CATHOLIC UNIVERSITY OF EASTERN AFRICA

BCOM – ACCOUNTING OPTION

INTRODUCTION TO AUDITING -CAC 321-1 NOTES
THE GENERAL AUDIT ENVIRONMENT

Chapter Objectives:

•• By the end of this chapter, you are expected to have a general understanding of the
following.
•• Definition of Auditing
•• Distinction between auditing and accounting
•• Objects of an audit
•• What is true and fair?
•• Benefits of an audit to a public limited company
•• Types of audits
•• Users of audited reports
•• Stages of an audit

Introduction

At the end of every financial year, company’s are expected by statute to have their financial
statements reviewed by an independent professional who after going through the accounts,
expresses an opinion as to whether the financial statements present a true and fair view of the

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financial position of the company. This procedure is normally called a year end audit and is
conducted by an auditor. This chapter gives an introduction of auditing and its benefits.
By the end of this chapter, you are expected to have a general understanding of the general
Audit environment by being able to distinguish between auditing and accounting, the objects of
an audit, types of audits, stages of an audit and the benefits

Key Terms

Audit This is the independent investigation into the quality of published accounting information.

Industry context

Audits are conducted for most businesses especially where there is separation of ownership from
management. At the end of an audit the auditor is expected to give a report to provide some form of
assuarance to the users of financial statements. An audit therefore is necessary in the current
world.

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 Need for an Audit

Industrialization has led to growth of business through pooling together savings of investors. This
has lead to a company having a large number of shareholders. Limited liability companies were
created with the intention of having widespread shareholding.
It is consequently impractical for the shareholder to be involved in everyday running of the company.
Also the shareholders may lack skills and the time to manage their company. Thus, the shareholders
delegate the task of running the company to a small number of qualified directors through agency
relationship. The agents who are the directors have a total discretion over strategy, investment and
financing decisions, which have enormous implication on the shareholders.
The directors can easily be tempted to satisfy their own welfare at the expense of shareholders
welfare by awarding themselves excessive remuneration packages. This situation shareholders
find themselves in entrusting their savings with the directors who can easily misuse the savings
is called the agency problem.
The shareholders must put in place mechanisms in order to protect themselves from possible
excesses of directors. This can be, through:
a. Remunerating the directors (agent) in such a way that their interests coincide with those
of the shareholders (principal) e.g. profit based salaries, bonus based performance or
share options that give the directors right but not obligation to buy specified number of
shares at a specified price.
b. Monitoring the action of the agent and penalize for any exploitation by having major
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shareholders as their representatives on the board of director the Kenya Companies

Act has put in place additional measures for monitoring management behavior for the
benefit of all shareholders. These are:
• Section 147 of the Companies Act requires the company to keep proper books of
accounts and other statutory records. This is to ensure that actions of directors will
be properly documented so that the shareholders can inspect the company
records at anytime they wish.
• Section 159 of the Companies Act requires the directors to prepare accounts of
their financial stewardship and sent them to all the shareholders so that they can
ascertain the operation and financial position of their company.
• The sixth schedule of Company Act and other several sections stipulate the
minimum information these accounts must state ensuring that the shareholders
have the relevant information for decision making and evaluation of directors.
• Section 159 further requires the directors to call an annual general meeting (AGM)
at which the company accounts are laid before the shareholders as a group. This
ensures that the shareholders can use their powers to oversee operation of their
company e.g. questioning the directors on matters of managing the company.
The major problem is that these company accounts and reports the shareholders use to evaluate
the financial stewardship of directors and which can be used to discipline or reward the directors
are prepared by the directors themselves. Indeed, any performance based bonus is likely to be
calculated from figures published in the company accounts.
This can tempt the directors to manipulate figures which are published in the accounts. Thus

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the company accounts prepared by the directors lack credibility and hence section 159 of the
Company Act requires that every company must have an auditor regardless of the wish of the
directors or shareholders.
The shareholders receive company accounts and other information from the directors therefore
need assurance regarding quality of the information. Hence an individual shareholder should
inspect the company accounts to establish their credibility if he so wishes but due to lack of time
and skill, an audit remains the obvious solution to the agency problem facing the shareholders.

