UNIT 2:LEGAL AND PROFESSIONAL REQUIREMENT►

UNIT 1 :FUNDAMENTAL CONCEPTS IN AUDITING

  • UNIT 1 :FUNDAMENTAL CONCEPTS IN AUDITING

    Key unit competence: To be able to explain the fundamental concepts 

    in auditing

    Introductory activity

    MUKESHIMANA decided to set up a business for selling flowers after S6 
    Accounting. She got up early in the morning, visited the market, and then 
    set up a stall by the side of the road. She started selling different kinds of 
    flowers. She was able to sell and gain some income from the business. For 

    the first year, everything went well.

    However, MUKESHIMANA thought that she could sell more flowers if she 
    was able to transport more to the place where she would sell them. She 
    also knew that there were several other roads nearby where she could sell 
    flowers.To achieve her ambition of selling more flowers; she needed to buy 
    a van and recruit more employees to transport flowers to different selling 

    points. 

    MUKESHIMANA realized the need for more money to expand her business. 
    Therefore, she requested her rich friend Alex to invest in the business.

    Alex found out the potential of MUKESHIMANA’s business and decided 
    to invest in it, but he did not want to be involved in the management of the 

    business and bear liablities in case of failure its failure (bankruptcy).

    He therefore suggested the following to MUKESHIMANA:
    • To establish a limited liability company;
    • To be the major shareholders (over 51%) and be entitled for more 
    dividends

    • Mukeshimana to be the managing director of the company

    At the end of the first year of trading as a limited liability company, Alex 
    received a copy of the financial statements. He noticed that the profit of 
    the company was lower than expected, and this lowered significantly his 

    dividends.

    He knew that MUKESHIMANA is being paid salary and she might not give 
    much attention to the performance of the company (making profit for the 

    company). 

    To have proper understanding of the performance of the business, there 
    was a strong need of Alex to engage the third parties to provide annual 

    assurance services on financial statements of the company. 

    Referring to the passage above, answer the following questions:

    1. How do you call the work done by the third parties appointed?
    2. What do you think about the work done by the third parties and the 
    work performed by MUKESHIMANA as managing Director?
    3. What are the advantages that Alex will obtain from the work performed 
    by the third parties?
    4. Differentiate the work of MUKESHIMANA from the work performed 

    by the third parties.

    1.1. Key terms applied in auditing 

    Learning activity 1.1

    c

    Analyze the photos above and answer the questions below:

    1. Who is the auditor?

    2. How do you call the work performed by the auditor?

    3. What are main principles of audit?


    1.1.1. Meaning of key terms

    a) Audit

    An audit is an official independent examination of the accounts or accounting 

    systems of an entity.

    Audit is defined as an independent examination of books of accounts and 
    vouchers of business with view of forming an opinion/ judgment as to whether 
    these have been kept properly according to the company’s Act and as to whether 
    or not the statements present a true and fair view of the financial position of a 

    business.

    An audit is an exercise that auditors carry out in order to be able to give the 

    statutory opinion whether financial statements give a true and fair view. 

    An audit is an independent examination and expression of an opinion on a set 

    of financial statements.

    b) Assurance

    The International Standards on Auditing (ISA) give a definition of an assurance 
    engagement as “ one in which a practitioner expresses a conclusion designed 
    to enhance the degree of confidence of the intended users other than the 
    responsible party about the outcome of the evaluation or measurement of a 

    subject matter against criteria. “

    Assurance means confidence. In an assurance engagement, an ‘assurance 
    firm’ is engaged by one party to give an opinion on a piece of information that 

    has been prepared by another party. 

    The opinion is an expression of assurance about the information that has been 
    reviewed. It gives assurance to the party that hired the assurance firm that the 

    information can be relied on.

    c) Auditor

    An auditor is a person who conducts an audit. An auditor is a person authorized 
    to examine and verify the books of account of an organization.
    An auditor is a qualified accountant appointed by the shareholders, government, 

    or management of a company to examine independently the financial information.

    d) Auditing

    Auditing may be defined as the examination of financial statements covering 
    the transactions over a period and ascertaining the financial position of an 
    organization on a certain date in order that the auditor may issue a report on 
    them. It means that the auditing is the application of auditing principles and 

    methods as may be considered as necessary by an auditor.

    e) Integrity 
    An auditor should be straightforward, honest and sincere in his/her approach to 

    his/her professional work.

    f) Objectivity
    Is not to allow bias, conflict of interest or undue influence of others to override 

    professional or business judgments

    g) Professional Independence
    The auditor is an agent/watchdog for the shareholders and must be independent 
    of directors and management who look after the interests of shareholders in a 

    company or of the government.

