Kotebe Metropolitan University

Course Name :Advanced Audit

By : Tekabe S.(Assistant Professor )

• Course Objective :
• At the end of this course the student able to explain :
 the concept of audit
 The d/t between Accounting and auditing
 Professional ethics in auditing
 Personal liability
 Audit planning
 internal control
 Types of audit report
chapter content :

Chapter One : an overview of auditing

 Definitions of auditing
 Distinguish b/n auditing and accounting
 Types of audits and auditor
 Types of auditors
 Assurance and non-assurance services
 The economic demand for auditing
Chapter Two: Professional auditing standards
 What is auditing standards
 Generally accepted auditing standards
 Professional qualification requirements
 Professional ethics
 Legal responsibility and liability of auditors
Chapter Three : planning and conducting the audit
 Main reasons for planning
 Planning an audit and designing an audit approach
CHAPTER FOUR: AUDITS OF INTERNAL CONTROL AND CONTROL RISK
Definition of internal control
Internal Control Objectives
Management and Auditor Responsibilities Related to Internal Control
Five Components of Internal Control
Process for Understanding Internal Control and Assessing Control Risk
Unit five : AUDIT REPORT
Types of audit report
 unqualified audit report
 unqualified audit report with modifying words
 Qualified audit report
 Adverse
 Disclaimer
• Reference
• Text Book
• Auditing, an integrated Approach by A. Arence, James K.
Loebbecke
• Evaluation
• Two individual assignment 30%
• One group Assignment =30%
• Final exam =40%
 Advanced Auditing

CHAPTER ONE

AN OVERVIEW OF AUDITING

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 1.1 INTRODUCTION
Reliable information is necessary if managers, investors,
creditors, and regulatory agencies are to make informed
decisions about resource allocation.
Auditing play an important role in this process by
providing objective and independent reports on the
reliability of information.
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 Cont’d…

 By adding the audit function to each situation, the

users of the financial statements have reasonable
assurance / guarantee that the financial statements
do not contain material misstatements or
omissions.
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 1.2. NATURE OF AUDITING
 1.2.1 Definition of Auditing

AAAs Committee on Basic Auditing concepts

developed a definition of auditing as follows:

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 Cont’d…
Auditing is

A systematic process of objectively / factually

obtaining and evaluating evidence regarding assertions
about economic actions and events to ascertain the degree
of correspondence between those assertions &
established criteria and communicating the results to
interested users.
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 Cont’d…
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.
Auditing should be done by a competent, independent
person.
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 Cont’d…
 Thus, auditing encompasses both an investigating
process and a reporting process.
In the audit of an entity's financial statements –Called a
financial statement audit :
investigation means :

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 Cont’d…
 systematic gathering & evaluation of evidence as a basis
for reaching an opinion about whether assertions made by
management in an entity's financial statements correspond
in all material respects with generally accepted accounting
principles (GAAP) or International financial reporting
standard (IFRS).
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Cont’d…

For example, management asserts all inventories exist

represent properties or rights of the entity, reflect all
related transactions for the period, are valued at
appropriate amounts, and are presented properly in the
financial statements.

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 Cont’d…

The opinion an auditor express in all audit report

depends on the information content of evidence

gathered during the audit and indicate either the

financial statements are presented fairly in conformity

with GAAP, IFRS or are not presented fairly.

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 Cont’d…

The International Federation of Accountants (IFAC) defines

an audit as:

 a work performed by an auditor to enable him/her to express an

opinion whether the financial statements are prepared, in all
material respects, in accordance with an identified financial
reporting framework.
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 Cont’d…

Therefore, an audit gives a reasonable assurance that the

financial statements must be free from material

misstatements.

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 1.3. Distinguish B/n Auditing and Accounting

Accounting is the recording, classifying, and summarizing of

economic events for the purpose of providing financial information
used in decision making.
Auditing is determining whether recorded information
properly reflects the economic events that occurred during the
accounting period.
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Accounting Provide certain quantitative information that management
and others can use to make decisions.
While Auditing is

Analytical work that starts with the end product of accounting to

lend credibility and fairness of the measurements.
In auditing, the recorded information properly reflects the economic
events that occurred during the accounting period.

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The auditor must also possess expertise knowledge in the
accumulation/gathering and interpretation of audit
evidence /facts.
When auditing accounting data, auditors focus on
determining whether recorded information properly reflects
the economic events that occurred during the accounting
period.
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Because GAAP or international accounting
standards provide the criteria for evaluating whether
the accounting information is properly recorded,
auditors must thoroughly understand those
accounting standards.

