CHAPTER ONE
1. An overview of auditing
1.1.Origin and Meaning of audits
Auditing is from the Latin word audire meaning “to hear” or listen
exercise auditing is
 Mesopotamia.
 Ancient Egypt
 Greece,
 UK
 Rome
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The first country
Demands for audits:- The essence of demands for audit is

Control mechanism

Resolve conflict b/n managers and owners

Reduce damaging consequences
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
Simplify complexity

Regulatory requirements
Advantages of Auditing.
 Auditing helps to assure the shareholders that the business enterprises is being run or
managed in their best interest.
 Audit accounts could be more easily acceptable the Inland Revenue for tax purposes.
 Audited accounts can be very useful for investigating bank loan or overdraft.
 Auditing helps to prevent or detect fraud or errors within an enterprise.
 Auditing helps to highlight those weakness or strength in the internal control system of
a company.
 Auditing serve as a psychological check and moral deterrent against fraudulent
practice by the employees of an enterprise
 Audited account s promotes the confidence of investors and investment analyst.
1.4. distinction b/n accounting and auditing
a c c o u n t i n g
1.4. distinction b/n accounting and auditing
a c c o u n t i n g a u d i t i n g
refers to preparation of final accounts and its interpretation help for mgmt. or refers to examination and checking of these account
records proprietor
need not be chartered accountant
whereas an auditor must be chartered accountant
an accountant is an employee of the
concern work directly under mgmt.
but an auditor is not an employee but
an independent person
ac ountant is a permanent worker /employe . an auditor is not and he may of the concern
changes from year to year
an accountant not need have thorough knowledge of auditing and
i t s t e c h n i q u e s
but an auditor must have thoroughknowledge of accountancy
accounting begins where the accountancyrecord.
begins where the accountancy work ends.
accounting is under taken through the year
. where a auditing is generally carriedout at the end financial year or periodically
.
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accounting
auditing
refers to preparation of final accounts
and its interpretation help for mgmt. or
records proprietor
account
need not be chartered accountant
refers to examination and checking of these
whereas an auditor must be chartered accountant
an accountant is an employee of the
concern work directly under mgmt.
independent person
but an auditor is not an employee but an
accountant is a permanent worker /employee
changes from year to year
an auditor is not and he may of the concern
an accountant not need have thorough knowledge
of auditing andits techniques
knowledge of accountancy
accounting begins where the accountancy record.
ends.
accounting is under taken through the year
end financial year or periodically
but an auditor must have thorough
begins where the accountancy work
where a auditing is generally carriedout at the
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1.5. Objective of auditing
Auditing objective is divided in to two.
Main objective (primary objective) and secondary objective ( subsidiary objective)
A.The main objective of auditing is not to detect errors and frauds but to find out whether the
accounts of particular concern exhibit a true and fair view of the earnings and financial state
of affairs.
B.Subsidiary object of audits, which is incidental to the main object is
1. Detection of errors
2. Detection of frauds.
1. Detection of errors
This errors arise
A. Clerical or technical errors
B. 2. Detection of frauds: - detection of frauds by the auditor is also considerable importance
and is more difficult than the detection errors.
While doing so, he should always avoid any hospitality and mistrust toward the staff of the
organ. And should always be polite
FRAUD is intentional and is knowingly committed to defraud the proprietors of the concern.
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 This done deliberately which means that there is intent to deceive, to mislead or conceal
the truth or material facts.
 They are more difficult to detect then innocent errors
 tactful take place by two methods
 misappropriation of cash and goods
 by false faction of accounts
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2.0 TYPES OF AUDIT
There are many types of audits: some of which are,
(1) Statutory Audit: audit carried on as base on the requirement of law is called statutory audit.
e.g.: all companies have to get their accounts audited as per the
provision of the company’s Act of 1956.
(2) Periodical/ Annual Audit: it is a kind of audit where the auditor verifies the account at the
end of the financial year. This is a common audit and is mostly used by small organizations.
(3) Interim audit:it’s an audit conducted in the middle of the accounting year before the
accounts are closed. The objective is to get periodical results, to declare interim dividend.
(4) Partial Audit: when an auditor is asked to audit only a part of the account system
it’s called partial audit. E.g.: he may be asked to audit only the payment side of cash book.
(5) Balance sheet audit: it’s a kind of partial audit and is concerned with the verification of only
those items appearing in the Balance Sheet. It is more popular in the USA. Infact while verifying
BS items the auditor verifies/ checks all related items/accounts.
(6) Management audit: Management audit may be defined as a comprehensive examination of
an organizational structure of a company, institution/government and its plans and objectives it
means of operations
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According to ethiopian contexiist Audits are often classified in to 3 major types:
Audit of Financial Statement
Compliance Audit
Operational Audits /Performance Audits/
Audit of Financial Statement
The goals of audit of financial statements are to determine whether the statements have been
prepared in conformity with generally accepted accounting principles.
To attest to information mean to provide assurance as to fairness or dependability.
 The audit of financial statements ordinarily covers the balance sheet and the related
statements of profit and loss and cash flows.
 Financial audit generally is conducted to ascertain whether the financial statements
present true and fair views of the financial position and working results of an
