1.

1 Background of the organization

The Ethiopian Revenues and Customs Authority (ERCA) was established by the proclamation
No. 587/2008 on 14 July 2008, by the merger of the Ministry of Revenue, Ethiopian Customs
Authority and the Federal Inland Revenue Authority for the purpose of enhancing the
mobilization of government revenues, while providing effective tax and Customs administration
and sustainability in revenue collection. Generally the main objective of the establishment of
ERCA was to make more efficient the public revenue generation function by bringing the
relevant agencies under the umbrella of the central revenue collector body.
1.1.1. Vision, Mission and Values of ERCA
Vision: “To be leading fair and modern tax and customs administration in Africa by
2020 that can be financing the Government expenditure through domestic tax revenue.

Mission: “To promote the voluntary compliance of the taxpayers, ensure integrity and develop
the skill of the employees, support modernization, trade and investment facilitation and
harmonization of the taxes and customs administration system, contribute to the economic
development and social welfare through effective revenue collection”.

Values:

 Customer focus service delivery (Trust, Respect, Protect, Support);

 Protect the wellbeing of society;
 Integrity;
 Professionalism; and
 Team working.

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 1.2 Meaning of Audit

The word audit is derived from the Latin word “AUDIRE” which means to hear. Initially
auditor was a person appointed by the owners to check account whenever the suspected fraud, he
was to hear explanation given by the person responsible for financial transactions. Emergence of
joint stock companies changed the approach of auditing as ownership was pestered from
management. The emphasis now is clearly on the verification of accounting data with a view on
the reliability of accounting statement

The international auditing practices committee defines auditing as “the independent examination
of financial information of any entity whether profit oriented or not and irrespective of size/legal
form when such an examination is conducted with a view to express an opinion thereon”.

1.3 Objectives of Auditing.

Auditors are basically concerned with verifying whether the account exhibit true and fair view of
the business. The objectives of auditing depends upon the purpose of his appointment.

 Primary Objective.
The primary objective of an auditor is to respect to the owners of his business expressing his
opinion whether account exhibits true and fair view of the state of affairs of the business.

 Secondary Objective

The following objectives are incidental to the main objective of auditing.

- Detection and prevention of fraud and error
1.4 Demand for Audit:

 Potential conflict of interest between users and preparers of the financial

information can result in biased information – Client management may not be
objective in financial reporting. It may provide impressive but biased, unrealistic, or
misleading financial statements to obtain benefits that it seeks. On the other hand,
financial statement users need unbiased, realistic, or reliable financial statements.
 Remoteness of users – Users do not have access to entity’s records to personally verify
the reliability of the financial information.

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 Complexity of subject matter requires expertise – Expertise is often required for
information preparation and verification. Users of financial statements are not equipped
with the necessary skills, competence, and knowledge of complexities of accounting and
auditing to determine whether the financial statements are reliable.
 Consequence for decision making – Financial statements are used for important
decisions that involve significant amount of money. If a decision is based on misleading
financial information, it could have substantial financial or economic consequences on
decision makers.

1.5 Differences between Accounting and Auditing

 Auditing involves verification of financial statements as to its fairness of presentation

while accounting involves preparation and presentation of financial statements
 Auditing begins when accounting ends. Accounting precedes auditing because without
financial statements there could be no audit of financial statements.
 The end product of the accounting process is a set of financial statements while the
end product of the audit process is an auditor’s report.
 An auditor must be proficient/expert in accounting (since the auditor will use GAAP in
evaluating the fairness of the financial statements) as well as in auditing, specifically, in
accumulation and interpretation of audit evidence. An accountant need not be proficient
in auditing.
 As to frameworks/foundations:
 Accounting – Framework for Preparation of Financial Statements
 Auditing – Framework for Assurance Engagements
 Auditing is governed by generally accepted auditing standards (GAAS) while accounting
is governed by GAAP/IFRS

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1.6 Types of Audit
A. Audit of financial statements : is the objective or independent examination of
financial statements of an entity to enable the auditor to express an opinion on
thereon, that is, whether the financial statements are prepared, in all material
respects, in accordance with an applicable financial reporting framework. An of
financial statements is the type of audit most frequently performed by CPAs (due
to the widespread use of audited financial statements) on a fee basis and for more
than one client. The financial audit is oriented to the past.

Audit of financial statements is sometimes called:

Independent audit because in an audit of financial statements the auditor

is independent of the client subject to audit.
External audit because it is performed by an external auditor who is not
an employee of the client subject to audit.

 Purpose of an Audit of Financial Statements: is to enhance the degree of confidence of

intended users in the financial statements.
 Objective of an Audit of Financial statements: is to enable the auditor to express an
opinion on whether the financial statements are prepared, in all material respects, in
accordance with an identified financial reporting framework.

B. Operational audit
involves a systematic review and evaluation of the specific operating units (or
procedures, methods or activities) of an organization in relation to specified objectives
for the purpose of measuring/assessing its performance in terms of efficiency and
effectiveness of operations, identifying opportunities for improvement and making
recommendations to improve performance (such as introduction of controls to reduce
waste).
 Also called performance audit or management audit
 Example: Evaluation of a company’s computerized accounting system
 Operational audits are usually performed by internal auditors

 An operational audit concerns performance for the future.

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 Objective of operational auditing:

a. To assess performance in terms of efficiency and effectiveness of operations

Efficiency relates to use of its resources, while effectiveness relates to

accomplishing objectives.

