Advanced Auditing &edp: Teklu K. Gizaw (PHD) Oct. 2019

Advanced Auditing &EDP
Teklu K. Gizaw(PhD)
Oct. 2019
Teklu K.teklukasu@g,ail.com
Course description
This module focuses on case-analyses based
accounting for IFRS and auditing standards
of Local, US and International Standards on
Auditing {ISA} of IAASB; Audit reports of
local and international companies; Reflects
and focuses on fraudulent cases relating to
violations of accounting principles, Ethics &
professional responsibility of auditors,
internal control systems, and fraud &
inherent risk assessment.
Course description
. The course covers IFRS and ISA, Performance
Audit & Audit Standards in Ethiopia, Internal
Control & IT Environment, Fraudulent Cases
Relating to Violation of Accounting Principles;
Ethics & Professional Responsibility of Auditors;
Internal Systems and Inherent Risk Assessment;
Consideration of Internal Control in an
Information Technology Environment; Auditing IT
Governance Controls; Auditing Operating
Systems and Networks; Auditing Database
Systems; Auditing the Revenue Cycle; and
Auditing the Expenditure Cycle.
Course objectives
Upon successful completion of this course,
students will be able to:
Assess an organization’s vulnerability to fraud
and misconduct, and design and implement
controls to prevent, detect and respond to these
occurrences.
Address increased regulatory enforcement and
enhanced scrutiny
Course objectives
Preserve and create value from corporate
governance and compliance programs.
Use technology and data analytics to
mitigate fraud and misconduct risks.
Evaluate the ongoing effectiveness of
compliance program.
Understand performance and
environmental audits in relation to
economy, efficiency and effectiveness
Contents
1. OVERVIEW OF AUDITING
2. International Standards on Auditing (GAAS&ISAS)
3. Performance Audit and Audit Standards in Ethiopia
4. Consideration of Internal Control in an Information
Technology Environment
5. Auditing IT governance controls
6. Auditing operating systems and networks
7. Auditing Database systems
8. Auditing the Revenue cycle
9. Auditing the Expenditure cycle
Work Load
Contact Hours...........................45
Self-Study Hours......................90
Total Hours.............................135
Evaluation
Individual Assignment……………..20
Group Assignment……………………
20
Test………………………………………..20
Final ………………………………………..40
Individual Assignment SD 23/2/12
Auditing after
Sarbanes -Oxley
Fraud Cases: Violation of Accounting
Principles
Case 1 Waste Management: The Matching Principle
Case 2 WorldCom: The Revenue Recognition Principle
Case 3 Qwest: The Full Disclosure Principle
Case 4 Sunbeam: The Revenue Recognition Principle
Case 5 Waste Management: The Definition of an Asset
Case 6 Enron: The Revenue Recognition Principle
Case 7 WorldCom: The Matching Principle
Case 8 The Fund of Funds: The Conservatism Constraint
Case 9 Qwest: The Revenue Recognition Principle
Case 10 WorldCom: The Definition of an Asset
Ethics and Professional Responsibility
Cases
Case 11 Enron: Independence
Case 12 Waste Management: Due Care
Case 13 WorldCom: Professional
Responsibility
Case 14 Enron: Quality Assurance
Case 15 Sunbeam: Due Care
Case 16 The Fund of Funds: Independence
Case 17 Enron: Audit Documentation
4 Internal Control Systems: Control
Activity Cases
Case 18 The Fund of Funds: Valuation of
Investments
Case 19 Enron: Presentation and Disclosure of
Special-Purpose Entities
Case 20 Sunbeam: Completeness of the
Restructuring Reserve
Case 21. Qwest: Occurrence of Revenue
Case 22. Waste Management: Valuation of Fixed
Assets
Case 23. Qwest: Occurrence of Revenue
Fraud and Inherent Risk Assessment Cases
Case 24. Enron: Understanding the Client's
Business and Industry
Case 25. WorldCom: Significant Business
Acquisitions
Case 26. Sunbeam: Incentives and Pressure to
Commit Fraud
Case 27. Qwest: Understanding the Client's
Business and Industry
Case 28. The Fund of Funds: Related Party
Transactions
COMPANY CASES
Case 29. Enron
Case 30. Waste Management
Case 31. WorldCom
Case 32. Sunbeam
Case 33.Qwest
Case 34. The Fund of Funds
Group
Assignment(30%)
SD Hidar 30/12
Review OFAG’s annual audit report about
the ministry of ----- during the last five
years and identify major violations, their
materiality ,its effect and corrective actions
taken
CHAPTER ONE
OVERVIEW OF AUDITING
Teklu K
Contents
Basic concepts of auditing
EDP Audit
1.Basic concepts of auditing
Essence
The word 'audit' comes from the Latin
‘audire’ meaning to hear
Auditing: A systematic process of
objectively accumulating and evaluating
evidence about quantifiable information,
processes, and activities for the purpose of
reporting on the degree of
correspondence between the actual
information and established criteria .
2. Features of Auditing
1. Systematic Approach: Auditing is purposeful and
logical and it is based on the disciplines of a
structured approach to decision making. It is not
haphazard, unplanned or unstructured. Based on
prescribed methods
2. Obtaining and evaluating evidence: auditing
involves a process of obtaining and evaluating
evidence that ultimately guides the auditor’s
decision. Evidence is any information used by
the auditor’s to determine whether the
information being audited is stated in
accordance with the established criteria.
3. Assertions about Economic actions and
events: In any audit engagement, an auditor is
given financial statements and other
disclosures by management. Through these
reports the auditor obtains managements’ explicit
assertions about economic events.
4. Ascertain the degree of correspondence
between the assertions and established criteria:
The purpose of obtaining and evaluating evidence is
to ascertain the degree of correspondence between
the assertions and established criteria.
5. Established criteria: In auditing the auditor
checks if financial statements are prepared in
accordance with some established and
accepted criteria or standard. The criteria
usually used are called Generally Accepted
Accounting principles(GAAP).
