Auditing Principles and

Practices I
CHAPTER ONE
AN OVERVIEW OF AUDITING
 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.

The historical development of auditing is related

to the development of accounting. 2
 1.1 INTRODUCTION
The available evidence indicates that a system of auditing
existed even in times of ancient civilizations. For example:-
Mesopotamian:- leftovers of commercial transactions in
Mesopotamian reveal tiny marks, dots, ticks, and circles at
the side of the figures which indicates that those figures
had been checked.
In ancient Egypt:- there were two officials recorded fiscal
receipts separately and other officials conducted the audit.
3
 1.1 INTRODUCTION
In Greece:- the accounts of public officials
were reviewed at the expiring of their terms of
office which has a sense of auditing concept.
In United kingdom:- In the UK during the
12th century records revealed that the
existence of a system of accounting and
auditing of the transactions of the state. 4
 1.1 INTRODUCTION
• 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.

5
 1.1 INTRODUCTION
• The term being derived from the Latin word
'audire,' which means to 'hear'.
• The 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: -

6
 1.1 INTRODUCTION
a) A shift in emphasis from the detection of fraud to the
determination of fairness of financial statements.
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.
7
 1.1 INTRODUCTION
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.
8
 1.2. NATURE OF AUDITING

1.2.1 Meaning of Audit

• Definition: The following are definitions of
Auditing, which explain auditing in a
comprehensive manner.
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
9
form an opinion as to their truth, fairness and
 Cont’d…

Auditing is :
 Ray (2003) defined as: auditing is concerned with the
verification of accounting data, with determining the accuracy
and reliability of accounting statements and reports.
 Spicer and Peglar also defined auditing as “An examination
of the books, accounts and vouchers of a business’s that
enable the auditor to satisfy himself whether or not the
balance sheet is properly drawn up so as to exhibit a true and
correct view of the state of the business.
10
 Cont’d…

Auditing is :
According to Arens & Loebbecke, 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. 11
 Cont’d…
 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).
12
 Cont’d…
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.
13
 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 :
14
 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).
Therefore, an audit gives a reasonable assurance that the
financial statements must be free from material
misstatements. 15
 Some basic features of Auditing
1. Audit is a systematic and scientific examination
of books of accounts of a business;
2. Audit is undertaken by an independent person or
body of persons who are duly qualified for job.
3. Audit is a verification of results shown by profit
and loss account and the state of affairs as
shown by balance sheet. 16
 Cont….
4. Audit is a critical review of the system of accounting and
internal control.

5. Audit is done with the help of vouchers, documents, information

and explanations received from authorities.

6. Auditor has to inspect, compare, check, review, scrutinize

vouchers supporting transactions and examine correspondence,
minute books of shareholders, directors, Memorandum of
Association and Articles of association etc., in order to establish
correctness of books of accounts. 17
 Cont’d…

2. Assurance Services Overview

• Definition: Assurance services are professional
engagements designed to improve the reliability of
information, which is critical for decision-making by
stakeholders.
• These services go beyond financial statement audits
and include non-financial information reviews.
18
 Cont’d…

 Types of Assurance Services:

 Audit: Focuses on financial statements.

 Review Engagements: Provide limited assurance, such as

quarterly financial updates.
 Other Engagements: Risk assessments, sustainability
reports, and compliance certifications.
 Example: A multinational company hires an assurance
provider to validate its sustainability report, ensuring it meets
international environmental standards for investor confidence.
19
 Aspect Auditing Assurance Services

Encompasses a broader range of services

Focuses on providing an opinion on
Definition that enhance the reliability of any
financial statements' fairness.
information.

Limited to financial statements and Broader, includes financial and non-financial

Scope
related disclosures. areas (e.g., risk assessments, compliance).

Standards Primarily follows ISA (International May follow ISAE or other relevant
Used Standards on Auditing). assurance standards.

Audit report expressing an opinion on Assurance report providing varying levels of

Deliverable
financial statements. assurance (e.g., reasonable or limited).

Conducted after financial statements May occur at any point, depending on the
Timing
are prepared. engagement’s nature.
Evaluative and consultative, can include
Analytical and critical, focusing on
Nature forward-looking or non-financial
verifying historical financial data.
information.

