FUNDAMENTALS OF AUDITING ACC311
Lecture 02
Standard format of
Auditor’s Report as per the International Auditing Standards:
INDEPENDENT AUDITOR’S
REPORT
[Appropriate
Addressee]
Introductory Paragraph
We have audited the
accompanying financial statements of ABC Company, which comprise the balance
sheet as at December 31,
20X1, and the income statement, statement of changes in equity and cash flow
statement for the year
then ended, and a summary of significant accounting policies and other
explanatory
notes.
Management’s
Responsibility for the Financial Statements
Management is
responsible for the preparation and fair presentation of these financial
statements in
accordance with
International Financial Reporting Standards. This responsibility includes:
designing,
implementing and
maintaining internal control relevant to the preparation and fair presentation
of financial
statements that are free
from material misstatement, whether due to fraud or error; selecting and
applying
appropriate accounting
policies; and making accounting estimates that are reasonable in the
circumstances.
Auditor’s Responsibility
Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted
We conducted
our audit in accordance
with International Standards on Auditing. Those standards require that we
comply
with ethical
requirements and plan and perform the audit to obtain reasonable assurance
whether the
financial statements are
free from material misstatement.
An audit involves performing
procedures to obtain audit evidence about the amounts and disclosures in the
financial statements.
The procedures selected depend on the auditor’s judgment, including the
assessment
of the risks of material
misstatement of the financial statements, whether due to fraud or error. In
making
those risk assessments,
the auditor considers internal control relevant to the entity’s preparation and
fair
presentation of the
financial statements in order to design audit procedures that are appropriate
in the
circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the entity’s
internal
control. An audit also
includes evaluating the appropriateness of accounting policies used and the
reasonableness of
accounting estimates made by management, as well as evaluating the overall
presentation
of the financial
statements.
We believe that the
audit evidence we have obtained is sufficient and appropriate to provide a
basis for our
audit opinion.
Opinion
In our opinion, the
financial statements give a true and fair view of (or” present fairly, in all
material
respects,”) the
financial position of ABC Company as of December 31, 20X1, and of its financial
performance and its cash
flows for the year then ended in accordance with International Financial
Reporting Standards.
Report on Other Legal
and Regulatory Requirements
[Form and content of
this section of the auditor’s report will vary depending on the nature of the
auditor’s
other reporting
responsibilities.]
[Auditor’s signature]
[Date of the auditor’s
report]
[Auditor’s address]
What stands for
auditor’s opinion?
The auditor, in his
report, does not say that the financial statements do show a true and fair
view. He can
only say that in his
opinion the financial statements show a true and fair view. The reader or user
of
financial statements
will know from his knowledge of the auditor whether or not to rely on the
auditor’s
opinion. If the auditor
is known to be independent, honest, and competent, then his opinion will be
relied
upon.
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What are the different
types of audit?
Three types of audits
are discussed in general, i.e.,
1. Financial statement
audits
2. Operational
audits
3. Compliance
audits
Financial Statement
Audits
An audit of financial
statements is conducted to determine whether the overall financial statements
(the
quantifiable information
being verified) are stated in accordance with specified criteria. Normally, the
criteria are the
requirements of the applicable International Financial Reporting Standards (IFRSs)
and the
Companies Ordinance
1984. The financial statements most commonly comprises of the Balance Sheet,
Income Statement,
Statement of Changes in Equity, Cash Flow Statement, and Notes to the accounts.
The assumption
underlying an audit of financial statements is that these will be used by
different groups for
different purposes.
Therefore, it is more efficient to have one auditor who will perform an audit
and draw
conclusions that can be
relied upon by all users than to have each user perform his or her own audit.
If a
user believes that the
general audit does not provide sufficient information for his or her purposes,
the user
has the option of
obtaining more data. 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.
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.
Because of the many
different areas in which operational effectiveness can be evaluated, it is
impossible to
characterize the conduct
of a typical operational audit. In one organization, the auditor might evaluate
the
relevancy and
sufficiency of the information used by management in making decisions to
acquire new fixed
assets, while in a
different organization the auditor might evaluate the efficiency of the paper
flow in
processing sales.
In operational auditing,
the reviews are not limited to accounting. They can include the evaluation of
organization structure,
computer operations, production methods, marketing, and any other area in which
the auditor is
qualified.
The conduct of an
operational audit and the reported results are less easily defined than for
either of the
other two types of
audits. Efficiency and effectiveness of operations are far more difficult to
evaluate
objectively than
compliance or the presentation of financial statements in accordance with
accounting
conventions and
principles; and establishing criteria for evaluating the quantifiable information
in an
operational audit is an
extremely subjective matter.
