COURSE OUTLINEFINANCIAL AUDIT

FINANCIAL AUDIT

AUDIT OF FINANCIAL STATEMENTS AND RELATED INFORMATION

What is an audit? Auditing?Put your own definition…..

Historical Background of audit The role of auditor goes back

many hundreds of years. There are records from ancient Egypt and Rome, showing that people were employed to review work done by tax collector and estate managers

The emphasis was very much on the detection of fraud and other irregularities

Historical Background of audit

Emphasis has changed and the role of the auditor becomes much more sophisticated

Stewardship requires an outsider with sufficient independence and objectively to review the accounts of stewardship and to express an opinion as to their honesty or otherwise.

DEVELOPMENT OF MODERN AUDITING Concept of a company as a separate legal entity came into

existence in the late ninetieth century. This led to the separation of ownership (shareholders) from

control (directors) and consequent need to safeguard the interests of the owners, who in all but the smallest of business where shareholders and directors were on and the same) were not involved in the day to day decisions made by the management

DEVELOPMENT OF MODERN AUDITING

Before 19th Century

the appointed auditor duties to discover fraudulent misrepresentations, the detection of fraud and error become the major objective of company audits.

After ( late 19th Century) However in later part of nineteenth century, there was a growing

school of thought that the prevention of fraud and error (as opposed to its detection) should be the major objective of the auditor (both external and internal) and that the management of a company should play a greater part and accept a larger degree of responsibility in this respect

DEVELOPMENT OF MODERN AUDITING

The Kingston Cotton Mill case of 1896, established the fact that the auditor should not be responsible for finding every fraud and error. Here, the judgment pronounced that the auditor’s role should be likened to that of a watchdog rather than bloodhound, and that what was required of auditors was that they should act with such reasonable care and skill as was appropriate circumstances

DISADVANTAGES OF AUDIT

The audit involves the client’s staff and management in giving time to providing information to the auditor. Professional auditors should therefore plan their audit carefully to minimize the disruption, which their work will cause.

The audit fee, clearly the services of an auditor must be paid for. It is for this reason that few partnership and even fewer sole trader are likely to have their accounts audited. The accountant’s role as the preparer of financial statements, as tax adviser and general financial adviser, becomes much more important to such concerns.

ADVANTAGES OF AUDIT

CompaniesDirectors

Assurance that statutory responsibilities concerning accounts have been carried out

Assistance with statutory responsibilities concerning accounts

Availability of expert professional advice

The letter of weakness

ADVANTAGES OF AUDIT To shareholders

Assurance that accounts show a true and fair view and comply with statutory requirements

Assurance that directors have fulfilled their statutory responsibilities for books and accounts, and the safeguarding of assets

Assurance that directors have fulfilled their statutory responsibilities for books of accounts and the safeguarding of assets

Assurance that all directors remuneration has been disclosed

ADVANTAGES OF AUDIT

Other organization with published accounts

Assurance to all users of accounts , that the accounts show a true and fair view and comply with statute

Assurance that ‘stewards’ have fulfilled their accounting and financial responsibilities

Private organizations such as partnerships

Assurance that accounts are reliableReasonable assurance that all fraud of

consequence has been disclosed. In addition they provide reliable accounts to regulatory bodies

such as the Companies Registry, the stock exchange etc.

DEVELOPMENT OF MODERN AUDITING

In previous years it was part of the appointed auditor duties to discover fraudulent misrepresentations, the detection of fraud and error become the major objective of company audits. However in later part of nineteenth century, there was a growing school of thought that the prevention of fraud and error (as opposed to its detection) should be the major objective of the auditor (both external and internal) and that the management of a company should play a greater part and accept a larger degree of responsibility in this respect

DEVELOPMENT OF MODERN AUDITING

The Kingston Cotton Mill case of 1896, established the fact that the auditor should not be responsible for finding every fraud and error. Here, the judgment pronounced that the auditor’s role should be likened to that of a watchdog rather than bloodhound, and that what was required of auditors was that they should act with such reasonable care and skill as was appropriate circumstances

DUTIES OF AUDITORS Carry out procedures designed to obtain

sufficient appropriate audit evidence, in accordance with International Standards of Auditing, to determine with reasonable confidence whether the financial statements are free from materials misstatement

Evaluate the overall presentation of the financial statements, in order to ascertain whether they have been prepared in accordance with relevant legislation and IFRS/IAS

Issue a report containing a clear expression of their opinion on the financial statements.

AUDIT AND AUDITING

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 parties.

AUDIT AND AUDITINGAUDIT REFERS

to an independent examination of the financial statements of an enterprise, conducted with a view to expressing an opinion

as to whether those statements give a true and fair view

What is true and fair view?We say financial

statements shows true and fair view….. What is it?

What is true and fair view?True

information is factual and conforms with reality, not false.

In addition the information conforms with required standards and law.

The accounts have been correctly extracted from the books and records

What is true and fair view? Fair

information is free from discrimination and bias and

in compliance with expected standards and rules.

The accounts should reflect the commercial substance of the company’s underlying transactions.

Objectives of Auditing

Primary Objective (main objective)To produce a report by the auditor of his opinion of the truth and fairness of financial statements so that any person reading or using them can have belief in them

Objectives of AuditingSecondary

To detect errors and fraud ( Consider materiality)

To prevent errors and fraud by the deterrent and moral effect of the audit

To provide spin- off effects. The auditor will be able to assist his clients with accounting , systems, taxation , financial , and other problems.

AUDIT OBJECTIVESValidityCompletenessCutoffOwnershipAccuracyValuationClassificationDisclosure

LIMITATION OF AUDIT The responsibility for preparation and

presentation of the financial statements is that of directors of the entity. The audit does not relieve the directors of any of their responsibilities. Auditors opinion is not a guarantee of the future

viability of the entity Auditors opinion is not an assurance of

management’s effectiveness and efficient Causes of limitations

The impracticality of examining all items within an account balance or class of transactions

The inherent limitation of any accounting and control system

The possibility of collusion or misrepresentation for fraudulent purposes

Most audit evidence is being persuasive rather than conclusive

PROFESSIONAL SCEPTICISM Material misstatement may exist in financial statement and

auditors should plan their work on this basis, i.e. professional skepticism, ISA, makes it clear that, even where auditors assess that the risk of litigation or adverse publicity as very low , they must still perform sufficient procedures according to auditing standards, ie there can never be a reason for carrying out an audit of a lower quality than that demanded by the ISA’s

PROFESSIONAL SCEPTICISM In carrying out his work the auditor should adopt an

attitude of professional skepticism, recognizing that circumstances may exist which cause the financial statements to be materially misstated.

The purpose of the independent audit is to ensure that the financial statements are OBJECTIVE, FREE from BIAS and MANIPULATION and RELEVANT to the need of users.

LEGAL FRAMEWORK OF AUDITING The work of an auditor is regulated by:

The Act requires auditors to have a recognized professional qualification,

Professional pronouncements on Auditing Professional pronouncements include the rules of

professional conduct The ethical principles that govern auditors’

responsibilities are Integrity

Objectivity

Independence

Professional competence an due care

Professional behavior confidentiality

TYPES OF AUDIT Statutory Audit, carried because the law

requires them. (FS filed to SEC, BIR, IC, Listed Cos., CDA etc.)

Private audits, because of auditor’s desire and not because of law e.g. sole trader and partnership

Internal audits, is the one conducted by an employee of a business into any aspect of its affairs.

Management audit, an inquiry into efficiency and effectiveness of management

Public sector audit, contract audit , computer audit etc

TYPES OF AUDITS-Financial statements audit -Compliance audits-Operational audits -Comprehensive audits-Forensic audits

TYPES OF AUDITORS-External auditors -Internal auditors-Government auditors -Forensic auditors

ISSUES AFFECTING THE PROFESSION-Expanded services -Globalization-Litigation -Independence issues

Presentation of the systems audit

Determine the audit approach

Ascertain relevant systems and controls

Document relevant systems and controls

Confirm operation of systems and controls

Evaluate operation of systems and controls

Submit Interim mgt and letter Select and perform test of controls

Carry out final review

Report to members

Select and perform substantive procedures

Select and perform restricted substantive procedures

Submit final management letter

Planning of the audit

Assessment of the accounting and internal control systems and audit risk assessments

Consideration of the ways in which audit evidence can be sought

Testing of Internal Controls ‘test of control’

Extensive testing of transactions and balances ‘substantive procedures’

Reduced testing of transactions and balances “substantive procedures’

Review of financial statements

Audit Report

ManagementAssertions

THE RELATIONSHIP OF EVIDENTIAL MATTER TO THE AUDIT REPORT

FinancialStatements

AuditObjectives

AuditProcedures

AuditReport

Evidence

MANAGEMENT ASSERTIONS

Existence or occurrence

Completeness

Rights and obligations

Valuation and allocation

Presentation and disclosure Existence or occurrence Completeness Rights and obligations Valuation and allocation Presentation and disclosure

KEY STAGES OF AUDIT

Determine audit approach Ascertain in the accounting system and

internal controls Assess the accounting system and internal

controls Test the accounting system and internal

controls Test the financial statements ( substantive

testing) Review the financial statements Express an opinionOR

KEY STAGES OF AUDITClient acceptance and continuanceEstablish the terms of the

engagementPlan the auditConsider internal controlConduct substantive audit

proceduresComplete the auditIssue audit report

ATTESTATION occurs when a practitioner is engaged to issue or does issue a written communication that expresses a conclusion about the reliability of a written assertion that is the responsibility of another party.

