ASR-02 (Part 4 of 4) Introduction to Auditing | CPA Exam

Summary

This script traces the evolution of auditing from its ancient roots in record-keeping to a formal profession during the Industrial Revolution. It highlights the shift from fraud detection to expressing opinions on financial statement fairness. The role of technology, corporate scandals, and regulatory changes like SOX in shaping modern auditing practices is discussed, emphasizing the current risk-based approach and the potential for AI and big data to further advance the field.

Takeaways

• 📚 Auditing has ancient origins, dating back to civilizations such as Mesopotamia, Egypt, and Babylonia, where early records show signs of audit functions like check marks and symbols.
• 👂 The term 'audit' comes from the Latin 'audeo', meaning 'to hear', reflecting the historical practice of listening to accounts described by servants to a lord's trusted person.
• 🏛 In ancient Greece, philosophers like Plato advocated for government accountability, laying the groundwork for auditing public expenditure and financial management by an independent body.
• 👔 The Industrial Revolution marked a significant shift in auditing, as management separated from ownership, leading to the rise of corporations and an increased demand for independent auditors.
• 🔍 Initially, auditors focused on detecting fraud and errors, but their role evolved to include expressing an opinion on the fairness of financial statements.
• 📊 Auditing methodology has advanced over time, with the introduction of concepts like audit sampling and the evaluation of internal controls to improve efficiency.
• 🌐 The 20th century saw a divergence in audit objectives between American and British auditors, with the former focusing on reporting actual financial conditions and the latter on fraud and error detection.
• 🌐 The post-WWII period saw widespread acceptance of audit sampling and the recognition that strong internal controls could reduce the extent of external testing.
• 📉 Accounting and corporate scandals have continually shaped the auditing profession, leading to the development of new standards and methodologies to address emerging challenges.
• 🛠️ The Treadway Commission, formed in response to fraudulent financial reporting, resulted in the COSO framework, an internal control framework that has influenced auditing practices.
• 🤖 Modern auditing faces opportunities for further automation and integration with technologies like artificial intelligence and big data, requiring accountants to adapt and innovate.

Q & A

What was the primary purpose of auditing in its early stages?

In its early stages, auditing was primarily for governmental accounting and was mostly concerned with record keeping rather than accounting procedures.

When did auditing begin to evolve into a formal profession?

Auditing began evolving into a formal profession during the Industrial Revolution, roughly from 1750 to 1850.

What was the initial focus of auditing during the Industrial Revolution?

The initial focus of auditing during the Industrial Revolution was on fraud and error detection.

How did the objective of auditing change over time?

Over time, the objective of auditing became more refined and aligned with expressing an opinion about the fairness of financial statements.

What does the term 'audit' originate from and why?

The term 'audit' comes from the Latin term 'audire', which means to hear or to listen. It is related to the auditory system because in the past, when common people could not read or write, trusted individuals would listen to servants describe the resources entrusted to them and note any discrepancies.

What was the role of auditing in ancient civilizations like Mesopotamia, Egypt, and Babylonia?

In ancient civilizations, auditing was performed through the use of check marks, dots, and other symbols on documents, indicating some form of auditing even before the term was used.

How did the concept of auditing public expenditure and financial management by an independent body originate?

The concept originated in ancient Greece, where philosophers like Plato advocated for government officials to be accountable for the resources entrusted to them.

What was the significance of the Industrial Revolution for the auditing profession?

The Industrial Revolution marked a period of economic growth that led to the separation of management from ownership, increasing the demand for auditors to detect errors and frauds, and thus giving birth to the concept of the independent auditor.

How did audit practices differ between American and British auditors in the early 20th century?

American auditors focused on reporting the actual financial condition of an entity, while British auditors focused on the detection of fraud and error. American audits also supported audit sampling, whereas British auditors favored detailed testing.

What is the significance of the Treadway Commission in the auditing profession?

The Treadway Commission sponsored a study on the causes of fraudulent financial reporting and made recommendations to reduce its incidence. Their work led to the development of the COSO framework, an internal control framework.

What major legislation was enacted in response to the Enron scandal, and what was its impact on auditing?

The Sarbanes-Oxley Act of 2002 was enacted in response to the Enron scandal. It introduced significant changes in the auditing of public companies, focusing on auditor assessment of internal controls and setting new standards for corporate accountability.

How is the auditing profession expected to evolve with advancements in technology?

The auditing profession is expected to elevate to a higher level of automation with the advent of artificial intelligence and big data, requiring accountants to adapt and implement new auditing methods to remain the professionals of choice for audit engagements.

