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FINANCIAL AUDIT AUDIT OF FINANCIAL STATEMENTS AND RELATED INFORMATION

1. What Is a Financial Audit? A financial audit is the critical analysis of a business's financial records and documentations. It can be done at any level, from local to governmental. A financial audit or financial profile of the company will be released by the auditor or forensic accountant after completion of the analysis. These financial analyses are usually done by certified public accounting firms and forensic accountants who provide an objective view of the true financial integrity of a company. Audits are intended to show whether a company's financial documentation matches its financial claims. It is not uncommon for a business to employee an internal auditor to monitor financial controls of a company in addition to hiring outside auditors. Financial auditing is an accounting process used in business. It uses an independent body to examine a business' financial transactions and statements. The ultimate purpose of financial auditing is to present an accurate account of a company's financial business transactions. The practice is used to make sure that the company is trading financially fairly, and also that the accounts they are presenting to the public or shareholders are accurate and justified. The results of the financial auditing procedure can be presented to shareholders, banks and anyone else with an interest in the company. One of the main reasons for a financial audit is to ensure that the trading company is not practicing any deception. This is the reason that the financial auditing body is an independent third party. Public records show that financial auditing has been in existence since 1314. However, before the 1930s, no corporations or businesses were legally required to hold audits. In 1934, the United States Securities Exchange Act made it a legal requirement for all public trading companies to be financially audited. The Securities and Exchange Commission (SEC) set up a department to deal specifically with this requirement. The SEC usually complies with the accounting industry as to its standards. The financial auditing process usually takes places once a year, most commonly at the end of the financial year. All financial aspects of the company are inspected, and a follow-up audit may also be undertaken after the year end in order to compare results. The financial auditing company has the difficult task of maintaining objectivity while being paid by the company they are auditing. Financial auditing is usually a thorough process, but in some cases, failures occur. The recent Enron scandal was a case in point, in which a company hid important facts and figures from both stakeholders and the banks. Enron filed for bankruptcy, and one of the largest accounting firms in the world, Arthur Andersen, lost the right to audit. Major incidents such as the Enron scandal have forced tighter and stricter regulations in the financial auditing process. Many innocent people lost thousands of dollars and life savings because unscrupulous companies such as Enron and WorldCom hid their financial details. Sadly, many of these stricter auditing regulations have come too late for the people who lost large amounts of money due to these companies.

a. Function Financial audits allow a company's management to have a creditable picture of the company's financial landscape. A company usually hires a firm to give an outside opinion of the financial documentation to the company's shareholders and investors. Financial audits help a company prove they are not "cooking the books," or altering the financial picture of a company. The Internal Revenue Service, financial institutions, banks, material providers, customers and employees all have access to the published financial audit and can gain a better understanding of where the company or business falls in a profit-loss market. Audits significantly reduce alternations to company records and can catch accounting errors. b. History The role of auditor goes back many hundreds of years. There are records from ancient Egypt and Rome, showing that people were employed to review work done by tax collector and estate managers The emphasis was very much on the detection of fraud and other irregularities The United Kingdom has the first cited mention of an audit performed in 1314 at the request of Queen Elizabeth. England appointed the Auditor of the Exchequer to install a system of checks and marks on government spending. The system did not show growth until 1866 when William Gladstone altered the monitoring program as a reform package on public finance. These reforms included spending done by Parliament. Since then, financial audits have become increasingly regulated through financial institutions, government bodies, courts and company investors. Parliament was the first government body to be audited, well the first recorded government body to be audited. But since then, governing bodies have been audited to detour corruption and prevent back-room deals. Emphasis has changed and the role of the auditor becomes much more sophisticated Stewardship requires an outsider with sufficient independence and objectively to review the accounts of stewardship and to express an opinion as to their honesty or otherwise. c. Significance People often read through a company's financial audit before deciding whether or not to become shareholders or investors in the company. Four major companies that do the majority of financial audits in the United States: KPMG, Deloitte, Pricewaterhouse Coopers and Ernest & Young. These companies provide tax support and audit management controls to companies they represent. d. Structure Financial audits are done before the end of the fourth quarter of a business's fiscal year to create a financial snapshot of how a business operated in that fiscal year. Auditors weigh industry regulations, the nature of the business and the way the business is administered. Audits look at the accuracy of internal controls, transaction records and ways to eliminate overhead. In addition to testing the accuracy of internal controls, the auditing firms also test new internal control systems. e. Considerations It is important for an auditing firm to remain objective throughout the auditing process to protect the integrity of the audit publication. The final step of the audit is the publication, which is documentation of what auditors found throughout the analysis of a company's financial documentation for management. In the publication, the auditor sites abnormalities, correct procedure and anything else worth mentioning about the overall documents provided to conduct the audit.

