hs lecture 1 students copy

8/7/2019 hs lecture 1 students copy

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Hammad Sarwar Page 1

LECTURE 1

Audit and Assurance

AUDIT: ( )

The general definition of an audit is an evaluation of a person, organization, system,

process, enterprise, project or product.

OBJECTIVE OF EXTERNAL AUDIT:

The phrases used to express the auditors opinion are give a true and fair view orpresent fairly, in all material respects, which are equivalent terms.

The auditor gives an opinion on whether the financial

statements:

y _______________________________________ and

y __________________________________________

THE PURPOSE OF ASSURANCE FOR FINANCIAL AND NON-FINANCIAL

INFORMATION:

An assurance engagement as opposed to an audit is one in which the independent

practitioner evaluates or measures a subject matter that is the responsibility of another

party, against suitable criteria and expresses an opinion that provides the intended user

with a level of assurance about the subject matter.

An external auditis a type ofassurance engagementthat is carried out by an auditor

to give independent opinion on a set of financial statements.

People will be surprised to

know that in EnglandCCAB comprises of sixaccounting bodies and all

of them can conductaudits.


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Subject matter could include data, systems, processes or behavior.

An assurance engagement will involve three separate parties;

y ______________

y ______________

y ______________

BENEFITS OF ASSURANCE WORK:

y _______________________________________________(to a lesser extent for

limited assurance)

y __________________________________.

DIFFERENT ASSURANCE ASSIGNMENTS:

y _______________________

y _______________________

y _______________________

y _______________________

y _______________________

y _______________________

THE IMPORTANCE OF INDEPENDENCE IN ASSURANCE:

Assurance reports are written for the benefit of the people reading them. The

readers need to be able to trust that the reports are reliable and correct. If they

sense any links between the auditors and the things being audited, they may not trust

the opinions given.

If there are any links between the auditors and the things being audited, the report

loses credibility and the assurance is undermined.

It is therefore a requirement if the auditors are independent of those they are auditing

June 10, Question 2 (a): Auditors are frequently required to provide assurance

for a range of non-audit engagements.


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Required:

List and explain the elements of an assurance engagement. (5 marks)

TRUTH AND FAIRNESS:

True = information is

1. ______________________, is not false.

2. Conforms to required ______________.

3. The accounts have been correctly extracted from _______________.

Fair= Information is

1. _____________________.

2. _________________________________________.

3. The accounts reflect _____________________.

WHY HAVE ACCOUNTS AUDITED:

Due to the directors most likely differing to the shareholders, the shareholders will need

some protection, and therefore the auditors will independently review that the directors

have acted in the best interests of the shareholders.

TYPES AND LEVELS OF ASSURANCE:

Reasonable assurance

y High level of assurance

y Positive opinion e.g. in our opinion the FS show a T&F view

y Audit is not an absolute guarantee that FS are free from material misstatement.

y Auditors cannot provide a guarantee because of limitations.

Limited assurance

y Moderate level of assurancey Negative assurance e.g. nothing has come to our attention to suggest that the

FS do not show a T&F view therefore looks reasonable.

y Need more evidence to support a higher level of assurance so limited assurance

generally is for cash flow forecasts, budgets etc


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Past Exam Questions

June 05, Question 5 (c): Briefly explain the difference between positive and

negative assurance, outlining the advantages to the directors of providing

negative assurance on their cash flow forecast. (4 marks)

June 08,Question 5 (d): In the context of the cash flow forecast, define the

term negative assurance and explain how this differs from the assurance

provided by an audit report on statutory financial statements.(4 marks)

TYPES OF AUDIT:

y ______________

y ______________

y ______________

y ______________

y ______________

y ______________

y ______________

STATUTORY AND NON-STATUTORY AUDIT:

y Statutory audit

y Non-Statutory audits


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STATUTORY AUDIT COMPARED TO OTHER ASSURANCE ENGAGEMENTS:

Statutory audit Other assurance work

Scope of work governed by the law Scope of work decided by parties

involved

Carry out in accordance with ethics,

ISAs

Carry out in accordance with ethics,

maybe other guidance

Report on T&F, Properly Prepared and

directors report consistent with FS

Reporting depends on scope of work

Report to members Report to party who engaged

SHOULD A COMPANY HAVE AN AUDIT?