In this sense,
operational auditing is more like “management consulting” than what is
generally regarded as
“auditing”. Operational
auditing has increased in importance in the past decade.
Compliance Audits
The purpose of a
compliance audit is to determine whether the entity is following specific
procedures, rules,
or regulations set down
by some higher authority.
A compliance audit for a
private business could include determining whether accounting personnel are
following the procedures
prescribed by the company controller, reviewing wage rates for compliance
with
minimum wage laws, or
examining contractual agreements with bankers and other lenders to be sure the
company is 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,
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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.
Management, as opposed
to outside users, is the primary group concerned with the extent of compliance
with certain prescribed
procedures and regulations. Hence, a significant portion of work of this type
is done
by auditors employed by
the entity itself.
There are exceptions;
when an organization wants to determine whether individuals or entities that
are
obligated to follow its
requirements are actually complying, the auditor is employed by the entity
issuing the
requirements.
An example is the
auditing of taxpayers for compliance with the federal tax laws, where the
auditor is
employed by the
government to audit the taxpayers’ tax returns.
Following table
summarizes the three types of audits and includes an example of each type and
an
illustration of three of
the key parts of the definition of auditing applied to each type of audit.
Examples of the Three
Types of Audits
TYPES OF
AUDIT
EXAMPLE
QUANTIFIABLE
INFORMATION
ESTABLISHED
CRITERIA
EVIDENCE
Financial
Statement Audit
Annual Audit of
General Motors’
financial
statements
Operational
Audit
Compliance
Audit
Evaluate whether
the computerized
payroll processing
for subsidiary is
operating
efficiently and
effectively
Determine if
bank
requirements for
loan continuation
have been met
General Motors
financial
statements
Number of payroll
records processed
in a month, costs of
the department, and
number of errors
made
International
Financial
Reporting
Standards
Company
standards for
efficiency and
effectiveness in
payroll
department
Company records Loan
agreement
provisions
AVAILABLE
Documents,
records, and
outside sources
of evidence
Error reports,
payroll records,
and payroll
processing costs
Financial
statements and
calculations by
the auditor
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FUNDAMENTALS OF AUDITING
AUDITING – AN INTRODUCTION
What are the advantages
and disadvantages of auditing?
Advantages of an audit
We have seen that the
need for an external audit in the case of companies arises primarily from the
existence of split-up of
ownership from control. There are however, certain advantages in having
financial
statements audited even
where no statutory requirement exists for such an audit in the case of a
sole-tradership,
partnership,
or
non-profit
organizations
for
example.
These
advantages can be
summarized
as follows:
a) Disputes between
management may be more easily settled. For instance, a partnership which has
complicated profit
sharing arrangements may require an independent examination of those
accounts to ensure, as
far as possible, an accurate assessment and distribution of the profits.
b) Major changes in
ownership may be facilitated if past accounts contain an independent audit
report,
for instance, where two
sole traders merge their business to form a new partnership.
c) Application to
lenders/financial institutions for finance may be strengthened by the
submission of
audited accounts.
However do remember that a bank, for instance, is likely to be far more
concerned about the
future of the business and available security, than by the past historical
accounts, audited or
otherwise.
d) The audit is likely
to involve an in depth examination of the business and so may enable the
auditor
to give more
constrictive advice to management on improving the efficiency of the
business.
Disadvantages of an
audit
Like most thing in life,
audits are not entirely without their disadvantages. There are two main points
to
make here:
b) The audit fee!
Clearly the services of an auditor must be paid for. It is for this reason that
few
partnerships and even
fewer sole traders are likely to have their accounts audited.
c) The audit involves
the client’s staff and management in giving time to providing information to
the auditor.
Professional auditors should therefore plan their audit carefully to minimize
the
disruption which their
work will cause.
What are the different
stages of audit?
Auditing is essentially
a practical task. The auditor always needs to reflect the nature of the
circumstances of
the entity under audit.
It is unlikely that any two audit assignments will ever identical. It is
however possible
to identify a number of
standard stages in a typical external audit. These are as follows:
- Audit
appointment
- Engagement letter
- Initial planning
Knowledge of the
business
Risk Assessment
Internal control
review (procedures)
Control procedures
(authorities/approvals/segregation of duties)
- Preparation of the
audit plan
- Accounting system
review
- Analytical review
techniques (Compliance procedures-Application of control test procedures)
like purchasing are according
to the controls established.
- Considering the ways
in which audit evidence can be sought
- Substantive testing
(transaction level procedures)
- Reasonable
assurance
- Review of the
financial statements (compliance with the standards/material misstatement etc.)
- Preparation and
signing of report
At the stage of
considering the ways of seeking audit evidence the auditor will make a
preliminary evaluation
of the entity’s control
system:
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