    The profession requires the auditor to be independent so as to be able to 
    express a balanced opinion on the accounts presented by the directors to the 

    shareholders whose company he has audited.

    h) Professional competence and due care
    To maintain professional knowledge and skils at the level required to ensure 
    that a client or employer receives competent professional services based on 
    current developments in practice, legislation and techniques and act diligently 

    in accordance with applicable techniques.

    i) Confidentiality
    The state of keeping or being kept secret or private, the auditor should not 

    disclose any information to the third party.

    j) Professional behavior
    Auditor should comply with laws and avoid any actions, which discredit the 

    profession.

    k) Planning
    Planning is the process of thinking regarding the activities required to achieve 

    a desired goal

    l) Impartiality
     Is the principle holding that decisions are based on objective evidence obtained 
    during audit, not on the basis of bias or prejudice caused by influence of different 

    interests of individuals or other involved parties.

    m) Evidence
    During the audit, the auditor can collect the evidence through the working 

    papers. He/she can surround his/her opinion on the audit evidence. 

    n) Consistency
    The consistency principle states that once you decide on an accounting method 
    or principle to use in your business, you need to stick with and follow this method 

    or principle consistently throughout your accounting periods.

    o) Legal Frame Work 
    The business activities may run within the rules and legal formalities. To protect 

    the rights of the interested party, rules must be applied/followed. 

    p) Working papers preparation
    Audit working papers are documents which contain all information gathered 
    from the company audited and show all evidences to help the auditor to prepare 

    the final report and to form his/her opinion.

    q) Internal Control 

    The auditor will examine the accounting system and internal control in operation. 

    r) Report
    Report is the end product of the external audit process or of the performed audit 

    work. 

    s) Professional skepticism
    Professional skepticism is defined in the ISAs as an attitude that includes a 
    questioning mind, being alert to conditions, which may indicate possible 

    misstatement due to error or fraud, and a critical assessment of audit evidence.

    Application activity 1.1

    1. What is the meaning of assurance in auditing?

    2. Briefly explain the following terms.

                       a. Integrity

                       b. Objectivity

    Learning activity 1.2

    1.2. Objectives, advantages and disadvantages of auditing


    1. Is it important to know the objectives of audit?

    2. What are the objectives of audit you know?

    1.2.1. Objectives of auditing

    The objectives of audit may be classified into two categories:

    a) Primary or principal objectives of auditing

    • To determine the accuracy of financial statements or accounts;
    • To prove the true and fair view of the company’s financial state of affairs;
    • To confirm that the proper books of accounts are being kept or not;
    • To prepare audit report;

    • To confirm the exactitude of final accounts.

    b) Secondary or subsidiary objectives of an auditing
    • To detect errors;
    • To detec frauds;
    • To prevent errors; 
    • To prevent frauds ;
    • To assist the client to improve their accounting systems;
    • To find out whether the internal control system is working properly or not;

    • To advice the management.

    1.2.2. Advantages and disadvantages of auditing
    a) Advantages of audit
    For the shareholders:
    • Shareholders are assured that directors and management are acting to 
    the best of their interests ;
    • They use audited accounts to determine amount to be paid to dead 
    partner;
    • They use audit report to admit a new partner by examining his/her 
    business;

    • Audit ensures that regulations and statutory requirements are followed.

    For the employees: 
    • Audit keeps accounting staff vigilant and careful in their work;
    • Employees ensure their job security and continuity of good remuneration 
    by the audited company;

    • Act as a detective and preventive measure against errors and frauds.

    For the state: 
    • Audited companies ensure the accomplishment of fiscal duties 
    regarding companies (payment of taxes and social contributions);
    • The government is assured that public funds are being well used;
    • The government ensures continuity of business for the purpose of 
    general interests of the people;
    • The state ensures that books of accounts are maintained according to 

    legal requirements and companies Act.