6. Communicating the results: Auditors will
ultimately communicate their findings to
interested users through their final audit
report.
7. Auditors’ independence: independence is the keystone
upon which the respect and dignity of a profession is
based. Independence implies that the judgment of a
person is not subordinate to the wishes and directions
of another person who might have engaged him or to
his own self interest
8. True and fair: the phrase ‘true and fair’ in the auditors’
report signifies that the auditor is required to express
as to whether the state of affairs and the results of
the entity as ascertained by him in the course of audit
are truly and fairly represented in the accounts under
audit
9. Audit evidence: It is the information used by
the auditor in arriving at the conclusions on
which the auditor’s opinion is based. Audit
evidence includes both information contained
in the accounting records underlying the
financial statements and other information.
Audit evidence should be sufficient and
appropriate
3. Demand for audit(Why Audit)?
 Legal and Contractual Requirements
 Covenant in debt agreements
 Credibility (Dependable financial
information )
 Improving economy and
efficiency
 Monitoring Device
 Modern Corporation Setup –
 Absentee Stockholders and professional
Managers Teklu K.teklukasu@g,ail.com
4. The Expectations from Auditors
 Public expectations go further and include
questions such as:
1. Is the company a going concern?
2. Is it free of fraud ?
3. Is it managed properly
4. Is there integrity in its database?
5. Do directors have proper and adequate
information to make decisions? ?
6. Are there adequate controls ?
7. What effect do the company’s products
and by-products have on the
environment ?Teklu K.teklukasu@g,ail.com
5.Theories on the demand
for auditing
 There are different theories that
explain the demand for audit
Services.
 The four important audit theories
1.The policeman
that explain the demandtheory
for audit
2.The
services lending credibility
are as follows:
theory
3.The theory of inspired
confidence
4.Agency Theory
1.The policeman
theory
 The policeman theory claims that
the auditor is responsible for
searching, discovering and
 preventing fraud.
In the early 20th century this was
certainly the case.
 However, more recently the main
focus of auditors has been to
provide reasonable assurance
and verify the truth and
fairness of the financial
1.The policeman theory
The detection of fraud is, however,
still a hot topic in the debate on the
auditor's responsibilities, and typically
after events where financial
statement frauds have been revealed,
the pressure increases on increasing
the responsibilities of auditors in
detecting fraud. Teklu K.teklukasu@g,ail.com
Discussion case
Prepare a term paper on the following topic on group
basis
1. Auditing in Ethiopia(common to all groups):History,
organization, current status, Business entities required by
law to produce audited Financial Statements in Ethiopia)
2. Take any three public bodies and consider its audit
reports of the last two years (2006 &2007)
A.Identify the audited financial statements
B.Evaluate the components of the audit report in each
year’s financial statements
C.Critically examine the audit procedures followed by the
audit and the comments given by the auditor in each year
D.Identify the type of audited opinions given by the auditor
and critically examine the basis of issuing such audit
opinion,
Note that
All Assignments will be presented in the class
• Date of submission of the assignments will be May 20, 2016.
• Reporting guideline to be provided.
Discussion question
 Assume you are an independent auditor of XYZ company.
During the past three audits, you have repeatedly warned
the top management of the company about the serious
weakness of internal control over cash disbursements.
However, management has not taken any corrective action.
Shortly after the audit, XYZ company learned that two
employees in its accounting department had been
embezzling money for the last two years. The embezzlement
scheme involved authorizing cash disbursement in various
expense accounts and then arranging to have the checks
cashed. The management of XYZ company has brought suit
against you for the amount of its losses in this cash fraud.
Required:
A-Suggest at least three arguments that you as an auditor can
defend your self to lessen or eliminate the liability.
B-What arguments might XYZ company advance to indicate
that you were negligent in failing to discover the
embezzlement scheme?
C-Briefly describe the auditors’ responsibility for the detection
of errors and irregularities.
he lending credibility theory
 The lending credibility theory
suggests that the primary
function of the audit is to add
credibility to the financial
statements.
 In this view the service that the
auditors are selling to the clients
is credibility.
 Audited financial statements are
seen to have elements that
increase the financial statement
3.The theory of inspired
confidence or Theory of rational
expectations
 States that the demand for audit
services is the direct
consequence of the
participation of third parties
or outside stakeholders in the
company.
 These parties demand
accountability from the
management, in return for their
investments in the company.
The theory of inspired
confidence or
Theory of rational expectations
 Though, information provided by
the management could be biased
due to conflict of interest, and
outside parties do not have direct
means of monitoring, an audit is
required to assure the
reliability of this information.
4. Agency theory
 The task of the management is to
coordinate these groups and
contracts and try to optimize
them by way of:
 low price for purchased
supplies,
 high price for sold goods,
 low interest rates for loans,
 high share prices and
 In these relationships,
Agency problem
Managers should make decision consistent
with the corporate objectives of
maximizing value of S.H wealth. But this
rarely occur.
When Managers make decision

