As per the International Standards of Auditing (ISA), an auditor’s responsibility is to provide reasonable (high level) assurance to the users of financial statements that the financial statements are free from material misstatement.
A high level of assurance is not an absolute level of assurance – which can’t be obtained due to the inherent limitations of an audit.
Due to the inherent limitations of an audit, the auditor is only able to obtain persuasive evidence and not conclusive evidence.
- Persuasive evidence: It is evidence that is able to convince the user of its truthfulness.
- Conclusive evidence: This is absolute evidence or solid proof of truth and does not leave any chance of doubt otherwise.
The inherent limitations of an audit are as follows:
- Judgment in financial reporting: Oftentimes, the judgment of management is required in estimating a particular item to be reported on the financial statements. Such an item can only be audited by obtaining persuasive evidence. Examples include the provision of bad debt.
- Sample-based auditing: Due to a large number of transactions occurring throughout the year, it is practically impossible for the auditor to identify and verify each transaction. Hence, the audit is performed on the basis of sampling; for example, sending positive confirmations to major debtors to verify the credit sales balance only.
- Management responsibility: It is the management’s responsibility to provide complete information to the auditor, which may not be the case. Hence, the application of audit procedure would be on incomplete information resulting in a worthless audit.
- Possibility of fraud: A calculated fraud may be designed to conceal it and dodge the auditor. The fraudulent person will ensure that the fraud goes undetected under the ordinary audit procedures.
- Limited time and cost: Since the audit is to be performed within a particular period of time and limited resources, without extension, only critical areas are focused, even if the work is extensive. This means that some areas may go undetected even after thorough audit procedures.