Chapter 1 - Introduction, Assurance & Audit defined

Learning outcomes
1. What is an Audit?
2. What is an assurance engagement?
3. What are the 2 levels of assurance?
4. What are the benefits of assurance?
5. Who needs to be audited? (Audit threshold)
6. What is the nature of work undertaken?
7. What is the Quality of evidence?
8. Apply what we learned - Practice questions

1. What is an Audit? How is Audit an assurance engagement?

Key elements
1) Three party involvement
2) Subject matter
1. Shareholders (User of information)
2. Audit/Assurance Firm
(Practitioner)
3. Directors (Responsible party)
Financial Statements

3) Relevant criteria Accounting Framework (FRS) &

Companies Act
4) Evidence To obtain sufficient and appropriate
evidence to support the audit opinion.
(This is required by International
Standard of Audit ISAs)

5) Written report in a suitable Form an audit opinion on the FS in the

form. Chapter 13 auditor’s report

2. What is an assurance engagement?

Includes audit plus other assurance services such as review of
internal controls, business plan, cash flow forecast, etc
What are the 5 elements?
a) 3 parties (practitioner, users, responsible party)
b) Subject matter
c) Suitable criteria
d) Sufficient appropriate evidence to support the conclusion
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 e) Written report containing a conclusion

3. What are the 2 levels of assurance?

Assurance type Assurance Opinion/ Example
(2 types) level Conclusion
1 Reasonable High Positive terms Audit of financial
Assurance -true and fair statement
and prepared
in accounting
framework
2 Limited Assurance Low/Moderate Negative- Review of
Nothing has financial
come to information/
attention that Cashflow
the underlying forecast/ forecast
assumption is
reasonable

 Go to Point 7.

4. What are the Benefits of assurance?

They give the following benefits to users:
(mainly on the subject matter – such as reported information or FS)
1. Enhances the credibility of the reported information
2. Reduces the risk :
a. Risk of management bias
b. Risk of error
c. Risk of fraud
on the reported information
3. Identified weaknesses in the information reported. Draws the
attention of the user on the weaknesses. Recommend
improvements.
4. Give the users (investors, banks) added confidence on the
reported information and the users can make informed decisions.
5. Improve the reputation of organisations.

5. Who needs to be audited? (Audit threshold)

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 Small companies are exempt from mandatory audit if they can satisfy
two out of three of the following criteria:
· The company has no more than 50 employees
· The company's turnover does not exceed £10.2 million
· The company's gross assets total does not exceed £5.1 million

6. Benefits of Audit for those companies where it is not required by

law:

Protection of those who, apart from management, nevertheless have

a financial interest in the company:

· Protection to banks and other providers of finance

· Minority shareholders who are not involved with managing the
business
· They value having their business scrutinised by another set of
professional eyes
· It provides additional assurance to third parties such as taxation
authorities concerning the reliability of the financial statements
· A growing business will one day require an audit
· Audit may have subsidiary benefits, such as the auditors
recommending improvements in company systems.

There are, however, some disadvantages relating to having an audit

from the entity's point of view. These drawbacks include the
following:

· Cost
· Staff time required in providing information, etc
· Disruption to client's business
· Time spent on the initial appointment process
· Dealing with confidentiality
· Expectations gap, particularly surrounding fraud detection
· Inherent limitations of audit

7. What is the nature of work undertaken?

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 Audit vs review assurance

ISA (UK) 500 ISRE 2400 / ISAE 3400

Statutory Audit Review engagements/
Assurance engagements
Audit procedures are set out in Scope is determined on
Nature of Work ISA 500: International Standards
on Review Engagement
-Inspection and international
-Observation Standards on Assurance
-Confirmation Engagement.
-Recalculation
-Reperformance -Inquiry
-Analytical Procedures -Analytical Procedures
-Inquiry -Written Management
representations
AEIOU- To remember better
Less work than audit

8. What is the Quality of evidence?

ISA (UK) 500 ISRE 2400/ISAE 3400
Statutory Audit Review engagements/
Assurance engagements
Reasonable but not absolute Usually limited
Level of assurance

More evidence: More reliable Less evidence: Less

Reliability of Evidence reliable

Evidence from confirmation Evidence from inquiry

and inspection is more and observation is less
reliable/solid/Substantial reliable

Report to Shareholders Usually Management/

Users (Bank)

Report on FS are True & Fair Report a conclusion

Circulation of report In the public domain once the
FS are filed
depending on the nature
of the work performed
(cash flow forecast)
Likely to be restricted

