Auditing 1A - Lecture 1 Notes

Theory and Philosophy of Auditing

  • What is an auditor? Traditional perceptions include: boring, conservative, grey men, green pens, bean counters.
  • Auditors are often described as "investigating the matter."
  • International Framework for Assurance Engagements Definition: An auditor expresses a conclusion designed to enhance the degree of confidence of an intended user.

Types of Auditors

  • Registered External Auditor:
    • Provides an opinion on the Annual Financial Statements (AFS). They are NOT an employee of the company being audited.
    • Designation: CA(NAM) - Chartered Accountant (Namibia).
  • Internal Auditor:
    • Can be contracted or employed by the organization.
    • Designation: CIA - Certified Internal Auditor.
  • Government Auditors:
    • Auditor General is an example; they are employed by the government.
  • Forensic Auditor:
    • Investigates mismanagement, fraud, and theft. Usually not employed by the entity being investigated.
  • Special Purpose Auditor:
    • Audits a particular field, such as environmental compliance or VAT audits. Can be contracted or employed.

Why the Need for Auditors?

  • Split Between Ownership and Management: Auditors bridge the gap of trust arising from the separation of ownership and management.
  • Confidence in Financial Information: Auditors enhance confidence in financial reporting.
  • Assurance:
    • Auditors enhance the degree of confidence of intended users and enhance the credibility of financial information.
    • Examples of intended users: pension funds, investors in listed companies.
  • Etymology:
    • The word 'Auditor' comes from the Latin word 'audire,' meaning 'to hear' or 'to listen.' Historically, accounts were given orally before records existed.
  • Ethical Principles: Due to the nature of their work, auditors must adhere to ethical principles:
    • Integrity
    • Objectivity
    • Professional Competence and Due Care
    • Confidentiality
    • Professional Behavior
  • Level of Assurance:
    • Audit Engagement: Provides reasonable assurance.
    • Review Engagement: Provides limited assurance.

Assurance and Non-Assurance Engagements

  • Assurance Engagements:
    • Audit of financial statements.
    • Other assurance engagements that are not audits but still provide assurance.
  • Non-Assurance Engagements:
    • Compilation of financial information.
  • Reasonable Assurance:
    • A high, but not absolute, level of assurance.
  • Limited Assurance:
    • A lower level of assurance than reasonable assurance.
  • Statutory Assurance Engagements:
    • Required by law (e.g., Companies Act).
  • Non-Statutory Assurance Engagements:
    • Not required by law (e.g., audit of a Close Corporation).

Assurance Engagement Elements

  • An assurance engagement requires the following elements:
    • Three-Party Relationship:
      • Professional Accountant (Registered Auditor)
      • Responsible Party (Directors)
      • Intended User (Shareholders)
    • Subject Matter:
      • Financial Position
      • Results of Operations
    • Suitable Criteria:
      • IFRS (International Financial Reporting Standards)
    • Sufficient and Appropriate Evidence:
      • Evidence to conclude that AFS (Annual Financial Statements) are free of material misstatement
    • Written Assurance Report:
      • Audit Report on fair presentation

Examples of Assurance Engagements

  • Audit of Financial Statements: Results in an audit opinion.
  • Report on Effectiveness of Client’s Internal Control System: Based on measurable criteria.
  • Report on Compliance Requirements: For example, the Sarbanes-Oxley Act of 2002 concerning certain controls in regard to US listing requirements.
  • Non-Assurance Engagements Examples:
    • If any element of an assurance engagement is missing, it becomes a non-assurance engagement.
    • Professional accountant engaged to collect, classify, and summarize information for a client without expressing an opinion.
      • Example: Reviewing information for a prospectus without issuing an opinion.
    • Compiling a tax return: No opinion or conclusion is given; only information is presented.

Audit of Financial Statements

  • Involves gathering evidence to form an opinion.

Other Assurance Engagements

  • Assurance engagement on the effectiveness of internal control.
  • Assurance engagement on corporate governance.

Non-Assurance Engagements

  • Tax return preparation and compilation of financial information.
  • The auditor expresses an opinion on fair presentation, providing reasonable assurance, rather than certifying absolute correctness.

Statutory and Non-Statutory Assurance Engagements

  • Statutory: Required by the Companies Act.
  • Non-Statutory: For example, an audit of a Close Corporation (CC).

Reasonable Assurance

  • Auditors do not certify or confirm the absolute correctness of financial information.
  • They provide an opinion on "fair presentation," which implies reasonable assurance.
  • The AFS, as a whole, are free from "material misstatements," not ALL misstatements.
  • The auditor provides an opinion that the most significant mistakes are covered, making the AFS reasonable as a whole.
  • The auditor does not guarantee that no misstatements exist or that the AFS are 100% correct.
  • Materiality: A misstatement is considered material if it could influence the economic decision-making of users.

