Topic 6- Elements of Auditing – Book Keeping Form 4
Elements of 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.
The Main Objective of Auditing
The objective of external audit is for the auditor to express an opinion on the truth and fairness of financial statements.
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.
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.
- 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.
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.
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.
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.
Meaning of Internal Control; Internal Check; Internal Audit
Internal control,
as defined in accounting and auditing, is a process for assuring
achievement of an organization’s objectives in operational effectiveness
and efficiency, reliable financial reporting, and compliance with laws,
regulations and policies.
Internal Check
check is a method of organizing the accounts system of a business
concern or a factory where the duties of different clerks are arranged
in such a way that the work of one person is automatically checked by
another and thus the possibility of fraud, or error or irregularity is
minimized unless there is collusion between the clerks. For example, the
receipt of cash is entered by the cashier on the debit side of the cash
book; this entry is carried to the ledger by another clerk; the
statement of account relating to this transaction is sent to the
customer by a third clerk and so on. Thus the same transaction has
passed through three different hands and the work of one is checked
automatically by the other. It is a kind of division of labour. This
minimizes the possibilities of frauds and errors unless all the three
join hands in defrauding their employer.
According
to the special committee on Terminology, American Institute of
Accountants, 1949 “Internal check-a system under which the accounting
methods and details of an establishment are so laid out that the
accounts procedures are not under the absolute and independent control
of any person – that, on the contrary, the work of one employee is
complementary of that of another, and that a continuous audit of the
business is made by the employees.”
- (a) Instituting of checks on day-to-day transactions.
- (b) These checks operate continuously as a part of routine system.
- (c) Work of each person is made complementary to the work of another.
working papers: are the document which record all audit evidence
obtained during financial statement auditing, internal management
auditing, information system auditing and investigations.
- Flow charts,
- manual,
- narrative note,
- checklist
Explain the different types of auditors reports and opinions
An audit report is an appraisal of a small business’s complete financial
status. Completed by an independent accounting professional, this
document covers a company’s assets and liabilities, and presents the
auditor’s educated assessment of the firm’s financial position and
future. Audit reports are required by law if a company is publicly
traded or in an industry regulated by the Securities and Exchange
Commission (SEC). Companies seeking funding, as well as those looking to
improve internal controls, also find this information valuable.
Often called a clean opinion, an unqualified opinion is an audit report that is issued when an auditor determines that each of the financial records provided by the small business is free of any misrepresentations. In addition, an unqualified opinion indicates that the financial records have been maintained in accordance with the standards known as Generally Accepted Accounting Principles (GAAP). This is the best type of report a business can receive. Typically, an unqualified report consists of a title that includes the word “independent.” This is done to illustrate that it was prepared by an unbiased third party. The title is followed by the main body. Made up of three paragraphs, the main body highlights the responsibilities of the auditor, the purpose of the audit and the auditor’s findings. The auditor signs and dates the document, including his address.
Qualified Opinion
In situations when a company’s financial records have not been maintained in accordance with GAAP but no misrepresentations are identified, an auditor will issue a qualified opinion. The writing of a qualified opinion is extremely similar to that of an unqualified opinion. A qualified opinion, however, will include an additional paragraph that highlights the reason why the audit report is not unqualified.
Adverse Opinion
The
worst type of financial report that can be issued to a business is an
adverse opinion. This indicates that the firm’s financial records do not
conform to GAAP. In addition, the financial records provided by the
business have been grossly misrepresented. Although this may occur by
error, it is often an indication of fraud. When this type of report is
issued, a company must correct its financial statement and have it
re-audited, as investors, lenders and other requesting parties will
generally not accept it.
On
some occasions, an auditor is unable to complete an accurate audit
report. This may occur for a variety of reasons, such as an absence of
appropriate financial records. When this happens, the auditor issues a
disclaimer of opinion, stating that an opinion of the firm’s financial
status could not be determined.