What do auditors in the UK mean by ‘reasonable
assurance’?
Michael Page1
Summary
‘Reasonable assurance’ has been adopted as a term in UK auditing regulation from
International Standards on Auditing (ISAs). It is also used in relation to auditing in the USA.
Attention has recently been paid to the meaning of ‘reasonable assurance’, where, in the
specific context of certification of internal controls under the Sarbanes Oxley Act, it has been
characterised as ‘a high level of assurance’. Analysis of the way in which the term is used in
the international and UK and Ireland versions of ISAs identifies some ambiguity of meaning
that it would be worth addressing, in order to clarify the application of ISAs in the UK and
Ireland and also to prevent the development of further ambiguity. For this purpose
‘reasonable assurance’ can be characterised as follows:
‘Reasonable assurance’ is the level of confidence that the financial statements are not
materially misstated that an auditor, exercising professional skill and care, is expected
to attain from an audit.
An auditor cannot attain absolute confidence because of numerous factors arising,
among other things, from the limitations of audit evidence, the impracticality of
examining all evidence and uncertainties as to the future.
The confidence that an auditor attains is subjective and is the basis for offering an
audit opinion. Users of financial statements derive their own confidence in the audited
financial statements from many sources, including a knowledge that the auditors work
to professional standards within a framework of regulation and that the auditors have
felt sufficiently confident that the financial statements are not materially misstated to
issue an opinion.
As a consequence of their confidence that financial statements are not materially
misstated, users of financial statements may also gain confidence that the
management of the entity are conducting its affairs in the knowledge that the financial
consequences of their actions will be reported.
1
Corresponding Address: Portsmouth Business School, Richmond Building, Portland Street, Portsmouth
PO1 3DE, e-mail mike.page@port.ac.uk. The author is grateful for comments received on an earlier draft of the
paper from members of the Group and Professor Laura Spira.
This working paper has been prepared for the Audit Purpose group to aid discussion of some of the issues
around the purpose of an audit and to help the group to develop the paper, Audit Purpose. The working paper
does not necessarily represent the views of the members of the Audit Purpose group or of the Audit Quality
Forum, individually or collectively. No responsibility for any person acting or refraining to act as a result of
any material in this paper can be accepted by the author, the Audit Purpose working group, or the ICAEW’s
Audit and Assurance Faculty.
The final paragraph above characterises how the stewardship function of financial reporting
operates. The focus of stewardship is the monitoring of management; directors act in the
knowledge that shareholders will be informed of the financial consequences of the directors’
decisions.
Reasonable Assurance
The Audit Quality Forum of ICAEW has set up a group to produce a paper articulating the
‘The purpose of the audit’ of UK companies. As part of this work the Audit Purpose Working
Group has needed to consider the meaning of the term ‘reasonable assurance’ when used in
an auditing context in the UK. This papers sets out a discussion of the meaning of the term,
followed by a suggested characterisation of the term2. Appendices draw an analogy with the
nature of confidence in a statistical context; set out the definition of ‘assurance’ as it appears
in the Oxford English Dictionary; and show extracts from auditing standards.
The Audit Purpose Working Group has concluded that the main purpose of the statutory audit
of a company is to ‘provide an independent opinion to the shareholders on the truth and
fairness of the financial statements, whether they have been properly prepared in accordance
with the Companies Act and to report by exception to the shareholders on the other
requirements of company law such as where, in the auditors’ opinion, proper accounting
records have not been kept’. As a consequence of the audit the shareholders, and other users
of the financial statements, have less uncertainty regarding the information contained in the
financial statements than would otherwise be the case. The subsequent discussion is framed
in terms of all users of the financial statements, although the main purpose of the audit needs
to be borne in mind.
‘Reasonable assurance’ is not a term of art that appears in either the Companies Acts or the
current Companies Bill. Nor has it figured prominently in litigation in the UK, but it does
appear in ISA (UK and Ireland) 200 which says:
An audit in accordance with ISAs UK and Ireland is designed to provide reasonable assurance that the
financial statements taken as a whole are free from material misstatement. Reasonable assurance is a
concept relating to the accumulation of the audit evidence necessary for the auditor to conclude that
there are no material misstatements in the financial statements taken as a whole. Reasonable assurance
relates to the whole audit process.
[Paragraph 8]
ISA UK&I 200 goes on to discuss the reasons that assurance cannot be absolute (see
Appendix 3).
What the quotation does not specify is to whom the reasonable assurance is provided. At first
sight it appears that reasonable assurance is provided to third parties, but the second sentence
of paragraph 8 seems to imply that the reasonable assurance is acquired by the auditor and is
a part of the process of forming a conclusion on the financial statements.
