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Principles of Auditing

Auditing - Principles governing an Audit - Practice Standards-10 AICPA Generally Accepted Auditing Standards-Types of audit Planning the Audit- Audit of accounts prepared as per US GAAP. Essential planning requirements Internal Control - Nature of internal control, evaluation and audit of internal control. Revenue & Collection Cycle - revenue recognition and the audit risk model to the revenue cycle - "Rogues of Revenue Recognition." Acquisition and Expenditure Cycle cost and expense-related restatements Production & Payroll Cycle Finance & Investment Cycle Completing the Audit - Overview of major events performed in completing the audit examination. Reports on Audited Financial Statements -Report decision trees

CPA- Certified Public Accountant AICPA American institute of CPAs AAA American Accounting Association ASB Auditing Standards Board FASAB - Federal Accounting Standards Advisory board SEC U.S. Securities & Exchange commission

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Introduction: Investors demand useful information in order to make educated decisions with respect to their investments. Information professionals (such as accountants, auditors, and other information assurance providers) help satisfy this demand. Investors depend on information professionals to serve as objective intermediaries who will lend some creditability to the information. This lending of creditability to information is known as Assurance. When the assurance is provided for specific assertions made by management, we often refer to the assurance provided as Attestation. When the assertions are embodied in a companys financial statements, we refer to the attestation as Auditing. The professional literature refers to 3 general types of services that provide assurance. They are Auditing, Attestation and Assurance Services. Many times these terms are used interchangeably as at the general level they encompass the same process. Oxford Dictionary defines Auditing as An examination of records or financial accounts to check their accuracy. The Committee on Basic Auditing Concepts defines Auditing as A systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users. Auditing improves the precision, quality and reliability of information made available to users of financial statements mainly for making investment decisions regarding equities and debt in the financial markets. Audited information helps lower the cost of debt offerings and contributes to greater investor confidence in the information provided. It also ensures that information is reliable, credible, relevant and timely. Auditors gather evidence to determine whether the financial statements are fairly presented in accordance to GAAP Generally Accepted Accounting Principles, and prepare an independent opinion that is shared with third- party users, management and the Board of Directors. Auditors also provide Attestation services on information beyond traditional historical financial information. Attest services occur when a practitioner is engaged to issue or does issue a report on subject matter, or an assertion about subject matter, that is the responsibility of another party.
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Subject matter in the case of attest services can take many forms including prospective information, analyses, systems and processes and behavior. The Special Committee on Assurance Services extended auditing and attests services to include Assurance Services. Assurance services are independent professional services that improve the quality of information or its context for decision makers. It allows the auditor to report not only on the reliability and on credibility of information but also on the relevance and timeliness of that information.

The Relationship among Auditing, Attestation and Assurance

Assurance engagements Attestation Engagements Auditing Engagements

Assurance services are independent professional services that improve the quality of information, or its context, for decision makers. Attestation A report on subject matter, or an assertion about subject matter that is the responsibility of another party. Definition of Auditing: The most general definition of auditing comes from a committee of the American Accounting Association (AAA) as follows: Auditing is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the
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degree of correspondence between the assertions and established criteria and communicating the results to interested parties. In other words, Auditing is the communication and evaluation of evidence about information to determine and report on the degree of correspondence between the information and established criteria. Auditing is a process of collection of evidence for the purposes of Reporting on economic information. Principles governing an Audit: There are certain basic Principles, which underlie every audit. For independent auditors, the criteria largely consist of the Generally Accepted Accounting Principles (GAAP).These principles provide the benchmark against which an auditors performance is evaluated. 1. Integrity, Objectivity and Independence: The auditor should be honest and sincere and objective, i.e., detached, fair and unbiased. 2. Confidentiality: The auditor has to ensure the confidentiality pertaining to his clients. 3. Skills and Competence: The audit should be performed and the report prepared with due professional care by persons who have adequate training in auditing. 4. Reliance on Work performed by others: The auditor has a duty to carefully direct, supervise and review the work delegated to assistants to ensure the work is adequate for his purpose. 5. Documentation: The auditor should document matters, which are important in providing evidence that the audit was carried out in accordance with the basic principles. 6. Planning: Plans should be based on knowledge of the clients business and other things also. 7. Audit Evidence: The auditor should collect sufficient and appropriate quantum of evidence by using the compliance and substantive procedures. 8. Accounting system: An independent financial auditor needs to understand the e accounting system through which the information, on which he has to report, is generated. 9. Audit conclusions and reporting: The auditors report is the end - product of Audit. The purpose of audit is to communicate in an efficient manner. This basis is the established criteria essential for effective communication. For independent auditors, the criteria largely consist of the GAAP.
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Practice Standards: Auditing standards serve as guild lines for and measures of the quality of the auditors performance.
House of GAAP Category (A) (Most authoritative) Category (B) Category (C) Category (D) (Least authoritative) FASB Standards and Interpretations Accounting Principles Board AICPA Accounting Research (APB) Opinions Bulletins (ARBs)

