INTRODUCTION TO AUDITING
The word Audit is derived from a Latin Verb ‘Audire’ which means ‘to hear’.
Various bodies and authors has defined auditing differently. The International Auditing Practices Committee (IAPC) stated that “Auditing is an Independent examination of and the expression of an opinion on the Financial Statement of an enterprise by an appointed auditor in accordance with the terms of his engagement and in compliance with relevant statutory obligation and professional requirements.
Spicer and Pegler defined an audit as the examination of the books, accounts and vouchers of a business as will enable the auditor to satisfy himself that the balance sheet is properly drawn-up, so as to give a true and fair view of the state of the affairs of the business, and whether the profit and loss accounts gives a true and fair view of profit or loss for the financial period, according to the best of his information and the explanations given to him and as shown by the books and if not, in what respect he is not satisfied.
R.B. Bose defined audit as the verification of the accuracy and correctness of the books of account by independent person qualified for the job and not in any way connected with the preparation of such accounts.
M.L. Shandily defined auditing as “inspecting, comparing, checking, reviewing, vouching, ascertaining, scrutinizing, examining and verifying the books of account of a business concern with a view to have a correct and true idea of its financial state of affairs”.
Considering the above definitions, it would be seen that audit is defined from different perspectives but with so many similarities. The following can be established about auditing:
1. Audit is an independent examination of an organization’s books of accounts.
2. Audit job is carried out by an independent person or body of persons that are professionally qualified.
3. The Auditor is expected to carry out the job in line with the agreement reached with the client and statutory requirements.
4. The Auditor must give a report at the end of the assignment of his findings and whether the organization financial record is a true and fair view of the company’s affair.
HISTORICAL BACKGROUND OF AUDIT
The role of the Auditor dates back hundreds of Years. There are records from ancient Egypt and Rome, which shows that the people were employed to review work done by Tax Collectors and Estate Managers.
In Medieval Britain, the normal practice then was for an independent Auditor to be employed by the Feudal Barons to ensure that the returns from Tenant Farmers accurately reflected the Revenue received from the estates. The Auditors after review of the financial records presented by the Tenants read out their Findings, hence the word ‘Auditor’. As at this period the emphasis was very much on the detection of fraud, financial misrepresentation and other irregularities. Thus, although the emphasis has changed and the role of an Auditor has become much more sophisticated, the Concept of Auditing is by no means a Modern one.
The introduction of the Joint Stock Company increased the supply of Capital for Industry and Commerce, small privately owned business, which was financed by a Sole Trader or a Partnership resulted in the establishment of Organization now known as the LIMITED Company. The body of shareholders delegated some of their members to act as a Board of Directors, and periodically the Board submits accounts to the Shareholders so that they could be aware of the state of affairs of the company in which they had an interest or investment. It was of utmost importance that the accounts presented by the directors did provide an objective view of the state of affairs of the company and should be satisfactory to the Shareholders. The financial statements presented by the Directors must provide the Shareholders with a true and fair view of the financial performance and financial position of the Organization, which can be relied upon.
The Joint Stock Company Act of 1844 was the first legislation in Britain to require all incorporated business to have their annual financial statements examined by an auditor. Early auditors were mostly non accountants who were required to state whether the accounts showed a ‘true and correct’ view of affairs of the Company. It was the Companies Act of 1900 that required the Auditor to be independent, and it wasn’t until the 1948 Companies Act that He was required to be professionally qualified.
WHO IS AN AUDITOR
An Auditor is an independent person or firm engaged to carry out the audit of an organization financial records. In Nigeria, an auditor must be a professional Accountant and must possess a valid license to practice.
QUALITIES OF AN AUDITOR
The Auditor is expected to possess some qualities among which are as follow:
- Integrity: The auditor must be an honest man and a person with unquestionable Character.
- Independence: The auditor must be a person that is free from personal bias.
- Objectivity: The auditor must be objective and must base his opinion on verified evidence.
- Confidentiality: The auditor must be able to keep information at his disposal confidential.
- Competence: An auditor must be vast in the knowledge of auditing and accounting and must be a professional Accountant.
OBJECTIVES OF AUDITING
The primary and statutory objective of an auditor is for the auditor to form an opinion on whether or not the financial statement show a true and fair view. The primary objective of an Auditor as stipulated under Company’s and Allied Matter Acts (CAMA), 2OO4, is for an appointed qualified auditor to express a professional independent opinion on the financial position and performance of a business entity as obtained in the financial statement prepared by the management so that shareholders, prospective investors and any other person reading and using information contained in the financial statements can rely on them.
