CHAPTER

1
NATURE, OBJECTIVE AND
SCOPE OF AUDIT

LEARNING OUTCOMES
After studying this chapter, you would be able to understand-
♦ Meaning, nature and scope of audit
♦ Objectives of audit
♦ Inherent Limitations of audit
♦ Benefits of audit
♦ Meaning of assurance engagements
♦ Difference between reasonable assurance engagement and
limited assurance engagement
♦ Meaning and basic purpose of engagement and quality control
standards
♦ Practicality of above concepts by studying through examples
and case studies

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2. ORIGIN OF AUDITING
 The reference to auditing is found in Kautilya’s Arthshastra even in
4th century BC.
 “audit” originates from Latin word “audire” meaning “to hear”.

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 Coming to more recent history, the first Auditor General of India was
appointed in British India in 1860 having both accounting and
auditing functions.
 The Institute of Chartered Accountants of India was established as a
statutory body under an Act of Parliament in 1949 for regulating the
profession of Chartered Accountancy in the country.

3. MEANING AND NATURE OF AUDITING

“An audit is an independent examination of financial information of any

entity, whether profit oriented or not, and irrespective of its size or legal
form, when such an examination is conducted with a view to expressing
an opinion thereon”.

An incisive analysis of above meaning of auditing brings out following

points clearly:

♦ Audit is an independent examination of financial information.

Independence, here, implies that the judgement of a person is

not subordinate to the wishes or direction of another person who
might have engaged him.

The auditor should be independent of entity whose financial

statements are subject to audit so that he can form an opinion
without being affected by any influence.

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♦ The entity whose financial information is examined need not

necessarily be profit oriented like in case of a business.

It can be a non-profit organization like an NGO or a charitable trust.

Audit can be undertaken in respect of any organization be it a
small, medium or large. Further, it can be conducted for any
entity irrespective of its legal structure i.e. such an entity may be a
proprietary concern, a partnership firm, a LLP, a private
company, a public company, a society or a trust.

The purpose of audit is to express an opinion on the financial

♦ statements.

Understand that preparation and presentation of financial

statements of an entity is responsibility of management of
entity.
The auditor expresses an opinion on financial statements by
means of written audit report.

In doing so, he has to see that financial statements would not

mislead anybody by ensuring that: -
 the accounts have been drawn up with reference to
entries in the books of account;
 the entries in the books of account are adequately
supported by sufficient and appropriate evidence;
 none of the entries in the books of account has been
omitted in the process of compilation;
 the information conveyed by the statements is clear and
unambiguous;
 the financial statement amounts are properly classified,
described and disclosed in conformity with
accounting standards; and

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 the statement of accounts presents a true and fair

picture of the operational results and of the assets and
liabilities.

4. INTERDISCIPLINARY NATURE OF
AUDITING- RELATIONSHIP WITH
DIVERSE SUBJECTS

Accounting

Production Law

Financial
Management Auditing Economics

Data Behavioural
Processing Science

Statistics &
Mathematics

Auditing and Accounting: Auditing reviews the financial statements

which are nothing but a result of the overall accounting process.
Auditing and Law: An auditor should have a good knowledge of business
laws affecting the entity.
Auditing and Economics: Auditor is expected to be familiar with the
overall economic environment of the client.

Auditing and Behavioural Science: Knowledge of human behaviour is

essential for an auditor to effectively discharge his duties.

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Auditing and Statistics &
Mathematics: Auditor is also expected to have the knowledge of
statistical sampling for meaningful conclusions and mathematics for
verification of inventories.
Auditing and Data Processing: EDP auditing in itself is developing as a
discipline in itself.
Auditing and Financial Management : Auditor is expected to have
knowledge about various financial techniques such as working capital
management, funds flow, ratio analysis, capital budgeting etc.
Auditing and Production: Good auditor is one who understands the
client and his business functions such as production, cost system,
marketing etc.

5. OBJECTIVES OF AUDIT
In conducting audit of financial statements, objectives of auditor in
accordance with SA-200 “Overall Objectives of the Independent
auditor and the conduct of an audit in accordance with Standards on
Auditing” are: -
(a) To obtain reasonable assurance about whether the financial
statements as a whole are free from material misstatement,
whether due to fraud or error, thereby enabling the auditor to
express an opinion on whether the financial statements are
prepared, in all material respects, in accordance with an
applicable financial reporting framework; and
(b) To report on the financial statements, and communicate as
required by the SAs, in accordance with the auditor’s findings.
An analysis of above brings out following points clearly: -
(1) Auditor’s objective is to obtain a reasonable assurance whether
financial statements as a whole are free from material
misstatement whether due to fraud or error.

Reasonable assurance is to be distinguished from absolute

assurance. Absolute assurance is a complete assurance or a
guarantee that financial statements are free from material
misstatements. However, reasonable assurance is not a complete

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guarantee. Although it is a high-level of assurance but it is not

complete assurance.

(2) Misstatements in financial statements can occur due to fraud or

error or both. He has to see effect of misstatements on financial
statements as a whole, in totality.
(3) Obtaining reasonable assurance that financial statements as a whole
are free from material misstatements enables the auditor to
express an opinion on whether the financial statements are
prepared, in all material respects, in accordance with an applicable
financial reporting framework.
(4) The opinion is reported and communicated in accordance with
audit findings through a written report as required by Standards
on Auditing. (You would be studying about these in subsequent parts
of this Chapter).

