UNIT ONE

INTRODUCTION TO AUDITING
1.1. Historical Development and Evolution of Auditing
The development of auditing is closely related, to the development of organized systems of
accounting. In the early stages of civilization, the number of transactions was usually so small
that an individual was able to record the transactions himself/herself. However, with the growth
of civilization and consequential growth in volume and complexities of transactions, it became
necessary to entrust the job of recording the transactions to other persons. The trend started with
the maintenance of accounts of empires by public officials. Almost simultaneously, a need was
felt to institute a check on the fidelity of the persons responsible for retaining the accounts. To
accomplish this purpose, it became customary to entrust a person with the responsibility to hear
those who had maintained the accounts. In the course of time, such persons came to be known as
auditors-the term being derived from the Latin word 'audre,' which means to 'hear'.

The available evidence indicates that a system of auditing existed even in times of ancient
civilizations. Mesopotamian relics of commercial transactions reveal tiny marks, dots, ticks, and
circles at the side of the figures. This indicates that those figures had been checked. In ancient
Egypt, two officials recorded fiscal receipts separately and other officials conducted the audit. In
Greece, the accounts of public officials were scrutinized at the expiring of their terms of office.
In the UK during the 12th century records revealed the existence of a system of accounting and
auditing of the transactions of the state. Special audit officers were appointed at the time to
ensure that the revenue and expenditure of the state were duly accounted for. The audit of the
accounting system of London towards the end of the 13 th century was aimed at ensuring the
absence of frauds, arithmetical accuracy of accounts and compliance with the authority given to
the custodian. The subsequent years witnessed the gradual maintenance of accounts by
individual agriculturists, estate owners, traders and others. Mercantile account took definite plan
in Europe during this period. Contemporarily the legal provisions and growth of the current
auditing scene have immeasurably enhanced to understand its earlier origins and the economical
situation.
The development of trade and commerce between medieval Italian cities and the east, which
fostered the sailing ships "joint venture" accounts to end the venture at the completion of the
voyage. Thus, responsibility for this function fell on the shoulder of the bookkeeper and the
lawyer. These events were further evolved by the growth of partnership and credit trade and
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commerce. During the 1500s the practice of outside verification spread to the rapidly developing
limited liability companies (LLC) who were responsible for outside investors.
In a parallel development, English manorial auditing began during the medieval period when
records of large manors (farms) were reviewed annually by auditors who represented the lord
and the council. This became the foundation of the British statutory audit in the 19 th century and
later spread throughout Europe. It is, however, the Industrial Revolution (1900) that the
accentuated the need for the verification of appropriate allocation of labor wages and proper
determination of profits to assess what is to be partaken by labour, government and owner.
This was the period where government regulation of business taxation and banking regulation of
business, and development in economic theory come to influence thoughts on business, costs,
and finance requiring more appropriate determination and evaluation of net income, and
valuation of balance sheet.

First, a voluntary company audit was instituted in to practice where companies were having their
accounts voluntarily audited. Then, in 1844 company audited by persons independent of
management become a requirement by law. Considerations of labor disputes, changes in
technology development in large scale enterprise (railways), and changes in economic thought,
emerging government regulatory bodies, income taxation and corporate entity concept were
influencing events preceding the stock market crash, all of which gave prominence to financial
control and accountability.

The stock market crash debacle in 1930 registered the establishment of the SEC, and the need for
investigation into false companies accompanied by new requirements on audits. Auditors'
responsibility in fraud detection was viewed in new perspective. The auditors' legal liability and
responsibility for third party, reliance and evidence was being affirmed through common law.
By 1940, interest in internal management efficiency and performance, and the need of
information for planning and decision making brought the development of management
accounting and internal control. This event directed focus of development in internal audit. In the
1950s and 60s system based approach to audit come to gain grounds and a new view on attest
function forged which stressed on disclosure requirement and social responsibility of the auditor.

