Ch-1 Nature, scope and objective of Audit

Question 1

What is audit ?

Answer 1

An audit is an independent examination of financial information of any entity, whether profit oriented or not, and irrespective of its size or legal form, when such an examination is conducted with a view to expressing an opinion thereon.

Question 2

How would an auditor ensure that financial statements would not mislead anybody?

Answer 2

he has to see that financial statements would not mislead anybody by ensuring that: -
o the accounts have been drawn up with reference to entries in the books of account;
o the entries in the books of account are adequately supported by sufficient and appropriate evidence;
o none of the entries in the books of account has been omitted in the process of compilation;
o the information conveyed by the statements is clear and unambiguous;
o the financial statement amounts are properly classified, described and disclosed in conformity with accounting standards; and
o the statement of accounts presents a true and fair picture of the operational results and of the assets and liabilities.

Question 3

OBJECTIVES OF AUDIT

Answer 3

SA-200 “Overall Objectives of the Independent auditor and the conduct of an audit in accordance with Standards on Auditing” are: -
(a) To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework; and
(b) To report on the financial statements, and communicate as required by the SAs, in accordance with the auditor’s findings.

Question 4

Scope of audit

Answer 4

The following points are included in scope of audit of financial statements: -
(1) Coverage of all aspects of entity
(2) Reliability and sufficiency of financial information
(3) Proper disclosure of financial information

Question 5

What is not included in the scope of audit?

Answer 5

1. Auditor is not expected to perform duties which fall outside domain of his competence. For example, physical condition of certain assets like that of sophisticated machinery cannot be determined by him.
2. An auditor is not an expert in authentication of documents.
3. An audit is not an official investigation into alleged wrong doing.
4. Auditor is not responsible for preparing and presenting financial statements.

Question 6

INHERENT LIMITATIONS OF AUDIT

Answer 6

Inherent Limitations of Audit (SA 200 “Overall Objectives of the Independent
Auditor and the Conduct of an Audit in Accordance with Standards on Auditing”):
The auditor is not expected to, and cannot, reduce audit risk to zero because there
are inherent limitations of an audit. The inherent limitations of an audit arise from:

1. The Nature of Financial Reporting: The preparation of financial statements involves judgment by management.
2. The Nature of Audit Procedures: There are practical and legal limitations on the auditor’s ability to obtain audit evidence such as:
   a) Possibility that management or others may not provide, intentionally or unintentionally, the complete information relevant for preparation and presentation of FS.
   b) Fraud may involve sophisticated and carefully organised schemes.
3. Not in the nature of Investigation: An audit is not an official investigation into
   alleged wrongdoing.
4. Timeliness of financial reporting and decrease in relevance of information over time: Relevance of information, and thereby its value, tends to diminish over time, and there is a balance to be struck between the reliability of information and its cost.
5. Future events: Future events or conditions may affect an entity adversely. Adverse events may seriously affect ability of an entity to continue its Business.

Question 7

WHY AUDIT IS NEEDED?

Answer 7

• Audited accounts provide high quality information. It gives confidence to users that information on which they are relying is qualitative and it is the outcome of an exercise carried out by following Auditing Standards recognized globally.
• In case of companies, shareholders may or may not be involved in daily affairs of the company. The financial statements are prepared by management consisting of directors. As shareholders are owners of the company, they need an independent mechanism so that financial information is qualitative and reliable. Hence, their interest is safeguarded by an audit.
• An audit acts as a moral check on employees from committing frauds for the fear of being discovered by audit.
• Audited financial statements are helpful to government authorities for determining tax liabilities.
• Audited financial statements can be relied upon by lenders, bankers for making their credit decisions i.e. whether to lend or not to lend to a particular entity.
• An audit may also detect fraud or error or both.
• An audit reviews existence and operations of various controls operating in any entity. Hence, it is useful at pointing out deficiencies.

Question 8

MEANING OF ASSURANCE ENGAGEMENT

Answer 8

“Assurance engagement” means an engagement in which a practitioner expresses 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 a subject matter against criteria.

Question 9

Elements of an Assurance Engagement

Answer 9

 Three Party relationship
 An appropriate subject matter
 Suitable Criteria
 Sufficient appropriate evidence
 Written assurance report in appropriate form

Question 10

Difference between reasonable assurance engagement and limited assurance engagement.

Answer 10

1. Reasonable assurance engagement provides high level of assurance. Limited assurance engagement provides lower level of assurance than reasonable assurance engagement.
2. It performs elaborate and extensive procedures to obtain sufficient appropriate evidence. It performs fewer procedures as compared to reasonable assurance engagement.
3. It draws reasonable conclusions on the basis of sufficient appropriate evidence. It involves obtaining sufficient appropriate evidence to draw limited conclusions.
4. Example of reasonable assurance engagement is an audit engagement. Example of limited assurance engagement is review engagement.

Question 11

Why are Standards needed?

Answer 11

• Standards ensure carrying out of audit against established benchmarks at par with global practices.
• Standards improve quality of financial reporting thereby helping users to make diligent decisions.
• Standards promote uniformity as audit of financial statements is carried out following these Standards.
• Standards equip professional accountants with professional knowledge and skill.
• Standards ensure audit quality.