(1) Effectiveness – To verify fulfillments of plans and sound business requirements

(2) Efficiency – To determine whether the entity is managing or utilizing its
resources economically and efficiently
b. To identify areas for improvement
c. To develop recommendations to improve performance

C. Compliance audit: a review of an entity’s degree of compliance with

applicable laws and rules/regulations or contracts
 Compliance audits are usually performed by government auditors

Examples:
o compliance of taxpayers with tax law, rules or regulation
o compliance of banks with banking laws, rules or regulations
o compliance of government transactions/expenditures with the requirements of
applicable laws, rules or regulations
1.7 Types of Auditor

a. External / Independent audit: performed by practitioners or independent CPAs who

offer their professional services for a fee to various clients on a contractual basis
 Independent or external auditors are not employees of the client
 External audit complements internal audit

b. Internal audit: audit performed by entity’s own employees known as internal auditors;
internal auditors investigate and apprise the effectiveness and efficiency of operations
and internal controls of the firm
 Internal auditors usually perform operational audits

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  Internal auditors usually focus on improving the efficiency and effectiveness
of their employer,
 they are employed by the entity thus they are not independent.

c. Government auditing: audit performed by government employees whose main concern

is to determine whether persons or entities comply with government laws, rules and
regulations

Scope of government audit: may extend to include:

i) Performance audit (includes (a) program results (effectiveness) audit and (b)
economy and efficiency audit)
ii) Compliance audit

1.8 The AICPA code of professional conduct

The Code states: It is in the public interest and, therefore, required by this Code of Ethics, that
members of assurance teams, firms and, when applicable, network firms be independent of
assurance clients. Independence in auditing means having a position to take an unbiased
viewpoint in the performance of audit tests, analysis of results, and attestation in the audit report.
Since the main product of attestation is the credibility added to financial information by the audit
report, it is essential that the auditor be independent and is perceived as such by the users
of audited financial statements.

Independencerequires:
(a) Independence of mind: The state of mind that permits the provision of an opinion
without being affected by influences that compromise professional judgment, allowing an
individual to act with integrity, and exercise objectivity and professional skepticism.
(b) Independence in appearance: The avoidance of facts and circumstances that are so
significant that a reasonable and informed third party, having knowledge of all relevant
information, including safeguards applied, would reasonably conclude a firm’s, or a member of
the assurance team’s, integrity, objectivity or professional skepticism had been compromised.

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Ethics can be defined broadly as a set of moral principles or values. Ethical behavior is
necessary for a society to function in an orderly manner. It can be argued that ethics is the glue
that holds a society together.

Professional qualification requirements

The term professional means a responsibility for conduct that extends beyond satisfying
individual responsibilities and beyond the requirements of our society’s laws and regulations

The reason for an expectation of a high level of professional conduct by any profession is the
need for public confidence in the quality of service by the profession, regardless of the individual
providing it.

Integrity
A professional accountant should be straightforward and honest in performing professional
services.

Objectivity (No Conflicts of Interest)

The principle of objectivity imposes the obligation on all professional accountants to be fair,
intellectually honest, and free of conflicts of interest.

Confidentiality
Professional accountants have an obligation to respect the confidentiality of information
about a client’s (or employer’s) affairs acquired in the course of professional services
Professional Competence and Due Care

 Professional competence requires a high standard of general education followed by

specific education, training, examination in relevant subjects, and work experience.
 Competence also requires continuing awareness by the professional accountants of
developments in the accountancy profession and adoption of a quality control program.

Publicity
When accountants market themselves and their work, they should:
■ Not use means which brings the profession into disrepute;
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■ Not make exaggerated claims for the services they are able to offer, the qualifications they
possess, or the experience they have gained; and
■ Not denigrate the work of other accountants.

Technical Standards
Professional services should always be carried out in accordance with the relevant technical and
professional standards.

Professional Behavior
An accountant should act in a manner consistent with the good reputation of the profession and
should refrain from any conduct that might bring discredit to the profession
regarding responsibilities to clients, third parties, other members of the accountancy
profession, staff, employers and the general public.

Contingent Fees and Commissions

 An assurance engagement should not be performed for a fee that is contingent on the
result of the assurance work or on items that are the subject matter of the assurance
engagement.

 The accountant should not pay a commission to obtain a client nor should
a commission be accepted for referral of a client or products or services of others to a
third party.

Professional Colleagues
An accountant, particularly one in a management position, should develop and hold his
own judgment in accounting matters, but should deal with differences of opinion between him
and his colleagues in a professional way

Advertising and Solicitation:

 Advertising is the communication to the public of information as to the services or skills

provided by professional accountants in public practice with a view to procuring
professional business.

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  Solicitation is an approach to a potential client for the purpose offering
professional services. When permitted, advertising and solicitation should be aimed at
informing the public in an objective manner and should be decent, honest, truthful and
in good taste
When permitted, advertising and solicitation should be aimed at informing the
public in an objective manner and should be decent, honest, truthful and in good
taste

1.9 Legal responsibility and liability of auditors

Liability to client

 The most common source of lawsuits against CPAs is from clients.

 The suits vary widely, including such claims as failure to complete a non audit
engagement on the agreed up on date, inappropriate withdrawal from an audit, failure to
discover an embezzlement (theft of assets), and breach of the confidentiality requirements
of CPAs.
 Typically, the amount of these lawsuits is relatively small, and they do not receive the
publicity often given to suits involving third parties. A typical lawsuit brought by a client
involves a claim that the auditor did not discover an employee theft as a result of
negligence in the conduct of the audit.
 The lawsuit can be for breach of contract, a tort action for negligence, or both.

Liability to third party

 A CPA firm may be liable to third parties if a loss was incurred by the claimant due to
reliance on misleading financial statements
 Third parties include actual and potential stockholders, vendors, bankers and other
creditors, employees, and customers.
 A typical suit occurs when a bank is unable to collect a major loan from an insolvent
customer and the bank then claims that misleading audited financial statements were

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 relied on in making the loan and that the CPA firm should be held responsible because it
failed to perform the audit with due care.

Liability for the detection of fraud and error

 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.
 The detection and prevention of error and fraud is the management’s responsibility by
designing and implementing appropriate internal control systems.

Legal concepts affecting liability

1 Prudent man concept

There is agreement within the profession and the courts that the auditor is not a guarantor or
insurer of financial statements. The auditor is expected only to conduct the audit with due care,
and is not expected to be perfect.

