Text 10. The Auditing Framework

When the independent auditor begins an audit assignment, he assumes that the internal control system of the enterprise is appropriate and effective; generally accepted accounting principles have been applied in all accounting processes underlying the financial statements; the generally accepted accounting principles utilized have been applied consistently between the current and the prior periods; and there is an adequate amount of informative financial disclosure in the financial statements and footnotes. Evidence gathering and its evaluation enable the auditors to reject or confirm these a priori assumptions. We are thus in a position to define auditing.

 Auditing

The analytical process of gathering sufficient evidential matter on a test or sampling basis to enable a competent professional to express an opinion as to whether a given set of financial statements meets established standards of financial reporting.

Now we can enumerate the major steps of the auditing process: become acquainted with the firm - its environment and its accounting, personnel, production, marketing, and the other systems: review and evaluate the management and the accounting control system in operation; gather evidential matter on the integrity of the system; gather further evidence related to the representations made in the financial statements; and formulate a judgment opinion on the basis of the evidence available.

Getting acquainted

Auditing is an analytical process applied to everyday business situations. Hence it is closely related to existing business practices. Without firsthand knowledge of the nature of these practices and their larger setting, the auditor would have to rely exclusively on available financial data. This would jeopardize both audit efficiency and effectiveness. Therefore a getting-acquainted phase (which usually includes s visit to a client's facilities and certain analytical preliminary tests and inquiries) initiates the typical audit process. While "getting-acquainted" preliminaries to the conduct of an audit are standard procedures today, they were quite novel prior to 1965. Initially such procedures were described as the "'business approach to auditing".

Control system review

The auditor's evaluation of the control systems operating within the enterprise has a direct influence on the scope of the examination he undertakes and the nature of the tests he conducts. However, even though preliminary evaluation of control system is an essential ingredient of planning the audit scope, we must remember that eventually both the system and the data it produces are covered by the audit process.

Example

The Brothers Three Shopping Center has leased space to Mr. Hines, who operates a quality restaurant named The Duncan Inn located within it. Lease payments are based on a minimum monthly amount sufficient to cover taxes and insurance on the building plus a graduated percentage of the restaurant's gross sales to diners and bar patrons. No percentage payments are due on catering services.

Bar and restaurants receipts of The Duncan Inn are collected in cash and from credit card billing. A select few patrons have the privilege of open credit with monthly billings.

In planning the initial audit of the Duncan Inn's financial statement a CPA finds that virtually no internal control exists over cash bar receipts. Hence tests covering cash bar receipts are scheduled more comprehensively than those extending to credit card sales.

Evidential matter

Evidential matter supporting financial statements consists of the underlying accounting data and all corroborating information available to the auditor. The auditor tests underlying accounting data by analysis and review, retracing some of the procedural steps followed in the original accounting process and reconciling the events with the information reported.

The auditor's evidential material is the result of tests, selected observations, and statistical sampling where large compilations of data are involved. The auditor must always balance the natural desire for more evidential matter to support an opinion against the costliness and social usefulness of completely reconstructing the underlying data and processes that produced the financial statements. One key justification for independent audits, as we have seen, is the economy that results from producing expert opinion-based judgments from limited but reliable evidential matter.

Example

Among tests covering cash bar receipts of The Duncan Inn, the CPA determined what the expected average ratios should be between liquor used, average number of individual drinks per bottle of liquor, and the price structure of drinks served. Making appropriate allowances for credit card sales, the CPA was then able to make a reasonable estimate of cash bar receipts for the period under audit. The estimate of the cash bar receipts constitutes evidential matter for purposes of the audit. (Note that the foregoing test has physical and financial dimensions. A purely financial test would be to subtract cash restaurant receipts from total bank deposits to arrive at cash bar receipts. In an actual engagement, an auditor might have undertaken both types of tests.)

 

Exercise 70 . Translate into Ukrainian the following word combinations from the text. Make up your own sentences with them.

Independent auditor, generally accepted accounting principles, to reject or confirm these priori assumptions, the analytical process of gathering sufficient evidential matter, on a test or sampling basis, a competent professional, to express an opinion, to meet established standards of financial reporting, to gather evidential matter on the integrity of the system, to formulate a judgment opinion on the basis of the evidence available, to rely exclusively on available financial audit process, to have a direct influence on the scope of the examination, preliminary evaluation of control system, to be covered by the audit process, to have the privilege of open credit with monthly billings, to consist of the underlying accounting data and corroborating information, key justification for independent audits, the estimate of the cash bar receipts.

 

Exercise 71 . Say whether the following statements are true or false according to the text.

1. The auditor does not assume that the company is regulating its own finances. 2. The auditor assumes that a company is observing all standard accounting procedures. 3. The auditor accepts that a company may use different assumption over time. 4. The auditor will believe, before an audit, that all necessary company information has been supplied.

 

Exercise 72. Looking at both sections of the example in the text, answer the following questions.

