First and foremost, an audit as defined by Investor Words is an independent appraisal performed by an independent expert of an activity or event. There are a few different kinds of audits, e.g. operational, technical, ecological. To elaborate, an audit means that a company's financial records, accounting records and supporting documents are examined and verified by employees of the organization (internally) or by an outside firm (externally). A process of obtaining and evaluating evidence shows that audit is both an investigative and reporting process. (Zachariah, Musa, 2012)
An in-depth analysis of the nature of an audit shows that it is the accumulation and evaluation of evidence about information, and then to make a decision based upon the degree of correspondence between the information and established criteria. As it critical to the finances of an entity, an audit should only be done by a competent and independent person. Caution is taken to prevent a cashier or book-keeper from embezzling the money. As studies show, the morale effect has prevented theft in many cases and is a more powerful point in favor of audit. (McCann, Donald C, 1973)
In short, Auditing is usually performed to ensure that the company's financial statements are consistent with the company's financial transactions. After a thorough analysis of the company's financial statements, the auditor will make a report and give a professional judgment about whether the statements are satisfactory and in compliance with accounting principles and standards.
B) The Differences between Accounting and Auditing.
Auditing begins where accounting ends. On the other hand, accounting starts when book-keeping ends. The process of accounting is to provide more details about the economic activities and the status of the assets and liabilities of an entity. This process is done by creating and preparing financial statements and other related financial information. Once completed, it will show up the company's cash flow and working capital to let the company gain a better understanding about their financial situation. This is done to ensure the stability of the company. (Messeir, Glover & Boh, 2007)
Conversely, auditing does not create any financial statements. It is an independent examination of the accounting data in a systematic way to check whether the statements are fairly presented. Auditing can also increase the credibility of those financial statements.
Auditing provides assurance that the information is true and gives an opinion in the audit report while accounting finds out the trading results. As an auditor of financial statements, one needs to understand the accounting process clearly to estimate the audit evidence. As an accountant, one does not need auditing knowledge and normally it only involves the maintenance of books of accounts. (Messeir, Glover & Boh, 2007)
In addition, audit evidence is gathered from accounting reports and documents. This evidence is to ensure the company's economic activities meet government regulations which go beyond books of account. An auditor will estimate the company's financial statements to see whether it matches up with the financial reporting framework standard.
C) The Objective of Auditing and Why It Is Needed.
According to the law, auditing is compulsory for a company. The primary objective of auditing is to report to the owners whether the company provides a true and fair financial statement to reflect the company's situation for the financial years. The financial statements usually refer to the balance sheet, profit and loss account and cash flow statement.
Apart from that, financial statements that have been audited are considered reliable allows the company to have a greater entrance to asset, finance and other credit lines.
The secondary objective of auditing is to find out the errors and fraud and to prevent them. (Kamal Gupta, 2005) Fraud is the intentional misrepresentation of financial information such as manipulation of accounts, misappropriation of cash or goods. On the other hand, errors refer to unintentional mistake in financial information. Fraud and errors are common since it will misstate a company's financial position.
Another useful feature of auditing is that it helps the company to analyze the system and keep record. This is to ensure the company has the opportunity to reduce risk, and to avoid any loss in the future. When a company is facing financial problems, they can secure loans easily after getting their accounts audited by qualified auditors. (B.N. Tandon & S.Chand, 2006)
Furthermore, auditing is needed to confirm whether the reports prepared by the company's manager match the contract provision. Lastly, it brings benefit when paying the company tax; the tax authorities accept the audited account for estimation of taxes. Thus, auditing avoids the need for further inquest from the tax department, which in turn reduces the concerns of the company.
D) Differences between the Role of Internal Auditors and External Auditors.
The Institute of Internal Auditors describes internal auditing as a self-regulating, unbiased assurance and consulting activity. Internal auditing is designed to help improve the operations of a company by ensuring an orderly controlled approach to assess and reduce risk, thus increasing control over the company. This in turn helps an organization to set targets and achieve goals.