Why Auditors Can’t Give Absolute Assurance

  • The Nature of Financial Reporting:
    • Financial reporting involves judgment in areas such as bad debts, inventory valuation, and depreciation.
  • The Nature of Audit Procedures:
    • Audit procedures have inherent limitations in extent and timing.
    • There's a possibility that information is not complete.
    • Audit evidence is persuasive rather than conclusive.
      • Auditors are persuaded that a transaction took place based on documents rather than witnessing the event.
    • Auditors use testing and cannot test every transaction.
  • Inherent Limitations of Accounting and Internal Control Systems:
    • Auditors rely on clients’ systems, which may have weaknesses.
  • Timeliness of Financial Reporting and the Balance Between Benefit and Cost:
    • Audits need to be reported within a reasonable time after year-end.
  • Other Matters That Affect the Inherent Limitations of an Audit:
    • Whether the auditor has been informed about factors that may affect going concern.

Auditing Postulates

  • A postulate is a basis for reasoning and thinking in the auditing profession.
  • Common Objective: Both the auditor and the client have the same objective (common desire) regarding fair presentation.
    • This postulate requires the auditor to rely on management’s integrity and their intention to not manipulate the AFS.
    • Professional skepticism is crucial.
  • Independence: The auditor must act exclusively as an auditor to give an independent, objective opinion.
    • The opinion can only be relied upon if it is free of bias.
    • The auditor must be independent in both appearance and in fact.
  • Professional Status: The knowledge, capabilities, and qualities of the auditor bring responsibilities.
    • Auditors must prioritize service over personal interest, act with due care, and serve efficiently and competently.
  • Verifiability: It is possible to verify financial data.
    • This means being able to determine whether something is true or false.
    • There must be sufficient evidence to support transactions and an adequate audit trail.
  • Internal Controls: Good internal controls reduce the possibility of errors or irregularities.
    • Example: A payment by cheque normally requires approval from two senior management staff, reducing the likelihood of fraudulent payments.
    • Auditing standards require assessing the effectiveness of internal controls even if one does not completely rely on them.
  • Consistency: What held true in the past will hold true in the future.
    • Historical evidence is used to assess judgments about the future (e.g., allowance for credit losses).
  • GAAP and Fair Presentation: Application of GAAP (Generally Accepted Accounting Practices) results in fair presentation.
    • In Namibia, GAAP is IFRS (International Financial Reporting Standards).
    • Applying a generally accepted framework should result in fair presentation and consistency in practice, making companies comparable.
  • Absence of Collusion and Irregularities: AFS for audit are free of collusive and other irregularities.
    • Collusion: Two or more staff members secretly agree to do something (e.g., override controls to steal money).
    • Irregularity: An illegal act of theft/fraud.
    • The auditor's objective is to form an opinion on the AFS, not to search for fraud.

How to Remember Auditing Postulates - The Acronyms

*Acronyms can be used to recall by using the first letter of each keyword to identify a pattern:
* Same objective (O)
* Independent (I)
* Responsibility (R)
* Possible to verify data (D)
* Internal controls (C)
* Framework (F)
* Post / future / historical (H)
* Fraud (F)
*Example?
Riff doch / ffor chid / crohffid (like crawford)
It needs to be a phrase that YOU will remember. Remember this is only to recall the key word, you would still have to apply and be able to explain the postulate properly. Saying ‘independent’ means nothing if not explained in what context

Attributes of Accounting Profession

  • Professional status is attained by obtaining certain attributes including:
    • Professional and specialised skills
    • Intellectual ability
    • Mastery of specialised body of knowledge
    • Mastery of application of specialised knowledge and intellectual ability
    • Quality of service be regulated to protect public (unethical behaviour / incompetence)
    • Laws restricting admission (regulated & strict)
    • Voluntary organisation to advance profession
    • Freedom for uninhibited competition in order to improve services
    • Active support of ethical code of conduct
  • Intellectual & ethical commitment
    • Priority: service motive, not purely financial gain (corruptible)
    • Peer evaluation is important (to maintain high standards of quality and consistency)
  • Accounting bodies
    • SAICA – South African Institute of Chartered Accountants
    • ACCA – Association of Chartered Certified Accountants
    • PAAB (public accountants & auditors’ board) -> was replaced by IRBA (independent regulatory board for auditors)
    • These bodies (such as SAICA) must be registered with IFAC (international federation of accountants)
    • IRBA deals with training, registrations, education, disciplinary measures, accreditation etc.