Definition of an Audit:

An audit is the independent examination of and expression of an opinion on the financial

statements of an economic entity by appointed auditor in pursuance of that appointment and in
compliance with any relevant statutory obligation .
The objective of an audit is to enable the auditor express an opinion whether financial
statements show a true and fair view of the company state of affairs in accordance with an
identified financial reporting framework.
The purpose of an audit is not to provide additional information but rather it is intended to provide
the users of the accounts with assurance that the information provided to then by directors is
reliable. However, the users should not assume the auditor’s opinion is one to efficiency with
which management has conducted the affairs of the entity.

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Financial statement: According to the Companies Act, the company accounts refers to the
balance sheet and the profit and loss account but due to development in business practice and
shareholders information needs, these are inadequate as to the information regarding financial
position and performance of the company. Since most balance sheets and profit and loss
accounts are summarized statements amplified by notes to the statements, the business
community and the accountancy profession require that a cash flow statement as well as a
statement of changes in equity be prepared. The terms company accounts and financial
statements have the sam e meaning.
Financial Reporting framework: According to International Auditing Standards (ISA 200, the
framework of international standards of auditing), financial statements are usually prepared and
presented annually and are directed at common informational needs of a wide range of users.
Many of the users rely on the financial statements as their major source of additional information
to meet their specific information needs. Therefore financial statements need to be prepared in
accordance with one or combination of:
•• International Financial Reporting Standards (IFRS)or IASs
•• National accounting standards
•• Any other authoritative and comprehensive financial reporting framework designed for
use in financial reporting and is identified in the financial statements. In Kenya the
financial reporting framework adopted is as prescribed by IFRS.

Role of IFRS and IASs in preparation of financial statements

Though not specifically set out in the preface to the statement of IFRS, it is well accepted within
the accountancy projection that IFRS do the following:
• Though not specifically set out in the preface to the statement of IFRS, it is well accepted
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within the accountancy projection that IFRS do the following:
 • They prescribe the approved method of accounting and disclosure.
• Where one or more methods of accounting are acceptable, they prescribe one method
which is preferred and called the benchmark treatment and the allowed alternative treatment
and conditions under which that allowed alternative is applied.
• They prohibit, discourage and restrict use of methods which will not lead to a true and fair
view of the financial statements.
• They increase comparability of financial statements. Application of appropriate IFRS
reduces areas of uncertainty and subjectivity in financial statements.
It is extremely unlikely that financial statements would give a true and fair view when appropriate
IFRS are departed from. When managers depart from the IFRS in preparing financial statements
they must include a note to the financial statements that they have departed from the financial
statements and they must justify that departure. Auditors can on their part refer to the departure
in their audit report and clearly indicate whether or not they concur with the departure.
International standards on auditing (ISAs) are issued by International auditing and practices
committee (IAPC) of the International Federation of accountants (IFAC) based in New York.
IFAC is the worldwide organization for the accountancy profession. It is comprised of 155
professional accountancy bodies in 114 countries, representing more than 2.4 million
accountants in public practice, education, government service, industry and commerce. IFAC's
mission is to develop and enhance the profession to enable it to provide services of consistently
high quality in the public. In addition to developing auditing standards through the IAASB, IFAC
also develops education, ethics, and public sector accounting standards. Membership in IFAC
automatically confers membership in International Accounting Standards Board (IASB). ISAs do
not override a country’s regulations which may be government statutes or statements issued by
regulatory or professional bodies in the country.
ISAs are prepared by IASB which has the responsibility of producing a single internationally
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acceptable set of high quality accounting standards.

Advantages of auditing

•• Dispute resolution. A partnership business with a complex profit sharing agreement

may require an independent examination of those accounts to ensure accurate
assessment and division of those profits.
•• Significant changes in ownership and structure can be easily effected if past accounts
contain unqualified audit reports. E.g. in mergers.
•• Auditors have access to the corporate strategy of the company thus are able to give
advice on gaining competitive advantage and on improvement of business efficiency.
•• Borrowing of finances from third parties is enhanced with availability of unqualified
audit report on the company’s financial statements.
•• Auditing protects the interests of the shareholders who are separated from the
management of their savings invested in the company.
•• Auditing assists in prevention and detection of fraud and error in financial statements
although this is not the primary objective of an audit.

