chapter 1

Concept of and need for

assurance
Contents

Introduction
Examination context
Topic List
1 What is assurance?
2 Why is assurance important?
3 Why can assurance never be absolute?
Summary and Self-test
Answers to Self-test
Answers to Interactive questions

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Introduction

Learning objectives Tick off

 Understand the concept of assurance

 Recognise the criteria which constitute an assurance engagement

 Recognise subject matter suitable to be the subject of an assurance engagement

 Understand the different levels of assurance that can be provided in an assurance

engagement, including reasonable assurance

 Understand the meaning of 'a true and fair view'

 Understand the need for professional accountants to carry out assurance work in the public
interest
 Understand why users desire assurance reports and recognise examples of the benefits
gained from them
 Compare the functions and responsibilities of the different parties involved in an assurance
engagement
 Understand the issues which can lead to gaps between the outcomes delivered by the
assurance engagement and the expectations of users of the assurance reports

 Identify how these 'expectations gaps' can be overcome

Specific syllabus references for this chapter are: 1a, b, c, d, e, h.

Practical significance
Users of financial and non-financial information want to have confidence that the information they are using
is reliable and that they can draw valid conclusions as a result of it. They want assurance about the quality
of the information they are using to make decisions. Provision of assurance services is therefore a very
important area of business for accountants. Accountants are able to provide assurance on a range of
matters because they are skilled business professionals. As accountants are subject to strict ethical codes,
they are perceived to be trustworthy, and therefore users of information believe that the assurance they
give can be trusted.
Some forms of assurance are required by law in many countries. For example, in the EU, all but the smallest
companies must have an annual audit of their financial statements. An audit is a high level of assurance
service which we will introduce in this syllabus and look at in more detail in your later studies.

Stop and think

What other information (financial and non-financial) might users want assurance in relation to?

Working context
As an audit is a legal requirement for many companies, many of you are likely to carry out a lot of your
practical training in audit. You will also focus on audit when you come to study for the Audit and Assurance
paper at the Application stage of the exams. The broad principles of assurance services can be applied to
many different engagements which may be carried out by your firm.

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CONCEPT OF AND NEED FOR ASSURANCE u
links
You have studied the basic books, records and financial statements of a company in the Accounting paper. It
is in relation to these records that the auditor will seek evidence to be able to give assurance. 1

As already mentioned, audit is a key form of assurance and you will be able to apply the basic principles
learnt in this paper to that form of assurance service both here and in the Audit and Assurance Paper.

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 Assurance

Examination context

Exam requirements
It is crucial to the whole syllabus that you understand the concept of assurance, why it is required and the
reason for assurance engagements being carried out by appropriately qualified professionals. You can
therefore expect to see questions in the exam testing your understanding of the definition of assurance and
the different levels of assurance.
In the sample paper, the first five questions relate to the subject matter you will cover in this chapter.

In the assessment, candidates may be required to:

 Describe the concept of assurance

 State the benefits of an assurance report

 Compare the functions and responsibilities of the different parties involved in an assurance
engagement

 Describe the levels of assurance obtained from different types of assurance engagement

 Describe the concept of the ‘expectations gap’

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1 What is s
 rance?
CONCEPT OF AND NEED FOR ASSURANCE 1
Section overview
 An assurance engagement is one 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.

 Key elements are: three party involvement, subject matter, suitable criteria, sufficient appropriate
evidence, written report.

 Assurance engagements can give either a reasonable level of assurance or a limited level of assurance.
 There are various examples of assurance services, the key example in Bangladesh is the audit.

1.1 Definition (parties, subject matter, criteria)

Definition
An assurance engagement is one 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.

The key elements of an assurance engagement are as follows:

 Three people or groups of people involved

– The practitioner (accountant)

– The intended users
– The responsible party (the person(s) who prepared the subject matter)
 A subject matter

As we shall see below, the subject matter of an assurance engagement may vary considerably.
However, it is likely to fall into one of three categories:
– Data (for example, financial statements or business projections)
– Systems or processes (for example, internal control systems or computer systems)
– Behaviour (for example, social and environmental performance or corporate governance)
 Suitable criteria

The person providing the assurance must have something by which to judge whether the information
is reliable and can be trusted. So for example, in an assurance engagement relating to financial
statements, the criteria might be accounting standards. The practitioner will be able to test whether
the financial statements have been put together in accordance with accounting standards, and if they
have, then the practitioner can conclude that there is a degree of assurance that they are reliable.
In the context of company behaviour, suitable criteria to judge whether something is reliable and can
be trusted might be the Combined Code on Corporate Governance, or, if the company has one, its
published Code of Practice.

