CHAPTER 1 – INTRODUCTION

 This chapter covers the following topics:

- Nature of auditing
- Definition and Objectives
- Differences between auditing and accounting
- Responsibilities of auditors and management
- Demand for auditing
- Types of audit
- Types of auditors
- Chartered Accounting firm – structure and professional services
- Principles of stewardship, accountability and agency theory
relationship
- Chronology of audit

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 OVERVIEW MAP – CHAPTER 1

AUDIT REPORT ON TRUE &FAIR VIEW

OF FINANCIAL STATEMENTS & COMPLIANCE
TO FINANCIAL REPORTING FRAMEWORK 1. DEFINITION
AND RULES & REGULATIONS

AUDIT EXAMINATION 2. OBJECTIVES OF

(ACCUMULATED AND EVALUATE AN AUDIT
EVIDENCE) – AUDIT PROCESS
AN OVERVIEW
OF AUDITING

i. primary ii. secondary

APPROVED
4.0 TYPES OF AUDIT AND TYPES OF 3.0 RESPONSIBILITY:
AUDITING STANDARD (ISA) AUDITOR i. AUDITOR
ii. MANAGEMENT

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 The Problem
Ahmad has set up in business selling flowers. For two years all goes well. The flowers sell
steadily and Ahmad receives some income from the business.
Ahmad feels that the business could make more money if he invested in some new premises
and if he employed as assistant. He needs more money to do this. He decides to ask his
rich friend Aisha to invest in the business.
Aisha wants to invest but she does not wish to work for the business or take on any risk for
the business debts.
Aisha suggests to Ahmad that he converts the business into a company. This will mean that
the company become insolvent, she will only lose at most the amount she has invested in
the company. Ahmad agrees. Aisha buys 95% of the shares and Ahmad buys 5%. They
both agree that Aisha is to be paid a reasonable salary as managing director of the business.
At the end of the first year of trading as a limited company, Aisha received a copy of the
financial statements. Profits are lower than she expected. This means that her return from
the company (in dividends) will not be as high as she had hoped.
Aisha contacts Ahmad for an explanation. He tells her that the financial statements are
accurate. Aisha knows that Ahmad gets paid a salary regardless of what the profits are. She
is concerned that this means he is not worried about profit level as she is.
Aisha feels she needs further assurance on the financial statements, but she does not know a
great deal about financial matters.
How can she obtain the assurance she wants?

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 NATURE OF AUDITING
Definition of an Audit
 Auditing is the accumulation and evaluation of evidence
about information to determine and report on the degree of
correspondence between the information and established
criteria.
 Auditing should be done by a competent independent person.
 Keyword:
◦ Information and Established Criteria – there must be
information in a verifiable form and some standards
(criteria) by which the auditor can evaluate the
information.
verifiable form ?
Criteria?

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 Nature Of Auditing (Cont’d)
 Accumulating & Evaluating Evidence:
Evidence –is any information used by the auditor to determined whether the
information being audited is stated in accordance with the established
criteria.
Examples: Oral testimony of the auditee (client), written communication with
outsiders, observations by the auditor & electronic data about transactions.
The auditors must obtain a sufficient quality and volume of evidence.
 Competent, Independent Person
- The auditor must be qualified to understand the criteria used.
- must be competent to know the types and amount of evidence to
accumulate to reach the proper conclusion
- must have an independent mental attitude – unbiased in the accumulation
& evaluation of evidence (independent auditors)
 Reporting – the final stage in the auditing process. Is the communications
of the auditor’s findings to users. It inform readers of the degree of
correspondence between information and established criteria.
Report differ in nature, in form and can vary from the highly technical type
usually associated with F/S audits to a simple oral report in the case of an
operational audit of a small department’s effectiveness

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 The audit definition
INPUTPROCESS OUTPUT
Quantifiable information:
Company’s financial
statements prepared The audit Auditor’s Report
by the management function (Fairly presented)
(by auditor) - Comply to
Companies Act
2016 &
Financial Reporting Framework(FRS )

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 Audit Of Financial Statements of A
Company
COMPETENT INFORMATION (VERIFIABLE)
INDEPENDENT
PERSON
(AUDITOR) Annual Financial Statements
ACCUMULATES &
EVALUATES EVIDENCE REPORT ON
RESULTS

