Introduction to Auditing

21-BBA(5th Semester)
Course Instructor: Dr. Waqar A. Sethar
Session 21st November, 2023 and onwards
Lecture Dates 21.11.2023
Lecture Objectives
 Explain the importance of auditing.
 Distinguish auditing from accounting.
 Explain the role of auditing in information risk reduction.
 Describe the other major types of audits and auditors
 Provide an overview of international auditing and its impact on Pakistan
Auditing Standards.
 Introduction to Course
Title of Subject : Auditing Marks: 100
Discipline : BBA
Code : ACT313
Semester : Fifth
Effective : 2019 Batch and onwards
Pre-requisites : Principles of Accounting
Assessment : 10% Attendance , 10% Sessional, 20% Mid Semester, 60%Final
Credit Hours : 03+00 Minimum Contact Hours: 42
 Recommended References / Textbooks
 Forensic and Investigative Accounting (Latest Edition) by D. Larry Crumbley, Lester E. Heitger , G.
Stevenson Smith, Wolters Kluwer, Holland.

 Fundamentals of Auditing, (2009), Sanjib Kumar Basu, Pearson Education India.

 Internal Auditing (Latest Edition) by Urton Anderson

 Auditing and Assurance Services by Alvin A. Arens, Mark S. Beasley, and Randal J. Elder

 Auditing Principles and Procedures by Prof. Khowaja Amjad Saeed

 Auditing an International Approach (Textbook)

 Course Learning Outcomes
•Upon successful completion of this course, each student will be able to:

 Identify the value proposition that stakeholders expect from the internal audit function.
 Understand the internal control systems and their evaluation; audit evidence and problems related to the
audit of particular assets, liabilities, and capital and income accounts.
 Explore and apply the nature of verification, audit evidence, testing, the elements of effective control
structures, the use of statistical sampling and evolution of external, internal and comprehensive auditing.
Evolution of Auditing
Beginning of 12th Century, the Exchequer
was established by Henry-I of England
 Double-Entry Book Keeping

Luca Pacioli “Father of Accounting” (1447 –

1517) published book “The treatise on the Art of
Book-Keeping”
 Industrial Revolution

Industrial revolution in 18th Century, led to the organization of large-

Scale businesses, and principle of limited liability encourage public to
invest in joint stock companies or corporation.
 Joint Stock Companies or
Corporations

Division of Owners and Management, Board of Directors must Independent , competent persons to
ensure the accuracy of accounts and need for third person who is audit the accounts led to the
well qualified to determine the accuracy of books of accounts to establishment of Professionals known
satisfy the shareholders. as “Accountants and Auditors”
 Development of Auditing Profession in
UK.

Companies Act of 1862 had provisions

to audit the accounts of joint Stock
Companies.

Amendment act of 1900, made audits

compulsory

Professional accounting and auditing societies between 1870

and 1880. Royal Charter by Queen in 1880 to establish Institute
of Chartered Accountants of England and Wales
 Development of Auditing Profession in
Pakistan
Pre Partition
Companies Act of 1913 , audit of company's compulsory, Bombay
government trained first groups of auditors. Audit Certificate Rules
in 1932 only registered accountants were required to carry out audit
of companies and other entities.
 Development of Auditing Profession in
Pakistan
Post-Partition
Auditor’s certificate rule (1932) was amended in 1950. “A person who could
satisfy certain conditions will entered in register maintained by Ministry of
Commerce”.

1952 – Institute of Accountants

1959 – Establishment of Department of Accountancy in MoC.
1960 – Institute of Chartered Accountants was established
1984 – Companies ordinance was promulgated (Legal and Cost Acc:)
2017 – Companies act was introduced and promulgated
 Development of Auditing Profession in
Pakistan
Institutions
International Federation of Accountants (Members)
Institute of Chartered Accountants of Pakistan
Institute of Cost and Management Accountants of Pakistan
Pakistan Institute of Public Finance Accountants