Examples: The effectiveness of internal control Financial information other than the financial statements Future-oriented financial information Compliance with statutory, regulatory, or contractual obligations Management’s discussion and analysis

AUDITING, ATTESTATION, AND ASSURANCE SERVICESAUDITING, ATTESTATION, AND ASSURANCE SERVICES

ASSURANCE ENGAGEMENT According to ISA, Audit client is an entity in respect of

which a firm conducts an audit engagement. When the audit client is a listed entity, audit client will always include its related entities. Audit engagement (An assurance engagement) to provide a high level of assurance that financial statements are free of material misstatement, such as an engagement in accordance with International Standards on Auditing. This includes a statutory audit which is an audit required by national legislation or other regulation.

ISA 100 Assurance Engagements, an assignment whereby a professional accountant is required to evaluate or measure a subject matter that is the responsibility of another party against identified suitable criteria, and to express a conclusion that provides the intended user with a level of assurance about the subject matter. It is important to distinguish between the levels of assurance given by an audit ( which gives a high level of assurance) to that given by other assurance engagements which , depending on the nature of the engagement, may give a lower level of assurance.

ASSURANCE ENGAGEMENT There is a broad range of assurance engagements ,

including any combination of the following : Engagements to report on a broad range of subject matters

covering financial and non-financial information. Engagements intended to provide high or moderate levels

of assurance Attest and direct reporting engagements Engagements to report internally or externally Engagement in the private or public sector.

ISA 910 states that the objective of a review of financial statements is to enable an auditor to state whether, on the basis of procedures which do not provide all the evidence that would be required in an audit, any thing has come to the auditor’s attention that causes the auditor to believe that the financial statements are not prepared, in all material respects, in accordance with an identified financial reporting frame work (negative assurance)

AUDITING, ATTESTATION, AND ASSURANCE SERVICES

ASSURANCE services are independent professional services that improve the quality of information, or its context, for decision makers.Examples:

Risk assessmentInformation system reliabilityElectronic commerceHealth care performance measurement

THE RELATIONSHIP BETWEEN AUDITING, ATTESTATION, AND ASSURANCE SERVICES

AttestationAuditing Assurance

-Materiality

-Audit risk

-Evidence

THREE FUNDAMENTAL CONCEPTS IN CONDUCTING AN AUDITTHREE FUNDAMENTAL CONCEPTS IN CONDUCTING AN AUDIT

THREE FUNDAMENTAL CONCEPTS IN CONDUCTING AN AUDIT

Materiality A misstatement or the aggregate of all misstatements in financial statements is considered to be material if, in light of surrounding circumstances, it is probable that the decision of a person who is relying on the financial statements, and who has a reasonable knowledge of business and economic activities ( the user), would be changed or influenced by such misstatement or the aggregate of all misstatements.

Audit risk is the risk that the auditor will fail to express a reservation in his or her opinion on financial statements that are materiality misstated

THREE FUNDAMENTAL CONCEPTS IN CONDUCTING AN AUDIT

Evidence Evidential matter supporting the financial statements consists of the underlying accounting records and all corroborating information available to the auditor.Relevance refers to whether the evidence relates to the specific audit objective being tested.Reliability refers to the whether or not a particular type of evidence can be relied upon to signal the true state of the assertion or audit objective.

INTERNAL AUDITING

An internal audit is an independent activity established by management to examine and evaluate the organization’s risk management process and systems of control, and to make recommendations for the achievement of company objectives.

INTERNAL AUDITING The internal audit staffs may also engage in

number of other activities : Examination and evaluation of financial and operating information

within the organization- in certain organization this can form a type of continuous auditing and may involve sophisticated information systems that capture monitoring of risk and evidencing of controls

Review of economy, efficiency and effectiveness of operations Review of compliance with external laws and regulations and

internal policy and procedures Review and advice on the development of key organizational

systems and on the implementation of major change.

INTERNAL AUDITING CONT… The current focus of internal audit is on

adding value to an organization through risk control and reviewing all types of risk and recommending relevant controls. The institute of internal Auditors definition has changed the focus of internal audit toward a more risk-based, consultancy type activity. The internal audit can be referred as

An independent, objective assurance and consulting activity

Designed to add value and improve an organization’s operations

Helps the organization accomplish its objectives Bring systematic, disciplined approach to

evaluate and improve the effectiveness of risk management, control and governance processes.

INTERNAL AUDITING cont…

There are four major areas of importance for internal audit that are addressedCorporate governanceRisk managementOrganizational controlCorporate objectives

INTERNAL AND EXTERNAL AUDITING

It is important to understand and recognize the differences and commonalities between internal and external audit. Internal and external auditor should work closely together, in particular to coordinate activity and maximize effectiveness and where appropriate external audit may rely on the work of internal audit. However, there are number of fundamental differences in their objectives, scope and responsibility.

Internal auditing External auditing

Objectives To advise management on whether the organization has sound systems of internal controls to protect the organization against loss

To provide an opinion on whether the financial statements provide a true and fair view

Legal basis All areas of the organization, operational as well as financial

Financial focus

Scope All areas of the organization, operational as well as financial

Financial focus

Approach Increasingly risk baseAssess risksEvaluate system of controlsTest operation of systemMake recommendation for

improvements

Increasingly risk basedTest underlying transactions that

form the basis of the financial statements

Responsibility To advice and make recommendations on the internal control and corporate governance

To form opinion on whether the financial statements provide a true and fair view.

ISA 610, “CONSIDERING THE WORK OF INTERNAL

AUDITING” ISA 610 requires external auditors to

consider the activities of internal auditors and their effect, if any, on the nature, timing, and extent of the external auditor’s procedures. The external auditor considers the organizational status of the internal audit function, the scope of its function, the technical competence of its members and the professional care they exercise when assessing the work of the department.

The auditing process is very similar between the external and internal auditors however; the audit objectives are often very different.

ISA 610, “CONSIDERING THE WORK OF INTERNAL AUDITING”There are number of factors to consider for an auditor to

rely on the work of internal auditor:

(a) Organizational status: Specific status of internal auditing in the entity and the effect this has on its ability to be objective. In the ideal situation, internal auditing will report to the highest level of management and be free of any other operating responsibility. Any constraints or restrictions placed on internal auditing by management would need to be carefully considered. In particular, the internal auditors will need to be free to communicate fully with the external auditor.

(b) Scope of function: The nature and extent of internal auditing assignments performed. The external auditor would also need to consider whether management acts on internal audit recommendations and how this is evidenced.

(c) Technical competence: Whether internal auditing is performed by persons having adequate technical training and proficiency as internal auditors. The external auditor may, for example, review the policies for hiring and training the internal auditing staff and their experience and professional qualifications.

(d) Due professional care: Whether internal auditing is properly planned, supervised, reviewed and documented. The existence of adequate audit manuals, work programs and working papers would be considered.

OUTSOURCING OF IA FUNCTION The National Board of Accountants and Auditors’ Governing Board

at its 132nd meeting held on 11th April 2005, among other issues, deliberated on the above professional issue and resolved that the outsourcing of the Internal Audit function in the country is a relatively new phenomenon, which needs some guidance. In view of this, it was agreed that institutions wanting to outsource the Internal Audit function may only do so under the following conditions:

(1) That the service be provided in the form of a consultancy by competent, qualified accountants registered with the Board in the registration category of CPA-PP.

(2) That the outsourced Internal Auditor be distinct from the External Auditor of the entity.

(3) That the institution seeking such professional services should have in place an Audit Charter.

(4) That such professional services be guided by very clearly worked out “Terms of Reference” showing:

– the scope of the audit – the number of man-days to be used – the reporting requirement including the types and

frequencies of reports to be prepared – the price of the consultancy

OUTSOURCING OF IA FUNCTION (5) That the consultancy be for a specified time frame after

which there should be need to change the internal auditor. (6) That the client (procuring entity) shall have the powers to

pre-maturely terminate the consultancy contract on unsatisfactory performance of the outsourced Internal Auditor (Consultant).

(7) That the Internal Audit process should be guided by programmes and detailed working papers which should be available for AQR purposes, should need arise.

(8) That the outsourcing of the Internal Audit function should avoid any kind of conflict of interest among the parties.

(9) That the Internal Auditor should exercise the pre-requisite independence when rendering such professional services.

(10) That such professional services should be procured based on competitive bidding processes.

All organizations / entities operating in Tanzania and the general public are required to note this development and observe the above guidelines.

