CHAPTER I

THE NATURE AND SCOPE OF AUDIT AND

ASSURANCE SERVICES

By Yoseph T(MSc)
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 LEARNING OUTCOMES

After studying this chapter, you should be able to:

▪ Distinguish the relationships among auditing, attestation, and

assurance services.

▪ Describe the general nature, and concepts of auditing, and its

historical development.

▪ Identify different types of audits and auditors

▪ Objectives of Auditing and Scope of Auditors

▪ Explain the demand for and economics of auditing.

▪ Articulate limitation of an auditing

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 1.1. Nature and Scope of Auditing, Attest and Assurance Services

 We live in a time there is a great need for the information

available for decision makers to be reliable, credible, relevant,
and timely.
 High quality information is necessary to make informed
decisions.
 This need for relevant and reliable financial information creates a
demand for auditing and assurance service.
 Auditing and assurance services play important role in ensuring
the reliability, credibility, relevance, and timeliness of both
private and public enterprise business information.
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 1.1. Nature and Scope of Auditing, Attest and Assurance Services

 Many times these terms are used interchangeably because, at a

general level, they encompass the same process: the evaluation of

evidence to determine the correspondence of some information to
a set of criteria, and the issuance of a report to indicate the
degree of correspondence.
 These services are presented from the most detailed (auditing)to

the most general (assurance).

 Auditing services are a subset of attest services, which, in turn,

are a subset of assurance services.

 Figure1-2 below shows the relationship among auditing, attest,
and assurance services.
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 1.1. Nature and Scope of Auditing, Attest and Assurance Services

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 1.1. Nature and Scope of Auditing, Attest and Assurance Services

▪ Assurance services is a broader term than auditing and a attest

services about various representations of management.
▪ Extending auditors’ activities to assurance services allows the
auditor to report not only on the reliability and credibility of
information but also on the relevance and timeliness of that
information.
▪ “Assurance services are independent professional services that
improve the relevance, credibility, and reliability of information or
quality of its context for decision makers”.

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 1.1. Nature and Scope of Auditing, Attest and Assurance Services

▪ Assurance services are valued because the assurance provider is

independent and perceived as being unbiased with respect to the
information examined.

▪ Assurance engagement means an engagement in which a

practitioner expresses a conclusion designed to enhance the
degree of confidence of the intended users other than the
responsible party about the outcome of the evaluation or
measurement of a subject matter against criteria’ (IFAC, 2004a:
150).

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 1.1. Nature and Scope of Auditing, Attest and Assurance Services

▪ According to IFAC, the subject matter, & its information, of

assurance engagement can take many forms, such as:
I. Financial performance or conditions(e.g. historical or prospective
financial position, financial performance and cash flows) for which
the subject matter information may be the recognition,
measurement, presentation and disclosure represented in
financial statements;
II.Non-financial performance or conditions (e.g performance of an
entity) for which the subject matter information may be a key
indicator of efficiency and effectiveness;
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 1.1. Nature and Scope of Auditing, Attest and Assurance Services

III. Physical characteristics (e.g., capacity of a facility) for which the

subject matter information may be a specifications document;

IV. Systems and processes (e.g., an entity’s internal control or IT

systems) for which the subject matter information may be an
assertion about effectiveness;

V. Behaviour (e.g., corporate governance, compliance with

regulation, human resources practices) for which the subject
matter information may be a statement of compliance or a
statement of effectiveness.

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 1.1. Nature and Scope of Auditing, Attest and Assurance Services

▪ CPAs can provide several levels of assurance when performing

assurance services.

▪ The common levels of assurance are described as follows:

a) Reasonable Assurance

b) Review level assurance

c) Agreed-upon procedures

d) Compilation without assurance

▪ Assurance can be categorized into attestation and non-

attestation services.
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 1.1. Nature and Scope of Auditing, Attest and Assurance Services

▪ Attestation services always involve a report that goes to a third

party and the narrowest service is an audit of f/statements.

▪ An attestation service is a type of assurance service in which the

CPA firm issues a report about the reliability of an assertion that is
made by another party.

