On 17th December 2018, the Competition and Markets Authority (CMA) published an update paper outlining serious competition concerns and proposing changes to legislation to improve the audit sector for the benefit of savers and investors alike.

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Home >Business & Finance homework help >Management homework help >On 17th December 2018, the Competition and Markets Authority (CMA) published an update paper outlining serious competition concerns and proposing changes to legislation to improve the audit sector for the benefit of savers and investors alike.

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Week 1 Introduction to auditing – the why of

auditing

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

What is an audit for?

• The purpose of an audit is to enhance the degree of confidence of intended users in the financial statements. This is achieved by the expression of an opinion by the auditor on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework.

• In the case of most general purpose frameworks, that opinion is on whether the financial statements are presented fairly, in all material respects, or give a true and fair view in accordance with the framework.

ISA 200 ‘Overall objectives of the independent auditor and the conduct of an audit in accordance with international standards on auditing’

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Auditing theory, postulates and concepts

Three basic academic writings considered fundamental to this area.

1) Theory of Rational Expectations – Limperg

The work carried out by the auditor should be governed by the rational expectations of those who use their reports so auditors should not disappoint those expectations. Further auditors should not seek to raise those expectations by any more than the work they do justifies.

2) The Philosophy of Auditing – Mautz & Sharaf

Auditing is based on scientific logic where the auditing process is a rational process of examination, observation and evaluation of evidence.

Does not consider risk or accountability between parties

3) Flint – Philosophy and Principles of Auditing

Expanded on Mautz & Sharaf . Based on the fundamental idea that auditing has a social benefit and is not simply a technical exercise for the purposes of regulation,

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

What is an audit ?

Shareholders own the business

Managers (or directors) manage the business

Shareholders use an independent expert to give an opinion on whether the accounts of their company which the managers prepare show a “true and fair view”

These experts are the auditors

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Stewardship and accountability

Directors act as agents for the shareholders

They have a duty to

▪ safeguard the assets of the business (stewardship), and

▪ account to the shareholders for their actions (accountability)

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Why are audits needed?

▪ Directors motivated to show good result

▪ Shareholders need realism

▪ Impractical for shareholders to check accounts

▪ Auditors also report on whether proper books and records have been kept and on any weaknesses in the accounting systems

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Value of financial information

Consider the value of reliable financial information to stakeholders in companies, for example:

– To potential investors

– to regulators of companies

– to employees

– to suppliers and customers

– to the taxation authorities

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Duties of Directors

A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to—

(a) the likely consequences of any decision in the long term,

(b) the interests of the company’s employees,

(d) the impact of the company’s operations on the community and the environment,

(e) the desirability of the company maintaining a reputation for high standards of business conduct, and

(f) the need to act fairly as between members of the company

Companies Act 2006 S172

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Fiduciary relationship

• The directors act in a fiduciary capacity towards the shareholders.

• They are in a special position of trust charged with preserving the assets of the business and, running it for the benefit of the shareholders so that it increases shareholder value and pays them some dividend.

• The fiduciary relationship between the parties places the onus firmly on the shareholders to be accountable for their actions and to be transparent in their reporting.

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Some more law about directors

• A director of a company must exercise independent judgment. (S173)

• A director of a company must exercise reasonable care, skill and diligence (S174).

• A director of a company must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company. (S175)

• A director of a company must not accept a benefit from a third party conferred by reason of:

(a) his being a director, or

(b) his doing (or not doing) anything as director. (S176)

• If a director of a company is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company, he must declare the nature and extent of that interest to the other directors (S177)

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

What does the auditor do?

The auditors job is to gather evidence to prove that

▪ Profits and losses are properly stated

▪ Assets and liabilities belong to the company and are shown at their correct values

▪ Accounting entries are properly recorded in the correct accounting period

To do this they

▪ Review the accounting records and controls

▪ Ask for explanations

▪ Obtain details from third parties

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Other benefits of the financial audit

During the course of their work auditors may be involved in

• discovering weaknesses in systems

• checking compliance with laws and accounting standards

• discovering frauds or errors

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Advantages of an audit

• The provider of finance, e.g. a bank usually requires audited accounts. If they were to ask for their own independent audits this might increase costs to the entity.

