be sent OR read at the AGM if the
Registrar does not permit on the application of the company or any other
person
o A company within 14 days after the AGM shall notify to the Registrar of
the
§ Appointment of new auditors with their consent letter
§ Retirement or removal of auditors
5. REMOVAL OF AUDITOR:
· First auditor appointed by the directors may be removed by the members in a
general meeting
· Auditor or auditors appointed in a general meeting may be removed before
conclusion of the next annual general meeting through a special resolution

6. QUALIFICATION OF AUDITORS:
For appointment as auditor of:
o Public Company
o Private Company which is a subsidiary of a Public Company
o Private Company having paid up capital of three million rupees or more
The person must be a Chartered Accountant within the meaning of the Chartered
Accountants Ordinance, 1961.
7. DISQUALIFICATIONS OF AUDITORS:
Following persons are not qualified to become auditors of a company
o Present directors, other officer or employees of the company or who held
these offices during the last three years.
o A partner or employee of a director, other officer or employee of the
company
o A spouse of a director
o A person who is indebted to the company
o A body corporate
o A person disqualified for appointment as an auditor due to above reasons
is disqualified from holding the office of auditor of another company
which is a subsidiary or holding company of that company
o A person or his spouse or minor children or in case of firm all partners of
such firm who holds any shares of an audit client or of its associated
companies
Provided that if such a person holds shares prior to his appointment as
auditors, whether as an individual or a partner in a firm the fact shall be
disclosed on his appointment as auditor and such person shall disinvest
such shares within ninety days of such appointment.
8. RIGHTS OF AN AUDITOR:
The following are the rights of auditor:
o Right of access to books of account and vouchers
o Right to receive information and explanations
o Right of access to books and papers of branch
o Right to receive notices of general meetings and to attend those meetings
o Right to make representation where another person is being appointed as
auditor

9. DUTIES OF AN AUDITOR:
The following are the duties of auditor:
o To give a report to the members on the accounts, books of account,
balance sheet and profit and loss account examined by him
o Where any matter reported upon is answered in the negative or with a
qualification the report shall include reasons for such qualification with
factual position
o To include in the report of the company such matters as directed by the
Federal Government.
o To attend those annual general meetings of a listed company, either
himself or through authorized person, in which the balance sheet, profit
and loss account and the auditors' report are to be considered
o To make report for inclusion in prospectus
o To certify receipts and payments account in the statutory report
o To make report on declaration of solvency in case of voluntary winding up

Test your knowledge
5. What are the provisions of the Companies Ordinance, 1984 regarding the
appointment and remuneration of auditors of Companies?
6. What are the provisions of the Companies Ordinance, 1984 with regard to
qualification and disqualification of auditor?
7. What are the powers and duties of auditors as provided in the Companies
Ordinance, 1984?
8. Describe the procedures to be followed for appointing an auditor of a company
under the following circumstances?

Auditing

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SYNOPSIS OF INTERNATIONAL STANDARDS ON AUDITING

Syllabus of Module D Examination 01

01 International Federation of Accountant (IFAC) 22

03 ISA 200: Objective and General Principles Governing an Audit 53

04 ISA 210: Terms of Audit Engagements 59

05 ISA 220: Quality Control for Audits 64

06 ISA 230: Audit Documentation 73

07 ISA 240: Fraud and Error 80

08 ISA 300: Planning 87

09 ISA 315: Understanding the entity and its environment 96

10 ISA 320: Audit Materiality 105

11 ISA 500: Audit Evidence 109

12 ISA 505: External Confirmation 119

13 ISA 520: Analytical Procedures 125

14 ISA 530: Audit Sampling 130

15 ISA 550: Related Parties 143

16 ISA 560: Subsequent Events 148

17 ISA 580: Management Representation 154

18 ISA 600: Using the work of another auditor 161

19 ISA 610: Considering the work of Internal Audit 166

20 ISA 620: Using the work of an Expert 172

21 ISA 700: Auditor’s Report 177

22 ISA 701: Modification to the auditor’s report 183

23 ISRE 2410: Review of Interim Financial Information 191

24 Legal Provisions relating to Auditors 197

INTERMEDIATE EXAMINATION – MODULE D PAPER D 11

SECTION SYLLABUS CONTENTS WEIGHTAGE

A General concepts & principles of audit 25

C Audit conclusions and reporting 20

From Desk of Yawer Zakaria Page No 1

· Introduction to international auditing and assurance standard setting body

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ISA-700 ISA-701 ISRE-2410

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A summary of the oral representation written by the auditor.

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· The length of time, in respect of which the reliance is being placed

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International Federation Of Accountant

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5. INTERNATIONAL AUDITING PRACTICES COMMITTEE

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automatically confers membership of the International Accounting Standards

6. INTERNATIONAL AUDITING AND ASSURANCE BOARD

· Establishing high quality auditing standards and guidance for financial

· Establishing high quality standards and guidance for other related

· Publishing other pronouncements on auditing and assurance matters,

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