The industrial revolution (1750-1850) was the catalyst of a great period of economic growth in Great Britain, one feature of which was the passing of management from owners to professional managers. This led, in the period 1850 to 1905, to an increased demand for auditors who were independent of management and who were engaged to detect not only clerical errors, but also management fraud. Consequently, auditors began to periodically report on the work they had performed to the owners of an entity, and thus the concept of what is now referred to as the "independent auditor's report" emerged.
It was during this time that the concept of 'testing' evolved. That is, auditors selected "a few haphazard cases" (to use the words in the often quoted "London and General Bank case" decision) where it was not economically feasible to physically examine all transactions that took place. The use of testing is recognized as one of the limitations of a modern day audit. Also, controls over cash were first recognized during this period as was the control inherent in double-entry bookkeeping. However, the recognition of the benefits of such controls did not affect the extent of auditors' procedures.
From 1905-1930, there was an independent progression of British and American audit objectives. In the USA, the audit objective gradually changed during this period from the detection of fraud to reporting on the 'actual' financial condition of an entity. In addition, there was considerable use of testing. In Great Britain, however, the primary objective continued to be the detection of fraud and error while the prominence of detailed checking (as opposed to testing) remained to the fore. Although auditors now recognized the benefits of internal control procedures, this recognition still had little, if any, effect on the nature, timing or extent of auditors' procedures.
During the period 1933-1940, there was an acceptance by auditors of somewhat 'softer' audit objectives and the wording of the standard auditor's report on the financial statements reflected this change. In the USA, the auditors reported as to whether financial statements "present fairly" the state of affairs of an entity, rather than the more precise "present a true and fair view" used in Great Britain. (It was not until the 1980's that Great Britain (and many British Commonwealth countries) adopted the wording used in the USA.)
By 1940, testing was now the rule and detailed checking the exception. There was also a general recognition that the adequacy of 'internal checks' (as internal controls were then called) could reduce the extent of testing by auditors. The relevance of effective internal controls, since that time until the present day, has been increasingly recognized by auditors as an important factor in the determination of the nature, timing and extent of audit procedures.
From 1940 onwards, it became increasingly accepted by the auditing profession, although not necessarily by the general public, that the primary objective of an audit was the provision of an opinion on the financial statements and that the detection of fraud and error was very much a secondary objective.
Since 1960, the auditing profession throughout the world experienced significant increases in wages' costs. This, combined with the increasing complexity of business and the proliferation of computerized information systems, led to an increased demand for more efficient and effective methods of auditing. During the period 1960-1980, an assessment of the reliability of internal control (or the 'system' of internal control) became the accepted method of determining the nature, timing and extent of many audit procedures. This led to the extensive use of what was called 'systems-based auditing'. Also, statistical methods were introduced to determine the extent of testing, although their use was not widespread. Around 1972, the concept of audit risk was recognized in the professional literature.
Since 1980, increasing fee pressures (as exemplified in the increasing practice of audit tendering) accentuated the need for audits to be both effective and efficient. As a result, there was, and still is, increasing recognition of the importance of audit risk concepts in audit practice. Audit firms adopted what is generally called a 'risk-based approach' in auditing. This approach involves a particular way of determining the nature, timing and extent of audit procedures. It is based on an explicit evaluation of the risk of the financial statements containing a material misstatement.
Although the objectives of an audit have remained unchanged since about 1940, pressure from the public to widen audit objectives to embrace, for example, the detection of fraud, continues. (See Expectations gap.)
Note that much of the above was summarized from Brown [1962].
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