inconsistent with the corporate objectives
of maximizing value of S.H wealth agency
problem will occur..
Reasons for agency problem
1. Divergence of owner ship and control.
Those who owns the company (SH) do not
manage it. Appoint agent (manager) on
their behalf.
2. The goal of managers differ from those
owners. Manager may work to maximize
its own wealth(value) rather than S.H
3. Asymmetry of information may exist
between managers and S.H
Reasons for agency problem
Managers run the firm on day –to –day
bases
They have access to management
accounting data and financial reports
S.H receive only financial report which may
be manipulated by managers.
The above things show that managers can
work for their own interest instead of
organizational interest
Possible management goals
Growth/ maximizing the size of the co.
Increasing managerial powers
Retaining job security
Increasing managerial pay and rewards
Perusing their own social objective/ pet

projects
Dealing with agency problem
Jensen and Meckling(1976) : There are two
ways to optimize the behavior managers
toward goal congruence b/n share holders and
managers.
1. Use of control devices
Audited financial statement
Additional reporting
Use of external analysts
2
Dealing with agency problem cont…
Incorporate clauses which encourage goal
congruence to managerial contract
Incentives : like
 PRP: Performance related Pay, give incentives to
managers based on profit, EPS,Return on asset
employed, etc.
 Stock option: Allow managers to buy some
stocks at fixed price over time. If they increase
value of stock, they will get benefit from it.
Punishments
Formalize constraints
6. Evolution of Auditing
The development of auditing is closely linked
to the development of organized system of
accounting.
 In the early stages of civilization, the number
of transactions was so small that an individual
was able to record the transactions
himself/herself.
With the growth of civilization and
consequential growth in volume and
complexities of transactions, it became
necessary to delegate the job of recording the
transactions to other persons.
6.Evolution of Auditing cont…
Early civilization
government accounting records were approved
only after a public reading where the accounts
were read aloud.
The purpose of the public reading was to
determine whether persons in official
responsibility were acting in an honest manner.
It was limited to verification of cash receipts and
payments.
It was merely a cash audit.
The industrial revolution:
As a result of the emergence of large
businesses, owners were forced to use
services of hired managers. (Separation of
owners and managers)
Owners needed auditors to protect
themselves from the danger of unintentional
errors and fraud committed by managers and
employees.
At this stage, audit was primarily concerned
with detection of fraud and error.
Since the first half of the 20th century,
Users of financial statements increased: (banks,
government, shareholder, etc.)
As a result, the purpose of auditing shifted from
detection of errors and fraud to determination of
the fairness of financial statements.
As large-scale corporate entities developed
rapidly in Great Britain and the United States,
auditors started to use various sampling
techniques in the auditing practice.
7.Types of Audits and
Auditors
Types of Audits:
There are different types of audits
conducted by different types of auditors.
Such difference is based :
Nature, objective, criteria, out come and users.
 Auditors perform different types of