DEVELOPMENT OF MODERN AUDITING Concept of a company as a separate legal entity came into existence in the late ninetieth century. This led to the separation of ownership (shareholders) from control (directors) and consequent need to safeguard the interests of the owners, who in all but the smallest of business where shareholders and directors were on and the same) were not involved in the day to day decisions made by the management. Before 19th Century, the appointed auditor duties to discover fraudulent misrepresentations, the detection of fraud and error become the major objective of company audits. After ( late 19th Century). However in later part of nineteenth century, there was a growing school of thought that the prevention of fraud and error (as opposed to its detection) should be the major objective of the auditor (both external and internal) and that the management of a company should play a greater part and accept a larger degree of responsibility in this respect. The Kingston Cotton Mill case of 1896, established the fact that the auditor should not be responsible for finding every fraud and error. Here, the judgment pronounced that the auditors role should be likened to that of a watchdog rather than bloodhound, and that what was required of auditors was that they should act with such reasonable care and skill as was appropriate circumstances THE ADVANTAGES AND DISADVANTAGES OF A FINANCIAL AUDIT A financial audit or audit of financial statements is a systematic process of evaluating an organization's financial data. In the United States, the Securities and Exchange Commission mandates all publicly listed companies to report audited financial statements. The major advantage of a financial audit is to protect the public from fraudulent accounting activities and corrupt business procedures. Though financial auditing is helpful in presenting a company's financial status accurately, the additional work and costs may be disadvantages. 1. Financial Audit - Independent certified public accountants carry out financial audits. The CPA examines the company's financial activities throughout the fiscal year and certifies that the financial data is audited, and the statements comply with the accounting rules and regulations set by federal securities laws. Auditors evaluate not only financial activities but also the companys policies, financial risk control measures and investment decisions. Assurance 2. Financial audits provide investors with additional assurance that the financial data reported on the statements can be relied upon. The additional assurance from an independent auditor helps the investor community make rational investment decisions. Government tax authorities also benefit from financial audits because the process of tax assessment is simplified with audited financial statements. In addition, to lend money, creditors and banks rely upon audited financial statements that explain a companys financial status accurately. Hence, companies can use audited statements to borrow money for business development. 3. Business Condition - Financial auditing motivates management to analyze operating efficiency. When the financial audit is in place, management gives more importance to understanding and monitoring financial records. An audit ensures that employees maintain integrity and keep accurate account books. An auditor's independent opinions help identify key areas for improvement and assess operating risks, efficiency, and quality of products or services. Furthermore, financial auditing serves as a tool for uncovering fraudulent and illegal financial activities. DISADVANTAGES

