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Audit and Corporate Governance Unit I.ppt

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Audit and Corporate Governance Unit I.ppt

  1. 1. Introduction to Audit - Abhishek Jha
  2. 2. History of Audit • Phase -1 (1840-1920) • Phase-2 (1920-1960) • Phase-3(1960-1990) • Phase-4(1990 till date)
  3. 3. History of Auditing in India • Companies Act 1913 • 1932 constitution of Accounting Board • Charted Accountants Act 1949 • Companies Act 1956 • Manufacturing and other companies order 1975 • Companies Act 2013
  4. 4. Definition of Auditing • According to ICAI • “Auditing is defined as a systematic and independent examination of data, statements, records, operations and performances of an enterprise for a stated purpose. In any auditing situation the auditor perceives and recognises the propositions before him for examination, collects evidence, evaluate the same on this basis formulates his judgement which is communicated through his audit report.”
  5. 5. Objective of Auditing • Primary Objective(expression of opinion) • Secondary Objective(Detection of errors and frauds)
  6. 6. Types of Errors • Error of Principle • Error of Omission • Error of Commission • Compensating Error
  7. 7. Fraud • Misappropriation of Asset • Misappropriation of goods • Misappropriation of cash
  8. 8. Principles governing An Audit • Integrity • Confidentiality • Skill and Competence • Work performed by others • Documentation • Planning • Audit evidence • Accounting System and internal control • Planning • Audit conclusions and Reporting
  9. 9. Advantages of Audit • Authenticity of Accounts • Detection of errors and frauds • Identification of loopholes • Acceptable to taxation authorities • Increased creditworthiness • Settlement of dispute among partners • Settlement of insurance claims • Helpful in making comparisons • Accounts department becomes vigilant
  10. 10. Limitations • Time consuming • Frauds not detected • Costly • Depends on judgement • All frauds can not be detected • Dependence on others
  11. 11. Qualities of an Auditor • Integrity • Objectivity • Independence • Confidentiality • Skills • Responsible • Intelligent • Vigilant • Communication skills
  12. 12. An Auditor is a watchdog and not a blood hound •In the case of a limited company, an auditor is appointed by the company’s shareholders. He is expected to work on their behalf in the role of a watchdog and should look after their best interests. •Unlike a bloodhound, the auditor’s main duty is towards verification of the client’s books rather than detection. During the course of his audit, if he finds something suspicious, he should extend his audit procedures to examine the matter in detail and should communicate the same to the shareholders. However, in the absence of any such suspicious circumstances, he is completely justified in relying upon the representations made by the client’s staff and management. When it comes to fraud and error, he has to exercise reasonable care only.
  13. 13. Features of an Auditor • An agent: The auditor is an agent of the company’s members assigned to execute tasks outlined in (a) the Companies Act, (b) the company’s Articles of Association, and (c) the audit engagement between the auditor and the client. • Not an advisor: An auditor is not a company advisor. It is not his responsibility to advise the board of directors or the shareholders.
  14. 14. Different types of audits • Internal Audits. Internal audits assess internal controls, processes, legal compliance, and the protection of assets. ... • External Audits. ... • Financial Statement Audits. ... • Performance Audits. ... • Operational Audits. ... • Employee Benefit Plan Audits. ... • Single Audits. ... • Compliance Audits.
  15. 15. Difference Between Accounting and Auditing Accounting Auditing Definition Accounting is referred to as the process of recording, classifying, summarising and interpreting the financial transactions, statements to determine the financial position of an organisation Auditing is referred to as the process of examining the financial records such as transactions and statements of an organisation in order to find any discrepancies during the process of recording of the transactions and also to verify the accuracy of the records Purpose Accounting is done with the purpose of showing the position, profitability and performance of the business entity or organisation Auditing is done to verify the accuracy of data presented by accounting. It is done with the purpose of revealing to what extent the true and fair view of records is maintained in the transactions Objective To determine profit and loss of the organisation or the financial position of an organisation for a period To determine the correctness of all the recorded transactions Mode of operation Accounting is done on a daily basis, as transactions happen on a daily basis for any business It is a periodical assessment and is done monthly, quarterly or yearly Performed by Accounting is done by accountants Auditing is done by auditors Sequence Accounting starts at the end of bookkeeping Auditing starts at the end of accounting
  16. 16. Types of Audit 1/3 Internal Audit • Internal audits are performed by the employees of a company or organization. These audits are not distributed outside the company. Instead, they are prepared for the use of management and other internal stakeholders. • Internal audits are used to improve decision-making within a company by providing managers with actionable items to improve internal controls. They also ensure compliance with laws and regulations and maintain timely, fair, and accurate financial reporting. • Management teams can also utilize internal audits to identify flaws or inefficiencies within the company before allowing external auditors to review the financial statements.
  17. 17. Types of Audit 2/3 • Performed by external organizations and third parties, external audits provide an unbiased opinion that internal auditors might not be able to give. External financial audits are utilized to determine any material misstatements or errors in a company’s financial statements. • External audits are important for allowing various stakeholders to confidently make decisions surrounding the company being audited. • The key difference between an external auditor and an internal auditor is that an external auditor is independent. It means that they are able to provide a more unbiased opinion rather than an internal auditor, whose independence may be compromised due to the employer-employee relationship.
  18. 18. Types of Audit 3/3 • Government audits are performed to ensure that financial statements have been prepared accurately to not misrepresent the amount of taxable income of a company. • Within the U.S., the Internal Revenue Services (IRS) performs audits that verify the accuracy of a taxpayer’s tax returns and transactions. The IRS’s Canadian counterpart is known as the Canada Revenue Agency (CRA). • Audit selections are made to ensure that companies are not misrepresenting their taxable income. Misstating taxable income, whether intentional or not, is considered tax fraud. The IRS and CRA now use statistical formulas and machine learning to find taxpayers at high risk of committing tax fraud.
