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The course in auditing is different from other courses in the accounting curriculum. The
other financial and managerial accounting courses are aimed at conveying financial or
managerial accounting principles and concepts and how they are applied in preparing and
using financial information. The approach to these financial and managerial courses has
been as a member of the organization’s management team, and the finished product—the
financial statements—was used either by management for decision making or reporting
the financial activities to stockholders, investors, lenders, or interested third parties.
It is also possible to approach a course in auditing from the standpoint of a member of
the organization, whose audits are performed by internal auditors. However, here we will
discuss the role of the external auditor, the auditor who is not an employee of the
organization. This approach requires the student to alter the orientation he or she has
assumed in other accounting courses. The new role is that of an outsider, or an
independent public accountant, hired not to prepare financial statements, but to give an
opinion on the fairness of the financial statements prepared by the internal company
accountants. This role will require a different approach to learning than previously
encountered in accounting courses and will demand unique skills that enable the auditor
to make decisions regarding the accuracy of an organization’s financial statements. The
first skill is the ability to approach and solve audit problems. In addition, the auditor must
possess an inquiring audit attitude to uncover problems and discrepancies when they
exist. Some have suggested that auditing cannot be learned in the classroom, and that it
is a subject that can only be learned by actual hands-on experience. While it is difficult
to duplicate or simulate the actual practice environment in the classroom, it is possible to
learn about auditing in the classroom. For those not intending to become professional
auditors, this course will illuminate the process of auditing, as well as the role played by
auditors in financial reporting. As potential users of independent audits, students will
find it valuable to know not only what an audit represents, but also its limitations.
Auditors are valued because of their technical knowledge and independence in providing
assurances, as well as their competence and experience in assiting companies to improve
operations. Auditors often make and help implement recommendations that improve
profitability by enahncing revenue or reducing costs, including the reduction of errors
and fraud, and by improving operational controls.
Assurance Services
Assurance services are independent professional services that improve the quality of
information for decision makers. Individiuals who are responsible for making business
decisions seek assurance services to help improve the reliability and relevance of the
information used as the basis for their decisions. Assurance services are valued because
the assurance provider is independent and perceived as being unbiased with respect to the
information examined.
Attestation Services
The source of accounting information for financial decision makers creates a potential
conflict of interest which is a condition that creates society’s demand for audit services.
Users need reliable information and this creates the need for professional auditors to
lend credibility to financial information. The lending of credibility is known as
attestation, and the independent auditing of financial statements is described as the attest
function.
There are three categories of attestation services: audit of historical financial statements,
review of historical financial statements, and other attestation services that may be
applied to a broad range of subject matter.
Auditing does not include financial report production. Auditors obtain evidence to
determine whether financial statements information prepared by management is reliable.
Auditors express an opinion that the company’s financial statements are in conformity
with generally accepted accounting principles. Independent auditors work for clients. A
client retains the auditor and pays their fee. An auditee is the entity being audited. The
client and the auditee are typically the same entity, but can be different.
When representing information in the form of financial statements, the client makes
various assertions about its financial condition and results of operations. External users
who rely on those financial statements to make business decisions look to the auditor's
report as an indication of the statements' reliability. They value the auditor's assurance
because of the auditor's independence from the client and knowledge of financial
statement reporting matters.
2. Review of Historical Financial Statements:
A review of historical financial statements is another type of attestation service
performed by CPAs. Many nonpublic companies want to provide assurance on their
financial statements, without incurring the cost of an audit. Whereas an audit provides a
high level of assurance, a review service provides a moderate amount of assurance on the
financial statements, and less evidence is necessary to support this level of assurance. A
review is often adequate to meet users' needs and can be provided by the CPA firm at a
much lower fee than an audit.
The demand for assurance on other types of information is expected to grow substantially
with new types of risks faced by businesses and increases in the amount of available
information sources.
The common feature of all assurance services, including audits and attestation services, is
the focus on improving the quality of information used by decision makers.
Auditing has no effect on either the risk-free interest rate or business risk, but it can have
a significant effect on information risk. If the bank manager is satisfied that there is
minimal information risk because a borrower's financial statements are audited, the risk is
substantially reduced and the overall interest rate to the borrower can be reduced. The
reduction of information risk can have a significant effect on the borrower's ability to
obtain capital at a reasonable cost.
Nature of Auditing
So far, we have discussed the importance of audits of financial statements and their
relation to other attestation and assurance services offered by CPA firms. We now
examine auditing more specifically using the following definition:
"Auditing is the accumulation and evaluation of evidence about information to determine
and report on the degree of correspondence between the information and established
criteria.” Auditing should be done by a competent, independent person.
Kinds of Audits
1. External Auditing
External auditors are certified public accountants who are independent of the
organizations whose assertions or representations are being audited. These independent
auditors offer their audit services on a contractual basis. The majority of audits performed
by external auditors are financial statement audits.
3. Governmental Auditing
Members of local, state and federal government units audit various organizational
functions for a variety of reasons such as the following:
Local and state government units audit businesses to determine whether sales
taxes have been collected and remitted according to stipulated laws or regulations
(a type of compliance audit).
The Internal Revenue Service audits corporate and individual income tax returns
to determine whether income taxes have been calculated according to the
applicable laws or interpretations of these laws (another type of compliance
audit).
Governmental audits also includes:
Financial audits that determine whether;
• Financial information is presented in accordance with established
criteria
• The entity has adhered to the financial compliance requirements,
and
• The entity’s internal control is suitably designed and implemented.
Performance audits (a type of operational audit), that review for efficiency
and economy in the use of resources.
But as we have told before, we will commonly be interested in the external auditing.
