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NATURE, PURPOSE AND SCOPE OF AUDIT AND REVIEW

NATURE, PURPOSE AND SCOPE OF AUDIT AND REVIEW

1 “AUDITING”

In independent examination

2 NATURE AND DEVELOPMENT

The word “audit” comes form the Latin word audire which means “to hear” because, in the middle Ages, accounts or revenue and expenditure were “heard” by the auditor.

Statutory audits (i.e. carried out in accordance with statutory provisions) become mandatory for companies in 1900. At this time the purpose of an audit was to detect fraud, technical errors and errors of principle.

However, the recognition in case law that it is unreasonable to expect auditors to detect all aspects of fraud, even though they exercised reasonable skill and care, means that this is not now a primary purpose.

Over the last 20 years or so the auditing profession has sought to broaden its role (e.g. with value for money, operational audits, etc – see later)

3 CONCEPTS

Stewardship

Directors or other managers of an enterprise have the responsibility of stewardship for the property of that enterprise.

Responsibilities, which may be duties embodied in statute, may include:

Keeping books of accounts and proper accounting records;

Producing a balance sheet and income statement that show a true and fair view;

Producing a directors’ report which is consistent with the financial statements and contains certain specified information.

Agency

A director can be described as an agent having a fiduciary relationship with a principal (i.e. the company that employs him).

(A fiduciary relationship is one of trust.)

In meeting their responsibilities of stewardship, managers have fiduciary duties to safeguard assets and implement and operate an adequate accounting and internal control system.

Accountability

Auditors act in the interest of the primary stakeholders whilst having regard to the wider public interest.

The identity of the primary stakeholders in determined by reference to the statute of agreement requiring an audit. For companies, the primary stakeholder is the general body of shareholders.

4 OBJECTIVE & GENERAL PRINCIPLES GOVERNING AN AUDIT OF FINANCIAL STATEMENTS

Audit

The objective of an audit is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an identified financial reporting framework.

It is management’s responsibility to prepare the financial statements.

Whilst the auditor’s opinion adds credibility to the financial statements:

It is no guarantee of future viability not of management’s efficiency or effectiveness.

A degree of imprecision is inevitable due to:

inherent uncertainties

use of judgment

Only reasonable assurance is given

The amount of audit work is determined by:

Judgement

Requirements of professional bodies and legislation

Agreed terms of the engagement

The need to exercise professional skepticism

The ability to reduce audit risk is limited by:

The necessity to sample

Inherent limitations in any accounting and control systems

Possible fraudulent collusion

Certain evidence will be persuasive not conclusive

Audit Opinion


The audit opinion is given on whether the financial statements give a true and fair view of the entity’s financial statements and whether they have been properly prepared in accordance with the applicable reporting framework.

This opinion is reached after:

Extensive risk assessment has been performed

Extensive testing of controls and substantive tests on transactions and balances for validity, accuracy and completeness of recording.

Extensive verification procedures have been performed to test for existence, ownership, valuation, presentation and disclosure of items in the financial statements.

Extensive review of whether the financial statements comply with applicable accounting standards and legal requirements.

As such, the audit opinion gives a high level of assurance to the users of financial statements.

Whenever an audit is conducted, it must be performed in accordance with ISAs or national auditing standards, and if it is a statutory audit, it cannot be restricted in any way.

An example of an audit report given in ISA 700 The auditor’s report on financial statements, illustrates the high level of assurance given by an audit:


Auditor’s Report to the Shareholders of ABC Company

We have audited the accompanying balance sheet of ABC Company as at 31 December 20X1, and the related statements of income and cash flows for the year then ended. These financial statements are the responsibility of the company’s management. Our responsibility is to express an opinion on these financial statements based on our audit

We conducted our audit in accordance with International Standards on Auditing (or to relevant national standards). Those Standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In out opinion, the financial statements give a true and fair view of (or present fairly, in all material respects) the financial position of the company as at 31 December 20X1, and of the results of its operations and its cash flows for the year then ended in accordance with International Accounting Standards (or title of national standards used) and comply with ( title of relevant statute or law)

Auditor Address


Date


Concept of “True and Fair”


· Many countries’ legislation requires that financial statements give a “true and fair view” (e.g. the UK) or “present fairly, in all material respects” (e.g. the USA)

· There has never been, however, any definition in legislation as to the meaning of the expression.

