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01 Auditing CH 1.ppt

  1. Auditing Principles and Practices - I
  2. CHAPTER ONE INTRODUCTION TO AUDITING • The historical development of auditing is related to the development of accounting. • In the earlier periods, the owners of business can manage their businesses and the need for independent auditors is minimal. • But because of the increase in complexity of business and different parties interested in achieving their objectives, the need for an independent auditor is becoming more important.
  3. Auditing is defined as, the accumulation and evaluation of evidence about information, to determine and report on the degree of correspondence between the information and established criteria. Whereas, Accounting is the process of identifying, analyzing, recording, summarizing, and communicating financial information about a business enterprise for sound financial decision.
  4. 1.1. Historical Development and Evolution of Auditing The development of auditing is closely related, to the development of organized systems of accounting. • The term being derived from the Latin word 'audire,' which means to 'hear'. • Read historcal development of Auditing till 20th century
  5. • These 20th century developments in auditing may be helpful to you in understanding the direction in which auditing is moving. Among them, the most significant developments are as follows: - a) A shift in emphasis from the detection of fraud to the determination of fairness of financial statements.
  6. b) Increased responsibility of the auditors to third parties, such as governmental agencies, stock exchanges and an investing public. c)The change of auditing method from detailed examination of individual transaction, to the use of sampling techniques, including statistical sampling. d)Recognition of the need to consider internal control as a guide to the direction and amount of testing & sampling to be preformed.
  7. e) Development of new auditing procedures applicable to electronic data processing systems and use of the computer as an auditing tool. f) Recognition of the need for auditors to find means of protection from the current wave of litigation. g) An increased demand for prompt disclosure of both favorable and unfavorable information concerning any publicly owned company. h) Increased concern with compliance by organizations with laws and regulations.
  8. 1.2. Definition and Terminologies of Auditing • The following are definitions of Auditing, which explain auditing in a comprehensive manner. a) In its modern sense, an audit is defined as a process carried out by suitably qualified auditors whereby the accounting records of the business entity are subject to inspection in such due as will enable the auditors to form an opinion as to their truth, fairness and accuracy. b)Auditing is also described as a process of collection and evaluation of evidence for the purpose of reporting on economic information.
  9. c) The institute of chartered accountants of India has defined auditing as "a systematic independent examination of data, statements, records, operations and performances of an enterprise for a stated purpose. d) According to Arens & Loebbecke, auditing is defined as, the accumulation and evaluation of evidence about information to determine and report on the degree of correspondence between the information and established criteria. • It be done by a competent independent person.
  10. • The description of auditing by Arens and Loebbecke includes several key terminologies which are important. Information and established criteria: To do an audit, there must be information in a verifiable form and some standards [criteria] by which the auditor can evaluate the information. Accumulating and evaluating evidence: any information used by the auditor (oral testimony, written communication and observation). Competent, independent person: The auditor must be qualified & competent and must have an independent mental attitude. Reporting: The final stage in the audit process is the audit report, which is the communication of the findings to users.
  11. Difference between Auditing and Accounting Accounting is the recording, classifying and summarizing economic events in logical manner for the purpose of providing information for decision making. In auditing the accounting data, the concern is with determining whether the recorded information properly reflects the economic events that occur during the accounting period.
  12. Accounting Auditing of financial statement  Is the process of identifying ,measuring, recording and communicating economic information about an organization in conformity with GAAP/IFRS  Is the process of obtaining and evaluating evidences and determining the fairness of financial statement inconformity with GAAS  Deliver financial statements to users  Deliver audit report(opinion) to users  Precede/lead auditing  Begins when accounting ends  No prescribed qualification is legally required for the accountant  The external auditor must be chartered accountant(CPA)  All accountant may not have auditing knowledge  Auditors must have accounting knowledge  An accountant is an employee of the firm  An auditor is independent professional (External)  Constructive and theoretical  Critical aspect of accounting and analytical in nature  Accountant are generally appointed by management and expected to perform according to the rule and regulation set by management  An Auditor is appointed by the shareholders’ or audit committee of the organization and is independent
  13. 1.3. Nature, Purpose and Scope of Auditing Nature of Auditing Framework of Auditing and Assurance Standards & Guidance Notes on Related service issued recently, distinguishes audits from related services. Related services comprise reviews, agreed-upon procedures and compilations. Audits and reviews are designed to enable the auditor to provide high and moderate levels of assurance respectively, such terms being used to indicate their comparative ranking.
  14. Assurance in this context refers to the auditor's satisfaction as to the reliability of an assertion/statement being made by one party for use by another party.  To provide such assurance, the auditor assesses the evidence collected as a result of procedures conducted and expresses a conclusion. • Absolute assurance in auditing is not attainable as a result of such factors as the need for judgment, the use of test checks, the inherent limitations of any accounting and internal control systems and the fact that most of the evidence available to the auditor is persuasive/influential, rather than conclusive, in nature.
  15. Purposes of Auditing Dependable financial information is essential to the very existence of the society. • In making a decision, such as, to buy or sell securities; the banker deciding to approve a loan; the government to obtain revenue based on income tax returns etc, all are relying upon information provided by auditors.
  16. There are many advantages of auditing to the modern society. The more important of these are as follows: A. Tool of Control over Resources • Auditing is a tool of control over those who harm resources belonging to others. • Audit acts as a mere protection against misuse of funds and reduces the possibility of errors & frauds.
  17. B. Tool for Enhancing Creditability of Economic Information • The shareholders’ of a company would give greater reliance on the financial statements of the company, if the auditor expresses the opinion that these statements present a true and fair view. C. Tool for Improving Economy and Efficiency • The auditor reviews the activities of the enterprise. He/she is, therefore, often in a position to make suggestions to improve the efficiency of various activities of the enterprise.
