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Why are auditors needed? From The Audit Process by Gray et al
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Chapter_1_Gray.ppt
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Audit Process: Principles, Practice and Cases, 6th edn ISBN 978-1-4080-8170-9 © Iain Gray, Stuart Manson and Louise Crawford, 2015 Introduction to audit Chapter 1 Why are auditors needed?
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Audit Process: Principles, Practice and Cases, 6th edn ISBN 978-1-4080-8170-9 © Iain Gray, Stuart Manson and Louise Crawford, 2015 Learning objectives • To understand in general terms what an audit is and to put into context some basic audit techniques. • To explain what kind of person should carry out an audit. • To suggest kinds of people who will benefit from an audit. • To form view on kind of information that might be prepared by those having control of resources held on behalf of others. • To recognize there are theoretical considerations underpinning audit practice. • To explain wider setting of and be aware of some of the problems facing the audit profession. 2
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Audit Process: Principles, Practice and Cases, 6th edn ISBN 978-1-4080-8170-9 © Iain Gray, Stuart Manson and Louise Crawford, 2015 Opening remarks •Auditing has become headline news •Mainly because of scandals such as: Enron – WorldCom – Parmalat – Satyam – and 2007-8 financial crisis. •Questions about competence / independence of auditors and apparent failure of corporate governance. •Role of audit needs re-defining and questions raised as to its value to society. 3
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Audit Process: Principles, Practice and Cases, 6th edn ISBN 978-1-4080-8170-9 © Iain Gray, Stuart Manson and Louise Crawford, 2015 Introduction to basic principles through a simple case •The Andrew and James case is of a simple organization, but brings out some important features of business and auditing developed later. 4
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Audit Process: Principles, Practice and Cases, 6th edn ISBN 978-1-4080-8170-9 © Iain Gray, Stuart Manson and Louise Crawford, 2015 Justification of audit •Information hypothesis – information becomes more reliable and useful as the result of audit. •Providers of resources cannot trust the managers to use the resources properly on their behalf (a basic idea of agency theory) – audit provides reassurance. •Insurance hypothesis – people who have lost as the result of reliance on the opinion given by auditors may be able to recover damages from them, assuming negligence on their part. 5
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Audit Process: Principles, Practice and Cases, 6th edn ISBN 978-1-4080-8170-9 © Iain Gray, Stuart Manson and Louise Crawford, 2015 Agency theory basic ideas • Both owners (principals) of organization and managers (agents) employed to manage it on their behalf try to maximize own wealth. • As a result principals need a monitoring mechanism in form of a financial report. • Agents likely to favour preparation of a financial report as principals will otherwise be unwilling to believe they are telling the truth. • Agents recognize that, for the owners to believe the financial report is valid, it will need to be verified by a party (the auditor) independent of both principals and agents. • Agency theory suggests the appointment of professional external auditors will be preferred as the most cost-effective of monitoring devices. • A particular problem is that the auditor may also be regarded as a wealth maximizer, raising possible doubts about value of the audit report, but agency theory suggests the auditors will provide a true report to maintain their reputation. 6
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Audit Process: Principles, Practice and Cases, 6th edn ISBN 978-1-4080-8170-9 © Iain Gray, Stuart Manson and Louise Crawford, 2015 Introduction to truth and fairness in accounting • Financial statements (FS) should not mislead. E.g. if there are liquidity problems, FS should reveal. If the entity finances non- current assets by leasing rather than buying, the reader should be informed. • FS – degree of accuracy built into them, but insignificant misstatements do not affect truth and fairness. • FS must be supplemented by notes, explaining e.g. accounting policies adopted, and date of repayment of long-term borrowing. • FS must give a reasonable view of financial affairs and results of the business. • Auditors try to collect sufficient appropriate evidence to prove the FS are true and fair before giving an opinion. • A major risk for auditors is that they may give an inappropriate opinion because they have failed to identify business risks and to collect the necessary evidence. 7
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Audit Process: Principles, Practice and Cases, 6th edn ISBN 978-1-4080-8170-9 © Iain Gray, Stuart Manson and Louise Crawford, 2015 Basic audit framework •Preliminary stage to set the scene, consider risks and agree the terms of the engagement. •Systems work and transactions testing often at an interim examination, following which a management letter may be issued. •Preparation for final work, including observation of inventory counts. •Final work, including final analytical review and issue of audit report. 8
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Audit Process: Principles, Practice and Cases, 6th edn ISBN 978-1-4080-8170-9 © Iain Gray, Stuart Manson and Louise Crawford, 2015 Some initial ideas on an extended role for audit • Examples of different kinds of audit work reporting: – Local authority providing services to people living in the area. – University providing educational services to students. – Water companies supplying water to private customers. – Hospital serving people in the surrounding area. – Nuclear power station feeding electricity into the national grid. – Charity collecting from the public to provide funds to specified good causes. 9
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Audit Process: Principles, Practice and Cases, 6th edn ISBN 978-1-4080-8170-9 © Iain Gray, Stuart Manson and Louise Crawford, 2015 Assurance services • Assurance services: broad set of services designed to improve the quality of information. • Kinds of services auditors provide: business risk assessments; measuring business performance against predetermined criteria; assessments of reliability of information and systems; assessments of viability of e- commerce and particular risks of this activity. • Auditor in a particularly good position to provide such services. • But potential threats to independence when auditors are engaged in activities for particular benefit of management. 10
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Audit Process: Principles, Practice and Cases, 6th edn ISBN 978-1-4080-8170-9 © Iain Gray, Stuart Manson and Louise Crawford, 2015 Summary of principles • Reliable financial statements very important. Reliability: aspect of truth and fairness. • Audit is form of investigation, using a number of useful techniques. • The auditor has to behave in an independent and competent manner. • Audit is a search for evidence to arrive at what the auditor perceives to be the truth. • An attitude of professional scepticism should be adopted. • Do not assume business people are engaged in fraudulent activity. • Not usually possible for provider of funds to carry out an audit themselves because of complexity of business organizations. • Unwise to rely on unaudited financial statements, as they lack sufficient credibility to form a reliable basis for decision-making. • Only a person entirely independent of the management and not financially involved with it can add the desired credibility to the financial statements – one of the prime ideas of agency theory. • Uncertainty heightens risk for both managers and auditors, required to state whether financial statements give a true and fair view. 11
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Audit Process: Principles, Practice and Cases, 6th edn ISBN 978-1-4080-8170-9 © Iain Gray, Stuart Manson and Louise Crawford, 2015 One definition of an audit of financial and other information •An audit is an investigation or a search for evidence to enable reasonable assurance to be given on the truth and fairness of financial and other information by a person or persons independent of the preparer and persons likely to gain directly from the use of the information, and the issue of a report on that information with the intention of increasing its credibility and therefore its usefulness. 12
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Audit Process: Principles, Practice and Cases, 6th edn ISBN 978-1-4080-8170-9 © Iain Gray, Stuart Manson and Louise Crawford, 2015 The auditors’ code: 9 fundamental principles of independent auditing •Accountability •Integrity •Objectivity and Independence •Competence •Rigour •Judgement •Clear, complete and effective communication •Association •Providing value 13
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