CHAPTER TWO

PROFESSIONAL AUDITING STANDARDS

2.1 INTRODUCTION
The work of an independent auditor is to express an objective opinion on financial statements of an
organization. To have this objectivity an auditor needs to always have an independent physical and
mental attitude in his/her work.
This unit looks at the principles and guidelines that auditors frequently refer to when conducting
their audit work. Auditors can be charged or sued because of their work.
2.2. INTERNATIONAL STANDARDS ON AUDITING(ISA)
The broadest guidelines available to auditors are the 10 International standards on auditing (ISA), fall
into three categories:
1. General standards
2. Standards of field work
3. Reporting standards

These standards are not sufficiently specific to provide any meaningful guide to practitioners, but
they do represent a framework.
Table 2.1: INTERNATIONAL STANDARDS ON AUDITING(ISA)

General Standards of Qualification and Conduct

1. The audit is to be performed by a person or persons having adequate technical training
and proficiency as an auditor.
2. An auditor must maintain an independent physical and mental attitude.
3. An auditor must exercise due professional care in his work.
Standard of Fieldwork:
1. Auditor's work must be properly planned and supervised.
2. Auditor's must study and evaluate internal control.
3. Auditor must gather sufficient and competent evidence through inspection,
observations, inquiries & confirmation.
Standards of Reporting:
1. The audit report must state whether financial statements have been prepared in
accordance with International financial reporting standards(IFRS)
2. The audit report must state whether the IFRS has been consistently applied with that
of the preceding period.
3. The audit is to be presumed to have adequate information disclosure unless and

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 otherwise stated so.
4. The audit report must maintain an expression of opinion on the financial statements as
a whole or an explanation for not expressing an opinion.

2.2.1. GENERAL STANDARDS

-The general standards relate to the qualification of the auditor and to the quality of
the auditor’s work.
-The three general standards of ISA relate to the personal integrity & professional qualification of
auditors.

-These issues are normally addressed before a firm accepts a prospective client.
A) Adequate Te chnical Tr ainin g and Proficiency:
-The first general standard requires competence-adequate technical training & proficiency as
an auditor.
-This competence starts with formal education accounting because auditors hold themselves
out as experts in accounting standards, financial reporting, & auditing.
- Experience, another dimension of competence, it grows with on-the- job training in developing
& applying professional judgment in real-world audit situations.
-Recent court cases clearly demonstrate that auditors must be technically qualified and
experienced in those industries in which their audit clients are engaged.

- In any case in which the CPA are qualified to perform the work, a professional obligation
exists to acquire the requisite knowledge and skills, suggest someone else who is qualified to
perform the work, or decline the engagement.

B) Independence in Mental Attitude

-Competence alone is not sufficient.

-The auditor must also be free of management’s influence in performing the audit & in reporting the
findings.

-this standard requires performing the audit-intellectual honesty.

-auditors are expected to be unbiased and impartial with respect to the F/S & other
information they audit.

-auditors expected to be fair for both to the companies & executives who issue financial
information & to the outside persons who use it.

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 -CPA firms are required to follow several practices to increase the likelihood of independence
of all personnel. For example, there are established procedures on larger audits when there is a
dispute between management and the auditors.
Why Do Auditors Need Independence?
-The very demand for audit calls for integrity objectivity in the person who is to be creditable by
all those who put trust and confidence in him and his work.
-How can independence, integrity and objectivity be best provided or guaranteed in the auditor's
function or personality is a constant challenge of the profession.
-The auditing profession has tried to delineate these within the framework of professional
qualification, ethics and legal liability and responsibility requisites.

C) Due Professional Care

-Just as the physician is expected to be prudent(xanqaqa) & thorough in performing a physical

examination & making a diagnosis, the auditor is expected to be diligent and careful in performing
an audit & issuing a report on the findings.

-Due care includes consideration of the completeness of the audit documentation, the sufficiency of
the audit evidence, and the appropriateness of the audit report.

