ADVANCED AUDITING

Chapter one
General Understanding of Auditing
DEFINITION OF AUDITING
 Anthropologists have found records of auditing
activity dating back to early Babylonian times (around
3000 BC).
 Originally, it was derived from the Latin word “audire”
meaning “to hear”.
 The Latin meaning of the word “auditor”

was a “hearer or listener” because in Rome

auditors heard taxpayers, such as farmers, give
their public statements regarding the results of
their business and the tax due.
 Agent – principal relationship
Auditing is a systematic process of objectively obtaining
and evaluating evidence regarding assertions about
economic actions and events to ascertain the degree of
correspondence between the assertions and established
criteria and communicating the results (auditors report)
to interested users.

Persons who rely on the

financial reports
•Creditors
•Investors
•government
 It is a form of attestation service in which the auditor
issues a written report expressing an opinion about
whether the financial statements are in material
conformity with recognized criteria like GAAP, IFRS or
others.
ELEMENTS OF DEFINITION OF
AUDITING
 A systematic process
 Management assertions and audit objectives

 Obtaining evidence

 Ascertaining the degree of correspondence between

established criteria
 Communicating results
 Systematic process : Audits are structured , planned and
organized activities that follow a logical sequence.
 Objectivity: This is a quality of the methods by which
information is obtained and also a quality of the person doing
the audit. Essentially it means freedom from bias.
 Obtaining and evaluating evidence: auditing involves a
process of obtaining and evaluating evidence that ultimately
guides the auditor’s decision. Evidence is any information used
by the auditor’s to determine whether the information being
audited is stated in accordance with the established criteria.
 Assertions about economic actions and events : An
assertion is essentially a proposition that can be proved
or disproved. They are used by the auditor to consider
the different types of potential misstatements that may
occur.
 Degree of correspondence … established criteria:
This means that an audit establishes the conformity of
assertions with specified criteria.
 Communicating results: To be useful, the results of the
audit need to be communicated to interested parties by
either oral or written means.
 The professional literature refers to three general types of
services that provide assurance: auditing, attest, and
assurance services. Many times these terms are used
interchangeably because, at a general level, they
encompass the same process: the evaluation of evidence to
determine the correspondence of some information to a set
of criteria, and the issuance of a report to indicate the
degree of correspondence.
 the most detailed (auditing) to the most general
(assurance).
 the relationship among auditing, attest, and assurance
services. Auditing services are a subset of attest services,
which, in turn, are a subset of assurance services.
 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.
 Assurance services are independent professional
services that improve the quality of information, or its
context, for decision makers.
Auditing Reliability A report on an examination of a client’s financial
Credibility statements (and for a public client, the entity’s
system of internal control over
financial reporting)

Attest Reliability A report on subject matter, or an assertion about

Credibility subject matter, that is the responsibility of another
party

Assurance Reliability Professional services that improve the quality of

Credibility information, or its context, for decision makers
Relevance
Timeliness
 The purpose of an Audit is to enhance the degree of
confidence of intended users in the financial statement
 To lend creditability to the financial statements
 Achieved by the auditor expressing an opinion on
whether the financial statement are prepared in all
material respect in accordance with an applicable
financial reporting framework like GAAP
User Demand for Reliable Information
 Today’s information
 More complex
 Demanded by remote users
 Demanded in a more timely manner
 Has far reaching consequences
 Information risk
 the risk (probability) that the information (mainly
financial) disseminated by a company will be
materially false or misleading.
users demand an independent third party assessment of
the information
The overall objective of every audit engagement can
include four basic aims:
■ to evaluate whether financial statements and
accompanying footnotes are in accordance with specified
criteria;
■ to evaluate the effectiveness and appropriateness of
internal control systems over financial reporting;
■ to evaluate the possibility of fraud occurring within the
organization;
■ to evaluate the likelihood that the organization will
continue as a going concern.
 Levels of assurance

 Assurance services are independent professional

services that improve the quality of information, or its
context, for decision makers. Assurance services
include many areas of information, including
nonfinancial areas
LEVEL OF ASSURANCE
 There are different levels of assurance, which depends
on the type of work that the assurance practitioner
performs, and these different levels also lead to different
types of conclusions.
Type of For example Nature of key work Example form of conclusion
assuranc performed
e
Reasona An audit Detailed testing, “We believe the financial
ble of financial evidence gathering statements present a true
assuranc statements and substantiation and fair view”.
e to support the
conclusion.