2 Liability for the acts of others

Generally, the partners, or shareholders in the case of a professional corporation, are

jointly liable for the civil actions against any owner.

3 Lack of privileged communication

CPAs do not have the right to withhold information from the courts on the grounds that the
information is privileged. Confidential discussions between the client and auditor cannot be
withheld from the courts.

1.10 GENERALLY ACCEPTED AUDITING STANDARDS

The broadest guidelines available to auditors are the ten generally accepted auditing standards
(GAAS), which were developed by the AICPA.

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The 10 generally accepted auditing standards fall into three categories:

General standards

 Adequate training and proficiency

 Independence in mental attitude
 Due professional care

Standards of field work

 Proper planning and supervision

 Sufficient understanding of the entity, its environment, and its internal control
 Sufficient appropriate evidence

Reporting standards

 Whether statements were prepared in accordance with GAAP

 Circumstances when GAAP not consistently followed

 Adequacy of informative disclosures

 Expression of opinion on financial statements

Brief explanation of the 10 GAAS standards

General standards

1. Training and Proficiency: - How does the independent auditors achieve “adequate training
and proficiency” required by the first general standard? This requirement is usually
interpreted to mean college and University education in accounting and auditing,
participation in continuing education programs, and substantial public accounting experience.
It fallows that a CPA firm must not accept an audit engagement without first determining that
members of its staff have the technical training and proficiency needed to function
effectively in the particular industry.

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2. Independence in mind : - It states an opinion by an independent public accountant as to the
fairness of the campaigns financial statements should be independent from other parties’
influence. If auditors owned share of stock in a company that they audited, or if they served
as members of the board of directors, they might subconsciously be biased in the
performance of auditing duties. A CPA should therefore avoid any relationship with a client
that would cause an outsider who had knowledge of all the facts to doubt the CPA’S
independence.
3. Due professional Care: - The third general standard requires due professional care in the
conduct of the audit and in the preparation of the audit report. This standard requires the
auditors to carry out every step of the audit engagement in an alert and diligent manner.

Standards of field work

4. Adequate planning and supervision: - It is one of the standards of fieldwork related to

accumulating and evaluating evidence sufficient for the auditors to express an opinion of the
financial statements and adequate planning is essential to a satisfactory audit. The
appropriate number of audits staff of varies level of skill and the time required of each need
to be determined in advance of field work.
5. Sufficient understanding of Internal Control: - An effective internal control structure
provides strong assurance that the client’s records are dependable and that its asset are
protected when auditors find this types of strong internal control. The quantity of other
evidence required is much less than if controls are weak.
6. Sufficient competent evidential matters: - The third standard of field work regards that the
auditors gather sufficient competent evidence to have a basis for expressing an opinion on the
financial statements. The term competent refers to the quality of the evidence.

Standards of Reporting
7. The auditor must state in the auditor’s report whether the financial statements are presented in
accordance with generally accepted accounting principles (GAAP).
8. The auditor must identify in the auditor’s report those circumstances in which such principles
have not been consistently observed in the current period in relation to the preceding period.
9. When the auditor determines that informative disclosures are not reasonably adequate, the
auditor must so state in the auditor’s report.

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10. The auditor must either express an opinion regarding the financial statements, taken as a
whole, or state that an opinion cannot be expressed, in the auditor’s report.

1.11 PLANNING THE AUDIT

The first generally accepted auditing standards of fieldwork requires adequate planning to be
made before auditing is carried out.

The wok is to be adequately planned, and assistants, if any, are to be properly supervised.

Reasons for proper Audit Plan

To enable the auditor to obtain sufficient competent evidence
To help keep audit costs reasonable
To avoid misunderstanding with the client

Audit planning includes the following steps:

Preplan

Obtain background

Information

Obtain information about

client’s legal obligations

Perform preliminary

Analytical procedures

Set materiality, and assess

acceptable audit risk and
inherent risk

Understand internal control and

assess control risk

Develop overall audit plan and audit

program
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Preplan the audit-It involves three things, all of which should be done early in audit.

 First, the auditor decides whether to accept a new client or continue serving an
existing one.
 Second, the auditor identifies why the client wants or need an audit.
 Thirdly, the auditor obtains an understanding with the client about the terms of
the engagements to avoid misunderstandings and staff the engagements.

Client acceptance procedure

i) Obtaining clients-As a starting point, it is essential for an auditor or auditors/audit firms/ to

maintain its integrity, objectivity, and reputation for providing high-quality services. The auditor
should investigate the history of prospective client, including such matters as the identities and
reputations of the directors, officers and major stockholders, financial strength and credit rating
of a prospective client to help assess the overall risk associated with particular business (business
risk).

ii) Submitting a proposal- To obtain the audit, the auditors may be asked to submit a
competitive proposal that will include information on the nature of services that the
firm offers, the qualifications of the firm’s personnel, anticipated fees, and other
information to convince the prospective client to select the firm.
iii) Communication with audit committees- Arrangements for the audit may be made
through contact with the company’s audit committee (if any). An audit committee
must be composed of at least three independent directors. During the course of the
audit the discussions with the audit committee members will focus on:
- Weakness in internal control
- Proposed audit adjustments
- Disagreement with management as to accounting principles
- The quality of accounting principles used by the company
- Indications of management fraud other illegal acts by corporate officer.

Iv). Fee Arrangements

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V) Communication with predecessor auditors

VI) Engagement Letters- The auditors should establish an understanding with the client
regarding the services to be performed, the objectives of the engagement, management’s
responsibilities, auditor’s responsibilities, scope and/or limitations of the engagements and other
related issues.

Obtain background information- An extensive understanding of the client’s business and

industry and knowledge about the company’s operations are essential for doing an adequate
audit. Most of this information is obtained at the client’s premises, especially for a new client.

