Auditing principles & Practice I AcFn4061

CHAPTER TWO
THE AUDITING PROFESSION
2.1 THE REGULATORY FRAMEWORK GOVERNING AUDITING
In Ethiopia, the regulatory framework governing auditing is primarily guided by the following key
elements:
1. The Ethiopian Commercial Code:
A commercial code is a set of laws that regulates and facilitates commercial transactions in a
country. Ethiopia revised the old commercial code to the new 2020 commercial code which has
825 Articles related to trade. The Ethiopian Commercial Code sets out the legal requirements and
standards for auditing in Ethiopia. It specifies the qualifications, rights, and responsibilities of
auditors and provides guidelines for auditing financial statements, including the presentation,
disclosure, and verification of financial information.
2. The Accounting and Auditing Board of Ethiopia (AABE):
The AABE is the regulatory body responsible for overseeing the accounting and auditing
profession in Ethiopia. It is mandated to develop and promote accounting and auditing standards,
issue auditing guidelines, monitor compliance, and ensure quality control within the profession.
The duties of AABE explained as follows
i. Licensing and Registration: The AABE is responsible for licensing and registering audit
firms and auditors in Ethiopia. It sets criteria for professional competence, independence,
and ethical conduct for auditors, which must be met for obtaining and maintaining a
license.
ii. Auditing Ethics: The AABE has established a Code of Ethics for auditors in Ethiopia. This
code sets out principles and ethical guidelines that auditors must follow to ensure
professional conduct, objectivity, integrity, and independence during audit engagements.
iii. Quality Control and Monitoring: The AABE conducts quality control and monitoring
activities to assess compliance with auditing standards, professional conduct rules, and
ethical guidelines. It is responsible for ensuring that audit firms maintain adequate quality
control systems and adhere to prescribed standards.
3. Legal and Regulatory Authorities: Various government bodies and agencies, including the
Ministry of Finance and relevant sector-specific regulators, may also have oversight and
regulatory roles concerning auditing practices in specific industries or sectors of the economy.

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2.2 INTERNATIONAL STANDARDS ON AUDITING (ISA)

The International standards of auditing (ISAs) are produced by the International Auditing and
Assurance Standards Board (IAASB), which is part of the International Federation of
Accountants (IFAC). The IFAC is a global organization for the accounting profession. The intention
is that the standards issued will improve the degree of uniformity of auditing practices, both in a
standardized approach to the audit and a standard reporting format.
The International Standards on Auditing (ISA) is a set of globally acknowledged professional
standards that prescribe guidelines to auditors for conducting audits on financial statements.
The ISA sets up principles and procedures that auditors must follow to maintain an audit’s
quality, consistency, and credibility. These standards aid in presenting an accurate and fair
view of an entity’s financial information and enhancing the reliability of its financial statements.
The ISA includes many areas and concerns within the auditing process, such as risk
assessment, internal control assessment, audit evidence, audit documentation, and reporting.
Additionally, it addresses particular audit engagements, like auditing financial statements
prepared in compliance with the International Financial Reporting Standards (IFRS), audits of
small and medium-sized firms, and other specialized areas. Some jurisdictions require the
auditors to follow the ISA mandatorily.
2.2.1 THE ISA’S IMPORTANCE
A. Enhances Audit Quality:
The ISA chalks out rules, regulations, and procedures that the auditors must follow. This aids in
maintaining reliability, consistency, and transparency in audit processes. The auditors enhance
the audit quality by maintaining these standards, which ensure that the financial statements offer
an accurate and fair view of an entity’s financial status.
B. Fosters Investor Confidence:

Authentic and dependable financial information lets investors make well-informed financial
decisions. These standards ensure that investors can trust the financial statements’ credibility as
they set guidelines on performing audits reasonably and with enough evidence.
C. Eases International Comparability:
The ISA facilitates the global business environment by setting up universal standards for auditing,
which are applicable worldwide. This framework provides a common basis for maintaining
international comparability and consistency in audit practices.

