Topic 1 Introduction

AUD339
AUDITING
TOPIC 1
INTRODUCTION
Auditing : Theory and Practice in Malaysia
Copyright 2013 F.Gul & N.Mahzan
CHAPTER OUTLINE
• Introduction
• Definition of auditing
– Nature of auditing
• Demand for auditing
• Objectives of financial statements audit
• Distinction between auditing and accounting
• Management and auditor’s responsibilities
• Types of audits
• Types of auditors
• Chartered accounting firms
Introduction
Developments in Malaysia
The Malaysian Institute The Malaysian Institute of
of Accountants Certified Public
• Regulatory Body , Accountants (MICPA)
established by • Formed in 1958
Accountants Act 1967 • A professional body
• Business managed by • Managed by Council
council members elected by members
• Issue auditing • Conducts professional
standards and Code exams
of ethics
• Does not conduct
professional exams
Introduction
Influences on the Development of Auditing
International Federation of Accountants (IFAC)
Develops and implements international auditing standards. The
International Statement of Auditing (ISA) and International Statement of
Quality Control (ISQC) are adopted and used by most jurisdictions
including Malaysia
The Quality Standards recommended by IFAC includes the following:
• having audit policies and a methodology for conducting transnational

audits in accordance with International Standards of Auditing
• complying with the IFAC Code of Ethics
• maintaining training programmes to keep partners and staff up to date
on international developments in financial reporting
• maintaining quality control standards and conducting regular quality
assurance reviews to monitor compliance with the firm’s policies and
methodology

Introduction
Influences on the Development of Auditing
Other regulatory requirements;
• Companies Act 2016

• Securities Commission Act 1963
• Capital Market and Services Act 2007
• Bursa Malaysia requirements
• MIA by laws

Definition
Academic definition
“Auditing is a systematic process of objectively

obtaining and evaluating 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.”
(source: American Accounting Association Committee on Basic Auditing Concepts (1973, p. 8)

Keywords
 Systematic process: audits are structured activities that follow a
logical sequence
 Objectively: a quality methods by which information is obtained
and also a quality of the person doing audit.(unbias)
 Obtaining and evaluating evidence: a matter of examining the
underlying support for assertions or representations
 Assertions about economic actions & events: An assertion is
essentially a proposition that can be proved or disproved.
(representations made by a responsible party in an accountability
arrangement that pertains to economic actions and events)
 Degree of correspondence…established criteria: an audit
establishes the conformity of assertions with specified criteria.
 Communicating results: to be useful, the results of the audit need
to be communicated to interested parties by either oral or written
means.

Nature Of Auditing
• Definition (2)
– “Audit is an independent examination of, and
expression of opinion on, the financial statements of
an enterprise by an appointed auditor (competent
independent person) in pursuance of that
appointment and in compliance with any relevant
statutory requirements”
– Keywords:
• Independent examination (using audit
procedures and carrying out tests to accumulate
self-generated evidence, third – party evidence,
etc which are independent from management
before arriving at the conclusions on which the
audit opinion is based)

Nature Of Auditing
– Keywords :
• Expression of opinion (to form an opinion

on the truth and fairness of financial
statements)
• Financial statement (all statements and
financial information identified within the
scope of an audit normally balance sheet,
profit & loss accounts, notes to the accounts,
cash flow statements, group accounts, etc)
• Enterprise (any form of entity whether profit
orientated or not)

Nature Of Auditing
• Appointed auditor (Section 263 of Companies Act 2016
– an approved company auditor or the Audit Firm – a
chartered accounting firm ranges from sole proprietorships
to partnerships providing broad categories of services
such as attestation services including audits, tax services,
accounting service and management advisory services.
• In pursuance of auditor’s appointment (as per statutory
requirements and other regulations including letter of
engagement)
• In compliance with any relevant statutory
requirements
(Companies Act (Malaysia) 2016, Banking Act, Industrial
Act, etc.)

