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Summary Auditing Theory Chapter 1-15 book
"Principles of Auditing "
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Erasmus Universiteit Rotterdam


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Auditing Theory (FEM11109)


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Elementaire Theorie AccountantscontrolePrinciples of Auditing


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13/12/2014
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14/15
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Auditing Summary of Chapter 1 to 7


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AT Learning Objectives Chapter 1: International Audit Overview Relate


Some of the early history of Auditing Discuss some of the Audit
expectations of the general public Audit expectation gap: a gap that
results from the fact that users of audit services have expectations
regarding the duties of auditors that exceed the current practice in
professions. Is the company a going-concern?; Is it free from fraud?; Is
there integrity? Etc. Identify organizations that affect international
accounting and auditing Name the standards set by the International
Auditing and Assurance Standards Board (IAASB) o International
Standards on Assurance Engagements (ISAEs) in assurance
engagements dealing with subject matters other than historical financial
information. o ISAs o International Standards on Quality Control (ISQCs)
relating to the quality of audit applied to all services. o International
Standards on Related Services (ISRSs) applied to compilation
engagements; apply agreed-upon procedures to information and other
related service engagements. o International Standards on Reviw
Engagements (ISREs) applied to the review of historical financial
information. Give an overview of the IFAC International Standards on
Auditing (ISA). o Requirements ISA 200: Comply with ethical
requirements; Professional skepticism that materially misstated;
Professional judgment; Sufficient appropriate audit evidence. o
Appropriate in the audit or review of historical financial information
Understand the basic definition of auditing in an international context o
The objective of an audit of FS to enable the auditor to express an opinion
whether the FS are prepared, in all material respects, in accordance with
an identified financial reporting framework. The phrases used to express
the auditors opinion are give a true and fair view or present fairly, in
all material respects. It is systematic process, obtaining and evaluating
evidence in regard of the assertions + established criteria and
communicating the results to users. Distinguish between the different
types of audits o Audit of FS o Operational Audit o Compliance Audit
Distinguish between the types of auditors and their training, licensing and
authority o Internal auditors o External Auditor o Public/Government
auditors o Accountant in Business. Name and categorise the key
management assertions.
AT Learning ObjectivesChapter 1: International Audit Overview Relate Some of
the early history of Auditing
Discuss some of the Audit expectations of the general public
Audit expectation gap: a gap that results from the fact that users of audit
services haveexpectations regarding the duties of auditors that exceed the
current practice in professions. Is the company a going-concern?; Is it free from
fraud?; Is there integrity? Etc. Identify organizations that affect international
accounting and auditing Name the standards set by the International Auditing
and Assurance Standards Board (IAASB)o International Standards on Assurance
Engagements (ISAEs) in assurance engagementsdealing with subject matters
other than historical financial information.
o ISAso International Standards on Quality Control (ISQCs) relating to the
quality of auditapplied to all services.o International Standards on Related
Services (ISRSs) applied to compilationengagements; apply agreed-upon
procedures to information and other related serviceengagements.o International
Standards on Reviw Engagements (ISREs) applied to the review ofhistorical
financial information.
Give an overview of the IFAC International Standards on Auditing (ISA).
o Requirements ISA 200: Comply with ethical requirements; Professional
skepticism thatmaterially misstated; Professional judgment; Sufficient
appropriate audit evidence.o Appropriate in the audit or review of historical
financial information
Understand the basic definition of auditing in an international context
o The objective of an audit of FS to enable the auditor to express an opinion
whether theFS are prepared, in all material respects, in accordance with an
identified financialreporting framework. The phrases used to express the
auditors opinion are give a trueand fair view or present fairly, in all material
respects. It is systematic process,obtaining and evaluating evidence in regard of
the assertions + established criteria andcommunicating the results to users.
Distinguish between the different types of audits
o Audit of FSo Operational Audito Compliance Audit
Distinguish between the types of auditors and their training, licensing and
authority
o Internal auditorso External Auditoro Public/Government auditorso Accountant in
Business.
Name and categorise the key management assertions.
o Representations by management that are embodied in the FS as used
by the auditor to consider the different types of potential misstatement
that may occurred. Existence BS exists Rights and obligations
has control/rights to BS. Occurrence took place during the period.
Completeness What should have been recorded, is recorded.
Valuation appropriate amount and valuation properly recorded
Accuracy Amounts are recorded appropriately Cut-off Recorded in
the correct period Classification Recorded in the proper accounts
Understandability appropriately classified and readable. Measurement
Presentation and Disclosure item is disclosed/classified with
framework. Give the components of the Audit process model o Phase
1: Client Acceptance o Phase 2: Planning o Phase 3: Testing and evidence
o Phase 4: Evaluation and judgment Describe how international
accounting firms are organized and the responsibilities of auditors at the
various level of the organization. Chapter 2 The Audit Market
Distinguish between different theories of audit services including Agency
theory. o Agency theory: Viewed as contracts in which groups make
contribution. Auditor is principal for third parties and management. o
Inspired confidence theory: Demand service is consequence of
participation of stakeholders (3rd party) in company. For contribution,
they demand accountability from managements. Information
management might be biased, because of interest, an audit of this
information is required. o Policeman theory: Auditors job to focus on
arithmetical accuracy and prevention and detection of fraud. o Lending
Credibility Theory: Audited FS are used by management to enhance the
stakeholders faith in managements stewardship Understand drivers
for audit regulation o Listed rules for listed companies; money companies;
statutory audits. Understand the role of public oversight o Legal liability
check auditor: Common law; Civil liability under statutory law; Criminal
liability under statutory law; Liability for members of professional
accounting organizations. Distinguish between different audit firms

