Auditing Principles and Practices Part I
CHAPTER ONE
The Nature, Purpose, Scope
of Audit & Assurance
Services
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1.1Brief History of Auditing
• Auditing was initially practiced in government settings
• The word auditing is derived from the Latin 'audire', meaning
'to listen'.
• In ancient time, Governmental accounting records were
approved only after a public hearing in which the accounts
were read aloud.
• A wise man that acts as an auditor is required to listen
carefully to a spoken description of a situation, applied his
judgment, and came to an opinion .
• Over time, auditing has developed and begin to be applied in
both the private and the public sectors and both
internally and externally.
• The development of auditing is highly related to the
development of commerce, accounting and bookkeeping.
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….Brief History of Auditing
• The invention of double entry in 1494, in Italy;
the industrial revolution that took place in Great
Britain, in 1980, which led to the emergence of
large corporations resulted in the increased
need for persons who check financial records.
• These developments resulted in the demand for
the services of book-keeping and auditing
(internal and external) who check the fairness
of financial records.
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….Brief History of Auditing
Brief Sketch of the major developments of Auditing in the 20th Century
• Ancient time: auditing
government accounts
was
hearing
/enquiry
of
• Medieval Period up to industrial Revolution: it is used to
determine whether persons in positions of fiscal
/economic/financial responsibility in government and
commerce were acting and reporting in an honest
manner.
• During Industrial Revolution (in Corporate setting):
Owners need auditors to protect themselves against the
danger of fraud by both managers and employees.
• In general, before 1900, auditing was concerned
principally with the detection of frauds.
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….Brief History of Auditing
…Brief Sketch of the development of auditing
In the first half of the 19th century, the direction of
audit work tended to shift from fraud detection
towards the new goal of determining whether
financial statements gave a fair picture of
financial position, operating results and
changes in financial position.
• This shift in emphasis was a response to the
needs of the millions of new investors in
corporate securities
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….Brief History of Auditing
…Brief Sketch of the development of auditing
• In recent years, the detection of large-scale
management fraud has assumed a larger role in audit
philosophy.
• The latest shift in emphasis is- a result of the dramatic
increase in the number of lawsuits /court
cases/litigations charging that:
• Management fraud has gone undetected by
independent auditors.
• (The situation has also increased the demand for
modern internal audit).
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….Brief History of Auditing
…Brief Sketch of the development of auditing
• Development of Sampling Techniques:
– In the early days of the auditing profession, auditing
involves a complete/whole review of all transactions.
– However, in about 1900, as large scale business
enterprises developed in Great Britain and US,
auditors adopted sampling techniques.
– This new auditing technique transformed the audit
process from detailed examination of individual
transactions to the use of sample (testing selected
transactions)
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….Brief History of Auditing
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…Brief Sketch of the development of auditing
• Internal control as a basis for testing and sampling:
– Evaluation of client’s internal control system became a prerequisite to
successful use of sampling techniques.
– By studying client’s accounting and internal control system (by
considering the work flows), auditors could determine the extent and
direction of the tests needed for a satisfactory audit of the financial
statements.
– The stronger the internal control, the lesser testing required by the
auditors.
– In areas where control is weak, auditors expand the scope and intensity of
their tests.
 The development of new auditing techniques applicable Electronic
data Processing System:

Organization’s reliance on computers has not lessened the importance of
internal control to auditors, however, it led auditors to develop new
approaches to studying internal control. (eg use of audit software..)
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….Brief History of Auditing
• Factors contributed for the development of Auditing
– Increase in complexity of business organizations
– Separation of ownership and management
– Legislative control- To safeguard the interests of
shareholders and third parties, governments pass
several laws (eg. Maintenance of books by companies,
qualifications of auditors, manner of their appointment,
their duties, rights and liabilities etc)
– Judicial pronouncements-Courts decisions on issues
related to the legal liabilities of auditors.
– Computerized accounting
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1.2 Nature of Auditing
• An Audit is defined as the independent examination and
expression of opinion on the financial statements of an
entity by a duly/proper appointed auditor in pursuit of that
appointment.