Secondary objectives of auditing includes the following:
- Detection of errors and frauds.
- Prevention of errors and frauds.
Other Services Provided by the Auditor
Aside the auditing of the books of accounts of an organization, an Auditor or Audit firm can be engaged to render the following services:
i. Accountancy services: Accountancy and Book-keeping services such as writing up of books of accounts, keeping financial records, preparation of payroll and final accounts for their clients.
ii. Taxation services: Auditors can be engaged for the computation of capital allowances and tax liability for his client for submission to the Federal Inland Revenue Service to form the basis for assessing the client. Tax clearance certificates may also be processed and procured on behalf of their clients.
iii. Investigation: The Auditor can be engaged to carry out an investigation on behalf of the client.
iv. Management consultancy and financial advisory services: The Auditor can be engaged to provide management consultancy and financial advisory services for their clients
v. Receivership and liquidation services: The Auditor can act as a receiver or liquidator for clients in a process of winding-up or liquidation.
vii. Recruitment and other consultancy works: The Auditor can be engaged to help a client to recruit employees.
BENEFITS/ADVANTAGES OF AUDITING
- Audited financial statement can be used to make insurance claims: In case of fire, flood and the other unexpected happenings, the insurance company may settle the claim for loss or damages on the basis of audited accounts of the previous year.
- It can be used to obtain loans: Loans and credit can easily be obtained from banks and other money lenders on the basis of properly audited accounts.
- It can be used for assessment purpose: Tax authorities generally accept the profit or loss account of an audited financial statement.
- It is more reliable in determining the going-concern of a business: The future trends of the business can be assessed with certainty from the audited books of accounts.
- It helps to avoid disputes between partners: In case of partnership firm, partners can utilize the audited accounts to settle their disputes in regard to adjustment of capital and valuation of goodwill at the time of admission, retirement and death of a partner.
- It helps in detecting errors and fraud: Errors and frauds are located very easily and at early stage. Therefore, chances of their repetition are reduced to the minimum.
DIFFERENCE BETWEEN ACCOUNTANCY AND AUDITING
The difference between Accountancy and Auditing is as follows:
1. Accountancy is mainly concerned with the preparation and maintenance of financial records while Auditing has to do with the verification of the books of accounts and the expression of opinion on it.
2. An accountant is an employee of the business while an auditor is an independent appointee.
3. As an employee of business, an accountant draws his monthly salary regularly from the organization while an auditor is paid a remuneration based on agreement reached with the client.
4. An accountant is not expected to have a knowledge of auditing but an auditor must possess a thorough knowledge of accountancy and auditing.
5. An auditor can be changed from year to year but an accountant is a permanent employee of the organization.
BOOK-KEEPING, ACCOUNTANCY AND AUDITING
Book-Keeping, Accountancy and Auditing are the three aspects of the term `Accountancy’ itself in its widest sense.
Book-keeping is the art of recording the daily transactions in a set of financial books. It is concerned with systematic recording of transaction in the books of original entry and their posting into ledger. A person with the knowledge of rules of journalizing and posting can very easily do the job.
Accountancy begins where book-keeping ends. “It means that an accountant comes into the picture only when the book keeper has done his job. The functions of accountant can be classified as follows:
(i) Checking the work of book-keeper.
(ii) Preparation of trial balance,
(iii) Preparation of Financial performance statement.
(iv) Preparation of Statement of Financial position.
(v) Passing entries for rectification of errors and making adjustments.
An accountant is supposed to be an expert in the accounting procedures as he has to examine analytically the final accounts.
It is said, “Where accountancy ends, auditing begins.” It is rightly said that an auditor has to verify the entries passed by the accountant and the final accounts prepared by him. Thus, auditing is the checking of the accounts of a business with the help of vouchers, documents and the information given to him and the explanations submitted to him. An auditor has to satisfy himself after due verification and complete. Checking of accounts as to whether the transactions entered into the books are accurate. An auditor is required to submit his report to the effect whether or not the balance sheet is a true and fair representation of the existing state of affairs of a business concern.
Thus, an auditor should have the proper knowledge of accounting principles. That is why he should be a chartered Accountant. He has to express his impartial opinion in his report which he cannot give unless he satisfies himself completely with the proper recording of transactions. Thus, auditing is based on accountancy and not accountancy on auditing. An auditor must be well familiar with the principles and practical aspects of accountancy but it is not necessary for an accountant to be an expert in the audit work.
