Chapter 2

Auditing Profession

01/30/2024 compiled by Abdulaziz K.

 Introduction
 Auditing standards are general guidelines to aid auditors in
fulfilling their professional responsibilities in the audit of
historical financial statements.
 They include consideration of professional qualities such as
competence and independence, reporting requirements, and
evidence.
 The three main sets of auditing standards are:
1. International Standards on Auditing,
2. U.S. Generally Accepted Auditing Standards
(AICPA auditing standards) for entities other than public
companies, and
3. PCAOB Auditing Standards

01/30/2024 compiled by Abdulaziz K.

 2.1.Generally Accepted Auditing Standards

Standards are authoritative rules for measuring the

quality of performance.
The existence of generally accepted auditing standards is
evidence that auditors are very concerned with the
maintenance of a uniformly high quality of audit work by
all independent auditors
There are 10 Standards, Which fall Into three categories:
1.GENERAL STANDARDS
2.STANDARDS OF FIELDWORK
3.STANDARDS OF REPORTING

01/30/2024 compiled by Abdulaziz K.

 Cont’d
Generally Accepted Auditing
Standards

General Field Work Reporting results

qualifications performance of
and conduct the audit
1. Whether statements were
1. Adequate training and 1. Proper planning and prepared in accordance with
proficiency supervision GAAP

2. Independence in mental 2. Sufficient understanding of 2. Circumstances when GAAP

attitude the entity, its environment, not consistently followed
and its internal control 3. Adequacy of informative
3. Due professional care
3. Sufficient appropriate disclosures
evidence 4. Expression of opinion on
financial statements

01/30/2024 compiled by Abdulaziz K.

 Generally Accepted Auditing Standards
(GAAS) - General Standard
 The General Standard
 "The examination should be performed and the report
prepared by a person or persons having adequate
technical training and proficiency in auditing, with due
care and with an objective state of mind“
 The general standards stress the important personal qualities
that the auditor should possess.
 General Standard therefore emphasizes:
1. Adequate technical training and proficiency as an auditor.
==Competence
2. Independence in mental attitude is to be maintained by the
auditor. ===Objectivity
3. Due professional care is to be exercised===Due
Professional Care
01/30/2024 compiled by Abdulaziz K.
 1. Adequate technical training and
proficiency as an auditor
 The first general standard is normally
interpreted as requiring the auditor to have
formal education in auditing and accounting,
adequate practical experience for the work
being performed, and continuing professional
education.
 Recent court cases clearly demonstrate that
auditors must be technically qualified and
experienced in those industries in which their
audit clients are engaged.
01/30/2024 compiled by Abdulaziz K.
 2. Independence in Mental Attitude
 audit firms are required to follow several practices to increase
the likelihood of independence of all personnel.
 For example, there are established procedures on larger audits
when there is a dispute between management and the
auditors.
3. Due Professional Care
 This means that auditors are professionals responsible for
fulfilling their duties diligently and carefully.
 Due care includes consideration of the completeness of the
audit documentation, the sufficiency of the audit evidence, and
the appropriateness of the audit report. As professionals,
auditors must not act negligently or in bad faith, but they are
not expected to be infallible.
01/30/2024 compiled by Abdulaziz K.
 1. Adequate Planning and Supervision
 The first standard requires that the audit be sufficiently planned to ensure
an adequate audit and proper supervision of assistants.
 Supervision is essential in auditing because a considerable portion of the
field work is done by less experienced staff members.
2. Understand the Entity and its Environment, Including Internal
Control
 To adequately perform an audit, the auditor must have an understanding of
the client’s business and industry.
 This understanding helps the auditor identify significant client business risks
and the risk of significant misstatements in the financial statements.
 For example, to audit a bank, an auditor must understand the nature of the
bank’s operations, federal and state regulations applicable to banks, and
risks affecting significant accounts such as loan loss reserves.
3. Sufficient Appropriate Evidence
 Decisions about how much and what types of evidence to accumulate for a
given set of circumstances require professional judgment.
01/30/2024 compiled by Abdulaziz K.
 Generally Accepted Auditing Standards=Standards of Reporting

 The reporting standards require the auditor to prepare a report on the financial
statements taken as a whole, including informative disclosures.
 The reporting standards also require that the report state whether the statements
are presented in accordance with GAAP and also identify any circumstances in
which GAAP have not been consistently applied in the current year compared with
the previous one.
 The following are the standards:
1. State whether the financial statements are presented in accordance with GAAP
2. Identify circumstances in which such principles have not been consistently applied
3. Informative disclosures are adequate unless otherwise stated in the report
4. Report should clearly state the degree of responsibility being assumed by the
auditors by expressing an opinion or stating that one cannot be expressed, and the
reason therefor

01/30/2024 compiled by Abdulaziz K.

