Auditing

Table of Contents page
Chapter One: Auditing -an overview ...........................................................................................1
1.1. Origin and meaning of Auditing..............................................................................2

1.2. Distinction between Accounting and Auditing .......................................................4
1.3. Types of Audits and Auditors .................................................................................6
1.4. Generally Accepted Auditing standards..................................................................8
1.5. Auditing Profession in Ethiopia ..............................................................................10
Chapter Two: Professional Ethics and Legal Liabilities of Auditors .........................................14
2.1. The need for Professional Ethics .............................................................................15
2.2. Code of professional conduct ..................................................................................15
2.3. Ethics for Internal Auditors .....................................................................................17
2.4. Legal liabilities of Auditors .....................................................................................19
2.5. Auditors’ liability to their clients under common law .............................................21
2.6. Auditors’ liability to third parties under common law.............................................22
Chapter Three: Audit Evidence ..................................................................................................26
3.1 Audit Evidence .......................................................................................................27
3.2 The relationship of evidence to Audit Risk.............................................................28
3.3 Sufficient Competent Evidential Matter .................................................................29
3.4 Types of audit evidence ..........................................................................................30
3.5 Evidence about Accounting Estimates ...................................................................31
3.6 Evidence for Related Party Transactions ...............................................................32
Chapter Four: Audit Planning Process ........................................................................................38
4.1 Client acceptance procedure......................................................................................39
4.2 Obtaining the engagement.........................................................................................42
4.3 Audit planning...........................................................................................................43
4.4 Designing Audit programs ........................................................................................44
4.5 Audit process.............................................................................................................45
Chapter Five: Internal Control.....................................................................................................48
5.1 Meaning and Objectives of Internal Control .............................................................49
5.2 Types of Internal Control (Accounting and Administrative) ...................................50
5.3 Control environment..................................................................................................50
5.4 Risk assessment ...........................................................................................................................51
5.5 Control activities .......................................................................................................51
5.6 Monitoring.................................................................................................................60
5.7 Auditor’s consideration of internal control ............................................................... 60
Chapter Six: Audit Sampling ........................................................................................................63
6.1 Need for Audit Sampling ........................................................................................ 64
6.2 Statistical Vs Non-Statistical sampling ................................................................... 64
6.3 Audit Sampling for Tests of Controls ..................................................................... 65
6.4 Attribute sampling................................................................................................... 66
6.5 Audit Sampling for Substantive Tests..................................................................... 67
6.6 Classical Variables Sampling.................................................................................. 70
6.7 Non-Statistical sampling for substantive Tests ...................................................... 73
Chapter Seven: Audit Working Papers.........................................................................................74
7.1 Audit working papers ............................................................................................... 74
7.2 Functions of Audit working papers ..........................................................................75
7.3 Types of Audit Working papers ...............................................................................75
7.4 Organization of Audit working papers .....................................................................76
7.5 Examination of the General Records........................................................................76
Chapter Eight ...................................................................................................................................78
8.1. Statutory Requirements ..............................................................................................79
8.2. Auditors' Report on Financial Statements ..................................................................80
8.3. Qualifications in Audit Reports..................................................................................85
UNIT ONE
OVERVIEW OF AUDITING
Contents
Aims and Objective
Introduction
1.1 Over view of Auditing
1.1.1 Definition
1.1.2 Demand for Audit
1.1.3 Internal Auditing
1.2 Distinction between Accounting and Auditing
1.2.1 Evolution of auditing
1.3 Objectives of Auditing
1.4 Types of Auditing
1.3.1 Financial Statement Audits
1.3.2 Compliance Audits
1.3.3 Operational Audits
Types of Auditors
1.3.4 External Auditors
1.3.5 Internal Auditors
1.3.6 Government Auditors
1.5 Generally Accepted Auditing standards
1.6 Auditing Profession in Ethiopia
1.7 Summary
1.8 Glossary
1.9 Answers to Check Your Progress
1.10 Model Examination Questions
INTRODUCTION
This unit deals with the definition of Auditing, why there is a demand for Auditing by stock
holders, managers, employees, and debt holders, what is the role of Internal Auditing in an
organization; and deals with description of types of Audits commonly used by the professional
Auditors.
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Copyright@ Rift Valley University Center for Distance Education
AUDITING I (ACCT-441)
The public accounting profession (CPA), as we knew it today grew mainly out of the demand
for financial statement Audits. Very specific auditing standards, referred to as generally accept
auditing standards (GAAS), are provided for conducting financial statement audits. However, In
recent years, the profession has been asked to provide services beyond the traditional financial
Statement Audit. These include compliance and operational Audits.
AIMS AND OBJECTIVES

After studying this unit, you should be able to:
- explain the meaning of Auditing
- explain the need for Auditing
- explain Internal Auditing, and
- Identify the types of Audits.
1.1 OVERVIEW OF AUDITING
1.1.1 Definition of Auditing
 Can you define Auditing?
______________________________________________________________________________
______________________________________________________________________________
__________________________________________-.
The American Accounting Association, committee on Basic Auditing concepts Defined Auditing
as:
Auditing is systematic process of objectively obtaining and evaluating evidence regarding
assertions about economic actions and events to ascertain the degree of correspondence between
assertions and established criteria and communicating the results to interested users.
The phrases in this definition require additional explanation. The phrase systematic process
implies there should be a well-planned approach for conducting an audit. This plan involves
objectively obtaining and evaluating evidence. The evidence gathered by the auditor must relate
to assertions about economic actions and events. For example, Financial statements prepared by
management contain numerous assertions. If the Balance sheet contains amount of Br. 10million
for property, plant and equipment, management is asserting (declaring) that the company owns
the assts, uses them in the production of goods and services, and that this amount represents their
un depreciated historical costs. The Auditor compares the evidence gathered to assertions about
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economic activity in order to assess the degree of correspondence between those assertions and
established criteria. Generally Accepted Accounting Principles (GAAP) are normally used for
measuring the degree of correspondence, for financial Audits. The last Phrase, communicating
the results to interested Users, is concerned with the type of report the auditor provides to the
intended users. (Banker, investors, stockholders, Creditors, e..t..c .
1.1.2 Demand for Audit
The essence of demand for audit refers to the question “why do organizations request an audit?”
the answer to this question can be described as follows:
(i) Control mechanism – audits whether important control mechanisms for

accountability. The auditor’s role is determining whether the reports prepared by
management are in conformity with the responsibility and duties provided in the
organization policies. The overall need for monitoring activities, need demands
(requests) auditing to provide credible or Audited financial information, Audited
performance reports, Audited implementation of rules, & regulations.
(ii) To resolve conflict of interest between management and the owners.

The Agency relationship that exists between the owner and manager produces a natural conflict
of interest. Because, the manager has more information about the “True financial position and
results of operations of the entity than the owner who is absentee. It both parties seek to
maximize their own self interest, It is likely that the manager will not act in the best interest of
the owner. Example The manager may spend organizational funds to provide excessive personal
benefits or manipulate the reported earnings in order to earn a larger bonus. Thus, the need for
Independent (non-pertain) opinions or view is necessary to resolve such conflicts.
(iii) To reduce damaging Consequences – Even though, the function of accounting is to

provide information for economic decision making; this information must be verified
by auditors, before they are used for decisions that have serious and subsequent
factual economic consequences.
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(iv) To simplify complexity – In our age, financial information & translation has been
come complex in preparation, content, and format. Therefore it demands drippy
specialized body of knowledge to prepare (compilation), verify and interpret them.
(v) Regulatory requirements – many business laws, memo random of association and
government regulation, make requirements’ annual audits. For Example –For renewal
of license, or permit, (commercial code to Ethiopia), financial Administration
regulation proclamation tax, requires audited financial statements.
1.1.3. Internal Auditing

Internal auditing is a managerial control activity performed with an organization as service to
management by an employee of the organization. It reviews operations through the measurement
and evaluation of other control mechanisms. Their primary activities are to conduct compliance
and operational audits within the organization. However, they assist the external auditor with the
annual financial statement audit. Internal auditors are employed by Individual companies,
partnerships, government agencies. The Institute of Internal Auditors (IIA) has developed set of
standards that should be followed by internal auditors and Established certification program –
which Includes passing of uniform writer examination. Like external auditors they must be
Independent and objective.
1.2 DISTINCTION BETWEEN ACCOUNTING VS AUDITING

W
What are the different between Accounting and Auditing?
______________________________________________________________________________
______________________________________________________________________________
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_______________________.
Accounting is the collecting (recording, classifying), summarizing, reporting and interpreting of
financial data.
Auditing is the testing of those accounting records for fairness, appropriateness. An accountant
only needs to know generally accepted accounting principles (GAAP). The auditor needs to
know GAAP, plus how to select and evaluate evidence related to the assertions of financial
statements.
Accounting is constructive. It starts with the raw financial data to process and produce financial
statements.
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Auditing on the other hand is analytical work that starts with financial statement to lend
credibility and fairness of the measurements.
1.2.1 Evolution of Auditing
It was recognized many years ago that whenever a fiduciary relationship with financial
implications existed there was a need for an outsider with sufficient independence and
objectivity to review the accounts of stewardship and to express an opinion as to their honesty or
otherwise. Modern auditing has developed since the concept of a company as a separate legal
entity came into existence. This led to the separation of ownership from management and a
consequent need to safeguard the interests of the owners (the shareholders), who in all but the
smallest of businesses (where shareholders and directors were one and the same) were not
involved in the day-to-day decisions made by the management. Directors must therefore be
accountable for their actions to the shareholders on a regular basis. This accountability mainly
occurs when the financial statements are formerly presented to shareholders.
Increasingly the services of professional accountants were being sought and employed in the
latter part of the nineteenth century and it was then that several professional accountancy bodies
were formed.
Some of the major auditing developments of the 20th century include:
1. A shift in emphasis to the determination of fairness in financial statements.
2. Increased responsibility of the auditor to third parties, such as governmental agencies,
stock exchanges, and an investing public numbered in millions.
3. A change in auditing methods from detailed examination of individual transactions to use
of sampling techniques, including statistical sampling.
4. Recognition of the need to consider the effectiveness of internal control as a guide to the
direction and amount of testing and sampling to be performed.
5. Development of new auditing procedures applicable to electronic data processing
systems, and use of the computer as an auditing tool.
6. Recognition of the need for auditors to find means of protecting themselves from the
current wave of litigation.
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1.3 TYPES OF AUDITING
C
Can you identify the types of Auditing?
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
___________________________.
While there are many types of audit based on the definitions previously provided, generally they
are discussed under three types: financial statement audits, compliance audits and operational
audits
1.3.1 Financial Statement Audits
The purpose of a financial statement audit is to determine whether the overall financial
statements present fairly in accordance with specified criteria. This type of audit usually covers
the basic set of financial statements (Balance sheet, Income statement, statement of stockholders
equity, and statement of cash flows); and Generally Accepted Accounting principles (GAAP)
serve as the criteria. However, certain financial statements audits may use of other criteria, such
as cash basis or Income tax basis.
1.3.2 Compliance Audits

The purpose of a compliance audit is to determine the extent to which rules, policies, Laws
covenants, or governmental regulation are followed by the entity being audited for example,
accompany may use auditors to determine whether the corporate rules, and policies are being
followed by departments within the organization. The corporate rules and policies serve as the
criteria for measuring the departments Compliance. Another example is examination of tax
returns (payment) of individuals and companies by the Internal Revenue Service for compliance
with Tax Laws.
1.3.3 Operational Audits

Operational Audit involves a systemic review of organizational activities, or apart of them, in
relation to the efficient and effective use of resources. The purpose of operational audit is to
assess performance, Identity areas of Improvement, and develop recommendations. Sometimes
this type of audit is referred to as a performance audit or management audit. Operational audits
are generally more difficult to conduct than financial and compliance audits. Since the purpose
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of an operational audit is to assess effectiveness and efficiency, it can be very difficult to identify
objective, measurable criteria that can be used for that purpose.
Examples of such audit include – audit of government programs, Efficiency of the food and Drug
administration’s procedures for Introduction of new Drugs, to market. Assessment of the
efficiency and effectiveness of organizations use of computer resources. e.t.c.
TYPES OF AUDITORS
C
Can you identify the types of Auditors?
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________.
The most known types of auditors are
1. Independent auditors,
2. Internal auditors,
3. Government auditors.
1. Independent (external auditors): - Independent auditors have no connection to the firm as an
owner or employee/manager. The basic task of independent auditor is to confirm to the
owners that the employees are correctly reporting on their financial position and
performance.
2. Internal auditor: - An internal auditor is paid salary as employee on the organization that is
being audits. He/she is responsible to appraise and investigation the performance of unit
and/or units within the organization and give recommendation to top management.
3. Government audit: - The government auditor is paid a salary by the government. He/she is
responsible to the legislature or executive.
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1.4 GENERALLY ACCEPTED AUDITING STANDARDS
C
Can you identify general accepted auditing standards?
______________________________________________________________________________
______________________________________________________________________________
Auditing standards are measures of the quality of the auditor's performance. The American
Institute of Certified Public Accountants (AICPA) first issued the ten generally accepted auditing
standards (GAAS) in 1947 and has periodically modified them to meet changes in the auditor's
environment. The GAAS are composed of three categories of standards: general standards of
qualification and conduct and standards of fieldwork and standards of reporting.
Table 1.1
Generally Accepted Auditing Standards
General Standards of Qualification and Conduct
1. The audit is to be performed by a person or persons having adequate technical training
and proficiency as an auditor.
2. An auditor must maintain an independent physical and mental attitude.
3. An auditor must exercise due professional care in his work.
Standard of Fieldwork:
1. Auditor's work must be properly planned and supervised.
2. Auditor's must study and evaluate internal control.
3. Auditor must gather sufficient and competent evidence.
Standards of Reporting:
1. The audit report must state whether financial statements have been prepared in
accordance with Generally Accepted Accounting Principles (GAAP).
2. The audit report must state whether the GAAP has been consistently applied wit that
of the preceding period.
3. The audit is to be presumed to have adequate information disclosure unless and
otherwise stated so.
4. The audit report must maintain an expression of opinion on the financial statements as
a whole or an explanation for not expressing an opinion.
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1.4.1 General Standards of Qualification and Conduct
The three general standards are concerned with the auditor's qualification and the quality of his
or her work. The first general standard recognizes that an individual must have adequate training
and proficiency as an auditor. This is gained through formal education, continuing education
programs, and experience. It should be recognized that this training is on going with a
requirement on the part of the auditor to stay up to date with current accounting and auditing
pronouncements. Auditors should also be aware of developments in the business world that may
affect the auditing profession.
The second general standard requires that the auditor always maintain an attitude of
independence on an engagement. Independence precludes relationships that may impair the
auditor's objectivity. A distinction is often made between independence in fact and independence
in appearance. An auditor must not only be independent in fact but also avoid actions that may
appear to affect independence. If an auditor is perceived as not being independent, users may
lose confidence in the auditor's ability to report truthfully on financial statements. Public
confidence is impaired if an auditor is found to lack independence.
Due professional case is the focus of the third general standard. In simple terms, due care means
that the auditor performs his or her duties with a degree of skill commonly possessed by others in
the profession. The third general standard imposes an obligation on the members of the audit
team to observe the standards of field work and reporting, and to perform the work at the same
level as any other professional auditor who offers such services to clients.
1.4.2 Standards of Field Work

The standards of fieldwork relate to the actual conduct of the audit. These three standards
provide the conceptual background for the audit process. The first standard of fieldwork deals
with planning and supervision. Proper planning can lead to a more effective audit that is more
likely to detect material misstatements if they exist. Proper planning also assists in completing
the engagement in a reasonable amount of time. Additionally, the standard requires that
assistants on the engagement be properly supervised.
The second standard of fieldwork requires that the auditor gain sufficient understanding of the
auditor’s internal control to plan an audit. Internal control is a process, affected by an entity's
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board of directors, management and other personnel that is designed to provide reasonable
assurance regarding the achievement of the following objectives: (1) reliability of financial
reporting, (2) compliance with applicable laws and regulations, and (3) effectiveness and
efficiency of operations. The degree to which the auditor relies on the auditor’s internal control
directly affects the nature, timing, and extent of the work performed by the independent auditor.
Sufficient, competent evidence is the focus of the third fieldwork standard. Most of the auditor's
work involves the search for and evaluation of evidence to support management's assertions in
the financial statements. The auditor uses various audit procedures to gather this evidence.
1.4.3 Standards of Reporting
The four standards of reporting require that the auditor consider each of the following issues
before rendering an audit report: (1) the financial statement are presented in accordance with
generally accepted accounting principles, (2) those principles are consistently applied, (3) all
informative disclosures have been made and (4) what degree of responsibility the auditor is
taking and the character of the auditor's work.
1.5 AUDITING PROFESSION IN ETHIOPIA
In Ethiopia audits seem to be done primary on account of government regulation. For example,
NGOS are audited because the assets of the NGOS are deemed a “national asset,” the use of
which is ultimately accountable to the government of Ethiopia.
Auditing in Ethiopia could be viewed in five main areas.