SHIFT OF EMPHASIS OF AUDIT The emphasis in approaching an audit has

shifted from detailed checking of individual items towards an overall review of the systems in operation; followed by an examination of the records and the financial statements prepared from them. Amongst the reason for this major shift of emphasis are: The increasing size and complexity of modern

enterprises The development of more accurate and

sophisticated computerized systems The requirement that the auditor should also

report on the profit and loss account, which entails a review of all transactions during the period, not simply of year-end balances as before.

INTERNAL AUDITING WORKED EXAMPLE

TPDC, parastatal organization dealing with industrial research development has recently decided to appoint a small internal audit team. The Chief Accountant has sent to you as statutory auditor for a number of years for your comment on the following job specification for the teamJob specification- internal auditYour role is to Review accounting systems and related internal controls Examine financial and operating information for management,

including detailed testing of transactions and balances Review the economy , efficiency and effectiveness of

operations and of non financial controls Review the implementation of corporate policies, plans and

procedures.

TPDC also state that the new internal audit team should enable the statutory auditors to reduce the amount of testing they undertake and thus, to increase overall efficiency and reduce the cost of the statutory audit.

INTERNAL AUDITING WORKED EXAMPLE

1. Describe the objectives and scope of internal audit function according to ISA 610

2. Comment briefly on the four items in the internal audit job specification indicating with examples the extent, which they might impinge upon the work of the statutory auditor.

3. List and explain five criteria which you would have to consider accordance to ISA 610, before deciding how much reliance you could place on the work done by the internal auditor

4. Outline the response, which you would make to TPDC regarding a possible reduction in the cost of the statutory audit.

5. If the management of TPDC decided to outsource the internal audit services. Comment briefly on possible advantages and disadvantages of the procedure.

6. Describe major ethical matters in accordance to ISA which external auditors to TPDC should consider in case they decide to undertake the external audit assignment

AUDIT AS A COMMUNICATION MEDIUM According to ISA 700, the objective of any audit

is for the auditor to obtain sufficient appropriate audit evidence to be able to express an opinion on the financial statements.

ISA 700, provides authoritative guidance on audit reporting.

Audit report is the primary means of communication between the auditor and the shareholders of the company.

In order to convey information of a succinct form, the audit report has become an extremely formalized group of phrases, each of which has special significance. These are similar to legal phrases know as “terms of art’. Such phrases do not mean merely what they appear to mean on the face of it , and have significance much greater that they first appear to. Any deviation from the standard format is regarded by accountants as being significant and may provide more important extra information.

THE AUDITOR'S STANDARD UNQUALIFIED AUDIT REPORT

This is the most common type of audit report. The standard unqualified audit report contains seven important

elements:

TitleAddresseeIntroductory paragraph Scope paragraphOpinion paragraphName of auditorDate of report

Example of unqualified report AUDITOR’S REPORT TO ..... We have audited the financial statements of ABC

Company for the year ended December 31, 19X0, from which the summarized financial statements were derived, in accordance with International Standards on Auditing (or refer to relevant national standards or practices). In our report dated March 10, 19X1 we expressed an unqualified opinion on the financial statements from which the summarized financial statements were derived.

In our opinion, the accompanying summarized financial statements are consistent, in all material respects, with the financial statements from which they were derived.

For a better understanding of the Company’s financial position and the results of its operations for the period and of the scope of our audit, the summarized financial statements should be read in conjunction with the financial statements from which the summarized financial statements were derived and our audit report thereon.

AUDITOR Date Address

QUALIFIED REPORT A qualified report is less common and is where an

auditor disagrees with the view presented in the accounts, or if he has not been able to form an opinion because of inadequate evidence.A sample of it can be obtained on ISA 800 appendix 643 as an appendix 4.

Reasons for qualification

A departure from IFRSScope limitationThe auditor is not independent

Example of qualified report AUDITOR’S REPORT TO ..... We have audited the financial statements of ABC Company for

the year ended December 31, 19X0, from which the summarized financial statements were derived, in accordance with International Standards on Auditing (or refer to relevant national standards or practices). In our report dated March 10, 19X1 we expressed an opinion that the financial statements from which the summarized financial statements were derived gave a true and fair view of (or presented fairly, in all material respects) ...except that inventory had been overstated by ....

In our opinion, the accompanying summarized financial statements are consistent, in all material respects, with the financial statements from which they were derived and on which we expressed a qualified opinion.

For a better understanding of the Company’s financial position and the results of its operations for the period and of the scope of our audit, the summarized financial statements should be read in conjunction with the financial statements from which the summarized financial statements were derived and our audit report thereon.

AUDITOR Date Address

Other reports In summary the audit report must contain; the heading which

shows the independence of the auditor, the fact that the report is addressed to the shareholders and the name of the company; Respective responsibilities of directors and auditors; the basis of opinion and the opinion. (Please visit google search on the Internet for various samples of audit report).

Other forms Qualified Denial/Disclaimer Adverse

AUDIT QUALIFICATION MATRIX

Nature of Circumstance

Material but not fundamental

Fundamental

Limitation of Scope

Except for ..might

Disclaimer

Disagreement Except for Adverse opinion

AUDIT QUALIFICATION MATRIX… cont.

Except for ..might auditors disclaim an opinion on a particular aspects of the accounts which is not considered fundamental

Disclaimer of Opinion- Auditor state they are unable to form an opinion in the truth and fairness

Except for , auditor expresses adverse opinion on particular aspects of accounts which is not considered fundamental

Adverse opinion, auditors state that accounts do not give a true and fair view.

AUDIT QUALIFICATION MATRIX … cont

Limitation of Scope, Absence of accounting records

Ownership of material assets

Disagreement Inappropriate accounting policies

Facts /amount

Manner or extent of disclosure

Failure to comply with legislation

REPORTING UNCERTAINITY

Inherent uncertainty, an uncertainty whose resolution is dependent upon uncertain future event outside the control of the reporting entity’s directors at the date financial statement are approved.

Fundamental Uncertainty, is an inherent where the magnitude of its potential impact is so great that, without a clear disclosure of nature and implication of uncertainty the view given by the f/s would be seriously misleading.

E.g. Going concern Major litigation

Worked Example During the course of your audit of the fixed assets of

NEDCO LTD at 31 March 2004 two problems have arisen.

The calculations of the cost of direct labour incurred on assets in course of construction by the company’s employees have been accidentally destroyed for the early part of the year. The direct labour cost involved is Tshs. 10,000,000/=

The company has received a government grant of Tshs25, 000,000/= towards the cost of plant and equipment acquired during the year and expected to last for ten years. The grant has been credited in full to the profit and loss account as exceptional income.

Other relevant financial information is as follows. Tshs.

Profit before tax 100,000,000/= Fixed asset additions 133,000,000/= Assets constructed by company 34,000,000/= Fixed asset at net book value 666,667,000/=

Worked Example

Required: List the general forms of qualification available to

auditors in drafting their report and state the circumstance in which each is appropriate.

State whether you feel that a qualified audit report would be necessary with respect to the treatment of the government grant, draft the section of the report describing the matter (the whole report is not required).

On the assumption that you decide that a qualified audit report is necessary with respect to the treatment of the government grant, draft the section of the report describing the matter (the whole report is not required).

Outline the auditor’ general responsibility with regard to the statement in the directors’ report concerning the valuation of land and buildings.

MISCELLANEOUS MATTERS

Timing of Audit work At or after year end- suitable for small business Interim and final audit-

Interim – test of controls, planning Final - Substantive balance sheet audit

Continuous audit – the auditor is present throughout the year , suitable for the large client

Responsibilities of directors Safeguard assets Prevent fraud and errors Ensure proper accounting records as per Companies act Prepare financial statements Prepare company’s return to registrar of companies Set up system of IC Directors are responsible to adopt consistent and appropriate

accounting policies for f/s, they must comply with Companies act and comply with accounting standards

Miscellaneous Issues cont… Responsibilities of Auditors

End result work for f/s on their true and fairness The auditor’s should have

Deep understanding and knowledge of accounting Directors will consult auditors of accounting policies to

adopt Ultimately auditors must stand back from accounting

function

Social Audit In Narrow sense it is a financial audit

It adds value Efficiency of markets and investment funds

Measuring social, ethical and Environmental conduct to ensure

CSR, accountability and transparency Ensures that in an ever competitive corporate

environment management do not sacrifice their social value in quest for higher profitability

AGENCY THEORY

Principal- Agent to perform task on his behalf

Agent will not act against the interest of the principal

Directors are like agents to shareholders

LETTER OF ENGAGEMENT It is a letter send by an auditor before

commencing any professional work, it show an agreement in writing, the precise scope and nature of the work to be undertaken

Purpose To define clearly the extent of the auditor’s

responsibilities To minimize misunderstandings between auditor firm

and client To confirm in writing the verbal agreement To confirm acceptance by the auditor of his

engagement To inform and educate the client Avoidance of implied contracts arising out of the

articles of Association or previous conduct of the auditor

LETTER OF ENGAGEMENT

Timing To all new clients before any professional work has been

started To all existing clients who have not previously had such a

letter Whenever there is significance changes of circumstances ( e.g.