In contrast, an external auditor checks the financial statements of the company and gives his own independent opinion. External auditing includes whether the statements follow the Financial Reporting Standards, whether they show the organization's financial position fairly, whether the profits and losses of the company are represented precisely, and whether any tampering had been done to the financial statements. (Lal Balkaran, 2008)
Internal auditors are an important part of the organization - their main clients are the management and the board of directors. Although internal auditors of the past have reported to the CEO of the company or other senior directors, nowadays, internal report their findings to the audit committee.
Conversely, external auditors are hired by the organization; they are not a part of it. The objectives of external auditors are set primarily by statute and by their main client, the board of directors.
Generally, internal audit functions are not compulsory for organizations, it is not legally required. Thus, companies or organizations can choose whether to hire internal auditors or not.
An external audit is a must for most corporations, especially those publicly traded on the stock exchange. External audits are also compulsory for some government agencies; therefore, government auditors are required to submit the audit report to their corresponding legislature.
Internal auditors do not necessarily need the proper qualifications; employees i.e. accountants and management personnel with a comprehensive knowledge of the company's operations and have gathered experience that makes them appropriately qualified to do internal auditing. Ultimately, it is up to the decision of the employer to choose the internal auditors.
External auditors are required to be properly trained to detect errors and small irregularities. Apart from that, they also have to design audits which are able to detect the finances of the company with reasonable accuracy, and report their findings. In the majority of countries, auditors of publically owned companies are required to be members of a body of professional accountants whom are recognized by the law. (Lal Balkaran, 2008)
Internal auditors often view the assessment of risk as one of the main priorities. This is because risk assessment will affect the planning of the company. Thus, an internal auditor will assess risk combined with other information, such as financial and operational information.
External auditors will only consider the financial aspects of risk. An external auditor uses the information of risk to determine the time period necessary for the audit, and also the procedures needed. (A. Pop, C. Bota-Avram, F. Bota-Avram, n.d.)
E) Importance of Audit to the Users of Financial Statements.
Internal and external users i.e. managers and investors need reliable information. This is because it is important for them to determine whether the company is trustworthy, and how a company affects the overall business industry to make the final decision.
Auditing helps the users to ensure the information is relevant, provide an external look at the accounting operation, and the overall fiscal health of a publicly held company. Furthermore, proper audits can increase the users confidence and also can attract more investor to further the investment. The users can have a clear view about the company's financial situation of the company through financial statements. Also, an audited financial statement is according to the needs of a variety of users to avoid bias against another group (Gramling, Rittenberg & Johnstone, 2010). Auditing acts as an examination which can check on employees from committing defalcation. Through auditing, the auditors would ensure that proper disclosures are made in the financial statements thus, ensuring there's a better alignment of information between the management and the users of financial statement.
F) Discuss the types of audit and provide ONE (1) example for each type.
The general definition of an audit refers to an examination and verification of a company's financial and accounting records and supporting documents. Auditing is done by a professional such as a Certified Public Account ("Audit," n.d.). According to the Oxford English Dictionary (9th ed.), audit is defined as an official inspection of an organization's account.
There are a number of types of audits that are available i.e. compliance audits, operational audits, financial audits and forensic audits. A compliance audit is conducted to determine whether an organization is following established procedures, rules and regulations ("Auditing," n.d.). In others words, it is a review of an organization's financial records to determine whether the organization follows the specific procedures set by an authority. A compliance audit is usually conducted by a regulatory agency, organization or a third party. (S.W. Teppler 2003)
For example, an organization employs an outside consultant to perform a compliance audit to meet governmental requirements in order to obtain an operating license. Compliance audits are also done to determine whether bank requirements for a loan continuation have been met. Also, compliance audits are done by district schools following the procedures set by higher government authorities.
Operational audits are designed to test the procedures and internal systems of an organization. Once conducted, operational audits will determine how those procedures will impact the organization. Operational audits also measure compliance with policies and procedures as well as applicable laws and regulations (Daher, D. L., 2005, p.8). Furthermore, an operational audit can refer to an organized test of effectiveness and efficiency of resource utilization. Thus, it evaluates the operating procedures of an organization. Operational audits are also known as performance audits or management audits.
