Topic: Introduction Nature and objectives of auditing

Class: ADP-4

Introduction:-

Auditing is the independent examination of financial information of an entity, regardless of its

size or legal form, to express an opinion on whether the financial statements present a true and
fair view. It involves gathering and evaluating evidence to determine the accuracy and reliability
of financial records.

Key aspects of the nature of auditing:

1.Independence:

Auditors must be independent of the entity they are auditing to ensure objectivity and
impartiality in their assessment.

2. Systematic and disciplined process:

Auditing follows a structured approach, including planning, risk assessment, testing controls,
performing substantive procedures, and reporting.

3. Focus on financial statements:

The primary objective of an audit is to examine the financial statements (balance sheet, income
statement, etc.) to assess their fairness and compliance with accounting standards.

4. Opinion formation:

Auditors provide an opinion on the financial statements based on the evidence gathered,
indicating whether they are presented fairly in accordance with applicable accounting
standards.

5.Secondary objectives:

Auditing also aims to detect and prevent errors and fraud, verify accounts and records, and
report on financial performance and position.

6. Inherent limitations:

Audits have inherent limitations, such as the reliance on sampling and the potential for
undetected errors or fraud.

7. Professional judgment:
Auditors must exercise professional judgment throughout the audit process to assess risks,
evaluate evidence, and form their opinion.

In essence, auditing provides assurance to stakeholders (like investors, creditors, and

management) that the financial information presented by an entity is reliable and trustworthy.

ORIGIN AND EVOLUTION

The term "audit" originates from the Latin word "audire," meaning "to hear." In the early
days of auditing, auditors would literally listen to financial reports being read aloud by
accountants to verify their accuracy, according to the Audit Office of New South Wales and
Deskera.

This practice evolved over time to encompass the verification of written financial records as
well, according to Deskera. The concept of auditing, however, has roots much deeper than its
linguistic origins. Evidence of checks and balances on financial records can be found in ancient
civilizations like Mesopotamia, Egypt, and Rome, where systems were developed to ensure the
accuracy of resource management and public spending. The need for accountability and
transparency in financial matters has been a constant throughout history, leading to the
development of various auditing practices across different cultures and time periods.

Definition:

Auditing is the process of independently examining and evaluating financial records, reports, or
statements to verify their accuracy and compliance with established standards. It aims to
provide assurance that the information presented is reliable and fairly represents the financial
position of an organization.

1. American Institute of Certified Public Accountants (AICPA):

"Auditing is a systematic process of objectively obtaining and evaluating evidence regarding

assertions about economic actions and events."

2. Institute of Internal Auditors (IIA):

"Auditing is an independent, objective assurance and consulting activity designed to add value
and improve an organization's operations."

3. According to Spicer and Pegler:

"An audit is an examination of a business's books, accounts, and vouchers to determine if the
balance sheet and profit and loss account provide a true and fair view of the company's
financial position and performance. Specifically, the auditor must satisfy themselves that the
balance sheet accurately represents the state of affairs, and the profit and loss account reflects
the profit or loss for the period. If the auditor is not satisfied, they must specify the aspects
where they are not in agreement."

OBJECTIVES OF AN AUDIT

A. Primary objective

B. Secondary objectives

C. Implied objective

(A) PRIMARY OBJECTIVE:

REPORTING:

The auditors are required to be appointed under the following provisions of Companies
Ordinance 1984 for submitting the report about the accuracy of business accounts at different
stagos:

(a) Statutory Report: [Section 157 (5)]

It requires an audit report to be included in the statutory meeting about the shares allotment
&& receipts and payments statement.

(b) Prospectus Report: [Section 53(1)]

It requires an audit report, to be included in the prospectus of the company about the
performance of the Company in the past five years.

(c) Annual Report: [Section 255(3)]

It requires a report of fairness about the profit & loss Account and the Balance sheet for the
latest year to be presented at the Annual General Meeting.

(d) Solvency Report: [Section 362(2)]

It requires an audit report about the solvency position of the company to be represented for
the purpose of passing liquidation resolution for voluntary liquidation by the members.

B) SECONDARY OBJECTIVES:

(1) DETECTION & PREVENTION OF ERRORS:

What are Errors?