Objective of FS Audit
Core Objectives

(a) To obtain reasonable assurance about whether the financial
statements as a whole are free from material misstatement,
whether due to fraud or error, thereby enabling the auditor to
express an opinion on whether the financial statements are
prepared, in all material respects, in accordance with an applicable
financial reporting framework; and

(b) To report on the financial statements, and communicate as
required by the ISAs, in accordance with the auditor’s findings.

(ISA 200, paragraph 11).

Demand For Auditing
Agency Theory
Owners (Principal) Manager (Agent)

Separation
This agency relationship is

“A contract under which one or more persons (the
principal/s engage another person (the agent) to
perform services on behalf which involves delegating
some decision-making authority to the agent.” (Jensen
and Meckling, 1976, p. 308) [1]

13
Demand For Auditing
Agency Theory
Demand For Auditing
Agency Problems
Agency Problems:
Interest Divergence and Information
Asymmetry
To reduce the agency problem:

Incentives and Monitoring

Demand For Auditing
Agency Theory in the Context of Auditing
Demand for Auditing to reduce information
asymmetry and also due to regulatory
requirements
A quality audit is defined in terms of the probability

that the auditor discovers unfaithful
representation of the financial statements and
having discovered such situation, the auditor
reports such findings to those charged with
governance and ultimately reports to
shareholders when required adjustments are not
made.

16
Demand For Auditing

 The audit of company is a statutory requirement under Companies Act 2016
 Demand arises because users are not in a position to establish the credibility of the
information they are presented with. This may be due to:
 Conflict of interest
 To increase the confidence level of the shareholders
 managers may present biased information, as they are also evaluated on the
information.
 Consequence
 information provided forms the basis of many users’ decisions.
 To reduce information risk i.e. risk that information provided is misleading/
inaccurate.
 Complexity
 many users do not have the expertise required to determine the quality of
information presented.
 Remoteness
 the separation of owners from management prevents users from assessing
information quality.
 Helps owners assess how well managers have discharged their stewardship
duties
17
Auditing vs. Accounting
• Accounting is the recording, classifying, and

summarizing of economic events in a logical
manner for the purpose of providing financial
information for decision making
• The difference… Auditor focus on determining
whether recoded information properly reflects the
economic events that occurred during the
accounting period
Accounting Auditing
The process Involves preparing books of Examine financial statement
accounts to make decision to prove true and fair view of
company’s affairs
Frequency Continuous process throughout a At year-end after the directors

financial period have prepared the financial
statement (though the planning
work is done earlier)
Compliance Act Generally accepted accounting International Standards on

standards Auditing (ISA)
Dependency Accounting is a management Auditor must be independent
function to assist management to of all the stakeholders i.e.
run the business efficiently management
Statutory It is a statutory requirement that It is a statutory requirement

requirement all companies maintain proper that F/S are audited
accounting records

Accountant Auditor
Recording transaction and provide Determine whether recorded
financial information information fairly reflect actual
transaction
Responsible to develop a system to Responsible to evaluate the system
ensure that transactions are properly to determine its effectiveness
recorded
Must understand accounting principles Must understand accounting
so that transactions were recorded principles so that he/she would be
according to the accepted standards able to detect non-compliance by the
Accountant
Possess expertise to record Possess expertise to accumulate and
transactions and prepare F/S interpret audit evidence

Management And Auditor’s Responsibilities
Management’s Responsibilities For The FS
• Responsibilities include:
– Preparation of FS
– Maintaining adequate accounting records and
internal control
– Apply appropriate accounting policies
– Safeguard of company’s assets
• Management’s responsibility for the fairness of the
representations (assertion) in the FS carries with it the
privilege of determining which disclosures it considers
necessary
Auditor’s Responsibilities For The FS
• ISA200 states ~ an audit is designed to provide

reasonable assurance that the FS taken as whole are
free from material misstatements
• The responsibility of the auditor is to plan and perform

an audit to obtain reasonable assurance about whether
the FS are free of material misstatements, whether
caused by error or fraud.
• Auditor’s main responsibility is to form a report and

give opinion on the FS
Auditor’s Responsibilities For The FS
Auditors are responsible for designing
the audit to detect material misstate-
ments (which include fraud, errors
& irregularities).
BUT
Auditors are not responsible for
finding all material fraud & other
irregularities.
Cont…
 Reasonable Assurance
 Assurance ~ the level of certainty that the