This page is not available in the preview.


Discuss the responsibilities of an accounting in public practice in
dealing with ethical conflicts that apply to his clients and colleagues. o
Provides professional services. State the topics of guidance that are
particularly relevant to professional accountants working in industry,
commerce, the public sector or education. Summarise the possible
disciplinary actions for violation of ethics codes. o IESBA has no authority
to require disciplinary action o Penalties reprimand to expulsion or
fine/prison. Chapter 4 An Auditors services Understand the general
definition in assurance services o At the request of the client, the auditor
provides an assurance report on the controls of the client. Identify the
assurance and non-assurance services normally performed by auditors.
Explain what an assurance engagements entails o Engagements in which
a practitioner expresses a conclusion that is designed to enhance the
degree of confidence intended users can have about the evaluation or
measurement of a subject matter, which is the responsibility of a party
other than the inted users or the practitioner, against criteria. Describe
the five elements exhibited by all assurance engagements o Three party
relations Practitioner Responsible party Intended users o Subject
matter o Suitable criteria o Evidence o Written report Distinguish
between the different suitable criteria applicable to an assurance service.
o Benchmarks (standards, objectives or set of rules) used to evaluate the
subject matter of an assurance engagement. (IFRS; US GAAP; National
Standards etc). o Required: Relevance; Completeness; Reliability;
Neutrality; Understandability Understand what distinguishes a review
from a compilation o Review The objective of a review of FS
engagement is to enable an auditor to state whether, on the basis of
procedures which do not provide all the evidence that would be required
in an audit, anything has come to the auditors attention that causes the
auditor to believe that the FS are not prepared, in all material respects, in
accordance with an identified financial reporting framework. o Compilation
engagement the accountant is engaged to use accounting expertise as
opposed to auditing expertise to collect, classify and summarise financial
information. Understand the place of professional judgment in audits
o The application of relevant training, knowledge and experience within
the context provided by auditing, accounting and ethical standards, in
making informed decisions about the courses of action that are
appropriate in the circumstances of the audit engagement. Describe
professional skepticism o Having a question mind an performing a critical
assessment of audit evidence through the audit process. Give the
inherent limitations of an audit o Limitation of scope a limitation of the
scope of the auditors work may sometimes be imposed by the entity
(term engagement specify that the auditor will not carry out the
procedure as he believes); by circumstances (timing of the auditors
appointment makes him unable to observe the counting of physical
inventories); in the opinion of the auditor, the entitys accounting records
are inadequate or when the auditor is unable to carry out an audit
procedure believed desirable. o Ability to detect material misstatement;
Risk by poor control environment. Discuss the requirements of
International Standard on Quality Control #1 o Applies to all firms of
professional accountants to audits and reviews, other assurance and
related services. o Requirements designed; related guidance. o ISA 220
deals with the quality control procedures for audits FS> Chapter 5: Client
Acceptance Explain what is meant by client acceptance o Examination
of proposed client, to see if there is any reason to object. (Acceptance OF
client) and convincing the client to hire (Acceptance BY client) o Decide on
acquiring a new client or continuation with existing client o Determine the
type and amount of staff Describe the seven primary procedures
involved in the client acceptance process o Evaluate the Background and
reasons of the client o Determine if auditor is able to meet ethical
requirements o Need for other professional o Communicate with
predecessor auditor o Prepare client proposal o Select staff to perform
audit o Obtain an engagement letter Understand the main reasons for
obtaining an understanding of clients business and industry. o Evaluate
the engagements risks o Determining professional and ethical
requirements Know the sources of client information and the methods
for gathering the information. o Publicly available information; Audit firm
experience; Information from client Discuss the ethical and
competency requirements of the audit team