The primary task of an operational auditor is to establish performance, express opinion on standards and criteria for assessment, and identify areas for improvement. Generally, operational auditors focus on performance and improvement. For example, an operational audit will evaluate the organization's computerized payroll system; the audit will determine whether the system is functioning efficiently and effectively.
Financial audits are designed to validate the accuracy and completeness of records and account balances. A financial auditor will determine whether the financial statements of an organization's functions, activities or departments fairly represent its financial position. The results of operations, changes in cash flow and financial position of the auditee must be in accordance with the Generally Accepted Accounting Principles (Daher, D. L., 2005, p.8). Generally, financial audits are mainly about the preparation of full set of financial statements and the evaluation of revenues and expenses of the organization. The audit is to ensure that those financial statements comply with the laws and regulations set by the Malaysian Accounting Standards Board (MASB) and financial reporting framework.
Public accounting firms provide financial audits with a true and fair view of an organization's financial integrity. Hence, audits need to state whether an organization's financial statements are accurate and reliable. For example, internal auditors are required to observe the financial statements and records of an organization. At the same time, external auditors are also needed. Those external auditors are usually employed from the Big Four i.e. Ernst & Young, KPMG, PricewaterhouseCoopers, and Deloitte.
A forensic audit is an evaluation or test of a company's financial information for use in court as evidence. According to the Auditing and Assurance Services in Malaysia, a forensic audit is often conducted to obtain or develop information as legal evidence or for use by expert witnesses in the courts of law (Messier, Glover, Prawitt & Boh, 2007, p.50 & 51). Furthermore, a forensic audit is conducted to understand the accounting records and show the true nature of the transactions being recorded; it requires assessing financial information to be used in legal proceedings. Thus, a forensic audit is done to obtain and develop information in accordance with the principles of law and business.
Forensic audits are often conducted when financial issues are present. Forensic audits are needed most during cases of negligence or deliberate misconduct; it is used to determine the consequences of business economic losses, shareholders and partnership disputes, and business or employee fraud. For example, the forensic audits deter employees from acting against the law while performing their respective tasks, especially when dealing with financial statements and reports. Also, forensic audits can be performed by internal auditors economists, certified public accountants and chartered accountants.
G) The Meaning of 'True and Fair View'.
A qualified auditor should be able to express a true and fair view opinion or 'present fairly, in all material respects' of the financial statements in accordance with the identified financial reporting framework. This will enhance the credibility of financial statements.
According to Merriam-Webster's dictionary, the word 'TRUE' have the same meaning as the word 'FACT'; it means that it is something which contains evidence and there is proof of its existence. In auditing, a 'TRUE' financial statement is free from material misstatement and everything should be evidence based.
On the other hand, the word 'FAIR' means free from bias. In auditing, it means that the auditor's decision must be reasonable; the financial statement is objectively presented, free from management bias, and relevant to the needs of users.
As a conclusion, 'true and fair' means that, in the auditor's opinion, the company's financial statements offer a true and fair view of its actual financial position, and that any assumptions they include are reasonable.
(H) Categories of Audit Report
There are four categories of audit report i.e. unmodified/unqualified opinion, qualified opinion, disclaimer opinion and adverse opinion.
An unmodified/unqualified opinion is the most complete type of auditing report, it shows that the accountant is able to access the financial information of the company, and that the information complies with the Generally Accepted Accounting Procedures (GAAP). (Henderson, K.J., n.d.) Therefore, the financial statements said to be in accordance with the financial accounting standards and other mandatory reporting requirements. (Leung, Coram, Cooper, 2007) According to John E. McEnroe and Stanley C. Martins, 'the unqualified audit report states that the financial statements of a company present fairly, in all material aspects, the financial position of that company at the end of a given year, in conformity with Generally Accepted Accounting Principles.' The objective of an unmodified auditor's report is to clarify the assurance by the auditor's opinion, and to give users a better understanding about the work done by the management of the company. (Marquis C., n.d.)
