ADVANCED

AUDITING
Refresher session 1
 AGENCY
Delegate Power
Principal Engage Agent
Agency Problem
• The desires / goals of the principal and agent
have a conflict; and
• It is difficult or expensive for the principal to
verify what the agent is actually doing (whether
he is working appropriately)
 COMPANY
Delegate Power
Shareholder Engage
• Wide ownership base,
(listed - stock exchanges)
• Lack of interest in the
management - limited risk
and liability
• Short term motive - Capital
gains in stock market
BOD
• Delegated the task to run
the company
• Does not share the
Principal's motive of profit
maximization – more
interested in remuneration
 INFORMATION
Elect
Shareholder B.O.D
Information
A
• Information is ASYMMETRIC U • Shareholder
• Principal cannot monitor D
appoints Ext.
I
whether their interest is served T Auditor
• Auditor give an
External Auditor OPINION

Independent
 Shareholder Information BOD

External Auditor I
N
F
Independent O
R
M

Internal Auditor A
T
I
O
• External auditor appointed by N
shareholders
• Internal auditor appointed by BOD
(Audit Committee) Employees
POLICEMAN THEORY
• Is an auditor responsible for discovering
fraud, like a policeman?
• The theory suggests that Auditor is responsible
for searching, discovering and preventing fraud.
• The theory is now redundant as it is established
that audit is “Verification of truth and fairness
of the financial statements” and not preventing
frauds and errors.
Assurance = Confidence
a) A three party relationship: 1) intended user, (2)
responsible party and (3) the Practitioner
b) A subject matter: data to be evaluated that has
been prepared by the responsible party i.e.
historical financial information, non-financial
performance (key performance indicators),
processes (internal control) and behavior
(compliance with laws and regulations).
c) Suitable criteria: The subject matter is evaluated or
measured against criteria in order to reach an
opinion (Accounting Framework).
d) Evidence: Sufficient appropriate evidence needs
to be gathered to support the required level of
assurance.
e) An assurance report: A written report (Audit
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.
 LEVELS OF ASSURANCE
Absolute Not used in cases of FS

High but not absolute

Reasonable Positive form of opinion (Audit)

Risk greater than Reasonable

Limited Negative form of opinion (Review)
The degree of assurance that can be provided about the reliability
of the financial statements will depend on:
• the amount of work performed in carrying out the assurance
process, and
• the results of that work
 A
Absolute S
S T
U E
Reasonable R S
A T
N I
C
N
E
Limited G

The objective of a reasonable assurance engagement (audit)

is a reduction in assurance engagement risk to an acceptably
low level. The conclusion would usually be expressed in a
positive form.
 PURPOSE OF AUDIT
The purpose of an audit is to enhance the degree of
confidence of intended users in the financial statements

Shareholder Information BOD

A
Financial Statements are U
D Auditor gives an OPINION
prepared, in all material respects, I on financial statements
in accordance with the applicable T
financial reporting framework
External Auditor
Independent
 APPOINTMENT
Every company shall at each AGM appoint an auditor to hold
office from the conclusion of that meeting until the conclusion of
the next AGM (Section 254 CO1984)

Shareholder Information BOD

• Shareholders will fix Chartered Accountant for:
A
auditor’s remuneration in U • All Public Cos & subsidiary
AGM D • Private Cos – only for
I
• Auditors appointed in AGM T those whose paid up
may be removed by special capital 3 million
resolution
External Auditor
 FINANCIAL STATEMENTS
Shareholder Information BOD
1. Annual Report
2. Half yearly financial statements (for listed cos.)
3. Quarterly financial statements (for listed cos.)
Annual Report includes: • Financial Highlights
• Financial Statements • Organogram
• Audit Report on Financial • CEO’s message
Statements • Shareholding Pattern
• Statement of Compliance – CCG • CSR report
• Audit Report on SC-CCG • Statement of value addition
 REPORTING FRAMEWORK
General Purpose Financial Statements: caters to common
financial information needs of a wide range of users

