intro to auditing (1)

یا باقی ا نت البا قی

نوراللہ محمد اللہ الا موجود لا

بسمل رقص سو بہر محفل، شمع نبی مجلس، میر خدااللہ حبیب یا بک واصحا الک وعلی اللہ رسول یا علیک والسلام الصلوۃ

اللہ نور یا بک واصحا الک وعلی اللہ نبی یا علیک والسلام الصلوۃغلام یار بحضور یار

AUDITINGChapter No.1: Introduction to Auditing

Origin, Base & History of Auditing

Origin: Latin word “Audire” which means “To hear” Base of Audit: Stewardship Accounting

When a person is trusted for some resources, he must account for it”

History: 5600 years ago: In Egypt, Rome & Greece, investors

used to hear the arguments of the managers In 15th Century (1494): Double entry system introduced

by LUCA PUSIALO, who in the last chapter of his book determined the rights, duties & liabilities of auditors

After Industrial Revolution (1700-1880): England passed Companies Act 1844 which made audit compulsory for companies

Definition of Auditing Definition: Independent examination of financial

information to enable an auditor to give reasonable assurance about the truth & fairness of accounts in accordance with international financial reporting standards True & fair view: Free from material misstatement (errors &

frauds) causing significant effect on the decisions of the users of financial information

Reasonable assurance: Certain material misstatements might have remained undetected due to persuasive evidences

Evidence: Proof of transactions Conclusive: Final evidence after obtaining of which, there is no

need for further evidence Persuasive: Which leads towards final evidence, but itself is not of

good quality

Objectives of Auditing Primary

To give independent opinion To give reasonable assurance of truth &

fairness of accounts To check compliance of prescribed laws To meet legal obligations

Secondary To detect & prevent from errors & frauds

Implied: Moral check

Objectives of Auditing Special

To assess the performance of the management To satisfy taxation officers To measure social performance of business To examine the wise use of resources To verify the correctness of cost accounts To check the efficiency of operations To determine the real value of business for bid offer To satisfy lenders about the creditworthiness of

business To maintain sufficient profits

Objectives of Auditing To enable shareholders to supervise the

management To attract new investors To satisfy workers for their pays To change the state of affairs in case of

admission, retirement, death, insanity or insolvency of partners

To determine loss to recover it from insurance company

To improve internal control system To enlist the business on stock exchange

Advantages of Auditing For Managers:

Independent & reasonable assurance about the truth & fairness of financial information

Detection & Prevention of errors & frauds Compliance of prescribed laws Improvement in internal control system Advice about weaknesses High credit rating Easy loans Easy tax payments Enlistment on stock exchange

Advantages of Auditing For Owners

Shareholders’ protection Moral check on management Improvement in efficiency & effectiveness Stability of profits Settlement of disputes Help in case of admission, retirement, death, insanity or

insolvency of partners For Government

Better performance of tax department Easy assessment & recovery of taxes Purchase of private business Sale of Government business Economic development

Advantages of Auditing For Creditors

Getting back of principal & interest in timely manner For Bidders

Determination of true value of business For Insurers

Determination of exact amount of loss For New Investors

Attraction towards high & stable returns For Workers

Satisfying workers by good pays

Limitations of Audit No absolute assurance Costly Checking of past actions Bias of auditors Frauds by management No true & fair view due to connivance with

management Misleading certificates No suggestions by auditors in case of no full

disclosure to them

Scope of Audit Process of Auditing

Understanding the client’s system Planning (Audit programme, audit

notebook, audit working papers) Sampling (Test checking) Vouching (Evidencing the transaction) Verification (Valuation of assets & liabilities) Investigation (Enquiries from stakeholders) Writing audit report

Scope of Audit Laws governing the process of auditing

International Standards on Auditing (ISAs) International Financial Reporting Standards (IFRS) Relevant legislations (e.g. Companies Ordinance

1984, Banking Companies Ordinance 1962) Relevant regulations (e.g. SBP’s prudential

regulations for banks, SECP’s regulations for NBFIs)

Terms of audit engagement letter Auditor’s knowledge, training & experience

Factors Affecting Scope of Audit Scale of business Cost Time Relevancy Materiality Risk Areas Sufficiency of information Reliability of internal control system

Auditor Independent examiner of financial information who gives

reasonable assurance about the truth & fairness of accounts in accordance with international financial reporting standards

