Auditing and Assurance

PROGRAMME : B TECH. IN COMPUTERISED ACCOUNTING

LECTURER: GARIBA O.A. ANINANYA

BOLGATANGA TECHNICAL UNIVERSITY
 Auditing and Assurance

The Concept of Audit and

Assurance Engagements
Overview The Concept of Audit and other
Assurance Engagements

The purpose of Accountability, Types of assurance

external audit stewardship and agency

Assurance and reports Communication to different

stakeholders

Concepts in reporting Levels of assurance

Materiality
True and fair
Reasonable assurance
 The Purpose of External Audit
Engagements
The purpose of external audit is to promote
confidence and trust in financial information.

External audit is 'the independent examination

and expression of opinion on the financial
statements of an entity'.
The Purpose of External Audit Engagements

The primary role of an external audit to is to report on the truth

and fairness of the financial statements of an entity presented by
the management of the entity to its investors, the shareholders.

The auditor gives an opinion on whether the financial

statements:
• Have been prepared in accordance with an acceptable
financial reporting framework, e.g. IFRSs; and
• Comply with any specific statutory requirements, e.g. to
keep adequate accounting records.
The Purpose of External Audit Engagements

Legislations of most countries require the directors of

all companies to produce financial statements for
presentation to their shareholders.
This is a recognition of the division between those who
invest in the company – the shareholders and those
who run it on a day-to-day basis – the directors.
The Purpose of External Audit Engagements

Appoint independent
Auditor
Adds credibility
Measure performance Prepare
Financial
Statements

Appoint

Shareholders Directors

Invest Manage
Company
The Purpose of External Audit Engagements

The directors are required to account for the

stewardship of the assets placed under their control.
They achieve this by preparing financial statements
which are presented to the shareholders.

An external audit is a legal requirement for

incorporated entities, although many smaller entities
are exempted from the requirement.
The Purpose of External Audit Engagements

The directors' statements have to be examined by

an independent expert, the auditor, who is
required to give an opinion on their truth and
fairness.
The auditor’s opinion enhances the credibility of
the financial statements by providing reasonable
assurance from an independent source that the
financial statements taken as a whole are free
from material misstatement.
 Accountability, stewardship and Agency

Agency theory
The role of external audit is often explained in
relation to the economic model of agency theory.
 Agency Relationship
Principal [Investor(s)] Agent [Auditor]

The shareholders (principal) engages an agent to perform a service on their behalf

Delegates some decision making authority to the agent, directors

Problems
May have concerns over motives of agents.
May question the trust they have placed in the agent.
Principal and agent may have different attitude to risk.

Possible solutions
Set up mechanisms to align the interests of agents with
principles (e.g. performance related pay)
Monitoring mechanisms (e.g. the audit)
 Agency Relationship
In the case of a company, the board of directors acts
as the agents of the body of shareholders, the
principals. The directors are accountable for their
stewardship of the company.

The shareholders have limited access to information

about the operations of the company.

They may lack trust in the directors and may believe

that the information in the financial statements is
biased.
 Agency Relationship

The external auditor, therefore, performs a

statutory audit to address a simple agency
Conflict between shareholders and directors.
In addition, the auditor can be seen as an agent
of the shareholders. Under law, they report to
and are appointed by the shareholders
 Agency Relationship
This raises more concerns with regard to trust and
confidence.
One key factor here is the importance that
shareholders place on the auditors' independence
from the directors.
Auditors have an important incentive to maintain
independence and protect their reputation in order
to keep and win more audit work.
The profession also imposes guidance in relation to
independence.
 Assurance

'An assurance engagement is 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.'
 Assurance

Practitioner

Criteria

Subject matter

Intended users Responsible party

Assurance engagements are generally voluntary but may be a

requirement imposed on the entity by another party.
 Elements of an Assurance Engagement [CREST]

An assurance engagement performed by a practitioner will

consist of the following elements:
A three party relationship
The three parties are the intended user, the responsible party and
the practitioner.
• Intended users: The person(s) or class of persons for whom
the practitioner prepares the assurance report.
• The responsible party: The party responsible for the
underlying subject matter (in a direct reporting engagement)
or subject matter information of the assurance engagement.
• The practitioner: The individual providing the professional
services by reviewing the subject matter and providing the
assurance.
 Elements of an Assurance Engagement
[CREST]
A subject matter
This is the data to be evaluated that has been prepared
by the responsible party.
It can take many forms, including financial performance
(e.g. historical financial information), nonfinancial
performance (e.g. key performance indicators),
processes (e.g. internal control) and behaviour (e.g.
compliance with laws and regulations).
 Elements of an Assurance Engagement
[CREST]

Suitable criteria.
The subject matter is evaluated or measured a
against a criteria in order to reach an opinion.

Evidence.
Sufficient appropriate evidence needs to be gathered to
support the required level of assurance.
 Elements of an Assurance Engagement
[CREST]
An assurance report.
A written report containing the practitioner's
opinion is issued to the intended user, in the
form appropriate to a reasonable assurance
engagement or a limited assurance engagement.
 Elements of an Assurance Engagement
[CREST]
One way to remember these five elements of an
assurance engagement is using the mnemonic
CREST.
• Criteria
• Report
• Evidence
• Subject matter
• Three party relationship
 Materiality

The objective of an audit of financial statements

is to enable the auditor to express an opinion on
whether the financial statements are prepared
in all material respects, with an identified
financial reporting framework
 Materiality
What is materiality?
(a) Information is material if its omission or misstatement
could influence the economic decisions of users taken on
the basis of the financial statements.

(b) The auditor must be concerned with identifying 'material'

errors, omissions and misstatements. Both the amount
(quantity) and nature (quality) of misstatements need to be
considered.

