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Chapter 1

AUDIT & ASSURANCE

INTRODUCTION -AN OVERVIEW OF AUDITING:
• Economic decisions in every society must be based upon the information available at the time the decision is made. For example, the decision of a bank to make a loan to a business is based upon previous financial relationships with that business, the financial condition of the company as reflected by its financial statements and other factors. • As a means of overcoming the problem of unreliable information, the decision-maker must develop a method of assuring him that the information is sufficiently reliable for these decisions. In doing this he must weigh the cost of obtaining more reliable information against the expected benefits. • A common way to obtain such reliable information is to have some type of verification (audit) performed by independent persons. The audited information is then used in the decision making process on the assumption that it is reasonably complete, accurate and unbiased.

in what respect he is not satisfied. according to the best of information and explanation given to him and as shown by the books. What is an Audit? . and if not. The phrases used.g. so as to give a true and fair view of the state of affairs of the business and that the profit and loss account gives true and fair view of the profit/loss for the financial period. international or local accounting standards and national legislations)." This view of audit is presented by ISA 200 Objective and General Principles Governing an Audit of Financial Statements. as will enable the auditors to satisfy himself that the balance sheet is properly drawn up.• • • • • Audit is an independent examination of financial statements of an entity that enables an auditor to express an opinion whether the financial statements are prepared (in all material respects) in accordance with an identified and acceptable financial reporting framework (e. "Auditing is such an examination of books of accounts and vouchers of business. “to express the auditor’s opinion” means that the financial statements give a true and fair view or have been presented fairly in all material respects. True and fair presentation means that the financial statement are prepared and presented in accordance with the requirements of the applicable International Financial Reporting Standards (IFRS) and local pronouncements/legislations.

. not merely on the facts. Independent essentially means that the auditor has no significant personal interest in the entity. It is not precisely defined for the auditor. • The end result of an audit is an opinion to assist the user of the financial statements. Auditing therefore relies heavily on professional judgment. • In order to make the user of the auditor’s report able to feel confident in relying on such report. the auditor is not responsible for the Preparation of the financial statements.2 • What we can understand as the essential features of an audit from the above definition and explanation are as under: • An auditor involves in examination of financial statements. This allows an objective. professional view to be taken. the auditor should be independent of the entity. • The auditor’s opinion makes reference to “true and fair” or “fair presentations” but “true and fair” is again a matter of judgment.

check. The auditor has to inspect. Audit is a critical review of the system of accounting and internal control. review. Audit is a systematic and scientific examination of the books of accounts of a business. • f. compare. • e.. Audit is done with the help of vouchers. information and explanations received from the authorities. • d. • b. directors. • G. Memorandum of Association and Articles of association etc. documents. in order to establish correctness of the books of accounts.• a. • c Audit is a verification of the results shown by the profit and loss account and the state of affairs as shown by the balance sheet. scrutinize the vouchers supporting the transactions and examine correspondence. The auditor has to satisfy himself with the authenticity of the financial statements and report that they exhibit a true and fair view of the state of affairs of the concern. FEATURES OF AUDITING . Audit is undertaken by an independent person or body of persons who are duly qualified for the job. minute books of share holders.

The incidental objective of auditing are: • i. misappropriation of cash and misappropriation of goods.e. Frauds can take place in the form of manipulation of accounts. Detection and prevention of Errors. The primary objective and the secondary or incidental objective. Detection and prevention of Frauds.OBJECTIVES OF AUDITING • There are two main objectives of auditing. . b) • Fraud refers to intentional misrepresentation of financial information with the intention to deceive. • Errors refer to unintentional mistake in the financial information arising on account of ignorance of accounting principles i. principle errors. or error arising out of negligence of accounting staff i. and prevent their recurrence. Clerical errors. Secondary objective – it is also called the incidental objective as it is incidental to the satisfaction of the main objective. It is of great importance for the auditor to detect any frauds. and • ii.e. a) Primary objective –the primary duty (objective) of the auditor is to report to the owners whether the balance sheet gives a true and fair view of the Company’s state of affairs and the profit and loss A/c gives a correct figure of profit of loss for the financial year.

