Audit and Corporate Governance Unit I.ppt

Intro to Audit

1. Introduction to Audit
-Abhishek Jha

2. History of Audit
•Phase -1 (1840-1920)
•Phase-2 (1920-1960)
•Phase-3(1960-1990)
•Phase-4(1990 till date)

3. History of Auditing in India
•Companies Act 1913
•1932 constitution of Accounting Board
•Charted Accountants Act 1949
•Companies Act 1956
•Manufacturing and other companies order
1975
•Companies Act 2013

4. Definition of Auditing
•AccordingtoICAI
•“Auditingisdefinedasasystematicand
independentexaminationofdata,statements,
records,operationsandperformancesofan
enterpriseforastatedpurpose.Inanyauditing
situationtheauditorperceivesandrecognisesthe
propositionsbeforehimforexamination,collects
evidence,evaluatethesameonthisbasis
formulateshisjudgementwhichiscommunicated
throughhisauditreport.”

5. Objective of Auditing
•Primary Objective(expression of opinion)
•Secondary Objective(Detection of errors and
frauds)

6. Types of Errors
•Error of Principle
•Error of Omission
•Error of Commission
•Compensating Error

7. Fraud
•Misappropriation of Asset
•Misappropriation of goods
•Misappropriation of cash

8. Principles governing An Audit
•Integrity
•Confidentiality
•Skill and Competence
•Work performed by others
•Documentation
•Planning
•Audit evidence
•Accounting System and internal control
•Planning
•Audit conclusions and Reporting

9. Advantages of Audit
•Authenticity of Accounts
•Detection of errors and frauds
•Identification of loopholes
•Acceptable to taxation authorities
•Increased creditworthiness
•Settlement of dispute among partners
•Settlement of insurance claims
•Helpful in making comparisons
•Accounts department becomes vigilant

10. Limitations
•Time consuming
•Frauds not detected
•Costly
•Depends on judgement
•All frauds can not be detected
•Dependence on others

11. Qualities of an Auditor
•Integrity
•Objectivity
•Independence
•Confidentiality
•Skills
•Responsible
•Intelligent
•Vigilant
•Communication skills

12. An Auditor is a watchdog and not a blood hound
•Inthecaseofalimitedcompany,anauditorisappointed
bythecompany’sshareholders.Heisexpectedtoworkon
theirbehalfintheroleofawatchdogandshouldlook
aftertheirbestinterests.
•Unlikeabloodhound,theauditor’smaindutyistowards
verificationoftheclient’sbooksratherthandetection.
Duringthecourseofhisaudit,ifhefindssomething
suspicious,heshouldextendhisauditproceduresto
examinethematterindetailandshouldcommunicatethe
sametotheshareholders.However,intheabsenceofany
suchsuspiciouscircumstances,heiscompletelyjustified
inrelyingupontherepresentationsmadebytheclient’s
staffandmanagement.Whenitcomestofraudanderror,
hehastoexercisereasonablecareonly.

13. Features of an Auditor
•An agent: The auditor is an agent of the
company’s members assigned to execute
tasks outlined in (a) the Companies Act,
(b) the company’s Articles of Association,
and (c) the audit engagementbetween the
auditor and the client.
•Not an advisor: An auditor is not a
company advisor. It is not his responsibility
to advise the board of directors or the
shareholders.

14. Different types of audits
•Internal Audits. Internal audits assess internal
controls, processes, legal compliance, and
the protection of assets. ...
•External Audits. ...
•Financial Statement Audits. ...
•Performance Audits. ...
•Operational Audits. ...
•Employee Benefit Plan Audits. ...
•Single Audits. ...
•Compliance Audits.

15. Difference Between Accounting and Auditing
Accounting Auditing
Definition
Accounting is referred to as the process of
recording, classifying, summarisingand
interpreting the financial transactions,
statements to determine the financial
position of an organisation
Auditing is referred to as the process of
examining the financial records such as
transactions and statements of an
organisationin order to find any
discrepancies during the process of recording
of the transactions and also to verify the
accuracy of the records
Purpose
Accounting is done with the purpose of
showing the position, profitability and
performance of the business entity or
organisation
Auditing is done to verify the accuracy of
data presented by accounting. It is done with
the purpose of revealing to what extent the
true and fair view of records is maintained in
the transactions
Objective
To determine profit and loss of the
organisation or the financial position of an
organisation for a period
To determine the correctness of all the
recorded transactions
Mode of operation
Accounting is done on a daily basis, as
transactions happen on a daily basis for any
business
It is a periodical assessment and is done
monthly, quarterly or yearly
Performed by
Accounting is done by accountants Auditing is done by auditors
Sequence
Accounting starts at the end of bookkeepingAuditing starts at the end of accounting

16. Types of Audit 1/3
Internal Audit
•Internalauditsareperformedbytheemployeesofacompanyor
organization.Theseauditsarenotdistributedoutsidethecompany.Instead,
theyarepreparedfortheuseofmanagementandotherinternal
stakeholders.
•Internalauditsareusedtoimprovedecision-makingwithinacompanyby
providingmanagerswithactionableitemstoimproveinternalcontrols.They
alsoensurecompliancewithlawsandregulationsandmaintaintimely,fair,
andaccuratefinancialreporting.
•Managementteamscanalsoutilizeinternalauditstoidentifyflawsor
inefficiencieswithinthecompanybeforeallowingexternalauditorstoreview
thefinancialstatements.