6. SCOPE OF AUDIT-WHAT IT INCLUDES

Scope refers to range or reach of something. The purpose of an audit is to
enhance the degree of confidence of intended users in the financial
statements. Users of financial statements may be shareholders,
employees, customers, government and regulatory authorities, bankers
etc. Enhancing of degree of confidence is achieved by the expression of an
opinion by the auditor on whether the financial statements are prepared,
in all material respects, in accordance with an applicable financial
reporting framework.

(Applicable financial reporting framework means a framework adopted in

the preparation and presentation of the financial statements that is
acceptable in view of the nature of the entity and the objective of the
financial statements, or that is required by law or regulation.)

For example, in case of companies in India, financial reporting framework

is provided under Schedule III of Companies Act,2013.
The following points are included in scope of audit of financial
statements: -

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(1) Coverage of all aspects of
entity
Audit of financial statements should be organized adequately to cover all
aspects of the entity relevant to the financial statements being
audited.
(2) Reliability and sufficiency of financial information
The auditor should be reasonably satisfied that information contained
in underlying accounting records and other source data (like bills,
vouchers, documents etc.) is reliable and sufficient basis for
preparation of financial statements.
The auditor makes a judgment of reliability and sufficiency of financial
information by making a study and assessment of accounting
systems and internal controls and by carrying out appropriate tests,
enquiries and procedures.
(3) Proper disclosure of financial information
The auditor should also decide whether relevant information is properly
disclosed in the financial statements. He should also keep in mind
applicable statutory requirements in this regard.
It is done by ensuring that financial statements properly summarize
transactions and events recorded therein and by considering the
judgments made by management in preparation of financial
statements.
The management responsible for preparation and presentation of
financial statements makes many judgments in this process of
preparing and presenting financial statements. For example,
choosing of appropriate accounting policies in relation to various
accounting issues like choosing method of charging depreciation on
fixed assets or choosing appropriate method for valuation of
inventories.
The auditor evaluates selection and consistent application of accounting
policies by management; whether such a selection is proper and
whether chosen policy has been applied consistently on a period-to-
period basis.
Understand that financial statements of an entity are prepared on
historical financial information basis. “Historical financial
information” means information expressed in financial terms in
relation to a particular entity, derived primarily from that entity’s
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accounting system, about economic events occurring in past time

periods or about economic conditions or circumstances at points in
time in the past.
For example, when purchases and sales are reflected in financial
statements of an entity, these are examples of historical financial
information. These are about transactions which have occurred in
past.

Since financial statements are prepared on the basis of historical financial

information, it is logical that audit of financial statements is also based
upon such historical financial information. Therefore, audit of financial
statements is based upon historical financial information.

6.1 Scope of audit-What it does not include

Auditor is not expected to perform duties which fall outside domain of his
competence. For example, physical condition of certain assets like that of
sophisticated machinery cannot be determined by him. Similarly, it is not
expected from an auditor to determine suitability and life of civil
structures like buildings. These require different skillsets which may be
performed by qualified engineers in their respective fields.
An auditor is not an expert in authentication of documents. The
genuineness of documents cannot be authenticated by him because he is
not an expert in this field.
An audit is not an official investigation into alleged wrong doing. He does
not have any specific legal powers of search or recording statements of
witness on oath which may be necessary for carrying out an official
investigation.
Audit is distinct from investigation. Investigation is a critical examination
of the accounts with a special purpose. For example, if fraud is suspected
and it is specifically called upon to check the accounts whether fraud
really exists, it takes character of investigation.
The objective of audit, on the other hand, as has already been discussed,
is to obtain reasonable assurance about whether the financial statements
as a whole are free from material misstatement, whether due to fraud or
error, thereby enabling the auditor to express an opinion.
The scope of audit is general and broad whereas scope of investigation is
specific and narrow.

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0 Test Your
Understanding 1
Lalji Bhai has purchased shares of a company listed on NSE. The audited
financial statements of the company provide picture of healthy financial
performance having robust turnover, low debt and good profits. On above
basis, he is absolutely satisfied that money invested by him is safe and
there is no chance of losing his money. Do audited results and audit
reports of companies provide such assurance to investors like Lalji Bhai? Is
thinking of Lalji Bhai correct?

Test Your Understanding 2

Good deeds Limited is engaged in business of recycling of wastes from
dumping grounds of municipal corporation of Indore to usable manure. It
is, in this way, also, helping to make the city clean.
During course of audit by Zoha & Zoha, a firm of auditors, it is observed
by auditors that company has received a notice from Central Bench of
National Green Tribunal for not following certain environmental regulations
involving imposition of hefty monetary penalty on the company. The
company is yet to reply to the notice. The auditors point out that same is
not stated in notes to accounts in financial statements. The company
points out that auditors are going beyond scope of their work. Does such a
matter fall within scope of audit?

Test Your Understanding 3

A huge fire broke out in NOIDA plant of KT Limited. Plant assets comprising
building, machinery and inventories were insured from branch of a public
sector insurance company. Apart from an insurance surveyor who was
deputed for assessing loss, the regional office of insurance PSU also
appointed a CA for verification of books of accounts/ financial records of
the company and circumstances surrounding the loss. He was also
requested to submit an early report. Would the report by CA in nature of
audit report?