-As professionals, auditors must not act negligently or in bad faith, but they are not expected to be
infallible.

2.2.2. STANDARDS OF FIELD WOR

The standards of field work concern evidence accumulation and other activities during the actual
conduct of the audit.

a) Adequate Planning and Super vision

-The first standard requires that the audit be sufficiently planned to ensure an adequate audit and
proper supervision of assistants.

- Proper supervision is essential in auditing because a considerable portion of the field work is done
by less experienced staff members. junior auditors due to this reason it need special supervision.

-The professional standards contain several lists of consideration for planning & supervision an
audit. They are all concerned with

 Preparing an audit program & supervising the audit work,

 Obtaining knowledge of the client’s business, &

 Dealing with deference of opinion among the audit firm’s personnel.

-A written audit program is required.

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-an audit program is a list the audit procedures the auditors need to perform to produce evidence for
good audit decision.

- The procedure in an audit program should be stated in enough detail to instruct the assistants about
the work to be done.

-An understanding of the client’s business & industry is an absolute necessity. This knowledge helps
auditors identifying areas for especial attention (the place where error or fraud might exist), evaluate
the reasonableness of accounting estimates made by management.

b) Understand the Entity and its Environment, Including Internal Control

-To adequately perform an audit, the auditor must understand the client’s business and industry.

-This understanding helps the auditor identify significant client business risks and the risk of
significant misstatements in the financial statements.

- For example, to audit a bank, an auditor must understand the nature of the bank’s
operations, federal and state regulations applicable to banks, and risks affecting significant accounts
such as loan loss reserves.
-One of the most widely accepted concepts in the theory and practice of auditing is the importance
of the client’s system of internal control for mitigating client business risks, safeguarding assets
and records, and generating reliable financial information.
- If the auditor is convinced that the client has an excellent system of internal control, one that
includes adequate internal controls for providing reliable data, the amount of audit evidence to be
accumulated can be significantly less than when controls are not adequate.
-In some instances, internal control may be so inadequate as to preclude conducting an effective
audit.
c) Sufficient Appropriate Ev idence
-Decisions about how much and what types of evidence to accumulate for a given set of
circumstances require professional judgment.
-the ultimate objective of field work standard is to require the auditor to have a reasonable basis
for expressing an opinion on the entity’s F/Ss.
- This field work standard requires that the audit team collect & evaluate sufficient competent
evidence to afford a reasonable & logical basis for audit decisions.
- Evidence is defined as “all of the information used by the auditor in arriving at the conclusions
on which the audit opinion is based.”

2.2.3. REPORTING STANDARDS

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-The four reporting standards require the auditor to prepare a report on the financial statements
taken as a whole, including informative disclosures.
-The reporting standards also require that the report state whether the statements are presented
in accordance with IFRS and identify any circumstances in which IFRS have not been consistently
applied in the current year compared with the previous one.
2.2.3.1. AUDITORS’ REPORTS
-Expressing an independent and expert opinion on the fairness of financial statements is the most
frequently performed attestation service rendered by the public accounting profession (Auditing).
-This opinion, which is expressed in the auditors’ report, provides users of financial statements with
reasonable assurance that the statements are in conformity with generally accepted accounting
principles or not.
-For users to understand the full implication of the auditors’ opinion, it is important for the report to
comply with the fourth standard ISA which is standards of reporting which states:
The auditors’ standard report meets this reporting standard by:
a. Stating that the audit was performed in conformity with generally accepted
auditing standards and
b. Expressing an opinion that the client’s financial statements are presented fairly
and in conformity with IFRS.
-However, if there are material deficiencies in the client’s financial statements or limitation in the
audit, or if there are other unusual conditions about which the reader of the financial statements
should be informed, auditors cannot issue the standard report. Instead, they must carefully modify
their report to make these problems or conditions known to users of the audited financial statements.
Financial statements:
The reporting phase of an audit begins when the independent auditors have completed the fieldwork
and have proposed any necessary adjustments to the client.
-Before drafting their report, the auditors will review the client-prepared financial statements for
form and content or draft the financial statements on behalf of the client.
-The basic financial statements on which the independent auditors customarily report is the balance
sheet, the income statements, the statement of retained earnings, and the statement of cash flows.
-Financial statements generally are presented in comparative form for the current year and one or
more preceding years and include explanatory notes.
-The financial statements for a parent corporation usually are consolidated with those of the
subsidiaries.

