Advanced Auditing Process - Essay Example

Topic: A A C W Order 165044 Deadline: 2007-04-23 17:40 Time Left: 8 hours Style: APA Language Style: English UK Introduction: Auditing is the accumulation and evaluation of evidence about information to determine and report on the degree of correspondence between the information and established criteria. A competent, independent person should do auditing. To do audit, there must be information in a verifiable form and some standards (criteria) by which the auditor can evaluate the information. Information can and does take many forms. Auditors routinely perform audits of quantifiable information, including companies' financial statements and individuals' federal income tax returns. Auditors also perform audits of more subjective information, such as the effectiveness of computer systems, the efficiency of manufacturing operations and also some others such as social audit and environment audit1. An illustration about auditing is given below: Figure-1: Audit of a Tax Return In this figure summarizes the important ideas in the description of auditing by illustrating an audit of an individual's tax return was prepared in a manner consistent with the requirements of the federal internal revenue code. To accomplish the objective, the agent examines supporting records provided by the taxpayer and from other sources, such as the taxpayer's employer. After completing the audit, the internal revenue agent will issue a report to the taxpayer assessing additional taxes, advising that a refund is due, or stating that there is no change in the status of the tax return 2. Question one: Requirement 1: Social and environmental auditing: Environmental auditing is a key component of Environmental Policy. This process is a systematic, objective evaluation of facility operations and practices which is designed to: 1. Verify compliance with environmental regulations, internal policies, and accepted practices. 2. Evaluate the effectiveness of environmental management systems in place. The key findings of a UK survey carried out by the University of Dundee in 1995 under the title "The financial auditor and the environment" can be summarized as follows: - For most auditors "environment" is just another business issue and is treated no Differently from any other area of actual and potential risk. For a small minority, the moral dimensions and the longer-term implications of sustainability do suggest that environmental issues are qualitatively different from other matters. - UK businesses and their auditors generally face an uncertain environmental and legislative climate. It is often very difficult to assess from where the next major issue will emerge. - Most of the big auditing firms have initiated procedures within both their audit manuals/processes and within their training schedules. However, the majority of auditors do not perceive environmental issues as requiring special attention. They are simply part of knowing clients' businesses thoroughly. The International Auditing Practices Committee (IAPC) is finalising a draft of a proposed Practice Statement, which provides guidance for auditors on how to deal with environmental issues in auditing financial statements. Whereas an earlier IAPC draft had a wide scope covering also non-financial audit situations, the draft Practice Statement will probably restrict itself to financial audit issues under the headings (EAAR, 1996): - Consideration of environmental laws and regulations; - Knowledge of the business; - Risk assessments and internal control; - Detection risk/substantive procedures; - Using the work of others; - Management representations; - Reporting. Social audit: To achieve these Policy objectives the company operating affiliates will - Build relationships with people in the host country and especially with people indigenous to areas of operations or exploration. Work continuously to understand the culture and social patterns of the people in the host country and also work especially among the people who are indigenous to areas of operations or exploration. To accomplish this, the company and its affiliates will undertake social, cultural and medical studies. Consult with local populations about important operational issues that will impact their communities. Work with the host country government, the local people and responsible non-governmental organizations to create and periodically update social integration and/or sustainable development plans for all operational sites. These plans shall address the issue of economic and social viability of each operating area after cessation of operations 3. Provide for periodic outside, independent audits of the social and human rights performance of the company. Obey the laws and regulations of the host country with respect to employment practices. Adhere to applicable international standards of health and safety; Employ as many citizens of the host country as practicable and will, wherever practicable, employ people who are indigenous to the operational or exploration site; Provide training to citizens of the host country and especially to those indigenous to an operational or exploration area to prepare them for employment in the operation; Promote employees on the basis of their willingness and build their ability to perform the job without discriminating on the basis of race, creed, gender or national origin. However, special efforts will be made to train and hire people indigenous to each operational or exploration area4. HUMAN RIGHTS The company and its affiliates will: Educate employees about human rights; Notify all employees that the company requires them to treat employees and non-employees in and around areas of company operation with dignity and respect. Take appropriate action against any employee who violates the human rights of others. Report any credible accusation of a human rights violations to the appropriate government authorities and other agencies. Provide the company's full cooperation with any responsible human rights investigation and to support appropriate punishment for any proven violations. Protect all employees who report suspected human rights violations. Work proactively to create a constructive climate for promotion of human rights in all areas where it operates by implementing programs and policies aimed at building positive relationships, and by setting a good example; Do all in its power