1. a) Six matters that should be considered before accepting the audit engagement
  • Assess whether the engagement is within the provisions of the Company’s Act.
  • Look at independence and ensure it won’t be compromised
  • Size and complexity of the company: number of personnel and resources required involvement of experts.
  • Any planned expansion of the group
  • Relevant skills needed e.g. use of computers
  • Timing of the audit of the component companies. Complete assignment earlier for auditor to review.
  • Qualification of audited financial information
  • Any listing of the group
  • Communication with previous auditors to assess integrity of management.


(a) John, Matthew and David commenced a partnership business in January 2014 using a bank loan for finance. The business retails luxury handmade furniture currently in a single retail outlet. Revenue for the first year of trading was Sh 90 million. The partners project a rapid growth in the next few years. –

The three partners are aware that the partnership is not required to subject its annual financial statements for audit by the-external auditors. However they are unsure whether there would be any benefits in a voluntary audit of die first year’s financial statements. The partners are also aware that a review of the financial statements could be performed as an alternative to a full audit for bank purposes.

John, Matthew and David currently employ a part time ,partly qualified accountant Mike Pesa who has prepared the statement of financial position as at 31 December 2014 and the income statement for the year ended 31 December 2014.Mike Pesa also prepares bi-monthly management accounts for the partnership.


Explain the potential benefits that the partners could derive from a financial statements audit of the partnership.

An annual audit will ensure that any material mistakes made by the partly qualified accountant in preparing the year end financial statements will be detected. This is important as the directors will be using the year end accounts to review their progress in the first year of trading and will need reliable figures to assess perfomance. An audit will give the directors comfort that the financial statements are a sound basis for making business decisions. Accurate first year figures will also enable more effective budgeting and forecasting, which will be crucial if rapid growth is to be achieved.

The auditors are likely to use the quarterly management accounts as part of normal audit procedure. They will be able to advise Pesa of any improvements that could be made to management accounts for example, increased level of detail, more frequent reporting. Better quality management accounts


will help the day to day running of the business and enable a speeder response to any problems arising during the year.

As a by-product of the audit, a management letter will be produced, identifying weaknesses and making recommendations on areas such as systems and controls which will improve the smooth running of the business.

It is likely that John, Mathew ana David will require more bank funding in order to expand and it is likely that the bank would like to see audited figures for review, before deciding on further finance. It will be easier and potentially cheaper to raise finance from other providers with an audited set of financial statements.

As the business deals in cash sales and retails small luxury items, there is a high risk of theft of assets. The external audit can act as both a deterent and defective control, thus reducing the risks of fraud and the resultant detrimental impact on the financial statements.

Accurate financial statements will be the best basis for risk assesment and tax planning. An audit opinion will enhance the credibility of the figures.

If the business grows rapidly then it is likely that at some point in the failure, the partners will convert it into a limited liability company .and thus an audit will become mandatory. Choosing to have an audit carried down to subsequent periods and thus avoid qualifications of opening balances.

 With specific reference to John, Matthew and David partnership in (a) above:

Discuss the objectives of a review engagement.

  • The objective of a review engagement is to enable the auditor to obtain moderate assurance as to whether the financial statements have been prepared in accordance with an identified financial reporting framework. In order to obtain this assurance, it is necessary to gather evidence using analytical procedures and enquiries with management. Detailed substantive procedures will not be performed unless the auditor has reason to believe that the information may be materially misstated. The auditor should approach the engagement with a high degree of professional sceptism, looking for circumstances that may cause financial statements be mistated for example, in the case of John, Mathew and David, the fact that the preparer of the financial statements is partly -qualified may lead the auditor to believe that there is a high inherent risk that the figures, are misstated. As a result of the procedures performed, the auditor’s objective is to provide a clear written expression of negative assurance on the financial statements. In a review engagement the auditor would state that “we are not aware of any material modifications that should be made to the financial statements”. This is normally referred to as an opinion of negative assurance. Negative assurance means that the auditor has perfomed limited procedures and has concluded that the financial statements appear reasonable. The user of the financial statements gains some comfort that the figures have been subject to review, but only a moderate level of assurance is provided. The user may need to carry out additional procedures of their own if they want to rely on the financial statements. For example, if John, Mathew and David were to use the financial statements as a means to raise further bank finance, the bank would presumably perform or require partnership to perform additional procedures to provide a higher level of assurance as to the validity of the figures contained in the financial statements.

Contrast the level of assurance provided by a review with that provided by an audit of financial statements.

  • In comparison in an audit, a high level of assurance is provided. The auditors provide an opinion of positive but not absolute assurance. The user is assured that the figures are free from material misstatement and that the auditor has based the opinion on detailed procedures.


Yon ‘are the auditor of Rex-Motors. While reviewing the financial statements and other information in the annual report of Rex Motors, you notice the following:

  • An amount of Sh.12 million- in the statement of changes in equity which is not referenced anywhere else in the financial statements. The amount has been described as “other difference not recognized in income’.
  • The unaudited management report attributes an amount of Sh.12 million not recognised in the statement of comprehensive income as arising from the revaluation of investment properties.
  • The management report states that the company had adopted International Accounting Standard (IAS) 40 (Investment Property) for the first time during the current year. The adoption of this ‘standard does not in any way significantly influence the financial position of Rex Motors during the current year.
  • The director’s report states among other things that; “Rex Motors has now achieved its place as One of the largest players in the motor industry with a consistent commitment to accountable ethical professionalism”.

Investigations, however, reveal that in the country of operation of Rex Motors, there are four major international car manufacturers which are twice the size of Rex Motors in both annual turnover and scale of operation.

  • Rex Motors, currently records assets of Sh.300 million, revenue of Sh.650 million and profit before tax of Sh.23 million.


Discuss how you would deal with the above stated matters during the current audit engagement.

  • In terms of materiality the amount of sh. 12 million constitutes 4% of total asset and

52.2% of the profit before tax. It is therefore material.

  • In this case the management report discloses the amount and the reason_for the change in profit while the same matter is not material in the financial statements. So there is a material inconsistency between other information and the financial statements.
  • There is therefore a need to amend the management report. The auditor should purpose that the management reports include a comment that the inconsistency results from the first time implementation of IAS 40.
  • While the adoption of JAS 40 does not have any significant impact on the results of operations it has resulted in an increase in revenue of almost 4%.
  • If the management refuses to amend the management report, the auditor should qualify the audit report on the basis of non-compliance with lAS 40.
  • With regard to the statement in the directors report regarding the size of Rex Motor’s operations that the information does not fall within the scope of the audited financial statements. This may give rise to a misstatement regarding the size of the company’s operations.
  • It thus creates a misleading impression of the company in the minds of investors and may undermine the credibility of the financial statements.
  • The auditor should request the management to change the director’s report. Failure to which he may not qualify but modify it to include an emphasis of matter paragraph.


The successor auditor should make specific and reasonable inquiries of the predecessor auditor regarding matters that will assist the successor auditor in determining whether to accept the engagement.

With reference to the above statement, outline five matters subject to inquiry by the successor auditor.

