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Auditing, an interdisciplinary field
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Auditing is a dynamic profession in constant search for ways to meet the growing public demand for quality services. Audit is not an inquisition and its mission is not of fault-finding. The research paper describes the various aspects of an auditing. Auditing is a vast ocean, and some of the important elements have been described in this paper. It covers the definition, types and the basic objectives of auditing. The modern methods for analysis of audits using computer software have also been presented. In order to specify the scope of the audit, an example of a state financial audit has been taken into consideration. An introduction to the appropriation audit has also been described along with the major differences between the internal audits of a socialist economy (say china) & capitalist economy (say Germany) has been described in this paper.
“Auditing is one that can be regarded as truly interdisciplinary”
Understanding of auditing
Auditing is a systematic process of objectively obtaining and evaluating the evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to the interested users.
Objective Of an audit:-
“TO PROVIDE REASONABLE BASIS FOR EXPRESSING AN OPINION REGARDING THE FINANCIAL STATEMENTS TAKEN AS A WHOLE”.
History of Auditing:-
Prior to 1500 AD, nearly all accounting was concerned with accounting for the activities of government and the only form of auditing was the keeping of separate records by two different scribes. The objective of maintaining such records was primarily to detect fraud (e.g. to prevent defalcations within the treasuries), to minimize the erroneous recording of transactions, and to ensure the honesty of those responsible for the custody of resources. Internal controls were nonexistent, although during the period 1500-1850, there was recognition that standardized systems of accounting could reduce the possibility of fraud.
The industrial revolution (1750-1850) was the catalyst of a great period of economic growth in Great Britain, one feature of which was the passing of management from owners to professional managers. This led, in the period 1850 to 1905, to an increased demand for auditors who were independent of management and who were engaged to detect not only clerical (office) errors, but also management fraud. Consequently, auditors began to periodically report on the work they had performed to the owners of an entity, and thus the concept of what is now referred to as the "independent auditor's report" emerged. T was during this time that the concept of 'testing' evolved. That is, auditors selected "a few haphazard cases" (to use the words in the often quoted "London and General Bank case" decision) where it was not economically feasible to physically examine all transactions that took place. The use of testing is recognized as one of the limitations of a modern day audit. Also, controls over cash were first recognized during this period as was the control inherent in double-entry bookkeeping. However, the recognition of the benefits of such controls did not affect the extent of auditors' procedures.
In India during the 1913 Indian Companies Act has for the first time appointed an accounted as an auditor.
Steps Present In an Audit Process:-
Scheduling an opening conference to discuss the audit objectives, timing, and report format and distribution.
Assessing the soundness of the internal controls or business systems and operations.
Testing the internal controls to ensure proper operation.
Discussing with management all preliminary observations.
Discussing with management the draft audit report and their responses, if available, prior to release of the final audit report.
Following up on critical issues rose in audit reports to determine if they have been successfully resolved.
Types of Audit:-
1) Financial audit
2) Operational audit
3) Information Systems (IS) audit
4) Integrated audit
5) Investigative audit
6) Follow audit
1) Financial audit:-
A historically oriented, independent evaluation performed for the purpose of attesting to the fairness and accuracy of financial data.
2) Operational audit:-A future-oriented, systematic, and independent evaluation of organizational activities. Financial data may be used, but the primary sources of evidence are the operational policies and achievements related to organizational objectives. Internal controls and efficiencies may be evaluated during this type of review.
3) Information systems audit: There are three types of IS audits namely.
3.1) General Controls Review: -
A review of the controls which govern the development, operation, maintenance, and security of application systems in a particular environment. This type of audit might involve reviewing a data center, an operating system, a security software tool, or processes and procedures (such as the procedure for controlling production program changes).
3.2) Application controls review: -
A review of controls for a specific application system. This would involve an examination of the controls over the input, processing, and output of system data. Data communications issues, program and data security, system change control, and data quality issues are also considered.
3.3) System Development review:-
A review of the development of a new application system. This involves an evaluation of the development process as well as the product. Consideration is also given to the general controls over a new application, particularly if a new operating environment or technical platform will be used.
4) Integrated audit:-
This is a combination of an operational audit, department review, and IS audit application controls review. This type of review allows for a very comprehensive examination of a functional operation within the University.
