AUDITING AND TAXATION

BY
JEAN PAUL RUHORIMBERE
 PART ONE :AUDITING
Introduction
The explanatory foreword to the ISA
International Standards on Auditing describes
audit as the independent examination and
expression of an opinion on the financial
statements of an enterprise by an appointed
auditor.
 Con’t
The purpose of an audit is not to provide
additional information but rather it is intended
to provide the users of the accounts with
assurance that the information
provided/presented to them is reliable.
 Con’t
The word ‘audit’ when used, mean the
independent investigation into the quality of
published accounting information
 DISTINCTION BETWEEN AUDITING AND
ACCOUNTING
1. Auditing

Involves examination of financial statements

to prove the true and fair view of company’s
affairs.
It is done mainly at year-end after the
directors have prepared the financial
statements
 Con’t
An audit is mainly governed by the
international standards on auditing (ISA)
The auditor must be independent of all the
stakeholders such as management.
It is a statutory requirement that financial
statements are audited.
 Con’t
2. Accounting
• It Involves preparation of books of accounts to
aid in decision-making.
• It is a continuous process carried out through
out the financial period.
• In preparing financial statements and
maintaining books of accounts, the accountant is
guided by generally accepted accounting
standards.
 Con’t
• Accountancy is a management function aimed
at assisting management to run the business
in an orderly efficient manner.
• It is a statutory requirement that all
companies must maintain proper accounting
records.
 The need for an audit
Today most businesses are operated by limited
companies, which are owned by the
shareholders and managed by directors
appointed by such shareholders. The appointed
management is faced with a conflict of interest
 Con’t
i.e. whether to act in the best interest of the
company and by extension the shareholders’
interest or to act in their best interest. This is
what is referred to as the agency problem.
 Con’t
The separation that exists between the owners
and management forces the absentee owners to
institute control measures to ensure honesty of
their company’s stewards (i.e. management).  
 Con’t
The companies Act attempts to remedy this
problem by requiring the management to
maintain proper accounting records of all the
transactions of the company and to prepare
financial statements that show a true and fair
view to be presented to the shareholders at the
annual general meeting.
 Con’t
However, even with this requirement there still
exists the risk that the accounting records
maintained and the financial statements
prepared by management might not be
accurate, free from bias and reflect the true
financial position and performance of the
company.
 Con’t
The companies Act therefore goes further to
require that management must have the
financial statements subjected to an
independent examination and a report issued to
the shareholders as to whether the financial
statements show a true and fair view.
 Con’t
The auditor carries out this independent
examination. To ensure independence of the
auditor the companies Act gives the power of
appointment and removal of the auditor from
office to the shareholders.
 Objectives of an audit

The primary objective of an audit of financial

statements is to enable the auditor to express
an opinion whether the financial statements are
prepared in accordance with an identified
financial reporting framework  
 Con’t
The auditor expresses an opinion as to whether
the financial statements give a true and fair
view of the financial position and performance
of the company.
 Other objectives

• To give credibility to the financial statements.

• An audit may assist in the prevention and
detection of errors and frauds.
• The auditor’s experience will enable him to
make recommendations on ways of improving
the accounting and internal control system.
 What is true and fair?

The companies Act requires that all limited

liability companies’ appoint an auditor whose
task is to express an independent opinion as to
whether the financial statements prepared by
the directors show a true and fair view of the
financial performance and position of a
company.
 Con’t
What constitutes true and fair is not defined by
the Act. Previously the auditor was required to
certify as to the truth and correctness of
accounts, the phrase true and correct implying
arithmetic accuracy.
Such an approach ignored the overall view of
the accounts, which are prepared using
subjective accounting policies and would be
difficult to prove.
 Con’t
It is not possible to certify that one set of
accounts is the correct set, because many
accounting areas are subject to a wide variety of
interpretations and therefore presentation.
 Con’t
As a result the auditor is only required to
express an opinion as to whether the accounts
show a true and fair view of the state of affairs
of the company and of its profit or loss for the
period.
 Con’t
NOTE: The auditor only expresses an opinion on
the accounts. He does not certify them as being
correct.
Benefits of an audit to a public limited
company
– An audit protects the interests of the shareholders
who are separated from the management of the
company. This is especially the case for minority
shareholders who have little say in the
management of their company.
 Con’t
– An audit being an independent examination of the
financial statements gives credibility to the
financial statements. The various users can
therefore place reliance on them.
 Con’t
– The auditors experience will enable him to make
recommendations on ways of improving the
accounting and the internal control system.