to make certain its property and/or any party in the violation of human rights does not use equipment 5. Question one: Requirement 2: Assurance services: Assurance services are independent professional services that improve the quality of information for decision makers. Individuals who are responsible for making business decisions seek assurance services to help improve the reliability and relevance of the information used as the basis for their decisions. Assurance services are valued because the assurance provider is independent and perceived as being unbiased with respect to the information examined 6. Assurance services can be performed by CPAs or by a variety of other professionals. For example, consumers union is a nonprofits organization that tests a wide variety of products used by consumers and reports their evaluations of the quality of the products tested in consumer reports. This information provided in consumer reports is intended to help consumers make intelligent decisions about the products they buy. The information provided in consumer reports is considered more reliable by many consumers than information provided by the product manufactures because consumers union is independent of the product manufacturers. Other examples of assurances provided by firms other than CPAs include the Nielsen television ratings and arbitral radio ratings. The need for assurance is not new. CPAs have provided many assurance services for years, particularly assurances about historical financial statement information. CPA firms have also performed assurance services related to lotteries and contests to provide assurance that winners were determined in an unbiased fashion in accordance with contest rules. More recently, CPAs have been expanding the types of assurance services they perform to include engagements that provide assurance about web site controls. The demand for assurance services is expected to grow as the demand for forward-looking information increases and as more real-time information becomes available through the Internet 7. One category of assurance services provided by CPAs is attestation services. An attestation service is a type of assurance service in which the CPA firm issues a written communication that expresses a conclusion about the reliability of a written assertion of another party. There are three categories of attestation services: audit of historical financial statements, review of historical financial statements, and other attestations services. Audit of historical financial statements: An audit of historical financial statements is a form of attestation service in which the auditor issues a written report expressing an opinion about whether they financial statements are in material conformity with generally accepted accounting principles. Audits represent the predominant form of assurance performed by CPA firms. When presenting information in the form of financial statements, the clients makes various assertions about its financial condition and results of operations. External users, who rely those financial statements to make business decisions look to the auditor's report as an indication of the statements' reliability, they value the auditor's assurance because of the auditor's independence from the client and knowledge of financial statement reporting matters 8. Review of historical financial statements: A review of historical financial statements are another type of attestation service performed by CPAs many nonpublic companies want to provide assurance on their financial statements, without incurring the cost of an audit. Whereas an audit provides a high level of assurance, a review service provides a moderate amount of assurance on the financial statements, and less evidence is necessary to support this level of assurance .a review is often adequate to meet users' needs and can be provided by the CPA firm at a much lower fee than an audit. Other attestation services: CPAs provide numerous other attestation services. Many of these services are a natural extension of the audit of historical financial statements, as users seek independent assurances about other types of information. For example, banks often require debtors to engage CPAs to provide assurance about the debtor's compliance with certain financial covenant provisions stated in the loan agreement. CPAs also provide assurance about the effectiveness of a client's internal controls over financial reporting. The information about the effectiveness of a client's internal controls over financial reporting is very essential. The information about internal controls is closely related to the financial statements, but it is also forward-looking because effective internal controls reduce the likelihood of future misstatements in the financial statements. CPAs also can attest to the information in a client's forecasted financial statements, which are often used to obtain financing 9. Statutory audit: Although the Fourth and Seventh Directives require annual and consolidated accounts to be audited by a qualified professional, the Directives do not contain a definition of the statutory audit. Similarly, the Bank Accounts and Insurance Accounts Directives require a statutory audit without defining what this means. According to the definition adopted by the IFAC 10, the objective of an audit is to enable the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an identified financial reporting framework. Numerous studies have shown that there are considerable differences between what the public expects from an audit and what the auditing profession believes that the auditor should do. The expectation gap resulting from this is a major problem for auditors since the greater the gap in expectations; the lower is the credibility and prestige associated with their work. It is an issue for the public at large, because the proper functioning of a market economy depends heavily on confidence in audited financial statements. Any definition of the statutory audit should consider the needs and the expectations of users to the extent that they are reasonable, as well as the ability of the statutory auditor to respond to those needs and expectations. As far as the needs and expectations of users are concerned, they can be considered Reasonable if: - Law has prescribed the tasks, - There are stakeholders who are willing to pay for the service (i.e. there is an effective