Special Audit Techniques - ICAI Knowledge Gateway · of special audit techniques (SAT) 2. ......
Transcript of Special Audit Techniques - ICAI Knowledge Gateway · of special audit techniques (SAT) 2. ......
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Special Audit Techniques
CA Final Paper 3: Advanced Auditing & Professional Ethics Chapter 5
CA Arijit Chakraborty
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Agenda for discussion - Special Audit Techniques
Audit evidence -Confirmation, inquiry, observation, Analytical review
Statistical Sampling- concept, types, technique, sampling risk , audit planning
Risk Based audit
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Special Audit Techniques
Inquiry
Observation
Confirmation
Analytical review
Statistical sampling , risk, error
Risk based audit
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Learning Objectives
1. Understand the concept and purpose of special audit techniques (SAT)
2. Learn the linkage of SAT with Audit Standards
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to determine correspondence between
auditor evidence
management assertions
established criteria
accumulates and evaluates
Auditor workflow-1
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then communicates results to
established criteria
auditor
management assertions
Users
evidence
accumulates and evaluates
to determine correspondence between
Auditor workflow- 2
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Sufficient Appropriate Audit Evidence ( SAAE)
• “Audit Evidence” SA 500 (Revised)
• , “Audit Evidence—Specific Considerations for Selected Items”
SA 501 (Revised)
• “External Confirmations” SA 505 (Revised),
• “Initial Audit Engagements – Opening Balances”
SA 510 (Revised)
• “Analytical Procedures” SA 520 (Revised)
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Sufficient Appropriate Audit Evidence ( SAAE)
• “Audit Sampling” SA 530 (Revised)
• “Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures” SA 540 (Revised)
• “Related Parties” SA 550
• “Subsequent Events” SA 560 (Revised)
• “Going Concern” SA 570 (Revised)
• ”Written Representations” SA 580 (Revised)
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Inspection
Observation
Confirmation
Re-calculation
Re-performance
Analytical Procedures
Inquiry
Inquiry alone, ordinarily, does not provide SAAE
Obtaining Audit Evidence - I
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SA 500 : Audit Evidence
Evidential matter: • Any information that corroborates or refutes an
assertion
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Audit Evidence
Some Relevant Terms used in SA 500:
Accounting Records
Appropriateness(of audit evidence)
Audit Evidence
Management’s Expert
Sufficiency(of audit evidence)
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Types of Evidence
Physical evidence
Third-party representations
Documentary evidence
Computations
Data Interrelationships
Client representations
Accounting records
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Types of Evidence Physical Evidence
Evidence that can actually be seen by auditors.
• This type of evidence is generally effective for supporting the existence assertion.
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Types of Evidence Third Party Representations
Confirmations
Lawyers’ Letters
Reports of Specialists
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Types of Evidence Documentary Evidence
Created by outside parties and transmitted directly to auditor
Created by outside parties and held by client
Created and held by client
Electronic documents
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Types of Evidence Computations Computations are: performed independently by auditor
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Types of Evidence Data Interrelationships
Data interrelationships (i.e., analytical procedures) rely on relationships among financial and non-financial data.
Effective for testing “reasonableness” of certain account balances
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Types of Evidence Oral and Written Client Representations
Responses to questions and inquiries toclients during an audit constitute auditevidence.
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Types of Evidence Accounting Records
Clients’ accounting records (e.g. ledgers and journals) may provide worthwhile evidence in themselves.