1. What are the two elements involved in Mr. Hines's lease payments? 2. Which element of the restaurant's income is not subject to satisfactory internal controls? 3. In what two ways could the auditor deal with the problem?

 

Exercise 73 . Find in the text and translate all sentences with Participles; analyze the Participles; define their functions (an attribute; adverbial modifier, part of a compound verbal predicate).

 

Exercise 74 . Sum up what the text says about the auditing framework.

Exercise 75. Read the text, divide it into the paragraphs and give the title to each of them.

Text 11. Auditing

The profession of the auditor is considered to be one of the most presti­gious and well-paid ones. Auditors are accountants who analyze financial state­ments of the company and their responsibility is to express an opinion as to whether the accuracy of the company's financial reporting meets the require­ments imposed by the government. In general, auditors deal more with oper­ating efficiency and managerial effectiveness than with the accuracy of the accounting data.

 Internal auditors are known to be hired by the company in order to help to identify accounting weakness and correct them before significant errors occur. They are often analytically minded people who make flowcharts of accounting systems and evaluate these flowcharts to suggest improvements in division of labour, paper flow, cash control, or other accounting respon­sibilities.

Independent auditors are employed by a company's board of directors to supply the stockholders with the results of checking the financial statements, in order to prove that annual reports are fair representations of the financial position of the company. Performing his work the auditor should follow sev­eral principles and assumptions: the company's accounts must represent a true financial position; generally accepted accounting principles have been used at all accounting steps and accounts can be compared with those of sim­ilar companies; the proper amount of information is disclosed in the finan­cial statements. As a result, the auditor's opinion should be based only on facts and it must be objective. Auditors are expected to maintain a relation­ship of strict independence and professionalism with the companies for whom they work, so they mustn't hold shares in these companies. On the one hand, the auditor should respect the client's confidence, so having access to some private information, the auditor must not spread it outside. On the other hand, he should think of public interests, that is why he must publish his opinion in a standard form and the information is to be clear to the stockholders. But he must always carry out his duties under the law and inform authorities about fraud.

 

Exercise 76. Answer the following questions on text 11.

1. What is the difference between internal and external auditors?   2. What main concepts should be considered by the auditor? 3. Why is it necessary to receive an independent auditor's opinion?

Exercise 77 . Translate into Ukrainian:

to be one of the most prestigious and well-paid professions; to meet the requirements imposed by the government; the accuracy of the company’s financial reporting; to deal with operating efficiency and managerial effectiveness; to deal with the accuracy of the accounting data; to help to identify accounting weakness and correct them before significant errors occur; to be analytically minded people; to make flow charts of accounting systems; to supply the stockholders with the results of checking the financial statements; to be fair representations of financial position of the company; to maintain a relationship of strict independence and professionalism with the companies for whom they work; to respect client’s confidence; to have access to some private information.

 

Exercise 78. Name the following definitions.

A person who officially examines the accounts of a company, a person who performs an audit; the state of being correct or exact and without error especially as a result of careful effort; a thing done wrongly, a mistake; a person or an organization that owns stocks and shares; a thing that is thought to be true or certain to happen, but is not proved; the skill or qualities required or expected of members of a profession; the action or an instance of deceiving smb in order to make money or obtain goods illegally; a feeling or belief that one can firmly trust or rely on smb or smb’s ability or smth that is said or reported.

 

Exercise 79 . Complete the following sentences using the text.

1. The profession of the auditor is …. 2. Auditors responsibility is …. 3. Internal auditors are known ….  4. Independent auditors are …. 5. The auditor should follow several principles and assumptions …. 6. As a result, the auditor’s opinion should be based only on …. 7. On the one hand, the auditor should respect the client’s confidence, so …. 8. On the other hand, the auditor should think of public interests, that is why he must …. 9. But he must always ….

Exercise 80 . Find in the text the sentences with Infinitive Subjective Construction (Complex Subject). Translate them into Ukrainian.

Exercise 81. Learn the following words and word combinations.

fixed assets	– основні фонди (капітал)
matching convention	– збалансована угода
to write off	– повністю списувати
gradual	– послідовний
depreciation charge	– сума нарахованого зношування
to compute	– підраховувати
historic cost	– початкова вартість
current value	– поточна вартість
scrap value	– вартість брухту
residual value	– залишкова вартість (ліквідаційна)
inherent	– притаманний, невід’ємний
physical wear	– фізичне зношення
obsolescence	– старіння, зношування
straight-line method of depreciation	– прямолінійний метод амортизації
accelerated depreciation	– прискорений метод амортизації
annuity method	– метод ануітету при нарахуванні зношування (амортизації)
the Sum of the Years’ Digits Method	– кумулятивний метод
the Reducing Balance Method	– метод зменшення балансової вартості

 

Exercise 82. Read, translate and give the gist of text 12.