In the 1990s, risk based approach obtained wide acceptance and application in the auditing
practice. Area of focus is by risk weight. Risk assumed are guided by level of assurance needed

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to obtain evidence and concomitant cost. Thus, the higher the risk objects, the more intensive the
audit is.
In general, these 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:
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 and sampling to be preformed.
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.
1.2. Definitions and Terminologies of Auditing
You might have heard of the terms 'Auditing' and 'auditors' many times. What is your knowledge of
the meaning of these terms? What in your understanding does auditor do? When such questions are
put to a group of people the replies would be quite different. Different people have defined auditing in
different ways. Most of these definitions give importance only to some aspects of auditing. In some
cases interestingly some would reply that an auditor is a person who checks the accounts and always
finds fault with what has been done. Some others say that auditing is a process through which frauds
and errors are detected. One would say that an auditor is a person who checks the correctness of
accounts of an enterprise before they were made public. Most of these definitions give importance
only to some aspects of auditing. Let us, however, begin our discussion on the nature of auditing
by the following definitions, which explain auditing in a comprehensive manner.

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a)In its modern sense, an audit is defined as a process carried out by suitably qualified auditors
where by the accounting records of the business entity are subject to scrutiny in such due as will
enable the auditors to form an opinion as to their truth, fairness and accuracy.
b) Auditing is also described as a process of collection and evaluation of evidence for the
purpose of reporting on economic information.
The definitions of auditing above, states that the purpose of auditing is "reporting" by auditors
about economic information. The auditor’s report is the end result of the audit process. The
auditors report can be of different kinds. In the case of an audit of balance sheet and profit or
loss account of an enterprise, the auditor expresses his/her opinion on reviewed financial
statement whether the accounts show a true and fair view of the financial position and financial
performance. The nature and scope of the auditor's report in a particular case depends primary on
the terms of engagement and the provision of applicable laws.
c)The institute of chartered accountants of India has defined auditing as "a systematic
independent examination of data, statements, records, operations and performances of an
enterprise for a stated purpose. In any auditing situation the auditor recognize propositions
before he/she programs for examination, collects evidence, evaluates the data and on this basis
formulates his/her judgment which is communicated through his/her audit report.

d)According to Arens and Loebbecke, auditing is defined as, 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.
The description of auditing by Arens and Loebbecke includes several key terminologies which
are discussed in this section briefly.

 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. Information can and does take many forms. Auditors routinely perform audits of
quantifiable information, including companies’ financial statements and individuals’ federal
income tax returns. Auditors also perform audits of more subjective information, such as the
effectiveness of computer systems and the efficiency of manufacturing operations. The
criteria for evaluating information also vary depending on the information being audited.

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 Accumulating and evaluating evidence: Evidence is defined as any information used by the
auditor to determine whether the information being audited is in accordance with the
established criteria. Evidence takes many different forms, including oral testimony of the
auditee, written communication with outsiders, and observations by the auditor. It is
important to obtain a sufficient quality and volume of evidence to satisfy the purpose of the
audit.