Determine and report

Public degree of correspondence
Examine accounting Audit Report
Accounting Records & supporting on financial
Firm documents statements
(CA)

Accounting Standards (MFRS)

Conduct audit in accordance to: & Companies Act 2016
*Auditing Standards ESTABLISHED CRITERIA
~ISA
~MASA
*GAAP
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 NATURE OF AUDITING
 Objectives of an audit
Primary Objectives
* To form and express an independent expert opinion based on the
audit work performed that the Financial Statements which are to be
relied upon by the users (internal or external i.e shareholders,
creditors, investors, etc) are free from material misstatements.
Secondary Objectives
* forming and expressing an opinion on compliance with statutory
requirements and other regulations
* to provide assistance to the client in improving financial controls
and financial reporting within the business
* to detect and prevent fraud and error in accounting records

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DISTINCTION BETWEEN AUDITING
AND ACCOUNTING
ACCOUNTING:
 Is the process of identifying, recording, classifying and
summarising
economic events in a logical manner for the purpose of
providing financial information for the decision making by the
various users of financial statements.
 It is use to provide relevant information so that management and
others can use to make financial decision
 The preparer is an accountant who must have:
* a thorough understanding of accounting principles and
rules that provide the basis for preparing the accounting
information
* must develop a system to make sure the economic events are
recorded on a timely basis and at a reasonable cost
* Accountancy is the writing up of the books of accounts from source documents and
the preparation of the financial statements

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Book-keeping and Accounting
function
INPUT PROCESS OUTPUT
The financial accounting function:
a. Book-keeping b. Accounting

Transactions Identification

Documentation

Recording

Collation Allocation

Valuation

Communication Financial Statements

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 continued
AUDITING:
Auditing is the accumulation and evaluation of evidence about
information to determine and report on the degree of
correspondence between the information and established criteria.
The auditor in auditing accounting data must thoroughly understand
the accounting principles and rules as the criteria (eg: MFRS) for
evaluating whether the accounting information is properly recorded
and properly reflects the economic events that occurred during the
accounting period.
the auditor must also possess expertise in the accumulation and
interpretation of audit evidence, determining the proper audit
procedures, sample size, particular items to examines, timing of the
tests and evaluating the results and problems before the auditor can
arrive at an independent opinion which will add credibility to the
information contained in the financial statements.
Auditing is related to financial accounting since it is the process of
lending credibility to the financial statements prepared by
management or those charge with governance.

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 RESPONSIBILITIES
* AUDITOR’S RESPONSIBILITIES:
 To state an opinion on the financial statements in auditor’s report based on
his independent examination
 To provide reasonable assurance that financial statements are free from
material misstatements
 Audit performed with due care and professional competence
 MANAGEMENT’S/BOD’S RESPONSIBILITIES:
 Preparation of yearly financial statements
 To maintain adequate accounting records and internal control systems
 Safeguarding of company’s assets
 Prevention and detection of errors, irregularities and fraud.

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 An Overview of Financial Statements Audit
Management Auditor
Terms of engagement

Implements internal
control Obtains audit
Evidence
evidence
Conducts
Transactions
Test management assertions
Accumulate
transactions into Assertions against criteria
account balances
Determine whether
Prepares
financial statements are
Financial
fairly presented
Statements

Issue financial Communication Issues audit report to

statements accompany financial
to shareholders statements
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Demand for Auditing
1. Regulations:
◦ Requirement under Companies Act 2016 – for
companies to undergo an examination by
external auditors.
2. External Parties
i. Shareholders
ii. Bondholders
iii. Potential investors

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 TYPES OF AUDITS
Types of audits may be classified as follows:
1. Financial Statement Audits
2. Compliance Audits
3. Operational (Management/Performance)
Audits
4. Forensic Audits
5. Tax Audits
6. Shariah Audits
7. Public sector Audits

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 TYPES OF AUDITS(CONT’D)
Financial Statement Audits:
o The audit is conducted to determine whether the overall financial
statements and quantifiable information are being verified and
stated in accordance with specific criteria (MFRS).
o The auditor performs appropriate tests to determine whether the
statements contain material errors or other misstatements
 Two audit approaches :
1. Integrated approached to auditing- focus on accounting
transaction
2. Strategic system audit approach – the auditor must have a
thorough understanding of the entity and its environment.
This holistic, top-level understanding includes knowledge of
the client’s industry and its regulatory and operating
environment.