• For the opinion to be valued, the auditor must be
independent
• Auditing is:
– The accumulation and evaluation of evidence about
information to determine and report on the degree of
correspondence between the information and
established criteria
– Performed by a competent, independent person
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… Nature of Auditing
The definition of auditing includes the following key
words and phrases:
– Information and established criteria
– Accumulating and evaluating evidence
– Competent, independent person
– Reporting
 It is a systematic process – Auditors use logical, structured
and organized steps and procedures to examine accounting
records and other documents of an organization.
 It involves a task of objectively obtaining and evaluating
evidence :
 - Auditors form opinion based on evidences examined and
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evaluated
without
bias and prejudice
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…Nature of Auditing
 It is conducted by competent and independent person – an
auditor is required to have the essential skill and experience
and has to be independent to avoid bias.
 It involves evaluations of evidences regarding assertions
about economic actions and events: The auditor acts as an
independent third party engaged by the principal to assess the
information provided by the agent and report on the fairness of
the financial statements
 It determines and report on the degree of correspondence
between the information and established criteria.
– The essence of auditing lies in checking realities against
standards. To conduct an audit, there must be verifiable
information and established criteria. Eg GAAPs/IFRS
forYA,financial
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audit; etc
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…Nature of Auditing
It involves Communicating the Results to interested users:
– Preparing the audit report is the final stage in the
auditing process.
The auditor’s findings are
communicated
to
userseg.
stockholders,
management, creditors, governmental agencies, and
the public.
• The nature of auditing can also be summarized as follows:
– Competent and independent person/s → accumulate
and evaluate evidence , ie, verify if the information
corresponds to the established criteria → then based
on the evaluation, audit reports are prepared.
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Example: Audit of a Tax Return
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1.3 Assurance Services: Overview
• Assurance service is a broader term that includes audits
and a variety of other assurances about various
representations of management.
“Assurance services are independent professional services
that improve the quality of information for decision
makers”.
“Assurance (information credibility) services are
professional services, for use by decision makers,
designed to enhance the credibility of information that is
the responsibility of another party by evaluating that
information against suitable criteria”.
Audit is one form of assurance
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… Assurance Services: Overview
Major points in the definitions of Assurance Services:
1. The concept of independence is a key aspect of assurance services.
Users rely on the assurance provider’s independence and derive
value from the fact that he/she is unbiased and objective.
2. The concept of professional services encompasses the application of
professional judgment that is a unique attribute that the assurance
provider brings to the engagement.
(eg. Auditors bring their
professional skepticism/doubt and objectivity to an engagement.
Technology cannot replace the practitioner’s professional judgment.)
3. The purpose of assurance service is to improve the quality of
information (to make information more useful for decision- decision
usefulness). Assurance services improve the quality of information by
improving its reliability or relevance.
4. Assurance services are intended to provide benefit to the decision
maker.
Decision
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1.2 Elements of an Assurance Engagement
There are five elements of An Assurance Engagement:
1. A three party relationship involving the practitioner, a responsible
party and intended user
- Practitioner -eg auditor responsible to determine the procedure
- Responsible party-eg, Mgt responsible for the information and
assertion
- Intended user-The party to which the practitioner prepare report
*Responsible party can be one of the intended users
2. Appropriate subject matter
- Can be financial performance, non financial performance (indicators
of efficiency and effectiveness), capability of facility, systems and
processes (eg entity’s internal control, IT system), Behavior (eg
corporate governance, compliance with regulation)
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… Elements of an Assurance Engagement
3.Suitable criteria
-Criteria are the benchmarks used to evaluate or measure the subject
matter
-Eg. When reporting on financial statement-using IFRS as criteria
. -When reporting on internal controls-using established internal control
framework as criteria
-When reporting on compliance-using the applicable law, regulation or
contract as criteria
 Suitable criteria needs to be :
-Relevant, Complete, Reliable, Neutral(free from bias), understandable
 The evaluation or measurement of a subject matter on the basis of
practitioner’s own expectation, judgment and individual experience
would not constitute a suitable criteria
 Criteria need to be available to the intended users to allow them to
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how
the subject matter has been evaluated or measured
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….Elements of an Assurance Engagement
4. Sufficient appropriate evidence
• Evidence is any information used by the practitioner to determine
whether the information being audited is stated in accordance with the
established criteria.