 Competent, independent person: The auditor must be qualified to understand the criteria
used and competent to know the types and amount of evidence to accumulate to reach the
proper conclusion after the evidence has been examined. The auditor also must have an
independent mental attitude. It does little good to have competent person who is biased
performing the evidence accumulation when unbiased information and objective thinking are
needed for the judgments and decisions to be made.
 Reporting: The final stage in the audit process is the audit report, which is the
communication of the findings to users. Reports differ in nature, but in all cases they must
inform readers of the degree of correspondence between information and established criteria.
Reports also differ in form and can vary from the highly technical type report usually
associated with financial statement audits to a simple oral report in the case of an operational
audit done of a small department’s effectiveness.
1.3. Difference Between Auditing and Accounting
Accounting is the recording, classifying and summarizing economic events in logical manner for
the purpose of providing information for decision making. The function of accounting is to
provide certain types of quantitative information that management and other can use to make
decision. To provide relevant information, accountant must have through understanding of the
principles and rules that provide base for preparing accounting information. In addition
accountant must develop a system to make sure that the activities, economic events are properly
recorded on timely basis at reasonable cost.
In auditing the accounting data, the concern is with determining whether the recorded
information properly reflects the economic events that occur during the accounting period. Since
the accounting rules are the criteria for evaluating whether the information is properly recorded,
any auditor involved with those data must thoroughly understand these rules that govern the
accountancy.
The difference between auditing and accounting is best summarized as follows:
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 Accounting Auditing of financial statement
 Is the process of identifying ,measuring, recording  Is the process of obtaining and evaluating
and communicating economic information about evidences and determining the fairness of
an organization in conformity with GAAP financial statement inconformity with GAAS
 Deliver financial statements to users  Deliver audit report(opinion) to users
 precede auditing  Begins when accounting ends
 No prescribed qualification is legally required for  The external auditor must be chartered
the accountant accountant(CPA)
 All accountant may not have auditing knowledge  Auditors must have accounting knowledge
 An accountant is an employee of the firm  An auditor is independent professional
 Constructive and theoretical  Critical aspect of accounting and analytical in
nature
 Generally appointed by management and  Appointed by the shareholders or audit
expected to perform according to the rule and committee of the organization and is independent
regulation set by management

1.4. Nature, Purpose and Scope of Auditing

1.4.1. Nature of Auditing
Framework of Auditing and Assurance Standards and Guidance Notes on Related service issued
recently distinguishes audits from related services. Related services comprise reviews, agreed-
upon procedures and compilations. Audits and reviews are designed to enable the auditor to
provide high and moderate levels of assurance respectively, such terms being used to indicate
their comparative ranking.
Assurance in this context refers to the auditor's satisfaction as to the reliability of an assertion
being made by one party for use by another party. To provide such assurance, the auditor
assesses the evidence collected as a result of procedures conducted and expresses a conclusion.
The degree of satisfaction achieved and, therefore, the level of assurance which may be provided
is determined by the procedures performed and their results. In an audit engagement, the auditor
provides a high, but not absolute, level of assurance that the information subject to audit is free
of material misstatement expressed positively in the audit report. In a review engagement, the
auditor provides a moderate level of assurance that the information subject to review is free of
material misstatement. This is expressed in the form of negative assurance. For agreed-upon
procedures, auditor simply provides a report of the factual findings, no assurance is expressed.
Instead, users of the report draw their own conclusions from the auditor's work. In a compilation

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engagement, although the users of the compiled information derive some benefit from the
involvement of a member of the Institute, no assurance is expressed in the report. Objective of an
audit is to enable the auditor to express an opinion whether the financial statements are prepared,
in all material respects, in accordance with an identified financial reporting framework "give a
true and fair view".
Absolute assurance in auditing is not attainable as a result of such factors as the need for
judgment, the use of test checks, the inherent limitations of any accounting and internal control
systems and the fact that most of the evidence available to the auditor is persuasive, rather than
conclusive, in nature. The objective of a review of financial statements 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 auditor's attention that causes the auditor to
believe that the financial statements are not prepared, in all material respects, in accordance with
an identified financial reporting framework. While a review involves the application of audit
skills and techniques and the gathering of evidence, it does not ordinarily involve on assessment
of accounting and internal control systems, tests of records and of responses to inquiries by
obtaining corroborating evidence through inspection, observation, confirmation and
computation, the auditor attempts to become aware of all significant matters, the procedures of a
review make the achievement less likely than in an audit engagement, thus the level of assurance
provided in a review report is correspondingly less than that given in an audit report.

In an engagement to perform agreed-upon procedures and auditor is engaged to carry out those
procedures of an audit nature to which the auditor and the entity and any appropriate third parties
have agreed and to report on factual findings. The report is restricted to those parties that have
agreed to the procedures to be performed since others, unaware of the reasons for the procedures,
may misinterpret the results. In a compilation engagement, a member of the Institute is engaged
to use accounting expertise as opposed to auditing expertise to collect, classify, and summaries
financial information. The procedures employed are not designed and do not enable the member
to express any assurance on the financial information. However, users derive some benefit as a
result of the member's involvement because the service has been performed with due
professional skill and care. An auditor is associated with financial information when the auditor
attaches a report to that information or consents to the use of the auditor's name in a professional
connection. If the auditor is not associated in this manner, third parties can assume no
responsibility of the auditor.

