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A BFA 3114 Principles of Auditing

T utorial 1- Introduction To Auditing

QUESTION 1
A) Companies:

In the case of companies, shareholders must of necessity place great reliance

upon a review of the accounts by an independent qualified auditor since they do
1) not have access to the books and records of the company and they are not
always familiar with the businesses in which they have an interest, nor indeed
with the accounting practices adopted => Agency theory=> Stewardship.

2) The audit ensures that the directors have fulfilled their statutory obligations under
Companies Act 2016.

Moreover, the audit act as a precaution against fraud on the part of employees. In
view of the independence check by external auditor, employees take care to make
3) fewer errors in performing accounting functions and less likely to misappropriate
company assets. Hence, company records are more reliable, reduces losses from
embezzlements and fraudulent reporting.

Additional benefits deriving include improvement of the company's internal control

4) and information systems, and possibly advice on improvement in standards of the
company's reporting to its members. (shareholders).
5) Where audited accounts are available this may make the accounts more
acceptable to the taxation authorities, i.e. by serving as a basis preparation for tax
return to IRB.
Facilitated major changes in ownership => especially when the past account
6) contain an unmodified opinions.
Unmodified opinions in the auditor's report will create creditability in the F/S for
7) the assessment of loan application.

B) Partnerships
Audited accounts in the case of a partnership provide a reliable basis for the
1) division of profits and for the setting of accounts between partners, reducing the
possibility of disputes and facilitating their settlement should they arise.

2) Audited accounts will assist in settling the partnership tax assessments.

3) Audited accounts provide a basis for negotiation in the case of an incoming

partner or the sale of the business.

4) On the death of a partner the total amount due to his estate should be more
readily determined and agreed, and the settlement of death duties facilitated.

In the special situation of a firm which has 'sleeping' partners, an audit is of

3) particular importance and advantage as such persons take no part in the
management of the business.

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C) Sole traders
Similar advantages accrue to the business of a sole trader, i.e. improvement of the
1) internal control system since there is a possibility of a breakdown in internal
control and accounting system.

An incidental but important advantage of an audit is that the professional firm of

2) accountants acting as auditors will be available to provide other services such as
advice and assistance on accounting, costing, management, taxation and
systems
problems.

QUESTION 2
(a)
Accounting:
Recording, classifying and summarizing of transaction in a systematic manner for
=> the purpose of providing financial information => economic / business decision
making.
Auditing:
A process of reviewing the transactions and balances of accounting records =>
=> express an audit opinion => true and fair view of the financial statements => All
material respect => In accordance with an identified financial framework.

(b)

the type of audit that he needs to do in compliance with Companies Act 2016 is
=>
Financial Statement Audit .
Overall financial statements are prepared according to the acceptable accounting
=>
principles.
=> Scope of audit:
5 components of Financial Statements : Statement of Financial Position,
i) Income Statement , Statement of Changes in shareholders' equity , cash
flow statement, notes to Financial Statements

Accounting system, internal control system and all the relevant

ii)
documentations.
=> Frequency : Once a financial year.

(c)

=> Agency theory.

Financial statement audit is mandatory for all the registered companies (private
=>
company and public company ) under Companies Act 2016.
=> The reason for making audit compulsory for the companies due to:
The existence of agency relationship between the shareholders (owners)
and directors (agents). In order to ensure that the financial statements are
i) drawn accurately, they employ auditors to check its reliability of financial
statements. The job of external auditors is to report whether the financial
statements prepared and presented by BOD shows True & Fair view.
By having this independence check the shareholders gain confidence in
ii)
terms of money is being handled properly.

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QUESTION 3
The solution is that the assurance Jane is seeking can be given by an independent audit
=>
or review of the financial statements by external auditor.
=> An auditor can provide the two things that Jane requires:
1) A knowledgeable review of the company’s business and of the accounts.
2) An impartial view, since Peter’s view might be biased.

QUESTION 4
a)
Similarities:
1) Approach :
=> Both internal audit and external audit uses risk based approach.

Differences:
1) Scope:
=> Internal audit covers all areas, including operation and finance functions
=> External audit covers mainly Financial statements.

2) Approach:
Internal audit uses Risk based approach => assess risk, evaluation on
=> control system, test on operations of system, makes recommendations for
improvement.

External audit uses Risk based approach => assess risk, test on business
=> transactions and balances that form the basis of the final financial
statement

3) Responsibility
Internal audit advises and makes recommendations on internal control
=> system and corporate governance.

External audit forms an audit opinion on financial statements prepared and

=> presented by BOD.

4) Objectives
Internal audit advises on how to protect organization against loss due to
=> weak internal control

External audit provides an audit opinion on financial statements whether

=> they present True & Fair view after reviewing all the material respects and
accordance to acceptable accounting principles.

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5) Legal

Internal audit is not a legal requirement , but recommended to have a good

=> internal control department for a good corporate governance practice.

External audit is a Legal requirement under Companies Act 2016 for all the
=> registered companies to have an audit on their financial statements.

b)
The focus of internal audit is on adding value to an organization through
1) improvements in controlling risk and looking at all types of risk and control in order
to achieve corporate objective , i.e. to maximize profits.
=> Example : Make recommendation on how to improve the work flow for "petty
cash".
It functions by examining, evaluating and reporting to management and the
2) directors on the adequacy and effectiveness of components of the accounting and
internal control systems
=>
Example : Report to BOD on the outcome of audit in Operation Department.

QUESTION 5
a)
1) Reasonable assurance means that auditor obtains HIGH degree of comfort
towards the financial statements that do not contain MATERIAL misstatement.

True is information is factual and conforms to the reality, not false. In addition the
2) information must conform to the required standards and laws. And, the accounts
have also been correctly extracted from the books and records.

Fair is information is free from discrimination and bias and in compliance with
3) expected standards and rules. The accounts should reflect the commercial
substance of the company's underlying transactions.
4) "True and fair" view implies that:
The financial statements comply with applicable financial reporting
i) framework. This includes the financial reporting standards whose purpose is
to narrow the areas of divergent opinion and practice in accounting.
ii) The financial statements is free from material misstatements.
iii) The financial statements is adequately disclosed and not misleading.
The financial statements is consistent with auditor’s understanding. The F/S
iv)
reflects the events or activities of the company during the year.

b)
1) Use of sampling testing.
Auditors use samples to test the transactions because it is impossible for
auditor to check every transaction. When applying sampling, there is always
=> a risk of taking the wrong samples. Hence, auditor may express
inappropriate audit opinion.

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2) Inherent limitations of internal control.

Even though the entity has a tight internal control system, there is always a
=> possibility of employee collusion, management overrides the control system
or human errors.

3) Audit evidence is persuasive, not conclusive.

Persuasive means giving evidence to believe; whereas, conclusive means
=>
100% correct or wrong.

Thus, auditor is not able to guarantee the financial statements is 100%

=> accurate.

4) Use of auditor judgment.

Auditors often use professional judgment to make decision where there is
=>
always a risk that the judgment may be inappropriate.

5) Limitations of the reporting framework

Auditor report given a fixed format which may not be understandable and
=>
readable by all the users.

6) Audit does not provide up-to-date position

The auditor's opinion given on the past information which may not be
=> relevant.

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