ADVANCED AUDITING 2024-2025
Inhoudsopgave
Lecture 1 – Demand for Auditing.....................................................................2
Lecture 2 – Audit risk / Fraud risk....................................................................7
Lecture 3 – Materiality..................................................................................17
Lecture 4 – Ethics & Biases...........................................................................26
Lecture 5 – Overview....................................................................................28
Lecture 6 – Understanding the client: strategic analysis/business processes,
business control........................................................................................... 32
Lecture 7 – Internal control evidence (overview)............................................36
Lecture 8 – Internal control evidence (IT).......................................................40
lecture 9 – Inquiry & analytical evidence........................................................44
Lecture 10 – Substantive evidence................................................................53
Lecture 11 – Aggregating evidence & auditor reporting..................................61
,LECTURE 1 – DEMAND FOR AUDITING
INTRODUCTION OF THE CONCEPT OF AUDITING
Accounting is the process of identifying, recording, classifying, aggregating and
reporting the information that is required for external purposes that has historically been
called generally accepted accounting principles (GAAP). It is the language of business. It
is through accounting that companies prepare their financial statements, communicating
the company’s financial health. And it ensures that stakeholders, whether managers,
investors or regulators, have information to base their decisions on.
The art of making informed decisions. Information should be 1) accurate, 2) reliable, 3)
timely, and 4) comparable. However, the provider of information may get sloppy or
behave in inappropriate ways when they are not the subject to independent scrutiny
(onafhankelijke controle). Stakeholders might not have sufficient expertise to evaluate
the quality of information. So, there is a need for assurance on the information provided.
Assurance;
The AICPA definition: independent professional services that improve the quality of
information for users. The IFAC definition: an engagement in which a practitioner aims to
obtain sufficient, appropriate evidence in order to express a conclusion designed to
enhance the degree of confidence of the intended users other than the responsible party
about the subject matter information.
Attestation is the process of providing assurance about the reliability
of specific information provided by one party to another. It focuses on a
specified assertion that is made in writing. The provider of attestation
does not generate the original information. The attester only adds their
opinion about the reliability of the information.
Auditing is the process of providing assurance about the
reliability of the information contained in a financial report
prepared by management in accordance with generally accepted
principles (=GAAP).
ECONOMICS OF AUDIT DEMAND
Demand by outside intervention: stewardship. Demand arises within the economy:
reliable information/valuation.
Exogenous audit demand is demand which is influenced by factors external to the
economic model or system, such as 1) government intervention, 2) statutory audit, 3)
environment agency requires audit of pollution reports, 4) ministry of health requires
audit of health care declarations by hospitals, and 5) government grant with condition
external audit.
Endogenous audit demand is demand which is influenced by factors within the
economic model or system.
- Agent relation: principal (shareholder) delegates decision-making to agent
(manager).
- Agency theory: conflicts of interests due to differences in incentives and
information asymmetry between two parties in a transaction.
2
, o Moral hazard: the agents’ actions not observed yet incentivized (work
hard/shirk = verwijst naar het fenomeen waarbij werknemers of managers
minder moeite doen dan nodig is of zich niet volledig inzetten voor hun
taken, in de verwachting dat hun onderpresteren niet zal worden
opgemerkt).
o Adverse selection: principal cannot observe the quality of the firm (lemon
= verwijst naar producten of diensten van lage kwaliteit die worden
gepresenteerd als producten van goede kwaliteit. In accountancy en audit
betekent een "lemon" dat een organisatie of financiële rapportage van
slechte kwaliteit kan zijn, maar dit wordt niet altijd direct herkend door
investeerders of auditors vanwege een gebrek aan volledige of eerlijke
informatie).
An independent audit is a high-quality report that ensures the truth about the agents’
hard work.
Theory of the firm: a firm is a nexus of contracts (Coase). Different contractual
arrangements provide different incentives for opportunistic behavior.
Enforcing of contracts:
- Bonding: commitments/guarantees that agents make to align their interests with
those of the principals.
- Monitoring (audit): to detect and prevent any deviations from agreed-upon
behaviors or objectives.
Agency cost:
Watts & Zimmerman (1983)
History of auditing
- 1200s, merchant guilds
o Bonding: alderman oath of all profits
o Monitoring: audit of expenses
o Auditors: committee of guild members
o Independence: fine and reputation
- 1500s, regulated companies
o Bonding: treasurer statement of receipts
o Monitoring: audit
o Auditors: committee of members
o Independence: fine and reputation
- 1600s, joint stock companies
o Bonding: sureties and guarantees by officers
o Monitoring: audit
o Auditors: committee of shareholders and directors
o Independence: fine and reputation
3
, - 1900s, professionalization
o 1844: UK companies act – required directors to keep accounts and required
those accounts to be audited by persons other than the directors,
incorporating into the law a version of a practice that had existed for 600
years.