 International Standards
on Auditing=cont’d

 International Standards on Auditing (ISAs)

are issued by the International Auditing and Assurance Standards Board
(IAASB) of the International Federation of Accountants (IFAC).
 ISAs do not override a country’s regulations governing the audit of financial or
other information, as each country’s own regulations generally govern audit
practices.
 Most countries, including the United States, base their auditing standards on
ISAs, modified as appropriate for each country’s regulatory environment and
statutory requirements

01/30/2024 compiled by Abdulaziz K.

AICPA Auditing Standards
 Auditing standards for private companies and other entities in the United States are
established by the Auditing Standards Board (ASB) of the AICPA.
 These standards are referred to as Statements on Auditing Standards (SASs).
Because the ASB has harmonized its agenda with the IAASB, the AICPA auditing
standards are similar to the ISAs,.
 When developing a new SAS, the ASB uses the ISA as the base standard and then
modifies that base standard only when modifications are appropriate for the U.S.
environment.
 If an auditor in the United States is auditing historical financial statements in
accordance with ISAs, the auditor must meet any ISA requirements that extend
beyond the requirements in the AICPA standards.
 The PCAOB now has responsibility for auditing standards for U.S. public
companies, while the ASB continues to provide auditing standards for private
companies and other entities. The AICPA auditing standards are also referred to as
U.S. generally accepted auditing standards (GAAS).

01/30/2024 compiled by Abdulaziz K.

PCAOB Auditing Standards
 The PCAOB initially adopted existing auditing standards
established by the ASB as interim audit standards. In addition, the
PCAOB considers international auditing standards when
developing new standards.
 As a result, auditing standards for U.S. public and private
companies are mostly similar. Standards issued by the PCAOB
are referred to as PCAOB Auditing Standards in the audit reports
of public companies and when referenced in this text, and apply
only to the audits of U.S. public companies.
 International auditing standards as adopted by standard-setting
bodies in individual countries apply to audits of entities outside
the United States.
 AICPA auditing standards are similar to international auditing
standards and apply to the audits of private companies and other
entities in the United States.
01/30/2024 compiled by Abdulaziz K.
 2.3. Auditing Professional Ethics
and legal liability of Auditors

01/30/2024 compiled by Abdulaziz K.

 Profession

A profession can satisfy the following

elements:
A. complex and Specialized of Knowledge
B.Need for public confidence
C.Standard of Conduct of behavior
D.Responsibility to serve the community

01/30/2024 compiled by Abdulaziz K.

