BAB 6

The feasting of corporate auditing

Before proceeding to the detail of this chapter, It is necessary to explain what is meant by the term
‘postulate’ In the context in which it is used throughout this text. The definition adopted is that of
Mautz and Sharaf (1961, pp. 37-0) :
Postulates are assumptions that do not lend themselves to direct verification. The propositions
deduced from the postulates of a given system, however, can be directly verified and such
verification bears evidence of the truth of the postulates themselves.
The provide the basis for making inferences which are valid and useful to the extent accept the
postulates we can draw propositions from them. They provide a basis for thinking about problems
and for arriving solutions.
In other words, using a deductive approach to the formulation of the theoretical propositions, the
postulates of corporate auditing, together with a function’s stated roles and objectives, provide a
basis from which to develop its main concepts and then its basic principles of practice (Moonitz,
1961, p.1; Chambers, 1963, p.15; and Flint, 1988, p.20). To do this successfully, however, the
stated postulates must be practically as well as theoritically sound. As Mautz and Sharaf (1961,
p.39). conclude :
… the postulates, once accepted as useful and valid, may at a later date be challenged and even
demonstrated to be invalid. As noted earlier, postulates cannot be directly verified. Neither can
they be proved untrue, or they would have no usefulness. That means that when a postulate can be
proved untrue, it has lost its value as a postulate and must be discarded.
Postulates are not only theoretical means of attempting to identify and understand the foundations
of corporate audit activity, they are also potentially a way of thinking about and resolving the
function’s inherent problems. They permit the student of corporate auditing to determine whether
such activity is based on sound theoretical grounds. As Chambers (1963, p.15) argues, postulates
exist :
Because a man’s postulates are the substance of his understanding of the world in which he acts;
if his postulates are irrelevant or inconsistent, neither he not his practices merit the esteem of his
fellows. Because to examine one’s postulates is the simplest and most effective way to discover
the possibility and direction of improvements and innovations in practice. Because man’s reasoned
judgment is his only protection against self-delusion, cant and deceit.
Postulates are the apparent and accepted truths of a subject or discipline. They are its a priori, the
basic descriptions of things in its environment and provide an outline of the intrinsic character of
such activity (Flint, 1988, p.20). In particular, postulates support all the terms and theorems of the
subject concerned (Mautz and Sharaf, 1961, p.38; and Chambers, 1963, p.15). They provide means
by which testable propositions can be derived (Mautz and Sharaf, 1961, p.38; and Chambers, 1963,
p.20). In effect, therefore, they bound both the theory and practice of a subject such as corporate
auditing.
But, in providing such shape, postulates have qualities which act as constraints or controls to their
spesification, use and acceptance, These are outlined by both Mautz and Sharaf (1961, p.51) and
Schandl (1978, pp.25-6). First, postulates should be coherent in the sense that they belong to the
one body of theoretical knowledge. Second, they should contribute to that knowledge by allowing
their user to deduced testable propositions, hypotheses or conclusions from them. Third, they
should have an independent status which determines that each stated postulate cannot be deduced
from any other postulate of the designated body of knowledge. Fourth, they should be internally
consistent to the extent that each can be accepted as true. And finally, they should be susceptible
to challenge and to being discarded as events and knowledge render them unacceptable as a basis
for theoretical deduction.
This is not the only view possible of the utility of specifying the postulates of auditing. Gwilliam
(1987, p.49). for example, concludes that such ‘quasi-philosophical’ underpinnings to audit theory
may be less useful than an alternative of examining it through the economics lens of agency theory.
In particular, he appears to be concerned that auditing postulates are not rationales for the audit
process as whole but, instead, represent no more than statements of potential feasibility (p.42). He
is particularly against the uncritical acceptance of the postulates originally specified by Mautz and
Sharaf (1961) (p.44).
