Week 1

Audit Framwork
Reviewd by: Kashif Gulzar
Basics
• Definition of Audit:
• The independent examination of and expression of opinion on the financial
statements of an entity by a duly appointed auditor.
• Objective of the audit:
• The purpose of an audit is to enhance the degree of confidence of intended users in
financial statements. This is achieved by the expressed on an option by the auditor
on whether the financial statements are prepare, in all material respects, in
accordance with an applicable financial reporting framework.
• Misstatement in Financial Statements:
• If there is something wrong in Financial Statement, it is called misstatement and it
communicated to shareholders via audit report.
• Misstatement can be intentional (fraud) or incidental (error).
Concept of Audit
Elements of Audit / Review
Engagements:
1 2 3 4 5
Three party relationship SubjectMatter SuitableCriteria Evidence Written Assurance Report
ShareholderDirectorsAuditor Financial Statements Applicable financial reporting Sufficient & Appropriate Statement containing the opinion
framework e.g. IFRS or GAAP. information form the basis of by auditor.
opinion
LEVEL OF ASSURANCE:
• At the start of audit engagement, shareholder decides about the required level of
assurance based on circumstances and legal requirements.
-Reasonable Assurance (Positive Assurance Opinion)
• It is a high level, but not absolute, which is expressed in positive form of conclusion. The auditor
identifies most of, not all, the misstatement. Engagement is called “audit” e.g. audit of financial
statements i.e. statutory audit.
• Example:In our opinion, these financial statements give true and fair view, This assurance is to
enhance the degree of confidence of the intended user.
-Limited Assurance (Negative Assurance Opinion)
• It is a moderate level which is expressed in negative form of conclusion. Engagement is called
“review” e.g. review all or part of financial statements or cash flow forecast for bank loan.
• Examples:Nothing has come to our attention which causes us to believe that financial statements
do not give true and fair view, In my opinion, there is no reason to believe that financial
statements don’t show true and fair view.
WHY ABSOLUTE ASSRUANCE
CANNOT BE PROVIDED:
Inherent limitation of audit
a)Time and cost limitation i.e. sampling. (sampling all areas but not all
transactions)
b)Fraud. [detection is hard for management due to manipulation of records]
c)Estimates in financial statements. [depreciation / bad debts / warranty,
impairment]
d)Judgment in audit due to sampling.
e)Incomplete information.
f)Legal restrictions (power to search)
g)Inherent limitations in clients internal control system.
h)Unavailability / shortage of staff.
Hierarchy
Class Exersice
Independent auditors’ report to the members of Tranmere Rovers Football Club for the year ended 31 July {Year}.
• We have audited the financial statements of Tranmere Rovers Football Club for the year ended 31 July {Year} which comprise
the Income statement (profit and loss account), the statement of financial position (the balance sheet), the cash flow
statement and the related notes.
• Respective responsibilities of directors and auditors
• The directors’ responsibilities for preparing the annual report and the financial statements are set out in the statement of directors’
responsibilities. Our responsibility is to audit the financial statements in accordance with relevant legal requirements and International
Standards on Auditing. We report to you our opinion as to whether the financial statements give a true and fair view.
• Basis of audit opinion
• We conducted our audit in accordance with International Standards on Auditing, issued by the IAASB. An audit includes examination, on a
test basis, of evidence relevant to the amounts and disclosures in the financial statements. It also includes an assessment of the significant
estimates and judgments made by the directors in the preparation of the financial statements, and of whether the accounting policies are
appropriate to the company’s circumstances, consistently applied and adequately disclosed.
• We planned and performed our audit so as to obtain all the information and explanations we considered necessary in order to
provide us with sufficient evidence to give reasonable assurance that the financial statements are free from material
misstatement, whether caused by fraud or other irregularity or error. In forming our opinion we also evaluated the overall
adequacy of the presentation of information in the financial statements.
• Opinion
• In our opinion the financial statements give a true and fair view of the state of the company’s affairs as at 31 July {Year} and of its loss for
the year then ended.
Required Class Exersice
Explain the following terms referred to in the above audit report:
(a)International Standards on Auditing (ISA);
(b)Estimates and judgments;
(c)Reasonable assurance;
(d)True and fair view;
(e)Materiality.
Solution Class Exersice
• International Standards on Auditing:
• The ISA are the rules that auditors are required to follow when auditing financial statements. The ISA
cover the whole of audit from planning through testing and on to reporting.
• Estimates and judgments:
• Financial reporting is full of guess work. To produce F/S, it is necessary for directors to use their
judgments when making estimates. For example, depreciation, warranty, bad debts, income taxes etc.
• Reasonable assurance:
• This is the confidence that the audit report gives that the F/S do show true and fair view. It is important
to note that the opinion is just an opinion and does not give guarantee.
• True and fair view:
• True =This is often taken to mean arithmetical accuracy within the limits of materiality (a threshold).
• Fair = It is often taken to mean an honest and clear presentation that reflects performance and position.