FASB Technical AICPA Industry Audit and AICPA Statements of Position Bulletins Accounting Guides (SOPs) FASB Emerging Issues Task Force AICPA AcSEC Practice Bulletins (EITF) AICPA Accounting Interpretations FASB Implementation Guides Widely recognized and (Q and A) prevalent industry practices

Statements on Auditing standards Issued by AICPA to interpret GAAP

Public Company Accounting Oversight Board (PCAOB) Public Companies

Securities and Exchange Commission (SEC) A federal agency that oversees the conduct of Securities markets

10 AICPA Generally Accepted Auditing Standards (GAAS): The PCAOB adopted 10 GAAS and refers them as the standards of the PCAOB. The standards issued by PCAOB are called Auditing Standards. Generally Accepted Auditing Standards (GAAS): Three General standards Three Standards of Field Work Four Standards of Reporting

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Generally Accepted Auditing Standards (GAAS): Three General standards 1. The audit is to be performed by a person or persons or persons having adequate technical training and proficiency as an auditor 2. In all matters relating to the assignment , an independence in mental attitude is to be maintained by the auditor or auditors 3. Due professional care is to be exercised in the planning of the audit and the preparation of the report. Three Standards of Field Work 1. The work is to be adequately planned and assistants, if any , are to be properly supervised PRACTICE STANDARDS STANDARDS OF FIELDWORK AND STANDARDS OF REPORTING 2. A sufficient understanding of internal Control is to be obtained to plan the audit and to determine the nature, timing, and extent of tests to be GAAS is a set of systematic guidelines used by auditors when conducting audits on companies' performed. finances, ensuring the accuracy, consistency and verifiability of auditors' actions and reports. They 3. Sufficient, competent and have undergone minor changes since then. were developed by the AICPA in 1947evidential matter is to be obtained through inspection, observation, inquires and confirmations to afford a reasonable basis guidelines promulgated by the financial statements The GAAS are broad rules andfor an opinion regarding the AICPA's Auditing Standards Board. CPAs employ GAAS in preparing for and performing audits of a client's financial statements. The under audit.

guidelines include references to the auditor's qualifications (general standards), audit fieldwork (statements of fieldwork), and reporting the audit results (standards of reporting). The broad standards Four Standards of Reporting are backed by detailed interpretative literature. An auditor unable to express an opinion on the financial statements must give reasons. A CPA who does not conduct an examination in accordance 1. The report shall state whether the Code of Professional Ethics and face legal action with GAAS can be held in violation of the AICPA'sfinancial statements are present in by affected parties. accordance with GAAP. By relying on GAAS, auditors can minimize the probability in relation materialpreceding Each consistently observed in the current period of missing to the information. section of the GAAS is littered with requirements that the auditor and the subject company must meet. In short, an period. must adequately plan the audit, be independent of the client at all times, and auditor 3. Informative disclosures in the must present their financial statements in accordance always obtain reliable evidence. The companiesfinancial statements are to be regarded with GAAP, as reasonable adequatereporting, and explicitly disclose all report. information. remain consistent in their unless otherwise stated in the pertinent

2. The report shall identify those circumstances in which have not been

4. The report shall contain either an expression of opinion regarding the financial statements, taken as a whole, or an assertion to the effect that The GAAS are as follows: an opinion cannot be expressed.
General standards Standards of fieldwork Standards of reporting

GENERAL STANDARDS 1. The audit must be performed by a person or persons having adequate technical training and proficiency as an auditor. 2. In all matters relating to the assignment, independence in mental attitude is to be maintained by the auditor or auditors. Manipal University, Dubai Campus Auditing Chapter 1 Page 7 of 14

3. Due professional care is to be exercised in the planning and performance of the audit and the preparation of the report. STANDARDS OF FIELD WORK 1. The work is to be adequately planned and assistants, if any, are to be properly supervised. SAS 108 revised this standard: "The auditor must adequately plan the work and must properly supervise any assistants" 2. A sufficient understanding of internal control is to be obtained to plan the audit and to determine the nature, timing, and extent of tests to be performed. SAS 109 revised this standard as follows: "The auditor must obtain a sufficient understanding of the entity and its environment, including its internal control, to assess the risk of material misstatement of the financial statements whether due to error or fraud, and to design the nature, timing, and extent of further audit procedures." 3. Sufficient competent evidential matter is to be obtained through inspection, observation, inquiries, and confirmations to afford a reasonable basis for an opinion regarding the financial statements under audit. SAS 106 revised this standard: "The auditor must obtain sufficient appropriate audit evidence by performing audit procedures to afford a reasonable basis for an opinion regarding the financial statements under audit." The new standards are in effect for audits of financial statements for periods beginning on or after December 15, 2006.