A sample extract of an unmodified opinion by the Hong Kong Institute of Certified Public Accountants is as follows:
We have audited the financial statements of ABC Limited ("the Company") set out on pages ........ to........, which comprise the [balance sheet][statement of financial position] as at 31 December 201X, and the [[income statement][statement of comprehensive income] statement of changes in equity][statement of income and retained earnings] and [cash flow statement][statement of cash flows] for the year then ended, and a summary of significant accounting policies and other explanatory notes.
A qualified opinion is a type of report which is issued only when the accountants are not completely satisfied about all aspects of the company's financial status. For instance, some particular records may be misplaced, or a portion of information may not be up to date with the Generally Accepted Accounting Principles. In some situations, the accountant may still be able to access the information but the information may not be fully validated. Consequently, the problems are recorded as they will make the accountant's judgment more inappropriate. However, the structure of qualified report is similar with the unqualified report, but it will have an emphasized part in an additional paragraph to make a clearer statement about the explanation for the qualification . (Henderson, K.J., n.d.)
A sample extract of a qualified opinion by the Hong Kong Institute of Certified Public Accountants is as follows:
In our opinion, except for the effects of such adjustments, if any, as might have been determined to be necessary had we been able to satisfy ourselves as to cash sales, the financial statements have been properly prepared, in all material respects, in accordance with the SME-FRS. [In addition, in our opinion, except for the effects of such adjustments, if any, as might have been determined to be necessary had we been able to satisfy ourselves as to cash sales, the balance sheet together with the notes thereon is properly drawn up so as to exhibit a true and correct view of the state of the Company's affairs as at 31 December 201X according to the best of our information and explanations given to us, and as shown by the books of the Company.]
.
A disclaimer opinion is prepared only when auditors are not able to form an accurate audit report which may be due to the refusal of the company to present their financial statements. In short, when there is not enough time or information available, a disclaimer opinion report is prepared. This is a very rare case, as an auditor will only engage this type of report if the company reluctant to disclose certain information or if the auditing firm and the company terminates their contract. In addition, a disclaimer opinion gives only a little information about the auditing procedure which includes an explanation paragraph. The auditor will also give a reason explaining why the financial status could not be determined. (Tyler L, n.d.)
A sample extract of a disclaimer opinion by the Hong Kong Institute of Certified Public Accountants is as follows:
Because of the significance of the matters described in the basis for disclaimer of opinion paragraph, we do not express an opinion on the financial statements as to whether they have been properly prepared, in all material respects, in accordance with the SME-FRS. [In addition, we do not express an opinion on the balance sheet together with the notes thereon as to whether they are properly drawn up so as to exhibit a true and correct view of the state of the Company's affairs as at 31 December 200X according to the best of our information and explanations given to us, and as shown by the books of the Company.]
An adverse opinion is the worst type of financial report that can be issued to a company. If the company's financial report is given an adverse opinion, this can only
signify that the company's financial information does not comply with the Generally Accepted Accounting Principles. In addition, the financial information provided by the company has been falsified or are in other way inaccurate. Although this may be caused by human error, it is often an evidence of fraud. A business must make amendments to its financial statement and have it re-audited, or stakeholders will generally refuse to accept it. (Henderson, K.J., n.d.)
A sample extract of an adverse opinion by the Hong Kong Institute of Certified Public Accountants is as follows:
In our opinion, because of the significance of effects of the matters described in the basis for adverse opinion paragraph, the financial statements have not been properly prepared, in accordance with the SME-FRS. [In addition, in our opinion the balance sheet together with the notes thereon is not properly drawn up so as to exhibit a true and correct view of the state of the Company's affairs as at 31 December 201X according to the best of our information and explanations given to us, and as shown by the books of the Company.]
