CAF-09

CONCEPT AND NEED FOR ASSURANCE

Chapter No. 1

In this chapter you will learn:

1.
2.
3.
4.

The Meaning of Audit

The Meaning and Types of Assurance
The Meaning and Types of Assurance Engagement
Key Features of the Audit Report

www.fb.com/AuditandAssurance

CONCEPT AND NEED FOR ASSURANCE

THE MEANING OF AUDIT
An audit is an official examination of the accounts (or accounting system) of an entity (by an auditor).
The main objective of an audit is to enable an auditor to convey an opinion as to whether or not financial statements
of an entity are prepared according to an applicable financial framework.

Concept of Accountability, Stewardship and Agency

An audit of a companys accounts is needed because in companies, the owners of the business are often not the
same persons as the individuals who manage and control that business.

The shareholders own the company.

The company is managed and controlled by its directors.

The directors have a Stewardship role. They look after the assets of the company and manage them on behalf of the
shareholders. In small companies, the shareholders may be the same people s the directors. However, in most of the
large companies, the two groups are different.
The relationship between the shareholders and the board of directors is also an application of the general legal
principle of Agency. The board of directors has a legal duty to act in the best interests of the shareholders, and
should be accountable to the shareholders for everything that he does as agent.
In order to show their Accountability to the shareholders, it is a general principle of company law that directors are
required to prepare annual financial statements, which are presented to the shareholders for their final approval.

Advantages of Statutory Audit

1. It increases the credibility of published financial statements.
2. It confirms to management that they have performed their statutory duties correctly.
3. It provides assurance to management that they have complied with non-statutory requirements (e.g.
corporate governance).
4. It provides feedback on the effectiveness of internal controls. Where internal controls are weak or
inadequate, the auditor will give recommendations for improvements.
5. Identify most of the frauds in the financial statements.
Even where a statutory audit is not required, it may be important for potential lenders (e.g. banks).

Disadvantages of Statutory Audit

1. The cost of an audit can be very high.
2. The disruption caused to a companys staff during the audit because they are required to assist the auditor.
3. Some items in the financial statements are estimates and depend on future events. This means the
assurance opinion is ultimately subjective and judgmental.
Prepared By:
Team Audit and Assurance CAF-09
Italic shows either definition or other key points.
For suggestions text on fb.com/AuditandAssurance

CONCEPT AND NEED FOR ASSURANCE

4. Audit evidence is persuasive rather than conclusive. Therefore, it does not provide absolute assurance.
5. In order to balance cost and efficiency the auditor routinely uses sampling rather than tests every item.
6. Entitys information system always incorporates some degree of inherent limitations.

THE MEANING AND TYPES OF ASSURANCE

Assurance means expression of confidence or credibility expressed by an assurance provider.
Types/Levels of Assurance
1. Absolute Assurance
It is a perfect level of assurance.
2. Reasonable Assurance
It is a high but not absolute level of assurance. It is expressed in positive form i.e. in our opinion the accounts
are true and fair. In statutory audit, reasonable assurance is provided.
3. Limited Assurance
It is a moderate level of assurance. It is expressed in negative form i.e. based on our review, nothing has
come to our attention that causes us to believe that the accompanying financial statements do not give a
true and fair view. In review engagement, limited assurance is provided.

Inherent Limitations Of An Audit/Why Absolute Assurance Cannot Be Provided?

Auditor cannot provide absolute assurance because audit risk cannot be reduced to Zero due to inherent limitations
of assurance/audit. These limitations are discussed below:
1. Nature of the Financial Statements
Some items in the financial statements are estimates and depend on future events. This means the
assurance opinion is ultimately subjective and judgmental. For example, provision for doubtful debts,
depreciation, warranty etc.
2. Weakness in Internal Control
Irrespective of how robust (strong) a clients systems are they will always incorporate some degree of
inherent limitations. For example, management is incompetent.
3. Nature of Audit
a. In order to balance cost and efficiency the auditor routinely uses sampling rather than tests every
item.
b. Audit is not a fraud-examination i.e. audit procedures may not detect a sophisticated and carefully
organized fraud.

Prepared By:
Team Audit and Assurance CAF-09
Italic shows either definition or other key points.
For suggestions text on fb.com/AuditandAssurance

CONCEPT AND NEED FOR ASSURANCE

c. Audit is not an official investigation i.e.
Management may not provide complete information to auditor; and
Auditor does not have specific legal powers e.g. power to search.

THE MEANING AND TYPES OF ASSURANCE ENGAGEMENT

An engagement in which a practitioner expresses a conclusion designed to enhance the degree of the intended users
(other than the responsible party) about the outcome of a subject matter against criteria.
An assurance engagement is consist of the following five elements:
1. A Three Party Relationship
Practitioner the individual providing professional services.
Responsible party the person(s) responsible for the subject matter.
Intended users the person(s) or class of persons for whom the practitioner prepares the assurance
report.
2. Subject Matter
This is the data that has been prepared by the responsible party for the practitioner to evaluate.
3. Suitable Criteria
These are the rules against which the subject matter is evaluated in order to reach an opinion.
4. Evidence
Information used by the practitioner in arriving at the conclusion on which their opinion is based.
5. Assurance Report
It is the report containing the practitioners opinion. It is issued to the intended user normally in written
form.

Types of Assurance Engagement

1. Audit
An audit provides a high but not absolute level of assurance that the audited information is free from any
material misstatement. The resulting opinion is usually expressed in the form of positive assurance.
This may be provided by external auditors or internal auditor.
a. An external auditor is performed by an appropriately qualified auditor appointed by the
shareholders and independent of the company.
b. An internal auditor is a department set up within an entity to provide a monitoring process as a
service to senior management within the entity.
Prepared By:
Team Audit and Assurance CAF-09
Italic shows either definition or other key points.
For suggestions text on fb.com/AuditandAssurance

CONCEPT AND NEED FOR ASSURANCE

2. Review
A review is a voluntary investigation. It provides only a moderate level of assurance that the reviewed
information is free of material misstatement. The resulting opinion is usually expressed in the form of
negative assurance.

KEY FEATURES OF THE AUDIT REPORT

The key features of the audit report are as follows:
1. Independence of the Auditor
The auditors producing the report are independent from the directors producing the financial statements.
The external auditor must be independent from directors while internal auditor may not be fully
independent.
2. True and Fair View
The report gives an opinion on whether the financial statements give a true and fair view or present
fairly the position and the results of the entity. The auditor does not certify that the financial statements
are correct.
The term true means free from error and fair means that there is no undue bias.
3. Materiality concept
The report considers whether the financial statements give a true and fair view in all material respects.
Information is material if it could influence the economic decisions of users if omitted or misstated.

Prepared By:
Team Audit and Assurance CAF-09
Italic shows either definition or other key points.
For suggestions text on fb.com/AuditandAssurance