  • Information that might bear on the integrity of management.
  • Disagreements with management as to accounting principles, auditing procedures or other similarly significant matters.
  • If there is any outstanding fee
  • Nature of business e.g if there are any illegal activities.
  • Communications to management and those charged with governance regarding illegal acts.
  • Risk associated with the engagement
  • If the removal of previous auditors was procedural.
  • The predecessor auditors understand as to the reasons for the change of auditors.



You are the audit partner in a firm that provides a variety of accountancy related services to a large portfolio of clients. The firm’s gross practice income is Sh.50 million. The firm has a successful tax department, which carries out a great deal of recurring and special tax work for both audit and non-audit clients. The tax manager has recently involved you in discussions with a major tax client who is considering changing its auditors. The client, Mpckuzi Ltd., would expect audit fees of around Sh.6 million which is a reasonable fee for the audit. Your daughter has been working as an administrative assistant in the sales department of Mpekuzi Ltd. for a year, after being introduced by the tax manager. She has just joined an employee share benefit scheme of the company.

The client is keen to use the firm to provide audit services as he is pleased with the taxation services that they provide. The Managing Director and major shareholder, Brain Tinega has therefore offered an incentive to the audit fee of an additional 1% of profits in excess of Sh.15 million annually. The current recurring taxation fee from Mpekuzi Ltd. is Sh.3 million and last year’s special tax work amounted to Sh.0.5 million. Last year’s tax fees remain outstanding. The Managing Director has suggested that you give consideration to the matter while staying for the weekend at his villa in Lamu.


Explain the matters that you should consider in deciding whether or not your audit firm can accept appointment as auditors of Mpekuzi Ltd.

Undue dependence

Accepting the work of Mpekuzi Ltd. may result in having undue dependence on the client. The audit fee discussed is substantial and in connection with the tax work, may affect the objectivity of the firm. This is especially true given that the audit fee and tax fee constitute 18% of the gross practice income.

Consideration should also be given to the regularity of special work undertaken by the firm on behalf of the client. . It may be arguable that this work is in some sense recurring and this would mean objectivity is impaired.

Contingency fee

This would be unacceptable. Linking the audit fee to the success of the clients business clearly affects objectivity. The firm should not accept these terms.

Unpaid fees


  • Overdue fees can be construed as a loan to a client which would adversely affect objectivity.
  • The auditor should consider whether the unpaid fees are overdue or whether it is normal practice for the firm to have such outstanding lees


The audit partner is related to a member of client’s staff. This could affect objectivity.

However, the staff member appears to be Junior in the organisation and is an adult daughter and therefore not dependent on the auditor. This should not therefore adversely affect the auditor’s objectivity.


As the daughter is not dependant of the auditor, her shareholding should not affect his objectivity towards this audit.

Other services

Provisions of other services to an audit client can affect objectivity of an audit. It appears that different staff would be involved in tax and audit work so other than the fee issue stipulated above, this should not pose any issue in relation to objectivity.


Auditors should beware of accepting excessive gifts which are given on terms other than normal commercial ones. The weekend in Lamu appears to be excessive and should not be accepted. The auditor should consider whether the offer of the free holiday cast significant doubt on the integrity of the director and whether this would affect his decision to accept the audit work.


Describe the procedures that a professional accountant should undertake in order to provide an assurance report on the prospective financial information.

  • Comparison of forecast amounts to historical performance to ensure consistency. While future results will not follow previous trends historical patterns give an indication of the capacity of the business.
  • Comparison of forecast amounts to actual results. Internally produced management accounts may therefore b available to use to access actual performance for the first few months of forecast period.
  • Forecasts of previous periods may be assessed in comparison of actual results to access how accurately management have-forecast in the past.
  • Reasonably certain income and costs may be verified by comparison of forecast amounts to documents such as orders, contracts, loan agreements.
  • Comparison of accounting policies/estimates used in forecasts in comparison to financial statements.
  • Inspection of non-current assets note to identify if assets are approaching the end of useful lives and require replacement
  • Comparison of working capital amounts/liquidity to assess whether liabilities can be met and the company can finance its short resourcing requirements
  • Comparison of the relationship between the reported figure, for example is a significant decrease in revenue supported by increased production costs.
  • Consider the events and circumstances that may have an impact on the business in the future.
  • Whether the firm requires investment in noncurrent assets.
  • When loan agreements shall expire.
  • Whether further forms of finance are being sought.
  • Whether there are new competitors/products that have been introduced or are about to he introduced.
  • Review assumptions used for forecast
  • Whether the company has invested in research and developments which may bear fruits.


Difference between a statutory audit and a forensic audit


Statutory Audit


1.     It expresses an opinion as to the true and fair view presentation of financial statement.

2.     The techniques used involve use of substantial and compliance procedures.

3.     The period covered is normally all transactions for particular accounting period.

4.     The findings translate into a negative opinion or a qualified opinion expressed with or without qualification.

5.     It is done by a qualified independent accountant.

6.     It’s required by the statute.

Forensic audit


1.     It determines the connections of the account on whether any fraud has taken place.

2.     Techniques used are the analysis of past trends, substantive or in depth or (through) checking of selected transactions.

3.     No such limitation in terms of the period’s accounts may be examined in detail for more than one financial year.

4.     The findings are legal determination of the fraud and naming the persons behind such fraud for proceedings to commence.

5.     It is done by a competent professional.

6.     it is required by the client on suspicion of fraud.



Specify the representations that should relate to the following matters

i. Financial statement.

  • Management acknowledgement of their responsibility for the fair presentation of the financial statement on financial position, results of operations and the cash flows in conformity with acceptable accounting principles.
  • Management beliefs that the financial statements are fairly presented in conformity with the acceptable accounting standards.
  • Completeness of information.
  • Disclosure of related party transactions.
  • Availability of all financial records and related data affecting financial statement.
  • Adequate returns obtained from the company branches or subsidiaries.
  • Availability of all minutes of B.O.Ds, executive committees and debenture holders.
  • Absence of unrecorded transactions / events affecting the business.

iii. Recognition, measurement and disclosure.

  • Disclosure of all material matters that affect the financial statement.
  • Management acknowledgement of their responsibility for the design and implementation of controls to prevent and defect irregularities.
  • Information concerning related party transaction and the annual receivable from or payable to related parties.
  • Accounting policies or concept applied in preparation of financial statement.


 There is a growing demand in both the public and private sectors for professional accountants to provide assurance on a variety of subject matters by expressing a conclusion regarding its quality or context.


Discuss the above statement in the context of International Standard on Auditing (ISA) 100: `Assurance Engagements’.

The statutory audit of historical financial statements is an example of a traditional assurance service which has been provided by auditors for many years. Factors which have contributed to a growing demand for different assurance services by accountants include:

  • Business expansion.
  • Developments in information technology and communication networks.  Greater accountability of corporate managers.

In the public sector, assurance is increasingly sought on information concerning the performance of National Health Service department and education providers.

In the private sector, there_ is an increasing demand for large companies to assess the quality of their-management and communication systems, whilst consumers demand assurance that e- commerce, data integrity and confidentiality.