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2.2.2 DIFFERENCE BETWEEN INTERNATIONAL STANDARDS ON AUDITING AND IFRS
 International Standards on Auditing (ISA):
The ISA aims to provide a set of requirements or guidance to auditors to conduct financial
statement audits. They aid in enhancing audit consistency, quality, and transparency worldwide.
The ISA focuses on the audit process, including planning, risk assessment, audit evidence, audit
documentation, internal control evaluation, and reporting. They offer guidance to auditors on how
to audit financial statements and ensure the credibility and reliability of the financial statements.
The International Auditing and Assurance Standards Board (IAASB), an independent body under
the International Federation of Accountants (IFAC), issued the International Standards On
Auditing. Certain laws or regulations in specific jurisdictions may require compliance with the ISA.
 International financial reporting standard (IFRS):
The IFRS is a set of accounting standards that dictate the rules and principles for preparing
and presenting financial statements. Thus they offer a standard structure for financial reporting.
It ensures the financial information’s transparency and comparability across different
organizations and jurisdictions. The IFRS applies to the individuals or entities who prepare the
financial statements, including companies, entities, and organizations that must or choose to adopt
them. They provide information on recognizing, measuring, presenting, and disclosing different
elements in financial statements. The International Accounting Standards Board (IASB) has issued
the IFRS. In many countries, listed companies must adopt the IFRS.
2.3 PROFESSIONAL ETHICS: FUNDAMENTAL PRINCIPLES, THREATS AND
SAFEGUARDS (ISA 200)
Ethics is derived from the Greek word “ethos” meaning “character”.
Ethics focuses on the ‘rights’ and ‘wrongs’ of human behavior i.e. how people act towards one
another.
Professional ethics represents a commitment by a profession to ethical principles and rules
of conduct. Professional ethics are the principles that determine what is right and wrong about a
profession, establish ethical rules about that profession, and oblige the members of the
profession to comply with these codes of conduct.
Professional Ethics in auditing refer to the moral and ethical principles that guide auditors' behavior
and decision-making processes while conducting audits.

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2.3.1 FUNDAMENTAL PRINCIPLES

ISA 200 sets out the general principles of an audit. The auditor should comply with the code of
ethics for professional accountants issued by the International Federation of Accountants.
Accountants require ethics because people rely on them for their expertise in specific areas. A
professional accountant shall comply with the following fundamental principles:
1. Integrity
The principle of integrity imposes an obligation on all professional auditors to be
straightforward and honest in all professional and business relationships. Integrity also
implies fair dealing and truthfulness.
2. Objectivity
The principle of objectivity imposes an obligation on all professional auditors not to
compromise their professional or business judgment because of bias, conflict of interest or
the undue influence of others. An auditor may be exposed to situations that may impair
objectivity. It is impracticable to define and prescribe all such situations. A professional shall not
perform a professional service if a circumstance or relationship biases or unduly influences the
accountant’s professional judgment with respect to that service.
E.g., An auditor must not accept the assignment for two rival companies which are competing.
*** the difference between integrity and objectivity is Integrity pertains to upholding ethical
standards and moral values; in short, it's about doing what is right and just. Objectivity is the ability
to remain independent, free from favoritism, bias or self-interest.
(c) Professional Competence and Due Care
A professional auditor has a duty to maintain professional knowledge and skill at the level
required. A professional accountant should act diligently and in accordance with applicable
technical and professional standards
E.g. After qualification, accountants must undergo Continuous Professional Development (CPDs)
courses to be updated with relevant changes in legislations and standards that affect them as
accountants.
(d) Confidentiality
A professional auditor should respect the confidentiality of information acquired and should
not disclose any such information to third parties without proper and specific authority

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unless there is a legal or professional right or duty to disclose.
E.g., An accountant is prohibited from disclosing to third party on any information gained on audit
process of the company.
The need to comply with the principle of confidentiality continues even after the end of
relationships between a professional accountant and a client. When a professional accountant
changes employment or acquires a new client, the professional accountant is entitled to use prior
experience. The professional accountant shall not, however, use or disclose any confidential
information either acquired or received as a result of a professional or business relationship.
(e) Professional Behavior

A professional accountant should comply with relevant laws and regulations and should
avoid any action that discredits the profession (i.e. behave with courtesy and consideration)
E.g., An accountant must not criticize or discredit an accountant of another company with the aim
of gaining the appointment. Professional accountants shall be honest and truthful and not:
(a) Make exaggerated claims for the services they are able to offer, the qualifications they
possess, or experience they have gained; or
(b) Make disparaging references or unsubstantiated comparisons to the work of others.

2.3.2 THREATS TO FUNDAMENTAL PRINCIPLES AND SAFEGUARDS

While carrying requirements of engagement auditors may face or they expect to face such
situations when they will not be able to fulfill ethical requirements. Such obstructions are called
threats to fundamental principles.
Threats in auditing refer to situations or circumstances that could compromise the auditor's
independence, objectivity, or professional skepticism, potentially leading to a biased or
compromised audit opinion. Although threats can make many different shapes but broadly they
can be classified in FIVE categories:
(I) Familiarity threat
This threat arises when auditor due to the nature of relation with the other party become too
sympathetic that it compromised the objective requirement of code.
For example such situations arise when client is close friend, relative or family member of the
auditor.

