1.1 Learning Objectives
After studying this chapter, you should be able to:
Relate some of the early history of auditing.
Discuss some of the audit expectations of the general public.
Identify organizations that affect international accounting and auditing.
Name the standards set by International Auditing and Assurance Standards Board.
Give an overview of the IFAC International Standards on Auditing (ISA).
Understand the basic definition of auditing in an international context.
Distinguish between audit risk and business risk
Differentiate the different types of audits.
Distinguish between the types of auditors and their training, licensing and authority.
Name and categorize the key management assertions.
Give the components of the audit process model.
Describe how international accountancy firms are organized and the responsibilities of auditors at the various levels of the organization.
1.2 Auditing through World History
Auditing predates the Christian era. Anthropologists have found records of auditing activity dating back to early Mesopotamian times (around 3000 BC). There was also auditing activity in ancient China, Greece and Rome. The Latin meaning of the word “auditor” was a “hearer or listener” because in Rome auditors heard taxpayers, such as farmers, give their public statements regarding the results of their business and the tax duty due.
Scribes of Ancient Times
Auditors existed in ancient China and Egypt. They were supervisors of the accounts of the Chinese Emperor and the Egyptian Pharaoh. The government accounting system of the Zhao (1046-221 BC) dynasty in China included an elaborate budgetary process and audits of all government departments. From the dawn of the dynastic era in Egypt (3000 BC) the scribes (accountants) were among the most esteemed in society and the scribal occupation was one of the most prestigious occupations.
Egyptian Pharaohs were very severe with their auditors. Each royal storehouse used two auditors. One counted the goods when they came in the door and the second counted the goods after they were stored. The supervisor looked at both accounts. If there was a difference, the auditors were both killed.
Bookkeeping as a support mechanism for the determination of profit or wealth, or as a decision support system for achieving profit maximization, was basically unknown in ancient cultures like the Mesopotamian, Egyptian, Greek or Roman. Auditing in English-speaking countries dates to 1130AD. Then, although they had highly developed economic systems, registration of economic facts or events was limited to the recording of single transactions whose sole purpose was to support the short-term memory of the trading partner.
Rational maximization of wealth or profit did not fit into the systems of these cultures. Wealth was not a function of keen entrepreneurship or of smart cost–benefit trade-offs. It was merely a reward for one’s loyalty to the government or for living in accordance with religious and moral principles and rules.
The attitude of profit maximization emerged at the end of the Middle Ages, with the emergence of large merchant houses in Italy. Trading was no longer the domain of the individual commercial traveler; it was now coordinated centrally at the luxurious desks of the large merchant houses in Venice, Florence or Pisa. As a result, communication became vital. Not unexpectedly, therefore, the system of double entry bookkeeping was first described in Italy, in Luca Pacioli’s Summa de Arithmetica dated 20 November 1494.
The practice of modern auditing dates back to the beginning of the modern corporation at the dawn of the Industrial Revolution. In 1853, the Society of Accountants was founded in Edinburgh. Several other institutes emerged in Great Britain, merging in 1880 into the Institute of Chartered Accountants in England and Wales. This nationwide institute was a predecessor to institutes that emerged all over the Western world at the end of the nineteenth century, for example, in the USA (in 1886) or in the Netherlands (in 1895).
Further developments of the separation between provision of capital and management and in the complexity of companies, along with the occurrence of several financial scandals (e.g. City of Glasgow Bank, 1883; Afrikaansche Handels-vereeniging, 1879)1 have led to a steady growth of the audit profession and regulation. The British Companies Acts (1845–62) were models for US auditing. The first US authoritative auditing pronouncement was issued in 1917.
At the same time, companies across the world experienced growth in technology, improvement in communications and transportation, and the exploitation of expanding worldwide markets. As a result, the demands of owner-managed enterprises for capital rapidly exceeded the combined resources of the owners’ savings and the wealth-creating potential of the enterprises themselves. It became necessary for industry to tap the savings of the community as a whole. The result has been the growth of sophisticated securities markets and credit-granting institutions serving the financial needs of large national, and increasingly international, corporations.
The flow of investor funds to the corporations and the whole process of allocation of financial resources through the securities markets have become dependent to a very large extent on financial reports made by company management. One of the most important characteristics of these corporations is the fact that their ownership is almost totally separated from their management. Management has control over the accounting systems. They are not only responsible for the financial reports to investors, but they also have the authority to determine the way in which the information is presented.