Professional accountants bring independence to assurance services because they are bound to adhere to an ethical code. Such codes require that other fundamental principle be observed. The term professional accountant includes auditor.

The objective of an assurance engagement is to enhance credibility of information. Thus assurance services improve the quality or context of information- for decision makers to use.

Types of assurance services include:

  • Risk assessments:
  • Performance measurement.
  • Information systems. 
  • E-commerce.

Subject matter, which may be as at a point in time or for a period of time, must be identifiable and in a form which allows evidence to be gathered. For example:

  • Data (for example prospective financial information).
  • Systems (for example internal controls).
  • Behaviour (for example corporate governance).

An engagement which seeks to provide a “high” (but not absolute) level of assurance (for example an audit) is concluded by the expression ()ran opinion on whether the subject matter (for example financial statements) conform, in all material respect to suitable criteria (for example financial statement assertions), This is called “positive assurance”.


You are an audit manager in the audit firm of Tuna Weza &Co. Certified Public Accountants. Your audit client, Mbao Ltd designs and manufactures wooden chairs and tables. The business has expanded rapidly the last two years, since the arrival of Mr John Sella, an experienced and well-connected .sales and marketing manager.

The directors of Mbao Ltd. intend to secure a loan of Sh 200 million in order to expand operations following the design of completely new range of wooden garden furniture.

The directors have approached Mpesha bank Ltd. for the loan. The bank has a lending criteria which stipulates the following:

“Loan applications must be accompanied by a detailed business plan including an analysis of how the finance will_be used .Mpesha Bank Ltd would like to ensure that the finance requested for is adequate for the proposed business purpose. The business plan must be supported by an assurance opinion on the adequacy of the requested finance.

Mbao Ltd has provided the following information on the estimated expenditure of the required financing of Sh 200 million:




Construction of new factory                                  84

Purchase of new machinery                                   66

Initial supply of timber raw materials                    17

Advertising and marketing of new product          33

Total                                                                     200


Your Firm has agreed to review the business plan and to provide an assurance opinion on the completeness of the request for financing. A meeting between the directors of Mbao Ltd and your firm has been scheduled to discuss the assurance engagement.


Explain the matters relating to the assurance engagement that would be discussed at the meeting.

  • Details of the business plan information relating to past business performance.
  • Availability of market for the new product
  • Availability of evidence In this case evidence will include discussions with key management and written representations of these discussions may be required. Mbao Ltd should be notified that audit opinion will be based on the information they provide to the auditor.
  • Cash flow projections
  • The intended recipient of the report

The auditor should clarify the name and address of the recipient at Mpesha Bank Ltd. For the limitation of professional liability, it should be clarified that Mpesha Bank Ltd, will be the only recipients and that the assurance opinion is being used as part of the bank’s overall lending decision.

  • Liability

To mitigate against audit liability the auditors may want be provided with a written statement saying that the report is for information purposes only, and does not give rise to any responsibility, liability, duly or obligation from the firm to the lender.

  • Timing

The deadline of the report should be discussed. This in turn will be influenced by when Mbao Ltd. needs the requested financing ofSh,200 million. The bank may need a considerable period of time to assess the request for financing prior to advancing the finance.

  • Procedures and regulations

The auditors need to discuss the kind of procedures that will be undertaken and confirm that they will be complying with relevant professional guidance, for instance ISAE 3000 Assurance engagement other than audits of reviews of historical financial information.

  • Fees and billing arrangements must be agreed before any work is carried out.The engagement letter
  • The engagement letter should be disclosed and signed at the meeting before any assignment work is conducted.
  • Assurance report

State the enquiries you would make with the directors of Mbao ascertain the adequacy

  • Forecast preparation

The experience and competence of the preparer of the forecast should be evaluated. Previous forecasts should also be reviewed to determine, if they were accurate and reliable.

  • Internal financing

Does the firm have surplus cash to cover for any shortfall, if there is cash within the firm then the bank should not meet the full cost of the project.

  • Whether the cost of finance has been included in the forecast.
  • Forecast operating cycle of the new project.


Your client Bimba Ltd. Sells machines subject to a warranty of one year included in the statement of financial position of Bimba Ltd. as at 30 April 2011 is a warranty provision of Sh 300,000,000 (2010: Sh 290,00.0,000).the managing director who owns 60% of the shares of the company estimates the cost of repairing detective machinery reported by customers. The estimates from the managing director form the basis of the warranty provision.

This is your first year as the auditors of Bimba Ltd whose turnover is Sh15 billion fOr the year 2011 compared to Sh 13 billion for the year 2010.


Describe four quality control procedures that are applicable to an audit engagement.

  • Competence of engagement tram

There should be procedures in place to ensure that the engagement team has the skills and expertise required to perform the audit engagement. The engagement partner should assess that the auditor for technical knowledge, ability to apply professional judgment and experience of audit engagements

  • Planning and direction

The engagement team should be directed by the engagement partner. Procedures should be undertaken to ensure that the team understands, the objective of the work they are to perform, their responsibilities approach to the performance of the audit etc.

  • Client acceptance procedures

There should be full documentation and conclusion on ethical and client acceptance issues in each audit assignment. The engagement partner should consider whether members of the audit team have complied with ethical requirements, for example, whether all members of the audit team are independent of the client.

  • Arrange for consultation

When faced with difficult matters the engagement partner should consult. This is done where a matter is discussed with a professional outside the engagement team and the audit firm’s consultations must be documented.

  • Supervision

It is critical that supervision should be continuous during the engagement. The main objective for this is to ensure that members of the audit team are carrying out their work in accordance with the planned approach to the engagement.

  • Review of audit work

All work performed must be reviewed by a more senior member of the audit team. This is one of the key quality control procedures

Explain the challenges that might be faced by a small firm of certified public accountants in implementing quality control procedures and recommend measures that could be taken to overcome the challenges


i.       Lack training on quality procedures. Small firms may find it hard to establish and in- house training function.

ii.     Independent review of audit engagement within small firms may not be possible because there are few experienced auditors

iii.   Consultations on specialist areas within small firms may not be possible due to shortage of specialist professionals. iv.    Most small firms lack resources to establish adequate and standard working papers.

v.     Lack of specialist experience


i.              Small firms may find it affordable to rely on external training consortia to provide training for its staff

ii.            Use external review service.

iii.          Make arrangements with other practices for consultation

iv.          In this, case documentation can be provided by external firms or professional bodies

v.            Bring in the special skill or subcontract to another practice


Quality control procedure NSA 220)

Review of work performed

Proper review procedures should be instituted. All working papers must be independently reviewed to ensure that work has been performed in accordance with the audit plan, that the appropriate risks have been identified and that the evidence supports the conclusions. The manger or partner should also review the audit file and final accounts before the audit report is finalized.


Responsibilities and duties of staff should be clearly shown in an organization chart.

Their job description should also be spelt out. These will be maintained and updated as appropriate.

The audit plan and resource/time allocation schedule will be used effectively to ensure that all team members should clearly understand their assignments by the help of the audit plan and the time allocation schedule.

The organization should keep records of assignments performed.