Limited A review Primarily enquiries “We have not become aware

assuranc of financial and of any matter to cause us to
e statements analysis, less believe the financial
detailed statements do not present a
procedures. true and fair view”.

No Preparing financial Preparation of the No conclusion provided

assuranc statements on behalf of financial statements
e management
(technically called
a compilation)
ACCOUNTING VS AUDITING
 Accounting is the recording, classifying, and
summarizing of economic events for the purpose of
providing financial information used in decision making.
 Auditing is determining whether recorded information
properly reflects the economic events that occurred
during the accounting period
Basis of Accounting Auditing
comparison
Primary Preparation of financial Audit of financial
responsibility statement statements

Criteria in Generally accepted Generally accepted

discharging accounting principles auditing standards
responsibilities (GAAP) (GAAS)
Its nature Constructive Analytical

End product Financial statements Audit reports

(auditing begins with
the end results of
accounting)
 FUNDAMENTAL PRINCIPLES UNDERLYING AN
AUDIT

 Fundamental principles were described as encompassing

high ideals of professional conduct and the essential
qualities underpinning every ISA (International standard
on Auditing ) audit.
Conceptually, fundamental principles should:
 Underpin the objectives of an audit, and help drive the
conduct of the auditor in using professional judgment to
meet the professional requirement of the auditing
standards
• Be easily understood both by the auditors and other
readers of auditing standards
• Be universally applicable to all audits
• Establish the expectation that the auditors are expected to
accept and abide by
 The expectation is that auditors will not depart from or
override these principles. These principles consist of:
(a) The fundamental principles of professional ethics and
(b) The fundamental principles that underlie the objective
of an audit undertaken in accordance with auditing
standards and pronouncements -
The fundamental principles of professional ethics :
 Integrity: An auditor should be straightforward and
honest in all professional and business relationship
 Objectivity: an auditor should not allow prejudice or bias
, conflict of interest
 Professional competence and due care:

