LO1: Understand the Nature, Purpose, and Scope of Audit and Assurance Services.

† Overview of Auditing
ISA definition of Auditing
“An audit is a systematic process of objectively obtaining and evaluating evidence regarding assertions
about economic actions and events to ascertain the degree of correspondence between these assertions and
established criteria, and communicating the results to interested users.”
Components of the Audit Definition
An audit is a systematic approach-
o The audit follows a structured, documented plan (audit plan) in such a way that those carrying
out the audit can fully examine and analyze all-important evidence..
An audit is conducted objectively.
▪ Objectivity is being unbiased and impartial in performing tasks. Auditors should maintain an
impartial attitude.
o Auditors are fair and do not allow prejudice or bias to override their objectivity.
o Auditor’s professional judgment should not be influenced by personal interest or bias, and that
the audit is done based on facts.
The evidence obtained and evaluated by the auditor concerns assertions about economic actions and
events.
– Assertions are representations by management, explicit or otherwise, that are embodied in
the financial statements.
These management assertions (implied) are:
1. Existence or occurrence
2. Completeness
3. Right and obligation
4. Valuation or allocation
5. Presentation and disclosure, etc.
The auditor obtains and evaluates evidence. The auditor assesses the reliability and sufficiency of
the information contained in the underlying accounting records and other source data by:
o studying and evaluating accounting systems and internal controls on which he wishes to rely and
testing those internal controls to determine the nature, extent and timing of other auditing
procedures; and
o carrying out such other tests, inquiries and other verification procedures of accounting
transactions and account balances.
The auditor ascertains the degree of correspondence between assertions and established criteria.
o auditor examines the evidence for the assertion presentation and disclosure to determine if the
accounts are described in accordance with the applicable financial reporting framework, such as
IFRS, local standards or regulations and laws.

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 The goal, or objective, of the audit is communicating the results to interested users.
o The audit is conducted with the aim of expressing an informed and credible opinion in a written
report.
o the auditors must state that in their opinion the statements ‘give a true and fair view’ or ‘present
fairly, in all material respects.’
o The purpose of the independent expert opinion is to lend credibility to the financial statements.
o The communication of the auditor’s opinion is called attestation, or the attest function.
† Essential Characteristics of Auditing (from the definitions)
Audit is an independent, scientific and critical examination.
Detection of errors and frauds is also part of auditing.
The job of auditing is performed by an independent person or body of persons qualified for the
job.
In order to report on the financial healthiness of a business, the auditor will have to go through
vouchers, documents, information's, and related evidence (internal or external).
The auditor may sufficiently satisfy himself about their correctness, accuracy and authenticity
of records and accounts and submit his/her report accordingly.
† The purpose/objective of an audit
✓ The purpose of an audit is to enhance the degree of confidence of intended users in the financial
statements.
✓ This is achieved by the expression of an opinion by the auditor on whether the financial
statements are prepared, in all material respects, in accordance with an applicable financial
reporting framework (such as IFRS or GAAP).
An audit conducted in accordance with ISAs and relevant ethical requirements enables the auditor to form
that opinion.
♣ The objective of an audit may be broadly categorized as;
1. Primary objective:
✓ To examine the accuracy of books of accounts (free from material misstatements)
✓ To express independent opinion on records and accounts of an entity based on the findings.
2. Secondary objective: Prevention and detection of errors and mistakes:
a) Prevention of errors and mistakes: B/c the people become aware that their work should be subjected
to audit.
b) Detection of errors and frauds.
† Scope of auditing
✓ Audit scope defines the extent and boundaries of an audit. Audit scopes vary depending on the type
of audit being performed.
✓ The scope of the audit includes
▪ checking the compliances of the relevant laws & regulations governing the entity.
▪ Ensuring the validity & authenticity of the financial records.
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 ▪ Reporting of fraud by or on the company, if the auditor identifies during the normal procedure
of audit program.
▪ Early detection of errors is also included within the scope of external audit.
▪ The audit should be organized to cover adequately all aspects of the auditee firm relevant to the
financial statements being audited.
▪ To form an opinion on the financial statements,
▪ the auditor should be reasonably satisfied as to whether the information contained in the
underlying accounting records and other source data is reliable and sufficient.
▪ the auditor should also decide whether the relevant information is properly disclosed in the
financial statements subject to statutory requirements, where applicable.
▪ The auditor is not expected to perform duties which fail outside the scope of his competencies.
▪ For example, the professional skill required of an auditor does not include that of a technical
expert for determining physical conditions of certain assets.
† The Need for an Audit
▪ Dependable information is essential to the existence of our society.
▪ Individuals, groups, or other society members depend on information provided by others in the
course of decision-making activities.
▪ The contribution of the independent auditor is, therefore, to provide credibility to the information
used by outsiders (such as stockholders, creditors, government regulators, customers, and other
interested parties) to make decisions of various kinds.
▪ Credibility in this case is to mean that the information can be believed by its users.
▪ Financial statements prepared by management and transmitted to outsiders without first being
audited by independent auditors (unaudited financial statements) leave a credibility gap for all of the
reasons such as (unintentional errors, lack of knowledge of accounting principles, unintentional bias,
and deliberate falsification).