• Depends on the effectiveness of internal controls
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Audit Procedures
• Physical examination • Observation • Confirmation • Tracing • Vouching • Inspection • Reconciliation • Re-performance • Analytical procedures • Inquiry • Comparison
Physical Evidence
Third-Party Representations
Documentary Evidence
Computations
Data Interrelationships
Client Representations
Accounting Records
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Reliability of Certain Types of Audit Evidence
RELIABILITY TYPE EXAMPLE
High Physical Inventory Observation Documentary External Cutoff Bank Statement External/Internal Purchase Invoice Internal Sales Invoice
Low Client Representations Management representation Letter
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Statistical Sampling
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Statistical Sampling
Provide guidance regarding the design and selection of an audit sample
Guide on the use of audit sampling in the audit engagement
Guidance on use of sample in risk assessment procedures and tests of controls performed by auditor
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Scope • Applies when auditor decides to use audit sampling in
performing audit procedures • Deals with auditor’s use of statistical and non-statistical
sampling when-
• Complements SA 500
Designing and selecting
audit sample
Performing tests of controls
and tests of details Evaluating results
from sample
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Objective
Objective of Auditor when using Audit Sampling are – • √ To provide a reasonable basis • √ To draw conclusions • √ About population from which
sample is selected
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Sampling – design & selection Design of Sample
The auditor should consider:
Specific audit objectives Population Sample size
Selection of Sample Commonly used methods:
Random selection and Use of CAATs Systematic selection Haphazard selection
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Sample Design, Size and Selection of Item (A) Sample Design • Purpose of audit procedure
• Characteristics of population • To design audit sample & determine sample size
• Tests of controls – Assessment of expected rate of deviation
• Tests of details – Assessment of expected misstatement
• Decision to use statistical or non-statistical is a matter for auditor’s judgment – sample size is not a valid criterion
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(B) Sample Size
Auditor to determine sample size sufficient to reduce sampling risk to an acceptably low level • Lower the risk auditor willing to accept, greater the
sample size
Sample size determined by application of –
• Statistically based formula, or • Exercise of professional judgment
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(C) Selection of Items for Testing Auditor to select representative sample – Each sampling unit in the population has a chance of selection
Statistical Sampling –
each unit has known probability
of being selected
Non-statistical Sampling –
judgment is used to select items
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Methods of selecting sample
Random selection
Applied through random generators, e.g., random number tables
Systematic selection
Number of sampling units/ sample size = sampling interval
Monetary unit sampling
Type of value w eighted selection – sample size, evaluation results in monetary amounts
Haphazard selection
Selection w ithout follow ing structured technique
Block selection
Selection of blocks of contiguous items from w ithin the population
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Nature & Cause of Deviations and Misstatements
Investigate nature & cause
of any deviations/ misstatements
Evaluate their possible effect on
-Purpose of audit procedure
-Other areas of audit
If common feature then identify all such items in a population
& extend audit procedures
to those items
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Projecting Misstatements
Tests of details – project misstatements to population • Gives broad view of scale of misstatement but
insufficient to determine amount to be recorded • Consider effect of uncorrected misstatement
Tests of controls - no explicit projection necessary • Sample deviation rate is also projected deviation
rate
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Evaluating Results of Audit Sampling
Tests of controls – unexpectedly high sample deviation
Tests of details – unexpectedly
high sample misstatement
May lead to an increase in assessed risk of material
misstatement
Unless further evidence substantiating initial
assessment Is obtained
May cause to believe that class of transactions/ account
balance is misstated
Unless there is absence of further evidence that there is no misstatement
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Evaluation of Sample Results
Analyse the nature and cause of any errors detected in the sample;
Project the errors found in the sample to the population;
Reassess the sampling risk; and
Consider their possible effect on the particular audit objective and on other areas of the audit engagement.
Risk may be reduced if additional audit evidence is obtained
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Analytical Review Procedures
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Analytical Procedures, SA 520
Applied
• At planning stage – to understand business and identify potential risks • Near end of audit – to conclude whether FSs correspond to knowledge
of business
When analytical procedures identify significant variances or inconsistent relationships – further investigation / explanations / corroborative evidence needed
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Analytical Procedures: Overview Provide guidance regarding the application of analytical procedures during audit
Deals with the aspects such as:
• the nature and purpose of analytical procedures, • analytical procedures as risk assessment procedures and
planning the audit • Analytical procedures as substantive procedures • Analytical procedures in the overall review at the end of
audit • Extent of reliance on analytical procedures
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Extent of Usage of the Analytical Procedures The significance of the area being examined.
The adequacy of the system of internal control.
