Introduction to Audit Flashcards
Statutory Audit of Financial Statements
- Directors are delegated responsibility for affairs of company
- Audit is important for assessing stewardship of directors
- S172 CA 2006 - directors duty to promote success, regard to interests of employees, foster relationships with suppliers, customers, community and environment
Although auditors are appointed by the members…
They liaise with the entity whose information they are reporting on
Entity = contractual client
Members = Beneficial client
Not all members are investing with their own money…
Some are institutional investors eg. invest other people’s money, premiums etc
FRC acknowledged institutional investors in 2010 by stewardship code.
Agency Theory
Economic/management theory
The parties to the contract are the absentee shareholder (principal) and the maneger/director (agent)
Jensen and Meckling 1976 - relationship causes conflict of interest
Agent is likely to be self serving - rational choice theory
Risk that directors will not align with the interests of the company - reckless behaviour causing loss on principals side - moral hazard
Agency theory model, the auditor’s role - “to represent the interests of the owners by
independently verifying and monitoring [the client’s] activities. The [statutory] auditors should
minimise agency problems.
(Arnold and de Lange, 2004, p. 761).
Stewardship Theory
Humanistic Theory
Managers are stewards of shareholder’s funds
Managers will act in best interests of the company rather than self serving (Donaldson 1990)
The premise = stewards/directors will be motivated by “a need to achieve, to gain intrinsic satisfaction through successfully performing inherently challenging work, to exercise responsibility and authority”
The auditor, being independent of the company and the directors, represents the interests of the shareholders in reviewing the financial statements and reports to them on the stewardship role of the directors in the independent auditor’s report.
Stakeholder Theory
Organisational Management Theory
Purpose is to create value for stakeholders not just members (Freeman 1984)
A statutory audit should provide
reassurance to other interested stakeholders such as potential investors, lenders, etc. (Watts and Zimmerman, 1986). - information hypothesis
Users have vested interest in reviewing audited information for informed business decisions
The efficient market hypothesis “suggests that in an efficient capital market, the share price incorporates all the information related to that investment.
Audit expectation gap - difference between what public expect and what auditors are required to do? (CMA) - ACCA published paper on closing expectation gap
ACCA - Closing Expectation Gap in Audit - The way forward on fraud and growing concern
Necessary to consider 3 separate components
- knowledge gap
- performance gap
- evolution gap
s475 CA 2006?
Company’s annual accounts MUST be audited
s477 CA 2006?
exemption from audit if…
company is
deemed small - s382
dormant -s480
A company qualifies as small if…
Satisfies at least two
- turnover less than 10.2m
- balance sheet total less than 5.1m
- average number of employees less than 50
Exemption does not apply if company is public company
s476 CA - allows members holding atleast 10% of share capital to require an audit of accounts
s495 CA 2006?
Requires auditor to report to the company’s members
must
- give a true and fair view of state of affairs of company at end of financial year and the profit or loss of company that year
- have been properly prepared in accordance with relevant FR framework and CA
True and Fair View?
Still relevant?
Courts have struggled to define it
Why may an entity still go ahead with an audit even if not required?
Discipline Vigilance Sense of Continuity Adjudication Compliance
Mautz and Sharaf (1961) Postulates of Auditing
Financial statements and information are verifiable
No necessary conflict of interest between auditor and management
Financial statements are free from collusive and irregularities
System of internal control eliminates irregularities
GAAP - fair presentation of financial position and results of operations
Auditor acts exclusively in capacity of auditor
Professional status of independent auditor imposes professional obligations on them
Flint (1998) Postulates of Auditing
- Primary condition - relationship of accountability
- Subject matter of accountability is too remote, complex and too great a significance to bypass audit
- Essential characteristics of audit are independence of its status and freedom from investigatory and reporting constraints
- Subject matter of audit - eg conduct, state of affairs or facts etc is susceptible to verification by evidence