Financial auditing incurs considerable costs for companies that must hire an independent CPA. According to the 2011 Audit Fee Survey, conducted by Financial Executives Research Foundation, the average audit fees paid by U.S. publicly held companies were $3.3 million for fiscal year 2010. Privately held companies reported an average of $222,300 in audit fees for 2010. Frequent visits and evaluation by CPAs may be timeconsuming. Auditors rely upon accounting entries and objective evidence provided by the companys staff.. In some cases, the audit may not be enough to identify and prevent fraud. The audit involves the clients staff and management in giving time to providing information to the auditor. Professional auditors should therefore plan their audit carefully to minimize the disruption, which their work will cause. The audit fee, clearly the services of an auditor must be paid for. It is for this reason that few partnership and even fewer sole trader are likely to have their accounts audited. The accountants role as the preparer of financial statements, as tax adviser and general financial adviser, becomes much more important to such concerns. ADVANTAGES OF AUDIT Advantages for companies (directors): - Assurance that statutory responsibilities concerning accounts have been carried out - Assistance with statutory responsibilities concerning accounts - Availability of expert professional advice - The letter of weakness To shareholders: - Assurance that accounts show a true and fair view and comply with statutory requirements - Assurance that directors have fulfilled their statutory responsibilities for books and accounts, and the safeguarding of assets - Assurance that directors have fulfilled their statutory responsibilities for books of accounts and the safeguarding of assets - Assurance that all directors remuneration has been disclosed Other organization with published accounts: - Assurance to all users of accounts, that the accounts show a true and fair view and comply with statute - Assurance that stewards have fulfilled their accounting and financial responsibilities Private organizations such as partnerships: - Assurance that accounts are reliable - Reasonable assurance that all fraud of consequence has been disclosed. - In addition they provide reliable accounts to regulatory bodies such as the Companies Registry, the stock exchange etc. DEVELOPMENT OF MODERN AUDITING In previous years it was part of the appointed auditor duties to discover fraudulent misrepresentations, the detection of fraud and error become the major objective of company audits. However in later part of nineteenth century, there was a growing school of thought that the prevention of fraud and error (as opposed to its detection) should be the major objective of the auditor (both external and internal) and that the management of a company should play a greater part and accept a larger degree of responsibility in this respect. The Kingston Cotton Mill case of 1896, established the fact that the auditor should not be responsible for finding every fraud and error. Here, the judgment pronounced that the auditors role should be likened to that of a watchdog rather than bloodhound, and that what

was required of auditors was that they should act with such reasonable care and skill as was appropriate circumstances AUDIT AND AUDITING 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 parties. Objectives of Auditing Primary Objective (main objective): - To produce a report by the auditor of his opinion of the truth and fairness of financial statements so that any person reading or using them can have belief in them Secondary To detect errors and fraud ( Consider materiality) To prevent errors and fraud by the deterrent and moral effect of the audit To provide spin- off effects. The auditor will be able to assist his clients with accounting , systems, taxation , financial , and other problems. AUDIT OBJECTIVES Validity Completeness Cutoff Ownership Accuracy Valuation Classification Disclosure LIMITATION OF AUDIT - The responsibility for preparation and presentation of the financial statements is that of directors of the entity. The audit does not relieve the directors of any of their responsibilities. - Auditors opinion is not a guarantee of the future viability of the entity - Auditors opinion is not an assurance of managements effectiveness and efficient - Causes of limitations - The impracticality of examining all items within an account balance or class of transactions - The inherent limitation of any accounting and control system - The possibility of collusion or misrepresentation for fraudulent purposes - Most audit evidence is being persuasive rather than conclusive Material misstatement may exist in financial statement and auditors should plan their work on this basis, i.e. professional skepticism, ISA, makes it clear that, even where auditors assess that the risk of litigation or adverse publicity as very low , they must still perform sufficient procedures according to auditing standards, ie there can never be a reason for carrying out an audit of a lower quality than that demanded by the ISAs In carrying out his work the auditor should adopt an attitude of professional skepticism, recognizing that circumstances may exist which cause the financial statements to be materially misstated. The purpose of the independent audit is to ensure that the financial statements are OBJECTIVE, FREE from BIAS and MANIPULATION and RELEVANT to the need of users.