The availability and reliability of financial information.
The precision with which the results of analytical procedures can be predicted.
The availability and comparability of information regarding the industry in which the organization operates.
The extent to which other auditing procedures provide support for audit results.
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Analytical Review - stages
Analytical Procedures in the Overall Review at the End of the Audit
forming an overall conclusion as to whether the systems, processes and controls as a whole are robust, operating effectively and are
consistent with the auditor's knowledge of the business.
Analytical Procedures as Substantive Procedures procedures to reduce detection risk relating to specific financial
statement assertions
Analytical Procedures as Risk Assessment Procedures and in Planning the Audit
to obtain an understanding of the business, the entity and its environment and in identifying areas of potential risk.
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Risk Based Audit
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Risk Based Audit – Learning objective
Applying risk based framework to audit, understanding audit risk
Prioritizing high risk areas in the audit plan
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Audit Risk
Audit accepts the risk that the audit conclusion may be wrong and that Audit may have allowed material error to remain undetected in the account.
Only a very small degree of audit risk would be acceptable as otherwise the audit process may lose its purpose.
A very high level of assurance (or confidence) is required when expressing the audit opinion.
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Relationship between materiality and audit risk
To calculate the level of assurance (or confidence) required from substantive audit tests, risk model is employed.
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Risk Model
Analytical tool for planning and execution.
Detects high-risk areas for concentrated audit efforts.
Audit can thus focus on areas which are likely to generate better assurance instead of sampling and testing of larger but low risk areas.
Structures the audit procedures and reorganizes the audit work in terms of risk perception
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Audit Risk
Risk of Material Risk that the Auditors Audit Risk = Misstatement * Fail to Detect the Misstatement = Inherent Control Detection Risk * Risk * Risk
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Inherent Risk
The risk of a material misstatement occurring in an assertion assuming no related internal controls.
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Control Risk
Risk that a material misstatement in an assertion will not be prevented or detected on a timely basis by the company’s internal control.
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Detection Risk
Risk that the auditors’ procedures will lead them to conclude that a material misstatement does not exist in an assertion when in fact such misstatement does exist.
Detection risk restricted by performing substantive tests
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Audit Risk Formula
AR = IR x CR x DR
AR = Audit risk
IR = Inherent risk
CR = Control risk
DR = Detection risk
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Illustration of Audit Risk
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Audit Risk Formula Solving for Detection Risk
Implications • Assuming constant, sufficiently low AR,
detection risk is inversely related to IR and CR • ↑ combined IR and CR ↓ allowed DR ↑
substantive evidence
CRIRARDR×
=
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Risk exposure
Risk exposure (likelihood of occurrence) to be assessed on a scale of 1-10 (10 being most likely).
Risk based Audit
Understand client’s business , operations, industry, legal regulations
Document possible risks which can impact account balance, class of transaction and Financial Statements
Prioritize risk exposure – High, Medium, Low
Conduct audit as per risk priority
Risk exposure is product of probability of occurrence and financial impact
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RISK STATEMENTS – Risk prioritization examples
S. No
Risk statement
Risk Risk
exposure
Heat zone
Severity
Detectab
Ility
Impact
1
Invoice may be raised without effecting physical delivery of the goods from depot/ plant
7
8
56
5
R1
2 Sales order may not be executed in time and in full
4
6
24
4
Y2
3 Debit / credit notes sent to customers may not contain adequate details
2
4
8
3
G2
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RISK STATEMENTS –Examples
S. No
Risk statement
Risk
Risk Risk exposure
Heat zone
Severity
DetectabIlity
Impact
1
Depreciation rates may have been incorrectly set up
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6
30
5
R3
2 Vendors account may not have been reconciled/ confirmed as per laid down frequency
5
5
25
4
Y2
3
Line items (individual entries) clearing may not have been carried out in vendor accounts
3
6
18
3
G2
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Lesson Summary
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3. We had discussed the concept and usage of Risk based audit
2. We had also seen the classification of special audit techniques and discussed the techniques
1. We have learnt the meaning and purpose of special audit techniques
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Testing time
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Special audit techniques- Multiple Choice Questions
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Multiple Choice Questions
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Question 1
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Which of the following analytical procedures is most applicable to inventory?
a. Comparison of sales of current and prior years. b. Comparison of gross profit ratios of current and
prior years. c. Comparison of marketing expense with budget. d. Comparison of ratios of sales to accounts
receivable of current and prior years. Solution b Reason Because the amount shown for inventory affects
cost of sale and the gross profit ratio, fluctuations in this ratio are investigated in connection with the audit inventory.
