20 Assurance

Question 1

Definition of assurance

Answer 1

An assurance engagement is one in which a practitioner aims to obtain sufficient appropriate evidence to express a conclusion designed to enhance the degree of confidence of the intended users other than the responsible party about the outcome of the evaluation or measurement of an underlying subject matter against criteria

Question 2

Elements of an assurance engagement

Answer 2

All assurance engagements must involve the following five elements:
 Three party relationship (practitioner, responsible party, user)
 Subject matter
 Criteria
 Evidence
 Written report

Question 3

Levels of assurance

Answer 3

Reasonable assurance engagements result in a positive expression of opinion and the level of assurance given is deemed to be high.

Limited assurance engagements result in negative assurance and the level of assurance given is
deemed to be moderate.

Question 4

Types of audit procedure

Answer 4

ISA 500 suggests that the following procedures can be used as risk assessment procedures, tests of
controls or substantive procedures in an assurance engagement:
 Inspection
 Observation
 External confirmation
 Recalculation
 Re-performance
 Analytical procedures
 Enquiry

Question 5

Internal controls

Answer 5

Internal controls
ISA 315 identifies the following control activities which may help an organisation to prevent and detect
fraud and error:
 Authorisation
 Performance reviews
 Information processing
 Physical controls
 Segregation of duties

Question 6

Prospective financial information

What is it?

Answer 6

Prospective financial information (PFI) means financial information based on assumptions about
events that may occur in the future, and possible actions by an entity.

Question 7

Prospective financial information - what is a forecast PFI?

Answer 7

A forecast is PFI based on future events which management expects to occur.

Question 8

Prospective financial information - what is a projection PFI?

Answer 8

A projection is PFI based on hypothetical assumptions about future events which are not necessarily expected to occur.

Question 9

Providing assurance on PFI
The need for assurance

Answer 9

Management may seek an assurance report over their forecasts and projections for many reasons, the most significant being
 To aid in negotiations around a potential takeover or merger (see due diligence below)
 To present as part of a business plan in order to raise finance

Question 10

Providing assurance on PFI
The Level of assurance

Answer 10

ISAE 3400 The Examination of Prospective Financial Information dictates that an assurance report in relation to PFI can only ever give limited assurance, since PFI is by definition highly subjective in
nature.

Question 11

PFI reports - how will the opinion be worded?

Answer 11

The opinion contained within a PFI assurance report will always be negatively worded, since the level of assurance is limited

Question 12

The main features of a PFI assurance report will be

Answer 12

 A statement of negative assurance as to whether the assumptions provide a reasonable basis
for the PFI
 An opinion as to whether the prospective financial information is properly prepared on the basis of the assumptions and the relevant reporting framework
 Appropriate caveats as to the achievability of the forecasts

Question 13

PFI assurance procedures

Typically, a PFI assurance engagement will focus mainly on enquiries and analytical procedures, since
traditional audit procedures on historical financial information will not be an option.

Suggested procedures when reviewing PFI include:

Answer 13

 Reviewing the experience of the preparer of the PFI
 Casting all financial information provided
 Performing sensitivity analysis
 Verifying historic comparative information to financial statements
 Obtaining quotes for any planned purchases
 Comparing forecast figures to similar figures in historic periods to identify unexpected trends
 Reviewing minutes of Board meetings to verify planned transactions e.g. dividend payments

Question 14

Due diligence

When is it used?

Answer 14

When a company is seeking to make an acquisition, there may be a need to engage an independent
firm to provide due diligence. This is essentially a fact-finding exercise to make the purchaser aware of any relevant information about the target company before a final decision is made and a purchase price is agreed.

Question 15

Types of due diligence

Answer 15

Financial due diligence

Commercial due diligence

Operational due diligence

Technical due diligence

IT and cyber due diligence

Legal due diligence

Question 16

Tell me about financial due diligence

Answer 16

Financial due diligence is a review of the target company’s financial position, financial risk and
projections (for example, in relation to earnings and cash flows). However, it is not the same as a
statutory audit, its purposes are more specific to an individual transaction and to particular user
groups, and there is normally a specific focus on risk and valuation.

This will involve evidence gathering procedures over historic financial statements using traditional audit testing techniques, as well as over forecast financial statements (see PFI above).

Question 17

Tell me about commercial due diligence

Answer 17

Commercial due diligence complements financial due diligence by considering the target company’s
markets and external economic environment. It examines where the target company’s competitive
advantage comes from and whether or not it is sustainable.

Some of the areas which commercial due diligence may focus on include

 Competitors
 Marketing strategy
 Resources and competencies
 KPIs used in appraising performance
 Review of industry and macroeconomic factors

Question 18

Tell me about operational due diligence

Answer 18

Operational due diligence considers the operational risks and possible improvements which can be made in a target company. This will involve consideration of the detailed practical issues which may
arise within the target business or during the acquisition process

Question 19

Tell me about technical due diligence

Answer 19

Technical due diligence involves reviewing the feasibility of any technical benefits expected as a result
of the potential acquisition

Question 20

Tell me about IT and Cyber due diligence

Answer 20

IT due diligence assesses the suitability and risks arising from IT factors in the target company (for example, any issues surrounding IT security, or integrating IT systems post-acquisition).

Question 21

Tell me about Legal due diligence

Answer 21

Legal due diligence aids in structuring the terms of a takeover, in addition to searching out hidden
liabilities or contingent liabilities which may be acquired with the target company.

This will include a review of the target company’s tax affairs to ensure that their payments are up to
date. In addition, tax due diligence will consider how the new group should be structured after
acquisition

Question 22

What are agreed upon procedures?

Answer 22

In an engagement to perform agreed upon procedures (AUP), a practitioner is required to carry out
and report on specific procedures, as agreed. No opinion is given by the practitioner, instead the recipients of the report will form their own conclusions.

(technically not an assurance engagement as no opinion)

Question 23

Service level agreements
Need for assurance

Answer 23

When a company enters into a new relationship with a customer or supplier, a service level agreement
may be written to clarify expectations of both parties

This may involve setting key performance indicators around such areas as
 Delivery times
 Quality of products and services provided
 Environmental and sustainability issues
 Recourse in the event of failure to meet contract terms

Assurance may be sought as to whether the conditions of a service level agreement have been met

Question 24

Assurance procedures for a joint venture partner - initial assurance

Answer 24

• Review JA agreement (in combination with legal advisers) for onerous, ambiguous or omitted clauses
• Ensure the purposes & scope of the JA is clear and the respective rights of both parties are established in the contractual arrangements
• Review tax status of JA entity, governance procedures, key decision making processes to ensure partner has appropriate level of control over key decisions
• Establish that initial capital has been contributed and legal rights to use assets
• Establish creditworthiness, going concern and reputation of partner
• Ensure terms of disengagement are clear
• Health and safety responsibility established

Question 25

Assurance procedures for a joint venture partner - ongoing assurance

Answer 25

• Audit rights and access of information need to be established
• Ensure the operations of the JA are within terms of the agreement
• Ensure internal controls and accounting systems are being applied and are effective
• accounting systems of JA need to be capable of recording accurately and completely the costs incurred. RIsk areas may include overhead allocations
• If permitted within terms of the contract, audit access to the accounting records of the partner would provide additional assurance (though may have to be reciprocated)
• Level of assurance needs to be determined