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audit note lecture 1

Why Study Auditing?
Auditing and assurance services play an important role in ensuring the reliability, credibility and relevance of business
information which is used for decision making purposes. Users of financial statements have additional assurance that the
financial statement are reported honestly and accurately, and the users will be more willing to rely on and trust these
financial statements. Reliable information is important for managers, investors, creditors, analysts, employees, regulatory
bodies, and others to make informed decisions in the form of economic and financial decision. Auditing also helps to
ensure that information is understandable, relevant, reliable, and trustworthy. Auditing is vital to the proper functioning of
the economic system
The Objectives, Purpose, and Importance of Audit
What is Auditing?
Auditing is the process of reviewing the financial statements, that is prepared by the management of the company, to
determine whether the financial statements:
Comply with the applicable financial reporting framework (i.e. accounting standards, MFRS/IFRS).
Are free of material misstatements; and
Comply with the requirements of the Companies Act, 2016
Overall objectives of an auditing
To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement,
whether the MM is due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial
statements are prepared in accordance with an applicable financial reporting framework; and
To report on the financial statements, and communicate as required by the ISAs, in accordance with the auditor’s findings.
Purpose of an Audit – ISA200
To enhance the degree of confidence of intended users in the financial statements. An auditor expresses an opinion on
whether the financial statements are prepared in accordance with an applicable financial reporting framework. An audit
conducted in accordance with ISAs and relevant ethical requirements enables the auditor to form that opinion.
Objectives and Purpose of an Audit – Important Phrases
Reasonable assurance is the highest level of assurance that can be given by an auditor to the users of financial
statements. Auditors do not provide absolute assurance which means 100% assurance.
Financial information/statements consist of income statements, statement of financial position, statement of
changes in equity, cash flow statements, notes to the financial statements
Misstatement is an unintentional errors or intentional fraud
Material is the concept of materiality
Applicable financial reporting framework consist of IFRS/MFRS; MPERS; or FRS)
Auditors’ Opinion can be either Unmodified/Clean/Unqualified OR Modified
Ethical requirements – MIA professional code of conduct, IESBA rule
Auditor’s Responsibilities
The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement, whether caused by error or fraud. Due to the nature of audit evidence and
the characteristics of fraud, the auditor is only able to obtain reasonable, but not absolute, assurance that material
misstatements are detected.
 Auditors’ Personal Responsibility
The auditors have a personal responsibility to:
Have appropriate competence
Comply with ethical requirements
Maintain professional scepticism and professional judgement
Professional Judgement
The auditor, within the context provided by auditing and ethical standards, applies relevant training, knowledge, and
experience in making informed decisions during the audit
Professional Skepticism
ISA 200 para 13 definition: “an attitude that includes a questioning mind, being alert to conditions which may indicate
possible misstatement due to error or fraud, and a critical assessment of audit evidence”.
ISAs explicitly require the auditor to plan and perform an audit with professional skepticism recognising that
circumstances may exist that cause the financial statements to be materially misstated
Professional scepticism requires that, throughout the audit, the auditors should be alert for:
Audit evidence that contradicts other evidence
Information that raises a question about the reliability of documents and responses to inquiries
Conditions indicating possible fraud
Circumstances suggesting the need for additional audit procedures beyond those ordinarily required
Reasonable Assurance
Auditors’ work in the audit of financial statements results in the auditors being able to obtain reasonable, but not absolute,
assurance that the financial statements follow applicable financial reporting framework
Reasonable assurance implies that there is a low level of audit risk (i.e. that the financial statements are properly stated
when they are not). The auditors express an opinion on the financial statements, not statement of fact
Reasonable assurance is achieved when audit risk is at an acceptably low level
Obtaining absolute assurance is not possible because:
1. The nature of financial reporting (e.g. necessary use of judgement and estimates)
2. The nature of audit procedures (e.g. audit procedures more often than not do not provide absolutely conclusive
evidence; use of sampling)
3. The need to conduct an audit within a reasonable period of time at a reasonable cost
4. Incidence of fraud is difficult to detect because it involves concealment, collusion, manipulation and overriding control
Independence of Auditors
It is critical that auditors remain independent when performing audits of financial statements. An auditor’s opinion on the
financial statements will be questioned unless the auditor is truly independent. An auditor who owns shares in a company
that they audit, or if the auditor serves as a director – the auditor is likely to be biased in the performance of his auditing
duties. The auditor should avoid any relationship with a client that would cause an outsider who have knowledge of all the
facts to doubt the auditor’s independence. Independence of auditor is a primary ethical requirement which is:
 Independent to report errors and irregularities which the auditor discovers
 Independence is the most critical area of the auditor’s credibility
Two factors are important to independence:
 Independence in fact (state of the mind where the auditors are expected to dissociate themselves from influences
that might affect their judgments)
 Independence in appearance (public perception of auditors’ independence)
The Role of Auditing
Auditing can be described within several contexts:
1. As a process of review
2. In the framework of the principal-agent relationship
3. As a major component of the corporate governance process
4. As a fundamental piece of the capital markets system
1. Auditing as a Process Review
Auditing is the process of reviewing (or examining) the financial information prepared by the management of a company
(the financial statements and the footnotes) to determine that it conforms to a particular standard (i.e. the applicable
financial reporting framework). The person conducting the assessment follows a set of standards (i.e. generally accepted
auditing standards / International Standard on Auditing). The person completing the assessment is not an employee of the
company but works for an accounting firm that is associated with the company by being hired to perform an audit (a firm
that is independent from the company).The person doing the assessment is hired to verify the truth and fairness of the
decisions recorded by the company so that outsiders have accurate information to make decisions. Without such
assessment, outsiders would be forced to rely solely on the information the company provided.
