Auditing is concerned with the verification of accounting data by determining the accuracy and reliability of accounting statements and reports.
The Report of the Committee on Basic Auditing Concepts of the American Accounting Association (AAA) defines,
Auditing is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users.
The audit is one of the most dynamic areas of the accounting sciences.
The word “audit” has Latin origins (audire, means listening). During the time this word has known a lot of definitions and classifications. In general, it is a synonym to control, check, inspect, and revise.
While the accounting has suffered a little change in time, the audit has permanently evolved, answering to the changes in the environment and modifying its objectives starting the middle age, passing through the industrial revolution up to the 21st century.
Companies prepare financial statements of their activities, which represent their overall performance. These financial statements are examined and evaluated by independent persons, who assess them according to the industry’s generally accepted standards.
This examination and evaluation is an audit.
Thus, an audit is an examination and verification of a company’s financial and accounting records and supporting documents by an independent professional against established criteria.
Definition of Audit
The term “audit” has been derived from the Latin word “audire”, which means “to hear”. Hence, an auditor is a person who hears or listens.
For centuries, audits were “oral hearing” in which people entrusted with fiscal responsibilities justified with their stewardship. Now audit is one of the assurance services provided by competent and qualified professional accountants.
The objective of an audit of financial statements is to enable the auditor to express an opinion as to where the financial statements are prepared, in all material respects, by an applicable financial reporting framework.
The form the audit conclusion takes is that auditors state whether the financial statements give a true and fair view. This is an expression of reasonable assurance.
A precise definition of the term ‘auditing’ is difficult to give. Some of the definitions given by different authors are as follows:
According to the definition given by the International Federation of Accountants (IFAC), “An audit is the independent examination of financial information of any entity, whether profit-oriented or not and irrespective of its size, or legal form when such an examination is conducted to express an opinion thereon.”
According to R.R. Comber, ‘’Audit is an independent examination of the financial books and records of some person or persons responsible or accountable to the third party with a view of verifying the accountancy of statement prepared by or for the accounting party.”
Spicer and Pegler, have defined audit as; “such an examination of the books, accounts and vouchers of a business, as will enable the auditor to satisfy himself that the Balance Sheet is properly drawn up, so as to give a true and fair view of the state of the affairs of the business, and whether the Profit and Loss Account gives a true and fair view of the profit or loss for the financial period, according to the best of his information and the explanations given to him and as shown by the books; and if not, in what respect he is not satisfied”.
According to the American Accounting Association (AAA); “Auditing is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users”.
According to Montgomery; “Auditing is a systematic examination of the books and records of a business or the organization to ascertain or verify and to report upon the facts regarding the financial operation and the result thereof”.
It is clear from the above definitions that;
- auditing is the systematic and scientific examination of the books of accounts and records of a business,
- enables the auditor to judge that the Balance Sheet and the Profit and Loss Account are properly drawn up so it exhibits a true and fair view of the financial state of affairs of the business and profit or loss for the financial period.
The auditor will have to go through various books and accounts and related evidence to satisfy himself about the accuracy and authenticity to report the financial health of the business.
Companies are expected to pass their audits, as the results are very important to the company’s reputation and success.
Audits are very valuable to external company affiliates, such as shareholders and investors, because they provide an extra reassurance of their choice in investments when issues arise.
Definition of an Auditor
An auditor is a professional that accumulates and evaluates evidence to report on the degree a company’s assertions that they comply with an established set of procedures or standards (criteria).
While it takes a highly trained accountant to work as an auditor, there are different types of auditors with different aims.
An efficient auditor must have certain qualities besides Professional qualification. He needs to carry out the audit efficiently and smoothly.
Auditing existed primarily as a method to maintain governmental accountancy, and record-keeping was its mainstay.
From the time of the ancient Egyptians, Greeks, and Romans, the practice of auditing the accounts of public institutions existed.
It wasn’t until the advent of the Industrial Revolution, from 1750 to 1850, that auditing began its evolution into a field of fraud detection- and financial accountability.