· The following would be generally accepted definition (based on legal opinion commissioned by the UK Accounting Standards Committee in 1983):

  • The financial statements comply with Accounting Standards whose purpose is to narrow the areas of divergent opinion and practice in accounting – these are the profession’s attempt, in the absence of statutory definition, to define true and fair view
  • By “true” is meant that financial statements are:

free from material misstatement

based on verifiable evidence

  • By “fair” is meant that the financial statements are:

objectively presented

free from management bias

relevant to the needs of users

  • The concept is a dynamic concept and is incapable of precise lasting legal definition, but to be true and fair, financial statements must live up to the current needs and expectations of users.

Concept of Materiality



Materiality is an important concept in the audit process and affects:

· Audit risk evaluation

· The nature, timing and extent of audit procedures (eg sample sizes)

· The determination of whether the financial statements are distorted by misstatements discovered

ISA 320 - Audit Materiality – defines the concept as follows:

Transactions, items, events will be material in financial statements if their omission, misstatement, misclassification or non-disclosure would distort the view given by the financial statements and would responsibly influence the understanding and economic decisions of users.

Materiality, however, is not capable of general mathematical definition since it involves qualitative as well as quantitative considerations

For example, materiality can be viewed in terms of size, an item being compared with a transaction or balance class or being compared with the financial statements as a whole (quantitative judgement)

It can also be viewed in terms of the nature of an item irrespective of size – e.g. the non-disclosure of an accounting policy or non-compliance with the requirements of law such as errors or omissions in relation to the disclosure of director’s remuneration (qualitative judgement)

5 GENERAL PRINCIPLES GOVERNING THE AUDITOR

5.1 Ethical Principles

The auditor should comply with the International Federation of Accountants’ (IFAC) “Code of Ethics for Professional Accountants”.

· Independence

· Integrity

· Objectivity

· Professional competence and due care

· Confidentiality

· Professional behaviour

· Technical standards.

5.2 Adherence to Standards on Auditing

An audit should be conducted in accordance with ISAs.

· ISAs provide:

Standards (i.e. basic principles and essential procedures); and

Related guidance (i.e. explanatory and other material).


5.3 Professional Skepticism

An audit should be planned and performed (“conducted”) with an attitude of “professional skepticism” recognizing circumstances that may bring about material misstatement in the financial statements.

· An auditor should assume neither dishonesty nor unquestioned honesty.

See also the auditor’s responsibilities for fraud and error

See all 3 photos
See all 3 photos

The audit process




· Engagement letter – Auditor should send all clients an engagement letter setting out the auditor’s duties and responsibilities.

· Planning – Planning and controlling audit work is essential to performing work to the required high standard of skill and care.

· Ascertain accounting systems – auditors enquire into and ascertain the client’s system of accounting and internal controls in order to understand how accounting data is prepared and to gain an impression as to whether systems are reliable.

· Test controls and transactions – Controls must be tested if the auditor intends to rely on them. Records must be tested to obtain evidence that they are a reliable basis for the preparation of accounts.

· Verify assets and liabilities – Figures appearing in financial statements must be verified

· Review financial statements – To see if, overall, they appear sensible.

· Obtain management representations – The auditor asks management to confirm formally the truth and fairness of certain aspects of financial statements.

· Sign auditor’s report – After the directors have approved the accounts.

7 PURPOSE

External Auditing

· Gives confidence in the integrity of corporate reporting for the benefit of stakeholders and society as a whole, by providing an external and objective view on the reports given by management.

Internal Auditing

An independent, objective assurance and consulting activity designed to add vcalue and improve an organization’s operations

· Objective is to assist management and staff in the effectivce discharge of their duties.

· Functions include

Examining, evaluating and monitoring the adequacy and effectiveness of the accounting and internal control systems

Providing analyses, appraisals and recommendations concerning the activities reviewed.

Value for Money Audit

An investigation into whether or not the use of resources is economic, efficient and effective.

· To identify and recommend ways in which the return for resources employed may be maximised.

Environmental Auditing

· A performance evaluation which aims to help safeguard the environment

· Facilitates management control of environmental practices.

· Assesses the degree of compliance with environmental legislation, external regulations and company policies.

Public sector Auditing

· National and local government, agencies, commissions, etc

· Scope and objectives are affected by interests and requirements of third party organisations.

· Specific requirements, reelevant regulations, ordinances or ministerial directives may affect the audit mandate.


8 SCOPE OF AN AUDIT OF FINANCIAL STATEMENTS

Audit Procedures Deemed Necessary

An audit conducted in accordance with ISAs must have regard to the requirements of:

· ISAs (ie to plan, evaluate controls, obtain evidence, form conclusions and report):

· Relevant professional bodies (eg ACCA):

· Legislation and regulations (eg Companies Acts);

· The terms of the audit engagement and reporting requirements.

Fundamental Concepts

Reasonable assurance – in an audit engagement, the auditor provides a high, but not absolute, level of assurance, expressed positively in the audit report as reasonable assurance, that the information subject to audit (ie the financial statements)is free of material misstatement.

· To provide such assurance, the auditor assesses the evidence collected in respect of the fianncial statements as a whole and expresses a conclusion thereon.

· Inherent limitations – However, the auditor may not be able to detect all material misstatements because:

Testing is on a sample basis

Any accounting and internal control system has inherent limitations.

Most audit evidence is presuasive rather than conclusive (eg an asset purchased by an entity, though physically possessed, may bo longer b eowned if title has been transferred to another);

Transactions between related parties (ie where one has the abilitiy to control or exercise significant influence over the other) may not be identified as such.

The rule of judgement – There are two areas in which judgement is particularly important.

· In gathering audit evidence (eg in deciding the nature, timing and extent of audit procedures);

·

Nature (eg whether to test controls over transactions or substantiate them “in depth” or using analytical procedures);

Extent(eg sample sizes);

Timing (eg at an interim visit during the year, the year end or after the year end at the final audit visit.

· In drawing conclusions based on that evidence (eg in assessing the persuasiveness of conflicting evidence from different sources)

9 NON-AUDIT ENGAGEMENTS:

· There ar a numbe of reporting assignments or engagemetns which do not give the same degree of assaurance as an audit to users.

· Gudance issued by the International Auditing and Assurance Standards Board (IAASB), a body set up by the International Federation of Accountants, is summarised below

· Non-audit engagements can be classified into 2 groups as follows:

9.1 Reviews: ISA 900 – Egnagements to review financial statements


· A review eggagement enables the auditor to state whether anything has come to the auditor’s attention which causes the auditor to belive that the financial statements are not prepared in all material repects with the applicable financial reporting framework.

· However, the auditor does not perform the extensive testing procedures.

· The main procedures involved comprise enquiries of management, analytical procedures (eg ratio anlysis, comparisons and trends analysis on total figurs rather than individual transactions), and comparison of financial statements with accounting records – without verification to underlying documentation.

· The opinion expressed is called a negative assurance

· The assurance given is therefore much lower than an audit opinion.

· Notes the following example of a review report and compare it with the audit report above:

Review report to (usually the direcotrs)

We have reviewed the accompanying balance sheet of ABC Company at 31 December 20X1 and the related income statement and cash flow statement for the year then ended. These financial statement are responsibility of the company’s management. Our responsibility is to issue a report on these financial statements based on our review.

We conducted our review in accordance with the (relevant Standard) applicable to review engagements. This standard requires that we plan and perform the review to obtain moderate assurance as to whether the financial statements are free from material misstatement. A review is limited primarily to enquiries of company personnel and analytical procedures applied to financial data and thus provides less assurance than an audit. We have not performed an audit and, accordingly, we do not express an audit opinion.

Based on our review, nothing has come to out attention that causes us to believe that the accompanying financial statements do not gie a true and fair view in accordance with accounting standards.

Date Auditor



Address



9.2 ISA 100 – Assurance engagements

· These assignments involve a 3 way relationship:

§ The accountant

§ A responsible party (usually client management)

§ An intended user (eg bankers, regulators)

· The accountant evaluates a subject matter which is the responsibility of the responsible pary against suitable criteria, and expresses an opinion providing the intended user with a level of assurance about the subject matter.

· The subject matter could be historical financial data or prospective financial data.

· Suitable criteria could be accounting standards, laws, regulations, contract terms.

· Assurance engagements include:

§ Direct reporting engagements – the auditor/accpimtamt reports on issues that have come to his attention during the course of the commsissioned assignment.

Such an assignment would be a ‘due diligence’ engagement where the auditor/accountant reviews the systems and accounts of a target company and reports to a propective purchaser.

§ Attest or attestation engagements the auditor/accountant declares that a given premise is either correct or not

A report on interim accounts might require the auditor to attest whether the accounting policies used are consistent with those used in the annual audited financial statements, and whether any material modifications should be made to the interim accounts.

Compilation engagements

· The accountant uses expertise other than auditing in such engagements

· For example, the accountant may be commissioned to prepare financial statements from a company’s records

· No audit tests will be performed and management will be solely responsible for the information complied.

· As stated above, no opinion and hence no assurance is given.


Agreed upon procedures

· The accountant reports on factual findings

· No assurance is given.

· Users draw their own conclusions.

· Thus client management may commission a report on accounts receivable or accounts payable – the accountant states the results of findings, such as the number of accounts in error and the number of balances agreed with supplier statements or agreed by customers in a debtors circularisation.


 Last updated on December 14, 2012

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Comments 27 comments

Han  4 years ago

a very detailed and well explained article. Best one one i have ever seen on AUDIT AND REVIEW

Keep up the good work.


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dallas93444 4 years ago from Bakersfield, CA

Comprehensive and consise. Seemingly in a "prior life," I was a staff accountant for a large oil company.... Great hub. Your attention to deatil I am sure has served you well!


Gammy 4 years ago

Thanks for posting it was helpful.


Ki4 4 years ago

Thanks for sharing useful info. It was of great help.


Confuse Girl 4 years ago

Great Work!! I am no more confuse now with this comprehensive article!


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Bilaras 4 years ago from Earth Hub Author

Thanks confuse girl.

Ki4 thanks for reading my hub.

gammy thanks for the comment.


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crystolite 3 years ago from Houston TX

Good hub with nice charts on it,thanks for sharing.


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Balinese 3 years ago from Ireland

thank you for breif explanations

the best one !


tazanuf majeed 3 years ago

im student of commerce and it is a helpful material for auditing subject


dollinnocent81 3 years ago

plz write in hidings

it will be easy to understand

It is a Good effort

Thanks


shabaash 3 years ago

thank u very very much for brief summarizing


HASHTYAMMA 2 years ago

Its very helpful &un derstandable esp.4 student whose future auditing


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umeraziz 2 years ago

nice audit tutorial. the way u compared audit engagement with other services offered by auditor is easy to understand.


viral 2 years ago

this has helped me when i was at my wits end

this is like eeeekkk number

full hard


moo 2 years ago

excellent work..keep it up ,it a great summary and very easy to understand


lerotholi 2 years ago

excellent, very brief and understandale summary. keep it up.


psyche 2 years ago

nice,,,

i really understand the explanation.


Bhargav Choppa 2 years ago

excellent material, and good way of explanation..


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Bilaras 2 years ago from Earth Hub Author

Thanks


saltiel 2 years ago

thnx 4 posti g this it was very helpful


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Bilaras 2 years ago from Earth Hub Author

your welcome saltiel , don't forget to share


Martin Tyler Marume 2 years ago

Aaaah this sufficing and it helps me a lot


amna 23 months ago

i ts good


Sama Poiya 20 months ago

this is really helpful,good on you!!!


Mazhar Awan 11 months ago

Audit is Systematic Examination of Books and records of a Busniness or Organisations in order to ascertain or verify and to report upon the other facts regarding its financial operation and the result therof.

It is clear that auditing is an independent checking of statements records operations and performance of a concern with a view to expressing an opinion in the form of written report.

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danish 7 months ago

thanx


Ameer 2 months ago

I want to know a simple answer.Can an Accountant Audit Construction as he is not competent in Construction.

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