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1.4.2. Purposes of Auditing
Dependable financial information is essential to the very existence of the society. In making a
decision, such as, to buy or sell securities, the banker deciding to approve a loan; the government
to obtain revenue based on income tax returns etc, all are relying upon information provided by
auditors. There are many advantages of auditing to the modern society. The more important of
these are as follows.
A. Tool of Control over Resources
The most advantage of auditing is that it acts as a tool of control over those who harm resources
belonging to others. In the case of government, audit seeks to ensure that the use the public
funds properly. Whenever a person or authority is entrusted with the resources belonging to
others, it becomes necessary to exercise suitable control over such people by officials to ensure
that the resources are used properly. Audit can act as an important instruction of practicing such
control. Experiences of certain countries show that whenever the audit becomes weak, there was
a gross misuse of public funds. Thus, audit acts as a mere protection against misuse of funds and
reduces the possibility of errors and frauds.
B. Tool for Enhancing Creditability of Economic Information
Another advantage of auditing is that it enhances the credibility of economic information, thus, the
shareholders of a company would give greater reliance on the financial statements of the company, if
the auditor expresses the opinion that these statements present a true and fair view. Apart from the
owners, other readers of financial statements of an enterprise also place great reliance on them if they
have been audited.
C. Tool for Improving Economy and Efficiency
During examination of any type of audit, the auditor reviews the activities of the enterprise.
He/she is, therefore, often in a position to make suggestions to improve the efficiency of various
activities of the enterprise. Certain types of audits are carried on to review the operations and
activities, so that, wastages and losses can be minimized, weaknesses in the system can be
discovered and overcome, and control can be strengthened. In internal audit of operational audit
or management audit the auditor generally makes proposals for improving the economy and
efficiency within which resources are employed.
The need for most types of audit arises only after the accounting process is completed. The
auditor conducts the final product of the accounting system and attempts to collect evidence to
enable him/her to express an opinion thereon. Therefore, in most audits, the auditors review the
completed work of an accountant from a specific outlook. Auditor's task begins where the task
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of the accountant ends. The auditor should reasonably assure himself/herself that the accounting
system is adequate and that all the accounting information that should be recorded has in fact
been recorded.
The auditor should gain an understanding of the accounting system and related internal controls and
should study and evaluate the operation of those internal controls upon which he wishes to help in
determining the nature, timing and extent of other audit procedures.
Upon completing the review and testing of the accounting records, the auditors should prepare a
working paper describing the records in use, the tests of controls and other audit procedures
followed, the nature and significant misstatements discovered, any suggestions for improving the
accounting system and the auditors conclusion as to the overall quality of accounting records.
This working paper summarizes an important part of the auditor's consideration of internal
control and may serve as a reference for determining appropriate modifications in the audit
program. At the beginning of the next annual audit, a review of the working paper will enable
the auditors to concentrate up on the most significant aspects of the accounting records.
1.4.3. Scope of Auditing
The scope of auditing depends on the type of auditing performed by the professional auditors.
The scope of internal audit activity includes examining and evaluating the policies, procedures
and systems which are in place to ensure: reliability and integrity of information, compliance
with policies, plans, procedures, laws and regulations; safeguarding assets; economical and
efficient use of resources; and accomplishment of established objectives and goals for operations
or programs. Internal Audit may provide consulting services within the organization concerning
issues related to internal controls, special investigations, and other areas of interest and concern.
Whereas, external audit is aimed at caring out such work as is necessary to form an opinion as to
whether:
a) The accounts are properly kept; and
b) The annual financial statements:
i) are prepared in accordance with the financial records; and
ii) Represent fairly the results of the operations and the financial in accordance with the
Accounting Standards, relevant legislation and other mandatory professional reporting
requirements. The auditor is to include in their proposal the extent to which the critical matters
such as revenue, expenditure, assets liabilities and equities will be audited to provide reasonable
assurance of whether these items are free of material misstatement caused either by fraud or