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o Industry/Regulation/Financial reporting framework; Nature of the
entity; Accounting policies; Objectives and strategies; Measurement and
review Describe what is done during initial interviews, discussions and
site visits with the client. o Checked what objectives, expectations and
reports are + Business activities o Observe the core activity, read reports
and manuals + view the facilities. Know how legal obligations of the
client are investigated. Give examples of management objective, the
related strategy and the resultant business risk. Identify the steps in
the strategy-oriented framework for understanding the entity. o
Understand the clients strategic advantages o Understand the risks that
threaten the clients objectives o Understand the key processes and
related competences to realize advantages o Measure and benchmark
process performance o Document the understand of client to create value
and generate CF, use a client business model, key performance indicators.
o Use comprehensive business knowledge, develop assertions o Compare
reported financial results to expectations and design audit tests. List
the different types of risk that the auditors must assess in planning. o
Inherent Risk o Control Risk o Detection Risk Define each type of risk.
o IR= knowing the industry o CR = misstatements not
prevented/detected/corrected by IC o DR = an auditors substansive
procedures that will not detect a misstatement that exist. Understand
what is meant by significant Risk. o A type of business risk that generally
relates to judgmental matters and significant non-routine transactions
requiring special audit considerations. Know the auditors definition of
materiality o Information is material if its omission or misstatement could
influence the economic decisions of users taken on the basis of the FS.
Materiality depends on the size of the item or error judged in the
particular circumstances of its omission or misstatement. Provides a
threshold or cut-off point rather than being a primary qualitative
characteristics which information must have if it is to be useful.
Illustrate the conditions that determine materiality o Size of item o Nature
of the item o Circumstances o Materiality level Understand the
difference between financial statement fraud and misappropriation of
assets. o Intentional act by one/more individuals in misrepresentation of
FS.
o Misappropriation theft of assets. Especially susceptible accounts are
inventory and cash Discuss the fraud triangle factors that may lead to
fraud. o Perceived pressure = someone believes to commit o Perceived
opportunity = favorable circumstances to commit o Rationalisation = self-
satisfying but incorrect reasons. Identify responses to fraud
assessments o Test appropriateness of journal entries recorded o Review
accounting estimates for biases o Review significant transactions outside
the normal course Grasp the role of the auditors expert in the audit. o
Duty to communicate to the management/with governance o Report to
third party Be acquainted with the relationship between the external
auditor and the auditees internal auditor. o Internal function is a service
to the entity, perform the activities of the internal audit functions. Be
aware of the audit procedures when the entity uses third-party service
organization for activities that impact the financial statements. o Part of
IS relevant to financial reporting. Must ask management for appropriate
persons Comprehend inherent risk and the procedures to assess it.
Be familiar with the planning memorandum and audit plan. o Audit plan
work plan that reflects the design and performance of all audit
procedures, consisting of a detailed approach for the nature, timing and
extent of audit procedures to be performed and the rationale for their
selection. The audit plan begins by planning risk assessment procedures
and once these procedures have been performed it is updated and
changed to reflect the further procedures needed to responds to the
results of the risk assessment. Planning memorandum: overview of
client company; industry environment; significant audit concern; areas of
interest in audit team; audit approach; audit budget. Chapter 7 Internal
Control and Control Risk Understand the basic definition of internal
control o A process, effected by an entitys board of directors,
management and other personnel designed to provide reasonable
assurance regarding the achievement of objectives in the following
categories: effectiveness and efficiency of operations, reliability of
financial reporting, and compliance with applicable laws and regulations
Committee of Sponsoring Organisations of the Treadway Commission
Discuss why internal controls are important to the auditor o To understand
the entity and to evaluate the desing o If it can detect and correct
material misstatements in classes of transactions

