Nature, Objective and Scope of Audit – Exam Notes

Lesson 1: Nature, Objective and Scope of Audit – Exam Notes

1. Meaning of Audit

Definition:

“An audit is an independent examination of financial information of any entity, whether profit-oriented or not, irrespective of size or legal form, conducted with a view to expressing an opinion thereon.”

Key Features

Independent Examination
- Auditor must be free from influence.
- Independence ensures objectivity.
Examination of Financial Information
- Includes financial statements and accounting records.
Applicable to Any Entity
- Company, LLP, Partnership, Trust, NGO, Society, etc.
Purpose: Expression of Opinion
- Auditor gives opinion through audit report.

2. Nature of Audit

Audit Provides Assurance

Audit increases confidence of users in financial statements.
It provides reasonable assurance, not absolute assurance.

Responsibilities

Management	Auditor
Preparation of Financial Statements	Expression of Opinion
Maintenance of Books	Verification & Reporting

3. Origin of Auditing

Historical Background

References found in Kautilya’s Arthashastra (4th Century BC).
Word Audit derived from Latin word “Audire” meaning “To Hear”.
ICAI established in 1949 for regulating Chartered Accountancy profession in India.

4. Interdisciplinary Nature of Auditing

Auditing is linked with several subjects:

(a) Accounting

Audit reviews accounting records and financial statements.

(b) Law

Knowledge of Companies Act, Tax Laws, etc.

(c) Economics

Understanding economic environment.

(d) Behavioural Science

Interaction with management and employees.

(e) Statistics & Mathematics

Sampling techniques.

(f) Data Processing

EDP/Computerized Auditing.

(g) Financial Management

Ratio Analysis
Working Capital
Funds Flow

(h) Production

Understanding business operations.

5. Objectives of Audit (SA 200)

Primary Objectives

1. Obtain Reasonable Assurance

Financial statements are free from material misstatements caused by:

Fraud
Error

2. Express an Opinion

Whether financial statements are prepared in accordance with the applicable financial reporting framework.

3. Report Findings

Issue audit report and communicate findings.

Reasonable Assurance vs Absolute Assurance

Reasonable Assurance	Absolute Assurance
High level assurance	Complete guarantee
Audit provides this	Audit cannot provide this

Exam Point: Audit provides High but not 100% assurance.

6. Scope of Audit

What Audit Includes

1. Coverage of All Relevant Aspects

Audit should be planned to cover all significant areas.

2. Reliability and Sufficiency of Information

Auditor evaluates:

Books of account
Vouchers
Bills
Documents

3. Proper Disclosure

Ensures:

Proper classification
Adequate disclosure
Compliance with Accounting Standards and Law

4. Expression of Opinion

Final outcome is audit report.

What Audit Does NOT Include

Auditor is NOT:

❌ Engineer
❌ Valuation expert for technical assets
❌ Expert in authentication of documents
❌ Investigator

Audit vs Investigation

Audit	Investigation
General purpose	Specific purpose
Broad scope	Narrow scope
Reasonable assurance	Detailed examination

7. Inherent Limitations of Audit

Because of these limitations, audit cannot provide absolute assurance.

(1) Nature of Financial Reporting

Management judgments involved.
Internal controls may fail.

(2) Nature of Audit Procedures

Sample checking.
Auditor cannot verify every transaction.
Possibility of fake documents.
Management may conceal fraud.

(3) Audit is not Investigation

No search powers.
No power to record statements on oath.

(4) Timeliness Constraint

Information loses relevance over time.

(5) Future Events

Future uncertainties cannot be predicted.

Mnemonic:

FNITF

F – Financial Reporting
N – Nature of Procedures
I – Investigation (Not)
T – Timeliness
F – Future Events

8. Engagement

Meaning

An arrangement under which auditor agrees to provide services to a client.

Engagement Letter

Formal agreement between auditor and client.

9. Benefits of Audit

Advantages

High-quality financial information.
Safeguards shareholders’ interests.
Moral check on employees.
Helps tax authorities.
Assists lenders and banks.
Detects frauds and errors.
Identifies control weaknesses.

10. Audit – Mandatory or Voluntary?

Mandatory Audit

Examples:

Companies Act Audit
Tax Audit

Voluntary Audit

Done because of benefits and stakeholder confidence.

11. Appointment of Auditor

Generally Appointed By:

Owners
Shareholders
Partners
Government authorities (where applicable)

Company Auditor

Appointed by shareholders in AGM.

Government Company Auditor

Appointed by the Comptroller and Auditor General of India (CAG).

12. Audit Report

Submitted To

The person who appoints the auditor.

Examples:

Company → Shareholders
Firm → Partners

13. Assurance Engagement

Meaning

An engagement where a practitioner provides a conclusion to increase users’ confidence in information.

Elements of Assurance Engagement

5 Elements

Three-party relationship
Appropriate subject matter
Suitable criteria
Sufficient appropriate evidence
Written assurance report

Mnemonic:

TPSEW

T = Three Party Relationship
P = Proper Subject Matter
S = Suitable Criteria
E = Evidence
W = Written Report

14. Audit vs Review

Basis	Audit	Review
Assurance	Reasonable	Limited
Level	High	Moderate
Procedures	Extensive	Fewer
Example	Statutory Audit	Interim Review

15. Types of Assurance Engagements

(A) Reasonable Assurance Engagement

Example:

Audit of Financial Statements

(B) Limited Assurance Engagement

Example:

Review of Financial Statements

(C) Other Assurance Engagements

Examples:

Prospective Financial Information
Internal Control Reports

16. Qualities of an Auditor

Important Qualities

Integrity
Independence
Tact
Patience
Judgement
Reliability
Professional Competence
Knowledge of Accounting
Clear-headedness

17. Engagement Standards

Types

1. Standards on Auditing (SA)

Audit of historical financial information.

Examples:

SA 200
SA 230
SA 315
SA 500
SA 700

2. Standards on Review Engagements (SRE)

Examples:

SRE 2400
SRE 2410

3. Standards on Assurance Engagements (SAE)

Examples:

SAE 3400
SAE 3420

4. Standards on Related Services (SRS)

Examples:

SRS 4400
SRS 4410

18. Standards on Quality Control (SQC)

SQC 1

Purpose:

Ensure compliance with professional standards.
Ensure quality control within firms.
Ensure appropriate reports are issued.

19. Why Standards Are Needed?

Global benchmarks.
Improve reporting quality.
Promote uniformity.
Enhance professional skills.
Ensure audit quality.

Exam Quick Revision

Definition of Audit

Independent examination of financial information to express an opinion.

Audit Provides

✅ Reasonable Assurance

Audit Does NOT Provide

❌ Absolute Assurance

Objectives of Audit

Reasonable assurance
Express opinion
Report findings

Inherent Limitations

FNITF

Financial reporting
Nature of procedures
Investigation (not)
Timeliness
Future events

Elements of Assurance Engagement

TPSEW

Three-party relationship
Proper subject matter
Suitable criteria
Evidence
Written report

Engagement Standards

SA + SRE + SAE + SRS

Quality Control Standard

SQC 1

Most Important SA for Chapter 1

SA 200 – Overall Objectives of the Independent Auditor and Conduct of Audit