• It is the foundation of any assurance service including audit.
• Practitioner plans and performs an assurance engagement with an
attitude of professional skepticism
• Professional skepticism -means the practitioner questions the validity
of evidence and is alert to evidence that brings into question the
reliability of documents
• Sufficiency-is a measure of quantity of evidence
• Appropriateness is a measure of relevance and reliability of evidence
(eg. Evidence gathered from external source is more reliable than
from internal source..)
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… Elements of an Assurance Engagement
5. Assurance Report
• Practitioner provides a written report containing a
conclusion (eg whether the subject matter is as per the
established criteria. Eg. the financial statements give a
true and fair view)
• Examples of Assurance engagements:
– Audit of FSs
– Review of FSs
– Systems reliability Report
– Verification of social and environmental information
– Review of internal controls
– Value for money audits (VFM audits) in public sector
organizations
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General principles for an Assurance Engagement

Assurance provider (eg. External auditor) -must perform engagements as
per the International Auditing Standards (ISAs)
 General principles : the Assurance provider (eg. External auditor) must follow in
performing such engagements include:
– Comply with ethical requirements (ISA 200)
– Apply professional skepticism and judgment (ISA 200)
– Perform acceptance and continuance procedures to ensure only work of
acceptable risk is accepted (ISA 210)
– Agree the term of engagement (ISA 210)
– Comply with quality control requirements (ISA 220)
– Plan and perform the engagement effectively (ISA 300)
– Obtain sufficient and appropriate evidence (ISA 500)
– Consider the effect of subsequent events on the subject matter (ISA 560)
– Form a conclusion expressing either reasonable or limited assurance as
appropriate (ISA 700)
– Document the evidence to provide a record of the basis for the assurance
report (ISA 230)
-ISA 200 is a pervasive standard that provide principles applied in all audit
engagements.
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Levels of Assurance:
– Reasonable Assurance
 This is the maximum level of assurance in an audit
engagement
 An audit provides the highest level of assurance
 Eg. Audit of financial statement gives reasonable assurance
that FSs are free from material misstatements due to
error/fraud.
 Audit does not give complete assurance that financial
statements are free from error
• - Limited Assurance: (eg for Review engagements)
• - Review engagements- are performed for companies not legally
required to have an audit.
• The review still provides some assurance to users but the work is not
as in depth as an audit of FSs.
• As only limited assurance is expressed, review involves few
procedures
such as analytical procedures, enquiries of mgt, (no
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tests of controls)
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•
•
•
•
•
An assurance service is an independent professional service that improves the quality of
information for decision makers. Such services are valued because the assurance
provider is independent and perceived as being unbiased with respect to the information
examined. I
Individuals who are responsible for making business decisions seek assurance services to
help improve the reliability and relevance of the information used as the basis for their
decisions
High level assurance
An audit is a methodical review and objective examination of the financial statements,
including the verification of specific information as determined by the auditor, or as
established by general practice.
PKF Mueller also performs physical inspections by observing your inventory
counting methods and test counts. We document and test each operating cycle
including sales and cash receipts, expenses and cash disbursements, and payroll.
Our audit papers include a detailed work program to document the examinations
and testing performed, as well as the client’s supporting work papers.
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•
•
•
•
REVIEW: LIMITED ASSURANCE
Less extensive than an audit, but more involved than a compilation, a review engagement
consists primarily of analytical procedures we apply to the financial statements, and
various inquiries we make of your company’s management team. If the financial
statements or supporting information appear inconsistent or otherwise
questionable, we may need to perform additional procedures.
A review doesn’t require us to study and evaluate your company’s internal controls, or
verify data with third parties, or physically inspect assets.
Why might a business request a review engagement? It can be a good middle ground,
providing the advantages of a CPA’s technical expertise without the work and expense of
an audit.
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1.5 Types of Assurance Engagement
.
