Week 1

Questions to Answer:
• What is an audit?

• What is its purpose?

• Who is it for?
• Who performs it?
• Who pays for it?
I. Pre-Lecture Notes:
i. Assurance Engagement: an engagement in which a
practitioner expresses a conclusion designed to enhance
the degree of confidence of the intended users other
than the responsible party about the outcome of the
evaluation or measurement of a subject matter against
criteria.
ii. External Audit: A systematic process of objectively
obtaining and evaluating evidence regarding
assertions about economic actions and events to
ascertain the degree of correspondence between those
assertions and established criteria and communicating
the results to interested users
iii. Central Assumption of auditing:
Agency Theory: Management (the agents) might use the
resources of the organisation to maximise their own
 wealth, not that of the shareholders/stakeholders.
(Agents might misuse the assets of the principal for his
or her own benefit.)
~ auditing reduces asymmetry between the principals
and agents.

iv. Purpose of an audit: to enhance the degree of

confidence of intended users in the financial statements.
This is achieved by the expression of an opinion by the
auditor on whether the financial statements are
prepared, in all material respects, in accordance with an
applicable financial reporting framework.1
~ The service that the auditor provides is the
independent verification of the credibility of the
information contained in a company’s financial
statements.
~ The value of the auditor’s service can be measured by
the increased confidence felt by users when using
audited financial statements as opposed to unaudited
ones.
~ An audit aims to improve the quality of information
presented in financial statements by reducing two
possible distortions, noise and bias.
v. Noise: Noise refers to the unintentional errors that
occur in the financial reporting process and are caused
by incompetence or weak controls.
vi. Bias: Bias refers to the creation of intentional errors
by management, intent on window dressing their own
performance. Bias can be arisen in two main ways:
(i) by creating deliberate mistakes, (such as valuing an
obsolete inventory product as if it were part of the
current range)
(ii) by the choice of accounting methods, which do not
comply with generally accepted accounting principles
(GAAP) (e.g. IFRS, US GAAP)
vii. Reduction of Noise and Bias: The auditor can reduce
noise and bias in two ways:
(i) by discovering errors during the normal routine of
audit testing and
(ii) by increasing the standard of care adopted by
employees who are conscious that their work will be
subject to independent scrutiny.

viii. Stages of the audit process:

ix. Professional Judgement: i) They have done enough
work.
x. ii) Based on all their work, they should issue a
qualified (not clean) report
xi. Professional scepticism: This is defined as 'An attitude
that includes a questioning mind, being alert to
conditions which may indicate possible misstatement
due to error or fraud, and a critical assessment of
evidence’.
xii. Current Challenges in Auditing:
~ Delayed audit reforms in the UK
~ High profile company collapses/frauds
~ Challenge of Responsibility allotment
~ Problem with audit quality
~ Any changes to audit market and regulation.
 READING
CHAPTER 1 (Pg. 13)

I.1. Introduction
i. Overview of the auditing profession.
ii. Industrial revolution led to the introduction of the limited
liability company.
iii.Auditor is an arbitrator and judge.
I.2. Agency Theory
i. Agents are the managers of the company, and the principals
are the shareholder.

ii.
iii.No agents are trustworthy, and they can try and make
themselves richer.
iv. The role of an auditor seems significant when the standard of
corporate morality is seen to be declining.
I.3. Why is there need for Audit?
i. The problem started when the day-to-day involvement of
the directors reduced.
ii. The management has a lot of power to control various
economic decisions.
iii.The royal Mail case where Lord Kyslant was convicted of
falsifying a prospectus to induce people to buy a failing
company’s share to prop up its finances – set a new world
for auditing. (Shifted from simply checking the balance
sheet to checking all financial statements.)
iv. Independent audit reassures the shareholders of the agents
work of their organisation.
v. They represent the work of the managers.
vi.Increase the confidence of the intended users once it has
been audited.
I.4. Audit process

