VU VICKY Virtual University Assignment Solution, Past Papers, Handouts and other material

FUNDAMENTALS OF AUDITING ACC311

Lecture 05

Lesson 05

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. 

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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.