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Safeguards
 Rotating the Audit Partner every 5 years for a public interest client, and the Audit Team
members every 2 to 3 years
(II) Advocacy threat
It arises from situations where the firm promotes a position or opinion to the point that
subsequent tobjectivity is impaired; for example
 Acting as an advocate on behalf of an audit client in litigation or disputes with third party

 Promoting shares of a listed client.

Safeguards
 A firm is prohibited from engaging in these events.
(III) Self-Interest
a) Financial interest in a client; To have a direct financial interest or indirect material
financial interest in a client.
b) Employment with an audit client (may also be ‘Familiarity’); It is possible that an audit

staff might transfer to a client, or that negotiation to facilitate such movement takes place. A
former Audit Manager / Partner is now a Finance Director at the client’s; thus, has too much
knowledge of the audit firm’s procedures
c) Temporary assignment of audit staff to client; Staff may be loaned for a brief period to
the audit client. Staff must not assume management responsibilities or undertake any audit
work that is prohibited by the Code.
d) High percentage of Fees; When a firm receives a high proportion of its fees income from
just one audit client, there is self- interest or intimidation threat, as the firm is concerned
about losing the client.
e) Overdue Fees; A self-interest threat arises if the fee due from an audit client remains unpaid
for a long time, especially if the fees remain unpaid prior to the issuance of an audit report.
f) Partner on Client Board; A partner or an employee of an audit firm should not serve on the

board of an audit client.

g) Gifts and Hospitality; An auditor or a firm is prohibited from receiving gifts or hospitality,
unless the amount is trivial and extended to all.
h) Conflict of Interest; A conflict between members and clients interest might arise if members

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compete directly with a client, or have a joint venture or similar with a company that is in
competition with the client. This may threaten the member’s objectivity.
i) Contingent Fees; The audit fees are calculated on a pre-determined basis relating to the
outcome or result of a transaction or the work performed. A firm is prohibited from receiving
contingent fees as it will create self-interest threat.
Safeguards for self-interest treat
 Dispose of the shares (and the auditor may be involved in the audit)
 Remove the audit team member (if he retains the shareholding)
 Assigning the individuals to the audit team who have sufficient experience
 The loaned staff should not have any responsibility / be involved in the audit after they
have performed the assignment at the client’s place and Conducting an additional review
of the work performed by the loaned staff
 Reduce dependency on the client
 External quality control reviews
 If the audit client is a public interest entity, the total fees received from the client
represents more than 15% of the firm’s total fees for two consecutive years, the firm:
Should disclose to those charged with governance
 Arrange for an external review by an external professional body or a regulatory body; the
review can be either before the audit opinion on the second year’s financial statement is
issued (pre-issuance review) or after it is issued (post-issuance review)
*** However, point must be noted that familiarity threat is different from self-interest threat because
in familiarity threat auditor feels sympathetic for others’ interests whereas in self-interest threat
auditor weighs his own interest above ethical requirements of the code.
(IV) Self-Review threat
This threat arises when auditor is asked to examine or report on his own assessment, opinion,
judgment or work and thus he is basically self-reviewing his work. It’s like asking student to
assess his own exam script. Such situations may push auditor to give biased evaluation just to save
reputation even if previous judgment was wrong.
a) Recent service with an audit client; Individuals, who have been director or officer of the
audit client, or an employee in a position to exert direct influence over the preparation of
the accounting records or financial statements in the period covered by the audit report,
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should not be part of the audit team.
b) Preparing accounting records and financial statements; Should the firm prepare the

accounting records and financial statements, and subsequently the audit, there is a self-
review threat.
c) Provision of Other Services to the Client; A firm may provide other services to an

audit client, depending on the nature of the services and the type of entity, however the
firm must not assume management responsibility.

Appropriate safeguards are:

 Separation of the staff involved in preparing the financial statements and audit
 If the audit client is a public interest entity, the firm is prohibited from providing
accounting and book-keeping services, or prepares financial statements on which the firm
will express an opinion.
(V) Intimidation
It arises when members of the audit team are deterred from acting objectively by threats,
actual or perceived.
For example auditor is given a threat that if he reports objectively then audit fee will not be paid
or subsequent audits with the auditor will be cancelled. It might take the shape of physical
threats like harming family members or use of coercion on auditor.
2.4 LEGAL LIABILITY OF AUDITORS (ISA 250)
The auditor’s liability represents the legal liability that is assumed when the auditor is
performing professional duties. In Ethiopia, auditors have assigned with different powers and
obligations that improves the efficiency of the companies. Thus, auditors are duty bound to
perform these obligations and responsibilities. Finally, auditors will be liable both civil and
criminally if they failed to observe their obligations provided under the Commercial Code of
Ethiopia.
Financial auditors are highly important people because, ultimately, they are responsible for
enhancing the reliability of financial statements for external users. Without independent and
competent auditors, many fraud cases worldwide would’ve gone unnoticed, notwithstanding all
the other cases that are still undiscovered. One code of professional conduct states that auditors
must go about their business with due care.

