FUNDAMENTALS OF ASSURANCE ENGAGEMENTS

Assurance engagement – 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.

Objective of Assurance Engagements:

According to the Philippine Framework for Assurance Engagements, an assurance engagement is

conducted:

a. To provide a high level of assurance that the subject matter conforms in all material respects
with identified suitable criteria; or

b. To provide a moderate level of assurance that the subject matter is plausible in the
circumstances.

Types of Assurance Engagements and their Objectives:

1. Reasonable assurance engagements – engagements that provide high, but not absolute,
level of assurance
 Also called high-level engagements
 The objective of a reasonable assurance engagement is a reduction in assurance
engagement risk to an acceptably low level as the basis for a positive form of expression
of the practitioner‘s conclusion.
2. Limited assurance engagements – engagements that provide only a ―moderate‖ or
―limited level of assurance
 The objective of a limited assurance engagement is a reduction in assurance
engagement risk to an acceptable level as the basis for a negative form of expression of
the practitioner‘s conclusion. Thus, the risk in limited assurance engagement is greater
than for a reasonable assurance engagement.
Assertion-based and Direct Reporting Engagements:

1.Assertion based engagements – evaluation or measurement of the subject matter is performed

by the responsible party, and the subject matter information is in the form of an assertion by the
responsible party that is made available to the interested users

 Assertion-based engagements are also known as attestation engagements

 Examples of assertion-based engagements:
a. Audit engagements
b. Review engagements

2. Direct reporting engagements – the practitioner either directly performs the evaluation or
measurement of the subject matter, or obtains a representation from the responsible p

Elements of Assurance Engagements:

Not all engagements performed by practitioners are assurance engagements. An assurance

engagement must have the following elements:

1. Three party relationship (involving a practitioner, a responsible party and intended

users)
2. Appropriate subject matter
3. Suitable criteria
4. Sufficient appropriate evidence
5. Written assurance report in the form appropriate to a reasonable assurance engagement
or a limited assurance engagement
I. A three-party relationship:

i. A practitioner: - is the individual conducting the engagement; should comply

with the requirements of the law, regulatory requirements, and code of ethics.
ii. A responsible party: - is the party responsible for the underlying subject matter;
may also be the engaging party and/or the measurer or evaluator.
iii. Intended users: - are the users of the assurance report; may be the responsible
party but not the only one; may be involved in determining the requirements of
the engagement.
 II. An appropriate subject matter; - The phenomenon that is measured or evaluated by
applying criteria.
“Subject matter information” refers to the outcome of the evaluation or measurement
of a subject matter.

III. Suitable criteria; - the benchmarks used to measure or evaluate the subject matter
that are established or developed by groups composed of experts that follow due
process procedures, including exposure of the proposed criteria for public comment,
are ordinarily considered suitable.

Characteristics of a Suitable Criteria:

1. Relevance – assists decision-making by the intended users.

2. Completeness – does not omit relevant factors that may affect decision making
of decision-making of intended users.
3. Reliability – it can be consistently used in measurement of underlying subject
matter.
4. Neutrality – free from bias
5. Understandability – result of subject matter information is understood by
intended users.
IV. Sufficient appropriate evidence; - Information used by the practitioner in arriving at the
opinion, conclusion, or findings on which the practitioner’s report is based.

Sufficiency of Evidence - The measure of the quantity of evidence. The quantity of the evidence
needed is affected by the risks of material misstatement and also by the quality of such evidence.

Appropriateness of Evidence - The measure of the quality of evidence, that is, its relevancy and
reliability in providing support for the practitioner’s opinion.
Ways in Gathering of Evidence:
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 that may indicate possible misstatement due to fraud or error, and a critical
assessment of audit evidence.
V. A written assurance report in the form appropriate to a reasonable assurance
engagement or a limited assurance engagement.

Types of Assurance Engagement based on the level of Assurance provided in the Assurance
Report:
1. Reasonable Assurance Engagement - the objective is a reduction in assurance
engagement risk to an acceptably low level in the circumstances of the engagement as the
basis for a positive form of expression of the practitioner’s conclusion.
2. Limited Assurance Engagement - the objective is a reduction in assurance engagement
risk to a level that is acceptable in the circumstances of the engagement, but where the
risk is greater than for a reasonable assurance engagement, as a basis for a negative form
of expression of the practitioner’s conclusion.

INTRODUCTION TO AUDITING

According to American Accounting Association (AAA), auditing defined 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 result to interested users”.

Auditing encompasses two processes: investigative process and a reporting process.