7. INHERENT LIMITATIONS OF AUDIT

The process of audit suffers from certain inbuilt limitations due to which an
auditor cannot obtain an absolute assurance that financial statements are
free from misstatement due to fraud or error. These fundamental
limitations arise due to the following factors: -

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(1) Nature of financial reporting
Preparation of financial statements involves making many judgments by
management. These judgments may involve subjective decisions or a
degree of uncertainty. Therefore, auditor may not be able to obtain
absolute assurance that financial statements are free from material
misstatements due to frauds or errors.
One of the premises for conducting an audit is that management
acknowledges its responsibility of preparation of financial statements
in accordance with applicable financial reporting framework and for
devising suitable internal controls. However, such controls may not
have operated to produce reliable financial information due to their
own limitations.
Consider, for example, that management of a company has devised a
control that all purchase bills should reflect stamp and signatures of
an authorised person in “Goods Receiving Section” of the company
stating the date and time of receiving goods in premises. It is an
example of internal control devised by the company to ensure that
only those purchase bills are produced for payment for which goods
have been actually received. Now, what happens if concerned
accountant and authorised person in “Goods Receiving Section”
collude. It is a case of overriding of internal controls devised by the
company due to collusion between two persons. Such a probable
collusion is one of limitations of internal controls itself.
(2) Nature of Audit procedures
The auditor carries out his work by obtaining audit evidence through
performance of audit procedures. However, there are practical and
legal limitations on ability of auditor to obtain audit evidence. For
example, an auditor does not test all transactions and balances. He
forms his opinion only
by testing samples. It is an example of practical limitation on
auditor’s ability to obtain audit evidence.
Management may not provide complete information as requested by
auditor. There is no way by which auditor can force management to
provide complete information as may be requested by auditor. In
case he is not provided with required information, he can only report.
It is an example of legal limitation on auditor’s ability to obtain audit
evidence.

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2 The management may consist of
dishonest and unscrupulous people and may be, itself, involved in
fraud. It may be engaged in concealing fraud by designing
sophisticated and carefully organized schemes which may be hard to
detect by the auditor. It may produce fabricated documents before
auditor to lead him to believe that audit evidence is valid. However,
in reality, such documents could be fake or non-genuine.
We have already discussed under section on scope of audit that an
auditor is not an expert in authentication of documents. Therefore,
he may be led to accept invalid audit evidence on the basis of
unauthentic documents.
It is quite possible that entity may have entered into some transactions
with related parties. Such transactions may be only paper
transactions and may not have actually occurred. The auditor may
not be aware of such related party relationships or audit procedures
may not be able to detect probable wrong doings in such
transactions.
(3) Not in nature of investigation
As already discussed, audit is not an official investigation. Hence, auditor
cannot obtain absolute assurance that financial statements are free
from material misstatements due to frauds or errors.
(4) Timeliness of financial reporting and decrease in relevance of
information over time
The relevance of information decreases over time and auditor cannot
verify each and every matter. Therefore, a balance has to be struck
between reliability of information and cost of obtaining it.
Consider, for example, an auditor who is conducting audit of a
company since last two years. During these two years, he has sought
detailed information from management of company regarding
various matters. During his thirdyear stint, he chooses to rely upon
some information obtained as part of audit procedures of second
year. However, it could be possible that something new has
happened and that information is not relevant. So, the information
being relied upon by auditor is not timely and may have lost its
reliability.

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(5) Future events
Future events or conditions may affect an entity adversely. Adverse
events may seriously affect ability of an entity to continue its
business. The business may cease to exist in future due to change in
market conditions, emergence of new business models or products or
due to onset of some adverse events.
Therefore, it is in view of above factors, that an auditor cannot provide a
guarantee that financial statements are free from material
misstatements due to frauds or errors.
Inherent Limitations of Audit (SA 200 “Overall Objectives of the
Independent Auditor and the Conduct of an Audit in Accordance with
Standards on Auditing”): The auditor is not expected to, and cannot,
reduce audit risk to zero because there are inherent limitations of an
audit. The inherent limitations of an audit arise from:

The Nature of Financial Reporting: The preparation of financial

statements involves judgment by management.

The Nature of Audit Procedures: There are practical and legal

limitations on the auditor’s ability to obtain audit evidence such as:

Possibility that management or others Fraud may involve

may not provide, intentionally or sophisticated and carefully
unintentionally, the complete organised schemes.
information relevant for preparation and
presentation of FS.

Not in the nature of Investigation: An audit is not an official

investigation into alleged wrongdoing.

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NATURE, OBJECTIVE AND SCOPE OF AUDIT

Timeliness of financial reporting and decrease in relevance of

information over time: Relevance of information, and thereby its
value, tends to diminish over time, and there is a balance to be struck
between the reliability of information and its cost.

Future events: Future events or conditions may affect an entity

adversely. Adverse events may seriously affect ability of an entity to
continue its Business.

8. WHAT IS AN ENGAGEMENT?
Engagement means an arrangement to do something. In the context of
auditing, it means a formal agreement between auditor and client
under which auditor agrees to provide auditing services.

8.1 External audit engagements

The purpose of external audit engagements is to enhance
the degree of confidence of intended users of financial
statements. Such engagements are also reasonable
assurance engagements.

9. BENEFITS OF AUDIT-WHY AUDIT IS

NEEDED?
♦ Audited accounts provide high quality information. It gives
confidence to users that information on which they are relying is
qualitative and it is the outcome of an exercise carried out by
following Auditing Standards recognized globally.

