Auditing Principles and

Practices
 CHAPTER ONE
UNDERSTANDING THE CONCEPT OF
AUDITING
 1.1. Nature of Auditing

• Auditing is a 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.
• Indeed it is worth to have an additional
explanation on some important phrases such
as:
• Systematic process – this phrase implies there
should be a well-planned approach for
conducting an audit. This technique involves
objectively obtaining and evaluating evidence.
• Conducted objectively – this phrase means an
audit is conducted with an impartial mental
attitude of the auditor. Auditors should be fair
and prejudice or bias shouldn’t override their
objectivity.
• Obtains and evaluates evidence – the
auditor should gather sufficient data from
different sources (such as financial
statements) and evaluates (tests, inquires,
verifies etc) so as to obtain adequate evidence
on the fairness of the statements.
• Assertions about economic actions and
events - The evidence gathered by the
auditor must relate to assertions about
economic actions and events. Assertions are
representations (declarations) made by
management about economic activities.
• 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
• Assets exist,
• The company owns the assts,
• The company uses the assets in the production of
goods and services, and
• This amount represents their un depreciated historical
costs etc
• Established criteria – The Auditor compares the
evidence gathered to assertions about economic
activity.
• The criteria used for this purpose can be
applicable financial reporting framework such as
Generally Accepted Accounting Principles (for
financial statement audit) and local standards –
rules, regulations, policies and procedures etc (for
operational and compliance audits).
• Communicates – lastly, auditing communicates
the results to interested Users, via the type of
report the auditor issues.
 1.2. Auditing Vs Accounting

• Accounting and Auditing are not one and the

same. They have differences. The differences
between them are explained below:
• Firstly, accounting is concerned with the collecting
(recording, classifying), summarizing, reporting
and interpreting of financial data. Auditing, on the
other hand, tests those accounting records
(financial statements) for fairness
(appropriateness).
• Secondly, an accountant only needs to know
generally accepted accounting principles (GAAP).
But, the auditor needs to know GAAP, plus how
to select and evaluate evidence related to the
assertions of financial statements.
• Thirdly, accounting is constructive. It starts with
raw financial data (business transactions) to
process and produce financial statements.
However; auditing is analytical i.e. it starts with
financial statement and works to lend credibility
on their fairness.
 1.3 The importance of Auditing

• There are number of advantages in having

accounts audited, even when there is no legal
requirement for doing so.
• Now people get their account audited by a
professional auditor with a view to run the
business more efficiently.
• Audit is very useful for every business
organization.
• Some of the important advantages are given
below:
• (1) Detection and Prevention of Errors and
Frauds Become Easier: Audit helps us to
detect and prevent the frauds and errors.
Errors and frauds can be located at an early
stage and can be rectified at the initial stage.
• (2) Greater Reliability and Authenticity:
Audited account carry a greater reliability
and authenticity in comparison of un-audited
accounts.
• (3) Up-to-Date Records Available: Where
staff knows that the auditor is going to visit
the organization to conduct audit then
accounts staff keep their records up-to-date.
• (4) Required Information Easily Available:
The up to date records, information required
by the management is always available
without delay when it is demanded or
required.
• (5) Execution of Decision without Delay:
Where reliable information is readily
available, the management is in position to
plan and execute the decision within
appropriate time.
• (6) Acceptability by the Authorities:
Audited accounts are readily acceptable by
the Income Tax, Sales Tax, and other
government departments.
• (7) Professional Advice Available: Where
accounts are audited, management and owner
can get professional advice on various decision
matters such as report on internal control
system of the organization from the auditor
and utilize the same in the present system.
• (8) Speedy Processing of Loan: Financial
institutions consider audited accounts for
speedy processing of loan proposals.
• (9) Settlement of Disputes: In case of
partnership firm, audited accounts are
helpful to settle the disputes between
management and labor unions.
• (10) Safeguard the Interest of various
Parties: Audit safeguards the interest of the
investors, owners, workers, financial
institutions, creditors and different taxation
department of the government.
 1.4 Types of audits and Auditors

• 1.4.1 Types of Audits

• Generally audits can be classified into three
categories. Those are financial statement
audits, compliance audits, and operational
audits. Each of those types of audits is
explained below.
 1. Financial Statement Audit

• This type of audit involves an examination of

financial statements so as express opinion on
their fair presentation.
• That means whether they are presented fairly
in conformity with established criteria. The
criterion, is Generally Accepted Accounting
Principles (GAAP or IFRS).
• In determining whether financial statements
are fairly stated in accordance with
accounting standards, the auditor gathers
evidence to determine whether the
statements contain material errors or other
misstatements.
• The objectives of Audit of financial statement
are:
• To determine whether financial statement
have been prepared in accordance to the
generally accepted accounting principles.
• To ensure the completeness of financial
statement
• To Vouch the existence of recorded
transactions in the financial statement
• To examine the accuracy of the financial
statement
• To ensure that the net income/loss is the
result of the operation for a given accounting
period
• To verify availability of assets recorded in the
balance sheet
 2. Compliance Audits

• A Compliance Audit is conducted to

determine whether the auditee is following
specific procedures, rules, regulations set by
some higher authority.
• Following are examples of compliance audits
for a private business.
• Determine whether accounting personnel are
following the procedures prescribed by the
company controller.
• Review wage rates for compliance with
minimum wage laws.
• Examine contractual agreements with
bankers and other lenders to be sure
company is complying with legal
requirements.
• Results of compliance audits are typically
reported to management, rather than outside
users, because management is the primary
group concerned with the extent of
compliance with prescribed procedures and
regulations.
• Therefore, a significant portion of work of
this type is often done by auditors employed
by the organizational units.
 3. Operational Audits

• Operational audits involve 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, identify areas for improvement,
and develop recommendations.
• Sometimes this type of audit is referred to as
a performance audit or management audit.
1.4.2 Types of Auditors

• Auditors are often viewed as falling into

three main types
• (1) Independent financial auditor/Certified
public Accountant/
• (2) Internal auditors
• (3) Government auditors
1. Independent Auditors

• Independent auditors, also called external

auditors, are either sole practitioners or
members of public accounting firms who
render professional auditing services to
clients.
• They are not employees of the organization
audited. Most independent auditors are
licensed to practice as Certified Public
Accountants (CPA).
2. Internal Auditors

• Internal auditors are employees of the entity

audited who function in a staff (not in line)
capacity.
• These types of auditors are involved in an
independent appraisal activity within an
organization.
• Internal auditors assist management of an
organization to effectively discharge their
responsibilities.
3. Government Auditors

• Auditors employed by different levels of

government (federal, state, local etc) are
known as government auditors.