LECTURE 1

CORPORATE GOVERNANCE
12.10.2017
 AUDITING AN INTRODUCTION

• Audit is an independent examination of

financial statements of an entity that
enables an auditor to express an
opinion whether the financial statements
are prepared (in all material respects-
misstated) in accordance with an
identified and acceptable financial
reporting framework.
 ESSENTIAL FEATURES OF AN AUDIT:

An auditor involves in examination of financial statements,

the auditor is not responsible for the preparation of the
financial statements.

The end result of an audit is an opinion to assist the user of

the financial statements. Auditing therefore relies heavily
on professional judgment, not merely on the facts.

The auditor’s opinion makes reference to “true and fair” or

“fair presentations” but “true and fair” is again a matter
of judgment. It is not precisely defined for the auditor.
WHY IS THERE A NEED FOR AN AUDIT?

Contain errors

Not disclose fraud

Be inadvertently misleading

Be deliberately misleading

Fail to disclose relevant information

Fail to conform to regulations

WHAT IS THE DISTINCTION BETWEEN
AUDITING AND ACCOUNTING?
• ACCOUNTING
• SOLELY RESPONSIBILITY OF MANAGEMENT

• AUDITING
• INDEPENDENT EXAMINER
 WHO CAN BE AN AUDITOR?
For appointment as auditor of:

a) a Public Company or

b) a Private Company which is a subsidiary of a Public Company.

c) a Private Company having paid up capital (the amount of money a

company has received from shareholders in exchange for shares of stock.)of three
million rupees or more.

The person must be a Chartered Accountant within the meaning of the Chartered
Accountants Ordinance, 1961.

For listed-Official Stock Exchange companies an auditor must have a satisfactory

QCR (quality control review: second pair of eyes to review engagement
performance: The firm and its personnel comply with professional standards and
applicable legal and regulatory requirements; and Reports issued by the firm or
engagement partners are appropriate in the circumstances.) rating issued by ICAP.
Rating: Rating: estimate a company's credit quality with respect to the probability of default and/or bankruptcy within 1 year.
 WHAT IS AN AUDITOR’S REPORT?

The primary aim of an audit is to enable the auditor to

say “these accounts show a true and fair view” or, of
course, to say that “they do not show a true and fair
view”.

At the end of his audit, when he has examined the entity,

its record, and its financial statements, the auditor
produces a report addressed to the owners/stake holders
in which he expresses his opinion of the truth and fairness,
and sometimes other aspects, of the financial statements.
WHAT ARE THE DIFFERENT TYPES OF
AUDIT?

Three types of audits are discussed in general, i.e.

Financial statement audits

Operational audits

Compliance audits
 FINANCIAL STATEMENT AUDITS
• IN ACCORDANCE WITH SPECIFIED CRITERIA:
• NORMALLY, THE CRITERIA ARE THE REQUIREMENTS OF THE APPLICABLE
INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRSS) AND THE
COMPANIES ORDINANCE 1984.
• GENERAL AUDIT:
• FOR EXAMPLE, A GENERAL AUDIT OF A BUSINESS MAY PROVIDE
SUFFICIENT FINANCIAL INFORMATION FOR A BANKER CONSIDERING
A LOAN TO THE COMPANY,
• BUT A CORPORATION CONSIDERING A MERGER WITH THAT
BUSINESS MAY ALSO WISH TO KNOW THE REPLACEMENT COST OF
FIXED ASSETS AND OTHER INFORMATION RELEVANT TO THE DECISION.
THE CORPORATION MAY USE ITS OWN AUDITORS TO GET THE
ADDITIONAL INFORMATION.
IFRSS: STANDARDS THAT WERE ISSUED BY IASC (THE PREDECESSOR OF
IASB) ARE STILL WITHIN USE TODAY AND GO BY THE NAME
INTERNATIONAL ACCOUNTING STANDARDS (IAS), WHILE STANDARDS
ISSUED BY IASB ARE CALLED IFRS. IAS WERE ISSUED BETWEEN 1973 AND
2001 BY THE BOARD OF THE INTERNATIONAL ACCOUNTING STANDARDS
COMMITTEE (IASC).
 OPERATIONAL AUDITS
• AN OPERATIONAL AUDIT IS A REVIEW OF ANY PART OF:
• AN ENTITY’S OPERATING PROCEDURES AND METHODS FOR THE PURPOSE
OF EVALUATING EFFICIENCY AND EFFECTIVENESS.
• AT THE COMPLETION OF AN OPERATIONAL AUDIT, RECOMMENDATIONS TO
MANAGEMENT FOR IMPROVING OPERATION ARE NORMALLY EXPECTED.

