Chapter No.

1: Introduction to Auditing
Origin: Latin word Audire which means To hear
Base of Audit: Stewardship Accounting
When a person is trusted for some resources, he must
account for it
History:
5600 years ago: In Egypt, Rome & Greece, investors used
to hear the arguments of the managers
In 15
th
Century (1494): Double entry system introduced by
LUCA PUSIALO, who in the last chapter of his book
determined the rights, duties & liabilities of auditors
After Industrial Revolution (1700-1880): England passed
Companies Act 1844 which made audit compulsory for
companies
Definition: Independent examination of financial
information to enable an auditor to give reasonable
assurance about the truth & fairness of accounts in
accordance with international financial reporting
standards
True & fair view: Free from material misstatement (errors
& frauds) causing significant effect on the decisions of the
users of financial information
Reasonable assurance: Certain material misstatements
might have remained undetected due to persuasive
evidences
Evidence: Proof of transactions
Conclusive: Final evidence after obtaining of which, there is
no need for further evidence
Persuasive: Which leads towards final evidence, but itself is
not of good quality

Primary
To give independent opinion
To give reasonable assurance of truth & fairness
of accounts
To check compliance of prescribed laws
To meet legal obligations
Secondary
To detect & prevent from errors & frauds
Implied:
Moral check

Special
To assess the performance of the management
To satisfy taxation officers
To measure social performance of business
To examine the wise use of resources
To verify the correctness of cost accounts
To check the efficiency of operations
To determine the real value of business for bid offer
To satisfy lenders about the creditworthiness of
business
To maintain sufficient profits

To enable shareholders to supervise the
management
To attract new investors
To satisfy workers for their pays
To change the state of affairs in case of
admission, retirement, death, insanity or
insolvency of partners
To determine loss to recover it from insurance
company
To improve internal control system
To enlist the business on stock exchange


For Managers:
Independent & reasonable assurance about the truth
& fairness of financial information
Detection & Prevention of errors & frauds
Compliance of prescribed laws
Improvement in internal control system
Advice about weaknesses
High credit rating
Easy loans
Easy tax payments
Enlistment on stock exchange

For Owners
Shareholders protection
Moral check on management
Improvement in efficiency & effectiveness
Stability of profits
Settlement of disputes
Help in case of admission, retirement, death, insanity or
insolvency of partners
For Government
Better performance of tax department
Easy assessment & recovery of taxes
Purchase of private business
Sale of Government business
Economic development


For Creditors
Getting back of principal & interest in timely manner
For Bidders
Determination of true value of business
For Insurers
Determination of exact amount of loss
For New Investors
Attraction towards high & stable returns
For Workers
Satisfying workers by good pays

No absolute assurance
Costly
Checking of past actions
Bias of auditors
Frauds by management
No true & fair view due to connivance with
management
Misleading certificates
No suggestions by auditors in case of no full
disclosure to them


Process of Auditing
Understanding the clients system
Planning (Audit programme, audit notebook, audit
working papers)
Sampling (Test checking)
Vouching (Evidencing the transaction)
Verification (Valuation of assets & liabilities)
Investigation (Enquiries from stakeholders)
Writing audit report

Laws governing the process of auditing
International Standards on Auditing (ISAs)
International Financial Reporting Standards (IFRS)
Relevant legislations (e.g. Companies Ordinance
1984, Banking Companies Ordinance 1962)
Relevant regulations (e.g. SBPs prudential
regulations for banks, SECPs regulations for NBFIs)
Terms of audit engagement letter
Auditors knowledge, training & experience
Scale of business
Cost
Time
Relevancy
Materiality
Risk Areas
Sufficiency of information
Reliability of internal control system

