Certified Forensic Accounting & Fraud Detection Auditing

Scope of an audit: 1. External Audit 2. Internal Audit

What is an External Audit?

The independent examination of, and expression of opinion on, the financial statements of an organization by an appointed auditor in compliance with any relevant statutory obligation. Independent Examination An auditor must play no part in the day-to-day running of the organisation and must not be controlled by the management of the organization. The Auditor must not only be independent but be seen to be independent. The definition of independence does not require the auditor to be completely free of all the factors that affect the ability to make unbiased audit decisions, but only free from those that rise to the level of compromising that ability. For example, the audit client pays the auditors fee, so complete independence is impossible and not necessary to meet the frameworks definition. The framework doesnt spell out specific examples of what would constitute rising to the level of compromising an auditors independence, but it does offer a structure that will allow an auditor to analyze whether undue bias exists in a particular situation. Further, independence is defined as more than just compliance with the independence rules. The proposed definition compels the auditor to make a personal assessment of his or her objectivityto determine if pressures and other factors compromise the ability to make unbiased audit decisions. While this introspective evaluation is critical, the definition also calls for an assessment of how activities and relationships with the audit client would appear to others; the guidance explains that the auditor should consider the rationally based expectations of well-informed investors and other users. Expression of Opinion An opinion may be referred to as qualified (except for.), unqualified (no significant concerns, true and fair view), adverse (does not express a true and fair view), disclaimer (does not express an opinion) Financial Statements Balance Sheet (Statement of financial position as at the end of the period) Income Statement (statement of comprehensive income for the period) Statement of changes in equity Statement of cash flows for the period Notes to the financial Statement Other explanatory material ( summary of accounting policies) that are identified as being part of the financial accounts

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Appointment of auditor For public companies, the directors appoint the first auditor of the company. The auditor then holds office until the end of the first meeting of the company at which the directors lay its accounts before the members. At that meeting, the members of the company can re-appoint the auditor, or appoint a different auditor, to hold office from the end of that meeting until the end of the next meeting at which the directors lay accounts. A casual vacancy in the office of the auditor may be filled by appointment by the directors or by the company in a general meeting. Until such appointment is made, the continuing or surviving auditors may perform the role of auditor. For private companies, the directors appoint the first auditor of the company. The members may then appoint or re-appoint an auditor at a meeting of the company's members, or by written resolution, within 28 days of the directors sending the accounts to the members. If they do not do so, however, the appointed auditor remains in office until the members pass a resolution to reappoint him or to remove him as auditor (5% of members, or fewer if the articles say so, can force the consideration of a resolution to remove an auditor). This provision about remaining in office, however, does not apply if the auditors most recent appointment was by the directors or the companys articles require annual appointment.

Statutory Obligation It is a duty imposed by the law. Auditors have statutory obligations because people want to be assured that the auditor has checked that certain matters e.g. laws and policies have been followed and adequate records have been kept. Other Obligations The main other obligation is to report serious irregularity e.g. improper use of the organisations funds.

The role of the External Auditor

According to the ISA 200 Objective and General Principles Governing an Audit of Financial Statement, the object of the audit is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an identified financial reporting framework. The auditor does not certify the financial statements or guarantee that the financial statements are correct, he reports that in his opinion they give a true and fair, or present fairly the financial position.

In addition, ISA 200 contains an objective relating to situations where reasonable assurance cannot be obtained, in which case the auditor, depending on the circumstances, may qualify the audit opinion, or disclaim an opinion, or withdraw from the assignment.
What is true and fair? Truth in accounting is quite different from scientific truth (conforming to reality, exact, accurate formation). Accounting does not deal with that type of truth which has a fixed an unchanging quality. No material misstatement. The word fair has the following meanings: on the one hand clear, distinct and plain, and on the other impartial, just and equitable.

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The audit should present clearly and equitably the financial state of affairs of the enterprise. It is necessary not only to present certain information impartially but also that this data is shown in such a way that it is clearly understood by the user. ...true and fair has become a term of art. It is generally understood to mean a presentation of accounts drawn up according to accepted accounting principles using accurate figures as far as possible and reasonable estimates otherwise, and arranging them so as to show within the limits of current accounting practice as objective a picture as possible free from wilful bias, distortion, manipulation or concealment of material facts. (Lee).