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 1.4 TYPES OF AUDITS AND AUDITORS

1.4.1. TYPES OF AUDITS

Generally there are three types of audits:

1. Financial statement audit

2. Compliance audits, and

3. Operational audit
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 1. Financial Statement Audit
The audit of financial statements ordinarily covers the
balance sheet and the related statements of income,
retained earnings, and cash flows.
The goal is to determine whether these statements have
been prepared in conformity with specified criteria.

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The criteria may be;

International Financial Reporting Standards (IFRS),

Generally accepted accounting principles (GAAP) as in the

USA,
National company laws as in Northern Europe, or

The tax code in South America

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Financial statement audits are normally performed
by firms or certified public accountants
(CPA)
 Users of auditors' reports include management,
investors, bankers (creditors) and government
agencies and etc
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 2. Compliance Audits
Is a review of an organization’s procedures to determine whether
the organization is following specific procedures, rules or
regulations set out by some higher authority.

The purpose of compliance audit is; Dependent upon the

existence of verifiable data and of recognized criteria or

standards, such as established laws and regulations, and or an

organization's policies and procedures. 26

Like an independent financial statement audits, a
compliance audit is designed to determine whether an entity's
financial statements are presented fairly in accordance with
generally accepted accounting principles or not.
Compliance audits are conducted by either independent
auditors or government auditors.

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 3. Operational Audits

An operational audit involves a systematic review of an

organization's activities, or a part of them, in relation
to the efficient and effective use of resources. Sometimes
this type of audit is referred to as a performance audit or
management audit:

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Effectiveness is a measure whether an organization achieves its
goals and objectives.
Efficiency shows how well an organization uses its resources to
achieve its goals.

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 1.4.2 TYPES OF AUDITORS

1. Internal Auditors,

2. External Auditors and

3. Government Auditors.
One important requirement of each type of auditor is
independence, in some manner form the entity being
audited.
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 1. Internal Auditors
A principal goal is to investigate and evaluate the effectiveness
with which the various organizational units of the company are
carrying out their assigned functions.
The institute of Internal Auditors (IIA) has developed a set of
standards that should be followed by internal auditors and has
established a certification program.

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An individual meeting the certification requirements set
by the IIA, passing a uniform written examination, can
become a certified internal auditor (CIA).
Like external auditors, internal auditors must be objective/ and
independent.

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The IAs are employees of the company in which they work,
subject to the employer – employee relationship.
Their primary activities are to conduct compliance and
operational audits within their organization.
However, they may also assist the external auditors with the
annual financial statement audit.

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 2. External Auditors
External auditors are often referred to as independent auditors or
certified public accountants.
Such auditors are called "external" because they are not employed
by the organization being audited.
An external auditor conducts financial statement audits.
They may also conduct compliance and operational audits.
An external auditor practice as a sole proprietor or as a member of a
CPA firm.
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Professionals standards require that external auditors
maintain their objectivity and independence when
providing auditing or other attestation services for clients.

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 3.Government Auditors
The primary responsibility of the government audit staff
is to perform the audit function for government.
The extent and scope of the audits performed are
determined by legislation in the various jurisdictions.

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 1.5. Assurance and non-assurance services
1.5.1. Assurance services
ASs are professional services that improve the quality of
information for decision makers.
Individuals who are responsible for making business decisions
seek assurance services to help improve the reliability and
relevance of the information.
Can be performed by CPAs or by a variety of other professionals.
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 Attestation Service

An attestation service is a type of assurance service in

which the CPA firm issues a report about the reliability
of an assertion/statements that is made by another
party.

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 1. Audit of Historical Financial Statements
 In this audit,
Management asserts that the statements are fairly stated in
accordance with applicable GAAP or international accounting
standards.

It is a form of attestation service in which the auditor issues a

written report expressing an opinion about whether the financial
statements are fairly stated in accordance with the applicable
accounting standards. 40
2. Audit of Internal Control over Financial Reporting
Internal controls have been developed and implemented following well
established criteria

3. Review of Historical Financial Statements

The statements are fairly stated in accordance with accounting standards,
the same as for audits.
The CPA provides a lower level of assurance for reviews of Financial
statement compared to a high level for audits, therefore less evidence is
needed.
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4. Attestation Services on Information Technology
For attestations on information technology, management makes
various assertions about the reliability and security of electronic
information.
 Many business functions, such as ordering and making payments,
are Conducted over the Internet or directly between Computers
using electronic data interchange (EDI).