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Comparative Financial Statements:
-Comparative statements show changes and trends in financial position and operating results of a
company over an extended period, and thus are more useful to investors and creditors than are
financial statements for a single period.
-Publicly owned companies are required to include in their annual reports the balance sheet for each
of the last two years and the related statements of income, retained earnings, and cash flows for each
of the last three years.
-The auditors’ report covers all financial statements that are presented.

2.3. PROFESSIONAL ETHICS

Ethics: - are moral principles & values that govern the behavior of individuals & groups. Example of
prescribed sets moral principles or values include laws & regulations, church doctrine, codes of
business ethics, & codes conduct within individual organizations.
The list of ethical principles incorporates the characteristics & values:
-Honesty, -Integrity, -Promise keeping, -Loyalty (fidelity),
-Fairness, -Caring for others, - Respect for others,
-Responsible citizenship, -pursuit of excellence, -Accountability
2.4. CODE OF PROFESSIONAL CONDUCT
The code of professional conduct consists of TWO sections: - principles & rules.
2.4.1. PRINCIPLES OF PROFESSIONAL CONDUCT
A) Responsibilities:
-In caring out the responsibilities as professionals member should exercise sensitive professional &
moral judgments in all their activities.
- All members have responsibilities to those who use their professional services.
-And they are responsible to improve the art of accounting, maintain public confidence in the
professional, & carryout the self-regulatory activities.
B) THE PUBLIC INTEREST:
Members should accept the obligation to act in a way that will serve the public interest, honor the
public trust, & demonstrate commitment to professionalism.
C) INTEGRITY
To maintain & broaden public confidence, members should perform all professional responsibilities
with the highest sense of integrity.
D) OBJECTIVITY AND INDEPENDENCE:
-a member should maintain objectivity and be free of conflicts of interest discharging professional
responsibilities.

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-A member in public practice should be independent in fact & appearance when providing auditing
& other attestation services.
-Objectivity means being impartial & unbiased in all matters pertaining to an engagement.
-The member must be independent in fact & in appearance.
E) DUE CARE:
-A member should observe the profession’s technical & ethical standards, strive continual to improve
competence & the quality of service, & discharge professional responsibility to the best of the
members’ ability.
F) SCOPE AND NATURE OF SERVICE
-A member in public practice should observe the principles of the code of professional conduct in
determining the scope & nature of service to be provided.
- In deciding whether to provide specific services in a given situation, a member should consider all
preceding principles.
- if any principle cannot be met, the engagement should be declined.
2.4.2. RULES OF CONDUCT
-This part of the code includes the explicit rules that must be followed by CPAs.
-The specific rules of conduct are:-
-Independence, integrity & objectivity, general standards, compliance with standards, accounting
principles, confidentiality, contingent fee, acts discreditable, advertising & other forms of
solicitation, commissions & referral fees, & form of practice & name.
a) Independence
- A CPA in public practice shall be independent in the performance of professional services.
-Independence in auditing means taking unbiased viewpoint in the performance of audit tests, the
evaluation of the results, & the issuance of the audit report.
-Independence must certainly be regarded as the auditor’s most critical characteristic.
The reason that many diverse users are willing rely upon the CPA’s reports as to the fairness of
financial statements is their expectation of unbiased viewpoint. Not only is it essential that CPAs
maintain an independent attitude in fulfilling their responsibilities, but it is also important that the
users of F/S have confidence in that independence. These two objectives are frequently identified as
independence in fact & independence in appearance.
Independence in fact exists when the auditor is actually able to maintain an unbiased attitude
throughout the audit, whereas independence in appearance is the result of others’ interpretations of
this independence.
According to the rule of independence one of the factors that affect the auditor’s independence is the
existence of financial interest.

