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Lesson#5
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REASONABLE ASSURANCE
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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.
page
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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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