These criticisms are not entirely appropriate when placed within the context of this text. First, the
postulates specified in the following sections are additional to the descriptions, explanations and
discussions of the rationale for corporate auditing in previous chapters. Second, attention should
be given in any theory text to the role of postulates to test the legitimacy and potential of the
specified normative prescriptions. In this case, it is not so much the feasibility of corporate audit
practice which is being questioned by means of postulates (although that is an inevitable
consequence). It is more reasonableness of the expectations contained within them regarding
corporate auditors and their function of verification and attestation.

The postulates of corporate auditing

There are three groups of postulates to be stated as the fundamental theoretical truths of corporate
auditing. The first is concerned with justifying assumptions relating to the existence of corporate
audit. The second group is focused on the actions of the corporate auditor, and deals with the
behavioural aspects of corporate auditing. The final group covers matters of corporate audit
procedure, and has the title of functional postulates.
Justifying corporate audit postulates
There are a number of corporate audit postulates which provide a theoretical basis for its existence
in practice. These are described as justifying assumptions, and are explained in the following
paragraphs.
The quality of the accounting information reported in the financial statements of the generality of
corporate organizations lacks sufficient credibility without formal verification and attestation to
be used with complete confidence by shareholders and other report users as part of the corporate
accountability process.
In the economic agency situation described as corporate organization, the process of accountability
by mens of reported financial statements is founded on the notion of corporate management
preparing these statements as explicit financial representations of the outcomes of its activities and
efforts, and thereby communicating its financial stewardship to shareholders and other legitimate
external interests. However, corporate management is responsible for and in control of the
production of the accounting information which comprises the content of these financial
statements. It is a process of self-assessment which lacks the appearance of impartiality on which
the credibility of the reported information depends for confident use. The managerial agent group
is responsible not only for reporting on its financial stewardship, but also for managing the
accounting means by which such reporting takes place to ownership and other interested groups.
If this situation were different, and the productions of reported financial statements could be
completed independent of corporate management, there would appear to be far less reason for
having an external auditor to verify and attest the quality of these statements. Under existing
circumstances, however, it is reasonable to presume that a situation in which corporate managers
have the power and authority to control the reporting of the financial consequences of their actions
in the form of unaudited financial statements to shareholders and others does not assist
meaningfully in the process of corporate governance and accountability. It is not conducive to the
confident use of the accounting information contained in these statements.
Thus, unless the above postulate is stated and accepted, there is little point in having an audit of
corporate financial statements. Put differently, no such audit is necessary if shareholders and other
interested users of these statements are willing to use them in an unaudited state. If they were so
willing, it would indicate a situation in which the benefits of external auditing were perceived not
to exceed the cost of such a function.
This postulate is the most fundamental of all in corporate audit theory. If it is not acceptable, then
no other is reasonable. However, it has been deliberately stated in terms of a ‘generality’ of
companies because it also recognizes that it is difficult to support in every case. There may be
situations (for example, with very small companies) when the main of sole users of financial
statements are the shareholders-managers. In such case, the absence of significant external
interests may cause the postulate to be unreasonable, Indeed, there is a persistent implied concern
about its legitimacy in the context of small companies (Page, 1991a).
 There is also a question-mark with respect to very large corporate organizations. Williamson
(1997, pp.29-30). For example, suggest that such entities internalize their markets by mean of
subsidiary company structures to protect or govern their competitive advantage and minimize
transaction cost. Consequently, as part of this governance structure, they internalize their control
mechanisms including audit. This would suggest that companies with internal audits may not have
the same need for external audit as suggested in this postulate (see Vinten, 1991).
What is therefore argue in this text is that for most corporate organizations the postulate holds true.
It is developed from one first stated in 1972 (Lee, 1972, p.53; and Lee, 1986, p.74). It is also used
by other audit theorists (Sharer and Kent, 1983, p.19). And it is similar in nature to a justifying
postulate stated by Flint (1988, P.22) that accountability is too remote, complex or significant to
be discharged effectively without an audit. Mautz and Sharaf (1961), on the other hand, di not
specify such a postulate in their exposition of auditing postulates, despite the main focus of their
study being reported financial statements.