 Sufficient appropriate evidence to support the assurance opinion

The practitioner must substantiate the opinion that he draws in order that the user can have
confidence that it is reliable. The practitioner must obtain evidence as to whether the criteria have
been met. We will look at the collection of evidence in detail later in this Study Manual.

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 Assurance

 A written report in appropriate form

Lastly, it is required that assurance reports are provided to the intended users in a written form and
contain certain specified information. This adds to the assurance that the user is being given, as it
ensures that key information is being given and that the assurance given is clear and unequivocal.

Worked example: Assurance engagement

In order to demonstrate these elements of an assurance engagement, the Worked example is that of a
house purchase. Imagine you are buying a house. There are certain issues you would want assurance about,
particularly whether the house is structurally sound. In this situation, you would be unlikely just to trust the
word of the person who was selling the house but would seek the additional assurance of a qualified
professional, such as a surveyor.
You should already be able to see the first key element of an assurance engagement, which is the
involvement of three people:
 You (the intended user)
 The house owner (the responsible party)
 The surveyor (the practitioner)
The subject matter of this assurance engagement is the house in question. The surveyor will visit the house
to test whether it is sound and will draw a conclusion.
The surveyor will judge whether the house is sound in the context of building regulations, planning rules
and best practice in the building industry. These are the criteria by which he will judge whether he can give
you assurance that the house is structurally sound.
In order to make a conclusion, the surveyor will obtain evidence from the house (for example, by looking
for damp patches and making inspections of key elements of the house).
Lastly, when he has drawn a conclusion, the surveyor will issue a report to you, outlining his opinion as to
whether the house is sound or not. This report will contain any limitations to his work, for example, if he
was unable to access any of the property or he was unable to lift fitted carpets to inspect the floor
underneath them.
Ultimately, when you have read the surveyor’s report, you will have more assurance about the state of the
property, and correspondingly, more confidence to pay the deposit, take out a mortgage and buy that
house.

Interactive question 1: Assurance engagement [Difficulty level: Easy]

You are an accountant who has been approached by Jamal, who wants to invest in Company X. He has
asked you for assurance whether the most recent financial statements of Company X are a reliable basis for
him to make his investment decision.
Identify the key elements of an assurance engagement in this scenario, if you accepted the engagement.

See Answer at the end of this chapter.

1.2 Levels of assurance

The definition of an assurance engagement given above is taken from the International Framework for
Assurance Engagements, which is issued by the International Federation of Accountants (IFAC), a global
organisation for the accountancy profession, which works with its member organisations to protect the
public interest by encouraging high quality practices around the world. ICAB is a member of IFAC.

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CONCEPT OF AND NEED FOR ASSURANCE h
adopted International Standards on Auditing (ISAs), some of which you will be introduced to
in this Study Manual. However, Bangladesh has not currently adopted the general international standards on
assurance provision, and the international framework although these represent good practice anywhere in
1
the world and some of the detail concerning assurance services you learn will be based on these standards.
The Framework identifies two types of assurance engagement:

 Reasonable assurance engagement

 Limited assurance engagement

Definition
Reasonable assurance: A high, but not absolute, level of assurance.

The reason that there are two types of assurance engagement is that the level of assurance that can be
given depends on the evidence that can be obtained by the practitioner. Using the surveyor example above,
a surveyor can only give assurance that a property is structurally sound if he is allowed to enter the
property to inspect it. If he is only given access to part of the building, he can only give limited assurance.
The key differences between the two types of assurance engagement are therefore:

 The evidence obtained

 The type of opinion given
We shall look in detail at obtaining evidence later in this Study Manual. The key point about evidence is that
in all assurance engagements, sufficient, appropriate evidence must be obtained. We will look at what
constitutes sufficient, appropriate evidence as we go through the course. What determines whether
evidence is sufficient and appropriate is the level of assurance that the practitioner is trying to give, so it is
tied in with the type of opinion being given, which we shall look at here. In summary, a lower level of
evidence will be obtained for a limited assurance engagement.
The opinion given in an assurance engagement therefore depends on what type of engagement it is. As
noted above, there are two levels of assurance expressed positively and negatively.
Say, for example, that a practitioner is seeking evidence to conclude whether the report issued by the
Chairman of a company in the financial statements is reasonable or not. He could seek evidence, conclude
that the statement is reasonable and state in a report something like this:
‘In my opinion, the statement by the Chairman regarding X is reasonable’.