new ISA’s , major change in management. The letter should be reviewed every year to see if there is a

need for revised letter To each member of the company of the group ( if it is a group)

Procedures and Content

Before acceptance discuss the precise terms with the management( board for a company)

Draft and sign the letter before commencing any part of an assignment

Receive the client’s written acceptance

Every year review the letter and consider if revision is necessary

CONTENTS OF LETTER OF ENGAGEMENT

The Board’s responsibilities according to company Act The auditor’s responsibilities to report on f/s and

consistency of view of directors report The scope of auditor’s work

Auditing standards Accounting systems review Collection of audit evidence Tests and reliance on internal controls

Sending of letter of weakness to the management Any special factors

Relation with internal audit Audit of division and branches Any overseas location problems Other auditors if any Significance reliance on supervision of the directors in small

proprietary companies

CONTENTS OF LETTER OF ENGAGEMENT

Any special factors Relation with internal audit Audit of division and branches Any overseas location problems Other auditors if any Significance reliance on supervision of the directors in small

proprietary companies The need for a letter of representation from the

management Irregularities and fraud – the directors’ primary

responsibility The auditor’s planning of his audit to have a reasonable

expectation of discovering material misstatement in accounts- non reliance on the auditor to uncover irregularities and frauds

Any agreement for the auditors to carry out work of a bookkeeping or accounting nature- this could be covered on separate letter

CONTENTS OF LETTER OF ENGAGEMENT CONT….

Any agreement to provide taxation services – this could be a separate letter

The CHINNESE WALL IDEA; where accounting and tax services are carried out the staff may be different from those engaged on audit work and so information given to tax or accounting staff is not thereby given to audit staff.

The fees and the basis on which they are charged

A request for written acknowledgement of the letter and that it creates a contractual obligations. In the case of a company the letter of acknowledgement should be signed on behalf of the board

CONCEPT OF MATERIALITY

According to ISA 320, the auditor should consider materiality and its relationship with audit risk when conducting an audit. Also glossary number 139 defines materiality as Materiality—Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement. Thus, materiality provides a threshold or cutoff point rather than being a primary qualitative characteristic which information must have if it is to be useful.

CONCEPT OF MATERIALITY

Auditors hope that their audit procedures will uncover any large errors in the financial statements they are auditing. Materiality should be considered by the auditor when:

Determining the nature, timing and extent of audit procedures;

Evaluating the effect of misstatements. Materiality is defined as the expression for

the relative significance or importance of a particular matter in the context of financial statements as a whole. A matter is material if its omission or misstatement would reasonably influence the decisions of an addressee of the auditor’s report. Materiality is not capable of the general mathematical definition as it has both qualitative and quantitative aspects.

CONCEPT OF MATERIALITY CONT…

Auditors’ responsibility is to plan and perform their audit to provide reasonable assurance that the financial statements are free of material misstatement and give a true and fair view. From audit point of view anything that would distort the view given by accounts must lead to qualification but only if it is material.

Example things that will fit the above definition include

Inclusion of deferred revenue expenditure, such as advertising costs, in debtors and prepayments

A loan which could not quickly be recalled shown under money at call at short notice

Omission of an item of stock

CONCEPT OF MATERIALITY CONT…

The key problem in practice is that of how ‘large’ an item has to be for it to be considered as material.

An initial assessment of materiality during audit planning assists in the determination of an efficient and effective audit approach. The preliminary materiality assessment helps auditor to decide such factors as what items to examine and whether to use sampling techniques and which ones. This enables them to select audit procedures that will reduce audit risk to an acceptable level.

MATERIALITY CONCEPT CONT….

Auditors must use their professional judgment in coming to a decision as to whether an item is, or is not, material. Important points to take into consideration are as follows:

What qualitative aspects are involved, such as the inaccurate or inadequate description of an accounting policy?

Relatively small amounts, such as a small error in a month end procedure, can cumulatively have a material effect, if repeated.

Materiality is relative factor and should be considered in relative terms. Shs.1,000,000 may be absolutely immaterial in the accounts of a larger company , whereas in a small organization the reverse would probably be true. Further, under this heading and amount must considered in relation to:-

MATERIALITY CONCEPT CONT…. Items in the overall financial statement level

Items at individual account balance or transaction level

Statutory and other disclosure requirements which may require disclosure regardless of value , such as those relating to directors’ emoluments.

The corresponding amount in previous years

What degree of latitude is allowable in deciding on the amount attributable to a particular item? Some items, such as directors’ fees, are capable of exact definition; other, such as depreciation and provisions for obsolete or damaged stock, are at best an intelligent estimate. The overriding consideration must be whether the accounts disclose a true and fair view. It is also clearly important that such items are consistently treated from year to year.

Materiality Cont….. Auditors must use their professional

judgment in deciding whether or not an item is material. They must consider:

Qualitative aspects The cumulative effect of small amounts The relative nature of materiality The degree of latitude that is allowable.

According to ISA 320:400, in evaluating whether the financial statements give a true and fair view, auditors should assess the materiality of the aggregate of uncorrected misstatements. This indicates that the overall effect of misstatements should be evaluated.

Materiality Cont….. If the auditor believes that the aggregate

of uncorrected misstatement may be material, they may wish to extend their audit testing to obtain more audit evidence in the relevant area, or request the directors to adjust the financial statements according to ISA 260 “Communication of audit matters to those who are charged with Governance”. In practice, once the directors have been informed of the misstatements in the draft accounts, they are likely to be happy for accounts to be adjusted. If the directors refuse any adjustments, the auditor should consider the implications for the audit report.

Materiality Cont…..

The following are some of audit tests to determine whether an item is material.

Who are the relevant users? What are their decision making

needs? For a given item, what is the

appropriate context for assessing its materiality?

In what range of values do items become critical in terms of materiality

Materiality Cont…..

The following are some of audit tests to determine whether an item is material…

For a given item, what is the appropriate context for assessing its materiality?

Securities and Exchange Commission in US (main regulator of US securities Laws) takes the following rule of thumb for materiality.

Errors over 10% - material Errors between 5% and 10% may be

material Errors less than 5% - not material. But

note that these are figures as guidelines only, judgment is required.

General Principles of an Audit The auditor should comply with the Code of Ethics for

Professional Accountants issued by the International Federation of Accountants. Ethical principles governing the auditor’s professional responsibilities are:

Independence;Integrity;Objectivity;Professional competence and due

care;Confidentiality; Professional behavior;

andTechnical standards.

• Integrity A professional accountant should be straightforward and honest in

performing professional services.* • Objectivity

A professional accountant should be fair and should not allow prejudice orbias, conflict of interest or influence of others to override objectivity.

• Professional Competence and Due CareA professional accountant should perform professional services with due care, competence and diligence and has a continuing duty to maintain professional knowledge and skill at a level required to ensure that a client or employer receives the advantage of competent professional service based on up-to-date developments in practice, legislation and techniques.

• ConfidentialityA professional accountant should respect the confidentiality of information acquired during the course of performing professional services and should not use or disclose any such information without proper and specific authority or unless there is a legal or professional right or duty to disclose.

General Principles of an AuditGeneral Principles of an Audit

• Professional BehaviorA professional accountant should act in a manner consistent with the good reputation of the profession and refrain from any conduct which might bring discredit to the profession. The obligation to refrain from any conduct which might bring discredit to the profession requires IFAC member bodies to consider, when developing ethical requirements, the responsibilities of a professional accountant to clients, third parties, other members of the accountancy profession, staff, employers, and the general public.

• Technical StandardsA professional accountant should carry out professional services in accordance with the relevant technical and professional standards.

Professional accountants have a duty to carry out with care and skill, the instructions of the client or employer insofar as they are compatible with the requirements of integrity, objectivity and, in the case of professional accountants in public practice. In addition, they should conform with the technical and professional standards promulgated by: . IFAC (e.g., International Standards on Auditing); . International Accounting Standards Board; . The member’s professional body or other regulatory body; and . Relevant legislation.

General Principles of an AuditGeneral Principles of an Audit

PROFESSIONAL SCEPTICISM

The auditor should plan and perform an audit with an attitude of professional skepticism recognizing that circumstances may exist that cause the financial statements to be materially misstated

An attitude of professional skepticism means the auditor makes a critical assessment, with a questioning mind, of the validity of audit evidence obtained and is alert to audit evidence that contradicts or brings into question the reliability of documents or management representations

In planning and performing an audit, the auditor neither assumes that management is dishonest nor assumes unquestioned honesty. (Remember Mautz and Sharaf audit postulates).

Accordingly, representations from management are not a substitute for obtaining sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the audit opinion.

SCOPE OF AUDIT The term “scope of an audit” refers to the audit

procedures deemed necessary in the circumstances to achieve the objective of the audit. The procedures required to Conduct an audit in accordance with ISAs should be determined by the auditor having regard to the requirements of ISAs, relevant professional bodies, legislation, regulations and, where appropriate, the terms of the audit engagement and reporting requirements.

