CHAPTER TWO

The Auditing Profession

BY
REDWAN KELIL
 OUTLINE
The Regulatory Framework
Governing Auditing
International Standards on Auditing
(ISA)
Professional Ethics: Fundamental
Principles, Threats and Safeguards
Legal Liability of Auditors
Rights and Duties, Appointment,
Dismissal and Resignation of an
Auditor
 The Regulatory Framework
Governing Auditing
• Auditing is governed by the regulatory
framework that outlines the common duties of
auditors, both internal and external, and their
specific powers.
• International Auditing and Assurance
Standards Board (IAASB).
• The objective of the IAASB is to serve the
public interest by setting high-quality auditing,
assurance, and other related standards and by
facilitating the convergence of international
and national auditing and assurance
standards.
 ISA – 200
OVERALL OBJECTIVES OF THE
INDEPENDENT AUDITOR AND
THE CONDUCT OF AN AUDIT
 Scope of this ISA
• This International Standard on Auditing
(ISA) deals with the independent
auditor’s overall responsibilities when
conducting an audit of financial
statements in accordance with ISAs.
• It sets out the overall objectives of the
independent auditor.
• ISAs are written in the context of an
audit of financial statements by an
auditor.
 An Audit of Financial Statements

• The purpose of an audit is to

enhance the degree of confidence of
intended users in the financial
statements.
• An audit conducted in accordance
with ISAs and relevant ethical
requirements enables the auditor to
form that opinion. (Ref: Para. A1)
 An Audit of Financial Statements

• The financial statements subject to audit are

those of the entity, prepared by management
of the entity with oversight from those
charged with governance.
• ISAs do not impose responsibilities on
management.
• ISAs require the auditor to obtain reasonable
assurance about whether the financial
statements as a whole are free from material
misstatement, whether due to fraud or error.
 An Audit of Financial Statements
• The concept of materiality is applied by
the auditor both in planning and
performing the audit.
• by the size or nature of a misstatement,
or a combination of both.
• The ISAs require that the auditor exercise
professional judgment and maintain
professional skepticism throughout the
planning and performance of the audit.
• " skepticism implies unwillingness to
believe without conclusive evidence.
 Overall Objectives of the Auditor
In conducting an audit of financial
statements.
• (a) To obtain reasonable assurance about
whether the financial statements as a
whole are free from material misstatement,
whether due to fraud or error.
• (b) To report on the financial statements,
and communicate as required by the ISAs,
in accordance with the auditor’s findings.
• the ISAs require that the auditor disclaim
an opinion or withdraw (or resign) from the
engagement.
 Requirements
• The auditor shall comply with
relevant ethical requirements,
including those pertaining to
independence, relating to financial
statement audit engagements.
 Independence
• The concept of independence refers
both to the state of mind of the
auditor and independence in
appearance.
• The independence of the auditor
from the entity whose financial
statements are subject to audit
safeguards the auditor’s ability to
form an audit opinion without being
affected by influences.
 Financial Interests
Self Interest Advocacy
Intimidation

Indirect Financial Interest

Direct Financial Interest  When family members other than
 When a partner/shareholder/Staff
close family members of
&/or their close family member
partner/shareholder/Staff own
owns shares in client company
shares in client company
Safeguard
If the person who owns the share
is the partner/shareholder and Safeguard
his/her close family of the firm How material is the
Reject the engagement investment/financial interest?
Sell the shares before the If material consider it as a
engagement direct investment and take
similar measures
If the person who owns the shares If its immaterial consider the
is a staff member and his/her ignore it as it will not affect
close family independence
Remove the staff from the audit
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team
 Professional Skepticism
• The auditor shall plan and perform
an audit with an attitude of
professional skepticism recognizing
that circumstances may exist that
cause the financial statements to be
materially misstated.
 Professional Judgment
• The auditor shall exercise
professional judgment in planning
and performing an audit of financial
statements.
Sufficient Appropriate Audit
Evidence
• In order to obtain reasonable
assurance, the auditor shall obtain
sufficient appropriate audit evidence
to be able to draw reasonable
conclusions on which to base the
audit opinion.
• Reasonable assurance is obtained
when the auditor has thereby
reduced audit risk to an acceptably
low level.
 Audit Risk
• Audit risk is the risk that the auditor
expresses an inappropriate audit opinion
when the financial statements are materially
misstated. This risk is a function of the risks
of material misstatement and detection risk.
• Detection risk relates to the nature, timing,
and extent of the auditor’s procedures that
are determined by the auditor to reduce
audit risk to an acceptably low level.
• Detection risk cannot be reduced to zero
because of the inherent limitations of an
audit.
 Inherent limitations of an
audit
• Financial Reporting and Business Processes:
There are certain limitations inherent in
financial reporting and business processes
that neither the entity nor the auditor can
overcome.
• Internal control, no matter how well designed
and operated, can only reduce, but not
eliminate, risks of material misstatement.
• The Nature of Audit Evidence and Procedures.
• Timeliness of Financial Reporting and the
Balance between Benefit and Cost
 Conduct of an Audit in
Accordance with ISAs
• The auditor shall comply with all ISAs
relevant to the audit. An ISA is
relevant to the audit when the ISA is
in effect and the circumstances
addressed by the ISA exist.
• In exceptional circumstances, the
auditor may judge it necessary to
depart from a relevant requirement
in an ISA.
 IESBA Code
• The International Ethics Standards Board
for Accountants (IESBA) develops ethical
standards and guidance for use by
professional accountants.
(a) Integrity;
(b) Objectivity;
(c) Professional competence and due care;
(d) Confidentiality; and
(e) Professional behaviour.
 IESBA Code
(a) Integrity: the quality of being honest and
having strong moral principles
(b) Objectivity: Objectivity is an unbiased mental
attitude that allows internal auditors to perform
engagements in such a manner that they
believe in their work product and that no quality
compromises are made.
(c) Professional competence and due care: “attain
and maintain professional knowledge and skill at
the level required to ensure that a client or
employing organisation receives competent
professional service” and to avoid harm to
another.
 IESBA Code
• (d) Confidentiality: means preserving
authorized restrictions on access and
disclosure, including means for protecting
personal privacy and proprietary information.
• Confidential information may be disclosed
when disclosure is authorized by the client,
required by law, or where there is a
professional duty or right to disclose
(e) Professional behaviour: means that
Members should act in a manner consistent
with the good reputation of the Institute and
the profession.
 LENDING