This is a positive statement of his conclusion that the statement is reasonable. Alternatively, he could state
in a report something like this:
‘In the course of my seeking evidence about the statement by the Chairman, nothing has come to my
attention indicating that the statement is not reasonable.’
This conclusion is less certain, as it implies that matters could exist which cause the statement to be
unreasonable, but that the practitioner has not uncovered any such matters. This is therefore called
negative assurance. It is the conclusion that a practitioner gives when he carries out a limited assurance
engagement and seeks a lower level of evidence.

SUMMARY OF TYPES OF ENGAGEMENT

Type of engagement Evidence sought Conclusion given

Reasonable assurance Sufficient and appropriate Positive

Limited assurance Sufficient and appropriate (lower level) Negative

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1.3 Examples of assurance engagements

The key example of an assurance engagement in Bangladesh is a statutory audit. We shall look briefly at the
nature of this engagement in the next section.
Other examples of assurance engagements include other audits, which may be specialised due to the nature
of the business, for example:
 Local authority audits

 Insurance company audits

 Bank audits

 Pension scheme audits

 Charity audits

 Solicitors' audits
 Environmental audits

 Branch audit (where an overseas company trades in Bangladesh through a branch and requires an audit
of that branch although an audit is not required by Bangladesh law)
There are also many issues users want assurance on, where the terms of the engagement will be agreed
between the practitioner and the person commissioning the report, for example:
 Value for money studies
 Circulation reports (for example, for magazines)
 Cost/benefit reports
 Due diligence (where a report is requested on an acquisition target)
 Reviews of specialist business activities
 Internal audit
 Reports on website security, such as WebTrust
 Fraud investigations
 Inventories and receivables reports
 Internal control reports
 Reports on business plans or projections

1.4 Audit
An audit is historically the most important type of assurance service in Bangladesh. This is because all
Limited Liability companies registered with the Registrar of Joint Stock Companies have been required by
law to have an audit.

Definition
The objective of an audit of financial statements is to enable the auditor to express an opinion whether
the financial statements are prepared, in all material respects, in accordance with an applicable financial
reporting framework.

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CONCEPT OF AND NEED FOR ASSURANCE d
example: Audit
The key criteria of an assurance engagement can be seen in an audit as follows:
1
 Three party involvement

– The shareholders (users)

– The board of directors (the responsible party)
– The audit firm (the practitioner)
 Subject matter

– The financial statements

 Relevant criteria

– Law and accounting standards

 Evidence

– As has been said earlier, sufficient and appropriate evidence is required to support an assurance
opinion. The specific requirements in relation to evidence on assurance engagements will be
looked at in Chapters 4 and 11.
 Written report in a suitable form

– Again, as has been said, an assurance report is a written report issued in a prescribed form. We
will look at the specific requirements for an audit report in Chapter 4.

In Bangladesh, the auditor will normally express his audit opinion by reference to the ‘true and fair view’,
which is an expression of reasonable assurance. Whilst this term is at the heart of the audit, ‘true’ and ‘fair’
are not defined in law or audit guidance. However, for practical purposes the following definitions are
generally accepted.

Definitions
True: Information is factual and conforms with reality, not false. In addition the information conforms with
required standards and law. The accounts have been correctly extracted from the books and records.
Fair: Information is free from discrimination and bias in compliance with expected standards and rules. The
accounts should reflect the commercial substance of the company’s underlying transactions.

Auditors in Bangladesh are subject to both legal and professional requirements. The legal requirements are
currently contained in the Companies Act 1994. Since the current wording of the Bangladesh audit report
(see Chapter 4) refers to the Companies Act 1994 this text refers to the Companies Act 1994 throughout.
The Companies Act 1994 requires that auditors must be a member of the Institute of Chartered
Accountants of Bangladesh: The ICAB is a Recognised Supervisory Body under the Ministry of Commerce
of the Government of Bangladesh. . Professional qualifications are a prerequisite of membership of ICAB.
ICAB has also the responsibility to implement procedures for monitoring its licensed auditors. The
Companies Act 1994 also sets out factors which make a person ineligible for being a company auditor, for
example, if he or she is:
i. an officer or employee of the company;
ii. a partner or an employee of any officer, employee to the company;
iii. a person who is indebted to the company exceeding Tk.1,000.
iv. A person who is a director or member of a private company, or a partner of a firm, which is the
managing agent of the company.
v. a person who is a director or holder of shares exceeding 5% of the subscribed capital.