(c) To put this into practice the auditor therefore has to set his
own materiality levels –which is a matter of judgement and
will depend on the level of audit risk.
 Materiality

The higher the anticipated risk, the lower the value of

materiality will be.
The materiality level will impact on the auditor's
decisions relating to:
• How many items to examine
• Which items to examine
• Whether to use sampling techniques
• What level of misstatement is likely to result in
a modified audit opinion conforming to ISA.
 Materiality

Auditors must therefore consider the risks of

material misstatement in qualitative disclosures
In doing so, the auditor should consider:
• The circumstances of the entity (eg any
business acquisitions or disposals during the
period)
 Materiality
• The applicable financial reporting framework
(eg new qualitative disclosures may be required
by a new financial reporting standard)
• Qualitative disclosures that are important to the
users of the financial statements because of
the
nature of the entity (eg liquidity risk disclosures
for a financial institution)
 Materiality
During planning, the auditor must establish
materiality for the financial statements as a
whole and set performance materiality levels
[the amount or amounts set by the auditor at
less than the materiality level].

This involves the exercise of professional

judgement.
 Materiality
Generally, a percentage is applied to a chosen
benchmark as a starting point for determining
materiality for the financial statements as a
whole.
The following factors may affect the
identification of an appropriate benchmark:
• Elements of the financial statements (eg
assets, liabilities, equity, revenue, expenses)
 Materiality
• Whether there are items on which users tend

to focus
• Nature of the entity, industry and economic
environment
• Entity's ownership structure and financing
• Relative volatility of the benchmark
 Materiality
The following benchmarks and percentages may be
appropriate in the calculation of materiality for the
financial statements as a whole.
• Value %
• Gross profit ½-1
• Revenue ½-1
• Total assets 1-2
• Net assets 2-5
• Profit before tax 5
• Profit after tax 5-10
 Materiality
Consider what would happen if this materiality
for the financial statements as a whole was
applied directly to, for example, different account
balances (such as receivables and inventory).
It could be that a number of balances (or
elements making up those balances) are untested
or dismissed on the grounds that they are
immaterial.
 Materiality
However, a number of errors or misstatements could
exist in those untested balances, and these could
aggregate to a material misstatement.
Objectives of an Assurance Engagement
The objective of an assurance engagement will depend
on the level of assurance given.

There are two forms of assurance engagements:

• Reasonable assurance engagements
• Limited assurance engagements
First we will consider a reasonable assurance
engagement, where a high, but not absolute, level of
assurance is given.
 Reasonable Assurance
No auditor can give 100% assurance. The highest
level of assurance given, as in the case of statutory
audit, is described as 'reasonable assurance'.

'Reasonable assurance' is less than absolute

assurance. Reducing assurance engagement risk to
zero is very rarely attainable or cost beneficial as a
result of factors such as the following:
(a) The use of selective testing.
 Reasonable Assurance
(b) The inherent limitations of internal control.
(c) The fact that much of the evidence available
to the practitioner is persuasive rather than
conclusive.
(d) The use of judgement in gathering and
evaluating evidence and forming conclusions
based on that evidence.
(e) In some cases, the characteristics of the subject
matter is evaluated or measured against
the identified criteria.
 Objectives of an Essurance Engagement

The objective of a reasonable assurance engagement is to

reduce the assurance engagement risk to an acceptably low
level in the circumstances of the engagement as the basis for
the assurance practitioner's conclusion.

The conclusion would usually be expressed in a positive form.

In order to give reasonable assurance, a significant amount of

testing and evaluation is required to support the conclusion.
 Limited Assurance

This is a lower level of assurance. The nature, timing

and extent of the procedures carried out by the
practitioner in a limited assurance engagement would
be limited compared with what is required in a
reasonable assurance engagement.
The procedures to be performed should be planned to
obtain a level of assurance that is meaningful, in the
practitioner's professional judgment.
 LEVELS OF ASSURANCE
Differences between reasonable assurance and limited assurance

Reasonable Assurance Limited Assurance

Type of engagement Type of engagement
• Reasonable assurance • Limited assurance engagement
engagement
e.g. review of half-year accounts
e.g. statutory audit
Evidence-gathering procedures
Evidence-gathering procedures
Sufficient appropriate evidence is
Sufficient appropriate evidence is
obtained as part of a systematic obtained as part of a systematic
engagement process that engagement process that includes:
includes:
• Obtaining an understanding of
the engagement circumstances
 LEVELS OF ASSURANCE
Differences between reasonable assurance and limited assurance

Reasonable Assurance Limited Assurance

Evidence-gathering procedures Evidence-gathering procedures
• Assessing risks • Obtaining an understanding of
• Responding to assessed risks the subject matter and other
• Performing further procedures engagement circumstances,
using a combination of but in which procedures are
inspection, observation, deliberately limited relative to
confirmation, re-calculation, a reasonable assurance
re-performance, analytical engagement.
procedures and inquiry.
 LEVELS OF ASSURANCE
Differences between reasonable assurance and limited assurance

