Assumptions of auditing

Assumptions (theoreticians sometimes call them postulates) are the
foundations of theory. Think back to your early studies of economic
theories which only ‘work’ if you make certain assumptions (for
example, the model for perfect competition assumes that consumers
aim to maximise utility and producers aim to maximise profits). If these
assumptions do not hold, the model fails. Let us now consider Flint’s seven
assumptions.

Assumption 1: There is a need for an audit based on a relationship of
accountability

The need could be based on a situation where one party owes a duty of
acceptable conduct to another or an audit has been imposed by one party
on another (for example, companies, government, charities).
In other situations, the need for an audit may come about because one
party wishes to establish the reliability and credibility of information for
which they are responsible and which will be used by another party; a
‘voluntary audit’ (for example, partnerships, companies which engage
environmental auditors, newspapers that have their circulation figures
audited).
In still other situations, the public interest in the proper and adequate
performance of some party may require an audit; this is sometimes
referred to as a ‘public interest audit’ (for example, academic audits
designed to test the robustness of the systems employed by educational
establishments in delivering services to their students).

Assumption 2: The subject matter is too remote, too complex or too
important to accept without an audit

Remoteness: those relying on information may not physically be able to
check the validity of the information themselves, perhaps because they are
remote from the company.
Complexity: the nature of the subject is so complex that it requires
special expertise to investigate and check. For example, most ordinary
shareholders do not possess sufficient accounting knowledge and skills to
be able to conduct the audit themselves.
Significance: the matter under audit has such economic significance
that an audit is required to lend it credibility. Note in contrast that
unincorporated entities are often not required to have an audit, because
lenders have recourse to the assets of the owners in the event that the
business entity cannot meet its liabilities.

Assumption 3: An audit must be conducted with independence and
without constraints either over conduct or in reporting findings

If an audit is to add credibility then it must be done independently,
without bias or prejudice. A prime example is that of state auditors, who
since the time of Aristotle have had to be independent of the government
which they are auditing. In the words of Emile Woolf, for many years
a leading authority on auditing matters: ‘The auditor who has lost his
independence has lost his raison d’être; he has become ‘dependent’, and a
dependent auditor is a contradiction in terms’ (Woolf, 1997, p.349).
The independence of auditors has been called into question once again
following the banking crisis. Inquiries into the current state of auditing
have caused politicians in the UK and elsewhere to ask tough questions
of the auditing firms which not only audited the banks but also provided
them with other professional services which earned the firms large fees. In
addition, other links between clients and auditors have cast doubt on the
objectivity of the latter, for example, when senior staff leave an audit firm
and join an audit client.

Assumption 4: The subject matter of an audit can be verified by
collection of evidence

Auditors report the results of their investigations. Without evidence
they have nothing on which to base their report, to make judgements or
criticisms. An audit is impossible if evidence is not available or cannot be
obtained. In practice, audit evidence comes from many sources. It varies in
its persuasiveness depending on quantity collected and quality (source).

Assumption 5: Standards of accountability, performance, etc., can be
set and actual performance can be measured against these standards

Parties to an accountability relationship must agree on what is acceptable
performance. Without this, auditors have nothing to go by. They cannot
set their own standards since these may be rejected by either party. In
company auditing some of these standards have been set down (by statute
or by professional guidance), but grey areas still remain. What constitutes
a ‘true and fair view’? What should auditors do when they discover a client
has committed an illegal act?

Assumption 6: The purpose of the audit is sufficiently clear that its
results can be communicated clearly

The purpose of an audit is to add value to information. If the nature or
purpose of the information itself is not clear, it cannot be audited. If the
audit findings cannot be communicated effectively then inevitably the
value of the audit will be diminished. Over the years a lot of debate has taken place over the contents of the
auditors’ report. Starting in the late 1980s we began to see an expansion
of the auditors’ report which had been a simple statement of one or two
paragraphs into a document that covered two or more pages with many
more items being covered within. Since the global financial crisis of 2008,
the audit regulators around the world have been moving towards further
radical changes in order to grapple more successfully with the problem of
better communicating the messages which auditors are trying to convey to
interested parties (this topic will be covered in more detail later).

Assumption 7: An audit produces an economic or social benefit
Since audit is a social control mechanism it should only be undertaken

if the benefits outweigh the costs. Auditors are expected to provide the
benefit at minimum cost. In most audit situations the major part of the
work involves the collection of evidence. While a minimum level of
confidence must be achieved, absolute certainty is unattainable. There is
a point at which the marginal benefit of obtaining additional evidence is
exceeded by the marginal cost. The direct costs of auditing are known but
the benefits are not so easily measured.

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