LO2: Examine the historical development & Evolution of Auditing, Define the
terminologies associated with auditing,

† The Regulatory Framework Governing Auditing

❑ Auditing is governed by the regulatory framework that outlines the common duties of auditors
(both internal and external) for specific powers.
❑ The regulatory framework of auditing consists of
▪ statutory requirements for audits
▪ code of professional conduct
▪ legal responsibilities and liabilities of auditors
† International Standards on Auditing (ISA)
❑ What is ISAs?
▪ The International Standards on Auditing (ISAs) are auditing guidelines developed by the
International Auditing and Assurance Standards Board (IAASB).
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 ▪ As the name implies, the ISAs are international standards devised to align auditing around the
globe.
▪ While not all countries require compliance with the ISAs, most at least use the standards as a guide
for their own home-brewed systems.
▪ As an auditor, CPA, or student, understanding the role ISAs play is of vast importance.
▪ Auditors will live and die—professionally—on the back of the standards, while CPAs will often
find themselves on the receiving end of an audit, having their work judged by the same standards.
ISAs: Objective
▪ Everything about the ISAs is centered on building back the trust of the public in financial reporting.
† The IESBA code of Ethics for Professional Accountants
 The IESBA code of professional conduct is designed to provide a framework for expanding
professional services and responding to other changes in the profession, such as the increasingly
competitive environment.
❑ Rather than a list of rules that must be obeyed to be an ethical accountant, the so-called ‘rule based’
approach which holds sway in many countries, the IESBA and IFAC have chosen to use a
‘conceptual framework’ approach.
✓ A conceptual framework requires a professional accountant to identify, evaluate and address threats
to compliance with the fundamental principles, rather than merely comply with a set of specific rules
which may be arbitrary.
✓ When an accountant identifies threats to compliance with the fundamental principles and
determines that they are not at an acceptable level,
✓ he/she shall determine whether appropriate safeguards are available and can be applied to
eliminate the threats or reduce them to an acceptable level.
Principles:- are a goal oriented, positively stated discussion of the profession’s responsibilities to the public,
clients and fellow practitioners.
✓ It provides overall framework for the rules.
✓ These principles of IESBA express the profession’s responsibilities to the public, clients, and
to colleagues.
✓ The principles call for an unlimited commitment to honorable behavior, even at the sacrifice
of personal advantages.
❑ There are five fundamental principles of ethics applicable to all accountants.
Integrity: to be straightforward and honest in all professional and business relationships.
➢ Integrity also implies fair dealing and truthfulness.
➢ A professional accountant must avoid reports and other information if she believes that the
material contained is false or misleading.
Objectivity: imposes an obligation on all professional accountants not to compromise their
professional or business judgement because of bias, conflict of interest or the undue influence of
others.
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 ➢ They should not perform a professional service if a circumstance or relationship biases
or unduly influences the accountant’s professional judgement.
➢ The auditor should be independent in course of his/her work.
Two distinct ideas are involved in the concept of independency.
a) Independence in fact: A CPA (auditor) must in fact be independent of any enterprise for which they
provide attestation services i.e. an auditor must be able to maintain an objective and impartial mental
attitude throughout the engagement.
b) Independent in appearance: The relationship between the CPAs and their client must be such that
the auditor will appear independent to third party.

Professional Competence and Due professional care: to maintain professional knowledge and skill
at the level required to ensure that a client receives competent professional services and act diligently
and in accordance with applicable technical and professional standards.
o Professional Competence
▪ requires that the professional accountant maintain professional skill and
knowledge.
▪ It should maintain high standard of general education followed by specific
education, training, examination in relevant subjects, and work experience.
o Due care includes
▪ consideration of the completeness of the working papers,
▪ the sufficiency of the audit evidence, and
▪ the appropriateness of the audit report.
Confidentiality – to respect the confidentiality of information acquired as a result of professional and
business relationships and,
o therefore, not disclose any such information to third parties without proper and specific
authority, unless there is a legal or professional right or duty to disclose, nor use the
information for the personal advantage of the professional accountant or third parties.
Professional Behavior – to comply with relevant laws and regulations and avoid any action that
discredits the profession.
o Refrain from activities that adversely affects the reputation of the accounting and auditing
profession.
† Legal liabilities and responsibilities of auditors.
▪ We live in an era of litigation in which persons with real or fancied grievances are likely to take their
complaints to curt.
▪ Therefore, CPAs must approach every engagement with the prospect that they may be required to
defend their work in court.
✓ Even if the court finds in favor of the CPAs, the costs of defending a legal action can be very
high.
✓ Moreover, lawsuits can be extremely damaging to a professional’s reputation.
✓ In extreme cases, the CPA may even be held criminal for professional malpractice.
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 ▪ Therefore, every member considering a career in public accounting should be aware of the legal
liability inherent in the practice of this profession and should conduct the audit with reasonable skill
and care.
❑ Definition of basic Audit Terminologies
Discussion of Auditors liabilities is best prefaced by a definition of some of the common business law
terms such as;
Negligence: also referred to as “ordinary or simple negligence” is violation of a legal duty to exercise
a degree of care that an ordinary prudent person would exercise under similar circumstances.
▪ For an auditor, negligence is failure to perform a duty in accordance with applicable
standards such as failure to exercise due professional care.
Gross Negligence: is the lack of even slight care, indicative of reckless for one’s professional
responsibilities.
▪ Substantial failures on the part of an auditor to comply with ISA/GAAS might be interpreted as
gross negligence.
Fraud: is defined as misrepresentation by a person of a material fact, known by that person to be
untrue or made with reckless with the intention of deceiving the other party and with the result that
the other party is injured.
Constructive fraud: differs from fraud as defined above in that constructive fraud does not involve a
misrepresentation with intent to deceive.
• a situation where a person or entity gained an unfair advantage over another by deceitful
or unfair methods.
Privity: is the relationship between parties to contract. A CPA firm is in privy with the client it is
serving, as well as with any third-party beneficiary.
Breach of contract: is failure of one or both parties to a contract to perform in accordance with the
contract’s provisions.
E.g. Failure by auditors(s) to perform in accordance with contractual specifications indicated in the
engagement letter.
A third-party beneficiary- is a person or institution not a contracting party who is named in a contract
or intended by the contracting parties to have definite rights and benefits under the contract.
An engagement letter: is the written contract summarizing the contractual relationships between the
CPA and client.
It typically specifies
• the nature and scope of professional services to be rendered,
• the expected completion date of the engagement,
• the amount of audit fees,
• the responsibility of auditors and responsibility of client/manager/ and other related matters.
Proximate/immediate/ cause: exists when damage to another is directly attributable to a wrong doer’s
act.
• The issue of proximate cause may be raised as a defense in litigation cases.