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Disadvantages of auditing

• Audit fees are normally high since auditors are highly qualified professionals hence small
firms such as sole proprietorships may not afford their financial statements to be audited.
• The audit exercise interrupts the clients operations because client staff have to spend time
in availing the required information to the auditors.
• Company secrets may leak to competitors since all company information is accessible to
the auditors.

Financial accounting and Auditing

Financial accounting entails provision of information about a business or company in form of

financial statements which are then made public. These statements are generally prepared on
an annual basis and used by management and other interested parties to make decisions. The
information contained in these financial statements must give a true and fair view of the state of
affairs in the organization.
Auditing is a check carried out by an independent auditor to make sure that what a company is
saying about its financial statement is true. Auditing therefore adds credibility to the financial
statements by ensuring the availability of accurate and reliable financial information.

Differences between Auditing and Financial Accounting

• Auditing is an independent examination of company accounts and expression of an opinion

whether they contain a true and fair view of company’s state of affairs. Financial Accounting
is the recording, classifying and summarizing events of an economic entity in order to assist
management in decision making.
• While auditing is conducted once in a financial period and usually at the end, financial
accounting is a continuous process throughout the financial period of a company.
• Auditing is governed by ISA while Financial Accounting is guided by GAAPs.

Similarities between Auditing and Financial Accounting

• Both auditing and accounting are statutory requirements i.e. that companies must maintain
proper books of accounts at that their financial statement must be audited

Objectives & General principles of an Audit

ISA 200 (Objectives And General Principles Governing An Audit Of Financial Accounting) states
that the objective of an audit of financial statement is to enable auditors give an opinion on
financial statements taken as a whole thereby provide reasonable assurance that the statements
give a true and fair view and have been prepared in accordance with relevant acco unting and
other requirements.
The auditor’s opinion is not a guarantee that the financial statements actually show true and a
fair view but that in his or her opinion, they show a true and fair view as to the state of affairs of
the company. (See True & Fair Below)

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 Users of Audited Financial Statements

• Present and potential investors. These risk capital providers and their advisors are concerned
with the risk that is inherent in their investment. They need information to help them
determine whether they should buy more shares, hold on to the shares they have or sell the
shares they have.
• Employees. These and their representative groups such as trade unions are interested in
information about the stability and profitability of their employers. They are also interested in
information which enable them assess the ability of the company to provide adequate
remuneration, retirement benefits and employment opportunities.
• Lenders. These are interested in information that enables them determine whether their
loans and interests arising from the loans will be paid back when due.
• Suppliers and other trade creditors. These users are interested in information that enables
them determine whether the amounts owing to them will be paid when due. Their interest in
the company is of shorter period than lenders while they are dependent upon the
continuation of the company as a major customer.
• Customers. These have interest in information about the continuance of the company
especially when they have long term involvement and or are dependent as the company.
• Government. The main interest of the government is allocation of resources. It also requires
information in order to regulate the activities of the enterprise, determine taxation policies
and obtain national income statistics.
• Public. A company affects public in a variety of ways. A company may make substantial
contribution to the local economy by employing people and obtaining supplies locally.
Financial statements assist the public in information on trends and recent developments of
the company in the economy .
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Others:
•• Lawyers
•• Competitors
•• Stock brokers
•• Statisticians
•• Financial journalists
•• Trade unions
•• Credit-rating agencies

Types of Audits

• Audits can be classified into two broadways.

• According to terms of engagement i.e. nature of work done.
• According to the approach to the work to be done/ timing.

According to nature of work done, audits may be either statutory of private.

Statutory audits
These are carried out as per the requirements of various statutes e.g. Companies Act Cap 486
requires that all public limited companies to have their financial statements subjected to an

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independent audit. The objective of the audit is to enable the auditor express an opinion whether
the financial statements have a true and fair view of the company’s state of affairs. The rights
and duties of the auditor are laid down in the relevant statute. The powers of appointment of the
auditors are vested on the shoulders.

Private audits
These are not governed by statutes. They are performed by independent auditors because the
owners, members or interested parties require them carried out. Private audits are carried out for
organizations such as non governmental organizations, partnerships and clubs and among
others. Appointment of auditors is carried out as a private contract between the auditor and the
relevant shareholder. The scope and objective of the work as well as rights and duties of the
auditor are determined by the agreed terms between the auditor and the client. The auditor is not
liable to third parties.

According to approach of the work to be done, audits can be continuous, interim

or final.

