Audit and Assurance · External audits

Nature and Purpose of External Audit for ACCA Audit and Assurance

Updated 11 October 2026 · Fact-checked

An external audit is an independent examination of financial statements by an auditor. Its objective is to give reasonable assurance, expressed in an opinion, on whether the statements give a true and fair view, or are fairly presented, in line with the financial reporting framework. It exists because owners cannot watch managers directly.

Understand Nature and Purpose of External Audit

Start with the problem. In a company, the shareholders own the business but the directors run it. The directors know more than the owners and prepare the financial statements about their own performance. The owners have no easy way to check them. This is the agency problem: the agents (directors) may act in their own interest, or present results in a flattering way.

An external audit answers this. An independent auditor examines the financial statements, collects evidence and gives an opinion. Users such as shareholders, lenders and investors can then place more trust in the figures. The audit adds credibility. It does not prepare the statements. That is management's job.

The objective of the auditor is to obtain reasonable assurance on whether the financial statements as a whole are free from material misstatement, whether caused by fraud or error. This lets the auditor give an opinion on whether the statements are prepared, in all material respects, in accordance with the applicable framework, such as IFRS Accounting Standards. Reasonable assurance is a high level of assurance, but not absolute. Auditors test samples, use judgement and face inherent limits, so they cannot guarantee that the statements are free from error.

True and fair view has no single legal definition. In practice it means the statements are free from material misstatement, follow the framework, and present the financial position and performance in a way that is not misleading. Some frameworks use the wording present fairly, in all material respects. The two wordings are treated as having the same meaning for the opinion.

Remember who is responsible for what. Directors prepare the statements and maintain internal control. The auditor forms and reports an opinion. The audit may also help governance, since the need for independent checks grows as ownership and management separate.

Key rules to remember

Objective of an external audit: Reasonable assurance → opinion on whether the financial statements give a true and fair view (or present fairly) in all material respects, per the framework; Learn this wording. It is the core definition examiners reward.
Reasonable assurance: Reasonable assurance = high, but not absolute, level of assurance; Positive assurance is given in the opinion. Never say an audit guarantees accuracy.
Agency relationship: Shareholders (principals) → appoint directors (agents) → auditor reports to shareholders; Use this to explain why an audit is needed.
Responsibility split: Directors: prepare statements and internal control. Auditor: opinion on the statements; A frequent exam point.

How to solve Nature and Purpose of External Audit questions

Use this method for any question on the nature or purpose of an external audit, whether a definition, a 'why needed' or a short written requirement.

1Read the requirement verb. 'Define' needs a short definition. 'Explain' needs reasons with development. 'Discuss' needs both sides.
2Give the definition first: independent examination of financial statements, resulting in an opinion.
3State the objective using exact wording: reasonable assurance, material misstatement, true and fair view or fair presentation, applicable framework.
4Explain the need: separation of ownership and management, agency problem, reliance by users, and legal requirement where it applies.
5Link to the scenario. Name the users in the question, such as lenders or minority shareholders, and say how they benefit.
6Add the limits: reasonable not absolute assurance, testing and judgement, directors remain responsible for the statements.
7Check marks against points. Make one distinct point per mark and finish.

Quickest way: Definition, Need, Limit in three lines

When to use it: Use for short objective test questions and for opening a written answer when time is tight.

Say what it is: independent opinion on the financial statements.
Say why it is needed: owners and managers are separate, so users need trust in the figures.
Say what it is not: not a guarantee, not preparation of the statements, not a check of every transaction.
In objective questions, reject any option with words such as 'absolute', 'guarantee', 'all fraud' or 'prepares'.