An audit in accordance with ISAs is designed to provide reasonable assurance that the financial statements taken as a whole are free from material misstatement. Reasonable assurance is a concept relating to the accumulation of the audit evidence necessary for the auditor to conclude that there are no material misstatements in the financial statements taken as a whole. Reasonable assurance relates to the whole audit process.

SCOPE OF AUDITREASONABLE ASSURANCE Vs ABSOLUTE ASSURANCE An auditor cannot obtain absolute assurance because there are

inherent limitations in an audit that affect the auditor’s ability to detect material misstatements. These limitations result from factors such as: The use of testing. The inherent limitations of internal control (for example, the

possibility of management override or collusion). The fact that most audit evidence is persuasive rather than

conclusive.

REASONABLE Vs ABSOLUTE ASSURANCE…..

Also, the work undertaken by the auditor to form an audit opinion is permeated by judgment, in particular regarding:

The gathering of audit evidence, for example, in deciding the nature, timing,

and extent of audit procedures; and The drawing of conclusions based on the audit evidence

gathered, for example, assessing the reasonableness of the estimates

made by management in preparing the financial statements.

QUALITY CONTROL

According to ISA 220, the audit firm should implement quality control policies and procedures designed to ensure that all audits are conducted in accordance with ISAs or relevant national standards or practices. The nature, timing and extent of an audit firm’s quality control policies and procedures depend on a number of factors such as the

size and nature of its practice, its geographic dispersion, its organization and appropriate cost/benefit considerations.

QUALITY CONTROL

The firm’s general quality control policies and procedures should be communicated to its personnel in a manner that provides reasonable assurance that the policies and procedures are understood and implemented. Further, The auditor should implement those quality control procedures, which are, in the context of the policies and procedures of the firm, appropriate to the individual audit.

OBJECTIVES OF QC (a) Professional requirements:

Personnel in the firm are to adhere to the principles of independence, integrity, objectivity, confidentiality and professional behavior.

(b) Skills and competence:The firm is to be staffed by personnel who have attained and maintain the technical standards and professional competence required to enable them to fulfill their responsibilities with due care.

(c) Assignment:Audit work is to be assigned to personnel who have the degree of technical training and proficiency required in the circumstances.

(d) Delegation:There is to be sufficient direction, supervision and review of work at all levels to provide reasonable assurance that the work performed meets appropriate standards of quality.

OBJECTIVES OF QC (e) Consultation:

Whenever necessary, consultation within or outside the firm is to occur with those who have appropriate expertise.

(f) Acceptance and retention of clients:An evaluation of prospective clients and a review, on an ongoing basis, of existing clients is to be conducted. In making a decision to accept or retain a client, the firm’s independence and ability to serve the client properly and the integrity of the client’s management are to be considered.

(g) Monitoring:The continued adequacy and operational effectiveness of quality control policies and procedures is to be monitored.

PRINCIPLES OF DELEGATION IN QC….

Any delegation of work to assistants would be in a manner that provides reasonable assurance that such work will be performed with due care by persons having the degree of professional competence required in the circumstances. In due course the following matters will be considered:

Direction

Supervision

Review

Principles of Delegation in QC Direction

Assistants to whom work is delegated need appropriate direction. Direction involves informing assistants of their responsibilities and the objectives of the procedures they are to perform. It also involves informing them of matters, such as the nature of the entity’s business and possible accounting or auditing problems that may affect the nature, timing and extent of audit procedures with which they are involved. The audit program is an important tool for the communication of audit directions. Time budgets and the overall audit plan are also helpful in communicating audit directions.

PRINCIPLES OF DELEGATION IN QC…..

SupervisionSupervision is closely related to both direction and review and may involve elements of both. Personnel carrying out supervisory responsibilities perform the following functions during the audit: Monitor the progress of the audit to consider

whether: Assistants have the necessary skills and competence to

carry out their assigned tasks; Assistants understand the audit directions; and The work is being carried out in accordance with the overall

audit plan and the audit program; Become informed of and address significant

accounting and auditing questions raised during the audit, by assessing their significance and modifying the overall audit plan and the audit program as appropriate; and

Resolve any differences of professional judgment between personnel and consider the level of consultation that is appropriate.

PRINCIPLES OF DELEGATION IN QC….

ReviewThe work performed by each assistant needs

to be reviewed by personnel of at least equal competence to consider whether: The work has been performed in accordance

with the audit program; The work performed and the results obtained

have been adequately documented; All significant audit matters have been

resolved or are reflected in audit conclusions; The objectives of the audit procedures have

been achieved; and The conclusions expressed are consistent with

the results of the work performed and support the audit opinion.

THINGS TO BE REVIEWED ON TIMELY BASIS The overall audit plan and the audit program; The assessments of inherent and control risks,

including the results of tests of control and the modifications, if any, made to the overall audit plan and the audit program as a result thereof;

The documentation of the audit evidence obtained from substantive procedures and the conclusions drawn there from, including the results of consultations; and

The financial statements, proposed audit adjustments and the proposed auditor’s report.

The process of reviewing an audit may include, particularly in the case of large complex audits, requesting personnel not otherwise involved in the audit to perform certain additional procedures before issuing the auditor’s report.

CONTEMPORARY AUDIT ISSUES AS PART OF AQR

Adhering generally to auditing standards and Guidelines

Obtaining confirmation direct from the company’s bankers of bank balances and other important matters known to the bankers.

Obtaining direct confirmation of balances owed by debtors

Attendance at stocktaking.

NATURE AND SOURCE OF AUDIT EVIDENCE ISA defines audit evidence as all of the information used

by the auditor in arriving at the conclusions on which the audit opinion is based. Audit evidence includes the information contained in the accounting records underlying the financial statements and other information. Auditors are not expected to address all information that may exist. Audit evidence, which is cumulative in nature, includes

audit evidence obtained from audit procedures performed during the course of the audit and

may include audit evidence obtained from other sources such as previous audits and a firm’s quality control procedures for client acceptance and

continuance.

The auditor seeks to obtain sufficient appropriate audit evidence at the class of transactions, account balance, and disclosure level in such a way that enables the auditor, at the completion of the audit, to express an opinion on the financial statements taken as a whole at an acceptably low level of audit risk. Auditors use various approaches to accomplish that objective.

AUDIT EVIDENCE CON.. Accounting records generally include the records of initial entries and

supporting records, such as checks and records of electronic fund transfers; invoices; contracts; the general and subsidiary ledgers, journal entries and other adjustments to the financial statements that are not reflected in formal journal entries; and records such as work sheets and spreadsheets supporting cost allocations, computations, reconciliations and disclosures. The entries in the accounting records are often initiated, recorded, processed and reported in electronic form. In addition, the accounting records may be part of integrated systems that share data and support all aspects of the entity’s financial reporting, operations and compliance objectives.

Management is responsible for the preparation of the financial statements based upon the accounting records of the entity.

The auditor obtains some audit evidence by testing the accounting records, for example, through analysis and review, reperforming procedures followed in the financial reporting process, and reconciling related types and applications of the same information. Through the performance of such audit procedures, the auditor may determine that the accounting records are internally consistent and agree to the financial statements.

However, because accounting records alone do not provide sufficient audit evidence on which to base an audit opinion on the financial statements, the auditor obtains other audit evidence.

Other information that the auditor may use as audit evidence includes minutes of meetings; confirmations from third parties; analysts’ reports; comparable data about competitors (benchmarking); controls manuals; information obtained by the auditor from such audit procedures as inquiry, observation, and inspection; and other information developed by, or available to, the auditor that permits the auditor to reach conclusions through valid reasoning

SUFFICIENCY,APPROPRIATENESS AND RELIABILITY OF EVIDENCE An auditor has to obtain sufficient, appropriate and reliable audit

evidence as to a material financial statement assertion. Sufficiency is the measure of the quantity of audit evidence. Appropriateness is the measure of the quality of audit evidence; that

is, its relevance and its reliability in providing support for, or detecting misstatements in, the classes of transactions, account balances, and disclosures and related assertions.

The quantity of audit evidence needed is affected by the risk of misstatement (the greater the risk, the more audit evidence is likely to be required) and also by the quality of such audit evidence (the higher the quality, the less may be required). Accordingly, the sufficiency and appropriateness of audit evidence are interrelated. However, merely obtaining more audit evidence may not compensate for its poor quality.

For example, inspection of records and documents related to the collection of receivables after the period end may provide audit evidence regarding both existence and valuation, although not necessarily the appropriateness of period-end cutoffs.

On the other hand, the auditor often obtains audit evidence from different sources or of a different nature that is relevant to the same assertion. For example, the auditor may analyze the aging of accounts receivable and the subsequent collection of receivables to obtain audit evidence relating to the valuation of the allowance for doubtful accounts.