♦ In case of companies, shareholders may or may not be involved

in daily affairs of the company. The financial statements are
prepared by management consisting of directors. As shareholders
are owners of the company, they need an independent
mechanism so that financial information is qualitative and
reliable.
An audit acts as a moral check on employees from committing
♦ frauds for the
fear of being discovered by audit.
♦ Audited financial statements are helpful to government
authorities for determining tax liabilities.
♦ Audited financial statements can be relied upon by lenders,

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bankers for making their credit decisions i.e. whether to lend or not
to lend to a particular entity.
♦ An audit may also detect fraud or error or both.

10. AUDIT- MANDATORY OR VOLUNTARY?

Audit is not always mandatory.

CASE STUDY-1
Rohit, Gurpreet, Ali and Goreti are friends since their school days based in
Mumbai. They have cleared CA foundation exams in the same attempt and
now plan to appear for CA Intermediate exams. All of them are avid news
listeners and regularly keep track of business news even on social media.
They are trying to understand new subjects including auditing. Rohit,
Gurpreet and Ali have also started attending Live Coaching Classes (LCC)
being conducted by Board of studies of ICAI. Goreti has not been able to
join Live Coaching Classes yet as she was away on a holiday with her
parents. However, she plans to catch it up with her friends very soon. Ali
had also joined the classes but he had skipped some lectures.
During one informal get together, their discussions centred around new
subject of auditing. They discussed many things regarding its nature,
scope, benefits and other general practical issues. Goreti was regular in
keeping track of audited results of companies being published in leading
newspapers. Her view was that audited financial statements of companies
give 100% guarantee to different stake holders. It is the main reason
behind so much reliance upon auditing. But she could not understand why
wrong doings in financial matters are being discovered after many years
have gone by.
Ali also concurred with her view and added that when financial statements
are audited, each and every transaction appearing in books of accounts is
verified.
However, he could not give clarity to Goreti.
Gurpreet was of the opinion that audit was conducted on the basis of
sample checking. He was also of the view that audited financial
statements are not a guarantee against probable wrong doings in financial
matters of the companies.
Not to be left behind, Rohit also jumped in the fray. He supported Gurpreet
and also added something of his own.

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Based on above, answer the
following questions: -
1. Gurpreet was of the view that audited financial statements are not a
guarantee against probable wrong doings in financial matters of
companies. What kind of assurance does audit of financial
statements provide?
(a) It provides reasonable assurance meaning a moderate level of
assurance.
(b) It provides reasonable assurance meaning a low level of
assurance.
(c) It provides reasonable assurance meaning a high level of
assurance.
(d) It provides reasonable assurance meaning an absolute level of
assurance.
2. Rohit added that auditor can force an employee of the company to
provide him required information and documents. Can he do so?
(a) Yes, he can do so. It is necessary to obtain audit evidence.
(b) Yes, he can do so. There are express rights given to him in this
respect.
(c) No, he cannot do so. He can only request for providing him with
necessary information and documents. But it cannot be forced
by him.
(d) No, he cannot do so. He has no right of seeking information and
documents. Therefore, question of forcing does not arise.
3. Ali had listened in one of the classes that audit covers all aspects of
an entity and concluded that each and every transaction of entity is
verified by auditor. Goreti also seemed to be in agreement with him
but she was of the view that besides this, it also meant that audit
should be so organized to cover all areas of an entity. Which of
following statements is appropriate in this regard?
(a) Only view of Ali is correct.
(b) Only view of Goreti is correct.
(c) Views of both Ali and Goreti are correct.
(d) Views of both Ali and Goreti are incorrect.

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4. All of them also discussed about benefits of auditing. Which of the

following is not a likely benefit of auditing?
(a) Since auditing is connected to future events, audited
information can be easily relied upon by users.
(b) Errors or frauds may be discovered during audit.
(c) Government authorities can make use of audited accounts for
different purposes.
(d) It can help in bringing out deficiencies in maintenance of
financial records.
5. Goreti told her friends that she had read a news report about how a
company had misled its auditors by producing some fabricated
documents. Which of following statements seems to be appropriate
in this regard?
(a) It was wrong on the part of auditor to rely upon fabricated
documents. He must have discovered it as the same falls within
the scope of his duties.
(b) Although it was wrong on the part of auditor to rely upon
fabricated documents, he cannot do anything in the matter. He
has to report on the basis of documents provided to him. He has
no duty in this regard.
(c) Auditor has to conduct audit by exercising professional skill. But
he is not an expert in discovering genuineness of documents.
Hence, management consisting of dishonest persons may have
led him to rely upon fabricated documents deliberately.
(d) Management cannot mislead auditor due to high level of
knowledge and expertise possessed by him. The above is an
outlier case-one of the rare odd cases.

Answer to Questions involving Case Studies

1. (c) 2. (c) 3. (d) 4. (a) 5. (c)

Test Your Understanding 4

Zeeba Products is a partnership firm engaged in trading of designer
dresses. The firm has appointed JJ & Co, Chartered accountants to audit
their accounts for a year. The auditors were satisfied with control systems
of firm, carried out required procedures and necessary verifications. In
particular, they carried out sample checking of purchases, traced purchase

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bills to GST portal and also made
confirmations from suppliers. They were satisfied with audit evidence
obtained by them as part of audit exercise. An audit report was submitted
to the firm giving an opinion that financial statements reflected true and
fair view of state of affairs of the firm.
However, later on, it was discovered that purchase manager responsible
for procuring dresses from one location was also booking fake purchases
of small values by colluding with unethical dealers. Payments to these
dealers were also made in connivance with accountant through banking
channel.
The partners of firm blame auditors for futile audit exercise. Are partners
of firm correct in their view point? Imagine any probable reason for such a
situation.

