DEPARTMENT FO FINANCIAL ACCOUNTING AND AUDITING CAEA 2218 AUDITING PRINCIPLES DR HASLIDA ABU HASAN

LECTURE 1 Logistics & Introduction to Auditing and Assurance Engagements

Logistic
Refer to course information distribution during lecture 1 Adhere to the course information closely Some lecture notes and/or other reading materials will be uploaded to e-learning site Tutorial arrangements Assignment arrangements

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Lecture Program
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. Introduction to Auditing Overview of financial statement audits Materiality and audit risks Audit evidence procedures Audit planning and tests Internal control review Auditing the revenue cycle Auditing the purchasing cycle Auditing the inventory cycle Auditing cash Auditing property plant and equipment Auditing long term liabilities, shareholders equity & income statement items 13. Auditing payroll cycle
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Definition of an audit
A systematic process of objectively gathering and evaluating evidence in order to ascertain whether assertions about economic actions and events made by individuals or organizations correspond with establish criteria and communicating the results of the examination to users of the reports in which assertions are made (American Accounting
Association, the association of US accounting academics)

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Distinction between accounting and auditing

Accounting: identifies, organises, classifies,
summarises and communicates information about economic events a creative process

Auditing: gathers and evaluates evidence with

respect to the accounting /economic events an evaluative process

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Classification of audit by their beneficiaries

External audits: undertaken by professionally qualified
and externally accredited auditors who are external to the audited business Big 4 and many other smaller audit firms. External audit are primarily for the benefit of shareholders and market efficiency.

Internal audits: traditionally undertaken by companys

own staff or auditing firms different from main auditor. Principally for the benefit of management, though the external auditor may draw upon the results of internal audits.

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Classification of audit by their objectives :

(1) Certification audits: involve the examination of an entitys
financial statement which have been prepared by the entitys management and directors for the benefit of shareholders and other interested parties

(2) Compliance audits: aim to determine whether an individual

or an entity has acted in accordance with procedures/regulations set by an autority (eg. tax authority; parent company )

(3) Operational audits: involve the systematic examination and

evaluation of an entitys operations for the purpose of improving the efficiency and/or effectiveness of the entity. This has become known in the public sector as value for money or VFM audits NKRA national key results area

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Assurance, Attestation, and Nonassurance Services

ASSURANCE SERVICES
ATTESTATION SERVICES Audits Reviews Certain Management Consulting

Internal Control over Financial Reporting Other Attestation Services (e.g., WebTrust, SysTrust)

Other Assurance Services

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Assurance, Attestation, and Nonassurance Services

NONASSURANCE SERVICES
Other Management Consulting Certain Management Consulting

Accounting and Bookkeeping

Tax Services

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Types of Auditors
Independent certified public accounting firms Governmental general accounting office auditors Internal Revenue agents Internal auditors

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The Audit Society Michael Power

Certification audits or financial statement audit has always been regarded as a low-profile activity In the public sector, this activity sat alongside regularity (spent according to the authorisation) and propriety (proper standards, relevant to the use of public money have been met). From 1980s, growth of Value for Money or performance auditing. From 1990s, massive extension of breadth and coverage of the notion of audit. Some connection to the withdrawal of government from production eg. denationalization of utilities and substitution of regulation for ownership. Controversy about whether too many people watching rather than doing, particularly affects public sector but is much more general than that

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The Role of Auditing

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Audit objectives :
Lending credibility to financial and non-financial information provided by management in annual reports Provision of management advisory services Increased responsibility for detecting fraud and reporting doubts about going concern Helping to secure responsible corporate governance Reporting to regulatory authorities on (i) fraud detected during audit; and (ii) doubts about auditees solvency

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Audit techniques:
Emergence of audit methodologies focusing on clients business risk (risk of auditees not meeting their objectives) Audit based on : - A thorough understanding of the client, its business, its industry and especially its risks; and - Identification of audit risk through analytical review Adaptation of auditing to the e-commerce, e-business environment

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Relationships Among Auditors, Client, and External Users

Client or audit committee hires auditor Auditor issues report relied upon by users to reduce information risk

Auditor

Provides capital

Client
Client provides financial statements to users

External Users
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Overview of the Financial Statement Audit Process

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A need for theory:

A practical subject, wholly utilitarian Practice has developed without theory Public conception has evolved without theory

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Can theory explain the existence of financial statement audit:

(1) AGENCY THEORY - Agency relationship : a contract under which one or more persons (principal) engage another person (agent) to perform some service on their behalf which involves delegating some decision making authority to the agent - assumptions : (a) rational utility maximisers; (b) information asymmetry - therefore auditors act as watchdog over the agents (directors) (2) INFORMATION HYPOTHESIS - an audit improves the quality of financial information (3) INSURANCE HYPHOTHESIS - audit serve as an insurance for managers (agents), managers shift responsibility for reported data to auditors and thus they lower the expected loss from litigation - politicians also demand audits for similar reasons, eg. to escape criticism in cases of failures
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Audit Expectations Gap

A gap between what the public expects or needs and what the auditors can and should reasonably expect to accomplish Consider both perception of roles and ignorance gap Sources of expectation gap - Audit assurance: guarantee of accuracy versus a probabilistic statement, changing nature of auditors responsibility for detection of fraud - Audit reporting: perception of unqualified (clean) audit opinion, going concern debate - Audit independence: the centre of gap
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Social Role of Auditing

To add credibility to financial statements (Mautz, 1975) Necessary for public to understand exactly what an audit can reasonably be expected to achieve Necessary that all relevant findings are communicated clearly

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8 postulates about auditing (Mautz & Sharaf)

1. Financial statements and financial data are verifiable 2. There is no conflict of interest between the auditor and management of the enterprise under audit 3. The financial statements and other information submitted for verification are free from collusive and other unusual irregularities 4. The existence of a satisfactory system of internal control eliminates the probability of irregularities 5. Consistent application of GAAP will results in the fair presentation of the financial position and the results of operations 6. In the absence of clear evidence to the contrary, what has held true in the past for the enterprise under examination will hold true in the future 7. When examining financial data for the purpose of expressing an independent opinion, the auditor acts exclusively in the capacity of auditor 8. The professional status of the independent auditor imposes commensurate obligations

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The 8 postulates led to 5 primary concepts of auditing

1. Evidence 2. Due audit care 3. Fair presentation 4. Independence 5. Ethical conduct
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