I.5. International Pressures and Globalization

i. The preparation of accounts for multinational
organisations comprising of a variety of activities and
many subsidiaries can be a complex process.
ii. The auditing sector promotes confidence and stability in
the market because reliable financial reports are
produced.
iii. Corporate failures especially including fraud reduce
confidence and create instability. (they increase
regulation).
iv. Greater accountability and control is needed over
corporate executives running the company.
v. Sarbanes-oxley legislation (The Sarbanes-Oxley Act of
2002 is a law the U.S. Congress passed on July 30 of
 that year to help protect investors from fraudulent
financial reporting by corporations).
I.6. Objectives of Auditing
i. Auditing has to be carried out in accordance to the FRC
(financial reporting council ~ regulator for auditing and
accounting profession in the UK and Ireland).
ii. Increases the degree of confidence of the intended users in
the financial statements. The crosschecking by an auditor
assures the users that the statements are prepared fairly
with no bias and provide a true and faithful representation
of the organisation.
iii. Firms provide a wide range of varity of services to the
client; including consultancy, taxation and legal advice.
I.7. Directors Responsibility
i. To produce true and fair accounts.
ii. Their task is to explain themselves their dealings with the
accounts to the shareholders.
iii. They are accountable to the shareholders.
I.8. Auditors Responsibility
i. Auditors should be from an independent firm to carry out
investigation of an organisation.
ii. They must gather all the sufficient information available
and ensure they are reliable so as to form an opinion.
iii. Auditors report is designed to enhance the confidence of
the users.
iv. They have to make a decision on the errors made, whether
they were intentional or accidental.
v. They have to check the underlying financial statements
together with the adjustments made by the directors to
form their opinions.
vi. PRIMARY OBJECTIVE: audit objective is to gather
sufficient reliable evidence so as to be able to express an
opinion to form the report and let the users know the
statements were made in fairness and truth.
vii. SECONDARY OBJECTIVE: They also have to state that
the financial statements are in accordance with the
underlying financial reports; they comply with the
 reporting standards and that all the information and
explanations has been made available to them.

I.9. Types of Assignment

i. Three types of assignment

a. Statutory audit:
~ carried out because law requires them. They form the
~ basis of the book.
~ They are a form of assurance assignment where the
level of assurance given to the person to whom the
report is addressed has to be reasonable.
~ no thing as absolute assurance, that would mean that
the reports were totally accurate.
b. Internal audits:
~ they are conducted by employees of a business or by
external firms acting as subcontractors to non-audit
clients.
~ priorities are set by the management; thus, can control
the work of the internal auditors.
c. Other assurance assignments:
~ these are enquiries into specific aspects of an
enterprise like the management, value of the money,
environmental matters etc.
~ asked to carry off one-off assignments. (Carrying of
fraud investigation, reporting on a prospectus for a
share issue, reviewing systems and procedures.
I.10. Advantages and Disadvantages of an audit
ADVANATGES DISADVANTAGES
Ø Provider of finance (bank) 1. Argument is that it is only
requires audited accounts. for compliance and not for
Their independent audits management.
increase the costs to the
company largely.
Ø They can help protect 2. Costs of audit represent
creditors. Helps reinforce non-productive expenses.
financial discipline. Better use of those funds.
 Ø Establishes credibility of 3. Banks and lenders can
the company at a time make their own conditions
when fraudsters are for lending and do not
committing a long term necessarily need audited
crime. accounts.
Ø Shareholders not involved 4. They can be up to 9 months
in the business need to be old when they come out to
protected by an the public.
independent audit.
Ø Provides reassurance to the
directors that the figures
they are using is reliable.
Ø Increases credibility with
HMRC and assists in
setting tax and VAT
liabilities

QUESTIONS:

Answer:
Ø Benefits of employing an independent auditor.
i. Banks require audit to be able to lend, or it would cost them extra.
ii. It would increase the credibility of the organisation to in times of fraud.
iii. It would reassure stakeholders and bertha to look over the figures.
iv. It would help in the computation of tax figures.
LECTURE NOTES
I. Assurance: audit is a subset of the umbrella term
assurance.
~ some independent individual provides assurance whether
the statements are an accurate representation of the
statements for the intended users.
~ provides a comfort.
II. External Audit: type of assurance engagement.
~ systematic process
~ obtaining and evaluating evidence
~ we compare it to a standard of data
III. Auditory means hearing; listening to the various
organisation and understand their point of view about the
materials on statements; using professional scepticism to
evaluate their sayings; question their sayings.
IV. Agency Theory: it is the discrepancies that arise between
shareholders (owners) and the managers (agents) due to
asymmetrical information.

i. The agents have more information, how would the

directors know that the information given to them is
reliable.
 ii. The auditors' job is to take that information from the
agent to audit it and to provide confidence to the
shareholder that the information supplied is reliable and
economic information can be made.
iii. The auditors provide their opinions on the financial
statements prepared in all material respects, in
accordance with an applicable financial reporting
framework.
iv. It provides credibility to the information supplied by the
agents.
v. Audit aims to improve the quality of information
presented in the financial statements by reducing noise
and bias
Noise: unintentional errors caused by incompetence.
Bias: intentional errors = deliberate mistakes = commit
fraud.
V. The Audit Process:

i.The auditors get into a contract with the management

and are presented with the statements.
VI. Stages of the Audit Process:
VII. Audits are performed by the registered audit firm; audit is
a commercial service and put up a price after considering
the profit margin; The auditor signs putting the individuals
and firms name on stake; the company i.e the shareholders
pay.
VIII. Qualified = problem; unqualified = no problem. (a
qualified statement puts off the company and can hinder
the relationship between the audit firm and company
audited) (lots of potential relations at play).
IX. Challenges:
i. Are auditors responsible for the bankruptcy of a
company? Did they raise the alarm?