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Concept and need for audit & assurance Page 1

Ch # 1 Concept and need for Audit and Assurance

The meaning of Audit

Definition and objective of audit

An audit is an official examination of the accounts of an entity by an auditor.

Main objective of an audit is to enable an auditor to convey an opinion as to whether or not the financial
statements of an entity are prepared according to an applicable financial reporting framework.

Financial statements (F/S)

A structured representation of historical financial information, including disclosures, intended to
communicate an entity’s economic resources or obligations at a point in time, or the changes therein for a
period of time, in accordance with a financial reporting framework.

As per IAS-1 F/S have the following components:

▪ Statement of Financial Position (Balance Sheet)
▪ Statement of Profit or Loss and other comprehensive income
▪ Statement of Changes in Equity
▪ Cash Flow Statement
▪ Notes to the Financial Statements
▪ Comparative information prescribed by the standard

Applicable financial reporting framework (AFRF)

The AFRF adopted by management and, where appropriate, TCWG in the preparation of F/S that is
acceptable in view of the nature of entity and objective of F/S, or that is required by law or regulation. The
AFRF is decided by legislative or regulatory environment within each individual country, and accounting
standards (e.g. IFRS).

Concepts of accountability, stewardship and agency

▪ The directors have a stewardship role.

▪ They look after the assets of the company and manage them on behalf of the shareholders.
▪ Relationship between shareholders and the board of directors (BOD) is also an application of the
principle of agency.
▪ The agent has a legal duty to act in the best interests of the principal
▪ As agents for shareholders, the BOD should be accountable to the shareholders.
▪ To show their accountability, it is a general principle of company law that the directors are required to
prepare annual F/S, which are presented to shareholders for their approval.

The audit report: independence, materiality and true and fair

The key features of the audit report are as follows:

▪ Auditors producing the report are independent from the directors producing the F/S.
▪ The report gives an opinion on whether the financial statements “give a true and fair view”, or
“present fairly” the position and results of the entity in all material respects.
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Independence of the auditor

▪ External auditor must be independent from the directors

▪ If he is not independent, his opinion is likely to be influenced by the directors.

True and fair view (fair presentation)

▪ The term ‘true’ implies free from error,

▪ The term ‘fair’ implies that there is no undue bias in the F/S or the way in which they have been
presented.
▪ The phrases ‘true and fair view’ and ‘present fairly’ indicate that a judgement is being given that F/S
can be relied upon and have been properly prepared in accordance with an appropriate AFRF.

Materiality concept

▪ The auditor reports in accordance with the concept of materiality.

▪ He gives an opinion on whether the F/S present fairly in all material respects the financial position and
performance of the entity.
▪ Information is material if, on the basis of the F/S, it could influence the economic decisions of users
should it be omitted or misstated.
▪ The auditor will not aim to examine every number in the F/S. He will concentrate his efforts on the
more significant items in the financial statements.

Advantages and Limitations of Statutory Audits

Advantages of statutory audits:

▪ Increases the credibility of published financial statements.

▪ Confirms to management that they have performed their statutory duties correctly.
▪ Provides assurance to management that they have complied with non statutory requirements
▪ Provides feedback on the effectiveness of internal controls.
▪ Where internal controls are weak or inadequate, the auditor will give recommendations for
improvement. This will assist management in reducing risk and improving performance of the
company.

Inherent Limitations of an Audit

▪ The cost of an audit can be very high.

▪ Disruption caused to a company's staff during the audit
▪ Some items in the subject matter might be estimates whose truth and fairness will not be known with
certainty until some point in the future. This means the assurance opinion is ultimately subjective and
judgmental.
▪ Most fraud will include an attempt to deliberately conceal the truth or misrepresent information.
▪ Auditor routinely uses sampling rather than tests every item.
▪ Irrespective of how strong a client's systems are, they will always incorporate some degree of inherent
limitations.
▪ Audit evidence is persuasive rather than conclusive.
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Meaning of Assurance

▪ ‘Assurance’ means confidence.

