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Concept and need for audit & assurance Page 1

Ch # 1 Concept and need for Audit and Assurance

The meaning of Audit

Definition and objective of audit

An audit is an official examination of the accounts of an entity by an auditor.

Main objective of an audit is to enable an auditor to convey an opinion as to whether or not the
financial statements of an entity are prepared according to an applicable financial
reporting framework.

Financial statements (F/S)

A structured representation of historical financial information, including disclosures, intended to
communicate an entity’s economic resources or obligations at a point in time, or the changes therein for
a period of time, in accordance with a financial reporting framework.

As per IAS-1 F/S have the following components:

 Statement of Financial Position (Balance Sheet)
 Statement of Profit or Loss and other comprehensive income
 Statement of Changes in Equity
 Cash Flow Statement
 Notes to the Financial Statements
 Comparative information prescribed by the standard

Applicable financial reporting framework (AFRF)

The AFRF adopted by management and, where appropriate, TCWG in the preparation of F/S that is
acceptable in view of the nature of entity and objective of F/S, or that is required by law or regulation.
The AFRF is decided by legislative or regulatory environment within each individual country, and
accounting standards (e.g. IFRS).

Concepts of accountability, stewardship and agency

 The directors have a stewardship role.

 They look after the assets of the company and manage them on behalf of the shareholders.
 Relationship between shareholders and the board of directors (BOD) is also an application
of the principle of agency.
 The agent has a legal duty to act in the best interests of the principal
 As agents for shareholders, the BOD should be accountable to the shareholders.
 To show their accountability, it is a general principle of company law that the directors are
required to prepare annual F/S, which are presented to shareholders for their approval.
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The audit report: independence, materiality and true and fair

The key features of the audit report are as follows:

 Auditors producing the report are independent from the directors producing the F/S.
 The report gives an opinion on whether the financial statements “give a true and fair
view”, or “present fairly” the position and results of the entity in all material respects.

Independence of the auditor

 External auditor must be independent from the directors

 If he is not independent, his opinion is likely to be influenced by the directors.

True and fair view (fair presentation)

 The term ‘true’ implies free from error,

 The term ‘fair’ implies that there is no undue bias in the F/S or the way in which they have
been presented.
 The phrases ‘true and fair view’ and ‘present fairly’ indicate that a judgement is being given
that F/S can be relied upon and have been properly prepared in accordance with an
appropriate AFRF.

Materiality concept

 The auditor reports in accordance with the concept of materiality.

 He gives an opinion on whether the F/S present fairly in all material respects the financial
position and performance of the entity.
 Information is material if, on the basis of the F/S, it could influence the economic decisions
of users should it be omitted or misstated.
 The auditor will not aim to examine every number in the F/S. He will concentrate his
efforts on the more significant items in the financial statements.

Responsibility of management and those charged with governance

Management and those charged with governance (TCWG) are responsible for:
 Prevention and detection of fraud
 Preparation of the financial statements
 Design and implementation of effective internal controls
 Providing the auditor with:
- Access to information relevant to the preparation of the F/S
- Additional information relevant to the audit
- Unrestricted access to persons whom he needs access to in order to complete the audit
 Providing written representations to the auditor at the end of the audit
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Meaning of Assurance

 ‘Assurance’ means confidence.

 In an assurance engagement, an ‘assurance firm’ is engaged by one party to give an opinion
on a piece of information that has been prepared by another party.
 The opinion is an expression of assurance about the information that has been reviewed.
 It gives assurance to the party that hired the assurance firm.

Levels of assurance

Assurance falls into one of two categories:

 Reasonable Assurance – A high (but not absolute) level of assurance provided by the
practitioner’s conclusion expressed in a positive form.
E.g. “In our opinion the F/S are true and fair”. (i.e. Audit)

 Limited Assurance – A moderate level of assurance provided by the practitioner’s

conclusion expressed in a negative form. It is necessary in the situations where the
accountant/auditor cannot obtain sufficient evidence to provide positive assurance

E.g. “Based on our review, nothing has come to our attention that causes us to believe
that the accompanying F/S do not give a true and fair view”. (i.e. Review)

Assurance provided by audit

 Provides a high, but not absolute, level of assurance

 Absolute assurance is not provided as there are some inherent limitations of an audit

Assurance provided by review

 A review is a ‘voluntary’ investigation.

