Course: Advanced Auditing

Course code: ACFN 592

Credit hours: 3

By: Meseret M. (PhD)

UNIVERSITY OF GONDAR, CoBE, DEPARTMENT

OF ACCOUNTING AND FINANCE
 Chapter One

Overview of Auditing
 Evolution of Auditing
• Prior to AD 1500, the only form of auditing was the keeping
of separate records by two different scribes- to detect fraud.
• The industrial revolution led, in the period 1850–1905, to
an increased demand for auditors who were independent
of management and who were engaged to detect not only
clerical errors, but also management fraud.
• Auditors began to periodically report on the work
they had performed to the owners of an entity -
‘independent auditor’s report' emerged.
• The concept of ‘testing’ evolved - auditors
selected ‘a few haphazard cases’.
• Controls over cash were first recognized.
 ……..Cont’d
• 1905–1930 - independent progression of British and
American audit objectives.
▫ In USA, the audit objective gradually changed from the
detection of fraud to reporting on ‘the actual condition of
an entity’ and there was considerable use of testing it.
▫ In Great Britain, the primary objective continued to be detection
of fraud and error and the prominence of detailed checking.
• 1933–1940 - acceptance by auditors of somewhat ‘softer’
audit objectives and the wording of the standard auditor's
report on the financial statements reflected this change.
▫ In the USA, the auditors reported as to whether
financial statements ‘present fairly’ the state of affairs
of an entity, rather than the more precise ‘present a
true and fair view’ used in Great Britain.
• By 1940, testing was the rule and detailed checking the exception.
 ……..Cont’d
• From 1940 onwards, it became increasingly accepted by the
auditing profession that the primary objective of an audit
was the provision of an opinion on the financial statements
and detection of fraud and error was a secondary objective.
• Since 1960, the auditing profession throughout the
world experienced significant increase in wages' costs.
• 1960–1980 - an assessment of the reliability of the
internal control - ‘system-based auditing’.
• Statistical methods were introduced to determine the
extent of testing, although their use was not widespread.
• Around 1972 - audit risk was recognized
• Since 1980, increasing fee pressure accentuated the need
for audit to be both effective and efficient.
• Audit firms adopted a ‘risk based approach’ in auditing.
 International Accounting and Auditing
Standards
International Financial Reporting Standards (IFRS)
• Auditing requires that the real-world evidence of financial
transactions be compared to financial standards.
• The standards to which an international auditor
compares financial statements are generally
standards in the reporting country (e.g. FAS in the
USA, or national standards in European Union (EU))
• In the future, companies and auditors in the EU and
other countries will use International Financial Reporting
Standards (IFRS), formerly called International
Accounting Standards (IAS), which are set by the
International Accounting Standards Board (IASB).
 ……. Cont’d International
• In March 2001, the IASC Foundation was formed
as a not-for-profit corporation.
• The IASC Foundation is the parent entity of the
International Accounting Standards Board, an independent
accounting standard setter based in London, UK.
• In April 2001, the International Accounting Standards
Board (IASB) assumed accounting standard setting
responsibilities from its predecessor body, the
International Accounting Standards Committee (IASC).
• New standards issued by the IASB will be called
International Financial Reporting Standards (IFRS). The EU
has agreed to apply most of the IFRS from 2005 onwards.
 ……. Cont’d International
International Standards on Auditing
• For consistent auditing around the world auditing
standards were required by multinational corporations.
• With a set of international standards adopt for the
world, international investors can be more confident
in financial statements prepared in another country.
• In the Peoples’ Republic of China, Chinese
Accounting Standards (CAS) are becoming more
and more in line with IFRS.
• Developing Nations Adopt International Auditing Standards
• The three main sets of auditing standards are
International Standards on Auditing, U.S. Generally
Accepted Auditing Standards for entities other than
public companies, and PCAOB Auditing Standards.
 ……. Cont’d International
IAASB Auditing Standards
• The International Auditing and Assurance Standards
Board (IAASB) is a standing committee of the Council of
IFAC which sets the international standards on auditing.
