Chapter 1

INTRODUCTION
Who is an Auditor?

An Auditor is someone who is

responsible for evaluating the
validity and reliability of a company
or organization’s financial
statements. An accountant who
checks another accountant.
Who is Accountant

An Accountant is a practitioner of accounting

or accountancy, which is the measurement,
disclosure or provision of assurance about
financial information that helps managers,
investors, tax authorities and others make
decisions about allocating resources.
Auditing Perception

“Methodical and independent check of

financial statements by an auditor and to
make an expert opinion on the results in
the audit report”
What is Auditing?

An exercise whose objective is to enable auditors to

express an opinion on whether the financial statements
give a true and fair view (or equivalent) of the entity’s
affairs at the period end and of its profit or loss (or income
and expenditure) for the period then ended and have been
properly prepared in accordance with the applicable
reporting framework (e.g. relevant legislation and
applicable accounting standards) or where statutory or
other specific requirements prescribe the term, whether the
financial statements “present fairly”.
 Audit has a well established role in society
 Auditor reports to the shareholders of the company
 Report on the truth and fairness of the financial statements
 High level of assurance
 Usually as a result of a statutory requirement
 An audit is required for all companies with a turnover a certain
amount.
 An audit is required by all banks or insurance companies or a
company registered under the Financial Services Act.
Types of Audit
1. Financial Statement Audits
Evaluates correspondence between financial statements and
GAAP
2. Operational Audits
Evaluates correspondence between org’s procedures and
methods and criteria of efficiency and effectiveness
3. Compliance Audits
Evaluates correspondence between org’s operations and specific
procedures or rules
4. Comprehensive Audits

A comprehensive audit examines the Management Control

Framework (MCF) of the company, which would identify
the division of responsibility within the company or the
areas covered by the audit. This includes an analysis of the
company's internal audit procedures, quality controls and
quality reviews.
Accounting Vs. Auditing

1. Accounting
 Recording, classifying and summarizing of economic events for the
purpose of providing financial information for decision making
 Requires understanding of GAAP
2. Auditing
 Determining whether recorded information properly reflects the
economic events of the period
 Requires understanding of GAAP AND of accumulation and
interpretation of audit evidence
 Advantages of Audit

An audit helps to identify weaknesses in the accounting systems and
enables us to provide suggestions for improvements
 An audit assures directors, who are not involved in the accounting
functions on a day-to-day basis, that the business is running in accordance
with the information they are receiving. An audit also helps reduce the risk
of fraud and poor accounting.
 An audit facilitates the provision of advice that can have real financial
benefits for a business, including how the business is running, what
margins can be expected, and how these can be achieved. Advice can cover
anything from the tightening of internal controls, to tax planning or
reducing the risk of fraud.
 An audit will enhance the credibility and reliability of the figures being submitted to
prospective investors. If an owner is planning on attracting investment or selling shares
in the next three years, carrying out regular audits is highly beneficial.
 Credit ratings may be affected by not having an audit. Suppliers may not be prepared
to give appropriate credit limits. Banks and trade suppliers rely in part on credit rating
agencies’ assessment of the company, and will look more favorably on companies that
have an audit.
 In the event of insurance claims, loss adjusters often have more faith in audited
accounts.
 An audit provides assurance to shareholders (if they are not directors closely involved
in the business) that the figures in the accounts show a true and fair view.
Disadvantages of Auditing

1. Frauds by management
Auditing fails to check planned frauds. The management
can play tricks to manipulate the accounts in order to conceal
their inefficiencies. The audited accounts could not show the true
view.
2. Wrong certificate
Auditing is based on many certificates taken from
management and other persons. Auditing may fail to provide the
desired results. When certificates provides wrong information.
3. False clarification
Auditing fails to disclose correct information. The management
may not provide correct clarification. The auditor is bound to
present his report even of the clarification is not true.
4. Absence of true picture
The auditing does not present true picture. Auditing fails to
disclose true picture when figures have been manipulated.
5. No correct view
Auditing fails to present correct view. There are limitations of
accounting so figures are not facts. These figures are based on
opinion. Thus auditing is unable to disclose correct view.
6. Absence of honesty
Honesty and independence are highly essential traits. The
auditor must certify what is true. The absence of honesty and
independence means failure of audit purpose.
7. Bias of auditor
The auditing fails to present fair view due to
bias of an auditor. It is the quality of an auditor that he
should be independent. The bias auditing fails to help
many people.
8. High cost
The audit work is completed without cost. The
cost of audit should not exceed of errors and frauds.
Auditing fails to serve million of business entities.
9. Previous action
Auditing is nothing more than checking of
past activities. It is not concerned with present or
future. The audit fees increase the cost of business.
Such cost does not help to improve market
standing of enterprises.
Objectives

