Auditing and

ASSURANCE
SERVICE I

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 CHAPTER ONE

The Nature, Purpose, Scope of Audit

And Assurance Service

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 CHAPTER ONE
The Nature, Purpose, Scope of Audit And
Assurance Service
• The historical development of auditing is related to
the development of accounting.
• In the earlier periods, the owners of business can
manage their businesses and the need for independent
auditors is minimal.
• But because of the increase in complexity of business
and different parties interested in achieving their
objectives, the need for an independent auditor is
becoming more important.
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Auditing is defined as, the accumulation and
evaluation of evidence about information, to
determine and report on the degree of correspondence
between the information and established criteria.

Whereas, Accounting is the process of identifying,

analyzing, recording, summarizing, and
communicating financial information about a business
enterprise for sound financial decision.

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1.1. Historical Development and Evolution of
Auditing
The development of auditing is closely related, to the
development of organized systems of accounting.
• The term being derived from the Latin word 'audire,'
which
means to 'hear'.
•

Read historcal development of Auditing till 20th

century

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• These 20th century developments in auditing may
be helpful to you in understanding the direction in
which auditing is moving.
Among them, the most significant developments
are as follows: -
a) A shift in emphasis from the detection of fraud to the
determination of fairness of financial statements.

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b) Increased responsibility of the auditors to third parties,
such as governmental agencies, stock exchanges and an
investing public.
c)The change of auditing method from detailed examination
of individual transaction, to the use of sampling
techniques, including statistical sampling.
d)Recognition of the need to consider internal control as a
guide to the direction and amount of testing & sampling to
be preformed.

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e) Development of new auditing procedures applicable to
electronic data processing systems and use of the computer as
an auditing tool.
f) Recognition of the need for auditors to find means of
protection from the current wave of litigation.
g) An increased demand for prompt disclosure of both
favorable and unfavorable information concerning any
publicly owned company.
h) Increased concern with compliance by organizations with
laws and regulations.
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 1.2. Definition and Terminologies of
Auditing
• The following are definitions of Auditing, which explain auditing in a
comprehensive manner.
a) In its modern sense, an audit is defined as a process carried out by
suitably qualified auditors whereby the accounting records of the
business entity are subject to inspection in such due as will enable the
auditors to form an opinion as to their truth, fairness and
accuracy.
b) Auditing is also described as a process of collection and evaluation
of evidence for the purpose of reporting on economic information.

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c) The institute of chartered accountants of India has defined
auditing as "a systematic independent examination of data,
statements, records, operations and performances of an
enterprise for a stated purpose.
d) According to Arens & Loebbecke, auditing is defined as,
the accumulation and evaluation of evidence about
information to determine and report on the degree of
correspondence between the information and established
criteria.
• It be done by a competent independent person.

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• The description of auditing by Arens and Loebbecke includes
several key terminologies which are important.
 Information and established criteria: To do an audit, there must be
information in a verifiable form and some standards [criteria] by which the
auditor can evaluate the information.

 Accumulating and evaluating evidence: any information used by the

auditor (oral testimony, written communication and observation).

 Competent, independent person: The auditor must be qualified &

competent and must have an independent mental attitude.

 Reporting: The final stage in the audit process is the audit report,
which is the communication of the findings to users.
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 Difference between Auditing and Accounting
Accounting is the recording, classifying and
summarizing economic events in logical manner
for the purpose of providing information for
decision making.
In auditing the accounting data, the concern is
with determining whether the recorded
information properly reflects the economic events
that occur during the accounting period.
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 Accounting Auditing of financial statement
 Is the process of identifying ,measuring,  Is the process of obtaining and evaluating
recording and communicating economic evidences and determining the fairness of
information about an organization in financial statement inconformity with
conformity with GAAP/IFRS GAAS
 Deliver financial statements to users  Deliver audit report(opinion) to users
 Precede/lead auditing  Begins when accounting ends
 No prescribed qualification is legally  The external auditor must be chartered
required for the accountant accountant(CPA)
 All accountant may not have auditing  Auditors must have accounting knowledge
knowledge
 An accountant is an employee of the firm  An auditor is independent professional
(External)
 Constructive and theoretical  Critical aspect of accounting and analytical
in nature
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 Accountant are generally appointed by  An Auditor is appointed by the
 1.3. Nature, Purpose and Scope of Auditing
Nature of Auditing
Framework of Auditing and Assurance Standards &
Guidance Notes on Related service issued recently,
distinguishes audits from related services.

Related services comprise reviews, agreed-upon procedures

and compilations.

