chapter 1 assurance engagements

8/10/2019 Chapter 1 Assurance Engagements

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Audit and Assurance

Chapter 1

Introduction to the Assurance


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Why to have audit

Particularly in larger companies, theowners of a company and the

management of that company aredistinct. Directors are accountable tothe shareholders in their role asstewards and agents . Accountablemeans being required to justify

actions and decisions.


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Agency relationship One of the primary sources of information about a company is the

financial statements. This contains information that almost all ofthe stakeholder groups will find useful. In particular, theshareholders (the primary stakeholder group) will need reliablefinancial statements to appraise the performance of theirshareholding.

The directors are responsible for managing the company in orderto achieve the objectives of that company (normally themaximization of shareholder wealth). However, directors oftendirectly benefit from increasing profit; director's remunerationmay include bonuses, linked to the level of profits

achieved.

The directors are also responsible for preparing the financialstatements; this creates a conflict of interest as the directorsbenefit from reporting higher profits. There is therefore a need foran independent review of these financial statements, i.e.assurance from an external practitioner to ensure the financialstatements give a true and fair view.


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Audit definitionAudit is independent examination andexpression of opinion on the financial

statements whether they are preparedin all material respects in accordance

with applicable financial reporting

framework.


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Independent

Auditor should be independentfrom the entity.

Independence of mind Independence of appearance


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Expression of opinion

Expression of opinion on thefinancial statements , opinion isrequired by the shareholder afteropinion they will be decide whether

to Buy or Sell the shares.


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Financial statements

Financial statements are of four types

Statement of financial position (SOFP) Statement of comprehensive income Statement of cash flow Statement of changes in Equity


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In all material respect

An item is said to be material ifits omission or misstatementcould influence the economicdecision of users of financialstatements.


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Applicable financial reporting framework

IFRS(International financial reportingstandards )

IAS (International accountingstandards )


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True and Fair

True: Information is factual and conforms withreality. In addition the information conformswith required standard and law.

Fair: Information is free from discriminationand bias and in compliance with expectedstandard and laws.


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Assurance engagement In assurance engagement is one in practitioner

expresses a conclusion designed to enhance the degreeof confidence of intended user about the out come ofthe evaluation of subject matter against suitablecriteria and then based on evidence the practitioner

issues a report for the intended users. It has five components1) Three way relationship

2) Subject matter3) Suitable criteria4) Evidence

5) Assurance report


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Three way relationship

A three way relationship involves

A practitioner (the reviewer of the subjectmatter who provides the assurance) Responsible party (i.e. those responsible for

the subject matter) Intended users (Shareholder)


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Subject Matter Subject matter should be identifiable and capable

of consistent evaluation against suitable criteria. E.G Financial Performance (F/s) Non-financial performance (KPIs) System and Procedures (Internal controls and IT

system) Behavior for example (Corporate Governance and

Compliance with law & Regulation)


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Evidence

A practitioner plan and perform an assuranceengagement to obtain sufficient andappropriate audit evidence whether thesubject matter is free from materialmisstatement.


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Assurance report

The practitioner provides a written reportcontaining a conclusion.

For example , in our opinion internal controlare effective based on this criteria. Or LimitedAssurance Nothing came to our attention.


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True and Fair


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Review engagement In a limited assurance assignment, the practitioner: Gathers sufficient appropriate evidence to be able

to draw limited conclusions. Concludes that the subject matter, with respect to

identified suitable criteria, is plausible in thecircumstances.

Gives a negatively worded assurance opinion.


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Negative assurance

Nothing has came to attention of auditorthat causes the auditor to believe that

Financial information is not prepared inall material respect in accordance withapplicable financial reporting framework.


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Assuranceservices

Assurance Given Purpose

External audit Reasonable Statutory externalaudit

Review Negative Review of interimfinancialstatements

Agreed uponprocedures

None Examination of specifichead in B/s

Compilation None Preparation offinancial statements


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Statutory Audit In most developed countries, publicly quoted

companies and large companies are required by law to produce annual financial statementsand have them audited by an external auditor:a statutory audit .

Companies that are not required to have astatutory audit may have an external auditbecause the company's shareholders or otherinfluential stakeholders want one and becauseof the benefits of an audit.


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Benefits of Statutory Audit An audit improves the quality and reliability of

information , giving investors faith in andimproving the reputation of the market. Independent scrutiny and verification may be

valuable to management. An audit may reduce the risk of management

bias , fraud and error by acting as a deterrent. An audit enhances the credibility of the financial

statements, e.g. for tax authorities/lenders. Deficiencies in the internal control system may be

highlighted by the auditor.


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Limitation of Audit

1. Auditing is not objective , It is subjective(judgments have to be made , Risk assessmentEstimates , Judgments)

2. Auditors do not test all transactions and

balances, they test on a sample basis.3. Audit report has inherent limitation(Standardformat , layman may not understand auditJargon)

4. Time lag (period reporting) 5. Assurance may be obtained from the operating

effectiveness of internal controls, which areinherently limited.


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Limitation of Audit1. A belief that auditors test all transactions

and balances; they test on a sample basis. 2. A belief that auditors are required to detect

fraud; auditors are required to provide

reasonable assurance that the financialstatements are free from materialmisstatement, which may be caused by

fraud.3. A belief that auditors are responsible for

preparing the financial statements; this is

the responsibility of management.


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June 2010

(a) Auditors are frequently required toprovide assurance for a range of non-auditengagements.

Required: List and explain the elements of an assurance

engagement. (5 marks)


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December 2011

Required:

Describe FIVE elements of an unmodifiedauditors report. (5 marks)

D b 2011


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December 2011 Question:- Explain the term limited assurance in the context of a

review of a company's cash flow forecast and explainhow this differs from the assurance provided by astatutory audit.

Answers A cash flow relates to the future, which is inherently

uncertain, and therefore it would not be possible toobtain assurance that it is free from materialmisstatement. Less reliance can therefore be placed on

the forecast than the financial statements, where thepositive assurance was given. With limited assurance, limited procedures are

performed; often only enquiry and analytical

d

chapter 1 assurance engagements

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