When using the audit function as part of the process of corporate accountability, verification and
attestation of the quality of reported financial statements to shareholders and other is the most
desired audit in the generality of corporate situations.
This postulate makes explicit the presumption that, of all possible audit functions which could be
undertaken on behalf of shareholders and other with a legitimate interest in corporate
organizations, the audit of reported financial statements is the most needed in terms of balancing
the benefit to their users against the costs of reasonable audit completion. When looking at the
widespread use made of corporate financial statement in a variety of decision contexts, it appears
reasonable to make this assumption – again in terms of the generality of corporate situations.
The postulate, like any other, is always open to challenge if evidence concerning expectations of
the corporate auditor reveals conclusively that a different form of audit is desired, and that the cost
of this will be borne because its perceived benefits to report users exceed such a cost. Alternative
economics-based audit functions to that specified in this postulate include fraud and error
detection, attesting the effectiveness and efficiency of corporate control systems, judging the
effectiveness and efficiency of corporate management, and assessing the financial soundness of
the corporate organization.
There is also a variety of spesific arguments for audits and accountability directly related to the
social behaviour of the reporting corporate organization – that is, concerning the potential and
actual impact of its operations on the community. For example, Chen (1975) and Tinker (1985)
argue for a broad societal stewardship, Gray (1990) examines the specific issue of reporting on the
impact of the corporate organization on its environment; and Willmott (1991) suggests the current
audit is too narrowly grounded with a main objective of satisfying the financial needs of corporate
ownership.
At the present time, however, despite these economic and societal arguments, and recent severe
criticisms of the existing audit function (for example, Briloff, 1990; and Mitchell et al., 1991), a
long-standing debate about an expectations gap in relation to fraud and error detection (for
example, Tweedie,1991), and some relatively dated empirical data of a broader range of audit
expectations (for example, Lee, 1970b; and Beck, 1973), there appears to be no overwhelming
reason for refuting the validity of this postulate. The present situation of the state mandating a
financial audit on behalf of corporate ownership is a world-wide practical reality.
The above postulate relates indirectly to the assumption of Schandl (1978, p.22) that there is a
purpose to the audit, and to that of Flint (1988, p.23) that there are economic and social benefits to
be derived from audit. As with the first postulate, this assumption is developed from an earlier
version (Lee, 1972, p.54; and Lee,1986, p. 75), used by other writers (Sherer and Kent, 1983,
p.19), but not specified by Mautz and Sharaf (1961).
Verification and attestation of the quality of reported financial statements to shareholders and other
is best achieved by regulation in the generality of corporate situations.
In most economic situations involving corporate organizations, the external audit of their reported
financial statements to shareholders and other with a legitimate interest in term is required by
means of a specific and formal regulatory provision. This postulate assumes that the external udit
of the quality of corporate financial statements is best achieved by such mandates and,
consequently, that is should not be left as a voluntaru function.
Once it is accepted that there is a relatively universal need for a corporate audit (as stated in the
first and second postulates above), it is logical to asume that an effective way of ensuring such a
need is generally satisfied is by explicit regulation. As Wallace (1985, p.53) argues, much of the
relevant literature is predicated on this notion. What it stipulates is that, given the character of
corporate financial information as a pubic good, it is necessary to provide consumer protection by
the imposition of an external audit ‘tax’ on reporting companies. This is a predominant view, given
the almost universal existence of regulated corporate audits, and is premised in this section.
However,as Wallace (1985, p.53) also points out, there is a contrary assumption which suggests
that the effects of the market in agency situations (including stewardship and insurance) provide
incentives to both principals and agents to voluntarily provide for external audit services.
Given the typical existence of corporate audit as a regulated activity, this alternative assumption
is recognized but not utilized in this chapter. The postulate specified above was first prescribed in
1972 (Lee, 1972, p.54), is used by Sherer and Flint (1983, p.19) but not stipulated by Mautz and
Sharaf (1961), Schandl (1978) or Flint (1988) – presumably because their thoretical expositions
are not specifically focused on corporate organizations.