Accumulating and Evaluating Evidence
Evidence is any information used by the auditor to determine whether the information
being audited is stated in accordance with the established criteria. Evidence takes many
different forms, including oral testimony of the auditee (client), written communication
with outsiders, observations by the auditor, and electronic data about transactions. It is
important to obtain a sufficient quality and volume of evidence to satisfy the purpose of
the audit. Determining the types and amount of evidence necessary and evaluating
whether the information corresponds to the established criteria is a critical part of every
audit.
Sufficiency
The auditor can rarely be certain of the validity of the financial statements. However, he
needs to obtain sufficient, relevant and reliable evidence to form a reasonable basis for
his opinion thereon.
Sufficiency of Evidence: Sufficiency, a question of how much competent evidence is
enough, a matter of auditor’s professional judgment.
Relevance
The relevance of the audit evidence should be considered in relation to the overall
auditing objectives of forming an opinion and reporting on the financial statements.
To achieve these objectives, the auditor needs to obtain evidence to enable him to draw
reasonable conclusions in answering the questions such as:
a) Balance Sheet
1. Have all of the assets and liabilities been recorded?
2. Are the assets owned by the enterprise and are the liabilities properly those of
the enterprise?
3. Have the amounts attributed to the assets and liabilities been arrived at in
accordance with the stated accounting policies on an acceptable and consistent basis?
4. Have the assets, liabilities and capital and reserves been properly disclosed?
5. Do the recorded assets and liabilities exist?
b) Profit and loss account
1. Have all income and expenses been recorded?
2. Did the recorded income and expense transactions in fact occur?
3. Have the income and expenses been measured in accordance with the stated
accounting policies, on an acceptable and consistent basis?
4. Have income and expenses been properly disclosed where appropriate?
Reliability
Although the reliability of audit evidence is dependent upon the particular circumstances,
the following general presumptions may be found helpful:
1. Documentary evidence is more reliable than oral evidence.
2. Evidence obtained from independent sources outside the enterprise is more
reliable than that secured solely from within the enterprise.
3. Evidence originated by the auditor by such means as analysis and physical
inspection is more reliable than evidence obtained from others.
Audit Evidence
The auditor should obtain relevant and reliable audit evidence sufficient to enable him to
draw reasonable conclusion from the following items:
Main accounting evidence from accounting system: balance sheet, profit and loss
account, ledger, daily book, cashbook, trial balance sheet are main accounting
evidence.
Evidence in support of the overall audit opinion: invoices, receipts, checks, bank
drafts and other documents.
The auditor will obtain evidence from several sources, which, together, will provide him
with the necessary assurance.
The auditor must be qualified to understand the criteria used and must be competent to
know the types and amount of evidence to accumulate to reach the proper conclusion
after the evidence has been examined. The auditor must also have an independent mental
attitude.
Auditors reporting on company financial statments are often called independent auditors.
Even though an auditor of published financial statements is paid a fee by a company, he
or she is normally sufficiently independent to conduct audits that can be relied on by
users. Although absolute independence is impossible, auditors strive to maintain a high
level of independence to keep the confidence of users relying on their reports. Although
internal auditors work for the company, they usually report directly to top management to
help maintain independence from the operating units being audited.
The Capital Market Board and Central Bank must qualify an auditor. An auditor must be
a member or officer of an independent auditing company and recognized by government
(Capital Market Board, Ministry of Finance).
Appointment of Auditor
Every country has different rules for appointment of Auditor. In Turkey, Board of
Directors of the company must appoint independent auditor by the approval of General
Assembly for minimum 2, maximum 4 years.
Statutory knowledge
The auditor must familiar with the requirements of the Capital Market Board Regulations
and Turkish Tax Regulations. The auditor also must appreciate the Trade Law and any
other legal maters specifically applying to the client.
Professional Skepticism
This phrase embodies an auditor’s tendency to not believe management assertions, but
rather to require management to “prove” assertions with evidence. Professional
skepticism on the part of auditors reprsents a concern for objectivity. An auditor should
carefully consider and investigate all material management assertions, whether they are
oral, written, or incorporated in the accounting records.
Other services
As mentioned, auditors are qualified accountants, and auditing is one of the accounting
professions. Professional firms of auditors and accountants provide a variety of services
separate from auditing, including accountancy, consultancy, investigations, taxation
advice, secretarial services, liquidations and any other area of financial advice. It must be
stressed that audit must be kept totally separate from these other services in order to
ensure that it is an independent operation and there is no conflict of interest where the
auditor provides other services.
Many financial statement users and members of the general public confuse auditing with
accounting. However, auditing and accounting do not define the same meaning.
Definitions Related to Fraud: Certain acts and devices that involve financial frauds are
referred to as white-collar crime. Fraud consists of knowingly making a
misrepresentation of facts with the intent of inducing someone to believe the falsehood
and act upon it and, thus, suffer a loss or damage. Examples of fraud and related activities
are employee fraud, embezzlement, defalcation, management fraud, fraudulent financial
reporting, errors, inequalities, direct-effect, illegal acts, and fraud auditing.
Characteristics of Fraudsters: White collar criminals are not like typical bank robbers.
Usually they are people who hold high executive positions, are respected, trusted
employees, have access to large amounts of money, have power to give orders, can
override controls, and “look like” most everybody.
The Art of Fraud Awareness Auditing: Fraud awareness auditing involves familiarity
with: the human element, organization behavior, knowledge of common fraud schemes,
evidence and its sources, standards of proof, and sensibility to red flags.
Differences between the audit approach of financial auditors and fraud examiners
- Access control risk in general - “Think like a crook” to imagine ways of controls
and specific terms to design that could be subverted
other audit approaches