 Cont’d
 All recognized professions have developed
codes of professional ethics.
 Professional ethics refer to the basic principles
of right action for the member of a profession.
 Professional ethics may be regarded as a
mixture of moral and practical concepts.
 Thus the professional ethics of an accountant
would signify his behavior towards his fellows
in the profession and other professions and
towards members of the public.
01/30/2024 compiled by Abdulaziz K.
 Professional Conduct
 The fundamental purpose of such codes is to
provide members with guidelines for
maintaining a professional attitude and
conducting themselves in a manner that will
enhance the professional stature of their
discipline.
 The AICPA code of professional conduct
considers the following to be followed by
auditors (accountants) in the conduct of
professional relations with others.
01/30/2024 compiled by Abdulaziz K.
 Cont’d
1. Integrity: - An accountant should be straightforward,
honest and sincere in his approach to his professional
work.
2. Objectivity: - An accountant should be fair and should
not allow bias to override his objectivity. When
reporting on financial statements, which come his
review, he should maintain an impartial attitude.
3. Independence: - When in public practice, an accountant
should both be and appear to be free of any interest
which might be regarded, whatever its actual effect, as
being incompatible with integrity and objectivity.
01/30/2024 compiled by Abdulaziz K.
 Con’d
4. Confidentiality: - A professional accountant should
respect the confidentiality of information acquired in
the course of his work and should not disclose any
such information to a third party without specific
authority or unless there is a legal or professional
duty to disclose. Exception for Confidentiality???
5. Technical standards: - An accountant should carry out
his professional work in accordance with the technical
and professional standards relevant to that work.
6. Professional competence: - An accountant has a duty
to maintain his level of competence throughout his
professional career.
01/30/2024 compiled by Abdulaziz K.
 Cont’d
7. Ethical behavior: - An accountant should conduct himself with a
good reputation of the profession and refrain from any conduct,
which might bring discredit to the profession.
8. Contingent fees: - The AICPA code of professional conduct
prohibits a CPA firm from rendering any professional services on
a contingent fee basis.
9. Responsibilities to colleagues: - The auditor should promote
cooperation and good relations with other members of the
profession.
10. Advertising: - The advertising should not be false or misleading,”
should not contravene “professional good taste,” should not
make “unfavorable reflection on the competence or integrity of
the profession,” and should not” involve a statement the
contents of which” cannot be substantiated.
01/30/2024 compiled by Abdulaziz K.
 Legal responsibility and liability of auditors
 The auditor is responsible for his report. The auditor then has
certain duties to fulfill to the users of the financial statements
that he reports on.
 Responsibilities impose liabilities if things go wrong.
 The auditor can be sued under the following legal concepts.
1. Prudent man concept: - The auditor is responsible for
exercising due professional care, and he is subject to lawsuit if
he fails to do so.
2. Liable for acts of others: - The partners are jointly liable for
civil actions against a partner.
3. Lack of privileged communication: - CPAS do not have the right
under common law to withhold information from the courts
on the grounds that the information is privileged.
01/30/2024 compiled by Abdulaziz K.
 A. Auditors’ liability to their clients
 When auditor’s take on any type of engagement, they
are obliged to render due professional care.
 This obligation exists whether or not it is specifically
set forth in the written contract with the client.
 Thus, auditor’s are liable to their clients for any losses
proximately caused by the auditor’s failure to exercise
due professional care.
 That is to recover its losses, an injured client need only
prove that the auditors were guilty of negligence and
that the auditors’ negligence was the proximate cause
of the client’s losses.
01/30/2024 compiled by Abdulaziz K.
• The most frequent source of lawsuit against CPAs is from clients.
• The suits vary widely including such claims as
 failure to complete an unaudited engagement on the agreed
upon date,
 inappropriate withdrawal from an audit, failure to discover a
defalcation, and breaching the confidentiality requirements of
CPAs.
 A typical lawsuit involves a claim that the auditor did not
discover an employee defalcation (theft of assets) as a result
of negligence in the conduct of the audit.
 The lawsuit can be for breach of contract, a tort action for
negligence, or both. Tort action (wrongful act or damage (not
involving breach of contract) for which an evil action can be
brought) can be based on ordinary negligence, gross
negligence or fraud.
01/30/2024 compiled by Abdulaziz K.
Auditors Defense against Client Suit
• The CPA firm normally one or a combination of four defense mechanisms when there
are legal claims by clients: Lack of duty to perform the service, non negligent
performance, contributory negligence and absence of causal connection.
A. Lack of Duty: Lack of duty to perform the service means that the CPA firm claims there
was no implied or expressed contract.
• For example, the CPA firm might claim that errors were not uncovered because the firm
did a review service, not an audit.
• A common ways for CPA firm to demonstrate a lack of duty to perform the service is by
use of an engagement letter.
B. Non-negligent Performance: For non-negligent performance in an audit, the CPA firm
claims that the audit was performed in accordance with Generally Accepted Auditing
Standards (GAAS).
• Even if there were undiscovered mistakes (errors) or intentional misstatements or
misrepresentations (irregularities), the auditor is not responsible if the audit was
properly conducted.

01/30/2024 compiled by Abdulaziz K.

C. Contributory Negligence: A defense of contributory negligence by the client
means that the CPA firm claims that if the client had performed certain obligations,
the loss would not have occurred.
• For example, suppose the client claims that the CPA firm was negligent in not
uncovering an employee theft of cash.
• A likely contributory negligence defense is the auditor's claim that the CPA firm
informed management of a weakness in the system of internal control that
enhanced the likelihood of the fraud but management did not correct it.
• Management often does not correct the internal control weakness because of
cost considerations, attitude about employee honesty, or procrastinations.
D. Absence of Causal connection: To succeed in an action against the auditor,
the client must be able to show that there is a close causal connection between the
auditor's breach of the standard of due care and the damages suffered by the client.
• For example, assume an auditor failed to complete an audit the agreed- upon
date. The client alleges that this caused a bank not to renew an outstanding loan,
which caused damages.
• A potential auditor defense is that the bank refused to renew the loan for other reasons,
such as the weakening financial condition of the client.

01/30/2024 compiled by Abdulaziz K.

 B. Auditors’ liability to third parties
 Bankers and other creditors or investors who utilize
financial statements covered by an audit report can recover
damages from the auditors if it can be shown that the
auditors were guilty of fraud or gross negligence in the
performance of their professional duties.
 Moreover, the auditors can be held liable for negligence to a
limited class of third parties if the auditors have actual
knowledge of such third parties or if there exists a special
relationship between the auditors and the third parties.
 The clients (plaintiffs) must prove that they sustained losses
that they relied on the audited financial statements, which
were misleading, that this reliance was the primate cause of
their losses, and that the
01/30/2024
auditors were negligent.
compiled by Abdulaziz K.
  Auditors Defense against Third Party Suit

1.Non-negligence performance
2.Lack of duty to Perform the
Services
3.Absence of Causal Connection

01/30/2024 compiled by Abdulaziz K.