TYPES OF AUDIT Statutory Audit, carried because the law requires them. Statutes include Companies Act, Parastatal organization Act Private audits, because of auditors desire and not because of law e.g. sole trader and partnership Internal audits, is the one conducted by an employee of a business into any aspect of its affairs. Management audit, an inquiry into efficiency and effectiveness of management Public sector audit, contract audit , computer audit etc KEY STAGES OF AUDIT Determine audit approach Ascertain in the accounting system and internal controls Assess the accounting system and internal controls Test the accounting system and internal controls Test the financial statements ( substantive testing) Review the financial statements Express an opinion Client acceptance and continuance Establish the terms of the engagement Plan the audit Consider internal control Conduct substantive audit procedures Complete the audit Issue audit report THREE FUNDAMENTAL CONCEPTS IN CONDUCTING AN AUDIT 1. Materiality A misstatement or the aggregate of all misstatements in financial statements is considered to be material if, in light of surrounding circumstances, it is probable that the decision of a person who is relying on the financial statements, and who has a reasonable knowledge of business and economic activities ( the user), would be changed or influenced by such misstatement or the aggregate of all misstatements. 2. Audit risk is the risk that the auditor will fail to express a reservation in his or her opinion on financial statements that are materiality misstated 3.Evidence. Evidential matter supporting the financial statements consists of the underlying accounting records and all corroborating information available to the auditor. Relevance refers to whether the evidence relates to the specific audit objective being tested. Reliability refers to the whether or not a particular type of evidence can be relied upon to signal the true state of the assertion or audit objective. INTERNAL AUDITING An internal audit is an independent activity established by management to examine and evaluate the organizations risk management process and systems of control, and to make recommendations for the achievement of company objectives. The internal audit staffs may also engage in number of other activities : - Examination and evaluation of financial and operating information within the organizationin certain organization this can form a type of continuous auditing and may involve sophisticated information systems that capture monitoring of risk and evidencing of controls - Review of economy, efficiency and effectiveness of operations - Review of compliance with external laws and regulations and internal policy and procedures

- Review and advice on the development of key organizational systems and on the implementation of major change. General Principles of an Audit The auditor should comply with the Code of Ethics for Professional Accountants issued by the International Federation of Accountants. Ethical principles governing the auditors professional responsibilities are: Independence; Integrity; Objectivity; Professional competence and due care; Confidentiality; Professional behavior; and Technical standards. Integrity A professional accountant should be straightforward and honest in performing professional services. Objectivity A professional accountant should be fair and should not allow prejudice orbias, conflict of interest or influence of others to override objectivity. Professional Competence and Due Care A professional accountant should perform professional services with due care, competence and diligence and has a continuing duty to maintain professional knowledge and skill at a level required to ensure that a client or employer receives the advantage of competent professional service based on up-to-date developments in practice, legislation and techniques. Confidentiality A professional accountant should respect the confidentiality of information acquired during the course of performing professional services and should not use or disclose any such information without proper and specific authority or unless there is a legal or professional right or duty to disclose. Professional Behavior A professional accountant should act in a manner consistent with the good reputation of the profession and refrain from any conduct which might bring discredit to the profession. The obligation to refrain from any conduct which might bring discredit to the profession requires IFAC member bodies to consider, when developing ethical requirements, the responsibilities of a professional accountant to clients, third parties, other members of the accountancy profession, staff, employers, and the general public. Technical Standards A professional accountant should carry out professional services in accordance with the relevant technical and professional standards. Professional accountants have a duty to carry out with care and skill, the instructions of the client or employer insofar as they are compatible with the requirements of integrity, objectivity and, in the case of professional accountants in public practice. In addition, they should conform with the technical and professional standards promulgated by: IFAC (e.g., International Standards on Auditing); International Accounting Standards Board; The members professional body or other regulatory body; and Relevant legislation. The auditor should plan and perform an audit with an attitude of professional skepticism recognizing that circumstances may exist that cause the financial statements to be materially misstated