• Their objective is to improve the degree of uniformity of auditing
practices and related services throughout the world by issuing
pronouncements on a variety of audit and attest functions.
• IAASB issues several sets of standards to be applied to
international auditing and assurance services.
• IAASB issues:
▫ International Standards on Auditing (ISAs) as the standards
to be applied by auditors in reporting on historical financial
information - developed by the International Federation of
Accountants (IFAC) through its International Auditing and
Assurance Standards Board (IAASB).
 ……. Cont’d International
▫ International Standards on Assurance Engagements (ISAEs) as the
standards to be applied by practitioners in assurance engagements
dealing with information other than historical financial information;
▫ International Standards on Quality Control (ISQCs) as
the standards to be applied for all services falling
under the standards of the IAASB;
▫ International Standards on Related Services
(ISRSs) as the standards to be applied on related
services, as it considers appropriate
▫ International Standards on Review Engagements
(ISREs) as the standards to be applied to the review of
historical financial information developed by the IAASB.
• IAASB aims for voluntary international acceptance of its
guidelines. Therefore, ISAs are not intended to override
national regulations or pronouncements
 ……. Cont’d International
• These ISAs are not yet authoritative in the way that
pronouncements of, say, the Auditing Standards
Board are to determine Generally Accepted Audit
Standards (GAAS) in the USA.
• ISAs will be mandatory in Europe in 2005, and other
regions in the world including the USA may follow.
• The standard-setting activities of the IFAC are carried
out by the International Auditing and Assurance
Standards Board (IAASB), the Ethics Committee, the
Education Committee, and the Public Sector Committee
with an interest in governmental financial reporting.
 ……. Cont’d International
• List of 2004 International Standards on Auditing
• AUDITS AND REVIEWS OF HISTORICAL
FINANCIAL INFORMATION
▫ 100–999 International Standards on Auditing (ISAs)
100–199 Introductory Matters
200–299 General Principles and Responsibilities
300–499 Risk Assessment and Response to
Assessed Risks 500–599 Audit Evidence
600–699 Using the Work of Others
700–799 Audit Conclusions and
Reporting 800–899 Specialized Areas
 ……. Cont’d International
Certified Public Accounting Firms
• Except for certain governmental organizations, the
audits of all general use financial statements in
the United States are done by CPA firms.
• Provide audit services, other attestation &
assurance services
• CPA firms also provide many other services to their clients,
▫ accounting and bookkeeping services,
▫ tax services, and
▫ management consulting services
• Big Four international CPA firms - 4 largest CPA firms in US
▫ Deloitte & Touche ▫ PricewaterhouseCoopers
▫ Ernst & Young ▫ KPMG
 ……. Cont’d International
Public Company Accounting Oversight Board
• Triggered by the bankruptcies and alleged audit failures
involving such companies as Enron and WorldCom, the
Sarbanes–Oxley Act is considered by many to be the
most important legislation affecting the auditing
profession since the 1933 and 1934 Securities Acts.
• The Sarbanes–Oxley Act established the Public
Company Accounting Oversight Board (PCAOB),
appointed and overseen by the SEC.
• The PCAOB provides oversight for auditors of public
companies, establishes auditing and quality control standards
for public company audits, and performs inspections of the
quality controls at audit firms performing those audits and
conducts inspections of registered accounting firms
10 generally accepted auditing standards (GAAS)
 ……. Cont’d International
International Standards of Supreme Audit
Institutions (ISSAI)
• Professional standards and best practice guidelines for public
sector auditors, officially authorized and endorsed by the
International Organization of Supreme Audit Institutions (INTOSAI).
• State the basic prerequisites for the proper functioning and
professional conduct of Supreme Audit Institutions and the
fundamental principles in auditing of public entities.
• The INTOSAI Guidance for Good Governance (INTOSAI
GOV) provides guidance to public authorities on the
proper administration of public funds.
• INTOSAI is an autonomous, independent, non-political and non-
governmental organization with special consultative status with
the Economic and Social Council (ECOSOC) of the United Nations.
 Auditing, Attest and Assurance Services Defined