 Threats to Principles of Professional Ethics (Independence)

• Independence is potentially affected by different types of threats.

 A. Self-Interest Threat: Occurs when a firm or a member of the assurance team
could benefit from a financial interest in, or other self-interest conflict with, an
assurance client.
 E.g : Potential employment with an assurance client
Contingent fees relating to assurance engagements.
•B. Self-Review Threat: Occurs when
 Any product or judgment of a previous assurance engagement or non-
assurance engagement needs to be re-evaluated in reaching conclusions on the
assurance engagement or
 Member of the assurance team was previously a director or officer of the
assurance client, or was an employee in a position to exert direct and
significant influence over the subject matter of the assurance engagement.

01/30/2024 compiled by Abdulaziz K.

C. Advocacy Threat: Occurs when a firm, or a member of the assurance team, promotes,
or may be perceived to promote, an assurance client’s position or opinion to the point that
objectivity may, or may be perceived to be, compromised. Examples:
 Dealing in, or being a promoter of, shares or other securities in an assurance client; and
 Acting as an advocate on behalf of an assurance client in litigation or in resolving
disputes with third parties.
D. Familiarity Threat: Occurs when, by virtue of a close relationship with an assurance
client, its directors, officers or employees, a firm or a member of the assurance team
becomes too sympathetic to the client’s interests.
E.g A member of the assurance team having an immediate family member or close family
member who is a director or officer of the assurance client;
E. Intimidation Threat: Occurs when a member of the assurance team may be deterred
from acting objectively and exercising professional skepticism by threats, actual or
perceived, from the directors, officers or employees of an assurance client.
Examples:
•Threat of replacement over a disagreement with the application of an accounting principle;
 Pressure to reduce inappropriately the extent of work performed in order to reduce fees.

01/30/2024 compiled by Abdulaziz K.

 The Profession’s Response
to Legal Liability

 Research in auditing

 Standard and rule setting

 Set requirements to protect auditors

 Establish peer review requirements

01/30/2024 compiled by Abdulaziz K.

 The Profession’s Response
to Legal Liability

 Oppose lawsuits

 Education of users

 Sanction members for improper conduct

and performance

 Lobby for changes in laws

01/30/2024 compiled by Abdulaziz K.

 Protecting Individual auditor’s
from Legal Liability

 Deal only with clients possessing integrity

 Hire qualified personnel

 Follow the standards of the profession

 Maintain independence

01/30/2024 compiled by Abdulaziz K.

 Protecting Individual auditor’s
from Legal Liability

 Understand the client’s business

 Perform quality audits

 Document the work properly

 Obtain an engagement and a representation letter

 Maintain confidential relations

01/30/2024 compiled by Abdulaziz K.
 Protecting Individual auditor’s
from Legal Liability

 Carry adequate insurance

 Seek legal counsel

 Choose a form of organization with limited liability

 Exercise professional skepticism/uncertainity

01/30/2024 compiled by Abdulaziz K.

POWERS & DUTIES OF AN AUDITOR

Right of access at all times to books, accounts, and vouchers of the

company
Right to receive notice and attend the general meeting .

Right to receive Remuneration

DUTIES OF AN AUDITOR
Compliance with Audit Standard

Duty to Report Fraud

Duty to sign audit reports

RE-APPOINTMENT OF AN AUDITOR- The retiring auditor shall NOT be re-appointed in the following -
 REMUNERATION OF AUDITORS
The remuneration of the auditor of a company shall be fixed in its
general meeting or in such a manner as may be determined therein:
Provided that the Board may fix remuneration of the first auditor
appointed by it.
The remuneration, in addition to the fees payable to an auditor, include
the expenses incurred by the auditor in connection with the audit of the
company and any facility extended to him but does not include any
remuneration paid to him for any other service rendered by him at the
request of the company.
 PUNISHMENT FOR ACTING IN
FRAUDULENT MANNER
• In case of an audit of a company being conducted by an
audit firm, it is proved that Partner or Partners of that audit
firm have acted in a fraudulent manner in relation to the
company, or its directors or officers, the Civil and Criminal
liability for such an act shall be of the partner concerned of
the audit firm, and of the firm joint and severally. If it is
proved that the partner has acted in a fraudulent manner,
such a partner and firm shall be punishable in accordance
with Section 447.