Certified Internal Auditors of Pakistan

Auditor General of Pakistan “The Auditor General's organization is the only institution mandated by
the Constitution to support parliamentary oversight over the raising and utilization of public financial
resources. In this capacity, the Auditor General plays a key role in ensuring accountability and
transparency in the governmental operations”
LO1: Explain the Importance of
Auditing
• Auditing receives media attention
• “Betrayed Investor”, “Accounting in Crisis” ,”Rotten Numbers”
• Auditing is critical for :
• Proper Functioning of Capital Markets
• If auditing fails so the capital Markets
• Without effective audit capital markets cannot be considered as efficient
economic systems that lead to higher living standards
• The European Commission states that:
• “The Auditors, regulators, and corporate governance are key contributors to
financial stability and economic growth”
LO1: Explain the Importance of Auditing
 LO1: Explain the Importance of Auditing
• The previous example shows the work of effective auditor in 21st Century
• In modern business, the role of auditing is so critical that references can be made
to audit societies
• In Audit Societies
• Economic activities are extensively monitored to ensure Market Efficiency
• Also auditors monitor the effectiveness and efficiency of government
• In Pakistan “PanamGate”, Dawn Leaks were the result of audit of questionable
transactions
• In 2022 the officials from the NBP, petroleum companies – Hascol Petroleum Limited
(HPL), Byco, etc, were booked by the Federal Investigation Agency (FIA) in a case in
2022 on charges of fraud, criminal breach of trust and money laundering etc.
• Due to these events audit is seen as a process of social control.
 LO1: Explain the Importance of Auditing
• But what is auditing, exactly? Simply put, auditing is the verification of
information by someone other than the one providing that information.
Since there are many types of information, there are many types of
audits. Most of this Lecture focuses on audits of financial statement
information, or financial statement auditing for short.
• Before describing auditing in more detail, we will try to make financial
statement auditing more intuitive through a simple illustration.
LO1: Explain the Importance of Auditing
• The illustrated example shows the value of audit in investment
decisions
• Auditing provides general social service
• Restaurant owner can retire with fair price
• Fair exchange price is based on trustworthy and accurate
information
• Accounting transactions are the “Raw Data” for the auditor
• All transactions are summarized in financial statements
• When auditors verify the this information this reduces the
information risk
LO1: Explain the Importance of Auditing
LO1: Explain the Importance of Auditing
• Three-party accountability.
• It is norm in the financial markets
• Corporations are required to hire independent auditors
• To Audit their financial information
• To reduce the information risk
• So that information should be reliable, trustworthy
 LO1: Explain the Importance of Auditing
• Agency Theory: How contracts can be designed to mitigate the agency
problem
• Task delegated to (Agent) by the (Principal), it can create potential
problems
• Three conditions are present
• a) the agent has objectives that are different from those of the principal,
• (b) the agent has more information than the principal does (information asymmetry),and
• (c) the contract between the two is incomplete in that not every possible contingency can be anticipated.
LO1: Explain the Importance of Auditing
• Arrow indicates the direction of accountability
• Management is accountable to owners
• One way is to prepare financial statements for accountability
• Management may bias the financial statements
• Making them less credible
• Auditor comes in as and independent accounting expert
• Auditor adds credibility to financial statements
• Help Monitor the Management
LO1: Explain the Importance of Auditing
• The auditor is responsible to owners (Principals) not to the
management
• They create payments historically for the auditors
• This creates the conflict of interest for auditor
• The auditor cannot help monitor management if, auditor is not
independent
• Auditor independence shape the ethical reasoning in the context
of auditing
• Important point the owners or capital providers do not have access
to important information as the management has
LO2: Distinguish auditing from
accounting.
• Demand for reliable information
• Complexity : A company’s transactions can be numerous and
complicated.
• Remoteness: Users of financial information are usually separated
from a company’s accounting records
• Consequences: Financial decisions are important to the state of
investors’ and other users’ wealth. Decisions can involve large dollar
amounts and massive efforts.
• Accounting is the process of recording, classifying, and
summarizing into financial statements a company’s transactions
that create assets, liabilities, equities, revenues, and expenses.
LO2: Distinguish auditing from
accounting.
• The function of financial reporting is to provide statements of
financial position (balance sheets), statements, of results of
operations (income statements), statements of results of
changes in financial position (cash flow statements), and
accompanying disclosure notes (footnotes) to outside decision
makers.
• Because of advances in information technology (IT), the form
and location in which accounting records are stored has
changed dramatically over the past few decades.
LO2: Distinguish auditing from
accounting.
• The function of financial reporting is to provide statements of
financial position (balance sheets), statements, of results of
operations (income statements), statements of results of
changes in financial position (cash flow statements), and
accompanying disclosure notes (footnotes) to outside decision
makers.
• Because of advances in information technology (IT), the form
and location in which accounting records are stored has
changed dramatically over the past few decades.
LO2: Distinguish auditing from
accounting.
• Accounting : is the process of recording, classifying, and
summarizing into financial statements a company’s,
transactions that create assets, liabilities, equities, revenues, and
expenses.