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Financial Statement Audit (cont’d)
 Audited Items:
A complete set of financial statements comprises:
(a) a statement of financial position as at the end of the period;
(b) a statement of profit or loss and other comprehensive income for the period;
(c) a statement of changes in equity for the period;
(d) a statement of cash flows for the period;
(e) notes, comprising significant accounting policies and other explanatory
information; comparative information in respect of the preceding period as specified in
paragraphs 38 and 38A; and10SB-FRS 1

An entity may use titles for the statements other than those used in this Standard. For
example, an entity may use the title ‘statement of comprehensive income’ instead of
‘statement of profit or loss and other comprehensive income’
 Accounting system
 Internal control system
 Relevant documentations

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 TYPES OF AUDIT (CONT’D)
Compliance Audits
- A compliance audit is conducted to determine whether
the auditee/client is following the specific procedures,
rules or regulations set by some higher authority .
For example, in private or government organisation, a
compliance audit may be required to check whether the
organisation has complied with the prescribed policies,
contractual agreement or legal requirement.
Results of compliance audits are generally reported to
someone within the organisational unit being audited
rather than to a broad group of users(creditors, investors,
etc)

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 TYPES OF AUDIT(CONT’D)
 Operational (Management/Performance) Audits
- An operational audits involves a systematic review of an
organisation’s activities, or a part of them, in relation to the
efficient and effectives use of resources (any part of an organisation
structure, computer operations, production methods and any other
area in which the auditor is qualified for the purpose of evaluating
effectiveness and efficiency of management itself).
- It also provide recommendation to the management for improving
the operations (report to the management)
- This kind of audit may be carried out by the internal auditor of a
company, management consultancy works by external auditor or
government auditors.
Note: Differentiate between effectiveness and efficiency.
Effective (resources) and efficiency ( activity and operation
procedures)

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Operational Audit (cont’d)
 Threebroad categories of operational audit:
1. Functional audits – categorising activities of a
business. Eg. Billing function and production function.
2. Organizational Audits – emphasis how efficiently
and effectively functions interact.
3. Special assignments – arise at the request of
management.

FOS
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 TYPES OF AUDITS(CONT’D)
 FORENSIC AUDITS:
- The purpose of a forensic audit is for the detection or deterrence
of a wide variety of fraudulent activities. The use of auditors to
conduct forensic audits is most relevant where the fraud involves
financial issues.
- Examples:
* Business or employee fraud
* Criminal investigation
* Shareholder and partnership disputes
* Business economics losses
* Matrimonial disputes

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Tax Audits
 The need to conduct tax audits arose when annual
tax evaluations were made a responsibility of the
business entity instead of the tax authority.
 The self-assessment tax regulation was imposed in
1992 and becoming familiar in the year 2000s
onwards.
 Are conducted by personnel from the tax authority,
which involves compliance as well as tax
evaluation and to determine whether tax is paid in
accordance with the regulations.

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Shariah Audits
It involves to any business categorised as
Shariah-compliant.
Securities Commission Malaysia and Bank
Negara Malaysia are the authorities to conduct
Syariah audits for Shariah-compliant
organization which practices compliance with
Syariah requirements in addition to the regular
standard requirements governing the
organization.

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Public Sector Audits
 Carried out by public sector auditor or government
auditor who is personnel from the Auditor General’s
office.
 It involves all department or ministry from the
government or public sector organizations.
 Audit of expenditures are conducted similar to audits of
financial statements, which include assessment of
internal controls on spending and activities of
department or ministry.
 A report is prepared at the end of each year and
presented before the King at Parliament by the Auditor
General.

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HOW MANY TYPES OF
AUDIT???