▪ An attestation is the process of providing assurance service in

which the public accountant issues a report about the reliability of
any information provided by one party to another.

▪ Financial statements can be considered a specialized set of

assertions, and Auditing is a specific form of attestation.
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 1.1. Nature and Scope of Auditing, Attest and Assurance Services

▪ An attestation, in a general sense, is an expert’s communication

of a conclusion about the reliability of someone else’s assertion.

▪ The examples of attestation services are;

✓ Audit of historical financial statements

✓ Audit of internal control over financial reporting

✓ Review of historical financial statements

✓ Attestation services on information technology

✓ Other attestation services that may be applied to a broad range

of subject matter
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 1.1. Nature and Scope of Auditing, Attest and Assurance Services

▪ Attest services occur when a practitioner is engaged to issue . . . a

report on subject matter, or an assertion about subject matter,
beyond f/ information that is the responsibility of another party.
▪ The audit of f/statements can be considered an attestation
examination which providing high but not absolute assurance on
assertions made to another party.
▪ An audit of financial statements is a form of attestation service in
which the auditor issues a written report expressing an opinion
about whether the financial statements are free of material
misstatements.
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 1.1. Nature and Scope of Auditing, Attest and Assurance Services

▪ The assurance engagement in the form of audit of financial

statements gives investors and creditors confidence in their
decision-making process.

▪ Table 1–2 summarizes the relationships among auditing, attest,

and assurance services.

▪ Note that the definitions included in Table 1–2 progress from very
specific for auditing services to very general for assurance
services.

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1.1. Nature and Scope of Auditing, Attest and Assurance Services

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1.1. Nature and Scope of Auditing, Attest and Assurance Services
▪ Non-Assurance Services

▪ Professional accountants perform other engagements that are

not assurance engagements, such as the following:

➢ Accounting (Bookkeeping)&Compilation services

➢ Tax services.

➢ Management Consulting Services

▪ Figure1-3 below, reflects the r/ship between assurance and non-

assurance services.

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1.1. Nature and Scope of Auditing, Attest and Assurance Services

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 1.2. Definition and Nature of Auditing
▪ The word auditing is derived from the latin word ‘Audire',
meaning 'to hear'.

▪ Auditing is 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.

▪ It is the accumulation and evaluation of evidence about

information to determine and report on the degree of
correspondence between the information & established criteria.
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 1.2. Definition and Nature of Auditing
▪ It is a form of attestation service in which the auditor issues a
written report expressing an opinion about whether the
f/statements are in material conformity with GAAPs/ IFRSs or
other recognized criteria.

▪ From the above definitions it is possible to understand that

auditing has the following attributes:

I.It is a systematic process:- Auditors use logical, structured and

organized steps and procedures to examine accounting records
and other documents of an organization.

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 1.2. Definition and Nature of Auditing
II. It involves task of objectively obtaining and evaluating evidence:-
Auditors form opinion based on evidences examined and
evaluated without bias and prejudice.
III. Auditing is conducted by competent and independent person:-
An auditor is required to have the essential skill and experience
and has to be independent to avoid bias.
IV.The auditor acts as an independent third party: engaged by the
principal to assess the information provided by the agent and
report on the fairness of the financial statements.
V. It involves communicating the results to interested users: The
auditor’s
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By Yoseph T are communicated to Saturday,
users; May 3,i.e.
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 1.2. Definition and Nature of Auditing
V. It involves communicating the results to interested users: The
auditor’s findings are communicated to users; i.e. stockholders,
management, creditors, governmental agencies, and the public
which is the final stage in the auditing process.

▪ Indeed, the definition of auditing encompasses both an

investigative process and a reporting process.

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 1.3. Evolution of Auditing
▪ It was recognized many years ago whenever fiduciary relationship
with financial implications existed, there was a need for outsiders
with independence & objectivity to review the accounts of
stewardship expressing opinion as to their honesty or otherwise.