5) Investigative audit:-
This is an audit that takes place as a result of a report of unusual or suspicious activity on the part of an individual or a department. It is usually focused on specific aspects of the work of a department or individual. All members of the campus community are invited to report suspicions of improper activity to the Director of Internal Auditing Services on a confidential basis.
7) Follow up audit:-
These are audits conducted approximately six months after an internal or external audit report has been issued. They are designed to evaluate corrective action that has been taken on the audit issues reported in the original report. When these follow-up audits are done on external auditors' reports, the results of the follow-up are reported to those external auditors.
MANAGEMENT AUDIT:- This is an independent activity which aims to determine what the management is doing for the fulfillment of the organization’s objectives. This may be defined as follows:
“A comprehensive and constructive examination of plans and objectives means of operation of an organization, institution or a branch of government.
Management audit is like a secret agent which keeps an eye on all levels of administration of a firm to ensure sound management thought which thus helps in maintaining effective relationship with the outside world.
Differences between Management audit & financial
1) It appraises past and simultaneously makes a future oriented approach.
2) It reports about the performance of management during that particular period.
3) It is concerned with the financial and other critical objectives of the firm
1) It is confined to historical records of past performance
2) It reports whether the financial statements show a fair view of state of affairs of a company on a particular date.
3) It is primarily concerned with financial aspect
Major Components of an audit:-
The compliance aspect of auditing in the above block diagram is to ensure that the company is pertaining to the rules and regulations and is also following the laws and ordinances that govern the handling of the general finances such as those pertaining to taxes, spending, investing and borrowing.
Terminology of Auditing
1) Footing: - The process of proving the totals of the verticals columns of figures.
2) Cross footing: - The process of proving the totals of the horizontal rows of figures.
3) Reconcile: - To establish relation between two sets of independently maintained, but related records.
4) Voucher: - The term used to describe a document which is supporting a transaction.
Modern Techniques of Auditing:-
Computer Assisted Techniques for Fraud Detection:-
Computer technology gives auditors a new set of techniques for examining the automated business environment. In fact, the detection of fraud is a perfect application for computer-assisted audit tools and techniques (CAATTs).
Audit software can highlight those transactions which are having a high level of fraudulent activity. With this software millions of transactions can be examined, previous year data can be compared for anomalies.
It helps the auditors to focus their efforts on areas of greatest risk and exclude low risk transactions.
Today's audit software makes "what if" analysis easy to formulate and perform. Auditors can form an initial hypothesis, test that hypothesis, and revise it as necessary, based on the results of interactive analyses.
Types of analysis using software: -
1) Digital analysis
2) Ratio analysis
3) Benford’s law
1) Digital Analysis: -It involves the searching of invoices with even dollar amounts such as 200$ or 50004.The existence of such even numbered amount may be a symptom of fraud and must be thus examined carefully.
Case study: - Travel expenses had always been a concern for the auditors of X Company since it was an area where the controls were weak. Employees had a maximum per diem rate when traveling but had to
Submit receipts to cover the actual expenses. Maximums were also established for meals: breakfast $10.00, lunch $20.00, dinner $30.00, and hotel lodging $100.00. The auditors configured the audit software to identify meal expenses that were multiples of $10.00. These transactions were compared to receipts to ensure that the amounts expensed were appropriate. A detailed review determined that many travelers were charging the maximum rates for meals even though their receipts did not justify the amounts
2) Ration analysis: -
Auditors concerned about prices customers were being charged for products could calculate the ratio of the maximum sales price to the minimum sales price for each product. If the ratio is close to 1.0, they can be sure that there is little variance between the highest and lowest prices charged to customers. However, if the ratio is large this could indicate that a customer was being charged too much or too little for the product. A large ratio indicates that the maximum value is significantly larger than the second highest value. Companies with max/max2 ratios of 5.0 or higher would be of interest to auditors and fraud examiners because they represent a significant deviation from the norm. This is particularly true if a company has a large number of transactions within a small dollar range, except for the maximum amount. For example, a suspicious pattern would be 100 transactions, 99 of which are between $1,000 and $2,000, with the highest at $12,000 (a max/max2 ratio of 6.0)
Case study: -
The auditors reviewed the patient billing system at Company Y to determine if the appropriate charges were being assessed by health care providers. An initial analysis of the data was performed to calculate the ratio of the highest and lowest charges for each procedure. A judgment was made that procedure with a max/min ratio of greater than 1.30 be noted and subjected to additional review.