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error. The scope of governmental auditing is to provide reasonable assurance of whether the
rules regulations and all the proclamations issued by the government is being respected by the
client.
1.5. Types of Auditors and Auditing
1.5.1. Types of Audits
Audits are often classified in to three major types:
1) Audit of Financial Statement
2) Compliance Audit
3) Operational Audits /Performance Audits/
1. Audit of Financial Statement
Audit of financial statements is actually part of the broader concept of the attest function. To
attest to information mean to provide assurance as to fairness or dependability. Certified Public
Accountants (CPAs) attest to a host of other types of information including the reasonableness of
financial forecasts, the adequacy of internal control and compliance with laws and regulations.
To attest to financial statements is to provide assurance as to their fairness and dependability.
The attest function consists of two phases. The first is the performance of an audit; the second is
the issuance of an audit report. The attest function leads to credibility to management's
representations that are contained in the financial statements.

The audit of financial statements ordinarily covers the balance sheet and the related statements of
profit and loss and cash flows. Financial audit generally is conducted to ascertain whether the
financial statements present true and fair views of the financial position and working results of
an enterprise or organization. The goals of audit of financial statements are to determine whether
the statements have been prepared in conformity with generally accepted accounting principles.
The aim of an independent financial audit is to ascertain if the financial statements of an
enterprise are reliable and dependable. Financial statements audits are normally performed by
certified public accountants. The contribution of the independent financial audit is to give
credibility to financial statements. Credibility, in this usage means that the financial statements
can be believed that is, they can be relied upon by outsiders, such as stockholders, creditors,
government and other interested third parties. The word “audited” when applied to financial
statements means that balance sheet, profit and loss statements and cash flows are accompanied
by an audit report prepared by independent auditors expressing their professional opinion as to
fairness of the enterprise's financial statements. Financial statements prepared by management

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and released to outsiders without first being audited by independent auditors leave a credibility
gap. The Objectives of Audit of Financial Statement are:
 To determine whether financial statements have been prepared in accordance to the
generally accepted accounting principles.
 To ensure the completeness of financial statements.
 To vouch the existence of recorded transactions in the financial statements.
 To examine the accuracy of the financial statements.
 To ensure that the net income / loss is the result of the operation for a given accounting
period.
 To verify availability of assets recorded in the balance sheet.
2. Compliance Audit
The performance of a compliance audit is dependent upon the existence of verifiable data and of
recognized criteria or standard established by an authoritative body. Such audits seek to
determine whether a tax collection is in compliance with tax laws and regulations.

Compliance audit is defined, as an audit to determine whether verifiable data such as income tax
returns or other financial statements are in conformity with established criteria, for example,
laws and regulations, society has always been concerned with compliance with laws and
regulations by all types of entities, business, government and non profit making organizations.
Legislative public officials and the general public want assurance about compliance. Many
governmental entities and non-profit making organizations that receive financial assistance from
banks are subject to periodic compliance audit. Such audits are designed to determine whether
the financial assistance is spent in accordance with applicable laws and regulations.
In auditing the financial statements of the governmental and non-governmental organizations, the
auditor must often perform tests of compliance with laws and regulations to determine that violations
do not have a direct and material effect on financial statements.
The Objectives of Compliance Audits are:
 To determine whether there have been violations of laws and regulations that may have a
material effect on the organizations financial statements.
 To provide a basis for additional reports on compliance procedures that is not tests of the
internal control policies and procedures. Compliance procedure is defined, as performing
procedures to act with laws and regulations.

