Company audit to move to new gold standard based on beliefs

8 November 2009

Auditors in the 21st Century should form their judgements on company accounts by "attacking the problem from many different angles," a recent Deakin University Colloquium in Auditing and Governance was told.

Professor Timothy Bell, former director at KPMG and Coggin Distinguished Professor of Accounting, University of North Florida said "triangulating evidence from a variety of sources will improve the quality of auditing and increase investors' confidence in the reliability of annual report information".

"Auditing has firmly evolved from its early beginnings when the manager owned the business," he said. "In those days the auditor would inspect every transaction included in the company's accounting records and 'test' whether amounts were recorded in the right accounts and whether the arithmetic was accurate. These clerical 'tests of details' were designed to detect bookkeeper fraud and error for the benefit of the owner-manager."

Professor Bell said the growth in the number of outside investors, and the separation of ownership rights from management control over company assets and operations precipitated a change in the purpose of the audit.

"The purpose of the audit changed from prevention and detection of bookkeeper fraud and error for the benefit of the owner-manager to assessment of the veracity of representations made by management to outside stakeholders about the state of the business," he said.

"Also, as companies grew larger and more complex it became prohibitively costly to audit every company transaction."

Professor Bell said as a result risk assessment methods emerged to help guide the auditor's strategic selection and testing of samples of accounting details pertaining to high risk transactions and accounts."

"Once judgments were made about which records should be tested and what should be the sample sizes for testing purposes, the auditors' work continued to focus primarily on clerical tests of details confined to the company records," he said.

Professor Bell said the profession is moving forward again.

"Auditors need to recognise that today's audit is less about testing the clerical accuracy of the details contained in company accounts, and more about assessment of the risk that management's representations to stakeholders are faithful representations of the true state of the business ," he said.

"Auditors must be able to demonstrate to others why and how their risk assessments rest on beliefs that are justified."

Professor Bell said the 21st century auditor needs to triangulate evidence from a range of sources including analytical business models, industry analyses, and key performance measures on the company's critical success factors.

Auditors would also examine the business controls designed to mitigate significant business risks, as well as the documentation in the company records, to assess whether management assertions have been distorted intentionally to deceive outside stakeholders.

"We are moving away from the test of details being the gold standard," he said. "Society has said 'no, I want you to look and go outside of the company records and develop your own beliefs about the state of the business and compare your beliefs to management's representations'.

"The new gold standard will be sufficiently well-justified beliefs – beliefs which have been based on sufficient and appropriate evidence obtained from probing the problem from many angles, following up and resolving satisfactorily any suspicions arising from differences between your beliefs and management's representations, and ensuring that you can demonstrate to others why and how your beliefs are justified."


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