Ch-1 Introduction to Auditing

What’s Financial Audit?

• An audit is an independent examination
• of financial information
• of any entity, whether profit oriented or not, and irrespective of size or legal form,
• when such an examination is conducted with a view to expressing an opinion thereon.

SA 200 Overall Objectives of Independent Auditor and

Conduct of an Audit in Accordance with Standards on Auditing

In conducting an audit of F.S., overall objectives of the auditor are:

(a) To obtain reasonable assurance about whether F.S. as a whole
• are free from material misstatement, whether due to fraud or error,
• thereby enabling auditor to express an opinion
• on whether F.S. are prepared, in all material respects,
• in accordance with an applicable FRF; and
(b) To report on the F.S., and communicate as required by SAs, in accordance with auditor’s findings.

In all cases when reasonable assurance cannot be obtained and qualified opinion is insufficient, auditor
shall disclaim an opinion or withdraw from engagement, where withdrawal is legally permitted.

Definitions
● Applicable financial reporting framework (FRF) – The FRF adopted by mgt and, where appropriate,
TCWG in preparation and presentation of F.S. that is acceptable in view of nature of entity and
objective of F.S., or that is required by law or regulation.

“fair presentation framework” refer to FRF that requires compliance with requirements of framework
AND:
(i) Acknowledges, to achieve fair presentation of F.S., it may be necessary for mgt to provide
disclosures beyond those specifically required by the framework; or
(ii) Acknowledges explicitly that it may be necessary for mgt to depart from a requirement of
framework to achieve fair presentation of F.S. Such departures are expected to be necessary only in
extremely rare circumstances.

The term “compliance framework” is used to refer to a FRF that requires compliance with requirements
of framework, but does not contain acknowledgements in (i) or (ii) above.

● Financial statements(F.S.) –Structured representation of historical financial information, including

related notes, 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.

● Misstatement – A difference between the amount, classification, presentation, or disclosure

(a/c/p/d) of a reported F.S. item & the amount, classification, presentation, or disclosure(a/c/p/d)
that is required for the item to be in accordance with the applicable FRF.
Misstatements can arise from error or fraud.

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● Those charged with governance – The person(s) or organisation(s) (e.g., a corporate trustee) with
responsibility for overseeing the strategic direction of the entity and obligations related to the
accountability of the entity. (Executive Members-CEO/CFO/MD)

Ethical Requirements Relating to Audit of Financial Statements

• The auditor shall comply with relevant ethical requirements, including those pertaining to
independence.
• Independence comprises both independence of mind and independence of appearance.
• Independence enhances auditor’s ability to act with integrity, be objective and maintain
attitude of professional skepticism.

Professional Skepticism [RTP Nov-22]

Professional skepticism refers to 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.

The auditor shall plan and perform an audit with professional skepticism recognising that
circumstances may exist that cause financial statements to be materially misstated.

Professional skepticism includes being alert to, for example:

• Audit evidence that contradicts other audit evidence obtained.
• Information that brings into question reliability of documents and responses to inquiries to be
used as audit evidence.
• Conditions that may indicate possible fraud.
• Circumstances that suggest the need for audit procedures in addition to those required by
the SAs.

Maintaining professional skepticism throughout the audit is necessary if the auditor is to reduce the
risks of:
• Overlooking unusual circumstances.
• Over generalising when drawing conclusions from audit observations.
• Using inappropriate assumptions in determining the nature, timing, and extent of the audit
procedures and evaluating the results thereof.

ü It also includes consideration of sufficiency and appropriateness of audit evidence obtained in

light of circumstances, for eg in case where fraud risk factors exist and a single document, of a
nature that is susceptible to fraud, is sole supporting evidence for a material F.S. amount.
ü Auditor may accept records and documents as genuine unless reason to believe contrary.
ü Auditor is required to consider reliability of information to be used as audit evidence.
ü In cases of doubt or indications of possible fraud, SAs require auditor to investigate further and
determine what modifications or additions to audit procedures are necessary to resolve the
matter.
ü The auditor cannot be expected to disregard past experience of honesty and integrity of entity’s
mgt and TCWG.
ü Nevertheless, a belief that mgt and TCWG are honest and have integrity doesn’t relieve auditor
of need to maintain professional skepticism.

