LECTURE_1_INTRODUCTION_TO_AUDITING.pptx

INTRODUCTION TO AUDITING

INTRODUCTION TO AUDITINGLECTURE 1Learning OutcomesDescribe auditingDistinguish between auditing and accountingDescribe different types of audit and auditors.Explain why there is a need for auditing and assurance servicesExplain the framework of auditing2Traditional Role of AuditingAuditing comes from the Latin word audire, meaning to hear.Began as far back as 3,500 B.C., long before it is required by law.The records of mesopotamian civilization show tiny marks at the side of numbers involved in the financial transactionsInternal controls, systems of verification, and the concept of division of duties probably originated at that timeEarly Egyptian, Chinese, Persian, and Hebrew records show similar systemsTraditional role of auditing - conformance role.Original report was verbal (oral verification)Why is auditing needed in a free market economy?

The Origin of Accounting and Auditing

The principal-agent relationship between the owner and manager often resulted in information asymmetry between the two parties. The manager generally has more information about the true financial position of the Company. Because their goals may not coincide, there is a natural conflict of interest between the manager and the owner. This gives rise to the need for auditing. AGENCY RELATIONSHIPCONFLICT OF INTERESTINFORMATION ASYMMETRYTHE NEED FOR AUDITINGAGENCY THEORY & THE NEED FOR AUDITINGAUDITING DEFINEDAUDITING (broadly defined) 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 parties.

AUDITING (narrowly defined) is a written report on the examination of financial statements of an entity.7Benefits of Financial statements auditObtain access to capital markets. Without an audit, companies may be denied access to capital markets by the SC and Bursa MalaysiaHave a lower cost of capital. Given the reduced risk resulting from audited financial reports, potential creditors may offer low interest rates and potential investors may be willing to accept a lower rate of return on their investment.Be a deterrent to inefficiency and fraud. Knowledge that an independent audit is to be performed is likely to result in fewer errors in the accounting process and reduce the likelihood of employee misappropriation of assets.Control and operational improvements. Based on observations made during the financial report audit, the independent auditor can suggest how controls could be improved and how greater operating efficiencies within the entitys organisation may be achieved.8Auditing, Attestation and Assurance Services Defined AuditingAssurance ServicesA 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. AttestationAuditing, Attestation and Assurance Services Defined AuditingAttestationAssurance ServicesOccurs when a practitioner is engaged to issue a report on a subject matter, or on an assertion about a subject matter, that is the responsibility of another party.

Reports the reliability of the subject matter or the assertion about the subject matter (financial or non-financial).

Effectiveness of internal controls, review of historical accounts, loan compliance, financial forecasts etc.Auditing, Attestation and Assurance Services Defined AuditingAttestationAssurance ServicesAre independent professional services (written or verbal) that improve the quality of information, or its context, for decision makers.

It increases decision makers confidence in the information.

Compliance with laws, contracts etc.

Objective of An Audit of Financial StatementsThe objective of an audit of financial statement is to enable the auditor to express an opinion whether the financial statements are prepared, in all material aspects, in accordance with an identified reporting framework (ISA 200)How is accounting different from auditing?

Accounting vs AuditingAccounting- the recording, classifying and summarising of economic events in a logical manner for the purpose of providing financial info for decision making.recordingclassifyingsummarisingAccounting vs AuditingAuditing- focus on determining whether recorded information properly reflects the economic events that occurred during the accounting period.- besides a thorough understanding of approved accounting standards, auditor must also possess expertise in the accumulation & interpretation of audit evidence.

Determining proper audit proceduresDeciding number & types of items to testEvaluating resultsPublic Accounting Firm-ServicesBookeepingCosting and management accountingInsolvency, liquidation and receivershipsManagement information systems and internal controlsSecretarial services17Overview of The Audit ProcessPreliminaryEngagementClient acceptanceTerms ofengagementObtain understanding of the entityMateriality and assess risk18Overview of The Audit ProcessAudit PlanningTest of control and substantive proceduresComplete the auditIssue the auditors report19Relationship among Internal Control, individual transactions and account balancesA company implements internal controls as a safeguard to ensure appropriate capturing and recording of individual transactions.These individual transactions are then collected into ending account balances. Ending account balances are then used to prepare the financial statements. Relationship among Internal Control, individual transactions and account balancesHow do we audit then?The auditor can obtain evidence from all three steps of the accounting process. For instance, an auditor can directly test the account balance (ex. by bank statement confirmation and reconciliation). This evidence is usually the highest-quality but costliest evidence. Or, the auditor can obtain indirect information by testing the individual transactions that make up an account balance. While an auditor will not have the resources to test each individual transaction, she or he can use sampling and project her or his findings onto the entire population of transactions. The least direct method of obtaining evidence is to evaluate and test the companys internal control to ensure that transactions are being properly handled. Auditors usually rely on a combination of evidence from all three areas.Beginning balanceSales$ 17,521$144,328$137,087Cash receipts$ 1,242Sales returnsand allowancesCharge-off ofuncollectibleaccountsEnding balance$ 20,197$ 3,323Accounts Receivable (in thousands)Relationship among Internal Control, individual transactions and account balancesSome fundamental concept