Auditing
• It is a systematic process of objectively obtaining and
evaluating evidence regarding assertions about economic
actions & events to ascertain the degree of
correspondence between those assertions and established
criteria and communicating the results to interested users.
Attestation
• Attest services occur when a practitioner is engaged to
issue ... a report on subject matter, or an assertion about
subject matter, that is the responsibility of another party.
 …….Cont’d

Assurance
• In the late 1990s, the accounting profession
expanded the potential breadth of auditors’
activities beyond auditing and attest services
to include a broader set of assurance services.
• Assurance services are independent
professional services that improve the quality of
information, or its context, for decision makers.
The Relationships Among Auditing, Attestation,
and Assurance Engagements

Assurance Services
Any Information

Attestation Services
Primarily Financial Information

Auditing
Financial Statements
 Objectives and Nature of Auditing
• Primary objective - to report to the owners that the
accounts, financial statements give a true and fair view
of the state of the company’s affairs at the end of its
financial year and profit or loss and cash flow for the
year and such other matters as may be prescribed.
• Secondary objective - incidental to the satisfaction
of the main objective.
▫ Detection and prevention of Frauds, and
▫ Detection and prevention of Errors.
▫ Detection of material frauds and errors as an incidental
objective of independent financial auditing flows from
the main objective of determining whether or not the
financial statements give a true and fair view.
 …….Cont’d
• Information and Established Criteria - To do an
audit, there must be information in a verifiable
form and some standards
• Accumulating and Evaluating Evidence - Evidence
is any information used by the auditor to determine
whether the information being audited is stated in
accordance with the established criteria.
▫ Electronic and documentary data about transactions
▫ Written and electronic communication with outsiders
▫ Observations by the auditor
▫ Oral testimony of the auditee (client)
• Competent, Independent Person
• Reporting - communicates the auditor’s findings to users
 Basic Principles Governing an Audit
• Integrity, Objectivity and Independence
• Confidentiality
• Skills and Competence
• Documentation
• Planning
• Audit Evidence
• Accounting System and Internal Control
• Audit Conclusions and Reporting
 Principal Aspects to be Covered in Auditing
• Accounting and Internal Control
• Arithmetical Accuracy
• Authenticity of Transactions
• Distinction between Capital and Revenue Items
• Verification of Assets
• Verification of Liabilities
• Comparison of the Financial Statements
• Truth and Fairness of Financial Statements
• Statutory Requirements
• Appropriate Reporting
 Relationship Between Auditing with Other Subjects
• Auditing is a multi-dimensional subject.
• The subject has its origin from accounting and take the
assistance of different other subjects to enrich the content of it.
• After proper checking, the auditor is supposed to submit a report
to the owners of the organization to state whether the books of
accounts give a true and fair view of the state of the affairs of the
organization as disclosed in the financial statements.
• The application of statistical and mathematical
tool in conducting audit is very important.
• How to get the required information from the organization
by interacting with the employees and staff members of
the organization is the subject matter of the behavioral
science and the auditor should develop the required skills
of behavioral science to discharge his duties efficiently.
 …….Cont’d
• Auditing Vs Law - In order to give this assurance,
the auditor is supposed to know all the legal
aspects governing the maintenance of accounts as
well as the functioning of the organization.
• Auditing and Economics- As the auditor is
concerned with the accumulation and presentation
of data relating to economic activity, he is expected
to be familiar with the overall economic
environment in which the organization is operating.
• Auditing and Management: financial management
and the production or operational management
• In order to cope up with the changes in the auditing
environment, the auditors are now supposed to know
the computer application to a comfortable level.
 The Audit Process
• Client acceptance/continuance

• Preliminary engagement activities

• Plan the audit

• Consider and audit internal control

• Audit business processes and related accounts

(e.g., revenue generation)
• Complete the audit

• Evaluate results and issue audit report

 Benefits and Limitations of Audit
• The auditor must prepare his audit report impartially
and effectively based on facts and actual figures.
• So, the following advantages can be expected from auditing

• FROM LEGAL POINT OF VIEW

▫ Filing of Income Tax Return
▫ Borrowing of Money from External Sources
▫ Settlement of Insurance Claim
▫ Sales Tax Payments
▫ Action Against Bankruptcy
• FROM INTERNAL CONTROL POINT OF VIEW
▫ Quick Discovery of Errors and Frauds
▫ Moral Check on the Employees
 …….Cont’d
▫ Advice to the Management
▫ Uniformity in Accounts
• FROM EXTERNAL AFFAIRS POINT OF VIEW
▫ Settlement of Accounts
▫ Valuation of Assets and Goodwill
▫ Future Trend of the Business
• An audit should have no limitations of its own. It is
designed to protect the interest of all parties
who are interested in the affairs of the business.
• If there be any shortcoming arising there from, it may be
due to its narrow scope of application in its related field
of operation and un-extended definition of the concept.
 …….Cont’d
• The audit suffers from the following shortcomings:
• Want of Complete Picture
▫ The audit may not give complete picture. If the
accounts are prepared with the intention to defraud
others, auditor may not be able to detect them.
• Problems of Dependence
▫ Sometimes the auditor has to depend on explanations,
clarification and information from staff and the client.
• Post-mortem Examination
▫ Auditing is a post-mortem examination. There is no use of
such examination when events have already been occurred.
• Existence of Error in the Audited Accounts
 …….Cont’d
▫ There may be error in the audited accounts
even after checking by the auditor.
• Lack of Expertise
• Diversified Situations
▫ Auditing is considered to be a mechanical work.
Auditors may not be in a position to frame audit
program, which can be followed in all situations.
• Quality of the Auditor
• Existence of Defective Policies
Chapter End!