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Relationships Among Auditors, Client, and External Users

Auditor issues
Client or audit Auditor report relied upon by
committee hires users to reduce
auditor information risk

Client Provides capital External

Users
Client provides financial
statements to users 43
 5. OTHER ASSURANCE SERVICES

Most of the other assurance services that CPAs provide do not

meet the formal definition of attestation services.
The CPA is not required to issue a written report.

The assurance does not have to be about the reliability of

another party’s assertion about compliance with specified
criteria.

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45
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No assurance Services Provided by CPAs

1. Accounting and bookkeeping services

2. Tax services

3. Management consulting services

Most accounting and bookkeeping services, tax services, and
management consulting services fall outside the scope of
assurance services, although there is some common area of
overlap between consulting and assurance services. 48
While the primary purpose of an assurance service is
to improve the quality of information,
The primary purpose of a management consulting
engagement is to generate a recommendation to
management.

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 1.6. THE ECONOMIC DEMAND FOR AUDITING
If the bank makes the loan, it will charge a rate of interest determined
primarily by three factors:

1.Risk-free interest rate: Is the rate the bank could earn by investing in
treasury notes for the same length of time as the business loan.

2. Business risk for the customer: possibility that the business will not
be able to repay its loan because of economic or business conditions,

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3. Information risk.
Information risk reflects the possibility that the
information upon which the business risk decision was made
was inaccurate.
A likely cause of the information risk is the possibility of
inaccurate financial statements.

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Auditing has no effect on either the risk-free interest rate or business
risk,
But it can have a significant effect on information risk.
If the bank officer is satisfied that there is minimal information risk
because a borrower’s financial statements are audited, the bank’s risk is
substantially reduced and the overall interest rate to the borrower can be
reduced.
The reduction of information risk can have a significant effect on the
borrower’s ability to obtain capital at a reasonable cost.
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“Why do organizations request an audit?"

Among the reasons the majors are the following:

1. Control Mechanism

Audits whether internally or externally performed are valued as

important control mechanisms for accountability, the overall
need for monitoring/supervise activities, for credibility/
trustworthiness for reported and unreported information.
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 2. 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.

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Information asymmetry ----- that the manager generally
has more information about the "true" financial position
and results of operations of the entity than the absentee
owner does.

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 3. Consequences
Accounting provides information for economic decision-making.

This Information is used for decisions that have serious and

substantial economic consequences.
Thus, the need for an audit is verifying the accuracy of
information before they are used in decisions.

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 4. Remoteness of information
Because of the separateness of the management from the
owners; information is prepared in a place far from the user.
The user is prevented from directly assessing the quality of
information he/she obtains.
Thus, the need for auditor services is to assess the information
on the users' behalf.

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 5. Regulatory Requirements
Many business laws, memorandum of association and
regulatory agencies acts make audits annual
requirements to be complied/act in accordance with for
renewal of license or authorize.

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For example the security exchange commission (SEC) in the
US; 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.

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• As society becomes more complex, decision makers are more
likely to receive unreliable information. There are several
reasons for this:
• remoteness of information, biases and
• motives of the provider, voluminous data, and the existence
of complex exchange transactions.

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Biases and Motives of the Provider
If information is provided by someone whose goals are inconsistent
with those of the decision maker, the information may be biased in favor
of the provider.
The reason can be honest optimism about future events or an intentional
emphasis designed to influence users. In either case, the result is a
misstatement of information.
For example, when a borrower provides financial statements to a lender,
there is considerable likelihood that the borrower will bias the statements
to increase the chance of obtaining a loan.
The misstatement could be incorrect birr amounts or inadequate or
incomplete Disclosures of information.

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Voluminous Data:
As organizations become larger, so does the volume of their
exchange transactions. This increases the likelihood that improperly
recorded information is included in the records—perhaps buried in a
large amount of other information.

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Complex Exchange Transactions In the past few decades,
exchange transactions between organizations have become
increasingly complex and therefore more difficult to record
properly.
• After comparing costs and benefits, business managers and
financial statement users may conclude that the best way to
deal with information risk is simply to have it remain
reasonably high.
• For larger businesses, it is usually practical to incur costs to
reduce information risk. There are three main ways to do so.

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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.
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
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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.

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END OF CHAPTER ONE

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