Nature, meaning of auditing, types and importance to the business world

Meaning of auditing
Auditing refers to a systematic and independent
examination of books, accounts, documents and vouchers of an organization to
ascertain how far the financial statements present a true and fair view of the
concern. It also attempts to ensure that the books of accounts are properly
maintained by the concern as required by law. Auditing has become such an
ubiquitous phenomenon in the corporate and the public sector that academics
started identifying an “Audit Society”. The auditor
perceives and recognizes the propositions before him/her for examination,
obtains evidence, evaluates the same and formulates an opinion on the basis of
his judgment which is communicated through his audit report.

Any subject matter may be audited. Audits
provide third party assurance to various stakeholders that the subject matter
is free from material misstatement. The term is most frequently applied to
audits of the financial information relating to a legal person. Other areas
which are commonly audited include: internal controls, quality management,
project management, water management, and energy conservation. As a result of
an audit, stakeholders may effectively evaluate and improve the effectiveness
of risk management, control, and the governance process over the subject matter
Nature of auditing
The
nature of auditing related to the auditors choices about the type of evidence
that they collect. The nature of auditing can be classified into three:
1.     
Risks assessment: The
auditor assess the risk of material in an assertion, whether performed early in
the audit engagement or in the response to new information. Recall that the
auditor uses risk assessment procedures to obtain evidence about inherent risks
and the risk of fraud.
2.     
Test of control: This
is designed to provide evidence about the operating effectiveness of various
aspect of internal control. Tests of control provide evidence to support
control risk assessment below the maximum.
3.     
Substantive assessment:
This is to
provide evidence about to fair presentation of
management’s assertions in the financial statements. Substantive test include:
·        
Initial procedures
that involve understanding the economic substance of the account balance or
transaction being audited and agreeing on detailed information about an account
to general ledger (such as comparing an accounts receivable subsidiary ledger
to the general ledger).
·        
Substantive analytic procedures
that involve the use of comparisons to assess the fairness of an assertion. For
example, the auditor might evaluate sales per square foot or retail space in
testing the reasonableness of revenues.
·        
Test of detail transactions
that involve examining documentary support for transactions. For example, an
auditor might inspect sales orders and a bill of landing behind a recorded
sales invoice.
·        
Test of details of balance
that involved examining support for a general ledger balance. For example, the
auditor might send confirmations to customers to obtain an evidence that they
owe receivables.
·        
Test of detail accounting estimates
that involve obtaining evidence in support of the client’s estimations process
and ensuring that the estimation process is applied consistently from period to
period.
·        
Test of details of disclosures
that involve examining support for financial statement disclosures. For
example, the auditor might read a loan contract to ascertain the maturity
schedule and debt covenants for the loan
Types of auditing
The
main types of auditing include:

External audit

External
audit, also known as financial audit
and statutory audit
, involves the examination of the truth and fairness
of the financial statements of an entity by an external auditor who is independent of the organization
in accordance with a reporting framework. The need for an external audit
primarily stems from the separation of ownership and control in large companies
in which shareholders nominate directors to run the affairs of the company on
their behalf. As the directors report on the financial performance and position
of the company, shareholders need assurance over the accuracy of the financial
statements before placing any reliance on them.

 

Internal audit

Internal
audit, also referred as operational
audit
, is a voluntary appraisal activity undertaken by an organization
to provide assurance over the effectiveness of internal controls, risk
management and governance to facilitate the achievement of organizational
objectives. Internal audit is performed by employees of the organization who
report to the audit committee of the board of directors as opposed to external
audit which is carried out by professionals independent of the organization and
who report to the shareholders via audit report.
Internal
audit is typically centered around certain key activities which include:
  • Monitoring the effectiveness of internal
    controls and proposing improvements
  • Investigating instances of fraud and theft
  • Monitoring compliance with laws and regulations
  • Reviewing and verifying where necessary the financial and operating
    information
  • Evaluating risk management policies and
    procedures of the company
  • Examining the effectiveness, efficiency and
    economy of operations and processes

 

Forensic Audit

Forensic
audit involves the use of auditing and investigative skills to situations that
may involve legal implications. Forensic audits may be required in the
following instances:
  • Fraud investigations involving
    misappropriation of funds, money laundering, tax evasion and insider
    trading
  • Quantification of loss in case of insurance
    claims
  • Determination of the profit share of business
    partners in case of a dispute
  • Determination of claims of professional
    negligence relating to the accountancy profession
Findings
of a forensic audit could be used in the court of law as expert opinion on
financial matters.