▪ Modern auditing has developed since the concept of a company

as a separate legal entity came into existence which led to the
separation of ownership from management and a consequent
need to safeguard the interests of the owners, (the shareholders)
who in all but where owners and directors were one (the same)
were not involved in the decisions made by the management.
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 1.4. Demand for Auditing
▪ The fundamental underlying reason for why there is demand for
an independent auditor to report on financial statements is
“Different interests may exist between the company preparing
the statements and the parties using the statements”.
▪ “Why do organizations request an audit?"
▪ The answer to this question can be found in the economic
relationships that exist within and between the organization, and
other parties that have a vested interest in the organization
among the major ones are; control mechanism, conflict of
interest, consequences, remoteness and regulatory requirements
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 1.5. Objectives of Auditing and Scope of Auditors
▪ The objectives of auditing is classified in to two depends upon the
purpose of appointment.

▪ Primary Objective:- to respect to the owners of the business

expressing opinion whether account exhibits true and fair view of
the state of affairs of the business.

▪ Secondary Objective:- the secondary objective of auditing is

detection and prevention of errors and frauds.

▪ It is not the main objective of the auditor to discover frauds and

irregularities, but if he/she finds anything of a suspicious nature,
he/she should propel it to the full.
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 1.5. Objectives of Auditing and Scope of Auditors
▪ In determining whether financial statements are ‘fairly stated’ or
‘give a true and fair view’ in accordance with specified criteria,
the auditor performs appropriate tests to determine whether the
statements contain material errors or other misstatements and
has responsibility to express an opinion on the authenticity of the
accounts and overall f/statements prepared in accordance with
an identified financial reporting framework.

▪ However, he/she has no power to take action against anybody, in

this regard it is said that “an auditor is a watch dog but not a
blood hound”.
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 1.5. Objectives of Auditing and Scope of Auditors
▪ Hence the overall objectives of every audit engagement can
include four basic aims:
➢ To evaluate whether financial statements and accompanying
footnotes are in accordance with specified criteria;
➢ To evaluate the effectiveness and appropriateness of internal
control systems over financial reporting;
➢ To evaluate the possibility of fraud occurring within the
organization;
➢ To evaluate the likelihood that the organization will continue as a
going concern.
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 1.6. Types of Audits and Auditors
▪ Audit may be classified in various ways:

1.The primary beneficiary of the audit

➢ Internal audit and

➢ external audit

2.The primary objectives of the audit

➢ Financial statement audits,

➢ Compliance audits,

➢ Operational audits and

➢ Forensic audits.
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 1.6. Types of Audits and Auditors
▪ Internal Audit:-is an audit conducted by internal auditor who is
employee of an organization into any aspect of its operation or it
may be performed by personnel from an outside source (such as
an accounting firm when the service is outsourced.).

▪ Internal auditors work focuses on investigation and appraisal of

the effectiveness of the company operations for management.

▪ Internal auditing is an independent, objective assurance and

consulting activity designed to add value and improve an
organization's operations.

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 1.6.Types of Audits and Auditors
▪ Internal audit has the following objectives.
➢ To comment on the effectiveness of the internal control system.
➢ To verify correctness accuracy and authenticity of the records
presented to management.
➢ To facilitate early detection of errors and frauds.
➢ To ensure that standard accounting practices are followed.
➢ To ensure that assets are properly acquired, safeguarded and
accounted for.
➢ To investigate in the areas as requested by the management.
➢ To see that exhibited liabilities are valid.
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 1.6. Types of Audits and Auditors
▪ Advantages of internal Audit
➢ Makes the system of IC more effective and efficient.
➢ Makes the auditor’s work simpler.
➢ Errors and frauds are detected early.
➢ Increases accountability of employees.

▪ Disadvantages of internal Audit

✓ Its not suitable for small organizations.
✓ The regular work of the organization will be affected.
✓ The auditor may lose the line of work if he does not complete his
work in a visit.
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 1.6. Types of Audits and Auditors
▪ External Audit: is an audit performed by external auditors for
parties external to the auditee. Experts, independent of the
auditee and its personnel, conduct these audits

▪ The best known and most frequently performed external audits

are statutory audits and public sector entities financial
statements. Compliance audits conducted by Customs office and
the Inland Revenue are also examples of external audits.