1. The office of the auditor general (OAG)
The powers and functions of the office of the OG are circumscribed through the proclamations
that established it, its sphere of activity lies in government audit.
2. The audit service corporation. The duty and functions of this entity involve mostly
commercial audits of commercial and productive enterprises wholly or partially owned
by government.
3. Private audit firms.
4. Ministry of finance audit and inspection.
Auditing activity in this area includes audit of ministries and government departments by
MF auditors and inspectors, including tax audit by Inland Revenue authorities.
5. State corporations’ and enterprises’ auditors.
These are audits performed by internal auditors within enterprise.
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 Check Your Progress Exercise
1. Discus what leads to the demand for auditing services in a free market economy?
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2. Define the three general types of audits and Auditors?
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3. What does the phrase systemic process means in the Auditing definition?
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4. List the established criteria other than GAAP that can be used to measure economic
information.
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SUMMARY
The primary reason for development of Auditing profession is the need of attest function. That
is, the need of Independent assurance of the reliability, credibility and quality of Information.
When certified public accountants attest to information they issue a report with a conclusion
about the reliability of a written assertion by management. In the case of financial statement
Audits, the Audit report most frequently includes an opinion about whether management is
financial statements conform to generally accepted accounting principles. Auditors also are being
asked to assume more responsibility for attesting to compliance with laws and regulations, and to
the effectiveness and Internal controls.
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Check list
Dear students tick “yes” or “no” to the following self check items. If your answer to
any one of the items is “no”, please go back and read the specific section again.
Number Can you Yes No
1 Discuss the types of Auditors and Audits
2 Differentiate general Accepted Audit standard
3 Define auditing
GLOSSARY
1. Assertion - are presentation or declaration, typically made by the management of entity.

2. Certified public Accountant (CPA) – A person licensed by the state to practice public
accounting is a profession, based on having passed the uniform CPA Examination and having
met certain educational and experience requirements.
3. Compliance Audit- An audit to maser the compliance of the organization with some
established criteria, for example, Laws and regulation.
4. Operational Audit- An analysis of department or other unit of business or governmental
organization to masseurs the effectiveness and efficiency of operation.
1.9 ANSWERS TO CHEEK YOUR PROGRAM QUESTION
1. The demand for Auditing in the free market economy economy among other includes:
- Control mechanism - to minimize bad consequences from the decisions
- to resole conflict of interest - to simplify completive
- to meet the regulatory requirements
1. The three general types of Audit are
a) Financial statements Audit b) compliance Audit and c) operational Audits
2. Systematic process in Auditing means that future should be a well – designed audit plan to
conduct an actual Audit.
3. These measuring criteria Include Laws and regulations, for compliance Audit; Plans and
standards or policies, programs, budgets, for operational Audits.
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1.10 MODEL EXAMINATION QUESTIONS
Instruction – choose the best answer for the following questions.
1. Independent Auditing can be best be described as:
A. A branch of accounting
B. A discipline which attests to the result‘s of accounting and other functional operations
and data.
C. A professional activity that measures and communicates financial and business data.
D. A regulatory function that prevents the issuance of Improper financial information.
2. An Independent Audit aids in the communication of economic data because the audit.
A. Confirms the accuracy of management of financial representations.
B. Lends credibility to the financial statements
C. Guarantees that financial data are fairly presented.
D. Assures the readers of financials that any fraudent activity has been corrected.
3. Operational auditing is oriented primarily toward:
A. Future improvements to accomplish the goals of management.
B. The accuracy of data reflected in managements financial records.
C. Verification that the company’s financial statements are fairly presented.
D. Past protection provided by existing Internal control
4. A typical objective of operational Audit is to determine whether an entities.
A. Internal control is adequately operating as designed.
B. Operational Information is in accordance with generally accepted governmental
standards.
C. Financial statements present fairly the results of operations.
D. Specific operating units are functioning efficiently and effectively.
5. Which of the following best describes the reason why an Independent auditor reports an
financial statements:
A. a management fraud may exist, and It is more likely to be defected by Independent
auditors.
B. Different Interest may exist between the company preparing the statements and the
persons using the statements.
C. A misstatement of account balances may exist, and It is generally corrected as result of
the Independent auditors work.
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UNIT TWO
PROFESSIONAL ETHICS AND LEGAL LIABILITIES OF
AUDITORS
Contents
Aims and Objectives
Introduction
2.1 The need for Professional Ethics
2.2 Code of professional conduct
2.3 Ethics for Internal Auditors
2.4 Legal liabilities of Auditors
2.5 Auditors’ liability to their clients under common law
2.6 Auditors’ liability to third parties under common law
Summary
Answer to Check Your Progress Exercises
AIMS AND OBJECTIVES
After you have completed this unit, you should be able to:
- explain what a profession means
- describe and explain GAAS
- describe the principles of professional conduct and ethics auditors follow
- Describe potential factors that can bring about legal liability on auditors and what
auditors can do to avoid legal liability.
INTRODUCTION
The work of an independent auditor is to express an objective opinion on financial statements of

an organization. To have this objectivity an auditor needs to have an independent physical and
mental attitude at all time in his work. This is one of the major ethical issues that auditors have to
deal with and need guidance on.
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This unit looks at the principles and guidelines that auditors frequently refer to when conducting
their audit work. Auditors can be charged or sued because of their work. This unit also looks at
why auditors can be charged and how they can avoid legal liability. In addition, the auditing
professional view on many aspects of the audit will be discussed.
2.1 THE NEED FOR PROFESSIONAL ETHICS
W
What do mean that professional ethics?
______________________________________________________________________________
______________________________________________________________________________
____________________________________.
A professional accountant should perform professional services with due care, competence and
diligence and has a continuing duty to maintain professional knowledge and skill at a level
required to ensure that a client or employer receives the advantage of competent professional
service based on up-to-date development in practice, legislation and techniques.
Auditing standards require auditors to have adequate educational requirement as well as other
moral and legal criteria fulfillment. The educational requirements are composed of theoretical
knowledge and practical experience
2.2 CODE OF PROFESSIONAL CONDUCT
All recognized professions have developed codes of professional ethics. Professional ethics refer
to the basic principles of right action for the member of a profession. Professional ethics may be
regarded as a mixture of moral and practical concepts. Thus the professional ethics of an
accountant would signify his behavior towards his fellows in the profession and other
professions and towards members of the public.
The fundamental purpose of such codes is to provide members with guidelines for maintaining a
professional attitude and conducting themselves in a manner that will enhance the professional
stature of their discipline.
The AICPA code of professional conduct considers the following to be followed by auditors
(accountants) in the conduct of professional relations with others.
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- Integrity: - An accountant should be straightforward, honest and sincere in his approach to
his professional work.
- Objectivity: - An accountant should be fair and should not allow bias to override his
objectivity. When reporting on financial statements, which come his review, he should
maintain an impartial attitude.
- Independence: - When in public practice, an accountant should both be and appear to be
free of any interest which might be regarded, whatever its actual effect, as being
incompatible with integrity and objectivity.
- Confidentiality: - A professional accountant should respect the confidentiality of
information acquired in the course of his work and should not disclose any such information
to a third party without specific authority or unless there is a legal or professional duty to
disclose.
- Technical standards: - An accountant should carry out his professional work in accordance
with the technical and professional standards relevant to that work.
- Professional competence: - An accountant has a duty to maintain his level of competence
throughout his professional career. He should only undertake works, which he or his firm
can expect to complete with professional competence.
- Ethical behavior: - An accountant should conduct himself with a good reputation of the
profession and refrain from any conduct, which might bring discredit to the profession.
- Contingent fess: - The AICPA code of professional conduct prohibits a CPA firm from
rendering any professional services on a contingent fee basis.
- Responsibilities to colleagues: - The auditor should promote cooperation and good relations
with other members of the profession.
- Advertising: - The advertising should not be false or misleading,” should not contravene
“professional good taste,” should not make “unfavorable reflection on the competence or
integrity of the profession,” and should not” involve a statement the contents of which”
cannot be substantiated.
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 Check Your Progress Exercise
1. What is the basic purpose of a code of ethics for a profession?
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2. Who makes the ultimate decision as to whether or not auditors maintain an appearance of
independence from their audit clients?
a. auditors
b. client
c. audit committee
d. publ i c
3. In which of the following situations would a CPA firm be in violation of the rules of
professional conduct in determining it fess?
a. A fee based on whether or not the auditor’s report leads to the approval of the client’s
application for a bank loan.
b. A fee to be established at a later date by the court due to the bankruptcy of the client.
c. A fee base on the nature of engagement rather than upon the actual time spent on the
engagement.
d. A fee based on the fee charged by the client’s former auditors.
2.3 ETHICS FOR INTERNAL AUDITORS
Can you identify the ethics of auditors?

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______________________________________________________________________________
_______________________________________________.
A profession is characterized by the following elements.
- Specialized body of knowledge
- Standard of qualification for admission
- Standard of conduct of behavior
- Level of status recognition
- Acceptance of social responsibility
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Special Body of Knowledge
A highly developed profession has a very highly specialized written body of knowledge. The
more the profession is highly developed the more specialized the body of knowledge and
voluminous requiring longer period of time to absorb. The body of knowledge is dynamic and in
constant development and growth and not static.
Standard of Qualification for Admission

A profession to be a profession must have well-recognized and accepted predetermined criteria
of qualification for admission into the profession. The standards include educational requirement
as well as other moral and legal criteria fulfillment. The education requirements are composed of
theoretical knowledge and practical experience. Usually the fulfillment of these requirements is
measured through tests of qualifying examinations to prove the consumption of the accumulated
body of knowledge that exist in the profession and competence in it.
Standard Conduct of Behavior

A profession has a standard conduct of behavior to be observed by the professional through
prescribed code of ethics that attempt to enforce general rules of conducts, and maximum and
minimum rules of competence and responsibility to client and colleagues. Good example of such
code of conduct is the 'Oath of Hypocrites', which is sworn by medical doctors at their
graduation.
Level of Status Recognition

The quality and level of professional services demanded by society determines the level of status
recognition to the profession. The level of status and recognition earned in a society is a function
of the quality of professional service rendered which in turn is a function of the standard of
professional qualification and the degree of the social, moral, and legal responsibility assumed.
The more rigorous are the standards of qualification and code of ethics needed for rendering the
professional services, the higher will be the level of status and recognition given to the
profession.
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Acceptance of Social Responsibility
A profession to be a profession must accept responsibility for the consequences of its action. Not
only legal responsibility, which arises out of the contractual obligation, but also moral
responsibility to the profession itself has a responsibility to assure the society of the quality of
services demanded and accept sanction for failure to do so.
We can find these characteristics in different stages of growth and development in various
professions. Some professions more than others seem to have attempted to fulfill some elements
better. The role of professional associations in the development of these is crucial. An
association is a body of professionals and it is this body that plays important role in prescribing
the professional standards and policing their implement ability.
2.4 LEGAL LIABILITY OF AUDITORS

 Can you identify the legal liabilities of auditors?
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________
The auditor is responsible for his report; he is not responsible for the financial statements, which
are the representations of management. However, the auditor can be sued for causing damage to
users of his audit report if he doesn't carry out his work properly. In other words, auditors face
legal liability if they conduct their work negligently. Legal liability means the probability that an
auditor would be liable to a legal (court) action for not performing his duties well.
In order to understand this section, you have to know the meaning of the following words as they
are used in the context of auditor's legal liability.
- Breach of Contract: when the auditor/client fails to meet the terms and obligations stated
in the contract for audit.
- Ordinary Negligence: an absence of reasonable or due care in performing an audit. An
auditor is negligent when she fails to do what other professional accountants would have
done under similar circumstances.
Eg. Failure to detect that there was an error in computing depreciation.
- Gross Negligence: an extreme deviation from professional standards of due care.
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Eg. Discovering but taking no action about management theft or fraud because of
carelessness.
- Fraud: wrongful actions taken with the intent of deceive client, the one whose financial
statements are being audited.
- Third Party: the contract for the audit is signed by the auditor and the client others who
have interest are referred to as third parties
Eg. Creditors, investors, potential investors etc
The following table summarized the auditor's legal liability.

The auditor can be charged by For
- Client - Breach of contract
- Negligence (gross and ordinary
negligence)
- A third party known to rely on the - Negligence (gross and ordinary
auditor's report for a particular purpose negligence)
- Fraud
- Foreseen third parties - Gross negligence
- Fraud
- Reasonably foreseeable third parties - Gross negligence
- Fraud
For any of the above parties to be able to successfully sue the auditor, they should be able
to show that:
1. The auditor had a duty to do something
2. He did not perform his duty
3. The plaintiff (person suing the auditor) relied on the work of the auditor.
The plaintiff suffered a loss as a result of relying on the auditor's work..
Liable for what?
The CPA can be sued under the following legal concepts.
(i) Prudent man concept: - The auditor is responsible for exercising due professional
care, and he is subject to lawsuit if he fails to do so.
20
(ii) Liable for acts of others: - The partners are jointly liable for civil actions against a
partner.
(iii) Lack of privileged communication: - CPAS do not have the right under common
law to withhold information from the courts on the grounds that the information is
privileged.
Definition of Terms
Negligence: is violation of legal duty to exercise a degree of care that an ordinary prudent
person would exercise under similar circumstances with resultant damages to another party.
Gross negligence: is lack of event slight care. Many jurisdictions consider gross negligence
equivalent to constructive fraud.
Fraud: is defined a misrepresentation by a person of a material fact, known by that person to be

untrue.
Constructive fraud: differs from fraud as defined above in that constructive fraud does not
involve a misrepresentation with the intent to deceive.
Privity: is the relationship between parties to a contract.
Breach of contact: is failure of one or both parties to a contract to perform in accordance

with the contract’s provisions.
Proximate cause: exists when damage to another is directly attributable to a wrongdoer’s act.
Contributory negligence: is negligence on the part of the client that has contributed to his or her
having incurred a loss.
2.5 AUDITORS LIABILITY TO THEIR CLIENT UNDER COMMON LAW

When CPAS take on any type of engagement, they are obliged to render due professional care.
This obligation exists whether or not it is specifically set forth in the written contract with the
client. Thus, CPAS are liable to their clients for any losses proximately caused by the CPA’S
failure to exercise due professional care. That is to recover its losses; an injured client need only
21
prove that the auditors were guilty of negligence and that the auditors’ negligence was the
proximate cause of the client’s losses.
Possible Changes by a Client
a) For breach of contract
The auditor would be sued for breach of contract if he fails to complete the service agreed to
in the contract with the client. E.g. If the auditor discontinues an audit without adequate
cause, or fails to submit the audit report before or on the deadline, he may be asked to repay a
part or the entire fee.
b) For ordinary or gross negligence
Auditors can be sued for negligence by their clients when they fail to show due care, i.e, a
level of carefulness usually possessed by others in the profession. For example, the client
may charge the auditor for not detecting a major fraud by one employee or for letting a
confidential information leak out.
2.6 AUDITORS LIABILITY TO THIRD PARTIES UNDER COMMON LAW