Assurance: statement made to give • confidence. .2 • Benefit of opinion: • It improves credibility of financial statements. It can also be evidence.

• • User • Subject matter • Practitioner (provides professional services with competence.) • Criteria (your expectation against which you'll decide your purchase is worthwhile): are benchmarks used to evaluate or measure subject matter. • Intended user: are the person(s) for whom the practitioner prepares the assurance report. has been evaluated or measured. Criteria need to be available to the intended users to allow them to understand how subject matter .. objectivity. evaluation measurement to support a conclusion • Type of report(unqualified report or qualified report) 2 . FS. independence and to expected standards)for example the AUDITOR.All Assurance Engagements require:. The practitioner is responsible for determining the timing. the nature and extend of procedures and is required to pursue anything that leads the practitioner to question whether a material modification should be made to the subject matter information • Responsible party (the person supplying goods/ services): the person responsible for the information and assertions. • Subject matter information (agent's details. The responsible party can be one of the intended user. Engagement process involves:• Agree terms of engagement (engagement letter) • Decide methodology for evidence gathering.

Accounting system review .Engagement letter . It is unlikely that any two audit assignments will ever identical.Reasonable assurance . It is however possible to identify a number of standard stages in a typical external audit. The auditor always needs to reflect the nature of the circumstances of the entity under audit.Preparation of the audit plan .Initial planning 􀂃 Knowledge of the business 􀂃 Risk Assessment 􀂃 Internal control review (procedures) 􀂃 Control procedures (authorities/approvals/segregation of duties) . These are as follows: .Analytical review techniques (Compliance procedures-Application of control test procedures) like purchasing are according to the controls established.Considering the ways in which audit evidence can be sought .) .Review of the financial statements (compliance with the standards/material misstatement etc.Preparation and signing of report • • • • • • • • .Audit appointment .Substantive testing (transaction level procedures) .What are the different stages of audit? • • • • Auditing is essentially a practical task. .

Management’s Responsibility for the Financial Statements • Management is responsible for the preparation and fair presentation of these financial statements in accordance with International Financial Reporting Standards. implementing and maintaining internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement. . selecting and applying appropriate accounting policies. This responsibility includes: designing. whether due to fraud or error. and making accounting estimates that are reasonable in the circumstances.

We conducted our audit in accordance with International Standards on Auditing. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material misstatement.Auditor’s Responsibility • Our responsibility is to express an opinion on these financial statements based on our audit. .

. • Auditor’s responsibility is to express an opinion thereon.Responsibility for the Financial Statements: • Responsibilities for preparing and presenting the financial statements are that of management.

or do not. • Shareholders need to be assured that they are accurate. • An audit report will be written to the shareholders. present a true and fair view (i.e.Positive Assurance • Companies prepare annual Financial Statements. . in the auditors‘ opinion.a term meaning that the FS have no “material” (important) errors. stating whether. • The criteria that the auditors will use to check the FS are the accounting standards. the FS do. positive assurance). • A team of auditors (qualified accountants) from outside the company will come in to check whether the FS are “true and fair” .

will check whether these systems are working properly. who may be from inside or outside the company. internal controls.Internal audit • Companies have many internal systems – risk management. accounting systems. combined with legal requirements and corporate governance. • A team of auditors. • An audit report will be written to the Directors. • The Directors need to be assured that the systems are working. • The criteria that the auditors will use are likely to be their own experience of what makes a good system. stating whether the systems are working and making recommendations for future improvement. .

The readers need to be able to trust that the reports are reliable and correct. the report loses credibility and the assurance is undermined. If they sense any links between the auditors and the things being audited. they may not trust the opinions given.The importance of independence in assurance • Assurance reports are written for the benefit of the people reading them. . • If there are any links between the auditors and the things being audited. • It is therefore a requirement if the auditors are independent of those they are auditing.