As you will see later in this course, the professional ethics of the ICAB are usually similar to that of IFAC.

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In Bangladesh the responsibility for issuing auditing standards is with the ICAB, which has adopted the
international standards.
ICAB is also responsible for issuing Ethical Standards (ESs) in relation to the independence, objectivity and
integrity of auditors. ICAB is an autonomous body under the Ministry of Commerce, to whom the
Bangladesh Government has delegated the task of independent monitoring of the Bangladesh accountancy
profession. These standards set professional requirements for auditors.
For example, BSA 200 Objectives and General Principles Governing an Audit of Financial Statements states that
auditors should comply with relevant ethical requirements relating to audit engagements. These will be
outlined later in this Study Manual. An auditor should conduct an audit in accordance with ISAs. Relevant
ISAs will be referred to in this Study Manual. Auditors are required to carry out their work with a degree
of professional scepticism, meaning that they must make a critical assessment.
Auditors must assess the risks associated with the audit and seek to minimise those risks so that the risk of
giving the wrong opinion on the financial statements is minimised. This risk is referred to as audit risk and it
will be outlined in detail later in this Study Manual.

2 Why is assurance important?

Section overview
 Who the users are will depend on the nature of the subject matter.
 Users benefit from receiving an independent, professional opinion on the subject matter.
 Users may also benefit from additional confidence in the subject matter given to others.
 The existence of an assurance service may prevent errors or frauds occurring in the first place.

2.1 Users
In the key assurance service of audit, which we looked at above, the users were the shareholders of a
company, to whom the financial statements are addressed. In other cases, the users might be the board of
directors of a company or a subsection of them.

2.2 Benefits of assurance

The key benefit of assurance is the independent, professional verification being given to the users. This
can be seen in the example of the house purchase given above. The importance of independence and
objectivity in assurance provision will be looked at in Chapters 14 and 15.
In addition, assurance may have subsidiary benefits.

Although an assurance report may only be addressed to one set of people, it may give additional confidence
to other parties in a way that benefits the business. For example, audit reports are addressed to
shareholders, but the existence of an unqualified audit report might give the bank more confidence to lend
money to that business, in other words, it enhances the credibility of the information.
The existence of an independent check might help prevent errors or frauds being made and reduce the risk
of management bias. In other words, the fact that an assurance service will be carried out might make
people involved in preparing the subject matter more careful in its preparation and reduce the chance of
errors arising. Therefore it can be seen that an assurance service may act as a deterrent.
In addition, where problems exist within information, the existence of an assurance report draws attention
to the deficiencies in that information, so that users know what those deficiencies are.
Assurance is also important in more general terms. It helps to ensure that high quality, reliable information
exists, leading to effective markets that investors have faith in and trust. It adds to the reputation of
organisations and even countries, so that investors are happy to invest in country X because there is a
strong culture of assurance provision there.

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3
 Why can assurance never be absolute?
1
Section overview
 Assurance can never be absolute.
 Assurance provision has limitations which may not be understood by users.
 The expectations gap also adds to the lack of guarantee given by assurance.

Assurance can never be absolute. Assurance providers will never give a certification of absolute correctness
due to the limitations set out below.

3.1 Limitations of assurance

A key issue for accountants is that there are limitations to assurance services, and therefore there is always
a risk involved that the wrong conclusion will be drawn. We shall look in more detail at this issue of
assurance engagement risk in Chapter 3.
The limitations of assurance services include:
 The fact that testing is used – the auditors do not oversee the process of building the financial
statements from start to finish.
 The fact that the accounting systems on which assurance providers may place a degree of reliance also
have inherent limitations (we shall look at control systems and their limitations in Chapter 5).
 The fact that most audit evidence is persuasive rather than conclusive.
 The fact that assurance providers would not test every item in the subject matter (this would be
prohibitively expensive for the responsible party, so a sampling approach is used – see Chapter 11).
 The fact that the client's staff members may collude in fraud that can then be deliberately hidden from
the auditor or misrepresent matters to them for the same purpose.
 The fact that assurance provision can be subjective and professional judgements have to be made (for
example, about what aspects of the subject matter are the most important, how much evidence to
obtain, etc).
 The fact that assurance providers rely on the responsible party and its staff to provide correct
information, which in some cases may be impossible to verify by other means.
 The fact that some items in the subject matter may be estimates and are therefore uncertain. It is
impossible to conclude absolutely that judgemental estimates are correct.
 The fact that the nature of the assurance report might itself be limiting, as every judgement and
conclusion the assurance provider has drawn cannot be included in it.