 Review would provide only a moderate level of assurance that the information under
review is free of material misstatement.
 The resulting opinion is usually expressed in the form of negative assurance.
 Negative assurance is an opinion that ‘nothing has come to our attention to suggest that the
information is misstated’.
 A review does not provide the same amount of assurance as an audit.
 Negative assurance is necessary in situations where the accountant/auditor cannot obtain
sufficient evidence to provide positive assurance.
(e.g. the management of a client entity may ask the audit firm to carry out a review of a
cash flow forecast that relates to the future and is based on many assumptions)
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Elements of an Assurance Engagement

An engagement in which a practitioner expresses a conclusion designed to enhance the degree

of confidence of the intended users other than the responsible party about the outcome of the
evaluation or measurement of a subject matter against criteria. The outcome of the evaluation
or measurement of a subject matter is the information that results from applying criteria.

An assurance engagement will consist of the following 5 elements:

1) A three party relationship:

 Practitioner (e.g. audit firm)

 Responsible party (e.g. directors and management)
 Intended users: (e.g. shareholders)

2) Subject matter:

This is the data such as the financial statements that have been prepared by the
responsible party for the practitioner to evaluate.

3) Suitable criteria:

Rules against which the subject matter is evaluated in order to reach an opinion. In a
statutory audit this would be the AFRF.

4) Evidence:

Information used by the practitioner in arriving at the conclusion on which their opinion is
based. This must be sufficient and appropriate.

5) Assurance report:

The report containing the practitioner's opinion. This is issued to intended user after the
collection of evidence.
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Statutory Audit - Regulatory framework (Companies Act 2017)

Appointment and remuneration of auditors (Sec 246)

Auditor Time of Appointment Appointed by Term of Office

First 90 days of incorporation Directors Till 1st AGM
Subsequent At AGM Members on recommendation Till next AGM
of the BOD
Casual Vacancy 30 days of such vacancy Directors Till next AGM

 Auditor, appointed by directors or the members, may be removed before conclusion of next
AGM by Special Resolution
 If auditor is removed by Special resolution, next auditor will be appointed by board with
prior approval of SECP.

SECP shall appoint auditor, on its own motion or on application by company or members, if:
 1st auditors not appointed by directors within 90 days of the incorporation
 Auditor not appointed in an AGM
 Casual vacancy not filled by directors within 30 days
 Auditors appointed are unwilling to act

Appointing Authority Remuneration Fixed by

Directors Directors
SECP SECP
All other cases Members

Retirement of existing and Appointment of new auditor in an AGM

 Member(s) having at least 10% shareholding shall also be entitled to propose any auditor
whose consent has been obtained.
 A notice shall be given to company at least 7 days before the date of the AGM..
 On receipt of such notice, company shall:
- Sent a copy of notice to the retiring auditor, forthwith.
- Post it on its website.
 Retiring auditor can make representation to company at least 2 days before AGM. It shall
be read in AGM and it shall be mandatory for auditor/representative to attend the meeting.
 Company shall intimate the registrar within 14 days of appointment / removal / casual
vacancy together with the consent of appointed auditor.
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Qualification and disqualification of auditors (Sec 247)

 Auditor shall be a CA having valid certificate of practice form ICAP or a Firm of CAs for:
- Public Company
- Private Company which is subsidiary of Public Company
- Private Company having paid up share capital of at least Rs. 3 million.
 For companies other than above, auditor shall be CA or CMA having certificate of practice
from respective institute or Firm of CAs/CMAs having such criteria as may be prescribed
 Firm where majority of partners practicing are qualified for appointment can be appointed
in firms name.
 Only partners meeting above criteria shall be authorized to act and sign on behalf of firm.

