Introduction to Auditing

and Assurance Services

History of Auditing

 Auditing is as old as accounting

 Signs of its existence in all ancient culture
 Purpose in olden days of audits was to gain information about the financial
system and records of the business
 Today, auditing has begun to include non-financial subject areas such as
safety, security, information system performance and environmental
concerns.
Origin of Audit

The term audit is derived form the Latin term “ audire” which means to hear.

Olden days – whenever proprietors suspected a fraud or error, certain people

were appointed to hear verbal evidence of transaction.
Auditing can be traced back to the 18th century, when the
practice of large scale production developed as a result of
the Industrial Revolution
A royal charter incorporated the Institute of Chartered
Accountants in England and Wales on May 11, 1880.
January 1923 – The British Association of Accountants and
Auditors got established, and a person could be fully
competent to work as a professional auditor after clearing
the exam.
Demand for audit and assurance services

 Financial statement users include investors, suppliers, customer, lender,

employees, governments and the general public
 These users demand audited financial statements because of their
remoteness from the entity, accounting complexity, their incentives
competing with those of entity’s managers, and their need for reliable
information on which to base decisions.
 Theories used to describe the demand for audit and assurance services are
a. Agency theory
b. Information hypothesis and
c. Insurance hypothesis

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Agency theory

 Agency theory attempts to explain and resolve disputes over priorities between
principals and their agents.
 Principals rely on agents to execute certain transactions, particularly financial,
resulting in a difference in agreement on priorities and methods.
 The difference in priorities and interests between agents and principals is known
as the principal-agent problem.
 Resolving the differences in expectations is called "reducing agency loss."
 Performance-based compensation is one way that is used to achieve a balance
between principal and agent.
 Common principal-agent relationships included in agency theory include
shareholders and management, financial planners and their clients, and lessees
and lessors.
 https://www.investopedia.com/terms/a/agencytheory
Information hypothesis
 Under the information hypothesis, audit services are demanded to reduce the
information risk to users of financial statements. Information risk is the risk
that user decisions may be based on incorrect information. Thus, auditors are
demanded to reduce losses due to faulty decisions resulting from errors or
irregularities in the financial statements.
https://canmedia.mheducation.ca/istudy3/
Insurance hypothesis
 The insurance hypothesis predicts that auditors are demanded so that they
may be sued in case there is a business failure or investors incur losses from
inaccuracies in the financial statements. Auditing thus provides investors a
form of insurance. If an investor purchases securities on the basis of audited
financial statements and subsequently sustains losses, the law provides some
degree of recourse against the auditor. In this way, the auditor can,
depending on how the court’s reasoning works, function as an indemnifier
against investment losses. http://canmedia.mcgrawhill.ca/college/olcsupport
Review

A theory which states that managers won’t work for the owners is ___

Agency theory
Review

The theory that states that audit is conducted to reduce the information risks of
the users of the information is
information hypothesis
Review

The theory stating that investors and creditors demand an audit to be prudent
and to insure against losses

Insurance hypothesis
Philosophy of an Audit

 Financial statements would remain as mere reports of an entity on itself

without much credibility until an independent auditor attest to the fairness,
integrity and authenticity of the data contained therein
 Users are assured of reliable information not resulting from
misrepresentation, irregularities, illegal acts, fraud or error.
 Financial statements attested by independent auditor would allow users to
make well informed decisions.
Definition of Auditing

 American Accounting Association (AAA)

Auditing – a systematic process by which a competent, independent person
objectively obtains and evaluates evidence regarding assertions about
economic actions and events to ascertain the degree of correspondence
between those assertions and established criteria and communicating the
results to interested users.

Financial statement assertions, or management assertions, are a company's

official statement that the figures the company is reporting are accurate. ...
Companies must attest to assertions of existence, completeness, rights and
obligations, accuracy and valuation, and presentation and disclosure.
Definition of Auditing
 International Federation of Accountants (IFAC)
Auditing – a structured process involving the application of analytical skill,
professional judgment and professional skepticism, using appropriate forms of
technology and adhering to a methodology, in compliance with relevant technical
standards and required standards of professional ethics.

Professional scepticism is an attitude that includes a questioning mind, being

alert to conditions which may indicate possible misstatement due to error or
fraud, and a critical assessment of audit evidence.
 Auditing is defined as the on-site verification activity, such as inspection or
examination, of a process or quality system, to ensure compliance to
requirements. An audit can apply to an entire organization or might be
specific to a function, process, or production step. Some audits have special
administrative purposes, such as auditing documents, risk, or performance, or
following up on completed corrective actions. https://asq.org/quality-
resources/auditing
Auditing

 Galanza, 2015

 Auditing is the critical and logical process by which a qualified practitioner

examines and evaluates an entity’s financial statements and relevant
accounting data, documents, and records to enable him to express an opinion
on the fairness of the presentation of the financials statements in accordance
with generally accepted accounting principles.
 Auditing is the independent verification of accounting information to
determine adherence to accounting principles and evaluate the accuracy and
reliability of financial statements and reports.
International Standard of Auditing (ISA)
An audit is the independent examination of financial statement or related
information of an entity, whether profit oriented or not, and irrespective of its
size, or legal form, when such an examination is conducted with a view to
expressing an opinion thereon.
International Standards on Auditing (ISA) are professional standards for the
auditing of financial information. These standards are issued by the International
Federation of Accountants (IFAC) through the International Auditing and
Assurance Standards Board (IAASB).
Objectives of Auditing

Framework of the Philippine Standards on Auditing (PSA 120) – The objective of

auditing is to enable the auditor to express and opinion whether the financial
statements are prepared in all material respects in accordance with an
applicable financial reporting framework
Review

______________a systematic process by which a competent, independent person

objectively obtains and evaluates evidence regarding assertions about
economic actions and events to ascertain the degree of correspondence
between those assertions and established criteria and communicating the
results to interested users.

Auditing
Review

 Otherwise known as management assertions ____________

 Ans. Financial statement assertions,

Review
The Concepts of Assurance

Information to be useful to decision makers has to have the quality of

a. Credibility
b. Reliability

To give assurance to something is to give confidence or believability to it so that other people

could use it and add value to whatever purpose the decision maker intend to use it.

The concept of assurance is related to two other concepts

a. Attestation
b. Auditing

Ng, Auditing and Assurance Principles, Standards and fundamentals

 Assurance engagement” means an engagement in which a practitioner
expresses a conclusion designed to enhance the degree of confidence of the
intended users other than the responsible party about the outcome of the
evaluation or measurement of a subject matter against criteria.

 The objective of an assurance engagement is to obtain sufficient appropriate

evidence to express a conclusion, providing reasonable or limited assurance,
as to whether the audited body has complied with the specified requirements
of the appropriate legislation (the 'criteria') in all material respects.
http://www.cleanenergyregulator.gov.au/
 Attestation services occur when a practitioner is engaged to issue or issues a
report on a subject matter, or an assertion about a subject matter that is the
responsibility of another party
 The practitioner reports about the reasonableness of a subject mater often
termed as an assertion which are representations being made by a responsible
party. The attest function formalizes the reporting responsibility that is
inherent in an assurance services.