Audit is a type of assurance engagement under which auditor gives an

opinion as to whether financial statements give a true and fair view of
state of affairs of the concern. However, assurance engagements are not
restricted to audit alone. We shall now discuss meaning of assurance
engagement and different types of assurance engagements.

13. MEANING OF ASSURANCE

ENGAGEMENT
“Assurance engagement” means an engagement in which a practitioner
expresses a conclusion designed to enhance the degree of confidence
of the intended users other than the responsible party about the
outcome of the evaluation or measurement of a subject matter against
criteria.
It means that the practitioner gives an opinion about specific information
due to which users of information are able to make confident
decisions knowing well that chance of information being incorrect is
diminished.

13.1 Elements of an Assurance Engagement

Following elements comprise an assurance engagement: -
1 three party relationship involving a practitioner, a responsible
party, and intended users
 practitioner is a person who provides the assurance. The term
practitioner is broader than auditor. Audit is related to historical

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information whereas practitioner may provide assurance not

necessarily related to historical financial information.
 A responsible party is the party responsible for preparation of
subject matter.
 Intended users are the persons for whom an assurance report is
prepared.
These persons may use the report in making decisions.

2. An appropriate subject matter

It refers to the information to be examined by the practitioner.
3. Suitable criteria
These refer to benchmarks used to evaluate the subject matter like
standards, guidance, laws, rules and regulations.
4. Sufficient appropriate evidence
The practitioner performs an assurance engagement to obtain sufficient
appropriate evidence. It is on the basis of evidence that
conclusions are arrived and an opinion is formed by auditor.
“Sufficient” relates to quantity of evidence obtained by auditor.
“Appropriate” relates to quality of evidence obtained by auditor.
One evidence may be providing more comfort to auditor than the
other evidence. The evidence providing more comfort is
qualitative .

5. A written assurance report in appropriate form

A written report is provided containing conclusion that conveys the
assurance about the subject matter. A written assurance report is
the outcome of an assurance engagement.

13.3 Types of Assurance Engagements- Reasonable

assurance engagement vs. Limited assurance
engagement

Reasonable assurance Limited assurance engagement

engagement

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Reasonable assurance engagement Limited assurance engagement
provides high level of assurance. provides lower level of
assurance than reasonable
assurance engagement.
It performs elaborate and It performs fewer procedures as
extensive procedures to obtain compared to reasonable assurance
sufficient appropriate evidence. engagement.

It draws reasonable conclusions It involves obtaining sufficient

on the basis of sufficient appropriate evidence to draw
appropriate evidence. limited conclusions.

Example of reasonable assurance Example of limited assurance

engagement is an audit engagement is review
engagement. engagement.

 Besides reasonable assurance engagements and limited assurance

engagements, there is another kind of assurance which is
related to matters other than historical financial information.
Such an assurance may relate to prospective financial
information and not to historical financial information. It may
relate to providing assurance on internal controls in an entity.
 “Prospective financial information” means financial information
based on assumptions about events that may occur in the future
and possible actions by an entity. It can be in the form of a
forecast or projection or combination of both.

 Here, it is important to note the difference between “Historical

financial information” and “Prospective financial information.” The
former relates to information expressed in financial terms of an
entity about economic events, conditions or circumstances
occurring in past periods. The latter relates to financial
information based on assumptions about occurrence of future
events and possible actions by an entity.
 In assurance reports involving prospective financial information, the
practitioner obtains sufficient appropriate evidence to the
effect that management’s assumptions on which the prospective
financial information is based are not unreasonable, the
prospective financial information is properly prepared on the basis

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of the assumptions and it is properly presented and all material

assumptions are adequately disclosed.
 Prospective financial information relates to future events.
While evidence may be available to support the assumptions on
which the prospective financial information is based, such evidence
is itself generally future- oriented. The auditor is, therefore, not
in a position to express an opinion as to whether the results
shown in the prospective financial information will be
achieved.
 Therefore, in such assurance engagements, practitioner provides a
report assuring that nothing has come to practitioner’s
attention to suggest that these assumptions do not provide
a reasonable basis for the projection.
 Hence, such type of assurance engagement provides only a
“moderate” level of assurance.

Assurance Engageme
nts

Reasonable Assurance Limited Assurance Assurance Engagements

Engagement Engagement dealing with matters other
than historical financial
information

Audit Review
Examination of prospective
financial information (like
forecast) or assurance
regarding operations of
controls

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14. QUALITIES OF AUDITOR

 Tactfull
 caution
 firmness
 good temper
 integrity
 discretion
 industry

15. ENGAGEMENT AND QUALITY CONTROL

STANDARDS: AN OVERVIEW
The following Standards issued under authority of ICAI Council are collectively
known as Engagement Standards: -
1. Standards on auditing (SAs) which apply in audit of historical financial
information.
2. Standards on review engagements (SREs) which apply in review of
historical financial information.
3. Standards on Assurance engagements (SAEs) which apply in assurance
engagements other than audits and review of historical financial
information.
4. Standards on Related Services (SRSs) which apply in agreed upon
procedures to information, compilation engagements and other related
service engagements.
The purpose of issue of these standards is to establish high quality
standards and guidance in the areas of financial statement audits and in
other types of assurance services.