STANDARDS OF REPORTING 1. The report shall state whether the financial statements are presented in accordance with Generally Accepted Accounting Principles. 2. The report shall identify those circumstances in which such principles have not been consistently observed in the current period in relation to the preceding period. 3. Informative disclosures in the financial statements are to be regarded as reasonably adequate unless otherwise stated in the report. 4. The report shall either contain an expression of opinion regarding the financial statements, taken as a whole, or an assertion to the effect that an opinion cannot be expressed. When an overall opinion cannot be expressed, the reasons therefore should be stated. In all cases where an auditor's name is associated with financial statements, the report should contain a clear-cut indication of the character of the auditor's work, if any, and the degree of responsibility the auditor is taking. OTHER ADDITIONAL FIELDWORK AND REPORTING RESPONSIBILITIES

For financial audits, Government Auditing Standards includes general standards, as well as fieldwork and reporting standards that are in addition to those required by generally accepted auditing standards (GAAS). There are a number of additional Government Auditing Standards fieldwork and reporting responsibilities specifically related to internal control, compliance with laws, regulations, and provisions of contracts or grant agreements, fraud, and abuse. Manipal University, Dubai Campus Auditing Chapter 1 Page 8 of 14

Other additional fieldwork and reporting standards include, among others, those related to audit documentation requirements, audit follow-up, obtaining and reporting the views of responsible officials about findings and planned corrective actions, and report distribution. Reference to the Government Auditing Standards will provide a full description and understanding of these additional fieldwork and reporting standards. A few of these have been discussed below: Audit Documentation Audit documentation related to planning, conducting, and reporting on the audit should contain sufficient information to enable an experienced auditor who has had no previous connection with the audit to ascertain from the audit documentation the evidence that supports the auditors' significant judgments and conclusions. Audit documentation should contain support for findings, conclusions, and recommendations before auditors issue their reports. Considering the Results of Previous Audits and Attestation Engagements Auditors should consider the results of previous audits and attestation engagements and follow up on known significant findings and recommendations that directly relate to the objectives of the audit being undertaken. Reporting Auditors Compliance with Generally Accepted Government Auditing Standards (GAGAS) Audit reports should state that the audit was performed in accordance with GAGAS. Reporting Views of Responsible Officials If the auditors' report discloses deficiencies in internal control, fraud, illegal acts, violations of provisions of contracts or grant agreements, or abuse, auditors should obtain and report the views of responsible officials concerning the findings, conclusions, and recommendations, as well as planned corrective actions. Reporting Privileged and Confidential Information If certain pertinent information is prohibited from general disclosure, the audit report should state the nature of the information omitted and the requirement that makes the omission necessary. Report Issuance and Distribution Government auditors should submit audit reports to the appropriate officials of the audited entity and to appropriate officials of the organizations requiring or arranging for the audits, including external funding organizations such as legislative bodies, unless legal restrictions prevent it. Auditors should also send copies of the reports to other officials who have legal oversight authority or who may be responsible for acting on audit findings and recommendations and to others authorized to receive such reports. Unless the report is restricted by law or regulation, or contains privileged and confidential information, auditors should clarify that copies are made available for public inspection. Non-government auditors should clarify the report distribution responsibilities with the party contracting for the audit and follow the agreements reached.

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CONCLUSION GAAS is a set of systematic guidelines promulgated by the AICPA's Auditing Standards Board. They are used by auditors when conducting audits on companies' finances, ensuring the accuracy, consistency and verifiability of auditors' actions and reports. The guidelines include references to the auditor's qualifications (general standards), audit fieldwork (statements of fieldwork), and reporting the audit results (standards of reporting). A CPA who does not conduct an examination in accordance with GAAS can be held in violation of the AICPA's Code of Professional Ethics and face legal action by affected parties. By relying on GAAS, auditors can minimize the probability of missing material information.

Types of audit: 1. According to Nature of assertion / data (Financial statements audit, operational audit, compliance audit) 2. According to types of auditor (External independent financial statements audit, internal audit, government audit); 1. Financial statements audit: The American Institute of CPAs (AICPA) definition is enough to encompass the main objective of financial audit is: The objective of the ordinary examination of financial statements by the independent is the expression of an opinion on the fairness with which they present, in all material respects, financial positing, results of operations, and cash flows in conformity with GAAP.

