FUNDAMENTALS OF AUDITING ACC311
Lecture 04
Lesson 04
OBJECTIVE AND GENERAL
PRINCIPLES GOVERNING
PRINCIPLES GOVERNING
AN AUDIT OF FINANCIAL
STATEMENTS
STATEMENTS
Objective of an Audit:
Objective of an audit of
financial statements is to enable an auditor to express an opinion whether the
financial statements is to enable an auditor to express an opinion whether the
financial statements are
prepared, in all material respects, in accordance with an identified financial
reporting
prepared, in all material respects, in accordance with an identified financial
reporting
framework (e.g.
International or Local Accounting Standards).
International or Local Accounting Standards).
The terms used to
express the opinion are “give a true and fair view” or “present fairly in all
material
express the opinion are “give a true and fair view” or “present fairly in all
material
respects”.
Benefit of opinion
It improves credibility
of financial statements.
of financial statements.
What an opinion does not
achieve?
achieve?
It does not provide any
assurance about
assurance about
i) Future viability of
the entity; and
the entity; and
ii) Efficiency or
effectiveness of management.
effectiveness of management.
General Principles of an
Audit:
Audit:
Professional Ethics
There are a number of
ethical matters that are extremely important for auditors to consider when
ethical matters that are extremely important for auditors to consider when
performing their work.
It is vital to the public image and credibility of the profession that the
It is vital to the public image and credibility of the profession that the
auditor is seen to be
behaving in an acceptable manner in addition to actually complying with the
behaving in an acceptable manner in addition to actually complying with the
ethical requirements.
It is important to
recognize that many groups in society rely on accountant’s work, not just the
recognize that many groups in society rely on accountant’s work, not just the
shareholders on whose
behalf the accountant is working. The accountant therefore has a public
behalf the accountant is working. The accountant therefore has a public
accountability.
In the light of this,
ICAP’s ethical guidelines emphasis the following key points about the
ICAP’s ethical guidelines emphasis the following key points about the
characteristics of
accountants:
accountants:
a)
Independence:
Auditor is
independent of management i.e. he is not under the control or influence of
independent of management i.e. he is not under the control or influence of
management.
b)
Integrity:
Auditor is honest and is
not corrupt. He is straight forward in performing his professional
not corrupt. He is straight forward in performing his professional
work
c)
Objectivity:
He obtains the evidence
needed to form an opinion and his opinion is based on that
needed to form an opinion and his opinion is based on that
evidence alone. He is
not subjective in forming his opinion.
not subjective in forming his opinion.
d)
Professional Competence
and Due Care:
and Due Care:
Auditor has attained
certain professional qualification, has acquired the requisite skill and
certain professional qualification, has acquired the requisite skill and
has attained the
experience necessary for the audit and performs his work with planning
experience necessary for the audit and performs his work with planning
and due diligence.
e)
Confidentiality:
Auditor neither
discloses the information obtained during the course of his audit without
discloses the information obtained during the course of his audit without
permission of his client
(except when required in a court of law) nor uses that information
(except when required in a court of law) nor uses that information
himself.
f)
Professional
Behavior:
Behavior:
He should not only
act in a professional manner but should also appear to be a
act in a professional manner but should also appear to be a
professional. He should
maintain his professional knowledge and skill at a level required to
maintain his professional knowledge and skill at a level required to
ensure that a client or
employer receives the benefit of competent professional service
employer receives the benefit of competent professional service
based on up-to-date
developments in auditing practice and relevant legislation.
developments in auditing practice and relevant legislation.
g)
Technical
Standards:
Standards:
Audit should be
performed by following certain standards, international or national.
performed by following certain standards, international or national.
9
International Standards
on Auditing (ISAs)
on Auditing (ISAs)
The auditor should
follow basic principles and essential procedures together with related guidance
follow basic principles and essential procedures together with related guidance
as contained in ISAs.
International Standards
on Auditing (ISAs) are issued by the International Auditing Practices
on Auditing (ISAs) are issued by the International Auditing Practices
Committee (IAPC). The
IAPC is a standing committee of the Council of the International
IAPC is a standing committee of the Council of the International
Federation of
Accountants (IFAC), which was formed in 1977 and is based in New York. IFAC
Accountants (IFAC), which was formed in 1977 and is based in New York. IFAC
has more than 150 member
bodies, representing over 2 million accountants in more than 100
bodies, representing over 2 million accountants in more than 100
countries, and
membership of IFAC automatically confers
membership of IFAC automatically confers
The IAPC issued
standards and statements on auditing and related services in order to improve
the
standards and statements on auditing and related services in order to improve
the
degree of uniformity of
auditing practice and related services throughout the world.
auditing practice and related services throughout the world.
The IAPC works closely
with its members and national standard setters in order to gain acceptance
with its members and national standard setters in order to gain acceptance
of international
Standards of Auditing (ISAs). Member bodies have increasingly sought to align
the
Standards of Auditing (ISAs). Member bodies have increasingly sought to align
the
national position with
the international positions IFAC and the IASC have gained influence and
the international positions IFAC and the IASC have gained influence and
recognition. Standard
setters increasingly refer to the international position in their consultative
setters increasingly refer to the international position in their consultative
documents as
authoritative support for a particular view.
authoritative support for a particular view.