Benefits Disadvantages

Independent confirmation to directors

of profits

Cost

Assurance of compliance with

accounting standards

Time consuming

Can make recommendations on

systems

Adds credibility to financial information


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ADVANTAGES OF NON-STATUTORY AUDIT:

In addition to advantages common to all forms of audit a non-statutory audit can bring

other advantages.

a) For partners.b) For taxation authorities

c) For loan

RESPONSIBILITIES:

y It is not the auditors responsibility to prepare and present the financial

statements.

y This is the responsibility of the directors.

EXPECTATION GAP:

There are certain misconceptions about the role of the auditor and this gap between

what the auditors actually do and what people think they do is known as the

expectations gap.

HOW CAN WE NARROW THE EXPECTATIONS GAP:

y Audit report includes details on responsibilities of auditors and directors.

y Audit report explains how the audit is conducted (test basis, reasonable

assurance etc.) Engagement letter.y Statement of directors responsibilities in the financial statements.

DISCUSS HOW THE EXPECTATION GAP HAS AN IMPACT ON THE AUDITOR:

The expectation gap is the difference between the auditors responsibilities and the

understanding the users have of assurance reports.

1. Users assume that the auditors are responsible for the preparation of

the financial statements, when in fact its the directors.

2. Users assume its the auditor is responsibility for detecting fraud when in fact

the auditors are concerned about detecting material misstatement which

could include fraud.

3. Users assume that the auditors check all work when in fact they test a sample.


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4. Users assume that the audit report is stating the Financial Statements are

correct when actually the auditors are stating they are factually materially

correct.

FORMS OF AUDIT:

y Periodic Audit

y Interim Audit

y Continuous Audit

THE AGENCY THEORY:

The agency theory implies the relationships between the various stakeholders in a

company. The Agency relationships occurs when one party, the principle, employs

another party, the agent, to perform a task on their behalf.

ACCOUNTABILITY:

Accountability is the quality or state of being accountable, that is, being required or

expected to justify actions and decisions. It suggests an obligation or willingness to

accept responsibility for ones actions.

STEWARDSHIP:

Stewardship another persons property

AGENTS:

Agents are people employed or used to provide a particular service. In the case of a

company, the people being used to provide the service of managing the business also

have the second role of being people in their own trying to maximize their personal

wealth.

MATERIALITY:

Materiality is an expression of the relative significance or importance of a particular

matter in the context of the financial statements as a whole.

A matter is material if its omission or misstatement would reasonably influence the

decisions of an addressee of the auditors report.

Materiality may also be considered in the context of any individual primary statement

within the financial statements or of individual items included in them.


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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.

LIMITATIONS OF AUDIT:

y Auditing is not objective. Judgments have to be made

y Not all items in the Financial statements are tested

y Limitations in accounting and control systems

y Audit report has inherent limitations

y Audit report is issued a long time after the balance sheet date

y Audit evidence sometimes indicated what is probable, not certain


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TYPES OF ENGAGEMENTS:

Audit engagement:

The auditor provides a high, but not absolute, level of assurance that the information

is audited is free of material misstatement. This is expressed positively in audit reportas reasonable assurance

Review engagement:

The objective of a review engagement is to enable a practitioner to state whether, on

the basis of procedures which do not provide all the evidence that would be required in

an audit, anything that has come to the practitioners attention that causes the

practitioner to believe that the financial statements are not prepared, in all material

respects, in accordance with an applicable financial reporting network.

In a review engagement, therefore the auditor gives negative assurance, reporting thathe is not aware that anything is materially wrong.