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Eg. Mr. H is an audit team member of a CA Firm WY and Associates. Mr. H was of opinion that
Professional Skepticism is required only at planning stage of audit because situations and
circumstances which are unusual in nature exist at beginning of an audit only.
Explain whether Professional Skepticism is only required at planning stage of an audit.

Professional Skepticism is not only required at planning stage of an audit, rather it is required during
entire process of audit because situations and circumstances that are not usual in nature exist during
entire process of an audit.

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 circumstances of audit engagement.

Professional judgment is necessary in particular regarding decisions about:

• Materiality and audit risk.
• The nature, timing, and extent(NTE) of audit procedures used to meet the requirements
of SAs and gather audit evidence.
• Evaluating whether sufficient appropriate audit evidence (SAAE) has been obtained, and
whether more needs to be done to achieve objectives of SAs and thereby, overall objectives
of auditor.
• The evaluation of management’s judgments in applying entity’s applicable FRF.
• The drawing of conclusions based on audit evidence obtained, for eg, assessing
reasonableness of estimates made by management in preparing F.S.

Sufficient & Appropriate Audit Evidence (SAAE)

To obtain reasonable assurance, auditor shall obtain SAAE to reduce audit risk to an acceptably low
level and draw reasonable conclusions on which to base auditor’s opinion
● Reasonable assurance – In context of audit of F.S, a high, but not absolute, level of assurance.
● Audit evidence – Info. used by auditor in arriving at conclusions on which auditor’s opinion is
based.
(i) Sufficiency is measure of quantity of audit evidence. Quantity is affected by auditor’s
assessment of risks of material misstatement (ROMM) and also by quality of such audit
evidence.
(ii) Appropriateness is measure of quality of audit evidence; that is, its relevance and its
reliability in providing support for conclusions on which auditor’s opinion is based.

Scope of Audit
Auditor’s opinion on F.S. deals with whether F.S. are prepared, in all material respects, as per applicable
FRF.
• Such an opinion is common to all audits of F.S.
• The auditor’s opinion therefore does not assure, future viability of entity nor the efficiency or
effectiveness with which mgt has conducted affairs of entity.
• In some cases, however, applicable laws and regulations may require auditors to provide opinions
on other specific matters, such as effectiveness of internal control, or consistency of a separate
management report with the F.S.

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• While SAs include requirements and guidance in relation to such matters to the extent they are
relevant to forming an opinion on F.S., auditor would be required to undertake further work if
auditor had additional responsibilities to provide such opinions.

The Premise (Responsibilities of Mgt & TCWG)

(i) For preparation and presentation of financial statements (PPFS) in accordance with applicable FRF;
this includes design, implementation and maintenance(DIM) of internal control(IC) relevant to
preparation and presentation of financial statements(PPFS) that are free from material misstatement,
whether due to fraud or error; &
(ii) To provide the auditor with:
(a) All information, such as records and documentation, and other matters that are relevant to
PPFS;
(b) Any additional info that auditor may request from mgt and, where appropriate, TCWG; and
(c) Unrestricted access to those within entity from whom auditor determines necessary to obtain
audit evidence.

As part of their responsibility for PPFS, mgt and, TCWG are responsible for:
• The identification of applicable FRF , in context of any relevant laws or regulations.
• The PPFS (Preparation & Presentation of F.S.) in accordance with that framework.
• An adequate description of that framework in F.S.

The preparation of F.S. requires mgt to exercise judgment in making accounting estimates that are
reasonable in circumstances, as well as to select and apply appropriate accounting policies. These
judgments are made in the context of applicable FRF.

The F.S. may be prepared in accordance with a FRF designed to meet:

• The common financial information needs of a wide range of users (i.e., “general purpose F.S.”); or
• The financial information needs of specific users (i.e., “special purpose F.S.”).

Inherent Limitations of Audit

The auditor is not expected to, and can’t, reduce audit risk to zero and cannot therefore obtain
absolute assurance that F.S. are free from material misstatement due to fraud or error.