15.1 Standards on Auditing

 Standards on Auditing apply in the context of an audit of financial
statements by an independent auditor.
 It is important to remember that Standards on Auditing apply in
audit of historical information.
 These establish high quality benchmarks and are followed by
auditors in conducting audit of financial statements.

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 Standards on Auditing have been issued on wide spectrum of

issues in the field of auditing ranging from
o overall objectives of independent auditor
o audit documentation
o planning an audit of financial statements
o identifying and assessing risk of material misstatement
o audit sampling
o audit evidence
Some examples of Standards on Auditing are: -
♦ SA 200 Overall Objectives of the Independent Auditor and the
Conduct of an
Audit in accordance with Standards on Auditing
♦ SA 230 Audit Documentation
♦ SA 315 Identifying and Assessing the Risks of Material Misstatement
through
Understanding the Entity and its Environment
♦ SA 500 Audit Evidence
Revised SA 700 Forming an Opinion and Reporting on Financial
Statements
♦
15.2 Standards on Review Engagements
 Standards on review engagements apply in the context of review
of financial statements. We have already understood that review
is a limited assurance engagement and it provides assurance
which is lower than that provided by audit.
 It is due to the fact that review involves fewer procedures as
compared to audit. Since a review also provides assurance to
users, it also involves obtaining sufficient appropriate evidence.
Examples of Standards on Review engagements are:
♦ SRE 2400 (Revised) Engagements to Review Historical Financial Statements
♦ SRE 2410 Review of Interim Financial Information Performed by the
Independent Auditor of the Entity.

15.3 Standards on Assurance Engagements

 There is another set of standards which apply in assurance
engagements dealing with subject matters other than historical
financial information.

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 Such assurance engagements do not
include “audit” or “review” of historical financial
information.
Examples of Standards on Assurance Engagements are:
♦ SAE 3400 The Examination of Prospective Financial Information
♦ SAE 3420 Assurance Engagements to Report on the Compilation of Pro
Forma Financial Information
Included in a Prospectus

15.4 Standards on Related Services

Lastly, there are standards on related services. These standards apply in
engagements to perform agreed-upon procedures regarding financial
information.
For example, an engagement to perform agreed-upon procedures may
require the auditor to perform certain procedures concerning individual
items of financial data, say, accounts payable, accounts receivable,
purchases from related parties and sales and profits of a segment of an
entity, or a financial statement, say, a balance sheet or even a complete
set of financial statements.
An engagement in which practitioner may be called upon to assist
management with the preparation and presentation of historical financial
information without obtaining assurance on that information. Such type of
compilation engagements fall in the category of related services and
practitioner issues a report clearly stating that it is not an assurance
engagement and no opinion is being expressed.
These types of services are called related services and standards have been
issued to deal with practitioner’s responsibilities in this regard.
Examples of Standards on related services are:
♦ SRS 4400 Engagements to perform agreed-upon procedures regarding
financial information
♦ SRS 4410 (Revised) Compilation engagements
It is to be clearly understood that all the above standards i.e., Standards
on Auditing (SAs), Standards on Review Engagements (SREs), Standards
on Assurance Engagements (SAEs) and Standards on related services
(SRSs) are collectively known as the Engagement Standards.

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Engagement Standards issued under the authority of Council of ICAI deal with
responsibilities of auditor/practitioner.

15.5 Standards on Quality Control

Standards on Quality Control (SQCs) have been issued to establish
standards and provide guidance regarding a firm’s responsibilities for its
system of quality control for the conduct of audit and review of historical
financial information and for other assurance and related service
engagements.
SQC 1 has been issued in this regard. It requires auditors/practitioners to
establish system of quality control so that firm and its personnel comply
with professional standards and regulatory & legal requirements and
reports issued are appropriate.
Its basic objective is that while rendering services, to which engagement
standards apply, there should be a system of quality control with in firms
to ensure complying with professional standards/legal requirements.
System of quality control ensures issuing of appropriate reports in the
circumstances.

Further, it is also to be remembered that Standards on Quality Control

(SQCs) are to be applied for all services covered by Engagement Standards.

15.6 Why are Standards needed?

• Standards ensure carrying out of audit against established benchmarks
at par with global practices.
• Standards improve quality of financial reporting thereby helping users to
make diligent decisions.
• Standards promote uniformity as audit of financial statements is carried
out following these Standards.
• Standards equip professional accountants with professional knowledge
and skill.
• Standards ensure audit quality.

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15.7 Duties in relation to
Engagement and Quality Control Standards
It is the duty of professional accountants to see that Standards are
followed in engagements undertaken by them. Ordinarily, these are to be
followed by professional accountants. However, a situation may arise
when a specific procedure as required in Standards would be ineffective in
a particular engagement. In such a case, he is required to document how
alternative procedures performed achieve the purpose of required
procedure. Also, reason for departure has also to be documented unless it
is clear. Further, his report should draw attention to such departures. It is
also to be noted that a mere disclosure in the report does not absolve a
professional accountant from complying with applicable Standards.