2. Auditing in the Framework of the Principal-Agent Relationship
Principal-agent relationship exists because the owners of the company (i.e. the principals) are not involved in the daily
management of the company. The management (i.e. the agent) is hired by the owners of the company (i.e. principal) to
run the company for them and to make daily decisions for the company. Owners of the company (i.e. principal) are
removed from the its daily operations and that management (i.e. agent) has more knowledge about the daily operations
than the owners. Owners would like management to report correctly, so the owners appoint an auditor to increase the
likelihood of correct reporting. Knowing that an auditor will assess the financial information, management is likely to
prepare the information in accordance with the accounting standards. Benefits outsiders too who will be getting the same
financial information as the owners.
3. Auditing as a Major Component of the Corporate Governance Process
A Model of Business:
Business organisations exist to create value for their stakeholders. Due to the way resources are invested and
managed in the modern business world, a system of corporate governance is necessary, through which managers are
overseen and supervised.The term Corporate Governance refers to the rules, processes and laws by which
businesses are operated, regulated and controlled. Effective corporate governance requires that the interests of a
company’s management, shareholders, creditors, and other stakeholders be properly balanced. The Corporate
Governance process protects outsiders from misstated financial statements. Auditor performs an important and
unique role in the CG process, being a trained professional independent of the company. Being independent, auditors
can provide an opinion on whether the financial statements presented by management have been prepared
according to an applicable financial reporting framework. Outsiders might reasonably trust an opinion from an
independent professional than an opinion from a non-independent person. Auditor will present a relatively unbiased
picture of the company’s compliance or noncompliance with the applicable financial reporting framework.
4. Auditing as a Fundamental Piece of the Capital Markets System
Capital markets require accurate information. Outsiders make decisions about the companies based on information
disclosed. If information is wrong, the decision is likely to be wrong. If auditors fail to do their job, their failure has
serious implications for the decisions made by outsiders.
 Banks may wrongly lend to companies that they shouldn’t or may lend at a lower interest rate than appropriate
had the banks known the correct information.
 Investors may fail to sell or buy shares in companies they wouldn’t if they had information that fairly presented the
company’s financial position.
Management’s Incentive to Misstate Financial Statements
To be a good auditor, it is important to understand management’s incentive to misstate financial statements.
Management of public companies typically prefer higher net income to lower net income. Net income can be
increased by either reducing expenses or increasing revenues .Managers may try to show that revenue has
increased, even if it has not, because outsiders, particularly stockholders, expect this level of growth and if companies
fail to meet these targets, the company’s stock price may drop. The principal reason to misstate financial statements
is to keep the company’s stock price from falling
The areas in which management is more likely to misstate transactions are riskier for the auditor => failure to
correct the misstatement may lead to the issuance of “clean” audit opinion on financial statements that are materially
Auditor’s should gather sufficient appropriate evidence and to assess with professional skepticism the decisions
that management made in preparing the financial statements
Plan the audit to devote an increased amount of time to transactions that are more likely to be wrong than other
Identify financial statement accounts with the most potential for misstatement
Design audit procedures to determine that the accounts are fairly presented according to the applicable financial
reporting framework
Gather evidence to support the assessment that the financial statements are prepared using applicable financial
reporting framework
Management Assertions about Financial Statements: An Introduction
Management Assertions
Management of businesses make implicit assertions about the financial statements to the users of these financial
statements. These assertions are implicit for each account in the financial statements. Financial statement assertions
(or management assertions about financial statements) are management’s expressed or implied claims about
information reflected in the financial statements. Financial statement assertions are important to the auditors:
The auditors collect sufficient appropriate evidence that management assertions about the financial statements
are correct
Understanding management assertions in terms of classes of transactions, account balances, and presentation
and disclosures help the auditors focus on the different types of audit procedures needed to test the assertions in
the 3 different categories
Assets – owners of assets have the right to use the assets in anyway that the owners want – rights management
Liabilities – creditors are obligated to pay and to settle their liabilities – obligations management assertion
Income statement for the year ended 30 June 2018 – implies that all transactions relating to income and expenses
for the financial year have been recorded in the proper accounting period – cut-off management assertion
Defining Auditing and Assurance
Auditing and Assurance Defined
Auditing definition
Assurance Definition
Distinction between Auditing and Accounting
What is Accounting?