Audits and reviews are designed to enable the auditor to

provide high and moderate levels of assurance respectively,
such terms being used to indicate their comparative ranking.
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 Nature of Auditing
• 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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 Accumulating and evaluating
evidence
• Evidence is any information used by the
auditor to determine whether the
information being audited is stated in
accordance with the established criteria.
• Transaction data
• Client Testimony
•Written and electronic Communications
with outsiders
• Observations

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 Example
• Observations=Inventory Take Cash Count
• Written and electronic Communications with
outsiders=
– A/R Customers
– A/P Suppliers
– Cash Bank
• Transaction data
– A/R ---------Sales Invoice
– A/P------Purchase Order
• Client Testimony

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 Competent, Independent Person
• Auditing should be done by a competent and
independent person.
• Competence=Skill Qualification Experience
Judgment
• Independence : No bias , No conflict of interest
&/or undue influence.
• Evaluation of Evidence: Proper Conclusion
• The final step communicates the findings to
users.

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 Importance of auditing
in reducing information risk.
• Economic demand for auditing
• Demand Driver=Information risk
• Auditing can have a significant effecton
information risk.
• What is meant by “Information risk”?

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 Causes of informationrisk
• Causes of information risk
 Remoteness of information
 Biases and motives of the provider
 Voluminous data
 Complex exchange transactions

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 Reducing information risk
 User verifies information
 User shares information risk with
management
 Audited financial statements are provided

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 Describe assurance services and distinguish audit
services from other assurance and non-assurance
services provided by CPAs.

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 Assurance
Services
An assurance service is an independent
professional service that improves the
quality of information for decision
makers.
 Assurance services can be done by
CPAs or by a variety of other
professionals. For example, Consumers
Union, a non-prof it organization, tests a
wide variety of products used by
consumers and reports their evaluations
of the quality of the products tested in
Consumer Reports.

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 Attestation Services

An attestation service is a type of assurance

service in which the CPA firm issues a report
about a subject matter or assertion that is made
by another party.
Primary categories of attestation services
include:
1)Audit of historical financial statements
2)Audit of internal control over financialreporting
3)Review of historical financial statements
4)Other attestation services that may
beapplied to a broad range of subject matter

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 Attestation Services cont'd…

1)Audit of historical financialstatements

In an audit of historical financial
statements, management asserts that the
financial statements are fairly stated in
accordance with applicable,
Audits are designed to provide reasonable
assurance that the financial statements are
free of material misstatements.
1-22

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 Attestation Services cont'd…

2) Audit of internal control over financial

reporting
an audit of internal control over financial
reporting, management asserts that internal
controls have been developed andimplemented
3) Review of historical financial statements
Management asserts that the statements are
fairly stated in accordance with accounting
standards(IFRS), the same as for audits.

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 Attestation Services cont'd…

4) Other attestation services that may be applied to a

broad range of subject matter
 Typically, the CPA is engaged to provide written
assurance about the reliability of an assertion made by
management.
5) Other assurance Services
 These assurance services differ from attestation
services in that the CPA is not required to issue a
written report, and the assurance does not have to be
about the reliability of another party’s assertion about
compliance with specified criteria.
• These other assurance service engagements focus on
improving the quality of information for decisionmakers, just
like attestation services.

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 Attestation Services cont'd…

Five
Categories
1. Audit 3. Review
Historical
Financial
Statements

2. Internal
Control over 4. I
Financial 5. Other
Reporting
n
f
o

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 Cont’d
• 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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 Non-assurance Services provided by CPAs

• CPA firms perform numerous other services that generally fall

outside the scope of assurance services. Three specific examples
are:
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 similarity between some
consulting and assurance services. 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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Non-assurance Services provided by CPAs

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 Differentiate the three main
typesof audits.

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 Types of Audit
 Operational Audit

 Compliance Audit

 Financial Statement Audit

 Forensic Audit

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 Operational Audit

 Operational Audit : An operation audit is a systematic

independent appraisal activity within an enterprise,
for a review of the entire departmental performance.
 Assess the organizations control mechanism for
their overall efficiency and reliability.
 It is to assist all levels of management in the effective
discharges of responsibilities, by furnishing (providing)
them with objective analysis, appraisal,
recommendations and pertinent comments concerning
the activities reviewed.
 Internal auditors often perform operational audits.

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 Compliance Audit
 Evaluate compliance with applicable laws, regulations,
policies and procedures. Some of this regulations may
have a significant impact on the company's financial
well-being.
It is dependent upon the existence of verifiable data and of
recognized criteria or standard established by an authoritative
body.
It is 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 non profit making organizations.
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 Financial Statement Audit

Audit of financial statements is actually part of the

broader concept of the attest/confirm/affirm
function.
To attest to financial statements is to provide
assurance as to their fairness and dependability.
The attest function consists of two phases:-
A. The first is the performance of an audit;
B. The second is the issuance of an audit report.