Paragraph 8 is a typical product of a drafting committee and acquires, by inclusion in an ex
cathedra statement, a halo of authority that may not have been intended. Such statements are
typically a compromise between differing points of view and include a level of ambiguity that
2
A ‘definition’ is not attempted since non-circular definitions inevitably introduce new undefined terms.
accommodates such differences. In particular, as mentioned above, the statement does not say
explicitly who acquires the ‘assurance’, and it conflates at least two of the shades of meaning
of assurance that the Oxford English Dictionary (online) sets out (Appendix 2).
Use of reasonable assurance in other jurisdictions
In the USA, ‘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) that the subject financial statements are free
of material misstatements’ (Goldwasser, 2006). The term is part of the standard wording of
audit reports of public companies, which include wording along the lines
…standards require that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.
Recently, in the context of attestation reports on internal controls SarBox 404, the PCAOB
has equated reasonable assurance with a ‘high level of assurance’ and has also published
rules for the preparation of such reports.
The term ‘reasonable assurance’ also appears in International Standards on Auditing (ISAs),
notably in ISA 700
When forming an opinion on the financial statements, the auditor evaluates whether, based on the audit
evidence obtained, there is reasonable assurance [emphasis added] about whether the financial
statements taken as a whole are free from material misstatement. This involves concluding whether
sufficient appropriate audit evidence has been obtained to reduce to an acceptably low level the risks of
material misstatement of the financial statements and evaluating the effects of uncorrected
misstatements identified. (ISA 700 paragraph 12)
Recently, in the US, there has been some discussion about whether ‘reasonable assurance’
implies that a particular set of audit procedures have been followed. The discussion that
follows suggests there is no support for such a contention in the UK.
Semantic and Grammatical Analysis
According to the OED definition in Appendix 2 there are two groups of senses of meaning of
‘assurance’: I ‘the action of assuring’ and II ‘the state of being sure or assured’.
In the context of an audit report, there are three possible senses of I: ‘1. A promise or
engagement making a thing certain; a formal engagement, pledge, or guarantee’; 3. ‘A
positive declaration intended to give confidence’; and ‘5. The action of insuring or securing
the value of property in the event of its being lost, or of securing the payment of a specified
sum in the event of a person's death; insurance’.
In sense II, only sense 8. ‘Subjective certainty; a being certain as to a fact, certitude;
confidence, trust’ is feasible (sense 6 ‘objective certainty’ is marked as obsolete).
The statements in which ‘reasonable assurance’ appears are all a bit odd. To say an ‘audit is
designed to provide reasonable assurance’ leaves much unsaid. Firstly, when assurance is
provided it is usually provided by one identified party to another – the audit is not a person,
and the group of people being provided with assurance is unspecified. That said sense, 3
above seems to fit context; ‘an audit is designed to provide a positive declaration intended to
give a reasonable level of confidence’ would seem to be an uncontroversial characterization
of the audit report. An audit does not seem to provide much by way of an ‘engagement
pledge or guarantee’ by the auditor to readers of the financial statement and auditors have
been at some pains to deny that they are providing insurance. Sense 8 is also possible; ‘an
audit is designed to provide a reasonable level of subjective certainty’ is a statement about the
effects of the audit on the mental state of someone unspecified.
The first sentence of the extract from ISA 700 is grammatically obscure and none of the
senses of ‘assurance’ in the OED can be inserted into it, with the possible exception of
(obsolete) sense 6 ‘objective certainty’.
When forming an opinion on the financial statements, the auditor evaluates whether, based on the audit
evidence obtained, there is a reasonable degree of objective certainty about whether the financial
statements taken as a whole are free from material misstatement.
As a rewording of ISA 700 Paragraph 12, the above seems unexceptional and is a reasonable
preamble to a paragraph relating to audit evidence. The senses of reasonable assurance as a
statement or as ‘subjective certainty’ do not fit easily into this sentence.
However, paragraphs 17-21 of ISA 200, which attempt to characterise reasonable assurance
(Appendix 3), use the phrase ambiguously; it is unclear whether the section is using the
phrase in the sense of objective certainty or subjective certainty. Paragraph 17 states:
An auditor conducting an audit in accordance with ISAs obtains reasonable assurance that the financial
statements taken as a whole are free from material misstatement, whether due to fraud or error.
The equivalent paragraph (paragraph 8) in the UK and Ireland version of the ISA 700 differs
significantly; it omits the reference to the auditor obtaining reasonable assurance. However
the subsequent paragraphs of both statements seem to refer to subjective certainty obtained
and therefore possessed by the auditor. A statistician would be unlikely to refer to, say,
extending a sample to obtain a particular level of confidence in an estimate; he or she would
be more likely to refer to ‘attaining’ a confidence level.
