Origins and Early History of Auditing

Historians believe that record keeping originated about 4000 b.c, when ancient civilizations in the Near East began to establish organized governments and businesses. From the be­ginning, governments were concerned with accounting for receipts and disbursements and collecting taxes. An integral part of this concern was establishing controls, including audits, to reduce errors and fraud on the part of incompetent or dishonest officials. Several "modern" forms of internal control are described in the Bible, which is generally viewed as covering the period between 1800 b.c. and a.d. 95, and the explanation of the logic behind instituting controls - that if employees have an opportunity to steal they may take advantage of it - reflects the same professional skepticism expected of auditors today. Specifically, the Bible discusses dual custody of assets, the need for competent and honest employees, restricted access, and segregation of duties.

The government accounting system of the Zhao dynasty (1122-256 b.c.) in China included an elaborate budgetary process and audits of all government departments. In fifth-century b.c. Athens, the popular Assembly controlled the receipt and disbursement of public funds. The public finance system inclu­ded government auditors who examined the records of all officeholders at the expiration of their terms. In the private sector, managers of estates conducted audits of the accounts. Public finance in the Riman Republic was under control of the Senate, and public accounts were examined by a staff of auditors supervised by the treasurer. The Romans maintained segrega­tion of duties between the officials who authorized taxes and expenditured and those who handled receipts and payments, and, like the Greeks, devised an elaborate system of checks counterchecks.

Historical Development of External Auditing

In the United States

The development of external auditing in this country owes much to the various Companies Acts enacted in Britain during the second half of the nineteenth century. Before 1850, audits were a minor part of an accountant's practice and were not routinely performed. When they were performed, they were viewed as a way to make managers and directors accountable to absentee stockholders for the stewardship of assets. The auditor's primary objective was the detection of fraud. Moreover, there were no standards governing what the examina­tion should consist of or the qualifications of those performing it. The Companies Acts aimed to establish auditing andreporting standards, beginning with the 1845 Act, which required that one or more of a company's stockholders be appointed to audit the balance sheet but did not address the issues of qualifications or responsibilities. The Companies Acts of 1855-1856 removed the requirement that auditors had to be stockholders and thus gave companies the option of engaging an external auditor. In addition, a petition by 20 percent of the stockholders could compel a company to appoint an external auditor. This was the first step toward compulsory independent audits. The Act of 1862 included a detailed description of an audit examination, as well as the first standard form of the auditor's report. It took until 1900, however, for annual audits to become mandatory for all limited companies. Standards for qualification of auditors, however, along with accounting and disclosure requi­rements, were not incorporated into British regulations until the twentieth century. The first comprehensive text on auditing, Auditing: A Practical Manual for Auditors, by Lawrence R.Dicksee, was published in England in 1892. Independendent audits in the United States up to the turn of the century were modeled on British practices. The audit work consisted of detailed scrutinies of clerical data relating to the balance sheet. Robert H.Montgomery, in the first edition of this book, called the early American audits "bookkeeper audits", and the estamated that three quarters of the audit time was spent on footings and postings. Since there were no statutory requirements for audits in America, and since most audits were performed by auditors from Britain who were sent by British investors in U.S. companies, the profession grew slowly at first. Only a small amount of auditing literature was published in the United States

prior to the 1900s. H.J. Mettenheim's 16-page work entitled Auditor's Guide (1869) contained suggestions for preventing fraud and instructions for auditing cash. Science of Accounts by G.P.Greer, published in 1882, described auditing procedures for various accounts; significantly, those procedures included gathering evidence from outside the books. In 1905 and again 1909, Montgomery published American editions of Dislsee's Auditing, and in 1912, recognizing the departurer of U.S. practice ' from the British, he wrote the first American auditing book, Auditing: Theory and Practice, subsequently to be retitled Montgomery's Auditing.

Gradually, American audits evolved into "test audits" as procedures were adopted to rapidly expanding American busi­ness, which considered Britishstyle detailed checking of footings and postings too time-consuming and expensive. In addition to increased use of testing methods, auditors began to obtain evidence from outside clients' records as a means of examining transactions.

Because of investors' concerns, they began to pay closer attention to the valuations' concerns, they began to pay closer attention to the valuations of assets and liabilities. These deve­lopments reflected a broadening of audit objectives beyond checking clerical accuracy and detecting fraud. Independent auditing in the modern sense was emerging in the United States, motivated largely by the demands of creditors, especially banks, for reliable financial information on which, to base credit decisions.

Financial statement users in the early years of this century continued to focus on the balance sheet as the primary indicator of a company's health, and, for most part, auditors emphasized the balance sheet in their work. The first U.S. authoritative auditing pronouncement, prepared by the American Institute of Accountants (now the American Institute of Certified Public Accountants [AICPA]) at the request of the Federal Trade Commission, was published in 1917 and referred to "balance-sheet audits". A revised pamphlet was published in 1929, under the title "Verification of Financial Statements". Although the pamphlet still emphasized the balance sheet audit, it discussed income statement accounts in detail, thus reflecting the growing interest in results of operations. The 1929 pamphlet also covered reporting practices and stressed reliance on internal controls.