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What is the history of Auditing – Acca Study Material

What is the history of Auditing

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What is the history of Auditing – Acca Study Material

HISTORY OF AUDITING

What is Audit ?

The word “audit” comes from the Latin word audire, meaning “to hear”.

According to R. K. Moutz, “Auditing is concerned with the verification of accounting data with determining the accuracy and reliability of accounting statement and record.“

An audit is the examination of the financial report of an organization – as presented in the annual report – by someone independent of that organization.

Objectives Of An Audit

Basic objective of auditing is to prove true and fairness of results presented by profit and loss account and financial position presented by balance sheet.The main objectives of audit are known as primary objectives of audit. They are as follows:

  1. Examining the system of internal check.
  2. Checking arithmetical accuracy of books of accounts, verifying posting, costing, balancing etc.
  3. Verifying the authenticity and validity of transactions.
  4. Checking the proper distinction of capital and revenue nature of transactions.
  5. Confirming the existence and value of assets and liabilities.
  6. Verifying whether all the statutory requirements are fulfilled or not.
  7. Proving true and fairness of operating results presented by income statement and financial position presented by balance sheet.

Evolution of Auditing

To facilitate the examination of the historical development of auditing, this review will be divided into the following five chronological periods:

  • Prior to 1840;
  •  1840s-1920s;
  •  1920s-1960s;
  •  1960s-1990s; and
  •  1990s–present

Prior to 1840

Generally, the early historical development of auditing is not well documented . Auditing in the form of ancient checking activities was found in the ancient civilizations of China, Egypt and Greece. The ancient checking activities found in Greece (around 350 B.C.) appear to be closest to the present-day auditing.Similar kinds of checking activities were also found in the ancient Exchequer of England.Prior to 1840 Generally, the early historical development of auditing is not well documented . Auditing in the form of ancient checking activities was found in the ancient civilizations of China, Egypt and Greece. The ancient checking activities found in Greece (around 350 B.C.) appear to be closest to the present-day auditing. Similar kinds of checking activities were also found in the ancient Exchequer of England.

When the Exchequer was established in England during the reign of Henry 1(1100-1135), special audit officers were appointed to make sure that the state revenue and expenditure transactions were properly accounted. The person who was responsible for the examinations of accounts was known as the “auditor”. The aim of such examination was to prevent fraudulent actions . According to Porter, et al (2005), auditing had little commercial application prior to the industrial revolution.

This is because industries during this period were mainly concerned with cottages and small mills which were individually owned and managed. Hence, there was no need for the business managers to report to owners on their management of resources. As a result, there is little use of auditing. In a nutshell, in the period pre-1840, the auditing at the time was restricted to performing detailed verification of every transaction. The concept of testing or sampling was not part of the auditing procedure.

1840s-1920s

During industrial revolution practice of auditing was emerged. According to Braown (1962) large scale operations, large factories and machine based production were resulted form industrial revolution and for that large amount of capital was needed. The emergence of a “middle class” during the industrial revolution period provided the funds for the establishment of large industrial and commercial undertakings.

Innocent investors were liable for business failure. Then the need for protection and this time was ripe for profession of auditing to emerge. Under company’s act 1862, in 1900 statutory audit was mandatory. Porter, et al (2005) commented that in this period the duties of auditor were influenced by the decision of court. The audit objective was mainly detection of fraud and errors.  It can be concluded that the role of auditors during the period of 1840s-1920s was mainly on fraud detection and the proper portrayal of the company’s solvency (or insolvency) in the balance sheet.

1920s-1960s

The growth of the US economy in the 1920s-1960s had caused a shift of auditing development from the UK to the USA. Meanwhile, the advancement of the securities markets and credit-granting institutions had also facilitated the development of the capital market in this period.The concept of materiality (Queenan, 1946) and sampling techniques (Brown, 1962) were used in auditing during this period

It was not necessary to make a detailed examination of every entry, footing, and posting during the period in order to get the substance of the value which resulted from an audit. In short, the social-economic condition in the period had highly influenced the development of auditing.

  1. The major characteristics of the audit approach during this period, among others, included:
  2. reliance on internal control of the company and sampling techniques were used;
  3. audit evidence was gathered through both internal and external source;
  4. emphasis on the truth and fairness of financial statements;
  5. gradually shifted to the audit of Profit and Loss Statement but Balance Sheet remained important;
  6. physical observation of external and other evidence outside the “book of account.

1960s to 1990s

The world economy continued to grow in the 1960s-1990s. This period marked an important development in technological advancement and the size and complexity of the companies. The duties of auditors were to affirm the truthfulness of financial statements and to ensure that financial statements were fairly presented

In the earlier part of this period, a change in audit approach can be observed from “verifying transaction in the books” to “relying on system”. Such a change was due to the increase in the number of transactions which resulted from the continued growth in size and complexity companies where it is unlike for auditors to play the role of verifying transactions. As a result, auditors in this period had placed much higher reliance on companies’ internal control in their audit procedures.

