What is Assurance?
1 Audit and assurance
We start with a little bit of revision of AA, and indeed you will be making use of AA skills throughout AAA (such as suggesting audit evidence to look for).
The paper is called ‘Advanced Audit and Assurance’ and we start by explaining what is meant by the terms ‘audit’ and ‘assurance’.
It is often not possible to check things for yourself, whether quality, accuracy, performance or existence: you might not have the skills or the time, or you might be in the wrong location. Therefore you must rely on someone else to give you assurance. This means you have to decide:
What standards should be applied?
What represents ‘good’, ‘acceptable’ or ‘unacceptable?
How much checking should be done? All checking and assurance has an associated cost.
Audit is one form of assurance. We will see that in AAA other forms of assurance might have to be described and discussed too, such as providing assurance to a bank that a company’s cash flow budget is not a work of fantastic fiction or that a take-over target is not hiding horrific liabilities.
An audit is defined as: the independent examination of and expression of opinion on the financial statements of an entity by a duly appointed auditor in pursuit of that appointment.
The important words here are ‘independent’ and ‘opinion’.
Independence is essential and underlies the value of auditing - and of all other forms of assurance
Opinion really means that one auditor or accountant could look at a set of financial statements (or a cash budget) and disagree with the opinion of another.
Judgment is essential to all assurance: there are no certainties and there are no certifications of correctness or accuracy.
Auditing is the most regulated form of assurance you will meet in AAA. Legislation, International Auditing Standards and financial reporting standards all lay down rules about how auditing should be carried out and how financial statements should be prepared. Other forms of assurance are much less uniform and this can cause a problem unless the work to be performed is precisely agreed between auditor and client at the very start. For example, if you are asked to give assurance about a cash flow forecast you need to find out if it is a one, three or five year budget as the work and difficulties are very different in each case.
2 Elements of an assurance engagement
2.1 The elements of an assurance engagement
The following are the five elements of an assurance engagement:
A three party relationship involving a practitioner, a responsible party and intended users.
Appropriate subject matter (eg the financial statements, a budget, a take-over target).
Suitable criteria (eg financial reporting standards)
Sufficient appropriate evidence.
A written assurance report in the form appropriate to a reasonable assurance engagement or a limited assurance engagement.
Item 4 on the list is sufficient appropriate evidence and if assurance had to be summed up in one word ‘EVIDENCE’ would be it. Assurance is not based on the auditor guessing or hoping that something is the case. All assurance is based on gathering sufficient appropriate evidence and if the required evidence is not available then assurance cannot be given.
It will be said again, but when it comes to the audit of financial statements evidence is required about two elements:
Is the amount materially correct?
Do the presentation and disclosures conform to the financial reporting standards?
There is no point in tracing research and development expenditure back to invoices supporting the accuracy of the amounts if you do not also give assurance that the amounts have been written off or capitalised in line with the IAS 38. Evidence is needed to support the treatment of the amounts.
2.2 Professional scepticism
A practitioner should plan and performs an assurance engagement with an attitude of professional scepticism to obtain sufficient appropriate evidence about whether the subject matter information is free of material misstatement. An attitude of professional scepticism means the practitioner questions the validity of evidence and is alert to evidence that brings into question the reliability of documents or representations.
Scepticism means that you don’t know. It does not mean that the practitioner assumes everyone is dishonest or that figures have been deliberately misrepresented. Nor does it mean that you believe all figures and statements are correct. It means you are aware that we can all be subject to optimism (perhaps too much), human error, giving quick answers because we are short of time, and misunderstanding. It also recognises that sometimes people are deliberately misleading or dishonest.
Scepticism means that evidence is required to test statements or assumptions. You could almost summarise the process of assurance in the phrase ‘collect evidence that supports everything that is being claimed’.
Sufficiency is the measure of the quantity of evidence. Appropriateness is the measure of the quality of evidence - its relevance and its reliability.
The reliability of evidence is influenced by its source and by its nature, and is dependent on the individual circumstances under which it is obtained, eg documentary evidence is better then oral, directly obtained evidence better then evidence provided by a client.
2.3 Assurance Report
The practitioner provides a written report containing a conclusion. There are two types of assurance reports:
In a reasonable assurance engagement the practitioner’s conclusion is worded in the positive form, for example: “In our opinion internal control is effective, in all material respects, based on XYZ criteria.” It is called ‘reasonable’ because the practitioner will never give guarantees. Only reasonable assurance is ever given.
In a limited assurance engagement the conclusion is worded in the negative form, for example, “Based on our work described in this report, nothing has come to our attention that causes us to believe that internal control is not effective, in all material respects, based on XYZ criteria.”
2.4 Examples:
Positive
The financial statements "present fairly, in all material respects..." / "show a true and fair view".
The value of amount of inventory lost is $x.
Negative
We have discovered nothing wrong with the financial statements.
The basis of the forecast is not unreasonable.
There is no evidence of discrimination in the appointment.
All statutory audits attempt to provide positive assurance that the financial statements "present fairly, in all material respects" / "show a true and fair view of" (these phrases are equivalent) the company's financial position, financial performance and cash flows. There are some types of assurance assignment where giving positive assurance is not possible. For example, it would be impossible to give assurances that a budget is correct because it depends on so many assumptions and factors that cannot be verified with certainty, such as the state of the economy next year, competitors’ plan and sales forecasts.
A practitioner would not express an unmodified conclusion for either type of assurance engagement when:
There is a limitation on the scope of the practitioner’s work (ie sufficient appropriate evidence cannot be obtained); or
The assertion is not fairly stated (in all material respects) or the subject matter information is materially misstated (ie the assertion is incorrect).