Accounting is the recording, classifying, and summarising of economic events in a logical manner for the purpose of
providing financial information for decision making. To provide relevant information, accountants must have a
thorough understanding of the principles and rules that provide the basis for preparing the accounting information.
Accountants must develop a system to ensure the company’s economic events are properly recorded on a timely
basis and at a reasonable cost.
Overview of the Financial Statement Audit Process
Distinction between Auditing and Accounting
Auditors focus on determining whether recorded information properly reflects the economic events that occurred
during the accounting period. Auditors must understand those international accounting standards that provide the
criteria for evaluating whether the accounting information is properly recorded. Auditor possess the expertise to
accumulate and interpret audit evidence – the differentiating factor that distinguishes auditors from accountants.
Fundamental Concepts in Conducting a Financial Statement Audit: An Introduction
Management assertions about the financial statements are used by the auditors as the framework to guide the
auditors in the collection of audit evidence. Management assertions, together with he auditor’s assessments of
materiality and audit risk influence the nature, timing and extent of the audit evidence to be gathered
Audit Risk
risk that the auditor expresses a wrong opinion
sedangkan the FS is actually mm
Evidence Regarding Management Assertions
Sampling: Inferences Based on Limited Observations
The Audit Process: An Introduction
The Audit Process
The Audit Report: An Introduction
Issue the Audit Report
The auditor’s report is the main product or output of the audit. The audit report with an unmodified (‘clean’) opinion
is the most common type of report issued.
The title line of the audit report includes the word ‘Independent’, and usually, the report is addressed to the
stockholders of the company.
The audit report includes an introductory paragraph, a management’s responsibility paragraph, an auditor’s
responsibility paragraph, an auditor’s opinion paragraph and basis of auditor’s opinion .
The audit report is signed and dated.
The auditor may issue a modified opinion.
Suppose an auditee’s financial statements contain a misstatement that the auditor considers material and the client
refuses to correct the misstatement. The auditor will likely qualify the opinion, explaining that the financial statements
are fairly stated except for the misstatement identified by the auditor.
The auditor may issue an adverse opinion.
Suppose a client’s financial statements contain a material misstatement and the auditor considers the significance of
the effect on the financial statements of the material misstatement pervasive. Given such a situation, the auditor will
issue an adverse opinion, indicating that the financial statements are not fairly stated and should not be relied upon.
Different Types of Auditors, and the Services provided by the Auditors
Types of Auditors
Types of Services Offered by Audit Firms
Public Accounting Firms
Audit Firms – Big 5
Audit Firms
Audit Firms – Others
Challenges Facing the Auditing Profession
Society’s Expectations and the Auditors’ Responsibilities
Society’s Expectations
Financial statement audits have a very important role in the functioning of the economy, thus, society expects auditors to
exercise professional judgement and maintain professional scepticism in their work .If the auditor fails to exercise
professional judgement and to maintain professional scepticism, he/she may be held liable for civil damages or even
criminal penalties
The Context of Financial Statement Auditing
Context of Financial Statement Auditing
A Model of Business
The Role of the Auditor in the Corporate Governance Process
Today’s auditor plays a crucial role in business and society. However, recent audit failures have taken a toll on the
accounting profession, including the loss of public reputation
Recent scandals have demonstrated the vulnerability of accounting firms and the high cost of audit failures
In 2002, Arthur Andersen‘s audit failure forced it out of business
The public value of the audit cannot be too highly emphasized. The negative impact of failed audits –loss of public
confidence and investors’ trust—is very apparent to observers of the profession. The accounting profession is currently
reforming itself. Auditors are expected to approach an audit with an independent mind and to recognise that they are
appointed to protect the interests of outsiders.
Principle A of the Malaysian Code on Corporate Governance (revised 2017) requires the integrity of financial and nonfinancial reporting to be upheld as one of the many responsibilities of the Board of Directors of public listed companies;
and Principle B of MCCG 2017 recommends that the Audit Committee of the Board of Directors of public-listed companies
establish policies and procedures to assess the suitability, objectivity and independence of external auditors
The Auditing Standards and the Auditing Standard-Setting Body
Ethics, Independence and the Code of Ethics
Ethical behaviour and auditors’ independence are vital to the audit function. Auditors are required to be competent and
independent. Auditors who are incompetent or lacks independence will result in affected parties placing little or no value
on the audit
IESBA Code of Ethics for Professional Accountants
Auditors’ Legal Liability