This page is not available in the preview.


o Hard controls: set of rules; constraints and activities. Tangible character
(formal and visible) o Intangible factors influence behavior of managers
and employees. (in culture or climate) Know what is meant by design
of controls Follow what an auditor does in preliminary planning
assessments of internal control risk o Inquiring; Observing and re-
performing application; inspecting; tracing transactions. Chapter 9
Auditors response to assessed risk (ISA 330, ISA 500) List audit
procedures responsive to assessed risk o Design and perform audit
procedures: nature; timing and extent to assessed risk. Emphasising
professional skepticism; assigning more experienced staff; providing
supervision; Incorporating unpredictability; General changes. Know the
definition of evidence in an audit and legal sense o Higher the assessment
of risk the more persuasive audit evidence needed. More relevant or
reliable . Everything that can make a person believe an assertion is true
or false. o In civil law suit the evidence must be strong to incline. In
criminal case: beyond reasonable doubt. Audit evidence provides only
reasonable doubt. Differentiate between nature, extent and timing of
audit procedures o Nature: its purpose&its type o Timing : when
performed o Extent: quantity to perform Understand the difference
between legal evidence and audit evidence o Legal evidence must be
strong enough to incline, audit evidence only provides reasonable doubt.
Identify the common management assertions for classes of
transactions, account balances and disclosure o Classes of transactions
and events: Occurrence; Completeness; Accuracy; Cut-off; Classification
o Account Balance: Existence; Rights and obligations; Completeness &
Valuation o Presentation and disclosure: Occurrence and rights and
obligations; Completeness; Classification and Understandability; Accuracy
and valuation Define the management standard assertions:
completeness; occurrence; accuracy; rights & obligations; valuation;
existence; cut-off; classification; understanding; presentation and
disclosure; and measurement Discuss the systematic process of
gathering evidence Recognise tests of controls for design and
effectiveness o Audit procedures designed to evaluate the operating
effectiveness of controls in preventing, or detecting and correcting,
material misstatements considering the circumstances
Charaterise a substantive procedure o An audit procedure designed to
detect material misstatement at the assertion level. o Alone it is not
sufficient appropriate evidence Explain what is meant by the nature,
timing and extent of substantive procedures o How controls are applied,
inquire, consistency, by whom or what. Tested upon other controls? List
and define the two types of substantive procedures o Compromise: Test of
details (classes of transactions, account balances and disclosures.) and
Substantive analytical procedures Realise the process of search for
unrecorded liabilities o On accounts payable = completeness ; evaluation
as to valuation. Auditor reviews disbursements for period after BS date.
Paid within reasonable time after BS -> potential population. Describe
the components of and the meaning of sufficient appropriate audit
evidence o ISA 500 to draw reasonable conclusions o ISA 200 reduce
audit risk o an acceptable low level o Sufficiency & Appropriateness o
Results; Source; Responses etc Determine which evidence is relevant
and which evidence is reliable o Relevance is the appropriateness o
Reliable is the quality when free from material error and bias. Chapter 10
Audit evidence Define auditing evidence o The information obtained by
the auditor in arriving at the conclusions on which the audit opinion is
based. Audit evidence will compromise source documents and accounting
records underlying the FS and corroborating information from other
sources Discuss what constitutes accounting records Characterise
risk assessment procedures regarding evidence Understand the seven
evidence-gathering techniques: inquiry; observations; inspections; re-
performance; recalculation; confirmation; and analytical; procedures
Discuss evidence-gathering procedures for physical inventory counting;
confirmation of AR; and search for unrecorded liabilities o Inquiry;
Observation; Inspection; Recalculation; Re-performance; Confirmation;
Analytical Procedures. Explain the confirmation process o Response to
an inquiry of a third party to corroborate information contained in the
accounting records. Process of obtaining and evaluating audit evidence
through a direct communication from a third party in response to a
request for information about a particular item affecting assertions made
by management in the FS