For a particular quarter, three procedures had ratios higher than 1.30, the highest being 1.42. A filter was used to identify the records related to the three procedures in question, and additional analysis was performed. This quickly determined that one doctor was charging significantly more than the other doctors for the same procedures. A comparison of charges from the billing system with payments in the accounts receivable system revealed that the doctor was skimming off the patient payments. The amount recorded in the receivable system was in line with the usual billing amount for the procedures. The doctor was unable to justify the higher prices or explain the difference in the billing and the receivable systems.
The third ratio compares data from different years, departments or operating areas, and the like. For example, the ratio of last year's purchases to current year's purchases for each supplier can point to symptoms of fraud such as kickbacks in the contracting section. If the total purchase from a supplier has gone from $100,000 to $400,000--a ratio of 4.0--further analysis may be in order.
3) Benford’s Law: -More advanced techniques take data analysis to another level, examining the actual frequency of the digits in the data. Benford's Law, developed by Frank Benford’s in the 1920s, predicts the occurrence of digits in data. Benford's Law concludes that the first digit in a large population of transactions (10,000 plus) will most often be a 1. Less frequently will the first digit be a 2; even less frequently a 3. Benford calculated the occurrence of each numeral appearing as the first digit and found that it decreased inversely with its value. Benford's Law calculates the expected frequencies (rounded to three decimal places) for first and second digits
Case study: - The auditors for Z Company were investigating possible fraud in the contracting section, where thousands of contracts were raised every month. They used Benford's Law to examine the first two digits of the contract amount. The results of their analysis revealed that the digits 49 were in the data more often than expected. Classifying on the contracting officer for all contracts with 49 as the first two digits determined that the contracting manager was raising contracts for $49,000 $49,999 to avoid contracting regulations. Contracts under $50,000 could be sole-sourced; contracts greater than $50,000 had to be submitted to the bidding process. He was raising contracts just under the financial limit and directing them to a company owned by his wife.
Consider an audit report by an accountant general of a state. Its scope will have the following features:
Scope of an Audit: - The scope of audit extends to the transactions of both State and Union Government offices located within the territorial jurisdiction of that particular place or region. The various aspects it covers are as follows: -.
1) Certification audit: -Certification of finance and the appropriation of accounts prepared by the A&E office and expenditure incurred by the state government on various projects sponsored by the central government and International Development Agencies like World Bank and UNFFA.
2) Audit of expenditure: -Examine the efficiency and correctness of the expenditure and the correctness of their accountal.
3) Audit of stores and stocks: -To ensure that departmental rules/regulations governing procurement/ purchase, receipt, issue, custody, condemnation, sale and stock taking of stores are strictly followed and to assess the quality of store management
4) Audit of loans, interest and other borrowings: - To ensure that:
(i) the transactions are within such limits if any prescribed and are in tune with the authority that govern them;
(ii) the transactions are correctly reflected in the accounts;
(iii) the balances relating to these accounts represent amounts which are realizable and there exists a mechanism for periodic confirmation of balances.
APPROPRIATION AUDIT: -
INTRODUCTION : -In accordance with the provision of Article 204 of the Constitution of India, soon after the grants under Article 203 are made by the State Legislature, an Appropriation Bill is introduced to provide for appropriation out of the Consolidated Fund of the State. The Appropriation Bill passed by the State Legislature contains authority to appropriate sums from the Consolidated Fund of the State for the specified services. Subsequently, supplementary or additional grants can also be sanctioned by subsequent Appropriation Acts in terms of Article 205 of the Constitution of India.
2.1.2 The Appropriation Act includes the expenditure which has been voted by the Legislature on various grants, in terms of Articles 204 and 205 of the Constitution of India, and also the expenditure which is required to be charged on the Consolidated Fund of the State. The Appropriation Accounts are prepared every year, indicating the details of amounts on various specified services actually spent by Government vis-à-vis those authorized by the Appropriation Act.