A auditor is prohibited from getting into a loan transaction with

client Why?
SELF INTEREST
FAMILIARITY
ADVOCACY
INTIMIDATION
Safeguard :-
Avoid any loan transaction with a client unless its under normal
lending procedure ,i.e., normal interest rate ,loan period,
collateral etc.

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 EMPLOYMENT OF
IMMEDIATE AND CLOSE
FAMILY
A case where MEMBERS.
family member/friend of the audit partner is in a
position that affect financial statements(chief executive
officer/accountant ect)

Potential Threats
 Familiarity
 Self Interest
 Intimidation
Safeguards
 Remove the partner/staff ,with kinship/friendship, from the
audit team.

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 JOINT CLOSELY HELD
INVESTMENTS WITH A
CLIENT
A case where an auditor and its client jointly own a company

XYZ Co.
Auditor Client
Jointly Owned
Company

Threat:- Self Interest, Intimidation, Advocacy

Safeguard:-Ensure that investment of client is no more than 5%
of total asset/Earning Before Interest and Tax of client

25
Litigation Between CPA Firm
and Client

A lawsuit or intent to start a lawsuit between

a CPA firm and its client, the ability of the
CPA firm and client to remain objective
is questionable.

5-26
Bookkeeping and Other Services

Bookkeeping
Consulting and other non- audit services
 Unpaid fees

5-27
 Unpaid Fees
Interpretations indicate that independence is considered
impaired if billed or unbilled fees remain unpaid for professional
services provided more than one year before the date of the
report. Such unpaid fees are considered a loan from the auditor
to the client and are therefore a violation of independence.
Unpaid fees from a client in bankruptcy do not violate
independence.
Threat
Self interest, Advocacy, Intimidation
Safeguard
Collect any outstanding payments before
starting a new engagement

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 Partner Rotation

The Sarbanes-Oxley Act requires that

the lead and concurring audit partner
rotate off the audit engagement
after a period of five years.

5-29
 Why People Act Unethically

The person’s ethical standards are different

from those of society as a whole.

The person chooses to act selfishly.

5-30
 Rationalizing
Unethical Behavior

 Everybody does it

 If it’s legal, it’s ethical

 Likelihood of discovery and consequences

5-31
 ISA – 250
CONSIDERATION OF LAWS AND
REGULATIONS IN AN AUDIT
OF FINANCIAL STATEMENTS
 Legal Liability
• There are many stakeholders who
rely on audited financial statements:
the client actual and potential
stockholders, vendors, bankers and
other creditors, employees,
customers, and the government.
 Legal Liability
1. Liability to Clients
• The legal action can be for breach of
contract, or for negligence.
• PwC settlement to Tyco
2. Liabilities to Third Parties
3. Criminal Liability
• Arthur Andersen,
4. Liabilities as Members of Professional
Accounting Organizations.
Legal Terms Affecting
CPAs’ Liability

Terms related to negligence and fraud:

Ordinary negligence

Gross negligence

Constructive fraud (unusual)

Fraud

4-35
Protecting Individual CPAs
from Legal Liability

Qualified
Honest Clients
Personnel

Follow
Maintain
Professional
Independence
Standards

4-36
 Protecting Individual CPAs
from Legal Liability
 Deal only with clients possessing integrity

 Maintain independence

 Understand the client’s business

 Perform quality audits

 Document the work properly

 Exercise professional skepticism

4-37
 Protecting Individual CPAs
from Legal Liability


Carry adequate insurance

Seek legal counsel

Choose a form of organization with limited liability

4-38
 General Standards

1. Adequate training and proficiency

2. Independence in mental attitude

3. Due professional care

2-39
 Standards of Field Work

1. Proper planning and supervision

2. Understanding of the entity

3. Sufficient appropriate evidence

2-40
 Standards of Reporting

1. Statements prepared in accordance with IFRS

2. Circumstances when IFRS not followed

3. Adequacy of disclosures

4. Expression of opinion on financial statements

2-41
 Additional Resource
Reading Material
Arens , Elder and Beasley, Auditing and Assurance Service, Global Edition, 16th
Edition, 2016

IAASB – 2018 – HB – Vol .I

•ISA 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with International Standards on Auditing (Page 76 – 104)

•ISA 250, Consideration of Laws and Regulations in an Audit of Financial Statements

(Page 206 -224)

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