Advanced Auditing and assurance ,chapter1

Advanced Auditing & Assurance
Chapter One
The Demand for Audit and other
Assurance Services

Points should be covered
o Meaning and Nature of Audit
o The Demand for Auditing and Assurance
o Role Auditing in reducing information risk
o Types of audit and auditors
o Assurance Services, Attestation Services
and other assurance Services
o Major phases of audit

Origin and definition of Auditing
The original meaning of the term Audit is
derived from the Latin word ‘Audere’
which means ‘to hear’ and the term
Auditor is ‘one who hear’.
In earlier periods, commercial and
governmental records were approved only
after a public reading in which the
accounts were read allowed to peoples
those hear.

Cont’d
During the industrial revolution, manufacturing
companies grew in size and their owners began
to use the service of hired managers.
With this separation of the ownership and
management groups, the owners turned
increasingly to the need of auditors to protect
themselves from the danger of intentional error
as well as fraud committed by managers and
employees.

Cont’d
In the first half the 20th century, the direction
of audit works tends to move away from
fraud detection towards a new goal of
determining whether financial statements
give a full and fair picture of financial
position, operating results, and change in
financial position.
In the middle of 20th century, the large scale
corporate entities growth rapidly, and
auditory began to examine selected
transaction rather than study all transactions.

Cont’d
In addition to sampling, auditors become
aware of the importance of effective
internal control.
Now a days, Auditors began to use
sophisticated computer soft ware to test the
intensity of firm’s internal control and the
accuracy financial statement balances.
In addition system audit is introduced as
one important types audit

Cont’d
The major auditing developments in the
current period are:
1. A shift in emphasis to the determination of
fairness in financial statements from error
and fraud detection
2. Increased responsibility of the auditor to
third parties, such as governmental agencies,
stock exchanges
3. A change in auditing method from detail
examination of individual transactions to use
of sampling techniques.

Cont’d
4. Recognition of the need to consider the
effectiveness of internal control as a guide to
the direction and amount of testing and
sampling to be performed
5. Development of new auditing procedures
applicable to computer systems and use of
the computers as an auditing tool
6. Introduction of system audit as one
important types audit

Definition of auditing
It is quite difficult to give a single and precise
definition of the term “Audit”.
Definition 1: Some authors define auditing as
an independent examination of an
expression of opinion on, the financial
statements of a concern by an appointed
auditor and in compliance with any relevant
statutory obligations.

Cont’d
Definition 2: Some scholars also define auditing
as an independent examination of the books of
account and the related documentary evidence
by a qualified person in order to ascertain the
accuracy of figures.
Definition 3: American Accountant & auditors
defined, auditing is a systematic examination of
the books and records of a business or other
organizations in order to ascertain or verify and
to report upon the facts regarding the financial
operations and the results thereof.

Nature of Auditing
The study of auditing is different from any of the
other accounting courses you have taken so far.
 Most accounting courses focus on learning the
rules, techniques, and computations required to
prepare and analyse financial information.
 Auditing focuses on learning the analytical and
logical skills necessary to evaluate the relevance and
reliability of the systems and processes responsible
for recording and summarizing that information, as
well as the information itself.

Cont’d
As such, you will find the study of auditing to be much
more conceptual in nature than your other
accounting courses. This is simply due to the following
nature of auditing:
A. Audit is a systematic and scientific examination of
the books of accounts of a business or organizations.
B. Audit is undertaken by an independent person or
body of persons who are truely qualified for the job.
C. Audit is a verification of the results shown by the
profit and loss account and the state of affairs as
shown by the balance sheet.
D. Audit is a critical review of the system of accounting
and internal control

Cont’d
E. Audit is done with the help of vouchers,
documents, information and explanations
received from the authorities.
F. The auditor has to inspect, compare, check,
review, scrutinize the vouchers supporting the
transactions and examine correspondence,
minute books of share holders, directors,
Memorandum of Association and Articles of
Association etc., in order to establish
correctness of the books of accounts.

Demands for Audit
The need for auditing increases when
ownership is separated from control. Because:
1. It helps prevent or detect misstatements -
errors or fraud
2. It helps to enhance the credibility of financial
information prepared by an entity
The independent audit ensure that those
financial statements are objective, free from
bias and manipulation and relevant to the
needs of users.

Cont’d
The major reasons for increase in demand of
auditing are:
1. Control Mechanism
Audits whether internally or externally
performed are valued as important control
mechanisms for accountability the overall need
for monitoring activities, especially financial
activity includes the need for auditing to
provide credibility for reported and unreported
information.

Cont’d
2. To resolve Conflict of Interest
The agency relationship that exists between
an owner and manager produces a natural
conflict of interest because of the information
asymmetry that exists between the manager
and the absentee owner.
Whenever there is a conflict of interest
between parties, the need for an arbiter or a
non-partisan view is obvious. Thus an audit is
required for an objective review of the
information.

