A preliminary overview of what auditing is all about and its relevance in corporate world.

1. WHAT IS AUDITING
A Brief Overview
JANUARY 25, 2017
LAHORE SCHOOL OF ECONOMICS
Ayesha Majid

2. Auditing is defined as conducting an examination of a series of events or activities to
verify that those events or activities are being maintained and recorded in accordance with
established guidelines, policies and procedures. The examination is conducted by an internal
auditor on a periodic basis and by an independent auditor on an annual basis. An audit is a
systematic and independent examination of books, accounts, statutory records, documents and
vouchers of an organization to ascertain how far the financial statements as well as nonfinancial
disclosures present a true and fair view of the concern. Financial Audit is Systematic
examination and verification of a firm's books of account, transaction records, other relevant
documents, and physical inspection of inventory by qualified accountants (called auditors). For
reliability of audit auditor independence is vital.
Auditor independence refers to the independence of the internal auditor or of the
external auditor from parties that may have a financial interest in the business that is audited.
Independence requires integrity and an objective approach to the audit process. it is
characterised by integrity and an objective approach to the audit process. The concept requires
the auditor to carry out his or her work freely and in an objective manner. It is formally defined
in code of ethics for the auditors. The description under Code of Ethics B section 290 is:
Independence is defined as follows: a. Independence of mind is the
state of mind that permits a member to perform an attest service without
being affected by influences that compromise professional judgment, thereby
allowing an individual to act with integrity and exercise objectivity and
professional skepticism. b. Independence in appearance is the avoidance of
circumstances that would cause a reasonable and informed third party, who
has knowledge of all relevant information, including safeguards applied, to
reasonably conclude that the integrity, objectivity, or professional
skepticism of a firm or member of the attest engagement team is
compromised. This definition should not be interpreted as an absolute. For
example, the phrase “without being affected by influences that compromise
professional judgment” is not intended to convey that the member must be
free of all influences that might compromise objective judgment. Instead, the
member should determine whether such influences, if present, create a
threat that is not at an acceptable level that a member would not act with
integrity and exercise objectivity and professional skepticism in the conduct
of a particular engagement or would be perceived as not being able to do so
by a reasonable and informed third party with knowledge of all relevant
information.
The code further talks about the remedies available to the auditor in case of breach of his
independence.
The repercussion of auditor independence makes it a pivotal point in determining the
quality of audit report. Recent financial conditions have highlighted the critical importance of

3. credible, high quality financial reporting in all sectors of the world economy, including the
capital markets, small companies, not-for-profit and government organizations. They have also
reinforced the need, in the public interest, for continual improvement to audit quality.
Especially after the events that lead to global crisis in 2007/8, commonly known as credit
crunch. The previous global crisis; the great depression 1930 did not rose the significance of a
quality audit.
Auditors are required to comply with relevant auditing standards and standards of
quality control within audit firms, as well as ethics and other regulatory requirements. The
Framework is not a substitute for such standards, nor does it establish additional standards or
provide procedural requirements for the performance of audit engagements. Auditor
independence issues are complex and contextual in nature.
The term “audit quality” is persistently used in debates among stakeholders, in
communications of regulators, standard setters, audit firms and others, and in research and
policy setting. Audit quality is a complex subject and no definition or analysis of it has achieved
universal recognition.
In the IAASB’s view, a quality audit is likely to be achieved when the auditor’s opinion
on the financial statements can be relied upon as it was based on sufficient appropriate audit
evidence obtained by an engagement team.
The importance of audit quality, especially the concept of “independence of the auditor”
came into being in British case of Re London and General Bank (1985). Justice Lindley’s
remarks in the Appellate court were
“It is a mere truism to say that the value of loans and securities
depends upon their realisation. We are told that a statement to that effect is
so unusual that the mere presence of those words is enough to excite
suspicion. But, as already stated, the duty of an auditor is to convey
information, not to arouse enquiry, and although an auditor might infer
from an unusual statement that something was seriously wrong, it by no
means follows that ordinary people would have their suspicions aroused by
a similar statement if, as in this case, its language expresses no more than
an ordinary person would infer without it”
Under English law, the Kingston Cotton Mill Co. case and the Re London and General
Bank (1985) have formed the basis for all subsequent decisions as to the determine of auditor's
negligence. In addition, the crucial importance in both instances is the recognition of auditing
as a profession. Finally, we may consider that auditors do not guarantee that the financial
statements a true and fair view any more than solicitors guarantee wining our case. Hence, both
these cases and the English case of Hedley Byrne v Heller, which laid basis of law of negligence
in profession, form persuasive precedent for Pakistani jurisprudence as both the legal systems
follow common law.

4. The independence of auditor is not enough but other things are also required as Lord
Justice Lopes said in his famous overruling in Kingston Cotton Mill (No 2) [1895],
“It is the duty of an auditor to bring to bear on the work he has to
perform that skill, care and caution which a reasonably competent, careful
and cautious auditor would use. What is reasonable skill, care and caution
must depend on the particular circumstances of each case. An auditor is not
bound to be a detective or as was said to approach his work with suspicion
or with a foregone conclusion that there is something wrong. He is a
watchdog but not a bloodhound. He is justified in believing tried servants of
the company in whom confidence is placed by the company”.
Therefore, the core ambition of an audit should be unbiased, objective assessments of
whether public resources are managed responsibly and effectively to achieve intended results,
auditors help public sector organizations achieve accountability and integrity, improve
operations, and instil confidence among citizens and stakeholders.
Organizational independence allows the audit activity to conduct work without
interference by the entity under audit. The audit activity should have sufficient independence
from those it is required to audit so that it can both conduct and be perceived to conduct its
work without interference. Thus when taking a mere glance at auditing independence of auditor
seems to be the most vital factor in determining the quality of audit report however an in-depth
review shows the importance of other factors as well specially professionalism and ethos of the
auditor.