Outlines

00:00

📚 The Evolution of Auditing Profession

This paragraph delves into the origins and evolution of the auditing profession. It begins with the early forms of auditing in ancient civilizations like Mesopotamia, Egypt, and Babylonia, where record-keeping and rudimentary checks were performed. The term 'audit' itself is traced back to the Latin 'audire', meaning 'to hear', highlighting the practice of listening to accounts in the past. The paragraph then moves through history, discussing the development of auditing during the industrial revolution, the separation of ownership and management, and the shift in focus from fraud detection to expressing an opinion on the fairness of financial statements. It also touches on the refinement of auditing objectives and the impact of business and technological advancements on the profession.

05:02

🌐 The Development of Modern Auditing Practices

The second paragraph outlines the progression of auditing practices into the modern era. It highlights the differences in audit objectives between American and British auditors in the early 20th century, with Americans focusing on the actual financial condition and the British on fraud and error detection. The adoption of audit sampling and the move towards a risk-based audit approach are discussed, along with the development of internal control frameworks like COSO in response to corporate scandals. The paragraph also covers the impact of major accounting failures, such as Enron, on auditing standards and the introduction of legislation like the Sarbanes-Oxley Act of 2002, which emphasized the importance of auditor assessment of internal controls.

10:03

🤖 The Future of Auditing in the Age of AI and Big Data

The final paragraph looks towards the future of the accounting and auditing profession, particularly in the context of artificial intelligence and big data. It emphasizes the opportunity for accountants to lead in the adaptation and implementation of advanced audit technologies, ensuring their relevance and value in audit engagements. The paragraph suggests that the profession must embrace automation and leverage new technologies to continue providing high-quality services and maintain their status as the professionals of choice in the dynamic and evolving business landscape.

Keywords

💡Auditing

Auditing refers to the systematic process of examining and verifying an organization's financial records and statements. In the context of the video, auditing is portrayed as an essential function that has evolved from simple record-keeping to a formal profession, with the primary objective of expressing an opinion on the fairness of financial statements. The script mentions the evolution of auditing from ancient civilizations to the modern profession, highlighting its importance in detecting fraud and errors, and ensuring accountability in financial management.

💡Industrial Revolution

The Industrial Revolution, which occurred between 1760 and 1840, marked a period of significant economic and social change due to the introduction of new manufacturing processes. In the script, it is noted as a pivotal time for the evolution of auditing, where the profession began to formalize and shift its focus from fraud and error detection to a more systematic approach, including the expression of opinions on financial statements.

💡Fraud Detection

Fraud detection is the process of identifying, investigating, and addressing fraudulent activities within an organization. The script emphasizes the initial focus of auditing on fraud detection, which was crucial during the early stages of the profession's development. As businesses grew more complex, the role of auditors expanded to include not only the detection of fraud but also the assessment of financial statements' fairness.

💡Financial Statements

Financial statements are formal records of an organization's financial activities, including balance sheets, income statements, and cash flow statements. The video script discusses how the objective of auditing has become aligned with expressing an opinion on the fairness of these financial statements, indicating the importance of accurate and reliable financial reporting for stakeholders.

💡Auditor Independence

Auditor independence refers to the lack of any financial, business, or personal relationships that could potentially compromise the objectivity and integrity of an auditor. The script explains that, historically, auditors were not independent, often being required to own stock in the companies they audited. Modern auditing standards, however, demand a high degree of independence to ensure the credibility and reliability of audit findings.

💡Sampling

Sampling in auditing is the process of selecting a subset of transactions or accounts for examination, rather than reviewing every single item. The script mentions the development of sampling during the industrial revolution as a response to the impracticality of examining all transactions in a business. This method allowed auditors to efficiently assess the financial statements while managing the risk of error or fraud.

💡Risk-Based Audit Approach

The risk-based audit approach is a modern auditing methodology that focuses on understanding and assessing the risks involved in an audit engagement to plan and design audit procedures effectively. The video script describes the gradual adoption of this approach by auditing firms, which involves evaluating the potential risks and tailoring the audit process to address them, thereby improving the efficiency and effectiveness of audits.

💡Internal Controls

Internal controls are the policies and procedures put in place within an organization to ensure the accuracy and reliability of financial reporting, as well as compliance with laws and regulations. The script discusses the importance of internal controls in reducing the extent of testing by external auditors and the evolution of auditing to include the evaluation of these controls as part of the audit process.