Cont’d
3. To reduce damaging consequences
Information is used for decisions that have
serious and substantial economic
consequences. Thus the need for an audit for
verifying the accuracy of information before
they are used in decisions that may bring
damaging consequences.
4. To simplify complexity
In our age, financial information & translation
has been come complex in preparation,
content, and format. Therefore it demands
drippy specialized body of knowledge to
prepare (compilation), verify and interpret
them.

Cont’d
5. Regulatory Requirements
Many business laws, memorandum of
association and regulatory agencies acts make
audits annual requirements to be complied
with for renewal of license or permit. For
example the Commercial Code of Ethiopia
(1966), and latter the Public Financial
Regulation of Procl 163/1999 in Ethiopia make
the filing of audited financial statements
annually.
Thus compliance requirements create a very
large demand for auditing services.

Accounting versus Auditing
Many financial statement users and
members of the general public confuse
auditing with accounting.
The confusion results because most auditing
is concerned with accounting information,
and many auditors have considerable
expertise in accounting matters.
The confusion is increased by the fact that
auditing is performed by individuals
described as public accountants.

Cont’d
The function of accounting, to an entity and to
society as a whole, is to provide certain
quantitative information that management
and others can use to make decisions.
To provide relevant information, accountants
need to have a thorough understanding of
the rules and principles and provide the basis
for preparing the accounting information.

Cont’d
Auditing on the other hand is analytical work
that starts with the end product of accounting
to lend credibility and fairness of the
measurements.
In auditing, the concern is with determining
whether recorded information properly
reflects the economic events that occurred
during the accounting period.

Cont’d
In addition to understanding accounting, the
auditor must also possess expertise knowledge
in the accumulation and interpretation of audit
evidence, determining the proper audit
procedures, sample size, particular items to
examine, timing of the tests, and evaluating
the results are unique to the auditor.
It is this expertise that distinguishes auditors
from accountants.

Types of Audits and Auditors
1. Types of Audits
Audits are often viewed as falling into four major
types:
1) Audits of financial statements,
2) Operational audits, and
3) Compliance audits.
4) Information System audit
1. Audits of financial statements: - The goal is to
determine whether the financial statements have
been prepared in conformity with generally
accepted accounting principles or IFRS

Cont’d
2.Operational audits: - An operational audit is
study of some specific unit of an organization for
the purpose of measuring its performance.
The operation of a unit can be evaluated for its
effectiveness and efficiency.
3.Compliance audits: - Compliance audit
determines whether the specified rules,
regulations, or procedures are being carried
out or followed.

Cont’d
2. Operational audits: - An operational audit is study
of some specific unit of an organization for the
purpose of measuring its performance. The
operation of a unit can be evaluated for its
effectiveness and efficiency.
3. Compliance audits :- Compliance audit determines
whether the specified rules, regulations, or
procedures are being carried out or followed.
4. Information system audit: Concerns with the
system used by the organization is appropriate to
detect errors and frauds and to deliver useful
information's to users.

Types of Auditors
 The most known types of auditors are
1. Independent auditors,
2.Internal auditors,
3.Government auditors.
1. Independent (external auditors): - Independent
auditors have no connection to the firm as an
owner or employee/manager. The basic task of
independent auditor is to confirm to the owners
that the employees are correctly reporting on
their financial position and performance.

Cont’d
2. Internal auditor: - 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. Government audit: - The government auditor
is paid a salary by the government. He/she is
responsible to the legislature or executive.

The Nature of Auditing In Ethiopia
In Ethiopia audits seem to be done primary on
account of government regulation.
Auditing in Ethiopia could be viewed in five
main areas.
1. The office of the auditor general (OAG)
 The powers and functions of the office of the
OAG are given through the proclamations that
established it, its sphere of activity lies in
government audit.
2. The audit service corporation. The duty and
functions of this entity involve mostly
commercial audits of commercial and
productive enterprises wholly or partially
owned by government.

Cont’d
3. Ministry of finance audit and inspection.
Auditing activity in this area includes audit of
ministries and government departments by MF
auditors and inspectors, including tax audit by
Revenue authorities.
4. ‘Corporations’ and enterprises’ auditors. These
are audits performed by internal auditors within
enterprise.
5. Private audit firms: Independent audit services
given by private audit firm or idividuals

The Role of Auditing
The auditor’s verification of the financial
information adds credibility to the report and
reduces information risk, or the risk that
information circulated by a company will be false
or misleading, potentially benefiting both the
owner and the manager as well as all other users
as whole.
While other forms of monitoring might be possible,
the extensive presence of auditing in such
situations suggests that auditing is a cost-effective
monitoring device.
But auditing role is highly increasing if measures
or decisions are taken based on audit findings
and auditors opinion.