▪ In an assurance engagement, an ‘assurance firm’ is engaged by one party to give an opinion on a piece
of information that has been prepared by another party.
▪ The opinion is an expression of assurance about the information that has been reviewed.
▪ It gives assurance to the party that hired the assurance firm.

Levels of assurance

Assurance falls into one of two categories:

▪ Reasonable Assurance – A high (but not absolute) level of assurance provided by the practitioner’s
conclusion expressed in a positive form.
E.g. “In our opinion the F/S are true and fair”. (i.e. Audit)

▪ Limited Assurance – A moderate level of assurance provided by the practitioner’s conclusion

expressed in a negative form. It is necessary in the situations where the accountant/auditor cannot
obtain sufficient evidence to provide positive assurance

E.g. “Based on our review, nothing has come to our attention that causes us to believe that the
accompanying F/S do not give a true and fair view”. (i.e. Review)

Assurance provided by audit

▪ Provides a high, but not absolute, level of assurance

▪ Absolute assurance is not provided as there are some inherent limitations of an audit

Assurance provided by review

▪ Review would provide only a moderate level of assurance that the information under review is free of
material misstatement.
▪ The resulting opinion is usually expressed in the form of negative assurance.
▪ Negative assurance is an opinion that ‘nothing has come to our attention to suggest that the
information is misstated’.
▪ A review does not provide the same amount of assurance as an audit.
▪ Negative assurance is necessary in situations where the accountant/auditor cannot obtain sufficient
evidence to provide positive assurance.
(e.g. the management of a client entity may ask the audit firm to carry out a review of a cash flow
forecast that relates to the future and is based on many assumptions)

Elements of an Assurance Engagement

Assurance Engagement
An engagement in which a practitioner aims to obtain sufficient appropriate evidence in order to express
a conclusion designed to enhance the degree of confidence of the intended users other than the
responsible party about the subject matter information (that is, the outcome of the measurement or
evaluation of an underlying subject matter against criteria)
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An assurance engagement will consist of the following 5 elements:

1) A three party relationship:

▪ Practitioner (e.g. audit firm)

▪ Responsible party (e.g. directors and management)
▪ Intended users: (e.g. shareholders)

2) Subject matter:

This is the data such as the financial statements that have been prepared by the responsible party for
the practitioner to evaluate.

3) Suitable criteria:

Rules against which the subject matter is evaluated in order to reach an opinion. In a statutory audit
this would be the AFRF.

4) Evidence:

Information used by the practitioner in arriving at the conclusion on which their opinion is based. This
must be sufficient and appropriate.

5) Assurance report:

The report containing the practitioner's opinion. This is issued to intended user after the collection of
evidence.
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Statutory Audit - Regulatory framework (Companies Act 2017)

Appointment and remuneration of auditors (Sec 246)

Auditor Time of Appointment Appointed by Term of Office

First 90 days of incorporation Directors Till 1st AGM
Subsequent At AGM Members on recommendation of Till next AGM
the BOD
Casual Vacancy 30 days of such vacancy Directors Till next AGM

▪ Auditor, appointed by directors or the members, may be removed before conclusion of next AGM by
Special Resolution
▪ If auditor is removed by Special resolution, next auditor will be appointed by board with prior
approval of SECP.

SECP shall appoint auditor, on its own motion or on application by company or members, if:
▪ 1st auditors not appointed by directors within 90 days of the incorporation
▪ Auditor not appointed in an AGM
▪ Casual vacancy not filled by directors within 30 days
▪ Auditors appointed are unwilling to act

Appointing Authority Remuneration Fixed by

Directors Directors
SECP SECP
All other cases Members

Retirement of existing and Appointment of new auditor in an AGM

▪ Member(s) having at least 10% shareholding shall also be entitled to propose any auditor whose
consent has been obtained.
▪ A notice shall be given to company at least 7 days before the date of the AGM..
▪ On receipt of such notice, company shall:
- Sent a copy of notice to the retiring auditor, forthwith.
- Post it on its website.
▪ Retiring auditor can make representation to company at least 2 days before AGM. It shall be read in
AGM and it shall be mandatory for auditor/representative to attend the meeting.
▪ Company shall intimate the registrar within 14 days of appointment / removal / casual vacancy
together with the consent of appointed auditor.

