Differing levels of audit assurance, ACCT1111: Auditing and Assurance Services

1. Outline of the topic

As the demand for assurance services is significantly increasing, the International Federation
of Accountants(IFAC), who is the worldwide organization for the accountancy profession, are
faced with the challenges of determine the appropriate levels of assurance needed and the
best method for reporting on these engagements. Under this pressure, the IFAC had released
a new study which provides an in-depth analysis of these issues and offers guidance that
help accountants worldwide and, especially those who use the reports they issue in the early
of this century. However, it is not so simple that auditors can follow this guidance. There are
several complicated situations with these issues. It evoked huge debates about this topic.
The accounting profession has long contended that an audit conducted in accordance with
generally accepted auditing standards (GAAS) provides “reasonable assurance” opposed to
“absolute assurance”. There are lots of definitions of what “reasonable assurance” means,
even the profession cannot tell.

There are responses of stakeholders’ (such as users, suppliers, standard setters and
regulators) regarding to these levels of audit assurance. This role play activity aims to try to
present the confusion of different users regarding to differing levels of audit assurance.

The key issues to be discussed:

 How comes an auditor could be possible to sign off different levels of assurance from
“reasonable assurance”?
 If the situation occurs, which level would that assurance be, higher or lower?
 Is there any possibility that auditors provide a higher level from a guarantee?
 Are the differing levels of audit assurance cost same?
 What would be the consequence for auditors’ legal liability if levels of assurance
existed?
 Is there confusion in the marketplace about the levels of assurance provided?

2. The motivation of choosing this topic:

Audit report is important for a company .Essentially, management is responsible for

designing an accounting information system that will capture all of its business transactions
and compile the financial statements. However, anyone outside the company, such as a
current or potential investor or creditor, may be concerned about whether management has
put the financial statements together without bias. The audit assurance is such an important
issue that it makes the auditors’ report trustable. Also it distinguishes different
circumstances to meet different users’ enquiries. Auditors now face an increasing demand
for more accountability, more perceived benefits and more profession for users of financial
information. To have better understanding what we are currently learning and doing about
the course of audit, this topic is necessarily for us to analyse. Also, we could benefit on the
issues which we could come across in our further careers.

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3. Full transcription of the dialog used in the video

Company Background
C&S Wool Products Australian Pty Ltd is a Medium-sized Enterprise company which
specialized in producing woolen product. C&S’s has a good reputation in Melbourne and
performs excellent in the related industry since 2000. Holding the dream of being the leader
of woolen products, the director is waiting for the opportunity to go public.

Scenario1:
In the late 2010, as the increasing demand of exporting the woolen products, it is the time
for the company to go public in Australia Stock Exchange (ASX) .The director of C&S asked the
CFO, Mandy to taking charge of this issue.

Location: Gelivable Agency Company

Character：Sara-Consultant Mandy-C&S company’s CFO

C: Hello, I am Mandy, from C &S Company. Here is my business card. I’ve made an
appointment a week ago.

A: Hi, I am Sara, in charge of your company’s case. Well, I went through all your companies`
background and all the information you provided for the last five years.

C: Cool, as you know, the demand of our products is increasing all over the world, now it is
time for us to being a listed company in the ASX Market. Thus it will provide an opportunity
to attract investors. We will have an even excellent development. What do you think? Is it
hard for us to achieve that goal?

A: That sounds your company has an extreme goal to achieve. That’s good. To be honest,
Australia provides a lower threshold for a company to be listed.

C: Oh, really?

A: Yes, definitely, you can compare with other countries, er.., like USA, Japan and Singapore.
Their requirements are much higher than ASX does.

C: That sounds lucky that we are in Australia.

A: Yes, that is right. For those companies, similar as your company, running well and wants to
get higher develop in the future. That is a good idea for your company to be listed in ASX in
order to widen your business.

C: Well, nice. You give me the confidence to achieve this goal.

A: (laugh) So, the next step is preparing all the stuff that meet the requirement of a listed

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company. Here is the check list.(pointed to the paper)

C: Wow… so many enquires to satisfy…

A: Yes, but don’t worry. See, your company has already satisfied these three items : (the $2
million net tangible assets; minimum 500 investors, each hold $2000; 1 million net profit
over past 3 years or more, or $400,000 net profit over last 12 months),right? Nevertheless,
the most important thing, in order to let you easily being listed, you have to provide a
professional auditor’s report with a high level of assurance which means that there is a
strong proof of your financial activities…emm…like financial report, income statement…ect.

C: Oh, that is perfect. I’ll ask auditor to provide that for you. And anything else we should do?

A: Oh, I nearly forgot… Your company must also meet some specific requirements like eligible
thing. Please take all documents next time, and we will discuss more detailed…Let me see
(schedule), can we meet at 1:00pm next Thursday?