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 • Even though the CPA firm might have been negligent in rendering services, it will not be
liable for the plaintiff’s (complaints) loss if its negligence was not the proximate cause of the
said loss.
Contributory negligence: is negligence on the part of the plaintiff that has contributed to his or her
having incurred loss.
Comparative negligence: is a concept used by courts to allocate damages (proportionate liabilities)
between negligent parties based on the degree to which each party is at fault.
The plaintiff: is the party claiming damages and bringing suit against the defendant.
❑ Liabilities to clients for audits often arise from;
✓ failure to uncover an embezzlement or defalcation being performed against the client by
client employees and also
✓ failure to provide reasonable assurance of detecting misstatements due to errors and fraud
that are material to the financial statements.
In general, to establish auditors’ liabilities, a client must prove
▪ Duty: that the auditor(s) or audit firm accepted a duty of care to exercise skill, prudence, and
carefulness.
▪ Breach of duty: that the auditor(s) or audit firm breached his/her/its duty of care through
negligent performance.
▪ Loss: that the client suffered a loss.
▪ Proximate-cause: that the loss is resulted from the auditor(s) negligent act or performance
Auditors Defense against client Suits:
As defendants, auditors’ basic defense is ordinarily that the audit was performed with reasonable
care and that they were not negligent in the performance of their duties.
Alternatively, they, might attempt to prove that, regardless of whether negligence was involved,
such alleged (assumed) negligence was not the proximate-cause of the client loss.
Moreover, demonstrating contributory negligence by the client is one means of showing that the
auditors’ negligence was not the sole cause of the client’s loss.

LO3: Understand the concept of client acceptance and planning the audit

† Client Acceptance or Continuance

The client acceptance phase of the audit has two objectives:
▪ Examination of the proposed client to determine if there is any reason to reject the engagement
(acceptance of the client);
▪ Convincing the client to hire the auditor (acceptance by the client).
A public accounting firm must use care in deciding which clients are acceptable.
The firm’s legal and professional responsibilities are such that clients who lack integrity or argue
(claim) constantly about the proper conduct of the audit and fees can cause more problems than
they are worth.
The Audit firm is required to consider the level of risk attached to the audit and whether this is
acceptable to the firm.
A public accounting firm must use care in deciding which clients are acceptable.

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 The firm’s legal and professional responsibilities are such that clients who lack integrity or argue
(claim) constantly about the proper conduct of the audit and fees can cause more problems than they
are worth.
The Audit firm is required to consider the level of risk attached to the audit and whether this is
acceptable to the firm.
Recognize that a variety of risks (such as financial and reputation risk) are associated with clients.
Recognize that a variety of risks (such as financial and reputation risk) are associated with clients.
Factors to consider: -
o The state of economic sector in which the client operates (a depressed sector my indicate risk)
▪ The firms may refuse clients in what they perceive to be high-risk industries (for example,
software technology) and may even discontinue auditing existing clients in those industries.
▪ Some smaller public accounting firms will not do audits of publicly held clients because
of the complexity of regulatory filings and the potential litigation risk.
o The clients previous audit history (frequent changes of auditor, and/or qualified reports are
obviously had news).
o The experience and qualifications of the management and their attitude towards control.
o Directors’ understanding of external auditors role and their own responsibilities.
o The current operating and financial situations of the company.
o The accounting policies used.
An auditor is unlikely to accept a new client or continue serving an existing client if overall acceptable
audit risk is below the threshold the firm is willing to accept.
† New Client Investigation
o Before accepting a new client, most public accounting firms investigate the company to
determine its acceptability.
o Many public accounting firms use considerable caution in accepting new clients from newly
formed, rapidly growing businesses.
o For prospective clients that have previously been audited by another public accounting firm, the
new (successor) public accountant is required to communicate with the predecessor auditor.
Before accepting an audit engagement consider:
1. Are they ethical? If the company is not morally straight, then there’s no need to move forward.
2. Are you independent? The time to determine your firm’s independence is the beginning—not at the
conclusion of the audit.
3. Do you have the technical ability to serve them?
▪ Appropriately understand the client and their industry before you conduct the engagement.
If the potential engagement involves a highly sophisticated industry and related accounting
standards for which you are ill-equipped? It may be better to let the engagement go and refer
it to an audit firm that has the requisite knowledge. Or maybe you can partner with the other
firm. Auditors should only perform audits that they can complete with professional
competence.
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 4. Do you have the capacity to serve them?
▪ If I can’t build additional capacity, then I may let the opportunity pass. Far too many firms
accept work without sufficient capacity. When this happens, corners are cut, and staff
members and partners suffer.
† Continuing Clients
❑ Considering whether or not to continue doing the audit of an existing client is as important decision
as deciding whether or not to accept a new client.
❑ For that reason, public accounting firms evaluate existing clients annually to determine whether
there are reasons for not continuing to do the audit.
▪ Previous conflicts over such things as the appropriate scope of the audit, the type of opinion
to issue, or fees may cause the auditor to discontinue association.
▪ The auditor may also determine that the client lacks basic integrity and therefore should no
longer be a client.
▪ If there is a lawsuit against a public accounting firm by a client or a suit against the client by
the public accounting firm, the firm should not do the audit because its independence could
be questioned.
† Audit Planning
❑ An audit plan is an overview of the engagement, outlining the nature and characteristics of the
client’s business operations and the overall audit strategy.
❑ The major purpose of audit planning is to provide information to aid the auditor in assessing
acceptable audit risk and inherent risk.
✓ These assessments will affect the auditor’s client acceptance or continuation decision, the
proposed audit fee, and the auditor’s evidence.
❑ A second purpose is to obtain information that requires follow-up during the audit. Doing so is
one step in obtaining sufficient competent evidences.
Generally, planning is very important to enable the auditors;
1) To obtain sufficient competent evidence for the circumstances.
✓ is essential if the audit firm is to minimize legal liability and maintain a good reputation in
the business community.
2) To keep audit costs reasonable
✓ helps the audit firm remains competitive and thereby retains or expand its client base
3) To avoided misunderstandings with the client.
✓ is important for good client relations and for facilitating high-quality work at reasonable
costs.
Procedures of audit planning and Designing an audit Approach
1. Preplanning
2. Obtain background information

