Auditing I

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Auditing I

• Lecturer Danielle McWall Room 3E/15
• Module Code ACF324J2
• Module level 2
• Credit points 20 (ie. 48 hours lectures/seminars
  and 152 hours independent study)
• 25 coursework - class tests
• 75 examination

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Auditing I

• AIMS
• To provide students with a broad foundation in
  the fundamentals of auditing which prepares them
  for advanced courses in other auditing areas.
• LEARNING OUTCOMES
• Understand the fundamental principles of
  auditing.
• Understand the nature, purpose and scope of
  auditing.
• Understand the role of an auditor including their
  legal and ethical responsibilities.
• Obtain a knowledge of current issues in auditing.
• Apply the fundamental principles of auditing.
• Identify the legal, ethical and professional
  requirements (including auditing standards) for
  various situations.
• Identify audit issues, discuss, analyse and draw
  reasoned conclusions from the information given.
• Review literature and write reports on a variety
  of auditing issues.
• Demonstrate the application of auditing standards
  and guidelines.
• Display good written communication skills.
• Obtain and utilise information from a variety of
  sources.
• Study independently and develop self-managed
  learning.

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The term audit

• The word audit comes from the Latin word audire
  meaning to hear.
• In the late middle ages in Britain, both accounts
  of revenue and expenditure for manors and estates
  were heard by an auditor. Their task was to
  examine such accounts.
• Modern meanings for audit are
• Review
• Check
• Inspection
• Examination
• Assessment
• Appraisal
• Stocktaking

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The Agency Relationship

• The agency relationship exists
• Between the owner/shareholder and the manager.
• In large companies owners are separate from
  managers.
• This in turn produces a natural conflict of
  interests because of information asymmetry.
• Information asymmetry generally means the manager
  has more information than the owner about the
  true state of the finances of the business.

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The Agency Relationship

• In general
• If both parties seek to maximise self interest.
• It is likely the manager will not act in the best
  interest of the absentee owner.
• For example, the manager may manipulate the
  reported earnings in order to earn a larger bonus.

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The Agency Relationship

• Hence the owner will wish to protect against the
  possibility of manager self interest by invoking
  the function of the audit.
• ie In order for owners to believe management
  reports they may wish to have them independently
  verified.

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The Audit Function

• The audit function has evolved in response to a
  perceived need of individuals or groups in
  society who seek information or reassurance about
  the conduct or performance of others in which
  they have an acknowledged and legitimate
  interest.
•   Flint D (1988) Philosophy and Principles of
  Auditing An Introduction

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Objectives of an Audit

• Today the APB define an audit as an exercise, the
  objective of which is to
• Enable auditors to express an opinion whether the
  financial statements
• Give a true and fair view of
• The entitys affairs at the period end, and of
• Its profit and loss for the period then ended.
• And have been properly prepared in accordance
  with the applicable reporting framework.

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Audit Definition

• Auditing is a systematic process of objectively
  gathering and evaluating evidence relating to
  assertions about economic actions and events in
  which the individual or organisation making the
  assertions has been engaged, to ascertain the
  degree or correspondence between those assertions
  and established criteria, and communicating the
  results to users of the reports in which the
  assertions are made.
• American Accounting Associations (AAA) Committee
  on Basic Auditing Concepts (1973).

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Audit Definition

• An audit is an investigation or a search for
  evidence to enable an opinion to be formed on the
  truth and fairness of financial and other
  information by a person or persons independent of
  the preparer and persons likely to gain directly
  from the use of the information, and the issue of
  a report on that information with the intention
  of increasing its credibility and therefore its
  usefulness.
• Gray and Manson, The Audit Process, (3rd Ed)

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Benefits of an Audit

• Gives credibility to financial statements and
  financial information
• Users of this information (stakeholders)
• Shareholders
• Banks other lending institutions
• Trade creditors
• Tax authorities
• Employees
• Management
• Society as a whole

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Developments in Auditing

• Socio-economic developments
• Statutory developments
• Development in the duties of auditors
• Change of emphasis due to environment
• The risk based approach

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Developments in Auditing

• Socio-economic developments
• The role of audit adapted to accommodate the
  changing characteristics of business enterprise.
• The main objective then was to
• Detect fraud and error and
• Proper portrayal of the companys solvency.