Reasonable Assurance Engagement
Limited Assurance Engagement
-The practitioner
-The practitioner
-Gathers sufficient and appropriate -Gathers sufficient and appropriate
evidence to be able to draw reasonable evidence to be able to draw limited
conclusions
conclusions
-Apply through procedure to gather -Apply
fewer
procedures
mainly
sufficient & appropriate evidence
enquiries and analytical procedures
-Concludes that the subject matter -Concludes that the subject matter, with
confirms in all aspects with identified respect to the criteria is believable in the
suitable criteria
circumstance
-Gives a positively worded assurance
opinion
-Gives a high level of assurance
-eg. In our opinion the FSs give a true and fair
-Gives a negatively worded assurance
opinion
-Gives a moderate /lower level of
assurance than that of audit
view/present fairly in all material respect…..) -eg. Nothing has come to our attention that
the financial position of ABC co. as at Dec causes us to believe that the financial
31, 20xx , and F/performance, cash flows for statements of XYZ Co. as of Dec. 31 of …are
the year ended,
as per IFRS.
not prepared in accordance with applicable
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F/R framework)
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…Types of Assurance Engagement
• .The report from a reasonable assurance engagements provide
greater confidence than the limited assurance engagement, due
to this:
– More standards govern reasonable assurance engagements
– Higher quality evidences are needed
– Through procedures are applied
 An External audit- is an example of a reasonable assurance
engagement.
ISA 200, “Overall Objectives of the Independent Auditor and the
Conduct of an Audit in Accordance with International Standards on
Auditing” states:
the purpose of an external audit engagement is to ‘enhance the
degree of confidence
of intended users in the financial
statements’’
-The auditors
opinion shows whether FSs are stated fairly in all
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material respect s and are prepared in accordance with IFRS.
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Other Assurance Service- Examples
Other Assurance Services
Service Activities
Controls over and risks related Assess the processes in a
to investments, including
company’s investment practices to
policies related to derivatives identify risks and to determine the
effectiveness of those processes
Mystery shopping
Perform anonymous shopping to
assess sales personnel dealings
with customers and procedures
they follow
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---- Other Assurance Service
Examples
Other
Service
Other Assurance
Assurance Services
Services
Service Activities
Activities
Assess
Assess risks
risks of
of accumulation,
accumulation, Assess
Assess security
security risks
risks and
and related
related
distribution,
controls
distribution, and
and storage
storage of
of
controls over
over electronic
electronic data,
data,
digital
including
digital information
information
including the
the adequacy
adequacy of
of backup
backup
and
and off-site
off-site storage
storage
Fraud
Develop
Fraud and
and illegal
illegal acts
acts risk
risk
Develop fraud
fraud risk
risk profiles
profiles and
and
assessment
assess
assessment
assess the
the adequacy
adequacy of
of company
company
systems
systems and
and policies
policies in
in preventing
preventing
and
and detecting
detecting fraud
fraud and
and illegal
illegal acts
acts
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…..Other Assurance Service
Examples
Other Assurance Services
Organic ingredients
Service Activities
Provide assurance on the amount of
organic ingredients included in a
company’s products
Compliance with entertainment Assess whether royalties paid to
royalty agreements
artists, authors, and others comply
with royalty agreements
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….. Other Assurance Service
Examples
Other Assurance Services
ISO 9000 certifications
Corporate responsibility and
sustainability
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Service Activities
Certify a company’s compliance with
ISO 9000 quality control
standards, which help ensure
company products are of high
quality
Report on whether the information in
a company’s corporate
responsibility report is consistent
with company information and
established reporting criteria
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1.6 Non-assurance Services
• Non-assurance services are services rendered by
audit firms that generally fall outside the scope of
assurance services such as:
– Accounting and bookkeeping services
– Tax services
– Management consulting services
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1.7 Economic Demand for Auditing
• Why Auditing is needed?-It is needed to reduce information risk
The Concept of Business Risk and Information Risk
– Business risk- refers to events such as inflation, competitors,
increased tax, discontinuance of government subsidies,
employees strike and so on.
– Auditors do not directly influences a company’s business risk,
but have significant effect on information risk.