Assignments should be performed in accordance with standardized documentation.

Assignment control and review procedures will ensure, that individual audits are completed to a high standard, using the right skills and resulting in a report that reflects the underlying facts.


Supervision and review of work should be carried out at all levels so that work performed meets appropriate standards of quality. Supervisors will receive appropriate training in the conduct of this supervision and be,appraised against the relevant management competencies.



Quick services Ltd. is a family owned entity which provides call center- services to various organisations. Mr. and Mrs. Omar Masumbuko are the major shareholders. The company is expanding rapidly in terms of its client base the number of staff it employs and profit growth.

You have been approached by Quick services Ltd. to perform the audit of the company for the year ending 31 December 2009.Yollr firm has not audited this company before. Quick services Ltd.  has had three firms of auditors since its incorporation five years ago.

The directors of Quick services Ltd. have indicated to you informally that the reason they wish to change the previous auditors is because of a disagreement about certain disclosures in the financial statement in the previous year. The directors consider the disagreement to be a trivial matter and have indicated that their chief accountant will be able to provide you with the details once the audit has commenced. Your firm has explained that before accepting the appointment, there are various matters to be considered within the firm and other procedures to be undertaken, some of which will require the corporation of the director.

The directors have requested your firm of auditors to commence the audit immediately in order for the accounts to be presented to their bankers your firm has other clients operating call centers and is currently engaged in various audit assignments.



Describe the matters to consider within your firm and other procedures that must be undertaken before accepting appointment as auditors of Quick Services Ltd.

  • Quality control procedures.

Quality control procedures should be in place so as to be able to guarantee the new client quality service.

  • Communication with outgoing auditor

The firm should request for permission to communicate with the outgoing auditors to confirm whether there are any matters that may make the auditor not accept appointment.

  • Statutory requirements.

Confirm whether there are statutory or regulatory requirements to be met before undertaking the and it.

The staff should not only ensure that it has enough staff but also they arc adequately trained with the relevant skill and expertise in this particular field and in audit in general.

  • Ethical requirements

The firm should ensure that all the professional requirements are adhered to including and especially matters of independence.

The audit firm should consider whether the timing requirements of the client are realistic?

Explain why it would be inappropriate to commence the audit before concluding the matters and procedures referred to in (i) above.

  • The matters enables the auditors obtain an initial understanding of the client and as a result the auditor is able to know what to expect during the audit and hence plan his audit accordingly, which is critical to the successful conduct of the audit.
  • If the auditor performs an audit contrary to this then he may be liable for negligence because the above matters are in accordance with ISAs and other standards that govern the conduct of an audit.
  • Failure to adhere to the above matters may attract penalties because the auditor will be in breach of professional conduct and the rules that govern the accountancy.
  • These matters and procedures are meant to safeguard the interests of the client and the auditor. Furthermore the matters provide a basis for which the auditor can negotiate terms with the client.

Explain the purpose of an engagement letter and list its contents.

According to ISA 210, the principal contents of an engagement letter include reference to:-

  • The objective of the audit of financial statements.
  • ManageMents responsibility for the financial statements
  • The scope of the audit, including reference to applicable legislation, regulations, or pronouncements of professional bodies to which the auditor adheres.
  • The form of any reports or other communication of results of the engagement.
  • The fact that because of the test nature and other inherent limitations of an audit together with the inherent limitations of any accounting and Internal Control System, there is an unavoidable risk that even some material misstatement may remain undiscovered.
  • Unrestricted access to whatever records, documentation and other information requested in connection with the audit.



The auditor may also wish to include in the letter:

  • Arrangement regarding the planning of the audit
  • Expectation of receiving from management written confirmation concerning representations made in connection with the audit
  • Request for the client to confirm the terms of the engagement by acknowledging receipt of the engagement letter
  • Description of any other letters or reports the auditor expects to issue to the client  Basis on which fees are computed and any billing arrangement.

When relevant the following points could also be made:


  • Arrangements concerning the involvement of other auditors and experts in some aspects of the audit.
  • Arrangements concerning the involvement of internal auditors and other client staff
  • Arrangements to be made with the predecessor auditor, if any, in the ease.of an initial audit.
  • Any restriction of the auditor’s liability when such possibility exists.
  • A reference to any further agreements between the auditor and the client.

The engagement letter serves the following

  • The letter defines the scope of work to be carried out and the respective responsibilities of the auditor and the client under the engagement. This helps in avoiding misunderstandings between the client and the auditor as regards to the scope of the work to be carried out and the respective responsibilities of both parties.
  • The letter documents and confirms the auditor’s acceptance of the appointment
  • It explains the forms of any reports to be issued under the engagement
  • To educate the client on: –
    • His duty to maintain proper hooks of accounts and to prepare financial statements that show a true and fair view.
    • His duty to prevent errors and frauds.
    • His duty to provide all the necessary information
    • That the audit should not be relied upon to detect errors and frauds.
    • To explain that the audit will be carried out on a test basis. – Basis of charging his fees.
  • Minimize auditor’s liability to third parties. The auditor may include a clause in the engagement letter limiting the client from distributing the audit report to parties other than those agreed on an identified in the engagement letter.



There is a growing demand in both the public and private sectors for professional accountants to provide assurance on a variety of subject matters by expressing a conclusion regarding the quality or context of the subject matter.


Identify the five key elements of an assurance engagement.

A three party relationship involving a practitioner, a responsible party and intended users. ii. An appropriate subject matter

  • Suitable criteria
  • Sufficient appropriate audit evidence and

A. written assurance report in the form appropriate to a reasonable assurance engagement or limited assurance engagement

Explain the engagement risks that face a professional accountant who accepts an assurance engagement.

Assurance engagement risk is the risk that the practitioner expressesinappropriate conclusions. In reasonable assurance engagements, the practitioner reduces the risk to an acceptably low level in the circumstances of the engagement to obtain assurance as the basis for a positive form of expression of the practitioner conclusion.

In general, assurance engagements can be represented by the following components, although not all of these components will necessarily be present or significant for all assurance engagements

The risk that the subject matter information is materially misstated which in form consists of

Inherent risk

Control risk

Detection risk: the risk that the practitioner will not defect a material misstatement that exists.

  • The degree to which the practitioner considers each of these components is affected by engagement circumstances, in particular by the nature of the subject matter and whether reasonable assurance or a limited assurance is being performed.

Explain why an absolute level of assurance may not be given and the circumstances in which a reasonable assurance can be given.

ISA 200 (objective and general principles governing an audit of financial statements) states that an auditor cannot give or obtain absolute assurance because there are inherent limitations in an audit that affects the auditors’ ability to detect material misstatements. These limitations result from factors such as;

  • the use of testing
  • the inherent limitations of internal control
  • the fact that audit evidence is persuasive rather than conclusive.

An auditor’s work is also permeated by judgement regarding gathering of audit evidence and drawing conclusions.

Reasonable assurance is a concept relating to the accumulation of audit evidence necessary for- the auditor to conclude that there are no material misstatements in the financial statements taken as a whole.