Qualification and disqualification of auditors (Sec 247)

▪ Auditor shall be a CA having valid certificate of practice form ICAP or a Firm of CAs for:
- Public Company
- Private Company which is subsidiary of Public Company
- Private Company having paid up share capital of at least Rs. 3 million.
▪ For companies other than above, auditor shall be CA or CMA having certificate of practice from
respective institute or Firm of CAs/CMAs having such criteria as may be prescribed
▪ Firm where majority of partners practicing are qualified for appointment can be appointed in firms
name.
▪ Only partners meeting above criteria shall be authorized to act and sign on behalf of firm.
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DISQUALIFICATIONS OF AUDITOR

1. Person who during preceding 3 years was director, other officer or employee of Company
2. Person who is a director, other officer or employee of Company
3. Person who is a partner or employee of a director, officer or employee of Company
4. Spouse of the director of Company
5. Person indebted to Company, other than in ordinary course of business of such entities
- Not be considered indebted, if owes less than 1,000,000 to a credit card issuer
- Not be considered indebted, if unpaid utility dues for ≤ 90 days to utility Company
6. Body Corporate
7. Person or his spouse and his minor children, or in case of a firm, all partners of a firm who holds any
shares in Company or its associated company.
(If he holds shares before appointment, the fact shall be disclosed at time of appointment and shall
disinvest such shares within 90 days of appointment)
8. Person who has given a guarantee/security in connection with the indebtedness of any third person
to the company other than in the ordinary course of business of such entities;
9. Person or a firm who, directly or indirectly, has business relationship with the company other than in
the ordinary course of business of such entities;
10. Person who has been convicted by a court of an offence involving fraud and a period of 10 years
has not elapsed from the date of such conviction;
11. Person who is not eligible to act as auditor under the code of ethics as adopted by the ICAP and
the ICMAP;

▪ Person disqualified as auditor of a Company shall also be disqualified for its Holding company, its
Subsidiary Company or Subsidiary Company of its Holding Company.
▪ If after appointment auditor becomes disqualified, he shall deem to vacate office with effect from date
he becomes disqualified
▪ If an unqualified/disqualified person is appointed as auditor; It shall be void and SECP may appoint a
qualified person in place of the auditor appointed by Company.
▪ A person, who not being qualified to be an auditor, acts as auditor of a company shall be liable to a
penalty of level 2

Rights and duties of auditors

RIGHTS (Sec 248)

▪ To access freely to all books & papers of Company and all supporting documents
▪ Access to copies/extracts of branch records as transferred to Principal office of company
▪ To require any of the following, to provide him necessary information or explanations:
- Any director, officer or employee of the company;
- Any person holding or accountable for any of company’s books, accounts or vouchers;
- Any subsidiary of the company;
- Any officer, employee or auditor of any subsidiary
- Any person holding or accountable for books, accounts or vouchers of any subsidiary
▪ The auditor is entitled to attend, receive all notices of any general meeting
▪ The auditor is entitled to be heard at any general meeting which he attends on any part of the business
which concerns him as auditor
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DUTIES (Sec 249)

▪ Conduct audit, prepare report and express opinion in compliance with the requirements of ISA
adopted by the ICAP.
▪ Carry out such examination to form an opinion as to
- Whether adequate accounting records have been kept and adequate returns have been received
from branches not visited by him; and
- Whether the company’s F/S are in agreement with accounting records and returns.
▪ Auditor shall make a report on books of accounts and F/S; shall be laid before AGM.
▪ The report shall state; whether or not:
- They have obtained sufficient audit evidence for audit
- In their opinion, proper books of accounts have been kept
- Statement of Financial position and profit and loss account and Other Comprehensive Income or
the income and expenditure account and the cash flows has been prepared in accordance with Act
and are in agreement with their books and returns.
- The true and fair view has been given by F/S
- In their opinion all the investments made, expenditure incurred and guaranteed extended was for
the purpose of the business.
- Zakat deductable under Zakat and Ushr Ordinance 1980 been deducted & deposited.
▪ If auditor's report makes reference to some other report or statement:
- Such report be annexed to auditor's report and be considered a part of report.
▪ SECP may direct any Company or class of Company that the auditor’s report shall also include a
statement of such additional matters as may be so specified.
▪ Where any qualification is put in auditor's report, there shall be added the reasons for it and the true
position of Company to the best of auditor's knowledge.
▪ For listed company, auditor or a person authorized by him in writing shall be present in the general
meeting in which financial statements and auditor’s report are to be considered.
▪ SECP may by general or special order, direct, that the statement of compliance to be attached with
Directors Report, shall be reviewed by the auditor who shall issue a review report to the members on
the format as specified.