demand). - There exists a statutory auditor who is willing to supply the service (for a price which reflects notably his level of qualification, the difficulty of the task, the number of hours and the risk involved) and is competent to do so. What statutory auditors can supply will depend not only on what clients are willing to pay for, but also on the auditors' technical skills and attitude to risk. Some of the demands placed on auditors may be unreasonable in that auditors cannot be expected to possess the skills necessary to do the work. The public expects the statutory auditor to have a role in protecting the interests of shareholders, creditors (e.g. suppliers, banks and credit institutions), pensioners, employees and the public generally by providing them with reassurances concerning 11: - The accuracy of financial statements - The going concern status / solvency of the company - The existence of fraud - The respect by the company of its legal obligations The responsible behavior of the company with regard to environmental and societal matters. The accuracy of financial statements: There seems to be a widely held view among users of financial statements, that an unqualified audit report guarantees the material accuracy of the financial statements 12. There are two misconceptions inherent in this expectation. The first is that it is possible to prepare financial statements that are "accurate" and the second is that the financial statements are the responsibility of the auditor. The going concern status / solvency of the company: Several surveys have shown that there is an expectation on the part of a significant proportion of the general public that the statutory auditor's report guarantees the financial soundness of a company. Auditors have a duty to be alert to factors that may increase the company's financial strength or decrease its resources, thus allowing them to assess whether the going concern basis is appropriate. They should warn the directors or supervisory board as soon as they become aware of matters that may threaten the going concern basis. Acceptance of the going concern basis implies solvency, that is, that at the balance sheet date the company's position was such that it would have been able to meet its liabilities in full as they fell due. Users expect the audit report to contain the auditor's opinion on solvency where the going concern basis is accepted. The existence of fraud: Audits have traditionally been associated with the detection of fraud. A survey carried out in the UK in 1989 found that 75% of the general public, including the majority of financially knowledgeable people, think that it is the statutory auditor's responsibility to detect fraud of all kinds. The same survey found that 61% of the general public thinks that it is the responsibility of the auditor actively to search for fraud. Regulatory bodies in a number of Member States have issued auditing guidelines related to the statutory auditor's responsibility in relation to fraud, other irregularities and errors. The guidelines specify the respective responsibilities of management and of the auditor. Management has primary responsibility for the detection of fraud, other irregularities and errors. This responsibility is seen as part of management's stewardship role. The auditor's responsibility is to plan, perform and evaluate his audit work so as to have a reasonable expectation of detecting material misstatements in the accounts, whether they are caused by fraud, other irregularities or errors 13. The guidelines recommend that if, during the course of the audit, the statutory auditor begins to suspect fraudulent activity, and he has a responsibility to investigate until his suspicions are either allayed or confirmed. The respect by the company of its legal obligations: It appears to be the general view that it is the auditor's duty to detect contravention of company law or of statutory regulations, which specifically relate to company law. The auditor cannot however be reasonably expected to report on matters beyond his competence or expertise, especially in today's complex legal environment. Responsible behavior by the company with regard to environmental and societal matters: Although it is unreasonable to expect the statutory auditor to make judgments on matters outside his competence and expertise, it can be argued that auditors should accept that their responsibilities would tend to increase in line with public expectations. The auditor can, given time and a sufficiently clear consensus on what is expected, avail him of the necessary expertise in are as which go beyond strict financial audit. Identification of the types of impediments that auditors are likely to face when undertaking these audits: Market Challenges: 1 - Weak rule of law 2 - Corruption in the bureaucracy 3 - Ignorance of best commercial practices in the government and private sectors 4 - Lack of transparency in regulatory and legislative processes 5 - Some abuse of phyto-sanitary and licensing regimes in both the pharmaceutical and food production industries to protect existing state and private interests Etc. Except these, auditors may face lack of independency, which may create hindrance in doing their tasks fairly 14. Question two: Requirement 1: The auditor must be qualified to understand the criteria used and must be competent to know the types and amount of evidence to accumulate to reach the proper conclusion after the evidence has been examined. The auditor must also have an independent mental attitude. The competence of the individual performing the audit is of little value if he or she is biased in the accumulation and evaluation of evidence. Auditors reporting on company financial statements are often called independent auditors. Even though a company pays an auditor of published financial statements a fee, he or she is normally sufficiently independent to conduct audits that can be relied on by users. Although absolute independence is impossible, auditors strive to maintain a high level of independence to keep the confidence of users relying on their reports. Although internal auditors work for the company, they usually report directly to top management to help maintain independence from the operating units being audited 15. To operate effectively, an internal auditor must be independent of the line functions in an organization, but he or she cannot be independent of the