Bankers and other creditors or investors who utilize financial statements covered by an audit
report can recover damages from the auditors if it can be shown that the auditors were guilty of
fraud or gross negligence in the performance of their professional duties.
Moreover, the auditors can be held liable for negligence to a limited class of third parties if the
auditors have actual knowledge of such third parties or if there exists a special relationship
between the auditors and the third parties.
The clients (plaintiffs) must prove that they sustained losses that they relied on the audited
financial statements, which were misleading, that this reliance was the primate cause of their
losses, and that the auditors were negligent.
Possible Charges by Third Parties
The auditor can be charged by third parties that the auditor knows would rely on his report for
negligence and fraud.
For example, Albo Co. engaged Bolke, a CPA, to audit its financial statements telling him that
they need the report to obtain a loan from a bank. In this case, Bolke can be held liable for both
22
ordinary and gross negligence to the bank in case the bank suffers a loss as a result of relying on
the auditor's opinion.
On the other hand, third parties that the auditor doesn't know would use his report can charge the
auditor and recover any losses only for gross negligence and fraud. But, the question would be
how is ordinary negligence differs from gross negligence?
Say financial statements have been deliberately overstated by management to deceive users. The
auditor has a duty to discover this. If the auditor applies GAAS properly and simply doesn't
suspect the fraud, he can only be accused of ordinary negligence. However, if the auditor
suspected that there was fraud but did not do additional investigation to try to uncover the fraud,
he can be accused of gross negligence.
If the auditor actually discovered the fraud and did not mention this in his audit report, in this
case he is participating in the fraud himself (i.e., constructive fraud).
Auditors’ responsibility for the detection of fraud and error
The detection and prevention of error and fraud is the management’s responsibility by designing
and implementing appropriate internal control systems. The auditor is not responsible for the
prevention and detection of error and fraud. The auditor is responsible to design audit
procedures to reduce the risk of not detecting a material error or fraud, to an appropriate level to
provide reasonable assurance. Accordingly, the auditor must exercise due care in planning,
performing, and evaluating the results of audit procedures.
Check Yourr Progress Exercise

1. A CPA firm will be liable for any fraudulent scheme it does not detect.
a) true
b) false
2. A CPA firm will not be liable if it can show that it exercised the ordinary care and skill of a
reasonable man in the conduct of its own affairs.
a) true
b) false
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SUMMARY
- A person is ineligible to act as auditor if he is an employee or officer or has various other

close connections with the company.
- Recognized supervisory bodies must follow a number of procedures to ensure their members
are fit and proper and competent and that audit work is conducted properly.
- Accounting standards are set by the Accounting Standards Board and have a direct impact on
the accounts on which auditors are reporting.
- The Auditing practices Board takes account of standards set by the International Auditing
Practices Committee when setting Auditing standards.
- Independence and objectivity are the most important characteristics of auditors.
- Potential threats to objectivity include:
o Undue dependence, on audit client
o Family and other personal relationships
o Beneficial interests in shares
o Acceptance of hospitality
o Provision of other services
- Auditors have a professional duty of confidentiality. However, they may be compelled by
law or consider it desirable in the public interest to disclose details of client's affairs to third
parties.
- Auditors can be sued for causing damage to users of his audit report if he does not carry out
his work properly.
Check list
- Dear students tick “yes” or “no” to the following self check items. If your answer to
- Any one of the items is “no”, please go back and read the specific section again.
Number Can you Yes No

1 Discuss professional ethics
2 Identify ethics of auditors
3 identify the legal liabilities of auditors
24
Check Your Progress Exercise
1. What is the definition of closely connected persons?
………………………………………………………………………………………………………
………………………………………………………………………………………………………
………………………………………………………………………………………
2. Under what circumstances is the auditor permitted to breach client confidentiality?
………………………………………………………………………………………………………
………………………………………………………………………………………………………
………………………………………………………………………………………
3. List the characteristics that make a profession a profession?
………………………………………………………………………………………………………
………………………………………………………………………………………………………
………………………………………………………………………………………
4. Why do Auditors need independence?
………………………………………………………………………………………………………
………………………………………………………………………………………………………
………………………………………………………………………………………
4. What are the major professional qualification requirements of auditor?
………………………………………………………………………………………………………
………………………………………………………………………………………………………
………………………………………………………………………………………
5. List the ten Generally Accepted Auditing Standards.
………………………………………………………………………………………………………
………………………………………………………………………………………………………
………………………………………………………………………………………
6. What are the potential threats of objectivity?
………………………………………………………………………………………………………
………………………………………………………………………………………………………
………………………………………………………………………………………
7. Under what circumstances the auditor can charged by (a) a client, (b) third party?
25
UNIT THREE
AUDI T E VI DE N CE
Contents
Aims and Objectives
Introduction
3.1 Audit Evidence
 Sufficient Appropriate Audit Evidence
 Reliability of Evidence
 Procedures for Obtaining Audit Evidence
3.2 The relationship of evidence to audit risk
3.3 Sufficient Competent Evidential Matter
3.4 Types of audit evidence
3.5 Evidence about Accounting Estimates
3.5 Evidence about Accounting Estimates
3.6 Evidence for Related Party Transactions
Summary
Answer to Check Your Progress Exercise
AIMS AND OBJECTIVES
- distinguish between the concepts of competence and sufficiency as they apply to audit
evidence
- describe the type of procedures used to obtain audit evidence
- list and describe the various types of evidence
- describe the auditors' approach to auditing accounting estimates
- describe the functions of audit working papers
- Discuss the factors that affect the auditor’s judgment as to the quantity, type and content
of the working papers.
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INTRODUCTION
Before we can start the audit, we must determine what kind of evidence we are looking for:
particularly what kind of evidence would satisfy an auditor and what kinds would not. In the
exam you might be asked to make judgments on the strength of particular types of evidence.
We also introduce the financial statement assertions. These will be particularly important when
we consider balance sheet testing, since the balance sheet tests are designed to obtain sufficient
evidence about the assertions in each area.
We will then look at how audit evidence is documented and the kind of working papers which
should be kept on file.
3.1 AUDIT EVIDENCE

 Can you define audit evidence?
______________________________________________________________________________
______________________________________________________________________________
__________________________________________.
Audit evidence is the information auditors obtain in arriving at the conclusion on which their
report is based. Audit evidence comprises source documents and accounting records underlying
the financial statement assertions and corroborative evidence from other sources.
Auditors should obtain sufficient appropriate audit evidence to be able to draw reasonable
conclusions on which to base the audit opinion.
Audit evidence can be obtained in many ways, often with a mix of tests of controls and
substantive procedures, although sometimes only substantive procedures will be used along with
requires as to the adequacy of the accounting system as a basis for the preparation of the
financial statements.
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3.2 THE RELATIONSHIP OF EVIDENCE TO AUDIT RISK
During financial statement audits, the auditors gather and evaluate evidence to form an opinion
on whether financial statements follow the appropriate criteria, usually GAAP.
Gathering sufficient appropriate audit evidence is the very essence of auditing. The third
standard of fieldwork states:
Sufficient appropriate evidence should be obtained by such means as inspection, observation,

enquiry, confirmation, computation and analysis, to afford a reasonable basis to support the
content of the report
The auditor’s judgment as to what constitutes sufficient appropriate evidence is influenced by
such factors as:
a. Materiality of the item.
b. Inherent risk and control risk considerations.
c. The experience gailed during previous audit examination as to the reliability of the
client’s records and representation.
d. The persuasions of the evidence.
e. Fraud or error while performing as audit procedures.
Audit risk was defined as the likelihood that an auditor may unknowingly fail to modify his or
her opinion on materially misstated financial statements. Audit risk is a combination of two
components.
The risks that material errors will occur in the process which financial statements are developed.
These can be classified further into control risk and inherent risk. The risk that any material
errors that occur will not be detected by the auditor is called detection risk.
Control risk
The first of these two components, the risk that errors will occur, can be calcified further in to
control risk. Control risk represents the risk that errors could occur, and would not be prevented
or detected by the entity’s internal controls .For example, control risk would be increased if an
entity did not maintain effective physical controls over blank checks.
28
Inherent risk
Inherent risk represents the susceptibility of an account balance to errors that could be material
and that are not monitored by related control procedures. For example, inherent risk is often
higher for liquid assets, such as cash, than for non liquid assets, such as property, plant, and
equipment. Because neither controls risk that material errors will occur-the first component of
audit risk-is not directly controllable by the auditor.
Detection risk
The second component of audit risk that material errors will not be detected is referred to as
detection risk. It is the risk that material errors will not be detected is referred to as detection
risk. It is the risk that errors could occur but would not be detect by the auditors procedures.
The risk that material errors will not be detected is directly controllable by the auditor through
substantive tests of details and other substantive audit procedures. For example, if both control
risk and inherent risk are high an auditor could reduce allowable detection risk by increasing
sample size.
3.3 SUFFICENT COMPETENT EVIDENTIAL MATTER
The reliability of audit evidence is influenced by its source (internal or external) and by its nature
(visual, documentary or oral). The following generations may help in assessing that reliability.
a) Audit evidence from external sources (e.g., confirmation received from a third party) is
more reliable than that obtained from the entity's records.
b) Audit evidence obtained from the entity's records is more reliable when the related
accounting and internal control system operates effectively.'
c) Evidence obtained directly by auditors is more reliable than that obtained by or from the
entity.
d) Evidence in the form of documents and written representations is more reliable than oral
representations.
e) Original documents are more reliable than photocopies, telexes or facsimiles.
Consistency of audit evidence from different sources will have a corroborating effect, making the
evidence more persuasive. Where such evidence is inconsistent, the auditors must determine
what additional procedures are necessary to resolve the inconsistency.
Auditors must consider the cost-benefit relationship of obtaining evidence but any difficulty or
expense is not in self a valid basis for omitting a necessary procedure.
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3.4 TYPES OF AUDIT EVIDENCE
IIdentify types of auditors?
______________________________________________________________________________
_________________________________________________
When auditors are employed to express an opinion on the financial statements of an entity, they
must ensure that they have sufficient competent evidence on which to base such an opinion. In
this unit you will learn to answer the question what constitute sufficient competent evidence.
Audit evidence is a fundamental concept in auditing. Audit evidence consists of underlying

accounting data and all corroborative information available to the auditor.
Both categories of evidential matter are required in making an audit in accordance with GAAS.
The principal types of corroborating information areas follow:
Analytical evidence
Analytical evidence involves comparison of current period client data, such as total revenues or
return on assets, with expected values for the data based on (1)historical or budgeted amounts for
the client or (2) industry data.
The reliability of analytical evidence is dependent on the relevance of the comparable data.
Documentary Evidence
Documentary evidence includes a wide variety source documents as well as such items as
minutes of board of director or executive committee meetings, lease agreements various other
contracts, and bank statements.
Confirmations
Confirmations constitute a special class of documentary evidence involving direct written
responses by knowledgeable third parties to specific requests for factual information.
Written representations
Written representations are signed statements by responsible and knowledgeable individuals that
bear on one or more of management’s assertions.
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Mathematical evidence
Mathematical evidence results from recompilations by the auditor and comparison of those
results the client’s computations.
Oral evidence
During the audit, an auditor receives oral responses to numerous inquiries directed to officers
and employees of the client and others.
Physical evidence
Physical evidence is obtained from the physical examination or inspection of tangible asset
3.5 EVIDENCE ABOUT ACCOUNTING ESTIMATES
The auditors must be especially careful in considering financial statement accounts that are
affected by estimates made by management (often referred to accounting estimates) particularly
those for which a wide range of accounting methods are considered acceptable. Examples of
accounting estimates include allowances for loan losses and obsolete inventory, and estimates of
warranty liabilities. Making accounting estimates is management's responsibility, and such
estimates are generally more susceptible to material misstatement than financial statement
amounts, which are more certain in amount. Standard of auditing requires the auditors to
determine that
a) all necessary estimates have been developed
b) the accounting estimates are reasonable, and
c) The accounting estimates are properly accounted for and disclosed.
Determining whether all necessary estimates have been developed and accounted for properly
requires knowledge of the client's business and the applicable generally accepted accounting
principles. When evaluating the reasonableness of accounting estimates, the auditors may use
one or more of the following three basic approaches:
1. Reviewing and testing management's process of developing the estimates – this will often
involve evaluating the reasonableness of the steps performed by management.
2. Independently developing an estimate of the amount to compare to management's estimate.
3. Reviewing subsequent events or transactions bearing on the estimate, such as actual
payments of an estimated amount made subsequent to year-end.
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3.6 EVIDENCE FOR RELATED PARTY TRANSACTION
 Identify Auditors obtain evidence procedures?
______________________________________________________________________________
______________________________________________________________________________
________________________________________________.
Auditors obtain evidence by one or more of the following procedures.
a) Inspection
b) Observation
c) Enquire and confirmation
d) Computation
e) Analytical procedures
a) Inspection
Inspection of records and documents involves inspecting documents, which demonstrate that
a transaction has occurred or is valid, or a balance exists. It may also involve comparing
documents to see that the information contained in both is consistent.
Inspection is an important test of control in that it can be used to test whether documents
such as invoices have been properly authorized. It can also highlight whether a transaction in
the accounting records does not relate to the client, for example a transaction supported by an
invoices which is not addressed to the client.
The reliability of audit evidences obtained by inspection of records and documents varies
according to the nature/source and effectiveness of internal control over their processing.
Three major categories of documentary evidence exist, given here in descending degrees of
reliability as audit evidence.
ii) created and provided to auditors by third parties
iii) created by third parties and held by the entity
iv) created and held by the entity
32
Inspecting of tangible assets provides reliable audit evidence about their existence but not
necessary as to their ownership or value. (The assets' appearance may indicate they are
obsolete, but more work will be required to confirm exact valuation).
b) Observation
Observation involves looking at a procedure being performed. Examples of observation are
attendance at the stock taker or at the opening of post.
In some ways observation gives limited assurance since it only provides evidence of how the
procedure was performed when the auditor was watching client staff may have been on their
best behavior on that occasion and be less conscientious of other items.
c) Enquires and Confirmation

Enquiries involve seeking information from the client's staff or external sources. Enquiries
may range from formal written ones to third parties to oral ones to person inside the entity
response may provide auditors with.
i) information not previously possessed; or
ii) corroborative audit evidence
The strength of the evidence depends on the knowledge and integrity of the source.
Confirmation aim to verity what is shown in the client's accounting records. Examples of
confirmations include direct confirmation of debts by debtors of the clients or bank balances
by the entity's bank.
d) Computation
Computations involve the auditor checking the arithmetic of the client's records or carrying
out other relevant calculations. Examples of computations include the adding up of bank
reconciliation or ledger accounts.
33
e) Analytical Procedures
Analytical procedures are the analysis of relationships.

i) between items of financial data, or between items of financial and non-financial data,
deriving from the same period; or
ii) Between comparable information deriving from different periods to identify
consistencies and predicted patterns or significant fluctuations and unexpected
relationships, and the results of investigation thereof.
Sufficient Appropriate audit evidence