– Information risk- reflects the possibility that the information
upon which the business risk decision was made was
inaccurate (a risk from use of inaccurate information)
– A likely cause of the information risk is the possibility of
inaccurate financial statements
• Auditing can have a significant effect on information risk
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…..Economic Demand for Auditing
• As information risk results from use of incomplete,
biased or misleading (not reliable, not relevant),
audit of financial statement is needed to reduce
information risk.
– Eg banks and other financial institutions reduce
information risk by relaying on audited financial
statements of borrowers.
– And reduce cost of capital(interest)
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1.8 Causes of Information Risk
• Reasons that increase the likelihood of decision
makers receiving unreliable information:
1. Conflict of interest, (Biases and motives of the
provider)- information providers act in their best interest
and to influence others
2. Consequences of error, - mistakes
3. Remoteness of information- decision makers are far
from the organization and receive information from others
that can be intentionally or unintentionally misstated.
4.Voluminous & complexity of transaction –improper
recording from volume /big information can happen
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….Causes of Information Risk
Conflict of interest
 If information is provided by someone whose
goal is different/inconsistent from the decision
maker, the information may be biased in favor of
the provider.
Eg. between borrowers and lenders;
b/n board of directors and the owners of a
corporation; b/n tax payers and the
government
Audit plays a vital role in helping to ensure that
preparers of financial statement provide, and users
are confident in receiving information which is a fair
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representation of entity’s financial affairs.

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…..Causes of Information Risk
2. Consequence of error
•
•
Information risk is caused by used of
inaccurate financial statements (use of
FSs with error/fraud)
If financial statement users base their
decisions on unreliable and misleading
financial statements, they may suffer
serious financial loss
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…..Causes of Information Risk
3. Remoteness of information
• Legal, physical, and economic factors,
constrain users not to verify
for
themselves the reliability of the information
contained in the financial statements.
• 4. Voluminous of Data
•
As companies grow in size, the volume
of their transactions have also increased,
this in turn will increase the chance that
transactions
may
be
recorded
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1.9 Reducing Information Risk

There are three main ways to reduce information
risk:
– User verifies information
– User shares information risk with management
– Audited financial statements are provided
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• User Verifies Information -The user may go to the business premises to examine records
and obtain information about the reliability of the statements. Normally, this is impractical
because of cost. In addition, it is economically inefficient for all users to verify the
information individually. Nevertheless, some users perform their own verification.
• Ex, if a business intends to purchase another business, it is common for the purchaser
to use a special audit team to independently verify and evaluate key information of the
prospective business
• User Shares Information risk with Management -There is considerable legal precedent
indicating that management is responsible for providing reliable information to users. If
users rely on inaccurate financial statements and as a result incur a financial loss, they
may have a basis for a lawsuit against management. A difficulty with sharing information
risk with management is that users may not be able to collect on losses. If a company is
unable to repay a loan because of bankruptcy, it is unlikely that management will have
sufficient funds to repay users.
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• audited Financial Statements are provided- The most common way for users to obtain
reliable information is to have an independent audit. Typically, management of a private
company or the audit committee for a public company engages the auditor to provide
assurances to users that the financial statements are reliable. External users such as
stockholders and lenders who rely on those financial statements to make business
decisions look to the auditor’s report as an indication of the statements’ reliability.
Decision makers can then use the audited information on the assumption that it is
reasonably complete, accurate, and unbiased. They value the auditor’s assurance
because of the auditor’s independence from the client and knowledge of financial
statement reporting matters
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Relationships Among Auditors,
Client, and External Users
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1.10 Types of Audits
Audits may be classified in various ways. They may be
classified according to:
1. The primary beneficiary of the audit – Internal and
external Audit
2. The primary objectives of the audit –Financial
statement audits, Compliance audits, Operational
audits and Forensic audits
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…Types of Audits
Internal Vs External Audit
• Internal Audit: it is an audit conducted by employee
of an organization into any aspect of its operation
• It is conducted for parties (usually management)
internal to the entity.
• It may be performed by personnel from an outside
source (such as an accounting firm when the service
is outsourced.).
• Internal auditors work focuses on investigation and
appraisal of the effectiveness of the company
operations
for management
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…Types of Audits
• The Institute of Internal Auditors (IIA) defined
internal auditing as follows:
• “Internal auditing -is an independent, objective
assurance and consulting activity designed to
add value and improve an organization's
operations.
