Chapter 2

The Financial
Statement
Auditing
Environment
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 Types of Auditors

External Auditors Internal Auditors

Government
Forensic Auditors
Auditors

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Types of Services Offered by
Audit Firms

Audit Services:
Financial statements audits, internal control audits, compliance audits,
operational audits and forensic audits
Review Services:
Review of financial information, e.g. review of interim financial
information
Other Assurance Services:
Assurance other than audit and reviews of historic financial
information, e.g. assurance on a entity’s reporting on its sustainability
performance
Related Services:
Agreed-upon procedures regarding financial information and
compilation of financial information
Other Non-Assurance Services:
Tax services and management advisory services
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 Audit Firms
Audit firms range in size from a single proprietor to
thousands of owners (or ‘partners’) and thousands of
professional and administrative staff employees.

Big 4 Mid-Tier National Local

Baker Tilly
Deloitte BDO

EY Crowe
Horwath

KPMG Grant
Thornton
PwC Praxity
RSM
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 Audit Teams
Table 2–1 Selected Duties of Audit Team Members

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A Time of Challenge and Change

1990 2000

During the economic boom of the

late 1990s and the early 2000s,
accounting firms aggressively sought
opportunities to market a variety of
high-margin non-audit services to
their auditees.
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 A Series of Scandals

Enron WorldCom

Parmalat
Lernout &
Hauspie
Ahold

Arthur
Andersen
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An Explosion of Scandals

Corporate
Giants
Brokerage
Firms

Stock
Exchanges

Mutual Fund
Managers Accounting
Firms

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 Regulation

Self-regulation by the profession

versus
government regulation

Stricter regulation
More public oversight and stricter
enforcement

International Standards on Auditing

more comprehensive

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Financial Crisis 2007-2009

Banks Rating
Agencies

Supervisors

Hedge Central
Funds Banks
Accounting
Firms
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 Society’s Expectations and
the Auditor’s Responsibilities
The auditor has a responsibility to plan and
perform the audit to obtain reasonable
assurance about whether the financial
statements are free of material
misstatement, whether caused by error or
fraud.
Because of the nature of audit evidence and
the characteristics of fraud, the auditor is able
to obtain reasonable, but not absolute,
assurance that material misstatements are
detected.
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 Context of Financial
Statement Auditing

The primary context with which an auditor is concerned is the industry or

business of his or her auditee. In other words, the context provided by the entity’s
business impacts the auditor and the audit, and is thus a primary component of
the environment in which financial statement auditing is conducted.

Thought Question:
How would your concerns about the
inventory account differ for a Computer
Hardware Manufacturer versus a Jewelry
Store?
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 A Model of Business
Business organizations exist to create value for their
stakeholders. Due to the way resources are invested
and managed in the modern business world, a
system of corporate governance is necessary,
through which managers are overseen and
supervised.

Board of Directors

Audit
Committee

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 A Model of Business

Objectives Strategies

Processes
(5 broad
categories)
Transactions

Controls

Reports

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A Model of Business Processes:

Five Components

Financing Purchasing
Process Process

Human Resource
Management
Process

Inventory
Revenue
Management
Process
Process

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 An Overview of Business
Figure 2-1 An Overview of Business

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 Organizations that Affect the
Accounting Profession
International Federation of International Accounting
Accountants Standards Board
IFAC IASB
International Auditing and
Assurance Standards Board International Organization of
(IAASB)
Supreme Audit Institutions
International Ethics Standards
Board for Accountants (IESBA) INTOSAI

International Organization of United States

Securities Commissions Securities and Exchange
Commission (SEC)
IOSCO Public Company Accounting
Oversight Board (PCAOB)
European Union Financial Accounting Standards
Board (FASB)
EU American Institute of Certified Public
EU 8th Directive on Statutory Audits Accountants (AICPA)
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 IAASB Standards

• International Standards on Auditing (ISAs)

• International Standards on Review Engagements
(ISREs)
• International Standards on Assurance
Engagements (ISAEs)
• International Standards on Related Services
(ISRSs)
• International Standards on Quality Control
(ISQCs)

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 Auditing Standards
Auditing standards serve as
guidelines for and measures of
the quality of the auditor’s
performance.