Independent examiner of financial information who gives
reasonable assurance about the truth & fairness of accounts
in accordance with international financial reporting standards
Qualifications: Any chartered accountant within the
meaning of Chartered Accountants Ordinance 1961, or audit
firm whose all CAs are practicing in Pakistan, is qualified to
conduct audit of a public Ltd. company or private Ltd
company having capital of Rs. 3 million and above or
subsidiary of a public Ltd. company, if
He/It is not present employee of the business to be audited
He/It has not been employee for the last 3 years
He/It has not any relation with any employee
He/It is not any debtor/creditor of the company to be audited
He/It is not disqualified for any subsidiary/ holding company of the
company to be audited
He/It is not a body corporate
Disqualifications: Not meeting the above qualifications
Appointment of Initial Auditor
By directors
Appointment time: Within 60 days from the incorporation of the
company
Term of office: Uptil the conclusion of 1
st
annual general
meeting
By shareholders (If directors have not appointed)
Appointment time: Within 60 days from the end of 1
st
60 days
Term of office: Uptil the conclusion of 1
st
annual general
meeting
By SECP (If shareholders have not appointed)
Appointment time: Within 30 days from the end of 2
nd
60 days
Term of office: Uptil the conclusion of 1
st
annual general
meeting

Appointment of Subsequent Auditor/Regular Auditor
By shareholders
Appointment time: In 1
st
AGM
Term of office: Till next AGM
By SECP (If shareholders have not appointed)
Appointment time: After 1
st
AGM
Term of office: Till next AGM
Appointment of Auditors for Casual Vacancy (If the regular
auditor leaves the job before the completion of audit)
By directors
Appointment time: Within 30 days from the occurrence of casual vacancy
Term of office: Till next AGM
By SECP (If directors have not appointed)
Appointment time: After 30 days from the occurrence of casual vacancy
Term of office: Till next AGM
Appointment under Income Tax Ordinance
2001
Any CA or CMA can be appointed as an auditor of
a Pvt Ltd. Co. having capital of Rs. 0.5 million or
above
A CA must be appointed for the audit of a public
Ltd. Co.
Remuneration: Audit Fee
Fixing authority: Appointing Authority
Removal
Companies Ordinance 1984 is silent about the
removal of an auditor before the completion of his
term of office
Reasons of removal:
Shareholders are not satisfied with the performance of the
auditor
Auditor is biased and partial
Procedure for removal:
Permission from the Government
14 days removal notice by the shareholders to the company
Copy of this notice sent to the auditor

7 days calling notice to the shareholders & the auditor to
attend the meeting
Auditor files representation before the company, which is
circulated among the shareholders before the meeting or read
out during the meeting
Resolution in general meeting
Qualities
Personal
Leadership
Foresight
Ability to plan & decide
Hardworking
Due care
Honesty
Independence
Alertness
Tactfulness
Professional
General Knowledge
Special Knowledge
Areas:
Accounting, Financial Management & Auditing
Knowledge about business organization and its
operations
Electronic data processing
Company Laws:
Companies Ordinance 1984, Companies Rules 1985
Mudarbah Companies Ordinance 1980, Mordarbah
Companies Rules 1981
Banking Companies Ordinance 1962

Mercantile Laws:
Contract Act 1872
Sales of Goods Act 1930
Common Carrier Act 1865
Negotiable Instruments Act 1881
Partnership Act 1932
Co-operative Societies Act 1925
Taxation Laws:
Income tax Ordinance 2001, Income Tax Rules 2002
Sales Tax Act 1990, Sales Tax Rules 2006, Sales Tax
Special Procedure Rules 2007
Federal Excise Act 2005, Federal Excise Rules 2005
Customs Act 1969
Ethics
A watchdog not a blood hound
Nether too soft nor too negative
Professional skepticism based on objective not
subjective approach
Impartiality
Integrity
Confidentiality (exceptions: permission of client,
court orders)

Rights
To make surprise visits of the premises
To access books of accounts
To call for information & explanation
To seek opinion from experts
To correct own statements
To receive notices to attend the meetings
To attend, speak & remain present at meetings
To receive remuneration
To complete the term of office
To make representation in case of removal
Duties
To examine the records
To help public prosecutors and taxation officers
To certify statutory report
To prepare & sign report on AGM
To certify solvency at the time of winding up
To give reasons in case of negative opinion
To follow instructions of Government if any
Liabilities
Civil Liabilities: For breach of terms of contract
Liability for Negligence: Auditor is liable to shareholders for
his carelessness causing loss to the client, Any
director/shareholder can file a suit against him to recover such
loss during the lifetime of the company
Liability for Misfeasance: Auditor is liable to shareholders
for his misuse of authority causing loss to the client, Any
liquidator can file a suit against him to recover such loss
within 5 years of order of winding up or appointment of
liquidator
Liability for libel: Auditor is liable to shareholders for
giving untrue adverse remarks for any officer of the
company. Any director/shareholder can file a suit against
him to recover defamation charges
Liability for third parties: Auditor is liable to third parties
for his negligence or fraud causing any loss to them if
He knows that his opinion is to be relied upon by them.
They have put reliance on his report
They have suffered loss
They have filed a suit against the auditor to recover such loss
Liability for breach of contract: Auditor is liable to
shareholders for failing to fulfill the terms & conditions
of the contract causing loss to the client. Any
director/shareholder can file a suit against him to
recover such loss.
Criminal Liabilities: For breach of prescribed
laws
Particulars Imprisonment Penalty (Rs.)
Professional Misconduct Decided by court Decided by court
Fraud during winding up of the company Decided by court Decided by court