• Materiality:
• This is the idea that material items could affect users’ decisions; immaterial items don’t.
Essentials of Proper Conduct of
Audit:
An auditor should have the following three important essential characteristics in order to conduct an audit:
[Link] Judgment:
The auditor has to apply professional judgment in the areas which are not specifically addressed in standards in order to arrive at
appropriate course of action.
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 appropriate financial reporting framework
Drawing conclusion based on audit evidence obtained. For e.g. assessing the reasonableness of the estimates by the
management
[Link] Skepticism
Professional skepticism includes three areas:
1. questioning mind
2. being alert to conditions which indicate possibility of misstatement and
3. critical assessment of evidence.

-Application of professional skepticism helps avoid overlooking, overgeneralization and inappropriate assumptions.
Class Exersice: APPLICATION OF
PROFESSIONAL SKEPTICISM
Following situations could increase the risk of material misstatement:
1. Plans to issue of shares, purchase of business, and acquisition of a loan.
2. Unusual change in sales (increase / decrease).
3. Management bonus is based on financial performance.
4. Significant transactions at year end.
5. Imports and exports, due to exchange rate translation adjustments.
6. Cash paid or received in advance. (accrual miss-matching = expense, revenue)
7. Inconsistency / contradiction / disagreement between different evidence sources like management vs.
lawyer, financial statements vs. other information, debtor balances vs. confirmation letter etc.
8. Going concern issues like increased competition, product failure, operating losses.
9. Significant related party transactions (risk of collusion)
10. Significant level of accounting estimates (warranty, depreciation, bad debts, pension etc.)
11. Identified deficiencies / weaknesses / deviations in internal control.
Class Exersice: APPLICATION OF
PROFESSIONAL SKEPTICISM (Continued...)
12. Lack of competence (= risk or error) or integrity (= risk of fraud) of management (=F/S level)
and employees (=assertion level).
13. Issues in inventory valuation.
14. Inventory held at different locations or 3rdparty or physical count was not done at balance
sheet date.
15. Significant purchase of PPE, especially at year end. (capitalization of expenses)
16. Revaluation of property, plant and equipment. (upward done, downward ignored i.e. selective)
17. Closure of factory, unit or product. (Held for sale & discontinued operations).
18. Provision of warranty. (Expense should match with sales and time of warranty).
19. Onerous contracts. (loss making contract)
20. Dispute with debtor / reconciliation issues.
21. Pending litigation against / by the company.
Essentials of Proper Conduct of
Audit: (Conitnued....)
3. Independence:
a) No Financial Relationship:
The auditor must have no financial interest / relationship with the
client. Like holding shares, business relationship, obtaining loan.
b) No Personal Relationship: For example, spouse, blood relationship,
long association, gift etc. Also, No Employment Relationship: For
example, auditor is an employee of client.
Responsibilities of Management and
Those Charged With Governance:
Primary Responsibilities:
• To draft “Financial Statements” as per “Applicable Financial Reporting
Framework” i.e. IFRS [International Financial Reporting Standards] and
Companies Act 2017.
• Selecting suitable accounting principles and applying them consistently;
• Making judgements and estimates that are reasonable and prudent;
• Stating whether IFRS have been followed, subject to any material departures
disclosed and explained in the financial statements; and
• Preparing the financial statements on a going concern basis, unless it is
inappropriate to presume that the Company will continue in business for the
foreseeable future.
Responsibilities of Management and
Those Charged With Governance:
Secondary Responsibilities:
• Designing, implementing and maintaining an effective system of
internal controls throughout the company;
• Maintaining statutory accounting records in compliance with local
legislation and accounting standards in the respective jurisdictions in
which the Company operates;
• Taking steps to safeguard the assets of the Company; and
• Detecting and preventing fraud and other irregularities.
Auditors Responsibilities:
• To obtain sufficient and appropriate audit evidence on the following
matters:
• Financial Statements as a whole are free from material misstatement whether
due to fraud or error.
• Financial statements have been prepared in accordance with applicable
financial reporting framework.
• To express opinion [audit report] as “reasonable assurance” whether financial
statements represent true and fair view of the state of the affairs of the
business.
Shareholders Responsibilities:
• Shareholders normally have some misconceptions about the audit
professional like:
Misconception (Expectations Gap) Reality
· Preparation of financial statements. · It is management’s responsibility.
· 100% checking. · Sample basis.
· Detect fraud. · Do reasonable effort.
· Absolute assurance. · Reasonable assurance.
· All misstatements. · Material misstatements with reasonable effort.
· Opinion on internal controls. · Opinion on financial statements.
Review
• Definition, Concept and Objective of the audit
• Misstatement in Financial Statements
• Elements of Audit / Review Engagements
Level of Assurance
• Reasonable Assurance
• Limited Assurance
• Absolute Assurance
• Essentials of Proper Conduct of Audit:
• Professional Judgment:
• Professional Skepticism
• Independence:
• Responsibilities of Management and Those Charged With Governance, Auditors and
Shareholders