• The goal of GAAP, which you study in your financial

accounting courses, is to yield financial statements that
• represent as faithfully as possible the economic conditions and
performance of a company.
LO2: Distinguish auditing from
accounting.
• Users of accounting information need
• Need reliable accounting information error-free
• Preparers of accounting may benefit from giving false information
• Society needs audit services
• This leads to potential conflict of interest
• Thus users of accounting information hire external auditors
• This adding of credibility is called assurance
• Audit does not involve production of financial reports
• This production is the job of accountants
LO2: Distinguish auditing from
accounting.
• Auditors determine the credibility of Financial reports
• They communicate this conclusion about:
• Financial position
• Results of operation
• Cash flow statement
• In accordance with GAAP
• They provide assurance services of three-party system
• They are frequently referred to as CPA (Certified public accountants)
LO2: Distinguish auditing from
accounting.
• Auditors work for clients:
• Clients could be company, BoD, agency or any other person
• They retain the auditor and pay the fees
• The auditee is the company or entity whose financial statements are being
audited.
• Reliable financial information helps make capital markets efficient
• Bank examiners, CRA auditors, provincial regulatory agency auditor
• Internal auditors employed by a company,
• Auditor General of Pakistan
LO2: Distinguish auditing from
accounting.
• Professional judgment
• Widely used concept in accounting and Auditing
• It is defined as “The application of relevant training, knowledge, and experience,
within the context provided by auditing, accounting, and ethical standards, in
making informed decisions about the courses of action that are appropriate in the
circumstances of the audit engagement”
• Professional judgment is a process used to reach a well-reasoned conclusion
• Professional judgment is critical to effectively performing an audit.
• Focus on most important aspect of audit
• Determining the nature, timing, and extent of audit procedures and
evaluating the appropriateness, of the application of GAAP by management
LO2: Distinguish auditing from
accounting.
• Professional judgment
• Careful and objective judgement
• Documentation is very important
• It demonstrate sound procedure was followed
• The words “ not documented, not done” are standards in audit
practice
• When professional judgment is appropriately applied it supports the
audit conclusion based on audit evidence, facts and figures
• Professional skepticism is essential to professional judgement process
LO2: Distinguish auditing from
accounting.
• Professional skepticism
• Auditor’s tendency to not to believe management’s claims
• Finds sufficient support for claims based on audit evidence
• Professional Skepticism is important aspect of professional judgement
• “Professional skepticism means recognizing that circumstances causing
the financial statements to be materially misstated may exist (CAS
200.15)”
• Application of reason and critical analysis in supporting a conclusion. Skepticism
as adopted by auditors is an important attitude for fulfilling their duties.
 LO2: Distinguish auditing from
accounting.
Overview of Key Aspects of Professional Judgment in Auditing
✓ Is well reasoned
✓ Determines the nature, timing, and extent of audit procedures
✓ Evaluates the appropriateness of applicable GAAP
✓ Identifies other reasonable alternative accounting treatments
✓ Is performed with a mindset of professional skepticism: an inclination to
question management assertions
✓ Is “not documented, not done”: contemporaneous documentation of
evidence and reasoning is needed