OBJECTIVE AND GENERAL PRINCIPLES GOVERNING AN AUDIT OF FINANCIAL STATEMENTS

<< Advantages and Disadvantages of Auditing

What is Reasonable Assurance >>

Fundamentals of Auditing ACC 311

Lesson 04

OBJECTIVE AND GENERAL PRINCIPLES GOVERNING

AN AUDIT OF FINANCIAL STATEMENTS

Objective of an Audit:

Objective of an audit of financial statements is to enable an auditor to express an opinion whether the

financial statements are prepared, in all material respects, in accordance with an identified financial reporting

framework (e.g. International or Local Accounting Standards).

The terms used to express the opinion are "give a true and fair view" or "present fairly in all material

respects".

Benefit of opinion

It improves credibility of financial statements.

What an opinion does not achieve?

It does not provide any assurance about

Future viability of the entity; and

ii)

Efficiency or effectiveness of management.

General Principles of an Audit:

Professional Ethics

There are a number of ethical matters that are extremely important for auditors to consider when

performing their work. It is vital to the public image and credibility of the profession that the

auditor is seen to be behaving in an acceptable manner in addition to actually complying with the

ethical requirements.

It is important to recognize that many groups in society rely on accountant's work, not just the

shareholders on whose behalf the accountant is working. The accountant therefore has a public

accountability.

In the light of this, ICAP's ethical guidelines emphasis the following key points about the

characteristics of accountants:

Independence:

Auditor is independent of management i.e. he is not under the control or influence of

management.

Integrity:

Auditor is honest and is not corrupt. He is straight forward in performing his professional

work

Objectivity:

He obtains the evidence needed to form an opinion and his opinion is based on that

evidence alone. He is not subjective in forming his opinion.

Professional Competence and Due Care:

Auditor has attained certain professional qualification, has acquired the requisite skill and

has attained the experience necessary for the audit and performs his work with planning

and due diligence.

Confidentiality:

Auditor neither discloses the information obtained during the course of his audit without

permission of his client (except when required in a court of law) nor uses that information

himself.

Professional Behavior:

He should not only act in a professional manner but should also appear to be a

professional. He should maintain his professional knowledge and skill at a level required to

ensure that a client or employer receives the benefit of competent professional service

based on up-to-date developments in auditing practice and relevant legislation.

Technical Standards:

Audit should be performed by following certain standards, international or national.

Fundamentals of Auditing ACC 311

International Standards on Auditing (ISAs)

The auditor should follow basic principles and essential procedures together with related guidance

as contained in ISAs.

International Standards on Auditing (ISAs) are issued by the International Auditing Practices

Committee (IAPC). The IAPC is a standing committee of the Council of the International

Federation of Accountants (IFAC), which was formed in 1977 and is based in New York. IFAC

has more than 150 member bodies, representing over 2 million accountants in more than 100

countries, and membership of IFAC automatically confers

The IAPC issued standards and statements on auditing and related services in order to improve the

degree of uniformity of auditing practice and related services throughout the world.

The IAPC works closely with its members and national standard setters in order to gain acceptance

of international Standards of Auditing (ISAs). Member bodies have increasingly sought to align the

national position with the international positions IFAC and the IASC have gained influence and

recognition. Standard setters increasingly refer to the international position in their consultative

documents as authoritative support for a particular view.

International auditing and accounting standards do not at present override local regulations.

Neither IFAC nor the IASC can currently compel any organization to comply with international

standards; nor are there specific sanctions where organizations claim to have complied with

international standards, but have not done so.

The preface to International Standards on Auditing and Related Services (ISA 100) states that IAPC guidance

falls into two categories:

International Standards on Auditing (ISAs).

ISAs contain basic principles and essential procedures (identified in bold type black lettering),

together with related guidance in the form of explanatory and other material (in plain type)

including appendices.

The basic principles and essential procedures are to be understood and applied in the context of

explanatory and other material that provides guidance for their application. The text of a whole

standard is considered in order to understand and apply the basic principles and essential

procedures.

International Auditing Practice Statements (IAPSs).

In conducting an audit in accordance with ISAs, the auditor is also aware of and considers

International Auditing Practice Statements (IAPSs) applicable to the audit engagement.

IAPSs provide practical assistance to auditors in implementing standards and promote good

practice. They are not intended to have the authority of standards.

The auditor may also conduct the audit in accordance with both ISAs and auditing standards of a specific jurisdiction

or country.

