The Role of Audit

April 14, 2018 Management

The Role of Audit An audit is ‘an independent examination of, and the subsequent expression of opinion on, the financial statements of an organization’ (Hussey, 1999, p. 33). The audit can be viewed as an integral part of corporate financial reporting, where the assurance it provides stems from the trust placed in the judgement of the auditor. The audit is designed to demonstrate ‘the completeness, accuracy and validity of transactions which, when aggregated, make up the financial statements’ (Power, 1997, p. 24).

An audit is ‘an independent examination of, and the subsequent expression of opinion on the financial statements of an organization’. (Hussey 1999). “There has to be an explanation of why auditors do what they do ,what they believe they can achieve an what the public think they can achieve. ”(Flint 1988) The postulate approach is designed to create a conceptual framework for audit practice. They identify various circumstances and requirements for the audit to be carried out in an efficient manner and ignore the alternative perspectives on the meaning of professionalism, managerial and commercial orientations of audit practice.

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In short it’s a normative approach which tells us “what what should be done” than “what is”. Postulates are “assumptions that don’t lend themselves to direct verification. The proposition deducted from postulates (.. ), however can be directly verified and such verifications bears evidence of the truth of the postulates themselves. ” (mautz and sharaf 1961). In other words , postulates are the basis of making valid and useful assumptions and the basis of thinking about problems and arriving at solutions .

The postulates are set up in a framework which includes justifying postulates, behavioural postulates, and functional postulates. Using the postulates you can derive four major concepts of auditing which are independence, responsibility, evidence, and reporting. Justifying postulates is the reason for companies to be audited. The basis for auditing could be due to the insufficient credibility in the company’s accounts for the use of shareholders confidently, therefore there is a need for the enhancement of credibility.

Another reason for the company to be audited is that it can be better for the shareholders if the company s accounts were created through the guidelines and regulations of financial reporting standards. As a result it could be said that auditing of a company’s statements will increase the shareholders satisfaction. Ex. Requirement of an external audit for large company is based on the requirement of an independent opinion for shareholders who have appointed the directors to manage their business.

The requirement for small firms is mainly due to 2 main reasons, -even though the statutory requirement have been removed ,some small companies still obtain an independent audit report in the event of getting a loan from a bank for example -in the event where there is a seldom separation of ownership and control in the event where 10% of the shareholders require an independent audit it should be carried out by the statutory requirement. This normally is the case where the individual doesnot take part in the day to day running of the business.

The other postulate within the postulate framework is the behavioural postulate which are necessary for the company to enhance the credibility of information. The credibility is generally enhanced when an audit is not interrupted due to a conflict between the auditor and the management. It also should be noted that the auditor is not restricted by law to carry out his duty and also would be independent both mentally and physically. It also must be taken into account that the auditor should be sufficiently skilled and must be accountable as a professional.

The last part of the postulate framework is the functional postulate which directly related to the actual work the carried out by the auditor. There must be sufficient reliable evidence in appropriate form to enable the auditor to perform the audit within a reasonable time and cost. The auditors work should also be free from fraud and error and exists through proper and exists through recognized concepts and frameworks so that there is a consistency in the reporting which ultimately leads to a fair presentation.

It could be said that the postulates and concepts are ideas to guide the performance of the audit function rather than the theory of its existence. There are also other theories for example the market based approach which suggests that auditing is a n economic function. The market based approach of auditing uses the agency theory, information theory and the financial economic concept which provides a theoretical framework for viewing an audit function. The market based theory also suggest that the audits are not only demanded by consumers but also valued (i. e. he perceived benefit > perceived costs) if not the resources used for the audits would be shifted towards other products. There are also 3 complementary hypothesis’s namely the stewardship(monitoring ) hypothesis , information hypothesis and the insurance hypothesis. The stewardship hypothesis delves into the agency relationship rational expectations. Under this hypothesis it expects asymmetric information as a result of the separation of ownership and control and it also could be said that the principals and the agents interest to diverge from each other.

As a result it could be said that the audit provides the stewardship between the principal and the agent and provides the principal the assurance that their interest is safeguarded. Plus •Agent rather than the principal is the source of demand for monitoring •Agents have incentives to provide financial statements to facilitate monitoring activities by principals. Moreover, the manager will agree to provide evidence that such evidence are carefully prepared . for ex.

In instances where the small firms are trying to obtain a loan from the bank , an audited financial statement has proven to be a more crutial to the bank for making lending decisions. The second hypothesis is known as the information hypothesis which is the demand for auditing information as a mean of reducing the risk of the investment , improving the internal and external decision making process and also the ability to enhance gains from trade by the individual’s improving the portfolio investment position.

The insurance hypothesis is the ability to shift financial responsibility of reported data to the hand of the auditor who lowers the expected loss from litigation, related settlements or other managers, creditors or other professionals in the the securities market. The auditor is renowned to provide a better insurance that the insurance companies for the reason being that the auditors improve the quality if information and checks internal records, educates the directors and so on. These theories regarding relationship between auditor reputation and audit regulation are very insightful.

The approach provides some reconciliation between normative and ‘sociological’ perspectives on audit professionalism. However conflicts still remain such as auditor independence. It is believed that audit research should be more based on social reasons such as the conflicts the auditor faces while working. On another note, we can say now that audit improves the quality of information and provides a check on internal records that the company has in place. The audit can also help in educated the director of a company about how well there company has been doing.

It also can help in ease other agency relationships. The agency relationship between companies that are not wholly family owned. This is because companies that are not wholly family owned may mean that directors may have a lack of trust between each other and an audit can help erode this. Additionally, it can help other agency relationships between company’s and lenders. For instance, a company can use the audit to provide evidence of the company’s ability to be profitable and will help in persuading lenders to finance their upcoming project.


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