enterprise or organization.
 Financial statements audits are normally performed by certified public accountants.
The contribution of the independent financial audit is to give credibility to financial statements.
Credibility, in this usage means that the financial statements can be believed that is, they can be
relied upon by outsiders, such as stockholders, creditors, government and other interested third
parties.
The objective of an audit of financial statement is to enable the auditor to express an opinion
whether the financial statements are prepared in all material respects in accordance with an
identified financial reporting framework.
The Objectives of Audit of Financial Statement are:
 To determine whether financial statements have been prepared in accordance to the
generally accepted accounting principles.
 To ensure the completeness of financial statements.
 To vouch the existence of recorded transactions in the financial statements.
 To examine the accuracy of the financial statements.
 To ensure that the net income / loss is the result of the operation for a given accounting
period.
 To verify availability of assets recorded in the balance sheet.
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Compliance Audit
Compliance audit is defined, as an audit to determine whether verifiable data such as income tax
returns or other financial statements are in conformity with established criteria, for example,
laws and regulations, society has always been concerned with compliance with laws and
regulations by all types of entities, business, government and nonprofit making organizations.
The performance of a compliance audit is dependent upon the existence of verifiable data and of
recognized criteria or standard established by an authoritative body. Such audits seek to
determine whether a tax collection is in compliance with tax laws and regulations.
The Objectives of Compliance Audits are:
To determine whether there have been violations of laws and regulations that may have a
material effect on the organizations financial statements.
To provide a basis for additional reports on compliance procedures that is not tests of the
internal control policies and procedures. Compliance procedure is defined, as performing
procedures to act with laws and regulations.
3. Operational audits /Performance Audits/
An operation audit is a systematic independent appraisal activity within an enterprise for a
review of the entire departmental performance as a service to management.
The overall objective of operational auditing is to assist all levels of management in the effective
discharges of responsibilities by furnishing them with objective analysis, appraisal,
recommendations and pertinent comments concerning the activities reviewed. It may be noted
that the terms, operation audit and performance audit often are used interchangeably.
Objectives of Operational Audits
Internal auditors often perform operational audits. The main users of operational audit
reports are managers at various levels including the board of directors. Decision makers need
assurances that every component of an enterprise is working to attain the organization's goals.
For example, the management needs the following information.
 Assessment of the unit performance in relation to management's objectives or
other appropriate criteria.
 Assurance that its plans are comprehensive, consistent and understood at the
operating levels.
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 Objective information on how well its plans and policies are being carried out in
all areas of operation's and opportunities for improvement in effectiveness,
efficiency and economy.
 Information on weakness in operating controls, particularly as to possible
sources of waste.
 Reassurance that all operating reports can be relied on as basis for action.
Audit Scope Meaning
Audit scope means the depth of an audit performed. Audits are performed for several purposes:
regular “checkups” of company records, to check for internal errors, for the purpose of finding
fraud inside a company, for the purpose of finding fraud in another company, or even for the
purpose of finding tax income and other offenses against IRS law. Due to this fact, audit scope
and objectives have a different meaning depending on the person performing the audit as well as
the reason behind the audit.
1.6.
Types of Auditors
Auditors are often viewed as falling into three main types
1. Independent financial auditor /Certified Public Accountant/
2. Internal auditors
3. Governmental auditor
1. Independent/external financial auditor
Independent financial auditor or certified public accountant is a person licensed by the state
to practice public accounting as a profession based on having passed the uniform CPA
examination and having met certain education and experience.
All recognized professions have developed codes of professional ethics.
The fundamental
purpose of such codes is to provide members with guidelines for maintaining a professional
attitude and conduct them in a manner that will enhance the professional values of their
discipline.
. It is the report by the independent auditors that gives credibility to a set of financial statements
and makes acceptable to investors, bankers, government and other users.
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2. Internal Auditors
An internal auditor is paid salary as employee on the organization. That is being audits.
He/she is responsible to appraise and investigation the performance of unit and/ or units
within the organization. And give recommendation to top management.
3. govt. auditor
The gov’t auditor is paid a salary by government. He/she is responsible to the legislature or
executive.
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CHAPTER TWO
Auditing profession
2.1.Profession
Profession is the job that needs special training or skills specially one that needs higher level
of education.
Professionals – are a group of people who possess a unique skill which benefit the society;
with intension of earning livelihood through it.
Any recognized profession has characteristics to be shared with other professions.
The most important of these characteristics are:
Responsibility to serve the public
 Complex body of knowledge
 Standards of qualifications for admission to the profession
 Need for public confidence (recognition)
2.2.The Objectives of the Profession
The Code recognizes that the objectives of the accountancy profession are:

