6/11/2023

CHAPTER 1:
CONCEPT OF AND NEED
FOR AUDIT
Instructor: Assoc.Prof. Dr. Doan Thanh Nga, CPA (Australia)

CHAPTER 1 LEARNING OBJECTIVES

1-1 Define the concept of assurance and compare the purposes and
characteristics of reasonable and limited levels of assurance obtained
from different assurance engagements
1-2 State why users desire assurance reports and provide examples of the
benefits gained from them such as to assure the quality of an entity’s
published corporate responsibility or sustainability report
1-3 Compare the functions and responsibilities of the different parties
involved in an assurance engagement

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1. WHAT IS ASSURANCE?

1.1. Definition

Assurance engagement: It is when 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.

1. WHAT IS ASSURANCE?
1.1. Definition

5 key elements of an assurance engagement:

Three party relationship

Subject matter

Criteria

Evidence

Report

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1. WHAT IS ASSURANCE?
1.1. Definition
Three party relationship

Three people or groups of people

involved:
– the practitioner (accountant)
– the intended users
– the responsible party (the person(s)
who prepared the subject matter)

1. WHAT IS ASSURANCE?
1.1. Definition
Subject matter

The subject matter of an assurance engagement may vary considerably.

However, it is likely to fall into one of three categories:
• Data (for example, financial statements or business projections)
• Systems or processes (for example, internal control systems or computer
systems)
• Behaviour (for example, social and environmental performance or
corporate governance)

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1. WHAT IS ASSURANCE?
1.1. Definition
Criteria
Criteria: to judge whether the information is reliable and can be trusted.

For example, in an assurance engagement relating to financial statements, the

criteria may be accounting standards
Other criteria:
o processes may be compared to establish industry best practices (accredited
management standards such as ISO 9000)
o or behaviours to ethical standards, corporate governance or
environmental standards.

1. WHAT IS ASSURANCE?
1.1. Definition
Evidence

• The practitioner obtain and evaluate sufficient and appropriate evidence

to support the assurance opinion.
• The practitioner must obtain evidence as to whether the criteria have been
met.
• We will look at the collection of evidence in detail later in this Workbook.

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1. WHAT IS ASSURANCE?
1.1. Definition
Report

• Provided in the form of a written report and will contain key information
and any issues or assurances given as a result of the engagement.

1. WHAT IS ASSURANCE?
1.1. Definition

Context example: Assurance engagement

Workbook: page 7

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Interactive question 1: Assurance engagement (p. 7)

You are an accountant who has been approached by Jamal, who wants to invest in
Company X. He has asked you for assurance whether the most recent financial
statements of Company X are a reliable basis for him to make his investment decision.
Requirement
Identify the key elements of an assurance engagement in this scenario, if you accepted
the engagement.

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1. WHAT IS ASSURANCE?
1.2. Levels of assurance
Summary of types of engagement
Type of Evidence obtained Example of wording Conclusion
engagement given

Reasonable Sufficient appropriate In our opinion, the financial Positive

assurance evidence is obtained by: statements present fairly, in expression
engagement: • Obtaining an understanding all material respects, (or give
High level of of the entity a true and fair view of) the
assurance (less financial position of the
than absolute • Assessing risk Company, and of its financial
assurance) • Responding to risk performance and its cash
Eg: statutory flows for the year.
• Performing further
audit procedures (sampling) to
draw a conclusion
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1. WHAT IS ASSURANCE?
1.2. Levels of assurance

Summary of types of engagement

Type of Evidence sought Example of wording Conclusion

engagement given
Limited The evidence gathered Based on our work described in Negative
assurance is limited, involving this report, nothing has come to expression
engagement techniques such as our attention that causes us to
(less than enquiry and analytical believe that internal control is
reasonable procedures not effective, in all material
assurance) respects, based on XYZ criteria.
Eg: review of
half-year
results

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1. WHAT IS ASSURANCE?
1.2. Levels of assurance

T/F Question:
Reasonable assurance is high level of assurance
A False
B True

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1. WHAT IS ASSURANCE?
1.2. Levels of assurance

The following is an extract from an independent accountant’s unmodified report on a

profit forecast: “Based on our examination of the evidence supporting the
assumptions, nothing has come to our attention which causes us to believe that these
assumptions do not provide a reasonable basis for the forecast.”