Overview of Engagement and Quality Control

Standards
Checkbo Engagement and Quality Control Standards
x
 Standards on auditing (SAs) apply in audit of historical
financial information.
 Standards on review engagements (SREs) apply in review of
historical financial information.
 Standards on assurance engagements (SAEs) apply in
engagements dealing in matters other than historical
financial information.
 Standards on related services (SRSs) apply in engagements
to perform agreed-upon procedures regarding financial
information and other services like assisting management in
preparation and presentation of financial statements.

 Standards on Quality control (SQC) apply for all services

covered by engagement standards i.e. SAs, SREs, SAEs and
SRSs.
 Duty of professional accountants to follow Standards. If not
followed, reason for departure to be stated in reports.
Test Your Understanding 6
CA. P Babu is conducting audit of financial statements of Quick Buy Private
Limited. He was not able to obtain external confirmations from certain

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debtors due to practical difficulties and peculiar circumstances. However,

such a procedure is mandated under one of Standards on Auditing.
Unable to obtain external confirmations from these debtors, he relied upon
sale details to these parties, e-invoices, e-way bills and also traced
payments from these parties in bank accounts of the company. He was
reasonably satisfied with audit evidence obtained. Is there any other
reporting duty cast upon him relating to not following a mandated
procedure in one of Standards on Auditing?

CASE STUDY-2
Me and You Private Limited has been newly incorporated. The plant of the
company has recently started production with the help of funds provided
by a bank for purchase and installation of machinery. Further, the
company is also utilizing working capital credit facilities from the same
bank for meeting its day to day working capital requirements like for
purchase of raw materials, labour payment etc. However, just within six
months of its operations, the management feels that working capital funds
are inadequate and situation is creating liquidity issues in the company.
The management of the company has approached its bankers and
requested for enhancement in working capital credit facilities. The bank
manager is insisting upon financial statements of the company for half
year along with report providing assurance in this respect duly signed by
Chartered Accountant as audit is far away. It also requires projected
financial statements for coming years along with a report from CA
providing assurance regarding these projections to consider request of
management.
The management approaches CA P, who has qualified recently and started
practising. Reports providing assurance for half yearly results and
projected financial statements are sought from CA P. The Management
provides necessary information and records to him in this regard.
Assume, in above case, the company only provides trial balance, financial
statements in draft/preliminary form along with accompanying records for
the relevant half year to CA P and requests him to provide duly signed
financial statements with a report for mutually agreed professional fees.

Based on above, answer the following questions: -

1. The management of company has engaged CA P to issue a duly
signed report for half year, as referred to in last para of case study.

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Which of the following standards, if any,
issued by ICAI are relevant for CA P?

(a) Standards on Review Engagements

(b) Standards on Auditing

(c) Standards on Related Services

(d) There are no standards for issuing report in such situation.

2. Which of the following statements is MOST APRROPRIATE in given

case situation?
(a) CA P can assist management in preparation of financial
statements of the company. However, issue of a report in such
a case is outside the scope of work.
(b) CA P can assist management in preparation of financial
statements of the company and he can issue an audit report.
(c) CA P can assist management in preparation of financial
statements of the company and he can issue a compilation
report in this respect.
(d) The responsibility of preparation of financial statement is of
company’s management. CA P cannot assist management in
preparation of financial statements of the company. However,
he can issue a review report.
3. In the above said scenario for issuance of signed financial
statements for half year by CA P, as discussed in last para of Case
Study, identify the MOST APPROPRIATE statement: -
(a) Standard on Quality control (SQC 1) is not applicable as CA P
cannot issue audit report.
(b) Standard on Quality Control (SQC 1) is not applicable as CA P
cannot issue review report.
(c) Standard on Quality Control (SQC 1) is applicable in such type of
engagement.
(d) Standard on Quality Control (SQC 1) is not applicable as CA P is
barred from issuing any report in such type of engagement.
4 The banker of company has also requested for projected financial
statements for coming years along with a report from CA regarding
these projections to consider request of management. Which of the

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following standards issued by ICAI are relevant for CA P in such a

situation, if any?
(a) Standards on Review Engagements
(b) There are no standards for issuing such type of reports.
(c) Standards on Related Services
(d) Standards on Assurance Engagements
5. Suppose CA P also accepts work of issuing projected financial
statements with a report to be signed by him. The management has
projected turnover of `100 core for the next year, `150 crore & `200
crore for following years respectively as compared to present turnover
of `25 crore in current half year. Identify the MOST APPROPRIATE
statement in this situation: -
(a) CA P has to satisfy himself regarding arithmetical accuracy of
projected data.
(b) CA P has to satisfy himself regarding reasonableness of
assumptions underlying projected turnover and its consistency
with actuals.
(c) CA P has to satisfy himself regarding arithmetical accuracy of
data along with its proper presentation to banker.
(d) CA P has to satisfy himself regarding reasonableness of
assumptions underlying projected turnover, its consistency with
actuals, disclosure and presentation.

Answer to Questions involving Case Study 2

1. c 2. c 3. c 4. d 5. d

TEST YOUR KNOWLEDGE

MCQs based Questions
1. Which of the following is not an advantage of audit?
(a) It provides high quality financial information.
(b) It acts as a moral check on employees.
(c) It enhances risk of management bias.
(d) It helps in safeguarding interests of shareholders.

