Chapter Two

The Financial
Statement
Auditing Environment

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A Time of Challenge and Change

1990 2000

During the economic boom of the late

1990s and the early 2000s, accounting
firms aggressively sought opportunities
to market a variety of high-margin
non-audit services to their audit
clients.

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A Time of Challenge and Change

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 A Series of Scandals

Enron
WorldCom

Parmalat
Lernout &
Hauspie
Ahold
Arthur
Andersen
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 Regulation

Self-regulation by the profession

versus
government regulation

Stricter regulation and more public

oversight
International Standards on Auditing
more comprehensive

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 Auditors’ Legal Liability

Threat of legal liability:

Main deterrent to auditor’s
misconduct

Legal doctrines:
•Joint and several liability
•Proportional liability
•Liability caps

Litigation exposure and audit markets:

•Concentration
•Barriers to entry
•Liability reforms
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International Federation of Accountants
(IFAC)

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International Organisations that Affect
the Accounting Profession
International Federation International Accounting
of Accountants Standards Board
IFAC IASB

International International Organization

Organization of of Supreme Audit
Securities Commissions Institutions
IOSCO INTOSAI
European Union United States
EU Securities and Exchange Commission
(SEC)
Public Company Accounting Oversight
EU 8th Directive on Statutory Board (PCAOB)
Audits Financial Accounting Standards Board
(FASB)
American Institute of Certified Public
Accountants (AICPA)
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International Auditing and Assurance
Standards Board (IAASB): Standards

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 Auditing Standards
Auditing standards serve as
guidelines for and measures of
the quality of the auditor’s
performance.

IAASB issues
International ISAs are
Standards on Auditing considered to
(ISAs). be minimum
standards of
IFAC performance
members for auditors.
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General Principles and Responsibilities
• ISA 200 Overall Objectives of the Independent Auditor and
the Conduct of an Audit in Accordance with International
Standards on Auditing
• ISA 210 Agreeing the Terms of Audit Engagements
• ISA 220 Quality Control for an Audit of Financial Statements
• ISA 230 Audit Documentation
• ISA 240 The Auditor’s Responsibilities Relating to Fraud in an
Audit of Financial Statements
• ISA 250 Consideration of Laws and Regulations in an Audit of
Financial Statements
• ISA 260 Communication with Those Charged with
Governance
• ISA 265 Communicating Deficiencies in Internal Control to
Those Charged with Governance and Management
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Risk Assessment and Response to
Assessed Risks

• ISA 300 Planning an Audit of Financial Statements

• ISA 315 Identifying and Assessing the Risks of Material
Misstatement through Understanding the Entity and Its
Environment
• ISA 320 Materiality in Planning and Performing an Audit
• ISA 330 The Auditor’s Responses to Assessed Risks
• ISA 402 Audit Considerations Relating to an Entity Using a
Service Organization
• ISA 450 Evaluation of Misstatements Identified during the
Audit

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 Audit Evidence
• ISA 500 Audit Evidence
• ISA 501 Audit Evidence – Specific Considerations for
Selected Items
• ISA 505 External Confirmations
• ISA 510 Initial Engagements – Opening Balances
• ISA 520 Analytical Procedures
• ISA 530 Audit Sampling
• ISA 540 Auditing Accounting Estimates, Including Fair Value
Accounting Estimates, and Related Disclosures
• ISA 550 Related Parties
• ISA 560 Subsequent Events
• ISA 570 Going Concern
• ISA 580 Written Representations
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 Using Work of Others

• ISA 600 Special Considerations – Audits of Group Financial

Statements (Including the Work of Component Auditors)
• ISA 610 Using the Work of Internal Auditors
• ISA 620 Using the Work of an Auditor’s Expert

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Audit Conclusions and Reporting

• ISA 700 Forming an Opinion and Reporting on Financial

Statements
• ISA 705 Modifications to the Opinion in the Independent
Auditor’s Report
• ISA 706 Emphasis of Matter Paragraphs and Other Matter
Paragraphs in the Independent Auditor’s Report
• ISA 710 Comparative Information – Corresponding Figures
and Comparative Financial Statements
• ISA 720 The Auditor’s Responsibilities Relating to Other
Information in Documents Containing Audited Financial
Statements