A. Obtain knowledge about the client’s industry and business-

 First, many industries have unique accounting requirements that he auditor must
understand to evaluate whether the client’s financial statements are in accordance with
generally accepted accounting principles..
 Second, the auditor can often identify risks in the industry that may affect the auditor’s
assessments of accepting audit risk, or even whether auditing companies in the industry is
advisable.
 Thirdly, there are inherent risks that are typically common to all clients in certain
industries. Understanding those risk aids the auditor in identifying the client’s inherent
risks

b) Tour the client plant and offices-A tour of the client’s facilities is helpful in obtaining
understanding of the client’s business and operations because it provides opportunity to observe
operations firsthand and to meet key personnel.

c) Identify related parties-Transactions with related parties are important to auditors because
generally accepted accounting principles require that they be disclosed in the financial statements
if they are material. A related party is defined in SAS-45 as an affiliated company, a principal
owner of the client company, or any other party with which the client

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 d) Evaluate need for outside specialists-when the auditor encounters situations requiring
specialized knowledge, it may be necessary to consult a specialist.

Obtain information about client’s obligations-three closely related types of documents and
records should be examined early in the engagement: corporate charter and bylaws, minutes of
board of directors’ and stockholders’ meetings, and contracts.

Perform preliminary analytical procedures

 Auditors are required to perform analytical procedures while planning the audit to assist
in determining the nature, timing, and extent of auditing procedures.
 Analytical procedures performed during the planning phases enhance the auditor’s
understanding of the client’s business and events occurring since the prior year’s audit.
 Planning analytical procedures also help the auditors identify areas that may represent
specific risks of material misstatements warranting further attention.
 Analytical procedures used in planning are often based on aggregate, companywide data.

Set materiality and assess acceptable audit risk and inherent risk

The scope paragraph in auditors’ reports includes two important phrases that are directly related to
materiality and risk.

Materiality and risk are fundamental concepts that are important to planning the audit and designing
the audit approach. Materiality is a major consideration in determining the appropriate audit report
to issue.

FASB has defined materiality as

The magnitude of an omission or misstatements of accounting information that, in the light of

surrounding circumstances, makes it probable that the judgment of a reasonable person relying on
the information would have been changed or influenced by the omission or misstatement.

There are five closely related steps in setting materiality. These are:

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Step-1: Set preliminary judgment about materiality Planning extent

Step-2: Allocate preliminary judgment about materiality to segments of test

Step-3: Estimate total misstatement in segments

Step-4: Estimate the combined misstatements evaluating results

Step-5: Compare combined estimate with preliminary or revised judgment about materiality

Understand internal control and assess control risk-

To effectively assess internal control for the purpose of reducing planned audit evidence,
auditors need to understand key internal control and control risk concepts.

 A system of internal control consists of policies and procedures designed to provide

managements with reasonable assurance that the company achieves its objective and goals.
 These policies and procedures are often called control especially those controls related to the
reliability of financial reporting , are important to the auditors purpose.

Develop over all audit plan and audit program-

 It deals the last step in the planning phase of audit.

 It is critical step because it results in the entire audit program the auditors plans to follow in
the audit, including all audit procedures, sample size, items to select, and timing.
 It is the process of making correct decisions in both the effectiveness of evidences and the
efficiency of the audit process.

1.12 Audit Evidence

Audit evidence- is the information obtained by the auditor in arriving at conclusions on which their
reports are based.

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  The auditors must gather sufficient competent evidence to provide an adequate basis for their
opinion on the financial statements.
 The audit evidence is intended to assure the users of accounting information that the financial
statements are a credible source of information about the organization.
 The users may not accept the auditor’s opinion on the truth and fairness of financial statements
unless the auditor has collected sufficient competent evidence about the material misstatements.

 Hence, the collection of evidence lies in the heart of the audit.

Hence, the requirement to obtain sufficient competent evidence is reflected in the third standard of
field work that states:

Sufficient competent evidential matter is to be obtained through inspection, observation, inquires, and
confirmation to afford a reasonable basis for an opinion regarding the financial statements under audit.

Audit risk which refers to the possibility that the auditors may unknowingly fail to appropriately modify
their opinion on financial statements that are materially misstated, can be greatly reduced by gathering
evidence.

 One way to gather additional evidence is to increase the extent of the audit procedures.
 However, additional evidence may also be obtained by selecting a more effective audit procedure
or by performing the procedures closer to the balance sheet date.
 The auditor must gather sufficient evidence to reduce audit risk to a low level in every audit and
this concept is reflected in the third standard of fieldwork.
 The evidence collected by the auditor must be sufficient and appropriate.

Assertions for which the evidence is sought-The auditor has to collect appropriate evidence and
evaluate whether it supports the various assertions on which the auditor has to express his
opinion. The nature of assertions for which the auditor collects evidences for an independent
financial audit is the following

1. Existence: the inclusion of an item of asset or liability in the balance sheet implies an assertion by the
preparer that the asset or the liability exists at the date of the balance sheet.
2. Rights and obligations: it is asserted that the assets shown in the balance sheet are the rights of the
organization and liabilities are the obligations on the date of the balance sheet

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3. Occurrence: there is an assertion that the transactions reflected in the financial statements are
occurred during the relevant accounting period and that they pertain to the organization.
4. Completeness: this assertion implies that there are no unrecorded assets, liabilities or transactions.
5. Valuation: this assertion implies that the assets and liabilities are included in the balance sheet are at
an appropriate value i.e. as per the normally accepted bases of valuation.
6. Measurement: this assertion implies that transactions have been recorded at proper amounts and that
revenues and expenses have been allocated to the proper accounting periods
7. Presentation and disclosure: this assertion implies that the disclosure, classification and description
of various item in the balance sheet and in the income statements are in accordance with the generally
accepted accounting standards and relevant statutory requirements

Audit Evidence Decisions

Major decision of an auditor involves determining the appropriate type and amount of evidence. In this
judgment the cost factor should be considered.