• Audits can help protect creditors. • An audit can reinforce financial discipline. • An audit helps establish the credibility of the company. • There may be shareholders who are not involved in the

business and their interests need to be protected by an independent audit.

• It provides reassurance for directors that the figures they are using are reliable.

• It improves credibility of the profits or losses with HMRC and assists in settling tax and VAT liabilities.

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Disadvantages of an audit

• An audit is only for compliance and doesn’t assist management in running the business – it is simply ‘red tape’.

• The costs of the audit represent a non-productive expense and the money could be better used elsewhere.

• Banks and other lenders, including suppliers, can make their own conditions for lending and don’t really need historical audited accounts. For example: • Banks will lend on security and personal guarantees; they will

monitor performance of the bank accounts; they may require regular monthly management information.

• Suppliers will deal on a pro-forma basis (i.e. cash before supply) until a depth of trust has been established.

• Historical accounts, taking advantage of limited disclosure requirements, are of little value as they can be up to nine months old when they become publicly available.

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Other benefits of the financial audit

An audit is useful to company management

Operational audit – check if management procedures followed

Compliance audit – check if rules of an outside regulator followed

This work may be done by an Internal Auditor who is likely to be company employee.

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

True and fair view

What does “true” and “fair” mean?

It does NOT mean

» Correct

» Totally accurate

» Free of errors

It means that the accounts are a reasonably fair representation of the company’s performance and of its assets and liabilities at the balance sheet date

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Rights duties and responsibilities

• Rights ▪ information and explanations ▪ access to company records ▪ receive notice of meetings, attend and speak ▪ in case of removal ▪ make representations to stay ▪ attend meetings

• Duties report to shareholders whether accounts show a true and fair view and comply with Companies Act

• Responsibilities ▪ statement on leaving ▪ resign if ineligible ...

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Globalisation

A strong auditing profession is important to global markets because • Reliable financial reporting promotes confidence and stability in the

market. • Markets need the confidence and the assurance a strong audit function

can bring in order to enable participants in the market , including the entities themselves, investors and potential investors, to make informed decisions.

• This involves reducing risk to potential investors by providing them with ‘sound’ information.

• Corporate failures, particularly those involving fraud by senior management reduces confidence and creates instability. It also tends to encourage increased regulation which may restrict market operations or encourage further deception.

• The concepts of agency require an auditing profession which is able to enforce standards of accountability on company managers though the mechanism of the auditors’ report .

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Audit issues

• Regulators require an improved standard of information, in terms of accuracy and timeliness, in order to protect investors. This applies particularly to banks.

• Increased corporate governance requirements have led to increased accountability and disclosure.

• Conflicts between a rules based approach to control audit firms and the UK and other countries which have adopted a non-legal audit framework based on self regulation. The two approaches necessarily conflict which has caused problems where the US jurisdiction and compliance requirements clash with non statutory approaches to audit regulation.

• The need for auditors to use technology and to develop new approaches to the audit of large, multinational businesses.

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Audit issues

• Problems faced by auditors and accountants in producing consolidated financial information in compliance with an appropriate accounting framework where the component information is prepared under a range of differing standards of quality and disclosure .

• Growth of internet based ‘on-line’ trading which has challenged conventional audit approaches.

• Audit firms are being increasingly required to carry out assurance type assignments for clients which require a lower standard of evidence than does an audit. This creates conflicts of interest.

• The development of auditing mega –firms who, they claim, are the only firms which have the resources to audit modern corporate behemoths. The audit profession is dominated by the ‘Big 4’ (PriceWaterhouseCoopers, KPMG, Ernst & Young and Deloitte).

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Introduction (ISA200/210)

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Introduction (ISA200/210)

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Introduction (ISA200/210)

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Introduction (ISA200/210)

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Introduction (ISA200/210)

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Introduction (ISA200/210)

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Introduction (ISA200/210)

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Introduction (ISA200/210)

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Introduction (ISA200/210)

Use with Auditing 10e by Alan Millichamp and John Taylor ISBN 9781408044087

Introduction (ISA200/210)