1 Introduction
This research paper discusses the history of financial auditing. Studies indicate that financial auditing has been evolving through many stages. In the 18th century, the practice of financial auditing was a traditional conformance to the role of auditing. It is clear that the auditing paradigm has been changing and will continue shifting into the future. Financial auditing originated from checking procedures in ancient civilizations such as Greece, Egypt and China. The industrial revolution period established the role of financial auditing. The Institute of Certified Public Accountants in America and The SEC (Securities Exchange Commission) play a critical role in financial auditing standards. After the formation of AICPA, it provided members with leadership; resources and information that helped them to offer professional services to the public (Rutherford, 2014). The SEC carried out the task of promulgating the accounting and auditing standards. The SEC oversaw the auditors' activities. The SEC fulfilled its mandate by ensuring that Public Companies submit their yearly reports in a timely manner. The Act Sarbanes –Oxley act demonstrates that internal control systems and the quality of financial reports were the duties of financial auditors and managers. The Act explains that internal control policies and the quality of financial reports were the duties of financial auditors and managers (Edwards, 2013). Part one of this report shows earliest references to financial auditing (before 1840).Part two of this report discusses financial auditing in 1840s-1930s (The Industrial Revolution). The third part discusses financial auditing in 1930s-1960s. The fourth section presents the 1933 and 1934 Securities Acts. The fifth section discusses financial auditing in 1970s-1990s. The sixth Part discusses financial auditing in 1990-2013. The last part presents the Sarbanes-Oxley Act (2002).
2 The evolution of financial auditing practices
2.1 Financial auditing before 1840 (Earliest references to financial auditing)
During the 18th century, the practice of financial auditing was a traditional conformance to the role of auditing. Later on, the auditors started playing the enhancing role. There are no accurate records concerning financial auditing prior to 1840.However, in ancient civilizations such as China, Greece and Egypt there were monitoring activities. Checking activities were similar to the present day financial auditing (Rutherford, 2014). There were checking clerks who checked public accounts. The clerks ascertained that the receipts and payments were duly recorded. Similarly, the Exchequer in England performed checking activities. The verification activities in England helped in accounting for revenues and expenses in the government. The audit officers in the Reign of King Henry 1 conducted financial auditing. The special audit officials examined all the books of accounts. The examinations and checks on the books of accounts helped in preventing fraud (Edwards, 2013).
Similarly, checking activities were present in Italian states. The traders of Venice, Florence and Geneon hired auditors to verify their wealth acquired from the captains of ships returning from Europe and The Old World. The merchants in Italy used auditing to detect fraud. The financial auditing tested the government accounts in a bid to ascertain whether there was defalcation in the accounting records. Financial auditing before 1840 had less commercial application than the subsequent periods (Rutherford, 2014). Financial auditing prior to 1840 was non-commercial because man industries dealt with cottage and small mills. Before 1840, managers did not report to shareholders because the businesses were owned and managed by individuals. Financial auditing was prior to 1840 entailed detail examination of all accounting transactions. Audit sampling and testing were not applicable in the financial auditing process. The concept of internal controls was not common during this period. Financial auditing before 1840 ascertained the honest of the officials in charge of the financial and accounting operations (Carnegie & Napier, 2012).
2.2 Financial auditing during 1840s-1930s (The Industrial Revolution)
During the industrial revolution (1840s-1920s) financial auditing was firmly established. During the industrial revolution, there were large scale financial transactions in the industries. Professional financial auditing emerged during the industrial revolution because the innocent investors needed protection from financial failures that were inherent in the industrial undertakings (Edwards, 2013). During the industrial revolution, the auditors checked all the transactions in the accounting and finance statements. The auditors paid little attention to the internal controls in companies. The court decisions influenced the duties of auditors during the industrial revolution. The court decisions emphasized that the duty of auditors was to detect frauds, technical errors. The role of financial auditing during the industrial revolution was to detect fraud, errors and to portray the solvent of a company in the Statement of financial position (Koh, Rajgopal & Srinivasan, 2013).
The industrial revolution necessitated the need for financial auditing because the shareholders required an independent party that would check the books of accounts to determine their accuracy. Financial auditing assured them of the security of the investments they had made in the industries and companies. The AICPA (Institute of Certified Public Accountants of America) was formed in 1887. The AICPA played a crucial role of representing the accounting profession nationally and globally. The AICPA was responsible for the development of standards used for auditing companies in the USA (Carnegie & Napier, 2012). The establishment of AICPA distinguished the accounting profession because of its educational requirements, professional standards, and code of ethics, commitment and licensing requirements. After the formation of AICPA, it provided members with leadership; resources and information that helped them to offer professional services to the public (Koh, Rajgopal & Srinivasan, 2013). The AICPA has influenced financial auditing by setting the technical standards for auditors and accountants. The AICPA gave its role of establishing GAAPs (Generally Accepted Accounting Principles) to the FASB (Financial Accounting Standards Board. AICPA governs the rules that deal with financial auditing (King, 2011).