The auditors' decisions on evidence accumulation can be broken down in to four sub
decisions:

Which audit procedure to use (Audit Procedure?)

Which sample size to select for a given procedure (Sample Size?)
Which Items to select from population (Items??)
When to perform the procedures (Timing)

1. Audit procedures
It is a detailed instruction for the collection of a type of audit evidence that is to be obtained at some
time during the audit. The instructions should be clearly and specifically stated.

Example: - Obtain cash disbursement journal and compare the payer name, amount, and date on the
cancelled cheque with cash disbursement journal.

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 2. Sample Size
After selection of audit procedure, the decision of how many items to test must be made by the auditor for
each audit procedures.
Example: - If 60,000 checks are recorded in cash disbursement journal, only 400 may be selected.

3. Items to Select

Following the sample size selection, it is necessary to decide which items in the population to test.
Example: - The auditor may see the 400 checks based on random selection, weakly selection, amount etc.

4. Timing
The timing decision is affected by when the client needs the audit to be completed. Also, it can be
affected by the auditors' belief on effective timing for accumulation and the availability of audit staff.
Example:- the auditor often prefer to count inventory up close to the balance sheet dates.

The audit procedure often incorporates the other three sub decisions.
Example: - obtain the October cash disbursement journal and compare the payee, name, amount, and
date on the cancelled cheque with cash disbursement journal for a randomly selected sample of 40
cheque numbers.

NATURE OF EVIDENTIAL MATTER

Evidential matter is any information that corroborates or refutes an assertion.

The two determinants of the persuasiveness of audit evidence are competence and sufficiency.

a) Competence of evidence
 This refers to the extent to which evidence can be believable or worthy of trust; sometimes
reliability is interchanged with competence.

 Competence of evidence deals only with the audit procedures selected.

 It isn't improved by selecting larger sample size or different population items.
 It can be improved only by selecting audit procedures that contain higher quality of
characteristics of competent evidence.

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Characteristics of competent evidence
Relevance: - Evidence must be relevant to specific audit objective.

For example if the auditor is interested to examine sales transaction, the evidences gathered must be
related to sale.

Independence of provider: - Evidences obtained outside the client company is more reliable than
that obtained from with in.

Effectiveness of client's internal control: - Strong internal control systems produce more reliable
evidence than weaker ones.

Auditor's direct knowledge: - Information obtained directly by the auditor through physical
examination, observation and computation are more competent.
Qualifications of individuals providing information
The person who provides information must be qualified to do so. This affects the competence of the
evidence. Examples include communications from banks, attorney that have relationship with business.

Degree of objectivity
Objective evidences are more reliable than subjective. Examples of objective evidence are physical
counts; confirmation from banks on cash balances, adding subsidiaries to check against related general
ledgers etc.
Timeliness
This refers either to when evidence is accumulated or the period covered by the audit. For balance sheet
items it is good if evidence is collected near balance sheet dates. For income statement it is timely if the
sample is taken from the entire period under audit rather than only from part of the period.

b) Sufficiency of evidence

This refers to the quantity of evidence. It is primarily measured by the sample size. The selection of
sample size is determined at least by:

 Auditor's expectations of misstatement

 The strength of client's internal control

In addition to sample size, individual items may affect sufficiency. For example,
Items with larger dollar value

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 Items susceptible to misstatement
Items representative of the population

To sum up, the persuasiveness of evidence is judged by the combined effect of competency and
sufficiency.

In answering the question of persuasiveness, cost consideration must also exist. The objective is to obtain
a sufficient amount of competent evidence at the lowest possible cost.

 TYPES OF AUDIT EVIDENCES

The major types of audit evidences gathered by the auditor during audit are the following:
1. Physical evidence: Actual physical examination or observation provides the best evidence of
the existence of certain assets. The existence of the property may be established through
physical examination. For example, the existence of plant assets, inventory, cash etc can be
verified by the physical examination. It might seem that physical examination of an asset
would be conclusive verification of all assertions relating to that asset. It may not be always
true. Physical verification gives evidence of the existence of the asset to the auditor
2. Documentary evidence: Another types of evidence relied upon by the auditor is the
documents. The worth of the documentary evidence depends on whether the documents are
created within the company (sales invoices) or it came from outside the company (vendors
invoice). Sometimes the documents created within the organization are sent outside for
endorsement and processing and these documents are regarded as very reliable evidence. In
accepting the reliability of the documentary evidence, the auditor should consider whether
the document is of a type that could easily be forged or created in its entirety by a dishonest
employee. The documentary evidence is classified into three categories and they are
a. Documents created outside the organization and transmitted directly to the
auditor- the most reliable documentary evidence consists of documents created by
independent parties outside the organization and transmitted directly to the auditors
without passing through the client’s hands. For example, the verification of accounts
receivable
b. Documents created outside the organization and held by the organization-many of
the externally created documents referred to by the auditors will be in the

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 possession of organization. For example, bank statements, vendor’s invoices and
statements, property tax bills notes receivables etc.
c. Documents created and held within the organization- most documents created
within the organization represent a lower quality of evidence because they circulate
only within the company and do not receive critical review by an outsider. For
example, the sales invoices, shipping notices, purchase orders etc. The degree of
reliance to be placed on documents created and used only within the organization
depends on the effectiveness of the internal control. If the accounting procedures are so
designed that another person must critically review a document prepared by one person
and if all documents are serially numbered and all numbers in the series accounted for,
these documents may represent reasonably good evidence. Adequate internal control
will also provide for extensive segregation of duties so that no one handles a transaction
from beginning to end.
3. Accounting records as evidence: the dependability of ledgers and journals as evidence is
indicated by the extent of internal control covering their preparation. An auditor will attempt
to verify an amount in the financial statements by tracing it back through the accounting
records. They will ordinarily carry this process through the ledgers to the journals and vouch
the item to such basic documentary evidence. To some extent, the ledger and journals
constitute worthwhile evidence in themselves to the auditors
4. Evidence from the analytical procedures: analytical procedures involve evaluations of the
financial statements by a study of relationships among financial and nonfinancial data. The
process of analytical procedures consists of four steps
a. Develop an expectation of an account balance
b. Determine the amount of difference from the expectation that can be accepted without
investigation
c. Compare the account balances with the expected account balance
d. Investigate the significant deviations from the expected account balance
Techniques used in performing analytical procedures range from complex models
involving many relationships and data from many years. For example, comparison of
revenue and expense amounts for the current year to those of the previous years and to
the industries average.