C: Ok, that is fine. See you next Thursday. Bye.

A: Bye.

(The next Thursday Mandy went to Pwd Auditing company to asked them to provide a report
with a high level assurance which cost high.)

C&S Company becomes a listed company successfully, and it has developed very well. The
company has a good performance that it attracts a lot of investors.

Scenario 2:
A year later…

Investor Jean saw the prospectus of C&S Company on ASX website, she intends to invest
$500,000 in that company. However, due to the failure of investment several years ago, she
becomes more cautious and wants to do a face to face enquiry with the company.

Character: Mandy-CFO of C&S Company, Jean-Investor

Location: C&S Company’s office

C: Hello, I’m Mandy, in charge of financial apartment of our company and here is my
business card.

I: Hi, I’m Jean, I just contacted your office yesterday afternoon.

C: Oh, yes, are you the lady who is interested in our company and want to invest in our

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company? Nice to meet you, Jean.(handshakes)

I: Nice to meet, you too. Actually I saw your prospectus on the website, and I think your
company is a new one on the list, the price is not that high per share, and according to your
past financial performance shown to the public, your company has a great potential to grow
in the future years.

C: As you may already know, our company has a good reputation in Melbourne and performs
excellent in the related industry since 2000. And our products are popular both in Australia
and overseas, our current productive capacity can’t meet the demand of all customers, our
company has a great potential to expand and pay more to our investors during the future
years.

I: Well, I already view the website of your company and have a basic understanding of your
company and I am confident in your company that’s why I’m here. But.. Err.. three years ago,
I invest a big amount in Fincorp company, do u know this company?

C: Oh, is that the one collapsed 3 years ago?

I: Exactly! During the financial crisis, it went bankrupt, which caused me lost $250,000. You
know, before I invested in Fincorp Company, I spent a lot of time researching on financial
situation and earning performance of Fincorp, and at that time I was pretty much sure it
would have a bright future and my investment must be brilliant, however, what happened
proved I failed. Now, I’m more cautious about my investment.

C: Oh, I got you, and although I’m 100% confident about our company, I totally understand
what you are worried about, then, what can I do for you, Jean?

I: If it is possible, I want a guarantee about the financial situation of your company to lower
my risk of investment, for example, a high level assurance of audit report of your financial
statement. Because I intend to invest about $500 000 in your company, I don’t want to face
the horrible situation again.

C: That’s really a huge amount, well, I will discuss with our director about whether we could
satisfy your requirement and response you as soon as possible. Anything else I could help?

I: That’s all, I will wait for your response.

C: Ok, really glad to talk with you, see you then.

I: Bye.

Scenario 3:
The CFO is confused about the existing audit report. She is not sure whether the high level

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of assurance last year is what the investor wants now. So she come to Pwd company‘s
auditor Julia’s office to ask for professional opinions

Character: Mandy-CFO of C &S company Julia-Auditor

Location: Auditor’s office

C: Good afternoon, Julia. I am Mandy from C &S Company and I’ve made an appointment
with you yesterday.

A: Oh…the CFO of C&S company. Nice to see you again. How can I help you?

C: Nice to meet you, too. I just have something confused. Last year you provided us a report
which is high level of assurance. Now the situation is that, one of the biggest investors is
interested in investing our company. She is cautious with her investment. She asked us to
provide an auditor’s report with high level of assurance like a “guarantee”. Can you just
provide a report like that to her?

A: Well, generally speaking, the audit assurance is different from that so-called “guarantee”.
It is impossible for us to give, because we are dealing with information provided by you-our
customer, in other words, the report is what we’ve expressing the view on. The “guarantee”
only can be given by your company’s performance. I cannot provide the high level of
assurance to her.

C: Okay, in what situation should you sign off a higher level of assurance?

A: Generally, we provide a reasonable level of assurance which means there is a relatively

low level of risk that material mis-statements will not be prevented or detected on a timely
basis. We cannot broaden the scope under the report unless it’s a special-purpose audit
which the client, the trustees, are asking to do, just like last time we did.2

C: Then what is the difference between different levels of audit assurance?

A: The auditing standards have only settled on one level of assurance for audit which is
reasonable assurance with the other level for assurance which is review the limited
assurance. Differing levels of audit assurance is for different purposes.

C: In what situation would you provide that higher level of audit assurance?

A: Like the circumstance last time, you are willing to go public…others like you want to apply
to bank loans, or some special purpose. We cannot broaden the scope this time, for your
investor’s guarantee. In the capital market, having differing levels of assurance for audits has
considerable cost in terms of potential confusion. There is more concentration on work
around the internal controls for higher levels of assurance. As I said to you last time, and you
are willing to pay for that level that we give you extra comfort3.