Continuous audits
This is an approach whereby an audit is carried out throughout the financial period usually at
predetermined intervals. This approach is ideal for large organizations with tight reporting
deadlines e.g. multinational banks. The approach ensures accounts are kept up to date, errors
and frauds are discovered in early stages and better audit reports are developed since more time
is taken.
However, this approach is expensive considering amount of time taken, has frequent

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interruptions of client work and auditors’ independence may be affected by their continuous
presence at clients premises.

Interim audits
This is an audit carried out halfway through the financial period. It usually precedes the final audit
and is a preparation for the final audit. It is ideal for dynamic businesses, cheaper compared to
continuous audits and enhances keeping of up to date records.

Final audits
These are usually done at the end of the year as either a continuation of the interim audit for
large and medium size companies or as a single audit for small companies at end of financial
period.

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 Other types of audits

Procedural audits. These require examination of procedures or records for reliability and
accuracy. They usually relate to company’s internal control systems, laid down guidelines and
procedures and records of the company.
Management audits. These involve investigation of the company’s entire management to
ascertain whether the directors are running the company in the most optimal way for the benefit
of the shareholders. It improves quality and efficiency of management in addition to checking the
budgetary system.
Balance sheet audits. This tests the strength of internal control system by working backwards
to get the initial transactions using assertion methodology.

Internal Audit

Management upon realizing the advantages of an audit have established within the company,
‘an independent activity to examine and evaluate the organizations risk management process
and systems of control and to make recommendations for the achievement of the company’s
objective’. This activity is called internal auditing. The duties of internal audit personnel are:
• Reviewing the economic efficiency and effectiveness of the company’s operations.
• Reviewing the company’s compliance with external laws and regulations and internal
policies and procedures.
• Reviewing and advising the management on development of key organizational systems
and implementation of major changes.
The focus of internal auditing is adding value to an organization through improvement in risk
control.
In 1999, the institute of internal auditors (IIA) defined internal auditing as ‘an independent
objective assurance and consulting activity designed to add value and improve an organization’s
operations, help it achieve its objective and improve the effectiveness of risk management,
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control and governance process.

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Internal auditing and external auditing compared.

Aspect Internal Auditing External Auditing

Objectives The main objective is to advice The objective is to provide
management on whether organization an opinion as to whether or
has sound internal control systems to not the financial statements
protect it against loss. show a true and fair view
of the company’s state
affairs.
Legal basis Internal auditing is not a legal It is a legal requirement for
requirement but corporate governance limited liability companies
advises and recommends that a and public bodies to have
company should have an internal audit their accounts audited.
department.
Scope It covers all areas of organization i.e. It has a purely financial
operational as well as financial. focus.
Approach It is increasingly risk based. The Its increasingly risk
approach is to assess risks, evaluate based as it only tests
systems of control and test operation underlying transactions
of the systems and finally make that form having of financial

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recommendations for improvement. statements.
Responsibility The responsibility is to advise and The responsibility is to
make recommendations on internal form an opinion on whether
controls and corporate governance. financial statements show
a true and fair view.

Scope & Objectives of Internal audit function

This depends on the size and structure of the entity and the responsibility assigned to it by
management. Ordinarily these would include:
• Review of accounting internal control systems. The management is responsible for
establishing internal control system. The system requires proper attention and continuous
review, a function usually assigned to internal audit. Internal Audit function designs a plan
on areas and control procedures that will be reviewed during the financial year.
• Carrying out examination of financial and operational information. This may include detailed
testing of transactions and operation procedures.
• Review of the economic efficiency and effectiveness of operations including non financial
controls of the entity.
• Review of company’s compliance with external laws and regulation. The internal audit
functions checks whether procedure are in place to ensure that all relevant laws and
regulations are adhered to.
• Review of entity’s compliance with management policies and other intern al requirements.
• Carrying out independent investigations into company affairs as required by management
e.g. investigation areas of suspected fraud or misuse of company’s resources.

