1 The Nature, Purpose and Scope of Auditing
1 The Nature, Purpose and Scope of Auditing
Reporting
The auditor examines the information under audit and expresses
his opinion on the same by way of a written report.
The audit report is the end product of the audit process.
Collection and Evaluation of Evidence
The auditors’ report stated above is formed by collecting and evaluating
evidence.
The auditor collects information employing techniques like:
Physical examination
Examination of documents
Obtaining certificates, confirmations and statements, etc.
According to Arens and Loebbecke, “auditing is the process by which a
competent, independent person accumulates and evaluates evidence
about quantifiable information related to a specific economic entity for the
purpose of determining and reporting on the degree of correspondence
between the quantifiable information and established criteria.”
This definition is also comprehensive like the one seen above but
stresses competence and independence of the auditor as well as
significance of established criteria or set of rules, regulations and
guidelines governing activities of the economic entity under audit,
against which actual performance is checked.
Distinction between Accounting and Auditing
Many users confuse auditing with accounting. The confusion is caused
as:
Most auditing is concerned with accounting information
Many auditors have considerable expertise in accounting
Individuals primarily responsible for the audit function are titled
‘Certified Public Accountants’
Proper descriptions of the two functions follow:
The reviews are not limited to accounting but can also include
evaluation of organizational structure, computer operations,
production methods, marketing and the like.
Efficiency and effectiveness of operations are difficult to evaluate
objectively and establishing criteria for evaluating quantifiable
information in an operational audit is an extremely subjective
matter.
Thus, operational auditors are usually more concerned with
making recommendations for improving performance than with
reporting on the effectiveness of existing performance.
Operational auditing, in this sense, is more similar to management
consulting than to what is generally regarded as auditing.
Compliance Audits
The purpose of compliance audit is to determine whether the auditee is
following specific procedures or rules set down by some higher authority.
There are prescribed policies, contractual agreements, and legal
requirements that call for compliance auditing in virtually every
organization.
For a private business a compliance audit may include:
Reviewing minimum wage rate for compliance with minimum
wage law
Examining various contractual agreements to ensure whether
the company is complying with relevant legal requirements
There is increased compliance auditing in government units due to
extensive regulations by higher government authorities.
Results of compliance audits are generally reported to someone within
the organizational unit being audited. Management, as opposed to
outside users, is the primary group concerned with the extent of
compliance. Hence, a significant portion of this type of work is done by
auditors employed by the organizations themselves.
Internal Auditors
Internal auditors are employed by individual companies to audit for
management and provide valuable information for making decisions
concerning effective operation of the business. The size and responsibility
of the internal audit group varies considerably depending upon the size
and requirement of the organization, and the internal audit reports to:
The president or the CEO directly
Another high executive officer
Or the audit committee of the board of directors
Some internal audit staffs consist of one or two employees and engage in
routine compliance auditing only; others may consist of numerous
employees who have diverse responsibilities, including many outside the
accounting area. Many internal auditors have become involved in
operational auditing or have developed expertise in evaluating computer
systems.
To operate effectively, the internal auditor must be independent of the
line functions in an organization, but he/she cannot be independent of
entity as long as the employer-employee relationship exists.
Independent External Auditors
The primary responsibility of the external auditors is the performance of
audit function on published financial statements. Most of the
discussions to be made hereafter shall refer to performance of this
function.
In Ethiopia the OFAG is the licensing authority as stated above and
membership of an internationally recognized professional body like ACCA
or CPA and post qualification audit experience of up to three years is
required to be licensed to practice as an independent auditor.
Purpose of Audit
The purpose of an external audit engagement is to enable the auditor
express an opinion on whether the financial statements audited:
Give a true and fair view or present fairly in all material respects
the entity’s affairs
Are prepared, in all material respects, in accordance with an
applicable financial reporting frame work
This opinion is embodied in the audit report and addressed to those
interested parties who commissioned the audit or to whom the auditor is
responsible under relevant statue.
In expressing the audit opinion the auditor has to carry out such
procedures and take such steps as designed to obtain reasonable
assurance that the financial are properly stated in all material respects.
There are certain inherent limitations present in any kind of examination
which require the use of judgment. Hence there is an unavoidable risk
that even some material misstatements may remain undiscovered, and
absolute certainty in auditing is rarely attainable.
However, it is the sacred duty of the auditor to plan and perform the
audit with an attitude of professional skepticism that the financial
statements being audited may be materially misstated and extend his
procedures even at the slightest indication of fraud or error which may
result in material misstatements so that he can confirm or dispel his
suspicions.
Thus the opinion expressed by the auditor helps to establish the extent
of credibility of the financial statements but should not be construed as
an assurance as to the future viability of the organization or as to the
efficiency or effectiveness with which the management has conducted the
affairs of that unit.
Agency Theory
Agency relationships occur when one party, the principal, employs
another party, the agent, to perform a task on their behalf. Modern
organization theory views an organization as comprising various interest
groups often called stakeholders.
The stakeholders a company are all those who are influenced by, or can
influence, the company’s decisions and actions and ranges from the
shareholders to management and the community in the local
neighborhood.
Those stakeholders charged with governance i.e. those whose role is to
supervise management need to ensure that the management operate the
business in the interests of the shareholders and other stakeholders and
not, purely in their own, personal interests.
In most countries it is possible for businesses to operate through
companies - a process known as incorporation which has two
implications:
The creation of a distinction between the owners of the business
and the business itself, which may in turn lead to the business
being run by managers who are distinct from its owners
The granting of limited liability status so that, if the business fails,
the owners only stand to lose a specific amount of money – hence
the term limited.
A legal framework was therefore needed for how companies should be
operated
To protect business owners from unscrupulous managers
To protect the business world and the public at large from owners
taking unfair advantage of limited liability status
This in turn had two results
The legal requirement for accounts to be prepared by management
on a regular basis to account to the shareholders for their
stewardship of the business
The recognition of the need for those accounts to be checked in
some way by someone independent of the managers – the auditor.
Stewardship is the responsibility to take good care of resources. A
steward is a person entrusted with management of another person’s
property.
Auditing Principles I 1. The Nature, Purpose & Scope of Auditing 10
Asrat Bekele
City University College Department of Accounting & Finance