Characteristics of a review engagement:

A review engagement has all the attributes of any assurance engagement:

y the practitioner who conducts the work

y the user who commissioned the work

y a responsible party

y the subject matter

y the subject matter information

y criteria

y sufficient appropriate evidence which needs to be documented

y a report

Agreed Upon Procedures:

The auditor simply provides a report of the actual findings, so no assurance is

expressed. Users of the report must instead judge for themselves the auditor procedure

and finding and draw their own conclusion

International Standard on Related Services (ISR) 4400, Engagements to Perform

Agreed Upon Procedures Regarding Financial Information. Examples of this type of

engagement could include the quantification of an insurance claim, or of the loss

suffered due to a fraud. The specialist area of forensic accounting and auditing could be

viewed as a specific type of agreed upon procedure engagement.


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Compilation of work:

Users of the compiled information gain some benefit from the accountants involvement,

but no assurance is expressed in the report.

Guidance to practitioners is given by the IAASB

in IS

R 4410, E

ngagements to CompileFinancial Information. Thus the engagement here is to prepare the financial

statements, and not to express any kind of opinion on them.

THE ENGAGEMENT PROCESS USUALLY INVOLVES:

y Agreeing the terms of the engagement in an engagement letter

y Deciding on a methodology for evidence gathering, and evaluation andmeasurement to support a conclusion

y Agreeing the type of report to be produced at the end of the engagement

COMPARISON OF EXTERNAL AND INTERNAL AUDITING:

External Audit Internal Audit

Appointed By Shareholders Directors

Reporting To Shareholders Directors

What they CheckAnnual Financial

Statements

Risk ManagementSystems

(anything management

ask them to check!)Legally Requirement Usually Yes Typically No

Independence They Must BeIdeally, but hard to

achieve

June 09, Question 4 (a): Contrast the role of internal and external auditors.

(8 marks)

Dec 09, Question 4 (a): Explain the difference between the interim audit and the

final audit.

(4 marks)


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THE EXTERNAL AUDIT TIMELINE:

INTERIM AUDIT:

The detailed audit planning and assessment of internal controls are

often carried out on an interim audit, which can be done without

waiting for the accounting year to end.

On very large audits, more than one interim audit visit may

be necessary.

FINAL AUDIT:

The Draft (unaudited) Financial Statements are now available.

The main focus is substantive testing results of control tests

determine how much substantive testing is required.

H.A.1

Objectives, characteristics and responsibilities (18 mins)

Your client, Mr. Neville, has written to you saying he has been considering setting up an internal

audit department but has heard from his brother that he would be better off abandoning this idea

and getting the external auditor to do some assurance work instead. His brother also claimed that

if the external auditor does some work for the company, there would be no need to have an

external audit.

Required

Write a letter to Mr. Neville explaining the objectives, characteristics and responsibilities ofinternal audit and external audit. (Total = 10 marks)

H.A.2(9 mins)

(1) When buying a house, it is common for the purchaser to obtain a number of reports to giveassurance that the property is sound and worth the money that is being offered. Describe threesuch reports and explain the assurance that is being sought.


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(2) A common example of a limited assurance engagement is when an accountant is engaged toreview a set of accounts. Identify and briefly describe the five elements of a review engagementto give limited assurance on whether a set of financial statements complies with ifrs.

(3) Complete all the boxes in the table below.

Nature of engagement Audit Review

Amount of work done decided by whom

Type of assurance engagement

Level of assurance provided

Type of report provided(Total = 5 marks)

H.A.3 (5mins)

(1) Does the external auditor report on whether the published financial statements are correct ornot?

(2) You are auditing the financial statements of AB Ltd and discover that a car has beendouble-counted in the fixed assets at the balance sheet date. The car has a net book value of$5,000, non current assets are stated at $400,000 the profit before tax for the year is $100,000.

What should do?(Total = 3 marks)

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