CHAPTER 1: OVERVIEW OF AUDITING

1.1 INTRODUCTION

Without question, the independent audit function plays an important role in both business and
society. Numerous third parties, including investors, creditors, and regulators, depend on the
competence and professional integrity of independent auditors.

Economic decisions are typically based upon the information available to the decision maker.
To obtain the most benefit, users should have economic information that is both relevant and
reliable.
This need for relevant and reliable financial information creates a demand for accounting and
auditing service.

1.2 DEFINITION AND BASIC FEATURES OF AUDITING

Auditing is 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 and independent person.

Auditing enable the auditor to express opinion whether the financial statements are prepared,
in all material respects, in accordance with an identified financial reporting framework. This
framework (criterion) might be generally accepted accounting principles (GAAP), or the
national standard of a particular country.

Financial statements include balance sheet, income statement, statement of cash flow, notes
and explanatory material that are identified as being part of financial statements.
The phrases used to express the auditor’s opinion are that the financial statements ‘give a
trued and fair view’ or ‘present fairly in all material respective’.

Note that the auditor does not certify the financial statements or guarantee that the financial
statements are correct, he reports that in his opinion they give a ‘true and fair view’, or present
fairly’ the financial position.

1.3 DEMAND FOR AUDIT

1
There is a need for auditing when ownership is separated from control. At a practical level, it
helps prevent or detect misstatements-errors or fraud. It may prevent or detect misstatements
on the part of (1) the employees who actually handle the money, or (2) management.
Auditing is needed to enhance the credibility of financial information prepared by an entity.
The independent audit requirement fulfils the need to ensure that those financial statements
are objective, free from bias and manipulation and relevant to the needs of users.

1.4 ACCOUNTING VS AUDITING

Accounting is the collecting (recording, classifying), summarizing, reporting and interpreting

of financial data.

Auditing is the testing of those accounting records for fairness, appropriateness. An

accountant only needs to know generally accepted accounting principles (GAAP). The
auditor needs to know GAAP, plus how to select and evaluate evidence related to the
assertions of financial statements.

Accounting is constructive. It starts with the raw financial data to process and produce
financial statements.

Auditing on the other hand is analytical work that starts with financial statement to lend
credibility and fairness of the measurements.

1.5 TYPES OF AUDITS AND AUDITORS

A. Types of Audits
Audits are often viewed as falling into three major types:
(1) Audits of financial statements,
(2) Operational audits, and
(3) Compliance audits.

2
1. Audits of financial statements: - The goal is to determine whether the
financial statements have been prepared in conformity with generally accepted accounting
principles.
2. Operational audits: - An operational audit is study of some specific unit of an
organization for the purpose of measuring its performance. The operation of a unit can be
evaluated for its effectiveness and efficiency.
3. Compliance audits: - Compliance audit determines whether the specified
rules, regulations, or procedures are being carried out or followed.

B. Types of Auditors
The most known types of auditors are
1. Independent auditors,
2. Internal auditors,
3. Government auditors.

1. Independent (external auditors): - Independent auditors have no connection to the firm as

an owner or employee/manager. The basic task of independent auditor is to confirm to the
owners that the employees are correctly reporting on their financial position and
performance.

2. Internal auditor: - An internal auditor is paid salary as employee on the organization that
is being audits. He/she is responsible to appraise and investigation the performance of
unit and/or units within the organization and give recommendation to top management.

3. Government audit: - The government auditor is paid a salary by the government. He/she
is responsible to the legislature or executive.
1.6 THE NATURE OF EXTERNAL AUDITING IN ETHIOPIA

In Ethiopia audits seem to be done primary on account of government regulation. For

example, NGOS are audited because the assets of the NGOS are deemed a “national asset,” the
use of which is ultimately accountable to the government of Ethiopia.

Auditing in Ethiopia could be viewed in five main areas.

3
1. The office of the auditor general (OAG)
(OAG)
The powers and functions of the office of the OG are circumscribed through the
proclamations that established it, its sphere of activity lies in government audit.
2. The audit service corporation.
corporation. The duty and functions of
this entity involve mostly commercial audits of commercial and productive enterprises
wholly or partially owned by government.
3. Private audit firms.
4. Ministry of finance audit and inspection.
inspection.
Auditing activity in this area includes audit of ministries and government departments
by MF auditors and inspectors, including tax audit by Inland Revenue authorities.
5. State corporations’ and enterprises’ auditors.
auditors.
These are audits performed by internal auditors within enterprise.