Investigation involves the systematic gathering and evaluation of evidence as a basis for
determining whether assertions or representations made by responsible person in a company’s
financial statements, correspond with the established financial reporting criteria, such as
generally accepted accounting principles (GAAP).

Forms of evidence: Transaction data; Communications with outsiders; Observations;

Client Testimony

Auditors must obtain sufficient and appropriate audit evidence to satisfy the purpose of
audit.

Auditing and Accounting Distinguished

Accounting is the recording, classifying, and summarizing of economic events in logical manner
for the purpose of providing financial information (ie., financial statements) for decision making.

Auditing focus on determining whether recorded information properly reflects the economic
events that occurred during the accounting period. In addition to understanding accounting,
auditors must possess expertise in the accumulation and interpretation of audit evidence. This
skill is the major characteristic that distinguishes auditors from accountants.

As an old saying goes, “auditing begins where accounting ends”.

• Reportinginvolves communicating an evaluation or opinion in audit report to

interested users.

Types of Audits

Audits may be classified according to subject matters or the nature of data or assertion being
audited (ie., financial statement audits, operational audits, compliance audits); or the type of
auditor performing in the engagement (ie., external audit, internal audit, government audit)

Types of Audit according to nature or assertion being audited.

 Financial Statement Audits – This refers to the gathering of evidence on the assertions
embodied in the financial statements of an entity and using the evidence to determine
whether the assertions adhere to generally accepted accounting principles (GAAP) or
another comprehensive and authoritative financial reporting framework. This type of
audit requires Certified Public Accountant (CPA).

Operational Audits involve “a systematic review of an organization’s activities in

relation to specified objectives for the purposes of assessing performance (he efficiency,
effectiveness and economy of operations), identifying opportunities for improvement,
and developing recommendations for improvement or further action. In operational audit,
financial data may be used, but the primary sources of evidence are the operational
policies and achievements related to organizational objectives.

Compliance Audits are used to determine whether a person or entity has adhered to laws
and regulations. Results of compliance audit are generally reported to a specific user
within the organization.

Types of Audit according to type of auditor

External Audit – performed by CPAs who are independent of the organizations whose
assertions are being audited. These CPAs are also known as independent auditors or
external auditors. The audits performed by external auditors are mainly of financial
statement audits, though compliance audits and operational audits may also be performed
by them.

Internal Audit - an independent appraisal function established within an organization to

examine and evaluate its activities as a service to the organization. The internal auditing
staff often reports to the audit committee o the board of directors, and also to the
president or another high executive. Regardless of the reporting level, however, internal
auditors are not independent in the same sense as external auditors (because internal
auditors are employees of the organizations whose activities they appraise). Internal
audits comprise mainly of operational audits and compliance audits.
 Government Audits involve the determination of whether government funds are being
handled properly and in compliance with existing laws and whether the government
programs a particular agency are being conducted efficiently and economically.
Government audit (or State Audit) has been classified into three main divisions:

• Compliance audit – the examination, audit and settlement in accordance with laws
and regulations.

• Financial audit – audit if the accounting and financial system and controls to
ensure reliability of recorded financial data.

• Performance audit – an objective examination of the financial and operational

performance of an organization, program activity or function and is oriented
towards opportunities for greater economy, efficiency and effectiveness.

• Economy and efficiency audit – also known as management audit

• Effectiveness audit – also known as program results audit.

The Audit Report

The audit report is the means through which the auditors provide reasonable assurance that
the financial statements are fairly stated. This report is uniform in format and suitably titled
to avoid confusion regarding the level of assurance being provided and to differentiate from
other reports which client management might include with the financial statements.

The Independent Financial Audit

• Objective: to enable the auditor to express an opinion whether the financial statements
are prepared, in all material aspects, in accordance with the applicable financial reporting
framework.

• Responsibility for the financial statements

• Assurance provided by the auditor

Limitations of an Audit

An audit is not a guarantee of the exactness of accuracy or assertions in the financial

statements. Based on the conclusion drawn from the audit evidence obtained, the auditor
expresses an opinion on the financial statements. However, and audit is not intended to and
cannot, provide a guarantee of absolute assurance (i.e., certainty) that the financial statements
are free from material misstatement due to fraud and error. This is because there are inherent
limitation of an audit arising from:

 The nature of financial reporting – involves judgment, subjective decisions and

assessments (such as estimates) by management.
 The nature of audit procedures – Audit procedures, however well designed, will not detect
every misstatement. Any sample of less than 100% of a population introduces some risk that
a misstatement will not be detected
 Nature of Audit Evidence Available – evidence tends to be persuasive in character rather
than conclusive.
 Timeliness of Financial Reporting – Users of financial statements expect that the auditor
will form his or her opinion within a reasonable period of time and at a reasonable cost.
Consequently, it is impracticable to address all information that may exist, or to pursue every
matter exhaustively on the assumption that information is in error or fraudulent until proved
otherwise.
Information risk

The risk that information is misstated or misleading is known as information risk. Several factors
contribute to the existence of information risk, including the following:

1. Remoteness of information
2. Biases and Motives of the Provider
3. Voluminous Data
4. Complex Exchange Transactions
Reducing Information Risk

1. Allow users to verify information – the user may go to the business establishment to verify the
information. This is often costly and impractical.
2. User shares information risk with management –If inaccurate information is provided,
management may be held responsible in a lawsuit.
3. Have the financial statements audited – External auditors are engaged to provide assurance that
the financial statements are reliable.

The most common option selected is to have the financial statements

SHORT QUIZ

1. Which of the following is NOT an assurance service?

A. Examination of prospective financial information
B. Compilation of financial information
C. Review of financial statements
D. Audit of historical financial statements
Answer: B. Compilation of financial information
2. Which of the following best describes the objective of an assurance engagement?
A. Assist in preparing the company’s financial statements
B. Enhance the credibility of information to meet the needs of the intended user
C. Compare the company’s information and policies with those of other entities
D. Improve the company’s outcomes
Answer: B. Enhance the credibility of information to meet the needs of the intended user
3. How many separate parties are involved in an assurance engagement?
Answer: Three
4. In an assurance engagement, the responsible party and the intended users
A. Should be from the same entity
B. Should be from different entities
C. May be from the same entity or different entities
 D. Are both responsible for determining the nature, timing and extent of the
procedures to be performed
Answer: C. May be from the same entity or different entities
5. The level of assurance provided by the practitioner in an audit is
A. Low
B. Moderate
C. Reasonable
D. None
Answer: C. Reasonable
6. Which of the following types of audit uses laws and regulations as its criteria?
A. Operational Audit
B. Financial Statement Audit
C. Compliance Audit
D. Performance Audit
Answer: C. Compliance Audit
7. A typical objective of operational audit is to determine whether an entity’s
A. Internal control structure is adequately operating as designed
B. Operational information is in accordance with generally accepted accounting
principles
C. Specific operating units functioning efficiently and effectively.
D. Financial statements present fairly the results of operations
Answer: C. Specific operating units functioning efficiently and effectively
8. The subject matter of any audit consists of
A. Assertions about economic actions and events
B. Economic data
C. Financial statements
D. Operating data
Answer: A. Assertions about economic actions and events
9. Most of the independent auditor’s work in formulating an opinion on financial
statement consist of
 A. Studying and evaluating internal control
B. Obtaining and examining evidential matter
C. Examining cash transaction
D. Comparing recorded accountability with assets
Answer: B. Obtaining and examining evidential matter
10. An audit of the financial statements of KIA Corporation is being conducted by an
external auditor. The external auditor is expected to
A. express an opinion as to the fairness of KIA’s financial statements.
B. express an opinion as to the attractiveness of KIA for investment purposes.
C. certify the correctness of KIA’s Financial Statements
D. examine all evidence supporting KIA’s financial statements.
Answer: A. express an opinion as to the fairness of KIA’s financial statements.

Most of the independent auditor’s

work in formulating an opinion on
financial
statement consist of
a. Studying and evaluating internal
control
b. Obtaining and examining
evidential matter
c. Examining cash transaction
d. Comparing recorded
accountability with assets
Most of the independent auditor’s
work in formulating an opinion on
financial
statement consist of
a. Studying and evaluating internal
control
b. Obtaining and examining
evidential matter
c. Examining cash transaction
d. Comparing recorded
accountability with assets
Most of the independent auditor’s
work in formulating an opinion on
financial
statement consist of
a. Studying and evaluating internal
control
b. Obtaining and examining
evidential matter
c. Examining cash transaction
d. Comparing recorded
accountability with assets
Most of the independent auditor’s
work in formulating an opinion on
financial
statement consist of
a. Studying and evaluating internal
control
b. Obtaining and examining
evidential matter
c. Examining cash transaction
d. Comparing recorded
accountability with asse 9. Most of the independent
auditor’s work in formulating an opinion on financial statement consist of a. Studying and
evaluating internal controlb. Obtaining and examining evidential matterc. Examining cash
transactiond. Comparing recorded accountability with assets