ISA 200, “Objective and General Principles Governing an Audit of Financial Statements,” is a standard issued by the International Auditing and Assurance Standards Board (IAASB) that provides guidance on the overall objectives and general principles that auditors should follow when conducting an audit of financial statements. The standard sets out the fundamental principles that underpin the audit process and help ensure that auditors perform their work with integrity, objectivity, professional competence, and due care. In this article, we will explore the key objectives and general principles of ISA 200, along with definitions, explanations, examples, and case studies to illustrate their application in practice.
Objective of an Audit:
The objective of an audit, as stated in ISA 200, is to enable the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework. In other words, the auditor’s ultimate goal is to provide reasonable assurance that the financial statements are free from material misstatement, whether due to fraud or error.
General Principles:
ISA 200 outlines the following general principles that auditors should adhere to when conducting an audit:
Integrity:
The auditor should perform the audit with integrity, which means being honest, straightforward, and candid in all professional and business relationships. The auditor should act in a manner that reflects the highest level of professionalism and ethical standards.
Explanation:
Integrity is a fundamental principle that ensures that auditors maintain their objectivity and independence throughout the audit process. It requires auditors to be honest, truthful, and transparent in their interactions with clients, colleagues, and other stakeholders. For example, an auditor should not knowingly withhold information, provide misleading statements, or engage in unethical conduct that could compromise their integrity.
Example:
During an audit of a company’s financial statements, an auditor discovers evidence of potential fraud committed by a senior executive. The auditor promptly reports the findings to the company’s audit committee and takes appropriate actions in accordance with the relevant laws and regulations, demonstrating integrity in their professional conduct.
Case Study:
In the case of Enron Corporation, one of the largest corporate scandals in history, the external auditors failed to demonstrate integrity by knowingly certifying the company’s financial statements that contained material misstatements, leading to the collapse of the company and subsequent legal and regulatory actions against the auditors.
Objectivity:
The auditor should exercise professional judgment objectively, without bias, and should not allow personal, financial, or other interests to compromise their professional judgment.
Explanation:
Objectivity requires auditors to maintain an impartial and unbiased mindset when performing their audit procedures. They should not be influenced by personal, financial, or other interests that could compromise their ability to form an independent opinion on the financial statements. Auditors should critically assess and evaluate all audit evidence without any preconceived notions or biases.
Example:
An auditor is assigned to audit the financial statements of a company where a close family member holds a senior management position. The auditor recognizes the potential conflict of interest and takes appropriate steps to mitigate the threat, such as obtaining additional review and supervision of their work, and documenting their professional judgment objectively.
Case Study:
In the case of Satyam Computer Services, one of the largest corporate frauds in India, the external auditors failed to exercise objectivity by colluding with the management and certifying false financial statements, resulting in severe consequences for the auditors and the company’s stakeholders.
Professional Competence and Due Care:
The auditor should possess the necessary professional competence and skills to perform the audit and should exercise due care in planning, conducting, and reporting on the audit.
Explanation:
Professional competence requires auditors to have the necessary knowledge, skills, and expertise to perform their audit work effectively. Due care requires auditors to exercise diligence, prudence, and thoroughness in their audit procedures and documentation. Auditors should also stay updated with changes in relevant laws, regulations, and auditing standards to ensure their work is performed in accordance with the latest requirements.
Example:
An auditor who is assigned to audit a complex financial instrument, such as a derivative, obtains the necessary training and knowledge about the specific accounting and auditing requirements related to such instruments. They exercise professional competence by applying the appropriate audit procedures and due care in documenting their work to ensure the audit is performed effectively.
Case Study:
In the case of Lehman Brothers, a global financial services firm that collapsed during the 2008 financial crisis, the external auditors were criticized for lacking professional competence in auditing the company’s complex financial instruments, resulting in significant misstatements in the financial statements that went undetected.
Confidentiality:
The auditor should maintain confidentiality of information obtained during the audit, and should not disclose such information to unauthorized parties without proper legal or professional authority.
Explanation:
Confidentiality is crucial in maintaining the trust and confidence of the client and protecting sensitive information obtained during the audit. Auditors should not disclose any information related to the client’s affairs, operations, or financials to unauthorized parties, unless there is a legal or professional requirement to do so.
Example:
An auditor discovers a material misstatement during the audit that could potentially harm the reputation of the client. The auditor takes appropriate steps to communicate the finding to the client’s management and audit committee in a confidential manner, following the established communication protocols.
Case Study:
In the case of KPMG and the U.S. Securities and Exchange Commission (SEC), KPMG was fined for violating confidentiality rules by accessing and using confidential information belonging to the PCAOB (Public Company Accounting Oversight Board), an audit regulator, which compromised the integrity and confidentiality of the audit process.
Professional Skepticism:
The auditor should exercise professional skepticism, which involves a questioning mindset and critical assessment of audit evidence, recognizing the possibility of material misstatements in the financial statements, whether due to fraud or error.
Explanation:
Professional skepticism requires auditors to maintain a questioning mindset throughout the audit process, considering the possibility of management bias, fraud, or error in the financial statements. Auditors should exercise professional judgment and critically assess the quality and sufficiency of audit evidence obtained to support their opinion.
Example:
During an audit of a company’s revenue recognition, an auditor identifies potential signs of aggressive revenue recognition practices, such as excessive sales returns, extended credit terms, and unusual changes in sales patterns. The auditor exercises professional skepticism by thoroughly investigating these indicators, including obtaining additional evidence and documentation, to ensure the accuracy and completeness of the reported revenues.
Case Study:
In the case of WorldCom, one of the largest accounting scandals in history, the external auditors failed to exercise professional skepticism and critically assess the company’s financial statements, leading to the discovery of massive accounting fraud that resulted in the company’s bankruptcy and legal actions against the auditors.
Conclusion:
ISA 200 sets out the fundamental objectives and general principles that auditors should follow when conducting an audit of financial statements. These principles, including integrity, objectivity, professional competence and due care, confidentiality, and professional skepticism, guide auditors in performing their work with diligence, independence, and professionalism. Examples and case studies illustrate how these principles are applied in real-world audit scenarios, emphasizing the importance of adhering to these principles to ensure the quality and reliability of audit opinions. By following these principles, auditors can enhance the credibility and trustworthiness of the financial statements, providing assurance to stakeholders about the accuracy and integrity of the reported financial information.