'Sufficiency and appropriateness' are interrelated and apply to both tests of controls and
substantive procedures.
a) Sufficiency is the measure of the quantity of audit evidence.
b) Appropriateness is the measure of quality or reliability of the audit evidence.
Auditors are essentially looking for enough reliable audit evidence. Audit evidence usually
indicates what is probable rather than what is definite (is usually persuasive rather than
conclusive) so different sources are examined by the auditors. However, auditors cannot give
absolute but only reasonable assurance that the financial statements are free from misstatement,
so not all sources of evidence are examined.
Sufficiency of Audit Evidence
The auditor judgment as to what is sufficient appropriate and evidence is influenced by factors
such as the following.
a) The assessment of the nature and degree of risk of misstatement at both the financial
statement level and the account balance or class of transactions level.
b) The nature of the accounting and internal control system, including the control
environment.
c) The materiality of the item being examined.
d) The experience gained during previous audit and the auditors' knowledge of the business
and industry.
e) The results of audit procedures, and from any audit works carried out in the course of
preparing the financial statements, including indications of fraud or error.
f) The source and reliability of information available.
34
If they are unable to obtain sufficient appropriate audit evidence, the auditors should consider the
implications for their report.
Tests of Control
In seeking to obtain audit evidence from tests of control, auditors should consider the
sufficiency and appropriateness of the audit evidence to support the assessed level of controls
risk.
There are two aspects of the relevant parts of the accounting and internal control systems about
which auditor should seek to obtain audit evidence.
a) Design: the accounting and internal control systems are capable of preventing or
detecting material misstatements.
b) Operation: The system exists and has operated effectively throughout the relevant period.
Substantive Procedures
In seeking to obtain audit evidence from substantive procedures, auditors should consider the
extent to which that evidence together with any evidence from test of control supports the
relevant financial statement assertions.
Substantive procedures are designed to support the financial statement assertions.
Financial statement assertions are the representations of the directors that are embodied in the
financial statements. By approving the financial statements, the directors are making
representations about the information therein. These representatives or assertions may be
described in general terms in a number of ways, one of which is as follows.
- Existence: an asset or liability exists at a given date
- Right and obligations: an asset or liability pertains to the entity at a given date
- Occurrence: a transaction or event took place which pertains to the entity during the
relevant period
- Completeness: there are no unrecorded assets, liabilities, transactions or events or
undisclosed items
- Valuation: an asset or liability is recorded at an appropriate value.
- Measurement: a transaction or even is recorded in the proper amount and revenue or
expense is allocated to the proper period.
35
- Presentation and disclosure: an item is disclosed, classified and described in accordance
with the applicable reporting framework. (eg. Relevant legislation and applicable
accounting standards).
- Audit evidence: is usually obtained to support each financial statement assertion and
evidence from one does not compensate for failure to obtain evidence for another.
However, tests may provide audit evidence of more than one assertion.
- Where tests of control provide satisfactory evidence as to the effectiveness of accounting
and internal control system, the extent of relevant substantive procedures may be
reduced, but not entirely eliminated. Substantive procedures may also be incorporated
within other procedures such as test of control.

1. Define 'sufficiency and appropriateness' in relation to audit evidence.
………………………………………………………………………………………………………
………………………………………………………………………………………………………
………………………………………………………………………………………
2. What generalizations are made in relation to the sources and nature of audit evidence?
………………………………………………………………………………………………………
………………………………………………………………………………………………………
………………………………………………………………………………………
3. What are the main procedures for obtaining audit evidence?
………………………………………………………………………………………………………
………………………………………………………………………………………………………
………………………………………………………………………………………
36
SUMMARY
The auditors must be able to evaluate all types of audit evidence in terms of its sufficiency and
appropriateness. Evidence can be in the form of tests of controls or substantive procedures.
Tests of controls concentrate on the design and operation of controls. Substantive testing aims to
test all the financial statement assertions.
- Existence
- Rights and obligations (ownership)
- Occurrence
- Completeness
- Valuation
- Measurement
- Presentation and disclosure
The reliability of audit evidence is influenced by its source and by its nature. Audit evidence can
be obtained by the following techniques.
- Inspection
- Observation
- Enquiry and confirmation
- Computation
- Analytical procedures
The proper completion of working papers is fundamental to the recording of the audit. They
should show when and by whom the work was performed and reviewed.
37
UNIT FOUR
AUDIT PLANNING PROCESS
Contents
Aims and Objectives
Introduction
4.1 Client acceptance procedure
4.2 Obtaining the engagement
4.3 Audit planning
4.4 Designing Audit programs
4.5 Audit process
Summary
AIMS AND OBJECTIVES
When you have completed this unit, should be able to:
- explain the auditor's responsibilities when planning the audit
- understand the concept of materiality and how materiality is assessed
- describe the manner in which an audit is affected by the auditor's assessment of audit risk
and materiality
- identify and explain the components of audit risk
- describe the general objectives of audit programmers for financial statement accounts
- describer the major steps in the audit process
INTRODUCTION
How do auditors determine whether a prospective client is reputable? After accepting an audit
client, how do auditors go about planning the engagement and preparing the initial audit
programmer? When one considers the professional responsibility and potential legal liability
involved, it becomes obvious that auditors do not merely accept at new audit client and then
arrive at the client's premises to "start auditing." The first examination standard states:
The audit work should be adequately planned and properly executed. If assistants are employed,
they should be properly supervised.
38
The concept of adequate planning includes investigating a prospective client before deciding
whether to accept the engagement, obtaining an understanding of the client's business operations,
and developing an overall strategy to organize, coordinate, and schedule the activities of the
audit staff. Although much planning is done before beginning the actual audit work, the planning
process continues throughout the engagement. Whenever a problem is encountered during the
audit, the auditors must plan their response to the situation.
In planning the audit, the auditor needs to consider the following:
- the terms of the engagement and the expected date of the report
- the nature of the client's business, including applicable statutory and contractual
requirements
- the experience gained during previous audit engagements
- the accounting policies and degree of complexity of the accounting system
- materiality and the components of audit risk
- any involvement of other auditors
- any involvement of internal auditors and persons having special expertise
- the intended reliance on internal control
- the level of experience and the number of audit staff for the engagement
- The timing and effectiveness of performing the audit procedures.
4.1 CLIENT ACCEPTANCE PROCEDURE
 Can you identify client acceptance procedure?
______________________________________________________________________________
_______________________________________________________________.
Auditors should have or obtain knowledge of the business of the entity to be audited, which is
sufficient to enable them to identify and understand the events, transactions and practices that
may have a significant effect on the financial statements or the audit thereof.
Obtaining the knowledge
This is discussed in three stages:
a) prior to acceptance of an engagement
b) following acceptance of an engagement; and
c) Updating knowledge for succeeding periods.
39
Prior to acceptance of the engagement
The auditors must, at this stage, obtain a 'preliminary knowledge the industry and of the
ownership, directors, management and operations of the entity to be audited.
Following Acceptance of an Engagement
Obviously, the auditors can obtain more detailed knowledge after they have accepted the
appointment. As much knowledge should be acquired as early as possible, at the start of the
engagement. However, the process should be seen as being 'continuous and cumulative',
allowing reassessment at all stages of the audit.
Updating Knowledge for Succeeding Periods
Auditors should consider the information gathered previously and perform procedures designed
to identify any significant changes since the last audit.
Sources of Knowledge
a) previous experience of the client and its industry
b) visits to the client's premises and plant facilities
c) discussion with the client's staff and directors
d) discussion with other auditors and with legal and other advisors who have provided
services to the client or within the industry
e) Publications related to the industry (e.g. Government statistics, surveys, texts, journals,
financial newspapers)
f) legislation and regulations that significantly affect the client
g) Documents produced by the client (e.g. Minutes of meetings)
h) Professional literature giving industry specific guidance.
Matters to Consider in Relation to Knowledge of the Business
- General economic factors
- The industry: conditions affecting the client's business
- The entity: directors, management and ownership
- The entity's business: products, markets, suppliers, expenses and operations
- Financial performance: factors concerning the entity's financial condition and
profitability
- Information technology
- Reporting environment: external influences which affect the directors in the preparation
of financial statements.
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Using the Knowledge
Having obtained knowledge relating to the entity discussed above, the auditors must use it:
a) to assess risks and identify problems
b) to plan and perform the audit effectively and efficiently and
c) to evaluate audit evidence.
The audit areas subject to judgment which may be affected by knowledge of the business are as
follows.
a) developing the overall audit plan and the audit programmers
b) Considering risks pertaining to the entity's business activities and the directors' response
thereto.
c) assessing inherent risk and control risk
d) determining a materiality level and assessing whether the materiality level chosen remain
appropriate
e) identifying areas where special audit, considerations and skills may be necessary
f) assessing audit evidence to establish its appropriateness and the validity of the related
financial statement assertions
g) evaluating accounting estimates and representations by the directors or management
h) making informed enquires and assessing the reasonableness of answers
i) Considering the appropriateness of accounting policies and financial statement
disclosures.
Communication of Knowledge
Knowledge of the entity can only be used effectively if it is communicated to members of the
audit team. The audit engagement partner should ensure that the audit team obtains such
knowledge of the business of the entity being audited as many reasonably be expected to be
sufficient to enable it to carry out the audit work effectively.
Such information will usually be provided in the planning documentation, but the partner should
ensure that staff regularly shares any subsequent knowledge they have gained with the rest of the
team
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Determine Acceptable
Audit Risk (Say 5%)
Investigate an d
Consider Industry
document internal
an d other
controls
background
Assess Control
information
Access Risk
Inherent
Risk
Test Controls
Calculate
Perfection
Risk Reassess
Control Risk
Design
substantive
tests based
on detection
risk
4.2 OBTAINING THE ENGAGEMENT
After the auditors have collected the necessary information on the potential client, they will be in
a position to assess the various risk involved with the audit and determine whether to attempt to
obtain the engagement. Often they will be asked to submit a proposal which will include
information on the nature of services that the firm will offer, the qualification of the firm’s
personnel, and other information to convince the prospective client to select the firm.
Fee arrangement: when the business engages the services of independent public accountant, it
will usually ask for an estimate of the cost of the audit.
42
Engagement letter: The preliminary understandings with the client should be summarized by the
auditors in an engagement letter, making clear the nature of the engagement, any limitations on
the scope of the audit, work to be performed by the client’s staff, schedule dates for performance
and completion of examination, and the basis for computing the auditors’ fee.
4.3 AUDIT PLANNING
Define audit planning?
______________________________________________________________________________
______________________________________________________________________________
_________________________________.
Once the client has been obtained, the planning process intensifies as the auditors concentrate
their efforts on obtaining a detailed understanding of the client business and developing an
overall audit strategy.
Audit planning involves the planning of the examination process, which includes preparation of
audit programmer, identification of audit approach, selection of staff for formation of an audit
team, determining procedures and techniques to be adopted, flow charting clients' organization
structure and management information cycle, and preparation of a time-table for critical audit
events.
An effective and efficient audit relies on proper planning procedures. Auditors should plan the
audit work so as to perform the audit in an effective manner.
The objectives of planning work involve:
a) ensuring that appropriate attention is devoted to the different areas of the audit
b) ensuring that potential problems are identified; and
c) facilitating review
Good planning helps in assigning those proper tasks to the members of the audit team,
coordinating outside experts, etc. All members of the audit team must have an understanding of
the entity's affairs.
Planning procedures will depend on the size of the entity. Audit procedures should be discussed
with the client's management, staff and/or audit committee in order to coordinate audit work,
including that of internal audit. However, all audit procedures remain the responsibility of the
external auditors.
A structured approach to planning will include the following stages:
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a) updating knowledge of the client by:
- reviewing engagement letters
- reviewing the client's business
- reviewing current operations
- preliminary client meeting
b) preparing the detailed audit approach considering risk, materiality, analytical procedures
c) Making administrative decisions such as drafting and budget.
. Audit evidence is usually persuasive rather than conclusive so some detection risk is usually
present, allowing the auditors to see 'reasonable confidence.'
The auditors' inherent and control risk assessments influence the nature, timing and extent of
substantive procedures required to reduce detection risk and thereby audit risk. Misstatements
discovered in substantive procedures may cause the auditors to modify their previous assessment
of control risk.
Regardless of the assessed levels of inherent and control risks, auditors should perform some
substantive procedures for financial statement assertions of material account balances and
transaction classes.
Substantive procedures can never be assessed at a low enough level, although substantive
procedures may be restricted to analytical procedures if appropriate.
Where the auditors' assessment of the components of audit risk changes during the audit, they
should modify the planned substantive procedures based on the revised risk levels.
When both inherent and control risks are assessed as high, the auditors should consider whether
substantive procedures can provide sufficient appropriate audit evidence to reduce detection risk,
and therefore audit risk, to an acceptably low level. For example, they may not be able to obtain
sufficient evidence about the completeness of income in the absence of some internal controls.
When auditors determine that detection risk regarding a material financial statement assertion
cannot be reduced to an acceptably low level, they should consider the implications for their
report.
4.4 DESIGNING AUDIT PROGRAMMES
An audit program is a detailed list of audit procedures to be performed in the course of the
examination. An audit program is designed to accomplish certain objectives with respect to each
44
major account in the financial statements. These objectives follow directly from the assertions
that are contained in the client’s financial statements
An audit programmer is a set of instructions to the audit team that sets out the audit procedures
the auditors intend to adopt and may include references to other matters such as the audit
objectives, timing, sample size, and basis of selection for each area. It also serves as a means to
control and record the proper execution of the work.
Auditors should develop and document the nature, timing and extent of planned audit procedures
required to implement the overall audit plan.
The auditors must, when developing the audit plan, consider the risks of error as well as the
necessary audit evidence required to fulfill the procedures. Other considerations include:
a) coordination of audit work with any work on preparing the financial statements
b) timing of tests of controls and substantive procedures
c) coordination of any assistance expected from the entity
d) the composition of the audit team; and
e) The involvement of other auditors or experts.
The audit programmer may contain references to other matters such as the audit objectives,
timing, sample size and basis of selection for each area. It serves as a set of instructions to the
audit team and as a means to control and record the proper execution of the work.
The level of detail and complexity depends not only on the complexity and size of the audit, but
also the experience of the members of the audit team and the extent of other documentation.
4.5 AUDIT PROCESS
In the early stages of an audit, the external auditors must become familiar with many aspects of
the client’s business. For example, the auditors must obtain knowledge of the client’s
organization plan, financial structure, physical facilities, products, accounting policies, and the
control procedures. However, information about the internal activities of the client is not in itself
sufficient.
45
If this information is to be interpreted and evaluated in a proper perspective, the auditor must
also understand the business environment in which the client operates. The auditors can gain
considerable information about both the client’s business environment and internal operations by
examining the client’s general records. The term general records is used to include the following
categories:
1. Non-financial records
 Articles and certificates of corporations and bylaws
 Partnership contract
 Minutes of directors and shareholders’ meetings
 Contracts with customers and suppliers
 Contracts with officers and employees
 Government regulations directly affecting the enterprise
 Correspondence files
2. Financial records
 Income tax returns of prior years.
 Financial statements and annual reports of prior years.
3. Accounting records
 General ledger.
 General journal.
1. Identify the two categories of evidential matter.
………………………………………………………………………………………………………
………………………………………………………………………………………………………
………………………………………………………………………………………
2. List the types of corroborative information that may be obtained in an audit.
………………………………………………………………………………………………………
………………………………………………………………………………………………………
………………………………………………………………………………………
3. What are the objectives of planning work?
46
………………………………………………………………………………………………………
………………………………………………………………………………………………………
………………………………………………………………………………………
4. What kind of knowledge should the auditors attempt to obtain prior to acceptance of an audit
appointment?
………………………………………………………………………………………………………
………………………………………………………………………………………………………
………………………………………………………………………………………
SUMMARY
The auditors will formulate an overall audit plan, which will be translated into a detailed audit
programme for the audit staff to follow.
In formulating the audit plan the auditors will consider:
- knowledge of the entity's business
- risk and materiality
- nature, timing and extent of procedures; and
- Coordination, direction and supervision and review.
Any changes in the audit approach during the audit should be documented very carefully. When
a new client is acquired the auditors must obtain knowledge of the business from various
sources.
Important aspects of knowledge of the business are:
- the industry
- directors, managers and ownership
- products, markets, suppliers, expenses and operations
- financial performance
- Reporting environment.
Audit is the risk that the auditors may give an inappropriate opinion on the financial statements.
A risk-based audit will make use of the risk model to determine the amount and extent of audit
testing. Audit risk comprises inherent, control and detection risk.
Materiality should be calculated at the planning stages of all audits. The calculation or estimation
of materiality should be based on experience and judgment. The materiality level chosen be
reviewed during the audit.
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UNIT FIVE
INTERNAL CONTROL
Contents
Aims and Objectives
Introduction
5.1 The Meaning and objective of Internal Control
5.2 Types of internal control
5.3 Control Environment
5.4 Risk Assessment
5.5 Control activities
5.6 Monitoring
5.7 The Auditors Consideration of Internal Control
Summary
AIMS AND OBJECTIVES

- define what is meant by internal control
- describe management's responsibility for internal control
- distinguish among the major components of a client's internal control structure: the
control environment, risk assessment, the (accounting) information and communication
system, control activities, and monitoring
- explain the characteristics of effective internal control
- describe the auditor's consideration of the internal control structure
- discuss the techniques used by auditors to obtain an understanding of internal control and
describe the results in their working papers
- Describe the auditor's responsibility for communication of internal control structure
related matter.
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INTRODUCTION
Our consideration of internal control in this unit has three major objectives. First to explain the
meaning and significance of internal control, second, to discuss the major components of a
client's internal control structure; and third, to show how auditors go about obtaining an
understanding of internal control to meet the requirements of the second standard of field work.
An attempt is made in this unit to present in brief the internal control procedures applicable to
particular kind of assets or liabilities or to particular types of transactions, such as purchases or
sales.
Internal control has attained greatest significance in large-scale business organizations.

