LU 1 - Chapter 1: Introduction to Auditing Flashcards
What is principal-agent theory?
Shareholders (principals) rely on directors (agents) to manage their investment.
What is assertions?
When preparing financial statements, management (or directors) make various claims about the entity’s financial position, performance, and cash flows. These claims are known as assertions.
Different types of assertions
Assertions for transactions, events, and related disclosures and Assertions for account balances and related disclosures.
Assertions for transactions, events, and related disclosures (income/expenses) include?
- Occurrence – actually occurred (not fictitious) and replate to entity.
- Accuracy – correct amounts, disclosures appropriately measured and described.
- Cut-off – correct accounting period.
- Completeness – all recorded and included.
- Classification – proper amounts.
- Presentation – appropriately presented and described, disclosures clearly expressed.
Assertions for account balances and related disclosures (assets, liability, equity) include?
1) Existence – Exists (not fictitious).
2) Accuracy, valuation & allocation – Correct amounts, adjustments appropriate; disclosures appropriately measured and described.
3) Rights and obligations – Hold/controls ownership | Obliged party.
4) Completeness – All recorded and included.
5) Classification – Recorded in the appropriate account.
6) Presentation – Appropriately presented and described, disclosures clearly expressed.
What is the need for external auditors?
Since directors may have different motives (such as financial incentives or personal relationships) there is a risk they could misrepresent financial statements.
To build trust, companies use external audits. Independent auditors review financial statements and report to shareholders, ensuring the directors have fairly presented the company’s financial position.
How does External Audits Add Value?
- Promotes Good Corporate Governance – External auditors help ensure that financial information is accurate and reliable, supporting transparency and accountability in corporate governance.
- Encourages Safer Investments – By verifying financial statements and assessing a company’s future viability, auditors enhance confidence in investment and lending decisions.
- Supports Fair Tax Collection – An independent audit reassures tax authorities, reducing the need for government inspections and ensuring businesses pay their fair share, benefiting all taxpayers.
- Improves Financial Statement Accuracy – Audits detect and correct errors, strengthening the reliability of financial data and ensuring more accurate reporting.
History of External Auditing in South Africa
1927: The Chartered Accountants Designation (Private) Act introduced the CA(SA) title.
1951: The Public Accountants and Auditors Act created the Public Accountants and Auditors Board (PAAB) to regulate the profession.
2005: The Auditing Profession Act replaced PAAB with the Independent Regulatory Board for Auditors (IRBA), making auditing oversight more independent and government involved.
How does the financial statement help shareholders?
Financial statements help shareholders assess management, guide investor decisions, and assist banks in evaluating loan applications. However, since management prepares these statements using estimates and judgments, their accuracy needs verification.
What is the purpose of the an External Audit?
An external audit enhances confidence in financial statements by ensuring they fairly represent the company’s financial position under the relevant reporting framework (e.g., IFRS).
What does Auditor do?
- Evaluates financial information using auditing and accounting expertise.
- Collects evidence to provide reasonable assurance that statements are free from material misstatements.
- Assesses whether the company can continue operating (going concern evaluation), though future success cannot be guaranteed.
What is an Audit-process?
The audit process, governed by International Standards on Auditing (ISAs), aims to minimise audit risk (the chance of issuing an incorrect opinion). However, an audit does not guarantee error-free financial statements, as absolute assurance is impossible.
What is assurance from an External Audit?
An external audit provides reasonable assurance that financial statements are free from material misstatements. However, due to audit limitations, absolute assurance is not possible, meaning some errors or fraud may go undetected.
What is the nature of the financial reporting for management?
Financial statements rely on management’s judgment and estimates, such as:
* Useful lives of assets (e.g., property, plant, and equipment).
* Expected credit losses (impairment of debtors).
* Inventory adjustments (write-downs to net realizable value).
Since financial reporting involves subjective decisions, some level of uncertainty is unavoidable, limiting an audit’s ability to detect all misstatements.
What are the limitations of the audit procedures?
Auditors face practical and legal limitations in obtaining audit evidence to verify management’s claims in financial statements:
* Reliance on Management: Auditors depend on documentation and explanations from company directors. If this information is incorrect, incomplete, or misleading—intentionally or not—it can affect the auditor’s conclusions.