Requirement:

Which one of the following best describes the type of assurance provided by this
statement?

A. Positive assurance expressed negatively

B. Negative assurance expressed positively

C. High level of assurance expressed negatively

D. Limited level of assurance expressed negatively 15

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1. WHAT IS ASSURANCE?
1.3. Examples of assurance engagements
The key example of an assurance engagement in the UK is a
statutory audit.
Other examples include:
• Pension scheme audits
• Charity audits (Companies Act, Charities Act)
• Solicitors’ audits (in line with the Solicitors' Accounts Rules)
• Environmental audits
• Insurance company audits
• Local authority audits
• Other types of audit, for example magazine or newspaper circulation
reports, due diligence on an acquisition target, fraud investigations.
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2. WHY IS ASSURANCE IMPORTANT?

2.1. Users

• In the key assurance service of audit, the users are the shareholders of a
company, to whom the financial statements are addressed.
• In other cases, the users might be the board of directors of a company or a
subsection of them

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2. WHY IS ASSURANCE IMPORTANT?

2.2. Benefits of assurance
Key benefit: Independent and external professional verification.

Additional benefits:
• May give confidence to other users (enhancing the credibility of the information)
• Preventing fraud and error and reducing management bias
• Draws attention to deficiencies or modifications in the prepared information
• Ensuring high quality and reliable information, leading to effective markets as
investors have more faith and trust in financial accounts and the underlying
companies
• Growing public perception that this is an important area and stakeholders are
unlikely to associate with businesses that could damage their reputation.
Corporate responsibility or sustainability reports provide assurance for
stakeholders that this published information is reliable and accurate
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Interactive question 2: Benefit of assurance (page 11)

Which three of the following are benefits of assurance work?

A. An independent, professional opinion
B. Additional confidence given to other related parties
C. Testing as a result of sampling is cheaper for the responsible party
D. Judgements on estimates can be conclusive
E. Assurance may act as a deterrent to error or fraud

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PhD. Ta Thu Trang

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3. WHY CAN ASSURANCE NEVER BE ABSOLUTE?

3.1. Limitations of assurance
• Testing is used – the auditors do not oversee the process of building the
financial statements from start to finish

• Accounting systems on which assurance providers may place a degree of

reliance also have inherent limitations

• Most audit evidence is persuasive rather than conclusive

• Sampling approach - Assurance providers would not test every item in the
subject matter

• Client’s staff members may collude in fraud that can then be deliberately
hidden from the auditor or misrepresent matters to them for the same purpose
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3. WHY CAN ASSURANCE NEVER BE ABSOLUTE?

3.1. Limitations of assurance (cont.)
• Assurance provision can be subjective and professional judgements have to be
made

• Assurance providers rely on the responsible party and its staff to provide
correct information, which in some cases may be impossible to verify by other
means

• Some items in the subject matter may be estimates and are therefore uncertain.

• Nature of the assurance report might itself be limiting, as every judgement and
conclusion the assurance provider has drawn cannot be included in it

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3. WHY CAN ASSURANCE NEVER BE ABSOLUTE?

3.1. Limitations of assurance (cont.)
• Assurance provision can be subjective and professional judgements have to be
made

• Assurance providers rely on the responsible party and its staff to provide
correct information, which in some cases may be impossible to verify by other
means

• Some items in the subject matter may be estimates and are therefore uncertain.

• Nature of the assurance report might itself be limiting, as every judgement and
conclusion the assurance provider has drawn cannot be included in it

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3. WHY CAN ASSURANCE NEVER BE ABSOLUTE?