To work to the highest standards of professionalism,

To attain the highest levels of performance and generally

To meet the public interest, honor public trust, and demonstrate commitment to
professionalism
2.3.Definitions: Ethics
 Moral philosophy Systematizing, defending, and recommending concepts of right and
wrong behavior
 Rules or standards governing the conduct of a person or the members of a profession
Ethical principle include
a. Competence
 Maintain professional competence.
 Perform professional duties in accordance with relevant laws, regulations, and
technical standards.
 Prepare complete and clear reports and recommendations
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b. Confidentiality
 Refrain from disclosing confidential information.
 Inform subordinates as to how to handle confidential information.
 Refrain from using confidential information for unethical or illegal advantage.
c. Integrity
 Avoid conflicts of interest.
 Refrain from activity that would prejudice their ability to carry out their duties
ethically.
 Recognize and communicate professional limitations that would preclude
responsible judgment.
 Refrain from engaging in or supporting any activity that would discredit the
profession
d. Objectivity

Communicate information fairly and objectively.

Disclose fully all relevant information that could reasonably be expected to
influence user's understanding of the reports, comments, and recommendations
presented.
Types of Unethical Conduct
 Abuse of accounting information
 Acceptance of bribes or gifts
 Conflict of interest
 Disclosure of confidential information
2.4.Generally Accepted Auditing Standards
Standards are means of measuring the quality and performance of auditors. In order to provide
and maintain uniformly high quality audit work there is a need to have generally accepted
auditing standards. There are ten GAAS recognized by AICPA which are divided in to three
categories.
General standards
Standards of field work
Standards of report
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A.General Standards
The general standard stresses the important personal qualities and professional
qualifications the auditor should process.This standard should include:A.Adequate technical training and proficiency
This standard is normally integrated as require the auditor to have
.Formal education in auditing and accounting
.Adequate practical experience of the work being performed
.Continuing profession education
.Computer proficiency and etc.
.Independency in mental attitude:- In all matters relating the assignment an independent in
mental attitude is to be maintained by the auditor.
B.Due professional care:-simply means that an auditor is professionally responsible for
fulfilling his/her duties diligently and carefully.
Standards of Field Work: -The field work standards concerned with evidence accumulation
and other activities during the actual conduct of audit in the field. This includes:A._Adequate planning and supervision:-This deals with ascertaining that the engagement is
sufficiently planed and supervised.
B._Understanding the clients’ internal control:-a sufficient understanding of internal control is
to be obtained to plan the audit and to determine the nature and extent of test to be performed.
C._Sufficient and competent evidence:- this standard concerns the decision as to how much and
what type of evidence to accumulate for a given set of circumstances to provide reasonable basis
for opinion
Standard of report:- Require the auditor to prepare a report on the financial statement taken as
a whole, including informative (Providing information; especially, providing useful or
interesting)disclosures. The reporting standard require that:The report shall state whether the financial statement are prepared in accordance with GAAP
The report shall identify circumstances in which the principles have not been consistently
observed in the current period in relation to the preceding period
Informative disclosure in financial statements are to be regarded as reasonably adequate unless
and otherwise stated in the report
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The report shall either contain an expression of opinion regarding the financial statement takenas
a whole or an assertion to the effect that an opinion cannot be stated. In all case where an auditor
name is associated with financial statement, the report should contain a clear cut indication of the
character of the auditors work if any and the degree of responsibilities the auditor is taking.
Basic Principles of Auditor
Basic principles, which govern the auditor's professional responsibilities and which should be
complied with whenever an audit is carried out. These are: Integrity,the auditor should be straightforward, honest and sincere in his approach to his
professional work.
 Objectivity, He must be fair and must not allow prejudice or bias to override his
objectivity.
 Independence: He should maintain an impartial attitude and appear to be free of any
interest which might be regarded. .
 Confidentiality:
The auditor should respect the confidentiality of information acquired in the course of his work
and should not disclose any such information to a third party without specific authority or unless
there is legal or professional duty to disclose. It is remarked that an auditor should keep his ears
and eyes open but his mouth shut.
 Skill and competence:
The audit should be performed and the report prepared with due professional care by persons
who have adequate training, experience and competence.
 Documentation:
The auditor should document matters, which are important in providing evidence that the audit
was carried out in accordance with the basic principles.
 Planning:
The auditor should plan his work to enable him to conduct an effective audit in an efficient and
timely manner. Plans should be based on knowledge of client's business. They should be further
developed and revised, if required, during the course of audit.
 Audit evidence:
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The auditor should obtain sufficient appropriate audit evidence through the performance of
compliance and substantive test procedure. It will enable him to draw reasonable conclusions
there from on which he has to base his opinion on the financial information.
 Audit conclusions and reporting:
The auditor should review and assess the conclusions drawn fromthe audit evidence obtained
and from his knowledge of business ofthe entity as the basis for the expression of his opinion on
thefinancial information. .
2.5.Legal Liability and Responsibility
We are in the era of litigation in which person real or fenced grievances are likely to their
compliances to courts. In this environment, investors & creditors who suffer financial reversal
find auditor as well as attorney & corporate directors tempting target for law suit alleging
professional “mal practice”. Therefore, auditors must approach any engagement with the
prospect that they may be required to defend their work in court.
-
In court of defending legal action which may be astronomical are not limited to monetary
measure. For instance
-
Law suit can be extremely damaging professional reputation which it once damaged is
difficult to return back.
-
The auditor may even be tried criminally for “mal practice”.
2.5.1. Auditors Legal Liability to client
When an auditor assumes any type of engagement, they are obliged to render due professional
care. These obligations exist whether or not it is specifically set forth in written contract with the
client which is ordinarily company itself as contrasted to shareholders.
Although legal difference exists between breach of contract and fort action, in general to
establish auditors liability a client must provide:
-
There is a duty: the auditor accept duty of care exercise skill prudence & diligence
-
Breach of duty: Auditor breach his/her duty of care through negligence performance
-
Loss – the client suffer loss
-
Proximate cause – the loss results from the auditors’ negligent performance.
2.5.2. Auditor responsibility to Third Party
Third party is another party beside the two parties (auditor & client) in contract.
E.g. stock holder’s suppliers, bankers and creditors
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The CPA {certified public auditor} firm may be liable to 3rd parties for any professional
“Mal Practice” this third party must establish the same elements as does the clients: in
summary.