 

Public Sector Audit

State
owned companies and institutions are required by law in several jurisdictions
to have their affairs examined by a public sector auditor. In many countries,
public sector audits are conducted under the supervision of the auditor general
which is an institute responsible for strengthening public sector
accountability and governance and promoting transparency.
Public
sector audit involves the scrutiny of the financial affairs of the state owned
enterprises to assess whether they have been operated in way which is in the
best interest of the public and whether standard procedures have been followed
to comply with the requirements in place to promote transparency and good
governance (e.g. public sector procurement rules). Public sector audit
therefore goes a step further than the financial audit of private organizations
which primarily focuses on the reliability of financial statements

 

Tax auditing

Tax
audits are conducted to assess the accuracy of the tax returns filed by a
company and are therefore used to determine the amount of any over or under
assessment of tax liability towards the tax authorities.
In
some jurisdictions, companies above a certain size are required to have tax
audits after regular intervals while in other jurisdictions random companies
are selected for tax audits through the operation of a balloting system.

 

Information system auditing

Information
system audit involves the assessment of the controls relevant to the IT
infrastructure within an organization. Information system audits may be
performed as part of the internal control assessment during internal or
external audit. Information system audit generally comprises of the evaluation
of the following aspects of information system:
·        
Design and internal controls of the system
·        
Information security and privacy
·        
Operational effectiveness and efficiency
·        
Information processing and data integrity
·        
System development standards

 

Environmental and social auditing

Environmental
and social audits involve the assessment of environmental and social footprints
that an organization leaves as a consequence of its economic activities. The
need for environmental auditing is increasing due to higher number of companies
providing environment and sustainability reports in their annual report
describing the impact of their business activities on the environment and
society and the initiatives taken by them to reduce any adverse consequences.
Environmental
auditing has provided a means for providing assurance on the accuracy of the
statements and claims made in such reports. If for example a company discloses
the level of CO2 emissions during a period in its sustainability
report, an environment auditor would verify the assertion by gathering relevant
audit evidence.

 

Compliance auditing

In
many countries, companies are required to conduct specific audit engagements
other than the statutory audit to comply with the requirements of particular
laws and regulations. Examples of such audits include:
·        
Verification of reserves available for distribution to shareholders
before the declaration of interim dividend
·        
Audit of the statement of assets and liabilities submitted by a company
at the time of liquidation
·        
Performance of cost audit of manufacturing companies to verify the cost
of production in order for a regulator to determine the maximum price to be
allowed after allowing a
reasonable profit margin
to companies operating in a sensitive sector
(e.g. pharmaceuticals industry)

 

Value for money auditing

Value
for money audits involves the assessment of the efficiency, effectiveness and
economy of an organization’s use of resources. Value for money audits are
increasingly relevant to sectors which do not have profit as their main
objective such as the public sector and charities. They are usually performed
as part of internal audit or public sector audit.
Importance of auditing to the business world
Auditing
is important to the business world in the following areas:
1.   
Detection of Errors:
The location and correction
of error is possible through auditing. The true and fair information about
business is made available through auditing.
2.   
Frauds are Discovered
The discovery of fraud is
possible through auditing. The guilty persons can be held responsible. The auditing
accounts show fair picture of the business.
3.   
Easy Management of Loans
Lenders rely on audited
account for granting loans acceptance of the auditor’s accounts. The reputation
of borrowers increases due to auditing. Thus audited accounts help the
businessman to expand his activities.
4.   
Advise about Weakness
Business owners and
managers seek advice from auditors. The auditors are professional and they know
their work very well. They can spotlight the grey area. It is the duty of the
business man to act upon the advice of the auditors.
5.   
High Moral Values
Auditing acts as a moral
check on the management and other staff. Auditing puts the pressure on the
staff of work honestly. There is no pending work so there are lesser chances of
errors and frauds.
6.   
Tax Payments
Tax authorities accept
audited accounts for assessment of taxes. There is no further inquiry or
investigation from department. The audited accounts lessen the worries of
business people.
References
Amat, O. (2008). Earnings management and audit adjustments: An empirical study of IBEX 35
constituents
. Luton: Gate Press.
Derek, M. (2010). History of
Auditing.
The changing audit process from the 19th century till date. London: Routledge-Taylor & Francis Group.
p. 6.
Gilbert, W. J. & Terry,
J. E. (2005).
“The Use of Control Self-Assessment by Independent Auditors”. The CPA
Journal 45 (10):
67-73
Ladda, R.L. (2008). Basic
Concepts Of Accounting
. Solapur: Laxmi Book Publication. p. 58.
Power, M. (1999). The Audit
Society: Rituals of Verification. Oxford: Oxford University Press.

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