The discussion in Appendix 1 is intended to show, by analogy with statistical reasoning, that
the concept of ‘materiality’ requires a concept of ‘confidence’ and that the idea of ‘reasonable
assurance’ fulfils that role.
What does ‘reasonable’ mean?
The qualification ‘reasonable’ does two things: it indicates that an audit does not provide
absolute certainty; and it indicates that the auditors are expected to exercise the level of effort
and skill that can reasonably be expected of a firm holding themselves out to be expert
professionals.
ISA 200 UK&I says much about the first of these but not much about the second.
A model of the reasonable assurance process
The figure below shows how ‘users’ acquire confidence in financial statement data. In this
model, users have prior expectations and beliefs about a company and the likely quality of its
financial statements that are created by the continuing flow of information about the
company, the economy and other relevant factors. When they receive financial statement data
in the form of an annual report or interim statement they analyse the data and form new
expectations about the company and the value of its securities. An important role of the
auditing of financial statements is to reduce users’ uncertainty about the data and the
information they derive from their analysis. Their confidence derived from the audit is the
amount of reduction in their uncertainty about the financial statement data, compared with the
uncertainty that it would be subject to if audits were not habitually carried out.
In this model users’ confidence is in part derived from, but is not the same as, the auditors’
confidence. Users know that, by issuing a clean audit report, the auditors have attained
‘reasonable assurance’, in their own minds, that the financial statements are not materially
misstated and so users gain confidence in the financial statements.
Auditing
standards and
regulation
Aspects of
audit firm
Reputation
of audit
firm
Quality of
audit
Audit firm’s
confidence (level of
assurance) in the
financial statements
User’s
estimate of
audit quality
Users’ prior
expectations
Users’
analysis of
data
Financial
statements
and audit
report
Users’
estimates
and
confidence
There are numerous factors that contribute to reducing the uncertainty that surrounds
financial statement data. Informed users of financial statements are aware that absolute
certainty does not attach to the numbers in financial statements. Users are also aware of the
regulatory background and audit practices that determine the planning and execution of
audits. They are also aware of the corporate governance role of auditing in preventing
managerial opportunism and reducing agency costs. This awareness affects not only their
analysis of the current position of a company but also their forecasts of likely future
outcomes, and their confidence in those forecasts.
Conclusion
Reasonable assurance is the degree of confidence that attaches to the assertion that financial
statements are not materially misstated. Although the term is used in various ways in
authoritative statements, reasonable assurance is essentially subjective. Auditors acquire
confidence in the financial statements from their audit work and in turn the users of financial
statements acquire confidence from the audit report and their knowledge of the regulatory
background and professional process that has determined the design and execution of the
audit. The primary purpose of information in financial statements is for shareholders to
exercise their rights as a body, but other users also gain confidence that the financial
statement are not materially misstated from the audit process.
As a result of the foregoing analysis it seems that a characterisation of ‘reasonable assurance’
as it is currently used in the UK could be as follows:
‘Reasonable assurance’ is the level of confidence that an auditor, exercising
professional skill and care, is expected to attain from an audit that the financial
statements are not materially misstated.
An auditor cannot attain absolute confidence because of numerous factors arising,
among other things, from the limitations of audit evidence, the impracticality of
examining all evidence and uncertainties as to the future.
The confidence that an auditor attains is subjective and is the basis for offering an
audit opinion. Users of financial statements derive confidence in the audited financial
statements from many sources, including a knowledge that the auditors work to
professional standards within a framework of regulation and that the auditors have felt
sufficiently confident that the financial statements are not materially misstated to
issue an opinion.
As a consequence of their confidence that financial statements are not materially
misstated, users of financial statements may also gain confidence that the
management of the entity are conducting its affairs in the knowledge that the financial
consequences of their actions will be reported.
The final paragraph above characterises how the stewardship function of financial reporting
operates. It is not so much the fact that shareholders are informed that enables the
stewardship function to operate, but directors’ knowledge that shareholders will be informed
of the financial consequences of the directors’ decisions.
