Basic Concept of Audit and its Engagement

12 months ago

Audit is an independent examination of financial information of any entity whether profit making or not, irrespective of its size & legal structure, when such an examination is conducted with a view to express an opinion thereon.

In Nepal, an audit is to be conducted by a professional having a good accounting and auditing background. A Chartered Accountant having certificate of practice under a special act, The Nepal Chartered Accountants Act, 1997 is eligible to conduct audit.

Some of us may be confused with the term accounting and auditing. These two can be differentiate from the following basis:

Basis Accounting Auditing
Meaning Accounting is an art of Recording, classifying and summarizing financial information. Audit is an independent examination of financial information of an entity to express an opinion thereon.
Function It records financial aspects of the entity. It reviews the accounting system.
By Whom Any person having good knowledge of accounting Statutory audit can only be conducted by a chartered accountant.
Principles As per accounting standards (AS) As per Auditing Standards (SAs)
Primary Responsibility The management is responsible for maintaining an up to date and proper accounting system. The auditor is responsible for forming and expressing an opinion on the financial statements.
Time of Occurrence Accounts are prepared by the management prior to getting them audited. Auditing is examination of financial information, thus, can’t be conducted prior to accounting.


The primary objective of audit of financial statements is reporting (i.e. to express an opinion on such financial statements). The auditor reports whether financial statements represent true and fair view.

True and fair view can be examined by considering whether:

  • Financial statement has been prepared using consistent and acceptable accounting policies.
  • Financial statement comply with the relevant rules and regulations as per SA- 250
  • Financial statements contain disclosure of all material matters.

The secondary objective of audit is detection of misstatement in financial statements. As per SA-240, the primary responsibility of prevention, detection and correction of misstatement lies with management. However, if there are doubtful situation that some material misstatement may exist, auditor should extent his procedure to confirm the doubt and again if he notices material misstatement resulting from fraud, he should communicate the same at appropriate level of management.

Preparation for an audit
To conduct an audit, first we need to know the process of audit. For this the auditor should first accept an audit from the entity which has requested to perform the audit of financial statements which compromise of Balance Sheet as at year end, Statement of Profit & Loss and Cash flow statement for the year then ended, and a summary of significant accounting policies and other explanatory information.

SA 210 Agreeing the terms of Audit Engagements

There is a Standard on Auditing (SA 210) which deals with the auditor’s responsibilities in agreeing the terms of audit engagement with management and, where appropriate, those charged with governance.

The objective of the auditor is to accept or continue an audit engagement only when the basis upon which it is to be performed has been agreed, through:

  1. Establishing whether the preconditions for an audit are present; and
  2. Confirming that there is a common understanding between the auditor and management and, where appropriate, those charges with governance of the terms of the audit engagement.


Preconditions for an audit:
The use by management of an acceptable financial reporting framework (FRF) in the preparation of the financial statements and the agreement of management and, where appropriate, those charged with governance to the premise on which an audit is conducted.

In order to establish whether the preconditions for an audit are present, the auditor shall:

  1. Determine whether the financial reporting framework to be applied in the preparation of the financial statement is acceptable.
  2. Obtain the agreement of management that it acknowledges and understands its responsibility:
  3. For the preparation of financial statements in accordance with applicable FRF including their fair presentation.
  4. For such internal control as management determines is necessary to enable the financial statements that are free from material misstatements, whether due to fraud or error; and
  5. To provide the auditor with:
  • Access to all information such as records, documentation and other matters;
  • Additional information that the auditor may request from management for the purpose of the audit; and
  • Unrestricted access to persons within the entity from whom the auditor determines is necessary to obtain the audit evidence.

If the preconditions for an audit are not present, the auditor shall discuss the matter with management. Unless required by law or regulations to do so, the auditor shall not accept the proposed audit engagement.

Also, prior to acceptance, if the management imposes limitations on the scope of the auditor’s work and the auditor believes the limitation will result in the auditor disclaiming an opinion on the financial statements, the auditor shall not accept the audit.

Agreement on Audit Engagement Terms
The auditor shall agree the terms of the audit engagement and shall be recorded in an audit engagement letter including:

  1. Objective and scope of audit of the financial statements;
  2. Responsibilities of auditor and management
  3. Identification of the applicable FRF for the preparation of the financial statements
  4. Reference to expected form and content of reports to be issued by the auditors

If Law or regulation prescribes terms, then no need for separate written terms, except that management acknowledges the same.

Financial reporting framework
 is defined as a set of criteria used in the preparation of the financial statements that is acceptable in the view of the nature of the entity and the objective of the financial statements, or that is required by law or regulation.

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