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Auditing and Accounting Information SystemsLecture 1
Introduction
Warren Buffett talked about leadership for a group of CEOs. The first thing he talked about is the
importance of accounting. He said that accounting is the most important thing to learn before
getting into business. Accounting is the language of business and you can’t understand business
unless you understand accounting. When you invest you need to understand the accounting part of
the firms. Annual reports and other accounting reports tell you everything you need to know about a
business and about the people running the business. Sometimes there are CEOs that really don’t
understand accounting and get scared when someone asks them about a balance sheet or an income
statement and they have to count on someone else for these decisions. Warren Buffett makes all his
acquisition decisions himself with his knowledge without counting on anyone else. It is his
responsibility to make acquisition decisions based on the numbers he sees and understands.
What is accounting?
Definition:
Accounting is the process of identifying, measuring and communicating economic information to
permit informed judgements and decisions by users of the information.
The environment within which accounting exists is known as accounting information system.
Accounting is an information-providing activity, so accountants need to understand:
- How the system that provides that information is designed, implemented and used;
- How financial information is reported, and
- How information is used to make decisions.
The accounting system:
In this overview we see that everything in a business starts with a transaction, for example a
purchase, which needs to be recorded in some way in a system to keep track of what is happening in
the business. This information from the system is then used for example by stakeholders, by
,investors, by the firm management to make decisions. This whole picture is accounting, the
definition of accounting is therefore very broad. The auditions are only the ones doing a check on
whether the information on the system is actually reliable. This is the part on which we will focus.
Example:
- Transaction: sale of a pair of shoes;
- Accounting Information System: record the transaction;
- Firm management: ‘how many pairs sold in location X and Y? Do we need to close down a
location?’;
- Auditor: ‘was the transaction recorded correctly? How did the business make sure that the
transaction is recorded correctly?’ – they make sure that people can rely on this information;
- Stakeholders: ‘is the business making a profit? What is this business’s market share?’
So in this course we assume that we already have the numbers of the financial statements, we focus
on where they come from and who will use those numbers.
In this course, we focus on Auditing and Accounting Information Systems. We want the information
in the system to be as precise as possible and the auditors plays a very big role in making sure that
this information is correct. Otherwise we can run into problems. An example is Wirecard, a fraud
case, in which the managers put money into their own bank accounts. The auditors should have
noticed that, in this case. But the auditors cannot check everything. Now there is a court case going
on. The auditor of this big German company was EY, the question is whether they knew, whether
they were involved in the fraud or why they didn’t detect the fraud. This imbers are correct, but if
they are not, the auditors can be held liable for it. So it is crucial for comps because if EY didn’t follow
the right procedure, they can also be held partially responsible for this fraud. So we see that the
auditors have some degree of responsibility: they have to check that the nuanies that their
information systems are working correctly so that the problems with the systems can be avoided.
The nature of auditing
We have audit because we have companies. Companies are very important in our lives, they create
products and deliver services, as well as providing jobs. These companies have to obey rules.
Companies are guided by human beings, who sometimes make mistakes, which can arise
intentionally or as a result of a process not carried out the way it was supposed to be.
Sometimes not everything goes smoothly as a result of human interaction. So we have audits
because companies have to follow rules, and this process sometimes doesn’t go as smoothly as it
should. The auditors are there to check whether companies are following all the rules they have to
follow.
Definition:
Auditing is a process in which a business requests an audit firm to examine its accounting records
and certify whether the numbers reported in the financial statements are accurate.
So through the auditing report, the auditors contribute to guaranteeing that people can rely on these
numbers: they provide credibility to this information.
A problem arises if the auditors are paid by the management: the more the management pays the
more the auditors will overlook the problems with the reports. An auditing firm is at the end of the
day just a business, which wants to make a profit. This is sometimes the point in which things go
,wrong. This is a point of public discussion, some people think that perhaps the government should
deal with this.
Auditing is about checking the information in the accounting information systems and the
information systems itself and verify whether this is reliable. They check the AIS because if these
systems are reliable, then all the information in it should also be reliable.
Big companies are forced to have an auditor, for public interest. But smaller companies are not
forced to.
If you look at the annual report of a company, you can read very clearly which parties have
responsibilities when reporting numbers. In the report of management of for example Coca Cola, you
see that the management of the company is responsible for the preparation and integrity of the
consolidated financial statements appearing in the annual report. They also claim that the
management is also responsible for establishing and maintaining a system of internal controls (in the
company, they control their accounting information systems to try and avoid risk and problems in the
company). So the management is responsible for the financial statements and to make sure that the
information systems runs smoothly. Then it is up to the auditors to check.
All these statements have to be signed: these parties sign so if they don’t keep their word, they can
also be held personally liable for any breach.
In the organization, there are several parties involved:
1. The management: prepares and presents the financial statements, designs, implements and
maintains internal control over the financial reporting and provides information (both on
financial statements and internal controls) to auditors
2. Internal audit function: that gives assurance on internal control to managers and audit
committee
3. Audit committee: subcommittee of the board of director, oversees the managers and
internal audit and hires external auditor
These three parties interact with
4. External auditor: provides independent audit of internal control and financial statements.
They make sure that the information is reliable also for investors.
Formal definition:
An Audit is a systematic process of objectively obtaining and evaluating evidence regarding
assertions about economic actions and events, to ascertain the degree of correspondence between
these assertions and establish criteria*, and communicating the results to interested users.
*They make sure there is correspondence between the rules and the numbers of the firm.
The first part of the definition refers to the assurance role of the audit (add credibility to some
information) and the second part refers to the reporting role of auditing (audit report, which is added
to the annual report).
Auditors can have different functions:
Assurance role of Audit
, Auditors can have an important audit function: they give credibility to the financial statements (they
check balance sheet, income statements and make sure that investors can rely on this information).
An example is Deloitte. But they also do attestation services, so they make an official statements but
not about financial statements. For example they can make a statement about future projections.
This information may not be legally mandated, for example corporate social responsibility. The
auditors can make a statement on whether they think this information is reliable.
Lastly, they can have assurance services, so auditors add credibility to any kind of information. So the
auditors are there to improve the quality of the information that is shared.
[Assurance service is something we can all do, for example by writing reviews and giving ratings.
Auditors do it in a more professional level].
Information role of Auditing
Auditing has a very important information role. It improves the quality of financial information.
Making sure that the information is credible has two consequences:
1. Reducing risk (risk-return trade off)
2. Improving decision making (noise-reduction)
For example, an auditor can solve information problems by providing valuable information about a
borrowing firm to a lending bank, potentially lowering the monitoring costs of debtholders (Jensen
and Meckling, 1976).
Pittman and Fortin (2004) say that young companies (facing strong information problems) with a high
quality auditor pay significantly lower interest rates, as opposed to companies with low quality
auditors.
Insurance role of Auditing
Auditors provide reasonable assurance about the accuracy of the financial statements of a company.
Users, such as investors, rely on these audited firm statements to make their decisions.
For example, if a material mis-statement is identified in financial statements and it is proven that it is
due to auditors having worked negligently, the users of the information can sue the auditors to
recover their losses.
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