Auditing, Attest, and Assurance Services
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:

Cont’d
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.
In this section, these services are
presented from the most detailed
(auditing) to the most general
(assurance).

Cont’d
 Auditing services are a subset of attest
services, which, in turn, are a subset of
assurance services.
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 those
assertions and established criteria and
communicating the results to interested
users.

Attestation
Auditors have a reputation for
independence and objectivity.
As a result, in the past various users
requested that auditors provide 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
This definition is broader than the one
previously discussed for auditing because it
is not limited to economic events or actions.
Subject matter in the case of attest services
can take many forms, including prospective
information, analyses, systems and processes,
and behaviour.

Cont’d
However, the auditor’s role is similar: He or
she must determine the correspondence of
the subject matter (or an assertion about
the subject matter) against criteria that are
suitable and available to users.
To accomplish this, the auditor obtains and
evaluates evidence in order to provide
reasonable support for the report.
Note that financial statement auditing is a
specialized form of an attest service.

Cont’d
 Attestation occurs when a practitioner is engaged
to issue or does issue a written communication
that expresses a conclusion about the reliability of
a written assertion that is the responsibility of
another party.
Examples:
 The effectiveness of internal control
 Financial information other than the financial
statements
 Future-oriented financial information
 Compliance with statutory, regulatory, or
contractual obligations
 Management’s discussion and analysis

Assurance:
 Extending auditors’ activities to
assurance services allows the auditor to
report not only on the reliability and
credibility of information but also on
the relevance and timeliness of that
information.
Assurance services are independent
professional services that improve the quality
of information, or its context, for decision
makers.

Cont’d
Examples:
 Risk assessment
 Information system reliability
 Electronic commerce
 Health care performance measurement

The Relationships Among Auditing, Attestation,
and Assurance Engagements
Assurance Services
Any Information
Assurance Services
Any Information
Assurance Services
•Any Information
Attestation Services
•Primarily Financial
Information
Auditing
•Financial
Statements

Relationships among Auditing, Attest, and Assurance
Services
Service
Value Added
to
Information
Reported on
Definition of Service
Auditing Reliability,
Credibility
A report on an examination of a client’s
financial statements (and for a public
client, the entity’s system of internal
control over financial reporting)
Attest Reliability,
Credibility
A report on subject matter, or an
assertion about subject matter, that is
the responsibility of another party
Assurance Reliability,
Credibility
Relevance,
Timeliness
Professional services that improve the
quality of information, or its
Credibility context, for decision makers

Fundamental Concepts in Conducting a Financial
Statement Audit
 The conceptual and procedural details of a
financial statement audit build on three
fundamental concepts:
Audit risk,
Materiality, and
Evidence relating to management’s financial
statement assertions.
 The auditor’s assessments of audit risk and
materiality influence the nature, timing, and
extent of the audit work to be performed (referred
to as the scope of the audit).

1. Audit risk
Audit risk is the risk that the auditor will fail
to express a reservation in his or her opinion
on financial statements that are materiality
misstated.
Audit risk is the risk that the auditor may
unknowingly fail to appropriately modify his
or her opinion on financial statements that
are materially misstated.

Cont’d
The auditor’s standard report states that the
audit provides only reasonable assurance
that the financial statements do not contain
material misstatements.
The term reasonable assurance implies some
risk that a material misstatement could be
present in the financial statements and the
auditor will fail to detect it.

Cont’d
The concept of reasonable assurance means
that an auditor could conduct an audit in
accordance with professional auditing
standards and issue a clean opinion, and the
financial statements might still contain
material misstatements.
Even careful and competent auditors can
only offer reasonable, rather than absolute,
assurance

2. Materiality
The second major concept involved in
auditing
The auditor can only provide reasonable
assurance that all material misstatements are
detected
 The auditor provides no assurance that
immaterial misstatements will be detected.

3. Evidence Regarding Management
Assertions
The third major concept involved in auditing is
evidence regarding management’s assertions.
Most of the auditor’s work in arriving at an
opinion on the financial statements consists of
obtaining and evaluating evidence.
Audit evidence consists of the underlying
accounting data and any additional
information available to the auditor, whether
originating from the client or externally.

Cont’d
Once the auditor has obtained sufficient
appropriate evidence that the management
assertions can be relied upon for each significant
account and disclosure, reasonable assurance is
provided that the financial statements are fairly
presented.
 In obtaining and evaluating the appropriateness
of audit evidence, the auditor is concerned with
the relevance and reliability of the evidence.

Cont’d
Relevance refers to whether the evidence
relates to the specific management
assertion being tested.
 Reliability refers to the diagnosticity of the
evidence. In other words, can a particular
type of evidence be relied upon to signal the
true state of the account balance or
assertion being examined?

