The objective of auditing financial statements is for the auditor to express an opinion on whether the statements are prepared, in all material respects, in accordance with the applicable financial reporting framework — not to certify that they are free of any error.
1 Reasonable, not absolute, assurance
An audit gives reasonable assurance: a high level of confidence, but not an absolute one. Three reasons make complete certainty impossible:
- Testing by sample rather than the whole population, for reasons of time and cost.
- The inherent limitations of internal control, such as collusion or management override.
- Judgements and estimates in the statements themselves, such as depreciation and the provision for doubtful debts.
The expectation gap
Many people assume the auditor “guarantees” that there is no fraud. In truth their responsibility is to obtain reasonable assurance that the statements are free of material misstatement, whether from fraud or error — less than a guarantee, and much more than a read-through.
2 Who appoints the auditor?
Audit committee
Reviews proposals, nominates and assesses independence
Board of directors
Puts the nomination to the general assembly
General assembly
Appoints the auditor and sets the fee
The auditor
Submits the report to the shareholders
A sequence that protects independence: the party being audited does not appoint its own auditor
In the Kingdom of Saudi Arabia the audit profession is regulated by the Saudi Organization for Chartered and Professional Accountants (SOCPA); the International Standards on Auditing as endorsed in the Kingdom are applied, and financial statements are prepared under the endorsed International Financial Reporting Standards.
3 What does the auditor examine?
| Assertion in the statements | The question the testing answers |
|---|---|
| Existence and occurrence | Does the asset actually exist? Did the transaction happen? |
| Completeness | Was everything that should have been recorded in fact recorded? |
| Rights and obligations | Does the organisation really own the asset, and is the liability really its own? |
| Valuation and allocation | Is the amount measured and allocated correctly? |
| Presentation and disclosure | Is it presented in the right place and disclosed as required? |
Why these assertions?
Because every figure in the statements carries an implicit claim by management. The auditor’s job is to test those claims one by one with evidence, not merely to read the numbers.
4 What is not the auditor’s job?
- They are not responsible for preparing the statements: that is management’s responsibility.
- They do not assess management’s competence or opine on the merits of its commercial decisions.
- They do not guarantee the organisation’s survival, though they do evaluate the going concern assumption and disclose material uncertainties.
- They do not examine every transaction, nor hunt for every irregularity however small.
The question: “The auditor audited our statements and gave us a clean opinion, and then a small embezzlement was discovered at one of the branches. Did the auditor get it wrong?”
The answer: not necessarily. The opinion concerns the statements being free of material misstatement. An embezzlement of an amount with no material effect on the statements may well not be caught by procedures designed at the materiality level. The more important question remains: where were internal control and internal audit? That is primarily their territory.
Lesson summary
- The objective of an audit is to express an opinion on whether the statements are fairly presented in all material respects.
- The assurance is reasonable, not absolute, because of sampling, control limitations and estimates.
- The audit committee nominates; the general assembly appoints and sets the fee.
- The auditor tests management’s assertions: existence, completeness, rights, valuation and presentation.
- Preparing the statements is management’s responsibility, not the auditor’s.
5 Test your understanding
Three quick questions
Pick the answer you believe is correct and you will see the result immediately.
1. What level of assurance does an audit provide?
Sampling, estimates and control limitations rule out absolute certainty, and the professional standard itself says “reasonable assurance”.
2. Who appoints the external auditor in a joint stock company?
If executive management appointed the auditor, the party being audited would be choosing its own auditor, and independence would collapse.
3. Who is responsible for preparing the financial statements?
Management prepares the statements and bears responsibility for them; the auditor expresses an independent opinion on them.