The report formats used are similar for the four opinions. The reason for the similarity is to control the effects of the circumstances of the audit report. If an individual format is used for each of the opinions, it will be difficult to determine which differences were due to the differing circumstances surrounding the qualification. (G. Holt, P. Moizer, 1990)
I) Category of Audit Report Issued to British American Tobacco (Malaysia) Berhad and AHB Holdings Berhad based on the Companies' Financial Statements
The categories of report that an auditor is able to give to a company are one of these four- Unqualified Opinion, Qualified Opinion, Disclaimer Opinion and Adverse Opinion.
When expressing an unqualified opinion, the auditor will state that the financial report gives a 'true and fair view' or 'presents fairly', in all material aspects. Apart from that, the auditor will also state that the financial statement is in accordance with the applicable financial reporting framework, e.g. The Financial Reporting Standards in Malaysia. A modified auditor's report is issued when the audit opinion is qualified or when it is appropriate for the auditor to draw attention to or emphasize a matter that is relevant to users. (Sylvia Barrett, 2004)
The auditors' opinion refers to the financial statements as a whole. Although the audit examination is performed item by item, the auditor must consider whether the overall impression created by the company's financial statements is consistent with the auditors' knowledge of the company and its financial position. (Sylvia Barrett, 2004)
The two case examples are as follows:
British American Tobacco (Malaysia) Berhad
According to the Basis of Opinion paragraph, the auditors have been 'performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements'. The auditors also 'evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates made by the directors, as well as evaluating the overall presentation of the financial statements.'
Thus, after conducting the audit of the company, the auditors have given British American Tobacco (Malaysia) Berhad an unqualified opinion. This is because according to the auditors' opinion, 'the financial statements of the Company have been properly drawn up in accordance with Financial Reporting Standards in Malaysia and the Companies Act, 1965.' Furthermore, according to the auditors' opinion, the financial statements give a true and fair view of the financial position of the group and the company.
As a result, the auditors have the opinion that British American Tobacco (Malaysia) Berhad has financial statements that present fairly, in all material aspects, the financial position and the results of operations and cash flows of the company is in accordance with the applicable reporting standards.
AHB Holdings Berhad
According to the Basis of Opinion paragraph, it was stated that
notwithstanding the impairment loss on trade receivables amounting to RM20,950,845 as disclosed in Note 16 to the financial statements, trade receivables of the Group amounting to RM2,065,362 have been long outstanding and were not impaired. Minimal or no payment was received from these receivables as at the date of this report. In the absence of any documentary evidence and alternative audit procedures, we are unable to obtain sufficient appropriate audit evidence to ascertain the recoverability of theabovementioned balances.
In short, the auditors were doubtful that the trade receivables could be recoverable by the company.
Therefore, after conducting the audit of the company, the auditors gave AHB Holdings Berhad a qualified opinion. The auditors mentioned that the financial statements have been properly drawn up in accordance with Financial Reporting Standards and the Companies Act, 1965 in Malaysia so as to give a true and fair view of the financial position of the Group and of the Company except for the matters described in the Basis for Qualified Opinion.
In conclusion, we find that the audit reports for British American Tobacco (Malaysia) Berhad and AHB Holdings Berhad are quite similar. The auditors stated that both companies have financial statements have been properly drawn up in accordance with Financial Reporting Standards and the Companies Act 1965. However, the only difference is that in the case of AHB Holdings Berhad, the matter of the trade receivables of the company has led the auditors to believe that it has affected the financial reporting of the company. As a result, a Qualified Opinion is given to AHB Holdings Berhad while an Unqualified Opinion is given to British American Tobacco (Malaysia) Berhad.
J) Unaudited Financial Statements and the Circumstances or Conditions under Which It Can be used.
Unaudited financial statements are accounting statements that have not been inspected by auditors for precision. One of the reasons why unaudited financial statements are used is because financial statements generally help to build up appearance of corporate executives being confident when speaking to stakeholders and journalists. Therefore, when audited financial statements are not available, the unaudited ones act as backup for the corporate executives to use.