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3. Obtain information about client’s legal obligations
4. Perform preliminary Analytical procedures
5. Set materiality, and assess acceptable audit risk and inherent risk
6. Understand internal control and assess control risk
7. Develop overall audit plan and audit program
❖ The organization of audit program usually is divided into two major sections.
✓ The first section deals with the “systems portions” (the procedures to assess the
effectiveness of the client’s internal control)
✓ The second section deals with the “substantive testing” of financial statements amounts, as
well as the adequacy of financial statements disclosure.
The relationship between test of controls and substantive tests
▪ Test of controls provides auditors with evidence as to whether prescribed controls are in use and
operating effectively.
✓ The result of these tests assists the auditors in evaluating the likelihood of material
misstatements having occurred.
▪ Substantive tests on other hand are designed to detect material misstatements if they exist in the
financial statements.
✓ The amount of substantive testing done by the auditors is greatly influenced by their
assessment of the likelihood that material misstatements exist.
❖ The stronger the internal control is, the less will be the likelihood of material misstatements
which in turn will lead to less degree of substantive testing and vice-versa.

LO4: Define audit responsibility & Evidence, perform audit operations

† Audit Responsibility and Objectives

❑ Objective of Conducting an Audit of Financial Statements
▪ The objective of the ordinary audit of financial statements is the expression of an opinion of the
fairness with which they present fairly, in all respects, financial position, result of operations, and its
cash flows in conformity with IFRS.
❑ Steps to Develop Audit Objectives
1. Understand objectives and responsibilities for the audit.
2. Divide financial statements into cycles.
3. Know management assertions about accounts.
4. Know general audit objectives for classes of transactions and accounts.
5. Know specific audit objectives for classes of transactions and accounts.
† Management’s VS Auditor’s Responsibilities
• Management is responsible for the financial statements and for internal control.

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 • The auditor is responsible of planning and performing the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement.
▪ The auditor is able to obtain reasonable BUT not absolute assurance that material
misstatements are detected.
▪ The auditor has no responsibility to plan and perform the audit to obtain reasonable
assurance that misstatements (caused by errors or fraud) that are not material to the
financial statements are detected.
† Audit Evidence
Concepts of Audit Evidence
▪ Audit evidence is all the information used by the auditor in arriving at the conclusions on which the
audit opinion/report/ is based.
▪ Information gathered in the course of an audit that supports the auditor’s opinion and conclusions.
▪ A solid understanding of the characteristics of evidence is obviously an important conceptual tool
for auditors
The following concepts of audit evidence are important to understand the conduct of the audit:
a) The nature of audit evidence.
b) The sufficiency and appropriateness of audit evidence.
c) The evaluation of audit evidence.
a) The Nature of Audit Evidence
▪ Audit evidence comprises source documents and accounting records underlying the financial
statement assertions and corroborative (supportive) evidence from other sources.
❑ The nature of the evidence refers to the form or type of information, which include accounting
records and other available information.
Accounting records include the records of initial entries and supporting records, such as checks and
records of electronic fund transfers; invoices; contracts; the general and subsidiary ledgers, journal
entries, and other adjustments to the financial statements that are not reflected in formal journal
entries; and records such as worksheets and spreadsheets (tables) supporting cost allocations,
computations, reconciliations, and disclosures.
Other information that the auditor may use as audit evidence includes minutes of meetings;
confirmations from third parties; industry analysts’ reports; comparable data about competitors
(benchmarking); control manuals; information obtained by the auditor from audit procedures such
as inquiry, observation, and inspection; and other information developed by, or available to, the
auditor that permits the auditor to reach conclusions through valid reasoning.
❑ The auditor gathers evidence by performing audit procedures
❖ These audit procedures consists of test of controls and substantive procedures.
i. Test of Controls:
▪ Are audit procedures to test the effectiveness of control policies and procedures to prevent or
detect material misstatement.
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 ✓ Depending on the results of this test, auditors may choose to rely up on client’s control
system as part of their auditing activities.
✓ The extent to which the test of controls are applied depends on the assessed control risk.
ii. Substantive tests:
▪ Substantive testing is an auditing technique that checks for any errors or material misstatements in
a company's accounts, financial statements or supporting documents.
▪ Are audit procedures designed to test for dollar misstatements directly affecting the correctness
of financial statement balances, accounts and supporting documents.
❖ These tests are needed as evidence to support that the financial records of an entity are
complete, valid and accurate.
There are three types of substantive tests:
1. Substantive tests of transactions: evaluating the client’s recording of transactions by verifying the
monetary amounts.
2. Analytical procedures: involves comparison of recorded amounts to expectations developed by
the auditor.
✓ They often involve the calculation of ratios by the auditor for comparison with previous
years’ ratios and other related data.
3. Tests of details of balances: focuses on ending general ledger account balances of both income statement
and balance sheet.
b) The Sufficiency and Appropriateness of Audit Evidence
▪ Auditors should obtain sufficient appropriate audit evidence to draw reasonable conclusions on
which to base the audit opinion.
✓ Sufficiency is the measure of the quantity of audit evidence.
✓ Appropriateness is a measure of the quality of audit evidence.
▪ Sufficiency and appropriateness of audit evidence are interrelated.
 The quantity of audit evidence needed is affected by the risk of misstatement and by the quality of
the audit evidence gathered.
✓ the greater the risk of misstatement, the more audit evidence is likely to be required
to meet the audit test and
✓ the higher the quality of the evidence, the less evidence that may be required to meet
the audit test.
▪ Accordingly, there is an inverse relationship between the sufficiency and appropriateness of audit
evidence.
 In most instances, the auditor relies on evidence that is persuasive (evidence that's good enough)
rather than convincing (trying to get absolute assurance) in forming an opinion on a set of
f/statements.
This occurs for two reasons.

