BASIC CONCEPTS AUDIT is an independent examination of the entitys financial statements. The term is also called external audit.

At times the companies are legally required to get their financial statements audited, if that is so, the term Statutory Audit is used for external audit. Independence means a scenario where the auditor is able to conduct the audit in a manner where the client is not in a situation to exercise an influence whether directly or indirectly. (Auditor should consider independence as the most important aspect of the audit and should avoid conflict of interest. That includes o long term association with the client, o shareholding in the client business both directly or indirectly, o financial dependence on the client, close family relations with the client) Financial Statements means Statement of financial position, statement of comprehensive income, cash flow statements, Statement of changes in equity and notes to the accounts. Misstatement includes Error and Fraud (the main difference is that of the intention). Frauds are difficult to identify as there is an act of concealment)

Auditors report though enhances the credibility of the financial statements it is not a guarantee of the following The efficiency with which the management has conducted the business (For example, if the entity has not been managed well and has incurred huge losses, the auditor is not concerned by the operational inefficiency and will only be responsible to report whether the financial statements as a whole are reflecting the actual position of the entity) The future viability of the entity (Though the auditor applies the procedures to identify the going concern assumption, yet there could be certain events beyond the control which could render going concern assumption inappropriate after the issue of the audit report ) OBJECTIVE OF THE AUDIT OF THE FINANCIAL STATEMENTS The objective of the audit is to express an opinion whether the financial statements are prepared in accordance with the identified financial reporting frame work and are free from material misstatement (Giving true and Fair view) SCOPE OF THE AUDIT The auditor before expressing an opinion on the financial statement applies procedures which are called audit procedures. Scope of audit means the audit procedures deemed necessary to achieve the objective of audit. Scope of the audit is determined by o ISAs, o Requirements of the local law and o guidance of the professional organizations. In the context of Pakistan, the term scope is determined by o ISAs, o Requirements of the SECP through Companies ordinance and other laws and o the guidance issued by ICAP.

RESPONSIBILITY OF THE MANAGEMENT AND THE AUDITOR Responsibility of the fair presentation and presentation of the financial statements is of the management. The responsibility of the auditor is to express an opinion based on audit.

AUDITORS REPORT Auditors report is the conclusion reached by the auditor in the form of an opinion. There are different types of opinion Modified and unmodified (detailed discussion in the ISAs pertaining to Audit report). MATERIALITY Information is material if its omission or misstatement affects the decision of the user taken on the basis of the financial statements Materiality could either be qualitative or quantitative (for qualitative materiality refers to the example of McDonalds India) Joint Audit Joint audit is a situation where more than one audit firms are responsible for the audit of the financial statements. Both firms are jointly and equally responsible and they normally sign a joint audit report INHERENT LIMITATION OF AUDIT Auditors opinion is basically an assurance. The auditor can only provide a reasonable assurance. Audit cannot provide an absolute assurance because of inherent limitations of an audit Examiner has tested this area many a times and generally the questions were 1) Why the audit cannot provide the absolute assurance 2) Why the auditor can only provide a reasonable assurance Answer is the inherent limitations There are certain limitations of audit which are as follows. 1. As the audit is of test nature there is a possibility that some material misstatement may remain undetected for example Accounts balance of debtor is 100,000. The auditor checked 35000 and the rate of error found is 10% Auditor will calculate the total error by projecting the misstatement found in the sample i.e. 3500+ projected error is 6500 making a total error of 10,000. It could not be concluded with 100% assurance that the total error in the debtor balance is 6500 (it might be higher or lower than 6500), hence the element of doubt does not allow the auditor to provide an absolute assurance.