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Developments in Auditing

• Statutory developments
• The use of joint stock companies (1844)
• The succession of Companies Acts to protect the
  investor and have the concept of limited
  liability.
• Combination of reports into a single audit report
  for the members.
• Final result today being the Companies Acts 1985
  1989

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Developments in Auditing

• Duties of Auditors
• Key legal court decisions
• Re London general Bank 1895
• Kingston Cotton Mill 1896
• Expectation of reasonable skill and care
• Lord Justice Lindley in the Cotton Mill case
• An auditor is a watch dog not a bloodhound
• Page 24 PSH

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Developments in Auditing

• Yet it took time for accounting practices to
  change from this bloodhound approach as
• Spicer Peglers 1911 textbook
• In the minds of the public at large, and of the
  majority of clients, the discovery of fraud is so
  far the principal function of the Auditor as to
  overshadow his other duties entirely, and there
  can be no question that it is of primary
  importance (p.5).

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Developments in Auditing

• Change of emphasis due to environment
• Focus switch to US - Wall Street crash 1929 and
  recovery of markets increased investment.
• Move towards profitable use of funds as well as
  honest and authorised use.
• Development in sampling techniques.
• Increased emphasis on external audit evidence.
• Auditing the profit loss account
• The Royal Mail case
• Change in audit objectives.
• Move away from prevention and detection of
  fraud to truth and fairness.

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Developments in Auditing

• Change in audit objectives
• Focus shift
• Providing credibility
• Decline in detection of fraud and error
• Spicer Peglers text (1936)
• The main object of an audit is the verification
  of accounts and statements prepared by a client
  or clients staff. Although of great importance
  the detection of fraud and error must be regarded
  as incidental to such main object (P.5)

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Developments in Auditing

• Risk Based Approach
• Evidence from wide variety of sources
• Increased use of IT
• Risk based auditing

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Developments in Auditing

• Risk Based Auditing
• Greater understanding of the client, their
  business environment and their industry.
• Understanding of client internal control
  procedures and systems.
• Effectiveness and efficiency of the audit.
• Added value to the client.

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Developments in Auditing

• Brief critique of Risk Based Auditing
• Main protagonists Levitt Turner former Chairman
  and Chief Accountant respectively of the SEC in
  USA.
• They felt less attention being paid to
  traditional methods of testing and examination.
• Rather firms are relying on analytical analysis.
• Use of lower echelon for most of the audit work.
• Recent headlines of accounting failures.
• Increased efficiency less effectiveness?

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Auditors code

• Issued 1996
• Key elements
• Accountability
• Integrity
• Objectivity and Independence
• Competence
• Rigour
• Judgement
• Clear communication
• Association
• Providing value

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Accounting v- Auditing

• Accounting
• Creative
• Involved
• Not necessarily qualified.

• Auditing
• Critical
• Unbiased
• Has to be qualified a qualified accountant and
  recognised by one of the RSBs.

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Types of audit

• Financial statement audits
• Compliance audits
• Operational audits
• External -v- internal

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Review Engagement

• Auditor provides
• A moderate level of assurance
• Information subject to review
• Is free from material misstatement

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Agreed Upon Procedures

• The auditor simply provides
• A report of the factual finding
• No level assurance is expressed
• Users assess for themselves
• Drawing their own conclusions

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Compilation engagements

• The accountant rather than the auditor
• Use accounting expertise to
• Collect
• Classify and
• Summarise financial information
• Again the users must derive their own conclusions
  from the summaries produced.