Audit RiskAudit risk is the risk that the auditor may unknowingly fail to appropriately modify his or her opinion on financial statements that are materially misstated. The auditors standard report states that the audit provides only reasonable assurance that the financial statements do not contain material misstatements.Reasonable assurance implies that there is some risk that a material misstatement could be present in the financial statements but the auditor fails to detect it.

25Independent auditorsIndependent auditors, often referred to as external auditors, are either individual practitioners or members of public accounting firms who render professional auditing services to clients

By virtue of their education, training and experience, independent auditors are qualified to perform the types of audits previously described25Auditors IndependenceAudit Independence is the cornerstone of auditing. Independence is the essence that underlies the success and credibility of the accounting profession and its service to the public.

Maintaining independence allows the auditing and accounting profession to be self-regulated, a highly prestigious character. This objectivity permits the profession to perform its attestation and monitoring functions effectively.

Independence is also a key component of the agency theory of auditing. In the management /shareholder agency relationship it is important that the monitoring function (audit) is and is seen to be separate from management, for it to be a value added service.2627Independence in mind and appearance Independence of Mind

The state of mind that permits the expression of a conclusion without being affected by influences that compromise professional judgment, allowing an individual to act with integrity and to exercise objectivity and professional scepticism2728Independence in Appearance The avoidance of facts and circumstances that are so significant that a reasonable and informedthird party, having knowledge of all relevant information, including safeguards applied, would reasonably conclude a firms or professional accountants integrity, objectivity or professional scepticism had been impairedIndependence in mind and appearance cont2829Specific threats to independenceFinancial interestsLoans and guaranteesClose business, family and personal relationshipsEmployment relationshipsRecent service and serving as an officer on the board of assurance clientsLong association

2930Specific threats to independenceProvision of non-assurance services to assurance clientsAppointment and removal of auditorsFees and pricingGifts and hospitality

30Types of Audits Operational

Compliance

Financial Statement

Forensic

Types of AuditsOperational Audits

- evaluates the efficiency & effectiveness of any part of organisations operating procedures & methods.- not limited to accounting - more difficult to evaluate- normally accompanied by recommendations for improving operations Types of AuditsCompliance Audits

- to determine whether the auditee is following specific procedures, rules or regulations set by higher authority.

- results normally reported to someone within the organisational unit being audited rather than to outside partiesTypes of AuditsFinancial Statement Audits

- to determine whether the overall financial statements are stated in accordance with specified criteria (normally FRS).

- the auditor performs appropriate tests to determine whether the statements contain material errors or other misstatements.Types of AuditsForensic Audits- purpose - to obtain & develop information as legal evidence or for use by expert witnesses in the courts of law.

- requires the use of critical analyses & investigative skills, integrated with accounting knowledge & business experience.

- Examples: business or employee fraud, criminal investigations, shareholder & partnership disputes.Types of AuditorsGovernment Auditor

auditor working for the Auditor General Dept, a non-partisan agency in the legislative branch of the federal govt.

primary responsibility - to perform audit function for all federal & states as well as statutory bodies & public authorities.Types of AuditorsInland Revenue Auditor

- responsible for enforcing the Income Tax Act- audit taxpayers returns to determine whether they have complied with the tax laws.- also called inland revenue assessment officers.- must have considerable tax knowledge & auditing skills to conduct an effective audit.Types of AuditorsExternal auditor

Independent auditor

responsible for auditing the published historical financial statements of all publicly traded companies and others

expected to express audit opinions on FSTypes of AuditorsInternal Auditor

- employed by individual companies to audit for management

- responsibilities may vary, depending on the employer. Their jobs can be routine compliance auditing, operational auditing or evaluating computer systems.

- internal auditors normally report directly to the president, chairman or audit committee of the board of directors.