International auditing
and accounting standards do not at present override local regulations.
and accounting standards do not at present override local regulations.
Neither IFAC nor the
IASC can currently compel any organization to comply with international
IASC can currently compel any organization to comply with international
standards; nor are there
specific sanctions where organizations claim to have complied with
specific sanctions where organizations claim to have complied with
international standards,
but have not done so.
but have not done so.
The preface to
International Standards on Auditing and Related Services (ISA 100) states that
IAPC guidance
International Standards on Auditing and Related Services (ISA 100) states that
IAPC guidance
falls into two
categories:
categories:
International
Standards on Auditing (ISAs).
Standards on Auditing (ISAs).
ISAs contain basic
principles and essential procedures (identified in bold type black lettering),
principles and essential procedures (identified in bold type black lettering),
together with related
guidance in the form of explanatory and other material (in plain type)
guidance in the form of explanatory and other material (in plain type)
including appendices.
The basic principles and
essential procedures are to be understood and applied in the context of
essential procedures are to be understood and applied in the context of
explanatory and other
material that provides guidance for their application. The text of a whole
material that provides guidance for their application. The text of a whole
standard is considered
in order to understand and apply the basic principles and essential
in order to understand and apply the basic principles and essential
procedures.
International
Auditing Practice Statements (IAPSs).
Auditing Practice Statements (IAPSs).
In conducting an audit
in accordance with ISAs, the auditor is also aware of and considers
in accordance with ISAs, the auditor is also aware of and considers
International Auditing
Practice Statements (IAPSs) applicable to the audit engagement.
Practice Statements (IAPSs) applicable to the audit engagement.
IAPSs provide practical
assistance to auditors in implementing standards and promote good
assistance to auditors in implementing standards and promote good
practice. They are not
intended to have the authority of standards.
intended to have the authority of standards.
The auditor may also
conduct the audit in accordance with both ISAs and auditing standards of a
specific jurisdiction
conduct the audit in accordance with both ISAs and auditing standards of a
specific jurisdiction
or country.
Professional
Skepticism
Skepticism
The audit should be
planned and performed with an attitude of professional skepticism i.e. forming
planned and performed with an attitude of professional skepticism i.e. forming
an opinion only after
obtaining sufficient and appropriate audit evidence instead of blindly
obtaining sufficient and appropriate audit evidence instead of blindly
accepting any
information or explanation given by the management.
information or explanation given by the management.
An attitude of
professional skepticism means the auditor makes a critical assessment, with a
professional skepticism means the auditor makes a critical assessment, with a
questioning mind, of the
validity of audit evidence obtained and is alert to audit evidence that
validity of audit evidence obtained and is alert to audit evidence that
contradicts or brings
into question the reliability of documents and responses to inquiries and other
into question the reliability of documents and responses to inquiries and other
information obtained
from management and those charged with governance.
from management and those charged with governance.
SCOPE OF AN AUDIT
What does it
mean?
mean?
The term “scope of
an audit” refers to the audit procedures that, in the auditor’s judgment and
an audit” refers to the audit procedures that, in the auditor’s judgment and
based on the ISAs, are
deemed appropriate in the circumstances to achieve the objective of the
deemed appropriate in the circumstances to achieve the objective of the
audit.
10
Audit
opinion
opinion
Reasonable
assurance
assurance
Sufficient
appropriate audit evidence
appropriate audit evidence
Audit procedures
(based on ISAs)
(based on ISAs)
Audit-Evidence:
It is obtained by
applying necessary audit procedures. Audit procedures should be based on
requirements of
applying necessary audit procedures. Audit procedures should be based on
requirements of
ISAs, relevant
professional bodies, legislation, regulations, and the terms of the audit
engagement and
professional bodies, legislation, regulations, and the terms of the audit
engagement and
reporting
requirements.
requirements.
Auditing is concerned
with the verification of accounting date and with determining the accuracy and
with the verification of accounting date and with determining the accuracy and
reliability of accounting
statements and reports.
statements and reports.
Verification does not
mean seeking proof or absolute certainty in connection with the data and
reports
mean seeking proof or absolute certainty in connection with the data and
reports
being audited. It means
looking for sufficient evidence depends on what experience and knowledge of
looking for sufficient evidence depends on what experience and knowledge of
contemporary auditing
standards tells one is satisfactory.
standards tells one is satisfactory.