Becoming a CA

  • Becoming a chartered accountant (CA(SA) or CA(NAM)) opens doors.
    • It is your gateway to a:
      • Challenging and exciting career,
      • Global mobility,
      • Flexibility and
      • Great earning potential in the business field of your choice.
  • For students at university level studying on a full time basis
    • Always aim to obtain good results all around.
    • A good grounding in English is essential as it will assist you to have a better understanding of the concepts.
    • To pursue a career as a chartered accountant you will need to enroll for a b com accounting degree or an equivalent CA(SA) undergraduate qualification at a saica accredited university.
    • Once you have completed your degree you will be required to complete your certificate in the theory of accounting (CTA). This course focuses on accounting, auditing, taxation and financial management. The course takes a minimum of one year and must be completed at a SAICA accredited university.
    • Upon completion of your CTA, you are then eligible to enter into a 3-year learnership with a registered training office (RTO) (to specialise in auditing) or an approved training organisation (ATO) (to specialise in financial management).

CA Training

  • Complete learnership (duration varies depending on level of qualification when entering into the learnership.)
  • Complete part one of the qualifying examination (ITC).
  • Complete specialist course relevant to your selected training programme in financial management or auditing.
  • Complete part two of the qualifying examination (QE 2) (financial management route) or professional practice exam (PPE) (auditing route) after having completed a minimum of 18-months of the training contract.
  • During your training it is your responsibility to drive your career. You must utilize every opportunity to learn about the business areas that your training office covers.
  • Tipp / Topp training
  • Qualifying as a CA(SA)
    • Successfully complete training and pass both examinations.
    • Register with SAICA or ICAN to be a member and only then may you use the CA(SA) or CA(NAM) designation.

Maintaining CA Membership

  • Ethics & conduct maintained – adhere to IFAC code of ethics
  • Conducting audit in accordance to ISAs
  • Maintaining skills
    • CPD hours – training, research etc.
    • Important legislations need to be known and applied

The Financial Statement Audit Engagement

  • Intro
    • External engagement = assurance engagement
  • ISA 200- overall objectives of an auditor
    • Objective: to express an opinion (specified date / criteria)
    • Opinion – provides no future viability on going concern nor efficiency (how well resources were used)
    • Its objective is not to discover / prevent fraud – only to the extent that it affects fair presentation
  • Roles of parties involved in an assurance engagement
    • Auditors, directors, shareholders – function?
  • Role of the companies’ act
    • Why created? To protect shareholders /investors interest and protect the economic system
    • Concepts: widely held company (ltd), limited interest company (pty ltd)

Companies Act

  • All companies must be audited if qualified in terms of:
    • Turnover
    • Size of work force
    • Nature and extent of activities
  • Duty to shareholders to appoint/dismiss auditors
  • Duty to shareholders to appoint/dismiss directors
  • Provides requirements for the form and contents of reports
  • Provides legal backing
  • Provides right to access companies records
  • Duty to auditor to report to shareholders
  • Duty of auditor’s report to include audit opinion

Role of International Standards on Auditing (ISA’s)

  • ISA’s provide the standards and guidance which auditors must attain to conduct audit
  • ISA’s should cover entire audit process.

Assertions

  • Embodied in AFS are assertions of management which are in effect their representations about companies assets, equity, liabilities, transactions and events
    • Completeness, all assets have been recorded
    • Occurrence, transactions recorded took place and pertains to company
    • Existence, assets exist at given date
    • Cut off, transactions recorded in correct accounting period
    • Accuracy, amounts recorded appropriately
    • Classification, transactions recorded in proper accounts
    • Rights and obligations , company holds or controls rights to assets
    • Valuation and allocation , assets included in AFS at appropriate amounts
    • Presentation and disclosure

Assertions Example

  • Accounts receivable – N$ 782924782 924
  • The directors are saying (asserting) following about accounts receivable
    • Completeness, all debtors have been recorded in balance
    • Existence, no fictitious debtors included or debtors overstated
    • Valuation and allocation , amount reasonably expected to be paid
    • Presentation and disclosure, all information relating thereto has been appropriately presented, described and clearly expressed
    • Rights, company has right to ownership to amounts owed by

Financial Statement Assertions

ASSERTIONSTRANSACTIONSBALANCESPRESENTATION
Occurrence√
Completeness√√√
Accuracy√√
Cut-off√
Classification√√
Existence√
Rights and Obligations√√
Valuation and Allocation√√