Accordingly, the greater part of the discussion in this unit is presented in terms of the large
corporation. A separate section is presented at the end of the unit, however, dealing with the
problem of achieving internal control in a small business.
5.1 THE MEANING OF INTERNAL CONTROL

What do you mean internal control?
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
_____________________________________________.
The internal control system comprises the control environment and control procedures. It
includes all the policies and procedures adopted by the directors and management of an entity to
assist in achieving their objective of ensuring, as far as practicable, the orderly and efficient
conduct of its business, including
- adherence of internal policies
- the safeguarding of assets
- the prevention and detection of fraud and error,
- the accuracy and completeness of the accounting records, and
- The timely preparation of reliable financial information.
Internal controls may be incorporated within computerized accounting systems. However

internal control system extends beyond those matters which relate directly to the accounting
system.
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5.2 TYPES OF INTERNAL CONTROL
Administrative and Accounting control

1. Administrative control
Administrative control /management control /
2. Accounting control
- Segregation of duties: accounting and checking functions
- Referencing of supplier invoices; numerical sequence and supplier reference
- Checking of suppliers' invoices
o price, quantities, accuracy of calculation
o comparison with order and good received note
- Recording purchases and purchase returns
- Regular maintenance of purchase ledger
- Comparison of supplier statements with purchase ledger
- Authorization of payments
o authority limits
o confirmation that goods have been received, accord with purchase order, and are
properly priced and invoiced
- Review of allocation of expenditure
- Reconciliation of purchase ledger
- Cut-off accrual of unmatched goods received notes at year end.
5.3 CONTROL ENVIRONMENT

Control environment is the framework within which controls operate. The control environment is
very much determined by the management of a business.
Control environment is the overall attitude, awareness and actions of directors and managers
regarding internal controls and their importance in the entity. The control environment
encompasses the management style and corporate culture and values shared by all employees. It
provides the background against which the various other controls are operated.
The following factors will be reflected in the control environment.
- The philosophy and operating style of management
- The entity's organizational structure
- The directors' methods of imposing controls.
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5.4 RISK ASSESSMENT
One of the components of internal control is risk assessment. Management should carefully
consider the factors that affect the risk that the organization's objectives will not be achieved.
When considering the financial reporting objective, these risks include the threats to preparing
financial statements in accordance with generally accepted accounting principles. For example,
the following factors might be indicative of increased financial reporting risk:
- changes in the organization's regulatory or operating environment
- changes in personnel
- implementation of a new or modified information system
- rapid growth of the organization
- changes in technology affecting production processes or information systems
- introduction of new lines of business, products, or processes
Management's process of risk assessment is similar to the auditor's assessment of audit risk, as
described in unit 3. However, the scope of management's risk assessment is more comprehensive
in that it involves consideration of factors that affect all of the organization's objectives. The
auditor's are concerned only with the level of inherent risk and control risk that affect the
organization's ability to produce financial statements that are in accordance with generally
accepted accounting principles.
5.5 CONTROL ACTIVITEES
Control procedures are those policies and procedures in addition to the control environment,
which are established to achieve the entity's specific objectives.
Control procedures include those designed to prevent or to detect and correct errors. Some of the
specific control procedures are:
- Segregation of duties
- Approval and control of documents
- Control over computerized applications
- Checking the arithmetical accuracy of records
- Maintaining and reviewing control accounts and trial balances
- Reconciliation
- Comparing the results of cash, securities and stock counts with accounting records
- Comparing internal data with external sources of information
- Limiting direct physical access to assets and records.
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OBJECTIVES OF INTERNAL CONTROL
Some studies suggest that management typically has the following objectives in setting up a
good system of internal control.
a) The orderly and efficient conduct of its business

An organization which is efficient and conducts its affairs in an orderly manner is much more
likely to be able to supply the auditors with sufficient appropriate audit evidence on which to
base their audit opinion. More importantly, the level of inherent and control risk will be
lower, giving extra assurance that the financial statements do not contain material errors.
b) Adherence to Internal Policies
Management is responsible for setting up an effective system of internal control and
management policy provides the broad framework within which internal controls have to
operate. Unless management does have a pre-determined set of policies, then it is very
difficult to imagine how the company could be expected to operate efficiently. Management
policy will cover all aspects of the company's activities and will range from broad corporate
objectives to specific areas such as determining selling prices and wage rates.
Given that the auditors must have a sound understanding of the company's affairs generally,
and of specific areas of control in particular, then the fact that management policies are
followed will make the task of the auditors easier in that they will be able to rely more
readily on the information produced by the systems established by the management.
c) Safeguarding of Assets
This objective may relate to the physical protection of assets (for example by locking monies
in a safe at night) or to less direct safeguarding (for example ensuring that there is adequate
insurance, cover for all assets). It can also be seen as relating to the maintenance of proper
records in respect of all assets.
The auditors will be concerned to ensure that the company has properly safeguarded its assets
so that they can form an opinion on existence of specific assets and, more generally, on
whether the company's records can be taken as a reliable basis for the preparation of financial
statements. Reliance on the underlying records will be particularly significant where the
figures in the financial statements are derived from such records rather than as the result of
physical inspection.
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d) Prevention and Detection of Fraud and Error
The directors are responsible for taking reasonable stops to prevent and detect fraud. They
are also responsible for preparing financial statements, which give a true and fair view of the
entity's affairs. However, the auditors must plan and perform their audit procedures and
evaluate and report the results thereof, recognizing that fraud or error may materially affect
the financial statements. A strong system of internal control will give the auditors some
assurance that frauds and errors are not occurring. Unless management are colluding to
overcome that system.
e) Accuracy and completeness of the accounting records/timely preparation of reliable
financial information
This objective is most clearly related to statutory requirements relating to both management
and auditors. The auditors must form an opinion on whether the company has fulfilling this
obligation and also conclude whether the financial statements are in agreement with
underlying records.
Detailed Internal Control Objectives

There are seven detailed objectives that an internal control system must meet to prevent errors in
the accounting records. A basic assumption that underlines the assessment of whether the
objectives were met is that the system of internal control was in operation as described for the
period of reliance. The auditor must be careful to ensure that the objectives were met
continuously and not just sporadically.
The client's system of internal control must be sufficient to provide reasonable assurance that:
1. Recorded transactions are valid (validity). The system should not permit the inclusion of
fictions or non-existent transactions in journal or other accounting records.
2. Transactions are properly authorized (authorization). If a transaction that is not
authorized takes place, it could result in a fraudulent transaction and it could also have
the effect of wasting or destroying company assets.
3. The existing transactions are recorded (completeness). The client's procedures must
provide controls to prevent the omission of transactions from the records.
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4. Transactions are properly valued (valuation). An adequate system includes procedures to
avoid errors in calculating and recording transactions at various stages in the recording
transactions at various stages in the recording process.
5. Transactions are properly classified (classification). The proper account classification
according to the client's chart of accounts must be made in the journals if the financial
statements are to be properly stated. Classification also includes such categories as
division and product.
6. Transactions are recorded at the proper time (timing). The recording of transactions either
before or after the time they took place increases the likelihood of failing to record
transactions or of recording them at the improper amount. if late recording occurs at the
end of the period, the financial statements will be misstated.
7. Transactions are properly included in subsidiary records and correctly summarized
(posting and summarization). In many instances individual transactions are summarized
and totaled before they are recorded in the journals. The journals are then posted to the
general ledger, and the general ledger is summarized and used to prepare the financial
statements. Regardless of the method used to enter transactions in the subsidiary records
and to summarize transactions, adequate controls are needed to make sure summarization
is correct.
The seven detailed internal control objectives must be applied to each material type of
transaction in the audit, such transactions typically include sales, purchases, cash receipts and
payments, acquisition and issuance provision of goods and services, payroll, and so on.
ELEMENTS OF INTERNAL CONTROL
It is necessary that a system have certain elements or characteristics that increase the likelihood
of reliable accounting records and safeguarding of assets. Elements are directly related to internal
control objectives and the way in which a company satisfies them. The following six are
discussed in this section. In evaluating the strength and weakness of a system of internal control
it is imperative to look into the following elements.
- Competent, trustworthy personnel with clear lines of authority and responsibility
- Adequate segregation of duties
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- Proper procedures for authorization
- Adequate documents and records
- Physical control over assets and records
- Independent checks on performance
Competent and Trustworthy Personnel

The most important element of any system of internal control is its personnel. If employees are
competent and trustworthy, even if some of the other elements are absent, reliable financial
statements will results. Honest, efficient people are able to perform at a high level even when
there are few other controls to support them. Conversely, even if the other five elements of
control are strong, incompetent or dishonest people can reduce the system to a shambles.
Adequate Segregation of Duties

Four general guidelines for segregation of duties to prevent both intentional and unintentional
errors are of special significance to auditors. A discussion of each follows.
Separation of the Custody of Assets from Accounting
The reason for not permitting a person who has temporary or permanent custody of an asset to
account for that asset is to protect the firm from fraud. When one person performs both
functions, there is an excessive risk of his disposing of the asset for personal gain and adjusting
the records to reliance himself of responsibility. For example, if the casher receives cash and
maintains both the cash and account receivable records, it is possible for has to take the cash
received from a customer and adjust the customer's account by failing to record a sale or by
recording a fictions credit to the account.
Separation of the Authorization of Transactions From the Custody of Related Assets
It is desirable, if possible, to prevent persons who authorized transactions from having control
over the related asset. For example, the same person should not authorize the payment of a
vendors invoice and also sing the cheque in payment of the bill. Similarly, the authority for
adding new employees to or eliminating terminated employees from the payroll should not be
given to the person responsible for distributing payroll cheques. As illustrated, the authorization
of the transaction and the handling of the related asset by the same person increase the possibility
of fraud within the organization.
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Separation of Duties within the Accounting Function
The least accounting system is one in which one employee is responsible for recording a
transaction from its origin to its ultimate posting in the general ledger. This enhances the
likelihood that unintentional or intentional errors will remain undetected and it may encourage
sloppy performance of duties. It is possible, however, that a single bookkeeper may be cost
effective.
There are many opportunities for automatic cross checking of different employees' work in a
manual system by simply segregating the recording in journals from the recording in related
subsidiary ledgers. It is also possible to segregate the responsibility for recording in related
journals, such as the sales and cash receipts journals.
Separation of Operational Responsibility from Record Keeping Responsibility

If each department or division in an organization were responsible for preparing its won records
and reports, there would be a tendency to bias the results to improve its reported performance. In
order to ensure unbiased information, record keeping is typically included in a separate
department under the controller.
The overall organizational structure of a business must provide proper segregation of duties, yet
still promote operational efficiency and effective communication.
Proper Procedures for Authorization

Every transaction must be properly authorized if controls are to be satisfactory. If any person in
an organization could acquire or expand assets at will, complete chaos would result.
Authorization can be either general or specific. General authorization means that management
establishes policies for the organization to follow. Subordinates are instructed to implement these
general authorizations by approving all transactions within the limits set by the policy. Examples
of general authorization are issuance of fixed price lists for the sale of products, credit limits for
customers, and fixed automatic recorder points for making purchases.
Specific authorization has to do with individual transactions. Management is often unwilling to

establish a general policy of authorization for some transactions. Instead, it prefers to make
56
authorizations on a case-by-case basis. An example is the authorization of a sales transaction by
the sales manager for a used car.
The individual or group who can grant either specific or general authorization for transactions
should hold a position commensurate with the nature and significance of the transactions. The
policy for such authorizations should be established by top management. For example, a
common policy is to have all acquisitions of capital assets over a set amount authorized by the
board of directors.
There is also a distinction between authorization and approval. Authorization is a policy decision
for either a general class transactions or specific transactions. Approval is the implementation of
management's general authorization decisions. For example, assume management sets a policy
authorizing the ordering of inventory when less than a three-week supply on hand. That is a
general authorization. When a department orders inventory, the desk responsible from
maintaining the perpetual record approves the order to indicate that the authorization policy has
been met.
Adequate Documents and Records
Documents and records are the physical objects upon which transactions are entered and
summarized. They include such diverse items as sales invoices, purchase orders, subsidiary
ledgers, sales journals, time cards and bank reconciliation. Both documents of original entry and
records upon which transactions are entered are important elements of a system, but the
inadequacy of documents normally causes greater control problems.
Documents perform the function of transmitting information throughout the client's organization
and between different organizations. The documents must be adequate to provide reasonable
assurance that all assets are properly controlled and all transactions correctly recorded. For
example, if the receiving department fills out a receiving report when material is obtained, the
accounts payable department can verify the quantity and description on the vendor's invoice by
comparing it with the information on the receiving report.
57
Certain relevant principles dictate the proper design and use of documents and records.
Documents and records should be:
- Pre-numbered consecutively to facilitate control over missing documents, and as an aid in
locating documents when they are needed at a later date.
- Prepared at the time transaction takes place, or as soon thereafter as possible. When there
is a longer time interval, records are less credible and the chance for error is increased.
- Sufficiently simple to ensure that they are clearly understood.
- Designed for multiple uses whenever possible, to minimize the number of different
forms. For example, a properly designed and used sales invoice can be the basis for
recording sales in the journals, the authority for shipment, the basis for developing sales
statistics, and the support for salesmen's commission.
- Constructed in a manner that encourages correct preparation. This can be done by
providing a degree of internal check within the form or record. For example, a document
might include instruction for proper routing, blank spaces for authorization and
approvals, designated column spaces for numerical data.
Physical Control over Assets and Records