Reasonable Assurance Limited Assurance

Evidence-gathering procedures
• The procedures may include
only inquiry and analytical
The assurance report procedures.
Description of the engagement The assurance report
circumstances, and a positive • Description of the
engagement circumstances,
expression of the conclusion
and a negative form of
expression of the
conclusion.
 Examples of Assurance Engagements
Examples of assurance engagements include:
• Annual external audit of financial statements
(‘statutory’ assurance)
• Half-year review of results
• Going concern review
• Review of effectiveness of an entity's IT system
• Review of compliance with corporate governance
requirements
 Benefits of Assurance Repot
An assurance report provides the following benefits to the
users of financial information:
• Independent opinion from an external source
that enhances the credibility of the information
• Management bias is reduced
• Modified opinion draws attention to risk
• The relevance of the information may be improved by
the expertise and knowledge of the assurance firm.
 Steps in Assurance Engagements
All assurance engagements, whether subjected to legal regulation such as
statutory audit or a contractual arrangement should be performed in a similar
manner:
• Agree on the scope of work to be performed
• Formalise all of the terms of the engagement in a contract
(engagement letter)
• Plan the work. The level of work should be based on the risk
and level of assurance desired
• Obtain sufficient appropriate evidence on which to base the
conclusion
• Perform overall review and form opinion
• Issue report to the client.
 Assurance and Reports
The objective of any assurance assignment is to
produce a conclusion in the form of a report.
The auditors' report on company financial statements is
expressed in terms of truth and fairness.
This means that the financial statements:
• Are factual
• Are free from bias
• Reflect the commercial substance of the
business's transactions.
 Assurance and Reports
True
Information is factual and conforms with reality. In addition,
the information conforms with required
standards and law. The financial statements have been
correctly extracted from the books and records.
Fair
Information is free from discrimination and bias and in
compliance with expected standards and rules.
The accounts should reflect the commercial substance of the
company's underlying transactions.
 Communication to different stakeholders

The report issued after a statutory audit is

addressed to the shareholders.
The addressees of other assurance reports will
vary from one assignment to another, depending
on the nature of the subject matter and the
purpose of the report.
 Stages of an external audit
The main steps in the conduct of an external audit are:
Plan the audit

Understand the entity (including documenting and

confirming the accounting systems and internal
control system)

Assess risk of material misstatement

Select audit procedures to respond to risk of
material misstatement
Stages of an external audit
Where risk assessment Risk assessment does
includes expectation not include expectation
that controls operate that controls operate
effectively effectively

Tests of controls
(to confirm
expectation)
Report
to management
Unsatisfactory

Restricted
substantive tests Full substantive tests
Satisfactory
Stages of an external audit

Overall review of financial statements

Report to

management

Auditor’s Report
 Audit planning and Documentation

The need for The Audit Strategy and Audit

Planning the Audit Plan Documentation

Interim and Final Audit

 The need for planning the Audit

• It is important for the auditor to formulate an

overall audit strategy and translate it into a
detailed audit plan for the audit staff to
follow.
 The need for planning the Audit

• This will enable the auditor to conduct an

effective audit in an efficient and timely
manner.
Audits are therefore planned to:
• Help the auditor devote appropriate attention
to important areas of the audit
 The need for planning the Audit
• Help the auditor identify and resolve potential
problems on a timely basis

• Help the auditor properly organise and

manage the audit so it is performed in an
effective manner
 The need for planning the Audit
• Assist in the selection of appropriate team
members and assignment of work to them

• Facilitate the direction, supervision and

review of work

• Assist in co-ordination of work done by

auditors of components and experts
 Audit Procedures
• Audit procedures should be discussed with the
client's management, staff and/or audit
committee in order to co-ordinate audit work,
including that of internal audit.

• However, all audit procedures remain the

responsibility of the external auditors.
Structured Approach to Audit Planning
A structured approach to planning will include:

Step 1 Ensuring that ethical requirements are met,

including independence

Step 2 Ensuring the terms of the engagement are

understood

Step 3 Establishing the overall audit strategy that sets the scope,
timing and direction of the audit and guides the development of
the audit plan
Structured Approach to Audit Planning
• Identify the characteristics of the engagement
that define its scope.

• Ascertain the reporting objectives to plan the

timing of the audit and nature of communications
required.

• Consider significant factors in directing the team's

efforts.

• Consider results of preliminary engagement

activities.
Structured Approach to Audit Planning

• Ascertain nature, timing and extent of

resources necessary to perform the
engagement.

Step 4 Developing an audit plan that includes

the nature, timing and extent of planned
risk assessment procedures and further
audit procedures
 The overall Audit Strategy and the Audit
Plan
The overall audit strategy and audit plan should
be updated and changed as necessary during
the course of the audit.
The Audit Strategy
The overall audit strategy sets the scope, timing
and direction of the audit, and guides the
development of a more detailed audit plan.
 THE OVERALL AUDIT STRATEGY: MATTERS
TO CONSIDER
The matters the auditor may consider in
establishing an overall audit strategy include the
following:
THE OVERALL AUDIT STRATEGY: MATTERS
TO CONSIDER
• Characteristics of the engagement
• Financial reporting framework
• Industry-specific reporting requirements
• Expected audit coverage
• Nature of business segments
• Availability of internal audit work
• Use of service organisations
• Effect of information technology on audit
procedures
• Availability of client personnel and data
 THE OVERALL AUDIT STRATEGY: MATTERS
TO CONSIDER
Reporting objectives, timing of the audit and
nature of communications
• Entity's timetable for reporting
• Organisation of meetings with management
and those charged with governance
• Discussions with management and those
charged with governance
• Expected communications with third parties
 THE OVERALL AUDIT STRATEGY: MATTERS
TO CONSIDER
Significant factors, preliminary engagement activities, and
knowledge gained on other engagements

• Determination of materiality
• Areas identified with higher risk of material
misstatement
• Results of previous audits
• Need to maintain professional scepticism
• Evidence of management's commitment to design,
implementation and maintenance of sound internal
control
THE OVERALL AUDIT STRATEGY: MATTERS
TO CONSIDER
• Volume of transactions
• Significant business developments
• Significant industry developments
• Significant changes in financial reporting
framework
• Other significant recent developments
 THE OVERALL AUDIT STRATEGY: MATTERS
TO CONSIDER
Nature, timing and extent of resources
• Selection of engagement team
• Assignment of work to team members
• Engagement budgeting

Examples of items to include in the overall audit strategy could

be:
• Industry-specific financial reporting requirements
• Number of locations to be visited
• Audit client's timetable for reporting to its members
• Communication between the audit team and the
client
 The Audit Plan