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o Commitments: Agreements that entity holds to fixed set of conditions,
regardless of what happens. Conduct a review after the BS date for
subsequent events and understand what events cause FS adjustments o
Subsequent events: between date of FS and auditors report. Facts after
auditors report. o After end before report: Adjustment to FS o After
report: No adjustment, but material than disclosures. Know the
auditors responsibilities when facts are discovered after the issuance of
the audit report o Before issuance FS: when amended Carries out
procedures; provide new report with amended FS. When not amended:
Release a qualified or adverse opinion. Notify governance body to not
issue FS and report. Explain the procedures involved in the review of
FS including disclosures and other information presented with the audited
FS o Obtaining & Understanding procedures established o Inquiring
management o Reading minutes of meetings o Reading the entitys
interims FS o Reading latest budgets o Consider if written representations
covers up the event. Design and perform the wrap-up procedures o
End of audit, when complete. Supervisory review; Final analytical
procedures; Working capital review Evaluating audit findings for material
misstatements; Client approval of adjusting entries; review of laws and
regulation; evaluation of going concern. Determine procedures to
evaluate going concern issues o Foreseeable future. In preparation of FS.
Inquire management; evaluate proposed future actions; Analyse
management cash flows; Request written representation from
management. Discuss the design and use of matters for attention of
partners o Report by audit managers, reviewed by partners detailing audit
decisions and reasons. Chapter 12 Audit reports and communication
Grasp who has responsibility for the FS and why o Management is
responsible for audit report / FS - SOX Understand the basic elements
of the auditors report: contents and form o ISA 700: Title; Addressee;
Introductory paragraph (management responsibility; Auditors
Responsibility; Opinion); Report on Other legal and regulatory
requirements; Signature; Date; Adressee Explain the contents and
importance of the unmodified (Unqualified) audit opinion o FS are
prepared, in all material respects, in accordance with framework. Clean
opinion. List the considerations of an auditor in giving an unmodified
(unqualified) opinion
Distinguish between the different types of opinions given in audit
reports of FS o FS adequately disclosed the policies; Estimates are
reasonable; Information is relevant; Disclosures intended users to
understand the effect; Terminology used is appropriate; Fair presentation
of framework. Describe the circumstances under which the auditor will
modify an opinion o When evidence is not material, but could be
persuasive. o Unable to obtain sufficient appropriate audit evidence.
Possible effect could be material/persuasive. Understand how some
uncertainties lead to qualification of opinions in the audit report on FS o
Not obtained enough sufficient evidence to give reasonable assurance.
Provide circumstances in which the unmodified opinion requires an
emphasis of a matter paragraph o After the opinion paragraph: matter
being emphasized and disclosures. o Uncertainty upon future: Existence
of related party transactions; Accounting matters; Comparability issues;
Losses; Regarding going-concern. State the two circumstances that
require an auditors report containing an opinion other than an unmodified
(unqualified) one o Limitation in scope o Auditors judgment about
pervasiveness of the effects on matter Discuss the audit matters of
governance interest arising from the audit of FS that the auditor must
communicate to those charged with governance of an entity o Material
weakness in IC; non-compliance; fraud; integrity; general approach;
selection/changes in policies. Give details contained in the long-form
audit report o Long-form report is to Audit Committee including: Overview
Audit Engagement; Analysis of FS; Risk Management and IC; Optional
Topics; Auditor Independence and quality control; Fees. List the
general content of a management letter o Issues not required to be
disclosed in Annual Financial report. Auditors concerns & suggestions
during audit, evaluation present system, problem areas, improvements,
discussions may require immediate action. Reasons why an auditor
may attend a meeting of the stockholders of a corporation Chapter 14
Other Assurance and Non-Assurance engagements Give the
distinguishing characteristics of the special area reports o Based on
historical financial information; but not FS as a whole or IFRS.
Understand what distinguishes a review from a compilation o Review:
nothing has come to our attention - Negative assurance o Describe
the key users of reports on prospective financial information Explain
the requirements of internal control reporting standards

