AUDITNG

TERMINOLOGIES

Stewardship: this is the practice by which productive resources owned by one person or group of persons are
managed by another person or group of persons. For example, today most business are operated by limited
companies or joint stock companies which are owned by their shareholders and managed by their directors
appointed by the shareholders.

Stewardship accounting: the process whereby the managers of a business accounts or report to the owners of
the business. This accounting and reporting is ordinarily done by means of a financial statement.

Accountability: the quality or state of being accountable i.e. being required or expected to justify actions on
decisions, or it’s an obligation or willingness to accept responsibility for one’s actions.

Financial statements: are ways in which the business entities communicate their financial performance,
financial position, and financial adaptability. International financial reporting standards (IFRS) under IAS 1
(Presentation of financial Statements) have identified the following financial statements:
¾ Income statement
¾ Balance sheet
¾ Statement in changes in equity
¾ Cash flow statements
¾ Notes to financial statement.

AUDIT
Is a Latin word meaning “he hears”
Audit can be defined as the process carried out by suitably qualified auditors whereby the accounts of the
business entities including limited companies, charities, trusts and professional firms’ e.t.c. are subjected to
scrutiny in such detail as will enable the auditors to form an opinion as to their accuracy, truth and fairness;
and there are prepared according to the international financial reporting standards (IFRS) and presented in the
manner required by the regulating body e.g. incase of the company, the company Act cap. 486.

This opinion is then embodied in an audit report then released to those interested parties who commissioned
the audit or to whom the auditors are responsible under statute. It is worthy noting that auditor’s report
a) Is an expression of opinion rather than statement of verified facts.
b) Auditor’s report enhances the credibility of financial statements by providing a high but not absolute
level of assurance.

Audited financial statements are the accepted means by which business corporations report their operating
results (financial performance) and financial position. The word audited, when applied to financial statements
means that all the financial statement mentioned above are accompanied by an audit report prepared by
independent auditor, expressing his professional opinion to the fairness of the company’s financial statement.
Financial statement prepared by management and transmitted to outsiders without first being audited by
independent auditor leave a credibility gap. In reporting on its own administration of the business,
management can hardly be expected to be entirely impartial and unbiased. Independent auditors have no
material personal or financial interest in the business, their reports can be expected to be impartial and free
from bias.

Unaudited financial statements may have been honestly, but carelessly prepared. For examples:
¾ Liabilities may have been overlooked and omitted from the balance sheet.
¾ Assets may have been overstated as a result of arithmetical errors or due to lack of knowledge of
international financial reporting standards.
¾ Net income may have been exaggerated because expenses were capitalized or because sales
transactions were recorded in advance of delivery dates.

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Finally there is the possibility that unaudited financial statements have been deliberately falsified in order to
conceal theft and fraud, or as a means of inducing the reader to invest in the business or to extend credit

For all these reasons i.e. accidental errors, lack of knowledge of accounting principles, unintentional bias,
deliberate falsification e.t.c.; financial statements may depart from international financial reporting standards.
Audits provide users with assurance that the financial statements do not materially depart from international
financial reporting standards.

REASON OR PURPOSES FOR AUDIT

Introduction:
Dependable information is essential to the very existence of our society. Information is required for the
following:
(i) The current and potential investors make decision whether to buy or sell securities
(ii) The banker deciding whether to approve a loan
(iii) The government in obtaining revenue based on income tax returns
e.t.c.
All are relying on information provided by others; for the information to give a reliable and information of
high assurances, it must be audited.

The need to have our financial statement audited is evidenced by the following:
1. In a financial statement audit, the auditors undertake to gather evidence and provide a high level of
assurance that the financial statements follow the international financial reporting standards. Reliable
accounting and financial reporting aid the stakeholders in allocating resources in an efficient manner.
This can only be achieved by having information which can be relied upon, achieved through
auditing.
2. The contribution of the independent auditor is to provide credibility to information, credibility in this
usage means that the information can be believed i.e. can be relied upon by outsiders e.g.
stockholders, creditors, government’s regulators, customers, employee, among others.
3. Increase in complexity in business, resulting from internal growth, mergers and other forms of
business combinations which lead to owners being divorced from management of the business, which
lead to steward reports, requiring the auditor to attest them to be true and fair.
4. Possibility that unaudited financial statements may have been deliberately falsified to conceal theft
and fraud as a means of inducing the reader to invest in the business or the lender extending loan, or
even a supplier extending credit facilities, to mention only a few.
5. Possibility of unaudited financial statements may contain errors, not disclose fraud, be accidentally or
deliberately misleading, fail to disclose relevant information, or fail to conform to regulations e.t.c.
hence requiring to be audited.
6. Auditing is a requirement for good corporate governance i.e. steward reports on how the business
entity is controlled and directed in order to achieve the predetermined objectives.

