Chapter Two

The Financial
Statement
Auditing Environment

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A Time of Challenge and

Change

1990

2000

During the economic boom of the late

1990s and the early 2000s, accounting
firms aggressively sought opportunities
to market a variety of high-margin
non-audit services to their audit
clients.
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A Time of Challenge and

Change

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A Series of Scandals
Enron

WorldCom
Parmalat
Lernout &
Hauspie

Ahold
Arthur
Andersen
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Regulation
Self-regulation by the profession
versus
government regulation

Stricter regulation and more public

oversight
International Standards on Auditing
more comprehensive
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Auditors Legal Liability

Threat of legal liability:
Main deterrent to auditors
misconduct
Legal doctrines:
Joint and several liability
Proportional liability
Liability caps
Litigation exposure and audit markets:
Concentration
Barriers to entry
Liability reforms
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International Federation of
Accountants (IFAC)

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International Organisations
that Affect the Accounting
Profession
International Federation
of Accountants

International Accounting
Standards Board

IFAC

IASB

International
Organization of
Securities Commissions

International Organization
of Supreme Audit
Institutions

IOSCO
European Union

EU
EU 8th Directive on Statutory
Audits

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INTOSAI
United States
Securities and Exchange Commission
(SEC)
Public Company Accounting Oversight
Board (PCAOB)
Financial Accounting Standards Board
(FASB)
American Institute of Certified Public
Accountants (AICPA)

International Auditing and

Assurance Standards Board
(IAASB): Standards

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Auditing Standards
Auditing standards serve as
guidelines for and measures of
the quality of the auditors
performance.
IAASB issues
International
Standards on Auditing
(ISAs).
IFAC
members
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ISAs are
considered to
be minimum
standards of
performance
for auditors.

General Principles and

Responsibilities
ISA 200 Overall Objectives of the Independent Auditor
and the Conduct of an Audit in Accordance with
International Standards on Auditing
ISA 210 Agreeing the Terms of Audit Engagements
ISA 220 Quality Control for an Audit of Financial
Statements
ISA 230 Audit Documentation
ISA 240 The Auditors Responsibilities Relating to
Fraud in an Audit of Financial Statements
ISA 250 Consideration of Laws and Regulations in an
Audit of Financial Statements
ISA 260 Communication with Those Charged with
Governance
ISA 265 Communicating Deficiencies in Internal
Control to Those Charged with Governance and
Management
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Risk Assessment and

Response to Assessed Risks
ISA 300 Planning an Audit of Financial Statements
ISA 315 Identifying and Assessing the Risks of
Material Misstatement through Understanding the
Entity and Its Environment
ISA 320 Materiality in Planning and Performing an
Audit
ISA 330 The Auditors Responses to Assessed Risks
ISA 402 Audit Considerations Relating to an Entity
Using a Service Organization
ISA 450 Evaluation of Misstatements Identified
during the Audit
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Audit Evidence
ISA 500 Audit Evidence
ISA 501 Audit Evidence Specific Considerations for
Selected Items
ISA 505 External Confirmations
ISA 510 Initial Engagements Opening Balances
ISA 520 Analytical Procedures
ISA 530 Audit Sampling
ISA 540 Auditing Accounting Estimates, Including
Fair Value Accounting Estimates, and Related
Disclosures
ISA 550 Related Parties
ISA 560 Subsequent Events
ISA 570 Going Concern
ISA 580 Written Representations
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Using Work of Others

ISA 600 Special Considerations Audits of
Group Financial Statements (Including the Work
of Component Auditors)
ISA 610 Using the Work of Internal Auditors
ISA 620 Using the Work of an Auditors Expert

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Audit Conclusions and

Reporting
ISA 700 Forming an Opinion and Reporting on
Financial Statements
ISA 705 Modifications to the Opinion in the
Independent Auditors Report
ISA 706 Emphasis of Matter Paragraphs and
Other Matter Paragraphs in the Independent
Auditors Report
ISA 710 Comparative Information
Corresponding Figures and Comparative
Financial Statements
ISA 720 The Auditors Responsibilities Relating
to Other Information in Documents Containing
Audited Financial Statements
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Specialised Areas
ISA 800 Special Considerations Audits of
Financial Statements Prepared in Accordance
with Special Purpose Frameworks
ISA 805 Special Considerations Audits of
Single Financial Statements and Specific
Elements, Accounts or Items of a Financial
Statement
ISA 810 Engagements to Report on Summary
Financial Statements