2.3 Financial auditing during1930s-1960s
After the industrial revolution, the USA economy expanded dramatically, and this increased the demand for financial auditing. The investments in USA grew very fast after the depression and the Wall Street Crash. The development of credit institutions and security markets facilitated the development of financial auditing (King, 2011). Companies increased in size, and this necessitated the need to separate the management and ownership functions. Financial auditing during this period helped in convincing the financial market participants that the financial statements of the companies were true and fair (Acito, Hogan & Imdieke, 2014).
Financial auditing during this period provided the credibility of financial statements produced by the company managers to the investor. The post-industrial revolution period necessitated the change of financial auditing objective from detection of frauds to verifying credibility. The focus of financial auditing shifted towards ascertaining the truthfulness and fairness of financial statements (Kopel & Sommer, 2013).The materiality and testing concepts were used in financial auditing. Materiality and sampling techniques were essential during this period because of the voluminous financial transactions of industries and companies. Additionally, financial auditors relied on the internal controls of companies.
Landmark auditing cases such as McKesson Versus Robbins of 1938 affected the principles used during financial auditing. Financial auditing emphasized on the physical verification of cash, stock and other assets. The Rail Mail case showed the essence of auditing the statement of profit and loss. The Securities Exchange Commission Act of 1934 enacted the requirement to audit the income statement. Financial auditors gathered internal and external evidence before making conclusions (Koh, Rajgopal & Srinivasan, 2013).In a nutshell, the economic conditions after the industrialization era influenced the development of financial auditing. The features of the audit approach during this period include internal, controls, sampling, and physical examination of assets and analysis of the income statement.
2.4 The 1933 and 1934 Securities Acts
2.4.1. 1933 Security Act
The first objective of the Securities Act of 1933 is to ensure that shareholders receive truthful and significant information concerning securities on sale. The second objective is to prevent deceit, fraud and misrepresentations during the sale of securities (Acito, Hogan & Imdieke, 2014).The act targets security issuers, and it fulfills its objectives through a mandatory registration procedure for all the issuers. The Act governs the timeline of the issuing of securities. The requirements of the registration process include a description of the issuer’s past performance, business, managers, audited financial accounts, officers, executive, compensation, business risks and legal information. The Act ensures that all issuers make the relevant disclosures for the benefit of investors (Kopel & Sommer, 2013)
According to section 11 of the Act, issues are liable for untrue information in the registration forms. Section five of the Ac allows buyers to sue sellers if they sell them non-registered exempt securities. The twelfth section of the Act explains that the issuer is criminally liable for selling securities using a prospectus that has material misstatements. Section 15 of the Act allows shareholders to get damages in the event of the insolvency of their control people. Section 17 of the Act is an ant-fraud provision because it explains that it is illegal to use material misstatements in securing transactions (Acito, Hogan & Imdieke, 2014).
2.4.2. 1934 Security Act
The SEC (Securities Exchange Commission) was established by the Securities Act of 1934.The SEC protected shareholders by maintaining efficiency, fair and orderly markets. The SEC facilitated the formation of auditing standards. The SEC ensures that all companies disclose relevant information concerning their securities. The SEC ensured that the traders, brokers and dealers treat the investors honestly and fairly. The SEC carried out the role of promulgating the accounting and auditing standards (Carnegie & Napier, 2012).
The SEC oversaw the auditors’ activities. The SEC fulfilled its mandate by ensuring that Public Companies submitted their yearly reports in a timely manner. The Security Act of 1934 empowers the Security Exchange commission to demand periodic accounting and financial information for companies that deal in public securities. The 1934 Act governs proxy solicitation used during special and annual general meetings of the shareholders.
According to the Act, the auditor should examine the tender offers during the public issue of the company's shares. The 1934 Act prohibits insider trading in the offer selling and purchasing of securities. The Act provides disciplinary measures for parties guilty of insider deals. According to the 1934 Act, the market participants should register with the oversight commission. The registration involves regular filling of disclosure forms. Therefore, the SEC simplifies the financial auditing process through the mandatory disclosures of the companies.
2.5 Financial auditing during 1970s-1990s
During the 1970s and 1990s the world economy grew due to technological innovations. The financial auditors played an important role in this period by ascertaining the credibility of financial statements and facilitating operations in the capital markets. Financial auditing underwent significant developments during this era (Carnegie & Napier, 2012).
The financing auditing approach during this period verified transactions in the financial records and relied on a system approach. Financial auditing relied on the companies’ control systems because of the large size and the complexity of their operations. Financial auditing accessed the accounting system by using information flows and internal controls. Financial auditors reduced substance testing for companies with sufficient internal controls.
In the 1980s, financial auditing entailed the use of analytical procedures because the use of internal controls was expensive. Adoption risk-based auditing was introduced during this period. Under the risk-based auditing, the financial auditors focused on the risk sections. Risk –based auditing required the use of detailed internal and external evidence. The main components of risk-based auditing include control, inherent and detection risks. Financial auditing used computers to track transactions and to test the evidence in the accounting records. Financial auditors relied on the computers as a major auditing tool.