AUDIT AND INVESTIGATIONS
There is a lot of difference between auditing and investigation which is as follows:
1. Audit is conducted to find out whether the balance sheet is properly drawn up and exhibits a true and fair view of the state of affairs of the business while investigation means a searching enquiry with certain object in view, e.g.; to find out the profit earning capacity, or the financial position of a concern or a fraud and the extent thereof.
2. Investigation covers several years, say, 3, 5, and 7 years to find out the average earning capacity, financial position, etc. of a concern while audit usually relates to one year.
3. Investigation may be carried out on behalf of outsiders who either want to purchase the business, to become partners, to advance loans or to purchase the shares of a firm. Audit is always conducted on behalf of shareholders only. However investigation may also be carried out on behalf of shareholders in case fraud is suspected.
4. Audited accounts are further investigated for some special purpose in view while investigated accounts are not audited in the ordinary course.
5. Audit is legally compulsory, especially in case of companies, but investigation is voluntary and depends upon the necessity of some purpose in view.
CLASSIFICATION OF AUDIT
Audit may be classified into two categories (a) according to types; and (b) according to approach.
Classifying audit according to types means according to the nature or requirement of the audit. These are as follows:
1. Statutory Audit
These are audits that are conducted under the statutory framework. The scope of the audit is determined under statute and no restriction is expected to be placed. Example of audit under this category is the audit of limited liability companies. The Company and Allied Matter Acts (CAMA) mandated that all companies must have their account audited regularly and also state the scope and guidelines for such audit.
2. Private Audit
There are usually performed by sole traders, partnership, clubs, societies, Churches, mosques etc. the work to be performed by the auditor is not regulated by the statute. It is the type of audit that is summoned at the instance of the client and conducted to the extent of agreement between the auditor and the client. A report will be prepared by the Auditor at the end of the assignment.
3. Internal Audit
An internal audit is an independent appraisal activity within an organization, set up for the review of operations as a service to management. It is a form of management control which functions by measuring and evaluating the effectiveness of other controls. The nature of work requires an element of independence although not to the extent of those of external auditors.
4. External Audit
These are those audits carried out by independent persons who are not in the employment of the enterprise. The principal purpose of such an audit is to report the true and fairness view shown by the financial statement of an enterprise.
5. Management Audit
This is an enquiring into the effectiveness of any of the policies of the directors in furthering the objectives of the Company as defined in the memorandum and article of association and also into the efficiency with which they are securing the execution of those policies.
According to Approach
Classifying audit according to approach means looking at audit from the perspectives of the manner at which it is conducted. These are as follows:-
1. Continuous Audit or Detailed Audit.
2. Final Audit or complete Audit.
3. Interim Audit.
4. Occasional Audit.
5. Partial Audit.
6. Balance Sheet Audit.
1. Continuous Audit or Detailed Audit:
According to Spicer and Pegler “A continuous Audit is one where the auditors staff is occupied continuously on the accounts the whole year round, or where the auditor attends at intervals, fixed or otherwise, during the financial year. Thus, a continuous audit involves the conducting of audit of accounts throughout the year at regular intervals, fixed or otherwise, of say, one month or months. The accounts in such a case are subjected to audit as and when they are prepared. Such an audit is necessary only for big business houses.
Continuous Audit is applicable in case of following business concerns:
(i) Where final accounts are prepared just after the close of the financial year, as in the case of a bank.
(ii) Where the transactions are many in number and thus it becomes necessary to get them audited at regular intervals.
(iii) Where the system of internal check in operation is not satisfactory.
(iv) Where the statements of accounts are prepared after every month or quarter to be presented to the management.
(v) Where sales effected are very large.