Therefore an auditor provides reasonable assurance when circumstances allow him/her to gather sufficient appropriate audit evidence.

Identify and explain the potential threats to the independence of an accounting firm involved in assurance engagements.

Independence requires independence of mind and independence in appearance according to the IFACs code of ethics for professional accountants.

Independence is threatened by self-interest, self-review; advocacy, familiarity and intimidation threats.

  • Self-interest threat occurs when a firm or member of assurance team could benefit from a financial interest in or other self-interest conflict with an assurance client


– A direct financial interest or material indirect financial interest in an assurance client – A loan or guarantee from an assurance client or any of its directors and officers.

  • Self-review threat occurs when any product or judgement of previous AE, or NAE needs to be re-evaluated in reading conclusions on the assurance engagements or when a member of the assurance team was previously a director or officer of the assurance client or was an employee in a position to exert direct or significant influence over the subject matter of the assurance engagement. iii) Advocacy threat — occurs when a firm or member of the assurance team, promotes or may be perceived to promote an assurance clients position or opinion to the point that objectivity may or may not be perceived to be compromised.
  • Familiarity threat occurs when, by virtue of a close relationship with an assurance client, its directors, officers or employees, a firm or member of the assurance team becomes too sympathetic to the client’s interests.
  • Intimidation threat occurs when a member of the assurance team may be deferred, from acting objectively and exercising professional skepticism by threats, actual or perceived, from the directors, officers or employees of an assurance client.



State the respective responsibilities of the directors and management of a company and its external auditors with respect to the financial statements.

ISA 200, explains the respective responsibilities.

The responsibility for the preparation and presentation of the financial statements in accordance with the applicable financial reporting framework is that of the management of the entity with oversight from those charged with governance.

The auditor is responsible for forming and expressing an opinion on the financial statements.

The audit of financial statements does not relieve management or those charged with governance their responsibility.

Describe the inherent limitations facing auditors in undertaking their work. (Hint: Don not confuse inherent limitations with inherent risk

  • The use of testing
  • The inherent limitations of internal control (for example, the possibility of management override or collusion)
  • The fact that most audit evidence is persuasive rather than conclusive
  • The work is also permeated by judgement
  • Assessing the reliability of estimates made by. management

Describe the significant types of judgements made by auditors in:

Gathering evidence .

The work undertaken by the auditor to form an audit opinion is permeated by judgement in particular regarding the gathering of audit evidence, for example in deciding the nature, extent and timing of audit procedures. Also the drawing of conclusions based on the audit evidence gathered for example, assessing the reasonableness of the estimates made by management in preparing the financial statements.

Arriving at an opinion on the financial statements.

In expressing an audit opinion, the auditor provides uses of financial statements with reasonable assurance that the financial statements are free from material misstatements. In other words, the engagement risk has been minimized to acceptable level. It implies that sufficient appropriate audit evidence has been obtained.

The auditor makes judgements regarding matters affecting or not affecting his audit opinion and also decides on the appropriate forms of the report.

He also considers compliance with laws to satisfy regulatory requirements in a given jurisdiction.


Before accepting other assurance engagements for audit clients, an auditor should consider the impact of the proposed engagement on the integrity and independence of the audit.


Define the term “assurance engagement” and explain its purpose

The International framework for assurance engagements defines assurance engagement as an engagement in which a practitioner expressed a conclusion designed to enhance the confidence of the intended users other than the responsible party about the outcome of the evaluation or measurement of a subject matter against criteria.

The outcome of the evaluation or measurement of a subject matter is the information that results from applying the criteria to that matter.

According to the framework”, an assurance engagement has the following elements;

  • A three party relationship involving a practitioner, a responsible party and intended users..
  • An appropriate subject matter
  • Suitable criteria
  • Sufficient appropriate evidence and
  • A written assurance report in the form appropriate to a reasonable assurance engagement or a limited assurance engagement.

Explain the engagement risk that faces a practitioner who accepts an assurance engagement.

  • Engagement risk that faces a practitioner who accepts an assurance engagement. According to the framework on AE, an assurance engagement risk is the risk that the practitioner expresses an inappropriate conclusion when the subject matter information is materially misstated.

Describe the forms of audit assurance reports that a firm involved in assurance engagements may give to minimise its assurance engagement risk.

  • Forms of reports that a firm involved in assurance engagements may give to minimise its assurance engagement risk.

The forms of reports given for assurance engagements include reasonable assurance reports and limited assurance reports conveying different levels of assurance in the opinion of the auditor on the subject. matter.

In these reports, the responsibilities of the parties should be clearly delineated and the auditor may consider a disclaimer with respect to the inappropriate use of the reports..


Identify and explain the potential threats to the independence of a firm involved in assurance engagements.

Independence requires independence of mind and independence in appearance according to the IFACs code of ethics for professional accountants.

Independence is threatened by self-interest, self-review, advocacy, familiarity and intimidation threats.

  • Self-interest threat occurs when a firm or member of assurance team could’ benefit from a financial interest in or other self-interest conflict with an assurance client


A direct financial interest or material indirect financial interest in an assurance client A loan or guarantee from an assurance client or any of its directors and officers.

  • Self-review threat occurs when any product or judgement of previous AE, or NA E needs to be re-evaluated in reading conclusions on the assurance engagements or when a member of the assurance team was previously a director or officer of the assurance client or was an employee in a position to exert direct or significant influence over the subject matter of the assurance engagement.
  • Advocacy threat — occurs when a firm or member of the assurance team, promotes or may be perceived to promote an assurance clients position or opinion to the point that objectivity may or may not be perceived to be compromised.
  • Familiarity threat occurs when, by virtue of a close relatiOnship with an assurance client, its directors, officers or employees, a firm or member of the assurance team becomes too sympathetic to the client’s interests.
  • Intimidation threat occurs when a member of the assurance team may be deferred, from acting objectively and exercising professional skepticism by threats, actual or perceived, from the directors, officers or employees of an assurance client.



You- are the partner in charge of the audit of Futuristic Components Limited, a private company which intends to seek a public quotation for its shares.

The company is required to prepare a prospectus which must incorporate a report by the auditors of the company. The directors intend to include a profit in the prospects and you’, as the company auditor, will therefore be required by the Stock Exchange to report on the base and calculations for the forecast.


What are the preliminary considerations to be borne in mind before you would accept responsibility for reporting on the profit forecast?

Acceptance of Engagement-

The International Standard on Assurance Engagements no. 3400 states that before accepting an engagement to examine prospective financial information, the auditor would consider, amongst other things:

  • The intended use of the information;
  • Whether the information will be for general or limited distribution;
  • The nature of the assumptions, that is, whether they are best-estimate or hypothetical assumptions;
  • The elements to be included in the information; and  The period covered by the information.

ISA 3400 adds that the auditor should not accept, or should withdraw from, an engagement when the assumptions are clearly unrealistic or when the auditor believes that the prospective financial information will be inappropriate for its intended use.

In your staff briefing as to the method of approach to be adopted in the profit forecast review, list six pertinent issues which staff should consider in their examination of procedures followed by the company in preparing the forecast.

