CHAPTER 1 Audit and Review
1 WHAT IS AN AUDIT
An audit has been defined as “an independent examination of, and expression of opinion on, the financial statements of an enterprise by a duly appointed auditor in pursuance of a relevant statutory or professional obligation”. Independent – an auditor is remote from the enterprise that he/she is reporting on. This independence is defined by law and professional practice. Opinion – an auditor gives an opinion. He does not certify or guarantee the financial statements as accurate or free from error or irregularity. Financial statements are themselves imprecise because they are based on judgements and conventions. It is a common misconception that auditors are employed primarily to detect or prevent fraud and error. Duly appointed auditor – an external auditor holds office because of legal rules contained in CA 85 and 89.
Postulates of auditing Academics have attempted to codify certain underlying principles or postulates, which serve as the basis of auditing theory. A postulate is a concept that can be observed to be relevant to some course of study. Certain postulates that underlie the practice of auditing have been identified: ♦ Truth and fairness – the auditor is concerned that the financial statements under examination conform to law and best practice. ♦ Independence – the auditor is independent through status and is truly objective in expression of opinion. ♦ Evidence – an auditor arrives at his opinion through the systematic collection of evidential data on which his judgement is based. ♦ Responsibility – the auditor does not prepare financial statements or guarantee their accuracy nor is he a business valuer. He is not responsible for the prevention or detection of immaterial fraud. Mautz and Sharaf in their seminal work The Philosophy of Auditing define various concepts which can be seen to be relevant to the present day. Eight further postulates were laid down by Mautz and Sharaf are as follows: (a) Financial statements and financial data are verifiable. (b) There is no necessary conflict of interest between the auditors and the management of the enterprise under audit. (c) The financial statements and other information submitted for verification are free from collusive and other unusual irregularities. (d) The existence of a satisfactory system of internal control eliminates the probability of irregularities. (e) Consistent application of generally accepted accounting principles (GAAP) results in the fair presentation of financial position and the results of operations. (f) In the absence of clear evidence to the contrary, what has held true in the past for the enterprise under examination will hold true in the future. (g) When examining financial data for the purpose of expressing an independent opinion thereon, the auditors act exclusively in the capacity of auditor. (h) The professional status of the independent auditor imposes commensurate professional obligations.
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Accountability and stewardship The legal duties of directors are explicitly defined in the CA 85: ♦ to maintain accounting records ♦ to produce accounts that give a true and fair view and lay them before the shareholders ♦ to satisfy the requirements of the law in relation to company administration. This covers such matters as the conduct of meetings and the filing of documents at Companies House. In addition directors have an implied duty to act with the best standards of skill and care in relation to their management of the company. This implied duty has been defined through legal decisions taken in the Courts. Directors are fiduciaries; they act in a position of trust. They cannot make any secret profits because of their office as directors. They must account for their actions with openness and integrity. Agency theory The essence of this theory is that the principal (the shareholders) employs the auditor as an agent for an annual...