IAASB issues ISAs are

International considered to
Standards on Auditing be minimum
(ISAs). standards of
performance for
auditors.
IFAC members
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 General Principles and
Responsibilities
• ISA 200 Overall Objectives of the Independent Auditor and
the Conduct of an Audit in Accordance with International
Standards on Auditing
• ISA 210 Agreeing the Terms of Audit Engagements
• ISA 220 Quality Control for an Audit of Financial Statements
• ISA 230 Audit Documentation
• ISA 240 The Auditor’s Responsibilities Relating to Fraud in an
Audit of Financial Statements
• ISA 250 Consideration of Laws and Regulations in an Audit of
Financial Statements
• ISA 260 Communication with Those Charged with
Governance
• ISA 265 Communicating Deficiencies in Internal Control to
Those Charged with Governance and Management
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 Risk Assessment and
Response to Assessed Risks
• ISA 300 Planning an Audit of Financial Statements
• ISA 315 Identifying and Assessing the Risks of Material
Misstatement through Understanding the Entity and Its
Environment
• ISA 320 Materiality in Planning and Performing an Audit
• ISA 330 The Auditor’s Responses to Assessed Risks
• ISA 402 Audit Considerations Relating to an Entity Using a
Service Organization
• ISA 450 Evaluation of Misstatements Identified during the
Audit

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 Audit Evidence
• ISA 500 Audit Evidence
• ISA 501 Audit Evidence – Specific Considerations for
Selected Items
• ISA 505 External Confirmations
• ISA 510 Initial Engagements – Opening Balances
• ISA 520 Analytical Procedures
• ISA 530 Audit Sampling
• ISA 540 Auditing Accounting Estimates, Including Fair Value
Accounting Estimates, and Related Disclosures
• ISA 550 Related Parties
• ISA 560 Subsequent Events
• ISA 570 Going Concern
• ISA 580 Written Representations
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 Using Work of Others

• ISA 600 Special Considerations – Audits of Group Financial

Statements (Including the Work of Component Auditors)
• ISA 610 Using the Work of Internal Auditors
• ISA 620 Using the Work of an Auditor’s Expert

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 Audit Conclusions and
Reporting
• ISA 700 Forming an Opinion and Reporting on Financial
Statements
• ISA 705 Modifications to the Opinion in the Independent
Auditor’s Report
• ISA 706 Emphasis of Matter Paragraphs and Other Matter
Paragraphs in the Independent Auditor’s Report
• ISA 710 Comparative Information – Corresponding Figures
and Comparative Financial Statements
• ISA 720 The Auditor’s Responsibilities Relating to Other
Information in Documents Containing Audited Financial
Statements

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 Specialized Areas

• ISA 800 Special Considerations – Audits of Financial

Statements Prepared in Accordance with Special Purpose
Frameworks
• ISA 805 Special Considerations – Audits of Single Financial
Statements and Specific Elements, Accounts or Items of a
Financial Statement
• ISA 810 Engagements to Report on Summary Financial
Statements

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 Sections in ISAs

• Introductory material
• Objectives
• Definitions
• Requirements
• Application and other
explanatory material

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Ethics, Independence and
the Code of Ethics

Ethics refers to a system or code of conduct

based on moral duties and obligations that
indicates how we should behave.

Professionalism refers to the conduct, aims,

or qualities that characterize or mark a
profession or professional person. All
professions operate under some type of code
of ethics or code of conduct.

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IESBA Code of Ethics for Professional
Accountants

IESBA Code of
Ethics
Conceptual
Framework Approach

Principles
•Integrity
•Objectivity Application to specific
•Professional competence situations, including
and due care situations that threaten
independence of
•Confidentiality
mind or independence
• Professional behaviour in appearance

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Auditors’ Legal Liability

Threat of legal liability:

Main deterrent to auditor’s misconduct

Legal doctrines:
• Joint and several liability
• Proportional liability
• Liability caps

Litigation exposure and audit markets:

• Concentration
• Barriers to entry
• Liability reforms

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