AUDITING

Chapter : 01
Nature of Auditing: auditing is the accumulation and evaluation of evidence about information
to determine and report on the degree of correspondence between the information and
established criteria. Auditing should be done by a competent, independent person.
Competent, Independent person: The auditor must be qualified to understand the criteria used
and must be competent to know the types and amount of evidence to accumulate in order to
reach the proper conclusion after examining the evidence. The auditor must also have an
independent mental attitude. The competence of those performing the audit is of little value if
they are biased in the accumulation and evaluation of evidence.
Independent auditors: Auditors strive to maintain a high level of independence to keep the
confidence of users relying on their reports. Auditors reporting on company financial
statements are often called independent auditors.
Audit report: The final stage in the auditing process is preparing the audit report, which
communicates the auditor’s findings to users. Reports differ in nature, but all must inform
readers of the degree of correspondence between the information audited and established
criteria. Reports also differ in form and can vary from the highly technical type usually
associated with financial statement audits to a simple oral report in the case of an operational
audit of a small department’s effectiveness.
Distinction Between auditing and accounting: Accounting is the recording, classifying, and
summarizing of economic events in a logical manner for the purpose of providing financial
information for decision making. To provide relevant information, accountants must have a
thorough understanding of the principles and rules that provide the basis for preparing the
accounting information.
When auditing accounting data, auditors focus on determining whether recorded information
properly reflects the economic events that occurred during the accounting period. Because U.S.
or international accounting standards provide the criteria for evaluating whether the
accounting information is properly recorded, auditors must thoroughly understand those
accounting standards.
Economic demand for auditing:
1. Risk-free interest rate: This is approximately the rate the bank could earn by investing in
U.S. treasury notes for the same length of time as the business loan.
2. Business risk for the customer. This risk reflects the possibility that the business will not be
able to repay its loan because of economic or business conditions, such as a recession, poor
management decisions, or unexpected competition in the industry.
3. Information risk: Information risk reflects the possibility that the information upon which the
business risk decision was made was inaccurate. A likely cause of the information risk is the
possibility of inaccurate financial statements.

Chapter: 02
Activities of CPA Firms: CPA firms provide audit services, as well as other attestation and
assurance services. Additional services commonly provided by CPA firms include accounting and
bookkeeping services, tax services, and management consulting and risk advisory services. CPA
firms continue to develop new products and services, such as financial planning, business
valuation, forensic accounting, and information technology advisory services.
Structure of CPA firms: 1. The need for independence from clients. Independence permits
auditors to remain unbiased in drawing conclusions about the financial statements.
2. The importance of a structure to encourage competence. Competence permits auditors to
conduct audits and perform other services efficiently and effectively.
3. The increased litigation risk faced by auditors. Audit firms continue to experience increases in
litigation-related costs. Some organizational structures afford a degree of protection to
individual firm members.
Organizational Structures: Six organizational structures are available to CPA firms.
proprietorship Only firms with one owner can operate in this form. Traditionally, all one-owner
firms were organized as proprietorships, but most have changed to organizational forms with
more limited liability because of litigation risks.
General partnership This form of organization is the same as a proprietorship, except that it
applies to multiple owners. This organizational structure has also become less popular as other
forms of ownership that offer some legal liability protection became authorized under state
laws.
General Corporation The advantage of a corporation is that shareholders are liable only to the
extent of their investment in the corporation. Most CPA firms do not organize as general
corporations because they are prohibited by law from doing so in most states.
professional Corporation A professional corporation (PC) provides professional services and is
owned by one or more shareholders. PC laws in some states offer personal liability protection
similar to that of general corporations, whereas the protection in other states is minimal. This
variation makes it difficult for a CPA firm with clients in different states to operate as a PC.
Limited Liability Company A limited liability company (LLC) combines the most favorable
attributes of a general corporation and a general partnership. An LLC is typically structured and
taxed like a general partnership, but its owners have limited personal liability similar to that of a
general corporation. All of the states have LLC laws, and most also allow accounting firms to
operate as LLCs.
Limited Liability partnership A limited liability partnership (LLP) is owned by one or more
partners. It is structured and taxed like a general partnership, but the personal liability
protection of an LLP is less than that of a general corporation or an LLC. Partners of an LLP are
personally liable for the partnership’s debts and obligations, their own acts, and acts of others
under their supervision. Partners are not personally liable for liabilities arising from negligent
acts of other partners and employees not under their supervision. It is not surprising that all of
the Big Four firms and many smaller firms now operate as LLPs.