OBJECTIVES FOR AUDITING:

The primary objective of auditing financial statements is to enable the auditor to express an opinion whether
the financial statements are prepared in all material respect in accordance with the identified financial
reporting framework and whether in the auditor’s opinion they give a true and fair or they present the
financial statements fairly in all material respect so that any person reading and using them can have believe
in them.

Subsidiary objective:
1) Detection of fraud and errors
2) Prevention of fraud and errors – an audit deters fraud
3) Advice the management on adherence to frameworks of best practices.
4) Assist its clients with accounting systems, taxations, financial advice and other problems.

The true and fair concept in context of auditing:

True: means that information is factual and conform with reality i.e. not false.
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Fair: information is free from discrimination and bias and is in compliance with expected standards and rules.

Previously, the auditor was required to certify as to the truth and correctness of the financial statements; the
phrase true and correct implying arithmetic accuracy. Such an approach ignored the overall view of the
financial statements, which are prepared using subjective accounting policies and would be difficult to prove.
It is not possible to certify that one set of accounts is correct set, because many accounting areas are subject to
a wide variety of interpretations and therefore presentation. As a result the auditor is only required to express
an opinion as to whether the financial statements show a true and fair view of the state of the affairs of the
company and of its profit and loss for the period.

AUDIT MATERIALITY (ISA 320):

At this point it is important to consider the concept of materiality. We will keep on referring to this concept
through out the course.

Materiality is defined as the magnitude of an omission or misstatement that, individually or in the aggregate,
in light of the surrounding circumstances, makes it probable that the judgment of a reasonable person relying
on the financial statements would have been changed or influenced by such omission or misstatement.

Materiality depends on the size of the item or error judged in the particular circumstances of its omission or
misstatement. Thus materiality provides a threshold or cut-off point rather than being a primary qualitative
characteristic which information must have if it is to be useful.”

The concept of materiality is important to the auditor when he is concluding whether financial statements
show a true and fair view. Hence the auditor can only report that financial statements do not show a true and
fair view on only material isssues.

In designing the audit plan, the auditor establishes an acceptable materiality level so as to detect quantitatively
material misstatements. However, both the amount (quantity) and nature (quality) of misstatements need to be
considered.

Examples of Qualitative misstatements,

1. Departure from an accounting Standard.
2. Non conformance with statutory requirements e.g. companies Act, Income tax, RBA

The auditor should consider materiality at both the overall financial statements level and in relation to
individual account balances, classes of transactions and disclosures.
For further information on materiality read ISA 320: “Audit Materiality”

USERS OF AUDITED FINANCIAL STATEMENTS

1. Present and potential Investors

The providers of risk capital and their advisers are concerned with the risks inherent in and return provided by
their investments. They need information to help them determine whether they should buy, hold and sell.
Shareholders are also interested in information which enables them to assess the ability of the enterprise to
pay dividends. Profitability and financial soundness would, therefore, be matters of prime importance to them.
2. Lenders, Suppliers and other Creditors.
These are entities that have extended or consider extending loans or credit. Lenders are interested in
information that enables them to determine whether their loans and the interest attaching to them will be paid
when due.
Suppliers and others creditors are interested in information that enables them to determine whether the
amounts owing to them will be paid when due. They will be concerned about the liquid assets of an enterprise
relative to the amount of liability falling due in the near future, and about the owner’s investment relative to

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outside funding. To the lenders, suppliers and other creditors, owner’s investment serves as a protecting
buffer between lenders, suppliers and other creditors and any losses which may befall the enterprise.

3. Employees
Employees and their representative groups are interested about the profitability and stability of their
employers. They are also interested in information which enables them to assess the ability of enterprises to
provide remuneration, retirement benefits and employment opportunities.