2.1.3 The objective of appropriation audit is to ascertain whether the expenditure actually incurred under various grants is within the authorization given under the Appropriation Act, and ensure that the expenditure required to be charged under the provisions of the Constitution is so charged. It also ascertains whether the expenditure so incurred is in conformity with the law.
Definition: - An ongoing appraisal of the financial health of a company's operations by its own employees is known as internal auditing. Employees who carry out this function are called internal auditors.
During an internal audit, internal auditors will evaluate and monitor a company's risk management, reporting, and control practices and make suggestions for improvement.
Internal auditing covers not only an organization's finance function, but all the operations and systems in a firm. While internal auditors are typically accountants, this activity can also be carried out by other professionals who are well-versed with a company's functions and the relevant regulatory requirements.
While internal audit is one of the most important function and procedure for internal control of the firms’ normal operations from the perspective of financial terms, however, different nations, due to their stages of economic developments (developed nations vs. developing nations), unique governmental regulations, and different societal and cultural traditions, have implemented different internal audit systems and approaches. This paper describes a comparative study exploring some key differences between the internal audit system in China and its counterpart in Germany – from the following five important aspects: the origin and development of internal audit, the structure of internal audit system, the relationship between firms’ internal audit and the government agency, the responsibility and accountability of internal audit, and the quality of internal auditors. Based on the comparative analysis, four suggestions are made for future improvement on the internal audit system in China, along with managerial discussions.
a COMPARATIVE STUDY ABOUT INTERNAL AUDITING APPROACH BETWEEN GERMANY AND CHINA:-
As the Chinese economic reform started in 1980s, the demand for a better internal control of enterprises forced the need of a formal internal audit and the development of a complete internal audit system. While internal audit has been recognized as an important function and procedure for internal control of the firms’ normal operations from the perspective of financial terms, however, different nations, due to their stages of economic developments (developed nations vs. developing nations), unique governmental regulations, and different social and cultural traditions, have implemented different internal audit systems and approaches. From a historical and comparative view of point, while the internal audit process in China has only started two decades ago and been actually developed during last ten years with many weaknesses and problems to be further addressed and improved, the internal audit in Germany, in comparison, has been evolved and developed over the last hundred years and its internal audit system has been well established and proven to be an effective internal control tool for enterprises in Germany. As such, it is believed that Chinese internal audit professionals can learn important and meaningful lessons from a comparative analysis between the two internal audit systems. That is the primary motivation for this research. This following report describes a comparative study exploring some key differences between the internal audit systems in China (communist economy) and its counterpart Germany(capitalist economy)
The four, main differences which have been described below are:-
1) the origin and development of internal audit
2) the structure of internal audit system
3) the relationship between firms’ internal audit and the government agency
4) the responsibility and accountability of internal audit, and
In China, the development and establishment and of firms’ internal audit has been pushed by the rapid development and growth of national market economy along with the implementation of government’s administrative policies (Jou 1997). In August 1983, the State Council approved and circulated the Request for Instructions on Several Issues Concerning audit Work by the National Audit Office, requiring the conduct of internal audit through setting up internal audit units within competent departments exercising unified leadership of their subsidiaries or with many subsidiaries, and large- and medium-sized enterprises and undertakings. In 1987, Chinese Institute of Internal Auditors was established, and it joined International Institute of Internal Auditors in December in the same year. In 1988, The State Council issued People’s Republic of China’s Auditing Standards, in which chapter VI stipulated the establishment and responsibilities of internal audit units, and the relationship between internal audit units and government audit institutions in its internal audit. In 1994, The State Council issued The Law of Auditing, and it also determined the legal status for internal audit. In 1995, The China National Audit Office published The Regulations on Internal Audit, making more specific rules on internal audit. In 2003, The China National Audit Office implemented The China National Audit Office’s Regulations on Internal Audit (2003), Which improved the regulations issued in 1994. On the other hand, the internal audit professionals have increased dramatically since 1987, and there are more than 10 test centers established up for the qualification examination of CIA (certified Internal Auditor). At the end of 2001, there were about 76,000 internal audit units in China with 193,000 certified professionals.