References
Goldwasser, & L., D. (2006). The past and future of reasonable assurance. CPA Journal.
http://www.nysscpa.org/cpajournal/2005/1105/special_issue/essentials/p28.htm
International Auditing Standards Board (IAASB), ISA 700 The independent auditor’s report
on a complete set of general purpose financial statements
http://www.ifac.org/Members/DownLoads/ISA_700-Auditors_Report_on_Financial_Statements.pdf (accessed 1
May 2006)
IAASB, ISA 200, Objective and General Principles Governing an Audit of Financial
Statements http://www.ifac.org/Members/DownLoads/ISA_700Auditors_Report_on_Financial_Statements.pdf (accessed 1 May 2006)
Auditing Standards Board (APB), International Standard on Auditing (UK and Ireland) (ISA
UK and I) 200 ‘Objectives and General Principles Governing and Audit of Financial
Statements’
APB ISA (UK and I) The Auditor’s Report on Financial Statements,
http://www.frc.org.uk/images/uploaded/documents/ACFAB4.pdf (accessed 1 May 2006)
Appendix 1
Reasonable assurance and confidence limits
There is an analogy to be drawn between the way propositions are expressed in statistical
terms and the way in which audit reports are framed. A statistical conclusion is often in the
form:
‘There is a 95% probability that the true value of X does not differ from Y by more
than e.’
That is to say the simple statement that some quantity X is equal to an observed value Y is
amplified by indicating a level of confidence, in this case 95%, and a range of possible values
(confidence limits), e.
The proposition that an audit provides reasonable assurance that the financial statements are
not materially misstated is a similar kind of statement, but a qualitative one rather than a
quantitative one. ‘Reasonable assurance’ corresponds to the level of confidence and the
materiality level corresponds to the confidence limits.
On this basis ‘reasonable assurance’ can be taken to mean that the risk that the financial
statements are materially misstated is below some (usually unstated) threshold.
In practice the boundary between what counts as material misstatement and what does not is
a complicated one which cannot be fully analysed. Similarly the risks and materiality levels
relevant to particular items in the financial statements may vary from item to item so that
reducing reasonable assurance to a probability is not feasible. Nevertheless, the analogy
demonstrates that, without the idea of reasonable assurance, auditing would be lacking a
concept of the degree of confidence that the financial statements are not materially misstated.
Appendix 2
‘Assurance’ as defined by Oxford English Dictionary Online
(Quotations have been omitted, except in the senses relevant to auditing.)
I. The action of assuring.
* Of making certain.
1. A promise or engagement making a thing certain; a formal engagement,
pledge, or guarantee.
b. esp. An engagement guaranteeing peace and safety; terms of peace. Obs. exc.
Hist.
2. A marriage engagement, betrothal. Obs.
3. A positive declaration intended to give confidence.
** Of making secure.
4. Law. The securing of a title to property; the conveyance of lands or tenements
by deed; a legal evidence of the conveyance of property.
5. The action of insuring or securing the value of property in the event of its being
lost, or of securing the payment of a specified sum in the event of a person's death;
insurance.
Technically, the present usage is to differentiate life-assurance, and fire- and marine-insurance;
though, as will be seen from the quotations, assurance was the original term in reference to marine
risks.
II. The state of being sure or assured.
6. Objective certainty; = ASSUREDNESS 1. Obs.
c1485 Digby Myst. (1882) II. 387, I can not beleve that thys ys of assurans. 1509 HAWES
Past. Pleas. XXXI. xvii, Wo worth the trust without assuraunce. 1603 KNOLLES Hist. Turks
(1621) 538 New friends of more assurance.
7. Security.
8. Subjective certainty; a being certain as to a fact, certitude; confidence, trust.
1375 BARBOUR Bruce XI. 309 In his hye cheuelry Thai had assouerans, trast trewly. c1374
CHAUCER Troylus v. 1259 O trust, O feith, O depe asseuraunce! 1601 CORNWALLYES Ess. II.
xxix, It is as naturall in men to purchase hope as assurance. 1605 SHAKES. Macb. IV. i. 183
But yet Ile make assurance double sure, And take a Bond of Fate. 1843 MILL Logic II. vi. §3
We can have full assurance of particular results. a1842 TENNYSON Two Voices 315 The
doubt would rest, I dare not solve..Assurance only breeds resolve.
b. in Theol. (See quot.)
1651 C. CARTWRIGHT Cert. Relig. I. 251 The Doctrine of Protestants concerning assurance
of salvation..viz. that a man may have this assurance. 1852 SIR W. HAMILTON Disc. (1853)
508 Assurance, Personal Assurance, Special Faith, (the feeling of certainty that God is
propitious to me, that my sins are forgiven).
9. Self-confidence, self-reliance; confidence of manner, steadiness, intrepidity.
10. In a bad sense: Hardihood, audacity, presumption, impudence.
Appendix 3: Extracts from ISAs
IAASB ISA 200 (as amended following ISA 700) on Reasonable
Assurance
Reasonable Assurance
17. An auditor conducting an audit in accordance with ISAs obtains reasonable assurance that the financial
statements taken as a whole are free from material misstatement, whether due to fraud or error. Reasonable
assurance is a concept relating to the accumulation of the audit evidence necessary for the auditor to conclude
that there are no material misstatements in the financial statements taken as a whole. Reasonable assurance
relates to the whole audit process.