3.2. The expectations gap
• The expectations gap is defined as the difference between the apparent public
perceptions of the responsibilities of auditors on the one hand (and hence the
assurance that their involvement provides) and the legal and professional
reality on the other.

• Common misconceptions are that auditors are responsible for detecting all
instances of fraud and error within the financial statements.

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3. WHY CAN ASSURANCE NEVER BE ABSOLUTE?

3.2. The expectations gap
Expectations gap – reasons:

• Users are not aware of the nature of the limitations on assurance

provision, or do not understand them.

• Distinction between reasonable and limited assurance may also be

misunderstood by users

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3. WHY CAN ASSURANCE NEVER BE ABSOLUTE?

3.2. The expectations gap
How to close this gap:

• by issuing an engagement letter spelling out the work that will be

carried out and the limitations of that work

• by regularly reviewing the format and content of reports issued as a

result of assurance work.

• ….

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4. THE STATUTORY AUDIT

4.1. Statutory audit - Audit of financial statements

• It is a legal (statutory) requirement in UK that all companies over a certain size

have an audit (with small companies being exempt).

• Audit of financial statements: The objective 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.

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4. THE STATUTORY AUDIT

4.1. Statutory audit - Audit of financial statements (Cont.)
The key outcome of the statutory audit is the audit opinion. In the UK, the
auditor will normally express their audit opinion by reference to the ‘true and
fair view’, which is an expression of reasonable assurance.

• True: Information is factual and conforms with reality, not false. In addition,
the information conforms with required standards and law. The accounts have
been correctly extracted from the books and records.

• Fair: Information is free from discrimination and bias in compliance with

expected standards and rules. The accounts should reflect the commercial
substance of the company’s underlying transactions
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4. THE STATUTORY AUDIT

4.2. Audit exemption in the UK
Small companies are not required to have an audit in the UK.

A company must meet two of three of the following criteria, for both this
financial year and the last financial year:

After 1st January 2016

Turnover No more than £10.2m
Total Assets No more than £5.1m
No of employees 50 or fewer on average

All companies above these thresholds must have an audit

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4. THE STATUTORY AUDIT

4.3. Legal and professional requirements

There are both legal and professional requirements for auditors in the UK.
The Companies Act 2006 requires that auditors are members of a Recognised
Supervisory Body (RSB), such as the ICAEW, and eligible under their rules to sign
auditor’s reports.

RSB are required to have rules to ensure that those eligible for appointments as
company auditor are either:
• Individuals holding an appropriate qualification; or
• Firms controlled by qualified persons.

RSB must also implement procedures for monitoring their registered auditor on a
regular basis
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4. THE STATUTORY AUDIT

4.3. Legal and professional requirements (Cont.)

In the UK, the Financial Reporting Council (FRC) is responsible for issuing
auditing standards, includes:
• auditing standards
• ethical standards for auditors
• practice notes
• bulletins (short news reports)
• standards for reviews of financial information and examination of prospective
financial information

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4. THE STATUTORY AUDIT

4.4. International Standards on Auditing (ISA Standards)

Statutory audits conducted in the UK must be conducted in accordance with ISA

Standards (UK) as issued by the FRC. ISA Standards are made up of:
• introductory material and definitions
• objectives
• requirements
• application and other explanatory material (including appendices)

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4. THE STATUTORY AUDIT

4.5. The value of the statutory audit

 Enhance the credibility of the financial statements

 Legal requirement

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4. THE STATUTORY AUDIT

4.6. Stages of an audit

Obtaining the engagement

Planning

Performing procedures

Review and completion

Reporting
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4. THE STATUTORY AUDIT

4.7. Overall objectives of the auditor

ISA (UK) 200, Overall objectives of the Independent Auditor and the Conduct of
an Audit:

 To obtain reasonable assurance about FSs as a whole are free from material
misstatement, enable the auditor to express an opinion on whether the FSs are
prepared in all material respect, in accordance with an applicable financial
reporting framework; and

 To report on the FSs and communicate as required by the ISAs

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4. THE STATUTORY AUDIT

4.7. Overall objectives of the auditor (cont.)

In order to do this, the auditor must:

 Comply with relevant ethical requirement
 Plan and perform the audit with professional scepticism
 Exercise professional judgement
 Obtain audit evidence that is both sufficient and appropriate

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4. THE STATUTORY AUDIT

4.7. Overall objectives of the auditor (cont.)

Professional scepticism

Professional scepticism is 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

Requires auditor to be alert to:

• Audit evidence that contradicts other audit evidence obtained;
• Information that brings into question the reliability of documents
and responses to inquiries to be used as audit evidence;
• Conditions that may indicate possible fraud; and
• Circumstances that suggest the need for audit procedures in addition
to those required by ISAs 36

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4. THE STATUTORY AUDIT

4.7. Overall objectives of the auditor (cont.)
Professional judgement

Professional judgement is the application of relevant training, knowledge and

experience in making informed decisions about courses of action that are
appropriate in the circumstances of the audit engagement.

ISA (UK) 200 requires the auditor to exercise professional judgement in

planning and performing an audit of financial statements, including, but not
restricted to the following:
• Materiality and audit risk
• Nature, extent and timing of audit procedures
• Evaluating sufficient and appropriate audit evidence obtained
• Evaluating management judgements
• Drawing conclusions on the evidence obtained 37

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4. THE STATUTORY AUDIT

4.8. Factors in professional scepticism
Factors facilitative of professional scepticism
 Characteristics of the audit team, including:
o Relevant technical or analytical skills
o Open-mindedness, and the capacity to notice facts which are inconsistent with expectations
o Independence
o Confidence and persistence to challenge management and to follow things through
o Knowledge of client and industry
 Provision of training relevant to the type of engagement, eg, particular industrial sector
 Review procedures within the audit team, and the presence of external review
 Partners and managers actively leading the audit team, and being accessible to other staff
during the audit
 A culture within the audit firm which emphasises the importance of scepticism, and of
making difficult audit judgements
 The embedding of scepticism within the firm’s training and competency frameworks, used
for evaluating and rewarding performance 38

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4. THE STATUTORY AUDIT

4.8. Factors in professional scepticism (cont.)
Factors hindersome of professional scepticism:
 Characteristics of the audit team, including:
o Lack of relevant technical or analytical skills
o Excessive trust in the client, and in the explanations given by client staff
o Timidity and a lack of assertiveness
o Lack of sufficient audit experience for the tasks allocated
 A checklist approach to audit procedures, in place of a more fundamental interest and
understanding

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4. THE STATUTORY AUDIT

4.9. Bookkeeping recap

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5. INTRODUCTION TO SUSTAINABILITY AND ASSURANCE

Sustainability: Meeting the needs of the present without compromising the ability
of future generations to meet their own needs.

Environmental, Social and Governance (ESG) issues derive from increasing

political and stakeholder concerns.
 Environmental: Counter the impact of climate change and reduce an
organisation’s impact on the environment
 Social: Consider the well-being and impact of their operations on society
and their stakeholders and creating a good working environment for its
employees.
 Governance: Implement good governance practices from the top down, so it
is well positioned to meet environment and social requirements.

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5. INTRODUCTION TO SUSTAINABILITY AND ASSURANCE

5.1. Sustainability and ICAEW

ICAEW Chartered Accountants need to recognise that sustainability is at the core of

what they do and analyse how to make the sustainable economy work for business,
for clients and the public interest.

Sustainability impacts across all modules of the ACA qualification. For Assurance,
this impacts the following four areas.
(a) Risk management
(b) Assurance
(c) Governance
(d) Sustainability Metrics and Targets
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5. INTRODUCTION TO SUSTAINABILITY AND ASSURANCE

5.1. Sustainability and ICAEW (cont.)
5.1.1 Risk management

 Climate change is clearly giving rise to significant risks for businesses.