  • Whether forecasts are regularly prepared for management or prepared only for this occasion
  • Whither the recasts are best estimates, honestly believed to be achievable, or simply targets
  • The extent to which forecasts for wholly or partly expired periods are covered by reliable interim accounts.
  • The extent to which the forecasts are built up form detailed divisional or activity based sectional accounts, distinguishing those with steady performance foam those with more volatile results
  • The treatment of material, extraordinary, and exceptional items
  • The adequacy of provisions for future losses and contingencies
  • The adequacy of working capital. If finance will be required to fulfil the forecast, this should have been arranged and confirmed.

If you do not consider that certain assumptions in the forecast appear to be realistic, what action should you take?

When the auditor believes that one or more significant assumptions do not provide a reasonable basis for the prospective financial information prepared on the basis of best-estimate assumptions or that one or more significant assumptions do not provide a reasonable basis for the prospective financial information given the hypothetical assumptions, the auditor should either express an adverse opinion in the report on the prospective financial information, or withdraw from the engagement.




John Mwangi has recently asked your firm’s advice on whether to purchase Nathoo Merchants Ltd, which is a small builders’ supply merchant. John Mwangi has previously been the proprietor of a small do-it-yourself business (which is a similar trade to the builders’ supply merchant, but sells mainly to individuals), and he has recently been-left a substantial sum of money on the death of his father.

Natho Merchants ltd sells:

  1. Paint and decorating material
  2. Hand tools and small electrical tools (for instance electric drills).
  3. Electrical fittings, and
  4. Building materials (bricks, wood, sand and cement).


The current owner of Nathoo Merchants ltd is retiring and is proposing to sell his business to John Mwangi. Nathoo Merchants ltd is -financed by equity, bank loans and overdrafts. There are no current accounts or loan accounts between the directors and the company.

The audited accounts of Nathoo Merchants ltd for the three years ended 30 April are available and John Mwangi has asked you to early out an investigation into whether the accounts are reliable. The accounts of Nathoo Merchants ltd have been prepared by the auditor. From your knowledge of the auditor’s reputation and the weakness in the system of internal control in Nathoo Merchants ltd, you believe there may be material errors in the accounts.

In the year ended 30 April 2002, Nathoo Merchants ltd had a turnover of 34 million. The company operates from its own freehold premises and it sells mainly to small builders and some individuals. Most of the sales are on credit but its sales to individuals are for cash. If he decides to purchase Nathoo Merchants ltd, John Mwangi plans to work full-time in the business.

You are required to:

  • List and briefly describe the investigations you would carry out in checking:


(i) The profit and loss accounts for the three years ended 30 April 2002.

  1. Carry out ratio analysis. I would compare the following ratios and compare, the rations with previous years ratios and the industry average: –
    • Gross profit margins
    • Other operating ratios such as mark up.
  2. Review the accounting policies used in preparing the profit and loss account and assess whether:
    • They are consistent with the international Accounting Standards and the generally acceptable accounting policies (GAAPS)
    • They are applied consistently from year to year.
  3. Inspect the items within the profit and loss account to determine their identity for example:
    • Sales – search for fictitious sales. Review of the sales daybook and cashbook and cash sales will identify fictitious sales.
    • Expenses or purchases -review suppliers statement and trend of payments made.
  4. Visit a number of the business premises to assess the volume of business actually being achieved.



(ii) The balance sheet as at 30 April 2002.

  1. Carry out ratio analysis. 1 would compute the following ratios.
    • Fixed assets turnover ratio
    • Current ratio
    • Acid test ratio
    • Stock turnover ratio
    • Debtors average collection period
    • Creditor’s payment period.

List and briefly describe the factors you would consider in advising John Mwangi whether:


Stock- assesses the existence and conditions of stock (by carrying out a stock take) and its apparent value.

Debtors – circularize debtors to assess their existence value Creditors – circularize diem to identify any unrecorded liabilities.

Fixed assets – inspect them to confirm their existence and condition and determine whether they have been denied necessary repairs and maintenance.



To purchase all the shares in Nathoo Merchants ltd     

To purchase all the shares: Is the company well known by its given name and is his significant businesses derived from the use of the name’? If so, then shares should be purchased.

    • The quality of the company’s assets
    • Contractual arrangement of Nathoo with third parties.
  • or

(ii) To purchase the assets, goodwill and liabilities from the company. Your answer should describe the factors, which you would consider in advising John Mwangi which assets and liabilities of Nathoo Merchants ltd he should purchase.

  1. To purchase assets, goodwill, and liabilities: –
    • Level of liabilities. If high, then it’s better to purchase only the assets.
    • If there is no goodwill, because the company’s reputation is poor, it is better to buy the assets and operate under a new name.
    • Continuity of trading arrangements. Some contracted arrangements lapse or need to be renegotiated when ownership of the company changes. As such, the name of the company has no real value and the assets and goodwill can be bought without the name.


Mr. Kimani and Mr. Mathenge are each 50% shareholders and the only directors of K&M Ltd., a company which operates as a building contractor involved in civil engineering contracts which frequently take more than one year to complete. The turnover of the company in the year ended 31 March 2000 was in the region of Sh.1,200 million. The company has been suffering cash flow problems in recent times. Mr. Kimani and Mr. Mathenge have disagreed on the management policies of the company. As a result of this disagreement, Mr. Mathenge has agreed to sell his shares to Mr. Kimani and has resigned as a director with effect from 31 March 2000. The consideration for the shares is to be fixed by a valuation of the shares based on the audited accounts for the year ended 31 ‘March 2000.

You have been appointed the investigating accountant to review the valuation of the shares. Mr. Kimani and the auditors of K&M Ltd. have agreed to cooperate fully.


As the investigating accountant, detail those matters which you would pay particular attention to in carrying out your review.

The engagement described has aspects of an investigation as well as a review engagement. Matters that require particular attention include procedural as well as subject matter issues.

This being an investigation and review of valuation of shares the procedure will be as follows:

  • Receive instructions from the clients and confirm the specific terms of reference
  • Communicate with other auditors as a matter of professional courtesy if the investigating accountant is not the auditor of the entity.
  • Discuss with the client and make logistical arrangements for the investigation
  • Obtain background information on the investigation including understanding the entity including its internal control and assess the risk of material misstatement in the financial statements.
  • Gathering of preliminary information with regard to the business and the valuation of shares
  • Prepare the report outline akid discuss with the client so that the terms of reference and client expectations are confirmed
  • Carry out the investigation and review in detail according to the clients instructions and other professional or statutory requirements
  • Prepare my draft report and discuss it with the client
  • Finalise the report and deliver it to the client
  • Be available for further discussions, inquiries or other investigations.

Taking the above procedures ensures that the clients and the investigating accountant understand their specific roles and expectations and thus minimizes disagreements, and protects the auditor- from litigation.