DISQUALIFICATIONS OF AUDITOR

1. Person who during preceding 3 years was director, other officer or employee of Company
2. Person who is a director, other officer or employee of Company
3. Person who is a partner or employee of a director, officer or employee of Company
4. Spouse of the director of Company
5. Person indebted to Company, other than in ordinary course of business of such entities
- Not be considered indebted, if owes less than 1,000,000 to a credit card issuer
- Not be considered indebted, if unpaid utility dues for ≤ 90 days to utility Company
6. Body Corporate
7. Person or his spouse and his minor children, or in case of a firm, all partners of a firm who
holds any shares in Company or its associated company.
(If he holds shares before appointment, the fact shall be disclosed at time of appointment
and shall disinvest such shares within 90 days of appointment)
8. Person who has given a guarantee/security in connection with the indebtedness of any
third person to the company other than in the ordinary course of business of such entities;
9. Person or a firm who, directly or indirectly, has business relationship with the company
other than in the ordinary course of business of such entities;
10. Person who has been convicted by a court of an offence involving fraud and a period of 10
years has not elapsed from the date of such conviction;
11. Person who is not eligible to act as auditor under the code of ethics as adopted by the
ICAP and the ICMAP;

 Person disqualified as auditor of a Company shall also be disqualified for its Holding
company, its Subsidiary Company or Subsidiary Company of its Holding Company.
 If after appointment auditor becomes disqualified, he shall deem to vacate office with effect
from date he becomes disqualified
 If an unqualified/disqualified person is appointed as auditor; It shall be void and SECP may
appoint a qualified person in place of the auditor appointed by Company.
 A person, who not being qualified to be an auditor, acts as auditor of a company shall be
liable to a penalty of level 2
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Rights and duties of auditors

RIGHTS (Sec 248)

 To access freely to all books & papers of Company and all supporting documents
 Access to copies/extracts of branch records as transferred to Principal office of company
 To require any of the following, to provide him necessary information or explanations:
- Any director, officer or employee of the company;
- Any person holding or accountable for any of company’s books, accounts or vouchers;
- Any subsidiary of the company;
- Any officer, employee or auditor of any subsidiary
- Any person holding or accountable for books, accounts or vouchers of any subsidiary
 The auditor is entitled to attend, receive all notices of any general meeting
 The auditor is entitled to be heard at any general meeting which he attends on any part of
the business which concerns him as auditor

DUTIES (Sec 249)

 Conduct audit, prepare report and express opinion in compliance with the requirements
of ISA adopted by the ICAP.
 Carry out such examination to form an opinion as to
- Whether adequate accounting records have been kept and adequate returns have been
received from branches not visited by him; and
- Whether the company’s F/S are in agreement with accounting records and returns.
 Auditor shall make a report on books of accounts and F/S; shall be laid before AGM.
 The report shall state; whether or not:
- They have obtained sufficient audit evidence for audit
- In their opinion, proper books of accounts have been kept
- Statement of Financial position and profit and loss account and Other Comprehensive
Income or the income and expenditure account and the cash flows has been prepared
in accordance with Act and are in agreement with their books and returns.
- The true and fair view has been given by F/S
- In their opinion all the investments made, expenditure incurred and guaranteed
extended was for the purpose of the business.
- Zakat deductable under Zakat and Ushr Ordinance 1980 been deducted & deposited.
 If auditor's report makes reference to some other report or statement:
- Such report be annexed to auditor's report and be considered a part of report.
 SECP may direct any Company or class of Company that the auditor’s report shall also
include a statement of such additional matters as may be so specified.
 Where any qualification is put in auditor's report, there shall be added the reasons for it
and the true position of Company to the best of auditor's knowledge.
 For listed company, auditor or a person authorized by him in writing shall be present in the
general meeting in which financial statements and auditor’s report are to be considered.
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 SECP may by general or special order, direct, that the statement of compliance to be
attached with Directors Report, shall be reviewed by the auditor who shall issue a review
report to the members on the format as specified.