Be that as it may, an unaudited financial statement often bears some discrepancy from the audited financial statement, being that audited financial statement are always more reliable than the unaudited ones. A great risk of fraud often comes with an unaudited financial statement, as no corporate reviewer has checked the financial statement for fraud. Although auditing does not eliminate such risk completely, it will help to reduce the frequency of fraud.
Stakeholders should not plainly rely on the unaudited financial statements, they should compare both audited and unaudited financial statement in the process of making the wisest decision. However, corporations use unaudited financial statements for a different reason. Corporations may use the unaudited financial statements in a loan application procedure or during the due diligence part of a company development purpose, such as during a merger, procurement or joint venture. Due diligence means inspecting a company or an individual before authorized a contract or acquisition of a company.
Business partners, such as suppliers and contractors, also request temporary financial statements to measure a company's financial condition. A good financial statement issued by the company, albeit unaudited, may encourage other business partners to conduct business activities with them. Furthermore, these statements allow commercial allies to determine a company's top-selling goods, and concentrate on companies that give them the highest returns on their money.
Appendix
Report on the financial statements- British American Tobacco (Malaysia) Berhad
We have audited the financial statements of British American Tobacco (Malaysia) Berhad on pages 141 to 203 which comprise the balance sheets as at 31 December 2011 of the Group and of the Company, and the statements of income, comprehensive income, changes in equity and cash flows of the Group and of the Company for the year then ended, and a summary of significant accounting policies, as set out on pages 151 to 163 and other explanatory notes, as set out on Note 1 to 31.
Directors' Responsibility for the Financial Statements
The Directors of the Company are responsible for the preparation of financial statements that give a true and fair view in accordance with Financial Reporting Standards in Malaysia and the Companies Act, 1965, and for such internal control as the directors determine are necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.
Auditors' Responsibility
Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with approved standards on auditing in Malaysia. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on our judgment, including the assessment of risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the entity's preparation of financial statements that give a true and fair view in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by the directors, as well as evaluating the overall presentation of the financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the financial statements have been properly drawn up in accordance with Financial Reporting Standards in Malaysia and the Companies Act, 1965 so as to give a true and fair view of the financial position of the Group and of the Company as of 31 December 2011 and of their financial performance and cash flows for the year then ended.
Report on the Financial Statements- AHB Holdings Berhad
We have audited the financial statements of AHB HOLDINGS BERHAD, which comprise the Statements of Financial Position of the Group and of the Company as at 30 June 2012, and the Statements of Comprehensive Income, Statements of Changes in Equity and Statements of Cash Flows of the Group and of the Company for the financial year then ended, and a summary of significant accounting policies and other explanatory notes as enumerated in Notes 1 to 33 and as set out on pages 9 to 60.
Directors' Responsibility for the Financial Statements
The Directors of the Company are responsible for the preparation of financial statements that give a true and fair view in accordance with Financial Reporting Standards and the Companies Act, 1965 in Malaysia, and for such internal control as the Directors determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.
Auditors' Responsibility
Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with approved standards on auditing in Malaysia. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on our judgement, including the assessment of risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the Company's preparation of financial statements that give a true and fair view in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by the Directors, as well as evaluating the overall presentation of the financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified audit opinion.
Basis for Qualified Opinion
Notwithstanding the impairment loss on trade receivables amounting to RM20,950,845 as disclosed in Note 16 to the financial statements, trade receivables of the Group amounting to RM2,065,362 have been long outstanding and were not impaired. Minimal or no payment was received from these receivables as at the date of this report. In the absence of any documentary evidence and alternative audit procedures, we are unable to obtain sufficient appropriate audit evidence to ascertain the recoverability of the abovementioned balances.
Qualified Opinion
In our opinion, except for the effects of the matters described in the Basis for Qualified Opinion paragraph, the financial statements have been properly drawn up in accordance with Financial Reporting Standards and the Companies Act, 1965 in Malaysia so as to give a true and fair view of the financial position of the Group and of the Company as at 30 June 2012 and of their financial performance and cash flows for the financial year then ended.