    For the management of an enterprise and third parties in general: 
    • Audit provides assurance and credibility to the accounts for interested 
    parties;
    • Third parties not taking active part in the organization are protected;
    • Audited accounts minimize disputes between parties;
    • Audited accounts are acceptable as the basis of ascertaining tax 
    liability;
    • The auditor promotes general management efficiency by advising 

    management.

    b) Disadvantages of auditing
    • If the auditor has many clients, planning and personnel problems lead to 
    inefficient audit, leaving errors and frauds undetected. Thus, increasing 
    auditor’s liability to third parties.
    • It is expensive and third parties may not be able to afford it.
    • The audit report provides information that may otherwise be confidential 
    to competitors.
    • A qualified report may affect the company’s credibility with third parties.
    • An audit can disrupt the client’s (audited company) work.
    • Audited figures may be altered (changed) leading to inaccurate opinion.
    • May prompt trade unions to demand for higher wages for their 
    employees e.g. in cases of unreasonable reserves.
    • An audit can lead to conflict between the internal auditor and 
    management in cases where the internal auditor co-operates with the 
    external auditor.
    • Revelations of weaknesses in the management letter or letter of 
    weaknesses may make managers to resign. Thus, leading to apathy in 

    the organization.

    Application activity 1.2

    1. Explain the advantages of audited accounts to shareholders.

    2. What are the primary or main objectives of auditing?

    1.3. Types of Audits according to the different classifications

    Learning activity 1.3

    G&P Partners is an auditing firm, registered in Rwanda to provide an audit 
    and advisory services since 2010. For the year ended 31st December 2021, 

    G&P Partners received the assignement from different clients as follows:

    1. On 05th January 2021, G&P Partners singed an engagement 
    letter with Sika Ltd for providing the audit opinion on their financial 
    statements and compliance with company’s procedures manuals, 
    rules and regulations. Sika Ltd agreed with auditor also to conduct 

    its audit in every 3 months until the end of the year. 

    2. On 20th March 2021, during the annual general meeting, Bwiza Ltd 
    appointed G&P Partners as a new auditor to conduct an audit of 

    their annual accounts. 

    3. On 01st April 2021, G&P Partners signed an engagement letter with 
    office of auditor general to conduct an audit for one of government 
    projects to evaluate whether the project objectives were attained or 
    not and to evaluate whether the transcations passed by the project 

    coordinator were made in economic, efficient and effective manner. 

    Question 

    From the above assignment received by G&P Partners, List the types of 

    audits that will be conducted.

    1.3.1. Forms of organizations

    a) Auditing of a sole proprietorship
    This is a form of audit of the accounts of a private individual or sole trader. An 
    auditor is asked to audit the accounts of a private individual or a sole trader. He/
    she must get clear instructions in writing from his/her client as to what he/she is 
    expected to do i.e. his/her duties, nature of work, scope of work etc and will be 

    clearly defined in the engagement letter. 

    Advantages of auditing of the accounts of sole trader are:
    • Assured that his/her accounts are properly kept or not;
    • Audited accounts are helpful in confirming that the profit or loss has 
    been made;
    • Sole trader agents are kept vigilant (in the case of consignment);
    • Taxes are assessed and paid very well;

    • Audited accounts are basis for obtaining bank loans and public markets.

    b) Auditing of partnership
    The scope and conduct of auditing and rights and duties of the auditors 
    are determined on the basis of the agreement between the firm and auditor 
    (engagement letter). While conducting auditing of partnership firm, the auditor 

    must also consider the partnership Deed.

    Advantages of auditing of partnership
    • Avoids any financial dispute among partners.
    • Third parties are assured that there are no frauds.
    • Helps in the valuation of goodwill of a dead partner and incoming 
    partner.
    • Expertise of audit contributes to increase profit, better management 

    and compliance with tax laws.

    Distinction between auditing of partnership firm and auditing of a 

    limited lability company


    c) Audit of limited company

    An audit of a limited liability company is an examination of the financial statements 
    of a company, such as the income statement, cash flow statement, and balance 
    sheet. Audit provides to investors and regulators the confidence in the accuracy 

    of a corporation’s financial reporting.

    During the audit of a limited liablty company, it is clarified whether the financial 

    statements are fairly presented and free from material misstatements.

    The auditor’s role is to examine annual final accounts of the company and make 

    sure they are correct and reliable but not to manage those accounts. 

    1.3.2. According to the nature of work

    a) Private Audit

    Private or voluntary audit is that audit which is not legally required. It is conducted 
    in line with the agreement between the auditor and the client (audited company), 

    and is not governed by any particular law.