17. Types of Audit 2/3
•Performedbyexternalorganizationsandthirdparties,externalaudits
provideanunbiasedopinionthatinternalauditorsmightnotbeabletogive.
Externalfinancialauditsareutilizedtodetermineanymaterial
misstatementsorerrorsinacompany’sfinancialstatements.
•Externalauditsareimportantforallowingvariousstakeholdersto
confidentlymakedecisionssurroundingthecompanybeingaudited.
•Thekeydifferencebetweenanexternalauditorandaninternalauditoris
thatanexternalauditorisindependent.Itmeansthattheyareableto
provideamoreunbiasedopinionratherthananinternalauditor,whose
independencemaybecompromisedduetotheemployer-employee
relationship.

18. Types of Audit 3/3
•Governmentauditsareperformedtoensurethatfinancialstatementshave
beenpreparedaccuratelytonotmisrepresenttheamountoftaxableincome
ofacompany.
•WithintheU.S.,theInternalRevenueServices(IRS)performsauditsthat
verifytheaccuracyofataxpayer’staxreturnsandtransactions.TheIRS’s
CanadiancounterpartisknownastheCanadaRevenueAgency(CRA).
•Auditselectionsaremadetoensurethatcompaniesarenot
misrepresentingtheirtaxableincome.Misstatingtaxableincome,whether
intentionalornot,isconsideredtaxfraud.TheIRSandCRAnowuse
statisticalformulasandmachinelearningtofindtaxpayersathighriskof
committingtaxfraud.

19. Case Study -1
Toshiba,a140-year-oldpillarofJapanInc,iscaughtupinthecountry'sbiggestaccountingscandalsince2011.
In2011,OlympusCorpwasembroiledinascandal.InJuly2015,ToshibaCorppresidentHisaoTanakaandhis
twopredecessorsquitafterinvestigatorsfoundthatthecompanyinflatedearningsbyatleast$1.2billion
duringtheperiod2009-2014.Toshibaisoneoftheearlyadoptersofthecorporategovernancereforms
initiatedinJapan.Thecorporategovernancestructuremetcorporategovernancestandards.Timeandagain
casesofcorporategovernancefailureshaveprovidedevidencethatgoodcorporategovernancestructuredoes
notnecessarilyleadtogoodcorporategovernance.Organisationcultureisacriticaldeterminantofthequality
ofcorporategovernance.
Someoftheobservationsoftheindependentinvestigationcommitteeofthecompanyoninternalaudit
demanddiscussionanddebate.
Theinvestigationcommitteeobserves,"AccordingtothedivisionofdutiesrulesofToshiba,thecorporateaudit
divisionisinchargeofauditingthecorporatedivisions,thecompanies,branchcompanies,andaffiliated
companies.However,inrealitythecorporateauditdivisionmainlyprovidedconsultationservicesforthe
'management'beingcarriedoutateachofthecompanies,etc(aspartofthebusinessoperationsaudit),andit
rarelyconductedanyservicesfromtheperspectiveofanaccountingauditintowhetherornotanaccounting
treatmentwasappropriate.“
TheobservationsofthecommitteegivetheimpressionthatthefaultoftheinternalauditinToshibawasthatit
focusedonconsultationserviceratherthanassuranceservice.Shouldinternalauditavoidproviding
consultationservice?Idonotthinkso.Itwasnotthefaultoftheinternalauditthatitprovidedconsultation
service.Thefaultwasthatitdidnotpayattentiontoaccountingaudit.
InToshiba,thetopmanagementusedtosettargetsthatareunachievable.Therewasexcessivepressurefrom
thetopmanagementtoachievethosetargets.