The audit plan details specific procedures to be

carried out to implement the strategy and
complete the audit.
It converts the audit strategy into a more
detailed plan and includes the nature, timing
and extent of audit procedures to be performed
by engagement team members in order to
obtain sufficient appropriate audit evidence to
reduce audit risk to an acceptably low level
 The Audit Plan

The audit plan shall include the following:

• A description of the nature, timing and
extent of planned risk assessment procedures

• A description of the nature, timing and

extent of planned further audit procedures at the
assertion level
 The Audit Plan
Examples of items included in the audit plan could be:
• Timetable of planned audit work
• Allocation of work to audit team members
• Audit procedures for each major account
area (e.g. inventory, receivables, cash)
• Materiality for the financial statements as a
whole and performance materiality
 The Audit Plan
Considering disclosures early in the audit helps
auditors to identify:
• Changes in the entity’s environment,
financial condition or activities
• Changes in the applicable financial
reporting framework
• The need to involve an auditor’s expert
(eg for disclosures related to pension)
Planning an Audit of Financial Statements

In conducting an audit of financial statements,

the overall objectives of the auditor are:

(a) To obtain reasonable assurance about

whether the financial statements as a whole
are free from material misstatement,
Planning an Audit of Financial Statements

whether due to fraud or error, thereby

enabling the auditor to express an opinion
on whether the financial statements are
prepared, in all material respects, in
accordance with an applicable financial
reporting framework; and
Planning an Audit of Financial Statements

(b) To report on the financial statements, and

communicate as required by the ISA, in
accordance with the auditor's findings.

The key requirements for the auditor to obtain

reasonable assurance and to express an
opinion are:
Ethics:
Comply with relevant ethical requirements
Planning an Audit of Financial Statements

Professional scepticism:
Plan and perform an audit with professional
scepticism, recognising that circumstances may
exist that cause the financial statements to be
materially misstated
Planning an Audit of Financial Statements

Professional judgement:
Exercise professional judgement in planning and
performing an audit
Sufficient appropriate audit evidence and audit risk:
Obtain sufficient appropriate audit evidence to
reduce audit risk to an acceptably low level
 Planning an Audit of Financial Statements

Understand the Entity and its Environment:

This will enable the auditor to;
 identify and assess risks of material misstatement
 design and perform audit procedures
 provide a frame of reference for judgements
Planning an Audit of Financial Statements

- Areas to gain an understanding of include:

• Industry, regulatory and other external factors
• Nature of the entity
• Selection, application and reasons for changes
of accounting policies
Planning an Audit of Financial Statements

• Objectives, strategies and related business

risks
• Measurement and review of the entity's
financial performance
• Internal control systems
Planning an Audit of Financial Statements

- Methods of obtaining an understanding of the

entity

• Enquiries of management (and others within

the entity)
• Analytical procedures (on both financial and
non-financial data)
Planning an Audit of Financial Statements

• Observation and inspection

• Audit team discussion of the susceptibility of the
financial statements to material misstatement
• Prior period knowledge (but should check that
it is still relevant)
Planning an Audit of Financial Statements

The auditor may use their prior period

knowledge, but must carry out procedures to
ensure that there have not been changes in the
year making that information invalid.
Planning an Audit of Financial Statements

The auditor is required to take the following steps with

respect to risk identification:

Step 1
Identify risks throughout the process of obtaining an
understanding of the entity

Step 2
Assess whether the identified risks relate more pervasively
to the financial statements as a whole
Planning an Audit of Financial Statements

Step 3
Relate the risks to what can go wrong at the
assertion level, and assess the controls in place to
address each risk

Step 4
Consider the likelihood of misstatement and
whether the risks are of a magnitude that could
result in a material misstatement
Planning an Audit of Financial Statements

Throughout this process, the size of the entity

being audited must be considered. For example,
in a small entity there is likely to be limited
segregation of duties.
This may be compensated for by increased
management oversight, however this in turn
increases the risk of override of controls.
 Audit Evidence
Audit evidence Quality of evidence

Financial statement
Sources of evidence
assertions

Use of assertions in obtaining

audit evidence
 Introduction

Audit evidence refers to any information

obtained by the auditor in arriving at the
conclusions on which the audit opinion is
based.
When undertaking an audit or a review
assignment, the auditor needs to find evidence
through testing of processes, transactions,
account balances and data to support the
findings of his report.
 Quality of Evidence

The auditor should obtain sufficient appropriate

audit evidence to be able to draw reasonable
conclusions on which to base the audit opinion.

.
 Audit Evidence
Quality of Evidence
Sufficient Appropriate
Quantity – Sufficient to
support the auditor’s opinion Relevant Reliable

The evidence
Factors to consider are: gathered  External better than
 Risk assessment must cover internal
 Nature of accounting and the financial  Internal more reliable
internal control systems statement when controls are effective
 Materiality of the item assertions  Auditor generated better
 Experience gained during If the auditor is unable to than client generated
previous audits obtain sufficient  Documentary better than
 Results of audit procedures appropriate evidence, oral
then he should consider  Original documents more
 Source and reliability of
the implications for the
information available auditor's report reliable than copies/faxes
 Sources of Evidence
Types of procedures
Audit evidence is obtained from an appropriate mix of the
following types of procedure:
Risk assessment procedures
Procedures to obtain an understanding of the entity and its environment, including its
internal control, to assess risks of material misstatement at the financial statement and
assertion levels.

Tests of controls
Procedures to test the operating effectiveness of controls in preventing, or detecting and
correcting, material misstatements at the assertion level (when
necessary or when the auditor has determined to do so).
Substantive procedures
Procedures to detect material misstatements at the assertion level and include tests of
details of classes of transactions, account balances and disclosures and substantive
analytical procedures.
 Procedures for obtaining evidence
(a) Analytical procedures – Evaluations of financial information made by a study
of plausible relationships among financial and non-financial data and the
investigation of identified fluctuations and
relationships inconsistent with other information
(b) Enquiry and direct confirmation – Seeking information of knowledgeable
persons throughout the entity or outside the entity and obtaining
representation
from a third party.