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 TYPES OF AUDITORS
FOUR TYPES OF AUDITORS:
- External Auditors (Audit Firm)
- Internal Auditors
- Government Auditors
- Forensic Auditors

GIFE
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 TYPES OF AUDITORS(CONT’D)
 INDEPENDENT EXTERNAL AUDITORS
(Certified Public Accounting Firms/ Chartered
Accountant Firm)
 Is an approved company auditor under Section 263 of the Company
Act 2016 to audit every company incorporated under the act.
 CA firms are responsible for auditing the published historical F/S
of all publicly traded companies, most other reasonably large
companies, and many smaller companies and non-commercial
organisations
 External Auditors work in the CA firm (Audit firm) which is a
public accounting firm ranges from sole proprietorships to
partnerships providing a wide range of services such attestation
services, accounting or tax services and management advisory
services to individuals, business and governments departments.

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 TYPES OF AUDITORS(CONT’D)
 INTERNAL AUDITOR:
 are employed by individual companies to audit for management
 Internal auditors’ responsibilities vary considerably, depending on the
employer
 Reported to an audit committee, board of directors or higher level of
management.

 GOVERNMENT AUDITOR:
 Is an auditor working for the Auditor General Department, a non-partisan
agency in the legislative branch of the federal government. Headed by the
Auditor General (the government auditor reports to) and is responsible
solely to Yang Di Pertuan Agong.
 The Auditor General’s primary responsibility is to perform the audit
function for all federal and states as well as statutory bodies and public
authorities.
 The final reports are to be reported by the Auditor General to the
responsible Ministry and Parliament.

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 TYPES OF AUDITOR (CONT’D)
 FORENSIC AUDITORS:
 Forensic auditors are trained in detecting, investigating, deterring
fraud and white-collar crime.
 This type of auditors may be employed by corporations,
government agencies, public accounting firms, or consulting and
investigative services firms.
 Some example of situation involved are:
 Analyzing financial transactions involving unauthorized
transfers of cash between companies.
 Reconstructing incomplete accounting records to settle an
insurance claim over inventory valuation

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Types of Audit
Internal Audit External
Audit

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 CHARTERED ACCOUNTANT(CA)
 Requirements for becoming a CA
 Is regulated by Malaysian Institute of Accountants (MIA) through Accountant
Act 1967.
 The requirement to obtain the license is must have at least three years of
experience in audit firms which are recognized under the Accountant Act
1967 and must have 75% works experience as an auditor.
 MIA membership:
1. Licensed accountant : under approval of Section 263 of the Companies

Act 2016.
2. Chartered Accountant (CAs): with a practicing license or without a
practicing license as an auditor
- *the license issues by the Ministry of Finance
3. Associate member - academicion
 to maintain the right to practice as independent auditors, CAs must meet
defined continuing education and licensing requirements.
 it is common for accountants to be CAs who do not practice as independent
auditors
*Malaysian Institute Certified of Public Accountants (MICPA) is the only
Malaysian accounting body conducted professional qualification examination
in Malaysia.

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Chartered Accounting(CA) Firm
Accounting firms that conduct public
accounting practice vary greatly in size.
It ranges from smallest firm (sole practitioner),
medium firm and larger firm (Big 4)
Most Big 4 are Deloitte, Ernst and Young (EY),
KPMG and PricewaterhouseCoopers(PwC)
Big 4 normally offer services such as tax
services, management advisory services, general
accounting and corporate secretarial services.

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Organisation of CA’s firm
 Staff positions and duties in a public accounting firm depend on the size of
the firm.
 In small firms – an employee may perform audit functions at different
levels and at other times perform the complete audit.
 In larger firms – the partner will bear the full responsibility for the practice.