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The auditors may discover violations of provisions of laws, regulations, contracts or grants that
result in which they estimate to be material misstatement to the organization's financial
statements. Such violations are known as material instances of non-compliance. Non-
compliance is the failure to act in accordance with laws or regulations. In these circumstances,
the auditors must consider the effect on their opinion issues on the financial statements. The
resulting misstatement, if left uncorrected, would normally require the auditors to issue a
qualified or adverse opinion. The auditors may also report a description or any indications of
illegal acts that could result in criminal prosecution.
3. Operational audits /Performance Audits/
An operation audit is a systematic independent appraisal activity within an enterprise for a
review of the entire departmental performance as a service to management. The overall
objective of operational auditing is to assist all levels of management in the effective discharges
of responsibilities by furnishing them with objective analysis, appraisal, recommendations and
pertinent comments concerning the activities reviewed. It may be noted that the terms, operation
audit and performance audit often are used interchangeably.

The purpose of an operational audit usually includes the intention to appraise performance of a
particular organizational function or group activities. However, the broad statement must be
expanded to specify precisely the scope of the audit and the nature of the report. The auditors
must determine specifically which policies and procedures are to be appraised and show their
relation to the specific objectives of the enterprise or organization.

Before starting the operational audit, the auditors must obtain a comprehensive knowledge of the
objectives, organizational structure, and operating characteristics of the unit to be audited. This
familiarization process might begin with a study of organizational charts statements of the
function and responsibilities assigned are management policies and directives and operating
policies and procedures.

In attempting to meet, managerial needs, operational auditors sample the work performance to see
whether it is in accordance with approved procedures. They verify the accuracy and consistency of
the information obtained in operating reports, and they study the format of the reports to determine
whether the information is presented in a meaningful form. The auditor's responsibility for seeing that
the enterprise's assets are safeguarded against fraud is expanded to a responsibility for providing
protection against all kinds of waste. An enterprise having a strong system of internal control over its
cash, inventory, and other personal property will never suffer a serious loss from fraud or theft.
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Now-a-days economic pressures are forcing companies and government enterprises at all levels
to economize, resulting in an increased demand for the information provided by operational
audits. The demand has been so pronounced that operational auditing has become an extension
of the internal auditing function of most large enterprises. Also governmental auditors engage
extensively in evaluating the economy, effectiveness and efficiency of various government
programs.
Objectives of Operational Audits
Internal auditors often perform operational audits. The main users of operational audit reports
are managers at various levels including the board of directors. Decision makers need
assurances that every component of an enterprise is working to attain the organization's goals.
For example, the management needs the following information.
 Assessment of the unit performance in relation to management's objectives or other
appropriate criteria.
 Assurance that its plans are comprehensive, consistent and understood at the operating levels.
 Objective information on how well its plans and policies are being carried out in al areas of
operation's and opportunities for improvement in effectiveness, efficiency and economy.
 Information on weakness in operating controls, particularly as to possible sources of waste.
 Reassurance that all operating reports can be relied on as basis for action.
In every audit, it is important to state clearly the boundaries of the examination. These
boundaries identify the economic entity to be examined and the time period to be covered. Thus,
the boundaries serve to define and to limit the auditors' responsibilities. The economic entity to
be audited may be a sole proprietorship, a partnership, a corporation and its subsidiaries.
1.5. Types of Auditors
Auditors are often viewed as falling into three main types
1. Independent financial auditor /Certified Public Accountant/
2. Internal auditors
3. government auditors
1. Independent financial auditor: Independent/financial auditor or certified public accountant
is a person licensed by the state to practice public accounting as a profession based on having
passed the uniform CPA examination and having met certain education and experience.
Including public accounting profession, all of the recognized professions have many common
characteristics. The most important of these characteristics are a responsibility to serve the public, of a
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complex knowledge, standards of admission to the profession and a need for public confidence. To
Certified Public Accountants, public confidence is of special significance. Credibility is the product
of the certified public accountants. Without public confidence in the attester, the attest function serves
no useful purpose. To attest to financial statements means to provide assurance as to their fairness and
dependability. The attest function includes, first, the independent public accountant, must carry out an
examination to provide the objective evidence that enables the auditors to express an informed opinion
on the financial statements. Second, the attest function is the issuance of the auditor's report, which
conveys to users of the financial statements the auditor opinion as to the fairness and dependability of
the financial statements.
Reliable financial information is essential to the very existence of society. Thus, good accounting and
audited financial statement aid society in allocation its resources in the most efficient manner. The
goal is to allocate limited resources to the production of those goods and services for which demand is
greatest. Economic resources tend to be attracted to the industries, and the organizational entities that
are shown by accounting measurements to be capable of using more resources to the best advantage.
Inadequate and inappropriate accounting result on the other hand, conceal waste and inefficiency and
thereby prevent resources from being allocated in a rational manner. It is the report by the
independent auditors that gives credibility to a set of financial statements and makes acceptable to
investors, bankers, government and other users.
2. Internal Auditors: Although most auditing literatures interest is primarily in the audit of
financial statements by Certified Public Accountants, other professional groups carry on large
scale auditing. These well known types of auditors are internal auditors.
The standard definition adapted by the Institute of Internal Auditors of United States of America,
however is that internal auditing is an independent appraisal activity established within an
organization or enterprise to examine and evaluate its activities as a service to the organization in the
effective discharge of their responsibilities by furnishing their analysis, appraisals, recommendations
and counsel. In performing these functions internal auditors can be considered as a part of the
organization's internal control structure. They represent high level control that functions by measuring
and evaluating the effectiveness of other internal control policies and procedures.
Internal auditors are not merely concerned with the organization's financial controls. Their work
encompasses the entire internal control structure of the organization or enterprise. They evaluate and
test the effectiveness of internal control policies and procedures designed to help the organization or
enterprises to meet all of its objectives.