2. The internal control has its limitation due to the management override of the control (example of Enron, where they had one of the best internal controls but those responsible for the implementation were part of the Fraud) 3. Work of the auditor is often permeated by judgment for example while verifying accounting estimates (example of a building constructed in Dubai say Burj Dubai. The % completions method will determine the revenues of the construction over time. The % completion of the building is an estimate and not an excant science, hence it cannot be concluded with 100% certainty and accordingly the auditor cannot provide an absolute assurance. Further example could be o provisions for warranties and claims, o provision for doubtful debts, o deferred tax asset, o provision for impairment etc) 4. Most audit evidences are persuasive rather than conclusive. (For example one of the procedures to verify the debtor balance is confirmation. Say a company has a receivable of Rs 100 from Debtor A. When the auditor receives a response from the debtor confirming the balance, the auditor will always be uncertain as to the fact that the debtor may not have understood the confirmation or may have signed it with reading the content or may have been influenced by the client to sign the confirmation). GENERAL ETHICAL PRINCIPLES GOVERNING AN AUDIT Following are the ethical principles 1. Independence 2. Integrity (auditor should not use the information obtained from the client to his personal advantage. Auditor may have some price sensitive information that has not been made public as yet, and the auditor uses that information to his advantage by investing in the shares of that company) 3. Objectivity (should be focused) 4. Professional competence and due care 5. Technical standards (should continuously update himself on new accounting / auditing standards, new laws etc) 6. Confidentiality (auditor should not disclose the information obtained from the client to a third party without the permission of the client) PROFESSIONAL CLEARANCE LETTER This letter is sent by the incoming auditor to the retiring auditor asking professional reasons why they should not accept the engagement. The retiring auditor after getting the permission of the management passes on the information to the incoming auditor. If the permission of the management is not given to the incoming auditor, the fact should be written to the incoming auditor in which case he should not accept the engagement. If the outgoing auditor informs the incoming auditor that there are

no professional reasons, there should be no issue for the incoming auditor to accept the engagement. However when the outgoing auditor informs the incoming auditor about the professional reasons, it is incoming auditors decision whether to accept the engagement or not. Professional reasons are like integrity issues of the client which could potentially affect the reputation of the auditor. Associating with a client may expose the auditor with reputational and other risks, hence the professional clearance letter is important MARCH 2011 Q4. A chartered accountant is required to comply with five fundamental principles specified by ICAP's Code of Ethics. However, compliance with the fundamental principles may potentially be threatened by a board of circumstances. Required: Briefly describe the categories of threats that may potentially affect compliance with the fundamental principles. Give two examples for each category. (10 marks) MARCH 2010 Q5b During the course of an audit, both quantitative as well as qualitative misstatements need to be considered. Give four examples of qualitative misstatements. (04 marks) Q7(a) Briefly explain the components of internal control as referred to in the International Standards on Auditing. (09 marks) March 2009 Q1 (a) ICAP's code of ethics has specified five principles of professional ethics for chartered accountants. The circumstances in which a chartered accountant operates may give rise to specific threats to compliance with these principles. Required: (i) Briefly describe each of the fundamental principles of professional ethics. (07 marks) (ii) Briefly describe different categories of the threats to compliance with fundamental principles. (05 marks) (b) Mustansar is the audit manager of a team engaged on the audit of a listed company. During his initial discussion with the chief executive officer (CEO) of the Company, he was informed that depressed economic conditions have badly affected the company and its liquidity. Due to uncertainty about the future of the company, certain key employees have left including several staff members of accounting and finance department. Consequently, the accounting records are in a bad shape and the management is making efforts to complete the draft accounts quickly. He therefore requested Mustansir to carry out necessary accounting work and to help prepare the annual financial statements at a fee to be agreed mutually. Required: Briefly describe the guidelines contained in the ICAP's code of Ethics and the extent of support that can be offered by the auditors, in the above situation. (06 marks) Q4. Distinguish between absolute and reasonable assurance. Identify the type of assurance that is expected in an audit of the financial statements, clearly outlining the reasons to justify your point of view. (08 marks)

Sep 2009 Q1(a) Briefly highlight the management's responsibilities relating to 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 to elaborate on the response of the audit manager. (08 marks) NEXT STANDARD AUDIT ENGAGEMENT LETTER PAST PAPERS MARCH 2011 Q1. Strawberry Pakistan Limited (SPL) was incorporated on March 1,2011. The directors of SPL are in the process of appointing the first statutory auditor of the company. They have requested your firm to submit a proposal for the statutory audit assignment. A partner of your firm has asked you to draft the proposal after assessing whether the preconditions for the audit exist. Required: (a) Briefly discuss the term 'preconditions for an audit'. (b) What are the steps that you would perform in order to ensure that preconditions for the audit exist? (c) Discuss whether your firm may or may not accept the assignment if one of the preconditions for the audit is not present. (15 marks) SEPTEMBER 2011 Q9. List the circumstances in which it may become necessary to revise the terms of audit engagement for a recurring audit. (07 marks) MARCH 2010 Q8. Your firm has been the auditor of Mujahid Limited (ML) for many years. Before the commencement of the current year's audit ML has requested that some changes made in the terms of engagement. Required: (i) what are the circumstances which may lead to changes in the terms of engagement? (03marks) (ii) Discuss the important points which should be considered before accepting changes in the terms of engagement. (05marks)