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Basic Postulates of Auditing structure

HI, Today we talk about audit postulate. Mautz and Sharaf presented an interesting idea about the postulates of auditing. In their study, they stated Basic Postulates of Auditing structure. My generalization about the postulates is as follows:
In my opinion, the postulates were valid in 1961. This was because Mautz and Sharaf carefully conducted a study and experimented with the nature and activities of auditing before they came up with the postulates. They were pioneering philosophers and experts in the auditing field. They did use their best judgment to arrive at the postulates that were best fitted to their existing environment and situation. Therefore, I believe the postulates were sufficient to support all audit theories and satisfied the needs of the auditing field at that time.

 The first postulate, which is “financial statements and financial data are verifiable”, is still valid because there is a need for financial statements and financial data’s audit. The Securities and Exchange Commission (SEC) requires public companies to have their financial statements examined by a registered public accounting firm annually. Financial statement users rely on the financial statements to measure the results of management’s performance. They rely on auditors to assure them that the financial data in the statements is unbiased, the transactions have been properly accounted for, and all relevant information has been disclosed so that their informed decisions can be made. The auditor’s opinions give investors, creditors, and other users confidence in the accuracy of financial data. Today, financial statements and financial data are still verifiable through auditors expertise in technical accounting, auditing, and knowledge of the business. Current audit practices and standards reflect a belief in this postulate through the uses of audit programs.

Basic Postulates of Auditing structure

Basic Postulates of Auditing structure

The second postulate, which is “there is no necessary conflict of interest between the auditor and the management of the enterprise under audit“, is not valid today. Recently, there are many cases that show the evidence of management’s influences on auditors works. For example, Arthur Anderson audited Waste Management’s 1993 financial statements. The engagement team proposed adjusting journal entries for $128 million misstatements, but Waste Management refused to record the adjusting journal entries and refused to correct the inappropriate accounting practices and other misstatements. Another example, the PricewaterhouseCoopers audit team for Tyco International recommended Tyco to disclose the existence of non-interest-bearing loans in the periodic reports. However, the management refused to make the disclosure and said that the loans were not material to Tyco’s financial statements. A study conducted by Koh and Woo (2001) reported that the self-interests of auditors and managers are not expected to coincide, and an audit expectation gap between the two groups can be expected. These show that management, especially big clients management, tend to be less cooperative with the auditors and there is the possibility of a necessary conflict of interest between them. As a result, current audit practices and standards do not reflect a belief in this postulate.

The third postulate, which is “the financial statements and other information submitted for verification is free from collusive and other unusual irregularities“, is certainly invalid. The Enron, Worldcom, Sunbeam, Waste Management, Polaroid, Tyco, and other fraudulent financial reporting cases can challenge this postulate. Certain items on a firm’s financial statements appear to be vulnerable to fraud. Examples are the failure to record loss contingencies and asset write-offs, the manipulation of acquisition reserves, the shifting of costs to improve current operating results, and the recognition of fictitious revenue. Therefore, current audit practices and standards do not reflect a belief in this postulate.

The fourth postulate, “the existence of a satisfactory system of internal control eliminates the probability of irregularities“, is not valid because the existence of a good system of internal control does not guarantee its effectiveness. The internal control usually has inherent limitations that management can override controls. Therefore, the existence of a good internal control system does not eliminate the probability of irregularities. Current audit practices and standards do not reflect the belief in this postulate.

The fifth postulate, “consistent application of generally accepted principles of accounting results in the fair presentation of financial position and the results of operations”, is valid. This is because the Generally Accepted Accounting Principles (GAAP) is a common set of standards and procedures that are generally accepted and universally practiced. Although GAAP has provoked both debate and criticism, most members of the financial community recognized them as the standard that over time have proven to be most useful. Most importantly, the SEC has affirmed its support for the GAAP and required its registrants to adhere to GAAP. Current audit practices and standards reflect a belief in this postulate.

The sixth postulate, “in the absence of clear evidence to the contrary, what has held true in the past for the enterprise under examination will hold true in the future”, is not valid. This is because there is a danger of relying too heavily on the previous audit work. For example, an organization that had a strong control environment in one year may be significantly different in the next year under new management. Current audit practices and standards do not reflect a belief in this postulate.

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