You are on page 1of 25

Definition of Auditing:

Auditing is the process by which a competent,

independent person accumulates and evaluates evidence about quantifiable information related to a specific economic entity for the purpose of determining and reporting on the degree of correspondence between the quantifiable information and established criteria.

a. Competent, Independent Person:


Qualified to understand the criteria used. Know the types and amount of evidence to accumulate to reach the proper conclusion after the evidence has been examined. Independence

Have an independent mental attitude (be independent in fact and in professionalism). Unbiased information and objective thinking are needed for the judgment and decisions to be made.

b. Accumulating & Evaluating evidence:


information used by the auditor to determine whether the quantifiable information being audited is stated in accordance with the established criteria.

Deciding the amount of audit evidence-planning. Accumulation of evidence implementation. Evaluation of evidence implementation. Drawing conclusion based on these evidence. Final stage.

Quality and volume of evidence must satisfy

the audit objective.

c. Quantifiable information & established criteria:

Quantifiable-Information in a verifiable form (can be

assessed against some criteria/standard/ benchmarks). Established criteria standards against which quantifiable information will be assessed. Example: * GAAP * IAS (International Accounting Standards) * Companies Act *Accounting Standards *Tax Ordinance *SEC Act Criteria used depend upon the objective of the audit.

d. Economic entity:

Economic entity legal entity e.g.

* corporation
* * * * * unit of govt. partnership, division, department, even individual.

Scope of the auditors responsibility identified by

defining the economic entity.

e. Reporting:
Reporting (final stage in audit process) preparing

audit report and communicating findings to users of financial statements. Audit is one of the assurance services/attestation services provided by the competent and qualified professional accountants.

Definition by American Accounting Association (AAA):

Auditing 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 users.

Definition by International Federation of Accountants (IFAC)

An audit is an independent examination of financial

statements or related financial information of an entity, whether profit oriented or not, and irrespective of its size, or legal form, when such an examination is conducted with a view to expressing an opinion thereon.

02.Objective of an audit

Primary and Secondary Objective of Audit i) Primary objective- Expression of Expert opinion ii) Secondary objectives- Prevention and detection of material misstatements in the financial statements, which are referred to frauds and errors; and communication of weaknesses in the accounting and internal control systems. i) Primary objective- Expression of Expert opinion As per requirements of the BSA 200 (Objective & general principles governing an audit of F/S) The objective of an audit of F/Ss is to enable to the auditor to express an opinion whether the F/Ss are prepared, in all material respects, in accordance with an identified financial reporting framework. The phrases used to express the auditors opinion are give a true and fair view or present fairly, in all material respects, which are equivalent terms. Para. 2, BSA 200)

02.Objective of an audit (contd.)

As per requirements of the Companies act 1994 (applicable for all the companies) the auditors responsibilities of reporting as follow: The auditors report shall state whether, in his opinion and to the best of his information and according to the explanation given to him, the accounts, balance sheet and profit and loss account and every other document to be part of or annexed to the balance sheet or profit and loss accounts give the information required by the Companies Act in the manner so require and give a true and fair view(a) in the case of the balance sheet, of the state of the companys affairs as at the end of the financial year; (b) in the case of the profit and loss accounts, of the profit or loss or its financial year [sec. 213(3)]

02.Objective of an audit (contd.)

The auditors report shall also state(a) whether he has obtained all the information and explanation which to the best of his knowledge and belief were necessary for the purposes of his audit; (b) whether, in his opinion, proper books of account as required by law have been kept by the company so far as it appears from his examination of those books and proper returns adequate for the purpose of his audit have been received from branches not visited by him; (c) whether the companys balance sheet and profit and loss account dealt with by the report are in agreement with the books of account and return. [Sec. 213(4)]

02.Objective of an audit (contd.)

ii) Secondary objectives- Prevention and detection of material misstatements in the financial statements Error- an unintentional misstatement in financial statements, including the omission of an amount or a disclosure, such as the following: A mistake in gathering or processing data from which financial statements are prepared. An incorrect accounting estimate arising from oversight or misinterpretation of facts. A mistake in the application of accounting principles relating to measurement of facts, recognition, classification, presentation, or disclosure.

02.Objective of an audit (contd.)

Fraud - refers to an international act by one or more individuals among management, those charged with governance, employees or third parties, involving the use of deception to obtain an unjust or illegal advantage.
Types of fraud:

Two types of international misstatements are relevant to the auditors consideration of fraud: * Misstatements resulting from fraudulent financial reporting; and * Misstatements resulting from misappropriation of assets.

02.Objective of an audit (contd.)

Responsibility with respect to fraud and error- the primary responsibility for the prevention and detection of fraud and error rests with both those charged with governance and the management of an entity (paragraph 1 &10 of BSA 240). Auditors responsibility with respect to fraud and error- An audit conducted in accordance with ISAs is designed to provide reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error. The fact that an audit is carried out may act as a deterrent, but the auditor is not and cannot be held responsible for the prevention of fraud and error (paragraph 13 of BSA 240).

The Key elements of Audit Engagement

1. Three party involvement 2. Subject matter 3. Relevant criteria

4. Evidence
5. Written Report

The phrases used to express the auditors opinion are

give a true and fair view or present fairly, in all material respects, True: Information is factual and conforms with reality, not false. In addition the information conforms with required standard and law. The accounts have been correctly extracted form the books and records. Fair: Information is free from any discrimination and bias in compliance with expected standards and rules. The accounts should reflect the commercial substance of the companys underlying transactions.

Level of Assurance
1. Reasonable level of assurance: which result in a

positive expression of opinion and where the level of assurance given is deemed to be high. 2. Limited level of assurance: which results in negative assurance and where the level of assurance given is deemed to be moderate. Engagement could be either type and this would need to be specified in the terms of engagement.

A report on the effectiveness of the managements

system of internal control structure may be In our opinion mgt has operated in effective system of internal control- A positive form of opinion. Nothing has come to our attention that indicates material internal control weakness- A negative form of assurance. Absolute level of assurance is not possible in case of audit because of the following factors:

Limitations of audit service

The limitation of assurance service include: 1. The fact that testing is used-the auditor do not oversee the process of building the financial statements from start to finish. 2. The fact that the accounting systems on which assurance providers may place a degree of reliance also have inherent limitations. 3. The fact that most audit evidence is persuasive rather than conclusive. 4. The fact that assurance providers would not test every item in the subject matter 5. The fact that the clients staff members may collude in fraud that can then be deliberately hidden from the auditor or misrepresent matters to them for the same purpose.

6. The fact that assurance provision can be subjective and

professional judgments have to be made 7. The fact that assurance providers rely on the responsible party and its staff to provide correct information, which in some cases may be impossible to verify by the other means. 8. The fact that some items in the subject matter may be estimates and are therefore uncertain. It is impossible to conclude absolutely that judgmental estimates are correct. 9. The fact that nature of the assurance report might itself be limiting, as every judgment and conclusion the assurance provider has drawn cannot be included in it.

Benefits of the assurance

1. Enhance the credibility of the information being

reported on. 2. Reduces the risk of mgt bias, error or even fraud in the information being reported on. 3. Draws the attention of the user to any deficiencies in the information being reported on. 4. Ensure circulation of high quality, reliable information in the market. 5. Give added faith to the investors in the market 6. Improve the reputation of organizations trading in the market.

Importance in the perspective of the mgt

1. They value having their business scrutinized by

another set of professional eyes. 2. It provides additional assurance to third parties such as taxation authorities concerning the reliability of the F/Ss. 3. A growing business will one day require an audit. 4. Audit may have subsidiary benefits, such as the auditors recommending improvements in company systems.

Expectation Gap
Users of audited financial statements expect auditors

to 1. Perform the audit with technical competence, integrity, independence and objectivity. 2. Search for and detect material misstatements, whether intentional or unintentional. 3. Prevent the issuance of misleading financial statements.

Example of benefits of audit.

SP Ltd was established in June 20x0 to produce medicine. The shares are owned equally by two executives and two non executive directors. The companys revenue increased steadily over the first two years of trading. The results for the first year of trading indicated an operating profit margin of 15% and the management accounts for the second year of trading indicate that this has increased to 18%. The directors are currently negotiating a contract worth TK 600,000 to supply a major retailer which has over 100 outlets throughout the country. The company will require an increased overdraft facility to fulfill the order. The finance director has prepared a business plan for submission to the companys bankers in support of a request for a large overdraft facility. The plan includes details of the companys products, management, markets, methods of operation and financial information. The financial information includes profit and cash flow forecasts for the six months ending 31 December 20x2 together with

details of the assumptions on which the forecasts are

based and the accounting policies used in compiling the profit forecast. The companys bankers require this financial information to be reviewed and reported on by independent accountants. The company was required by its bankers to have an audit of its F/Ss for the year ended 30 June 20x1.