AAS-2
Objectives and Scope of the Audit of Financial Statements

[Submitted by Mr. K. Pavan Kumar,
CA(final) student,
Bellary]

January 25, 2007

1. LENGTH OF THE STANDARD - 14 Paragraphs

2. SYNOPSIS

a) Introduction & Applicability
b) Audit Objective
c) Responsibility for the financial statements
d) Audit Scope
e) Effective date

3. a) Introduction and its applicability

(1) Introduction

This auditing and assurance standard deals with the overall objective and scope of the audit cast upon the auditor while performing the audit of an entity /enterprise with reference to the General Purpose Financial Statements (GPFS)

In the above paragraph the term "Auditor" is to be construed as "independent auditor"

For the above said purpose GPFS includes
i) Balance sheet
ii) Profit and loss account
iii) Other statements and Explanatory Notes which form part thereof
Issued for the use of:-
i) Shareholders / Members
ii) Creditors
iii) Employees
iv) Public at large
(Para3.3 -Preface to the Statements of Auditing Standards issued by the ICAI)

(2) Applicability
This Auditing & Assurance Standard is to be applied while performing the audit in the capacity of an independent auditor of an enterprise (profit oriented /not for profit organization, small, medium or big enterprises, trading or manufacturing or service sector, etc) of its financial statements i.e. the standard to be applied in the audit of financial statement of any entity whether profit oriented or not and irrespective of its size or legal form (unless specified otherwise)
(Para3.1 -Preface to the Statements of Auditing Standards issued by the ICAI)

b) Objective of an audit

(1) Objective of audit of financial statement:-
To enable an auditor to express an opinion on such financial statements

(2) Financial statements :-
The financial statements are to be prepared within a framework of recognized accounting policies and practices and relevant statutory requirements, if any. (Para 2)

(3) The primary objective of audit is reporting on the financial statements of an entity pertaining to the period for which the aforesaid financial statements relate to.

(4) The opinion expressed by the auditor helps to determine the true and fair view of the enterprise on

• The Financial Position - Balance Sheet
• The Operating Result - Profit and loss account

(5) However the user of the aforesaid financial statements should not assume that the opinion expressed by the auditor is neither in the nature of assurance with reference to the future viability of the enterprise nor assures as to the efficiency or effectiveness with which the management has conducted the affairs of the enterprise (Para 3)

(6) Further the user of the financial statements should not infer from the above opinion that all fraud and errors or illegal acts are detected by the auditor.

c) Responsibility for the financial statements:

(1) Preparation of the financial statements is the primary and sole responsibility of the management of an enterprise

(2) In facilitating the management of its primary and sole responsibility of preparing the financial statements it is assisted by many factors, important among them being:-

• Maintenance of adequate accounting records
• Internal controls
• Selection and application of appropriate accounting polices
• Safeguarding the assets of the enterprise

(3) Further just because the audit is completed for a particular financial period and the auditor expresses his opinion on such financial statements, the management of the enterprise is not relieved of its responsibilities. This means that the management still continues to be responsible for wrongful acts or information which lie undetected despite such financial statements are audited ( may be error/ illegal acts/ unintentional mistake ) in future .

d) Scope of an audit (Para 5)

(1) The scope of an audit of financial statements will be determined by the auditor.

(2) Scope - According to Oxford dictionary the term scope means (noun) the range of things that a subject, an organization , an activity, etc deals with

(3) The scope has to be determined having regard to the following :

• Terms of engagement
• Requirements of relevant legislation
• The pronouncements of ICAI.

Question:
Can the auditee (client) instruct / restrict the auditor to conduct and complete the audit without verifying / asking for cash book and creditors details

Response:
The terms of engagement, cannot restrict the scope of an audit in relation to matters which are prescribed by legislation or by the pronouncements of the ICAI.

PARA 6
(1)

• Auditor should cover
• all relevant aspects of the enterprise on the underlying financial statements and
• conduct the audit
• for the purpose of formation of opinion.

(2) The formation of opinion on the financial statements is based upon the fact that the auditor should satisfy himself as to the

• Reliability and
• Sufficiency
  of the information which is contained in:
        - the underlying accounting records and
        - other source data
  considering both as the basis for the preparation of the financial statements.

(3) In formation of his opinion the auditor should also verify and satisfy himself as to the relevant information whether properly disclosed in the financial statements as required by the relevant statutory provisions to the extent applicable.

(4) According to Oxford Advanced Learner's dictionary

• Reliability - That can be trusted to do something well
• Sufficiency - An amount that is enough for the particular purpose

PARA 7.
The auditor assesses the reliability and sufficiency of information contained in the underlying accounting records and other source data by accounting system and internal control system.

PARA 8
Proper disclosure of relevant information in the financial statements is determined by the auditor-

• By comparing the financial statements with
       - the underlying accounting records, and
       - other source data
• By considering other factors viz:-
       - Assessment of selection and application of accounting policies consistently
       - Manner of Classification of information
       - Adequacy of disclosure
       - Judgments made by the management in preparing the financial statements.

PARA 9
Question:
Based on the aforesaid discussion can it be said that "Absolute Certainty is attainable in auditing"?
Response:
Absolute certainty is rarely attainable in auditing because of the following factors:-

• Auditors work involves exercise of judgment in various areas
       - Deciding extent of audit procedures.
       - Assessment of reasonableness of the judgments made by the management in preparing the financial statements
       - Estimates made by the management in preparing the financial statements
• Substantial evidence available to the auditors can enable him to draw only reasonable conclusions from them.

PARA 10

• In an audit an element of unavoidable risk with reference to some material misstatement remaining undiscovered is recognized because of
       - The test nature of audit.
       - Other inherent limitations of an audit
       - Inherent limitations of any system of internal control
   
• Discovery of material misstatement is not the main objective of audit nor auditors programme of work is designed for such discovery however in many situations discovery of such material misstatements by the management may often arise during the conduct of audit
   
• Primary objective being formation of opinion on the financial statements, the auditor follows procedures designed to satisfy himself that the financial statements depict true and fair view of
  . Financial Position - Balance Sheet
  . Operating Results - Profit and Loss Account
   
• Hence the audit cannot be relied upon to ensure discovery of all frauds or errors
   
• But where the auditor has any such indication then he should extend his audit procedures to confirm or dispel his suspicions.

PARA 11
Question:
What are materiality /material items?
Response:
     1. Material items are those which might influence the decisions of the user of the financial statements

     2. Auditor is primarily concerned with items which are either
          - Individually or
          - As a group
     is material in relation to the affairs of an enterprise?

Question:
What is the yardstick to identify material items?

Response:

• It is rather difficult to lay down any definite standard / measuring rod to identity material items / by which materiality can be judged.
• Materiality is a matter in which, based on the auditor's professional experience and judgment, a decision is arrived at.

PARA 12
Question:
Are there any exception(s) to the scope of audit?

Response:
The auditor is expected to perform duties which are within his scope and not the one which is outside the scope of his competence

E.g. Physical condition of certain assets is to be determined by a technical expert and not the auditor.

PARA 13
Question:
Can there be restrictions on the scope of audit of financial statements?

Response:
The terms of engagement cannot restrict the scope of an audit in relation to the matters which are either
     - Prescribed by any legislation or
     - by the Pronouncement(s) of ICAI

• Further where the scope of work impairs the ability of the auditor to express an unqualified opinion on such financial statements, the auditor should state the restrictions and issue a qualified opinion or disclaimer of opinion, as is appropriate.

PARA 14
This auditing and assurance standard applies to all audits relating to accounting periods beginning on or after 1-4-1985.

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