Purpose and scope of an audit - True and fair presentation a...

Learning Outcomes

After studying this article, you will be able to explain the purpose and scope of an audit for the ACCA FAU exam, including the need for audits due to the separation of ownership and control. You will learn to describe what 'true and fair presentation' and 'reasonable assurance' mean in auditing, and identify the distinctions between director and auditor responsibilities.

ACCA Foundations in Audit (FAU) Syllabus

For ACCA Foundations in Audit (FAU), you are required to understand the core objectives and outcomes related to audits. This article focuses on:

• The nature, purpose, and key objective of an audit
• The need for audits due to the agency relationship between owners and managers
• The meaning and implication of 'true and fair presentation'
• The concept and practical limits of 'reasonable assurance'
• Roles and responsibilities of directors versus auditors
• The auditor’s report and the expression of opinion

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is the main objective of an external audit?
   1. Guaranteeing financial success of an entity
   2. Certifying that there is no fraud
   3. Expressing an independent opinion on the truth and fairness of the financial statements
   4. Preparing management accounts

2. True or false? An auditor’s report provides absolute assurance that the financial statements are correct in all respects.

3. In the context of companies, what does 'true and fair presentation' mean for financial statements?

4. What level of assurance does an auditor give, and why is it not absolute?

Introduction

In many businesses, there is a separation between those who own the entity (for example, shareholders) and those who manage it day-to-day (the directors). Because this separation can lead to differences in interests and information, there is a need for an independent review of the financial statements that management prepares. The audit provides this review and forms the basis of trust between owners, managers, and wider stakeholders.

An audit is not primarily about detecting every error or fraud, but about assessing whether the financial statements as a whole present a fair and unbiased picture of the entity’s position and performance.

Key Term: audit
An independent examination of financial statements, conducted to enable the auditor to express an opinion on whether they give a true and fair view.

Purpose and Need for Audit

The key reason audits exist is to bridge the information gap caused by the division of ownership and control.

• Principals: The owners or shareholders, who need information to assess how effectively their resources are managed.
• Agents: The directors or managers, who carry out the day-to-day operations and prepare financial statements.

There is a potential for bias or error in the information provided by management. An audit addresses this by providing an independent opinion, giving greater credibility to the financial statements.

Key Term: agency relationship
A relationship where the owners (principals) appoint managers (agents) to run the entity on their behalf. The audit helps resolve trust issues inherent in this setup.

True and Fair Presentation

A central principle of the auditor’s report is the requirement that financial statements show a "true and fair view" (sometimes worded as "present fairly, in all material respects").

This does not mean that every figure must be perfectly accurate, but rather that:

• The statements are free from material errors or misstatements,
• The information provided is reliable, neutral, and complete as far as users need,
• Judgements and estimates are reasonable and made in line with relevant accounting standards.

Everyday meanings of "true" and "fair" do not easily apply to financial statements. There are always estimates and some subjectivity (such as asset valuations, provisions, or depreciation policies). Therefore, the auditor applies professional judgement to assess whether the overall picture conveyed is honest and unbiased.

Key Term: true and fair presentation
The requirement that the financial statements are free from material misstatement and present an unbiased, reliable summary of an entity's financial position and results.

Reasonable Assurance: The Auditor’s Objective

The main audit objective is to obtain reasonable, but not absolute, assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error. The auditor then expresses an opinion in a report addressed to the owners.

The audit cannot provide a guarantee for several reasons:

• Auditors use sampling, not detailed checking of every transaction.
• Internal controls have inherent weaknesses (e.g., human error, management override).
• Some audit evidence is persuasive, not conclusive.
• Estimates and judgements are unavoidable.

Key Term: reasonable assurance
A high but not absolute level of confidence, based on sufficient and appropriate evidence, that the financial statements are free from material misstatement.

Worked Example 1.1

A company's profit has doubled in one year according to the directors’ report. Some shareholders suspect this is exaggerated to secure bonuses for the directors. How does the audit provide comfort to shareholders?

Answer:
The audit involves independent examination of the evidence supporting the profit figure. By expressing an unmodified opinion that the accounts give a true and fair view, the auditors give shareholders confidence that the reported profit is not materially misstated. This helps ensure that management’s claims are credible and trustworthy.

Exam Warning

A common misconception is that auditors certify financial statements are completely correct. In reality, the audit gives reasonable assurance only—the nature of evidence and testing means some risk of undetected material misstatement always remains.

Scope and Responsibilities

The audit covers the entity's entire financial statements for the period, usually prepared under a defined financial reporting framework (such as IFRS).

• Directors are responsible for preparing the financial statements and maintaining effective internal controls.
• Auditors are responsible for obtaining reasonable assurance and reporting independently to the owners.

The auditor’s work includes:

• Understanding the business, internal controls, and risks of material misstatement,
• Planning audit procedures (including sampling, substantive tests, and analytical review),
• Forming an opinion based on gathered evidence.

Reporting: Expression of Opinion

At the end of the audit, the auditor issues a formal report. The standard report states:

• Which financial statements were audited,
• The basis for the auditor’s opinion,
• The auditor’s opinion—whether the statements give a true and fair view (or are fairly presented),
• The basis of accounting used,
• Responsibilities of management and the auditor.

If the auditor cannot obtain sufficient evidence, or identifies a material misstatement, the opinion may be modified.

Worked Example 1.2

If an auditor finds a minor error that does not affect the overall view of the accounts, what assurance is provided?

Answer:
Provided the error is not material, the auditor can still express an unmodified opinion. “Reasonable assurance” is based on the absence of material—not all—misstatements.

Summary

An audit is an independent review of the financial statements, necessary due to the agency relationship between owners and managers. The main objective is to express an opinion on whether the statements offer a true and fair view, supported by reasonable assurance from sufficient evidence. This gives users confidence, even though an audit is not a guarantee of absolute accuracy.

Key Point Checklist

This article has covered the following key knowledge points:

• Define the purpose and scope of an audit
• Explain the agency relationship and why audits are needed
• State what is meant by ‘true and fair presentation’
• Describe the concept and limits of reasonable assurance
• Differentiate between responsibilities of directors and auditors
• Summarise the contents and role of the auditor’s report

Key Terms and Concepts

• audit
• agency relationship
• true and fair presentation
• reasonable assurance