Chapter Two

The Auditing Profession

Contents
 Generally Accepted Auditing
Standards
 Professional ethics
Legal liability
 Generally Accepted Auditing
Standards (GAAS)
First issued by the American Institute of
Certified Public Accountants (AICPA) in
1947 and has periodically modified to
meet changes in the auditor's environment.

The GAAS are composed of three

categories of standards: general standards
of qualification and conduct, standards of
fieldwork and standards of reporting.
 General Standards of Qualification and
Conduct
 The four general standards are concerned with
the auditor's qualification and the quality of
his/her work.
1. Professional Competence:
 Adequate professional proficiency & competence
 Competence involves both technical qualifications
of the member and member's staff and ability to
supervise and evaluate the quality of work
performed
 Sound judgment
 Adequate training and proficiency (education &
experience)
 General Standards of Qualification and
Conduct (cont…)
2. Independence:
 Should be free from personal
and external impairments to
independence
 Should maintain an independent
attitude(fact) and appearance
 Why? To maintain public
confidence
 General Standards of Qualification and Conduct (cont…)

3. Due professional care:

 Should perform duties with a degree of skill
commonly possessed by others in the profession
 Observe the standards of field work and

reporting
4. Internal quality control system:
◦ should have an appropriate internal
quality control system in place and
perform an external quality control review
(assurance:- comply with professional standards and applicable regulatory
and legal requirements)
 Standards of field work
 what the auditor is expected to
follow at the time of performing the
actual field work
1.Planning and supervision:
• scope, timing, objectives, criteria
,methodology, resources required …
efficiency & effectiveness
• assistants on the engagement be
properly supervised (directed)
Standards of field work (cont…)
2.Sufficient understanding of the auditee's
internal control:
– a process, effected by an entity's BoD, management
and others, designed to provide reasonable
assurance regarding the achievement of the ff
objectives:
– (1) reliability of financial reporting,
– (2)compliance with applicable laws and regulations, and
– (3) effectiveness and efficiency of operations.

3.Sufficient, competent and relevant evidence:

reasonable basis for the auditors’ findings and conclusions.
 Standards of Reporting
 The auditor consider each of the
following issues before rendering an
audit report:
(1) the financial statement are presented in
accordance with GAAP,
(2) those principles are consistently applied,
(3) all informative disclosures have been made
and
(4) what degree of responsibility the auditor is
taking and the character of the auditor's
work
AICPA Code of Professional Ethics
 Ethics
◦ rules designed to:
 maintain a profession on a dignified level,
 guide members in their relations with each other,
 assure the public that the profession will maintain
a high level of performance.
◦ are derived from fundamental values
◦ The purpose of professional ethics is to:
 build the public confidence,
 judge the quality of audit work,
 produce guidance of conduct for practitioner,
emphasize positive activity and encourage high
level of performance while preventing mal-
practices.
AICPA Code of Professional Ethics (cont…)
 It consists four parts:
 Concepts of Professional Ethics: goal
oriented, positively stated discussions of
the profession’s responsibilities to the
public, clients, and fellow practitioners.
 Rules of Conduct: enforceable applications
of the principles.
 Interpretation of Rules of Conduct: provide
guidelines for the scope and application of
the rules
 Ethics rulings: explain the rules and
interpretations to specific factual
circumstances
 Auditors’ Liability
 Auditors can be held liable under two broad
categories of law:
◦ Common law: Case law developed over
time by judges who issue legal opinions
when deciding a case (the legal principles
announced in these cases become precedent for
judges deciding similar cases in the future).

◦ Statutory law: Written law enacted by the

legislative branch of federal and state
governments.
 Definition of Words
 Breach of contract: Occurs when the client or auditor fails to
meet the terms and obligations established in the contract,
which is normally finalized in the engagement letter.
 Civil law: All law which is not criminal.
 Class action Lawsuit: filed by one or more individuals on
behalf of all persons who may have invested on the basis of
the same false and misleading information.
 Criminal law: Statutory law which defines the duties citizens
owe to society and prescribes penalties for violations.
 Fraud: Actions taken with the knowledge and intent to
deceive.
 Gross negligence: An extreme, flagrant, or reckless departure
from professional standards of due care. This is also referred
to as constructive fraud.
 Definition of Words (cont…)
 Ordinary negligence: An absence of
reasonable or due care in the conduct of an
engagement.
 Privity: A contract or specific agreement

exists between two parties.

 Scienter: Acting with intent to deceive,

defraud or with knowledge of a false

representation.
 Tort: A wrongful act other than a breach of

contract for which civil action may be taken.

 Types of Liability and Auditors’ Actions Resulting in Liability

Type of Liability Auditors’ Actions Resulting in

Liability
Common law—clients Breach of contract
Negligence
Gross negligence/constructive fraud
Fraud
Common law—third Negligence
parties Gross negligence/constructive fraud
Fraud
Federal statutory law— Negligence
civil liability Gross negligence/constructive fraud
Fraud
Federal statutory law— Willful violation of federal statutes
 Liability
 The client/plaintiff must prove the following:

A duty owed by the auditor to the client to

conform to a required standard of care.
Failure by the auditor
A causal connection between the auditor’s
negligence and the client’s damage.
Actual loss or damage to the client.
 Defensive mechanisms
 Auditors’ defenses include the following:
◦ No duty was owed.
◦ The client was negligent
◦ The auditor’s work was performed in
accordance with professional standards.
◦ The client suffered no loss.
◦ Any loss was caused by other events.
◦ The claim is invalid because the statute of
limitations has expired