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 • First, because an audit must be completed in a reasonable amount of cost and at a reasonable time,
the auditor examines only a sample of the transactions that compose the account balance or class of
transactions.
✓ Thus, the auditor reaches a conclusion about the account or class based on a subset of the
available evidence.
• Second, due to the nature of evidence, auditors must often rely on evidence that is not perfectly
reliable.
✓ the types of audit evidence have different degrees of reliability, and even highly reliable
evidence has weaknesses.
E.g., An auditor can physically examine inventory, but such evidence will not ensure that obsolescence is
not a problem.
✓ Thus, the nature of the evidence obtained by the auditor rarely provides absolute
assurance about an assertion.
 Evidence is considered appropriate when it provides information that is both relevant and reliable.
Relevance: the evidence relationship to the assertion or to the objective of the control being tested.
• If the auditor relies on evidence that is unrelated to the assertion, he or she may reach an
incorrect conclusion about the assertion.
Reliability: The reliability or validity of evidence refers to whether the evidence can be relied upon to signal
the true state of an assertion.
• Because of varied circumstances on audit engagements, it is difficult to generalize about the
reliability of various types of evidence.
However, the reliability of evidence is influenced by;
1. The source from where the evidence is obtained
✓ i.e. whether external or internal. Evidence obtained directly by the auditor from a
knowledgeable independent source outside the entity is usually viewed as more reliable than
evidence obtained solely from within the entity.
2. The effectiveness of the internal control system of the client company.
✓ Evidence obtained directly by the auditor from a knowledgeable independent source outside
the entity is usually viewed as more reliable than evidence obtained solely from within the
entity.
3. The collection procedure of the evidence
✓ i.e. whether obtained directly or indirectly. Evidence obtained directly by the auditor (e.g.,
observation) is generally considered to be more reliable than evidence obtained indirectly or
by inference
4. The types of evidence
✓ i.e. whether they are documents/written or oral evidence. Audit evidence is more reliable
when it exists in documentary form, whether paper, electronic, or other medium.

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 ✓ Eg., a written record of a board of directors meeting is more reliable than a subsequent oral
representation of the matters discussed.
The documentary evidence is classified into three categories;
1) Documents created outside the org. and transmitted directly to the auditor:
▪ The most reliable documentary evidence consists of documents created by independent
parties outside the organization and transmitted directly to the auditors without passing
through the client’s hands. E.g. the verification of accounts receivable
2) Documents created outside the organization and held by the organization:
▪ Externally created documents referred by the auditors will be in the ownership of
organization. E.g. bank statements, vendor’s invoices, property tax bills, notes receivables
3) Documents created and held within the organization:
▪ Most documents created and held within the organization represent a lower quality of
evidence because they circulate only within the company and do not receive critical review
by an outsider. E.g., the sales invoices, shipping notices, purchase orders etc.
▪ The degree of reliance to be placed on this documents depends on the effectiveness of the
internal control.
✓ if all documents are serially numbered and all numbers in the series accounted for,
these documents may represent reasonably good evidence.
C) The Evaluation of Audit Evidence
▪ The ability to evaluate evidence appropriately is another important skill an auditor must develop.
▪ Proper evaluation of evidence requires that;
✓ the auditor understand the types of evidence that are available and their relative reliability.
▪ The auditor must be capable of assessing,
✓ when a sufficient amount of appropriate evidence has been obtained in order to determine
the fairness of management’s assertions.
▪ In evaluating evidence, an auditor should be thorough in searching for evidence and unbiased in its
evaluation.

LO5: Recognize and be guided by the social, professional, and ethical issues involved in
auditing and preparation of financial statements;

What is an Audit Report?

▪ An auditor’s report is the independent examination of and expression of opinion on the financial
statements of the company by appointed auditors in pursuance of that appointment and in compliance
with any statutory obligations.
▪ The auditor’s report is the end product of an audit examination communicated to the users of the
f/statements, the auditor’s conclusion regarding;

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 ✓ Whether f/statements portray a true and fair view of the company's financial position and
performance.
✓ Whether the f/statements comply with the relevant legislations. e.g. company lows,
regulations, provisions, etc
❑ The responsibility for the preparation of the financial statements and the presentation of the
information included therein rests with management of the company.
❑ The auditors’ responsibility is to make a report to the members of the company on the books of
accounts and financial statements besides others necessary and relevant documents examined by
him/her/them.
▪ The auditor’s report does not guarantee the truth or otherwise of the matter reported upon; it is
expression of auditors’ opinion on the financial statements.
✓ All they can do is to report whether or not, in his opinion, the financial statements are true
and fair.
✓ Different auditors may form different opinion based on their exercises of judgment on the
same set of financial accounts.
✓ Thus, an auditor is not a guarantor or an insurer.
❑ Purpose and form of audit report
1. Purpose of audit report
1. It prove that the financial information of the company reflects a true and fair picture of the
state of affair of clients business.
2. It summarizes the result of the audit work carried out by the auditors.
3. A report from introducing the shareholders with material facts about the affairs of company’s
business, it offers an opportunity to the users of financial statements to get reliable insight
into the financial position of the company as reflected by its profit and loss accounts and the
balances sheet.
4. Auditors’ report is the indicator of credibility of financial statements.
2. Form of audit report
▪ International Auditing Guidline-13 provide guidance on the form and content of the auditors’
report issued after an examination of financial statements.
❑ According to the guidelines, the basic elements of the auditors’ report are as follows:
1. Title: An appropriate title as ‘Independent Auditors Report,’ helps the users /readers/ to identify
the report and to distinguish it from reports issued by others.
2. Address: The report should be appropriately addressed.
✓ For example, in the case of a statutory audit of a company, the report is addressed to the
shareholders.
3. Identification of financial statements: The financial statements can be identified by including the
name of the entity and the date period covered by the F/s. (Introductory paragraph)

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 4. Reference to auditing standards or practices: Such references in the report assure the reader that
the audit has been carried out in accordance with established standards or practices. (Scope
paragraph)
5. Opinion on the financial statements: The report should clearly set forth the auditors opinion on
the entity’s financial positions and operational results. e.g. the financial statements give a true and
fair view. (Opinion paragraph)
6. Signature: The report should be signed in the name of the audit firm or the personnel name on behalf
of the firm in case of statutory audit of companies.
7. Auditors’ or Audit firm’s Address: The report should also mention the specific location in the city
where the auditor(s), or audit firm maintain his offices.