Audit of Cost Accounts (Sec 250)

Where any company or class of companies are required to keep cost accounts, SECP may direct audit of
cost accounts be conducted in specified manner & stipulations by a CA or CMA having same powers,
duties etc as auditor, and other prescribed powers, duties & liabilities

Such audit shall be directed by SECP subject to the recommendation of the regulatory authority
supervising the business of relevant sector.

Any contravention or default in complying with requirements of sections 246, 247, 248 and 250 shall be an
offence liable to a penalty of level 3 on the standard scale (Sec 252)
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Following definitions are important to understand and to be memorised in the context of

answering the scenarios of Companies Act area in the ICAP exams

Associated Company (Section 2(4) – Companies Act 2017)

Tutor Two or more companies/undertakings, interconnected with each other in the following
Note manner
▪ If one is the subsidiary of another; or
▪ If companies or undertakings are under common management or control; or
▪ If undertaking is a modaraba managed by the company; or
▪ If owner, partner, director or person having ≥ 20% voting power in one
company/undertaking, is also owner, partner, director or person having ≥ 20% voting
power in other company/undertaking; or

Note: Investment of spouse or minor children deemed to be investment of that person:

Following person / investments do not create relationship of associates

▪ Nominee director of Federal/Provincial Government or a financial institution
owned/controlled by those or NIT.
▪ Directorship of a person appointed as an “independent director”; or
▪ Shares owned by the NIT or a financial institution directly or indirectly owned or controlled
by the Federal Government or a Provincial Government or CDC

Subsidiary company (Section 2(68) – Companies Act 2017)

It means a company or body corporate whose more than 50% voting securities are held or
controlled (directly or indirectly), by some other company or such other company controls
the composition of the board of such company.

How to deal with case study question in exam

(Companies Act 2017)

Tutor’s
Note
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International Standards on Auditing (ISAs)

Introduction to IFAC and IAASB

IFAC

▪ ICAP is a member of IFAC.

▪ IFAC is the global organization for the accountancy profession.
▪ It is dedicated to serving public interest by strengthening the profession and contributing to the
development of strong international economies.
▪ It has 175 members and associates in 130 countries, representing approximately 3 million accountants
in public practice, education, government service, industry, and commerce.
▪ IFAC provides the structures and processes that support the development, adoption, and
implementation of high quality international standards.
▪ IFAC supports the development of the accountancy profession in emerging economies, and speaks out
on public interest issues where the profession’s voice is most relevant.
▪ IFAC promotes its values of integrity, transparency, and expertise.
▪ IFAC includes four boards:
- IAASB: The International Auditing and Assurance Standards Board
- IAESB: The International Accounting Education Standards Board
- IESBA: The International Ethics Standards Board for Accountants
- IPSASB: The International Public Sector Accounting Standards Board

IAASB

▪ It is an independent standard-setting body

▪ It sets high-quality international standards for auditing, assurance, and other related standards
▪ It facilitates the convergence of international and national auditing & assurance standards.

Process of issuing auditing standards

▪ A subject is selected for detailed study, with a view to eventually issuing an ISA.
▪ After study and research, if there is agreement to proceed, an exposure draft is produced.
▪ The exposure draft is approved by the IAASB
▪ After approval it is distributed widely amongst the profession and others for comment.
▪ Comments and proposed amendments are considered by the IAASB.
▪ The draft standard is then modified and approved by the IAASB.
▪ The new ISA is then published.