  18. Scope of Auditing:  Scope of Audit is internal and external The scope of internal audit activity includes examining and evaluating the policies, procedures and systems which are in place to ensure: reliability and integrity of information, compliance with policies, plans, procedures, laws and regulations; safeguarding assets; economical and efficient use of resources; and accomplishment of established objectives and goals for operations or programs.
  19. External audit: is aimed at carrying-out such work as is necessary to form an opinion as to whether: a) The accounts are properly kept; and b) The annual financial statements: i) are prepared in accordance with the financial records; and ii) Represent fairly the results of the operations and the financial in accordance with the Accounting Standards, relevant legislation and other mandatory professional reporting requirements.
  20. 1.5. Types of Audits and Auditors 1.5.1. Types of Audits: Audits are often classified in to three major types: 1) Audit of Financial Statement 2) Compliance Audit, and 3) Operational Audit /Performance Audit/
  21. 1. Audit of Financial Statements Audit of financial statements is actually part of the broader concept of the attest/confirm/affirm function. To attest to financial statements is to provide assurance as to their fairness and dependability. The attest function consists of two phases:- A. The first is the performance of an audit; B. The second is the issuance of an audit report.
  22. The audit of FSts. ordinarily covers the balance sheet and the related statements of profit and loss and cash flows. The goals of audit of FSts. are to determine whether the statements have been prepared in conformity with GAAP/ IFRS. FSts. audits are normally performed by certified public accountants (CPAs). The contribution of the independent financial audit is to give credibility to financial statements.
  23. The word “audited” when applied to financial statements means that; balance sheet, profit and loss statements and cash flows are accompanied by an audit report prepared by independent auditors’ expressing their professional opinion as to fairness of the enterprise's financial statements.
  24. The Objectives of Audit of Financial Statements are: To determine whether financial statements have been prepared in accordance to GAAP/IFRS. To ensure the completeness of financial statements. To vouch/insure the existence of recorded transactions in the financial statements. To examine the accuracy of the financial statements. To ensure that the net income / loss is the result of the operation for a given accounting period. To verify availability of assets recorded in the balance sheet.
  25. 2. Compliance Audit It is dependent upon the existence of verifiable data and of recognized criteria or standard established by an authoritative body. It is an audit to determine whether verifiable data such as income tax returns or other financial statements are in conformity with established criteria, for example, laws and regulations, society has always been concerned with compliance with laws and regulations by all types of entities, business, government and non profit making organizations.
  26. The Objectives of Compliance Audits are: To determine whether there have been violations of laws and regulations that may have a material effect on the organizations financial statements. To provide a basis for additional reports on compliance procedures that is not tests of the internal control policies and procedures. The auditors may discover violations of provisions of laws, regulations, contracts or grants that result in which they estimate to be material misstatement to the organization's financial statements.
  27. 3. Operational Audit /Performance Audit/ An operation audit is a systematic independent appraisal activity within an enterprise, for a review of the entire departmental performance. It is to assist all levels of management in the effective discharges of responsibilities, by furnishing (providing) them with objective analysis, appraisal, recommendations and pertinent comments concerning the activities reviewed. Internal auditors often perform operational audits.
  28. The purpose of an operational audit usually includes the intention to appraise performance of a particular organizational function or group of activities. • The auditors must determine specifically which policies and procedures are to be appraised and show their relation to the specific objectives of the enterprise or organization. Before starting the operational audit, the auditors must obtain a comprehensive knowledge of the objectives, organizational structure, and operating characteristics of the unit to be audited.
  29. Objectives of Operational Audits The main users of operational audit reports are managers at various levels. The management needs the following information: Assessment of the unit performance in relation to management's objectives or other appropriate criteria. Assurance that its plans are comprehensive, consistent and understood at the operating levels.
  30. Objective information on how well its plans and policies are being carried out in all areas of operation and opportunities for improvement in effectiveness, efficiency and economy. Information on weakness in operating controls, particularly as to possible sources of waste. Reassurance that all operating reports can be relied on as basis for action.
  31. 1.5.2. Types of Auditors Auditors are often viewed as falling into three main types: A. Independent financial auditor /Certified Public Accountants/ B. Internal auditors C. Government auditors
  32. A. Independent financial auditors Independent auditor is a person licensed by the state to practice public accounting as a profession based on having passed the uniform CPA examination and having met certain education and experience. The most important characteristics of these auditors are a responsibility to serve the public, of a complex knowledge, standards of admission to the profession and a need for public confidence.
  33. It is the report by the independent auditors that gives credibility to a set of financial statements and makes acceptable to investors, bankers, government and other users.
  34. B. InternalAuditors Internal auditing is an independent appraisal activity established within an organization or enterprise to examine and evaluate its activities, as a service to the organization in the effective discharge of their responsibilities.
  35. It is a part of the organization's internal control structure. They represent high level control that functions by measuring and evaluating the effectiveness of other internal control policies and procedures. It is not merely concerned with the organization's financial controls. Their work encompasses the entire internal control structure of the organization or enterprise. The internal auditing head often accordingly reports to the general manager or board of directors or president or another high executive.
  36. C. Government Auditors  A government audit is conducted primarily to ensure that financial transactions are recorded with proper sanction and authorization. In Ethiopia, the office of Auditors General and Office of control has been given the responsibility to conduct the audit of the central government and the state governments.
  37. Government auditors examine and make sure that: - Transactions are correctly recorded and activities conform to the rules and regulations. Ensure that public funds are not misused. Examine the efficiency and effectiveness of selected projects or program run by government.
  38. Audit Auditors Internal auditors Independent Auditors Government Auditors Operational Audit Primary Nominal Primary Financial Audit Secondary Primary Nominal Compliance Audit Primary Secondary Primary