    This audit is conducted to obtain an audit report for the use by different users of 
    the financial statements( management for an organization, investors, employees 

    etc...).

    The private audit includes the audit of sole trader, and audit of partnership. 
    The contract (engagemennt) between auditor and his/her clients is important 
    because: 
    • It defines the scope of audit; 
    • It is the basis of charging the audit fees;
    • It is the basis of the information to include in the report;
    • It serves as an evidence;
    • It protects both parties;
    • It prevents misunderstanding between parties;
    • It is legal binding;
    • It specifies the rights and duties of both parties;
    • It can be used to solve disputes between parties;
    • It minimizes risks;

    • It outlines expectation for both parties.

    b) Statutory Audit
    Statutory audit is the audit conducted under the provisions of the companies 

    Act.

    Similarities between statutory and private audits 
    • In both audits, the auditor’s duties and scope of work can be increased 
    by the client. 
    • In both audits, the auditor earns the audit fee.
    • Both audits are conducted at the end of the year when the records 
    have been balanced and closed off.
    • In both audits, the auditors apply similar techniques and audit tests. 
    • Both auditors might be the members of professional accountants’ body 
    like ICPAR, ACCA, and IFAC.
    • In both audits, valuable advice is provided to the client at the end of 
    audit work. 
    • Both audits are used as basis for decision-making.
    • Both safeguard company’s assets.
    • In both audits, the auditors issue audit reports. 
    • Both audits are concerned with the review of the activities of the 
    company.
    • They are concerned with the preventive measures against errors and 
    frauds.

    • They are concerned with the strength of the ICS.

    c) Internal Audit
    Internal auditing is an independent, objective assurance and consulting activity 
    designed to add value and improve an organization’s operations. It helps an 
    organization to accomplish its objectives by bringing a systematic, disciplined 
    approach to evaluate and improve the effectiveness of risk management, control, 

    and governance processes.

    The report of internal audit is used by the management for the improvement of 

    internal control system. 

    The internal auditor carries out checking work throughout the year. Although, 
    he/she is an employee of the organization, he/she is given some form of 

    independence in order to perform his/her duties as required.

    d) External Audit
    An external audit is an objective examination by an auditor to examine the 
    company’s books of accounts and determine if the company’s financial 
    statements are fair and true. An auditor also determines if the company follows 
    accounting standards and systems. An independent auditor reviews the 
    accounts and provides the reassurance and transparency to the company›s 
    shareholders about the correctness of the accounts.It makes the company and 

    its financial statements more credible and respected.

    External audit is conducted by an independent auditor who is not an employee 
    of the organization.The external auditor is appointed by owners of a business 

    andby the shareholdres in a case of a limited company.

    The main purpose of external audit is to provide an audit report on financial 
    statements audited. The audit report is used by the shareholders and third 

    parties like bank managers, creditors, and income tax authorities.

    Differences between Internal Audit and External Audit

    Differences between an internal Auditor and External Auditor



    1.3.3. According to the time 

    a) Final audit (periodic/Detailed/Complete Audits)

    It is conducted at the end of the financial period when accounts have been 

    closed off, and financial statements have been prepared and approved.

    Advantages of final Audit

    • Chances of figures being changed are minimal.
    • It is flexible as the auditor can prepare good programme to cover all 
    areas well.
    • It is very ideal for small business whose transactions are few and can 
    be audited at one sitting.
    • It is not expensive.
    • This audit does not interrupt the client’s work.
    • It eliminates notes taking which are a phenomenon of other audits.

    Disadvantages of final audit
    • The delays may occur if there is large volume of work.
    • The frauds and errors are discovered after the close of the year. 
    Sometimes, it is too late to rectify or take preventive measures.
    • As the financial periods of most of the clients end on the same date , it 

    becomes difficult for the auditor to deploy audit staff adequately.

    b) Interim Audit
    Interim audit is conducted to a particular date within the accounting period. 
    It is conducted within the accounting period usually half yearly. It is a kind of 
    audit which is conduted between the two periods or during transitional period. 
    It is aimed at assessing the company’s performance in order to pay interim 

    dividends.

    Advantages of interim audit

    • It facilitates completion of the final audit.
    • Errors and frauds can be more quickly found and detected during the 
    course of the year.
    • It is ideal for situations under which the company is required to publish 
    figures for purposes of paying interim devidend.
    • It is less expensive than continuous audits because the auditor will 
    spend less time in the company in interim audit.
    • It has a moral effect on the staff of the client in that they will be upto 

    date .