Major Phases of the Audit
 The audit process can be broken down into a
number of audit phase
 These phases are sequential, they are
cumulative and interrelated in nature.
 Phases often include:
1. Client acceptance/continuance and
establishing an understanding with the client
2. Preliminary engagement activities
3. Establish materiality and assess risks

Cont’d
4. Plan the audit
5. Consider and audit internal control
6. Audit business processes and related
accounts (e.g., revenue generation)
7. Complete the audit
8. Evaluate results and issue audit report

1. Client Acceptance/Continuance and Establishing
an Understanding with the Client
Professional standards require that public
accounting firms establish policies and procedures
for deciding whether to accept new clients and to
retain current clients.
The purpose of such policies is to minimize the
likelihood that an auditor will be associated with
clients who lack integrity.
If an auditor is associated with a client who lacks
integrity, the risk increases that material
misstatements may exist and not be detected by
the auditor.

Cont’d
The auditor’s understanding of the entity and its
environment
Should include information about each of the
following categories:
 Industry, regulatory, and other external factors.
 Nature of the entity, including the entity’s
application of accounting policies.
 Objectives, strategies and related business risks,
including the entity’s risk assessment process.
 Measurement and review of the entity’s financial
performance.
 Internal control.

2. Preliminary engagement activities
There are generally two preliminary
engagement activities:
(1) Determining the audit engagement team
requirements and
(2) Ensuring the independence of the audit
team and audit firm.
The auditor starts by updating his or her
understanding of the entity and its
environment.

3. Establish materiality and assess risks
 In order to plan the audit properly,
 The audit team must make a preliminary
assessment of the client’s business risks and
determine materiality.
 The audit team relies on these judgments to
then assess risk relating to the likelihood of
material misstatements in the financial
statements.

4. Plan the audit
Proper planning is important to ensure that the
audit is conducted in an effective and efficient
manner.
In developing the audit plan, the auditor should be
guided by
(1) The procedures performed to gain and document
an understanding of the entity and
(2) The results of the risk assessment process.
As part of the planning process, the auditor may
conduct preliminary analytical procedures (such as
ratio analysis) to identify specific transactions or
account balances that should receive special
attention due to an increased risk of material
misstatement.

Cont’d
Audit planning should take into account
the auditor’s understanding of the
entity’s internal control system.
The auditor should prepare a written
audit plan that sets forth the nature,
extent, and timing of the audit work.

5. Consider and audit internal control
 Internal control is designed and effected by an
entity’s board of directors, management, and
other personnel to provide reasonable assurance
regarding the achievement of objectives in the
following categories:
(1) Reliability of financial reporting,
(2) Effectiveness and efficiency of operations, and
(3)Compliance with applicable laws and
regulations.
When obtaining an understanding of the entity
and its environment, the auditor should gain an
understanding of internal control

6. Audit business processes and related accounts
The auditor typically assesses the risk of material
misstatement by examining the entity’s business
processes or accounting cycles (e.g., purchasing
process or revenue process).
The auditor then determines the audit procedures
that are necessary to reduce the risk of material
misstatement to a low level for the financial
statement accounts affected by a particular
business process.
Individual audit procedures are directed toward
specific assertions in the account balances that
are likely to be misstated.

Cont’d
 For example, if the auditor is concerned about the
possibility of obsolete inventory, the auditor could
conduct lower-of-cost-or-market tests to determine if
the inventory on hand is properly valued.
 On most engagements, actually conducting the
planned audit tests comprises most of the time spent
on a financial statement audit or an audit of internal
control over financial reporting.
 For public company clients, the audit of internal control
is done in an integrated way with the financial
statement audit.

7. Complete the audit
After the auditor has finished testing the account
balances, the sufficiency of the evidence gathered is
evaluated.
The auditor must obtain sufficient appropriate
evidence in order to reach and justify a conclusion on
the fairness of the financial statements.
In this phase, the auditor also assesses the possibility
of contingent liabilities, such as
 lawsuits, and searches for any events subsequent to
the balance sheet date that may impact the financial
statements.

8. Evaluate results and issue audit report
The final phase in the audit process is to
evaluate results and choose the appropriate
audit report to issue.
The auditor’s report, also known as the audit
opinion, is the main product or output of the
audit.
 The audit report culminates the process of
collecting and evaluating sufficient appropriate
evidence concerning
the correspondence between management
assertions and the applicable reporting criteria
(usually GAAP, IFRS).

Advanced Auditing and assurance ,chapter1

More Related Content

What's hot (20)

Similar to Advanced Auditing and assurance ,chapter1 (20)

More from seidIbrahim2 (6)

Recently uploaded (20)

Advanced Auditing and assurance ,chapter1