The most important type of protective measure for safeguarding assets and records is the use of
physical precautions. An example is the use of storerooms for inventory to guard against
pilferage. When the storeroom is under the control of a competent employee, there is also
further assurance that obsolescence is minimized. Fireproof safes and safety deposit vaults for
the protection of assets such as currency and securities are other important physical safeguards.
Physical safeguards are also necessary for records and documents. The redevelopment of lost or
destroyed records is costly and time consuming. Imagine what would happen if an accounts
receivable master file were destroyed. The considerable cost of backup records and other
controls can be justified to prevent this loss. Similarly, such documents as insurance polices and
promissory notes should be physically protected.
Mechanical protective devices can also be used to obtain additional assurance that accounting
information is correctly and accurately recorded. Cash registers and certain types of automatic
data processing equipment are all potentially useful additions to the system of internal control for
this purpose.
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LIMITATIONS OF INTERNAL CONTROL
Auditing standards states that the directors of an entity will set up internal controls in the
accounting system to assess the following.
a) Transactions are executed with proper authorization
b) All transactions and other events are promptly recorded at the correct amount, in the
appropriate accounts and in the proper accounting period.
c) Access to assets is permitted only in accordance with proper authorization.
d) Recorded assets are compared with the existing assets at reasonable intervals and
appropriate action is taken with regard to any differences.
However, any internal control system can only provide the directors with reasonal assurance that
their objectives are reached, because of inherent limitations, such as the following.
a) The usual requirement that the cost of an internal control does not outweigh the potential
loss, which may result from its absence.
b) Most systematic internal controls tend to be directed at routine transactions than non-
routine transactions. Hence it is important for auditors to ascertain what may go on
outside the accounting system.
c) The potential of human error in the operation of internal controls due to careless,
distraction, mistakes of judgment and the misunderstanding of instructions.
d) The possibility of controls being by passed because two or more people collude.
Collusion may be between people inside the organization, but may involve outsiders as
well.
e) The possibility that a person responsible for exercising internal control could abuse that
responsibility by overriding an internal control.
f) The possibility that procedures may become inadequate due to changes in conditions or
that compliance with procedures may deteriorate overtime. This may particularly apply if
a business is expanding internal controls designed to cope with a smaller business may
well have problems coping.
These factors show why auditors cannot obtain all their evidence from tests of the systems of
internal control.
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5.6 MONITORING
The last specific element of control is the careful and continuous review of the other five, often
referred to as independent checks or internal verification. The need for a system of independent
checks arises because a system tends to deteriorate over time unless there is a mechanism for
frequent review. Personnel are likely to forget or intentionally fail to follow procedures or
become careless unless someone observes and evaluates their performance. In addition, both
fraudulent and unintentional errors are always possible, regardless of the quality of the controls.
An essential characteristic of persons performing internal verification procedures is

independence from the individual originally responsible for preparing the data. A considerable
portion of the value of checks on performance is lost when the individual doing the verification
is a subordinate of the person originally responsible for preparing the data or lacks independence
in some other way.
5.7 THE AUDITOR'S CONSIDERATION OF INTERNAL CONTROL
The second standard of fieldwork states:

A sufficient understanding of the internal control structure is to be obtained to plan the audit and
to determine the nature, timing, and extent of tests to be performed.
The Auditor's understanding of their client's internal control provides a basis both to (1) plan the
audit, and (2) assess control risk.
In planning an audit it is essential that the auditors have a sufficient understanding of the client's
internal control structure. This encompasses both an understanding of the design of the policies,
procedures, and records, and knowledge of whether they have been placed in operation by the
client. It is difficult to imagine designing tests of financial statement balances without an
understanding of the internal control structure. For example, auditors who do not understand the
client's policies and procedures for executing and recording credit sales would have a difficult
time substantiating the balances of account receivable and sales.
The auditor's consideration of the internal control structure also provides a basis for their
assessment of control risk – the risk that material misstatements will not be prevented or detected
60
by the client's internal control structure. If the auditors determine that the client's internal control
is effective, they will assess control risk to be low. They can then accept a higher level of
detection risk, and substantive testing can be decreased. Conversely, if internal controls are
weak, control risk is high and the auditors must increase the scope of their substantive tests to
limit the level of detection risk. Therefore, the auditors' understanding of internal control is a
major factor in determining the nature, timing, and extent of substantive testing necessary to
verify the financial statement assertions.
Since an effective internal control structure is a major factor in an audit, the question arises as to
what action the auditors should take when internal control is found to be seriously deficient. Can
the auditors complete a satisfactory audit and properly express an opinion on the fairness of
financial statements of a company in which control risk is considered to be extremely high? The
answer to this question depends on whether the auditors believe that inherent risk is at a
satisfactory level so that substantive tests can be designed that will reduce audit risk to an
acceptable level. For example, the auditors of a small business with a limited segregation of
duties often apply an approach of restricting detection risk through extensive substantive tests of
financial statement assertions, rather than performing tests of internal control.
 Check Your Progress Exercise
1. What is an internal control?
………………………………………………………………………………………………...……
……………………………………………………………………………………………...
2. Define the control environment?
………………………………………………………………………………………………...……
……………………………………………………………………………………………...
3. What are the internal control procedures?
………………………………………………………………………………………………...……
……………………………………………………………………………………………...
4. What are the major objectives of internal control?
………………………………………………………………………………………………...……
……………………………………………………………………………………………...
5. What are the inherent limitations of internal control?
………………………………………………………………………………………………...……
……………………………………………………………………………………………...
6. What are the elements of internal control?
………………………………………………………………………………………………...……
……………………………………………………………………………………………...
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7. Which auditing standard states about the auditor's consideration of internal control?
………………………………………………………………………………………………...……………
……………………………………………………………………………………...
8. Why must auditors obtain an understanding of the client's accounting system?
………………………………………………………………………………………………...……………
……………………………………………………………………………………...
9. What procedures should be in place to control goods inwards?
………………………………………………………………………………………………...……………
……………………………………………………………………………………...
10. What are the key controls over cash receipts and payments?
…………………………………………………………………………………………...
…………………………………………………………………………………………….
SUMMARY
The auditors must understand the accounting system and control environment in order to
determine the audit approach.
Specific control procedures include the following
- approval and control of documents
- controls over computerized applications and the information technology environment
- checking the arithmetic accuracy of the records
- maintaining and reviewing control accounts and trial balances
- reconciliation
- comparing the results of cash, security and stock counts with accounting records
- comparing internal data with external sources of information
- limiting direct physical access to assets and records
The auditors understanding of internal control provide a basis both to plan the audit and assess
control risk.
In small businesses auditors must rely much more on substantive tests of account balances and
transactions rather than tests of controls.
The tests of controls of the sales system will be based around
- selling (authorization)
- goods outwards (custody)
- accounting (recording)
Similarly, the purchases system tests will be based around
- buying (authorization)
- goods inwards (custody)
- accounting (recording)
Key controls over wages cover
- documentation and authorization of staff changes
- calculation wages and salaries
- payment of wages
- authorization of deductions
Controls over cash receipts and payments should prevent fraud and theft. Inventory controls are
designed to ensure safe custody. These include
- restriction of access to stock
- Documentation and authorization of movement
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UNIT SIX
AUDIT SAMPLING
Contents
Aims and Objectives
Introduction
6.1 Need for Audit Sampling
6.2 Statistical Vs Non-Statistical sampling
6.3 Audit Sampling for Tests of Controls
6.4 Attribute sampling
6.5 Audit Sampling for Substantive Tests
6.6 Classical Variables Sampling
6.7 Non-Statistical sampling for substantive Tests
Summary
AIMS AND OBJECTIVES
After studying this chapter, you will be able to:
 Describe the nature of attributes sampling in an audit engagement.
 Describe the role of audit risk in determining a sampling plan.
 Distinguish between statistical and non statistical sampling.
 list the steps in a general sampling plan appropriate for tests of control, and
 List out alternative attributes sampling techniques used in practice in tests of controls.
INTRODUCTION
The sampling plan usually used by auditors while performing tests of control is referred to as
attributes sampling. This chapter, begins by introducing the nature of attributes sampling in
auditing discussing audit risk in the context of audit sampling and explaining the difference
between statistical and non-statistical sampling.
The chapter introduces a general sampling plan for accomplishing tests of controls and shows
you how to apply the general attributes sampling plan discussed in section2. There are three
important and frequently used audit sampling techniques: attribute estimation sampling,
sequential (stop or go) sampling and discovery sampling and also discusses non-statistical
sampling for attributes.
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6.1 NEED FOR AUDIT SAMPLING
What do you mean Audit sampling?
______________________________________________________________________________
______________________________________________________________________________
__________________________________.
There is neither sufficient time nor given what we know about the laws of probability, sufficient
reason to test all of the transactions underlying an entity’s account balances or classes of
transaction. As a result many of the conclusions auditors reach about account balances and
classes of transactions are based on testing samples rather than entire populations. In this section,
you will consider sampling in general and its relationship with audit risk in particular. You will
also describe the difference between statistical and non-statistical sampling.
Sampling examines less than 100 percent of the items that constitute a population. In most cases
a sample can be sufficiently representative of a population to warrant reasonably reliable
conclusions without testing the entire population. For example, a randomly selected sample of
100 sales invoices drawn from a population of 10,000 sales invoices can be audited in about 1
percent of the time. It would take to audit the entire population and because of the laws of
probability can yield fairly reliable conclusions. A population consists of all the items within a
class of transaction such as all credit sales processed for the year ended December 31, 2005 or all
the transactions constituting an account balance such as Accounts Receivable.
6.2 STATICAL VS NON-STATICAL SAMPLING
Statistical sampling involves the use of mathematical procedures, such as probability theory to
draw conclusions reached about the population. Non-statistical sampling techniques rely on the
auditors’ judgment to draw conclusions
Statistical sampling plans: apply the laws of probability to aid an auditor in designing an
efficient sample in measuring the sufficiency of evidence obtained, and in evaluating the sample
results.
Non statistical sampling plans: rely exclusively on subjective judgment to determine sample
size and to evaluate sample results. A properly designed non statistical sampling application can
provide results as effective as those from a properly designed statistical sampling application.
However, there is one crucial difference between a statistical and a non statistical sampling
64
application. Statistical sampling plans allow an auditor to measure sampling risk quantitatively
whereas non statistical sampling plans do not.
The choice between a statistical and a non statistical sampling plan is based primarily on the
auditor’s assessment of the relative costs and benefits.
For example, an auditor might use non statistical sampling if the cost selecting a tactical random
sample were too high. However, an auditor might consider the cost justifiable if the related
controls were critical, and a measure of sampling risk was therefore, essential. Note that the
choice between a statistical and a non statistical sampling plan is made independently of the
selection of audit procedures since audit sampling, whether statistical or non statistical is merely
a means for accomplishing audit procedures.
In some instances, audit sampling is inappropriate, and the auditor must therefore test the entire
population. For example, an auditor may not be willing to accept any sampling risk for
contingent liabilities. Sampling is also inappropriate in tests of control procedures that depend
primarily on segregation of duties or that otherwise provide no audit trail. Audit evidence for
these types of controls is gathered through observation and inquiry.
6.3 AUDIT SAMPLING FOR TESTS OF CONTROLS

The procedures used to test a sample- aids the practitioner in forming conclusions about one or
more characteristics of either a particular class of transaction or a particular account balance. For
example, the sample of 100 sales invoices could offer conclusions about credit approval controls
and about recorded sales and receivables balances. In any sampling plan, however, the
characteristic of interest depends on whether the practitioner is performing tests of controls or
substantive tests.
Once selected, the sampling units should be examined for the attributes of interest, and
deviations should be documented in the working papers. In practice, auditors usually select more
sampling units than required, thereby providing replacements for voided items and for
documents that cannot be located. For example, an auditor might select 75 sampling units even
though required sample size is 65, and then use the remaining ten in the order selected if needed.
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6.4 ATTRIBUTE SAMPLING
An attributes sampling plan is most commonly used to test an entity’s rate of deviation (also
called rate of occurrence) from a prescribed control procedure. For example, an auditor might
use an attributes sampling plan to test controls for disbursement processing, billing systems,
payroll and personnel systems, inventory pricing, and depreciation, among other things. In
contrast, substantive tests are designed to obtain evidence about whether monetary error exists
within a class of transactions or an account balance, and the auditor’s characteristic of interest is
called a variable.
A variable sampling plan is most commonly used to test whether recorded account balances are
fairly stated. For example, an auditor might use a variable sampling plan to test recorded dollar
amounts for receivables, inventory, payroll expense, and fixed asset additions, among other
things. In summary, attributes sampling is generally used to reach a conclusion about a
population in terms of a rate of deviation, and variables sampling is generally used to reach
conclusions about a population in terms of a rate of deviation, and variables sampling is
generally used to reach conclusions about a population in terms of a dollar amount. This chapter
is devoted to attributes sampling, and the next unit is devoted to variables sampling.
In general, population size has very little effect on sample size, particularly for populations over
5,000 items. The following table illustrates the limited effect of population size on sample size,
assuming a 5% acceptable risk of assessing control risk too low, a 5% tolerable deviation rate
and a 1% expected population deviation rate.
Population Size Required Sample Size