    Disadvantages of Interim audit

    • Figures already audited can be changed/altered after this audit.
    • It will interrupt the client’s work as his/her books will be taken away for 
    the purpose of audit.
    • It involves a lot of notes taking.
    • The client’s staff may develop the habits of depending upon the audit’s 
    staff to solve their accounting problems.
    • Since it is aimed at the declaration of interim dividends, the management 
    may manipulate the accounts to show more profits so as to declare 
    better dividend which will amount to a big fraud.

    • This means additional work.

    c) Continuous Audit
    It is that audit which involves detailed examination of the books of accounts at 
    regular intervals of 1, 2 or 3 months. Continuous audit is applied where:
    • Financial businesses whose transactions must be up to date to prevent 
    errors and frauds;
    • The number of transactions are too numerous to audit at the end of the 
    year;
    • There are no satisfactory internal control systems; in risky businesses 
    where decision making has to be made timely and accurately;
    • It is desired to present the accounts just after the end of the financial 
    year for example in banks;
    • The statement of accounts is required to be presented to the 
    management after every month or each quarter;

    • There is no satisfactory internal control system in operation.

    Advantages of continuous audit
    • Easy and quick discovery of errors.
    • Quick presentation of accounts.
    • Moral check on staff.
    • Keeps client’s staff regular.
    • Audit staff can be kept regular.

    • Efficient audit.

    Disdvantages of continuous audit
    • Alteration of figures.
    • Altered by dishorest clerk.
    • Dislocation of client’s work.
    • This method is expensive.

    • It involves extensive note taking so as to avoid alteration of figures.

    Distinction between continuous audit and Interim audit.

    1.3.4. According to the method of approach

    According to the method of approach ,various types of audits are:

    a) Procedural audit
    A procedural audit is an examination and review of the internal procedures and 
    records of an organization in order to ascertain their accuracy and reliability.The 
    main purpose of this audit is to ascertain whether the internal procedures are 

    reliable or not.

    Advantages of procedural audit
    • This audit will provide a feedback to the management.
    • The audit will reveal which procedures are outof dated and uneconomical 
    and which calls for replacement.
    • It will identify the strength or weakness in ICS.
    • It will reveal the management weakness in supervising the company’s 
    operations.
    • It will ensure co-ordination of the company’s operations which may 
    boost its profitability.
    • It will reveal whether procedures in accounting department are working 

    propely or not.

    Disadvantages of procedural audit 
    • It may be a very expensive audit.
    • It may be frustrated for the management.
    • It may mean duplication of effort if the same procedures are examined 
    in the final audit. 
    • This type of audit may be tedious in particular if the company has 

    numeruos procedures.

    b) Management audit
    Management audit is an independent and systematic analysis and evaluation 
    of a company’s overall activities and performance. It is a valuable tool used to 
    detremine the efficiency,functions,accomplishments and achievements of the 

    company.

    The purpose of this audit is to prepare a report on the effectiveness of the 
    management from the point of view of the profitability and efficient running of 

    the business.

    Advantages of management audit 
    • It will improve the quality of the management in the business.
    • It will identify how decisions are made in a business.
    • It will reveal the weaknesses of the management.

    • It will reveal the efficiency of budgetary system and its management.

    Disadvantages of management audit
    • It may lower the morale of top management.
    • It is not possible for the mangement and audit staff to reveal their 
    inefficiencies during the auditor’s presence and this may lead to a 

    biased report.

    c) Vouching Audit
    Vouching audit is that audit where the auditor checks each and every transaction 
    right from the origin in the books of prime entry till they are posted and the final 

    accounts are prepared from the amounts posted.

    d) Balance sheet audit
    The term balance sheet audit means verification of the value of assets,liabilities,the 
    balances of reserves and provisions and the amount of profit earned or loss 
    incurred by a business during the year.
    The balance sheet items are verified by checking the following;
    • Description
    • Ownership (recording of items)
    • Net Book Value (NBV=cost less totaldepreciation) 

    • Existence (physical existence of the asset)

    Advantages of a balance sheet audit 
    • Less expensive because it only checks the balance sheet items.
    • Results in a balanced opinion because the balance sheet contains the 
    most important items the auditor’s report is based on.

    • Chances of changing figures after the audit are minimal.