▪ The primary reason why publicly-traded corporations follow the

practice of having external auditor is to enhance auditor
independence from the management of the corporation.
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 1.6. Types of Audits and Auditors
Internal Audit External Audit
1. Conduct by an internal auditor is a 1. Conduct by a professional auditor
regular employee of the company. appointed by shareholders or by govt
outside of the auditee.
2. Duties and rights of the auditor 2. The scope of audit work liabilities,
determined by management. and duties etc are stated by concerned
statutes.
3. It’s not compulsory. 3. It is compulsory for all companies.
4. An auditor acts as advisor to the 4. He is independent of the
management. management.
5. Internal Auditor ensures that the 5. The internal auditor comment on the
system of accounting is efficient. true and fair view of business.
6. reports to the management. 6. reports to the shareholders.
7. is a continuous process. 7. It is a periodic process.
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 1.6. Types of Audits and Auditors
▪ Based on the primary objectives of the audit, CPA’s functions can
be classified into the following types audits.
▪ Financial statement audit:- is conducted to evaluate whether the
financial statements give true and fair view of or fairly represent
in accordance with specified criteria such as GGAPs or
international accounting standards.
▪ Its result report to shareholders, creditors, regulatory agencies

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 1.6. Types of Audits and Auditors
▪ Compliance Audit:- is conducted to evaluate whether the auditee
is following specific procedures, rules, or regulations set by some
higher authority for their financial or operating activities of an
entity.
▪ Evaluating whether accounting personnel are following the
procedures pre scribed by the company controller.
▪ Review wage rates for compliance with minimum wage laws.
▪ Examine contractual agreements with bankers and other lenders
to be sure the company is complying with legal requirements are
examples of compliance audit.
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 1.6. Types of Audits and Auditors
▪ Results of compliance audits are typically reported to
management, rather than outside users, because management is
the primary group concerned with the extent of compliance with
prescribed procedures and regulations.
▪ The primary objective of compliance testing in a financial
statement audit is to determine whether Internal controls are
functioning as designed.

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 1.6. Types of Audits and Auditors
▪ Operational Audit: also called a performance audit or a
management audit evaluates the efficiency and effectiveness of
any part of an organization’s operating procedures and methods.
▪ Apply to the organization as a whole or to a segment of the
organization, such as subsidiary, division or department.
▪ In operational auditing, the reviews are not limited to accounting,
it include the evaluation of organizational structure, computer
operations, production methods, marketing, and any other area in
which the auditor is qualified and conducted for the purpose of
identifying areas for cost savings.
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 1.6. Types of Audits and Auditors
▪ In operational audits, an overall assessment of the organization is
performed, and this information is inserted into the following
year's strategic plans.
▪ Operational auditing is not a type of performance audits instead it
is more like management consulting than what is usually
considered auditing.
▪ Consultant audits are performed to determine the maturity of a
company in the quality pursuit and to help identify areas to be
addressed in future quality plans.

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 1.6. Types of Audits and Auditors
▪ Forensic Audit:- is conducted to find out the detection or
deterrence of a wide variety of fraudulent activities.
▪ Some examples where a forensic audit might be conducted:
➢ Business or employee fraud,
➢ Criminal investigation,
➢ Shareholder or partnership disputes,
➢ Business economic losses and
➢ Matrimonial disputes (divorce proceedings).
▪ CPAs perform three primary types of audits, as illustrated with
examples in Table 1-2:
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 1.6. Types of Audits and Auditors

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 1.6. Types of Audits and Auditors
▪ Basically, auditors are divided into independent/external auditors
and internal auditors.
▪ Depending on the skills they possess and the activities they
conduct, auditors can also be commonly classified as:
▪ Certified Public Accounting Firms
▪ Government Auditors both Government Accountability Office
(GAO)and Internal Revenue Agents.
▪ Forensic Auditors: are employed by corporations, government
agencies, public accounting firms & consulting and investigative
services firms.
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 1.6. Types of Audits and Auditors
▪ The concept which means that the auditors should not
automatically assume that their clients are honest, but that they
(the auditors) must have a questioning mind and a persistent
approach to evaluating evidence for possible misstatements is
known as professional skepticism.
▪ Claims regarding the condition of the business organization and in
terms of its operations, financial results, and compliance with
laws and regulations, are referred to as management assertions.