Special Purpose framework: caters to the special needs

of specific users of financial statements i.e. financial
statements prepared using cash basis, or guidelines
provided by regulatory bodies under specific situations
i.e. at the time of liquidation.
 AUDIT FRAMEWORK
Shareholder Information BOD
A
- IFRS U International Standards on
- IFRS for SME D Auditing (ISA) issued by
I
- SSE T International Auditing and
- Guidelines on NGO / Assurance Standards Board
NPO Auditor
Generally Accepted Generally Accepted
Auditing Principles Auditing Standards
(GAAP) (GAAS)
 FAIR PRESENTATION
Fair presentation framework is one that requires compliance with
the requirements of the framework and:
1. Acknowledges explicitly or implicitly that, to achieve fair
presentation of the financial statements, it may be necessary for
management to provide disclosures beyond those specifically
required by the framework; or
2. Acknowledges explicitly that it may be necessary for
management to depart from a requirement of the framework to
achieve fair presentation of the financial statements. Such
departures are expected to be necessary only in extremely rare
circumstances
Compliance framework requires compliance but not (1) and (2)
 MANAGEMENT’S RESPONSIBILITY
• To prepare Financial Statements in accordance with
applicable reporting framework
• (Those charge with governance (BOD) are responsible
for oversight)
• Implement Internal Controls necessary to prepare FS
without material misstatement (ICFR in USA)
• Provide auditor with all information
• Unrestricted access to audit staff within entity
Management should acknowledge all of the above
 AUDIT OPINION
1. Financial Statements are prepared, in all material
respects, in accordance with an applicable financial
reporting framework
2. Financial statements are presented fairly; or
Financial Statements give a true and fair view
 AUDIT OPINION (CO1984)
• Whether or not Auditor has obtained all the information and
explanations which were necessary for purposes of the audit;
• Whether or not in their opinion proper books of accounts as
required by CO1984 have been kept;
• Whether or not in their opinion the B-S and P&L account have
been drawn up in conformity with CO1984 and are in agreement
with the books of accounts;
• Whether or not in their opinion and to the best of their
information and according to the explanations given to them, the
said accounts give the information required by this Ordinance in
the manner so required and give a true and fair view
 AUDIT OPINION (CO1984)
Whether or not in Auditor’s opinion-
• the expenditure incurred during the year was for the purpose of
the company’s business; and
• the business conducted, investments made and expenditure
incurred during the year were in accordance with the objects of
the company
• zakat deductible at source under the Zakat and Usher
Ordinance, 1980, was deducted by the company and deposited
in the Central Zakat Fund
 HONDA ATLAS
https://www.atlashonda.com.pk/wp-content/uploads/2018/06/AHL-
Annual-Report-2018.pdf
PROFESSIONAL SKEPTICISM
Auditor’s questioning. Ask questions, get
answers, verify answers (corroborate).
Being alert for:
• Audit evidence that contradicts other audit
evidence obtained.
• Information that brings into question the
reliability of documents and responses to
inquiries to be used as audit evidence.
• Conditions that may indicate possible fraud.
 OVERALL AUDIT RISK
Audit risk is the risk that the auditor expresses an
inappropriate audit opinion when the financial statements
are materially misstated.
Audit Risk = Inherent Risk x Control Risk x Detection Risk

Auditors will want their overall audit risk to be at an

acceptable level. Inappropriate opinion will result in
damages / costs
 AUDIT RISK
• Acceptable Audit Risk = Inherent x Control x Detection
• Detection Risk = AAR / (IR x CR)

Industry & Environment

Business Operations
Understanding Client’s
Business Management & Governance

Objectives & Strategies

Assess Risk
 INHERENT RISK
Inherent risk is the susceptibility of an assertion to a
misstatement that could be material individually or when
aggregated with other misstatements, assuming there
were no related internal controls.