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The internal auditing head often accordingly reports to the general manager or board of directors or
president or another high executive. This strategic placement high in the organizational structure
helps assure the internal auditors will have ready access to all units of the business and that their
recommendations will be given prompt attention by department heads. This reporting standard
provides guidance for the head of internal auditing in managing the internal auditing functions. The
head of internal auditing is responsible for properly managing the departments to help assured that, the
audit work is preformed in accordance with professional standards and fulfills the general purposes
and responsibilities developed by management of the organization and the resources of the internal
auditing department are efficiently and effectively employed.
A large part of the internal auditors consists of operational audits in addition; they may conduct
numerous compliance audits. The number and kind of investigative activities varies from year to
year. Unlike the certified public accountants who are committed to verify each significant item in the
annual financial statements the internal auditors are not obliged to repeat their audits in annual basis.
3. Government Auditors: A government audit is conducted primarily to ensure that financial
transactions are recorded with proper sanction and authorization. In Ethiopia, the office of auditors
General and office of control has been given the responsibility to conduct the audit of the central
government and the state government. Government auditors examine and make that
 Transactions are correctly recorded and activities conform to the rules and regulations

 Ensure that public funds are not misused

 Examine the efficiency and effectiveness of selected projects or program run by government.

To sum up, auditors and type of auditing area or audit emphasis are summarized as follows.
Auditors
Audit Internal auditors Independent Auditors Government Auditors
Operational Audit Primary Nominal Primary
Financial Audit Secondary Primary Nominal
Compliance Audit Primary Secondary Primary

1.6 Generally Accepted Auditing Standards (GAAS)

Standards are authoritative rules for measuring the quality of performance. They serve as rods against
which work performed is compared and thus principles are translated in to more practical and
adherable terms. In this regard standards are more specific than principles. The American Institute of
certified Public accountants (AICPA) has formulated the following 10 generally Accepted Auditing
Standards (GAAS) categorized in to three.
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A. GENERAL STANDAREDS
1. Adequate Training and Proficiency: The audit is to be performed by a person or persons
having adequate technical training and proficiency as an auditor. How does the independent
auditor achieves the adequate technical training and proficiency required by the first general
standard? This requirement is usually interpreted to mean college or university education in
accounting and auditing, substantial public accounting experience, ability to use procedures
suitable for computer based systems, and participation in continuing education program. A
technical knowledge of the industry in which the client operates is also part of the personal
qualification of the auditor. It follows that a CPA firm must not accept an audit engagement
without first determining that members of its staff have the technical training and proficiency
needed to function effectively in particular industry.

