CHAPTER TWO

THE AUDITING PROFESSION

 Introduction
• Professional organizations are interested in audit
function because they are issuer of standards.

• In a similar fashion, government needs audit

function in order to protect the interest of the public
and for its interest too (tax purpose).

• The function of auditor is to re assure financial

statements are stated in accordance with Standards.
• Reliance on these financial statements can
only place if and only if the auditors perform
the audit in an ethical manner i.e. being
independent both in appearance and in fact.

• The purpose of this International Standard on

Auditing (ISA) is to establish standards and
provide guidance on the objective and general
principles governing an audit of financial
statements.
 The Regulatory Framework Governing
Auditing
Objective of an Audit of Financial Statements

• To enable the auditor to express an opinion whether the

financial statements are prepared, in all material respects, in
accordance with an applicable financial reporting framework.

• The Framework defines and describes the elements and

objectives of an assurance engagement.

• The ISAs apply the Framework in the context of an audit of

financial statements and contain the basic principles and
essential procedures, together with related guidance, to be
applied in such an audit.
Ethical Requirements Relating to an Audit of
Financial Statements

• The auditor should comply with relevant ethical

requirements relating to audit engagements.

Conduct of an Audit of Financial Statements

• The auditor should conduct an audit in

accordance with International Standards on
Auditing.
• The auditor may also conduct the audit in
accordance with both ISAs and auditing
standards of a specific jurisdiction or country.

Scope of an Audit of Financial Statements

• The term “scope of an audit” refers to the

audit procedures that, in the auditor’s
judgment and based on the ISAs, are deemed
appropriate in the circumstances to achieve
the objective of the audit.
• In determining the audit procedures to be performed
in conducting an audit in accordance with
International Standards on Auditing, the auditor
should comply with each of the International
Standards on Auditing relevant to the audit.

• The auditor should not represent compliance with

International Standards on Auditing unless the
auditor has complied fully with all of the
International Standards on Auditing relevant to the
audit.
Professional Skepticism

• The auditor should plan and perform an audit

with an attitude of professional skepticism
recognizing that circumstances may exist that
cause the financial statements to be materially
misstated.
Reasonable Assurance

• An auditor conducting an audit in accordance with ISAs

obtains reasonable assurance that the financial
statements taken as a whole are free from material
misstatement, whether due to fraud or error.

• Reasonable assurance is a concept relating to the

accumulation of the audit evidence necessary for the
auditor to conclude that there are no material
misstatements in the financial statements taken as a
whole.

• Reasonable assurance relates to the whole audit process.

• An auditor cannot obtain absolute assurance
because there are inherent limitations in an audit
that affect the auditor’s ability to detect material
misstatements.

• These limitations result from factors such as the

following:

 The use of testing.

 The inherent limitations of internal control (for
example, the possibility of management override or
collusion).
 The fact that most audit evidence is persuasive
rather than conclusive.
Audit Risk and Materiality

• The auditor should plan and perform the audit to

reduce audit risk to an acceptably low level that is
consistent with the objective of an audit.

• The auditor reduces audit risk by designing and

performing audit procedures to obtain sufficient
appropriate audit evidence to be able to draw
reasonable conclusions on which to base an audit
opinion.

• Reasonable assurance is obtained when the auditor

has reduced audit risk to an acceptably low level.
• Audit risk is a function of the risk of material
misstatement of the financial statements (or simply,
the “risk of material misstatement”) (i.e., the risk
that the financial statements are materially misstated
prior to audit) and the risk that the auditor will not
detect such misstatement (“detection risk”).

• Inherent risk and control risk are the entity’s risks;

they exist independently of the audit of the financial
statements.
Inherent risk:- is the susceptibility of an assertion to a
misstatement that could be material, either individually
or when aggregated with other misstatements,
assuming that there are no related controls.

Control risk:- is the risk that a misstatement that could

occur in an assertion and that could be material, either
individually or when aggregated with other
misstatements, will not be prevented, or detected and
corrected, on a timely basis by the entity’s internal
control.
• Is a function of the effectiveness of the design
and operation of internal control in achieving
the entity’s objectives relevant to preparation
of the entity’s financial statements.

Detection risk:- is a function of the effectiveness

of an audit procedure and of its application by
the auditor.
Responsibility for the Financial Statements

• While the auditor is responsible for forming and

expressing an opinion on the financial statements,
the responsibility for the preparation and
presentation of the financial statements in
accordance with the applicable financial reporting
framework is that of the management of the entity,
with oversight from those charged with governance.
Professional Ethics: Fundamental Principles,
Threats and Safeguards

• The term ethics represents the moral

principles or values of conduct recognized by
an individual or group of individuals.

• Ethics are a moral code of conduct that

requires an obligation by us to consider not
only ourselves but others.
• The purpose of professional ethics in the auditing
profession as well as in any other profession is to
build the public confidence, to judge the quality of
audit work and means of grounding guidance of
conduct for practitioners.

• The standards of the auditing profession are heavily

determined by the public interest.
 Fundamental Principles
• In order to achieve the objectives of auditing
profession, auditors have to observe a number
of prerequisites or fundamental principles.

The fundamental principles are:

Integrity:
• Auditors should be straightforward and honest
in performing professional services.
Objectivity:
• Auditors should be fair and should not allow
prejudice or bias, conflict of interest or
influence of others to override objectivity.

