Principles of Auditing Mount Kenya University (MKU) PDF Notes

Introduction to Auditing

The Definition for Audit and Assurance Standard AAS-1 the Institute of Chartered Accountants of India(ICAI) — “Auditing is the independent examination of financial information of any entity, whether profit oriented or not, and irrespective of its size or legal form, when suchan examination is conducted with a view to expressing an opinion thereon.”
The general definition of an audit is an evaluation of a person, organization, system, process, enterprise, project or product. The term most commonly refers to audits in accounting, but similar concepts also exist in project management, quality management, and energy conservation.
This topic attempts at explaining the reasons as to why auditing exist as a specialized discipline. The chapter further explains the need for the audit. It also explains the objectives of auditing besides explaining the parties who are interested in financial statements of any business organisation.

Agency Theory and Auditing

An agency relationship arises whenever one or more individuals called principals use other people or individual/s called agents to perform some services on their behalf. The principals delegate decision making authority to the agents. In case of public limited company, agency relationship may take two forms:

  • Agency Relationship Between Shareholders and The Management
  • Between shareholders and Creditors

More often than not conflicts may arise between the principals and agents.
Public companies are owned shareholders but are managed directors who in turn employ the top management to manage the affairs of the company on their behalf.
The shareholders and other stakeholders are interested in knowing whether their hard earned resources are managed in more transparent and profitable manner. The management reports the affairs of the business through financial statements such as:

  • Income statement
  • Cash flow statement and
  • Statement of financial position

The authenticity of these financial statements must ascertained an independent and qualified party. This party happens to be the auditor.


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