Types of AuditorsForensic Auditors

- a new area of auditing- trained in detecting, investigating, and deterring fraud & white-collar crimes.- to detect fraudulent financial reporting and misappropriation of assets- responsible for obtaining reasonable assurance that material statements, whether due to errors or fraud, are detected.UnqualifiedQualifiedAdverseDisclaimerThe final phase in audit chose the appropriate form of audit reports to issue:The Audit ReportThe Auditors Standard Unqualified Audit ReportThe most common type of audit report issued is the standard unqualified audit report because managements assertions about the entitys financial statements are usually found to conform to FRS.TitleAddresseeIntroductory ParagraphScope ParagraphOpinion ParagraphExplanatory ParagraphAuditor NameReport DateEXHIBIT 1-1Other Types of Audit ReportsQualifiedIssued for either a material scope limitation or departure from FRS (the except for report).DisclaimerIssued for serious (material and pervasive) scope limitation or lack of auditor independence.AdverseIssued when the overall financial statements are not presented fairly in conformity with FRS.

Public Accounting FirmsPublic accounting firms range in size from a single proprietor to thousands of owners (or partners) and thousands of professional and administrative staff employees.Deloitte ToucheErnst & Young KPMG Peat MarwickPricewaterhouse Coopers Big 4 Public Accounting FirmsEthics, Independence, and the Code of Professional ConductEthics refers to a system or code of conduct based on moral duties and obligations that indicates how we should behave. Professionalism refers to the conduct, aims, or qualities that characterize or mark a profession or professional person. All professions operate under some type of code of ethics or code of conduct.Too much fees may not be very good!!

Can you really be independent with these kind of fees paid to you? (Independentan issue that well look at very closely later on in this course)Auditors ResponsibilitiesISA200 - an audit in accordance with ISAs is to be designed to provide reasonable assurance that the FS taken as a whole are free from material misstatements- Material versus immaterial misstatements- Reasonable assurance- Errors versus fraud- Fraud resulting from fraudulent financial reporting versus misappropriation of assets- Professional skepticismMisstatements are considered material if the combined uncorrected errors & fraud in the FS would likely to have changed or influenced the decisions of a reasonable person Reasonable assurance - less than absolute assurance and more than a low level of assurance Errors - unintentional misstatement; Fraud - intentional (misappropriation of assets & fraudulent financial reporting)Professional skepticism - questioning mind & a critical assessment of audit evidence Assume possibility of management dishonesty

The Auditors Responsibility for Detecting Errors and Fraud The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.Because of the nature of audit evidence and the characteristics of fraud, the auditor is able to obtain reasonable, but not absolute assurance that material misstatements are detected. The auditor has no responsibility to plan and perform the audit to obtain reasonable assurance that misstatements, whether caused by errors or fraud, that are not material to the financial statements will be detected.ISA 240R The Auditors Responsibility to Consider Fraud in an Audit of Financial StatementsRequires the auditor to:

Perform procedures to obtain info that is used to identify the risksIdentify & assess the risks of material misstatementDetermine overall responses to address the risksDesign & perform audit procedures to respond to the risk of management override of controlsDetermine responses to address the assessed risksConsider whether an identified misstatement may be indicative of fraudObtain written representationsCommunicate with managementProvides guidanceEstablish documentation requirementsSome definitions reviewMisstatementMisstatement in F/S can arise from fraud or error, that include omissions of an amount of disclosure

FraudIntentional act involving the use of deception to obtain an unjust or illegal advantage

ErrorUnintentional misstatements e.g. mistake in data collection, processing or application of GAAP

Auditors Responsibilities for Discovering Illegal ActsIt is NOT the auditors responsibility to detect all illegal acts. However, the auditor is to plan and perform the audit with professional skepticism on whether the entity is complying with laws and regulations.Auditors Responsibilities for Discovering Fraud / Illegal ActsWhat to do when discovers fraud / illegal acts?

Verify existenceCommunicate to higher managementConsider effects on FS (disclosure / qualified / adverse opinion)Withdraw from engagement if necessaryReport to SC (seek legal council opinions first)ASSURANCE SERVICESIndependent professional service to increase degree of confidence to users by evaluating the subject matter against identified criteria so that it can increase the credibility of such information.

NON AUDIT SERVICETax servicesManagement advisory servicesAccounting and review servicesCompany Secretary services

Audit profession and regulatory environment in Malaysia Malaysian Institute of Auditing (MIA)Regulatory body established under the Accountants Act 1967 to regulate accounting profession in Malaysia MIA By-laws

International Federation of Accountants (IFAC)An international body committed to develop and enhance accountancy profession MIA is a member of IFAC

International Auditing Practices Committee (IAPC)Established by IFAC to develop and issue standards and statements on auditing and related services56Organization relates to Financial Reporting and auditingCompanies Commission of Malaysia, Regulates companies and reporting requirements of companies

Malaysia Accounting Standards BoardEstablished under Financial Reporting Act 1997Accounting Standards for Private Entities/ Other than Private Entities

Securities Commission and Bursa Saham MalaysiaSupervises stock exchanges/ reporting requirements for listed companies

57THE END