The objective of the audit of financial statements is to express

an opinion whether the financial statements present fairly, in
all material respects, the financial position, results of
operations and changes in financial position in accordance
with generally accepted accounting principles.
1. Opinion
2. Fairly
3. Materiality
4. GAAP
Benefits of being Audited

1. Operational Audits
 Improves efficiency and effectiveness
2. Compliance Audits
 Reduces cost of non-compliance
 Reassures external parties
3. Financial Statement Audits
 May be mandatory
 Reduces cost of capital. Why?…….
Business Risk VS. Information Risk

1. Business Risk
 Risk that organization will fail to achieve its objectives
2. Information Risk
 Risk that the information upon which a business decision was
made is inaccurate

The financial stakeholders of a firm face both

types of risk. A financial statement audit reduces
information risk, but not business risk
Source of Information Risk

 Remoteness of Information
 Voluminous Data
 Complex Exchange Transactions
 Bias and Motives of Information Provider
Who Perform Audits?

1. Public Accounting Firms

 Independent as external to audit client
 Primarily f/s audits, but can be hired to perform other types of audits
2. Internal Auditors
 Employees of org. Less independent :depends on org structure
 Primarily operational and compliance audits
3. Government Auditors
 Often perform comprehensive audits, but depends on mandate
4. Revenue Canada Auditors
 Compliance audits
Authority of Professional Bodies

Institute of Chartered Accountants of Pakistan (ICAP)

Institute of Cost and Management Accountants of Pakistan (ICMAP)
Pakistan Institute of Public Finance Accountants (PIPFA)
Securities and Exchange Commission of Pakistan (SECP)
 Publish materials for members
 Set entrance standards and administer exams
 Continuing professional education
 Codes of Professional Conduct
 Inspection and Discipline
Generally Accepted Auditing
Standards (GAAS)
 The General Standard
 "The examination should be performed and the report prepared by a
person or persons having adequate technical training and proficiency in
auditing, with due care and with an objective state of mind" [Sept 1975 ]
 General Standard therefore emphasizes:
 Competence
 Objectivity
 Due Professional Care
Examination Standards:
 Adequate Planning and Supervision
The work should be adequately planned and properly executed. If assistants
are employed they should be properly supervised. [Sept. 1975]
 Sufficient Understanding of Internal control
A sufficient understanding of internal control should be obtained to plan the
audit. When control risk is assessed below maximum, sufficient appropriate
audit evidence should be obtained through tests of controls to support the
assessment. [Oct. 1992]
Sufficient and Appropriate Audit Evidence
 Sufficient appropriate audit evidence should be obtained by such means as
inspection, observation, enquiry, confirmation, computation and analysis,
to afford a reasonable basis to support the content of the report.
GAAS Reporting Standards
i. The report should identify the financial statements and distinguish between the
responsibilities of management and the responsibilities of the auditor.
ii. The report should describe the scope of the auditor's examination.
iii. The report should contain either an expression of opinion on the financial
statements or an assertion that an opinion cannot be expressed. In the latter case,
the reasons therefor should be stated.
iv. Where an opinion is expressed, it should indicate whether the financial statements
present fairly, in all material respects, the financial position, results of operations
and changes in financial position in accordance with an appropriate disclosed basis
of accounting, which except in special circumstances should be generally accepted
accounting principles. The report should provide adequate explanations with respect
to any reservation contained in such opinion."