Types of External Audits

1. Statutory audits that are required by law. These include those that are listed companies 2. Non-statutory audits that are performed for companies that are not listed on the stock exchange Examples of Statutory and Non-statutory Audits Statutory Audits Non-statutory Audits Banks Clubs Limited companies Small charities Trade Unions and employee Sole traders associations Housing associations Partnerships Large charities Investment business

Limitations of an External Audit

It should be noted that an audit is not a guarantee of the future viability of the entity, nor is it an assurance of managements effectiveness and efficiency. There are inherent limitations, which affect the auditors ability to discover material misstatements. The limitations arise due to the following factors. 1. Auditing is not a purely objective exercise. Auditors are required to make judgements (provisions for depreciation, provisions for obsolescence, deposit liability) in a number of areas including risk assessment. Their assessment of the risk associated (as determined by the auditor) with the organisation would be a key factor in determining the audit work to be performed and ultimately the audit opinion given. 2. Auditors do not check every item in the accounting records; they use sample method for most of their audit work 3. The inherent limitations with the internal controls and the accounting systems, since their systems might not be able to cope with changing circumstances or unusual transactions 4. Client staff may be dishonest and collude to commit fraud 5. Audit evidence indicates what is probable rather than what is definite 6. Audits are performed months after year-end. The accounts might not show and up-to-date position of the company. If the audit is performed too soon after year-end there might not be sufficient evidence in relation to certain figures in the balance sheet 7. The audit report itself is unlikely to reflect all the aspects of the audit Page 3 of 5

Some DOs and DONTs of External Auditing DOS DONTS Auditors maintain independence from management Look at every transaction carried out by the and directors so that the tests and judgments are organization made objectively Auditors discuss the scope of the audit work with Test the adequacy of all of the organisations the organisation internal controls Auditors determine the type and extent of the audit Identify all possible irregularities procedures they will perform depending on the risks and controls they have identified Auditors form an opinion on the Audit other information provided to the members information in the financial report of the organisation eg the directors report

What is fraud?
Fraud is a deliberate misrepresentation of a material fact to gain an unfair advantage. Misstatements related to fraud: 1. Misstatements arising from fraudulent financial reporting intentional misstatements or omissions of amounts or disclosures designed to deceive financial statement users usually involving the override of controls by management 2. Misstatements arising from misappropriation of assets involving theft and embezzlement of an entitys assets

The detection of fraud and error

Following a judgement in 1859, stating that it was part of the auditors duties to discover fraudulent misrepresentations, the detection of fraud and error became the major objective of company audits. However, during the latter part of the nineteenth century, there was a growing school of thought that the prevention of fraud and error as opposed to its detection should be the major objective of the auditor, and that the management of a company should play a greater part and accept a larger degree of responsibility in this respect. The leading case, which established the fact that the auditor should not be responsible for finding every fraud or error, is the Kingston Cotton Mill case of 1896. Here the judgement pronounced that the auditors role should be likened to that of a watchdog rather than a bloodhound, and that what was required of him was that he should as with such reasonable care and skill as was appropriate in the circumstances. Later cases confirmed this view of the auditor. Obviously, with the growth of professionalism, the degree of care and skill expected of the auditor increased in the eyes of the public. The various accountancy bodies recognised this fact and sought by various means to improve the standard of auditing. There is no statutory duty to seek out fraud. The auditors duty under statute is confirmed to expressing an opinion as to whether the financial statements under review show a true and fair view of the companys results and position, and comply with the Companies Acts. To discharge this duty, he must Page 4 of 5

carry out such audit procedures as he thinks necessary in the light of the companys circumstances and of current auditing standards. Material discrepancies should be discovered as a result of normal audit procedures and of course the very existence of an audit may itself act as a deterrent. The detection of errors or fraud is therefore not the main objective of the audit.

External Audit Procedures

Conduct enquiries of management and others within the entity, including: The Audit Committee Internal auditors Those outside management (e.g. operational personnel) Those outside the finance function (e.g. in-house legal counsel) Consider results of analytical procedures (including revenue analytics) Be aware of conditions generally present to commit fraud and assess risks of fraud throughout the audit Evaluate managements programmes and controls relating to fraud Examine journal entries and other adjustments Review accounting estimates, current and retrospective, for biases Evaluate business rationale for significant unusual transactions Add an element of unpredictability in audit procedures year to year Use of fraud or forensic specialists - if applicable

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