Role and Origins of Audit Flashcards
Define an audit as per the Auditing Practices Board (APB).
An audit is an exercise whose objective is to enable auditors to express an opinion on whether financial statements give a true and fair view of the entity’s affairs for the period and have been properly prepared in accordance with the applicable reporting framework.
What are the two key components of ‘truth’ in the concept of ‘true and fair view’?
- Truth: Compliance with generally accepted accounting principles and standards, and correct extraction of accounts from the books.
- Fairness: Reflecting the commercial substance of transactions, meeting user expectations, and ensuring relevance, objectivity, and freedom from bias.
Why is an audit necessary under the concept of stewardship accounting?
An audit is necessary to provide credibility to reports and accounts prepared by managers on behalf of owners to ensure they:
1. Contain no errors.
2. Disclose fraud.
3. Provide relevant and reliable information.
4. Conform to regulations.
List the primary objective and three benefits of an audit.
Primary Objective: To enable the auditor to express an opinion on whether financial statements present a true and fair view.
Benefits:
1. Independent opinion boosts confidence in financial statements.
2. Facilitates decision-making for third parties, such as banks and investors.
3. Helps detect and prevent errors or fraud.
What are three limitations of an audit?
- Judgement-based decisions, such as materiality levels or risk assessment.
- Sampling of transactions instead of full coverage.
- Inability to guarantee fraud detection if management collusion occurs.
Differentiate between statutory and non-statutory audits.
Statutory audit: Mandated by law (e.g., Companies Act) for entities like public companies.
Non-statutory audit: Conducted voluntarily by entities (e.g., partnerships) to meet specific needs.
Outline the historical development of auditing prior to 1840.
Auditing existed in ancient civilizations (e.g., China, Egypt, Greece) for checking transactions. In medieval England, audits were used to ensure state revenues were properly accounted for. These early audits focused on fraud detection through transaction verification.
What major changes occurred in auditing during the period 1840s–1920s?
- Introduction of the Joint Stock Companies Act (1844) requiring company audits.
- Statutory audit and presentation of financial statements became mandatory under the Companies Act (1900).
- Auditors’ primary role focused on fraud detection and confirming solvency.
How did the focus of auditing evolve between 1920 and 1960?
The focus shifted from fraud detection to adding credibility to financial statements, driven by the growth of capital markets. Concepts like materiality, sampling, and reliance on internal controls emerged. Regulations like the Securities and Exchange Commission Act (1934) formalized these developments.
What advancements occurred in auditing from the 1960s to the 1990s?
- Introduction of risk-based auditing and analytical procedures.
- Increased reliance on computer auditing skills due to technological advancements.
- Expansion of audit firms into advisory services, making them multidisciplinary.
What triggered reforms in auditing after the 1990s?
A series of financial scandals (e.g., Enron, WorldCom) led to a crisis of confidence in auditors’ work. This resulted in:
1. Splitting of consulting and audit functions in major firms.
2. Increased emphasis on fraud detection and corporate governance.
3. Adoption of a business risk approach to auditing.
Explain the concept of the business risk approach in modern auditing.
The business risk approach focuses on identifying risks that could affect financial statements. By understanding the client’s business environment, auditors can assess significant risks and ensure timely reporting of relevant matters.