18. An auditor cannot obtain absolute assurance because there are inherent limitations in an audit that affect the
auditor’s ability to detect material misstatements. These limitations result from factors such as the following:
• The use of testing.
• The inherent limitations of internal control (for example, the possibility
of management override or collusion).
• The fact that most audit evidence is persuasive rather than conclusive.
19. Also, the work undertaken by the auditor to form an audit opinion is permeated by judgment, in particular
regarding:
(a) The gathering of audit evidence, for example, in deciding the nature,
timing and extent of audit procedures; and
(b) The drawing of conclusions based on the audit evidence gathered, for example, assessing the reasonableness
of the estimates made by management in preparing the financial statements.
20. Further, other limitations may affect the persuasiveness of audit evidence available to draw conclusions on
particular assertions1 (for example, transactions between related parties). In these cases certain ISAs identify
specified audit procedures which will, because of the nature of the particular assertions, provide sufficient
appropriate audit evidence in the absence of:
(a) Unusual circumstances which increase the risk of material misstatement beyond that which would ordinarily
be expected; or
(b) Any indication that a material misstatement has occurred.
21. Accordingly, because of the factors described above, an audit is not a guarantee that the financial statements
are free from material misstatement, because absolute assurance is not attainable. Further, an audit opinion does
not assure the future viability of the entity nor the efficiency or effectiveness with which management has
conducted the affairs of the entity.
IAASB ISA 700
12. When forming an opinion on the financial statements, the auditor evaluates whether, based on the
audit evidence obtained, there is reasonable assurance about whether the financial statements taken as a
whole are free from material misstatement. This involves concluding whether sufficient appropriate
audit evidence has been obtained to reduce to an acceptably low level the risks of material
misstatement of the financial statements and evaluating the effects of uncorrected misstatements
identified.
ISA 700 (UK and Ireland)
The UK and Ireland version of ISA 700 contains the following in relation to reasonable
assurance:
13. The report should include a statement that the audit was planned and performed to obtain
reasonable assurance about whether the financial statements are free of material misstatement
13.1 In the UK and Ireland the auditor’s statement that the audit was planned and performed to obtain
reasonable assurance about whether the financial statements are free of material misstatement, includes
reference to material misstatement caused by fraud or other irregularity or error. ….
ISA 200 (UK and Ireland)
Reasonable Assurance
8. An audit in accordance with ISAs (UK and Ireland) is designed to provide reasonable assurance that
the financial statements taken as a whole are free from material misstatement. Reasonable assurance is
a concept relating to the accumulation of the audit evidence necessary for the auditor to conclude that
there are no material misstatements in the financial statements taken as a whole. Reasonable assurance
relates to the whole audit process.
9. An auditor cannot obtain absolute assurance because there are inherent limitations in an audit that
affect the auditor's ability to detect material misstatements. These limitations result from factors such
as:
• The use of testing.
• The inherent limitations of internal control (for example, the possibility of management
override or collusion).
• The fact that most audit evidence is persuasive rather than conclusive.
• The impracticality of examining all items with a class of transactions or account balance.
• The possibility of collusion or misrepresentation for fraudulent purposes.
9-1 the view given in financial statements is itself based on a combination of fact and judgment and,
consequently, cannot be characterized as either ‘absolute’ or ‘correct’. A degree of imprecision is
inevitable in the preparation of all but the simplest of financial statements because of inherent
uncertainties and the need to use judgment in making accounting estimates and selecting appropriate
accounting policies.
10. Also, the work undertaken by the auditor to form an audit opinion is permeated by judgment, in
particular regarding:
(a) The gathering of audit evidence, for example, in deciding the nature, timing, and extent of audit
procedures; and
(b) The drawing of conclusions based on the audit evidence gathered, for example, assessing the
reasonableness of the estimates made by management in preparing the financial statements.
11. Further, other limitations may affect the persuasiveness of audit evidence available to draw
conclusions on particular assertions (for example, transactions between related parties). In these cases
certain ISAs (UK and Ireland) identify specified audit procedures which will, because of the nature of
the particular assertions, provide sufficient appropriate audit evidence in the absence of:
(a) Unusual circumstances which increase the risk of material misstatement beyond that which would
ordinarily be expected;
(b) Any indication that a material misstatement has occurred.
12. Accordingly, because of the factors described above, an audit is not a guarantee that the financial
statements are free of material misstatement.