- An attitude of professional skepticism means the auditor makes a critical assessment, with a questioning mind, of the validity of audit evidence obtained and is alert to audit evidence that contradicts or brings into question the reliability of documents or management representations In planning and performing an audit, the auditor neither assumes that management is dishonest nor assumes unquestioned honesty. (Remember Mautz and Sharaf audit postulates). Accordingly, representations from management are not a substitute for obtaining sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the audit opinion. SCOPE OF AUDIT The term scope of an audit refers to the audit procedures deemed necessary in the circumstances to achieve the objective of the audit. The procedures required to Conduct an audit in accordance with ISAs should be determined by the auditor having regard to the requirements of ISAs, relevant professional bodies, legislation, regulations and, where appropriate, the terms of the audit engagement and reporting requirements. An audit in accordance with ISAs is designed to provide reasonable assurance that the financial statements taken as a whole are free from material misstatement. Reasonable assurance is a concept relating to the accumulation of the audit evidence necessary for the auditor to conclude that there are no material misstatements in the financial statements taken as a whole. Reasonable assurance relates to the whole audit process. An auditor cannot obtain absolute assurance because there are inherent limitations in an audit that affect the auditors ability to detect material misstatements. These limitations result from factors such as: The use of testing. The inherent limitations of internal control (for example, the possibility of management override or collusion). The fact that most audit evidence is persuasive rather than conclusive. Also, the work undertaken by the auditor to form an audit opinion is permeated by judgment, in particular regarding: The gathering of audit evidence, for example, in deciding the nature, timing, and extent of audit procedures; and The drawing of conclusions based on the audit evidence gathered, for example, assessing the reasonableness of the estimates made by management in preparing the financial statements. QUALITY CONTROL According to ISA 220, the audit firm should implement quality control policies and procedures designed to ensure that all audits are conducted in accordance with ISAs or relevant national standards or practices. The nature, timing and extent of an audit firms quality control policies and procedures depend on a number of factors such as the: size and nature of its practice, its geographic dispersion, its organization and appropriate cost/benefit considerations. The firms general quality control policies and procedures should be communicated to its personnel in a manner that provides reasonable assurance that the policies and procedures are understood and implemented. Further, The auditor should implement those quality control procedures, which are, in the context of the policies and procedures of the firm, appropriate to the individual audit.

OBJECTIVES OF QC (a) Professional requirements: Personnel in the firm are to adhere to the principles of independence, integrity, objectivity, confidentiality and professional behavior. (b) Skills and competence: The firm is to be staffed by personnel who have attained and maintain the technical standards and professional competence required to enable them to fulfill their responsibilities with due care. (c) Assignment: Audit work is to be assigned to personnel who have the degree of technical training and proficiency required in the circumstances. (d) Delegation: There is to be sufficient direction, supervision and review of work at all levels to provide reasonable assurance that the work performed meets appropriate standards of quality. (e) Consultation: Whenever necessary, consultation within or outside the firm is to occur with those who have appropriate expertise. (f) Acceptance and retention of clients: An evaluation of prospective clients and a review, on an ongoing basis, of existing clients is to be conducted. In making a decision to accept or retain a client, the firms independence and ability to serve the client properly and the integrity of the clients management are to be considered. (g) Monitoring: The continued adequacy and operational effectiveness of quality control policies and procedures is to be monitored. Principles of Delegation in QC - Direction Assistants to whom work is delegated need appropriate direction. Direction involves informing assistants of their responsibilities and the objectives of the procedures they are to perform. It also involves informing them of matters, such as the nature of the entitys business and possible accounting or auditing problems that may affect the nature, timing and extent of audit procedures with which they are involved. The audit program is an important tool for the communication of audit directions. Time budgets and the overall audit plan are also helpful in communicating audit directions. Supervision Supervision is closely related to both direction and review and may involve elements of both. Personnel carrying out supervisory responsibilities perform the following functions during the audit: - Monitor the progress of the audit to consider whether: - Assistants have the necessary skills and competence to carry out their assigned tasks; - Assistants understand the audit directions; and - The work is being carried out in accordance with the overall audit plan and the audit program; Become informed of and address significant accounting and auditing questions raised during the audit, by assessing their significance and modifying the overall audit plan and the audit program as appropriate; and Resolve any differences of professional judgment between personnel and consider the level of consultation that is appropriate.

Review The work performed by each assistant needs to be reviewed by personnel of at least equal competence to consider whether: The work has been performed in accordance with the audit program; The work performed and the results obtained have been adequately documented; All significant audit matters have been resolved or are reflected in audit conclusions; The objectives of the audit procedures have been achieved; and The conclusions expressed are consistent with the results of the work performed and support the audit opinion. BIBLIOGRAPHY: 1. Arens/ Beasley/ Elder Auditing 12/e, Prentice Hall Business Publishing, 2008 2. Encyclopedia of Business and Finance, 2001 Gale Cengage. 3. Ravinder Kumar, Virender Sharma, Auditing:Principles and Practice 4. Beasley, M. S., F. A. Buckless, S. M. Glover and D. F. Prawitt. 2005. Auditing Cases (3rd Edition). Prentice Hall.