• It helps an organization accomplish its objectives
by bringing a systematic, disciplined approach
to evaluate and improve the effectiveness of
risk management, control, and governance
processes”.
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…Types of Audits
• It
is
conducted
in
accordance
management's requirement
with
• The requirements may be wide-ranging or
narrowly-focused, and continuous (ongoing) or
one-off in nature.
• For example, it may be as broad as investigating
the appropriateness of, and level of compliance
with, the organization’s systems of internal
control, or as narrow as examining the entity’s
policies
and
procedures
for
ensuring
compliance with health and safety regulations.
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…Types of Audits
• Internal auditors must be independent of the
department heads and other executives whose work
they review.
• Internal auditors, however, can never be independent
in the same sense as the independent auditors
because they are employees of the company they are
examining.
Two ways of maintaining independence for IA:
• 1. Reporting to the audit committee (Reporting to a level
in the organization that does not affect its
independence)
2.making
auditors independent from the
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activities they audit
…Types of Audits
External Audit
• It is an audit performed for parties external to the auditee.
-Experts, independent of the auditee and its personnel,
conduct these audits
• The best known and most frequently performed external
audits are statutory/legal/constitutional audits (audits
carried out because the law requires them of
compliances)’ and public sector entities financial
statements (ie financial statement audits).
• Compliance audits conducted by Customs office and
the Inland Revenue are also examples of external audits.
• External audits are also described as a societal control
which serves the needs of internal and, more importantly,
external financial information users.
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• part
External
auditors
conduct opinion audit
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…Types of Audits
CPAs perform three primary types of audits:
 Financial statement audit
 Compliance audit
 Operational audit
Financial statement audit
It examines whether financial statements give true and
fair view of or fairly represent the financial position,
result and cash flows
The results of financial statement audits are distributed
in the form of audit reports to users such as
shareholders, creditors, regulatory agencies, and
the general public
In addition, the external auditor also prepares a report
to the audit committee of the board of directors,
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controls and other audit findings.
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•
•
As businesses increase in complexity, it is no longer sufficient
for auditors to focus only on accounting transactions. An
integrated approach to auditing considers both the risk of
misstatements and operating controls intended to prevent
misstatements.
The auditor must also have a thorough understanding of the
entity and its environment. This understanding includes
knowledge of the client’s industry and its regulatory and
operating environment, including external relationships, such as
with suppliers, customers, and creditors. The auditor also
considers the client’s business strategies and processes and
critical success factors related to those strategies.
This analysis helps the auditor identify business risks
associated with the client’s strategies that may affect whether
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thepartfinancial
statements
are fairly stated.
•
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…Types of Audits
Compliance audit
• A compliance audit is a review of an organization’s
procedures to determine whether certain financial or
operating activities of an entity confirm to specified
conditions, procedures, rules, or regulations set by some
higher authority.
• A compliance audit measures the compliance of an entity
with established criteria.
• The established criteria in this type of audit may come from a
variety of sources. Eg creditors, govt
• Results of compliance audit are also reported to the
management within the organizational unit being audited.
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examples of compliance audits for a private
business
•
•
•
•
Determine whether accounting personnel are following
the procedures prescribed by the company controller
. • Review wage rates for compliance with minimum wage
laws.
• Examine contractual agreements with bankers and other
lenders to be sure the company is complying with legal
requirements.
• Determine whether a mortgage bank is in compliance with
newly-enacted government regulations.
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

Governmental units, such as school districts, are subject to
considerable compliance auditing because of extensive
government regulation.
Many private and not-for-profit organizations have prescribed
policies, contractual agreements, and legal requirements that
may require compliance auditing.
Compliance audits for federally funded grant programs are
often done by CPAs and are discussed in detail in Chapter
26. Results of compliance audits are typically reported to
management, rather than outside users, because
management is the primary group concerned with the
extent of compliance with prescribed procedures and
regulations. Therefore, a significant portion of work of this
type
done
by auditors employed by the organizational
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units

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…Types of Audits
Operational audit
• This type of audit is sometimes referred to as a performance audit
or a management audit.