Furthermore, obtaining audit evidence relating to a particular assertion, for example, the physical existence of inventory, is not a substitute for obtaining audit evidence regarding another assertion, for example, the valuation of inventory.

FACTORS INFLUENCING RELIABILITY OF AUDIT EVIDENCE The reliability of audit evidence is influenced by its source and by

its nature and is dependent on the individual circumstances under which it is obtained. While recognizing that exceptions may exist, the following generalizations about the reliability of audit evidence may be useful • Audit evidence is more reliable when it is obtained from independent sources outside the entity.• Audit evidence that is generated internally is more reliable when the related controls imposed by the entity are effective.• Audit evidence obtained directly by the auditor (for example, observation of the application of a control) is more reliable than audit evidence obtained indirectly or by inference (for example, inquiry about the application of a control).• Audit evidence is more reliable when it exists in documentary form, whether paper, electronic, or other medium (for example, a contemporaneously written record of a meeting is more reliable than a subsequent oral representation of the matters discussed).• Audit evidence provided by original documents is more reliable than audit evidence provided by photocopies or facsimiles.

When information produced by the entity is used by the auditor to perform audit

procedures, the auditor should obtain audit evidence about the accuracy and completeness of the information.

FACTORS INFLUENCING RELIABILITY OF AUDIT EVIDENCE.. The auditor ordinarily finds it necessary

to rely on audit evidence that is persuasive rather than conclusive; however, to obtain reasonable assurance, the auditor is not satisfied with audit evidence that is less than persuasive. The auditor uses professional judgment and exercises professional skepticism in evaluating the quantity and quality of audit evidence, and thus its sufficiency and appropriateness, to support the audit opinion.

USE OF ASSERTIONS FOR AUDIT EVIDENCE The auditor should use assertions for classes of transactions,

account balances, and presentation and disclosures in sufficient detail to form a basis for the assessment of risks of material misstatement and the design and performance of further audit procedures. The auditor uses assertions in assessing risks by considering the different types of potential misstatements that may occur, and thereby designing audit procedures that are responsive to the assessed risks. Other ISAs discuss specific situations where the auditor is required to obtain audit evidence at the assertion level.

Assertions used by the auditor fall into the following categories: Assertions about classes of transactions and events for the

period under audit: Occurrence—transactions and events that have been recorded

have occurred and pertain to the entity. (ii) Completeness—all transactions and events that should have

been recorded have been recorded. Accuracy—amounts and other data relating to recorded transactions

and events have been recorded appropriately. Cutoff—transactions and events have been recorded in the correct

accounting period. Classification—transactions and events have been recorded in the

proper accounts.

ASSERTIONS CONT….

Assertions about account balances at the period end: Existence—assets, liabilities, and equity interests exist. Rights and obligations—the entity holds or controls the rights to assets,

and liabilities are the obligations of the entity. Completeness—all assets, liabilities and equity interests that should

have been recorded have been recorded. Valuation and allocation—assets, liabilities, and equity interests are

included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded.

Assertions about presentation and disclosure: Occurrence and rights and obligations—disclosed events, transactions,

and other matters have occurred and pertain to the entity. Completeness—all disclosures that should have been included in the

financial statements have been included. Classification and understandability—financial information is

appropriately presented and described, and disclosures are clearly expressed.

Accuracy and valuation—financial and other information are disclosed fairly and at appropriate amounts.

AUDIT PROCEDURES FOR OBTAINING AUDIT EVIDENCE Obtain an understanding of the entity and its

environment, including its internal control, to assess the risks of material misstatement at the financial statement and assertion levels (audit procedures performed for this purpose are referred to in the ISAs as “risk assessment procedures”);

When necessary or when the auditor has determined to do so, test the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the assertion level (audit procedures performed for this purpose are referred to in the ISAs as “tests of controls”); and

Detect material misstatements at the assertion level (audit procedures performed for this purpose are referred to in the ISAs as “substantive procedures” and include tests of details of classes of transactions, account balances, and disclosures and substantive analytical procedures).

TEST OF CONTROLS

Tests of controls are necessary in two circumstances. When the auditor’s risk assessment includes an expectation of the operating effectiveness of controls, the auditor is required to test those controls to support the risk assessment. In addition, when substantive procedures alone do not provide sufficient appropriate audit evidence, the auditor is required to perform tests of controls to obtain audit evidence about their operating effectiveness.

Examples of tests Walkthrough tests – this includes taking a few

transactions and following them through every stage of the system, from material requisition to settlement of supplier’s invoice.

Test of controls- Taking a representative sample of transactions, and testing certain significant controls. For purchases, test control over payments by checking purchases invoices have been authorized before payments

Substantive procedures – Taking a larger sample of balances, and testing for completeness and accuracy. For creditors, compare suppliers statements with purchases ledger to ensure creditors are stated at their correct amount.

EVIDENCE IN E-COMMERCE

The nature and timing of the audit procedures to be used may be affected by the fact that some of the accounting data and other information may be available only in electronic form or only at certain points or periods in time. Source documents, such as purchase orders, bills of lading, invoices, and checks, may be replaced with electronic messages. For example, entities may use electronic commerce or image processing systems. In electronic commerce, the entity and its customers or suppliers use connected computers over a public network, such as the Internet, to transact business electronically. Purchase, shipping, billing, cash receipt, and cash disbursement transactions are often consummated entirely by the exchange of electronic messages between the parties. In image processing systems, documents are scanned and converted into electronic images to facilitate storage and reference, and the source documents may not be retained after conversion. Certain electronic information may exist at a certain point in time. However, such information may not be retrievable after a specified period of time if files are changed and if backup files do not exist. An entity’s data retention policies may require the auditor to request retention of some information for the auditor’s review or to perform audit procedures at a time when the information is available.

USE OF CAAT TO OBTAIN ELECTRONIC EVIDENCE

When the information is in electronic form, the auditor may carry out certain of the audit procedures described below through CAATs

Inspection of Records or Documents Inspection of Tangible Assets Observation -consider ISA 501, “Audit Evidence

—Additional Considerations for Specific Items” Inquiry- consider ISA 580, “Management

Representations” for further guidance on written representations.

Confirmation- consider ISA 505, “External Confirmations” for further guidance on confirmations.

Recalculation Reperformance Analytical Procedures – consider ISA

520,“Analytical Procedures” for further guidance on analytical procedures.

MANAGEMENT ASSERTIONS Example inventory

Existence- inventory in the balance sheet physically exists. Inventory is held for sale or use in the ordinary course of business

Completeness Inventory quantities include all items on hand, in transit and

stored at outside locations. Inventory listings are accurately included in the inventory accounts.

Rights and Obligations – the company has legal title or similar rights of ownership to the inventory. Inventory excludes items billed to customers or owned by others..

Valuation – inventory is properly stated at cost. Valuation is reduced , where appropriate, to the market lower than cost

Presentation and Disclosure – inventory is properly classified as a current asset. Major inventory categories and their valuation bases are adequately disclosed in notes. Pledge or assignment of inventory as collateral is appropriately disclosed in notes

EXISTENCE TESTS CUT OFF PROCEDURES

CUTOFF REFERS TO RECOGNIZING ASSETS AND LIABILITIES AS OF A PROPER DATE AND ACCOUNTING FOR REVENUE, EXPENSE AND OTHER TRANSACTIONS IN THE PROPER PERIOD.•SIMPLE CUT OFF ERRORS CAN OCCUR

When last December sales invoices are record for goods not actually shipped until January or when cash

receipts are recorded through the end of the week ( e.g.., Friday, January 4) and the last batch for the year should have been processed on December 31

In Auditor’s jargon, the cutoff date refers to the client's year end balance sheet date. Proper cutoff means

accounting for all transactions that occurred during the period and neither postponing some recordings to the next period nor accelerating next-period transactions

into the current- year accounts.

The auditors use seven basic types of evidence an seven general procedures to gather it. One or more of these procedures may be used no matter what account balance , control procedures, class of transactions or other other information is under audit. The auditor arrange the procedures in an AUDIT PROGRAM

Management Assertions and Audit Objectives

Sufficient appropriateEvidence

General Audit procedures

Audit Working papers

GENERAL AUDIT PROCEDURES

TYPES OF EVIDENCE AND RELATED AUDIT PROCEDURES

TYPES OF EVIDENCE EVIDENCE GATHERING PROCEDURES

Physical observation, inspection Observation and Examination by the Auditor

Auditor’s calculations Recalculation by the auditor

Statement by independent parties Confirmation letter

Statement by client personnel Verbal inquiry and written representations

Documents prepared by independent parties

Examination of documents ( vouching or tracing)

Documents prepared by the client Examination of documents ( vouching or tracing)

Data interrelationship Scanning and Analytical procedures

INTERNAL CONTROLS Internal control system is the whole system of

controls, financial and otherwise, established by the management in order to carry on the business of enterprise in an orderly and efficient manner ensure adherence to management policies, safeguard the assets and secure as far as possible the completeness and accuracy of the records.