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1

HAYES - Principles
of Auditing, an
international
perspective
1
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ByRick S. HAYES
and Arnold
SCHILDERWith
Roger Dassen &
Philip Wallage
Engelstalige
samenvatting,sa
mengesteld uit
de outlines per
hoofdstuk
op www.auditing
text.com
Outline
Table of
Contents
1. International A
uditing Overview
2. The Audit Mark
et3. Ethics for Pr
ofessional Accou
ntants4. Introduc
tion to Audit Proc
ess5. Client Acce
ptance6. Internal
Control and Its C
omponents7. Au
dit Planning8. Rel
ying on Internal
Control in the Au
dit Process9. Sub
stantive Testing1
0. Completing th
e
Audit11. External
Audit Reports12.
An audit step
by
step13. Auditing
beyond 2000This
compilated
outline is free
available
onwww.pentagan
.nl

HAYES - Principles
of Auditing, an
international
perspective
2
Chapter 1:
Internatio
nal
Auditing
Overview
A.
Introduction
A. Historical
background1. An
thropologists
have found
records of
auditing
activity dating
back to early
Babylonian times
(around 3,000BC)
.2. The practice
of modern
auditing dates
back to the
beginning of the
modern corporati
on at the dawn
of theIndustrial
Revolution.3. Ma
nagement and
financial reports:
the flow of
investor funds to
the corporations
and the whole
process
ofallocation of
financial
resources
through the
securities
markets has
become
dependent to
a very
largeextent upon
reports made by
management.
Management can
scarcely be
expected to take
an impartialview
of this
process.4. The
role of an
auditor: to
provide with an
independent and
expert opinion on
the fairness of
the
financialreports.B
. The Auditor,
Corporations and
Financial Informa
tionBy the audit
process, the
auditor enhances
the usefulness
and the value
of the financial
statements, but
he alsoincreases
the credibility of
other non-
audited
information
released by
management.
i
C. Accounting
and Auditing
Standards1. Man
y countries have
issued
local auditing
standards under
which companies
are audited in
their
homecountry.2. I
nternational Acco
unting
Standards: The
International
Accounting Stand
ards Committee
(IASC)
has workedfor
over twenty
years
to harmonize
international
accounting
standards and its
pronouncements,
International
Accounting
Standards (IAS).
The IASs have
been adopted by
many countries
which do
nothave their
own national
accounting
standards or
which believe
that international
comparability is
to
bepreferred.3. Int
ernational Auditi
ng Standards:
Auditing standar
ds were required
by multinational
corporations
whichwanted a
world wide,
consistent, high
quality audit.
International
auditing
standards have
existed since
theInternational
Federation of
Accountants
(IFAC) came into
being as a result
of initiatives put
forward in
1973and
approved in
1977. Although
ISAs are not
required by
all countries, we
will use them as
the
basicstandards
throughout this
book because
they represent
the highest and
best international
representation
ofgenerally
accepted
auditing
standards.4. A
listing of the
International
Standards on
Auditing is given
llustration 1-1.D.
Audit definitions
1.
There is no
definition of
an audit, per se,
in the
International
Standards on
Auditing. The
definition given
inISA 200 states
the
objective of an
audit
ii
, The objective
on an audit
of financial
statements is to
enable
theauditor to
express an
opinion whether
the financial
statements are
prepared, in all
material
respects,
inaccordance
with an
identified financi
al reporting
framework of
other criteria.
2.
A better, more
general definition
of auditing is the
definition
put forth by the
American
AccountingAssoci
ation
iii
,
An audit is a
systematic
process of
objectively
obtaining and
evaluating
evidence
regarding asserti
ons about
economic actions
and events
to ascertain the
degree of
correspondence
between
these assertions
and established
criteria and
communicating
the results to
interested users.
a. An audit is a
systematic
approach: the
audit follows a
structured,
documented plan
(audit
plan).b. An audit
is
objectively
conducted: an
audit is an
independent,
objective and
expert examinati
on andevaluation
of
evidence.c. The a
uditor
obtains and
evaluates
evidence
. The auditor
assesses the
reliability and
sufficiency of
theinformation
contained in the
underlying
accounting
records and
other source
data.d. The
evidence
obtained and
evaluated by the
auditor regards
assertions about
economic actions
and events
. The basis of
evidence gatheri
ng objectives,
the thing that the
evidence must
prove are the
assertions
of
management.e.
The auditor
ascertains the
degree of
correspondence
between
assertions and
established
criteria
. Theaudit
program tests
most assertions
by examining the
physical
evidence of
documents,
confirmation,inqu
iry and
observation.f. Th
e
goal, or objective
, of the audit is
communicating
the results to
interested users
. The audit
isconducted with
a view of
expressing an
informed and
credible opinion,
in a written
report.