  19. 19. Case Study - 1 Toshiba, a 140-year-old pillar of Japan Inc, is caught up in the country's biggest accounting scandal since 2011. In 2011, Olympus Corp was embroiled in a scandal. In July 2015, Toshiba Corp president Hisao Tanaka and his two predecessors quit after investigators found that the company inflated earnings by at least $1.2 billion during the period 2009-2014. Toshiba is one of the early adopters of the corporate governance reforms initiated in Japan. The corporate governance structure met corporate governance standards. Time and again cases of corporate governance failures have provided evidence that good corporate governance structure does not necessarily lead to good corporate governance. Organisation culture is a critical determinant of the quality of corporate governance. Some of the observations of the independent investigation committee of the company on internal audit demand discussion and debate. The investigation committee observes, "According to the division of duties rules of Toshiba, the corporate audit division is in charge of auditing the corporate divisions, the companies, branch companies, and affiliated companies. However, in reality the corporate audit division mainly provided consultation services for the 'management' being carried out at each of the companies, etc (as part of the business operations audit), and it rarely conducted any services from the perspective of an accounting audit into whether or not an accounting treatment was appropriate.“ The observations of the committee give the impression that the fault of the internal audit in Toshiba was that it focused on consultation service rather than assurance service. Should internal audit avoid providing consultation service? I do not think so. It was not the fault of the internal audit that it provided consultation service. The fault was that it did not pay attention to accounting audit. In Toshiba, the top management used to set targets that are unachievable. There was excessive pressure from the top management to achieve those targets.
  20. 20. Case Study – 1 (Cont1) The variable pay is a significant portion of the total pay. The compensation of executive officers comprises a base compensation based on title and a role compensation based on work content. Forty per cent to 45 per cent of the role compensation is based on performance of the overall company or business department. 'Challenge' to achieve unachievable targets and performance-based pay provide enough motivation to manage earnings. Therefore, accounting audit should have been a focus area for internal audit. Internal audit can function independently only if the audit committee is capable, independent and effective, and the internal auditor reports to the audit committee. In Toshiba, the audit committee was neither capable nor independent. The three external members of the audit committee had no knowledge of finance and accounting. An ex-Chief Financial Officer (CFO), who was the CFO during the timeframe when accounting irregularities occurred, was the only whole time member of the audit committee. Therefore, the internal audit was not independent of the management. Earnings management had the tacit approval of the top management. Therefore, it is not surprising that accounting audit was excluded from the scope of internal audit. It is incorrect to infer that the accounting audit did not receive the attention of the internal audit because its focus was on providing consultation service.
  21. 21. Case Study – 1 (Cont2) Contemporary literature defines internal audit as 'assurance and consulting service'. The issue is of balancing between consultation service and assurance service. Problem arises when the internal auditor forgets that the internal audit is primarily an assurance function. The consultation service flows from the assurance service. Although, the primary objective of operation audit is to obtain assurance that the internal control that is installed to achieve operation objectives is adequate and operating effectively, the auditees look to the internal auditor for suggestions and consultancy. Such consultation service is a by-product of the assurance service. Auditees should not be denied the benefits of internal auditor's understanding of the industry and the business, and the challenges before the auditees in achieving operation objectives. Exclusion of consultation service from the scope of internal audit would result in sub-optimal utilisation of internal audit resources. Organisation culture also determines the effectiveness of internal audit. The investigation committee observes, "A corporate culture existed at Toshiba whereby employees could not act contrary to the intent of their superiors". In such a culture an upright internal auditor cannot survive, particularly if he is not independent of the management. Perhaps, it is the reason that the internal audit in Toshiba had chosen the easy path of focusing on 'consultation service' only without reporting internal control weaknesses. Internal auditor is the 'eyes and ears' and 'go-to man' of the audit committee. Therefore, internal audit failure leads to corporate governance failure.
  22. 22. Audit Case Study - 2 • Fraud is a practice that can make businesses to undergo some massive losses. It is noteworthy that a small company like XYZ has a small operating capital that could diminish drastically if not well managed. Fraud cases such as skimmed payments from customers, cash theft, improper handling of petty cash and misuse of the company’s credit cards are some of the practices that can lead to total failure of a company. • It is quite expensive for a small business like XYZ Ltd to create an internal audit department, however, the company can create a system that checks and controls the financial operations and the company employees. An informal internal audit process would somewhat reduce fraud cases resulting from personal interests (Chi & Huang 2011). It is noteworthy that the parent company would have split due to extreme cases of fraud. • Prevention of fraud through an informal audit exercise would enable the small XYZ Company to prosper and grow into a big multinational company and even surpass the projected turnover of £2.8 million in the first year of trading. • It is important for the company to create a program that would help in monitoring employees and enforce strict rules regarding any employee who is found guilty of committing fraud cases. The establishment of an internal audit would facilitate the above-mentioned practices though a persistent analysis of the company’s operations.
  23. 23. Audit Case Study -2 (Cont1) Testing and monitoring of internal controls • An Informal internal audit calls for recurrent analysis of the operations within a company. The habitual analysis enables the company’s operations to occur smoothly, where, the employees are kept on toes to offer the best of services. A small company like XYZ Ltd can employ auditors who would design, modify, and control the internal activities of the company. • Though auditing, the company is able to streamline its activities in a manner that would enable it to achieve its goals and objectives (Holm & Zaman 2012). Essentially, XYZ Ltd is a profit making company that would aim at generating the maximum profits possible.

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