Types of internal control Organizational

Plan of an organization Define and allocate responsibilities Identify lines of reporting

Authority to purchase items of plant may be vested in BoD Segregation of Duties

No one person should be responsible for the recording and processing of the entire transaction.

Several people reduces the risk of intentional or accidental manipulation or error

Authorization, execution and custody , recording

INTERNAL CONTROLS…. Physical

Limit access to authorized personnel only Documentation of access Controls for valuables , portable , exchangeable or desirable assset e.g .locking of securities,in

safe with procedures for the custody and use of keys

Authorization and approval Approval by authorized person, limits of authorization should be specified e.g credit sale must

be approved by the credit control dept. Arithmetical and accounting

Controls in the recording function which check that the transactions have been authorized, they are all included and that they are correctly recorded and accurately processed.

Checking the arithmetical accuracy of the records the maintenance and checking of total, reconciliations

Previews, bank reconciliation

Personnel Procedures to ensure that personnel operating a system are competent and motivated to

carry out the task to them as the proper functioning of a system depends upon the competence and integrity of operating personnel

Appropriate remuneration and promotion and career development prospects, selection of people with appropriate personal characteristics and training , and , assignment to the task of the right level

Supervision All actions by all levels of staff should be supervised. Responsibility for supervision should be

clearly laid down and communicated to the persons being supervised. Management

Controls exercised by mgt which are outside and over and above the day to day routine of the system

Overall supervision controls, reviews of mgt controls, comparisons with budgets , internal audits

INTERANL CONTROLS…..

Other controls

Acknowledgement of Performance A person performing data processing operations should

acknowledge their activities by means of signatures, initials , rubber stamps.

Budgeting Is a quantitative plan of action

Budgets can be compared with actual turn and differences investigated

AUDIT TESTING

WALK THROUGH TESTS An auditor must record the accounting system and its associated

internal controls When the record has been prepared in the previous year or earlier or

when it has been prepared by the staff of the client, it is necessary for the auditor to be sure that the record correctly describes the system as it exists and is operated. To test the correctness of the description, the auditor takes a few transactions of each type. This means tracing the transaction from its initiation to the entry in the books of account, looking at all documents and records produced, the manner of preparation and the internal controls applied. The objective is not to test the effectiveness of the system but that the auditor has a correct description and understanding of the system.

The walk through test should also be applied In situation where the auditor has not obtained his description of the

system from a personal investigation of the system by the questioning operating staff and examining documents and records

At the final audit when he needs to review the system form the date of the interim completion of the year end . She must determine if the system has changed and walk through checks will achieve this.

COMPLIANCE TESTS Those tests which seek to provide audit evidence that provides audit

evidence that internal control procedures are being applied as prescribed.

COMPLIANCE TESTS The first stage is preliminary review of the effectiveness of

the system by using an internal control evaluation questionnaires which contains key questions.

E.g. can wage be paid to piecework personnel for work not done? The system would then be inspected o see if it included

procedures to ensure that this could not happen. If the system appears to be defective or weak then the auditor

may need to abandon the system approach and apply substantive test. If the system is effective, then the next stage is for the auditor to obtain evidence that the system is effective , then the next stage is for the auditor to obtain evidence that the system is applied as his description at all times. This evidence is obtained by examining a sample of the transactions to determine if each has been treated as required by the system.

NOTE: Compliance tests is the application of the system that is

being tested not the transactions although the testing is through the medium of the transactions

If the discovery is made that the system was not complied with in any particular, then; She may need to revise his system description and re-appraise

its effectiveness She will need to determine if the failure of compliance was an

isolated instance or was symptomatic.

SUBSTANTIVE TESTS

Are those tests (other than compliance tests) of transactions and balances and other procedures such as analytical review, which seek to provide evidence as to the completeness , accuracy and validity of the information contained in the accounting records or the financial statements.

Substantive test is any test which seeks direct evidence of the correct treatment of a transaction, a balance , an asset , a liability, or any item in the books or accounts.

Examples Transactions

A balance e.g. deposit account

Analytical review

Completeness of information

Accuracy of information

Validity of information

TECHNIQUES OF AUDIT TESTING

Inspection Observation Inquiry Computation

ROTATIONAL TESTS Rotation of audit emphasis – the auditor

performs a systems audit on all areas of the client’s business every year but each year he select one are ( wages, sales, stock control, purchasing) for special in-depth testing

Visit rotation – where the client has numerous branches , factories, locations, etc, it may be impractical to visit them all each year.

AUDIT WORKING PAPERS The audit work must be adequately planned, controlled and

recorded. The purpose of working papers

To control current year’s work, the record of work done is essential for the audit clerk, supervisor, manager and partner and other person who will review the work done.

To form the basis for the plan of the audit of the following year Evidence of the work carried out.

The working papers should contain Information and documents which are continuing importance to each

annual audit Audit planning and control information Details of the client’s system and records with the auditor’s evaluation

of them Schedules in support of the accounts additional to, or summarizing the

detail in the client’s Books. Details of the audit work carried out, notes of queries raised with action

taken thereon and the conclusion drawn by the audit staff concerned Evidence that the wok of the audit staff has been properly reviewed by

more senior people A summary of significant points affecting the financial statements and

the audit report ( e.g. the guarantee above), showing how these points were dealt with

FORMS OF WORKING PAPERS The Permanent file

The permanent file usually contains documents and matters continuing importance which will be required for more than one audit

Statutory materials- governing conduct, accounts and audit of the enterprise

The rules and regulations of the enterprise , example article and memorandum of association

Copies of documents of continuing importance such as letter of engagement, minutes of appointment of auditor; trade, license, and royalty agreements entered into by client, debenture notes, guarantees and indemnities entered into.

An organization chart; the principal dept and subdivision thereof with note for number of peoples involved; and names of responsible officials

List of books and other records and where they are kept, names , positions, specimens of signature and initials of persons responsible for books and documents should also be included. Account codes and classifications should also be held

An outline history of organization – eg. Share capital , reserves, provisions, prospectuses, ; acquisition of subsidiaries and businesses. There should also be a record of important account ratios

List of accounting matters of importance. E.g. accounting policies for stock, work in progress, depreciation,

Notes of interviews and correspondence ( internal control matters and all past letters of weakness)

Clients’ internal audit and accounting instructions List of directors , their shareholdings and service contracts List of company’s properties and investments with notes on verification A list of company advisors, bankers, solicitors, lawyers

It is important that the permanent file is updated on the occasion of each audit.

THE WORKING PAPERS…… The current file

A copy of accounts being audited, authenticated by director’s signatures An index of the file A description of the ICS in the form of an ICQ, flowchart, or written

description together with specimen documents An audit programme

A list of work to be carried out by audit staff A list with details of tests actually carried out The result so the tests and the conclusions drawn from them Cross reference to IC record and letter of weakness Were rotational testing over a period of years is used , reference to appropriate

part of Permanent File A schedule for each items in the profit and Loss Account showing its make

up Checklist for compliance with statutory disclosure requirements; IAS A schedule of each item in the Balance sheet. Each schedule should show;

The item at the beginning of the year, changes during the year and the balance at the end

Details of how its existence , ownership , value and appropriate disclosure have been verified

Documents of external verification e.g. bank letter A record showing queries raised during the audit and coming forward from

previous years. This record will show how the queries have been dealt with, by whom ( i.e. audit clerks, supervisor, manager or partner) and if not satisfactory answered, the treatment adopted which may be a qualification of the auditor’s report, and contingent liabilities.

Current File cont…. Schedule of important statistics. These will include

quantitative matters such as the output, sales composition, employment, and also accounting ratios such as capital employed , gross and net profit rations and liquidity rations. Comparison of these statistics with those of previous years( note din the Permanent File) must be made to determine significant variation. The variations need to be investigated and explanation sought

A record or abstract from the minutes of The company The directors Any internal committee of the company whose

deliberations are important to the auditor . E.g. internal audit committee, a budget committee, a capital expenditure committee.

Copies of letters to the client setting out internal control weaknesses

Letters of Representation- these are letters written by the Directors ( or equivalent in organization other than companies) to the auditors, being written confirmation of information given or opinions expressed by the directors on such matters as the value of stock, value of properties, uncertain obligations

Working papers cont…..

Both the permanent and current files contain material on IC. It a matter of opinion where this data is filed; some audit firms adopt a filing system whereby IC matters are stored in a third file, the Internal Control File.

Throughout the current file , reference should be as to how each item is used as audit evidence. Conversely , for each type of transactions and balance , the nature of the audit evidence supporting it should be demonstrated. The evidence may be from internal control reliance , substantive testing or from analytical review or form a combination of these sources.

INTERNAL CONTROL QUESTIONNAIRES

Functions: A method of ascertainment of the system Enabling the auditor to review and assess the adequacy of

the system Enables the auditor to identify the areas of weakness Enabling the auditor to design a series of tests. In effect this

means enabling the auditor to draw up his audit programme Enables the auditors staff to familiarize themselves with the

system quickly and comprehensively.

I.C.Q CONT….

