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ACT 3301 – AUDIT 1

INTRODUCTION
TO
AUDITING

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Traditional Role of Auditing

 ‘Auditing’ comes from the Latin word audire,

meaning ‘to hear’.
 Traditional role of auditing – conformance role.
 First appeared in Britain during the 1800s.
 Development of the auditing role is very much
an outcome of court cases.

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Current Roles of Auditing

• Provide assurance for the credibility of financial

report
• Enhance the integrity of financial information &
its usefulness in decision-making by
management & other users

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The Demand for Auditing and

Assurance

The development of the corporate form of

business and the expanding world economy
over the last 200 years have given rise to
an explosion in the demand for assurance
provided by auditors.

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1750-1840

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Principals and Agents

A public company is a company that sells its stocks or
bonds to the public, giving the public a valid interest in
the proper use, or stewardship, over the company’s
resources.

Managers Stockholders

Agents Principals

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The Role of Auditing

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AGENCY THEORY & THE NEED

FOR AUDITING

AGENCY THEORY

INFORMATION ASYMMETRY

CONFLICT OF INTEREST

THE NEED FOR AUDITING

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Nature of Auditing

 Purpose
– An audit of FS is a process that involves
obtaining sufficient appropriate evidence
about the FS conformity with criteria (normally
identified financial reporting framework).
- Purpose – to enable the auditor to express an
opinion whether the FS present a true & fair
view.

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AUDITING DEFINED
 AUDITING (broadly defined) is a systematic process
of objectively obtaining and evaluating evidence
regarding assertions about economic actions and
events to ascertain the degree of correspondence
between those assertions and established criteria and
communicating the results to interested parties.

 AUDITING (narrowly defined) is a written report on

the examination of financial statements for an entity.

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Nature of Auditing

 Subject Matter
- historical financial statements.
 Evidence gathering
- systematic process of objectively accumulating
& evaluating evidence regarding the mgmt
assertions contained in the FS.
 Reporting
- auditors communicate the results to the
appropriate parties by expressing an opinion on
the FS in the form of an auditor’s report.

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Auditing, Attest, and Assurance

Services Defined

Assurance
Auditing Attest
Services

A systematic process of objectively

obtaining and evaluating evidence
regarding assertions about economic
actions and events to ascertain the
degree of correspondence between
those assertions and established
criteria and communicating the results
to interested users.
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Auditing, Attest, and Assurance

Services Defined

Assurance
Auditing Attest
Services

Services occur when a practitioner is

engaged to issue or does issue a
report on subject matter, or an
assertion about subject matter, that is
the responsibility of another party.

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Auditing, Attest, and Assurance

Services Defined

Assurance
Auditing Attest
Services

Are independent professional services

that improve the quality of information,
or its context, for decision makers.

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Accounting vs Auditing
 Accounting
- the recording, classifying and summarising of
economic events in a logical manner for the
purpose of providing financial info for decision
making.

classifying
recording
summarising

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Accounting vs Auditing
 Auditing
- focus on determining whether recorded information
properly reflects the economic events that occurred
during the accounting period.
- auditor must possess expertise in the accumulation &
interpretation of audit evidence.

Determining proper audit procedures

Deciding number & types of items to test

Evaluating results

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Fundamental Concepts in Conducting a

Financial Statement Audit

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Audit Risk
Audit risk is the risk that the auditor may
unknowingly fail to appropriately modify his or her
opinion on financial statements that are materially
misstated.

The auditor’s standard Reasonable assurance

report states that the audit
provides only reasonable
assurance that the
financial statements do not
contain material
misstatements.
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implies some risk that a
material misstatement
could be present in the
financial statements and
the auditor will fail to
detect it.
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Materiality

Materiality is the magnitude of an

omission or misstatement of
accounting information that, in
light of surrounding
circumstances, makes it probable
that the judgment of a reasonable
person relying on the information
would have been changed or
influenced by the omission or
misstatement.
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Evidence Regarding Management

Assertions
Evidence that assists the auditor in evaluating
management’s financial statement assertions
consists of the underlying accounting data and any
corroborating information available to the auditor.

Relevance Reliability

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Sampling: Inferences Based on

Limited Observations

Auditors use (1) their knowledge about the

transactions and/or (2) a sampling approach to
examine the transactions.

It would be too
costly for the auditor
to examine every
transaction.

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Major Phases of the Audit

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Types of Audits

 1) Operational Audits
- evaluates the efficiency & effectiveness of any
part of organisation’s operating procedures &
methods.
- not limited to accounting
- more difficult to evaluate

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Types of Audits

 2) Compliance Audits
- to determine whether the auditee is following
specific procedures, rules or regulations set by
higher authority.
- results normally reported to someone within
the organisational unit being audited.

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Types of Audits

 3) Financial Statement Audits

- to determine whether the overall financial
statements are stated in accordance with
specified criteria (normally FRS).
-the auditor performs appropriate tests to
determine whether the statements contain
material errors or other misstatements.

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Types of Audits

 4) Forensic Audits
- purpose – to obtain & develop info as legal
evidence of for use by expert witnesses in the
courts of law.
- requires the use of critical analyses &
investigative skills, integrated with accounting
knowledge & business experience.
- Examples where forensic audits might be
conducted include: business or employee fraud,
criminal investigations, shareholder &
partnership disputes.

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Types of Auditors

 1) Certified Public Accounting Firms

- responsible for auditing the published historical
financial statements of all publicly traded
companies.
- expected to express audit opinions on FS
- also called external auditor or independent
auditor

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Types of Auditors

 2) Government Auditor
- auditor working for the Auditor General Dept, a
non-partisan agency in the legislative branch of
the federal govt.
- primary responsibility – to perform audit
function for all federal & states as well as
statutory bodies & public authorities.

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Types of Auditors

 3) Inland Revenue Auditor

- responsible for enforcing the Income Tax Act
- to audit the taxpayers’ returns to determine
whether they have complied with the tax laws.
- also called inland revenue assessment officers.
- must have considerable tax knowledge &
auditing skills to conduct an effective audit.

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Types of Auditors

 4) Internal Auditor
- employed by individual companies to audit for
management
- responsibilities may vary, depending on the
employer. Their jobs can be routine compliance
auditing, operational auditing or evaluating
computer systems.
- internal auditors normally report directly to the
president, chairman or audit committee of the
board of directors.

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Types of Auditors

 5) Forensic Auditors
- a new area of auditing
- trained in detecting, investigating, and
deterring fraud & white-collar crime.
- to detect fraudulent financial reporting and
misappropriation of assets
- auditors are responsible for obtaining
reasonable assurance that material statements,
whether due to errors or fraud, are detected.

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ASSIGNMENT 1

 “Without audits, companies may be denied (1)

access to the capital markets. In addition,
auditing provides several other benefits such as
companies will be able to (2) enjoy lower cost of
capital, (3) deterrent to inefficiency and fraud,
and it acts as (4) control and operational
improvements” (Gill, et al., 1996).
 Explain how audits can lead to each economic
benefit mentioned above.

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