HAYES - Principles
of Auditing, an
international
perspective
3E. General
Principles
Governing an
Audit of Financial
Statements 1.
The financial
statementsaudite
d under
international
standards
iv
are the balance
sheets, income
statements
v
,and cash flow
statements
vi
and the notes
thereto. The first
International
Standard on
Auditing, ISA 1
(Subjectmatter
Number 200)
vii
, discusses the
principles
governing
an audit of
financial
statements.a. IS
A 200 (1) states
that an auditor
could comply
with the Code of
Ethics for
Professional
Accountantsissue
d by IFAC, which
is discussed later
in Chapter
3.b. ISA 200
further states
that the
auditor should
conduct an audit
in
accordance with
InternationalStan
dards on
Auditing.c. The
term scope of
an audit refers
to the audit
procedures
deemed
necessary in the
circumstances
toachieve the
objective of the
audit.d. An audit
in accordance
with ISAs is
designed to
provide
reasonable
assurance.
viii
e. There are
certain inherent
limitations in an
audit that affect
the auditors
ability to detect
materialmisstate
ments.f. The
audit of the
financial
statements does
not relieve
management of
its responsibilitie
s.
III. Types of
Audits
A. Audits of
financial stateme
nts examine
financial
statements to
determine if
they give a true
and fair view
orfairly present
the
financial stateme
nts in conformity
with specified
criteria.B. An
operational
audit
is a study of
a specific unit of
an organization
for the purpose
of measuring
itsperformance.C
.A
compliance
audit

is a review of an
organizations
procedures
performed to
determine
whether
theorganization
is following
specific
procedures, rules
, or regulations
set out by some
higher authority.
IV. Types of
Auditors
A. Internal
auditors are
employed by
individual
companies
to investigate
and appraise the
effectiveness ofc
ompany
operations
for management.
B. Independent
auditors are
certified either
by a professional
organization.
Certified auditors
are
called:1. Certifie
d Public Account
ants (CPA);2. Cha
rtered Accountan
ts (CA);3. Contad
or Pblico (CP);4.
Expert Comptabl
e;5.
Auditor;6. Other t
itles.
V. The Audit
Process Model
A. Philip Wallage
has likened
the audit
process to
the empirical
scientific cycle.
ix
B. The audit
process begins
with a clients
request for an
audit of
financial stateme
nts, is followed
by a plan ofthe
audit and tests of
evidence,
culminating in
a judgement or
opinion. In this
book we will use
a four
phasestandard
audit process
model based on
the scientific
empirical
cycle.C. Phases o
f an audit are:
-