(c) Inspection – Examining records, documents and tangible assets.

(d) Observation – Looking at a process or procedure being performed by

others.

(e) Recalculation – Checking the arithmetical accuracy of documents or records

and the auditor's independent execution of
procedures and reperfomance of controls.
Section 1.2
 The use of Assertions in obtaining Audit Evidence

Assertions are the representations of the directors

which are embodied in the financial statements.
The auditor should use assertions for classes of transactions,
account balances and disclosure as a basis for:
• Assessing the risks of material misstatement, and
• Designing and performing further audit procedures.
These are the assertions used by auditors :
 Accuracy
Amounts and other data relating to recorded
transactions and events have been recorded
appropriately.
The use of Assertions in obtaining Audit Evidence

 Completeness
All transactions, events, assets, liabilities, equity
interests and disclosures that should have
been recorded have been recorded.
 Cut off
Transactions and events have been recorded in
the correct accounting period.
The use of Assertions in obtaining Audit Evidence

 Allocation
Assets liabilities and equity interests are
recorded in the correct class of account
 Classification/understandability
Transactions and events have been recorded

in the proper accounts.

The use of Assertions in obtaining Audit Evidence

 Occurence
Transactions and events that have been recorded have occurred and
relate to the entity.
 Valuation
Assets, liabilities and equity interests are included in the financial
statements at appropriate amounts and any resulting valuation is
appropriately recorded.
 Existence
Assets, liabilities and equity interests exist.
 Rights and obligations
The entity holds or controls the rights to assets and liabilities of the
entity.
 The use of Assertions in obtaining Audit Evidence

 Income statement
Occurrence, completeness, accuracy, cut-off and
classification typically relate to transactions and
events for the period under review.

 Balance sheet
Existence, rights and obligations, completeness,
valuation and allocation typically relate to account
balances at the year end.
 Going Concern
Consider whether the going concern assumption is
appropriate, and whether disclosure of any going concern
problems is sufficient.
Going Concern Assumption
An entity is viewed as continuing in business for the
foreseeable future.
General purpose financial statements are prepared on a
going concern basis, unless management either intends
to liquidate the entity or to cease operations, or has no
realistic alternative but to do so.
 Going Concern

 When the use of the going concern assumption is

appropriate, assets and liabilities are recorded on the
basis that the entity will be able to realise its assets
and discharge its liabilities in the normal course of
business.
 Before preparing the financial statements it is
important for management to assess the entity's
ability to continue as a going concern, even if the
financial reporting framework does not include an
explicit requirement to do so.
 Going Concern
The following factors should be considered when management is
making the assessment.
(a) The degree of uncertainty about the events or
conditions being assessed increases significantly
the further into the future the assessment is made.

(b) Judgements are affected by the size and

complexity of the entity, the nature and condition
of its business and the degree to which it is
affected by external factors.

(c) Judgements are made on the basis of the

information available at the time.
 The objectives of the Auditor
The objectives of the auditor are:
(a) To obtain sufficient appropriate audit evidence
regarding, and conclude on, the appropriateness of
management's use of the going concern basis of accounting
in the preparation of the financial statements;
(b) To conclude, based on the audit evidence obtained, whether a

material uncertainty exists in relation to events or conditions

that may cast significant doubt on the entity's ability to
continue as a going concern; and
(c) To report in accordance with ISA and other relevant
statutes and frameworks.
 Examples of events causing doubts over going concern

The following are examples of events or conditions that may cast significant
doubt about the going concern assumption.

(a) Financial
(i) Net liabilities or net current liability position

(ii) Fixed-term borrowings approaching maturity without

realistic prospects of renewal or repayment, or excessive
reliance on short-term borrowings to finance long-term
assets

(iii) Indications of withdrawal of financial support by lenders

Examples of events causing doubts over going concern

(iv) Negative operating cash flows indicated by

historical or prospective financial statements.
(v) Adverse key financial ratios

(vi) Substantial operating losses or significant

deterioration in the value of assets used to
generate cash flows
Examples of events causing doubts over going concern

(vii) Arrears or discontinuance of dividends

(viii) Inability to pay creditors on due dates
(ix) Inability to comply with the terms of loan
agreements
(x) Change from credit to cash-on-delivery
transactions with suppliers
(xi) Inability to obtain financing for essential new
product development or other essential
investments
Examples of events causing doubts over going concern

(b) Operating
(i) Management intends to liquidate the entity or to
cease operations
(ii) Loss of key management without replacement
(iii) Loss of a major market, key customer(s),
franchise, licence or principal supplier(s)
(iv) Labour difficulties or shortages of important
supplies
 Examples of events causing doubts over going concern

(v) Emergence of a highly successful competitor

(c) Other
(i) Non-compliance with capital or other statutory requirements
(ii) Pending legal or regulatory proceedings against the entity
that may, if successful, result in claims that the entity is
unlikely to be able to satisfy
(iii) Changes in law or regulation or government policy expected
to adversely affect the entity
(iv) Uninsured or underinsured catastrophes when they
occur
Examples of events causing doubts over going concern

Significance of such events and conditions often can be

mitigated by other factors. For example,
 the loss of a key supplier may be mitigated by the
availability of a suitable alternative source of supply.
 the size of an entity may affect its ability to withstand
adverse conditions.
 Small entities may be able to react quickly to exploit
opportunities but may lack reserves to sustain
operations.
 Evaluating management's assessment