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The audit of FSts. ordinarily covers the balance
sheet and the related statements of profit and loss
and cash flows.
The goals of audit of FSts. are to determine whether
the statements have been prepared in conformity
with GAAP/ IFRS.
FSts. audits are normally performed by certified
public accountants (CPAs).
The contribution of the independent financial audit is
to give credibility to financial statements.

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The word “audited” when applied to financial statements
means that; balance sheet, profit and loss statements and
cash flows are accompanied by an audit report prepared by
independent auditors’ expressing their professional opinion
as to fairness of the enterprise's financial statements.

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The Objectives of Audit of Financial Statements are:
To determine whether financial statements have been
prepared in accordance to GAAP/IFRS.
To ensure the completeness of financial statements.
To vouch/insure 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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 Forensic Audit
 Forensic Audit is an examination and evaluation of a
firm or an individuals financial records to derive
evidence that can be used for different functions.
 A forensic audit used to uncover criminal behavior
such as fraud or embezzlement.
 The examination of a company accounts and financial
record to find illegal financial activity.
 Essential to identify fraud and concealed activity
discovered.
 The main purpose is to derive evidence that could
potentially be used in court.

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 Operational Audit

Example Evaluate computerized payroll system

for efficiency and effectiveness
Information Number of records processed, costs
ofthe department, and number of
errors
Established Company standards for efficiency and
Criteria effectiveness in payroll department
Available Error reports, payroll records,
andEvidence payroll processing costs

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 Compliance Audit

Compliance Audit
policies, procedures, rules and regulations.
Determine whether bank requirements
Example
for loan continuation have been met

Information Company records

Established
Loan agreement provisions
Criteria
Available Financial statements and
Evidence calculations by the auditor
33

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 Financial Statements of Audit
Checks if financial statements are prepared/stated in
accordance with specified criteria(International (IFRS)
Annual audit of Boeing’s financial
Example
statements

Information Boeing's financial statements

Established
International IFRS
Criteria
Available Documents, records, and outside
Evidence sources of evidence
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 Forensic Audit
A forensic audit is an examination and evaluation of a firm's or
individual's financial records to derive evidence that can be used in a court
of law or legal proceeding.

Example Tax evasion investigation

Information ABC International's financial statements

Established Tax regulations

Criteria International GAAP/IFRS
Available Documents, records, and outside
Evidence sources of evidence
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 Types of auditors
Certified public accounting firms:
Certified public accounting(CPA) firms are
responsible for auditing the historical financial
statements of all publicly traded companies, most
other reasonably large companies, and many
smaller companies and noncommercial
organizations.
Government Accountability Office Auditor
Auditor working for the Government Accountability
Office (GAO), a nonpartisan agency in the legislative
branch of the federal government. Headed by the
Comptroller/Audit General, the GAO reports to and is
responsible solely to Congress/House of Peoples
Re1p
-
entative
res
37

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 Types of auditors
IRA(internal revenue agents)
IRA(internal revenue agents) is responsible for enforcing the federal
tax laws as they have been defined by Congress and interpreted is
responsible for enforcing the federal tax laws as they have been defined
by Congress and interpreted by the courts. A major responsibility of the
IRS is to audit taxpayers’ returns to determine whether they have
complied with the tax laws. These audits are solely compliance audits.
The auditors who perform these examinations are called internal
revenue agents.
• Internal auditors are employed by all types of organizations to audit for
management with oversight by the board of directors, much as the GAO
does for Congress. Internal auditors’ responsibilities vary considerably,
depending on the employer. To maintain independence from other
business functions, the internal audit group typically reports directly to
the president, another high executive officer, or the audit committee of
the board of directors. However, internal auditors cannot be entirely
independent of the entity as long as an employer–employee relation38ship
exists.

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 Types of auditors
Internal auditor is an independent appraisal activity
established within an organization or enterprise to
examine and evaluate its activities, as a service to the
organization in the effective discharge of their
responsibilities.

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It is a part of the organization's internal control structure.
They represent high level control that functions by
measuring and evaluating the effectiveness of other internal
control policies and procedures.

It is not merely concerned with the organization's financial

controls. Their work encompasses the entire internal
control structure of the organization or enterprise.

The internal auditing head often accordingly reports to the

general manager or board of directors or president or
another high executive.
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 •8
Describe the requirementsfor becoming
Certified Accountant.
•

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 Three requirementsfor becoming a
Certified Accountant.

Educational requirement

Uniform CPA examination requirement

Experience requirement

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Educational Requirement Examination Requirement

•14 Papers
An undergraduate or •A person can sit four
graduate degree with a Experience
times a year .
major in business requirement
studies or any other Minimum of 3
field years as
Depending on a
person’s background an audit manager.
the association
provides exemptions
of 4 papers.

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 CPA Examination section

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 END OF
CHAPTER ONE

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