CHAPTER 1:

THE MEANING OF AUDIT AND

ASSURANCE
BY. AYESHA MUNIR
WHAT IS AUDIT?
 The term ‘Audit’ is derived from a Latin word
“audire” which means “to hear”.
Definition:
 An official examination of the accounts (or
accounting systems) of an entity by an auditor.
 An external audit is a type of assurance
engagement that is carried out by an auditor to give
an independent opinion on a set of financial
statements.
OBJECTIVE OF AUDIT
 To enable the auditor to express an opinion on whether
the financial statements are prepared, in all material
respects, in accordance with an applicable financial
reporting framework (e.g. IFRS) and comply with
statutory requirements.
 The primary role of an external audit is to report on
truth and fairness of the financial statements of an
entity on behalf of its owners (shareholders).
EXTERNAL AUDIT VS. INTERNAL AUDIT
Appoint
independent
Auditor

Measure Adds
performance credibility

Prepare
Financial statements

Appoint
Shareholders Directors

Own Manage
Company
STATUTORY VS. NON STATUTORY AUDIT

Statutory audit Non statutory audit

 A statutory audit is an examination of  Non-statutory audits are performed by

an entity's financial records in auditors because the company's
accordance with the requirements of a owners, or other interested parties
law and also known as external audit. want them, rather than because the law
requires them.
 Conduct voluntarily
 Conduct because of Law force
 The employer or partners determine
 The relevant statute or law determines
the scope of work.
the scope of work.
 The auditor need not possess any
 The academic or professional
academic or professional
qualification is prescribed for the
qualifications.
auditor.
 The agreement between an auditor and
 The statute dictates the powers, rights
firm decides these matters.
and duties of an auditor.
 The auditor does not enjoy such
 The auditor has independence in status
independence.
and in mental attitude.
  The auditor is liable for negligence only under
 The auditor is liable for negligence the Common Law.
under the Common Law and for
misfeasance under the relevant statute
governing the audit.  The audit report is made known to the employers
 The audit report is published for the or partners.
public.
ADVANTAGES OF THE NON-STATUTORY AUDIT
1. It can provide a means of settling accounts between the partners.
2. The sale of the business or the negotiation of loan or overdraft facilities
may be facilitated if the firm is able to produce audited accounts.
3. An audit on behalf of a 'sleeping partner' is useful since generally such a
person will have few other means of checking the accounts of the business
or confirming the share of profits due to them.
OTHER TYPES OF AUDIT
 External Audit:- When the auditor is not appointed by the management. For
example director of the company can not appoint the statutory auditor directly
but the statutory auditor is appointed by the shareholders. It means the
statutory auditor is also called an external auditor.
 Internal Audit:- Internal auditor is the employee of the company and gives his
report to management only. Internal auditors not only audits the financial data
but also evaluates the existing systems, operations and policies to suggest
improvement in respect of them.
 Compliance audit. This is an examination of the policies and procedures of an
entity or department, to see if it is in compliance with internal or regulatory
standards. This audit is most commonly used in regulated industries or
educational institutions.
 Construction audit. This is an analysis of the costs incurred for a specific
construction project. Activities may include an analysis of the contracts granted
to contractors, prices paid, overhead costs allowed for reimbursement, change
orders, and the timeliness of completion. The intent is to ensure that the costs
incurred for a project were reasonable.
OTHER TYPES OF AUDIT
 Information systems audit. This involves a review of the controls over
software development, data processing, and access to computer systems.
The intent is to spot any issues that could impair the ability of IT systems to
provide accurate information to users, as well as to ensure that unauthorized
parties do not have access to the data.
 Investigative/Forensic audit. This is an investigation of a specific area or
individual when there is a suspicion of inappropriate or fraudulent activity.
The intent is to locate and remedy control breaches, as well as to collect
evidence in case charges are to be brought against someone.
 Operational audit. This is a detailed analysis of the goals, planning
processes, procedures, and results of the operations of a business. The audit
may be conducted internally or by an external entity. The intended result is
an evaluation of operations, likely with recommendations for improvement.
 Tax audit. This is an analysis of the tax returns submitted by an individual
or business entity, to see if the tax information and any resulting income tax
payment is valid.
 Accountability, stewardship and agency

PRINCIPAL (e.g.. AGENT/STEWARD

Shareholders) S (e.g..Directors)
•Engages another person to
perform a service on their
behalf
•Delegate some decision
making authority

Problems Possible solution

•May have concerns over •Set up mechanism to
motives of agent? align interests of agent
•Principal and agents with principal like
have different attitudes to
performance related pay
risk
•Conflict of interests and
•Monitoring mechanisms
trust issues like audit
 Agency relationship in audit

• Board of directors act as agent of the body of shareholders, the principals. The
directors are accountable for their stewardship of the company.
• Shareholders may have limited access to information regarding company’s
operation and may lack trust in the directors and may believe that information
in financial statements is biased.
• The external auditor performs a statutory audit to address agency conflict
between shareholders and directors.
THE AUDIT REPORT
 An auditor reports to the shareholders on the financial statements
produced by a company’s management that adds credibility to the
financial statements.
 The key features of the audit report are :
 The auditors producing the report are independent from the directors producing
the financial statements
 The report gives an opinion on whether the financial statements ‘give a true and
fair view’ of the position and results of the entity.
 The report considers whether the financial statements give a true and fair view in
all material respects. The concept of materiality is applied in reaching an audit
opinion.
 INDEPENDENCE OF THE AUDITOR
 The external auditor must be independent from the directors; otherwise his
report will have little value. If he is not independent, his opinion is likely to
be influenced by the directors.
 In contrast to external auditors, internal auditors may not be fully
independent from the directors.