Susceptibility = likelihood
Assertion = statement / claim by management.
 MATERIALITY
A misstatement in the financial statements can be considered
material if knowledge of the misstatement will affect a decision of a
reasonable user of the statements
a) Amounts are immaterial (ignored… clean opinion)
b) Amounts are material but do not overshadow the financial
statements as a whole (except for…. Opinion)
c) Amounts are so material or so pervasive that overall fairness of
the statements is in question (… maybe adverse opinion)
• Pervasiveness is when an error affects different parts of FS.
• A misclassification between cash and AR affects two accounts
• Failure to record a material sale affects sales, AR, income tax
expense, and retained earnings etc.
• Both the amount (quantity) and nature (quality) of
misstatements need to be considered i.e. disclosure
• Auditor has to set his own materiality levels – this will
always be a matter of judgment
• Generally, a percentage is applied to a chosen
benchmark as a starting point. The following factors may
affect benchmark:
a) Elements of the financial statements (e.g. assets,
liabilities, equity, revenue, expenses)
b) Whether there are items on which users tend to focus
c) Nature of the entity, industry and economic environment
d) Entity's ownership structure and financing
e) Relative volatility of the benchmark
The following benchmarks and percentages may be
appropriate
• Profit before tax 5%
• Gross profit ½% – 1%
• Revenue ½% – 1%
• Total assets 1% – 2%
• Net assets 2% – 5%
• Profit after tax 5% – 10%

Performance materiality is the amount set by the auditor at

less than materiality for the F/S as a whole to reduce to an
appropriately low level the probability that the aggregate of
misstatements exceeds materiality for the F/S as a whole.
Determining performance materiality is dependent on the
auditor’s professional judgment. It is affected by:
• The nature and extent of misstatements identified in
prior audits
• The auditor’s understanding of the entity
• Result of risk assessment procedures
Materiality has qualitative aspects that can cause
misstatements:
a) Disclosures required by Law i.e. related party
transactions, directors emoluments, fee of NED
b) Disclosures in relation to the industry i.e. research &
development expense
c) Aspect requiring emphasis i.e. newly acquired business
• Inventory = 1,000,000
• Current Asset = 3,000,000
• Net Profit = 2,000,000
• Error in F/S is 100,000 (overstated inventory – wrong
method)
• Error is 10% of inventory, 3.3% of CA, 5% of net profit

If inventory error also results in 150,000 of excess A/R

• Error is 8.3% of CA, and 12.5% of net profit
• Auditor must consider all accounts affected by a
misstatement (pervasiveness).
• Materiality is both about amount (quantity) and nature
(quality) of transactions.
 SETTING MATERIALITY LEVEL
Step 1 : Preliminary judgment
Step 2: Allocating materiality to segments
Step 3: Estimate total misstatement in segment
Step 4: Estimate combined misstatement
Sept 5: Compare estimated combined
misstatement with preliminary judgment
 PRELIMINARY JUDGMENT
• Maximum amount by which the auditor believes the
statements could be misstated and still not affect the
decisions of reasonable users.
• Auditor’s continuously change Preliminary Judgment
• Materiality is a relative rather than an absolute concept
• Bases are needed for evaluating materiality
• Qualitative factors also affect materiality (fraud etc.)
 CONTROL / DETECTION
• Control risk is the risk that a material misstatement,
that could occur in an assertion and that could be
material will not be prevented or detected and
corrected on a timely basis by the entity's internal
control.
• Detection risk is the risk that the procedures
performed by the auditor to reduce audit risk to an
acceptably low level will not detect a misstatement
PROFESSIONAL JUDGMENT
• Materiality and audit risk.
• The nature, timing and extent of audit procedures used
to meet the requirements of the auditing standards and
gather audit evidence.
• Evaluating whether sufficient appropriate audit
evidence has been obtained.
• The evaluation of management’s judgments in applying
the entity’s applicable financial reporting framework.