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5. Evidence from computations: to prove the arithmetical accuracy of the client’s records, the
auditor make computations independently as another form of audit evidence. Computations
verify the mathematical processes and used to prove the calculation of the client.
6. Evidence provided by the specialists: since the auditors may not be experts in all the fields
of business of the client, he may get the services of the experts in performing highly technical
tasks such as valuation of inventory, or making the actuarial computations to verify liabilities
for postretirement benefits. The expert should be independent person. If the auditor feels that
the expert is not an independent person, he may perform additional procedures or engage
another specialist.
7. Oral evidence: during the examination of records, the auditor may ask many questions to the
officers and the employees of the organization on the endless topics ranging from the
location of records and documents, the reasons underlying an unusual accounting procedures,
the probabilities of collecting a long past due accounting receivables etc. The answers the
auditor receives to the questions constitute another type of evidence.
8. Evidence from client representation letters: The auditor should get a representation letter
from the client summarizing the most important oral representations made during the
engagement. These letters are dated as the last day of the fieldwork and usually signed by the
chief executive officer and chief finance officer. Most of the representations fall into the
following categories
1. All accounting records, financial data and minutes of the directors meetings have
been made available to the auditors
2. The financial statements are complete and prepared in conformity with the generally
accepted accounting principles
3. All items requiring disclosure have been properly disclosed
The relationship of audit risk and audit evidence

Audit risk-refers to the possibility that the auditors may unknowingly fail to appropriately modify their
opinion on financial statements that are materially misstated. In other words, it is the risk that the auditors
will issue an unqualified opinion on financial statements that contain a material departure from generally
accepted accounting principles. Thus, the more sufficient and competent the audit evidence obtained, the
less will be the audit risk.

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For each financial statement account, audit risk consists of the possibility that

(1) A material misstatement in an assertion about the account has occurred, and
(2) The auditors do not detect the misstatement.

Inherent Risk- The possibility of a material misstatement of an assertion before considering the client’s
internal control is referred to as inherent risk. Factors that affect inherent risk related to either the nature
of the client and its industry or to the nature of the particular financial statements account.

Control risk- The risk that a material misstatement will not be prevented or detected on a timely basis by
the client’s internal control is referred to as control risk. This risk is entirely based on the effectiveness of
the client’s internal control.

Detection risk-The risk that the auditors will fail to detect the misstatement with their audit procedures is
called detection risk.

The bag of sand in the figure represents inherent risk, the susceptibility of an account balance to
material misstatements.

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* The sieves represent the ways by which the client and the auditors attempt to remove the
misstatements from the financial statements.

The first sieve represents the client’s internal control, and the risk that it fails to detect or prevent a
misstatement is control risk.

The auditors’ audit procedures are represented by the second sieve, and the risk that it will fail to
detect a misstatements is detection risk. The risk that the misstatement wills get through both sieve is
audit risk.

Measuring audit risk- In practice, the various components of audit risk are not typically quantified.
Instead, the auditors usually use qualitative categories, such as low risk, moderate risk, and maximum
risk. Statements of Auditing Standards (SAS-47), allows the use of either quantified or non quantified
approach. In any way, the relationships among audit risk, inherent risk, control risk, and detection risk can
be put generally as follows:

AR=IR×CR×DR, where, AR = Audit risk IR = Inherent risk CR = Control risk DR= Detection risk

Procedures to Obtain Evidence

1. Recalculation/ Re performance- redoing calculations already performed by audit personnel
 Mathematical evidence can serve the objectives of both existence and valuation for FS
amounts that result from calculations
2. Observation- consists of looking at how policy or procedures are applied by others
● Provides highly reliable evidence as to performance/conditions at given point of time, but not
over long periods
● E.g. observe data entry procedures, petty cash control procedures, or auditee’s inventory
counting procedures
3. confirmation- and enquiry, usually written, to verify accounting records; direct correspondence
with independent external parties
 Produces evidence on existence, ownership, valuation, and cutoff
○ Positive confirmation: requests a reply in all cases, whether account balance is
considered correct/incorrect
○ Negative confirmation: requests replies only if the account balance is considered
incorrect

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4. Enquiry- generally involves collecting oral evidence from independent parties, auditee officials,
and employees
 Evidence gathered by formal and informal enquiry of auditee personnel generally

5. Inspection- consists of looking at records and documents or at assets with physical substance.
 Procedures are or varying degrees of thoroughness: examining, perusing, reading, reviewing,
scanning, scrutinizing, and vouching
 Physically inspecting tangible assets provides reliable evidence of existence and may give
some evidence of condition, hence valuation, but not on ownership
6. Vouching- Examination of Documents
 Auditor selects item of financial info from an account (e.g. posting of
sales invoice) and goes backward through the accounting and control
system to find the source documentation supporting that item
 Vouching helps auditors decide if all recorded data are adequately
supported (existence/occurrence), but it doesn’t provide evidence
that all events were recorded
 E.g. sales invoice: auditor finds AJE, sales summary, sales invoice
and shipping docs, and customer purchase order
7. Tracing- Examination of Documents
 Auditor selects samples of basic source documents and goes forward
through the accounting and control system to find the final record of the
accounting transaction
 Example, samples of payroll payments are traced to expense accounts,
sales invoices to sales account, cash receipts to A/R accounts, and cash
disp. to A/P
 Auditor can decide whether all events were recorded (completeness) and
compliment the evidence obtained by vouching (some events may have
not been recorded in the accounting system)

8. Analysis- obtaining evidence about FS accounts by methods of study and comparison

Risk assessment and overall conclusion stage of audit, and also when auditors use analysis as
an evidence gathering procedure

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 9. Physical examination is the inspection or count by the auditor of a tangible asset.
This type of evidence is most often associated with inventory and cash, but it is also
applicable to the verification of securities, notes receivable, and tangible fixed assets

1.13 Working paper

Are the materials the auditors prepare or obtain and retain in connection with the performance of
the audit.