❑ Types of auditors’ reports (opinions)

• Expressing an independent and expert opinion on the fairness of financial statements is the most
important and valuable service rendered by auditors.
• Thus, the auditors’ reports may be classified as follows.
1. Unqualified report……clean, clear, unconditioned
2. Qualified report (except for opinion)……limited, modified
3. Adverse report (do not present fairly)……poor, unfavorable, bad
4. Disclaimer of opinion (no-opinion) ….denial, rejection
1. Unqualified (clean) report
❑ An auditors’ report with an unqualified opinion may be issued only when the following conditions
have been meet.
1. The financial statements are presented in conformity with GAAPs/IFRS, including
disclosure.
2. The audit was performed in accordance with ISA/GAAS.
3. No significant scope limitations preventing the auditors from gathering the evidence
necessary to support their opinion.
4. There are no circumstances requiring the addition of an explanatory paragraph or
modification of the wording of the report.
❖ It is the most desirable report from the client’s point of view.
❖ The client usually will make a necessary adjustment to the statements to enable the auditors to issue
this type of opinion.
❑ The unqualified auditor’s report could take either of the following two forms.
1. An unqualified opinion - standards report:-
▪ The standard report express a “clean opinion” and may be issued only when the conditions
listed in the preceding sections have been met and no conditions requiring explanatory
language exists.
2. An unqualified opinion - with explanatory language:-
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 ▪ Under certain circumstances, auditors add explanatory languages to their report, even when
issuing an unqualified opinion.
✓ Adding the additions languages is not regarded as a qualified; rather, the language
merely draws attention to a significant situation.
❖ Unqualified Report with Explanatory Paragraph
1. Conditions for Unqualified Report with Explanatory Paragraph;
Lack of consistent application of GAAPs/IFRS.
Substantial doubt about going concern.
Justified departure from promulgated accounting principles.
Emphasis of a matter.
Reports involving other auditors.
Lack of consistent application of GAAPs/IFRS.
1. When the auditors believe that the new principles is generally accepted and the change is
justified, the audit report is modified to highlight the lack of consistent application of
acceptable accounting principles, but the opinion remains unqualified.
Substantial doubt about going concern.
2. Significant frequent operating losses or working capital deficiencies.
3. Inability of the company to pay its obligations as they come due.
4. Loss of major customers, the occurrence of uninsured catastrophes.
5. Legal proceedings, legislation that might jeopardize (threaten) the entity’s ability to operate.
Justified departure from promulgated accounting principles.
▪ The auditor must be satisfied and must state and explain, in a separate paragraph or
paragraphs in the audit report, that adhering to the principle would have produced a
misleading result in that situation.
Emphasis of a matter.
▪ Auditors also may issue an unqualified opinion that departs from the wording of the standards
report in order to emphasize a matter regarding the financial statement.
Reports involving other auditors.
▪ When part of the audit is carried out by another CPA firm, the principal CPA firm has two
options:
1. Making no reference to other auditor’s work
▪ When the other auditor is well known;
▪ When the principal hired the other auditor;
▪ When the principal auditor has visited and reviewed the work of the other auditor;
▪ The principal auditor assumes full responsibility and no need of explanatory
paragraph/wording.

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 2. Make reference to the other auditor
▪ Shared responsibility opinion is issued; even though it is signed only by the
principal auditors.
▪ Usually issued when the other auditors were engaged by the client, rather than the
principal;
▪ The auditors’ additional wording is not qualification, rather indication of shared
responsibility.

2. Qualified opinions
▪ A qualified opinion expresses the auditor’s reservations or uncertainty about fair presentation in
some areas of the financial statements but not so significant as to necessitate a disclaimer or adverse
opinion.
 The opinion states that except for the effects of some deficiency in the F/statements, or some
limitations in the scope of the auditors’ examination, the F/statements are presented fairly.
❖ All qualified reports include a separate explanatory paragraph before the opinion paragraph
disclosing the reasons for the qualification.
 Qualified audit reports should include precisely worded qualifying languages that include the phrase
such as “except for” or “with the exception of”.
 Opinion paragraph of a qualified report includes the appropriate qualifying language and a
reference to the explanatory paragraph.
 When the report is qualified, the introductory and scope paragraph of the standard report are
unaffected.
 The modification involves adding an explanatory paragraph following the scope paragraphs
and qualifying the opinion paragraph.
 Following is an example of the explanatory and opinion paragraphs of an audit reports qualified for
a departure from IFRS/GAAPs.
Explanatory Paragraph of qualified reports
Sony corporation has not presented segment information for each of the three years in the period
ended march 3, 2018. The presentation of segment information concerning operations in different
industries, and foreign operations and export sales is required by GAAPs/IFRS for a complete
presentation of the consolidated f/statements.
Opinion Paragraph
In our opinion, “except for” the omission of the segment information as discussed in the third
paragraph of this report, the f/statements audited by us presents fairly, in all material respects, the
financial position of sonny corporation and its consolidated subsidiary at March 31, 2017 and
2018, and the results of its operations and their cash flows for each of the three years in the period
ended march 31, 2018, in conformity with GAAPs/IFRS.