 Partners - They concern themselves with public relations and making new
client contacts. May review final audit report, audit working papers and
signing the audit report
 Managers – less experience than partners but may have developed a
specialisation. Normally they meets with client’s official for audit
planning and discuss with the client about the audit report.
 Audit seniors – normally qualified as professional accountants through
examinations and the requisite practical experience. They have day-to-day
contacts with the client on routine matters.
 Junior employees – classified as audit assistant. They follow instructions
of the superior who has the responsibility for closely reviewing their work
and making constructive criticism.
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 CA’s FIRM SERVICES
 Assurance services – independent professional services that
improves the quality of information for decision makers.
- can be performed by auditors or by a variety of other
professionals

 Attestation Services – a type of assurance service in which the CA

firm issues a report about the reliability of an assertion that is the
responsibility of another party
◦ Fall into 4 categories :
1. Audit of historical F/S
2. Effectiveness of internal control over financial reporting
3. Review of historical F/S
4. Other attestation services that may be applied to a broad range of
subject matter

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 Advantages of an audit
 Disputes between partners or shareholders could be largely
avoided.
 Independent verification of the assets and liabilities.
 Audited financial statements when submitted for tax purposes carry
greater authority.
 Application to banks for financing are enhanced if supported by
audited financial statements.
 Recommendations by auditors on improvement to systems of
internal control.
 Auditors could assist on other areas of the business eg. Financial
advices, listing exercises, restructuring scheme, corporate recovery
services, receivership and liquidation, advices on computerization,
IT audit and internal audit services, etc

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 Limitations of a Statutory Audit
 Audit is on a test basis and may not be in-depth
enough to discover any irregularities
 Audit is carried out only once or twice a year only
(depending on size and complexity of company)
 Audit involves professional judgments.
 Audit involves the concept of materiality
Note: Statutory audit – the scope of the audit should be in accordance with- (a)
Local legislations
(b) Local regulations
(c) Rules and standards set by local professional accounting
bodies

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 PRINCIPLES OF STEWARDSHIP,
ACCOUNTABILITYAND AGENCY
 Stewardship or Agency Theory :
 Is a name given to the practice by which productive resources owned by one
group or person are managed by another person or group of persons.
 Most business (enterprise) which are owned by their shareholder and
managed by directors appointed by their shareholders.
 Directors are accountable to shareholders. They are agents of the
shareholders
 Stewardship Accounting:
 Owners who appoint managers to look after the owner’s property will be
concerned to know what was happened to their property.
 Today the process whereby the managers of a business account or reporting
to the owners of the business is called “stewardship accounting”.
 Directors act as stewards of the shareholders’ investment.
 This reporting and accounting is usually done by means of Financial
Statements

ACC3573CHAP1 37
continued
 Accountability – the quality or state of being
accountable, that is, being required or expected to justify
actions and decisions. It suggests an obligation or
willingness to accept responsibility for one’s actions.
 Stewardship: the duties and obligations of a person
who manages another person’s property.
 Agents: people employed or used to provide a
particular service. In the case of a company, the people
being used to provide the service of managing the
business also have the second role of trying to maximise
their personal wealth in their own right.

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 Overview of the Principal-Agent Relationship
Leading to the Demand for Auditing
Principal provides capital and hires agent
to manage it

Principal Information
(Absentee asymmetry and Agent
Owner) conflicts of interest (manager)
lead to information
risk for the principal

Agent is accountable to principal; provides

financial reports
Auditor gathers evidence
to evaluate fairness of Agent hires auditor to
agents financial report. report on the fairness
Auditor issues audit Auditor of agent’s financial
opinion to accompany reports. Agent pays
agent’s financial reports. auditor to reduce
Adding credibility to the principal’s
reports and reduce information risk.
principal’s information
risk.

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 Chronology of an audit
Preliminary engagement activities

Obtain understanding of the entity

PLANNING
THE AUDIT

Establish materiality and assess risks

Planning: Set overall audit strategy & develop audit plan

Tests of control and audit business processes

(substantive procedures)
PERFORMING
THE AUDIT

Complete the audit

Evaluate results & issue audit report CONCLUDING

& REPORTING

40
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Types of Audit Report
1. Unmodified Auditor’s Report:
 Adequate accounting records have been kept.
 Adequate returns have been received
 The financial statements agree with underlying records.
 Information and explanations required by the auditors have been
given by the company officials.
 The information in the Director’s Report is consistent with the
financial statements.
2. Modified Auditor’s Report:
2.1 Qualified Report except for
2.2 Adverse Report
2.3 Disclaimer report
Copies of the auditors’ report must be:
1. Circulated to members of the company (often at the AGM)
2. Put on the public record
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The end……

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