20. Case Study –1 (Cont1)
Thevariablepayisasignificantportionofthetotalpay.Thecompensationofexecutiveofficerscomprisesa
basecompensationbasedontitleandarolecompensationbasedonworkcontent.Fortypercentto45per
centoftherolecompensationisbasedonperformanceoftheoverallcompanyorbusinessdepartment.
'Challenge'toachieveunachievabletargetsandperformance-basedpayprovideenoughmotivationtomanage
earnings.Therefore,accountingauditshouldhavebeenafocusareaforinternalaudit.
Internalauditcanfunctionindependentlyonlyiftheauditcommitteeiscapable,independentandeffective,
andtheinternalauditorreportstotheauditcommittee.
InToshiba,theauditcommitteewasneithercapablenorindependent.Thethreeexternalmembersofthe
auditcommitteehadnoknowledgeoffinanceandaccounting.Anex-ChiefFinancialOfficer(CFO),whowasthe
CFOduringthetimeframewhenaccountingirregularitiesoccurred,wastheonlywholetimememberofthe
auditcommittee.Therefore,theinternalauditwasnotindependentofthemanagement.Earnings
managementhadthetacitapprovalofthetopmanagement.Therefore,itisnotsurprisingthataccounting
auditwasexcludedfromthescopeofinternalaudit.Itisincorrecttoinferthattheaccountingauditdidnot
receivetheattentionoftheinternalauditbecauseitsfocuswasonprovidingconsultationservice.

21. Case Study –1 (Cont2)
Contemporaryliteraturedefinesinternalauditas'assuranceandconsultingservice'.Theissueisof
balancingbetweenconsultationserviceandassuranceservice.Problemariseswhentheinternalauditor
forgetsthattheinternalauditisprimarilyanassurancefunction.Theconsultationserviceflowsfrom
theassuranceservice.Although,theprimaryobjectiveofoperationauditistoobtainassurancethatthe
internalcontrolthatisinstalledtoachieveoperationobjectivesisadequateandoperatingeffectively,
theauditeeslooktotheinternalauditorforsuggestionsandconsultancy.Suchconsultationserviceisa
by-productoftheassuranceservice.Auditeesshouldnotbedeniedthebenefitsofinternalauditor's
understandingoftheindustryandthebusiness,andthechallengesbeforetheauditeesinachieving
operationobjectives.Exclusionofconsultationservicefromthescopeofinternalauditwouldresultin
sub-optimalutilisationofinternalauditresources.
Organisationculturealsodeterminestheeffectivenessofinternalaudit.Theinvestigationcommittee
observes,"AcorporatecultureexistedatToshibawherebyemployeescouldnotactcontrarytothe
intentoftheirsuperiors".Insuchacultureanuprightinternalauditorcannotsurvive,particularlyifhe
isnotindependentofthemanagement.Perhaps,itisthereasonthattheinternalauditinToshibahad
chosentheeasypathoffocusingon'consultationservice'onlywithoutreportinginternalcontrol
weaknesses.
Internalauditoristhe'eyesandears'and'go-toman'oftheauditcommittee.Therefore,internalaudit
failureleadstocorporategovernancefailure.

22. Audit Case Study -2
•Fraudisapracticethatcanmakebusinessestoundergosomemassivelosses.Itis
noteworthythatasmallcompanylikeXYZhasasmalloperatingcapitalthatcould
diminishdrasticallyifnotwellmanaged.Fraudcasessuchasskimmedpayments
fromcustomers,cashtheft,improperhandlingofpettycashandmisuseofthe
company’screditcardsaresomeofthepracticesthatcanleadtototalfailureofa
company.
•ItisquiteexpensiveforasmallbusinesslikeXYZLtdtocreateaninternalaudit
department,however,thecompanycancreateasystemthatchecksandcontrolsthe
financialoperationsandthecompanyemployees.Aninformalinternalauditprocess
wouldsomewhatreducefraudcasesresultingfrompersonalinterests(Chi&Huang
2011).Itisnoteworthythattheparentcompanywouldhavesplitduetoextreme
casesoffraud.
•PreventionoffraudthroughaninformalauditexercisewouldenablethesmallXYZ
Companytoprosperandgrowintoabigmultinationalcompanyandevensurpassthe
projectedturnoverof£2.8millioninthefirstyearoftrading.
•Itisimportantforthecompanytocreateaprogramthatwouldhelpinmonitoring
employeesandenforcestrictrulesregardinganyemployeewhoisfoundguiltyof
committingfraudcases.Theestablishmentofaninternalauditwouldfacilitatethe
above-mentionedpracticesthoughapersistentanalysisofthecompany’soperations.

23. Audit Case Study -2 (Cont1)
Testing and monitoring of internal controls
•AnInformalinternalauditcallsforrecurrentanalysisof
theoperationswithinacompany.Thehabitualanalysis
enablesthecompany’soperationstooccursmoothly,
where,theemployeesarekeptontoestoofferthe
bestofservices.AsmallcompanylikeXYZLtdcan
employauditorswhowoulddesign,modify,andcontrol
theinternalactivitiesofthecompany.
•Thoughauditing,thecompanyisabletostreamlineits
activitiesinamannerthatwouldenableittoachieve
itsgoalsandobjectives(Holm&Zaman2012).
Essentially,XYZLtdisaprofitmakingcompanythat
wouldaimatgeneratingthemaximumprofitspossible.