Summary Principles of Auditing, Hayes, Wallage & Gortemaker
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Course
Auditing
Institution
Vrije Universiteit Amsterdam (VU)
Book
Principles of Auditing
The first 12 chapters of Principles of Auditing are summarised based on the learning objectives at the beginning of each chapter. This way of making and reading summaries is more effective because the information serves a purpose, making it easier to store and recall.
Principles of Auditing Chapter 1 (Summary / Exam Notes)
AUE3761 ASSIGNMENT 1 2020
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Auditing learning objectives (Hayes et al) Patrick Keller
Chapter 1: International Auditing Overview
1. Relate some of the early history of auditing.
Auditing dates back to early Mesopotamian times (3000 bc), ancient Greece, Rome and
China. The focus was on checking if people paid their due taxes. Auditors in Egypt and China
were responsible for supervising the accounts of the emperor. At the end of the Middle Ages,
an attitude of profit maximization emerged among merchants in Italy. Trading upscaled and
as a result communication became more important. Double entry bookkeeping made its
entrance and the separation between provision of capital and managing an organization
developed. Over the centuries, recording and communicating about (financial) business
practices became more and more professionalized and regulated.
2. Discuss some of the audit expectations of the general public.
The public expects more information about a company than their financial statements alone.
Such as:
- Is the company a going concern?
- Is it free of fraud?
- Is it managed properly?
- Is there integrity in its database?
- Do directors have proper and adequate information to make decisions?
- Are there adequate controls?
- What effect do the company’s products and by-products have on the environment?
- Can an ‘unfortunate mistake’ bring this company to its knees?
3. Identify organizations that affect international accounting and auditing.
The IASC is the parent entity of the IASB. The IASB sets accounting standards, known as IFRS.
The EU chose to apply most of IFRS. The EU European Commission (EC) has two ways of
achieving its law objectives:
- Directives must be incorporated into the laws of member states.
- Regulations become EU laws without having to pass through member states.
A company that sets auditing standards is the IAASB, supported by the IFAC. The IFAC
appoints members to the IAASB according to recommendations from the IFAC Nominating
Committee. The nominees must be approved by the PIOB, to make sure that actions taken by
the IAASB are properly responsive to public interest.
4. Name the standards set by International Auditing and Assurance Standards Board (IAASB).
The IAASB issues sets of auditing standards containing essential principles and procedures:
- International Standards on Auditing (ISAs): Standards for auditing historical financial
information
- International Standards on Assurance Engagements (ISAEs): quality control standards for
assurance engagements other than historical financial information.
- International Standards on Quality Control (ISQCs): to be applied to all services falling
under IAASB standards.
- International Standards on Related Services (ISRSs): to be applied on appropriate related
services.
- International Standards on Related Services (ISREs): Standards for reviewing historical
financial information.
,Auditing learning objectives (Hayes et al) Patrick Keller
5. Give an overview of the IFAC International Standards of Auditing (ISA).
200-299 General principles and responsibilities
300-499 Risk assessment and response to assessed risks
500-599 Audit evidence
600-699 Using the work of others
700-799 Audit conclusions and reporting
800-899 Specialized areas
6. Understand the basic definition of auditing in an international context.
An audit is a systematic process of objectively obtaining and evaluating evidence regarding
assertions about economic actions and events to ascertain the degree of correspondence
between these assertions and established criteria, and communicating the results to
interested users.
- Systematic: An audit follows a structured documented plan using various techniques.
- Objectively: An audit is an independent objective evaluation of evidence, without
prejudice.
- Obtaining evidence: The auditor assesses the reliability and sufficiency of data by
studying accounting systems and internal control and carrying out tests of accounting
transactions and account balances.
- Correspondence: The auditor compares assertions (statements) by management to a set
of criteria, such as IFRS or local laws.
- Communicating: The goal of an audit is to communicate the results to interested users
whether the financial statements ‘give a true and fair view’ of ‘present fairly, in all
material respects’ the financial position of the company. The communication of the
auditor’s opinion is an attestation. This attestation is called an audit report in the audit.
The purpose of an audit is to enhance the degree of confidence of intended users in the
financial statements.
7. Distinguish between audit risk and business risk.
The risk of financial statements being materially misstated are considered at two levels: the
overall financial statements might be misstated or the classes of transactions, account
balances and disclosures might be misstated.
The risk of overall misstatement is often related to an entity’s control environment and is
relevant to the auditor’s consideration of fraud. Risks in misstating transactions, account
balances and disclosures help determining the nature, timing and extent of further audit
procedures.