• When performing risk assessment procedures as

required by ISA , the auditor shall consider whether
there are events or conditions that may cast significant
doubt on the entity's ability to continue as a going
concern.
• In so doing, the auditor shall determine whether
management has already performed a preliminary
assessment of the entity's ability to continue as a going
concern, and:
 Evaluating management's assessment

(a) If such an assessment has been performed, the auditor

shall discuss the assessment with management and
determine whether management has identified events or
conditions that, individually or collectively, may cast
significant doubt on the entity's ability to continue as
a going concern and, if so, management's plans to
address them; or
 Evaluating management's assessment

(b) If such an assessment has not yet been performed, the

auditor shall discuss with management the basis for the
intended use of the going concern assumption, and
inquire of management whether events or conditions
exist that, individually or collectively, may cast
significant doubt on the entity's ability to continue as a
going concern
 Evaluating management's assessment

These procedures allow for more timely discussions with

management, including a discussion of management's plans
and resolution of any identified going concern issues.
The auditor shall remain alert throughout the audit for
evidence of events or conditions that may cast significant
doubt on the entity's ability to continue as a going concern.
It may be necessary to revise the auditor's assessment of the
risks of material misstatement if these are found.
 Evaluating management's assessment

The auditors may evaluate:

 The process management followed to make its
assessment
 The assumptions on which management's
assessment is based
 Management's plans for future action and whether
these are feasible in the circumstances
 Evaluating management's assessment

• Management do not need to make a detailed

analysis.
• The auditors also donot need to carry out detailed
procedures, if the entity has a history of profitable
operations and ready access to financial resources.
 Evaluating management's assessment

In evaluating management's assessment of the entity's

ability to continue as a going concern, the auditor shall
cover the same period as that used by management to
make its assessment as required by the applicable financial
reporting framework, or by law or regulation if it specifies a
longer period.
 Evaluating management's assessment

If management's assessment covers a period of less than 12

months from the date of the financial statements, the
auditor shall request management to extend its assessment
period to at least 12 months from that date.
In evaluating management's assessment, the auditor shall
consider whether management's assessment includes all
relevant information of which the auditor is aware as a
result of the audit
 Evaluating management's assessment

The auditor shall inquire of management as to its

knowledge of events or conditions beyond the period of
management's assessment that may cast significant doubt
on the entity's ability to continue as a going concern.
Because the time period is some way into the future, the
indications of potential going concern problems would have
to be significant.
 Evaluating management's assessment

Auditors do not have to carry out specific procedures to

identify potential problems which may occur after the
period covered by management's assessment.
However, they should be alert during the course of the
audit for any indications of future problems
 Additional audit procedures

If events or conditions have been identified that may cast

significant doubt on the entity's ability to continue as a
going concern, the auditor shall obtain sufficient appropriate
audit evidence to determine whether or not a material
uncertainty exists related to events or conditions that may
cast significant doubt on the entity's ability to continue as a
going concern (hereinafter referred to as 'material
uncertainty') through performing additional audit
procedures including consideration of mitigating factors.
 Additional audit procedures

These procedures shall include:

(a) Where management has not yet performed an
assessment of the entity's ability to continue as a
going concern, requesting management to make its
assessment

(b) Evaluating management's plans for future actions

in relation to its going concern assessment, whether the
outcome of these plans is likely to improve the situation
and whether management's plans are feasible in the
circumstances
 Additional audit procedures

When events or conditions are identified which cast

doubt on the appropriateness of the going concern
assumption, auditors may also have to carry out
additional procedures.
The ISA lists various procedures which the auditors may
carry out in this context.
• Analysing and discussing cash flow, profit and other
relevant forecasts with management
• Analysing and discussing the entity's latest available
interim financial statements
 Additional audit procedures

• Analysing and discussing cash flow, profit and other

relevant forecasts with management
• Analysing and discussing the entity's latest available
interim financial statements
• Reading the terms of debentures and loan agreements
and determining whether any have been breached
• Reading minutes of the meetings of shareholders, those
charged with governance and relevant committees for
reference to financing difficulties
 Additional audit procedures

• Enquiring of the entity's legal counsel regarding

litigation and claims
• Confirming the existence, legality and enforceability
of arrangements to provide or maintain financial
support with related and third parties and assessing
the financial ability of such parties to provide
additional funds
• Evaluating the entity's plans to deal with unfilled
customer orders
 Additional audit procedures

• Performing audit procedures regarding subsequent

events to identify those that either mitigate or
otherwise affect the entity's ability to continue as a
going concern
• Confirming the existence, terms and adequacy of
borrowing facilities
• Obtaining and reviewing reports of regulatory
actions
• Determining the adequacy of support for any
planned disposal of assets
 Additional audit procedures

Evaluating management's plans for future actions may

include enquiries of management regarding, for example
its plans to liquidate assets, borrow money or restructure
debt, reduce or delay expenditures, or increase capital.
Management’s assumptions include continued support by
third parties, and such support is important to an entity's
ability to continue as a going concern, the auditor may
need to consider requesting written confirmation to obtain
evidence of their ability to provide such support.
 Audit Conclusions and Reporting
The following table summarises the various situations.
Is Going Concern Are treatment and Effect on auditor's report
Assumption appropriate? disclosures adequate?