Qualifications: Any chartered accountant within the meaning of Chartered Accountants Ordinance 1961, or audit firm whose all CAs are practicing in Pakistan, is qualified to conduct audit of a public Ltd. company or private Ltd company having capital of Rs. 3 million and above or subsidiary of a public Ltd. company, if

He/It is not present employee of the business to be audited He/It has not been employee for the last 3 years He/It has not any relation with any employee He/It is not any debtor/creditor of the company to be audited He/It is not disqualified for any subsidiary/ holding company of the

company to be audited He/It is not a body corporate

Disqualifications: Not meeting the above qualifications

Auditor Appointment of Initial Auditor

By directors Appointment time: Within 60 days from the incorporation of the

company Term of office: Uptil the conclusion of 1st annual general meeting

By shareholders (If directors have not appointed) Appointment time: Within 60 days from the end of 1st 60 days Term of office: Uptil the conclusion of 1st annual general meeting

By SECP (If shareholders have not appointed) Appointment time: Within 30 days from the end of 2nd 60 days Term of office: Uptil the conclusion of 1st annual general meeting

Auditor Appointment of Subsequent Auditor/Regular Auditor

By shareholders Appointment time: In 1st AGM Term of office: Till next AGM

By SECP (If shareholders have not appointed) Appointment time: After 1st AGM Term of office: Till next AGM

Appointment of Auditors for Casual Vacancy (If the regular auditor leaves the job before the completion of audit) By directors

Appointment time: Within 30 days from the occurrence of casual vacancy Term of office: Till next AGM

By SECP (If directors have not appointed) Appointment time: After 30 days from the occurrence of casual vacancy Term of office: Till next AGM

Auditor Appointment under Income Tax

Ordinance 2001 Any CA or CMA can be appointed as an

auditor of a Pvt Ltd. Co. having capital of Rs. 0.5 million or above

A CA must be appointed for the audit of a public Ltd. Co.

Remuneration: Audit Fee Fixing authority: Appointing Authority

Auditor Removal

Companies Ordinance 1984 is silent about the removal of an auditor before the completion of his term of office

Reasons of removal: Shareholders are not satisfied with the performance of the

auditor Auditor is biased and partial

Procedure for removal: Permission from the Government 14 days removal notice by the shareholders to the company Copy of this notice sent to the auditor

Auditor 7 days calling notice to the shareholders & the auditor to attend

the meeting Auditor files representation before the company, which is

circulated among the shareholders before the meeting or read out during the meeting

Resolution in general meeting Qualities

Personal Leadership Foresight Ability to plan & decide Hardworking Due care Honesty Independence Alertness Tactfulness

Auditor Professional

General Knowledge Special Knowledge

Areas: Accounting, Financial Management & Auditing Knowledge about business organization and its

operations Electronic data processing

Company Laws: Companies Ordinance 1984, Companies Rules 1985 Mudarbah Companies Ordinance 1980, Mordarbah

Companies Rules 1981 Banking Companies Ordinance 1962

Auditor Mercantile Laws:

Contract Act 1872 Sales of Goods Act 1930 Common Carrier Act 1865 Negotiable Instruments Act 1881 Partnership Act 1932 Co-operative Societies Act 1925

Taxation Laws: Income tax Ordinance 2001, Income Tax Rules 2002 Sales Tax Act 1990, Sales Tax Rules 2006, Sales Tax

Special Procedure Rules 2007 Federal Excise Act 2005, Federal Excise Rules 2005 Customs Act 1969

Auditor Ethics

A watchdog not a blood hound Nether too soft nor too negative Professional skepticism based on objective

not subjective approach Impartiality Integrity Confidentiality (exceptions: permission of

client, court orders)

Auditor Rights

To make surprise visits of the premises To access books of accounts To call for information & explanation To seek opinion from experts To correct own statements To receive notices to attend the meetings To attend, speak & remain present at meetings To receive remuneration To complete the term of office To make representation in case of removal

Auditor Duties

To examine the records To help public prosecutors and taxation officers To certify statutory report To prepare & sign report on AGM To certify solvency at the time of winding up To give reasons in case of negative opinion To follow instructions of Government if any

Liabilities Civil Liabilities: For breach of terms of contract

Liability for Negligence: Auditor is liable to shareholders for his carelessness causing loss to the client, Any director/shareholder can file a suit against him to recover such loss during the lifetime of the company

