Overall objective of the audit of financial statements: ISA 200

ISA 200: Overall Objectives provides a summary overview of many other ISAs (organized by key paragraph numbers). We can view this ISA as the conceptual framework for financial statement auditing. The ISAs are a true principles-based set of standards in the sense that the other ISAs (i.e., the more detailed ISAs) cannot deviate from, and must be consistent with, the overall objective as stated in ISA 200. The underlying logic of the ISAs is thus similar to the logic of the Rules of Professional Ethics as discussed in Chapter 2, except now the objective is clearer. Specifically, while the overall objective of professional ethics is to act in the public interest, in ISA 200 the auditor’s role is made operational by the requirement to provide reasonable or high assurance that there is no material misstatement in the financial statements (also see ISA 210 summarized below). However, as we will see in Chapter 11, the logic of GAAP conceptual frameworks indicates that financial accounting standards are not so strongly principles-based in terms of their reasoning in practice. This helps explain observed, persistent problems documented in audit research—the suitable criteria used in evaluating the financial reporting can be a critical factor. This is an important point that auditors need to be aware of. Below follows a summary of key aspects of ISA 200. Note that this standard supports both a fair presentation and compliance reporting view of the audit.

ISAs 200.3 and .11 state that the overall audit objective is “to obtain reasonable assurance that financial statements (henceforth FS) are free of material misstatement (henceforth

MM) ... in accordance with an applicable financial reporting (henceforth FR) framework.” Note that these objectives implicitly assume that the information contained in the financial statements is auditable (verifiable). If it is not, then there can be no guarantee that the objectives will be met.

200.13 also makes the important distinction that a “fair presentation framework” requires compliance with a reporting framework but allows (explicitly or implicitly):

i. disclosure beyond the requirements

ii. departure from requirements (in order to achieve fairness of presentation)

A “compliance framework” does not allow (i) and (ii) above. There is nothing more stated in the standards about this distinction. The recent Palmrose and Kinney (2018) and DeFond et al. (2018) commentaries suggest that there may be much more in the auditor’s social role than is indicated by the 200.13 definitions. Specifically, fair presentation may require more of an attempt to capture “economic substance” in financial reporting. As argued in Chapter 11, this may require considering more explicitly the acceptability of risks in reporting on forecasts of future events such as future cash flows on which financial economic theories are built.

200.13 (i) defines a “misstatement" as the difference between what is reported and what should be reported in accordance with an applicable reporting framework. We will see that this definition is ambiguous, for example in that it does not allow a departure from “requirements” in fair presentation reporting that DeFond et al. (2018) argue may be necessary to better capture economic substance. This definition is also inconsistent with the concept of misstatement that incorporates auditor assessment of unreasonable management judgments of ISA 540. For example, if one of the assumptions of the applicable reporting framework, such as the going concern assumption, is not met in the particular client circumstances, then failure to account for this in the applicable reporting framework would not be treated as a misstatement by the 200.13 definition.
200.13 (n:), risk of material misstatement (henceforth RMM), is the risk that the financial statements are materially misstated prior to applying detailed audit substantive procedures. RMM can be approximated by IR X CR as discussed below (normally covered in an introductory audit course).
200.14: audits should comply with ethical requirements (e.g., CPA Ontario’s Rules of Professional Conduct).
200.15: professional skepticism relates to alertness regarding material misstatements in the financial statements.
200.16: professional judgment (PJ) needs to be exercised in planning and performing an audit of the financial statements (FS).

200. A29: the quantity of evidence is affected by assessed risks of misstatement (R.MM as outlined above and the quality of evidence (the higher the quality, the less evidence may be required).
200.A36: the term “audit risk” is first used in ISAs here. It is later defined in ISA 320.Al as follows: “audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.” Audit risk is a type of global or aggregate effectiveness risk as defined in ISA 530.
200.A45: audit risk is not reducible to zero. Since the risk is never zero in practice, this helps explain why auditors need to be concerned with controlling it at some acceptable (non-zero) level.
200.A46: audit procedures cannot eliminate uncertainties for accounting estimates in financial reporting. A range of acceptable interpretations or judgments can be made. This is another idea in ISAs that is unclear. We address this through the concept of accounting risk discussed in Chapter 11.
200. A52: an auditor cannot settle for less than persuasive audit evidence. This is equivalent to saying that evidence risk should be at some appropriately low (acceptable) level.