Audit book by m asif chapter 2 with reference to ICAP 2015 study text

Auditing – Study Notes Chapter 2 Basic Concepts of Auditing CHAPTER TWO BASIC CONCEPTS OF AUDITING LO # LEARNING OBJCTIVE ICAP'S STUDY TEXT REFERENCE* PART A – FINANCIAL REPORTING FRA

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Auditing – Study Notes Chapter 2 Basic Concepts of Auditing

CHAPTER TWO

BASIC CONCEPTS OF AUDITING

LO # LEARNING OBJCTIVE ICAP'S STUDY TEXT REFERENCE* PART A – FINANCIAL REPORTING FRAMEWORK

LO 1 FINANCIAL REPORTING FRAMEWORKS Question Bank Q. # 5 (c i) of

LO 2 WHAT IS MEANT BY TRUE AND FAIR VIEW 1.1.3 (True and fair view)

PART B – RESPONSIBILITIES OF PARTIES INVOLVED IN AUDIT

LO 3 MANAGEMENT’S (AND TCWG’S) RESPONSIBILITIES 1.3.9 (Responsibi of mana ement…) ity

LO 4 AUDITOR’S RESPONSIBILITIES/OBJECTIVE 1.4.5

LO 5 STAKEHOLDERS’ RESPONSIBILITIES 1 4.2

PART C – SCOPE OF AUDIT

LO 6 SCOPE OF AUDIT 1.4.6 (e Field work) cluding Audit

LO 7 ESSENTIALS OF PROPER CONDUCT OF AUDIT 1.4.4(Profes judgment), 3.1.2 ional

PART D – REGULATORY ENVIRONMENT OF AUDITING

LO 8 INTERNATIONAL FEDERATION OF ACCOUNTANTS

LO 9 INSTITUTE OF CHARTERED ACCOUNTANTS OF

STANDARDS ON AUDITING (ISAs)

1.4.4 (Other International Standards)

*Explanation of Reference:

First digit in Study Text’s Reference represents chapter number, second and third digits represents section and sub-section number Contents in brackets (if any) represent part of the sub-section which is covered by the learning objective

Coverage from Question Bank:

After completion of this chapter, you will be able to attempt following questions in ICAP's Question Bank:

 Q # 4 (available in practice set Q # 3)

 Q # 59 ci (available in practice set Q # 1)

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PART A – FINANCIAL REPORTING FRAMEWORK

LO 1: FINANCIAL REPORTING FRAMEWORKS AND APPLICALBE FINANCIAL REPORTING FRAMEWORK:

A financial reporting framework is a set of criteria used to prepare financial statements

There are two main types of financial reporting frameworks i.e Compliance Framework and Fair Presentation Framework

Compliance Framework:

Compliance framework is a financial reporting framework that requires compliance with requirements of the framework, and does not contain acknowledgment of fair presentation framework

For example, Tax-basis Framework

Fair Presentation Framework:

Fair presentation framework is a financial reporting framework that requires compliance with requirements of the framework, and contains acknowledgment that, to achieve fair presentation, it may be necessary for management:

 To provide additional disclosures beyond requirements of framework or

 To depart from a requirement of framework

For example, IFRS

LO 2: WHAT IS TRUE AND FAIR VIEW:

If AFRF is a fair presentation framework, auditor also checks whether financial statements presents true and fair view

True and Fair View:

The term “True and Fair View” has not been defined in the Companies Ordinance 1984 or in ISAs or

in IASs Therefore, it is the most difficult and judgmental aspect of audit Generally,

 true means “free from error” and

 fair means “free from undue bias in financial statements or the way in which they are presented”

Applicable Financial Reporting Framework/AFRF:

AFRF is the financial reporting framework which management adopts

in preparation of financial statements considering legal requirements, nature of entity, nature of financial statements, and purpose of financial statements

Study Tip

Terms “give true and fair view” and “present fairly, in all material respects” are

equivalent However, first term is more common in practice

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PART B – RESPONSIBILITIES OF PARTIES INVOLVED IN AUDIT

LO 3: MANAGEMENT’S (AND TCWG’S) RESPONSIBILITIES:

In an audit of financial statements, management (and where applicable TCWG) is responsible:

1 For the preparation of financial statements in accordance with AFRF This responsibility includes:

 Selecting the applicable financial reporting framework (AFRF)

 Applying appropriate accounting policies and reasonable accounting estimates

 Prevention and detection of fraud

2 For design, implementation and operating effectiveness of internal control which is necessary to prepare financial statements in accordance with AFRF; and

3 To provide the auditor with:

i Access to all information relevant to the preparation of the financial statements of which management is aware;

ii Additional information that the auditor may request from management for the purpose of the audit engagement; and

iii Unrestricted access to persons within the entity to obtain audit evidence

LO 4: AUDITOR’S OVERALL OBJECTIVE/RESPONSIBILITY:

Auditor’s Primary responsibility/Overall objective is:

 To obtain reasonable assurance that financial statements are free from material misstatement (whether due to error or fraud); and express an opinion on financial statements (through auditor’s report) and

 To communicate in accordance with the auditor’s findings (e.g communication to TCWG if there

is non-compliance of laws and regulation or significant deficiencies in internal control)

To meet overall objective, auditor is also responsible to:

• Perform procedures in accordance with ISAs and regulatory and professional requirements

• Apply professional judgment and professional skepticism in planning and performing audit

• Comply with code of ethics

Study Tips

1 Same responsibilities are included in Engagement Letter and in Auditor’s Report

2 “Premise of an audit” means management has acknowledged and understands

that it has above responsibilities

Study Tip

These responsibilities are included in Engagement Letter as well as in Auditor’s

Report

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LO 5: STAKEHOLDERS’ RESPONSIBILITIES:

It is the responsibility of general public (i.e stakeholders) to understand and eliminate expectation gap so that scope of audit is not misunderstood

Some Common Misunderstandings (i.e Expectation Gap) about Audit:

Some examples of misunderstandings in public’s expectations are as follows:

1 Auditor checks all transactions of entity

2 Auditor has a duty to detect and prevent fraud

3 Auditor is responsible to detect all misstatements

4 Auditor provides absolute assurance (guarantee) about F/S

5 Audit assures that entity will be Going Concern

Consequences of Expectation Gap:

There is increasing tendency to file legal actions against auditors without any valid basis

How to Reduce Expectation Gap:

 By steps taken by SECP and ICAP e.g changes in Code of Corporate Governance to strengthen the role and responsibilities of directors for good internal control and accounting systems

 By expanding the format of auditor’s report

 By mentioning Management’s Responsibilities, Auditor’s Responsibilities and Inherent limitations of audit in Engagement Letter

 By mentioning Management’s Responsibilities and Auditor’s Responsibilities in Auditor’s Report

PART C – SCOPE OF AUDIT

LO 6: SCOPE OF AUDIT:

Scope of audit means nature, timing and extent of audit procedures which are necessary to achieve the overall objective of audit (i.e to obtain reasonable assurance that financial statements are free from material misstatement) Scope of audit is determined by ISAs, legal and professional requirements and auditor’s professional judgment

An audit also includes:

 Assessment of risk of material misstatement In making risk assessment, auditor considers understanding of entity and understanding of internal control relevant to preparation of financial statements

 evaluating appropriateness of accounting policies, reasonableness of accounting estimates and overall presentation of financial statements

Expectation Gap:

Expectation Gap is the difference between ‘what general public

perceives of role and responsibilities of auditor’ and ‘what statutory

role and responsibilities of auditor are’

Study Tip

If auditor is unable to obtain reasonable assurance about financial statements, this

is called “Limitation on Scope of Audit” or precisely “Scope Limitation”

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LO 7: ES ENTIALS OF PROPER CONDUCT OF AUDIT:

For the successful completion of a good audit, it is necessary that auditor has following attributes throughout the audit engagement:

Professional

Judgment

Professional Judgment is the application of Cumulative Audit Knowledge, Experience and Training, in different circumstances to reach an appropriate course of action or conclusion

Application of professional judgment is necessary to comply with ISAs

Professional

Skepticism

Professional skepticism is an attitude which includes questioning mind (being alert to circumstances which may indicate possible misstatement), and critical assessment of audit evidence

Consequently, auditor should not believe everything management tells He should remain alert to circumstances that indicate the possibility/risk of misstatement or fraud

PART D – REGULATORY ENVIRONMENT OF AUDITING

LO 8: INTERNATIONAL FEDERATION OF ACCOUNTANTS (IFAC):

International Federation of Accountants:

IFAC is the global organization of professional accountants dedicated to serving the public interest

by strengthening the profession in the area of auditing, ethics, professional education and public sector

IFAC’s mission is to serve the public interest by:

 development of high-quality standards and guidance

 Facilitating the adoption and implementation of standards and guidance

 promoting the value of professional accountants worldwide

 Speaking out on public interest issues

IFAC includes following four boards:

 International Auditing and Assurance Standards Board (IAASB);

 International Accounting Education Standards Board (IAESB);

 International Ethics Standards Board for Accountants (IESBA); and

 International Public Sector Accounting Standards Board (IPSASB)

International Auditing and Assurance Standards Board:

IAASB is one of the boards within IFAC It serves the public interest by enhancing quality and consistency of auditing and assurance practice throughout the world It is a standard-setting body which issues standards to be applied in providing the audit, review and related services It also provides facilitation in adoption and implementation of international standards

Following types of international standards are issued by IAASB:

 International Standards on Assurance Engagements (ISAEs) These are applied on all types of assurance engagements (i.e on Audits and Review)

 International Standards on Auditing (ISAs) These are applied on audit of financial statements

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 International Standards on Review Engagements (ISREs) These are applied on review of financial statements