Fundamental Concepts
Audit Risk, Materiality, and Evidence

2. Operational Audits:

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Operational auditing refers to study of business operations for making recommendations about the efficient use of resources, effective achievement of business objectives, and compliance with company polices. The goal of operational auditing is to help mangers discharge their management responsibilities and improve profitability. 3. Compliance Audit: A compliance audit determines the extent to which rules, polices, laws, covenant (contract), or government regulations are followed by the entity being audited.

4. Internal Audit: Internal Audit uses a variety of content determinants and formal determinants to identify the appropriate audit method to use for a specific engagement. The Sarbanes Oxley Act required (1) That managements of public companies assert to the effectiveness of their control systems and (2) That auditors of public companies attest to this management assertion. An audit control is not required for private entities. 5. Governmental Auditing: The U.S. General Accounting Office (GAO) is an accounting, auditing, and investigating agency of the U.S.Congress, headed by the U.S. comptroller General. It is conducted primarily about accountability for taxpayers resources, and performance audits are means of seeking to improve accountability for the efficient and economical use of resources and the achievement of program goals. 6. Forensic Audits: A forensic audits purpose is the detection or deterrence of fraudulent activities. Some examples where a forensic audit might be conducted include Business or employee fraud Criminal investigations Shareholder and partnership disputes Business economic losses Matrimonial disputes.
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Types of Auditors:A number of different types of auditors can be identified under the following headings External Auditors:They are often referred to as Independent auditors or CPA. An external auditor may practice as a sole proprietor or as a member of a CPA firm. They are not employed by the entity being audited. They audit financial statements for publicly traded and private companies, partnerships, municipalities, individuals and other types of entities. They may also conduct compliance, operational and forensic audits for such entities. Internal Auditors:Auditors employed by individual companies, partnerships, government agencies; individuals and other entities are called internal auditors. The Institute of Internal Auditors IIA is the primary organization supporting internal auditors. The IIA defines internal auditing as an independent, objective assurance and consulting activity designed to add value and improve an organizations operations. It helps an organization accomplish its objectives by bringing a systematic, disciplines approach to evaluate and improve the effectiveness of risk management, control and governance processes. Internal auditors may conduct financial, internal control, compliance, operational and forensic audits within their organizations. They in some cases may assist the external auditors with the annual financial statement audit. They may also be involved in assurance and consulting engagements for their entities. Government Auditors:They are employed by federal, state and local agencies. They are considered as a subset of internal auditors. At the federal level, 2 agencies use auditors extensively: The Government Accountability Office (GAO) and the Internal Revenue Service (IRS). GAO auditors conduct audits of activities, financial transactions and accounts of the federal government. They also assist Congress by performing special audits, surveys and investigations. The majority of the audits conducted by GAO auditors are compliance and operational audits. The IRS is part of the U.S. Treasury Department. The main activity of IRS auditors is examining and auditing the books and records of organizations and individuals to determine their federal tax liability. IRS audits are typically compliance audits, ensuring that individuals and organizations are complying with federal tax laws. Forensic Auditors:They are employed by corporations, government agencies, public accounting firms and consulting and investigative services firms. They are trained in detecting, investigating and deterring fraud and white-collar crimes. The Association of Certified Fraud Examiners ACFE is the primary organization supporting forensic auditors.
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Regulatory Auditors:They audit for fraud and tax evasion. Their reports can either clear a taxpayers return or claim that additional taxes are due.

Attest Services:Auditors can provide numerous types of attest services. Two examples are as follows, Reporting on Internal Control:Though it is not required, private companies or other entities sometimes ask auditors to provide an attest report on management assertions about the effectiveness of the organizations internal control. Financial Forecasts and Projections:Entities often prepare prospective i.e. forward-looking financial information and request that auditors attest to that information. Financial Forecasts are prospective financial statements that present expected financial results and Financial Projections are prospective financial statements that present financial results for an entity. Assurance Services:They are provided by the Certified Public Accountant CPAs and are governed by either the attest or the consulting standards. Examples of assurance services are Risk Assessment:Organizations that manage risk well are more likely to succeed in an environment marked by ever changing technology and globalization. Auditors can provide assurance on an entitys profile of business risks and can evaluate whether the entity has appropriate systems in place to manage those risks effectively. Performance Measurement:Through performance management services, the accountant can assist a client to understand drivers of the business and to measure their performance. Many organizations ask their auditors to provide assistance in benchmarking their business processes and performance.

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