Business risk is the client’s risk of not meeting their objectives/strategies. When a business
risk affects the financial statements (i.e. valuation of materially affected inventory due to
corona crisis), it is called an inherent risk. Inherent risks are a component of audit risks. In
order for an auditor to assess inherent risk, he should be aware of business risks the entity is
facing. Other types of audit risk are control risk (the risk that a company’s internal controls
fail to prevent or detect and correct material misstatements) and detection risk (the risk that
an auditor will not detect a misstatement.
,Auditing learning objectives (Hayes et al) Patrick Keller
8. Differentiate the different types of audits.
There are three types of audits: Audits of financial statements, operational audits and
compliance audits.
- Financial statements: To examine if financial statements give a true and fair view, or
fairly present the financial statements in conformity with specified criteria (like IFRS or
GAAP).
- Operational: Studying a specific unit of an organization for the purpose of measuring its
performance. Effectiveness is the degree to which objectives are met, efficiency is the
measure of how well a company uses its resources to achieve its goals.
- Compliance: To examine whether an organization’s procedures follow a specific set of
procedures, rules or regulations set out by a higher authority.
9. Distinguish between the types of auditors and their training, licensing and authority.
Governmental auditors
Independent external auditors Internal auditors
- Internal auditors are employed by individual companies to investigate and appraise the
effectiveness of company operations for management. They mostly do operational
audits. If they do compliance audits, an external auditor should review their work. They
can be used to provide assistance to external auditors.
- Independent external auditors primarily audit published financial statements of publicly
traded companies, they are typically certified by a professional organization or a
government agency.
- Governmental auditors take up roles of both internal as independent external auditors.
An auditor is academically trained and meets certain licensing requirements. The EU directive
has a minimum experience requirement of three years, in the US that’s only two.
10. Name and categorize the key management assertions.
Management implies or expresses certain representations about classes of transactions,
related accounts in the financial statements. Those are called management assertions. An
auditor’s job is to gather evidence to ascertain the correctness of those assertions. A
categorization of assertions is as follows:
With regards to classes of transactions and event for the period under audit:
- Occurrence: All recorded transactions need to have occurred.
- Completeness: All occurred transactions need to have been recorded.
- Accuracy: Amounts and data from transactions are recorded appropriately.
- Cut-off: All recorded transactions have occurred within the accounting period.
- Classification: All recorded transactions are recorded in the proper accounts.
Assertions about account balances at the period end:
- Existence: All assets, liabilities and equity actually exist.
- Rights and obligations: The entity holds control to the rights of assets and liabilities are
the obligations of the entity.
- Completeness: All assets, liabilities and equity are recorded.
- Valuation and allocation: All assets, liabilities and equity have been properly valuated
and recorded.
Assertions about presentation and disclosure:
- Occurrence and rights and obligations: All disclosed events pertain to the entity.
, Auditing learning objectives (Hayes et al) Patrick Keller
- Completeness: All disclosures that should have been included in the financial statements,
are included.
- Classification and understandability: Financial information is appropriately presented and
described and disclosures are clearly expressed.
- Accuracy and valuation: financial and other information are disclosed fairly and at
appropriate amounts.
11. Give the components of the audit process model.
The audit process model is composed of four phases.
Phase 1: Client acceptance
Objective Determine acceptance by a client and acceptance of a client. Decide on
acquiring new client or continuing relation with an existing one. Decide the
type and amount of staff required.
Procedures 1. Evaluate the client’s background and reasons for the audit
2. Determine whether the auditor is able to meet the ethical
requirements regarding the client.
3. Determine the need for other professionals
4. Communicate with predecessor auditor
5. Prepare client proposal
6. Select staff to perform the audit
7. Obtain an engagement letter
Phase 2: Planning
Objective Determine the amount and type of evidence and review required to give the
client (reasonable) assurance that there is no material misstatement of
financial statements.
Procedures 1. Perform audit procedures to understand the entity and its
environment, including entity’s internal controls.
2. Assess the risks of material misstatements of the financial
statements
3. Determine materiality
4. Prepare the planning memorandum and audit program, containing
the auditor’s response to the identified risks.
Phase 3: Testing and evidence
Objective Test for evidence supporting internal controls and the fairness of the
financial statements.
Procedures 1. Test of controls
2. Substantive test of transactions
3. Analytical procedures
4. Tests of details of balances
5. Search for unrecorded liabilities
Phase 4: Evaluation and reporting
Objective Complete the audit procedures and issue an opinion
Procedures 1. Evaluate governance evidence
2. Perform procedures to identify subsequent events
3. Review financial statements and other report material
4. Perform wrap-up procedures
5. Prepare matters for attention of partners
6. Report to the board of directors
7. Prepare audit report
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