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Fundamentals of Auditing

AN INTRODUCTION Next >>>
 
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Fundamentals of Auditing ­ACC 311
VU
Lesson 01
FUNDAMENTALS OF AUDITING
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
pronouncements/legislations.
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
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Fundamentals of Auditing ­ACC 311
VU
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.
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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