CPA breaching{open} of duty of care and

Loss – resulted from CPAs performance
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Chapter three
Planning the Audit
31 Audit Planning
The first generally accepted auditing standard of field work requires adequate planning.
There are three main reasons why the auditor should properly plan engagements:
 to enable the auditor to obtain sufficient appropriate evidence for the circumstances,
 to help keep audit costs reasonable, and
 to avoid misunderstandings with the client.
Objectives of planning
Adequate audit planning helps to:
 Ensure that appropriate attention is devoted to important areas of the audit.
 Ensure that potential problems are promptly identified;
In planning his audit, the auditor will consider factors such as

complexity of the audit,

The environment in which the entity operates

his previous experience with the client and knowledge of the client’s business.
The auditor may wish to discuss elements of his overall plan and certain audit procedures with
the client to improve the efficiency of the audit and to coordinate audit procedures with work of
the client’s personnel.
The overall audit plan and the audit programme, however, remain the auditor’s responsibility.
Planning an Audit and Designing an Audit Approach
Accept client and perform initial audit planning
Initial audit planning involves four things, all of which should be done early in the audit:

The auditor decides whether to accept a new client or continue serving an existing one.

The auditor identifies why the client wants or needs an audit.

To avoid misunderstandings, the auditor obtains an understanding with the client about
the terms of the engagement.