3.2 The expectations gap

The problems users may experience in connection with assurance provision also arise from the limitations
and restrictions inherent in assurance provision. This is often because users are not aware of the nature of
the limitations on assurance provision, or do not understand them and believe that the assurance provider
is offering a service (such as a guarantee of correctness) which in fact he is not.
The distinction between reasonable and limited assurance may also be misunderstood by users.
We shall look at the concept of the expectations gap in more detail in Chapter 4, in the context of
reporting, but in essence it is this lack of understanding which constitutes the expectations gap – meaning
that there is a gap between what the assurance provider understands he is doing and what the user of the
information believes he is doing.
Assurance providers need to close this gap as far as possible in order to maintain the value of the assurance
provided for the user. This is done in a variety of ways, for example, by issuing an engagement letter spelling
out the work that will be carried out and the limitations of that work (which we shall look at in the next
chapter) and by regularly reviewing the format and content of reports issued as a result of assurance work.

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Interactive question 2: Benefits of assurance [Difficulty level: Exam standard]

Which three of the following are benefits of assurance work?

An independent, professional opinion

Additional confidence given to other related parties

Testing as a result of sampling is cheaper for the responsible party

Judgements on estimates can be conclusive

Assurance may act as a deterrent to error or fraud

See Answer at the end of this chapter.

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m
mary and Self-test
CONCEPT OF AND NEED FOR ASSURANCE 1

Summary

An assurance engagement is one in

which a practitioner expresses a
conclusion designed to enhance
the degree of confidence of the Levels of assurance:
intended users other than the – Limited
responsible party about the – Reasonable (high)
outcome of the evaluation or
measurement of a subject matter
against criteria.

Key elements: Key example: audit

– Three party relationship Directors, auditors, shareholders
– Subject matter Financial statements
– Suitable criteria Law and accounting standards
– Sufficient appropriate evidence As prescribed by ISA 500
– Written report Audit report

Benefits: Limitations:
– Independent, professional opinion Subjective, sampled, limitations of
– Added confidence to other users systems, information from third
– Deterrent to error/fraud parties, limitations of reporting,
includes estimates

Self-test
Now answer the following questions.

1 Assurance services are required by law.

True

False

2 What five elements are required for an engagement to be an assurance engagement?

1........................................

2........................................

3........................................

4........................................

5........................................

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 Assurance

3 Name four limitations of an assurance service.

1........................................

2........................................

3........................................

4........................................

4 Reasonable assurance is a high level of assurance.

True

False

Now, go back to the Learning Objectives in the Introduction. If you are satisfied you have achieved these
objectives, please tick them off.

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ers to Self-test
CONCEPT OF AND NEED FOR ASSURANCE 1

1 False (an audit is required by law for all registered limited liability companies, not the assurance
services).
2 1 Three party relationship
2 Subject matter
3 Suitable criteria
4 Sufficient appropriate evidence
5 Written report
3 From:

1 Subjective exercise
2 Sampling
3 Limitations in systems
4 Limitations in report
5 Information from third parties
6 Estimations
4 True

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 Assurance

Answers to Interactive questions

Answer to Interactive question 1

1 Three party involvement:
 Jamal (the intended user)
 You (the practitioner)
 The directors of Company X as they produce the financial statements (the responsible party)
2 Subject matter

The most recent financial statements of Company X are the subject matter

3 Relevant criteria

It is most likely in this instance that the criteria would be accounting standards, so that Jamal was
assured that the financial statements were properly prepared and comparable with other companies'
financial statements

4 Evidence

You would have to agree the extent of procedures in relation to this assignment with Jamal so that he
knew the level of evidence you were intending to seek. This would depend on several factors,
including the degree of secrecy in the proposed transaction and whether the directors of Company X
allowed you to inspect the books and documents

5 Report

Again, the nature of the report would be agreed between you and Jamal, however, it would be a
written report containing your opinion on the financial statements

Answer to Interactive question 2

An independent, professional opinion

Additional confidence given to other related parties

Assurance may act as a deterrent to error or fraud

16 © The Institute of Chartered Accountants in England and Wales, March 2009