• It is usually initiated by the entity’s management and is conducted
by competent, experienced professionals (internal or external to
the organization) who report their findings to management.
• An operational audit may apply to the organization as a whole or
to a segment of the organization, such as subsidiary, division or
department.
• The objective of the audit may be broad, for example, to improve the
overall efficiency of the entity or narrow and designed for
example, to solve a specific problem such as excessive staff
turnover.
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•
In operational auditing, the reviews are not limited to accounting. They
can include the evaluation of organizational structure, computer
operations, production methods, marketing, and any other area in
which the auditor is qualified. Because of the many different areas in
which operational effectiveness can be evaluated, it is impossible to
characterize the conduct of a typical operational audit. In one
organization, the auditor might evaluate the relevancy and sufficiency of
the information used by management in making decisions to acquire
new fixed assets. In a different organization, the auditor might evaluate
the efficiency of the information flow in processing sales. It is more
difficult to objectively evaluate whether the efficiency and effectiveness
of operations meets established criteria than it is for compliance and
financial statement audits. Also, establishing criteria for evaluating the
information in an operational audit is extremely subjective. In this sense,
operational auditing is more like management consulting than what is
usually considered auditing.
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…Types of Audits
Forensic audit
• The purpose of forensic audit is the detection
or deterrence of a wide variety of fraudulent
activities.
• Some examples where a forensic audit might
be conducted include:
– Business or employee fraud,
– Criminal investigation, Shareholder or
partnership disputes,
– Business economic losses and Matrimonial
disputes (business divorce proceedings).
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Examples of the Three Types of
Audit
Type of Audit Example
Operational
audit
Auditing part I
Information
Established
Criteria
Evaluate whether Number of
Company
the
payroll
standards for
computerized
records
efficiency
payroll
processed in
and
processing for
a month,
effectiveness
a Chinese
costs of the
in payroll
subsidiary is
department,
department
operating
and number
efficiently and
of errors
effectively
made
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Available
Evidence
Error reports,
payroll
records, and
payroll
processing
costs
58
…….Examples of the Three Types of
Audit
Type of Audit Example
Information
Established
Criteria
Available
Evidence
Compliance
audit
Determine
whether bank
requirements
for loan
continuation
have been met
Company
records
Loan
agreement
provisions
Financial
statements
and
calculations by
the auditor
Financial
statement
Audit
Annual audit of
Apple’s
financial
Statements
Apple’s
financial
statements
IFRS,
Generally
accepted
accounting
Principles
Documents,
records, and
outside
sources of
Evidence
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Let’s Discuss
• List five examples of specific operational audits that can
be conducted by an internal auditor in a manufacturing
company.
• What knowledge does the auditor need about the client’s
business in an audit of historical financial statements?
Explain how this knowledge may be useful in performing
other assurance or consulting services for the client.
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1.11Types of Auditors
• Basically, auditors are divided into independent/external auditors and
internal auditors.
 Governmental auditors take both the functions of internal and external
auditors.
• Depending on the skills they possess and the activities they conduct,
auditors can also be commonly classified as:
1. Certified Public Accounting Firms (Independent Auditors)
2. Government Accountability Office Auditors, (Govt. Auditors)
3. Internal Revenue Agents,
4. Internal Auditors.
5. Forensic Auditors
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1. Certified Public Accountant
• CPA is regulated by state law through the licensing
departments of each state
– They render services to clients on fee basis.
– The title CPA/CPA firms indicate that those who
express an audit opinions on financial statements
should be licensed as CPAs.
• There are three requirements for becoming a CPA:
– Education
– Uniform CPA examination
– Experience and Ethics
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Three Requirements for Becoming a
CPA
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2. Government Accountability Office
Auditors, (Government Auditors)
• Government auditors are employed by various local, state, and
federal governmental agencies.
• They conduct comprehensive audits which combine elements
of financial report, compliance and performance auditing.
• In US, the US Government Accountability Office (GAO)
contains the Congress’s audit staff and is headed by the
Comptroller General.