 Confidentiality

 Professional behavior: should comply with relevant laws

and regulation
 The fundamental principles underlying the objective of
an audit
 Knowledge: an auditor should have adequate
understanding of the entity and the environment
 Responsibility: The auditor should take responsibility
for the audit opinion, maintaining an adequate level of
involvement in the audit engagement, properly
supervising any assistants and evaluating the work of
experts or others upon whom reliance is placed.
 Quality control : The auditor should follow quality
control procedures, including consultation with others as
necessary, that support the issuance of an audit report
that is appropriate in the circumstances.
 Rigor and skepticism : The auditor should plan and
perform an audit with thoroughness and with an attitude
of professional skepticism, critically assessing with a
questioning mind the validity and reliability of evidence,
and recognizing circumstances that may cause the
financial report to be materially misstated.
 Evidence : The auditor should obtain sufficient
appropriate evidence to constitute a reasonable basis for
expressing an opinion on the financial report.
 Documentation: The auditor should document matters
that are important in providing evidence to support the
audit opinion.
 Communication : The auditor should communicate
significant matters affecting the entity’s financial report to
management, to those charged with governance and, while
respecting the confidentiality of information, to others
where compliance with local laws and regulations requires
additional communication in the broader public interest.
 Association : The auditor should not be associated with
or allow the use of the auditor’s name or their report to
be associated with information known by the auditor to
be misleading, unless the auditor reports on the
information and how it is misleading.
 Reporting : The auditor should report to those who
have appointed the auditor to the engagement. The
auditor’s report should contain a clear expression of
opinion in writing and set out all information necessary
for a proper understanding of the opinion and its basis.
ETHICAL PRINCIPLES
 WHAT ARE ETHICS?
A sense of agreement in a society as to what is right and
wrong.
Ethics represent a set of moral principles, rules of conduct
or values.
 Ethicsapply when an individual has to make a decision from
various alternatives regarding moral principles.
What are the fundamental principles of professional ethics
 Integrity: auditor should act with consistency. It imposes an
obligation on the auditor to be straightforward and honest in all
professional and business relationships and requires fair dealing
and truthfulness.
 Objectivity: auditor must be fair and without bias, conflict of
interest or the undue influence of others to override their
objectivity.
 Competence & due care: auditor has duty to attain and
maintain their level of professional competence and should
undertake work they can expect to complete with professional
competence. Must also maintain a level of professional
competence through continuing professional development.
 Confidentiality: auditor should respect the confidentiality of
information obtained during the course of their work and
should not disclose such information to a third party without
authority.
 Professional behavior: auditor should comply with the
relevant legislation and conduct themselves in a manner
consistent with the good reputation of their profession and
refrain from any conduct that could bring discredit to it.
 Demand for assurance
 Competing incentives
Theoretically explained by: Agency theory: is where investors are
the principals in a relationship, who entrust the managers with
their resources, who act as their agents or stewards of the
resources. This gives rise to a demand for assurance to ensure
that the agents have acted in the interests of the principals. Also
known as the stewardship hypothesis.
 Need for reliability (main reason)
Theoretically explained by : Information hypothesis: posits
that the demand for auditing is a result of investors
wanting reliable information that can be used effectively
in decision making, unlike agency theory the emphasis is
not so much on the agent as on the reliability of
information.
 Report Complexity (makes it easier to interpret)
Theoretically explained by: Insurance hypothesis: a view
that posits that managers and professional participants
are in financial activities seek to use and auditor as a
means of insurance- that is, as a means of shifting
financial responsibility if any losses are expected from
litigation.
 Remoteness of users
THE EXPECTATION GAP
 differences have been identified between the
expectations of auditors and financial report users
concerning the role and responsibilities of auditors.
 Porter (1993) defines the expectation gap as ‘the gap
between society’s expectations of auditors and auditors’
performance, as perceived by society’.
 two components of the expectation gap can be identified.
1. the reasonableness gap: the gap between what society
expects auditors to achieve and what they can reasonably
be expected to accomplish; and
2. the performance gap: the gap between what society can
reasonably expect auditors to accomplish and what they
are perceived to achieve.
Performance gap may be further subdivided into:
● deficient standards: the gap between the duties that can
reasonably be expected of auditors and auditors’ existing
duties as defined by law and professional promulgations;
and
● deficient performance: the gap between the expected
standard of performance of auditors’ existing duties and
auditors’ perceived performance, as expected and
perceived by society.
 The potential causes of the expectation gap are many and
varied. Humphrey et al. (1992)
point out that the gap has been attributed to a number of
different causes, including:
■ the probabilistic nature of auditing;
■ the ignorance, naivety, misunderstanding and
unreasonable expectations of non-auditors
about the audit function;
 the evaluation of audit performance based upon
hindsight not available to the auditor at the time the audit
was completed;
■ the evolutionary development of audit responsibilities,
which create response time lags to changing
expectations; and
■ corporate crises which lead to new expectations and
accountability requirements, and periods of high
standard-setting activities.
Expectation Gap reduced by:
 Auditors – performing at expected level, peer reviews,
improved standards, clearer reporting
 The Public – improved education
SUMMARY
 Accounting
the recording, classifying, and summarizing of economic events in a
logical manner for the purpose of providing financial information for
decision making
 Assurance Service

an independent professional service that improves the quality of

information for decision makers
 Attestation service

a type of assurance service in which the CPA firm issues a report about
the reliability of an assertion that is the responsibility of another party
 Audit of historical financial statements

a form of attestation service in which the auditor issues a written report

stating whether the financial statements are in material conformity
with accounting standards
 Audit report
the communication of audit findings to users

 Auditing
the accumulation and evaluation of evidence about
information to determine and report on the degree of
correspondence between the information and established
criteria
 Evidence

any information used by the auditor to determine whether

the information being audited is stated in accordance with
established criteria
 Information risk
the risk that information upon which a business decision is
made is inaccurate
End of chapter one