In the early 20th century, the reporting practice of auditors, which involved submitting reports of their duties and findings, was standardized as the “Independent Auditor’s Report.”
The increase in demand for auditors leads to the development of the testing process. Auditors developed a way to strategically select key cases as representative of the company’s overall performance.
This was an affordable alternative to examining every case in detail, and it required less time than the standard audit.
Essential Features of an Audit
From the definitions, the six essential features of auditing can be described as follows:
- Systematic process
- Three-party relationship
- Subject matter
- Evidence
- Established criteria
- Opinion
Objectives of an Audit
The objective of an audit is to express an opinion on financial statements. The objectives of the audit can be categorized into (i) primary objectives and (ii) subsidiary objectives.
Primary Objectives of Audit
The main objectives of the audit are known as the primary objectives of the audit.
They are as follows:
- Examining the system of internal check.
- Checking arithmetical accuracy of books of accounts, verifying posting, casting, balancing, etc.
- Verifying the authenticity and validity of transactions.
- Checking the proper distinction between capital and revenue nature of transactions.
- Confirming the existence and value of assets and liabilities.
Subsidiary Objectives of Audit
These are such objectives that are set up to help in attaining primary objectives.
They are as follows:
- Detection and prevention of errors.
- Detection and prevention of fraud.
- Under-or over-valuation of stock.
Scope of Audit
The scope of an audit is the determination of the range of the activities and the period of records that are to be subjected to an audit examination.
Scope of an audit are;
- Legal Requirements.
- Entity Aspects.
- Reliable Information.
- Proper Communication.
- Evaluation.
- Test.
- Comparison.
- Judgments.
Read More about Scope of Audit.
Economic Benefits of an Audit
Some specific economic benefits accrue from audits. Among the economic benefits of financial statement audits are the following:
Access to Capital Market
Public limited companies must satisfy audit requirements under the Securities and Exchange Commission to register securities and have them traded in the securities markets.
Without audits, companies would be denied access to these capital markets.
Lower Cost of Capital
Because of the reduced information risk associated with audited financial statements, creditors may offer lower interest rates, and investors may be willing to accept a lower rate of return on their investment.
Deterrent to Inefficiency and Fraud
When employees know that an independent audit is to he-made. they take care to make fewer errors in performing the accounting function and are less likely to misappropriate company assets.
Control and Operational Improvements
The independent auditor can often make suggestions to improve controls and achieve greater operating efficiencies within the client’s organization.
Limitations/Disadvantages of an Audit
A key issue for accountants is that there are limitations to assurance services and therefore there is always a risk involved that’ the wrong conclusion will be drawn. Assurance can never be absolute. Assurance providers will never give a certification of absolute correctness due to the limitations set out below:
- Testing is used – the auditors do not oversee the process of building financial statements from start to finish.
- The accounting systems on which assurance providers may place a degree of reliance also have inherent limitations.
- Most audit evidence is persuasive rather than conclusive.
- Assurance providers would not text every item in the subject matter.
- The client’s staff members may collude in fraud that can then be deliberately hidden from the auditor or misrepresent matters to them for the same purpose.
- Assurance provision can be subjective and professional judgments have to be made. For example, about what aspects of the subject matter are the most important, how much evidence to obtain, etc.
- Assurance providers rely on the responsible party and its staff to provide correct information, which in some cases may be impossible to verify by other means.
- Some items in the subject-matter may be estimates and are therefore uncertain. It is impossible to conclude absolutely that judgmental estimates are correct.
- The nature of the assurance report might itself be limiting, as every judgment and conclusion the-assurance provider has drawn cannot be included in it.
- It does not take into account the productivity and the skills of the employees of the business.
- The financial data is never current and does not reveal much about the present financial position of a company.
- Different accountants use different. techniques; therefore it would be hard to compare audits between companies who have used different accountants.
- For smaller companies, hiring a firm to carry out an audit can be costly.
- A bad audit can discourage investment.
- It can time consuming to answer the auditor’s questions and the business may not work to maximum capacity.
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