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Fundamentals of Auditing

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Fundamentals of Auditing ­ACC 311
VU
Lesson 05
REASONABLE ASSURANCE
What is reasonable assurance?
It means a conclusion that the financial statements are not materially misstated. An auditor cannot obtain
absolute assurance because of limitations described in paragraph below.
Reasonable assurance through audit evidence
Audit evidence:
 For internal control
 For transactions & accounts balances
 For financial statements
Factors affecting reasonable assurance
i)
Inherent limitation of an audit, i.e. failure of audit procedures to detect material
misstatements in financial statements because of:
a)
The use of testing (application of procedures on samples).
b)
The inherent limitations of accounting and internal control system.
c)
Persuasive nature of audit evidence rather than conclusive (Persuasive:
one leading to an opinion; one which causes to believe; Conclusive: final,
convincing).
ii)
Exercise of judgment by the auditor in gathering of evidence and drawing of
conclusion.
iii)
Existence of other limitations like related parties etc.
Inherent Limitations of Accounting and Internal Control
 Management over rides
 Collusion with employees
 Collusion with third party
 Unaffordable cost of internal control
 Human error
Accordingly, because of the factors described above an audit is not a guarantee that the financial statements
are free from material misstatement, because absolute assurance is not attainable. Further, an audit opinion
does not assure the future viability of the entity nor the efficiency or effectiveness with which management
has conducted the affairs of the entity
AUDIT RISK AND MATERIALITY
Entities pursue strategies to achieve their objectives, and depending on the nature of their operations and
industry, the regulatory environment in which they operate, and their size and complexity, they face a
variety of business risk. Management is responsible for identifying such risks and responding to them.
However, not all risks relate to the preparation of the financial statements. The auditor is ultimately
concerned only with risks that may affect the financial statements.
The auditor obtains and evaluates audit evidence to obtain reasonable assurance about whether the financial
statements give a true and fair view or are presented fairly, in all material respects, in accordance with the
applicable financial reporting framework. The concept to reasonable assurance acknowledges that there is a
risk the audit opinion is inappropriate. The risk that the auditor expresses an inappropriate audit opinion
when the financial statements are materially misstated is known as "audit risk".
Audit Risk
The risk that the auditor expresses inappropriate audit opinion when the financial statements are
materially misstated.
The concept of reasonable assurance acknowledges that there is a risk the audit opinion is in
appropriate.
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Fundamentals of Auditing ­ACC 311
VU
Materiality
Risk of material misstatement levels:
 Overall Financial Statement level
 Often relates to entity's control environment
 Also relates to declining economic conditions
 Transactions, account balances, & disclosures level
Auditor is not responsible for detection of misstatements that are not material.
The auditor should plan and perform the audit to reduce audit risk to an acceptably low level that is
consistent with the objective of an audit
Responsibility for the Financial Statements:
Responsibilities for preparing and presenting the financial statements are that of management. Auditor's
responsibility is to express an opinion thereon.
This responsibility includes:
 Designing, implementing and maintaining internal control relevant to the preparation and
presentation of financial statements that are free from material misstatement, whether due to fraud
or error;
 Selecting and applying appropriate accounting policies; and
 Making accounting estimates.
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Table of Contents:
  1. AN INTRODUCTION
  2. AUDITORSí REPORT
  3. Advantages and Disadvantages of Auditing
  4. OBJECTIVE AND GENERAL PRINCIPLES GOVERNING AN AUDIT OF FINANCIAL STATEMENTS
  5. What is Reasonable Assurance
  6. LEGAL CONSIDERATION REGARDING AUDITING
  7. Appointment, Duties, Rights and Liabilities of Auditor
  8. LIABILITIES OF AN AUDITOR
  9. BOOKS OF ACCOUNT & FINANCIAL STATEMENTS
  10. Contents of Balance Sheet
  11. ENTITY AND ITS ENVIRONMENT AND ASSESSING THE RISKS OF MATERIAL MISSTATEMENT
  12. Business Operations
  13. Risk Assessment Procedures & Sources of Information
  14. Measurement and Review of the Entityís Financial Performance
  15. Definition & Components of Internal Control
  16. Auditing ASSIGNMENT
  17. Benefits of Internal Control to the entity
  18. Flow Charts and Internal Control Questionnaires
  19. Construction of an ICQ
  20. Audit evidence through Audit Procedures
  21. SUBSTANTIVE PROCEDURES
  22. Concept of Audit Evidence
  23. SUFFICIENT APPROPRIATE AUDIT EVIDENCE AND TESTING THE SALES SYSTEM
  24. Control Procedures over Sales and Debtors
  25. Control Procedures over Purchases and Payables
  26. TESTING THE PURCHASES SYSTEM
  27. TESTING THE PAYROLL SYSTEM
  28. TESTING THE CASH SYSTEM
  29. Controls over Banking of Receipts
  30. Control Procedures over Inventory
  31. TESTING THE NON-CURRENT ASSETS
  32. VERIFICATION APPROACH OF AUDIT
  33. VERIFICATION OF ASSETS
  34. LETTER OF REPRESENTATION VERIFICATION OF LIABILITIES
  35. VERIFICATION OF EQUITY
  36. VERIFICATION OF BANK BALANCES
  37. VERIFICATION OF STOCK-IN-TRADE AND STORE & SPARES
  38. AUDIT SAMPLING
  39. STATISTICAL SAMPLING
  40. CONSIDERING THE WORK OF INTERNAL AUDITING
  41. AUDIT PLANNING
  42. PLANNING AN AUDIT OF FINANCIAL STATEMENTS
  43. Audits of Small Entities
  44. AUDITORíS REPORT ON A COMPLETE SET OF GENERAL PURPOSE FINANCIALSTATEMENTS
  45. MODIFIED AUDITORíS REPORT