DEFINITION, OBJECTIVE AND GENERAL PRINCIPLES GOVERNING AN AUDIT (ISA – 200)Khawar Shahzad Jaffar ACCA, CPA

Audit An audit is independent examination of

financial statements and related information of an entity with a view to express an opinion.

Auditing is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users.

Objective of Audit The objective of an audit is to enable the

auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an identified financial reporting framework.

It is management’s responsibility to prepare the financial statements.

Auditor’s responsibility is to give reasonable assurance that the financial statements give a true and fair picture.

Audit Opinion The audit opinion is given on whether

the financial statements give a true and fair view of the entity’s financial statements and whether they have been properly prepared in accordance with the applicable reporting framework.

Audit Opinion This opinion is reached after:

Extensive risk assessment has been performed. Extensive testing of controls and substantive tests

on transactions and balances for validity, accuracy and completeness of recording.

Extensive verification procedures have been performed to test for existence, ownership, valuation, presentation and disclosure of items in the financial statements.

Extensive review of whether the financial statements comply with applicable accounting standards and legal requirements.

Applicable Reporting Framework The financial reporting framework

adopted by management and, where appropriate, those charged with governance in the preparation of the financial statements that is acceptable in view of the nature of the entity and the objective of the financial statements, or that is required by law or regulation.

Audit Evidence Information used by the auditor in

arriving at the conclusions on which the auditor’s opinion is based. Audit evidence includes both information contained in the accounting records underlying the financial statements and other information.

Audit Evidence For purposes of the ISAs:

Sufficiency of audit evidence is the measure of the quantity of audit evidence. The quantity of the audit evidence needed is affected by the auditor’s assessment of the risks of material misstatement and also by the quality of such audit evidence.

Appropriateness of audit evidence is the measure of the quality of audit evidence; that is, its relevance and its reliability in providing support for the conclusions on which the auditor’s opinion is based.

Audit Risk The risk that the auditor expresses an

inappropriate audit opinion when the financial statements are materially misstated. Audit risk is a function of the risks of material misstatement and detection risk.

Detection Risk The risk that the procedures performed

by the auditor to reduce audit risk to an acceptably low level will not detect a misstatement that exists and that could be material, either individually or when aggregated with other misstatements.

Risk of Material Misstatement The risk that the financial statements are

materially misstated prior to audit. This consists of two components, described as follows at the assertion level: Inherent Risk – The susceptibility of an

assertion about a class of transaction, account balance or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls.

Risk of Material Misstatement

Control Risk – The risk that a misstatement that could occur in an assertion about a class of transaction, account balance or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity’s internal control.

Materiality Transactions, items, events will be

material in financial statements if their omission, misstatement, misclassification or non-disclosure would distort the view given by the financial statements and would responsibly influence the understanding and economic decisions of users.

Materiality, however, is not capable of general mathematical definition since it involves qualitative as well as quantitative considerations.

Misstatement A difference between the amount,

classification, presentation, or disclosure of a reported financial statement item and the amount, classification, presentation, or disclosure that is required for the item to be in accordance with the applicable financial reporting framework. Misstatements can arise from error or fraud.

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.

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.

Reasonable Assurance In the context of an audit of financial

statements, a high, but not absolute, level of assurance. Positive Assurance Negative Assurance

True and Fair View Auditor shall state in audit report

whether the financial statements give a “true and fair view” or “present fairly, in all material respects” (both are equilents terms)

By “true” is meant that financial statements are: Free from material misstatement Based on verifiable evidence

True and Fair View By “fair” is meant that the financial

statements are: Objectively presented Free from management bias Relevant to the needs of users

Those Charged With Governance The person(s) or organization(s) (for example,

a corporate trustee) with responsibility for overseeing the strategic direction of the entity and obligations related to the accountability of the entity. This includes overseeing the financial reporting process. For some entities in some jurisdictions, those charged with governance may include management personnel, for example, executive members of a governance board of a private or public sector entity, or an owner-manager.

Ethical Requirements Relating to an Audit The auditor is subject to relevant ethical

requirements, including those pertaining to independence, relating to financial statement audit engagements.

The fundamental principles with which the auditor is required to comply are: Integrity; Objectivity; Professional competence and due care; Confidentiality; and Professional behavior

The Audit Process Engagement letter – Auditor should send

all clients an engagement letter setting out the auditor’s duties and responsibilities.

Planning – Planning and controlling audit work is essential to performing work to the required high standard of skill and care.

Ascertain accounting systems – auditors enquire into and ascertain the client’s system of accounting and internal controls in order to understand how accounting data is prepared and to gain an impression as to whether systems are reliable.

The Audit Process Test controls and transactions – Controls

must be tested if the auditor intends to rely on them. Records must be tested to obtain evidence that they are a reliable basis for the preparation of accounts.

Verify assets and liabilities – Figures appearing in financial statements must be verified.

Review financial statements – To see if, overall, they appear sensible.

The Audit Process Obtain management representations –

The auditor asks management to confirm formally the truth and fairness of certain aspects of financial statements.

Sign auditor’s report – After the directors have approved the accounts.