Advantage of Continuous Audit:
i. Easy and quick discovery of Errors and frauds: Errors and frauds can be discovered easily and quickly as the auditor checks the accounts at regular intervals and in details.
ii. Helps the auditor in making valuable suggestions: since the auditor remains more in touch with the business, he is in a position to know the technical details of it and hence can be of great help to his clients by making valuable suggestions.
iii. Quick presentations of accounts: As the checking work is already performed during the year, the final audited accounts can be presented to the shareholders soon after the close of the financial year at the annual general meeting.
iv. Make the client’s staff to regularly update the books: As the auditor visits the clients at regular intervals, the staff of the organization will be very regular in keeping the accounts up-to-date.
v. Moral check on the client’s staff: If the auditor pays surprise visits, it will have a considerable moral check on the staffs preparing the accounts.
vi. Efficient Audit: As the auditor has more time at his disposal, he can check the accounts with greater attention and in detail and his work will be more efficient.
vii. Preparation of Interim Accounts: If the directors of a company wish to declare an interim dividend. Continuous audit will help in the preparation of the interim accounts without much delay,
viii. Audit staff can be kept busy: The audit staff may be sent to other clients after having finished the work for one client and thus can be kept busy throughout the year.
i. Alteration of figures: Figures in the books of account which have already been checked by the auditor at his previous visit, may be altered by a dishonest staff to defraud the organization.
ii. Interruption of client’s work: As the auditor visits frequently, it may interrupt the work of his client and cause inconvenience to the latter.
iii. Expensive: It is an expensive system of audit as such an audit is carried on throughout the financial year at regular intervals.
iv. Queries may remain outstanding: As there may be a long interval between the two visits, the audit clerk may lose the link between the past and present work and the queries which he wanted to-make may remain outstanding.
v. Mechanical work: Under such an audit, the work of the auditors becomes mechanical and his frequent visits may also cause boredom to him.
vi. Familiarization: The frequent visit of the audit staff may lead to too much familiarization and closeness among the audit firm’s staff and the client’s staff and this can affect the Auditor independence.
2. Final or Complete Audit:
This is a system under which the auditor takes up his work of checking the books of account and other related documents, only at the end of the accounting period when the transactions for the whole period are completely recorded, balanced and financial statements have been prepared. The Auditor would complete his audit work in one continuous session or without any interval, In other words the auditor visits his client only once a year and goes on checking the accounts and other related documents until the audit work for the whole of the period is completed.
i. The work of audit does not present any inconvenience and interruption in the work of the client as the auditor comes only once a year.
ii. It is less expensive and more useful for small business concerns than continuous audit.
iii. In final audit the work of the auditor can be finished quickly and within a reasonable time.
iv. The audit work does not become mechanical for the auditor.
v. Undue collusion is not established between the auditor and the client’s staff.
i. In final audit, detailed checking of accounts is not possible.
ii. There is a greater chance of errors and frauds in accounts as the auditor visits his client only once a year and not at regular intervals.
iii. If such an audit is undertaken in large concerns it takes more time to complete the audit and hence presentation of auditor’s report to the shareholders is delayed. But shareholders are usually very anxious for the dividends which cannot be declared until the final accounts have been prepared and audited. Therefore, such an audit is not practicable for big concerns.
3. Interim Audit:
Interim audit is one which is conducted in between the two annual audits for some interim purpose, say, to enable a company to declare an interim dividend. This kind of audit involves a complete checking of the accounts prepared by a company for a part of the year to the date set for interim accounts, say, quarterly or half-yearly accounts.
i. This audit is helpful when the publication of interim figures becomes necessary.
ii. With interim audit, the final audit can be completed easily and within short period of time.
iii. Errors and frauds can be more quickly found and detected during the course of the year.
iv. Since the interim audit is performed during the course of a year, it helps in exercising moral check on the staff of the client.
i. There is greater possibility of altering figures in the accounts which have already been audited.
ii. Interim audit involves additional work as the audit staff will have to prepare notes after the conclusion of the interim audit.
4. Occasional Audit:
An audit which is conducted occasionally, that is, once a while whenever the need arises and the client desires it to be undertaken. For instance, the audit is not compulsory in case of sole proprietorship and partnership business but whenever the need arises, the owners can get the accounts audited.
5. Partial audit:
Under partial audit, an auditor is asked to check some of the records and books for a part or whole of the period. For example, auditor may be instructed to audit only the payment side of the cash book. Such an audit is not permitted in case of private or public limited companies.
6. Statement of Financial Position Audit:
Under such an audit, the auditor checks capital, reserves, assets and liabilities, etc., given in the Statement of financial position. Those items of Statement of profit or loss are also checked which have a bearing on the statement of financial position items. For example, the purchase of goods on credit will increase the liabilities to creditors, increase the stock and will be shown in the income statement as an increase in purchases and closing stock. So this item will have to be verified. This type of audit can be successful in those business concerns where efficient system of internal check and control is in operation.