Professional Skepticism

The audit should be planned and performed with an attitude of professional skepticism i.e. forming

an opinion only after obtaining sufficient and appropriate audit evidence instead of blindly

accepting any information or explanation given by the management.

An attitude of professional skepticism means the auditor makes a critical assessment, with a

questioning mind, of the validity of audit evidence obtained and is alert to audit evidence that

contradicts or brings into question the reliability of documents and responses to inquiries and other

information obtained from management and those charged with governance.

SCOPE OF AN AUDIT

What does it mean?

The term "scope of an audit" refers to the audit procedures that, in the auditor's judgment and

based on the ISAs, are deemed appropriate in the circumstances to achieve the objective of the

audit.

Fundamentals of Auditing ACC 311

Audit opinion

Reasonable assurance

Sufficient appropriate audit evidence

Audit procedures (based on ISAs)

Audit-Evidence:

It is obtained by applying necessary audit procedures. Audit procedures should be based on requirements of

ISAs, relevant professional bodies, legislation, regulations, and the terms of the audit engagement and

reporting requirements.

Auditing is concerned with the verification of accounting date and with determining the accuracy and

reliability of accounting statements and reports.

Verification does not mean seeking proof or absolute certainty in connection with the data and reports

being audited. It means looking for sufficient evidence depends on what experience and knowledge of

contemporary auditing standards tells one is satisfactory.

An auditor obtains audit evidence regarding management's assertions for the following areas:

a. Existence: an asset or liability exists at the Balance Sheet date. This is an obvious assertion with such

items as land and buildings, stocks and others

b. Rights and obligations: an asset or liability pertains to the entity at the Balance Sheet date. This

means that the enterprise has for example ownership of an asset. Ownership as an idea is not simple

and there may be all sorts of rights and obligations connected with a given asset or liability.

c. Occurrence: a transaction or event took place which pertains to the enterprise during the relevant

period. It may be possible for false transactions (e.g. sales or purchases) to be recorded. The assertion is

that all recorded transactions actually took place.

d. Completeness: there are not unrecorded assets, liabilities, transactions or events or undisclosed items.

This is important for all accounts items but is especially important for liabilities.

e. Valuation: an asset or liability is recorded at an appropriate carrying value Appropriate may mean in

accordance with generally accepted accounting principles, the companies Act rules, Accounting

Standards requirements and consistent with statements of accounting policies consistently applied.

f. Measurement: a transaction or event is recorded at the proper amount and revenue or expense

allocated to the proper period.

g. Presentation and disclosure: an item is disclosed, classified and described in accordance with

applicable reporting framework. For example fixed assets are subject to the Companies Ordinance rules

and to IAS 16.

An example:

We will look at an item in a balance sheet, bank overdraft Rs. 10,250. In reporting this item in the balance

sheet, the directors are making these assertions:

a. That there is a liability to the company's bankers.

b. That at the balance sheet date this liability was Rs. 10,250.

c. That this amount is agreed by the bank

d. That the overdraft was repayable on demand. If this were not so, it would not appear amongst the

current liabilities and terms would be stated.

e. That the overdraft was not secured. If it were secured this fact would need to be stated.

f. That the company has the Authority to borrow from its Memorandum and Articles.

g. That a bank reconciliation statement can be prepared.

h. That the bank is willing to let the overdraft continue.

If no item `bank overdraft' appeared in the balance sheet, it would represent an assertion by the directors

that no overdraft liability existed at the balance sheet date.

REASONABLE ASSURANCE

What is reasonable assurance?

A conclusion that the financial statements are not materially misstated. An auditor cannot obtain absolute

assurance because of limitations described in Para below.

How reasonable assurance is achieved?

It is achieved by obtaining audit evidence.

Factors affecting reasonable assurance

Fundamentals of Auditing ACC 311

Inherent limitation of an audit, i.e. failure of audit procedures to detect material

misstatements in financial statements because of:

The use of testing (application of procedures on samples).

The inherent limitations of accounting and internal control system.

Persuasive nature of audit evidence rather than conclusive (Persuasive: one leading

to an opinion; one which causes to believe; Conclusive: final, convincing).

ii)

Exercise of judgment by the auditor in gathering of evidence and drawing of conclusion.

iii)

Existence of other limitations like related parties etc.

Audit Risk and Materiality

Guidance provided by ISA 200 in this matter is discussed in later chapters which specifically and exclusively

discuss it.

Responsibility for the Financial Statements:

Responsibilities for preparing and presenting the financial statements are that of management. Auditor's

responsibility is to express an opinion thereon.

Table of Contents: