FUNDAMENTALS OF AUDITING ACC311
Lecture 01
AN INTRODUCTION
What is an Audit?
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) in accordance with
an
identified and
acceptable financial reporting framework (e.g. international or local
accounting standards and
national legislations)
This view of audit is
presented by ISA 200 Objective and General Principles Governing an Audit of
Financial
Statements.
The phrases used; “to
express the auditor’s opinion” means that the financial statements give a true
and fair
view or have been
presented fairly in all material respects.
True and fair
presentation means that the financial statement are prepared and presented in
accordance with
the requirements of the
applicable International Financial Reporting Standards (IFRS) and local
What we can understand
as the essential features of an audit from the above definition and explanation
are
as under:
• 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.
• In order to make the
user of the auditor’s report able to feel confident in relying on such report,
the
auditor should be
independent of the entity. Independent essentially means that the auditor has
no
significant personal interest
in the entity. This allows an objective, professional view to be taken.
You will note that this
is a wide concept of an audit which can be applied to any entity, not just to
limited
companies. However, in
this course, we are concerned primarily with audits of limited companies (often
known as statutory or
external audits). Any other audit applications will be clearly indicated for
you in the
text.
Why is there a need for
an audit?
The problem that has
always existed at the time when the manager reports to the owners is that:
whether
the owners will believe
the report or not? This is because the reports may:
a. Contain errors
b. Not disclose fraud
c. Be inadvertently
misleading
d. Be deliberately
misleading
e. Fail to disclose
relevant information
f. Fail to conform to
regulations
The solution to this
problem of credibility in reports and accounts lies in appointing an
independent person
called an auditor to
examine the financial statements and report on his findings.
A further point is that
modern companies can be very large with multi-national activities. The
preparation
of the accounts of such
groups is a very complex operation involving the bringing together and
summarizing of accounts
of subsidiaries with differing conventions, legal systems and accounting
and
control systems. The
examination of such accounts by independent experts who are trained in the
assessment of financial
information is of benefit to those who control and operate such organizations
as
well as to owners and
outsiders.
Many financial
statements must conform to statutory or other requirements. The most notable is
that all
company accounts have to
conform to the requirements of the Companies Ordinance 1984 but many
other
Lesson 01
1
bodies (like: Charities,
Building Societies, Financial Services business etc) have detailed accounting
requirements as required
by the relevant legislations. In addition all accounts should conform to the
requirements of
International Financial Reporting Standards (IFRSs).
It is essential that an
audit of financial statements should be carried out to ensure that they conform
to these
requirements.
What is the distinction
between auditing and accounting?
Relationship between
auditing and accounting
Auditing and accounting
are closely connected but both are separate activities. The directors of a
company
are responsible for
establishing books of accounts that will accurately record financial
information and that
are used for preparing
the annual financial statements. It is similarly the responsibility of the
directors to
adopt consistent and
appropriate accounting policies in order to prepare and present the financial
statements. The
financial statements have to comply with national legislative requirements and
International
Financial Reporting
Standards (IFRSs).
Accounting is the
process of recording, classifying, summarizing and reporting financial
information in a
logical/systematic
manner for the purpose of decision making. To provide relevant & reliable
information,
accountants must have a
thorough understanding of the principles and rules that provide the basis for
preparing the financial
statements.
In auditing the
financial statements, the concern is with determining whether the presented
financial
statements properly
(true and fair) reflect the financial information that occurred during the
accounting
period. Since auditors
are primarily concerned with the end result of this work i.e. do the financial
statements show a true
and fair view? In order to arrive at their conclusion the auditors must have a
deep
knowledge and
understanding of accounting (including applicable accounting standards) and in
practice, the
directors will consult
with the auditors as to appropriate accounting policies to follow.
Many financial statement
users and members of the general public confuse auditing with accounting. The
confusion results
because most auditing is concerned with accounting information, and many
auditors have
considerable expertise
in accounting matters. The confusion is increased by giving the title
“Chartered
Accountant” to
individuals performing a major portion of the audit function.
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 of three million rupees or more.
The person must be a
Chartered Accountant within the meaning of the Chartered Accountants Ordinance,
1961.
For listed companies an
auditor must have a satisfactory QCR (quality control review) rating issued by
ICAP.
2
Fundamentals of Auditing
Auditing – An
Introduction
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.
Standard format of
Auditor’s Report as per the Companies Ordinance 1984:
FORM 35A
AUDITORS’ REPORT
We have audited the
annexed balance sheet of COMPANY NAME as at THE DATE and the related profit
and loss account, cash
flow statement and statement of changed in equity together with the notes
forming
part thereof, for the
year then ended and we state that we have obtained all the information and
explanations which to
the best of our knowledge and belief were necessary for the purposes of our
audit.
It is the responsibility
of the company’s management to establish and maintain a system of internal
control
and prepare and present
the above said statements in conformity with the approved accounting standards
and the requirements of
the Companies Ordinance, 1984. Our responsibility is to express an opinion on
these statements based
on our audit.
We conducted our audit
in accordance with the auditing standards as applicable in Pakistan. These
standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
above said statements
are free of any material misstatement. An audit includes examining, on a test
basis,
evidence supporting the
amounts and disclosures in the above said statements. An audit also includes
assessing the accounting
policies and significant estimates made by management, as well as evaluating
the
overall presentation of
the above said statements. We believe that our audit provides a reasonable
basis for
our opinion and, after
due verification, we report that:
a) In our opinion,
proper books of accounts have been kept by the company as required by the
Companies Ordinance,
1984
b) In our
opinion:
i. The balance sheet and
profit and loss account together with the notes thereon have been
drawn-up in conformity
with the Companies Ordinance, 1984, and are in agreement with the
books of account and are
further in accordance with accounting policies consistently applied
ii. The expenditure incurred
during the year was for the purpose of the company’s business; and
iii. The business
conducted investments made and the expenditure incurred during the year
were
in accordance with the
objects of the company.
c) In our opinion and to
the best of our information and according to the explanations given to us,
the
balance sheet, profit
and loss account, cash flow statement and statement of changes in equity
together
with the notes forming
part thereof conform with approved accounting standards as applicable in
Pakistan and, give the
information required by the Companies Ordinance, 1984, in the manner so
required and
respectively give a true and fair view of the state of the company’s affairs as
at DATE and
of the profit/loss its
cash flows and changes in equity for the year then ended; and
d) In our opinion Zakat
deductible at source under the Zakat and Usher Ordinance, 1980 was deducted by
the company and
deposited in the Central Zakat Fund established under Section 7 of that
Ordinance.
Date
Signature
Place
(Name(s) of Auditors)
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