💡Accounting Scandals

Accounting scandals refer to instances where companies manipulate their financial reports to deceive stakeholders, often resulting in significant financial losses and damage to reputations. The video script cites examples like Enron and the impact of such scandals on the auditing profession, leading to increased regulatory scrutiny and changes in auditing standards to prevent future occurrences.

💡Sarbanes-Oxley Act (SOX)

The Sarbanes-Oxley Act of 2002, also known as SOX, is a U.S. legislation enacted in response to major corporate and accounting scandals. The script highlights SOX as a significant development in auditing and accounting standards, mandating stricter auditor assessments of internal controls and enhancing corporate governance and accountability.

💡Artificial Intelligence (AI)

Artificial Intelligence refers to the simulation of human intelligence in machines that can perform tasks such as learning, reasoning, and problem-solving. The video script suggests that AI, along with big data, presents an opportunity for the auditing profession to elevate audit processes to a higher level of automation, requiring accountants to adapt and implement new technologies for future audit engagements.

Highlights

Auditing originated from governmental accounting and record-keeping rather than accounting procedures.

The Industrial Revolution marked the evolution of auditing into a formal profession focused on fraud and error detection.

Audit objectives have refined to expressing opinions on the fairness of financial statements.

Ancient civilizations like Mesopotamia, Egypt, and Babylon show early signs of audit functions in record-keeping.

The term 'audit' derives from the Latin 'ordere', meaning to hear or listen, reflecting its historical roots in listening to accounts.

Ancient Greek philosophers advocated for government accountability and reporting on resources entrusted to them.

Medieval manorialism in Europe featured advanced record-keeping and segregation of duties, with trusted individuals overseeing records.

The earliest mention of a public official auditor dates back to 1314 in England.

The Industrial Revolution led to the separation of management from ownership, increasing the demand for independent auditors.

Auditors began reporting their findings to company owners, marking the birth of the independent auditor concept.

20th-century differences emerged between American and British auditing objectives and methodologies.

World War II era saw the widespread acceptance of audit sampling and the focus on internal controls to reduce external testing.

The 1970s introduced the concept of audit risk and the modern risk-based audit approach in professional literature.

The Treadway Commission in 1987 developed the COSO framework for internal control in response to accounting scandals.

The Enron scandal led to the Sarbanes-Oxley Act of 2002, focusing on auditor assessment of internal controls.

The accounting and auditing profession faces opportunities for automation with artificial intelligence and big data.

Accountants are encouraged to lead in adapting and implementing future audit technologies.

Transcripts

[Music]

now in order to understand the

profession of auditing better it's not

worthy to look back on its origin and

how it evolved through time until what

it is today

auditing initially existed primarily for

governmental accounting and it was

concerned mostly with record keeping

rather than accounting procedures

it wasn't finally until the industrial

revolution roughly that was from 750 to

1850 that auditing began evolving into a

formal profession

it initially focused on fraud and error

detection

until later the objective had been more

refined and aligned to what objective of

audit is today so which is as mentioned

earlier the expression of opinion about

the fairness of the financial statements

so finally advancement in business and

technology people for the development of

the profession and corporate and

accounting scandals continue to

calibrate the profession even until

today to address the changing needs of

various stakeholders

auditing dates back as far as the

earliest human civilization

such as those in early mesopotamia egypt

and babylonia where earliest records of

documents already show signs or

indication of the audit function

like check marks dots and other symbols

being performed on them

thus ancient merchants and people those

days already perform some form of

auditing even before the term auditing

has been first used or adapted

actually the word audit came from the

latin term odere which means to hear or

to listen

hence in our human anatomy our ears

belong to what we call the auditory

system because centuries ago when common

people do not know how to read and write

yet the kings and lords have a trusted

person who listen to servants as they

describe the resources that were

entrusted to them

the king or the lord's trusted personnel

who is doing the audit function notes

any error or inconsistencies based on

what they hear from the servant or

peasants

however the concept of auditing public

expenditure and even financial

management by an independent body has

its roots in ancient greece

philosophers during that time starting

from plato started

stated rather that people running the

government should be accountable to the

resources entrusted to them and should

deport to the people who elected them on

how they exercise the power conferred

unto them

roman officials like their greek

counterpart also submit their records to

auditors when they leave their offices

during medieval and renaissance period

manorialism is the organization of rural

economy and society in medieval western

and parts of central europe where a lord

is vested with legal and economic power

supported economically from his own land

holding and taxes from the present

population under the lord's rule

these manners have some of the

sophisticated and advanced record

keeping and techniques during that

period

segregation of duties was observed and a

trusted person of the lord still resents

to the recordings of the hans by the

servants

the earliest mention of public official

in charge of the audit function

is a reference to the auditor of

extracurr in england in 1314.