Hypothesis: committees of auditors survived because they had efficient methods of
monitoring contracts between managers and those supplying capital.
- 1900s, professionalization of auditing
o The complexity of accounts, legal liability of directors, and the size and
number of corporations increased in the latter half of the 19th century.
o Government regulation of railroads and utilities, as well as taxation policies
increased the complexity of accounts, necessitating more sophisticated
accounting procedures.
o The nominal value of listed securities on the London Stock Exchange
increased significantly, leading to a greater need for reliable audits. This
growth encouraged specialization in auditing and the development of
professional firms.
Professional societies established brand names by setting and monitoring standards of
conduct, administering examinations for admission, and adopting the title “chartered
accountant”. This mechanism was later used to certify adopting and independence in
audits.
o The 1900 companies act mandated that all companies must have their
accounts audited annually by a qualified auditor.
o By this time most of them were already audited by chartered accountants.
Practice had again outrun legal minima.
There were two major market developments that can explain the shift from shareholder
to professional auditors: 1) an increase in the demand for audits, and 2) the introduction
of a low-cost mechanism for certifying auditor competence and independence.
Conclusion:
- Audit existed early in the development of corporations (endogenous)
- Evolved to mandatory audit by first UK Companies Act (exogenous)
- Monitoring is crucial to formation of firms
- Long survival of audit: efficient tool for organizing a firm.
THE AUDIT PROFESSION TODAY
Requirements audit engagement. Once again, auditing is the process of providing
assurance about the reliability of the information contained in a financial report prepared
by management in accordance with generally accepted accounting principles (GAAP).
There must be an assertion being made by one party, the accuracy of which is of interest
to another party. There must exist agreed-upon and objective criteria that can be utilized
to assess the accuracy of the assertion. The assertion must be amenable to verification
by an independent party. The accountant should prepare a written conclusion about the
accuracy of the assertions.
Generally accepted accounting principles (GAAP): financial reporting standards
refer to a single set of rules established by a single standard-setting body which is 1)
high-quality, 2) understandable, 3) enforceable, 4) globally accepted, 5) comparable to
ensure that relevant and faithful information is disclosed.
International financial reporting standards (IFRS):
4
Inhoudsopgave
Lecture 1 – Demand for Auditing.....................................................................2
Lecture 2 – Audit risk / Fraud risk....................................................................7
Lecture 3 – Materiality..................................................................................17
Lecture 4 – Ethics & Biases...........................................................................26
Lecture 5 – Overview....................................................................................28
Lecture 6 – Understanding the client: strategic analysis/business processes,
business control........................................................................................... 32
Lecture 7 – Internal control evidence (overview)............................................36
Lecture 8 – Internal control evidence (IT).......................................................40
lecture 9 – Inquiry & analytical evidence........................................................44
Lecture 10 – Substantive evidence................................................................53
Lecture 11 – Aggregating evidence & auditor reporting..................................61
,LECTURE 1 – DEMAND FOR AUDITING
INTRODUCTION OF THE CONCEPT OF AUDITING
Accounting is the process of identifying, recording, classifying, aggregating and
reporting the information that is required for external purposes that has historically been
called generally accepted accounting principles (GAAP). It is the language of business. It
is through accounting that companies prepare their financial statements, communicating
the company’s financial health. And it ensures that stakeholders, whether managers,
investors or regulators, have information to base their decisions on.
The art of making informed decisions. Information should be 1) accurate, 2) reliable, 3)
timely, and 4) comparable. However, the provider of information may get sloppy or
behave in inappropriate ways when they are not the subject to independent scrutiny
(onafhankelijke controle). Stakeholders might not have sufficient expertise to evaluate
the quality of information. So, there is a need for assurance on the information provided.
Assurance;
The AICPA definition: independent professional services that improve the quality of
information for users. The IFAC definition: an engagement in which a practitioner aims to
obtain sufficient, appropriate evidence in order to express a conclusion designed to
enhance the degree of confidence of the intended users other than the responsible party
about the subject matter information.
Attestation is the process of providing assurance about the reliability
of specific information provided by one party to another. It focuses on a
specified assertion that is made in writing. The provider of attestation
does not generate the original information. The attester only adds their
opinion about the reliability of the information.
Auditing is the process of providing assurance about the
reliability of the information contained in a financial report
prepared by management in accordance with generally accepted
principles (=GAAP).
ECONOMICS OF AUDIT DEMAND
Demand by outside intervention: stewardship. Demand arises within the economy:
reliable information/valuation.