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 Specialised Areas

• ISA 800 Special Considerations – Audits of Financial

Statements Prepared in Accordance with Special Purpose
Frameworks
• ISA 805 Special Considerations – Audits of Single Financial
Statements and Specific Elements, Accounts or Items of a
Financial Statement
• ISA 810 Engagements to Report on Summary Financial
Statements

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 Sections in ISAs

•Introductory material
•Objectives
•Definitions
•Requirements
•Application and other
explanatory material

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 Society’s Expectations and
the Auditor’s Responsibilities
The auditor has a responsibility to plan and
perform the audit to obtain reasonable
assurance about whether the financial
statements are free of material misstatement,
whether caused by error or fraud.
Because of the nature of
The auditor has no responsibility
audit evidence and the
to plan and perform the audit to
characteristics of fraud, the
obtain reasonable assurance
auditor is able to obtain
that misstatements, whether
reasonable, but not
caused by errors or fraud, that
absolute, assurance that
are not material to the financial
material misstatements are
statements will be detected.
detected.

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Ethics, Independence, and IFAC Code of
Ethics for Professional Accountants

Ethics refers to a system or code of conduct

based on moral duties and obligations that
indicates how we should behave.

Professionalism refers to the conduct, aims,

or qualities that characterise or mark a
profession or professional person. All
professions operate under some type of code
of ethics or code of conduct.

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Ethics, Independence, and IFAC Code of
Ethics for Professional Accountants
IFAC Code of
Ethics
Conceptual
Framework Approach

Principles
•Integrity Application to
•Objectivity specific situations,
•Professional competence including situations
and due care that threaten
•Confidentiality independence of
• Professional behaviour mind or
independence in
appearance
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 Audit Firms
Audit firms range in size from a single proprietor to
thousands of owners (or “partners”) and thousands
of professional and administrative staff employees.

Big 4 Mid-Tier National Local

BDO
PwC
Grant
Thornton
Deloitte
RSM
EY Praxity
Baker Tilly
KPMG Crowe
Horwath

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Annual Global Revenue of Major Audit
Network Firms

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 Audit Teams

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Types of Services Offered by Audit Firms

Assurance Services:
Audit of financial statements, review of financial information, and
other assurance services (e.g. assurance on a entity’s reporting
on sustainability performance)
Related Services:
Agreed-upon procedures regarding financial information and
compilation of financial information
Other Services:
Tax services, advisory services, accounting services and
specialised services (e.g. forensic audit)

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Global Practice Mix of Services by Major
Audit Network Firms (Revenue)

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 Types of Auditors

External Auditors Internal Auditors

Government
Forensic Auditors
Auditors

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Context of Financial Statement Auditing

The primary context with which an auditor is concerned is the

industry or business of his or her audit client. In other words,
the context provided by the client’s business impacts the auditor
and the audit, and is thus a primary component of the
environment in which financial statement auditing is conducted.

How would your concerns about the inventory

account differ for a Computer Hardware
Manufacturer and a Jewellery Store?
What assertions would you be most concerned
about and why?
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 A Model of Business
Business organizations exist to create value for their
stakeholders. Due to the way resources are invested
and managed in the modern business world, a
system of corporate governance is necessary,
through which managers are overseen and
supervised.

Board of Directors

Audit
Committee

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 A Model of Business

Objectives Strategies

Processes
(5 broad
categories)

Controls Transactions

Reports

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A Model of Business Processes:
Five Components

Financing Purchasing
Process Process

Human
Resource
Management
Process

Inventory
Management Revenue
Process Process

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An Overview of Business

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 Management Assertions
Financial statements issued by
management contain explicit and implicit
assertions.

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 Management Assertions –
An Example with Inventory
Which specific assertion from the relevant category
is being described in the three examples below?

Transactions Account Presentation

Balances & Disclosure

Management Management Management

asserts that asserts that the asserts that the
transactions entity owns the financial
related to inventory statements
inventory actually represented in the properly classify
occurred. inventory account. and present the
inventory.
Occurrence Rights and
Obligations Classification
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 End of Chapter 2

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