while the auditors of the impressed were

established under queen elizabeth the

first in 1559 with formal responsibility

of auditing extra payments

more positions related to audit function

were formalized later on during the 17th

to 19th centuries in england

now the big break of auditing as a

profession came during the period what

we call the industrial revolution the

industrial revolution is marked with

great period of economic growth in

england

during those times to support larger

economic and divorce people started

pulling their money and resources and

management functions were passed from

the owners to professional business

managers

so this is the time where the management

is separated from the owners and thus

gave birth to companies or corporations

as we know them today

english corporations were formally

registered with the state

shareholder audits were performed by

auditors who possess little or no

independence as auditors at that time

were required to own stock in the

audited company unlike today where

auditors are required to be independent

separation or this separation of owners

from management

created an increased demand for auditors

who were engaged not only to detect

clerical errors but as well as frauds

thus auditors began to report on the

work they had to perform that it had

performed to the owners of the company

the concept of the independent auditor

was born

sampling was also developed during this

period where auditors select few

haphazard items if it's not economically

visible to examine all transactions of

an enterprise

in early 20th century

american audits and british audits in

england began to differ in terms of

audit objective

american auditors focus on reporting

actual financial condition of an entity

while british auditors focus on

detection of fraud and error

furthermore american audits supported

audit sampling while british auditors

favored detailed testing

during the period 1933 to 1940

americans started reporting as to

whether financial statements present

fairly the state of affairs of an entity

while british auditors used the more

precise true and fair view reporting

in the period 1940s to 1980s also marked

the start of world war ii which lasted

until

1945. during this period audit sampling

was now widely accepted

it was also generally accepted that the

adequacy of internal controls or

internal check could reduce the extent

of testing by external auditors

furthermore it became also increasingly

accepted by the auditing profession that

the primary objective is the provision

of opinion on the financial statements

moving forward

businesses became more complex and

computerized information systems were

being adapted by the companies so this

led to search for more efficient and

effective methods of auditing

studying and evaluation of internal

controls became a standard part of the

audit process

system-space auditing was extensively

used and statistical sampling methods

were introduced to further reduce

sampling risk

around early 70s the concept of audit

risk started to appear in professional

auditing literature

gradually auditing firms adapted the

modern auditing technology or sorry

methodology which is also known as the

risk-based audit approach so this

approach involves understanding of the

relationship among the risks involved in

audit engagement so that auditors may

properly plan and design their audit

procedures

today

risk-based audit are the standard

methodology of doing audit

now despite the improvements in auditing

profession at that time there were still

a number of accounting and corporate

scandals affecting the hunting and

auditing profession that is why

major accounting organizations sponsored

a study as to the causes of fraudulent

financial reporting and make

recommendations to reduce its incidence

it was popularly known as the treadway

commission and the result of their work

was published in a report and issued in

1987 which led to the development of an

internal control framework known as the

cause of framework or internal control

integrated framework

koso stands for committee of sponsoring

organization of the threadway commission

which is one

responsible for making the study and

issue the recommendations about internal

control

finally major changes in auditing and

accounting standards and methodology

usually occur after major accounting or

auditing failures have occurred a

classic example would be the case of

enron

an american energy company based in

houston texas in 2001.

the company succeeded in manipulating

its financial refor reports to defraud

its shareholders and creditors

eventually enron filed for bankruptcy

and its senior officers were convicted

the company's auditor at the time arthur

anderson was considered as one of the

largest accountancy firm globally with

hundreds of offices worldwide however

because of its audit blunder with enron

its professional license had been

rebooked and was not allowed to do audit

anymore after the incident

the incident also gave way to an

important u.s legislation

the sardines oxley act of 2002. also

known as the public company accounting

reform and investor act of 2002 or

simply sox

according to the american institute of

certified public accountants or aicp

sarbin's oxley act instead introduced

the first major change in the mandate of

the audit of public companies so this

new prescription focuses on auditor

assessment of internal controls which is

a very important step in the assurance

of future systems that will be modular

computerized and often outsourced

today the accounting and auditing

profession

faces an opportunity to further elevate

the audit to a higher level of

automation in this age of artificial

intelligence and big data

so therefore it is imperative that

accountants ultimately lead the way

in adapting and implementation of future

audit such that they continue to be the

professionals of choice relative to

audit engagements now and of the future