AN EXAMPLE OF AN OPERATIONAL AUDIT IS EVALUATING THE EFFICIENCY

AND ACCURACY OF PROCESSING PAYROLL TRANSACTIONS IN A NEWLY
INSTALLED COMPUTER SYSTEM. ANOTHER EXAMPLE, WHERE MOST
ACCOUNTANTS WOULD FEEL LESS QUALIFIED IS EVALUATING THE
EFFICIENCY, ACCURACY, AND CUSTOMER SATISFACTION IN PROCESSING
THE DISTRIBUTION OF LETTERS AND PARCELS BY A COURIER COMPANY
SUCH AS TCS.
 COMPLIANCE AUDITS
• PURPOSE
• TO DETERMINE WHETHER THE ENTITY IS FOLLOWING SPECIFIC
PROCEDURES, RULES, OR REGULATIONS SET DOWN BY SOME
HIGHER AUTHORITY.
• ALSO COMPLYING WITH LEGAL REQUIREMENTS.
• IN THE AUDIT OF GOVERNMENTAL UNITS SUCH AS DISTRICTS
SCHOOL, THERE IS EXTENSIVE COMPLIANCE AUDITING DUE TO
EXTENSIVE REGULATION BY HIGHER GOVERNMENT AUTHORITIES. IN
VIRTUALLY EVERY PRIVATE AND NON PROFIT ORGANIZATION, THERE
ARE PRESCRIBED POLICIES, CONTRACTUAL AGREEMENTS, AND
LEGAL REQUIREMENTS THAT MAY CALL FOR COMPLIANCE AUDITING.
• RESULTS OF COMPLIANCE AUDITS ARE TYPICALLY REPORTED TO
SOMEONE WITHIN THE ENTITY BEING AUDITED RATHER THAN TO A
BROAD SPECTRUM OF USERS.
 EXAMPLES OF THE THREE TYPES OF
AUDITS
TYPES OF AUDIT EXAMPLE QUANTIFIABLE ESTABLISHED AVAILABLE
INFORMATION CRITERIA EVIDENCE

Financial Statement Annual Audit of General Motors International Documents,

Audit General Motors’ financial statements. Financial Reporting records, and
financial statements. Standards. outside sources
of evidence.
Operational Audit Evaluate whether the Number of payroll Company standards Error reports,
computerized payroll records processed in a for efficiency and payroll records,
processing for month, costs of the effectiveness in and payroll
subsidiary is operating department, and payroll department. processing costs.
efficiently and number of errors
effectively. made.

Compliance Determine if bank Company records Loan agreement Financial

Audit requirements for loan provisions. statements and
continuation have calculations by
been met. the auditor.
 WHAT ARE THE
ADVANTAGES AND
DISADVANTAGES OF
AUDITING?
 ADVANTAGES OF AN AUDIT

These advantages can be summarized as follows:

Disputes between management

Major changes in ownership

Application to lenders/financial Institutions for finance

in depth examination
 DISADVANTAGES OF AN AUDIT

audit fee

Time to providing
information to the auditor
PRINCIPLES OF FRAUD AUDITING
Fraud auditing is unlike financial auditing. It is more a mind-set
than a methodology.

Fraud auditors are unlike financial auditors. Fraud auditors focus

on exceptions, oddities/twists, accounting irregularities, and
patterns of conduct, not on errors and omissions.

Fraud auditing is learned primarily from experience, not from audit

text books or last year’s work papers. Learning to be a fraud
auditor means learning to think like a thief “Where are the
weakest links in this chain of internal controls?”

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 PRINCIPLES OF FRAUD AUDITING
From an audit perspective, fraud is intentionally misrepresenting
financial facts of a material nature. From a fraud-audit perspective,
fraud is an intentional misrepresentation of financial facts.

Frauds are committed for economic, egocentric/selfish, ideological,

and psychotic reasons. Of the four, the economic motive is the most
common.

Frauds tends to encompass a theory structured around motive,

opportunity, and benefit.

Fraud in a computerized accounting environment can be committed at

any state of processing—input, throughput, or output. Input frauds
(entering false and fraudulent data) are the most common.

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 PRINCIPLES OF FRAUD AUDITING
The most common fraudulent schemes by lower-level employees involve
disbursements (payables, payroll, and benefit and expense claims).

The most common fraudulent schemes by higher-level managers involve “profit

smoothing” (deferring expenses, booking sales too early, overstating inventory).

Accounting-type frauds are caused more often by absence of controls than by

loose controls.

Fraud incidents are not growing exponentially, but fraud losses are.

Accounting frauds are discovered more often by accident that by financial audit
purposes or design. Over 90 percent of financial frauds are discovered by
accident.

Fraud prevention is a matter of adequate controls and work environment that

places a high value on personal honesty and fair dealing.

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Auditing in Public
Sector
 DEFINITION OF GOVERNMENT AUDIT
According to the INTOSAI (International Organization of Supreme Audit
Institutions) Auditing Standards, the full scope of government auditing
includes regularity and performance audit.

Regularity audit comprises of the attest of Financial Statements called

Certification Audit and Compliance with Authority Audit. Regularity
audit embraces:

• Attestation of financial accountability of accountable entities, involving examination

and evaluation of financial records and expression of opinion on Financial Statements;
• Attestation of financial accountability of the government administration as a whole;
• Audit of financial systems and transactions including an evaluation of compliance with
applicable statues and regulations;
• Audit of internal control and internal audit functions;
• Audit of the probity/correctness and propriety/just of administrative decisions taken
within the audit entity; and
• Reporting of any other matters arising from or relating to the audit that the Supreme
Audit Institution considers should be disclosed.
 PERFORMANCE AUDIT
Performance audit is concerned with the audit of
economy, efficiency and effectiveness and embraces:
• Audit of the economy of administrative activities in accordance with
sound administrative principles and practices, and management
policies;
• Audit of the efficiency of utilizing of human, financial and other
resources, including the examination of information systems,
performance measures, monitoring arrangements, and procedures
followed by audited entities for remedying identified deficiencies;
and
• Audit of the effectiveness of performance in relation to the
achievement of the objectives of the audited entity, and audit of the
actual impact of activities compared with the intended impact.
• Detailed guidelines for Performance Audit have been issued by the
DAGP (Department of audit general of Pakistan) which are being
updated under a special program initiated by PIFRA (Project to
Improve Financial Reporting and Auditing.)
AUDIT ACCOUNTABILITY CYCLE
GOVERNMENT OF PAKISTAN
 TYPES OF AUDIT IN PUBLIC SECTOR
DIRECTORATE GENERAL AUDIT, FEDERAL GOVERNMENT CONDUCTS THE
FOLLOWING TYPES OF AUDIT

• CERTIFICATION AUDIT
• COMPLIANCE WITH AUTHORITY AUDIT
• PERFORMANCE AUDIT
 CERTIFICATION AUDIT
Objectives of certification audit
• The Financial Statements properly present, in all
material respects, the government’s financial
position, the results of its operations, its cash flows
and its expenditures and receipts by
appropriation;
• Ensure that assessed revenue is promptly collected
and deposited in government treasury and
properly classified in the Financial Statements; and
• The sums expended have been applied in all
material respects, for the purposes authorised by
Parliament and have, in all material respects, been
booked to the relevant grants and appropriations.
 METHODOLOGY FOR CERTIFICATION AUDIT
Understanding the auditee;

Conducting risk assessment;

Defining detailed audit objectives;

Developing audit programmes;

Performing analytical procedures;

Testing the internal controls;

Determining sample size for substantive testing of detail;

Conducting substantive tests;

Evaluating results;

Reporting; and

Follow up.
 COMPLIANCE WITH AUTHORITY AUDIT
• AUDIT AGAINST THE PROVISION OF FUNDS TO ASCERTAIN WHETHER THE MONEYS
SHOWN AS EXPENDITURE IN THE ACCOUNTS WERE AUTHORIZED FOR THE PURPOSE
FOR WHICH THEY WERE SPENT.
• AUDIT AGAINST RULES AND REGULATION TO SEE THAT THE EXPENDITURE INCURRED
WAS IN CONFORMITY WITH THE LAWS, RULES AND REGULATIONS FRAMED TO
REGULATE THE PROCEDURE FOR EXPENDING PUBLIC MONEY.
• AUDIT OF SANCTIONS OF EXPENDITURE TO SEE THAT EVERY ITEM OF EXPENDITURE WAS
DONE WITH THE APPROVAL OF THE COMPETENT AUTHORITY IN THE GOVERNMENT FOR
EXPENDING THE PUBLIC MONEY.
• PROPRIETY AUDIT WHICH EXTENDS BEYOND SCRUTINIZING THE MERE FORMALITY OF
EXPENDITURE TO ITS WISDOM AND ECONOMY AND TO BRING TO LIGHT CASES OF
IMPROPER EXPENDITURE OR WASTE OF PUBLIC MONEY.
• WHILE CONDUCTING THE AUDIT OF RECEIPTS OF THE GOVERNMENT, THE AUDITOR-
GENERAL SATISFIES HIMSELF THAT THE RULES AND PROCEDURES HAVE BEEN PROPERLY
ADOPTED AND ENSURES THAT THE ASSESSMENT, COLLECTION AND ALLOCATION OF
REVENUE ARE DONE IN ACCORDANCE WITH THE LAW AND THERE IS NO LEAKAGE OF
REVENUE WHICH LEGALLY SHOULD COME TO GOVERNMENT.
• REVIEW, ANALYZE AND COMMENT ON VARIOUS GOVERNMENT POLICIES RELATING TO
DIFFERENT SECTORS.
 METHODOLOGY
Updating the understanding of the business processes with respect to control structure;

Identification of key controls on the basis of prior years’ audit experience /special directions from the head office etc.;

Prioritising risk areas by determining significance and risks associated with identified key controls;

Design audit programmes including analytical procedures for testing identified risk conditions;

Selection of audit formations i.e. DDOs on the basis of: Materiality/significance and Risk assessment

Selecting samples as per sampling criteria;

Execution of audit programmes;

Identification of weaknesses in internal controls and development of audit observations and
recommendations relating to non compliance of laws, rules, regulations and prescribed procedures;

Integrating the work with financial attest audit , where possible;

Evaluating results;

Reporting; and

Follow up.
 KEY ELEMENTS OF AN EFFECTIVE PUBLIC
SECTOR AUDIT ACTIVITY

Organizational independence

A Formal Mandate

Unrestricted Access

Sufficient Funding

Competent leadership

Objective Staff

Competent Staff

Stakeholder support

Professional Audit standards

 PUBLIC SECTOR AUDITING – PART OF
EFFECTIVE GOVERNANCE

In a system of representative democracy, the

institutions of government and the officials exist
to serve the interests of the public. In such a
constitutional system, the Parliament is the
public’s representative forum and it derives its
ultimate legitimacy from the public on whose
behalf it has been elected and acts. Parliament
has the responsibility to promote the goals of
openness, accountability and integrity.
 TYPES OF AUDITORS

Internal Auditors

Independent Auditors

Government Auditors
 INTERNAL AUDITORS

Employees of the organization

They do Financial Statements audit, Compliance

audit and operational audit.

Assist external Auditors

They are not independent

 INDEPENDENT AUDITORS

Certified public accountants

Opinion of independent auditor more

credible

Government Auditor
• They work in various local, state, federal and central
government.
 POWERS & DUTIES OF AUDITORS

a) Ensure compliance of all auditing standards

b) Consolidation of accounts Exercise your right to access to the records of

all its subsidiaries if required.

c) Ensure you have sought the desired information. Keep all backups
preferably certified copies.

d) The auditor’s report shall state any qualifications, reservation or adverse

remark relating to the maintenance of accounts and other matters connected
therewith.

e) The auditor’s report to state whether company has adequate internal

financial controls systems in place and operating effectiveness of such
controls.
 POWERS & DUTIES OF AUDITORS

f) If an auditor of a company, in the course of

the performance of his duties as auditor, has
reason to believe that an offence involving
fraud is being or has been committed against
the company by officers or employees of the
company, he shall immediately report the
matter to the Central Govt immediately but
not later than thirty days of his knowledge
or information, with a copy to the audit
committee or in case the company has not
constituted an audit committee, to the Board.