With regard to the financial statements and the valuation of shares, matters to pay particular attention to include:

  • After observing the above procedures, normal courtesies, obtain copies of the audited accounts of the previous years (say three years) and critically analyse them
  • Whether the accounting policies adopted are suitable and have been consistently applied over-the years
  • Perform analytical review of the figures and whether the figures and rations make sense
  • Whether there were any qualifications in the auditors reports for the previous years and the nature of the qualifications

The audited accounts for the current period will be reviewed including:-

  • Tests of controls over the controls relevant for the preparation of reliable financial statements
  • Search specifically for any evidence of creative. accounting such as fictitious sales, over valuation of assets, understatement of liabilities, big bath provisioning, impairment of assets and vice versa.


After the above, I would then pay particular attention to the basis of the valuation of shares.

In general, the value of equity shares are determined by the expected performance of the business and current financial performance, position, cash flows and the perceived economic environment.

In particular, attention will be focused on:-

The relevance and reliability of forecast performance and economic benefits inflow. The benefits expected to be derived from continuing to hold the shares such as expected dividends, capital gains and control of the resources of the company. Historical figures are important as a basis for forecasts.

Evaluate the methods of share valuation and ensure the accuracy of the computations. There are two main bases;

  1. Earnings basis
  2. Assets basis

The earnings basis has two approaches;

  1. Dividend yield method
  2. Earnings yield method

The assets basis has two approaches also

  1. Going concern basis
  2. Break-up value basis


  • Since the company is a going concern and the shareholding to be disposed of is significant, the methods of dividend yield and break-up value is not relevant.
  • In my procedures, I will ensure that they have not been used.

I would review the computations obtained using any of the other two methods and ensure that the value is reasonable, taking into consideration the nature of the business



Auditors are frequently required to provide assurance for a range of non-audit engagements


List and explain the elements of an assurance engagement.

  1. A three party relationship. The three parties are the intended user requiring the assurance report, the responsible party (responsible for preparing the subject matter) and the practitioner, who will review the subject matter and provide assurance.
  2. A subject matter. This is the data to be evaluated that has been prepared by the responsible party. iii. Suitable criteria. The subject matter is evaluated or measured against criteria in order to reach an opinion.
  3. Sufficient appropriate evidence needs to be gathered to support the level of assurance.
  4. An assurance report, A report containing the practitiOnces opinion is issued to the intended user;



Reports produced by internal auditors are different from audit reports produced by external auditors performing audits tinder international Standards on Auditing. The reports are produced for different purposes, and are directed at different users. They differ substantially in both lot in and content. Internal audit reports often comprise the following:

  • A cover page;
  • Executive summary
  • The main report contents;


List and briefly describe the general categories of information that you would expect to find in an internal audit report under each of the four headings above

Categories of information.

  • Cover page

This would include a title, a date, the name of the author of the report and a distribution list.

  • Executive summary This would include:
    • Background to the assignment
    • Objectives of the assignment
    • Major outcomes of me work
    • Key risks Identified
    • Key action points
    • Summary of the work left to do
  • The main report contents This would include
    • Details of audit tests carried out and their findings
    • A full list of action points and who has responsibility for carrying them out
    • Future time-scales
    • Costs
  • Appendices

These would include detailed schedules and summaries which form the basis of the conclusions in the report.

List the main contents of most external audit reports. Note. You are not required to reproduce a full external audit report.

In accordance with ISA 700 Forming an opinion and reporting on financial statements the following are the basic elements of the external audit report:

  •  Title
  • Addressee
  • introductory paragraph identifying the financial statements audited
  • A statement of management’s responsibility for the financial statements
  •  A statement of the auditor’s responsibility
  • Opinion paragraph containing an expression of opinion on the financial statements
  • Any other reporting responsibilities and conclusion
  • Auditor’s signature
  •  Date of the report
  •  Auditor’s address

Explain why the contents of external audit reports prepared under International Standards on Auditing and internal audit reports are different

The format and content of the external audit report is governed by legislation and auditing standards. There is no standard format for an internal audit report. It depends on the requirements of management and the approach chosen by the individual internal auditor.

The requirement to issue an external audit report comes from company law. The internal audit reports produced as a result of the management’s decision to commission certain projects and reviews.

The main aim the external audit report is to express an opinion as to whether the financial statements are presented fairly in all material respects (or give a true and fair view). It does not aim to give a detailed account of the work performed or to offer solutions for problems identified. The Internal audit report is, normally expected to be an assessment of the work completed. It will therefore summarize results, conclusions and action points. iv) The external audit report is normally addressed to the shareholders and is a published document available to a wide range of users. As a result of this it is a highly regulated document. The internal audit report is for internal purposes only. The content can therefore be tailored more specifically to the needs of the individual business and management team.




ISA 210 Agreeing the terms of audit engagements explains the content and use of engagement letters.



State six items that could be included in an engagement letter

  • Objective of the financial statements
  • Management’s responsibility for the financial statements
  • Scope’ of the audit
  • Form of any reports or other communication of results from the engagement
  • A statement that due to the test nature and inherent limitations of the audit and internal control, there is a risk that some material misstatements may remain undetected
  • Unrestricted access to records and documentation requested for-the audit
  • Arrangements regarding planning and performance of the audit
  • Expectation of receiving written representations on specific matters
  • Request for client to confirm the terms of the engagement by acknowledging receipt of the letter
  • Basis on which fees are calculated and any billing arrangements
  • Description of any letters or reports the auditor expects to issue to the client


  • ISA 500 Audit evidence explains types of audit evidence that the auditor can obtain.

Required;-State, and briefly explain four types of audit evidence that can be obtained by the auditor.


Inspection can encompass examining records, documents or assets. Looking at records and documents: provides different levels of reliability depending on their nature and source. Inspection of assets can provide good evidence of existence but not of rights and obligations or valuation.


This consists of looking at a process or procedure being performed. An example would be observation of inventory counting.


Inquiry consists of seeking information from knowledgeable individuals, both from within and outside the organization, being audited. It can encompass either formal written inquiries or informal oral inquiries,


This is the process of obtaining a representation of information or of an existing condition from a third party, for example, a bank confirmation.


Recalculation is checking the mathematical accuracy of documents or records


This is the auditor’s independent execution of procedures or controls that were originally performed as part of the organization’s internal control, either manually or using CAATs.

Analytical procedures

Analytical procedures consist of evaluations of financial information made by a study of plausible relationships among both financial and non-financial data.

Modified audit opinions

There are three types of modified opinion:

Qualified opinion

A qualified opinion will be issued due to either the auditor being unable to obtain sufficient appropriate audit evidence in respect of a material matter or because the auditor concludes the financial statements contain material misstatements. The opinion will be expressed as being ‘except for the effects’ (or possible effects; of the matter that the qualification relates to. The misstatements (or possible misstatements) will be material but not pervasive.

Disclaimer of opinion

Where the auditor is unable to obtain sufficient appropriate audit evidence and the possible effects are both material and pervasive, the auditor is unable to express an opinion on the financial statements and a disclaimer of opinion will be expressed

Adverse Opinion

Where the auditor concludes the accounts are materially misstated andthe misstatements are both material and pervasive, the financial statements are misleading, and an adverse opinion will be expressed


  • ISA 705. Modifications to the opinion in the independent auditor’s report sets out the different types of modified opinions.


State three ways in which an auditor’s Opinion may be modified and briefly explain each modification.



