Chapter 4 Auditing

Financial auditing is the process of examining an organization's (or individual's) financial records to determine if they are accurate and in accordance with any applicable rules (including accepted accounting standards), regulations, and laws.

External auditors come in from outside the organization to examine accounting and financial records and provide an independent opinion on these records. Law requires that all public companies have their financial statements externally audited.

Internal auditors work for the organization as internal employees to examine records and help improve internal processes such as operations, internal controls, risk management, and governance.

Auditing Standards

The Public Company Accounting Oversight Board (PCAOB) maintains external auditing standards for public companies (issuers) registered with the Securities and Exchange Commission (SEC).

As of 2012, PCAOB has 15 permanent standards approved by the SEC and a number of interim standards that reflect generally accepted auditing standards, as described in standards issued by the Auditing Standards Board (ASB), which is part of the American Institute of CPAs (AICPA).

The ASB also issues Statements on Auditing Standards (SASs) that apply to preparing and releasing audit reports for nonissuers (companies not required to register with the SEC). AICPA members who audit a nonissuer are required by the AICPA Code of Professional Conduct to comply with these standards. As of 2012, there are more than 60 active standards.

For internal auditing, the Institute of Internal Auditors provides a conceptual framework called the International Professional Practices Framework (IPPF) that provides guidance for internal audits. Some of the guidance is mandatory, while others are considered strongly recommended, but not required by law.

Audit Planning

Audit planning includes deciding on the overall audit strategy and developing an audit plan.

Auditing Standard No. 9 from the PCAOB describes an external auditor's responsibility and the requirements for planning an audit. According to standard No. 9, an audit plan is expected to describe the planned nature, extent, and timing of the procedures for risk assessment and the tests to be done on the controls and substantive procedures, along with a description of other audit procedures planned to ensure the audit meets PCAOB standards.

For internal auditing, the Institute of Internal Auditors provides guidance for audit planning. Planning starts with determining the scope and objectives of the audit.

Internal auditors need to understand the business, operations, and unique characteristics of the department/unit being audited and to develop an audit plan that defines the procedures needed to do an efficient and effective audit.

Auditor

An auditor is a person or a firm appointed by a company to execute an audit.^[1] To act as an auditor, a person should be certified by the regulatory authority of accounting and auditing or possess certain specified qualifications. Generally, to act as an external auditor of the company, a person should have a certificate of practice from the regulatory authority.

Types of Auditor

·         External auditor/ Statutory auditor is an independent firm engaged by the client subject to the audit, to express an opinion on whether the company's financial statements are free of material misstatements, whether due to fraud or error. For publicly traded companies, external auditors may also be required to express an opinion over the effectiveness of internal controls over financial reporting. External auditors may also be engaged to perform other agreed-upon procedures, related or unrelated to financial statements. Most importantly, external auditors, though engaged and paid by the company being audited, should be regarded as independent.

·         Internal Auditors are employed by the organizations they audit. They work for government agencies (federal, state and local); for publicly traded companies; and for non-profit companies across all industries. The internationally recognised standard setting body for the profession is the Institute of Internal Auditors - IIA (www.theiia.org). The IIA has defined internal auditing as follows: "Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization's operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes"

4.2 Auditor-Client Realtionship

Consistent with our predictions, strong social exchange relationships develop between auditors and their clients in response to auditor perceptions of fair treatment and support received from the client. Specifically, perceived client fairness predicts perceived client support, and perceived client support predicts auditor commitment to the client. Auditor tenure with the client also yielded greater commitment to the client. We find that higher client commitment is associated with more value-added services. Also, as expected, more experienced auditors provide their clients with more value-added audit services. Figure 1 depicts our results. We also separated respondents into two groups and tested the predictions for each group. The staff group consisted of staff and seniors, and the management group consisted of managers, senior managers, and partners. We divided the sample this way because staff and seniors perform different types of audit procedures compared to engagement management (Hirst and Koonce 1996; Trompeter and Wright 2010; Han et al. 2011; Luippold and Kida 2012). The type of work performed by staff and seniors, or their relative lack of business experience, may limit their ability to provide insights on more complex business processes or accounting issues. Indeed, our analyses revealed that the management group provided clients with significantly higher levels of value-added services compared to the staff group. Nevertheless, our predictions were supported for each group. Thus, our research model was effective in predicting variation in value-added audit services for auditors at both higher and lower levels.

4.1 Charts And Graphs

Accounting data is often presented in the form of tables of numbers, sometimes simply as a print out from a spreadsheet or reports from an accounting software package. While this style of presentation provides detailed figures, it may not always be the most effective way to present and communicate information. It may be that some key information should be highlighted, perhaps relationships between certain figures should be emphasised, or trends identified. Appropriate presentation of data in the form of graphs or charts can be a useful analysis tool and if the data is then effectively interpreted this can facilitate the decision-making process. The syllabus for Papers MA2 and F2/FMA require that candidates should be able to describe the key features of different charts, identify suitable charts in particular situations and interpret data presented in charts. The material in this article is also relevant for candidates sitting Paper MA1.

There are many software packages that allow the user to create charts that look very professional but it is important to consider the different types of charts available and select an appropriate chart type for the data being presented. Presenting data in an inappropriate chart can convey information which may be misleading. The term ‘chart’ is generally considered to include all types of graphs and any other type of chart used to give a pictorial presentation of the data. Some types of charts tend to be described as graphs while others use the term chart, eg it is more common to hear the term line graph but the term bar chart. The words ‘chart’ and ‘graph’ are considered to be interchangeable for the purposes of this article.

A variety of chart types will be reviewed in this article, and the features that make a particular chart type appropriate for the type of data being presented will be highlighted. Some useful tips on presentation will also be provided, together with guidance on interpreting the data presented in the charts. To illustrate the point of ensuring that an appropriate chart type is selected, some data has been presented using an inappropriate chart type resulting in ineffective communication of information.

Column, bar and line charts for a single data set (Charts 1-5)

In each of the Charts 1-5, a single series of data is represented on the graph. Often the data being presented in this type of chart spans a number of time periods such as years, quarters or months but these types of charts can also be used to represent data from one time period but, for example, from different regions or perhaps for different output levels. These charts are drawn with two axes, with the independent variable being shown on the x-axis and the dependent variable shown on the y-axis.

Charts 1 and 2 are examples of simple column charts. The columns represent the value of the data vertically and each column will be of a uniform width. Note that the heights of the columns vary to reflect the data values but the width of each column on a specific graph will be the same. Although the two charts are the same basic chart type, there are some minor differences in style that are worth pointing out. Chart 1 shows data for total sales over a five-year period with the years being shown on the x-axis and the $ amounts on the y-axis. A key or legend is displayed emphasising that the data relates to Total Sales and while a legend is often included automatically by the charting software it is not necessary when there is only one data series as long as the chart has an appropriate title. Chart 2 is also a simple column chart but the data relates to one year only and each column represents a division of the business so the x-axis is not years but the divisions, North, South, East and West. Notice also that the style of the chart has slightly changed as it is presented in a 3D format, the legend has been removed and the y-axis scale is in round thousands with the axis label having been changed appropriately.

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