2.6 Financial auditing during 1990s-2013
The increasing growth of economies in the world led to a change in the financial auditing. Financial auditing expanded beyond the testing function. Financial auditing during this period depended on the business risk perspectives of the companies. Financial auditing used the business risk approach because failure to control business risks leads to financial misstatements. Audi firms have been offering financial auditing and consultancy services.
Financial auditing companies faced criticism due to the financial auditing scandals of Enron, Sunbeam, Adelphia, Xerox, Waste management and Worldcom. There were rampant ligations against financial auditors and firms, and this led to the separation of financial auditing and consultancy services in the auditing companies. There were stringent rules that aimed increasing the independence of the financial auditors.From1990 to 2013, financial auditing was automated. Financial auditing entailed the use of CAATs (Computer Assisted Auditing Techniques).The CAATs helped in extracting data and processing financial auditing procedures (Edwards, 2013).
2.7 Sarbanes-Oxley Act (2002)
The first title of the act offers the guidelines regarding the Public Company Accounting Oversight Board. The title emphasizes on independence and quality control. The second issue focuses on the need for auditor independence. The third issue presents issues pertaining corporate responsibility. The fifth title gives matters concerning financial disclosures. The fifth topic discusses about conflict of interest. The sixth section is about the commission’s authority and resources (Edwards, 2013).
The Act presents studies and reports in the seventh issue. The Eight topic is about accountability on corporate and criminal fraud. The ninth issue discusses penal enhancements for white –collar crimes. The tenth issue is about tax returns for corporate. The last section is about corporate accountability and fraud. The Sarbanes Act was implemented as a result of Enron’s fall. The Act gives the auditor’s role on independence. The act emphasizes on controlling of audit quality, audit rotation and prohibition of self-interest threats. The Act explains that the financial auditor should report to the audit committee.
The Act created the (PCAO) Public Company Accounting Oversight body that controls all audit firms. The Act established the procedures of enforcing accounting standards in various companies. According to the Sarbanes –Oxley act, the financial auditor should assess internal controls that deal with financial reporting. The Act recognizes that internal controls prevent financial errors and frauds. The Act explains that the auditor’s role should converge by focusing on the interests of the public, promoting integrity in the financial statements. The Act redefines the financial auditing relationship and separates the financial audit functions from advisory services (Kopel & Sommer, 2013).
The Act reverses the audit methods to basics such as fraud awareness, detection of risks, independence and objectivity and increasing attention on the interest of the users of the audited statements. The Act imposes changes on the accounting profession on public companies. The Act explains that internal control policies and the quality of financial reports were the duties of financial auditors and managers. The act requires financial auditors to address fraud in the process of examining the books of account (Rutherford, 2014).
3 Conclusion
In summary, this research paper has discussed the history of financial auditing. Studies indicate that financial auditing has been growing through many stages. During the 18th century, the practice of financial auditing was a traditional conformance to the role of auditing. Financial auditing originated from checking procedures in ancient civilizations such as Greece, Egypt and China. The industrial revolution period created the role of financial auditing. The merchants in Italy used auditing to detect fraud. The financial auditing tested the government accounts in a bid to ascertain whether there was defalcation in the accounting records. Financial auditing before 1840 had less commercial application than the subsequent periods. Professional financial auditing emerged during the industrial revolution because the innocent investors required protection from financial failures that were inherent in the industrial undertakings. The AICPA (American Institute of Certified Public Accountants), was formed in 1887. The AICPA played a crucial role of representing the accounting profession nationally and globally. After the industrial revolution, the USA economy expanded dramatically, and this increased the demand for financial auditing. The post-industrial revolution period necessitated the change of financial auditing purpose from detection of frauds to determining credibility. Landmark auditing cases such as McKesson Versus Robbins of 1938 affected the principles used during financial auditing. Financial auditing emphasized on the physical verification of cash, stock and other assets. The objective of the Securities Act of 1933 is to ensure that shareholders receive truthful and significant information concerning securities on sale. The SEC (Securities Exchange Commission) was established by the Securities Act of 1934.The SEC protected shareholders by maintaining efficiency, fair and orderly markets. The SEC facilitated the formation of auditing standards. During the 1970s and 1990s the financial auditors played an important role in this period by ascertaining the credibility of financial statements and facilitating operations in the capital markets. The increasing growth of economies in the world led to a change in the financial auditing from 1990 to 2013. The Sarbanes –Oxley act brought man changes to financial auditing. According to the Sarbanes –Oxley act, the financial auditor should assess internal controls that deal with financial reporting. The Act recognizes that internal controls prevent financial errors and frauds. The AICPA has influenced financial auditing by establishing the technical standards for auditors and accountants. The history of financial auditing shows that that financial auditing has been evolving through the years.
References
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