Appropriate Adequate  Standard unmodified

report, which describes
both management's and
the auditor's
responsibilities in
relation to going concern
Appropriate, but Material Adequate
Uncertainty exists  Unmodified opinion
 Section headed 'Material
Uncertainty Related to
Going Concern'
 Refer to FS disclosures
 State that opinion is not
modified
 Audit Conclusions and Reporting

Appropriate, but Material Inadequate  Qualified or adverse opinion

Uncertainty exists  Statement in 'Basis for
Qualified/Adverse
Opinion' paragraph that
disclosures are inadequate

Inappropriate Inadequate Adverse opinion

FS inappropriately  Description of circumstances
prepared using going in 'Basis for
concern assumption Adverse Opinion' paragraph

Inappropriate Adequate  Unmodified opinion

FS prepared on  Consider using Emphasis of
alternative basis, eg Matter paragraph to draw
liquidation basis attention to alternative
basis of preparation
 Use of Going Concern Appropriate But A
Material Uncertainty Exists
Determine whether the disclosures are adequate.
 Whether the financial statements adequately
disclose the principal events or conditions that
may cast significant doubt on the entity's ability
to continue as a going concern, and
 Management's plans to deal with these events
or conditions.
 Use of Going Concern Appropriate But A
Material Uncertainty Exists
The financial statements should clearly disclose
that there is a material uncertainty and,
therefore, that the entity may be unable to realise
its assets and discharge its liabilities in the normal
course of business.
If the Disclosures are Adequate
Include a separate paragraph in the auditor's
report, headed 'Material uncertainty in relation
to going concern'.
 Use of Going Concern Appropriate But A
Material Uncertainty Exists
If Disclosures are Not Adequate
If adequate disclosure is not made in the financial
statements, then:
(a) Express a qualified opinion or adverse opinion.

(b) State that a material uncertainty exists that may cast

significant doubt on the entity's ability to continue as a

going concern and that the financial statements do not

adequately disclose this matter.
 Use of Going Concern Assumption Inappropriate

If the financial statements have been prepared

on a going concern basis, but in your judgement
this is inappropriate, express an adverse opinion
regardless of whether the financial statements
include disclosure of the inappropriateness of
management's use of the going concern
assumption.
 Use of Going Concern Assumption Inappropriate

If the financial statements are prepared on an

alternative basis, eg a liquidation basis, then the
auditor's opinion is unmodified but it is good to
include an Emphasis of Matter paragraph
highlighting the use of an alternative basis.
 Emphasis of Matter Paragraph

A paragraph included in the auditor's report that

refers to a matter appropriately presented or
disclosed in the financial statements that, in the
auditor's judgment, is of such importance that it
is fundamental to users' understanding of the
financial statements.
 Other Matter Paragraph

A paragraph included in the auditor's report that

refers to a matter other than those presented or
disclosed in the financial statements that, in the
auditor's judgment, is relevant to users'
understanding of the audit, the auditor's
responsibilities or the auditor's report.
 Inadequate Assessment by Management

In certain circumstances, the auditor may

request management to make or extend its
assessment.
If management is unwilling to do so, a
qualified opinion on the grounds of his
inability to obtain sufficient appropriate
audit evidence or a disclaimer of opinion in
the auditor's report may be appropriate.
 Communication with those charged with Governance

Unless all those charged with governance are

involved in managing the entity, the auditor shall
communicate with those charged with governance
events or conditions identified that may cast
significant doubt on the entity's ability to continue
as a going concern.
 Communication with those charged with
Governance
This communication must include:
 Whether the events or conditions constitute a
material uncertainty
 Whether the use of the going concern
assumption is appropriate in the preparation
and presentation of the financial statements
 The adequacy of related disclosures in the
financial statements
 Significant Delay

When there is a significant delay in approving

the accounts, it is important to the reasons for
the delay.
If you believes that the delay could be related to
events or conditions relating to the going
concern assessment, perform additional audit
procedures necessary, and consider the effect
on the your conclusion regarding the existence
of a material uncertainty
 Going Concern Statements

Some companies are required to include a

statement in their annual report that the business
is a going concern.
If that is the case, assess whether the statement is
consistent with the audited financial statements
and with the evidence obtained from the audit.
 DUE DILIGENCE
Due diligence is a kind of review engagement, but in
practice its definition is flexible and can mean a
variety of different things.
A typical due diligence engagement is where an
adviser (often an audit firm) is engaged by one
company planning to take over another to perform an
assessment of the material risks associated with the
transaction to ensure that the acquirer has all the
necessary facts and that the perceived business
opportunities are in fact real.
 DUE DILIGENCE

This is important when determining purchase price.

Similarly, due diligence can also be requested by
sellers.
Due diligence may include some or all of the
following aspects.
 Financial due diligence (a review of the financial
position and obligations of a target to identify
such matters as covenants and contingent
obligations)
 DUE DILIGENCE
 Operational and IT due diligence (extent of
operational and IT risks, including quality of
systems, associated with a target business)

 People due diligence (key staff positions under

the new structure, contract termination costs
and costs of integration)
 DUE DILIGENCE

 Regulatory due diligence (review of the

target's level of compliance with relevant
regulation)
 Environmental due diligence (environmental,
health and safety and social issues in a target)
 DUE DILIGENCE
A typical due diligence review could include enquiries
into:
 Structure, including how the target is owned and
constituted and what changes will be necessary
 Financial health, based on a detailed examination of
past financial statements and an analysis of the
existing asset base
 Credibility of the owners, directors and senior
managers, including validation of the career
histories of all the main players in the business
 DUE DILIGENCE
 Future potential, reflected in the strengths of its
products or services and the probability of
earnings growth over the medium to long term
 Assessment of the risk to the acquiring business,
in terms of their markets, strategy and likely
future events
 The business plan, in terms of how realistic it is,
how solid the assumptions used are and how well
it conveys the potential
 DUE DILIGENCE
It can be performed as any of the following.
 As a review of historical financial information
(limited assurance)
As an assurance engagement (limited
assurance)
As agreed-upon procedures (no assurance)
 FORENSIC AUDIT
Meaning of Forensic Audit
Forensic Audit is an examination and evaluation
of a firm’s or individual’s financial information
for use as evidence in court, to prosecute a
party for fraud, embezzlement or other financial
claims or to determine negligence or how much
spousal or child support an individual will have
to pay.
Meaning of Forensic Audit
 Key benefits of Forensic Audit
Some key benefits of Forensic Audit are listed below:
1. Detection and Responsibility of Corruption
In a Forensic Audit, while investigating fraud, an
auditor would look out for:
• Conflicts of interest
• Bribery
• Extortion
To this end, Forensic Audit aids in detecting the corruption
in an entity and also determine responsibility of the person
liable for the corruption and its practices.
 Key benefits of Forensic Audit
2. Detection of Asset Misappropriation
This is the most common and prevalent form of
fraud. Misappropriation of cash, raising fake
invoices, payments made to non-existing
suppliers or employees, misuse of assets, or
theft of Inventory are a few examples of such
asset misappropriation.
 Key benefits of Forensic Audit
3. Detection of Financial Statement Fraud:
Companies get into this type of fraud to try to
show the company’s financial performance as
better than what it actually is. The goal of
presenting fraudulent numbers may be to
improve liquidity, ensure top management
continue receiving bonuses, or to deal with
pressure for market performance.
 Key benefits of Forensic Audit