Common mistakes in Nature and Purpose of External Audit

Saying the audit gives absolute assurance or guarantees the statements are correct.
Students assume an audit checks everything.
Fix: Always write 'reasonable assurance'. Auditors test samples and use judgement, so some risk remains.
Saying the auditor prepares the financial statements or is responsible for them.
Mixing up the roles of auditor and accountant.
Fix: Directors prepare the statements and keep internal control. The auditor only expresses an opinion.
Stating the objective as 'to detect all fraud and error'.
The public often believes this, so students repeat it.
Fix: The objective is an opinion on material misstatement. Fraud and error matter only where they are material, and the auditor cannot detect all of them.
Explaining true and fair view as 'completely accurate'.
'True' sounds like exact.
Fix: Explain it as free from material misstatement, in line with the framework, and not misleading. Estimates and judgements mean exact accuracy is not possible.
Giving 'why needed' without agency theory or users.
Answers stay generic, such as 'the law requires it'.
Fix: Describe the owner-manager split, then link to named users in the scenario.
Confusing the external audit with an internal audit or a general assurance engagement.
Both are called audits and both give comfort.
Fix: External audit is independent of the entity, reports on the financial statements and gives an opinion to the owners. Internal audit is part of the entity and reports to management.

Worked examples

Example 1

Explain why the shareholders of a large company with a separate board of directors need an external audit. (4 marks)

Show the solution

Identify the relationship: shareholders own the company, directors manage it. This is an agency relationship.
Point 1: directors have more information than shareholders, so shareholders cannot check performance themselves.
Point 2: directors prepare the statements about their own performance, and may have incentives such as bonuses to present results favourably.
Point 3: an independent auditor provides an opinion, so shareholders can place more reliance on the statements when assessing directors and making decisions.
Point 4: other users, such as lenders and investors, also rely on the audited statements.

Answer: An external audit is needed because ownership and management are separate. Directors control the information and may have reasons to present it favourably. An independent auditor gives reasonable assurance, through an opinion, that the statements are free from material misstatement, which increases credibility for shareholders and other users.

Example 2

Which ONE of the following best describes the objective of an external audit of financial statements?
A. To guarantee that the financial statements are free from fraud and error
B. To prepare the financial statements for the directors
C. To obtain reasonable assurance on whether the financial statements as a whole are free from material misstatement, so as to express an opinion
D. To test every transaction recorded by the company during the year

Show the solution

Test A: a guarantee is absolute assurance, and an audit gives only reasonable assurance. Reject.
Test B: preparing statements is the directors' responsibility. Reject.
Test C: matches the objective, covering reasonable assurance, material misstatement and an opinion. Keep.
Test D: auditors use sampling and do not test every transaction. Reject.

Answer: C

Exam tips

Learn the objective in exact words: reasonable assurance, free from material misstatement, opinion, applicable framework.
In a written answer on 'why needed', always start with the agency problem, then tie it to the users named in the scenario.
In objective questions, eliminate options with absolute words such as 'guarantee', 'all', 'every' or 'ensure'.
Keep the directors' and auditor's responsibilities separate. A one-line statement of the split often earns a mark.
Objective test questions are all-or-nothing, so read each option fully before choosing.

Nature and Purpose of External Audit in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Nature and Purpose of External Audit: frequently asked questions

What is the purpose of an external audit in ACCA AA?

The purpose is to give users confidence in the financial statements. The auditor obtains reasonable assurance and gives an opinion on whether the statements give a true and fair view, or present fairly, in line with the framework. This helps owners and other users rely on the figures.

What does true and fair view mean?

It has no single fixed definition. In practice it means the statements are free from material misstatement, comply with the applicable framework and are not misleading. It does not mean exact accuracy.

Why is an external audit needed according to agency theory?

Shareholders (principals) appoint directors (agents) to run the company, but directors know more and may act in their own interest. An independent audit reduces this information gap by giving shareholders assurance on the statements the directors prepare.

Does an external audit detect all fraud?

No. The auditor aims to obtain reasonable assurance that the statements are free from material misstatement, whether from fraud or error. Because of sampling, judgement and the way fraud can be concealed, some risk of undetected misstatement remains.