2. Independence: In all matters relating to the auditing assignment, independence in mental

attitude and in appearance is to be maintained by the auditor or auditors. An opinion by
independent public accountant as to the fairness of a company’s financial statement is of no
value unless the accountant is truly independent. Consequently, the auditing standard that state in
all matters relating to the assignment, an independent in mental attitude is to be maintained by
the auditors, perhaps is the most essential factor in the existence of a public accounting
profession. If an auditor owned shares of stock in a company that they audited, or if they served
as members of the board of directors, they might subconsciously be biased in the performance of
auditing duties. A CPA should therefore avoid any relationship with the client that would cause
an outsider who had knowledge of the facts to doubt the CPA independent. It is not enough that
the CPA be independence, they must conduct themselves in such a manner that informed
members of the public will have no reason to doubt their independence.

3. Due Professional Care: the third general standard requires due professional care in the
conduct of an audit and in the preparation of the audit report. This standard requires the auditor
to carry steps of the audit engagement in an alert and diligent manner. Full compliance with this
standard would rule out any negligent acts or material omissions by the auditors. Of course,
auditors, as well as members of other profession, inevitably make occasional errors in judgment,
but this human element doesn’t justify indifference or inattention to professional responsibility.
B. STANDAREDS OF FIELD WORK
4. Adequate Planning and Supervision: adequate planning is essential to a satisfactory audit.
Some portion of the examination can be performed prior to the end of the year under audit: some
information may be completed by the client’s staff and made available for the auditors review.
The appropriate number of audit staff of various levels of skill and the time required of each
need to be determined in advance of filed work. These are but a few of the elements of planning
the audit. Most of the filed work of an audit is carried out by staff members with limited
experience. The key to successful use of relatively new staff members is close supervision at
every level. This concept extends from providing specific written instruction to staff members all
the way to an overall review by the partner in charge of the engagement.

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5. Sufficient Understanding of Internal Control: An excellent internal control structure
provides strong assurance that the clients records are dependable and that its assets are protected.
When the auditor find this type of strong internal control, the quality of other evidence required
is much less than if control were weak. Thus, the auditor’s assessment of internal control has
great impact on the length and nature of the audit process.

6. Sufficient Competent Evidential Matter

The third standards of filed work require that the auditor gather sufficient competent evidence to
have a basis for expressing an opinion on the financial statement. The word “competent” refers
to the quality of the evidence; some forms of evidence are stronger and more convincing than
other.

C. STANDARDS OF REPORTING
There are four reporting standards that require the auditor to prepare a report on the financial
statement taken as a whole, including informative disclosure. The reporting standards requires
that the report states whether the statements are presented in accordance with GAAP and also
identify any circumstances in which GAAP have not been consistently applied in the current year
compared with the previous one.
7. In Accordance with GAAP: The report shall state whether the financial statements are
presented in accordance with Generally Accepted Accounting Principles.
8. Deviations from GAAP: The report shall identify those circumstances in which such
principles haven’t been consistently observed in the current period in relation to the preceding
period.
9. Adequate Disclosure: Informative disclosures in the financial statements are to be regarded as
reasonably adequate unless otherwise stated in the report.
10. Expression of Opinion: The report shall either contain an expression of opinion regarding
the financial statements, taken as a whole, or an assertion to the effect that an opinion cannot be
expressed; the reasons therefore, should be stated. In all cases where an auditor’s name is
associated with financial statements, the report should contain a clear-cut indication of the
character of the auditor’s work, if any, and the degree of responsibility the auditor is taking.

The above 10 standards are also acceptable by the Canadian institute of chartered accountant and
more or less by many UK professional public accounting associations
(ACCA and CA). Therefore we can say that these standards are acceptable worldwide

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