 International Standards on Related Services (ISRSs) These are applied on Agreed upon Procedures Engagement and Compilation Engagement

 International Standards on Quality Controls (ISQCs) These are applied for all of the above engagement

IASB also issues International Auditing Practice Statements (IAPS) to help auditors in implementing ISAs and to promote good auditing practice in general

Process of Producing a new ISA by IAASB:

 A subcommittee of IAASB determines an appropriate subject matter to issue a new ISA or to

revise an existing ISA

 After study and research, an exposure draft is produced for consideration by IAASB

 If exposure draft is approved by IAASB, it is circulated to member bodies and is published

on IAASB website

 Comments and proposed amendments are considered by IAASB and draft is amended as

necessary

 Finally exposure draft is issued an ISA or IAPS

LO 9: INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN (ICAP):

At national level, auditors can be regulated by their own professional bodies (called self-regulation) or/and by government (called independent/state-regulation)

In Pakistan, ICAP is the professional body regulating auditors Role of ICAP is as follows:

− Offers professional qualification to become auditor in Pakistan

− Establishes procedures to ensure professional competence of auditors e.g Continuing Professional Development (CPD) of members, Quality Control Reviews of audits (QCR)

− Maintains a list of “registered auditors” for public

− Adopts international accounting and auditing standards for implementation in Pakistan and also provides guidance on their implementation

LO 10: AUTHORITY/ TATUS OF INTERNATIONAL STANDARDS ON AUDITING (ISAs):

In Pakistan, ISAs are adopted by ICAP (being a member of IFAC) ICAP has adopted most of ISAs

In Pakistan, format of auditor’s report states that audit was conducted in accordance with auditing standards as applicable in Pakistan, therefore, it is compulsory for auditors to comply with all required procedures of all adopted ISAs unless:

 a required procedure is not relevant, or

 a required procedure is not practicable and is necessary to depart In this case auditor has

to document reason of departure from required procedure and alternative procedures performed to obtain evidence

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Auditing –Practice Set Chapter 2 Basic Concepts of Auditing

CHAPTER TWO

BASIC CONCEPTS OF AUDITING

QUESTIONS

CONCEPT REVIEW QUESTIONS Q.1 Differentiate between the following:

 Fair presentation framework and compliance framework (04 marks)

(CA Certificate Stage – Spring 2012)

Q 2 Briefly discuss the term “true and fair view” in the context of an audit (05 marks)

Q.3 (a) Briefly highlight the management’s responsibilities relating to the financial statements?

(07 marks)

(b) During the audit team planning meeting, a member of the audit team passed a comment that based on past experience with the client, he was confident that the management of the client was honest and there was no issue as regards management integrity or risk of fraud in the Company The audit manager responded that the auditor should always maintain an attitude of professional skepticism throughout the audit

Required:

Briefly describe ‘Audit Skepticism’ and elaborate on the response of the audit manager (08 marks)

(CA Certificate Stage – Autumn 2009)

Q.4 What is the primary objective of an audit? (04 marks)

(CA Certificate Stage – Autumn 2001)

Q.5 What is the “expectation gap” and how could it be removed or reduced by the auditing profession?

(04 marks) (CA Final, Summer 1994)

Q.6 What is the scope of an audit? Also discuss as to who is responsible to prepare financial statements

(07 marks)

LO3

LO7

LO4

LO5

LO3

LO6

LO1

LO2

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Q 7 Briefly describe the meaning of professional judgment

(CA Inter, Spring 2013)

Q.8 During the course of the audit of Smart Services Limited for the year ended March 31, 2010,

the auditor noted certain contradictions between the results of inquiries from company’s legal advisor and the representation provided by the management in respect of certain contingencies Considering the above scenario:

(i) Define “Professional Skepticism” (02 marks)

(ii) Explain how the attitude of “Professional Skepticism” would help the auditor to deal with such matters? (03 marks)

(ICMA Pakistan – Summer 2010)

Q 9 (a) Discuss briefly the role of the following:

(i) International Federation of Accountants (03 marks)

(ii) International Auditing and Assurance Standards Board (03 marks)

(b) Briefly discuss the authority attaching to International Standards on Auditing (ISAs) with respect to audit of a limited company in Pakistan (03 marks)

organization? (03 marks)

CONCEPT APPLICATION QUESTIONS

Q 11 You were the engagement partner on the audit of a commercial bank which has a network of more

than 200 branches, across the country During a recent meeting, a member of the audit committee referred to an instance of irregularity in a branch, whereby the Branch Manager had extended credit to a close relative without following the bank’s credit disbursement procedures The member criticized the auditors for their failure to highlight such instances

Required:

As an engagement partner, write a letter to the audit committee explaining your point of view in detail with specific references to the International Standards on Auditing, wherever applicable

(09 marks) (CA Final – Winter 2008)

LO7

LO8

LO10

N/A

LO4

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