ISA Para 4 says

"Unintentional mistakes in financial statements are called errors.

KIND OF ERRORS

(a) Clerical Errors:

Those committed at the initial stage by the Clerical staff.

(i) Omissions: Where one or both parts of the transaction have been omitted to record.

(ii) Commission: Where different amount than actual has been recorded.

(iii) Compensatory: Where the second error has compensated the effect of first error.

(iv) Trail Balance: Where incorrect transfer or posting is made in the trail balance.

(b) Principal Errors:

(i) Incorrect allocation: Where a capital item is treated as revenue or revenue as capital.

(ii) No adjustment for accrued item or liabilities.

(iii) No adjustment for prepaid items & assets:

LOCATION OF ERRORS:

Following techniques can be helpful in detection and prevention of errors.

(a)Careful vouching of books & ledgers will highlight errors of omission.

(b) Compression: An auditor may detect errors by comparing the data of previous period with
current period.

(c) Inquiries: Errors made by principals can only be traced by general inquiries and by
independent checking.

(d) Trail checking & Verification: Trail checking & verification are also helpful devices for the
location of errors,

DETECTION AND PREVENTION OF FRAUDS:

(2) ISA Para 3 says.

"An intentional act by one or more individuals among management, employees or third parties,
which results in a misrepresentation of financial statements is called fraud."
 KINDS OF FRAUDS

(a) FRAUDS OF CASH:

(1) Understatement of Cash Receipts:

(i) No record of accounts receivables

(ii) Less record of accounts receivables

(iii) No record of casual sales e.g., scrap, bad debts recovered.

(iv) Discount recorded but not allowed.

(iv) Teeming & Lading: Creating a deficiency in the account of a debtor and concealing it
through another deficiency and so on for a short period i.e., Short Banking or Delayed
Accounting.

(vi) Under casting the receipts of a particular page

(vii) Overstatement of

(i) Fictitious payments on forged bills.

(ii) Double record of the same voucher by change of date.

(iii) Personal expenditure paid out of business e.g. utility bills & entertainment bills.

(iv) Overcasting the payment side.

(b) Frauds of Goods

(i) Understatement of quantity received.

(ii) Overstatement of quantity issued.

(iii) Less balance of available stock.

(iv) No record of material returned back from the department.

(c) Fraud of Accounts (Manipulation of Accounts):

This type of fraud is comparatively more difficult to detect. The directors or the management
usually carries out these frauds.

Manipulation of Accounts is defined as:

 "The presentation or record of accounts in a manner slightly different than the original way"

(i) Inflation of Sales:

By way of arranging sales order through another company in the closing period.

(ii) Deflation of Sales:

By delaying the record of normal sales especially few a large or

(iii) Inflation of Purchases:

By arranging purchase order with another company.

(iv) Deflation of Purchases:

By delaying the record of normal purchases.

(v) Use of Secret Reserve:

The management may resort to adopt the method of secret reserve, its creation and use
instead of the above steps in any of the following manners:

a) ( Increase or decrease in the rate of depreciation.

(b) Increase or decrease in the rate of bad debts reserve.

(c) By changing the method of diminishing balance or into the reverse practice.

(d) By charging a capital expenditure to revenue or in the reverse practice.

Location of Frauds:

A careful examination of vouchers, invoices, wage sheets and other evidences of transactions
can discover many frauds. But only a good system of internal check can provide adequate
protection against embezzlement of cash and pilferage of stores.

(c) IMPLIED OBJECTIVE:

Related guideline in this respect, contained in ISA 1, is explained below:

Moral Check:

The system of audit if adopted regularly in the business will put a check on the business
employees and they will not commit irregularities, as they know that these will be discovered
and reported later on through audit. Thus it is claimed that audit prevents the occurrence of
errors and frauds before it starts.

"the objective of an audit of financial statement, prepared within a framework of recognized

accounting policies, is to enable an auditor to express an opinion on such financial
statements."

Conclusion:

In conclusion, auditing objectives aim to ensure financial statement accuracy, evaluate internal
controls, promote compliance, and enhance operational efficiency, ultimately promoting
transparency and good governance.