Exogenous audit demand is demand which is influenced by factors external to the
economic model or system, such as 1) government intervention, 2) statutory audit, 3)
environment agency requires audit of pollution reports, 4) ministry of health requires
audit of health care declarations by hospitals, and 5) government grant with condition
external audit.
Endogenous audit demand is demand which is influenced by factors within the
economic model or system.
- Agent relation: principal (shareholder) delegates decision-making to agent
(manager).
- Agency theory: conflicts of interests due to differences in incentives and
information asymmetry between two parties in a transaction.
2
, o Moral hazard: the agents’ actions not observed yet incentivized (work
hard/shirk = verwijst naar het fenomeen waarbij werknemers of managers
minder moeite doen dan nodig is of zich niet volledig inzetten voor hun
taken, in de verwachting dat hun onderpresteren niet zal worden
opgemerkt).
o Adverse selection: principal cannot observe the quality of the firm (lemon
= verwijst naar producten of diensten van lage kwaliteit die worden
gepresenteerd als producten van goede kwaliteit. In accountancy en audit
betekent een "lemon" dat een organisatie of financiële rapportage van
slechte kwaliteit kan zijn, maar dit wordt niet altijd direct herkend door
investeerders of auditors vanwege een gebrek aan volledige of eerlijke
informatie).
An independent audit is a high-quality report that ensures the truth about the agents’
hard work.
Theory of the firm: a firm is a nexus of contracts (Coase). Different contractual
arrangements provide different incentives for opportunistic behavior.
Enforcing of contracts:
- Bonding: commitments/guarantees that agents make to align their interests with
those of the principals.
- Monitoring (audit): to detect and prevent any deviations from agreed-upon
behaviors or objectives.
Agency cost:
Watts & Zimmerman (1983)
History of auditing
- 1200s, merchant guilds
o Bonding: alderman oath of all profits
o Monitoring: audit of expenses
o Auditors: committee of guild members
o Independence: fine and reputation
- 1500s, regulated companies
o Bonding: treasurer statement of receipts
o Monitoring: audit
o Auditors: committee of members
o Independence: fine and reputation
- 1600s, joint stock companies
o Bonding: sureties and guarantees by officers
o Monitoring: audit
o Auditors: committee of shareholders and directors
o Independence: fine and reputation
3
, - 1900s, professionalization
o 1844: UK companies act – required directors to keep accounts and required
those accounts to be audited by persons other than the directors,
incorporating into the law a version of a practice that had existed for 600
years.
Hypothesis: committees of auditors survived because they had efficient methods of
monitoring contracts between managers and those supplying capital.
- 1900s, professionalization of auditing
o The complexity of accounts, legal liability of directors, and the size and
number of corporations increased in the latter half of the 19th century.
o Government regulation of railroads and utilities, as well as taxation policies
increased the complexity of accounts, necessitating more sophisticated
accounting procedures.
o The nominal value of listed securities on the London Stock Exchange
increased significantly, leading to a greater need for reliable audits. This
growth encouraged specialization in auditing and the development of
professional firms.
Professional societies established brand names by setting and monitoring standards of
conduct, administering examinations for admission, and adopting the title “chartered
accountant”. This mechanism was later used to certify adopting and independence in
audits.
o The 1900 companies act mandated that all companies must have their
accounts audited annually by a qualified auditor.
o By this time most of them were already audited by chartered accountants.
Practice had again outrun legal minima.
There were two major market developments that can explain the shift from shareholder
to professional auditors: 1) an increase in the demand for audits, and 2) the introduction
of a low-cost mechanism for certifying auditor competence and independence.
Conclusion:
- Audit existed early in the development of corporations (endogenous)
- Evolved to mandatory audit by first UK Companies Act (exogenous)
- Monitoring is crucial to formation of firms
- Long survival of audit: efficient tool for organizing a firm.
THE AUDIT PROFESSION TODAY
Requirements audit engagement. Once again, auditing is the process of providing
assurance about the reliability of the information contained in a financial report prepared
by management in accordance with generally accepted accounting principles (GAAP).
There must be an assertion being made by one party, the accuracy of which is of interest
to another party. There must exist agreed-upon and objective criteria that can be utilized
to assess the accuracy of the assertion. The assertion must be amenable to verification
by an independent party. The accountant should prepare a written conclusion about the
accuracy of the assertions.
Generally accepted accounting principles (GAAP): financial reporting standards
refer to a single set of rules established by a single standard-setting body which is 1)
high-quality, 2) understandable, 3) enforceable, 4) globally accepted, 5) comparable to
ensure that relevant and faithful information is disclosed.
International financial reporting standards (IFRS):
4