Risk-based auditing is an audit approach where an auditor will focus on those areas which are more likely to contain errors. Similarly, auditors placed heavy reliance on the advanced computing auditing tool to facilitate their audit procedures. In addition to the auditing of financial statement, auditors at the same time were providing advisory services to the audit clients.

1990s-present

Present-day auditing has developed into new processes that build on a business risk perspective of their clients.Presently, the ultimate objective of auditing is to lend credibility to financial and non- financial information provided by management in annual reports.High level of litigation and criticism against the auditors observed.

Some of the key reform activities include: The Sarbanes-Oxley Act (The US) .It outlines the rules on auditor independence, for example, the control of audit quality, and the rotation of audit partners as well as the prohibition of conflict-of-interest situation.

Ramsay report (Australia): It was recommended that auditor independence can be improved through the following ways:

  1. Include a statement in the Corporations Act that auditors are to be independent;
  2.  Require auditors to declare to the Board of Directors that their independence is maintained;
  3.  Prohibit special relationships between the auditor and client
  4. Establish an auditor independence supervisory board
  5.  Establish an audit committee to oversee the issue of non-audit services, audit fees, scope disagreements and auditor-client relationships

 In summary auditing first engaged in form of ancient checking in China, Egypt, Greece. The modern auditing established during industrial revolution. Mid 1800 to early 1900 audit practice can be regarded “traditional conformance role of auditing”. Over the past 30 year or so auditor played an “enhancing role” by enhancing integrity and credibility. Today auditor not only enhancing integrity and credibility also provide value added service. It is evident that the paradigm of independent auditing has shifted over the year.

TYPES OF AUDIT

  • Financial Audit: The purpose of conducting a financial audit is to give an opinion on whether the financial statement prepared by the public sector agencies shows a true and fair view of the Financial position
  • Compliance Audit: Compared to a financial audit, it is not compulsory for the compliance audit to be conducted to all government agencies yearly. This type of audit is performed on cyclical basis. In compliance auditing , the Auditor General will examine and review the transactions and activities of ministers/departments or agencies to determine whether they have conformed to all laws and regulations.
  • Performance Audit: The performance audit involves studies and evaluation of specified programs or activities of ministers/department and other government agencies

Advantages of Audit

  1. Verification Of Books And Statement :- The main object of audit is the verification of the books and the financial statements of the company concerned.
  2. Discover and Prevention Of Error :- While examining the books, auditors detect some errors. These are various kinds of errors. So audit is very useful in preventing and detecting the errors.
  3. Moral Check :- When each staff of the company knows that this financial transactions will be examined by the auditor then he fears to do that fraud. The fear of their detection acts as a moral check on the staff of the company
  4. Check On Directors :- Audit acts a check upon the directors and precaution against fraud on the part of the management.
  5. Proper Supervision :- Sometimes owner of the business can not look after the business personally. Audit acts as a check on employees and it saves the owner from losses.
  6. Valuable Advice :- The auditor has expert knowledge about the accounts and finance problems, so he may be consulted about these problems.

Disadvantages of Audit

  1. The payment of audit fee brings extra cost burden to the organizations
  2. During and audit the auditors requires the attention several companies stuff and therefore cause disruption
  3. An audit doesn’t assure future viability of the organization audited
  4. An audit doesn’t assure the effectiveness and efficiency of management
  5. Auditor express opinions and therefore doesn’t give total assurance of the two fair presentation of annual reports

Conclusion

A review of the historical development of auditing has shown that the objective of auditing and the role of auditors are constantly changing as they are highly influenced by contextual factors such as the critical historical events (e.g. the collapsed of big corporations), the verdict of the courts, and technological developments (e.g. advancement of computing systems and CAATs). It can be observed that any major changes in these contextual factors are likely to cause a change in the audit function and the role of auditors. As a result, auditing is seen to be evolving at all times.

 However, it is important to note that the change in society’s expectation and the response of the auditing profession towards these changes are not always at the same pace. Hence there is a natural time gap between the changing expectation of the users and the response by the profession and due to this time gap there arises what has been stated as the expectation gap or audit expectation gap (Saha & Baruah, 2008). Even though the existence of such a natural time gap is inevitable, Flint (1998) advises that auditors should be sensitive to the changing expectation of the relevant groups while at the same time containing these expectations within the constraints of what is possible. He also claims that there are inevitably economic and practical limitations on what an audit can do, and this is something which those who wish the benefit must understand.

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