auditor has obtained at the completion of the
audit
 Reasonable, but NOT absolute assurance ~
the auditor is not an insurer or guarantor of the
correctness of the FS
 Means that the audit opinion given by the
auditor is not an absolute guarantee that the FS
are accurate or free from errors. Instead, the
auditor only provides assurance that the FS do
not contain material misstatement.
Cont…
 Reasons why the auditor is responsible for
reasonable but not absolute assurance:
1. Most audit evidence results from testing a sample

of population
2. Accounting presentation enclose complex
estimates, which involve uncertainty & can be
affected by future events
3. Fraud is extremely difficult/impossible to detect
Cont…
 Material misstatements
 Materiality
Information is material if its omission or misstatement could
influence the economic decision of users taken on the basis
of the FS
 Misstatement
A mistake in financial information which would arise from
errors and fraud
 Auditor’s responsibility is limited to material financial

information. It is impractical for auditors to provide
assurances on immaterial amounts
26
Types Of Audit
• Financial Statements Audit

• Operational Audit
• Compliance Audit
• Forensic Audit
27
Types Of Audit
Financial Statement Audit
• Is conducted to determine whether the overall FS
(the information being verified) are stated in
accordance with specific criteria i.e. an approved
accounting standards
• Results of the audit – draw conclusions on the FS
that can be relied upon by different group of users
for the different purposes
• Performed by the external auditor on the frequent
interval e.g. quarterly, half yearly or yearly basis
Types Of Audit
28
Operational Audit
• Evaluate the efficiency & effectiveness of any part
of an organization's operating procedures &
methods
• E.g. evaluate the efficiency & accuracy of processing
payroll transactions in a newly installed computer
system
• Results of the audit - recommendation for improving
the operations are proposed to the management
• Performed by the internal auditor of a company or
management consultancy works by external auditor
29
Types Of Audit
Compliance Audit
• Is conducted to determine whether the auditee is
following specific procedures, rules or regulations
set by higher authority
• E.g. Determining whether accounting personnel are
following the procedures prescribed by company
controller
• Results of the audit – Findings are reported to
higher management of the unit being audited for
necessary improvements
• Performed by the internal auditor, external auditor &
government auditor
30
COMPLIANCE AUDIT VS
OPERATIONAL AUDIT
Compliance audit Operational audit
To determine whether specific To evaluate effectiveness and
procedures/ rules and regulations efficiency of operating/
were being complied with procedures
Example: Determining whether Example: Evaluate the efficiency

accounting personnel are following & accuracy of processing payroll
the procedures prescribed by transactions in a newly installed
company controller computer system
Performed by the IA, EA and Performed by the IA of a

government auditor company or mgt consultancy
works by external auditor
AUD390_DEC2015_UiTM KEDAH
31
Types Of Audit
Forensic Audit
• Involved the detection of a wide variety of
fraudulent activities particularly financial fraud.
• Examples:
 Business or employee fraud
 Criminal investigation
 Shareholder and partnership disputes
32
Types Of Auditors
• External Auditor
• Internal Auditors
• Government Auditors
• Forensic Auditors
33
Types Of Auditors
External Auditor
• S8 of the Companies Act (CA) 1965 …requires a
company to appoint an “approved company
auditor” to audit every company incorporated under
the Act
• External auditor work in the CPA firm i.e. public
accounting firm ranges from sole proprietorship to
partnership providing services such as attestation
services, accounting or tax services and
management advisory services
34
Types Of Auditors
Internal Auditor
• Employed by individual companies to audit
for management
• Involved in operational auditing or have
expertise in evaluating computer systems
and made recommendations for improving
operations
35
INTERNAL AUDITOR VS. EXTERNAL AUDITOR