Auditor Liability for Misfeasance: Auditor is liable to

shareholders for his misuse of authority causing loss to the client, Any liquidator can file a suit against him to recover such loss within 5 years of order of winding up or appointment of liquidator

Liability for libel: Auditor is liable to shareholders for giving untrue adverse remarks for any officer of the company. Any director/shareholder can file a suit against him to recover defamation charges

Liability for third parties: Auditor is liable to third parties for his negligence or fraud causing any loss to them if

He knows that his opinion is to be relied upon by them. They have put reliance on his report They have suffered loss They have filed a suit against the auditor to recover such loss

Auditor Liability for breach of contract: Auditor is

liable to shareholders for failing to fulfill the terms & conditions of the contract causing loss to the client. Any director/shareholder can file a suit against him to recover such loss.

Criminal Liabilities: For breach of prescribed laws

AuditorParticulars Imprisonment Penalty (Rs.)Professional Misconduct Decided by

courtDecided by court

Fraud during winding up of the company

Decided by court

Decided by court

Disqualified Auditor - 25,000Delayed Report after 2 months from the end of accounting period or extended time

- 5000

Non-compliance 6 months 2000Intention to profit 6 months 2000Failure to assist taxation officer 1 year 10,000False evidence 2 years Decided by

courtMisstatement in prospectus 2 years 10,000 or bothSigning untrue certificate required by law

2 years Decided by court

Falsification of accounts 2 years 20,000False statement 3 Years 20,000 or both

Auditor Other

Liability in case of joint audit: Each auditor will be held responsible for any misappropriation made by him

Liability in case of honorary audit: If any auditor accepts to audit any company without receiving any remuneration, his liabilities will be the same as those of the paid auditors

Difference between Accounting & Auditing

Accounting AuditingDefinition

Preparation of books of accounts & financial statements to show the financial position of business

Independent examination of financial information to enable an auditor to give reasonable assurance about the truth & fairness of accounts in accordance with international financial reporting standards

ProcessRecording in journal, classification in ledgers, summarizing in trial balance, compilation of financial results in financial statements

Checking reverse accounting process through Understanding the client’s system, Planning, Sampling, Vouching, Verification, Investigation, Writing audit report

HistoryHistory of business & accounting went side by side

History of auditing is shorter as compared to accounting


Accounting AuditingPeriod

Throughout the year Either periodically or at the end of financial year

KnowledgeAbout accounting About accounting, financial

management and auditingNature of work

Mechanical InvestigativeNature of Information

Financial Both financial & non-financialApproach of work

Constructional AnalyticalManagerial Influence

Yes No


Accounting AuditingPurpose

Depicting financial position Checking truth & fairness of financial information

Legal necessityFor every business Not for every business

Conceptual frameworkInternational Accounting Standards & generally accepted principles

International Standards on Auditing, relevant legislations, regulations, terms of engagement letter, auditor’s judgments

PrinciplesGoing concern, separate entity, accrual, consistency, monetary measurement, prudence, matching, realization, accounting period.etc

Independence, full disclosure, objectivity, materiality


Accounting AuditingKinds

Cash basis, Accrual basis Continuous, interim or final.etcTechniques

Depreciation, and stock valuation methods

Vouching, verification etc.

Status of accountant vs. auditorAccountant is employee of the business

Auditor is an independent party, agent of the shareholders

Qualification of accountant vs. auditorAny qualification to make him adept in accounting

Must be Chartered Accountant in case of public Ltd. Co., Pvt Ltd Co with 3million capital or more and subsidiary of public Co.

Appointment of accountant vs. auditorBy management By shareholders, directors or SECP


Accounting AuditingRemoval of accountant vs. auditor

By management at any time By shareholders in next annual general meeting

Code of EthicsAccounts are not required to follow the code of conduct of any council

Auditors are required to follow the code of ethics given by Institute of Chartered Accountants of Pakistan

Rights, Duties & Liabilities of accountant vs. auditorDetermined by management Determined by Companies Ordinance

1984 and ISAsReward of accountant vs. auditor

Salary FeeDetermination of remuneration

Fixed by management Fixed by appointing authorities


Accounting AuditingAnswerable

To managers To shareholdersReport

Financial statements Auditor’s opinion about the truth & fairness of financial statements

intro to auditing (1)

Documents