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 Similarities between internal audit and external audit
• Both auditors are concerned about the strength and proper functioning of the internal control
system. The internal auditor is concerned it is his or her responsibility while the external
auditor is concerned as he or she relies on the strength of internal control system to carry
out systems based audits.
• Both auditors have as part of their duties to ensure that the company adheres to all
relevant laws and regulations.
• Both auditors interested in ensuring that the company keeps proper books of records. The
internal auditor uses the company accounts to appraise the functioning of the internal
control system while external auditor uses them to collect audit evidence to corroborate his
audit opinion.
• Both auditors are concerned about prevention and detection of errors and frauds. The
internal auditor ensures errors or frauds are prevented and detected by having strong
internal control system while the external auditor has the incidental duty of detecting and
preventing material errors and frauds which would otherwise distort the true and fair view of
the financial statements.
• Both auditors have interest in safeguarding company assets. The internal auditor through
strong internal control system ensures safety of company’s assets while external auditor
must ensure that company assets are safeguarded against theft and misuse so that the true
of fair view of financial statements is maintained.

External auditor’s reliance on work of internal auditor

Before deciding on whether to rely on work of internal audit function with the intention of reducing
audit procedures, the external auditor should evaluate the internal audit function to determine the
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scope of the function its independence and the extent to which its work can be relied on. In
evaluating internal audit function, the external auditor considers the following factors:
• Organization status. Since internal audit function is part of the entity, it cannot be totally
independent. To aid in its independence, the internal audit function should report to the
highest level of management. The internal auditor should also be free from duties such as
accounting functions which may bring about conflict of interest. The internal auditor should
not have any restrictions upon him or her from management which could impair
effectiveness of doing his or her work.
• Scope of the function. The external auditor should ascertain the nature and depth of
coverage of internal audit assignments. Also to be considered are the management actions
on the recommendations of internal auditor. In case the management does not follow up on
the recommendations, the external auditor must reduce his reliance on work of internal audit
function as this means it is weak.
• Technical competence. The external auditor should assess the competence experience,
qualifications, technical training and proficiency of the staff members in the internal audit
function.
• Due professional care. The external auditor should ascertain whether due professional care
has been observed in doing the work of the internal audit function e.g. whether there were
work plans, supervision and documentation of audit evidence in executing internal audit
functions.
• Availability of resources. The external auditor should consider whether the internal audit
function has adequate resources to enable it carry out its functions as expected e.g.
adequate staff and time.

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Advantages of Internal Audit function

• It reinforces application of internal controls thus enables the company to operate in an

orderly and efficient way.
• It prevents and detects errors and frauds through periodic comparison of budgets, routine
and surprise checks.
• Assists management in implementation of company policies through reporting on
adherence or non adherence to laid down policies of the company.
• Assists external auditor in highlighting areas of weaknesses in internal control system.
This reduces audit time for the external auditor and thus there is a saving on audit fees.
• Assists the company in achieving its objective by ensuring that all laid down rules,
procedures and policies are followed e.g. adherence to budgets and forecasts assists in
decision making.
• The internal audit function guards company’s resources against theft and misuse through
proper functioning of the internal control system and periodic verification of assets.

Limitations of an Internal Audit

• The cost of installing and maintaining an internal audit function is high and in particular for
large companies as they may require highly qualified staff while for small companies the
department may not be justifiable.
• If management ignores the recommendations of internal audit function, members of internal
audit function may be frustrated as errors and frauds may continue being undetected.
• Management may deny the internal audit function its due independence by assigning it
accounting duties or even management responsibilities.

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• If company operations are few or has complex technical aspects may limit the proper
functioning of the internal audit function.
• The internal audit department may fail e.g. if it points out problems without giving solutions
or ignoring some departments within the company.
• The internal audit may lack the necessary support from top level management if top
management views the function as not important.

Factors necessitating growth in Internal Audit

• Increase in business size. As business grow, it becomes more and more necessary to have
a function that checks all the increasing levels of internal control and operation.
• Dynamic technology- the frequent changes in technology has made some companies to
have their controls updated on a continuous basis. This calls for constant feed back on
controls requiring updating through use of expert advice for internal audit function.
• Legislation and regulatory requirements. As the concept of corporate governance becomes
necessary in business management, the need of internal audit has increased. Companies
are now required by regulations to have audit committees to oversee operation of controls
within the company and to which the internal audit function reports.
• Competition. High competition in business calls for efficient operations by companies so as
to survive. This can be achieved through strong controls and cost effectiveness which is
enhanced by internal audit.