    Disadvantages of a balance sheet audit 
    • It is partial audit and not therefore suitable to limited companies.
    • It is only applicable to companies with a strong internal control system.
    • If undertaken for a limited company, it may increase the auditor’s 

    liabilities because it covers a limited area.

    e) Standard audit 
    This is a type of audit, which is conducted to ascertain whether the client 
    accounting system complies with the required levels of standards set by the 

    professional bodies. 

    These may include: 
    • Statement of standards of accounting practices (SSAP);
    • International Accounting Standards (IAS);

    • Generally Accepted Accounting Principles (GAAPs).

    1.3.5. According to the public sector’s audit
    Main Objective
    The main objective of public sector’s audit is to provide assurance to parliament, 
    the government and the public that government departments, ministries and 
    agencies are operating and accounting for their performance in accordance 

    with the Act of Parliament, the relevant regulations and public interests.

    The three main types of public sector’s audits 

    a) Financial audit

    It focuses on determining whether an entity’s financial information is presented 
    in accordance with the applicable financial reporting and regulatory framework. 

    This is accomplished by obtaining sufficient and appropriate audit evidence to 
    enable the auditor to express an opinion as to whether the financial information 

    is free from material misstatement due to fraud or error. 

    b) Performance audit 
    It focuses on whether interventions, programs and institutions are performing in 
    accordance with the principles of the economy, efficiency and effectiveness and 
    whether there is room for improvement. 

    Performance audit is executed against suitable criteria, and the causes of 

    deviations from those criteria or other problems are analyzed. 

    The aim is to answer key audit questions and to provide recommendations for 

    improvement. 

    c) Compliance audit 
    It focuses on whether a particular subject matter is in compliance with identified 
    criteria obtained from laws and regulations. Compliance auditing is performed 
    by assessing whether activities, financial transactions and information are, 
    in all material respects, in compliance with the existing laws and regulations 

    governing the audited entity.

    Application activity 1.3
    1. Explain the following types of audits according to the time factor.
     a. Final audit
     b. Interim audit
     c. Continuous audit

    2. Give the advantages and disadvantages of procedural audit.

    1.4. Investigation

    Learning activity 1.4

    Analyze the photos above and answer the follow questions: 

    1. What do you see on the image above? 

    2. Differentiate these persons according to their work

    1.4.1. The difference between auditing and investigation

    a) The meaning of investigation

    Investigation is an act that involves the examination of accounts and the use 
    of accounting procedures to discover financial irregularities and to follow the 
    movement of funds and assets in and out of organisations.
    Investigation is an inquiry commissioned by a client for some purpose. 
    Investigating is a kind of special audit with a limited or extended scope according 

    to the purpose for which it is conducted. 

    b) Difference between auditing and investigation

    1.4.2. Characteristics and reasons of investigation
    a) Characteristics of investigation
    • Investigation is an enquiry.
    • Investigation implies systematic and critical examination of accounts 
    and records of a business enterprise for a specific purpose.
    • It is conducted for a specific purpose (suspicion).
    • Its specific purpose may be evaluated of state of affairs or establishment 
    of a fact.
    • Conducted for a non-fixed period (any time) and any person (police, 

    lawyers, consultants, etc.) and describes a fact not an opinion.

    b) Reasons for investigation

    Investigation is carried out due to the following reasons:

    Purchase of a company
    When an individual is interested to purchase a business, he/she can appoint an 
    accountant of his/her choice to carry out investigation in respect of business 
    which he/she wants to purchase. The main purpose of this investigation is to 
    find out the details about this purchase. If the investigation report is in favor of 

    this business, then it can be purchased.

    Admission of a new partner
    An investigation may arise, either on behalf of a person intending to bring capital 
    in order to become a partner, or for the existing proprietors who intend to take 
    in a partner. If the investigation is arranged by the prospective partner. The main 
    purpose will be to ascertain whether to become a partner is beneficial or not. In 

    this case, investigation will be similar as in the case of a purchase of a business.

    Fusion of the companies (Acquisition of a Merger)
    Mergers mean to convert two or more business enterprises into one unit. In 
    this case, one business enterprise can acquire the assets or shares of another 
    enterprise. The most important term that must be negotiated in a merger 
    arrangement is the price the acquiring firm will pay for the acquired business. In 
    mergers or fusions, a larger firm generally takes over a small one and assumes 

    all management control. 