The auditor develops an overall strategy for the audit, including engagement staffing and
any required audit specialist
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CHAPTER FOR
AUDIT EVIDENCE
Auditing is a systematic process of objectively obtaining and evaluating evidence regarding
assertions about economic actions and events
 Evidence is anything that can make a person believes that a fact, proposition, or
assertion is true or false.
 Audit evidence is all of the information used by the auditor in arriving at the
conclusions on which the audit opinion is based.
 Audit evidence includes the accounting records and other information underlying the
financial statement.
Sufficient and Appropriate Audit Evidence
 Sufficiency is the measure of the quantity of audit evidence.
 Appropriateness is the measure of the quality of audit evidence, that is, its relevance
and its reliability in providing support for, or detecting misstatements in, the classes
of transactions, account balances, and disclosures and related assertions.
Generally the reliability of audit evidence are useful:
 Audit evidence is more reliable when it is obtained from knowledgeable independent sources
outside the entity.
 Audit evidence that is generated internally is more reliable when the related controls imposed
by the entity are effective.
 Audit evidence obtained directly by the auditor
 Audit evidence is more reliable when it exists in documentary form, whether paper, electronic,
or other medium (for example, a contemporaneously written record of a meeting is more
reliable than a subsequent oral representation of the matters discussed).
 Audit evidence provided by original documents is more reliable than audit evidence provided
by photocopies or facsimiles.
assertion used by the auditor fall into the following categories:
Assertions about classes of transactions and events for the period under Audit
i)
Occurrence. Transactions and events that have been recorded have occurred and pertain to the
entity.
ii)
Completeness. All transactions and events that should have been recorded have been recorded.
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iii)
Accuracy. Amounts and other data relating to recorded transactions and events have been
recorded appropriately.
iv)
Cut-off. Transactions and events have been recorded in the correct accounting period.
v)
Classification. Transactions and events have been recorded in the proper accounts.
B. Assertions about account balances at the period end
i) Existence. Assets, liabilities, and equity interests exist.
ii) Rights and obligations. The entity holds or controls the rights to assets, and liabilities are the
obligations of the entity.
iii) Completeness. All assets, liabilities, and equity interests that should have been recorded
Valuation and allocation.
C. Assertions about presentation and disclosure
i) Occurrence and rights and obligations. Disclosed events and transactions have occurred and
pertain to the entity.
ii) Completeness. All disclosures that should have been included in the financial statements have
been included.
iii) Classification and understand ability. Financial information is appropriately presented and
described and disclosures are clearly expressed.
iv) Accuracy and valuation. Financial and other information are disclosed fairly and at
appropriate amounts.
5.5 Types of Audit Evidence
The auditor obtains audit evidence by one or more of the following procedures:
1 Inspection
Inspection of document consists of examining records or documents, whether internal or
external, in paper form, electronic form, or other media. Inspection of records and documents
provides audit evidence of varying degrees of reliability, depending on their nature and source
and, in the case of internal records and documents, on the effectiveness of the controls over their
production.
2 Observation
Observation consists of looking at a process or procedure being performed by others, for
example, the observation by the auditor of the counting of inventories by the entity’s personnel
or observation of internal control procedures that leave no audit trail.
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Observation provides audit evidence about the performance of a process or procedure
Observation of Physical Inventory Procedures
A good example of an observation audit procedure is count of physical inventory.
3 Inquiry
Inquiry consists of seeking information of knowledgeable persons, both financial and
nonfinancial, inside or outside the entity. Inquiry is an audit procedure that is used broadly
throughout the audit and often is complementary to performing other audit procedures
Considering the knowledge, objectivity, experience, responsibility, &
 Qualifications of the individual to be questioned.
 Asking clear, concise, and relevant questions.
 Using open or closed questions appropriately.
 Listening actively and effectively.
 Considering the reactions and responses and asking follow-up questions.
 Evaluating the response.
4 Confirmations
Confirmation consists of the response to an inquiry of a third party to corroborate information
contained in the accounting records.. Confirmation is the act of obtaining audit evidence from a
third party in support of a fact or condition.
Confirmation, which is a specific type of inquiry, is the process of obtaining a representation of
information or of an existing condition directly from a third party.
Four key characteristics of confirmations
i.
Information requested is by the client auditor.
ii. From independent third party
iii. Request and response is in writing, sent to the auditor.
iv. Written or oral response
v. Response comes from an independent third party.
vi. Positive confirmation involves a receipt of information.
5 Recalculation
Recalculation consists of checking the mathematical accuracy of documents or records.
Recalculation can be performed through the use of information technology.
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5.6 Reliability and Cost of Audit Evidence
The most reliable evidence gathering techniques (audit procedures) should be used whenever
they are cost effective., a list of the most reliable to the least reliable evidence-gathering
techniques are in general:
 recalculation,
 inspection,
 re performance,
 observation,
 confirmation,
 analytical procedures,
 Inquiry.
The most expensive evidence gathering techniques are confirmation and inspection.
Confirmation is costly because of the time and outlay required in preparation, mailing, receipt,
and follow-up. Inspection procedures that require the presence of both the client and auditors,
such as an inventory count, are also expensive. Confirmation of documents is moderately
expensive if clients are organized and have documents easily available. The three least expensive
evidence-gathering procedures are observation, analytical procedures, and inquiries. Observation
is normally done concurrently with other audit procedures.
The evidence-gathering procedures in order of cost from most costly to least costly are in
general:
 confirmation (most costly),
 inspection,
 recalculation,
 re performance,
 observation,
 analytical procedures,
 Inquiry (least costly).
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