– An audit assists in the prevention and detection of

errors and frauds through the moral and deterrent
effect
 USERS OF AUDITED FINANCIAL
STATEMENTS
The annual accounts and report are primarily
prepared by the directors to the shareholders.
However, the following parties need financial
statements.
1. Those parties with vested interests in a
business.
– Employees.
– Creditors or suppliers
– Lenders
– The management
2. Those with potential interests

• Potential shareholders
• Trustees
• Suppliers
• Customers
3. Those with representative interests

• The government
• The general public
• Lawyers
 TYPES OF AUDITS

Audits can be classified in two broad ways

according to: - 
a) Terms of engagements i.e. nature of work
done
b) Method of approach of work done.
 a) According to the terms of engagement-
nature of work done.
1. Statutory audits
These are carried out as per the requirements of
the various statutes e.g. the Companies which
requires that all public limited companies must
have their financial statements subjected to an
independent audit.
 Con’t
The objectives of the audit are to express an
opinion as to whether the balance sheet and the
profit and loss account show a true and fair
view.
 Con’t
2. Private audits
These are audits performed by an independent
auditor because the owners, members or other
interested parties require them and not because
the law requires them to be carried out.
 Con’t
Private audits are carried out for organizations
such as NGOs, partnerships, clubs and charities
among others. The appointment of the auditor
is usually carried out as a private contract
between the auditor and the relevant
stakeholder.
 Con’t
The scope and objective of the work is
determined by the agreed terms between the
auditor and the client.
 Comparison between private and statutory audits
SIMILARITIES
 
Both are carried out by qualified auditors.
2) They involve the assessment of the internal
control system.
3) They facilitate detection of errors and frauds.
4) Reports issued by the auditors can be used by
third parties.
 
 
 
 
 
 
DIFFERENCES
1. STATUTORY AUDITS
It is a requirement of an Act of parliament e.g. the
Companies Act.
2. The scope and objective of work is defined in
the Act
3. The report is addressed to the shareholders.
4. The auditor has full independence.
2. PRIVATE AUDITS
1. It is not a requirement by the Act.
2. The scope is agreed between a client and the
auditor therefore it is limited.
3. Report is addressed to relevant stakeholder.
4. Private appointment by the owner. .
 b) Method of approach to work.

1. Continuous audits
This is an approach whereby the audit is carried
out throughout the financial period. The audit
work is carried out at predetermined intervals
usually around three audit visits. This approach
is ideal for large organizations with tight
reporting deadlines e.g. multinational banks.
 Work carried out will include:

• Obtaining a good understanding of the clients

business or updating the business
understanding obtained in the previous audits.
• Identifying any developments in the clients
business that could have a significant impact
on the audit such as new legislation.
• Identifying any changes that have taken place
ADVANTAGES
Con’t DISADVANTAGES
1. Accounts are usually kept up to date. 1. It is expensive to have a continuous audit due to the amount
2 Errors and frauds are discovered at an early stage. 2. Frequent disruptions of the clients work during the audit.
3 The auditor gathers sufficient knowledge of the business as a result of his 3. The auditor’s independence may be adversely affected by t
frequent visits. the client’s premises.
4 Saves time during final audits. 4. Tendencies to over depend on auditing staff to solve accounti
5 Better report is developed, as time spent is more. 5. Interference of work, which has already been audited by the
   
 
 CON’T

2. interim audits
This is an audit that is usually carried out mid
way through the accounting period.
The Work carried out during an interim audit
usually include:
• Obtaining an understanding of the nature of
the client’s business;
 Con’t
• Evaluating any significant changes
• Ascertaining, recording and testing the clients
accounting and internal control system.
 Con’t
• Concluding on the level of reliance to be
placed on the internal control system.
• Plan and design the substantive procedures to
be carried out during the final audit;
• Reporting to management on any significant
weaknesses identified in the internal control
system.
 Con’t
Note that
An interim audit is usually carried in preparation
for the final audit at which the financial
statements will be reviewed.
 
