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Fundamentals of Auditing

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Fundamentals of Auditing ­ACC 311
VU
Lesson 03
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-trader-
ship, 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:
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Audit appointment
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Engagement letter
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Initial planning
Knowledge of the business
Risk Assessment
Internal control review (procedures)
Control procedures (authorities/approvals/segregation of duties)
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Preparation of the audit plan
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Accounting system review
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Analytical review techniques (Compliance procedures-Application of control test procedures)
like purchasing are according to the controls established.
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Considering the ways in which audit evidence can be sought
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Substantive testing (transaction level procedures)
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Reasonable assurance
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Review of the financial statements (compliance with the standards/material misstatement etc.)
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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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Fundamentals of Auditing ­ACC 311
VU
1. If the controls are likely to lead to a true and fair set of financial statements the auditor will test
those controls.
2. If they appear weak he will not rely on the controls but carry out extensive testing of the
transactions and balances which appear in the financial statements by means of substantive
procedures.
3. If the controls are operating effectively, the auditor can reduce the amount of substantive testing
described above and adopt a reliance approach.
4. If not then the auditor will be forced into a extensive substantive approach
What are the features of auditing profession?
In Pakistan auditing profession is allied with the Institute of Chartered Accountants of Pakistan (ICAP). It
is an autonomous body incorporated under the Chartered Accountants Ordinance 1961.
ICAP is a regulatory body that enjoys a self regulatory status. Its affairs are run by a council which is elected
by its member (Chartered Accountants).
Only those members of the ICAP are eligible of doing audit who have obtained license for the purpose,
these are known are practicing members.
Management of ICAP
The President is the Chief Executive of the Institute. The administrative head of the Institute is the
Executive Director/Secretary who functions under the directions of the Council, Executive Committee,
The President and the Vice Presidents
The Executive Director in performance of his functions is assisted by:
 Secretary
 Director Technical Services
 Director Professional Standards Compliance
 Director Education & Training
 Director Examinations
 Regional Director North
The prime responsibilities of Executive Director include Personnel Management; Financial Management;
Office Administration; Publications; Information Systems; Conducting and performing Secretarial functions
for the Council and Executive Committee Meetings.
Knowing the audit profession and other services?
Auditing firms do not describe themselves as auditors. They describe themselves as Chartered Accountants.
Auditing firms are composed of accountants who perform audits for their clients. They also perform other
services. The small chartered accountant firms especially may spend more time on other services than on
auditing.
The other services may include:
a.  Writing up books of accounts (Book keeping)
b. Balancing books of accounts (Extracting trial balance)
c.  Preparing final accounts
d. Tax management
e.  Statutory form filling
f.  Financial consultancy
g. Management and system consultancy
h. Liquidation and receivership work
i.  Investigations (Fraud audit)
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Table of Contents:
  1. AN INTRODUCTION
  2. AUDITORSí REPORT
  3. Advantages and Disadvantages of Auditing
  4. OBJECTIVE AND GENERAL PRINCIPLES GOVERNING AN AUDIT OF FINANCIAL STATEMENTS
  5. What is Reasonable Assurance
  6. LEGAL CONSIDERATION REGARDING AUDITING
  7. Appointment, Duties, Rights and Liabilities of Auditor
  8. LIABILITIES OF AN AUDITOR
  9. BOOKS OF ACCOUNT & FINANCIAL STATEMENTS
  10. Contents of Balance Sheet
  11. ENTITY AND ITS ENVIRONMENT AND ASSESSING THE RISKS OF MATERIAL MISSTATEMENT
  12. Business Operations
  13. Risk Assessment Procedures & Sources of Information
  14. Measurement and Review of the Entityís Financial Performance
  15. Definition & Components of Internal Control
  16. Auditing ASSIGNMENT
  17. Benefits of Internal Control to the entity
  18. Flow Charts and Internal Control Questionnaires
  19. Construction of an ICQ
  20. Audit evidence through Audit Procedures
  21. SUBSTANTIVE PROCEDURES
  22. Concept of Audit Evidence
  23. SUFFICIENT APPROPRIATE AUDIT EVIDENCE AND TESTING THE SALES SYSTEM
  24. Control Procedures over Sales and Debtors
  25. Control Procedures over Purchases and Payables
  26. TESTING THE PURCHASES SYSTEM
  27. TESTING THE PAYROLL SYSTEM
  28. TESTING THE CASH SYSTEM
  29. Controls over Banking of Receipts
  30. Control Procedures over Inventory
  31. TESTING THE NON-CURRENT ASSETS
  32. VERIFICATION APPROACH OF AUDIT
  33. VERIFICATION OF ASSETS
  34. LETTER OF REPRESENTATION VERIFICATION OF LIABILITIES
  35. VERIFICATION OF EQUITY
  36. VERIFICATION OF BANK BALANCES
  37. VERIFICATION OF STOCK-IN-TRADE AND STORE & SPARES
  38. AUDIT SAMPLING
  39. STATISTICAL SAMPLING
  40. CONSIDERING THE WORK OF INTERNAL AUDITING
  41. AUDIT PLANNING
  42. PLANNING AN AUDIT OF FINANCIAL STATEMENTS
  43. Audits of Small Entities
  44. AUDITORíS REPORT ON A COMPLETE SET OF GENERAL PURPOSE FINANCIALSTATEMENTS
  45. MODIFIED AUDITORíS REPORT