True and fair view

• The phrase ‘true and fair view’ has no legal definition, the term ‘true’
implies free from error, and ‘fair’ implies that there is no undue bias in the
financial statements or the way in which they have been presented.
MATERIALITY
What is materiality?
 A matter is material if its omission or misstatement would reasonably be
expected to influence the economic decisions of users taken on the basis of the
financial statements. Materiality depends on the size of the item or error judged
in the particular circumstances of its omission or misstatement.
 The auditor must be concerned with identifying material errors, omissions and
misstatements. Both the amount (quantity) and nature (quality ) of
misstatements need to be considered.
MEANING OF ASSURANCE
 Assurance’ means confidence
 An assurance engagement is one in which: A practitioner aims to obtain sufficient
appropriate evidence in order to express a conclusion designed to enhance the
degree of confidence of the intended users other than the responsible party about the
outcome of the measurement or evaluation of an underlying subject matter against
criteria. (IFAC, 2016(e))
 Assurance can be provided by:
 audit: this may be external audit, internal audit or a combination of the two
 review
ELEMENTS OF AN ASSURANCE
1. A three party relationship. The three parties are the intended user, the responsible party
and the practitioner
2. A subject matter. This is the data to be evaluated that has been prepared by the responsible
party. It can take many forms, including financial performance (e.g. financial information),
nonfinancial performance (e.g. key performance indicators), processes (e.g. internal control)
and behavior (e.g. compliance with laws and regulations).
3. Suitable criteria. The subject matter is evaluated or measured against criteria in order to
reach an opinion.

4. Evidence. Sufficient appropriate evidence needs to be gathered to support the required level
of assurance.

5. An assurance report. A written report containing the practitioner's opinion is issued to the
intended user, in the form appropriate to a reasonable assurance engagement or a limited
assurance engagement.
LEVEL OF ASSURANCE
 ISAE 3000 (Revised) Assurance engagements other than audits or
reviews of historical financial information distinguishes between two
forms of assurance engagements:
 Reasonable assurance engagements/positive assurance – By audit
 Limited assurance engagements /negative assurance – By review

Reasonable Assurance/ Assurance provided by audit

 An audit provides a high, but not absolute, level of assurance that the
audited information is free from any material misstatement. This is often
referred to as reasonable assurance. The conclusion would usually be
expressed in a positive form e.g. statutory audit.
'the financial statements have been prepared in accordance with applicable
legislation and accounting standards'
LEVEL OF ASSURANCE

 Reducing assurance engagement risk to zero is very rarely attainable or cost

beneficial because of factors like:
 The use of selective testing
 The inherent limitations of internal control
 The fact that much of evidence available to the practitioner is persuasive rather than
conclusive
 The use of judgment in gathering and evaluating evidence and forming conclusions based
on that evidence
LEVEL OF ASSURANCE
Limited assurance / Assurance provided by review
 Limited assurance is a lower level of assurance. The nature, timing and
extent of the procedures carried out by the practitioner in a limited
assurance engagement would be limited compared with what is required
in a reasonable assurance engagement
 In contrast to the ‘reasonable’ level of assurance provided by an audit, a
review into an aspect of the financial statements would provide only a
moderate level of assurance that the information under review is free of
material misstatement. This would usually be expressed in a negative
form of words.
 Negative assurance is an opinion that nothing is obviously wrong: in
other words, ‘nothing has come to our attention to suggest that the
information is misstated’.
'nothing has come to our attention that causes us to believe that the financial statements are not
prepared in accordance with applicable legislation and accounting standards'
LEVEL OF ASSURANCE
 Negative assurance is necessary in situations where the
accountant/auditor cannot obtain sufficient evidence to provide
positive assurance.
For example
The management of a client entity may ask the auditor to carry out
a review of a cash flow forecast. A forecast relates to the future and
is based on many assumptions, and an auditor therefore cannot
provide positive assurance that the forecast is accurate. However, he
may be able to provide negative assurance that there is nothing he is
aware of to suggest that the forecast contains material errors.
Steps of performing assurance engagement

• Agree the scope of work to be performed

• Formulate all the terms of the engagement in the contract (engagement
letter)
• Plan the work on basis of risk and level of assurance desired
• Obtain sufficient appropriate evidence on which to base the conclusion
• Perform overall review and form opinion
• Issue report to the client
 Benefits of Assurance report

• Independent opinion from an external source that enhances the credibility

of information.
• Management bias is reduced
• Modified opinion draws attention to risk
• The relevance of the information may be improved by the expertise and
knowledge of the assurance firm.