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 Risk and Materiality (ISA 320 Materiality)

ISA 320 discusses the concepts of risk and materiality. An audit risk is the risk that an auditor
may give an inappropriate opinion i.e. an opinion that contradicts the true nature of the financial
situation of the company. Materiality plays a role in each of the following two stages.
a. Planning stage. (in planning what audit work should be done)
b. Reporting stage (in deciding what opinion to give.)
The international auditing and assurance standards board (IAASB) in its framework for
preparation and presentation of financial statement defines materiality as follows; ‘information is
material if its omission or misstatement could influence the decision of users taken on basis of
the financial statements.’ Therefore materiality provides a threshold or cut off point rather than
being a primary qualitative characteristic which information must have if it is to be useful.
ISA 320 further states a number of audit principles as follows:
• The auditor should consider materiality and its relationship to audit risk when conducting an
audit. If the auditor assesses the risk associated with an account balance or internal control
system to be high, it will be reflected in a lower level of materially thus additional testing will
be required.
• The objective of an audit is to enable the auditor express an opinion whether financial
statements are prepared in all material respects and in accordance with the identified
financial reporting framework. The auditor needs to establish an appropriate materiality level
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so that quantitatively, material misstatements which are likely to destroy the true and fair
view of financial statements are identified.
• Materiality at planning stage is usually set at lower level than necessary in order to reduce
risk of undiscovered misstatements and to deal with the problem of having to adjust
materially at later date in light of evidence obtained.
• Materiality should be considered by the auditor when;
•• Determining nature, timing and extent of audit procedures
•• Evaluating effect of misstatements.
The auditor should plan sufficient audit procedures so that he or she has reasonable expectation
of detecting material misstatements in financial statements. Any immaterial item will not affect the
truth and fair view of the financial statement and thus can be ignored.

Materiality and judgment

Auditors consider the following before appropriately testing whether an item is material or not. 1.
Qualitative aspects: these may include inadequate or inaccurate descriptions of an accounting
policy.
2. Cumulative effect of small amounts: small errors at a month end procedure could
individually be immaterial but continuous errors of this kind throughout the financial year
could be material.
3. Relatively of materiality. A figure of Kshs. 100,000 may be absolutely immaterial for a
large company but absolutely material for a small company. An amount must be
considered in relation to:
•• Items on the overall financial statements level.
•• Items at individual account balance or transaction level

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 • Legal and other disclosure requirements which may require disclosure regardless of
the monetary value e.g. director’s fees.
•• The corresponding amount in the previous year.
4. The degree of latitude allowable in deciding on the amount attributable to a particular item.
While some items such as director’s fees are capable of an exact definition, others such as
depreciation and allowance for doubtful debts are at best an intelligent estimate. In some
countries e.g. US, the security exchange commission estimate materiality as follows;
•• Errors greater than 10% are material
•• Errors between 5% and 10% may be material
•• Errors below 5% are not material
5. In evaluating the true and fair presentation of financial statement, the auditor should assess
whether the aggregate of uncorrected misstatements that have been identified in the audit is
material. The auditor should reconsider all uncorrected misstatements and check whether
this total is material.

True and fair view

The true and fair view is a concept of the Companies Act. However, the Companies Act does not
define or even describe what is true and fair view. The companies Act requires that all limited
liability companies to appoint an auditor whose task is to express an independent opinion as to
whether financial statement show true and fair view of the financial performance and position of
the company. True and fair view implies that the financial statements are not prejudicial to any
user of the financial statements. Financial statements will present a true and fair view if:

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• They contain in all material respects with the disclosure requirement of the Company Act
and other relevant regulations.
• They contain material matter and not full of needless details.
• They are complete in every respect within the constraints of materiality and the inevitable
estimation of some items.
• The values attributed to the items in the financial statements are reasonable amounts within
a range in which if a major decision was taken on their basis the user would not make a
material error.
• The information contained there in is presented and disclosed without bias and all relevant
information for evaluation and decision making is available.

Assertion Methodology

In preparing financial statements which show true and fair view of the company’s financial
position and performance, the management explicitly or implicitly makes certain assertions.
These assertions are categorized as:
i Existence
ii Completeness
iii Occurrence
iv Rights & obligation
v Measurement
vi Valuation, presentation and disclosure.
vii Classification
viii Cut-off
ix Accuracy
x Allocation
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 Existence
This is the assertion that an asset or liability exists at a given date. It is either true or not true that
an asset or liability reflected in the balance sheet was in existence at the balance sheet date.