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C: In what situation could company enquiry to have that high level?

A: Generally speaking, companies are very reluctant to go and ask for auditors to broaden
their scope and pay for broadened scope. Also, there is the threat of legal liability impedes
auditors providing many potentially value-adding services.4
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C: Oh…I thought last time we sign-off that high level of assurance is like guarantee for us…

A: There are different perceptions regarding to different levels between users and suppliers,
which the auditors have been termed it” expectation gap”. That’s why it happens. Generally,
different levels of audit assurance depend on the circumstances. We have been expected to
provide assurance in varying degrees and for different purposes. The standard setters only
defined the level of “reasonable assurance” which makes stakeholders confused. There are
some scopes to for us to broaden but it is only for special-purpose, such as going public,
bank loans which users or trustees asked to do. Also, different levels of audit assurance have
different cost.

C: Ok, I understand. I’ll reply to that investor.

A: Don’t worry your company performance so well since going public. Your financial
performance should be a strong evidence to prove that your company is full with potential
developing opportunities.

C: Thanks, Julia. You make me clear about the level of audit assurances.

A: You are welcome. See you next time.

4. Consider other research on the topic

i. Investors and financial statement users long have agreed on the usefulness of the audit
in financial reporting. Over time, however, auditors have been expected to provide
assurance in varying degrees and for different purposes. Differences in
perception--especially regarding assurances provided--between users, preparers and
auditors have been termed the "expectation gap." This article provides some startling
evidence of the existence of such a gap in investor perceptions of the assurance
provided by an audit.( by Marc J.Epstein, Marshall A. Geiger,journal of
Accountacy,vol.177,1994)
ii. The accounting profession has long contended that an audit conducted in accordance
with generally accepted auditing standards (GAAS) provides “reasonable assurance” (as
opposed to “absolute” assurance) To be sure , the term “reasonable assurance” leaves

4 See reference “Future of Audit”, page646

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much to the imagination. That in itself poses a problem for the profession, which, since
the mid-1980s, has striven to close what it has called the “expectation gap”—the gap
between the level of assurance that financial statement readers expect of an audit
report and the level of assurance that an audit report actually provides. Just as troubling
is the lack of a definition of what constitutes “a high level of assurance.” Some might
characterize it as being somewhat greater than the “more likely than not” threshold
required for tax opinions, while others might characterize it as being only slightly below
a guarantee, or absolute assurance. Faced with such latitude, it is difficult to understand
how this term would do anything but confuse auditors. At the same time, this shift in
auditing standards could also have a detrimental effect on financial statement users,
who may be prompted to forgo other means of reducing their financial risks (such as
better internal controls or more-diversified investment portfolios), in the belief that an
audit report can effectively eliminate the possibility of a financial fraud.( By Dan
L.Goldwasser, 2005)

5. Conclusion

After analyzing and discussing this topic, we found that it is essential to understand the
differing levels of audit assurance. Also, this issue is very important in auditing. There are
situations where not only the defined reasonable level of audit assurance can be satisfied.
There are variations above that level, higher or lower. It depends on the situation. Also, there
are situations that auditors cannot provide higher level due to legal liabilities or potential
provisions, etc. SME may require a lower level of audit assurance. As a result, it evokes
confusion or expectation gap between users and supplier-auditors. Auditors try to provide
different levels of assurance for different financial or special purposes. Users may have no
ability to distinguish the high level of assurance from guarantee, just like our scenario. Even
the standard setter and regulators cannot tell the exact difference between different levels.
Auditors’ report is the view on the financial report which provided by a third party---the
company. The level of audit assurance is the degrees of that report’s reliability. To conclude,
different levels of audit assurance is used for different users for different purposes.

6. Future implications

As the confusion exists, there is demand for the level of audit assurance to be clearly defined
and clearly scoped. Although standard setters said that it is hard to articulate the current
levels of audit assurance to the market for audit assurance in Australia, auditors and users
are willing to have clear definitions of differing levels assurance and situations where
auditors should broaden the scope of reasonable assurance. That would be a huge challenge
for standard setters and regulators.

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Bibliography

1. Houghton K.A.,C.Jubb, M.Kend and J.Ng,2010, “The future of audit: Keeping capital markets
efficient, Towards A national strategy on the future of auditing”.
2. “IFAC Releases Study on Levels of Assurance to Help Accountants World Wide Meet User
Needs”,http://press.ifac.org/news/2002/06/ifac-releases-study-on-levels-of-assurance-to-hel
p-accountants-world-wide-meet-user-needs ,Viewed on 17/08/2011.
3. “The past and Future of reasonable Assurance”,
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