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 Financial interest classified in to two (2), direct & indirect.
Direct financial interest exists:

i) When the auditor has investment or a stock in an audit client or/and

ii) When there is investment in an audit client by the auditor’s spouse, dependent
children, or a relative living in a common household which is supported by the
auditor.
Indirect financial interest includes having a financial interest or investments by distance relatives
in an audit client. The followings are the cases:
i) Being a stockholder of a bank that loaned money to an audit client
ii) Investment in audit client by other close relatives such as parents, brothers, sisters
and non –dependent children of the auditor.
-When the auditor has a direct financial interest, his/her independence is automatically impaired
irrespective of whether the interest is material or not. However, indirect financial interest affects the
auditor’s independence if it is material. The level of materiality is left to the professional judgment of
the auditor.
-Loan to or from the audit client may also affect the auditor’s independence if it is taken without
fulfilling normal lending procedures.
Other examples that may affect the auditor’s independence are:-
 More than one year’s professional fees due from the client that remained unpaid for an
extended period of time.
 The auditor obtains loan from an audit client at an interest rate lower than the usual
lending rate.
 The auditor accepts more than a taken gift from a client.
 The auditor has a part in the operations of the audit client like:
 Cosigning the checks of a client,
 Preparing the client’s payrolls
 Providing other bookkeeping services,
 Recruiting & hiring the internal auditor, accountant & other employees who
assume an audit sensitive position.

b) Integrity and objectivity

This rule requires the member to be free of any bias and base his/her conclusion on fact rather than
on any predetermined judgments. It applies to all types of professional services rendered by CPAs.
c) General standards

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The auditors shall comply with the following standards in the performance of any professional
services. These are:
Professional competence: undertake only those professional services that the member or
the member’s firm can reasonably expect to expect to complete with professional
competence.
Due professional care: exercise due professional care in the performance of professional
services.
Planning & supervision: adequately plan and supervise the performance of professional
services.
Sufficient relevant data: obtain sufficient relevant data to afford a reasonable basis for
conclusions or recommendations in relation to any professional services performed.
d) Compliance with standards
An auditor should not issue unqualified opinion on F/s unless these statements are prepared
according to the principles and standards outlined by the various designated bodies such as FASB.
However, if application of the principles and standards result in misleading F/S, the auditor should
explain in the departure and show the effect of the departure on the F/S.
e) Confidential client information:
An auditor in public practice shall not disclose any confidential client information without specific
consent of the client.
Note: this rule does not relieve the auditor’s obligation to comply with necessary legal &
professional requirements.
Eg. – Validity issued & enforceable subpoena or summons (directives or commands);
- A regulating body that evaluates the professional performance of auditors ;
- A recognized investigative or disciplinary body.
f) Contingent fees
For purpose of this rule, a contingent fee is a fee established for the performance of any service
pursuant to an arrangement in which no fee will be charged unless a specified finding or result is
attained, or in which the amount of the fee is otherwise dependent upon the finding or result of such
services.
Eg. Suppose a CPA firm permitted to charge a fee of birr 15,000 if an unqualified opinion was
provided, but only birr 8,000 if it was qualified.
-such an agreement may tempt an auditor to issue the wrong opinion & would be a violation of rule
of contingency fee.
g) Acts discreditable