 

Text 12. Methods of Depreciation

By definition, fixed assets are those which will provide services over a number of years and the matching convention tells us that we should recognize the expense in the same period as we recognize the associated revenue. Thus we must not write off, or expense, the whole cost of the asset in the period in which the asset is acquired, but should instead convert the asset into an expense over its life. This gradual conversion is known as depreciation.

How should we compute the depreciation charge for each year? An obvious way would be to compare the current value of an asset at the end of the year with its value at the start of the year and say that the difference is depreciation. But as we have already emphasized, traditional accounting practice is based on historic cost and not current values; consequently that method is generally not acceptable. The traditional approach is to estimate the total expenditure to be written off, i.e. the cost of the asset less its estimated scrap value, and then to write off that expenditure over the estimated life of the asset by using one of the methods that we shall describe.

It would be helpful to look at a simple example. If a firm purchased a machine on 1 January 199X for $22,000, which is expected to last for four years and then be sold for $2,000:

Cost	$22,000
Estimated residual value	$ 2,000
Amount to be written off over 4 years	$20,000

The life of the asset is usually measured in time, but in some instances may be measured on the basis of actual usage.

Depreciation on the basis of “actual usage” is rare.

In order to consider the difficulties inherent in estimating the life of an asset we should think about the reasons why most fixed assets, other than land, have a limited life. These reasons may be classified as physical wear and rear, and obsolescence. Obsolescence may be of the asset itself, e.g. a new machine may make the use of the original asset, an older machine, uneconomic because the new machine is faster or requires less labour. Obsolescence may also be caused by the object produced by the asset, if, for example, it goes out of fashion. In the latter case, the degree of obsolescence will depend on the specific nature of the asset; some assets may be easily adapted to alternative uses while others may have only one use the original.

None of the above variables can be determined with any accuracy: obsolescence, in particular, is rapidly increasing in importance because of rapid changes in technology.

Deciding how much should be written off and over what period is not the only problem, for there are a number of depreciation methods from which to choose. A firm's management must decide which one to employ, and a user of financial statements who wishes to compare the financial performance of a number of companies must appreciate the effects of the various methods.

In practice we find two main methods of depreciation – the straight-line basis and accelerated depreciation. There is another method, the annuity method which takes account of the interest costs.

Exercise 83 . Translate into Ukrainian.

Fixed assets, to provide services, to recognize the expense, to recognize the associated revenue, to write off, to convert the asset into an expense, gradual conversion, depreciation, to compute the depreciation charge, current value, to be based on historic cost, consequently, to be generally acceptable, scrap value, estimated residual value, actual usage, inherent, physical wear, obsolescence, to require less labour, to go out of fashion, to be easily adapted to alternative uses, accuracy, the straight-line depreciation, accelerated depreciation, annuity method of depreciation, per annum, the Sum of the Years’ Digits Method, the Reducing Balance Method, digit, net amount.

Exercise 84. Say whether the following statements are true or false according to the text 12.

1. The cost of an asset is usually written off over a period of time.

2. Depreciation is never calculated on the basis of how much an asset is used.

 

Exercise 85 . Complete these sentences about obsolescence using only information contained in the text.

1. Obsolescence is one of the reasons why … . 2. Obsolescence can be caused either … because or because … . 3. … decides how obsolescent a change in fashion for its product makes it.

 

Exercise 86. Put each word into one of the sentences below, using the correct grammatical form.

Convention, associated, compute, scrap, residual, inherent, determined, appreciate, takes account of, accumulated.

1. Usually obsolescent machinery has to be ….. . 2. Trying to … future costs at a time of growing inflation is difficult. 3. Rules which are generally followed but are not obligatory are … . 4. Given their shortage of foreign exchange, there are … difficulties in trading with Eastern Europe. 5. … the taxes of self-employed workers can be very complex. 6. Any sensible system of taxation must … the need to encourage business enterprise. 7. The difficulties of exporting are sometimes not … by companies wishing to expand. 8. Together with the income produced by a new product there are … costs. 9. Owing to its inefficient management, the company … debts of $10,000,000 up to now. 10 After a company has paid a dividend there is a … amount known as retained profits.

 

Exercise 87 . Discuss the text “Method of Depreciation” with your partner using the following questions.

1. How many methods of calculating depreciation are there?

2. What are the two accelerated methods of depreciating assets?

 

Exercise 88. Learn the following words and word combinations.

rational	– раціональний, розумний, доцільний
depreciation	– зношування, амортизація, зниження вартості
physical depreciation	– фізичне зношування
moral depreciation	– моральне зношування
deterioration	– псування, пошкодження, зношення
wear out	– зношувати, виснажувати
obsolete	– застарілий
up-to date	– останній, сучасний
means of production	– засоби виробництва
obsolescence	– старіння, спрацювання
commodity	– товар, предмет споживання, продукт
go out of fashion	– виходити з моди
rust	– іржа
decadence	– занепад
erosion	– ерозія

Exercise 89. Read, translate and give the gist of text 13.

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