You are the audit manager, of Hood Enterprises a limited liability company. The company s annual revenue is over $ 10 million.


Compare the responsibilities of the directors and auditors regarding the published financial statements of Hood Enterprises.

Preparation of financial statements

The directors have a legal responsibility to prepare financial statements giving a true and fair view. This implies that they have been prepared in accordance with the relevant lASs and IFRSs

The auditor’s duty is to carry out an audit (according to the International Standards on Auditing) and to give an opinion on whether a true and fair view is given (or whether the financial statements present fairly, in all material respects, the financial, position of the entity). In doing this they will have to consider whether the relevant accounting standards have been properly followed.

Estimates and Judgments and accounting policies

The directors have the responsibility for making the estimates and judgments underlying the financial statements and for selecting the appropriate accounting policies.

The auditor’s responsibility is to assess the appropriateness of the director’s judgments and to modify the audit opinion in the case of any disagreement causing the auditors to conclude the financial statements are not free from material misstatement.

Fraud and error

The directors have a duty to prevent and detect fraud and error. This is a duty they owe to the shareholders and there is no ‘materiality’ threshold attached to their duty.

The auditor is responsible (under ISA 240) for obtaining reasonable assurance that the financial statements are free from material misstatement including material misstatement caused by fraud.

The auditor is responsible for maintaining professional scepticism throughout the audit, considering the possibility of management override of controls. The audit team must discuss how and where the entity’s financial statement may be susceptible to material misstatement due to fraud, including how fraud might occur.


The directors are responsible for disclosing all information required by law and accounting standards.

The auditor’s responsibility is to review whether all the disclosure rules have been followed and whether the overall disclosure is adequate. There are certain pieces of information, which, if not disclosed by the directors, must be disclosed by the auditor in his report. Examples of this are related party transactions and j transactions. with directors.

Going concern

The directors are responsible for assessing whether it is appropriate to treat the business as a going concern. In doing this they should look at forecasts and predictions for at least twelve months from the reporting date. They should also disclose any significant uncertainties over the going concern status of the company.

The auditors’ responsibility is to consider whether there are any indicators of going concern problems in the company, and assess the forecasts made by directors and decide whether the correct accounting basis has been used and whether there is adequate disclosure of significant uncertainties.

The auditor must consider modifying the audit opinion in the auditor’s report if:

  1. The directors have considered a period of less than twelve months from the reporting date (this could result in a qualified opinion due to an inability to obtain sufficient appropriate evidence)
  2. The directors have used the going concern basis when the auditor believes that its use is not appropriate (this will be a result in an adverse opinion)
  • The auditor agrees with the basis chosen by the directors but feels that the disclosures are inadequate (this will probably result in a qualified except for opinion)
  1. The auditor agrees with the chosen basis, and that the disclosures are adequate but there are uncertainties over the going concern status of the company, in this case the opinion will be unmodified but an emphasis of matter paragraph will be added.
  2. b) Errors in the report extract

Presentation of information in the company’s annual report’

The auditor’s legal responsibilities relate to the financial statements, which comprise the primary statements plus the supporting notes. They do not extend to any other information, for example’s chairman’s statement or 5-year summary. To make this clear, this section should refer only to Ulf financial statements.

Under ISA 720 The auditor’s responsibilities relating to other information in documents containing audited financial statements the auditor has a responsibility to read the other information to identify whether there are any inconsistencies with the financial statements or anything that is misleading, but the primary opinion is given on the financial statements only. `In accordance with Auditing Standards’

The report should specify exactly which auditing standards have been used so that there is no risk that readers misunderstand how the audit has been done. It should specify that the audit has been performed in accordance with international Standards on Auditing.

‘Evaluating the reasonableness of all accounting estimates’

It is inappropriate to imply that the auditor has considered every estimate made by management.

This is unlikely to be true because auditors do not look at every single transaction and item in the financial statements; it is the duty of the auditor to give assurance only on whether the financial statements are -free from material misstatement.

‘As much audit evidence as possible in the time available’

This phrase is inappropriate because it implies that the auditor has not had time to obtain all the evidence that is needed, The auditor is expected to obtain sufficient evidence on which to base conclusions. The-auditor should have planned the audit so as to obtain sufficient evidence in the time available.


This word should not be used because it implies a greater degree of certainty than is possible based or’ normal audit procedures. The certainty implied by the word ‘confirm’ may expose the auditor to negligence; claims if it turns out that there are any material errors in the financial statements. A more accurate description of the level of assurance given by an audit is ‘reasonable assurance’

‘No liability for errors can be accepted by the auditor

This disclaimer at first might appear to be useful in protecting the auditor against liability. However, the view of the ACCA is that general disclaimers should not be included in audit reports, as their use would tend to devalue the audit opinion.

‘The directors are wholly responsible for the accuracy of the financial statements’

This statement should not appear in the auditor’s responsibility section of the report. Details of management’s responsibilities are differently worded and should appear in an earlier separate section of the report outlining the responsibility of management for the preparation of the financial statements.

  1. Extracts from the draft audit produced by an audit junior are given below:

We have audited the accompanying financial statements of Hood Enterprises Limited which comprise………….We have also evaluated the overall adequacy of the presentation of information in the company’s annual report.

Auditor’s responsibility

………..We conducted our audit in accordance with Auditing Standards, Those standards require that we comply with ethical requirements and plan and perform the audit so that we can confirm the financial statements are free from material misstatement. The directors however are wholly responsible for the accuracy of the financial statements and no liability for errors can be accepted by the auditor.

An audit involves performing procedures to obtain as much audit evidence as possible in the time available about the amounts and disclosures in the financial statements.

An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of all accounting estimates made by management as well as evaluating the presentation of the financial statements


Identify and explain the errors in the above extract. Note. You are not required to redraft the report.

  1. c) The directors of Hood Enterprises have prepared a cash flow forecast for submission to the bank. They have asked you as the auditor to provide a negative assurance report on this forecast.


Briefly explain the difference between positive and negative assurance, outlining the advantages to the directors of providing negative assurance on their cash flow forecast.

Positive assurance is the form of words used in a report where the auditor has obtained sufficient evidence to feel confident to give reasonable assurance that the information is free from material error. A normal audit opinion takes this form, i.e. ‘in our opinion the financial statements present fairly, in all material respects, (or give a true and fair view of) the financial position of Negative assurance is the form of words used where the auditor has obtained a lower level of evidence and can therefore give only a lower level of assurance. A review of a forecast would be an appropriate example of when this would be used. The auditor cannot be as confident about forward-looking information, based on the directors] assumptions.

A negative assurance opinion would be worded perhaps as nothing has come to our attetitiori tO suggest that the information is, not based on reasonable assumptions…

The advantages of the negative assurance would be:

  • The bank will be able to place more reliance on the forecast as it has been subject to review by an independent professional. The level of comfort given will be less than that of an audit but forecast information cannot be verified to the same degree as historical information so the negative assurance is the best that could be expected in the circumstances.

Negative assurance requires a lower level of work than a full scope audit so will be cheaper for the company.

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