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Let us consider the possible entities that may sue an auditor and the possible reasons for lawsuit.
1. Client: Breach of Contract. Auditors obtain an engagement letter and any breach of the
stated terms can be a valid reason for legal action by the company against the auditor.
2. Financial Statement Users: Negligence. The auditor has failed to use due care and has
failed to identify a material misstatement. By not identifying a material misstatement,
financial statement users are harmed, as they may rely on the published financials when
making an investment decision.
3. Government: Fraud, also known as Gross Negligence. The auditor has knowingly issued
an incorrect audit report. The government requires public company financial statements to
accurately reflect the company’s actual results. If an incorrect audit report is issued, then
this undermines the government’s duty to help protect investors.
2.5 RIGHTS AND DUTIES, APPOINTMENT, DISMISSAL AND RESIGNATION OF AN AUDITOR
2.5.1 RIGHTS & POWERS OF ANAUDITOR
 Right of access at all times to books, accounts, and vouchers of the company
 Right to receive notice and to attend general meetings
 Right to obtain information and explanations
 Right to visit branches
 Right to sign audit reports
 Right to receive remuneration
2.5.2 DUTIES OF AN AUDITOR
 Compliance with audit standard
 Duty to report fraud
 Duty not to provide certain service (consulting and specialized service)
 Duty to sign audit report
 Duty to attend general meeting
 Duty to enquire (investigate or question)
2.5.3 APPOINTMENT OF AUDITOR
The Auditor's appointment is a vital procedure for a company as it makes sure about the
transparency and accuracy of the company's financial statements. An auditor is an independent
professional who is appointed to measure the company's financial statements. Who can appoint
the auditor?

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a. Directors; The board of directors shall appoint the auditor of the company within one
month of the date of registration of the company.
b. Shareholders; In case the directors fail to appoint the auditor the shareholders shall do so
at a general meeting by passing a resolution.
c. The central government; If the company at annual meeting fails to appoint an auditor, the
central government may appoint a person to fill the vacancy. The company has to give
notice of the above fact to the government within 7 days of annual general meeting. The
appointment by the central government is made from the panel of names suggested by the
applicants.
A person do not qualify to be an auditor of a company or of another company within the same
group if the person is:-
 An officer or servant of the company
 A partner of Or is in the employment of, either of the above.
The reason is that, the person may not be impartial or could be influenced.
2.5.4 REMOVAL AND RESIGNATION OF AN AUDITOR

A. REMOVAL OF AUDITOR
Statutory provisions of the Companies Act were drafted to ensure that Auditors cannot be
removed simply because they have a disagreement with Directors (a member who have the power
to remove the Auditor)
Removal procedures

 A company may remove its Auditors before the expiration of the term by ordinary
resolution i.e majority of those attending and voting.
 But special notice is required, at least 28 days before the date of relevant meeting a notice
must be given by the proposer to the company which will be given to members. And within
14 days a notice of such removal, the company must give a notice to the registrar.
 The existing Auditor has the right to make written representation to the company
concerning the matters which they should be brought it to members’ attention
 The company must send a copy of representation to every member to whom a notice of the
meeting is sent. Also the Auditor has the right to speak on the AGM where there are matters
to be brought to the attention of members.

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B. RESIGNATION OF AUDITORS

Resignation procedures
Auditors may resign prior to the completion of their term of Office. The auditor may do so by
depositing a written notice of resignation at the company’s office. The notice must contain a
statement explaining if there are no circumstances connected with resignation that should be
brought to the member’s attention or statement of any such circumstances.
Action by Company
Within 14 days of the receipt of the notice, the company must send a copy to the registrar. If the
notice contain a statement of any circumstances which the Auditor consider should be brought to
member’s attention, the company must also send a copy to every person entitled to receive copies
of the accounts
The auditors right to an EGM
 The Auditors may require the directors to convene an Extraordinary General Meeting for the
purpose of explaining the circumstances connected with the resignation which the Auditors
considers should be brought to the member’s attention.

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