• The audit staff reports to the Congress
•
GAOs assignment include:
– audits of government agencies
– Operational audits
– examinations of corporations holding government contracts
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Government Accountability Office Auditors, (Government
Auditors)
• In Ethiopia, Auditor General Office performs audit of Governmental
Offices & Public Sector entities such as hospitals and educational
institutions.
• These auditors perform Value-for Money Audits as part of
Comprehensive Auditing.
• Comprehensive Auditing has three facets:
• The traditional financial attest audit,
• A compliance audit-in the private sector, (compliance with
corporate policies, control procedures,); in the public sector,
(compliance with government rules and regulations );
• The Value for Money or operational Audit,
which evaluates
economy, efficiency and effectiveness.. The auditor will asses whether financial,
human, and physical resources are managed with due regard to Economy, efficiency and
Effectiveness (3Es).
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Ethiopian Audit of General
•
•
•
•
In addition to Guide the daily activities and governing the
behavior of the audit staff: the office of the Auditor General
has the following objectives:
-Build public trust and respect
-Build confidence and trust among auditors themselves
-Gaining high credibility from legislative or executive
authority the general public and audited entities
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3.Internal Revenue Agents
Internal revenue agents are auditors who are responsible to
determine whether tax payers returns/tax liabilities are
properly calculated, recorded and paid to the
government.
• They basically perform compliance audit.
• Auditors assigned in this area should have sufficient
knowledge about tax laws and the skill to conduct an
effective audit.
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4. Internal Auditors
Internal auditors are employees of the organization they
audit;
• They are employed by individual companies to investigate
and appraise the effectiveness of company operations
for management.
• The scope of the internal audit function extends to all
phases of organizational activities.
• A large part of their work consists compliance audit and
operational audits.
• In many countries internal auditors are highly involved in
financial audits.
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…4. Internal Auditors
• Internal auditors report directly to the highest
authority in an organization or to the audit
committee of the BODs.
• This strategic placement high in organization
structure helps -to assure that internal audits
will have ready access to all units of the
business, and that their recommendations will
be given prompt attention by department
heads.
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5. Forensic Auditors
• Forensic
auditors
are
employed
by
corporations, government agencies, public
accounting firms, and consulting and
investigative services firms.
• They are trained in detecting, investigating,
and deterring fraud and white-collar crime(nonviolent crimes committed by business or government
professionals)-breach of trust/managerial or administrative
fraud)
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Benefits of an Audit
Benefits of an Audit
• Higher quality of information, which is more reliable
• Independent scrutiny/inspection and verification may
be valuable to management
• Reduces the risk of management bias and fraud and
error by acting as a deterrent/constraint . An audit may
also detect bias, fraud and error
• Enhances the credibility of the financial statements
eg, for tax authorities, for lenders
• Deficiencies in internal control system may be
highlighted by the auditor
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Benefits of an Audit
…Economic Benefits of an Audit
• Access to capital market (eg. the requirement that
without audit, companies cannot register securities and
trade on securities market)
• Low Cost of capital - the reduced information risk
associated with audited financial statements, makes
creditors to offer loans with lower interest rates to
borrowers.
• Deterrent to inefficiency and fraud
• Control
and
Operational
(recommendations for improvement)
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Expectation Gap
• Some users incorrectly believe that an audit provides
absolute assurance, that, the audit opinion is a guarantee that
financial statements are ‘correct’.
• This and other misconceptions about the role of an auditor are
referred to as ‘Expectation Gap’
• Examples of expectation Gaps:
– A belief that the auditor tests all transactions and balances
– A belief that the auditor will detect all frauds-the auditor is
required to provide reasonable assurance that the FSs are
free from material misstatement , which may be caused by
fraud
– A belief that the auditor is responsible to prepare financial
statements
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Limitations of an Audit
• Nature of financial reporting
– F/S amounts involve management judgment , hence,
subject to bias
• Nature of audit procedures
– Information provided by the client may be incomplete, or
falsified documents may be provided.
• Timeliness of financial reporting
– The relevance of information diminishes over time and the
auditor cannot investigate every matter exhaustively. (IAS
200)
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Brief History of Auditing
– Assignment:
– History of Auditing in Ethiopia ( maximum 10 pages)
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END OF CHAPTER ONE
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