 Form and Content of working papers - These are affected by matters such as –
o The nature of the engagement
o The form of auditor's report
o The nature and complexity of the client's business.
o The nature and condition of the client's records and degree of reliance on internal
controls, and
o The need in particular circumstances for direction, supervision and review of
work performed by assistants.

 Preparation of working papers - Following care should taken while preparing for
working papers -

 Working papers should be designed and properly organized

 They should be standardized
 They should be adequately complete and detailed
 All significant matters, which require the exercise of judgment and the auditor's
conclusion as regards them, should be included in working papers.
 The auditor should ensure that the schedules, analysis and other working papers prepared
by the client and utilized in the course of the audit have been properly prepared.
 In case of recurring audits, some working paper files may be classified as permanent
audit files and current audit files.

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 Contents of permanent Audit file –auditors’ files that contain data of a historical or
continuing nature pertinent to the current audit such as copies of articles of incorporation,
bylaws, bond indentures, and contracts
o Information concerning the legal organizational structure of the entity, such as
Memorandum and Articles of Association in case of a company, and relevant
regulations in the case of a statutory corporation.
o Extracts or copies of important legal documents, agreements and minutes relevant
to the audit.
o A record of the study and evaluation of internal controls related to the accounting
system.
o Copies of audited financial statements of previous years.
o Analysis of significant ratios and trends.
o Copies of management letter, issued by auditor, if any:
o Record of communication with the retiring auditor, if any, before the acceptance
of the appointment as auditor.
o Notes regarding significant accounting policies.
o Significant audit observations of earlier years.
o List of officers, their financial powers and authorities.
o List of offices, factories, etc.
 Contents of current audit file all audit files applicable to the year under audit
o Correspondence relating to acceptance of annual reappointment.
o Extracts of important matters in the minutes of Board meetings and general
meetings, as are relevant to audit.
o Evidence of the planning process of the audit and audit programme.
o A record of nature, timing and extent of auditing procedures performed, and the
results of such procedures.

 Ownership of Working Papers

Working papers are the property of the auditor.

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 1.14 Audit Report

Basic elements of an Auditor’s Report

a. Title: It may be appropriate to use the term “Auditor” to distinguish the auditor’s report
from report issued by others.

b. Addressee: The auditor’s report should be appropriately addressed as required by the

circumstances of the engagement and applicable laws and regulations.

c. Opening or Introductory paragraph: The report should identify the financial statements
that have been audited including the date and period covered by the financial statements.
The report should include a statement of responsibility of the entity’s management and of
the auditor.

d. Scope paragraph: The report should describe the scope of the audit by stating that the audit
was conducted in accordance with the auditing standards generally accepted in India. The
report should include a statement that the audit provides a reasonable basis for opinion.

e. Opinion paragraph: The report should clearly indicate the financial reporting framework
used to prepare the financial statements and express an opinion on the true and fair view in
accordance with that financial reporting framework and where appropriate the compliance
with the statutory and or regulatory requirements.

f. Date of the report: The report should be dated as of the completion date of the audit, which
should not be earlier than the date on which the financial statements are signed or approved
by the management.

g. Place of signature: The report should name the specific location which is ordinarily the city
where the audit report is signed.

h. Auditor’s signature: The report should be signed in the name of the firm, the personal
name of the both as appropriate.

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Type of audit report

 An unqualified opinion : should be expressed when the auditor concludes that

the financial statements give a true and fair view in accordance with the financial
reporting framework used for preparation and presentation of the financial
statements.

 Qualified opinion : should be expressed when the auditor concludes that an

unqualified opinion cannot be expressed but that the effect of any disagreement with
the management is not so material and pervasive as to require a adverse opinion, or
limitation on scope is not material and pervasive as to require a disclaimer of
opinion.

 Disclaimer opinion: should be expressed when the possible effect of a limitation

on scope is so material and pervasive
 Adverse opinion: should be expressed when the effect of a disagreement is so
material and pervasive to the financial statements that the auditor concludes that a
qualification of the report is inadequate to disclose the misleading or incomplete
nature of the financial statements.
The auditor is unable to obtain sufficient appropriate audit evidence and is hence unable
to express an opinion on the financial statements.

The results obtained about tax audit up on ERCA-SOUTH REGION branch office which focus

 type of tax audit performed,

 the purpose of audit,
 the audit case selection methods,

The audit program follows a three stage phase;

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  Audit planning,
 execution and
 completion

Audit planning is a vital stage of the audit program primarily conducted

at the beginning of the audit process to ensure that:
a. Potential tax risks are promptly identified.
b. Appropriate attention is devoted to key tax risks.
c. Audit work is completed expeditiously and is properly coordinated.
d. Audit is carried out efficiently and effectively.
e. Adequate and proper resource allocation for the proper conduct of the audit.

Audit execution
Audit execution chronologically follows the audit planning phase. It seeks to implement the audit
plan in order to obtain sufficient and appropriate audit evidence regarding aspects of tax
leakage (risk) identified during planning phase.

The audit execution phase is made up of the following stages:

1) Initiating the tax audit.

2) Entry conference.

3) Audit procedures for obtaining audit evidence and the relevant audit working papers.