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Sections in ISAs
Introductory material
Objectives
Definitions
Requirements
Application and other
explanatory material

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Societys Expectations and

the Auditors
Responsibilities
The auditor has a responsibility to plan and
perform the audit to obtain reasonable
assurance about whether the financial
statements are free of material misstatement,
whether caused by error or fraud.
Because of the nature of
audit evidence and the
characteristics of fraud, the
auditor is able to obtain
reasonable, but not
absolute, assurance that
material misstatements are
detected.
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The auditor has no responsibility

to plan and perform the audit to
obtain reasonable assurance
that misstatements, whether
caused by errors or fraud, that
are not material to the financial
statements will be detected.

Ethics, Independence, and

IFAC Code of Ethics for
Professional Accountants
Ethics refers to a system or code of conduct
based on moral duties and obligations that
indicates how we should behave.
Professionalism refers to the conduct, aims,
or qualities that characterise or mark a
profession or professional person. All
professions operate under some type of code
of ethics or code of conduct.
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Ethics, Independence, and

IFAC Code of Ethics for
Professional Accountants
IFAC Code of
Ethics
Conceptual
Framework Approach

Principles
Integrity
Objectivity
Professional competence
and due care
Confidentiality
Professional behaviour
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Application to
specific situations,
including situations
that threaten
independence of
mind or
independence in
appearance

Audit Firms
Audit firms range in size from a single proprietor to
thousands of owners (or partners) and thousands
of professional and administrative staff employees.

Big 4

Mid-Tier

PwC

BDO

Deloitte
EY
KPMG

Grant
Thornton
RSM
Praxity
Baker Tilly
Crowe
Horwath

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National

Local

Annual Global Revenue of

Major Audit Network Firms

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Audit Teams

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Types of Services Offered by

Audit Firms
Assurance Services:
Audit of financial statements, review of financial information, and
other assurance services (e.g. assurance on a entitys reporting
on sustainability performance)
Related Services:
Agreed-upon procedures regarding financial information and
compilation of financial information
Other Services:
Tax services, advisory services, accounting services and
specialised services (e.g. forensic audit)

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Global Practice Mix of

Services by Major Audit
Network Firms (Revenue)

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Types of Auditors
External Auditors

Internal Auditors

Government
Auditors

Forensic Auditors

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Context of Financial
Statement Auditing
The primary context with which an auditor is concerned is the
industry or business of his or her audit client. In other words,
the context provided by the clients business impacts the auditor
and the audit, and is thus a primary component of the
environment in which financial statement auditing is conducted.

How would your concerns about the inventory

account differ for a Computer Hardware
Manufacturer and a Jewellery Store?
What assertions would you be most concerned
about and why?
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A Model of Business
Business organizations exist to create value for their
stakeholders. Due to the way resources are invested
and managed in the modern business world, a
system of corporate governance is necessary,
through which managers are overseen and
supervised.

Board of Directors
Audit
Committee

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A Model of Business
Objectives

Strategies

Processes
(5 broad
categories)

Transactions

Controls

Reports

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A Model of Business
Processes:
Five Components
Financing
Process

Purchasing
Process

Human
Resource
Management
Process
Inventory
Management
Process

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Revenue
Process

An Overview of Business

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Management Assertions
Financial statements issued by
management contain explicit and implicit
assertions.

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Management Assertions
An Example with Inventory
Which specific assertion from the relevant category
is being described in the three examples below?

Account
Balances

Presentation
& Disclosure

Management
asserts that
transactions
related to inventory
actually occurred.

Management
asserts that the
entity owns the
inventory
represented in the
inventory account.

Management
asserts that the
financial
statements
properly classify
and present the
inventory.

Occurrence

Rights and
Obligations

Transactions

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Classification

End of Chapter 2

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