In the generality of corporate situations, the quality of reported financial statements to shareholders
and others can be satisfactorily attested by the verification process of an external audit.
This postulate is one which is developed from earlier versions (for example, Lee, 1972, p.55; and
Lee, 1986, p.76). It is also to be found in the postulate listings of other audit theorists and, thus,
there appears to be a degree of consensus on the matter. For example, Mautz and Sharaf (1961,
p.42) assume financial statements and related data are verifiable. Flint (1988, p.22), on the other
hand, assumes that the subject -matter of auditing, whatever its form, is susceptible to verification
by evidence. The version of the assumption used in this text is also stated by Sherer and Kent
(1983, pp.19-20).
What this postulate articulates is a prior acceptance that the specified informational quality of
corporate financial statements is auditable. To believe otherwise would be asking the corporate
auditor to attempt an impossible task. Corporate auditors implicitly accept this assumptions on
each occasion they carry out the audit task. There are, however, certain circumstances which are a
threat to the universality of this postulate, and which have caused it to be phrased in general terms.
For example, the size, volume and complexity of the largest corporate organizations may be such
that, despite the use of a variety of audit procedurs, there remain doubts as to wheather any audit
would be sufficient to satisfactorily verify and attest the quality of such an entity’s financial
statements. In these situations, however, the prence of internal audit may well act as a
counterweight to these doubts (AICPA, 1991, pp.98-9). Equally, in certain smaller companies,
inevitable weaknesses in control system may be such that the postulate cannot be expressed in a
strong form (Page, 1991a, p.217). The present consensus is relatively unclear as to what is the
preferred position (pp.221-2). Meantimes, therefore, the postulate is stated in the restricted form
of a generality of companies.
In the generality of corporate situations, shareholders and other with a legitimate interest are lot in
a position to verify and attest personally to the quality of the reported financial statements.
This assumption was originally prescribed in 1972 (lee, 1972, p.56) developed in later version (for
example, Lee, 1986, p.77), and is isued by Sherer and Kent (1983, p.20). It does not appear in the
work of other audit theorists specifying postulates (for example, Mautz and Sharaf, 1961; Schandl,
1978; and Flint, 1988).
The structure of the corporate organization tends to physically divorce its shareholders and other
constituent interest from its management. This is a typical agency situation in which corporate
managers act as agents for shareholder-owners, and is particularly observable as a definite
sequence in cases in which a small private ‘family-run’company has extended into a larger public
entity. In other words, as corporate organizations grow, their shareholders and other external
interests increasingly tend not to be conversant with the daily operations of the reporting entity.
They become both mentally and physically separate from it.
In addition, and gain particularly in larger organizations, shareholders and other external
constituents may only have a temporary interest in a reporting company that is, their involvement
with it extends temporarily to the point at which they cease to invest, lend or do business with it.
Thus, there may be little motivation in the relationship to sustain a long-standing personal interest
in ther reporting entity. And, even if this personal interest doest exist, the size and technical
complexities of the corporate financial reporting function is beyond the competence of almost all
external report users. Indeed, available empirical evidence supports this conclusion in the context
of both private shareholders (Lee and Tweedie, 1977, p.177), and institutional investors (Lee and
Tweedie,1981, p.141).
Finally, even if the motivation and expertise are available to personally audit, it would place
impossible administrative burdens on corporate management if individual shareholders and other
report users were able to verify and attest personally accounting record and financial statements.
For this reason, the normal practice (and theoretical assumption) is that corporate organizations
employ suitably qualified professional accountants to act as corporate auditors on behalf of their
external constituents.
Behavioural corporate audit postulates
Corporate auditing is a service function whose nature and quality is dependent to a considerable
extent on the personal attributes of the corporate auditor. This aspect of corporate audit theory
therefore comprises certain key assumptions about the behavioural characteristics of an auditor
charged with the task of verifying and attesting the quality of the accounting information in
corporate financial statements. In this respect, the term ‘auditor’ is used to denote those individuals
responsible for the corporate audit function in practice. In reality, however, the auditor is usually
a firm of suitably qualified professional accountants employing sufficient staff to complete the
verification task and justify the attest opinion.