4) Communication of preliminary audit findings in the form of queries. These queries will be
cleared based on additional evidence from the taxpayer.

5) Reconciliation and communication of reconciled audit findings with the taxpayer.

Audit completion
Audit completion is the final phase of the audit program and is as important as the audit planning
and audit execution phase. It is at this stage that the audit is concluded notwithstanding that the

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taxpayer may appeal the outcome and will require a review of the audit findings and assessments
thereof.

Exit conference

Upon completion of the field work, the auditors are expected to meet with the taxpayer and
explain the audit procedures and findings with regard to

- i. All records examined;

ii. A detailed description of audit procedures used and audit adjustments supported with
evidence where appropriate;

iii. Minor errors for which no adjustments were made;

iv. Applicable law and procedures; v. Any additional information the taxpayer may provide
within a set time to reduce the tax liability;

vi. Taxpayer’s objection and disagreements with the audit; vii. Proposed tax adjustments;

viii. Payment procedures;

ix. Policies and procedures pertaining to penalty and interest imposition waiver.

At exit meeting, the audit staff are required to document areas of disagreement which originate
from application of tax law, audit procedures and methods used, and the non-availability of
records. Auditors are required to educate the taxpayer as to the proper procedures to follow in
future, and make recommendations on proper reporting methods without attempting to redesign
the taxpayer’s accounting system.

Communicating the final audit findings

After the exit meeting, the audit team is expected to communicate the final audit findings to the
taxpayer in a letter, making reference to the assessment notice issued.

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Tax auditors selection criteria were based on field of study, training and examination as well
as related past experiences. However, Auditors in the branch has a work experience less than five
years and shortage of senior auditors in the branch.

As per the interviews the main reasons for their shortage was:

 workload without additional benefits,

 absence of suitable and free working environment,
 absence of satisfactory allowance for their duties and
 uneven compensation payment for similar field activities and
 Absence of performance based promotion.

The type of audit program performed in ERCA branch office were mostly comprehensive audit
followed by fraud and field audits respectively.

As the result ERCA-LTO tax audit case selection is supported by intelligence input. In addition to that tax
payers are selected based on their associated compliance risk.

Similarly audit case selection is based on taxpayer’s

 high tax potential risk ,

 series tax evasion and fraud are basis for audit tax selection is applicable.

How audit cases are selected

When answering for the question that how audit cases are selected, respondents said;

First the risk time make assessment and select audit file then transfer to the concerned

 Department Cases are selected based on risk selection criteria

 Audit cases are also selected when customers ask for the service

 Based on risk criteria and the request by the tax payers

 Based on the nature of the business activity as well as there is un usual posted material

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  type of tax audit performed,

1.15 Conclusion and Recommendation

1.15.1 Conclusion
 Lack of consistent short term brain-wash PA trainings and low level of salary scales in
organizations.
 The non-cooperation of audit as well as management bodies.
 Auditors‘ reports are not revised promptly and exercised (effected) timely by the concerned
(responsible) body. No management commitment to take proper actions on audit timely after it
gets audit reports.
 Uncompetitive salary payment scale: This can force experienced tax auditors to resign and to
be substituted by new un experienced auditors. Finally it can lead to poor Tax Audit performance
 Insufficient number of Tax Auditor : the number of Tax Auditors done do not match with
that of the number of Tax payers

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Tax Payers Complain : High customer complains to pay tax due to system problem and miss-match
between the number of tax collection staffs and number of tax payers this takes the tax payers two or
three days to pay his tax. Which resulted in customer complain

1.15.2 Recommendation
The primary objective of tax audit should be detection of compliance risk and increase compliance
taxpayers and educate tax payers rather than to assess and collect additional revenues, which should be
the end goal of the objective.

The management of ERCA should increase the number of tax auditors and improve the capability of total
audit staff resources and facilitating both short and long term training schedules based on the gap
identified for any business sectors that help to improve their audit skills.

ERCA should supply sufficient necessary audit materials for auditors to facilitate their work and provide
suitable and free working environment such as fair treatment, by providing different promotional schemes
based on their performance.

To retain the experienced tax auditors, ERCA should investigate the reason for the reassignment from
their position after some years of experience and give appropriate solution for the problem.

The authority should revise the time frame allocation and give more time for complex cases to properly
detect noncompliance and achieve the required audit quality. Giving equal time, 45 days per audit cases,
for all business to be audited might result operational inefficiency including decrease in audit quality and
coverage.

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 Reference

 Minster of revenue (2019) tax Audit manual, Addis Ababa

 A. Arens, & J. Elder, ( 2012 ) Auditing and assurance services: an integrated
approach/
 Ethiopian revenue and custom Authority. (2002 E.C)."Education and public
relations".Hand Book

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 Table of Contents
1.1 Background of the organization .............................................................................................................. 1
1.1.1. Vision, Mission and Values of ERCA ............................................................................................ 1
1.2 Meaning of Audit .................................................................................................................................... 2
1.3 Objectives of Auditing. ........................................................................................................................... 2
1.4 Demand for Audit: .................................................................................................................................. 2
1.5 Differences between Accounting and Auditing ...................................................................................... 3
1.6 Types of Audit ........................................................................................................................................ 4
1.7 Types of Auditor ..................................................................................................................................... 5
1.8 The AICPA code of professional conduct .............................................................................................. 6
1.9 Legal responsibility and liability of auditors .......................................................................................... 9
1.10 GENERALLY ACCEPTED AUDITING STANDARDS .................................................................. 10
1.11 PLANNING THE AUDIT .................................................................................................................. 13
1.12 Audit Evidence.................................................................................................................................... 17
1.13 Working paper..................................................................................................................................... 28
1.14 Audit Report........................................................................................................................................ 30
1.15 Conclusion and Recommendation....................................................................................................... 35
1.15.1 Conclusion ................................................................................................................................... 35
1.15.2 Recommendation ......................................................................................................................... 36

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