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CHAPTER TWO
BASIC CONCEPTS OF AUDITING
LO #
LEARNING OBJCTIVE
LO 2
Q. # 59(c i) of
Question Bank
1.1.3 (True and fair
view)
1.3.9 (Responsibility
of management)
LO 3
LO 4
AUDITORS RESPONSIBILITIES/OBJECTIVE
1.4.5
LO 5
STAKEHOLDERS RESPONSIBILITIES
15.4.2
SCOPE OF AUDIT
LO 7
LO 8
LO 9
AUTHORITY/STATUS
OF
INTERNATIONAL
STANDARDS ON AUDITING (ISAs)
LO 10
1.4.1, 1.4.2,
1.4.3, 1.4.4
1.3.9
1.4.4 (Other
International
Standards)
*Explanation of Reference:
First digit in Study Texts 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.
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.
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.
If AFRF is a fair presentation framework, auditor also checks whether financial statements presents
true and fair view.
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.
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.
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 auditors professional judgment.
For the successful completion of a good audit, it is necessary that auditor has following attributes
throughout the audit engagement:
Characteristic
Professional
Judgment
Professional
Skepticism
Explanation
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 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.
IASB also issues International Auditing Practice Statements (IAPS) to help auditors in implementing
ISAs and to promote good auditing practice in general.
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.
In Pakistan, format of auditors 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.
CHAPTER TWO
BASIC CONCEPTS OF AUDITING
QUESTIONS
CONCEPT REVIEW QUESTIONS
Q.1
Q. 2
Briefly discuss the term true and fair view in the context of an audit.
(05 marks)
(CA Certificate Stage Spring 2004)
Q.3
(a) Briefly highlight the managements responsibilities relating to the financial statements?
LO1
LO2
LO3
LO7
(04 marks)
(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)
(04 marks)
Q.4
Q.5
What is the expectation gap and how could it be removed or reduced by the auditing profession?
Q.6
What is the scope of an audit? Also discuss as to who is responsible to prepare financial statements.
LO4
LO5
LO3
LO6
(04 marks)
(CA Final, Summer 1994)
(07 marks)
Q. 7
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 companys legal
advisor and the representation provided by the management in respect of certain contingencies.
LO7
LO7
Q. 9
LO8
LO10
Q. 10
N/A
Q. 11
LO4
(03 marks)
(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)
(CA Certificate Stage Spring 2006)
What do you understand by governance? Who is normally charged with governance in an
(03 marks)
organization?
(CA Certificate Stage Spring 2005)
CONCEPT APPLICATION QUESTIONS
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 banks 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)
Q.1
SUGGESTED SOLUTIONS
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.
Q. 2
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.
Examiners Comments:
It was a routine question at this level that was not well answered by the students in general. Most of
the students did not define truth and fairness separately.
A minority also confused their explanations between true and fair, for example, stating true means
unbiased.
Q.3
(a)
Management has following responsibilities relating to financial statements:
1. For the preparation of financial statements in accordance with AFRF. This responsibility
includes:
1. Selecting the applicable financial reporting framework (AFRF).
2. Applying appropriate accounting policies and reasonable accounting estimates.
3. 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
(b)
Audit 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.
Elaboration on the response of the audit team manager:
3
Viewpoint expressed by member of the audit team is Incorrect and viewpoint of by audit manager
is correct.
Though Professional skepticism does not mean to disregard past experience about competence and
integrity of management; but auditor should remain alert in every audit that there may be
circumstances that indicate the possibility/risk of misstatement or fraud.
A belief that management and those charged with governance are honest and have integrity does
not relieve the auditor of the need to maintain professional skepticism or allow the auditor to be
satisfied with less than persuasive audit evidence when obtaining reasonable assurance.
Q.4
Q.5
Q.6
Scope of an 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 auditors professional judgment.
An audit also includes:
4
Examiners Comments:
This was an ISA based question but the students could not answer this part in an organized and
concise manner. However, majority of the students managed to pass in this part.
Q. 7
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.
Q.8
(i)
Professional skepticism is an attitude which includes questioning mind (being alert to
circumstances which may indicate possible misstatement), and critical assessment of audit
evidence.
(ii)
Auditor should perform further specific procedures to determine which source of evidence is
reliable e.g.
1. further inquiry of management and legal advisor about reasons of difference.
2. inspect documents relating to litigations and contingencies.
3. obtain opinion from other lawyers.
4. consider effect of events after the balance sheet date.
Q. 9
Examiners Comments:
(i) Professional Skepticism:
Majority of the examinees could not appropriately define the term.
(ii) Ways in which Professional Skepticism is Helpful for Auditor:
Majority of examinees failed to explain the application of the attitude of Professional Skepticism to
handle and resolve the contradictions between audit evidence collected from two different sources.
(a)
(i) 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.
IFACs 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
5
(ii) 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.
(b) In Pakistan, ISAs are adopted by ICAP (being a member of IFAC). ICAP has adopted most of ISAs.
In Pakistan, format of auditors 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
Examiners Comments:
(a) Students had a surface knowledge of such roles.
(b) This part was designed to test the candidates knowledge about the applicability of the ISAs in
Pakistan. Very few candidates mentioned the relevant points.
Q. 10
Meaning of Governance:
Governance means act of supervision, direction and control.
Who is charged with Governance in an organization:
1. Board Of Directors of company, and
2. Audit Committee
Examiners Comments:
Very few students knew the exact definition of the term governance, that is, act of supervision,
direction and control.
Q. 11
Examiners Comments:
Answers to this question were disappointing as the majority of candidates failed to appreciate that
the irregularity cited in the scenario did not, in itself, result in a misstatement in the financial
statements and consequently its detection was not part of the external auditors responsibilities.
6