 Con’t
3. Final audits
Usually done at the end of the year on the
financial statements
 OTHER TYPES OF AUDITS

Procedural audits
Requires an examination of procedures or
records for reliability and accuracy
Management audits
This involves investigation of the company’s
entire management to ascertain whether the
management is running the organization in the
best interest of the stakeholders
 LESSON TWO
INTERNAL CONTROL SYSTEMS AND INTERNAL AUDIT

1. Internal controls
If the auditor wishes to place reliance on any
internal controls he should ascertain and evaluate
those controls and perform compliance tests on
their operation.
 Con’t
If the clients system is evaluating as being
effective, the auditor can rely on these controls
and reduce the level of detailed substantive
work.
 Definition
An internal control systems consists of all the policies
and procedures (internal controls) adopted by
management of an entity to assist in achieving
management’s objective as far as practicable the
orderly and efficient conduct of its business, including
adherence to management policies, safeguarding of
assets, the prevention and detection of fraud and
error, the accuracy and completeness of the
accounting records and the timely preparation of
reliable financial information.
 Con’t
The internal control system extends beyond
these matters, which relate directly to the
functions of the accounting system.
 Importance of the internal control
system
1. Enables management to carry out the
business in an orderly and efficient manner.
Internal controls lay out the various
procedures to be followed in conducting the
affairs of the organisation
 Con’t
2. Ensures adherence to management policies,
Management policies vary from the broad objectives to
the detailed policy matters necessary to make those
objectives realisable
3. Safeguard the company’s assets
Some controls are designed specifically to
ensure the assets of the company are protected
from theft, destruction and that they are used in
the best interest of the company.
 Con’t
4. ICS help in ensuring completeness and accuracy of the records
maintained. The company’s Act requires that a company keep proper books
of accounts. These records are the basis for the preparation of the financial
statements.
5. Strong internal controls help in preventing and detecting
errors and frauds. The responsibility for the prevention and
detection of fraud and error rests with management.
 Con’t
This is achieved through the implementation and continuous
operation of an adequate system of internal controls. Such a
system reduces but does not eliminate the possibility of fraud
and error.
 TYPES OF INTERNAL CONTROLS

This refers to the various types of control

procedures that management can put in place in
running the operations of the company. The mix
of types of controls implemented by
management will depend on the control
objectives in each accounting area.
 Con’t
• Organizational plans/controls
Companies should have proper organization
plans, They seek to ensure that the entity is
properly departmentalized
 Con’t
The functions of every department are specified
and the duties of every individual in the
department are specified. Delegation of
authority and limits of authority should be well
and clearly defined. Such a plan boosts
accountability within the organization and
reduces duplication of effort
 Con’t
• Segregation of duties
This refers to the separation of the various
duties and responsibilities such that one person
cannot process and record complete
transactions from beginning to the end without
being checked by another person.
 Con’t
E.g. in the purchase of a company’s fixed assets
a single individual should not authorise the
purchase, place the order, receive the asset and
record the transaction in the accounting records.
 Con’t
• Physical controls
These are security measures concerned with the
custody of assets by limiting access to
authorized people only.
Restriction of access to valuable assets to only
authorized persons. There should be direct
measures and indirect measures.
 Con’t
• Internal audit
This is a control function set up by management
to review the accounting and internal control
systems. Internal audit carries out continuous
evaluation of the operating effectiveness of the
internal control policies and procedures.
 Con’t
The findings and recommendations are reported
to management.
 Limitations of the internal control system

No internal control system, however elaborate,

can be by itself guarantee efficient
administration and completeness and accuracy
of the records nor can it be proof against
fraudulent collusion, especially on the part of
those holding positions of authority and trust.
This is mainly due to the following inherent
limitations of an internal control system
 Con’t
1. Most internal controls tend to be directed
towards routine transactions rather than
non-routine transactions
2. Human error due to carelessness, distraction,
mistakes of judgement and misunderstanding
instructions could undermine the internal
control system
 Con’t
.