An auditor obtains audit
evidence regarding management’s assertions for the following areas:
evidence regarding management’s assertions for the following areas:
a. Existence: an asset
or liability exists at the Balance Sheet date. This is an obvious assertion
with such
or liability exists at the Balance Sheet date. This is an obvious assertion
with such
items as land and
buildings, stocks and others
buildings, stocks and others
b. Rights and
obligations: an asset or liability pertains to the entity at the Balance Sheet
date. This
obligations: an asset or liability pertains to the entity at the Balance Sheet
date. This
means that the
enterprise has for example ownership of an asset. Ownership as an idea is not
simple
enterprise has for example ownership of an asset. Ownership as an idea is not
simple
and there may be all
sorts of rights and obligations connected with a given asset or
liability.
sorts of rights and obligations connected with a given asset or
liability.
c. Occurrence: a
transaction or event took place which pertains to the enterprise during the
relevant
transaction or event took place which pertains to the enterprise during the
relevant
period. It may be
possible for false transactions (e.g. sales or purchases) to be recorded. The
assertion is
possible for false transactions (e.g. sales or purchases) to be recorded. The
assertion is
that all recorded
transactions actually took place.
transactions actually took place.
d. Completeness: there
are not unrecorded assets, liabilities, transactions or events or undisclosed
items.
are not unrecorded assets, liabilities, transactions or events or undisclosed
items.
This is important for
all accounts items but is especially important for liabilities.
all accounts items but is especially important for liabilities.
e. Valuation: an asset
or liability is recorded at an appropriate carrying value Appropriate may mean
in
or liability is recorded at an appropriate carrying value Appropriate may mean
in
accordance with
generally accepted accounting principles, the companies Act rules, Accounting
generally accepted accounting principles, the companies Act rules, Accounting
Standards requirements
and consistent with statements of accounting policies consistently
applied.
and consistent with statements of accounting policies consistently
applied.
f. Measurement: a
transaction or event is recorded at the proper amount and revenue or expense
transaction or event is recorded at the proper amount and revenue or expense
allocated to the proper
period.
period.
g. Presentation and
disclosure: an item is disclosed, classified and described in accordance with
disclosure: an item is disclosed, classified and described in accordance with
applicable reporting
framework. For example fixed assets are subject to the Companies Ordinance
rules
framework. For example fixed assets are subject to the Companies Ordinance
rules
and to IAS 16.
An example:
We will look at an item
in a balance sheet, bank overdraft Rs. 10,250. In reporting this item in the
balance
in a balance sheet, bank overdraft Rs. 10,250. In reporting this item in the
balance
sheet, the directors are
making these assertions:
making these assertions:
a. That there is a
liability to the company’s bankers.
liability to the company’s bankers.
b. That at the balance
sheet date this liability was Rs. 10,250.
sheet date this liability was Rs. 10,250.
c. That this amount is
agreed by the bank
agreed by the bank
d. That the overdraft
was repayable on demand. If this were not so, it would not appear amongst the
was repayable on demand. If this were not so, it would not appear amongst the
current liabilities and
terms would be stated.
terms would be stated.
e. That the overdraft
was not secured. If it were secured this fact would need to be stated.
was not secured. If it were secured this fact would need to be stated.
f. That the company has
the Authority to borrow from its Memorandum and Articles.
the Authority to borrow from its Memorandum and Articles.
g. That a bank
reconciliation statement can be prepared.
reconciliation statement can be prepared.
h. That the bank is
willing to let the overdraft continue.
willing to let the overdraft continue.
If no item ‘bank
overdraft’ appeared in the balance sheet, it would represent an assertion by
the directors
overdraft’ appeared in the balance sheet, it would represent an assertion by
the directors
that no overdraft
liability existed at the balance sheet date.
liability existed at the balance sheet date.
REASONABLE ASSURANCE
What is reasonable
assurance?
assurance?
A conclusion that the
financial statements are not materially misstated. An auditor cannot obtain
absolute
financial statements are not materially misstated. An auditor cannot obtain
absolute
assurance because of
limitations described in Para below.
limitations described in Para below.
How reasonable assurance
is achieved?
is achieved?
It is achieved by
obtaining audit evidence.
obtaining audit evidence.
Factors affecting
reasonable assurance
reasonable assurance
11
i) Inherent limitation
of an audit, i.e. failure of audit procedures to detect material
of an audit, i.e. failure of audit procedures to detect material
misstatements in
financial statements because of:
financial statements because of:
a) The use of testing
(application of procedures on samples).
(application of procedures on samples).
b) The inherent
limitations of accounting and internal control system.
limitations of accounting and internal control system.
c) Persuasive nature of
audit evidence rather than conclusive (Persuasive: one leading
audit evidence rather than conclusive (Persuasive: one leading
to an opinion; one which
causes to believe; Conclusive: final, convincing).
causes to believe; Conclusive: final, convincing).
ii) Exercise of judgment
by the auditor in gathering of evidence and drawing of conclusion.
by the auditor in gathering of evidence and drawing of conclusion.
iii) Existence of other
limitations like related parties etc.
limitations like related parties etc.
Audit Risk and
Materiality
Materiality
Guidance provided by ISA
200 in this matter is discussed in later chapters which specifically and
exclusively
200 in this matter is discussed in later chapters which specifically and
exclusively
discuss it.
Responsibility for the
Financial Statements:
Financial Statements:
Responsibilities for
preparing and presenting the financial statements are that of management.
Auditor’s
preparing and presenting the financial statements are that of management.
Auditor’s
responsibility is to
express an opinion thereon.