INTERNAL AUDITOR VS. EXTERNAL AUDITOR…
cont’d
37
Types Of Auditors
Government Auditor (Auditor General)
• Working for the Auditor General Department,
headed by the Auditor General and reports to
& is responsible solely to Yang Dipertuan
Agong
• Responsible to evaluate the operational
efficiency & effectiveness for all federal &
states as well as statutory bodies & public
authorities
• Assure that the expenditure of public funds is
in accordance with its directives and the law
38
Types Of Auditors
Forensic Auditor
• Trained in detecting, investigating fraud and white-
collar crime.
– E.g: fraud, bribery, embezzlement,
money laundering, identity theft

Chartered Accounting Firms
Structure of the firms (p.16)
• The public accounting firm vary in size.
• The smallest is the sole practitioner, whereby there are also large international public
accounting firms with hundreds of accountants as partners.
• The large firm is controlled by partners
• Bear the full responsibility for the practice
• Will review the audit working papers, discuss procedures and findings and make
enquiries necessary for assurance that the audit was properly and effectively conducted.
• Below the partner are managers.
• Less experience than partner, but may have developed specialization.
• Meets with client to plan audit
• Given responsibility for staff training
• Was assigned a number of audit seniors or supervisors
• Audit seniors
• Qualified as professional accountants through exam and practical experience
• Was placed in direct charge of sizeable audits – supervise several audit assistants
• Day-to-day contact with clients
• Has sufficient experience and knowledge to coordinate audit
• Able to prepare a draft audit report
• Junior auditor – audit assistant
• Not obtained professional qualifications
Organization of Accounting Practice
Big Accounting Firms
PWC
Ernst and Young
KPMG
Small Medium Practices
Deloitte
(SMP)
BDO KHR
Grant Thornton
Stephen Moore
Cheng & Co

Professional services
 Assurance services
 A type of professional service usually provided by CPAs. Assurance
services can include review of any kind of financial document or
transaction, such as a loan, contract or financial website. This review
certifies the correctness and validity of the item being reviewed by the
CPA.
 Include assurance on:
 the reliability of e-commerce
 the due diligence review
 the interim FS review
 the prospective FS
 Non-assurance services
 Services provided by the CPA firm to improve the quality of
information.
 Falls outside the assurance services
 This include accounting and bookkeeping services, tax services and
management consulting services.
QUESTIONS AND ANSWERS

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Topic 1 Introduction

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AUD339

• having audit policies and a methodology for conducting transnational

Auditing : Theory and Practice in Malaysia

• Companies Act 2016

Auditing : Theory and Practice in Malaysia

“Auditing is a systematic process of objectively

(source: American Accounting Association Committee on Basic Auditing Concepts (1973, p. 8)

Auditing : Theory and Practice in Malaysia

Auditing : Theory and Practice in Malaysia

Auditing : Theory and Practice in Malaysia

• Expression of opinion (to form an opinion

Auditing : Theory and Practice in Malaysia

Auditing : Theory and Practice in Malaysia

Auditing : Theory and Practice in Malaysia

Owners (Principal) Manager (Agent)

This agency relationship is

Auditing : Theory and Practice in Malaysia

To reduce the agency problem:

Auditing : Theory and Practice in Malaysia

A quality audit is defined in terms of the probability

Auditing : Theory and Practice in Malaysia

Demand For Auditing

Auditing vs. Accounting

• Accounting is the recording, classifying, and

Frequency Continuous process throughout a At year-end after the directors

Compliance Act Generally accepted accounting International Standards on

Statutory It is a statutory requirement that It is a statutory requirement

Auditing : Theory and Practice in Malaysia

Auditing : Theory and Practice in Malaysia

• ISA200 states ~ an audit is designed to provide

• The responsibility of the auditor is to plan and perform

• Auditor’s main responsibility is to form a report and

 Assurance ~ the level of certainty that the

1. Most audit evidence results from testing a sample

 Auditor’s responsibility is limited to material financial

• Financial Statements Audit

Example: Determining whether Example: Evaluate the efficiency

Performed by the IA, EA and Performed by the IA of a

INTERNAL AUDITOR VS. EXTERNAL AUDITOR

money laundering, identity theft

Auditing : Theory and Practice in Malaysia

Auditing : Theory and Practice in Malaysia

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