* Fraud Risks: Management fraud may involve sophisticated schemes to conceal wrongdoing. Auditors are not forensic experts and may not always detect falsified documents.
What is timeliness, cost and limitations of an audit?
Auditors must balance time, cost, and reliability when conducting an audit:
* Time Constraints: Users expect financial statements to be audited promptly. Delays reduce their relevance, but time pressure limits how much audit work can be done.
* Cost vs. Benefit: Obtaining audit evidence can be costly. Auditors must weigh the cost against its reliability and usefulness. For example, if a debtor in a remote area cannot be reached, alternative verification methods may be needed.
* Sampling Approach: Auditors do not check every transaction but instead test a sample. This creates a risk that some fraud or errors may go undetected.
What is an Assurance Engagement?
An assurance engagement is when an auditor gives an opinion to boost users’ confidence in financial or non-financial information.
What are the 5 elements in an aussurance engagement?
- Three-party relationship
–>Practitioner: Auditor or reviewer appointed by shareholders.
–> Responsible party: Management preparing the information.
–> Intended users: Shareholders, investors, or other stakeholders. - Subject matter: What are they asking you to work with? (e.g., financial statements, internal controls, corporate governance).
- Suitable criteria (IFRS standards and listed company) for measuring accuracy.
- Evidence: The auditor must gather enough reliable evidence to support their opinion.
- Assurance report: A written conclusion summarizing the assurance provided.
What is non-assurance engagement?
The practitioner does not express an opinion or provide any assurance on the information. These engagements focus on providing services (providing advice and support) without any formal evaluation of the information’s accuracy or fairness.
Example, compiling financial statements, consulting, business advisory services and estate planning services.
What is the definition of an external audit?
An external audit is a systematic process where an independent auditor gathers and evaluates evidence regarding the claims made in a company’s financial statements. The auditor assesses whether these claims align with established standards (like IFRS) and then communicates the results of this evaluation in a written report to the users of the financial statements.
4 different types of auditors?
- External auditor
- Internal auditor
- Government auditor
- Forensic auditor
What is an external auditor?
An external auditor works for an independent auditing firm and is not an employee of the company being audited. They provide an independent opinion on the fairness and accuracy of the company’s financial statements. Their work assures third-party users (e.g., investors, creditors) that the financial statements are reliable, which increases their confidence in using them for economic decisions.
What is an internal auditor?
An internal auditor is an employee (or an outsourced provider) of the company they are auditing. They provide objective assurance and consulting services to help improve the organization’s operations. Their focus is on evaluating and improving the effectiveness of the organization’s risk management, internal controls, and governance processes. They help ensure that internal controls are functioning effectively. The internal audit department typically reports to the audit committee, which consists of independent non-executive directors, to maintain independence.
What is government auditor?
A government auditor conducts audits of government departments at the local and national levels. Their primary objective is to enhance public confidence in the functioning and reporting of government entities. In South Africa, the government auditor is known as the Auditor-General. Their audits provide transparency and accountability regarding public sector financial activities.
What is a forenic auditor?
A forensic auditor investigates instances of fraud or fraudulent activities. They perform detailed investigations and typically issue a report that is used as evidence in legal proceedings. Forensic audits are often requested when there is suspicion of misconduct, and their findings are frequently used in court to support legal action.
What is professional body?
A profession is a job that requires specialized training, education, and adherence to strict ethical standards.
Each profession has a professional body that:
* Sets and evaluates exams to determine membership,
* Supports ongoing learning and development,
* Publishes professional journals or magazines,
* Provides networking opportunities,
* Issues a code of conduct for ethical behaviour, and
* Handles complaints and disciplinary actions.
What are some of the professional bodies in South Africa?
- The South African Institute of Chartered Accountants (SAICA)
- Independent Regulatory Board of Auditors (IRBA)
- Chartered Institute of Management Accountants (CIMA)
- Association of Chartered Certified Accountants (ACCA)
- South African Institute of Professional Accountants (SAIPA)