. The Draft (unaudited) Financial Statements are now available.THE EXTERNAL AUDIT TIMELINE • Interim audit. On very large audits. more than one interim audit visit may be necessary. a number of audit procedures are likely to occur: = Attend client's year end stock-take = Perform a debtor circularization = Perform a creditor circularization = Request Bank Letter. which can be done without waiting for the accounting year to end. The main focus is substantive testing – results of control tests determine how much substantive testing is required. • Final audit. At the client year end. • Year end. The detailed audit planning and assessment of internal controls are often carried out on an interim audit.

ii) Exercise of judgment by the auditor in gathering of evidence and drawing of conclusion. there are no mistakes that anyone reading the Financial Statements would want to know about. and even if they did. and presented with no bias).e. failure of audit procedures to detect material misstatements in financial statements because of: a) The use of testing (application of procedures on samples). In other words. i) Inherent limitation of an audit. materiality • • • • • • REASONABLE ASSURANCE What is reasonable assurance? A conclusion that the financial statements are not materially misstated. Factors affecting reasonable assurance. true and fair view. An auditor cannot obtain absolute assurance because of limitations described in Para below. As a result. i. auditors carry out their work until they are reasonably assured (not 100% certain!) that the Financial Statements are true and fair (no clear errors.Reasonable assurance.. Conclusive: final. the auditors can only be assured that the Financial Statements are free from material errors or misstatements. . How reasonable assurance is achieved? It is achieved by obtaining audit evidence. c) Persuasive nature of audit evidence rather than conclusive (Persuasive: one leading to an opinion. one which causes to believe. b) The inherent limitations of accounting and internal control system. iii) Existence of other limitations like related parties etc Auditors cannot test every single transaction . Since not all transactions have been tested.. convincing). it is usually impossible to know for sure that things have been correctly recorded.

2 • Reasonable Assurance(positive assurance):• Gathers sufficient appropriate evidence • Concludes subject matter conforms in all material respects with identified suitable criteria (information given is reliable) • His opinion.positive assurance • Reasonable Assurance(negative assurance):• Gathers sufficient appropriate evidence to be satisfied that subject matter is plausible in the circumstances • Gives his report.negative assurance .

2. FS these are collectively called General Purpose FS by IASB) are the most common assurance engagement Reports are directed to different STAKEHOLDERS who have different reporting needs. timing and extent of procedures Evidence is persuasive rather than conclusive Evidence is gathered on test basis Reporting the outcome of assurance engagement • Practitioner > reports > user • • • Two types of reports a) positive assurance b) negative assurance • Audit of Co's (annual. Financial Institutions): often on a limited assurance basis require reports on financial viability of a Co Management: employment and environmental practices to satisfy demands of employees+ local community groups .Assurance report/ opinion is not an absolute opinion. statutory. 3. Because of lack of precision often associated with subject matter (FS subject to estimation and judgment) Nature. showing fair & true view and safeguarding of CO's assets Lenders (Banks. why? 1. 4. these are Mgt + those in charge of governance: how effective the Co's systems are as a mechanism for producing FS.

A report • • 1. in all material respects. 2. 3. 6. 4. on the basis of procedures which don't provide all the evidence that would be required in an audit. in accordance with an applicable financial reporting framework. . 7. anything that has come to the practitioner attention that causes the practitioner to believe that the financial statements are not prepared. 5. 8. The user who commissioned (means specially-made)the work A responsible party The subject matter The subject matter information Criteria Sufficient appropriate evidence which needs to be documented. Characteristics of review engagement: A review engagement has all the attributes of assurance engagement: The practitioner who conducts the work.Review Engagement(limited assurance): • The objectives of a review engagement: is to enable to practitioner to state whether.