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The inventory observation provides least
evidence of a. Presentation c. Valuation b. Existence d. Rights Solution A Reason Observation of inventory on hand provides little
evidence about the classification of inventory.
Question 2
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Question 3
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The observation of inventories is a(n) a. Generally accepted auditing standard. b. Generally accepted auditing procedure c. Alternative auditing procedure. d. Optional auditing procedure. Solution b Reason Observation of inventories is a procedure, i.e.,
an act to be performed.
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Question.4
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During an inventory observation auditors normally record certainty of their test counts to
a. Be used in compiling the client’s inventory. b. Check the accuracy of the client’s account. c. Compare with the final inventory listing. d. Test the client’s counting procedure.
Solution c Reason Recorded test counts are compared with the client’s
final inventory listing to provide assurance that the client’s counts were not changed between the time they were made and the time the final inventory listing was prepared.
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Question.5 During an inventory observation an auditor
may detect obsolete items by all of following except
a. Observing unusual amounts of rust or dust. b. Observing items with prior year inventory tags. c. Computing gross profit ratios. d. Inquiry of plants personnel. Solution C Reason The gross profit ratio will not detect obsolete goods
in inventory although other ratios such as inventory turnover will.
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Question.6
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To test the receiving cut off auditors record the last several numbers of documents used prior to the taking of the inventory. These documents are
a. Vendor invoices. b. Purchase orders. c. Receiving reports. d. Purchase requisition Solution c Reason Receiving reports are used to test the receiving cut off.
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Question.8
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In which of the following types of inventories would an auditor be least likely to need the assistance of a specialist to determine existence?
a. Baked goods b. Coal Pile c. Precious gems d. Art work Solution a Reason The auditor could evaluate baked goods, but would
need a surveyor for the coal pile and appraisers for the gems and art work.
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Question.9
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The most important objective in the audit of current liabilities is
a. Existence b. Completeness c. Valuation d. Presentation and disclosure. Solution c Reason Unrecorded items constitute the auditor’s main risk when
auditing current liabilities.
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Question.10 In determining which accounts payable to select for
confirmation, an auditor is most likely to pick a. Accounts with the largest balances to obtain dollar coverage. b. Major vendors and suppliers regardless of the amount of the
balances. c. Accounts with debit balances. d. Any account with zero balance. Solution b Reason Because the auditor is primarily concerned with the
completeness assertion, he or she sends confirmations to vendors that should have large balances (the major vendors).
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True and False
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• The taking of an accurate physical inventory is a generally accepted auditing procedure.
F The observation of the
physical inventory is a generally accepted auditing procedure.
True and False.1
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True and False.2
• Before the start of the inventory, the auditor should review the client’s inventory instructions.
T
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True and False.3
• The test of inventory pricing in a job-order cost system usually involves a review of the flow and accumulation of costs by cost centre for the major products.
F
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True and False.4
• The objective of a receiving cut off test is to determine whether items that are received near the end of the year and included in inventory also are recorded as purchases and accounts payable.
T
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True and False.5
• The auditor tests a client’s inventory cut off to determine that physical items and their related costs are treated in a consistent manner.
T
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CA Final question ( May 2009) • What are the considerations to be kept in mind while
performing analytical procedures on date prepared by the client ?
• Solution outline • Refer SA 520 – Analytical Procedures • Factors • 1. accuracy with which expected results of
substantive analytical procedures can be predicted. • 2. degree to which information can be segregated • 3. availability of financial and non-financial
information
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Thank You
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