What Auditing Is
Chapter One
Syllabus topic 1, "Basics – Financial Statements, Users of Information, Definition of Auditing, Objectives of Auditing, Inherent limitations of Audit, Difference between Accounting and Auditing, Investigation and Auditing."
Pages 1 to 3 of 98
In one line
Auditing is the independent examination of the financial statements of an entity, by a person appointed for the purpose, so that he can express an opinion on whether they give a true and fair view.
The definition to learn
Spicer and Pegler's is the one most quoted, and it is quoted because it names every element.
An audit is such an examination of the books, accounts and vouchers of a business as will enable the auditor to satisfy himself that the balance sheet is properly drawn up so as to give a true and fair view of the state of affairs of the business, and whether the profit and loss account gives a true and fair view of the profit or loss for the financial period, according to the best of his information and the explanations given to him, and as shown by the books.
Six elements, and each is a mark.
| Element | What it fixes | |
|---|---|---|
| 1 | An examination | Of the books, accounts and vouchers; the evidence, not just the statements |
| 2 | By an auditor | Somebody appointed for the purpose, and independent of those who prepared them |
| 3 | To satisfy himself | The standard is his own reasonable satisfaction, not certainty |
| 4 | True and fair view | The test the statements must meet |
| 5 | Of the position and of the result | Balance sheet and profit and loss account, both |
| 6 | According to the information and explanations given, and as shown by the books | The limits within which he works |
Element six is the one students omit and it is the auditor's protection. He reports on what the books show and what he was told; he cannot report on what was hidden from him and does not appear.
The statutory definition
The Companies Act 2013 nowhere defines an audit. What it does instead is fix the duty, in section 143(2):
The auditor shall make a report to the members of the company on the accounts examined by him and on every financial statement required to be laid before the company in general meeting, and the report shall state whether the said accounts and financial statements give a true and fair view of the state of the company's affairs at the end of its financial year and of the profit or loss and cash flow for the year.
So the law describes the audit by its output. Learn the section number: a question on what an audit is, answered with Spicer and Pegler and then section 143(2), is complete.
What is audited
The financial statements, which section 2(40) of the Companies Act defines as the balance sheet, the statement of profit and loss, the cash flow statement, the statement of changes in equity where applicable, and any explanatory note forming part of them.
What Auditing Is
And what lies behind them. The auditor does not examine the statements alone; he examines the books of account section 128 requires, the vouchers behind the entries, and the internal controls that produced them.
| Layer | What the auditor does with it |
|---|---|
| The financial statements | Forms his opinion on them |
| The books of account | Tests whether they support the statements |
| The vouchers and documents | Tests whether they support the books |
| The internal control system | Assesses it, because it decides how much testing the books need |
The word "opinion", and what it is not
| An audit report is | An audit report is not |
|---|---|
| An opinion, professionally formed on evidence | A guarantee that the accounts are correct |
| Based on test checking, not on examining everything | A certificate, which is an assertion of exact fact |
| Reasonable assurance, which is high but not absolute | Absolute assurance |
| About whether the statements are true and fair | About whether the business is well managed or will survive |
The difference between a certificate and a report matters. A chartered accountant certifies a statement of facts he has verified exactly, such as a turnover figure for a subsidy claim. He reports an opinion on financial statements, because a complete verification of every transaction of a year is not possible and is not what an audit is.
Who may do it
Section 141 of the Companies Act 2013: only a chartered accountant may be appointed auditor of a company, and where a firm is appointed, only its partners who are chartered accountants may act and sign.
Independence is the other half of the requirement, and section 141(3) lists the disqualifications that protect it. The Appendix chapter on eligibility takes them.
Why an audit exists at all
Because the people who own a business are not the people who run it, and the people who run it prepare the accounts on which the owners judge them.
That separation is the whole justification, and it is worth one sentence in any answer on objectives, advantages or limitations. A sole trader who keeps his own books and reads them needs no audit. A company with 40,000 shareholders and a board of six does, and the law says so.
Quick revision
| Definition | An independent examination of financial statements so as to express an opinion on whether they give a true and fair view |
| Six elements | Examination, by an auditor, to his satisfaction, true and fair, position and result, on the information given and as shown by the books |
| The Act's duty | Section 143(2), a report to the members |
| What is examined | The statements, the books, the vouchers, and the internal control |
| The output | An opinion, not a guarantee and not a certificate |
| Who may audit a company | A chartered accountant, section 141 |
| Why it exists | Ownership is separated from management |
What Auditing Is
Test yourself
- Give a definition of auditing and name three of its elements.
- Which section fixes the auditor's duty to report, and to whom does he report?
- What is the difference between a report and a certificate?
- Name the four layers an auditor examines.
- Why does a sole trader keeping his own books need no audit?
Answer in one sentence
1. An independent examination of the books, accounts and vouchers of a business enabling the auditor to express an opinion on whether the financial statements give a true and fair view; the elements include the examination, the independence of the auditor, and the true and fair test.
2. Section 143(2) of the Companies Act 2013, and he reports to the members, not to the directors who appointed the accounts.
3. A certificate asserts facts the accountant has verified exactly; a report expresses a professional opinion formed on evidence that is persuasive rather than conclusive.
4. The financial statements, the books of account, the vouchers and documents, and the internal control system.
5. Because he is both the owner and the manager, so there is no separation between the person who prepares the accounts and the person who relies on them.
The rest of this subject
These notes are cut from the University's printed syllabus. Open the syllabus itself, or the past papers, for the same subject.