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Auditors may issue qualified audit opinion when:
1. There is a departure from GAAPs/IFRS by client and auditors do not agree with the accounting
principles used in preparing financial statements.
 When the departure is immaterial, an unqualified opinion may be issued.
 But, when it is material but not material enough to make the financial statements misleading,
a qualified opinion is appropriate.
 So, when material departure to make the financial statement misleading adverse opinion is
appropriate.
2. Scope limitations; limitation on the scope of an audit arise when the auditors are unable to perform
essential audit procedures.
❑ Limitation may be imposed either;
✓ by circumstances surrounding the audit (e.g., the auditors were engaged too late in the
year to observe the client’s beginning inventory or
✓ by the client (e.g., the client refuses to allow the auditor to send confirmation to customers).
▪ the auditor will attempt to perform alternative procedures to gather sufficient competent evidential
matter, and may issue an unqualified opinion if the collected evidential matters are believed by the
auditors to be sufficient.
 Otherwise, qualified opinion may be issued or an auditor may disclaim an opinion
3. When
 the account do not disclose a true and fair view of the companies affair, and
 books of accounts have not been kept in accordance with the law and profit and loss
accounts are not in agreements with the books of account and other related issues.
▪ Explanatory paragraph is added between the scope and opinion paragraph.
3. Adverse Opinions
▪ An adverse opinion is the opposite of an unqualified opinion; it is an opinion that is issued when;
1. The financial statements do not present fairly the financial position, results of operation, and cash flows
of the client in conformity with GAAPs/IFRS.
2. When the deficiencies (departure) from GAAPs/IFRS in the financial statements are so material, the
departure overshadows the overall f/statements or misleading financial statements.
▪ When the auditors express an adverse opinion, they must disclose in a separate paragraph of their
report the reasons for the adverse opinion and the principal effect on the financial statements.
Introductory Paragraph
Scope Paragraph
Explanatory Paragraph………….. the reasons for the adverse opinion
▪ Opinion Paragraph for adverse report
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 ▪ In our opinion, because of the effects of the matters discussed in the preceding paragraph, the
f/statements referred to above do not present fairly, in conformity with GAAPs/IFRS the financial
position of XYZ company as of Dec., 31, 20x9, or the results of its operations or its cash flows for
the year then ended.
4. Disclaimer of opinion
▪ A disclaimer of opinion means giving no opinion as to the status of the financial statements under
audit.
▪ Auditors issue a disclaimer whenever:
1. Auditors are unable to form an opinion or have not formed an opinion as to the fairness of
presentation of the financial statements due to significant scope limitations either by
substantial circumstances and/or by client and this limitations of scope prevents the auditors’
compliance with ISA/GAAS and
2. When a material uncertainty affects the financial statements.
E.g. the probable outcome of a very significant lawsuit against the client
▪ A disclaimer can only be issued when the auditors do not have sufficient information to form an
opinion on the financial statements.
✓ Issued when there is substantial scope limitations.
✓ Issued in rare cases.
✓ Scope paragraph is omitted and replaced by explanatory paragraph.
Since the Co. did not take physical inventories and we were not able to apply other auditing procedures
to satisfy ourselves as to inventory quantities and the cost of property and equipment, the scope of our work
was not sufficient to enable us to express, and we do not express, an opinion on these financial statements.
▪ Independent auditors report the phrase “Financial statements present fairly, in all material
respects”
✓ The auditors cannot say that the “statements present exactly or correctly the financial position
or operating results” since many of items in the financial statements cannot be measured
exactly.
▪ The meaning of “present fairly” in independent auditor’s report is to state the fairly stated
financial statements are;
✓ Prepared in accordance with accounting principles that have general acceptance and are
appropriate in the circumstance.
✓ Information of matters that may affect their use, understanding and interpretation are
classified, summarized and presented in a reasonable manner, neither too detailed nor too
condensed.
✓ Prepared to reflect transactions and events within a range of reasonable limits.

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† Sample Questions

1. Which of the following best describes why an independent auditor is asked to express an
opinion on the fair presentation of financial statements?
A) It is difficult to prepare financial statements that fairly present a company's financial
statements without the expertise of an independent auditor.
B) It is management's responsibility to seek available independent aid in the appraisal of
the financial information shown in its financial statements.
C) The opinion of an independent party is needed because a company is not likely to be
considered objective with respect to its own financial statements.
D) It is a customary courtesy that all stockholders of a company receive an independent
report on management's stewardship in managing the affairs of the business.
2. The definition of auditing refers to auditing as a "systematic process of objectively obtaining
and evaluating evidence regarding assertions…. " What is meant by "systematic process"?
A) All audits involve obtaining the same evidence.
B) All audits involve evaluating evidence in the same manner.
C) The audit follows a structured and documented plan for obtaining and evaluating
evidence.
D) The audit considers all assertions are equally important for all audits.
3. Which of the following is an accurate statement regarding audit evidence?

A) Responses to the auditor's questions by client employees is considered highly

persuasive evidence.
B) Audit evidence should provide an absolute level of assurance.
C) All evidence must be highly persuasive.
D) The auditor uses evidence to determine whether the statements are fairly presented.
4. The basic purpose of a financial statement audit is to

A) Provide reasonable assurance regarding whether the client's financial statements are
fairly stated.
B) Detect fraud.
C) Examine individual transactions so that the auditor may certify as to their validity.
D) Assure the consistent application of correct accounting procedures.
5. Which of the following is wrong about auditing?
A) Auditing is intended to provide complete assurance that financial statements are free
from material misstatements.
B) Auditing is a process which aims at expressing an opinion on the fairness of financial
statements.
C) The term Auditing can be used to describe a profession.
D) Auditing aims at establishing and reporting on the degree of correspondence between
financial information and the established criteria.

