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TOPIC 5 – DEPARTMENTAL ACCOUNTS
TOPIC 6 – ELEMENTS OF AUDITING
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Aspects and Elements of Culture
Elements of Auditing
Meaning of Auditing
Auditing refers to a systematic and independent examination of books, accounts, documents and vouchers of an organization to ascertain how far the financial statements present a true and fair view of the concern. It also attempts to ensure that the books of accounts are properly maintained by the concern as required by law. Auditing has become such a ubiquitous phenomenon in the corporate and the public sector that academics started identifying an “Audit Society”.
The auditor perceives and recognizes the propositions before him/her for examination, obtains evidence, evaluates the same and formulates an opinion on the basis of his judgment which is communicated through his audit report.
Any subject matter may be audited. Audits provide third party assurance to various stakeholders that the subject matter is free from material misstatement. The term is most frequently applied to audits of the financial information relating to a legal person. Other areas which are commonly audited include: internal controls, quality management, project management, water management, and energy conservation.
As a result of an audit, stakeholders may effectively evaluate and improve the effectiveness of risk management, control, and the governance process over the subject matter.
The Main Objective of Auditing
Purpose & Objectives of Auditing Financial Statements
Objective
The objective of external audit is for the auditor to express an opinion on the truth and fairness of financial statements.
Accountability
The main necessity for conducting the audit of financial statements stems from the fact that the persons responsible for the preparation of financial statements are often different from the owners of large corporations.
Whereas in small owner managed companies, the owners have firs hand knowledge of the affairs of their business, management and ownership is normally separate in the case of large companies that often have thousands of shareholders. In large corporations, shareholders appoint directors to run the enterprise on their behalf. This separation of ownership and control creates the need for external audit.
Financial statements are the main source of accountability of management performance by the shareholders. However, as the management is responsible for the preparation of financial statements, shareholders have to rely on external verification by auditors in order to gain reasonable assurance that the accounts are free from material misstatements and can therefore be relied upon to be presenting true and fair view of the affairs of the company.
Reliability
Apart from the needs of owners, other users of financial statements may need to place reliance on the financial statements. External audit is a means of providing a reasonable basis for the users to place reliance on financial statements.
Examples of stakeholders (other than shareholders) that rely on audited financial statements include the following:
Tax authorities rely on audited financial statements to determine the accuracy of tax returns filed by the companies.
Financial institutions require audited accounts of prospective borrowers for assessing the credit risk by analyzing their liquidity and financial position.
Management uses the audit exercise to re-evaluate the company’s risk management processes and internal control system by considering the feedback given by external auditors during the course of the audit in this regard.
Scope
Financial audit is intended to provide a ‘reasonable’ assurance over the accuracy of financial statements. It therefore does not provide absolute assurance that the financial statements are free from all misstatements. The purpose of audit is confined to provide reasonable assurance in order to avoid excessive time and cost in the performance of the audit that may outweigh any benefit that may be derived from the enhanced assurance. Absolute assurance is also impossible to guarantee in most cases due to the inherent limitations of audit.
Types of Auditing
Internal audit -is a function that, although operating independently from other departments and reports directly to the audit committee, resides within an organization (i.e. they are company employees). It is responsible for performing audits (both financial and non-financial) within a wide range of areas within a business, as directed by the annual audit plan. Internal audit look at key risks facing the business and what is being done to manage those risks effectively, to help the organization achieve its objectives. For example, they may look at risks to the company’s reputation such as the use of cheap labor in foreign countries, or strategic risks such as producing too many products in comparison to resources available etc.
External audit -is an independent body which resides outside of the organisation which it is auditing. They are focused on the financial accounts or risks associated with finance and are appointed by the company shareholders. The main responsibility of external audit is to perform the annual statutory audit of the financial accounts, providing an opinion on whether they are a true and fair reflection of the company’s financial position. As part of this, external auditors often examine and evaluate internal controls put in place to manage the risks which could affect the financial accounts, to determine if they are working as intended.