 The accountancy and assurance profession has a particular interest in the topic
of risk, notably the identification, measurement and management of business
and financial risk, including reputation risks that may threaten the survival of an
enterprise.

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5. INTRODUCTION TO SUSTAINABILITY AND ASSURANCE

5.1. Sustainability and ICAEW (cont.)
5.1.2 Assurance
All types of sustainability and ESG information is affected by the need for credibility
when disclosed to stakeholders, for example, for:
 Financial markets, both debt and equity, in attesting information relating to
sustainability, and its consequences, and thereby reducing risk for investors;
 Government in supporting compliance with laws and regulations by preparing or
attesting information relating to sustainability;
 Employees, to provide confidence in systems and establish progress against targets;
 Specialists, including market analysts, credit rating agencies and listing authorities;
 Business partners, to strengthen the supply chain; and
 Communities, to establish credibility with neighbours and local organisations. 44

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5. INTRODUCTION TO SUSTAINABILITY AND ASSURANCE

5.1. Sustainability and ICAEW (cont.)
5.1.3 Governance
Assurance engagements may be particularly useful in advising on governance required
to provide social, environmental and economic data both within the company and to
external stakeholders.

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5. INTRODUCTION TO SUSTAINABILITY AND ASSURANCE

5.1. Sustainability and ICAEW (cont.)
5.1.4 Sustainability metrics and targets
Assurance experts may be expected to:

 Take a role in advising on future supporting measurement of climate change and

its consequences by providing relevant and reliable information in an accessible,
meaningful and comparable way.

 Interpret the results of ESG related performance measures against targets.

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5. INTRODUCTION TO SUSTAINABILITY AND ASSURANCE

5.2. Current developments in sustainability reporting
5.2.1 Climate-related risks in an audit of financial statements
 Currently there is no mandatory international framework for reporting climate-
related risks

 However, there is growing support for climate-related financial reporting

generally within the financial statements.

 Where climate change impacts the entity, the auditor needs to consider the risk of
material misstatement related to amounts and disclosures that may be affected by
climate-related risks.

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5. INTRODUCTION TO SUSTAINABILITY AND ASSURANCE

5.2. Current developments in sustainability reporting (cont.)
5.2.2 Sustainability-related disclosure standards
At present there are two exposure drafts that have been issued by ISSB (established by
IFRS Board):

 IFRS S1, General requirements for disclosure of sustainability-related financial

information

 IFRS S2, Climate-related disclosures focuses on significant climate-related risks

and opportunities and the information that an entity needs to disclose in order the
satisfy users of financial statements

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5. INTRODUCTION TO SUSTAINABILITY AND ASSURANCE

5.2. Current developments in sustainability reporting (cont.)
5.2.3 Auditing climate-related risks
The Financial Reporting Council (‘FRC’) has made recommendations for auditing
climate-related risks in their November 2020 publication

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5. INTRODUCTION TO SUSTAINABILITY AND ASSURANCE

5.2. Current developments in sustainability reporting (cont.)
5.2.4 Governance
Boards of directors are now responsible for several climate-related disclosures. The
government and the FCA have now placed a requirement on the largest companies in
the UK to report all significant climate-related matters using the approach laid down by
the Task Force on Climate-related Financial Disclosure (TCFD) under the following
four headings:
(a) Governance
(b) Strategy
(c) Risk management
(d) Metrics and targets
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5. INTRODUCTION TO SUSTAINABILITY AND ASSURANCE

5.2. Current developments in sustainability reporting (cont.)
5.2.4 Governance (cont.)
At the time of writing, there is no requirement for these disclosures to be subject to any
form of independent assurance but given the significance of these disclosures, it is
possible that such assurance will become inevitable.

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