There is no conflict of interest between the corporate auditor and corporate management which
hinders his or her verification and attestation of the quality of reported financial statements to
shareholders and other interested users.
Having presented a rationale for a coorporate audit function, it is sensible to assume that, once
instituted, it can be carried throught to a satisfactory conclusion. The rational expectations
argument in agency theory suggest that, In addition to the relatively obvious needs of shareholders
and other constituents for audit monitoring, and even in the absence of regulation, it is in corporate
management’s best interest to demand an external audit service. Provision of such a function
maximizes its compesation for good management as it will be seen to be acting in the interests of
the shareholders – principal (Wallace, 1985, p.19). In other words, a corporate audit provides
management with credible information for stewardship reporting, improves the informational
influnce on its decision-making, and provide an insurance against poor quality accounting (p.14).
It is therefore postulated in this section that corporate auditors will not be in position in which
they are prevented by the actions of management from attempting to achieve their stated
objectives.
They presumption is therefore that corporate auditors will be able to meet their objectives
regarding verification and attestation of corporate financial statements (and supporting accounting
records) because they have the fullest co-operation of and access to corporate management and its
accounting systems. In particular, it is assumed that corporate auditors have access to all record,
statements and other evidence they need in order to determine and report on the quality of the
financial statements. In certain situations, they are given this right access to relevant evidence by
specific regulation (for example, in the UK in the companies act, 1985,s.389A(1). In other cases,
it is implied in auditing standards relation to the need for the corporate auditor to obtain sufficient
competent evidential material to support his or her opinion (AICPA, 1991, P.7).
Function corporate audit postulate
There is third groups of fundamental postulates which concern corporate audit activity. These are
stated in this text in support of the functional and procedural aspect of corporate auditing. They
relate to the nature of the quality of audited accounting information, the availability and sufficiency
of audit evidence, and the need for the corporate auditor to report meaningfully.
The over-riding quality of reported financial statement for corporate audit purposes is interpreted
mainly in terms of their relevance and reliability, and there are standars by which the corporate
auditors can determine the existence of such a quality.
There is sufficient competence and reliable evidential material available to allow the corporate
auditor to properly substantiate an audit opinion on the quality of the reported financial statement
to shareholders and other report users; and the corporate auditor can collect and evaluate this
material within a reasonable time and at a reasonable cost.
Mautz and Sharaf (1961, p.42) originally spesified this postulate in two part verifiable financial
statements are free of irregularities; and internal control eliminate the probability of such
irregularities. It was combined into one postulate in 1972 (Lee, 1972, p.62), and is used by Sherer
and Kent (1983, p.21). It does not appear in the postulates outlined by Flit (1988) or Schandl
(1978).
The relevance and reliability of reported financial statements to shareholders and other report
users can be reported meaningfully to them by the corporate auditor.
This final postulate of corporate auditing makes the relatively common-sense point that the
corporate audit report is the means of communicating the results of the corporate auditor’s work
to the shareholders and other report users as part of corporate governance and managerial
accountability. Consequently, rational argument suggest that the effectiveness of such a
communication is related to whether its readers can determine from it the meaning and significance
of the auditor’s comments on the quality of the verified accounting information. Unless it is
assumed that financial statement user are capable of understanding and interpreting the auditor’s
attestation, the impact of the corporate audit is questionable.
The evidence to date on this point is not reassuring. Lee and Tweedie (1977, p.55;and 1981, p.79)
reveal the corporate audit report as one of the most neglected areas of corporate financial reports.
And Hatherly and Skuse (1991) review the long-standing debate concerning the frailties of the
short -form report and the need for a more coherent long-form communication. The postulate,
however, is recognized by Schandl (1978) in terms of assumption thet the audit required a
judgement in the form of a communicated opinion, and that such a communication is meaningful
(p.23); and by Flint (1988, 0.23) in terms approximates to thistext.