Phase I: Client Ac
ceptance(pre-
planning),
-

Phase II: Plannin


g,
-

Phase III: Testing


and Evidence,
-

Phase IV: Evaluat


ion and Judgeme
nt.
VI.
International
Public Account
ancy Firms
A. The Big Six:
Arthur Andersen
& Co.; Coopers &
Lybrand; Deloitte
& Touche; Ernst
& Young; KPMG;
andPrice
Waterhouse.B. Th
e allocation
of personnel to
an audit:1. Staff
Accountants
(or Junior
Assistants then
Senior);2. Senior
Accountants
(or Supervisor);3.
Managers;4.
Partners/Director
s.
VII.
Organizations
That Affect
Auditing
A. International
Federation of
Accountants
(IFAC):
International
Standards on
Auditing (ISA) are
developed by
TheInternational
Federation of
Accountants
(IFAC) through
its International
Auditing
Practices
Committee
(IAPC).B. Internat
ional
Accounting Stand
ards Committee
(IASC):1. Formula
te and publish
in the public
interest
accounting stand
ards;2. To
work generally fo
r
the improvement
and harmonizatio
n of
regulations;C.
The European
Union (EU): Has
issued a series
of accounting
standards for the
community.
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HAYES - Principles
of Auditing, an
international
perspective
4
Chapter 2
- The
Audit
Market
I. Brief history
of auditing
A.
Determined by
the history of
accounting or
bookkeeping.
B.
The attitude of
profit
maximization
emerged at the
end of the
middle ages,
with the
emergence of
largemerchant
houses in Italy.
C.
Double-entry
bookkeeping was
first described
in Italy.
D.
Another
revolution: the
Industrial
Revolution which
started in Great-
Britain around
1780. This
revolutionlead to
the emergence
of large industrial
companies,
with:1. Complex
bureaucratic stru
ctures and, grad
ually.2. The
need to look for
external funds in
order to finance
further expansio
n: theseparation
between capital
provision
and managemen
t.E. In 1853, the
Society of
Accountants in
Edinburgh was
founded.
II. Theories On
The Demand
And Supply Of
Audit Services
A.
The demand for
audit services
has
been explained
by several
different
theories:
1. Policeman The
ory
a.
The most widely
held theory on
auditing until the
1940s.
b.
Auditing was
focused on
arithmetical
accuracy and on
prevention and
detection
of fraud.
c.
Inability to
explain the shift
of auditing
to 'verification of
truth and
fairness of the
financial stateme
nts'.2. Lending Cr
edibility Theorya.
Primary function
of auditing
the addition
of credibility to
the financial
statements.b. Th
e theory as such
is unable to
explain
the various
other functions
the users of
financial
statements
expectthe
auditor to
assume as part
of attestation
function.3. Moder
ator of Claimants
Theorya. Under
this theory, it is
important that all
vital participants
in an
organization
continue
to contribute.b. It
cannot
explain the other
attributes of
the attestation
function, nor
does it explain
the shift in
attention overtim
e.4. Quasi-
Judicial Theorya.
The auditor is
regarded as a
judge in the
financial informat
ion distribution
process.b. This th
eory cannot be s
ustained because
:
-
an auditor's
decisions and
decision process
are not publicly
available,
-

the doctrine of
precedence/consi
stency is not
guaranteed
in auditing,
-
an auditor's
independence
differs from a
judge's
independence
because of
thedifferent
reward systems
involved, Porter
(1990),5. Theory
of Inspired Confid
encea. Develope
d in the late
1920s by
the Dutch
professor Theodo
re
Limperg.b. addre
sses both the
demand and the
supply of
audit services.6.
Agency Theory
a.
A reputable
auditor is
appointed not
only in the
interest of third
parties, but also
in the interest
ofmanagement.
b.
A company is
viewed as the
result of more or
less formal
'contracts', in
which several
groups make
somekind of
contribution to
the company,
given a certain
'price'.
c.
Agent
'management'
has a
considerable adv
antage over the
principals
regarding
information
about
thecompany.
d.
Agency theory
can also be
used to explain
the supply side
x
of the audit
market. The
contribution of
an auditto third
parties is
basically
determined by
(1) the
probability that
the auditor will
detect errors in
the
financialstateme
nts (or other
irregularities,
such as fraud
or illegal acts)
and (2)
her willingness to
report these
errors(e.g., by
qualifying her
auditor's report),
even against the
wish of the
auditee (auditor
independence).

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