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 1.6. Types of Audits and Auditors
▪ The management assertion related to valuation of transactions
and account balances would include all of the following:
✓ Accurate in terms of dollar amounts and quantities
✓ Supported by detailed evidence
✓ Correctly summarized
▪A type of assurance services that involves accumulating and
analyzing support for the information provided by management is
called an Audit.
▪ The main purpose of an audit is to assure users of the financial
information about the: accuracy &completenessofthe information
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 1.7. Economics of Auditing
▪ To illustrate the need for auditing, consider the decision of a bank
officer in making a loan to a business.
▪ This decision will be based on such factors as previous financial
relationships with the business and the financial condition of the
business as reflected by its financial statements.
▪ If the bank makes the loan, it will charge a rate of interest
determined primarily by three factors:
▪ Risk-free interest rate. This is approximately the rate the bank
could earn by investing in treasury notes for the same length of
time as the business loan.
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 1.7. Economics of Auditing
▪ Business risk- This risk reflects the possibility that the business will
not be able to repay its loan because of economic or business
conditions, such as inflation/ recession, poor management
decisions, or unexpected competition in the industry, increased
tax, employees strike and so on.
▪ Information risk. Information risk reflects the possibility that the
information upon which the business risk decision was made was
inaccurate.
▪ Auditing has no effect on either the risk-free rate or business risk,
but it can have a significant effect on information risk.
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 1.7. Economics of Auditing
▪ As society becomes more complex, decision makers are more
likely to receive unreliable information.
▪ There are several reasons for this and ae known as the causes of
information risk,
➢ Biases and Motives of the Provider (conflict of interest);
➢ Voluminous Data (consequences);
➢ complexity; and
➢ remoteness.

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 1.7. Economics of Auditing
▪ Biases and Motives of the Provider (conflict of interest) is the
context of agency theory which mean that management has more
information about the entity's true financial position than do the
absentee owners (i.e. stockholders).
▪ In accordance with the consequences condition, information can
have substantial economic consequences for decision-makers and
the users of financial information will attach greater importance
to satisfying themselves as to the quality of information received.
▪ Auditing can be viewed as a ‘detection mechanism’, that reduces
consequences information risk.
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 1.7. Economics of Auditing
▪ When financial data become more complex and the process by
which it is turned into information becomes more complicated,
the users of information will find it increasingly difficult to satisfy
themselves as to the quality of the information being received.
▪ The presence of an external auditor provide the assurance to the
users as to the quality of the information.
▪ Remoteness defines the conditions under which users of financial
information are frequently prevented from directly assessing the
quality of information received caused by legal or institutional
barriers.
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 1.7. Economics of Auditing
▪ After comparing costs and benefits, business managers and
financial statement users may conclude that the best way to deal
with information risk is simply to have it remain reasonably high.
▪ There are three main ways to reducing information risk:
➢ User verifies information
➢ User shares information risk with management
➢ Audited financial statements are provided.
▪ Figure 1-2 illustrates the relationships among the auditor, client,
and financial statement users.

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 1.7. Economics of Auditing

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 1.8. Limitations of Auditing
▪ So far, we have seen the economic benefits of an audit in access
to reliable information , low cost of capital - the reduced
information risk, deterrent to inefficiency and fraud and control
and operational improvements (recommendations for
improvement, an audit the following limitations:
▪ Reasonable Cost: a limitation on the cost of an audit results in
selective testing, or sampling, of the accounting records and
supporting data.

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 1.8. Limitations of Auditing
▪ Reasonable Length of Time: usually there is a time constraint, and
this may affect the amount of evidence that can be obtained
concerning subsequent events, and the time may not be sufficient
to resolve uncertainties existing at the statement date.
▪ Alternative Accounting Principles and estimates: accounting
principles and estimates are inherent part of the accounting
process; thus uncertainties exist. An audit cannot add exactness
and certainty to financial statements when these factors do not
exist.

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 End of Chapter-I

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