What is reasonable assurance: why an auditor does not guarantee «not a single error», and the key terms of audit

Rustam from the first lesson invited an independent auditor, Nilufar, to audit his three shops. As the contract was being signed, he asked straight out: «After the audit, will you guarantee that not a single error is left in my accounts?» Nilufar answered calmly: «No. I will give you a high level of assurance, but I cannot give an absolute guarantee.» Rustam was puzzled: then what is the use of an audit? In this lesson we answer that question.

What is reasonable assurance?

International standards on auditing apply in Uzbekistan as the standards of auditing activity (Law «On Auditing Activity», Article 9). ISA 200, which sets out the auditor's overall objectives, expresses this objective in exactly these words: the auditor must obtain reasonable assurance that the statements contain no material misstatement.

By the standard's definition, reasonable assurance is a high, but not absolute, level of assurance. The auditor achieves it by gathering sufficient appropriate evidence and reducing the risk that a material misstatement remains in the statements to an acceptably low level. The standard also gives the reason why it is not absolute: most of the evidence the auditor gathers is persuasive rather than conclusive.

A simple comparison: a doctor says «you are healthy» on the basis of tests and an examination. You can rely on this conclusion, but it is not a guarantee that you will never fall ill in the future.

Why there is no absolute guarantee: three reasons

ISA 200 links the inherent limitations of an audit to three sources. Let us look at them in Rustam's shops:

1. The statements themselves rely on estimates. Some figures come not from an exact count but from judgement. For example, nobody knows exactly which customers who bought on credit will not repay their debt. The auditor checks that such an estimate is reasonable, but cannot foresee the future.
2. Audit procedures have limited reach. The auditor does not have an investigator's powers. If two sales assistants collude, sell without issuing receipts and do not put the money in the till, such deliberately concealed activity is very hard to find.
3. Time and cost are limited. More than 30 000 receipts were issued in the three shops in a year. Checking all of them one by one would take months and cost more than the benefit the audit provides. That is why the auditor checks selectively.

Eight key terms of audit

1. Audit evidence. Any information on which the auditor's opinion is based: a document, the result of a count, an external confirmation, a recalculation. Mini example: Nilufar counted the sacks of flour in the shop and compared them with the balance in the books; the result of the count is her evidence.
2. Materiality. A measure of how large a misstatement must be to influence the decisions of a user of the statements. Mini example: a rounding difference of a few thousand soum does not affect Rustam's decisions, but if a whole month's takings of one shop were left unrecorded, that would be a material misstatement.
3. Audit risk. The risk that the auditor expresses a positive opinion when the statements contain a material misstatement. The auditor reduces it not to zero but to an acceptably low level. Mini example: if Nilufar did not check the stock balance at all, the risk of missing a hidden shortage would rise sharply.
4. Audit sampling. A method of checking part of a population and applying the conclusion to the whole population. Mini example: from more than 30 000 receipts the auditor selects some according to a set rule and, based on the differences found, draws a conclusion about the whole population.
5. Professional skepticism. A questioning mind: checking every explanation against evidence. ISA 200 requires the auditor to plan and perform the audit with this attitude. Mini example: a sales assistant said «there is no shortage», but Nilufar counted the goods anyway. This is not distrust of the assistant, it is simply how the work is done.
6. Internal control. The procedures the business itself has put in place to prevent errors and abuse. Mini example: every evening the till report is checked not by the sales assistant but by another employee. The auditor studies how reliable such controls are and plans the work accordingly.
7. Fraud. Deliberate deception to obtain an unjust gain. Its difference from an ordinary error is that an error is made unknowingly. Mini example: a sales assistant sells without issuing a receipt and keeps the money. The second reason above is connected with exactly this kind of situation.
8. Unmodified opinion. The positive opinion the auditor expresses on concluding that the statements have been prepared correctly in all material respects. Mini example: the phrase «in all material respects» in Nilufar's report expresses exactly reasonable assurance: it says «there is no material misstatement», not «there are no errors whatsoever».

The glossary page for each term is in the links at the end of the page.

Practical takeaways for Rustam

• «The auditor did not find it» does not mean «there is no error». An audit reduces the risk of material misstatements, but it does not replace day-to-day control.
• Internal control is needed alongside the audit. The second person checking the till works every day, while the auditor comes after the period has ended.
• Give the auditor complete information. The more complete the evidence, the better grounded the auditor's opinion.

In the next lesson

In the third lesson we will get to know the types of audit: how external and internal audit, and mandatory and voluntary (initiative) audit, differ from each other.