Disqualified Auditor - 25,000
Delayed Report after 2 months from the end
of accounting period or extended time
- 5000
Non-compliance 6 months 2000
Intention to profit 6 months 2000
Failure to assist taxation officer 1 year 10,000
False evidence 2 years Decided by court
Misstatement in prospectus 2 years 10,000 or both
Signing untrue certificate required by law 2 years Decided by court
Falsification of accounts 2 years 20,000
False statement 3 Years 20,000 or both
Other
Liability in case of joint audit: Each auditor will
be held responsible for any misappropriation
made by him
Liability in case of honorary audit: If any
auditor accepts to audit any company without
receiving any remuneration, his liabilities will be
the same as those of the paid auditors

Difference between Accounting &
Auditing
Accounting Auditing
Definition
Preparation of books of accounts &
financial statements to show the financial
position of business
Independent examination of financial
information to enable an auditor to give
reasonable assurance about the truth &
fairness of accounts in accordance with
international financial reporting standards
Process
Recording in journal, classification in
ledgers, summarizing in trial balance,
compilation of financial results in financial
statements
Checking reverse accounting process
through Understanding the clients system,
Planning, Sampling, Vouching, Verification,
Investigation, Writing audit report
History
History of business & accounting went side
by side
History of auditing is shorter as compared
to accounting
Difference between Accounting &
Auditing
Accounting Auditing
Period
Throughout the year Either periodically or at the end of financial
year
Knowledge
About accounting About accounting, financial management
and auditing
Nature of work
Mechanical Investigative
Nature of Information
Financial Both financial & non-financial
Approach of work
Constructional Analytical
Managerial Influence
Yes No
Difference between Accounting &
Auditing
Accounting Auditing
Purpose
Depicting financial position Checking truth & fairness of financial
information
Legal necessity
For every business Not for every business
Conceptual framework
International Accounting Standards &
generally accepted principles
International Standards on Auditing, relevant
legislations, regulations, terms of
engagement letter, auditors judgments
Principles
Going concern, separate entity, accrual,
consistency, monetary measurement,
prudence, matching, realization,
accounting period.etc
Independence, full disclosure, objectivity,
materiality
Difference between Accounting &
Auditing
Accounting Auditing
Kinds
Cash basis, Accrual basis Continuous, interim or final.etc
Techniques
Depreciation, and stock valuation
methods
Vouching, verification etc.
Status of accountant vs. auditor
Accountant is employee of the business Auditor is an independent party, agent of the
shareholders
Qualification of accountant vs. auditor
Any qualification to make him adept in
accounting
Must be Chartered Accountant in case of
public Ltd. Co., Pvt Ltd Co with 3million
capital or more and subsidiary of public Co.
Appointment of accountant vs. auditor
By management By shareholders, directors or SECP
Difference between Accounting &
Auditing
Accounting Auditing
Removal of accountant vs. auditor
By management at any time By shareholders in next annual general
meeting
Code of Ethics
Accounts are not required to follow the
code of conduct of any council
Auditors are required to follow the code of
ethics given by Institute of Chartered
Accountants of Pakistan
Rights, Duties & Liabilities of accountant vs. auditor
Determined by management Determined by Companies Ordinance 1984
and ISAs
Reward of accountant vs. auditor
Salary Fee
Determination of remuneration
Fixed by management Fixed by appointing authorities
Difference between Accounting &
Auditing
Accounting Auditing
Answerable
To managers To shareholders
Report
Financial statements Auditors opinion about the truth & fairness
of financial statements