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HWMP/BBA/Auditing/Chapter 2: Fundamental Concepts in Auditing

2.1 Introduction
2.2 Academic Contribution and Professional Exploration
In the early 1960s two US writers, Mautz and Sharaf, published a highly influential book1 creating a philosophy of auditing.
Mautz and Sharaf used their postulates to develop five primary concepts (ideas) which they regarded as essential to
explaining the processes of auditing:
1) Evidence, 2) Due audit care, 3) Fair presentation, 4) Independence 5) Ethical conduct
Writing in the UK in the 1980s, Flint examined the audit function from the perspective of society generally and asked what
the role of accounting in society was. Flint used these seven postulates as a basis for defining audit as a social
phenomenon. He saw three main branches of audit theory: 1) Authority and independence, 2) Evidence and reporting, 3)
Standards of performance.
In the Netherlands, Limperg in 1932 wrote his Theory of Inspired Confidence. Later, in 1985, he explained that this theory
rested on the opinion that the accountant is obliged to carry out his work in such a way that he does not betray the
expectations which he evokes in the sensible layman.
2.3 Independence
2.3.1 Mautz & Sharaf distinguished between practitioner independence and professionindependence.
a) Practitioner independence = Programming ind + Investigative ind + Reporting ind
Programming independence protects the auditors ability to select the most appropriate strategy for the audit work. Investigative
independence protects the manner in which the auditors implement their planning strategy. Reporting Independence is
essential aspect of the auditors independence that there is direct communication with the shareholders of the company.
b) Profession independence: The profession of auditing is organised through professional bodies. These bodies serve two main
purposes. One is to maintain the highest standards of audit work in serving the client and the public interest but the other is to
serve and protect the interests of their members.
2.3.2 Flints view of independence: He referred to the mental attitude of the individual and to the public belief in independence.
Flint proposed that personal qualities of integrity and strength of character are essential.
2.3.3 Factors affecting independence: IAASB Code of Ethics, 2004
(a) Independence of mind the state of mind that permits the provision of an opinion without being affected by influences that
compromise professional judgment, allowing an individual to act with integrity, and exercise objectivity and professional
skepticism; and
(b) Independence in appearance the avoidance of facts and circumstances that are so significant a reasonable and informed
third party, having knowledge of all relevant information, including any safeguards applied, would reasonably conclude a firm s,
or a member of the assurance team s, integrity, objectivity or professional skepticism had been compromised. (IAASB Code of
Ethics, 2004)
2.3.4 Guidance from the Auditing Practices Board
In the UK an ethical guide for auditors has been issued by the Auditing Practices Board in the form of a series of ethics
statements, taking effect from 2004. (Ethical Standard 1,2,3,4 and 5)
General threats to objectivity are seen in the following matters:
The self-interest threat The self-review threat The management threat The advocacy threat The familiarity or trust threat
The intimidation threat
Safeguards against above threats
Safeguards are provided through professional bodies (code of ethics, training, knowledge, standards, etc.)
ES1 Recommendations are 1) Review of partner 2) Ways of communicating with people who are in charge of governance 3)
Appointment of Ethics Partner 4) Having adequate control policies and procedures which are properly documented and
applied, 5) Rotation of engagement partner and staff, 6) Professional training
2.3.5 Parliamentary legislation
2.3.6 Audit independence and corporate governance The Cadbury and Hampel Committee
2.3.7 Audit committees: The audit committee should comprise at least 3 directors, all non-executive. The audit committee
should keep under review the scope of the audit and the independence and objectivity of the auditors.

2.3.8 European Union


2.3.9 Research findings
2.4 True and Fair View
2.4.1 Meaning of true and fair
True can mean in accordance with the facts.
Fair has many elements, amongst which are: in accordance with expectations; relevance to informational needs;
concordance with accounting purposes; objectivity; freedom from bias; disclosure and materiality.
What is very clear is that there are very different international interpretations of the true and fair requirement.
2.4.2 True and fair within the IAS Regulation
2.4.3 Creating and maintaining the concept of true and fair
2.4.4 Ensuring adherence to the concept of true and fair
2.4.5 Auditors responsibility
2.5 Detecting and Reporting fraud and error
2.5.1 Definitions
Errors are unintentional mistakes. Auditors are primarily interested in the prevention, detection and disclosure of those errors
which are of such a magnitude that they may affect the truth and fairness of the view given by the financial statements.
Fraud involves the use of deception to obtain an unjust or illegal financial advantage.
2.5.2 Directors responsibilities
1) Prepare accounts for each financial year which give a true and fair view of the state of affairs of the company and 2)
safeguard the assets of the company and hence for taking (general and specific) reasonable steps for the prevention and
detection of fraud and other irregularities.
2.5.3 Auditors responsibilities
ISA 240 The auditors responsibility to consider fraud in an audit of financial statements explains that an auditor conducting an
audit in accordance with ISAs obtains reasonable assurance that the financial statements taken as a whole are free from
material misstatement, whether caused by fraud or error.
2.6 The Audit Agenda Programme of the UK Auditing Practices Board
2.6.1 The future development of auditing (Published in 1992)
Redefining the role and scope of audit Enhancing the independence of auditors
Mitigating the effects of litigation
2.6.2 The Audit Agenda (Published in 1994)
Key proposal 1 the future role of auditors and scope of audit, Key proposal 2 objectivity
Key proposal 3 litigation, Key proposal 4 other developments and research
2.6.3 The Audit Agenda Next Steps (Published in 1996): Different responses to key proposals
2.6.4 The Auditors Code
The enduring principles of auditing as outlined in the 1992 and 1994 documents, were encapsulated in The Auditors Code
the nine fundamental principles of independent auditing. The principles are as follows.
1 Accountability, 2 Integrity, 3 Objectivity and independence, 4 Competence, 5 Rigour, 6 Judgement, 7 Clear communication, 8
Association and 9 Providing value
2.7 Audit Expectations
2.7.1 History
The notion of an expectation gap appears to have originated in the
USA in the 1970s when the public became concerned about the inability
of auditors to detect failures and wrongdoings.
2.7.2 The expectations debate
The expectations debate falls into three areas: Audit assurance Audit reporting Audit independence
2.7.3 Auditing Practices Board