Verifying that the financial statements Providing assurance on a company's carbon

Example
comply with IFRS/GAAP. emissions data or IT security policies.
20
 Objective of auditing
1. Assess the Reliability and Accuracy of
Financial Statements:
• Verify whether the financial position, profit
and loss statement, and other financial reports
accurately represent the organization's financial
performance and condition.
2. Ensure a True and Fair View of Business
Transactions:
• Evaluate whether the financial statements
present an accurate and unbiased reflection of
the business's financial activities in compliance
with applicable standards (e.g., GAAP, IFRS). 21
 Cont…
3. Provide Independent Judgment and Opinion:
• Offer an independent and objective opinion on the
reliability of financial statements, ensuring they
are free from material misstatements and align with
established accounting principles.
4. Detect and Prevent Fraud:
• Identify and mitigate instances of fraud, such as:
a) Misrepresentation of Assets: Inflating or
undervaluing assets to distort financial performance.

22
 Cont…
b) Misrepresentation of Accounting Policies: Using
inappropriate or inconsistent accounting methods to mislead
users.
c) Recording Transactions Without Substance:
Documenting fictitious transactions to manipulate financial
statements.
d) Manipulation or Alteration of Records/Documents:

Tampering with records or falsifying documentation to conceal

fraudulent activities.
23
 Cont…
5. Detect and Prevent Errors:
• Identify unintentional mistakes in recording, classification,
or summarization of financial data and recommend
measures to prevent recurrence.
• These objectives collectively ensure that an audit not only
safeguards the integrity and transparency of financial
statements but also strengthens stakeholder confidence
in the organization’s financial reporting and governance.

24
 1.3. Distinguish B/n Auditing and
Accounting
Accounting is the process of identifying, recording,
classifying, and summarizing, and communicating of
economic events of an organization for the users in in
making informed decision.
Auditing is determining whether recorded
information properly reflects the economic
events that occurred during the accounting 25
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.
26
The auditor must also possess expertise
knowledge in the accumulation/gathering
and interpretation of audit evidence /facts.
Not legally mandatory; certification preferred
for accounting.

27
 Key Comparison Table
Aspect Accounting Auditing
Preparing and presenting
Evaluating financial statements for fairness
Definition financial information per
as per GAAS/ISA.
GAAP/IFRS.
Objective Provide financial statements. Provide an independent audit opinion.
Continuous process during the
Timing Starts after accounting is complete.
financial period.
Not legally mandatory;
Qualifications Must be a CPA, CA, or equivalent.
certification preferred.
Internal employee, reports to Independent professional, reports to
Role
management. shareholders/audit committee.
May not include auditing Requires knowledge of accounting
Knowledge Base
knowledge. principles.
Constructive and focused on Analytical, investigative, and focused on
Nature of Work
record-keeping. verification.
Preparing tax returns and Verifying that reported revenues are free
Examples 28
budgets. from misstatement or fraud.
 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
29
 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. 30
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
 GAAS/ISA

31
 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

32
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 GAAP/IFRS or not.
Compliance audits are conducted by either
independent auditors or government auditors.

33
 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:

34
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.

35
 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.
36
 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
37
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.

38
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. 39
 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.
40
Professionals standards require that external
auditors maintain their objectivity and
independence when providing auditing or
other attestation services for clients.

41
 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.
42
 1.5. SCOPE OF AUDITS
 Comprehensive Coverage: Audits examine various
aspects, such as the organization’s operations,
internal controls, compliance, and risk management
processes.
 The scope of audit is increasing with the increase in
the complexities of the businesses.
 It covers cost audit, management audit, social audit,
technology audit etc. 43
 Cont….
 The scope of internal audit activity:- includes
examining and evaluating the policies, procedures and
systems to ensure; reliability and integrity of information
in compliance with plans of the firm.
 The scope of external audit:- is aimed at carrying out
audit work to form an opinion as to whether:
a) the accounts are properly kept; and

b) the annual financial statements are prepared in accordance with the

Accounting Standards. 44
 1.6. THE ECONOMIC DEMAND FOR AUDITING

“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.
45
 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.
46
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.

47
 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.

48
 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.
49
 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.

50
END OF CHAPTER ONE

51