entity, as an employer-employee relationship exists. Internal auditors provide management with valuable information for making decisions concerning effective operation of its business. Users from outside the entity are unlikely to want to rely on information verified solely by internal auditors because of their lack of independence. The value of auditing depends heavily on the public's perception of the independence of auditors. Independence in auditing means taking an unbiased viewpoint in the performance of audit tests, the evaluation of the results, and the issuance of the audit report. If the auditor is an advocate for the client, a banker, or anyone else, he or she cannot be considered independent. Independence must certainly be regarded as the auditor's most critical characteristic. The reason that many diverse users are willing to rely on the CPA's reports as to the fairness of financial statements is their expectation of an unbiased viewpoint. It is not surprising that independence is included as a generally accepted auditing standard and a rule of conduct. CPA firms are required to be independent for certain services that they provide, but not for others. The last phase in rule 10116,"as required by standards promulgated by bodies designed by council" a convenient way for the AICPA to include including or excluding independence requirements for different types of services. For example, the Auditing Standards Board requires that auditors of historical financial statements be independent. Rule 101 therefore applies to audits. Independence is also required for other types of attestations, such as review services and audits of prospective financial statements. However, a CPA firm can do tax returns and provide management services without being independent. Rules 101 do not apply to those types of services. Not only is it essential for auditors to maintain an independent attitude in fulfilling their responsibilities, but also it is also important that the users of financial statements have confidence in that independence. These two objectives are often identified as independence in fact and independence in appearance. Independence in fact exists when the auditor is actually able to maintain an unbiased attitude throughout the audit, whereas, independence in appearance is the result of others' interpretations of this independence. If auditors are independent in fact, but users believe them to be advocates for the client, most of the value of the audit function will be lost. Although it is possible to take the extreme position that anything affecting either independence in fact or in appearance must be eliminated to ensure a high level of respect in the community, it is doubtful whether this would solve as many problems as it would create. The difficulty with this position is that it is likely to significantly restrict the services offered to clients, the freedom of CPAs to practice in the traditional manner, and the ability of CPA firms to hire competent staff. At this point it will be helpful to examine some conflicts of independence that have arisen within the profession, evaluate their significance, and determine how the profession has resolved them. The profession deals with most independence issues through interpretations of the Rules of conduct. There are more interpretations for independence than for independence than for any of the other rules. Lavin 17 noted that the value of auditors to the business community lies not only in their competence in accounting and auditing, but also in their freedom from allegiance to management. The auditors' role has added significance as they act as representatives of third parties, who for one reason or another, may wish to examine the financial statements. Blough (1960) observed that an auditor need not only act but should also be seen to act independently. Mautz et al (1985)18 described an auditor's independence on two dimensions practicing independence and professional independence. The former refers to the ability of the auditor to be objective when planning the audit, when carrying out the verifications, and finally when preparing the reports. On the other hand, professional independence reflects the image of the auditor whether he/she is perceived to be a professional or merely acts as a worker of the client. Similar sentiments were expressed by Noordin (1990) who indicated that the auditor's have independent deals with the actual and perceived ability of their activity with integrity and objectivity. The Accountants' Guide 19 defines independence to be an attitude of mind characterized by integrity and an objective approach to professional work. Auditors' independence is not a new issue and many investigations regarding an auditor's independence have been carried out in developed countries (Firth, 1978, 1980; Estes and Reimer, 1977; Lavin, 1977; Imhoff, 1978; Dykxhoorn and Sinning, 1981). Requirement 2: Independence and ethical behavior are very much related; an auditor's conduct could determine whether or not he/she is "seen" or "perceived" to be independent. Independence has been traditionally viewed as the cornerstone of the public accounting profession, it being one of the fundamental principles underlying the auditor's work. According to my point of view, auditors have to be independent. If they are not independent, their tasks are not fairly performed. For example, an auditor of a particular company is also managing director of that firm. In this situation, the auditor will show the financial statements of the company are fairly presented by the company to encourage the investors to invest in this company. But in fact, the financial statements are showed as window -dressing. It can create two types of impacts on outsiders. One outsider will be interested to invest in that company. Another is, outsiders do not believe as auditors are their own people and a negative impact will be created on the people's mind14. References: 1. Arens Alvin, A. James, K. Leobbecke, "Auditing", 8th ed., Prentice Hall 2000, p.2-3, 9-10, 86-88. 2006. 2. Hill, R. A., Financial Management: An Active Approach (Part B), Leicester Finance Study Group, 2007. 3. Pandey, I. M. Financial Management, 8th ed. 2001, Vikas Publishing House Pvt. Ltd, p. 676, 808-876, 4. Khan. M. Y. & Jain P.K.," Financial Management", 2nd ed. 1999, Tata McGraw-hill Publishing Company Limited, New Delhi, p.9-12, 22-23, 317-346. Read More