Some examples of the form that financial

statement fraud takes are the intentional forgery
of accounting records, omitting transactions –
either revenue or expenses, non-disclosure of
relevant details from the financial statements, or
not applying the requisite financial reporting
standards.
 Key benefits of Forensic Audit
4. Fraud Identification and Prevention: Fraud is
quite common in big organizations where the
number of daily financial transactions is huge. In
such an environment, an employee can easily
undertake fraudulent activities without being
caught.
 Key benefits of Forensic Audit
Forensic accounting helps in analyzing whether
an entity’s accounting policies are followed or
not, and whether all the transactions are clearly
stated in the books of accounts.
Any deviation observed in the books of accounts
can help in identifying fraud, and necessary
measures can be taken to prevent it in the
future.
 Key benefits of Forensic Audit
5. Making Sound Investment Decisions
It provides a path for investors to make
thoughtful investment decisions. An entity
engaged in fraud is definitely not a good option
for investment. Therefore, the reports of
forensic accountants act as a guide for potential
investors of an entity.
 Key benefits of Forensic Audit

Many organizations also apply for loans from

various financial institutions. By performing an
analysis, such institutions can come to a decision
on whether they would like to fund an entity or
not.
 Key benefits of Forensic Audit
6. Formulation of Economic Policies
Various cases of fraud that becomes evident
after forensic analysis act as a reference for the
government to formulate better economic
policies that would be able to curb such
fraudulent activities in the future. By doing so,
the government can strengthen the economy
and prevent such illegal activities in the country.
 Key benefits of Forensic Audit
7. Rewarding Career Opportunity
As a career, forensic auditing is extremely
rewarding.
The acceptance of reports generated by a forensic
auditors by the court of law, gives them an upper
hand as compared to other accountants.
Good forensic auditors are in high demand and
can easily draw a striking starting salaries around
the globe.
 Key benefits of Forensic Audit
Other Advantages
• Objectivity and Credibility - An external party
as a forensic auditor would be far more
independent and objective than an internal
auditor or company accountant who ultimately
reports to management on his findings.
An established firm of forensic auditors and its
team would also have credibility stemming from
the firm’s reputation, network and track record.
 Key benefits of Forensic Audit

• Accounting Expertise and Industry Knowledge

- An external forensic auditor would add to the
organization’s investigation team with breadth
and depth of experience and deep industry
expertise in handling frauds of the nature
encountered by the organization.
 Key benefits of Forensic Audit

• Provision of Valuable Manpower Resources -

An organization in the midst of reorganization
and restructuring following a major fraud would
hardly have the full-time resources to handle a
broad-based exhaustive investigation.
 Key benefits of Forensic Audit

The forensic auditor and his team of assistants

would provide the much needed experienced
resources, thereby freeing the organization’s
staff for other more immediate management
demands.
 Key benefits of Forensic Audit

This is all the more critical when the nature of

the fraud calls for management to move quickly
to contain the problem and when resources
cannot be mobilized in time.
 Key benefits of Forensic Audit
• Enhanced Effectiveness and Efficiency
This arises from the additional dimension and
depth which experienced individuals in fraud
investigation bring with them to focus on the
issues at hand.
Such individuals are specialists in rooting out
fraud and would recognize transactions normally
passed over by the organization’s accountants or
auditors.
 Key benefits of Forensic Audit

The above discussed advantages of Forensic

Audit confirm that Forensic Audit is a strategic
approach in detecting the financial frauds in
organizations along with enhancing their
financial stability at par.
Key benefits of Forensic Audit
 Forensic Audit vis-à-vis Audit
Major difference between Audit and Forensic
Audit include the following:
• Objective of financial auditing is to express
opinion as to ‘true & fair’ presentation.
Forensic Audit determines correctness of the
accounts or whether any fraud has actually
taken place.
 Forensic Audit vis-à-vis Audit
• Techniques used in the financial auditing are

more of ‘Substantive’ and ‘compliance’

procedures.
The techniques used in forensic auditing are
analysis of past trend and substantive or ‘in
depth’ checking of selected transactions.
 Forensic Audit vis-à-vis Audit

• Normally all transactions for the particular

accounting period are covered under financial
audits.
Forensic audits don’t face any such limitations.
Forensic auditors may be appointed to examine
the accounts from the beginning.
 Forensic Audit vis-à-vis Audit
• For ascertaining the accuracy of the current
assets and the liabilities financial auditor
relies on the management certificate or
representation of management.
Forensic auditors are required to carry out
the independent verification of suspected or
selected items.
 Forensic Audit vis-à-vis Audit
• Whenever the financial auditor has adverse
findings, then the auditor expresses a qualified
opinion, with/without quantification.
In case of adverse findings, the forensic auditors
are required to quantify the damages to the
clients and identify the culprit. In most cases,
Legal action may be sought.