What is an assurance engagement?
An assurance engagement is one in which a practitioner expresses a
conclusion designed to enhance the degree of confidence of the
intended users other than the responsible party about the outcome of
the evaluation or measurement of a subject matter against suitable
criteria
Who is the responsible party?
entity or individual accountable for the subject matter being reported on
What is reasonable assurance, include an example
> high level of assurance
opinion expressed positively (confident)
audit of financial statements ( typically only example)
What does reasonable assurance require?
> more evidence of higher quality
detailed and substantive testing eg transactions and balances
comprehensive procedures
Why can a report on any assurance engagement not provide absolute assurance?
> reliance on sampling
reliance on persuasive rather than conclusive evidence
possibility of fraud or error
Benefits of assurance for the users
> enhanced credibility of information to allow for borrowing from lenders
reduced risk of management bias, error or fraud eg fraudulent employee
draws attention to any deficiencies within the information being reported on eg identify and improve on deficiencies in internal controls
External audits are governed by
International Standards on Accounting (ISAs)
Who needs to follow ISA?
Any company who has a statutory audit
all public companies and large private companies that meet specific size criteria for turnover, assets, and number of employees.
ISA 200 overall objectives of the auditor when conducting
an audit of the financial statements:
> to obtain reasonable assurance about whether the financial
statements are free from material misstatement and properly
prepared in accordance with an applicable financial reporting
framework
to report on the financial statements and to communicate with
those charged with governance.
Companies Act 2006 exempts small private limited companies from a
mandatory audit if it satisfies two out of the following three criteria:
> no more than 50 employees
turnover does not exceed £10.2m
gross assets total does not exceed £5.1m
What other type of company are exempt from an audit?
Subsidiary companies are exempt if their parent company guarantees their liabilities
Any company that takes advantage of an audit exemption must include a statement to that effect in the financial statements
What companies must have an audit even if they meet the criteria for exemption,
insurance companies, banks, public companies (unless dormant), and where
shareholders owning at least 10% of the shares ask for an audit.
Benefits of audit
> it provides an independent scrutiny of the business by professionals
additional assurance may be required for third parties e.g. banks, tax authorities
it promotes discipline over maintaining accounting records, reducing the risk of
misstatement or non-compliance with statutory responsibilities
audits provide additional benefits such as reports to those charged with
governance on significant deficiencies in internal control (covered in the
reporting area of the course)
Why can it be argued that for small owner-managed businesses, an audit is irrelevant?
> There is no separation of ownership and management,
Owners in owner-managed businesses often have a hands-on understanding of the company’s financial position and internal processes, making an external audit seem redundant
save on the associated costs by submitting unaudited accounts to Companies House.
See tables at end of chapter 1
Elements of an assurance engagement
> practitioner
user of the report
subject matter
criteria
sufficient appropriate evidence to support the conclusion
a written report containing a conclusion
An engagement will be governed by
Its terms of engagement
An engagement will need to be
Planned
Performed
Concluded upon
Reported on
The expectation gap (users-side factors) - misunderstanding
> Unrealistic expectations: Users may expect auditors to have a more expansive role, such as guaranteeing against all fraud, even though this is not the primary goal of an audit.
Knowledge gap: The entity being audited may not understand the audit process, policies, or procedures, leading to a disconnect.
Communication gap: Public expectations may be unreasonable, and there is a gap in how auditors and users communicate about their respective roles and responsibilities.
The expectation gap: audit side factors- performance and application
> Performance gap: Users expect auditors to perform tasks beyond what is required by auditing standards.
Misapplication of framework: Some argue the gap is a “fallacy” and that a proper, correct application of the existing statutory framework would eliminate it.
Defensive “expectations gap” defense: Auditors might use the “expectations gap” as a defensive tactic to deflect attention from their own negligence in failing to spot fraud, suggesting the problem is not a gap in understanding but a gap in performance or application.
What is an audit threshold
a set of financial and employee-related criteria that determine if a company is required by law to undergo a statutory audit
Even if a company comes under the audit threshold, an audit must be carried out if;
> the articles of association require one
shareholders who own more than 10% of the shares ask for one
the company is a non dormant public company
the company is involved in the insurance or banking markets
Adv of a small business having an audit
> value having their business scrutinised by another set of professional eyes
provides additional assurance to third parties such as taxation authorities concerning the reliability of their financial statements
a growing business will one day require an audit
audit may have subsidiary benefits such as the auditor recommending improvements in the company’s systems