50 45
100 64
500 87
1000 90
2000 92
5000 93
100000 93
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6.5 AUDIT SAMPLING FOR SUBSTANTIVE TESTS
As it was defined earlier what an attribute in tests of control is and stated that the sampling plan
used in tests of control is referred to as attributes sampling. In this section, you will learn the
steps involved in attributing sampling in a general sense. The illustration of this general
discussion is reserved for the next section.
Determine the Objectives of the Test
A general sampling plan appropriate for tests of control is presented in the figure below. Look at
it before you proceed.
1. Determine the objectives of the test.
2. Define the attribute and deviation conditions.
3. Define the population.
4. Determine the method of sample selection.
5. Determine sample size.
6. Perform the sampling plan
7. Evaluate the sample results
What do you think are the steps in taking samples for performing tests of controls?
--------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------
The first step in an attributes sampling plan for tests of control, as you can see from the figure is
determining the objective of the test of control under consideration.
What do you think is the objective of performing any test of control?
---------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------
As discussed earlier, tests of controls are designed to assess the effectiveness of control
procedures in preventing or detecting material misstatements in the financial statements. Thus, in
general terms auditor’s objectives are stated in the context of determining whether the controls
for a particular transaction cycle are sufficiently effective to conclude that control risk is below
the maximum tolerable level. In practice, sampling is generally used when an entity’s controls
leave a trail of observable evidence (such as approval initials on the face of a vendor’s invoice)
and when the controls do not depend primarily on adequate segregation of duties which is
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observable but not documented. However, the sampling plan requires that observations be
planned early in the engagement. For example, if an auditor wishes to observe cash collection
procedures at a theater, he or she would have to select the days for observation early in the
engagement in order to allow each day in the period audited an equal chance of being selected
for observation.
A. Define the Attribute and Deviation Conditions
Note all of a client existing controls are tested in a financial statement audit. Only those relevant
to assertions embodied within the financial statements audited are tested. For each control that is
tested the auditor identifies what are called attributes and deviations.
An attribute is a characteristic of a control, and a deviation is the absence of an attribute. To
illustrate, assume an auditor’s objective is to determine whether controls over sales returns are
effective. The client prepares a credit memorandum for each return. In this case, one attribute,
that is, one characteristic of the control system is that quantity, and other data on the credit
memorandum agrees with the receiving report, a document prepared when the client receives
retuned goods. For this attribute, a deviation would occur each time an auditor found that the
quantities or other data indicated on a credit memorandum disagreed with the related receiving
report.
B. Define the population
In attributes sampling, a population consists of all the items constituting a class of transaction.
Because sample results can be projected only into the population from which the sample is
selected, the defined population must be appropriate for the auditor’s objectives. For example, if
an auditor’s objective is to test controls designed to assure that all shipped goods are billed, the
population would be all shipping documents issued during the period, not all sales invoices.
Erroneously defining the population as all invoices issued during the period would ignore
shipped goods that were not billed, the test is intended to detect. That is, the auditor wants to
check that every shipping document has got a corresponding bill (invoice) instead of checking
whether every invoice is accompanied by a shipping document. Once the auditor decides the
population, two issues that go with determining the population are defining the period covered
by the attributes under consideration and determining the sampling unit. Both are discussed
below:
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I. Define the period Covered
Tests of controls are typically accomplished during the interim period of an engagement, which
for a December 31 year end client might be as early as four or six months before the end of the
financial year.
Performing tests of controls prior to year end, however, creates an audit problem because, in
order to design substantive tests, the auditor needs to reach a conclusion about the entire
population of transactions covered by the yearend financial statements-for example, January 1 to
December 31 not just the months subjected to interim tests. Thus, when tests are conducted at
interim, the auditor might define the population to include transactions through December 31,
perform initial tests through the interim date, and complete the tests at year end.
Alternatively, the auditor might decide to define the population to include transactions through
the interim date, and then consider the following factors in judging whether additional tests are
necessary for the remaining period the results of interim tests, responses to inquiries of
management about the remaining period. The length of the remaining period, the nature and
amount of the transactions completed during the remaining period, and evidence of effective
controls within the remaining period obtained through year end substantive tests.
The important point to recognize is that sample results can be generalized only to the population
from which the sample items are selected. As a result, if interim tests are performed on
transactions completed through October 31 for a December 31 year end client, then the auditor’s
conclusions relate only to the ten-month period ended October 31.
II. Define the Sampling unit
A sampling unit is any of the individual elements constituting a population, and should be
defined in the context of the control to be tested and in light of audit efficiency. For example, if
the audit objective is to test whether disbursements contain signatures authorizing payment, the
sampling unit must be defined as a voucher, which is a summary form attached to a purchase
document, such as a vendor’s invoice.
Alternatively, if one voucher pays several invoices from the same vendor, the sampling unit
might be defined as a line item on a voucher, with each line item representing an individual
vendor invoice. Thus, a sampling unit might be a document, a line item on a document, or even a
journal entry, among these things, depending on the auditor’s objective.
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C. Determine the Method of Sample Selection
The objective of audit sampling is to draw conclusions about one or more population
characteristics without testing the entire population. But even with the most carefully designed a
sampling plan; there is still a degree of uncertainty about whether sample results represent the
population.
Examining every item in the population is the only way to eliminate stratified sampling
uncertainty arising from sampling risk. However, if a sample is selected at random i.e., if each
sampling unit is given an equal chance of being selected, the laws of probability can be applied
to determine the likelihood that the sample is representative of the population from which it was
drawn. A sample can be evaluated in terms of probability only if the sample is randomly selected
and thus free from sampling bias. If each item in a population is not given an equal chance of
selection, the sample would be biased toward the population items with the greater chance of
selection.
You will next take a look at some commonly used methods of selecting a sample. These are:
 random-number sampling
 Systematic sampling.
 slack sampling
 Haphazard sampling.
Each method is discussed below. In practice, populations may be subdivided in some cased, and
samples chosen separately for each subgroup. This technique, known as stratified sampling, is
also discussed.
6.6 CLASSIFICATION VARIABLE SAMPLING
I. Random-number Sampling
Random-number sampling uses random-number tables or computer generated random
numbers to select sampling units from a population. Random-number tables contain columns and
rows of randomly generated digits. An auditor begins at any digit in the table- a random start-
and proceeds along a column or row or diagonal, selecting digits corresponding to identification
numbers on the sampling units (e.g., invoice numbers or check numbers).
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If the sampling units do not have identifying numbers, the auditor could establish
correspondence between population items and random digits by assigning numbers to each
population item. To minimize potential bias in starting point selection, an auditor could
periodically proceed to a new starting (or continuing) point while selecting the sample. Random-
number sampling is appropriate both for statistical sampling and for non statistical sampling.
II. Systematic Sampling

Systematic sampling involves selecting every nth item from a population of sequentially ordered
items. Systematic sampling eliminates the need to establish correspondence between population
items and random numbers, and therefore, is useful when population items lack identification
numbers. The number of sequential items to skip when selecting a sample systematically is
determined by dividing population size by sample size.
For example, assuming population and sample sizes of 5,000 and 200, respectively, an auditor
would select a random starting point and proceed to select every 25 th sampling unit (5,000/200).
Continuing points may be changed periodically to minimize any potential starting point bias.
Systematic sampling is useful for non statistical sampling, and if the starting point is selected at
random, it can be useful for statistical sampling.
III. Block Sampling

A block sample is a group of items arranged contiguously within a larger grouping of sampling
units. For example, a block sample could consist of a vendor invoices processed on January 21,
May 24, September 28, and November 13. In this case, if 75 invoices had been processed on
these four days, then the sample would consist of 4 items, not 75 since the sampling unit is
expressed in blocks of time-that is, in days-not transactions.
Generally, so few blocks of sample items are insufficient to justify generalizing sample results to
the population suggesting that block sampling often results in excessively high sampling risk.
Although, a block sample could be designed with enough blocks to minimize sampling risk,
testing large numbers of blocks is likely to be inefficient. Thus, an auditor should not use block
sampling for either statistical or non statistical sampling unless he or she exercises considerable
care in controlling sampling risk.
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IV. Haphazard Sampling
A haphazard sample consists of sampling units selected without special reason, but also without
conscious bias. For example, a haphazard sample could consist of 80 items selected simply by
pulling vendor invoices from a file cabinet drawer. Like block sampling, haphazard sampling
may file to select samples that are wholly representative of the population tested. Although it
may be useful for non statistical sampling, haphazard sampling is inappropriate for statistical
sampling.
V. stratified Sampling
Stratified sampling involves subdividing populations into homogenous sub-groups or strata, and
selecting (and evaluating) separate samples for each subgroup. The samples may be selected by
random numbers, systematically, in blocks, or haphazardly. Stratified sampling is based on the
assumption that items in some population strata are more similar to each other than to any other
items in the population. For example, individual vendor invoices of less than $ 100 are apt to be
more similar to each other than to invoices over $100,000.
When compared, the subgroups are apt to have strikingly dissimilar characteristics, such as
different credit terms and different potential for material errors or fraud. Thus, each group
represents a stratum, and the variability of sampling units in each stratum is apt to be less than
the variability of all population items.
Determine Sample Size

How many sample items do you think are enough when performing tests of controls?
______________________________________________________________________________
__________________________________________________________________
Before auditors start the actual work of examining sample items, they have to determine how
many sample items to check from the population under consideration. In order to determine
sample size for an attributes sampling plan, auditors must first consider the following:
 Acceptable risk of assessing control risk too low.
 tolerable rate of deviation, and
 Expected population deviation rate.
You will discuss each in the following pages.
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6.7 NON- STATISTICAL SAMPLING FOR SUBSTANTIVE TESTS
Tests of controls are designed to obtain evidence about whether an entity is complying with the
controls that management prescribes. The characteristic of interest while performing tests of
controls is called a Normal. Thus the name attribute sampling is used to refer to a sampling plan
that is usually used while performing tests of controls.
Voided items generally should not be considered deviations. However, missing items would
ordinarily be considered deviations since the auditor would have no basis to conclude that the
tested controls were operating as prescribed by management.
Occasionally, an auditor might find a large number of deviations before, completing tests of the
entire sample. If the large number of deviations suggested that the sample deviation rate were
likely to exceed the tolerable rate, the auditor would probably discontinue the sampling plan and
conclude that the control is ineffective. In this case, the benefits of continuing the sampling plan
are not likely to exceed the cost.
Activity Questions III

1. What risks does an auditor sustain solely as a result of sampling?
___________________________________________________________________________
2. Explain how an ineffective audit can increase audit risk.
_________________________________________________________________________
3. What are the three factors that must be considered determining sample size?
________________________________________________________________________
4. What are the two issues that should be consider after determining the population?
______________________________________________________________________
5. Discuss about some of commonly used sample selecting method.
______________________________________________________________________
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UNIT SEVEN
AUDIT WORKING PAPERS
Contents
Aims and Objectives
Introduction
7.1 Audit working papers
7.2 Functions of Audit working papers
7.3 Types of Audit Working papers
7.4 Organization of Audit working papers
7.5 Examination of the General Records
Summary
AIMS AND OBJECTIVE
When you have studied this unit you should be able to:
 State the typical contents of working papers.
 Describe sampling as applied to auditing.
7.1 AUDIT WORKING PAPERS
Working papers are vitally important tools of the auditing profession.
Working papers are the connecting link between the client's accounting records and the auditors
report. They document all of the work performed by the auditors and provide the justification
for the auditors’ report.
The documentation of audit evidence is provided in working papers. Working papers provide
- The principal support for the auditor’s report.
- A means for coordinating and supervising the audit.
- Evidence that the audit was made in accordance with GAAS.
74
Working papers are records kept by the auditor of the procedures applied, the test performed, the
information obtained, and the pertinent conclusions reached in the audit. For example, when
samples are takes for audit tests, the items drawn must be recorded and computations must be
made.
Working papers provide:

 The principal support for the auditor’s report.
 A means for coordinating and supervising the audit, and.
 Evidence that the audit was made in accordance with GAAS.
Working papers normally include the audit plan and programs, documentation of the auditor’s
understanding of the internal control structure, the assessed level of control risk, account
analyses explaining the composition of account balances, reconciliation of related records, letters
of confirmation and representation, recommended journal entries if necessary to correct the
accounts, and trial balances and other schedules that summarize the contents of other working
papers.
7.2 FUNCTION OF AUDIT WORKING PAPERS

Audit working papers assist auditors in several major ways: they
a) Provide a means of assigning and coordinating audit work;
b) Aid seniors, managers, and partners in supervising and reviewing the work of assistants;
c) Provide the support for the auditors’ report;
d) Document the auditors’ compliance with GAAS; and
e) Aid in planning and conducting future audits of the client.
7.3 TYPES OF AUDIT WORKING PAPERS

The auditors usually maintain two files of working papers for each client:
1) Current files for every completed examination and
2) A permanent file of relatively unchanging data.
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7.4 ORGANIZATION OF AUDIT WORKING PAPERS
All audit work must be documented; the working papers are the tangible evidence of the work
done in support of the audit opinion. Auditor should document in their working papers matters,
which are important in supporting their report.
Working papers are the material the auditors prepare or obtain, and retain in connection with the
performance of the audit. Working papers may be in the form of data stored on paper, firm,
electronic media or other media.
Working papers support, amongst other things, the statement in the auditors' report as to the
auditors' compliance or otherwise with auditing standards to the extent that this is important in
supporting their report.
Working papers are a record of

a) the planning and performance of the audit
b) the supervision and review of the audit work; and
c) The audit evidence resulting from the audit work performed which the auditors consider
necessary and on which they have relied to support their report.
7.5 TYPES OF AUDIT WORKING PAPERS
Working papers would normally include the following matters:

 Information concerning the legal and organizational structure of the entity.
 Copies of important legal documents, agreements and minutes.
 Information concerning the industry, and economic environment.
 Evidence of the planning process.
 Evidence of the auditors’ understanding of the accounting and internal control systems.
 Evidence of inherent and control risk assessments.
 Analysis of transactions and balances.
 Analysis of significant ratios and trends.
 Details of procedures regarding components whose financial statements are audited by
other auditors.
 Copies of communications with other auditors, experts, and other third parties.
 Letters of representation by the client’s management.
 Copies of the approved financial statements and auditors’ reports.
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1. Which of the following is not a primary purpose of audit working papers?
a) To coordinate the examination.
b) To assist in preparation of audit report.
c) To support the financial statements.
d) To provide evidence of audit work performed.
2. Which of the following is the most persuasive evidence?
a) Information detained through inquiry direct from independent sourced audit the client
organization.
b) Information obtained through inquiry from the management the organization.
c) Evidence obtained by re-performing calculations and reconciliation made by the client.
d) Evidence obtained by observing employment while performing their tasks..
SUMMARY
In this unit we have examined the matters relating to audit evidence. The financial statements
are explained in terms of the primary assertions management makes in them, and these assertions
are identified as the focal points of the auditors’ procedural evidence gathering work. The unit
closes with some basic points about the purpose, confidentiality, and content of audit working
papers.
77
UNIT EIGHT
AUDIT REPORT
Contents
Aims and Objectives
Introduction
7.1 Statutory Requirements
7.2 Auditors Report on Financial Statements
7.3 Qualifications in Audit Report
Summary
AIMS AND OBJECTIVES

- describe the standard audit report
- discuss how materiality affects the considerations of the type of audit report to be issued
- explain the main elements of an audit report
- Identify the circumstances that may result in qualified opinions, adverse opinions, and
disclaimers of opinion.
INTRODUCTION
The audit report is the means by which the auditors express their opinion on the truth and
fairness of a company's financial statement for the benefit principally of the shareholders, but
also for the users. Statue has consistently recognized its importance by requiring that certain
mandatory statements appear in the report.
You should learn what the auditor reports on explicitly and what the auditor reports on by
exception. You will not be required to reproduce a full audit report in the exam, however you
may be required to:
78
(a) describe how the audit report in a specific situation differs from an unqualified audit
report,
(b) Describe to give extracts from an audit report dealing with uncertainties or
disagreements.
8.1 STATUTORY REQUIREMENTS
International Auditing Standards require the auditors to state explicitly whether in the auditors'
opinion the annual accounts have been properly prepared in accordance with the GAAP and in
particular whether a true and fair view is given.
- In the balance sheet, of the state of the company's affairs at the end of financial year.
- In the profit and loss account, of the company's profit or loss for the financial year; and
- In the case of group accounts, of the state of affairs at the end of financial year and the
profit or loss for the year of undertakings including in the consolidation, so far as
concerns member of the company.
In addition, certain requirements are reported on by exception; the auditor only has to report if
they have not been met. The following are matters with which the auditors imply satisfaction in
an unqualified report.
- Proper accounting records have been kept and proper returns adequate for the audit
received from branches not visited.
- The accounts are in agreement with accounting records and returns.
- All information and explanations have been received as the auditors think necessary and
they have had access at all times to the company's book, accounts and vouchers.
- Details and directors' emoluments and other benefits, and particular of higher paid
employees have been correctly disclosed in the financial statements.
- Particulars of loans and other transactions in favor of directors and others have been
correctly disclosed in the financial statements.
- The information given in the directors' report is consistent with the accounts.
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Directors' Emoluments
The auditor should include in their report the required disclosure particulars of directors'
emoluments and transactions with directors, if these requirements have not been complied with
in the accounts. This means that the auditors carryout various procedures to ensure that they are
aware of all such emoluments and transactions by reference to directors' service contracts, board
minutes, cash book payments and so on. Benefits received in kind may be particularly hard to
identify.
8.2 AUDITORS' REPORT ON FINANCIAL STATEMENTS
Auditors' reports on financial statements should contain a clear expression of opinion based on
review and assessment of the conclusions drawn from evidence obtained in the course of the
audit.
8.2.1 Basic Elements of the Audit Report

Auditors' reports on financial statements should include the following matters.
a) A title identifying the person or person to whom the report is addressed.
b) An introductory paragraph identifying the financial statement audited.
c) Separate sections, appropriately headed, dealing with
- respective responsibilities of directors (or equivalent persons) and auditors
- the basis of the auditors' opinion
- the auditors' opinion on the financial statements
d) The manuscript or printed signature of the auditors and
e) The date of the auditors' report.
Unqualified Opinion
Example 1: Unqualified Opinion
Auditors' Report to the shareholders of XYZ PLC we have audited the financial statements on
pages __ to __ which have been prepared under the historical cost convention and the accounting
policies set on page ….
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Respective Responsibilities of directors and auditors
As described on page … the company's directors are responsible for the preparation of financial
statements. It is our responsibility to form an independent opinion, based on our audit, on those
statements and to report our opinion to you.
Basis of opinion
We conducted our audit in accordance with audit standards issued by the audit practices board.
An audit includes examination, on a test basis, of evidence relevant to the amounts and
disclosures in the financial statements. It also includes an assessment of the significant estimates
and judgments made by the directors in the preparation of the financial statements, and of
whether the accounting policies are appropriate to the company's circumstances, consistently
applied and adequately disclosed.
We planned and performed our audit so as to obtain all the information and explanations which
we considered necessary in order to provide us with sufficient evidence to give reasonable
assurance that the financial statements are free from material misstatement, whether caused by
fraud or other irregularity or error. In forming our opinion we also evaluated the overall
adequacy of the presentation of information in the financial statements.
Opinion
In our opinion the financial statements give a true and fair view of the state of the company's
affairs at 31 December 20__ and of its profit (loss) for the year then ended and have been
properly prepared in accordance with GAAP.
Registered Auditor
Date Address
The report recommends the use of standard format as an aid to the reader, including headings for
each section, for example 'Qualified Opinion'. The title and address and the introductory
paragraph are fairly self-explanatory.
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Statements of Responsibility and Basic Opinion
a) Auditors should distinguish between their responsibilities and those of the directors by
including in their report.
i) a statement that the financial statements are the responsibility of the reporting
entity's directors
ii) a reference to a description of those responsibilities when set out elsewhere in
the financial statements or accompanying information: and
iii) a statement that the auditors' responsibility is to express an opinion on the
b) Where the financial statements or accompanying information (for example the directors'
report) do not include an adequate description of directors' relevant responsibilities the
auditor report should include a description of those responsibilities.
Example wording of a description of the directors' responsibilities for inclusion in a company's