In Germany, the establishment and development of internal auditing is the product of rapid development of the market economy and the changing objectives of internal audit (Wang 2003). The first modern internal audit department emerged in Friedrich Krupp Company in 1875. The internal audit developed quickly in Germany in sixty years after the middle of 20th century. At beginning, the objective of internal audit was checking error and protecting malpractices. Along with the development of economy, the structure of business companies becomes complicated, and the need to strengthen internal control and management was intensified. So the objective of internal audit is changed to improving economic benefits of company. The internal auditors are not only the member of management team, but also the protectors of company. Currently, there are about 50,000 certified professionals in the internal audit units in Germany.
(2) The Structure and Establishment of Internal Audit System:
Based on the current international practice, there are three different system structures of establishment of internal audit units in a business enterprise. In the first structure, the internal audit unit is established parallel to the Board of Directors and is directed by the leader of the monitoring committee. In comparison, under the second structure, the internal audit unit is established parallel to the other departments in the company and is administered by the Board of Directors. Finally, with the third structure, the internal audit unit is placed inside the finance unit, as internal auditing is one of key functions of the finance department. Under the first structure, the internal auditors can keep independence during the audit process as the internal audit unit can set up and do auditing work without outside interference and any influences from other departments. Under the second structure, the internal auditors’ independence is limited and it is difficult for internal audit unit to audit the other departments at the same level. Under the third structure, it is obvious that the internal auditors can hardly keep independence during the audit process because finance department has financial supervisory function on its subsidiary and other departments and the internal audit is also one function of finance department.
In China, all internal audit units are structured into the business enterprises according to either the second or the third structures described above. Comparatively, in Germany, all internal audit units are established based on the first structure. As such, the internal audit units in Germany can keep much more independence during the audit process than their Chinese counterparts in China.
(3) The Relationship between Internal Audit and Government:
In China, the internal audit units in the government owned companies have a close relationship with the government regulation agency. All business internal audit units are established according to the government’s administrative guidelines. The No. 29 Standards in National Auditing Law regulates the establishment of internal audit units, and the internal audit units in government owned companies must be guided and supervised by local government. This standard clarifies the legal relationship between business internal audit units and government audit agency and does not lay down rigid rules for setting up of internal audit functions allowing for difference between business internal audit units and government audit agencies. That is, in China, a business internal audit unit is under dual-supervision. One is from the leadership of its own department or enterprise, and another is from the guidance and supervision of the state auditing departments, which represent the government (Jou 1997; and Cai 1997).
In comparison, there is no law or regulations about establishment of internal audit units in Germany. The internal audit units are set up as self-discipline mechanism of enterprises, and the internal audit units in any business entities will not be supervised by local government (He 2001). In fact, the Internal Auditor Association in Germany functions as a bridge and bond between government and business and professional enterprises. Through enacting audit standards, Internal Auditor Association functions in communicating audit work experience, conveying audit messages, developing related working theory, and guiding internal audit practice.
(4) The Responsibility, Accountability, and Content of Internal Audit:
The article No. 9 in The Regulations on Internal Audit published by the China National Audit Office regulates the responsibilities of internal auditors in China: (1) the internal auditors should audit the economic activities about public finance revenue, the public finance expenditure, financial revenue, and financial expenditure in the enterprises and their subordinates. (2) The internal auditors should audit the management and application of capital inside budget and outside the budget. (3) The internal auditors should audit the accountability of leaders during their terms of office. (4) The internal auditors should audit project construction. (5) The internal auditors should examine and evaluate soundness and efficiency of internal control system and risk management. (6) The internal auditors should do operational or performance auditing. (7) And finally, the internal auditors should perform other auditing works required and regulated by laws or regulations. From the standards listed above, it can be seen that the China’s internal audit systems pay more attention on financial audit and compliance audit – a single function. That is, the internal audit stresses on supervision function only, checking out violation of rules and regulations, but ignoring how to strengthen the ability of administration, or improve service efficiency to help business managers make related important decisions.
In Germany, the responsibilities of internal auditors include: (1) determining whether the internal control and monitoring system are perfect and effective; (2) evaluating the economic benefits enterprises; (3) evaluating whether the laws and regulations are observed (Wang 1999). In addition, the internal auditors also provide services, such as consulting, guiding the departments to improve operations and helping them to resolve the problems. The Germany’s internal audit systems focus more on management audit and performance audit – with multiple functions including both supervision and providing service.
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