Advantages The use of standardized I.C.Q. ensures that all the important

questions are asked and the important characteristics of a system are brought out

The I.C.Q. is a comprehensive , all in , inclusive method of ascertaining , recording g, and evaluating a system of IC

An example of a part of I.C.Q includes separate columns for ; questions, Answers- if possible Yes/N; assessment of IC strength; Disposal of weakness and cress reference to audit programmme

INTERNAL CONTROL EVALUATION QUESTIONNAIRES

Some audit firms uses ICQ's exclusively, others prefer to ascertain the system by questioning staff and recording the system by means of flowcharts or by written notes.

I.C.E.Q is a standardized set of questions which has the advantage, like the I.CQ. , of ensuring all right questions are asked and the strength and weakness of a system are brought about.

The basic questions in an I.C.E.Q are called control questions, an example from the sale area is “ can sales be invoiced but not recorded in the books? Each control questions requires an answer Yes or No.

FLOWCHARTS

Flowcharts are a relatively new method of recording internal control system form the auditor's standpoint

Advantages It enable the system to be recorded in such a way that it can be understood

by New staff coming to the audit Supervisors, managers, and partners Client staff, who can have weaknesses pointed out more easily

The overall picture of the firm can be seen , and in particular the auditor can be assured he has the whole picture as slow lines going nowhere can be easily spotted

Flowcharting is a consistent system of recording Flowcharting is a disciplined method of recording Flowcharting highlights relationship between different pats of a system Weaknesses are easier to spot Flowcharts are permanent record but are easily updated In complex cases, flowcharting is the only way to gain an understanding of

the system Disadvantages

Time consuming Can become a fetish i.e. ends in themselves They are of little use in systems 9 e.g. small concerns) where internal

control is ineffective or very simple Numerous symbol systems abound which can cause confusion

FLOWCHARTING… CONT….

The objective of a flowchart is that it is complete in itself and can be read and understood quickly and comprehensibly.

The following are important in preparing flowcharting An organization chart is an essential concomitant Simplicity and clarity are fundamental It must not be congested Use only horizontal and vertical lines Chart the flow of goods and documents on separate charts Serial number the operations Cross reference to ICQ, ICEQ, Audit program , letter of weakness It must show

Initiation for each document and operation Sequence of all operational on documents and all copies of

documents , especially operations of control, inspecting, checking, comparing and approving

To ultimate destination Sections or individuals who perform the operations Use chart symbols only , if possible Specimens of documents should be attached and cross referenced

AUDIT PROGRAMME It is simply a list of work an auditor does on the

occasion of his audit. Example: “vouch three months’” There would be columns

for the periods selected and of the initial of the audit clerk and the date of the test.

Advantages They provide a clear se of instructions on the work to be

carried out They provide a clear record of the work carried out and by

whom Work can be reviewed by supervisors, managers Work will not be duplicated No important work will be overlooked Evidence of work done is available for use in defense

actions for negligence Disadvantages

Work may become mechanical Parts may be executed without regard to whole system.

ACCOUNTANT’S LIEN

Accountant’s are considered to have a particular lien over any books of account, files and papers which their clients have delivered to them and also over any documents which have come into their possession in the course of their ordinary professional work In particular the lien gives the possessor the right to retain

goods until a debt arising in connection with those goods is paid

REPORT TO MANAGEMENT

The ISA on IC indicates that the auditor should report to his client's management on all significant weaknesses that they came across in the course of his audit whilst pointing out that there may be other weaknesses which were not discovered.

The title to the letter to management varies from firm to firm , such titles include ; letter of weakness, management letter, post audit letter, letter of comment, letter of recommendation, internal control letter, follow –up letter

REPORTING TO MGT CONT…..

Purposes To enable the auditor to give his comments on the

accounting records, systems and controls To enable the auditor to bring to the attention of

mgt areas of weakness that might lead to material errors.

In some audit engagements there is a requirement to make a report. These includes local authorities, stock exchange firms

To enable the management to be right matters that may otherwise have led to audit report qualification

To enable the auditor to point out areas where management could be more efficient or more effective or where economies could be made or resources used more effectively. E.g unnecessarily large balances may occur occasionally in the bank.

LETTER OF WEAKNESS

Procedures As weaknesses or breakdowns are

identified they should be discussed in detail with the operating staff included and / or with more senior management. It is vital that the auditor has his facts right

The report should be written, and then discussed with addressee

The report should then be sent An acknowledgement should be obtained

form management stating what they propose to do about the weaknesses

The weakness should be followed up on the next visit.

LETTER OF WEAKNESS CONTENTS

The list of weaknesses in the structure of accounting systems and internal controls

A list of deficiencies in operation of the records or controls.

Unsuitable accounting policies and practices Non-compliance with accounting standards and

legislation Explanations of the risks arising from each

weakness Comments on inefficiencies as well as

weaknesses Recommendations for improvementThe first to third items may require the auditor to

qualify the report to the MEMBERS as required by statutes ( e.g. company’s Act) on proper accounting records, accounting requirements and true and fair view and professional duty

LETTER OF WEAKNESS - FORMAT

An opening paragraph explaining the purpose of the report

A note that it contains only those matters which came to the auditor’s ATTENTION and cannot be a comprehensive list of all weaknesses

If required that report may be tiered by having major weaknesses separated from minor weaknesses

A request that management should reply to each point made

TRACING AND VOUCHING

Vouching in the examination of documents is the direction of the search for audit evidence. In vouching , an item of financial information is selected from an account( e.g. , the posting of a a sales invoice in a customer’s master file record), then the auditor goes backward through the accounting and control system to find the source documentation that supports the item selected. The auditor finds the journal entry or data input list, the sales summary , the sales invoice copy and the shipping documents, and finally , the customer’s purchase order. Vouching does not provide evidence to show whether all events were recorded . This can be shown by tracing

VOUCHING AND TRACING…

Tracing in the examination of documents takes the opposite direction from vouching . When an auditor performs tracing, he or she selects sample items of basic source documents and proceeds forward through the accounting and control system to find the final recording of the accounting transactions. For example, samples of payroll payments are traced to cost and expense accounts , sales invoices to sales accounts , cash receipts to accounts receivable subsidiary accounts, and cash disbursements to accounts payable subsidiary accounts.

AUDIT WORKING PAPERS

Working papers are the auditors’ record of compliance with ISAs

They should contain support for the decisions regarding procedures necessary in the circumstances and all other important decisions made during the audit.

Though the auditor is the legal owner of the working papers professional ethics require that they not be transferred without consent of the client because of the confidential information recorded in them.

TYPES OF WORKING PAPERS

There are three categories The permanent file papers

Audit administrative papers

Audit evidence papers

The last two categories are often called the current file because they relate to the audit of one year.

PERMANENT FILE PAPERS

The permanent file contains information of continuing interest over many years’ audits of the same client. This file can be used year after year, while each year’s current audit evidence papers are filed away after they have served their purpose.

The documents include Copies or excerpts of the corporate charter

and bylaws, or partnership agreements; Copies or excerpts of continuing contracts,

such as leases, bond indentures, and royalty agreements;

PERMANENT FILE CONT….

A History of the company,its products, and its markets

Copies of excerpts of stock holders, directors, and committee minutes on matters of lasting interest

Continuing schedule of accounts whose balances are carried forward for several years, such as owner's equity, retained earnings

Copies of prior years’ financial statements and audit reports may also be included.

The permanent file is a ready source of information for familiarization with the clients by new personnel on the engagement.

AUDIT PLANNING AND ADMINISTRATIVE WORKING PAPERS

The following items are usually among the administrative working papers in each year’s current working paper file Engagement letter Staff assignment Clients organization chart Memoranda of conferences with management Preliminary analytical review notes Initial risk assessment notes Initial materiality assessment notes

CURRENT PAPER FILE CONT….

Engagement planning memorandum

Audit engagement time budget

Internal control questionnaire and control analyses

Management controls questionnaire

Computer control questionnaire

Internal control system flow chart

Audit program

ISA REQUIRES AUDIT WORKING PAPERS TO EXHIBIT

The client’s accounting records agree with or reconcile with the financial statement s

The work was adequately planned and supervised

A sufficient understanding of control structure obtained

Sufficient competent evidential matters was obtained as a reasonable basis for an audit opinion

Should be able to sufficiently show that the financial statements conforms with IFRS and that the disclosure are adequate.

WORKING PAPERS ARRANGEMENT AND INDEXING

Indexing- each paper is given an index number, like a book page number

Cross indexing- numbers or memoranda related to to other papers carry the index of the papers so that connections can be followed

Heading – each paper is titled with the name of the company , audit period and descriptive title of contents of the working paper

WORKING PAPERS ARRANGEMENT AND INDEXING

Signatures and initials the auditor who performs the work and the supervisor who reviews it must sign the papers so personnel can be identified

Dates of audit work the date of performance and review are recorded on the working papers so reviewers of papers can tell when the work work preformed

Tick marks and explanations- “tick marks are auditors\s shorthand for abbreviating comments about work performed