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an auditor shall not commit an act discreditable to the profession. Some of the acts that are
considered to be discreditable to the professional are:
-It is a discreditable act to retain a client’s records after a demand is made for them. Assume,
management did not pay an audit fee and the partners of the CPA firm therefore refused to return
client-owned records. The partners have violated this rule – acts discreditable.
-Employment on the basis of race, color, religion, sex, age, or national origin.
-Negligence in the preparation of reports.
h) Advertising & other form of solicitation
A member in public shall not seek to obtain clients by advertising or other forms of solicitation in a
manner that is false, misleading, or deceptive. Solicitation by the use of coercion (pressure, force),
overreaching, or harassing conduct is prohibited. Solicitation or advertising that is not false is
acceptable.

i) Form of practice and Name

A member may practice public accounting only in the form of a proprietorship, a partnership, or
professional corporation.
A member shall not practice public accounting under a firm name that is misleading. This rule
permits practitioners to organize as a proprietorship, a partnership, or professional corporation.
A proprietorship & each partner in a partnership must be a CPA to be qualified to practice.
When a public accounting firm is established in the form of professional corporation all shareholders
should be CPAs, and all shareholders I professional corporations are individually liable in litigation
against the CPA firm.
2.5. Auditors’ Professional Responsibility and Liability
2.5.1. Auditors’ Professional Responsibility:
Auditors have primary responsibility to serve the society.
To this end, auditors should be able to have:
Better communication- auditors should communicate to users the work done by the
auditor and the character and limitation of an audit.
Detection of errors & irregularities- the auditor is required to design the audit to provide
reasonable assurance of detecting errors & irregularities that are material to the F/S.
-The term error refers to unintentional misstatements or omissions in F/S, such as mistakes in
gathering or processing of data, incorrect accounting estimates & mistakes in the application
accounting principles.
-The term irregularities refer to intentional misstatements or omissions in F/S.

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 Detection of illegal client Acts- the auditor should design the audit to detect illegal
acts.
-An illegal acts refers to such acts as the payment of bribes, the making of illegal political
contributions, and the violation of other specific laws & governmental regulations.
-When irregularities or illegal acts having a material effect on F/S are not properly accounted, the
auditor should express a qualified opinion or an adverse opinion b/c the F/S are not conformity with
IFRS.
Reporting Doubts as to an entity’s Ability to continue as a Going Concern
-the auditor has a responsibility to evaluate & disclose whether there is substantial doubt about the
entity’s ability to continue as a going concern for a reasonable period of time, not to exceed one year
beyond the date of the F/S being audited.
2.5.2. Auditor’s Legal Liability
-The auditor is responsible for every aspect of his /her public accounting work.
-most of the lawsuit against auditors are related with audited F/S
-auditors are liable to their clients & third party.
o Auditor’s Liability to Clients:
-Auditors should fulfill the implied or expressed contracts with clients
-Auditors are liable to their clients for negligence &/or breach of contract if they fail to provide the
services or if they fail to exercise due care in their performance.
-An auditor may be liable to a client to a breach of contract or wrongful act w/n s/he:
 Issue a standard audit report w/n s/he has not made an examination in accordance with ISA;
 Doesn’t deliver the audit report by the agreed-upon date;
 Violate the clients confidential relationship;
 Fail to exercise the degree of care a person of ordinary prudence (a reasonable person)
would exercise under the same circumstances (ordinary negligence);
 Fails to use even slight care in the circumstances(gross negligence);
 Intentionally deceits, such misrepresentation concealment or nondisclosure of material fact,
that results in injury to an others (fraud); &
 If he/she breaches the contract.
o Liability to Third Parties(actual & potential users):
-The auditor owes a duty of care to third parties whose reliance is foreseen by the auditor.
-The third party is an individual who is not in privities with the parties to a contract.
-privities refers to the existence of direct relationship b/n parties through a contract.
- Third parties can be classified as primary beneficiary & other or general third beneficiaries.
- A primary beneficiary is one about whom the auditor was informed prior the conducting the audit

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- Those third parties there existence is not known are referred to as general third beneficiaries.
-The auditor is liable to more general third parties for gross negligence & fraud.

END OF CH 2

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