This is because there are inherent limitations of an audit.

The inherent limitations of an audit arise from:

(i) The Nature of Financial Reporting: The preparation of F.S. involves judgment by mgt in applying
requirements of entity’s applicable FRF to facts and circumstances of entity. In addition, many F.S.
items involve subjective decisions or assessments or a degree of uncertainty, and there may be a range
of acceptable interpretations or judgments that may be made.

(ii) The Nature of Audit Procedures: [RTP Nov-21/22]

There are practical and legal limitations on auditor’s ability to obtain audit evidence. For eg:
1. There is possibility that management or others may not provide complete info that is relevant to
preparation and presentation of F.S. or that has been requested by auditor.
2. Fraud may involve sophisticated and carefully organised schemes designed to conceal it.

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3. An audit is not an official investigation into alleged wrongdoing. Accordingly, auditor is not given
specific legal powers, such as power of search, which may be necessary for investigation.

(iii) Timeliness of Financial Reporting and Balance between Benefit and Cost: The matter of difficulty,
time, or cost involved is not in itself a valid basis for auditor to omit an audit procedure for which
there is no alternative.

Relevance of information, and thereby its value, tends to diminish over time, and there is a balance to
be struck between reliability of information and its cost.

(iv) Other Matters that Affect Limitations of an Audit: In case of certain subject matters, limitations
on auditor’s ability to detect material misstatements are particularly significant.
Such assertions or subject matters include:
- Fraud, particularly fraud involving senior management or collusion.
- The existence and completeness of related party relationships and transactions.
- The occurrence of non-compliance with laws and regulations.
- Future events or conditions that may cause an entity to cease to continue as a going concern.
[RTP Nov-18]

Q. DEF & Co. CAs successfully carried out audit of Shree Garments for FY 2019-20. After completion
of audit, there were found material misstatements due to fraud in F.S. which were not noticed and
reported by auditor. Management alleges that it is failure on part of auditor. Comment. [MTP Oct-20]
Ø Because of limitations of an audit, there is unavoidable risk that some material misstatements of
F.S. may not be detected, even though audit is properly planned and performed in accordance with
SAs.
Ø Accordingly, subsequent discovery of material misstatement of F.S. resulting from fraud or error
does not indicate failure to conduct audit in accordance with SAs.
Ø However, inherent limitations of audit are not justification for auditor to be satisfied with less-
than-persuasive audit evidence.

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 Conduct of an Audit in accordance with SAs
• Complying with SAs Relevant to the Audit:
Ø The auditor shall comply with all SAs relevant to the audit.
Ø An SA is relevant to the audit when the SA is in effect and the circumstances
addressed by the SA exist.
Ø The auditor shall have an understanding of the entire text of an SA including
application
Ø The auditor shall not represent compliance with SAs in auditor’s report unless auditor
has complied with requirements of this SA and all other SAs relevant to the audit.

• Objectives Stated in Individual SAs:

Ø Achieve overall objective à using objectives of relevant SAs
Ø Having regard to interrelationships among SAs:
• Determine if any audit procedure in addition to that required by SAs is
necessary.
• Evaluate whether SAAE has been obtained

• Complying with Relevant Requirements

Ø The auditor shall comply with each requirement of an SA unless, in circumstances of
audit:
a. An SA is not relevant;(Eg. SA 610 not applicable if not internal audit fn) or
b. There’s conditional requirement & condition doesn’t exist.
Ø In exceptional circumstances, auditor may depart from relevant requirement in SA. In
such cases, auditor shall perform alternative audit procedures to achieve aim of that
requirement.

• Failure to achieve an Objective

Ø Evaluate if it prevents auditor from achieving overall objective &
Ø Requires to modify opinion or withdraw from engagement
Ø It’s a significant matter requiring documentation as per SA 230

Whether auditor has performed an audit in accordance with SAs is determined by

• audit procedures performed in the circumstances,
• sufficiency and appropriateness of audit evidence obtained as a result thereof and
• suitability of auditor’s report based on an evaluation of that evidence in light of overall
objectives of auditor.

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