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2. Which of the following is NOT TRUE
about an assurance engagement?
(a) It relates to providing assurance about historical financial
information only.
(b) The practitioner obtains sufficient appropriate evidence.
(c) There is some information to be examined by practitioner.
(d) A written assurance report in appropriate form is issued by
practitioner.
3. Which of the following is TRUE about Engagement Standards?
(a) Engagement standards ensure proper rights to practitioners in
course of performance of their duties.
(b) Engagement standards ensure preparation and presentation of
financial statements in a standardized manner.
(c) Engagement standards ensure uniformity by practitioners in
course of performance of their duties.
(d) Engagement standards ensure savings in resources of clients.
4. Consider following statements in relation to “Limited assurance
engagement”:-
Statement I - It involves obtaining sufficient appropriate evidence to draw
reasonable conclusions.
Statement II - Review of interim financial information of a company is an
example of limited assurance engagement.
(a) Statement I is correct. Statement II is incorrect.
(b) Both Statements I and II are correct.
(c) Both Statements I and II are incorrect.
(d) Statement I is incorrect. Statement II is correct.
5. Which of the following is TRUE about Standards on auditing?
(a) These deal mainly with voluntary responsibilities of auditors.
(b) These deal mainly with mandatory responsibilities of auditors.
(c) Their sole purpose is to help government authorities in
augmenting revenues.

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(d) These deal mainly in carrying out audit according to legal

provisions.

Correct /Incorrect
State with reasons (in short) whether the following statements
are correct or incorrect:
(i) The basic objective of audit does not change with reference to
nature, size or form of an entity.
(ii) The purpose of an audit is to enhance the degree of confidence of
intended users in the financial statements.
(iii) The auditor is not expected to, and cannot, reduce audit risk to zero
and cannot therefore obtain absolute assurance that the financial
statements are free from material misstatement due to fraud or
error.

Theoretical Questions
1. “Choosing of appropriate accounting policies in relation to
accounting issues is responsibility of management”. Do you agree?
Discuss duty of auditor, if any, in relation to accounting policies.
2. Assurance engagements are not restricted to audit of financial
statements alone. Discuss.
3. An assurance engagement involves a three party relationship.
Discuss meaning of three parties in such an engagement.
4. A Chartered Accountant is specifically asked to check accounts
whether fraud exists. State with reasons whether it is an example of
reasonable assurance engagement.
5. An audit does not provide absolute assurance. Discuss how nature of
audit procedures itself is one of the reasons due to which audit
cannot provide absolute assurance.

ANSWERS/ SOLUTIONS
Answers to the MCQs based Questions
1. (c) 2. (a) 3. (c) 4. (d) 5. (b)

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Answers to Correct/Incorrect
(i) Correct: An audit is an independent examination of financial
information of any entity, whether profit oriented or not, and
irrespective of its size or legal form, when such an examination is
conducted with a view to expressing an opinion thereon. It is clear
that the basic objective of auditing, i.e., expression of opinion on
financial statements does not change with reference to nature, size
or form of an entity.
(ii) Correct: As per SA 200 “Overall Objectives of the Independent
Auditor and the Conduct of an Audit in Accordance with Standards on
Auditing”, the purpose of an audit is to enhance the degree of
confidence of intended users in the financial statements. This is
achieved by the expression of an opinion by the auditor on whether
the financial statements are prepared, in all material respects, in
accordance with an applicable financial reporting framework.
(iii) Correct: As per SA 200 “Overall Objectives of the Independent
Auditor and the Conduct of an Audit in Accordance with Standards on
Auditing”, the auditor is not expected to, and cannot, reduce audit
risk to zero and cannot therefore obtain absolute assurance that the
financial statements are free from material misstatement due to
fraud or error. This is because there are inherent limitations of an
audit, which result in most of the audit evidence on which the auditor
draws conclusions and bases the auditor’s opinion being persuasive
rather than conclusive.

Answers to the Theoretical Questions

1. Choosing of appropriate accounting policies is responsibility of
management. The role of auditor lies in evaluating selection and
consistent application of accounting policies by management- Refer to
scope of audit- what it includes.
2. Refer to examples on assurance engagements.
3. Refer to elements of assurance engagement.
4. It is not a reasonable assurance engagement. It is in nature of
investigation.
5. Refer to second point of inherent limitations of audit.

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Answers to Questions involving Test Your

Understanding
1. An audit does not provide assurance to investor in shares regarding
safety of his money. Share prices of securities are affected by range
of factors. An audit only provides reasonable assurance that financial
statements are free from material misstatement whether due to
fraud or error. Hence, thinking of Lalji Bhai is not correct.
2. Proper disclosure of financial information is well within scope of audit.
3. Appointment of CA for verification of books of accounts/financial
records and circumstances surrounding the loss is for a specific
objective to determine genuineness of loss and any issue affecting
liability of insurance company. It is an investigation and not in nature
of audit report.
4. It is example of failure of internal controls of the firm. The internal
control has not operated due to collusion between employees which
is a limitation of internal control itself. The auditor has relied upon
internal controls. It is very nature of financial reporting that
management is responsible for devising suitable internal controls.
This is an inherent limitation of audit.
5. Such report would be in nature of “review”. However, auditors would
have to obtain sufficient appropriate evidence.
6. He is required to document how alternative procedures performed
achieve the purpose of required procedure. Reason for departure has
to be documented unless it is clear. His report should draw attention
to such departure.

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