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6. Which one of the following is not true about the main grounds for the reasonable assurance
given by the auditor?
A) This is due to audit is conducted based on sample.
B) Most audit evidence is persuasive rather than conclusive.
C) This is due to that when the auditor assesses all transactions, he/she may not
investigate important transactions due to tiresome.
D) Due to the inherent limitations arise from the control system of the client.
7. All of the following are true about auditing; except

A) It is a work conducted by the auditor for the purpose of expressing an opinion on the
fairness of presented financial information.
B) It involves a process of obtaining and evaluating evidence that ultimately guides the
auditor’s decision.
C) The objective of auditing is preparation of financial statements and then investigating
their fairness.
D) To conduct an audit presentation of financial statements is the responsibility of the
company’s management.
8. The auditor will not be liable when he/she,

A) Was negligent in course of the work C) Made a gross negligence

B) Did a fraud D) Did in accordance with GAAS/ISA
9. Which of the following means can the auditor use in defending him/herself against lawsuits?
The auditor
A) may show that he performs in accordance with GAAS/ISA.
B) may argue that the plaintiff did not suffer a real loss.
C) Show his negligence was not the proximate cause of the client’s loss.
D) may demonstrate the contributory negligence of the client.
E) All
10. Which of the following is not a characteristic of the reliability of evidence?
A) effectiveness of client internal controls
B) education of auditor
C) independence of information provider
D) timeliness
11. Auditors are most likely to use the most rigorous audit procedures to examine
A) Routine transactions.
B) Management assertions that are deemed to be of low risk.
C) Only the rights and obligations assertion.
D) Management assertions that are deemed to be of high risk.
12. Appropriateness of evidence is a measure of the
A) quantity of evidence. C) sufficiency of evidence.
B) quality of evidence. D) meaning of evidence.

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13. Two determinants of the persuasiveness of evidence are
A) competence and sufficiency. C) appropriateness and sufficiency.
B) relevance and reliability. D) independence and effectiveness.
14. The two characteristics of the appropriateness of evidence are
A) relevance and timeliness. C) relevance and reliability.
B) relevance and accuracy. D) reliability and accuracy.

15. Which one of the following statements best describes the concept of materiality?
A) Materiality is determined by reference to specific quantitative guidelines
established by the AICPA.
B) Materiality depends only on the dollar amount of an item relative to other items in
the financial statements.
C) Materiality depends on the nature of an item but not on the dollar amount of the
item.
D) Materiality is largely a matter of professional judgment

16. Before accepting an engagement to audit a new client, an auditor is required to

A) Make inquiries of the predecessor auditor.
B) Tell the client whether or not the auditor is willing to issue a "clean" opinion.
C) Prepare a memorandum setting forth the staffing requirements and documenting the
preliminary audit plan.
D) Become a member of the client's board of directors
17. Preliminary engagement activities include
A) Evaluating internal controls.
B) Assessing audit risk at the account balance level.
C) Setting materiality.
D) Performing background checks on top management.
18. The auditor's report is generally addressed to the
A) Chief operating officer. C) Stockholders of the company.
B) Securities and Exchange D) Chief financial officer.
Commission.
19. An auditor would issue an adverse opinion if
A) The auditor encounters adverse attitudes toward the auditor on the part of client
management.
B) A qualified opinion cannot be given because the auditor is not qualified to do so.
C) An immaterial misstatement is present.
D) The statements taken as a whole do not fairly present the financial condition and
results of operations of the company.
20. Evidence is reliable if it
A) Signals the true state of a management assertion.
B) Applies to the period being audited.
C) Relates to the audit assertion being tested.
D) Is consistent with management's assertions.

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21. Which of the following best describes the concept of audit risk?
A) The risk of the auditor being sued because of association with an audit client.
B) The risk that the auditor will provide an unqualified opinion on financial statements
that are, in fact, materially misstated.
C) The overall risk that a material misstatement exists in the financial statements.
D) The risk that auditors use audit procedures that are inappropriate.
22. An auditor who accepts an audit engagement and does not possess expertise with respect to
the business entity's industry, should
A) Engage financial experts familiar with the nature of the business entity.
B) Obtain a knowledge of matters that relate to the nature of the entity's business.
C) Refer a substantial portion of the audit to another CPA, who will act as the principal
auditor.
D) First inform management that an unqualified opinion cannot be issued.
23. When obtaining an understanding of the entity and its environment, the auditor should obtain
an understanding of internal controls primarily to
A) Identify areas of relatively high risk of misstatement and plan the audit accordingly.
B) Provide suggestions for improvement to the client.
C) Serve as a basis for setting audit risk and materiality.
D) Decide whether to perform an audit for the client.
24. 21. The phrase “do not present fairly” is used in the:
A) Unqualified opinion C) Qualified opinion
B) Adverse audit report D) Disclaimer audit report
25. An auditor’s responsibility to express opinion on the financial statements is presented in the:
A) Introductory paragraph C) Explanatory paragraph
B) Opinion paragraph D) Scope paragraph
26. Which of the following statements relating to the competence of the evidential matter is
false?
A) Evidence obtained from the client is more reliable
B) Evidential matter gathered by the auditor from outside an enterprise is reliable
C) Oral representations made by the management are additional sources of
Evidence
D) Accounting data developed under strong internal control are more reliable
27. The auditing profession recognizes the need for uniformity in reporting to.……………
A) Avoid confusion C) Give common understanding
B) Avoid misunderstanding D) All
28. Which of the following audit reports have not separate explanatory paragraph?
A) Unqualified audit report C) Qualified audit report
B) Adverse audit report D) Disclaimer audit report
29. When the auditor concludes that there is material but not sever scope limitation in course of
the audit, what type of audit report to be issued?
A) Qualified opinion C) Standard unqualified opinion
B) Adverse opinion D) Disclaimer opinion
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30. Who is primarily responsible for the fair presentation of the financial statement?
A) The auditor C) The shareholders
B) The board of directors D) The client
31. What is the date to be written in the audit report?
A) Balance sheet date C) Audit report issuance date
B) Engagement date D) Audit exit conference date
32. Which is least reliable type of evidence?
A) Oral evidence C) Analytical evidence
B) Written representation D) Mathematical evidence
33. “We do not express an opinion on these financial statements.” In which type of audit report
do the auditors are use?
A) Unqualified opinion C) Adverse opinion
B) Qualified opinion D) Disclaimer opinion

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