LECTURE 1: INTRODUCTION TO AUDITING
Before we begin looking at the details of each of the AUE2601 topics and chapters, it is important that you understand what auditing is about. It’s really important that you can visualise the process from start to finish. So that as we add each little detail in and as we go through each topic and each piece of information, you understand where it fits into the entire process. This means that you’ll be a lot more comfortable to deal with each of the bits of detail, to deal with each of the chapters.
So we’ll go through a little example; we’ll go through some stuff, and we’ll continually go back and forth to the big picture to ensure that you understand where each of these items and each of these bits of knowledge come in. This will definitely help you with your auditing studies for the rest of your auditing studies because the more comfortable you are right up front, the easier your life is going to be.
The first thing that you need to understand is that auditing is a process. Auditing is a task; it’s an objective; it’s a project, which means that there is a start; there’s a finish; there is a process. You need to be very aware of how that process works from beginning to end, the way that it works, the things that can go wrong, the how to do the stuff, in order to make sure that you do this project successfully.
WHAT IS AUDITING?
So the first thing we’re going to talk about is what auditing actually is. In order to do that comfortably, I’m going to use an example that has absolutely nothing to do with auditing or business whatsoever.
Let’s assume that you want to buy a car, and instead of going to a car shop or instead of going to some retail outlet like a lot of people would, you decide for some reason that you’re going to buy your car online. You’re going to go to some online website; you’re going to go through some second-hand car dealerships online, and you’re going to choose your car online.
This has a lot of conveniences, and this is good, but at the same time it leaves you with a little bit of a risk. Because there’s a little bit of a concern maybe that the people that are advertising the cars aren’t actually being honest and the information that they’re giving you is not reliable. If you can’t see that car yourself, if you don’t have access to that, if you don’t have the expertise to identify and assess the car properly, it could be a little bit of a problem.
So we need to be aware that in order for you to make your decision, you are going to have a list of criteria. Your list, for example, could say:
- I’m only going to buy a car if it is potentially red
- If it’s a 2011 model
- It needs to be in a certain price range
- I want it to have certain types of accessories
- I want it to be in a certain condition.
So this is your criteria. You will consider buying a car if it meets that criteria. Your problem is that there very well could be a couple of cars that are advertised online that appear to meet that criteria. Your question though is – can you rely on the information that you’re looking at?
Because you don’t have as much detail, as much information, you can’t see this car for yourself; there’s a very good probability that someone might try and sell you a car that doesn’t meet that criteria, but they say that it does.
This is a little bit of a concern for you, and obviously, you would feel a lot better if there was a third party in here. If that third party said to you, “Don’t worry, I’m going to take a look at that car, and I’ll tell you whether or not it meets your criteria. And once I’ve taken a look at it, I’ll give you the information, and I’ll either say to you, ‘Yes, that car meets your criteria.’ Or ‘No, it doesn’t.’”
You’re looking for some kind of assurance from that third party. You’re hoping that that third party can give you assurance about the reliability of that car before you actually buy it. Before you part with your money, you want to know whether or not the person saying that they’re selling this car is actually telling the truth about this. You’re worried about the liability of the information.
Be very careful about this. What is that the third party is telling you? They are giving you assurance about the reliability of the information. They’re saying to you that this car you look at is actually red, it is a 2011 model, it is within your price range, the accessories you’re looking for are there, and it is in the condition they say it is in. That third party – you do not need them to tell you whether or not you should be buying a red car. It is not their job to tell you whether or not you should be buying a car with certain types of accessories or within a certain price range. You don’t need them to tell you whether this is value for money or a good deal or whether or not you should or shouldn’t buy this car. All you really want them to do is tell you whether or not the car that is advertised actually meets the criteria that you already have set up.
So let’s make very sure that you are comfortable with the fact that the third party is there to give you information and assurance about the reliability of that car rather than tell you what it is that you should be buying.
The question is, why would you trust the third party over the online website? Why is it that you would place your trust in this third party? Why would you feel more comfortable? And why would you take assurance from anything they say rather than the online site?
Most of the reason for that lies in the fact that they are independent. The more independent they are, the more it means that they have nothing to gain or lose by telling you whether or not this car meets that particular criteria. They don’t make money out of this deal, so it’s not like they’re going to benefit if they sell you something that doesn’t meet your criteria. They’re not selling it to you, it’s got nothing to do with them, they completely are a third party, and therefore their independence is important.
The other thing, obviously, that is quite important is their knowledge. Do they actually know what it is that they are looking for when you said you wanted it in a certain condition? Do they have the knowledge and ability to assess that and give you the right information?
CASE STUDY CONCLUSION
When we take a look at this, it’s a very simple example, and there are a couple of concepts that we’ve picked up, and we need to make sure that we’re comfortable with these concepts because we are going to overlay a business example onto this and the same basic concept applies.
We have spoken about reliability of information and the fact that the concern is, you are going to be making a decision, and you are wondering whether or not the information that you are looking at is reliable. We’re also talking about offering assurance - the fact that we are looking for someone to offer us assurance about the reliability of the information. We have spoken a little about trust and why we would place trust in a third party, as well as the fact that that trust comes from independence and the knowledge of the third party. So although this example isn’t actually auditing, it gives us a really good base to move onto the audit itself.
So let’s change this. If we are looking at this from our auditing knowledge, it wouldn’t be a car that you are buying online; it would be a set of financial statements that you are looking at. You’re not looking to buy a car; potentially you are looking to invest in a company or give a loan to a company.
You are going to be making some kind of decision about this company based on their financial statements. The rest of it is pretty much the same. Your concern is whether or not you can rely on the information in these financial statements in order to make that investment or give this company that loan. So your worry is that the people who put the financials together, which would be the directors, are telling you what you want to hear.
You are concerned about the reliability of the information in those financials. And so exactly the same as with the car example, you are looking for a third party to come in and assess the reliability of the information, and that obviously would be us as auditors. The auditors would be giving you assurance about the reliability of the information.
Again, why would you trust the auditors? Because you expect them to be independent and you expect them to have the knowledge to assess the financial statements.
Please note that you are not expecting the auditors to give you information or give you advice on whether or not to invest in this company. All you need them to tell you is these financial statements; they’re reliable. What is said in here is reliable and it is actually a representation of what went on. So when you look at the profit, when you look at the sales, when you look at the assets, whatever you see there you can rely on that information in order to make your decision.
So that’s a very simple example, we’ve overlaid the auditing process over this and the more that you can understand this basic concept, and this basic example, the easier it’s going to be for you to understand why we do all the little bits and pieces that we do as an auditor. As we go through each of the bits of detail, we can fit them into this particular process and understand why we do this a little bit better.