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Chapter 1
11.2 University of Downtown
Explains how and why the level of assurance provided by the report on the cash
flow forecasts differs from the level of assurance provided by an auditor’s report
on annual financial statements.
The level of assurance provided by the auditor report is reasonable but not absolute.
There is more evidence related to the audit work hence more reliable. Therefore, the
evidence gathered from audit is more substantial. The financial statements are likely
to be reported on true and fair basis. The report will be read as “In our opinion
management has operated and effective system of internal control”. This is a positive
form of opinion deriving from a reasonable assurance engagement. It will be a
reasonable assurance; its assurance level is higher, and the opinion is positive.
The level of assurance provided by the report on the cash flow forecasts is limited.
The provide less evidence and hence less reliable. It is usually reported to
management and user of information. The report will be read as “Nothing has come
to our attention that indicates material internal control weakness. This is a negative
form of assurance deriving from a limited assurance engagement. The report on
cash flow is subject to uncertainty also. Therefore, it is a limited assurance, its
assurance level ranges from low to moderate and the opinion is negative.

(8 marks)
12 mins

Corrections:
How
Cash flow forecasts

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  Cash flow forecasts provide limited assurance as to the credibility for the
information.

 It provides a moderate level of assurance

 The opinion is expressed in a negative term that “Nothing has come to our
attention that causes us to believe the assumptions do not provide a
reasonable basis for the forecast”.
Audit
 Audits provide reasonable assurance but not absolute assurance that the
financial statements are free from material misstatement.

 It provides a high level of assurance.

 The opinion is expressed in a positive term that the ‘Financial Statement give
a true & Fair view prepared in accordance with relevant accounting framework
and Companies Act.

Why
 Audit is based on historical data which can be verified by the auditor to a
greater degree.

 Review of cash flow forecast is subject to uncertainties to the various

underlying assumptions and judgements.

 Evidence from audit is more reliable as the evidence is obtained by

confirmation and inspection of documents/ assets. In audit, subsequent
events and testing is done.

 Whereas evidence from review of cash flow forecast is less reliable as

evidence is obtained from enquiry, analytical review and based on
management representations.

Hence, a review of forecast provides less assurance than an audit. (Optional)

54.1 Gidget Ltd
Describe the differences between the scope of the review of Gidget’s financial
statements for the year ended 31 August 20X6 and the scope of the external audit of

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the financial statements for the year ended 31 August 20X7. Give reasons for these
differences. (6 marks)

The scope of the review of the Gidgets financial statement is that the auditor would
need to make inquiry, do an analytical procedure, assess the assumption,
recompute, and create a written representation.
While the scope of the external audit of the financial statement is that the auditor
needs to inspect the documents, assets, observe, do an external confirmation,
recalculate, reperformance, analytical procedures and inquiry.

Corrections:
Scope of review of financial information

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  Procedures limited to inquiry, analytical review, and management
representation (1 mark)

 No responsibility to perform procedures to identify subsequent events. (1

mark)

 Scope of the work is less than audit. (1/2 mark)

Scope of external audit of financial statements

 Procedures cover confirmation and inspection of documents/ assets. Use of
test of details and tests of control. (1 mark)

 There is a need to perform specific procedures to test subsequent events up

to the date of the auditor’s report. (1 mark)

 Scope of the work is more detailed and more than a review of financial
information. (1/2 mark)

Reasons
 A review of financial information provides limited assurance which is
expressed negatively. (1 mark)

 An audit provides reasonable assurance which is expressed negatively. (1

mark)

 The objective of a review is to reduce the engagement risk to an “acceptable”

level (1 mark)

 The objective of an audit is to reduce the engagement risk to a ‘low” level. (1

mark)

 A review is conducted in accordance with ISRE 2400 whereas an audit is

conducted in accordance with ISAs and Companies Act 2006. (1 mark)
Predator plc
Predator plc, a large listed company, is considering taking over Target Limited, a
small, family owned company. Predator has asked Talbot and Co, chartered

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accountants, to carry out due diligence in relation to this prospective purchase. They
want them to review the financial statements of the last three years and ensure that
they were prepared under generally accepted accounting practice in the UK. They
also want them to review the budgets for the coming twelve months and ensure that
they are reasonably and internally consistent.
List the benefits that the company may obtain from the assurance engagement.
(4 marks)
Benefits to Predator PLC
1. Predator is given the assurance that the financial statements are prepared
according to UK GAAP . Therefore, the FS are understandable and comparable
with other companies they might be considering taking over.

2. Predator is given the assurance that the budgets are reasonable and internally
consistent. Therefore, they can trust or rely on the budgets as an indicator of the
company’s future operating.

3. Predator can make an informed decision about whether to takeover Target and
how much to pay for the takeover.

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