Chapter:03
Standard unqualified audit report:
1. Report title: Auditing standards require that the report be titled and that the title include the
word independent.
2. Audit report address: The report is usually addressed to those for whom the report is
prepared, including the company, its stockholders, or the board of directors.
3. Introductory paragraph: The first paragraph of the report indicates that the CPA firm has
performed an audit, which distinguishes the report from a compilation or review report. The
first paragraph also lists the financial statements that were audited, including the notes to the
financial statements as well as the balance sheet dates and the accounting periods covered in
the income statement and statement of cash flows.
4. Management’s responsibility: The report must include the heading “Management’s
Responsibility for the Financial Statements” and a paragraph that describes management’s
responsibility for the financial statements.
5. Auditor’s responsibility: This section must include the heading “Auditor’s Responsibility”
followed by three paragraphs that describe the auditor’s responsibility.
6. Opinion paragraph: This section must include the heading “Opinion” preceding the final
paragraph in the standard report, which states the auditor’s conclusions based on the results of
the audit. This part of the report is so important that often the entire audit report is referred to
simply as the auditor’s opinion.
7. Signature and address of CPA firm: The signature identifies the CPA firm or practitioner who
performed the audit. Typically, the firm’s name is used because the entire CPA firm has the
legal and professional responsibility to ensure that the quality of the audit meets professional
standards. The city and state of the audit firm should also be indicated.
8. Audit report date: The appropriate date for the report is the one on which the auditor
completed the auditing procedures needed to obtain sufficient appropriate audit evidence. This
date is important to users because it indicates the last day of the auditor’s responsibility for the
review of significant events that occurred after the date of the financial statements.

Chapter: 04
What are ethics?
Ethics can be defined broadly as a set of moral principles or values. Each of us has such a set of
values, although we may or may not have considered them explicitly. Philosophers, religious
organizations, and other groups have defined in various ways ideal sets of moral principles or
values. Examples of prescribed sets of moral principles or values include laws and regulations,
church doctrine, codes of business ethics for professional groups such as CPAs, and codes of
conduct within organizations.
Need for ethics: 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. Imagine, for example, what
would happen if we couldn’t depend on the people, we deal with to be honest. If parents,
teachers, employers, siblings, coworkers, and friends all consistently lied, it would be almost
impossible to have effective communication.
Why people act Unethically: Most people define unethical behavior as conduct that differs
from what they believe is appropriate given the circumstances. Each of us decides for ourselves
what we consider unethical behavior, both for ourselves and others. It is important to
understand what causes people to act in a manner that we decide is unethical.
The following are the six core ethical values that the Josephson Institute associates with
ethical behavior: Trustworthiness includes honesty, integrity, reliability, and loyalty. Honesty
requires a good faith intent to convey the truth. Integrity means that the person acts according
to conscience, regardless of the situation. Reliability means making all reasonable efforts to
fulfill commitments. Loyalty is a responsibility to promote and protect the interests of certain
people and organizations.
Respect includes notions such as civility, courtesy, decency, dignity, autonomy, tolerance, and
acceptance. A respectful person treats others with consideration and accepts individual
differences and beliefs without prejudice.
Responsibility means being accountable for one’s actions and exercising restraint.
Responsibility also means pursuing excellence, self-restraint, and leading by example, including
perseverance and engaging in continuous improvement.
Fairness and justice include issues of equality, impartiality, proportionality, openness, and due
process. Fair treatment means that similar situations are handled consistently.
Caring means being genuinely concerned for the welfare of others and includes acting
altruistically and showing benevolence.
Citizenship includes obeying laws and performing one’s fair share to make society work,
including such activities as voting, serving on juries, conserving resources, and giving more than
one takes.
Ethical Dilemmas : An ethical dilemma is a situation a person faces in which a decision must be
made about the appropriate behavior.