Audit of Cost Accounts (Sec 250)

Where any company or class of companies are required to keep cost accounts, SECP may
direct audit of cost accounts be conducted in specified manner & stipulations by a CA or CMA
having same powers, duties etc as auditor, and other prescribed powers, duties & liabilities

Such audit shall be directed by SECP subject to the recommendation of the regulatory
authority supervising the business of relevant sector.

Any contravention or default in complying with requirements of sections 246, 247, 248 and 250
shall be an offence liable to a penalty of level 3 on the standard scale (Sec 252)

Following definitions are important to understand and to be memorised in the

context of answering the scenarios of Companies Act area in the ICAP exams

Associated Company (Section 2(4) – Companies Act 2017)

Two or more companies/undertakings, interconnected with each other in the

Tutor
following manner
Note  If one is the subsidiary of another; or
 If companies or undertakings are under common management or control; or
 If undertaking is a modaraba managed by the company; or
 If owner, partner, director or person having ≥ 20% voting power in one
company/undertaking, is also owner, partner, director or person having ≥
20% voting power in other company/undertaking; or

Note: Investment of spouse or minor children deemed to be investment of that person:

Following person / investments do not create relationship of associates

 Nominee director of Federal/Provincial Government or a financial
institution owned/controlled by those or NIT.
 Directorship of a person appointed as an “independent director”; or
 Shares owned by the NIT or a financial institution directly or indirectly owned
or controlled by the Federal Government or a Provincial Government or CDC

Subsidiary company (Section 2(68) – Companies Act 2017)

It means a company or body corporate whose more than 50% voting securities
are held or controlled (directly or indirectly), by some other company or such
other company controls the composition of the board of such company.
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How to deal with case study question in exam

(Companies Act 2017)

Tutor’s
Note
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International Standards on Auditing (ISAs)

Introduction to IFAC and IAASB

IFAC

 ICAP is a member of IFAC.

 IFAC is the global organization for the accountancy profession.
 It is dedicated to serving public interest by strengthening the profession and contributing
to the development of strong international economies.
 It has 175 members and associates in 130 countries, representing approximately 3 million
accountants in public practice, education, government service, industry, and commerce.
 IFAC provides the structures and processes that support the development, adoption, and
implementation of high quality international standards.
 IFAC supports the development of the accountancy profession in emerging economies, and
speaks out on public interest issues where the profession’s voice is most relevant.
 IFAC promotes its values of integrity, transparency, and expertise.
 IFAC includes four boards:
- IAASB: The International Auditing and Assurance Standards Board
- IAESB: The International Accounting Education Standards Board
- IESBA: The International Ethics Standards Board for Accountants
- IPSASB: The International Public Sector Accounting Standards Board

IAASB

 It is an independent standard-setting body

 It sets high-quality international standards for auditing, assurance, and other related
standards
 It facilitates the convergence of international and national auditing & assurance standards.

Process of issuing auditing standards

 A subject is selected for detailed study, with a view to eventually issuing an ISA.
 After study and research, if there is agreement to proceed, an exposure draft is produced.
 The exposure draft is approved by the IAASB
 After approval it is distributed widely amongst the profession and others for comment.
 Comments and proposed amendments are considered by the IAASB.
 The draft standard is then modified and approved by the IAASB.
 The new ISA is then published.
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International Auditing Practice Statements

In addition to ISAs, the IAASB also issues International Auditing Practice Statements (IAPSs).
IAPSs aim to:
 Provide help to auditors in implementing ISAs
 Promote good auditing practice in general.