audits. Mainly there are four types of
audits:
1. Financial statement audit,
2. Operational/performance audit,
3. compliance audit and
4. forensic audit. Teklu K.teklukasu@g,ail.com
Auditors
1. Financial statement audit:
This type of audit is conducted to determine whether the
overall financial statements such as income statement,
balance sheet, statements of retained earnings and
cash flow statements are stated in conformity with
generally accepted accounting principles
• The assumption underlying an audit of financial statements
is that different groups will use these statements for
different purposes.
• Therefore, the contribution of an independent auditor is to
give credibility to financial statements.
• Credibility means that the financial statements can be
believed; that is they can be relied upon by outsiders.
• Audited financial statements are now the accepted means by
which business corporations report their operating results
and the financial position.
2. Operational Auditors
audit: An operational audit is a
review of any part of an organization’s operating
procedures and methods for the purpose of
evaluating efficiency and effectiveness.
At the completion of an operational audit,
recommendations to the management for improving
operations are normally expected.
This audit is designed to measure the
performance of an organization, which can be
evaluated in terms of efficiency and
effectiveness.
This type of audit as it aims on measuring the
performance of the organization is some times
called performance audit.
study to streamline(make something more
efficient) operations: It is a systematic check
or assessment of the efficiency or effectiveness
of a company's business operations.
7. Types of Audits and Auditors
3. Compliance Audit: This type of audit
helps to determine whether the auditee is
following specific procedures or rules
set out by some higher authority such
as management, government, board of
directors etc.
The performance of compliance audit is
dependent upon the existence of verifiable
data and of recognized criteria or
standards established by an authoritative
body. A familiar example is the audit of an
income tax return by an auditor of the
Inland Revenue Authority (IRA).
7. Types of Audits and Auditors
3. Forensic audit: A forensic audit’s
purpose is the detection of a wide
variety of fraudulent activities.
Some of the examples where
forensic audit might be conducted
include:
• Business or employee fraud
• criminal investigations
• shareholders and partners disputes
• Business economic losses
• Matrimonial disputes.
Types of Auditors
• External Auditors
( independent auditors)
• Internal Auditors
• Government Auditors
(1) External auditors
The auditor has no connection to the
organization being audited.
S/he conducts the audit on a fee basis.
S/he is primarily responsible to third
party such as creditors and shareholders.
The type of audit carried out by an
independent auditor is financial
statement audit.
(2) Internal auditor
Internal auditors are employees of the

companies they audit.
S/he conducts the audit on a salary basis.
S/he is part of and primarily responsible
to the management of the organization.
The type of audit carried out by an
internal auditor is compliance audit and
operational audit.
(3) Government Auditors
• They are employed by various local, state,
and federal governmental agencies.
• In our country, the auditors from the office
of Auditor General, the Audit Service
Corporation, and the Ministry of revenue
are government auditors.
• The Office of Auditor General is responsible
for conducting financial statement audit,
compliance audit and operational audit of
various Federal Government Offices.
(3) Government Auditors Cont’d…
• The Audit Service Corporation audits the financial
statements of the public enterprises.
• The ERCA and the regional and state revenue

agencies are responsible for administering the tax
laws.
• Thus, tax the auditors examine the tax returns of the

taxpayer to ensure that it is prepared in accordance
with the tax laws and regulations.

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Advanced Auditing &EDP

When Managers make decision

Increasing managerial powers

Retaining job security

Increasing managerial pay and rewards

Perusing their own social objective/ pet

 Auditors perform different types of

Internal auditors are employees of the

• The ERCA and the regional and state revenue

• Thus, tax the auditors examine the tax returns of the

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