Rights and obligation

This is the assertion that an asset or liability in financial statements pertains to the entity at a
given date i.e. an asset is a right of the entity and a liability a genuine obligation of the entity.

Occurrence
This is the assertion that a transaction or event took place which pertains to the entity during the
financial period or that a recorded event or transaction actually took place as recorded and it is a
valid transaction pertaining the entity. It is either the transaction took place as recorded or not.

Completeness
This is the assertion that there are no unrecorded assets, liabilities, transactions or undisclosed
items. It would suggest 100% completion and accuracy however, this is impossible under accrual
basis of accounting. The users of the financial statements do not expect 100% completeness in
financial statements but completeness within a certain range such that they can still make
justifiable decisions. This assertion is therefore assessed for reasonableness as some
transactions may be excluded if they are not material.
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Valuation
This is the assertion that an asset or liability is recorded at an appropriate carrying value. It is the
most crucial assertion of all the assertions. In arriving at appropriate carrying value of an asset or
liability, the management considers.
1 Overall valuation basis. The management must consider the entity as a whole and make an
assessment whether it is appropriate to apply the going concern assumption in preparing
the financial statements. The basis of preparing financial statement when entity is going
concern is radically different from preparing financial statement on basis that the entity is not
a going concern.
2 Suitable accounting policies. In determining carrying amount of an asset or liability
appropriate accounting policies must be followed. The accounting policies must be in line
with the generally accepted accounting principles (GAAPs), appropriate to the
circumstances of the entity, applied consistently, be in conformity with entity’s industry
practices and be adequately disclosed.
3 Desirable qualitative characteristics. The suitable accounting policy adopted must be applied
after taking into consideration the qualitative characteristics of materiality, prudence and
substance over form. Since it may subjective whether an entity is a going concern or not, the
accounting policy adopted can be subsequently subjective thus the assertion of valuation
can only be assessed for reasonableness.
Measurement
This is the assertion that a transaction or an event is recorded and proper amounts of revenue and
expense are allocated to the proper period for proper reporting purposes. Whether a transaction
brings into being an asset or liability, revenue or expense depends largely on the capitalization policy
of an entity i.e. the guidance as to what items are revenue items and capital items.

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The period in which a transaction took place may be influenced by management’s desire
to reflect a given financial position. However, where revenue or expense of an item is
spread
over more than one accounting period is called allocation rather than measurement
and is a
component of
valuation.

Presentation and disclosure

This is the assertion that an item is disclosed, classified and described in
accordance with the applicable financial reporting framework. The information in
financial statements should be presented without bias, be relevant to the needs of
the users and meet qualitative characteristics of understandability, relevance,
reliability and comparability. This assertion is not assessed for truth but rather
adequacy or reasonableness.
In conclusion, truth and fairness of financial statements can be assessed on these
seven assertions i.e. the financial statements will reflect a true and fair view of
company’s financial position and performance if the seven assertions are used as
guidelines in preparing the financial statements .

Classification
Are transactions recorded in appropriate accounts?

Cut-off
Are transactions recorded in appropriate period?

Accuracy
Are the amounts disclosed in the financial statements appropriate?

Allocation
Are account balances included in appropriate accounts?

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SUMMARY

The primary objective of an audit of financial statements is to enable the auditor to

Express an opinion whether the financial statements are prepared, in all material
respects, in accordance with an identified financial reporting framework.
• The annual accounts and report are primarily prepared by the directors
to the shareholders.
• After examining the end year financial statements the auditor then forms his
Opinion as to whether the financial statements show a true and fair view and reports this
to the shareholders.
• The appointment of the auditor is usually carried out as a private contract
between the auditor and the relevant stakeholder. The scope and objective of the work is
determined by the agreed terms between the auditor and the client. The auditors’
rights and duties are also laid out in the contract.
• The companies Act requires that all limited liability companies’ appoint an auditor
whose
task is to express an independent opinion as to whether the financial statements
prepared
by the directors show a true and fair view of the financial performance and position
of a
company.
Questions
1 List the objectives of an audit.
2 List the benefits of an audit to a public limited company.
3 List the properties of a statutory audit that are different from a private audit

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