Balancing books of accounts (Extracting trial balance) c. Financial consultancy g. Investigations (Fraud audit) . Writing up books of accounts (Book keeping) b. Statutory form filling f. The small chartered accountant firms especially may spend more time on other services than on auditing. Preparing final accounts d. Auditing firms are composed of accountants who perform audits for their clients. They describe themselves as Chartered Accountants.Knowing the audit profession and other services? • Auditing firms do not describe themselves as auditors. • The other services may include: a. Liquidation and receivership work i. They also perform other services. Management and system consultancy h. Tax management e.

• • • • There is a legal requirement for accounts to be produced by Mgt on a regular basis to account to shareholders for their STEWARDSHIP of the business. and STEWARD: person entrusted with mgt of another person's property. he is accountable for the way he carries out his role FIDUCIARY RELATIONSHIP: the relationship where one person has a duty of care towards someone else it is a relationship of good faith between shareholders and directors of CO Separation of ownership (shareholders) and control (directors) Therefore. therefore compelled to explain their decisions criticized/ punished if they have abused their position accountable for using Co's assets efficiently and effectively We have two issues on reporting area:- • . The recognition of the need for these accounts to be checked in some way by someone INDEPENDENT of the managers (the AUDITOR) STEWARDSHIP:-the responsibility to take good care of resources. directors must take decisions in the interests of the shareholders rather than their own selfish personal interests ACCOUNTABILITY: people in positions of power can be held to account for their actions.

2 • AGENCY RELATIONSHIP: 1. are fraudulent?? There was a need for independent audit 5. FS comply with legal and regulatory requirements 1. A need for 100% verification of FS and that they are correct. What if FS contains errors. It is a relationship between various stakeholders in a Co are described in term of agency theory Directors are agent for shareholder Employees " " directors Auditors " " shareholders 3. this is a typical assurance engagement (and NOT an absolute assurance) that 1. there is a problem 1. Too expensive due to amount of work 2. 2. And. Occur when one party (principal) employs another party (agent) to perform a task on their behalf. gives confidence to SH that FS are true & fair view 2. Co's mgt account for their stewardship of Co at regular intervals by producing FS 4. May prove to duly disruptive of Co's operations Therefore auditors are established as forming an independent opinion about:1. Reduce risk of misstatement . or even worse. Truth and fairness of FS 2.

Planning and performing the audit with the attitude of professional skepticism recognizes that FS may be materially misstated . Compliance with applicable auditing standards (IAASB/ ISA) • 3.3 • EXTERNAL AUDIT • It is a requirement by Law in most developed countries that its objective is to enable auditors to express an opinion on whether FS • presented fairly in all material respects (true & fair view) • prepared in accordance with an applicable financial reporting framework (which vary from country to another) • • • GENERAL PRINCIPLES • 1. Compliance with applicable ethical principles (IFAC code of ethics for professional accountants) and ethical pronouncements of auditors' professional body (e. ACCA rules of professional conduct) • 2.g.

• If auditors are needed mid-year (e.APPOINTMENT OF EXTERNAL AUDITORS • In most countries. the auditors are reporting to the shareholders. • The Board of Directors will propose a Firm and this will then be voted on by the shareholders. they are appointed on an annual basis at the AGM. there will be a specialist Board Committee that will recommend a Firm to the main Board – this committee is called the Audit Committee. so are appointed by the shareholders. • Usually. because the previous Firm resigned) then it is often possible for the Board of Directors to appoint a Firm up till the next AGM. .g. • In most large companies.

governments typically leave further detailed guidance to the RSB to decide. set by a Recognised Qualifying Body (RQB). .WHO IS ALLOWED TO BE AN EXTERNAL AUDITOR? • To be allowed to do external audits. or of any associated companies = the auditor must not be an Employee or Business Partner of a Director or Employee of the company. there are additional rules: = the auditor must not be a Director or Employee of the company. • To be allowed to do the external audit of a particular company. • Beyond these rules. The process includes: = Must pass an approved set of professional examinations. This helps to ensure quality. someone must go through an approval process. Examples of RQBs include the ACCA and ICAEW = Must become a member (and stay a member!) of a Recognised Supervisory Body (RSB). The ACCA and ICAEW are also examples of RSBs. or of any associated companies.