FUNDAMENTALS OF AUDITING ACC311
Lecture 05
Lesson 05
REASONABLE ASSURANCE
What is reasonable
assurance?
assurance?
It means a conclusion
that the financial statements are not materially misstated. An auditor cannot
obtain
that the financial statements are not materially misstated. An auditor cannot
obtain
absolute assurance
because of limitations described in paragraph below.
because of limitations described in paragraph below.
Reasonable assurance
through audit evidence
through audit evidence
Audit
evidence:
evidence:
• For internal control
• For transactions &
accounts balances
accounts balances
• For financial
statements
statements
Factors affecting reasonable
assurance
assurance
i) Inherent limitation
of an audit, i.e. failure of audit procedures to detect material
of an audit, i.e. failure of audit procedures to detect material
misstatements in
financial statements because of:
financial statements because of:
a) The use of testing
(application of procedures on samples).
(application of procedures on samples).
b) The inherent
limitations of accounting and internal control system.
limitations of accounting and internal control system.
c) Persuasive nature of
audit evidence rather than conclusive (Persuasive:
audit evidence rather than conclusive (Persuasive:
one leading to an
opinion; one which causes to believe; Conclusive: final,
opinion; one which causes to believe; Conclusive: final,
convincing).
ii) Exercise of judgment
by the auditor in gathering of evidence and drawing of
by the auditor in gathering of evidence and drawing of
conclusion.
iii) Existence of other
limitations like related parties etc.
limitations like related parties etc.
Inherent Limitations of
Accounting and Internal Control
Accounting and Internal Control
• Management over rides
• Collusion with
employees
employees
• Collusion with third
party
party
• Unaffordable cost of
internal control
internal control
• Human error
Accordingly, because of
the factors described above an audit is not a guarantee that the financial
statements
the factors described above an audit is not a guarantee that the financial
statements
are free from material
misstatement, because absolute assurance is not attainable. Further, an audit
opinion
misstatement, because absolute assurance is not attainable. Further, an audit
opinion
does not assure the
future viability of the entity nor the efficiency or effectiveness with which
management
future viability of the entity nor the efficiency or effectiveness with which
management
has conducted the
affairs of the entity
affairs of the entity
AUDIT RISK AND
MATERIALITY
MATERIALITY
Entities pursue
strategies to achieve their objectives, and depending on the nature of their
operations and
strategies to achieve their objectives, and depending on the nature of their
operations and
industry, the regulatory
environment in which they operate, and their size and complexity, they face a
environment in which they operate, and their size and complexity, they face a
variety of business
risk. Management is responsible for identifying such risks and responding to
them.
risk. Management is responsible for identifying such risks and responding to
them.
However, not all risks
relate to the preparation of the financial statements. The auditor is
ultimately
relate to the preparation of the financial statements. The auditor is
ultimately
concerned only with
risks that may affect the financial statements.
risks that may affect the financial statements.
The auditor obtains and
evaluates audit evidence to obtain reasonable assurance about whether the financial
evaluates audit evidence to obtain reasonable assurance about whether the financial
statements give a true
and fair view or are presented fairly, in all material respects, in accordance
with the
and fair view or are presented fairly, in all material respects, in accordance
with the
applicable financial
reporting framework. The concept to reasonable assurance acknowledges that
there is a
reporting framework. The concept to reasonable assurance acknowledges that
there is a
risk the audit opinion
is inappropriate. The risk that the auditor expresses an inappropriate audit
opinion
is inappropriate. The risk that the auditor expresses an inappropriate audit
opinion
when the financial
statements are materially misstated is known as “audit risk”.
statements are materially misstated is known as “audit risk”.
Audit Risk
The risk that the
auditor expresses inappropriate audit opinion when the financial statements
are
auditor expresses inappropriate audit opinion when the financial statements
are
materially misstated.
The concept of
reasonable assurance acknowledges that there is a risk the audit opinion is
in
reasonable assurance acknowledges that there is a risk the audit opinion is
in
appropriate.
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Materiality
Risk of material
misstatement levels:
misstatement levels:
• Overall Financial
Statement level
Statement level
• Often relates to
entity’s control environment
entity’s control environment
• Also relates to
declining economic conditions
declining economic conditions
• Transactions, account
balances, & disclosures level
balances, & disclosures level
Auditor is not
responsible for detection of misstatements that are not material.
responsible for detection of misstatements that are not material.
The auditor should plan
and perform the audit to reduce audit risk to an acceptably low level that is
and perform the audit to reduce audit risk to an acceptably low level that is
consistent with the
objective of an audit
objective of an audit
Responsibility for the
Financial Statements:
Financial Statements:
Responsibilities for
preparing and presenting the financial statements are that of management.
Auditor’s
preparing and presenting the financial statements are that of management.
Auditor’s
responsibility is to
express an opinion thereon.
express an opinion thereon.
This responsibility
includes:
includes:
• Designing,
implementing and maintaining internal control relevant to the preparation and
implementing and maintaining internal control relevant to the preparation and
presentation of
financial statements that are free from material misstatement, whether due to
fraud
financial statements that are free from material misstatement, whether due to
fraud
or error;
• Selecting and applying
appropriate accounting policies; and
appropriate accounting policies; and
• Making accounting
estimates.