    Before the merger of two or more business enterprises, investigations are carried 

    out through some accountants by the firm, which intends to acquire other firms. 

    The main purpose of these investigations is to find out the details about financial 

    position of the other businesses.

    Prospecting of the investments (Prospective investment)
    Some individuals or firms might be interested to make some investments in 
    the form of shares or debentures of other companies. In order to make their 
    decisions, they want to know the details about the financial standing of those 
    companies. For this purpose, they can arrange some investigations through 

    some accountants. 

    Prospecting of a loan or investigations on request for loans (Prospective 
    lending)
    Some banks carry out some investigation before advancing loans to some 
    business enterprises. Similarly, some suppliers need independent investigation’s 

    reports before granting credit facilities to their clients. 

    Suspicion of fraud or fraud investigation (Fraud)
    Investigations are carried out on the instructions of management to detect fraud 
    if the behavior of some employee is suspicious. If the fraud is concerned only 
    with the section of the work e.g. the entry of dummy workmen on a wages sheet 
    by one clerk, the extent of the investigation should be restricted to that one 

    section. 

    On the other hand, if misapplication of cash is the result of collusion between 
    two or more employees then the investigation can be extended to various 

    sections or departments of the organization.

    Legal or statutory investigation
    Investigation conducted to satisfy some legal requirements. The following cases 
    indicate when a legal investigation can be conducted:
    • An investigation by the liquidator of a company where directors are 
    suspected of fraud regarding the affairs of the company;
    • An investigation by a trustee in a bankruptcy where the bankrupt is 

    suspected of having acted fraudulently in the past.

    c) Steps of investigation
    • Determine the scope/objectives of investigation.
    • Planning the investigation (Formulate investigation program).
    • Establishment of the fields of application (by examining or studying 
    various records).
    • Analysis and interpretation of findings/results. 
    • Preparation of the investigation’s report/writing of the investigation 

    report.

    d) Report of investigation.
    On the completion of investigation, the report is submitted to concerned parties. 
    The report submitted in respect of an investigation should cover the following 
    points:
    • Reference to instruction given by the client;
    • Reference to basic documents covering information obtained;
    • General outline of the work done;
    • Summary of information obtained;

    • Recommendations in accordance with information obtained. 

    Application activity 1.4

    1. The scope of investigation is very large than the scope of accounting.
    State some areas in which investigation should be applied.

    2. What are the steps of investigation?

    1.5. Auditing and acccounting

    Learning activity 1.5

    1. Observe carefully the pictures above and establish the difference 

    among them.

    1.5.1. Difference between auditing and accounting

    1.5.2. Benefits and limitations of an audit

    a) Benefits of an audit
    • The shareholders of a company are given an independent opinion as 
    to the true and fair view of the accounts that have been prepared by 

    management. 

    • The use made by third parties such as suppliers and banks adds 
    confidence in the performance of a company. 
    • While not responsible for detecting fraud, the very fact that an audit 
    is carried out and may uncover evidence of fraud, can help to mitigate 

    against such risks. 

    b) Limitations of an audit
    • Every item is not checked. In fact, only test checks are carried out by 
    auditors. 
    • Auditors depend on representations from management and staff. 
    • Evidence gathered is persuasive rather than conclusive. 
    • Auditing is not purely an objective exercise. Judgments have to be 
    made in a number of areas. 
    • The timing of an audit. 
    • An unqualified audit opinion is not a guarantee of a company’s future 
    viability, the effectiveness and efficiency of management, nor that fraud 

    has not occurred in the company. 

    Application activity 1.5

    1. You are a shareholder in AKARABO Co.Ltd. What are the benefits 
    could you get from an audit?

    2. Explain the limitations of an audit

    Skills lab activity 1
    Using two learning groups, one being as an accountant and another as 
    an auditor. Students visit library and pairs exchange roles as the teacher 
    supports accordingly. Let students present their views on the similarities 

    between auditing and accounting.

    End unit 1 assessment
    1. Write short notes on the following:
    a. Statutory Audit
    b. Private Audit
    c. Interim Audit
    2. Explain the term continuous audit and outline its advantages and 
    disadvantages.
    3. What are the types of audits according to the time factor?
    4. Give the difference between Auditing and Accounting
    5. Explain the following principles of auditing:
    a. Objectivity
    b. Professional Independence
    6. What are the elements of an investigation report?

    UNIT 2:LEGAL AND PROFESSIONAL REQUIREMENT►