Professional Competence and Due Care:

• Auditors should perform professional services
with due care, competence and diligence
Confidentiality:
• Auditors should respect the confidentiality of
information acquired during the course of
performing professional services

Professional Behavior:
• Auditors must act in a manner consistent with
the good reputation of the profession and
refrain from any conduct which might bring
discredit to the profession.
Technical Standards:
• Auditors should carry out professional services in
accordance with the relevant technical and
professional standards.

In addition, they should conform to the technical

and professional standards promulgated by:

 International Standards on Auditing;

 International Accounting Standards Board;
 The member’s professional body or other
regulatory body; and
 Relevant legislation.
 Threats to Independence
• Independence is potentially affected by self-
interest, self-review, advocacy, familiarity and
intimidation threats.
LEGAL RESPONSIBILITY AND LIABILITY
OF AUDITORS
• The auditor is responsible for his/her report.
The auditor then has certain duties to fulfill to
the users of the financial statements that he
reports on.
• Responsibilities impose liabilities if things go
wrong.
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Liable for what?

1. Auditors Legal Liability to client

•The most frequent source of lawsuit against CPAs

is from clients.

•The suits vary widely including such claims as

failure to complete an unaudited engagement on the
agreed upon date, inappropriate withdrawal from an
audit, failure to discover a defalcation, and
breaching the confidentiality requirements of CPAs.
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Auditor Liability to Third Party
•A CPA firm may be liable to third parties if a loss was incurred
by the claimant due to reliance on misleading financial
statements.

Auditors Responsibility for detecting Misstatements

•The auditors have responsibility to plan and perform the audit

to obtain reasonable assurance about whether the financial
statements are free of material misstatement of whether caused
by error or fraud. 25
 Appointment, Remuneration and Removal of
auditors in Ethiopia
Article 368 Appointment of auditors
(1)The general meeting of every company limited by
shares shall elect one or more auditors and one or
more assistant auditors
(2)Shareholders representing not less than 20% of the
capital may appoint an auditor selected by them
(3)Where there is more than one auditor, they may
exercise their duties jointly or separately
(4)A body corporate may act as auditor
Art. 369- Nomination and term of Appointment
(1)Auditors shall be elected by the meeting of
subscribers and thereafter by the annual
general meeting
(2)Auditors elected by the meeting of subscribers
shall hold office until the first annual meeting.
Auditors elected at an annual general meeting
hold office for three years
(3)When signing as auditor, an auditor shall add the
name of the company whose accounts he is
auditing.
Art. 371. Revocation/cancellation
of the appointment of Auditors
• A general meeting may at any time
revoke the appointment of any
auditor without prejudice to any
claim he/she may have for
wrongful dismissal.
Offences and Penalty
1. Any person who: Fails to produce or make available
books, documents, ledgers, vouchers or any other
documentary or oral evidence which the Federal Auditor
General Directly or through his employees or his
representatives requires for auditing
2. Any Auditor who: In consideration for the performance
or for the omission of an act in violation of the duties
proper to his office solicits, exacts a promise of or
receives a gift, money or any other advantage; or accepts
any auditable document as genuine where he knows that
is not or unduly rejects any valuable document
submitted to him by the one to be audited
a. defrauds or cooperates with others by creating conducive
conditions so that they can defraud or conspires in
defrauding money of the federal Government; or
b. with intent to obtain or procure undue advantage for
himself or to a third person or to cause a harm on any
other person, causes to disappear or falsify or cause to be
falsified or forges any books, documents, ledgers,
vouchers or any other evidence submitted to him by the
one to be audited: Shall be punished with imprisonment
from 5 to 10 years and with a fine from 10,000 up to
Birr 15,000 (ten thousand up to fifteen thousand Birr
 MATERIALITY

A misstatement in the financial statements can be considered material if knowledge of the

misstatement would affect a decision of a reasonable user of the statements.

Levels of Materiality

 Amounts are immaterial: When a misstatement in the financial statement exists but is unlikely to
affect the decision of a reasonable user, it is considered to be immaterial.

 Amounts are material but do not overshadow the financial statements as a whole:
misstatement in the financial statement would affect a user’s decision but the overall statements
are still fairly stated and therefore useful.

 Amounts are so material or so pervasive that overall fairness of the statements is in question:
highest level of materiality exists when users are likely to make incorrect decisions if they rely on
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the overall financial statements when the highest level of materiality exists
 Error and Fraud
•Error – An error represents an unintentional
misstatement of the financial statement. It may be
material or immaterial.

- Mistake in gathering and reporting data

- Mistake in application of IFRS
- Unintentional omission of amount
- Informative disclosure on financial statement. 32
Fraud: Fraud represents an intentional
misstatement of the financial statement which can
be material or immaterial. The misstatement due to
fraud may occur due to either of:

1.Misappropriation of assets defalcations or

employee fraud. E.g. theft of cash or another
asset.

2.Fraudulent financial reporting often called

management fraud.
E.g. intentional misstatement of sales near the
balance sheet date to increase reported earning. 33
Truth and Fairness
•The term truth and fairness are essential elements of
audit report.

•There is no statutory or professional definition of truth

and fairness.

•Truth and fair is a technical in the phrase to be looked at

as entirely.

•In general, the word "true" means, information is factual

confirms to reality, not false. The information confirms
with standards. 34
•Fairness means; clear distinct and plain
- Impartial, not biased or
- Just and equitable
•To show true and fairness accounts
must be prepared
- In accordance with IFRS
- On constant basis so as not to be
misleading
- The accounts must be taken from
books and records. 35
END OF CHAPTER

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