3. The possibility that procedures maybe

inadequate due to changes in conditions
4. etc..  
 ADVANTAGES AND DISADVANTAGES OF
INTERNAL CONTROL SYSTEM

Advantages of ICS to the Auditor

1. ICS will reduce the amount of audit work to
be done in so far as the auditor will be able to
use systems based audits to apply tests which
will facilitate his audit work.
2. A strong ICS will minimise chances of errors
and frauds, and the introduction of inter-
checking supervision
 Con’t
3. Will reduce the amount of audit evidence to
be gathered, because it will facilitate reaching
and using a greater variety of audit
evidence available within the business
4. The presence of an internal check system
strengthens the credibility of audit evidence
gathered.
 Con’t
5. ICS emphasises the use of control accounts
thus assuring the auditor of up to date account
reconciliation information which will facilitate
his examinations.
6. etc….
 Disadvantages of ICS to the Auditor

1. The management may over rely on the

strength of the ICS and therefore relax their
supervision which may leave room for errors
and frauds
2. The presence of ICS may lead to the auditor
reducing the volume of examination carried out
which may lead to smaller samples of data thus
leaving other areas to possibilities of errors and
frauds which may expose him to civil liabilities .
 Con’t
3.ICS may reduce the auditor’s vigilance and
observations with an unfavourable effect on the
quality of the audit.
 AUDIT EVIDENCE

Audit evidence refers to the information

obtained by the auditor in arriving at the
conclusions on which the audit opinion on the
financial statements is based.
 Con’t
The sources and amount of evidence needed to
achieve the required level of assurance is
determined by the auditor’s judgment. His
judgment will be influenced by the materiality of
the item being examined, the relevance and
reliability of evidence available from each source
and the time and cost involved in obtaining it.
 Con’t
Audit evidence is obtained from an appropriate
mix of tests of controls and substantive
procedures. Where the internal control system is
considered weak, evidence maybe obtained
entirely from substantive procedures.
 Reliability of audit evidence

The reliability of audit evidence refers to the

credibility of the source of the evidence.
This credibility is influenced by its source;
whether from internal sources or external
sources and by its nature; whether visual,
documentary or oral.
 Con’t
Reliability of the evidence depends on individual
circumstances but we can make the following
generalizations:
1. Audit evidence from external sources
2. Audit evidence generated internally
3. Evidence obtained by the auditor himself is
more reliable than that obtained from the
entity
 Con’t
5. Evidence in the form of documents and
written representations is more reliable than
oral representations
 Con’t
The auditor seeks evidence from different
sources. Evidence is more persuasive when
evidence from different sources is consistent.
Conversely, when audit evidence obtained from
one source is inconsistent with that obtained
from another, the auditor should perform
further procedures to resolve the inconsistency.
 METHODS OF OBTAINING EVIDENCE

1. The auditor may rely on sufficient appropriate

evidence obtained by substantive testing to
form his opinion. Alternatively he may be able to
obtain assurance from the presence of a reliable
internal control system and therefore reduce the
extent of substantive testing. The auditor
obtains evidence in performing compliance and
substantive procedures using the following
methods;
 Con’t
• Inspection
This consists of examining records, documents
or tangible assets. The reliability of the
evidence obtained from inspection of records
and documents depends on the nature,
source and effectiveness of the internal
control system.
 Con’t
Inspection of tangible assets provides evidence
with respect to their existence but not as to
their value and ownership.
 Con’t
• Observation
This involves looking at procedures being
performed by others. E.g. observing the
counting of stock by the client’s personnel.
 Con’t
• Inquiry and confirmation
Inquiry consists of seeking information of
knowledgeable persons inside or outside the
entity. This ranges from formal written
inquiries addressed to 3rd parties to oral
inquiries addressed to persons within the
entity.
 Con’t
The information may be new to the auditor or
may corroborate evidence from other sources.
Confirmation is the response to an enquiry to
corroborate information contained in the
accounting records.
 Con’t
• Computation
This involves checking the arithmetical
accuracy of source documents and accounting
records or performing independent
computations. E.g. re-computing the amount
of provision for depreciation and comparing
this against that computed by the client.
 Con’t
• Analytical procedures
The analysis of relationships such as between
items of financial data to identify consistencies
and predicted patterns or significant
fluctuations and unexpected relationships and
the results of investigations thereof.