LECTURE 1 – Chapter-1
Topic: Introduction To Assurance
LO 1: ORIGIN AND ADVANTAGES OF ASSURANCE SERVICE:
Origin of Assurance Services:
Since the Industrial Revolution in 18th century, businessmen started forming Joint Stock Companies to do
business. Usually, people who manage the company (called management or directors) are separate
from those who own the company (called shareholders). Although in some companies, both may be
same (in owner managed business such as SMCs and Family businesses).
To judge the performance of management and directors, shareholders asked them to prepare and
present them financial statements (F/S). Soon after, it was realized that financial statements prepared by
management/directors presented “best-view” of business instead of “true-and-fair- view” due to some
Incentives (e.g. bonus) or Pressures (e.g. fear of removal) faced by management.
Thus, credibility of financial statements was questioned. To enhance the credibility/ confidence/
assurance on these financial statements, an expert person (called assurance provider or auditor) was
hired by Shareholders to verify financial statements. Auditor is independent of both management and
shareholders.
Services of auditors were appreciated greatly. Now a days, assurance engagements are performed
either because:
they are required by law (called statutory assurance engagements e.g. most companies are required
by law to get their annual financial statements audited before they are given to shareholders), or
they are not required by law but are voluntarily performed because of its advantages (called non-
statutory assurance engagements e.g. audit or review of Sole- proprietorships, Partnerships, Not for Profit
Organizations, and Small companies conducting an audit).
Relationship between shareholders and directors/management:
Following concepts explain the nature of relationship of directors/management with shareholders:
STEWARD:
Stewardship is the practice of managing other person’s property. The directors have a stewardship role.
They look after the assets of the company, and manage them on behalf of shareholders.
AGENT:
An agent is an individual who acts on behalf of the principal. In a company, Directors are agents and
shareholders are principal i.e. directors act in accordance with instructions and in best interest of
shareholders.
ACCOUNTANBLE:
As agents of the shareholders, directors are accountable to shareholders. Directors show their
accountability to shareholders by preparing annual financial statements and presenting them to the
shareholders for their decision making.
Advantages of Audit/Assurance Engagement:
1. It increases credibility of financial statements, as most of the misstatements are identified.
2. Auditor identifies deficiencies in entity’s internal control system, and gives recommendations to
management to improve it.
3. It confirms that management is performing its statutory and non-statutory duties.
4. It assists in sale or purchase of business.
5. It assists in grant of loan by bank.
LO 2: DEFINITION AND ELEMENTS OF ASSURANCE ENGAGEMENT:
Assurance Engagement:
“Assurance engagement” means an engagement in which a practitioner obtains evidence about
evaluation of a subject matter against suitable criteria, and expresses his conclusion to enhance the
confidence of the intended users (other than the responsible party).
Elements of Assurance Engagement:
Every assurance engagement consists of following 5 elements:
2
LO 3: LEVELS OF ASSURANCE AND WHY ABSOLUTE ASSURANCE
CANNOT BE PROVIDED:
Assurance means confidence. There are three levels of assurance depending on extent of
work i.e.
3
4
SUGGESTED ANSWERS:
Author’s Comments:
In a question of reproduction, students are advised to write in exam only what they learn from book. Do
not try to produce or explain material on your own. Usually, it results in ‘irrelevant’ points.
5
6
7
-------------------------------------Best Wishes-----------------------------------