Standards issued by IAASB

Type of standard When applied

International Standards on Auditing (ISAs)
International Standards on Review
Engagements (ISREs)
International Standards on Assurance
Engagements (ISAEs)
International Standards on Related Services
(ISRSs)
International Standards on Quality Control
(ISQCs)
In the audit of historical financial information
In the review of historical financial
information
In assurance engagements other than audits
or reviews of historical financial information
On compilation engagements & engagements
to apply agreed upon procedures
Apply to all services carried out under the
IAASB’s engagement standards

 The IAASB’s pronouncements do not override local laws or regulations.

 If local laws or regulations differ from, or conflict with, the IAASB’s standards then a
professional accountant should not state that he has complied with the IAASB’s standards.

International Standards on Auditing (ISAs)

Each ISA contains:

 An introduction
 Objectives
 Definitions (if necessary)
 Requirements which are shown by word “shall” and are to be applied as relevant to audit
 Application and other explanatory material which is for guidance only.

Overall objectives of independent auditor and conduct of audit in accordance with ISA

The objectives of the auditor are to:

 Obtain reasonable assurance about whether the F/S as a whole are free from material
misstatement, whether due to fraud or error in accordance with AFRF.
 Report on the F/S, and communicate in accordance with the auditor’s findings.
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ISA 200 requires the auditor to:

 Comply with all ISAs relevant to the audit
 Comply with relevant ethical requirements
 Plan and perform an audit with professional scepticism
 Exercise professional judgement in planning and performing an audit
 Obtain sufficient appropriate audit evidence to allow him to obtain reasonable assurance

Professional skepticism –An attitude that includes a questioning mind, being alert to conditions which
may indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence.

Professional judgment – The application of relevant training, knowledge and experience, within the
context provided by auditing, accounting and ethical standards, in making informed decisions about the
courses of action that are appropriate in the circumstances of the audit engagement.

Sufficient appropriate audit evidence –Sufficiency is the measure of the quantity of audit evidence.
Appropriateness is the measure of the quality of audit evidence in terms of its relevance and reliability.

 An audit involves performing procedures to obtain sufficient appropriate audit evidence

about the amounts and disclosures in the F/S.
 The procedures include the assessment of risks of material misstatement of the F/S,
whether due to fraud or error.
 In making those risk assessments, the auditor considers internal control relevant to the
entity’s preparation and fair presentation of F/S in order to design appropriate audit
procedures, but not for the purpose of expressing an opinion on their effectiveness.
 An audit also includes evaluating the appropriateness of accounting policies used and the
reasonableness of accounting estimates made by management

Scope of Interim audit and Final Audit

Audit fieldwork is typically performed in two phases:

 Interim audit – this is performed before the end of the accounting period and may include:
- Discussions with staff and management designed to enhance auditor’s understanding
of the entity and the environment.
(To more fully plan the audit and hopefully reduce the work performed at year end)
- Recording information about internal control systems that are relevant to the audit;
- Performing some preliminary controls testing or substantive procedures

 Final audit – this is performed after the year-end when the draft F/S are available and
include full-year balances.
- Normally the interim audit work is performed by fewer but more senior staff.
- The final audit is then much longer and involves the whole audit team.
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Advantages and Limitations of Statutory Audits

Advantages of statutory audits:

 Increases the credibility of published financial statements.

 Confirms to management that they have performed their statutory duties correctly.
 Provides assurance to management that they have complied with non statutory
requirements
 Provides feedback on the effectiveness of internal controls.
 Where internal controls are weak or inadequate, the auditor will give recommendations for
improvement.
 This will assist management in reducing risk and improving the performance of the
company.

Inherent Limitations of an Audit

 The cost of an audit can be very high.

 Disruption caused to a company's staff during the audit
 Some items in the subject matter might be estimates whose truth and fairness will not be
known with certainty until some point in the future. This means the assurance opinion is
ultimately subjective and judgmental.
 Most fraud will include an attempt to deliberately conceal the truth or misrepresent
information.
 Auditor routinely uses sampling rather than tests every item.
 Irrespective of how strong a client's systems are, they will always incorporate some degree
of inherent limitations.
 Audit evidence is persuasive rather than conclusive.