International Auditing Practice Statements

In addition to ISAs, the IAASB also issues International Auditing Practice Statements (IAPSs). IAPSs aim
to:
▪ Provide help to auditors in implementing ISAs
▪ Promote good auditing practice in general.
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Standards issued by IAASB

Type of standard When applied

International Standards on Auditing (ISAs) In the audit of historical financial information
International Standards on Review Engagements In the review of historical financial information
(ISREs)
International Standards on Assurance In assurance engagements other than audits or
Engagements (ISAEs) reviews of historical financial information
International Standards on Related Services On compilation engagements & engagements to
(ISRSs) apply agreed upon procedures
International Standards on Quality Control Apply to all services carried out under the IAASB’s
(ISQCs) engagement standards

Compilations
Practitioner is engaged to prepare information, rather than to audit information prepared by
someone else. (e.g. preparing a tax computation for a client)
Tutor’s
Note Agreed-upon procedures
An engagement where the party hiring the practitioner specifies the procedures that the
practitioner should follow when performing the assignment.

▪ The IAASB’s pronouncements do not override local laws or regulations.

▪ If local laws or regulations differ from, or conflict with, the IAASB’s standards then a professional
accountant should not state that he has complied with the IAASB’s standards.

International Standards on Auditing (ISAs)

Each ISA contains:

▪ An introduction
▪ Objectives
▪ Definitions (if necessary)
▪ Requirements which are shown by word “shall” and are to be applied as relevant to audit
▪ Application and other explanatory material which is for guidance only.

Overall objectives of independent auditor and conduct of audit in accordance with ISA

The objectives of the auditor are to:

▪ Obtain reasonable assurance about whether the F/S as a whole are free from material misstatement,
whether due to fraud or error in accordance with AFRF.
▪ Report on the F/S, and communicate in accordance with the auditor’s findings.

ISA 200 requires the auditor to:

▪ Comply with all ISAs relevant to the audit
▪ Comply with relevant ethical requirements
▪ Plan and perform an audit with professional scepticism
▪ Exercise professional judgement in planning and performing an audit
▪ Obtain sufficient appropriate audit evidence to allow him to obtain reasonable assurance

Professional skepticism –An attitude that includes a questioning mind, being alert to conditions which
may indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence.
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Professional judgment – The application of relevant training, knowledge and experience, within the
context provided by auditing, accounting and ethical standards, in making informed decisions about the
courses of action that are appropriate in the circumstances of the audit engagement.

Sufficient appropriate audit evidence –Sufficiency is the measure of the quantity of audit evidence.
Appropriateness is the measure of the quality of audit evidence in terms of its relevance and reliability.

Examples of Professional Skepticism

▪ Audit evidence that contradicts other audit evidence
▪ Information that bring into question the reliability of documents
▪ Condition that may indicate possibility of fraud

Maintaining Professional Skepticism throughout the audit is necessary to reduce the risk of:
▪ Overlooking unusual transaction
▪ Over generalizing when drawing conclusion from audit observation
▪ Using inappropriate assumptions in determining the nature, timing and extent of audit procedures and
evaluating result thereof

Uses of Professional Judgement

▪ Materiality and audit risk
▪ Nature, timing and extent of audit procedures used to obtain audit evidence
▪ Evaluate whether sufficient appropriate audit evidence has been obtained
▪ Evaluation of management judgement in applying AFRF
▪ Drawing conclusion based on audit evidence obtained.

Scope of Audit (Tutor’s Note: ideally to be read after understanding the audit in much detail)

▪ An audit involves performing procedures to obtain sufficient appropriate audit evidence about the
amounts and disclosures in the F/S.
▪ The procedures include the assessment of risks of material misstatement of the F/S, whether due to
fraud or error.
▪ In making those risk assessments, the auditor considers internal control relevant to the entity’s
preparation and fair presentation of F/S in order to design appropriate audit procedures, but not for
the purpose of expressing an opinion on their effectiveness.
▪ An audit also includes evaluating the appropriateness of accounting policies used and the
reasonableness of accounting estimates made by management