A description of the directors' responsibilities can be produced by the directors or included by the
auditors in their report.
Company law requires the directory to prepare financial statements for each financial year which
give a true and fair view of the state of affairs of the company and of the profit or loss of the
company for the period. In preparing these financial statements the directors are required to:
a) select suitable accounting policies and then apply them consistently
b) make judgments and estimates that are responsible and prudent:
c) state whether applicable accounting standards have been followed, subject to any material
departures disclosed and explained in the financial statements
d) Prepare the financial statements on the going concern basis unless it is inappropriate to
presume that the company will continue in business (if not separate statement on going
concern is made by the directors).
The directors are responsible for keeping proper accounting records, which disclose with
reasonable accuracy at any time the financial position of the company and to enable them to
ensure that the financial statements comply with the companies Act 1985. They are also
responsible for safeguarding the assets of the company and hence for taking reasonable steps for
the prevention and detection of fraud and other irregularities.
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Explanation of Auditors' Opinion
Auditors should explain the basis of their opinion by including in their report:
a) a statement as to their compliance or otherwise with Auditing standards, together with the
reasons for any departure there from:
b) a statement that the audit process includes
i) examining, on a test basis, evidence relevant to the amount and disclosures in
the financial statements
ii) assessing the significant estimates and judgments made by the reporting
entity's directors in preparing the financial statements;
iii) considering whether the accounting policies are appropriate
To the reporting entity's, circumstances, consistently applied and adequately disclosed.
c) A statement that they planned and performed the audit so as to obtain reasonable
assurance that the financial statements are free from material misstatement, whether
caused by fraud or other irregularity or error, and that they have evaluated the overall
preparation of the financial statements.
In some exceptional circumstances, a departure from auditing standards may be appropriate to

fulfill the objective of a specific audit more effectively. If this is the case, the auditor should
explain the reason for that departure in their report. Other than in such exceptional and justifiable
circumstances, a departure from an auditing standard is a limitation on the scope of work
undertaken by the auditors.
Expression of Opinion
An auditors' report should contain a clear expression of opinion on the financial statements and
on any further matters required by statute or other requirements applicable to the particular
engagement.
An unqualified opinion on financial statement is expressed when in the auditors' judgment they
give a true and fair view (where relevant) and have been prepared in accordance with relevant
accounting or other requirements. This judgment entails concluding whether inter alia.
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a) The financial statements have been prepared using appropriate consistently applied
accounting policies
b) The financial statement have been prepared in accordance with relevant legislation,
regulations or applicable accounting standards (and that any departures are justified and
adequately explained in the financial statements); and
c) There is adequate disclosure of all information relevant to the proper understanding of the
Date and Signature of the Auditors' Report

a) Auditors should not express an opinion on financial statement until those statements and
all other financial information contained in a report of which the audited financial
statements form a part have been approved by the directors, and the auditors have
considered all necessary available evidence.
b) The date of an auditors' report on a reporting entity's financial statements is the date on
which the auditors signed their report expressing an opinion on those statements.
The date of the auditors' report is, therefore, the date on which, following;
a) receipt of financial statements and accompanying documents in the form approved by the
directors for release
b) review of all documents which they are required to consider in addition to the financial
statements (for example the directors' report, chairman's statement or other review of an
entity's affairs which will accompany the financial statements); and
c) completion of all procedures necessary to form an opinion on the financial statements
(and any other opinion required by law or regulation) including a review of post balance
sheet events.
The auditors sign their report expressing an opinion on the financial statements for distribution
with those statements.
If the date on which the auditor signs the report is later than that on which the directors approve
the financial statements, then the auditors must check that the post balance sheet event review
has been carried out up to the date they sign their report and that the directors would also have
approved the financial statement on that date.
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8.2.2 Forming an Opinion on the Financial Statement
The principal matters, which auditors consider in forming an opinion, may be expressed in three
questions.
a) Have they completed all procedures necessary to meet auditing standards and to obtain
all the information and explanations necessary for their audit?
b) Have the financial statements been prepared in accordance with the applicable accounting
requirements?
c) Do the financial statements, as prepared by the directors, give a true and fair view?
Note: requirements are referred to in terms of generally accepted accounting principles.
8.3 QUALIFICATIONS IN AUDIT REPORTS
Prior to the introduction of auditing standards, qualified audit reports were often criticized as
failing to convey the meaning intended.
The standard on audit reports aimed:

a) to outlaw the use of ambiguous ways of qualifying
b) to categorize the circumstances giving rise to qualification
c) to prescribe suggested wording and format for different categories of qualification
d) to introduce a distinction between material and fundamental problems
e) To promote better drafting by using non-technical language and clear presentation.
8.3.1 The Qualification 'Matrix'

Auditing standards give the circumstances in which each sort to qualification would be
appropriate where the auditors are unable to report affirmatively on the matters contained in the
paragraphs about which they are reservations, they should give:
a) a full explanation of the reasons for they qualification
b) Whenever possible, a quantification of its effect on the financial statements. Where
appropriate, reference should be made to non-compliance with relevant legislation and
other requirements.
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The standard stresses the fact that a qualified audit report should leave the reader in no doubt as
to its meaning and its implication for an understanding of the financial statements. In order to
promote a more consistent understanding of qualified audit reports, Accounting Practices Board
(APB) recommends that the forms of qualification described in the standard should be used
unless, in the auditors' opinion, to do so would fail to convey clearly the intended meaning.
The APB takes the view that the nature of the circumstances giving rise to a qualification of the
auditor's opinion will generally fall into one of two categories.
a) Where there is a limitation in the scope of work which prevents the auditors from
forming an opinion on a matter (uncertainty).
b) Where the auditors are able to form an opinion on a matter but this conflicts with the
view given by the financial statements (disagreement).
Case, uncertainty or disagreement, may give rise to alternative forms of qualification. This is
because the uncertainty or disagreement can be:
a) material but not fundamental; or
b) Of fundamental importance to the overall true and fair view.
The standard requires that the following forms of qualification should be used in the different
circumstances outlined below.
Qualification Matrix
Nature of circumstances Material but not fundamental Fundamental
Limitation in scope Except for … might Disclaimer Adverse
disagreement Except for …
- Except for …might: Auditors disclaim an opinion on a particular aspect of the accounts,
which is not considered fundamental.
- Disclaimer of opinion: Auditors state they are unable to form an opinion on truth and
fairness.
- Except for: Auditors express an adverse opinion on a particular aspect of the accounts, which
is not considered fundamental.
- Adverse opinion: Auditors state the accounts do not give a true and fair view.
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8.3.2 Limitations on the Scope of an Audit
One source of uncertainties is limitations in the scope of the audit. Scope limitations will arise
where the auditor is unable for any reason to obtain all the information and explanations, which
he considers necessary for the purpose of his audit, arising from:
a) absence of proper accounting records
b) Inability to carryout audit procedures considered necessary as, for example, where the
auditor is unable to obtain satisfactory evidence of the existence or ownership of material
assets.
When there has a limitation on the scope of the auditors' work that prevents them from obtaining
sufficient evidence to express an unqualified opinion.
a) The auditor’s report should include a description of the factors leading to the limitation in
the opinion section of their report.
b) The auditors should issue a disclaimer of opinion when the possible effect of a limitation
on scope is so material or pervasive that they are unable to express an opinion on the
c) A qualified opinion should be issued when the effect of the limitation is not as material or
pervasive as to require a disclaimer and the wording of the opinion should indicate that it
is qualified as to the possible adjustments to the financial statements that might have been
determined to be necessary had the limitation not existed.
When giving this type of qualified opinion, auditors should assess:
a) the quality and type of evidence which may reasonably be expected to be available to
support the figure or disclosure in the financial statements,
b) The possible effect on the financial statements of the matter for which insufficient
evidence is available.
Example 2: Qualified Opinion: Limitation on the auditor's work
(Basis of opinion: excerpt)
… or error. However, the evidence available to us was limited because Br. .. of the company's
recorded turnover comprises cash sales, over which there was no system of control on which we
could rely for the purposes of our audit. There were no other satisfactory audit procedures that
we could adopt to confirm that cash sales were properly recorded. In forming our opinion we
also evaluated the overall adequacy of the presentation of information in the financial statements.
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Qualified opinion arising from limitation in audit scope
Except for adjustments that might have been found to be necessary had we been able to obtain
sufficient evidence concerning cash sales, in our opinion the financial statements give a true and
fair view of the state of the company's affairs as at 31 December 20.. and of its profit(loss) for
the year then ended and have been properly prepared in accordance with generally accepted
accounting principles. In respect alone of the limitation on our work relating to cash sales:
a) we have not obtained all the information and explanations that we considered necessary
for the purpose of our audit, and
b) We were unable to determine whether proper accounting records had been maintained.
Example 3: Disclaimer of Opinion

Opinion: Disclaimer on view given by financial statements
Because of the possible effect of the limitation in evidence available to us, we are unable to form
opinion as to whether the financial statements give a true and fair view of the financial affairs as
at 31 December 20.. or of its profit(loss) for the year then ended. In all the respects, in our
opinion the financial statements have been prepared in accordance with GAAP. In respect of the
limitation on our work relating to stock and work in progress.
a) We have not obtained all the information and explanations that we considered necessary
for the purpose of our audit, and
b) We were unable to determine whether proper accounting records had been maintained.
8.3.3 Circumstances Giving Rise to Disagreements

The explanatory notes suggest that circumstances giving rise to disagreement include the
following.
a) Inappropriate accounting policies
b) Disagreement as to facts or amounts included in the financial statements.
c) Disagreement as to the manner or extent of disclosure of facts or amounts in the financial
statements.
d) Failure to comply with relevant legislation or other requirements
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Where the auditors disagree with the accounting treatment or disclosure of a matter in the
financial statements, and in the auditors' opinion the effect of that disagreement is material to the
a) the auditors should include in the opinion section of their report
i) a description of all substantive factors giving rise to the disagreement
ii) their implications for the financial statements
iii) Whenever practicable, a quantification of the effect on the financial statements.
b) when the auditors conclude that the effect of the matter giving rise to disagreement is so
material or persuasive that the financial statements are seriously misleading, they should
issue an adverse opinion:
c) in the case of other material disagreements, the auditors should issue a qualified opinion
indicating that it is expressed except for the effects of the matter giving rise to the
disagreement.
1. What are the basic elements of the auditors' report?
………………………………………………………………………………………………………
……………………………………………………………………………………….
2. Write down a description of the directors' responsibilities, which should be included in the
financial statements?
………………………………………………………………………………………………………
………………………………………………………………………………………………………
……………………………………………………………………………………….
3. What will the judgment of whether the financial statements show a true and fair view entail?
………………………………………………………………………………………………………
………………………………………………………………………………………………………
……………………………………………………………………………………….
4. When will a qualified opinion be issued?
………………………………………………………………………………………………………
………………………………………………………………………………………………………
……………………………………………………………………………………….
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5. What is the effect of a limitation of scope on the audit report?
………………………………………………………………………………………………………
………………………………………………………………………………………………………
……………………………………………………………………………………….
6. When should the auditors' report be dated?
………………………………………………………………………………………………………
………………………………………………………………………………………………………
……………………………………………………………………………………….
SUMMARY
Generally Accepted Auditing standards require the auditor to state explicitly whether in the
auditors' opinion the annual financial statements have been properly prepared in accordance with
GAAP and in particular whether a true and fair view is given.
The main elements of an unqualified audit report are:

- a title identifying the addressee
- an introductory paragraph identifying the financial statements audited
- sections dealing with
o responsibilities of directors and auditors
o basis of auditors' opinion
o a clear statement of opinion
Auditors may qualify their audit opinion on the grounds of disagreement or limitation of scope;
these may be material or fundamental.
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Table of Contents page

Chapter One: Auditing -an overview ...........................................................................................1

1.1. Origin and meaning of Auditing..............................................................................2

AIMS AND OBJECTIVES

(i) Control mechanism – audits whether important control mechanisms for

(ii) To resolve conflict of interest between management and the owners.

(iii) To reduce damaging Consequences – Even though, the function of accounting is to

1.1.3. Internal Auditing

1.2 DISTINCTION BETWEEN ACCOUNTING VS AUDITING

1.3.2 Compliance Audits

1.3.3 Operational Audits

1.4.2 Standards of Field Work

Auditing in Ethiopia could be viewed in five main areas.

1. Assertion - are presentation or declaration, typically made by the management of entity.

AIMS AND OBJECTIVES

The work of an independent auditor is to express an objective opinion on financial statements of

Can you identify the ethics of auditors?

Standard of Qualification for Admission

Standard Conduct of Behavior

Level of Status Recognition

2.4 LEGAL LIABILITY OF AUDITORS

The following table summarized the auditor's legal liability.

Fraud: is defined a misrepresentation by a person of a material fact, known by that person to be

Privity: is the relationship between parties to a contract.

Breach of contact: is failure of one or both parties to a contract to perform in accordance

2.5 AUDITORS LIABILITY TO THEIR CLIENT UNDER COMMON LAW

2.6 AUDITORS LIABILITY TO THIRD PARTIES UNDER COMMON LAW

Check Yourr Progress Exercise

- A person is ineligible to act as auditor if he is an employee or officer or has various other

Number Can you Yes No

3.1 AUDIT EVIDENCE

Sufficient appropriate evidence should be obtained by such means as inspection, observation,

3.3 SUFFICENT COMPETENT EVIDENTIAL MATTER

Audit evidence is a fundamental concept in auditing. Audit evidence consists of underlying

The principal types of corroborating information areas follow:

3.5 EVIDENCE ABOUT ACCOUNTING ESTIMATES

c) Enquires and Confirmation

Analytical procedures are the analysis of relationships.

Sufficient Appropriate audit evidence

Check Your Progress Exercise

AIMS AND OBJECTIVES

After studying this unit, you should be able to:

Internal control has attained greatest significance in large-scale business organizations.

5.1 THE MEANING OF INTERNAL CONTROL

Internal controls may be incorporated within computerized accounting systems. However

Administrative and Accounting control

5.3 CONTROL ENVIRONMENT

5.5 CONTROL ACTIVITEES

a) The orderly and efficient conduct of its business

Detailed Internal Control Objectives

ELEMENTS OF INTERNAL CONTROL

Competent and Trustworthy Personnel

Adequate Segregation of Duties

Separation of Operational Responsibility from Record Keeping Responsibility

Proper Procedures for Authorization

Specific authorization has to do with individual transactions. Management is often unwilling to

Physical Control over Assets and Records

An essential characteristic of persons performing internal verification procedures is

The second standard of fieldwork states:

6.2 STATICAL VS NON-STATICAL SAMPLING