4. Management
Management requires accounting information to assist them in discharging their managerial function. The
management process may be analyzed into five major functions i.e. planning, organizing, staffing, directing
and controlling the activities of the enterprise. These various management functions have one thing in
common that is they are all concerned in decision making.

5. Government and their agencies.

Government and their agencies are interested in the allocation of resources and therefore the activities of
enterprises. They also require information in order to regulate the activities of enterprises, determine taxation
policies and as a basis for national income and similar statistics. These will include employment, provision of
goods and services and the contribution of enterprises to socio-economic development.

6. Customers
Customers have an interest in information of an enterprise indicating the continuance of an enterprise
especially when they have a long-term involvement with, or are dependent on the entity. Customers would
also be concerned about the fairness of pricing policies, differential costs between one product and another
produced by the same firm at a different price.

(mention something on environmental audit and NEMA)

7. Competitors
Enterprises compare their performance with those of other enterprises. They assess their position against their
competitors. Financial statements enable them to know profit-margins, value of assets, and resource
utilization among other items of their competitors.

8. Public
The general public requires information on the activities of enterprises in light of social benefits and costs that
accrue to the community. The public is very dependent on enterprises not only because they provide
employment but because they affect socio-economic structures of the environment. Firms provide
employment; create demand for local services, as well as extensions in the provisions of welfare services as
the economic well being of the community improve.

EXPECTATION GAPS
Expectation gap is the difference between the expectations of the users of financial statements and the auditor
understanding of their responsibility. It includes:
1) Many people think that the auditors report to the directors of the company rather than the members of
the company i.e. shareholders.
2) Some people think that a qualified audit report is more favourable than a non-qualified audit report
whereas the converse is true.
3) There is a perception that it is the auditor’s duty to detect frauds and errors when infact the detection
of frauds and errors is the responsibility of directors.
4) Many people think that audited financial statements give guarantee to completeness and accuracy of
the financial statements and report to misuse of resources e.t.c. whereas the work of an auditor is just
to form an opinion.

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RESPONSIBILITY OF MANAGEMENT
a) The primary responsibility of management is preparation and presenting the financial statements
which are free from material misstatement and are prepared in accordance with identified financial
reporting framework.
b) Prevention and detection of frauds and errors; management needs to set the proper tone, create and
maintain a culture of honesty and high ethics, and establish appropriate controls to prevent and detect
fraud and errors within the entity on timely basis.
c) Ensure the integrity of an entity’s accounting and financial reporting systems and that appropriate
controls are in place, including those for monitoring risks, financial control and compliance with law.
d) Establish a control environment and maintain policies procedures to assist in achieving the objective
of ensuring as far as possible, the orderly and efficient conduct of the entity’s business. This includes
implementing and ensuring the continued operation of accounting internal control systems which are
designed to prevent and detect fraud and error.

RESPONSIBITY OF AUDITORS
The objective of an audit of financial statements is to enable the auditor to express an opinion whether the
financial statements are prepared, in all respect, in accordance with an identified financial reporting
framework. An audit conducted in accordance with ISAs is designed to provide reasonable assurance that the
financial statements taken as whole are free from material misstatement, whether caused by fraud or error.
The fact that an audit is carried out may act as a deterrent, but the auditor is not and cannot be held
responsible for the prevention of fraud and error.

N.B. If a special examination for irregularity is required by the entity then this should be specified in the
engagement letter but not in the audit section.

LEVELS OF ASSURANCE
¾ Means that the auditors satisfaction as to the reliability and assertion made by one party for use by
another party; (i.e. by management for use by the users of the financial statements).
¾ To provide such assurance the auditor must come up with evidence corrected as a result of procedures
conducted and then express a conclusion. The degree of satisfaction achieved and therefore the level
of assurance which may be provided is determined by the procedures performed and their results.

SUMMARY

While auditing the financial statements the auditor undertakes:

a) To gather evidence to form an opinion about the financial statements
b) To provide a high level of assurance to the users of the financial statements, so that they can believe
in them and have confidence while making economic decisions.
Audit involves:
1. Searching and verifying accounting records
2. Examining other evidence supporting the financial statements
3. The management assertions i.e.
¾ The assets listed in the balance sheet really exist and that the company has title or right to the assets.
¾ Valuations assigned to the assets have been established inconformity with the generally accepted
accounting principles.
4. Gathering evidence to show that the balance sheet contains all the liabilities of the company.