Audit Chapter 11

8/8/2019 Audit Chapter 11

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AUDITING


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An audit is the independent examination of, and expression of opinion

on , the financial statements of an entity by a duly appointed auditor

In pursuit of that appointment.

It is important to realize that auditor is not certifying the accuracy

Of the financial statements.


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Corporate Governance

- the purpose of an external audit

y Corporate governance- the system by which companies are directed and

governed.

PRINCIPLES OF CORPORATE GOVERNANCE

The rights of shareholders-

Corporate governance framework should protect the right of the shareholders.

The equitable treatment of shareholders

CGF should ensure the equitable treatment of all the shareholders including


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Minority and foreign shareholders

All the shareholders should have the opportunity to obtain effective redress

For any violation of their rights

The role of stakeholders

CGF should recognize the rights of the stakeholders and encourage the active

cooperation between the entities and stakeholders in creating wealth, jobs and

sustainability of financially sound entities.


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Disclosure and Transparency

CGF should ensure that timely and accurate disclosure is made on all the

Material matters regarding the entity, including the financial situation,

Performance, ownership and governance of the entity.

Responsibility of the Board

CGF should ensure the strategic guidance of the entity, the effective

Monitoring of the management by the board and the boards accountability

to the entity and its shareholders.


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Auditors Code of Conduct

Integrity- Straightforward and Honest

Objectivity- Free from Bias

Professional competence- current development, legislations

Confidentiality

Professional behavior


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Self Interest

Financial

Close business relationships

Past Employment

Family relationships

Loans and Guarantees

Overdue Fees

Contingent Fees

High percentage fees


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Low Balling

Recruitment for the client

SELF REVIEW

Problem of criticizing your own work

ADVOCACY

Where the assurance firm promotes a point of view or opinion

That subsequent objectivity is compromised

INTIMIDATION

Black mailing and physical threats


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AUDITORSREPORT

U

nmodified

Modified

MODIFIED

Matters that do not

Affect the auditors opinion

Matters that do affect the

Auditors opinion

Emphasis of matterQualified opinion:

Limitation on scope or

Disagreement


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A paragraph in an auditors report used when the auditor specially wishes todraw the readers attention to some matter already properly and clearly disclosed

Within the FS

Such a paragraph does not constitute a qualification of the auditors opinion

Without qualifying our opinion above, we draw attention to NOTE 10 of the FS. 5days before the directors formally approved the FS, the company received

notification that they are to be named as defendants in a proposed legal action

At this early stage it is not possible to estimate the ultimate outcome of this matter.,

and no provision has been included within the FS.


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GoingConcern

Should assess going concern over the 12 months from the balance sheet

date

Negative operating cash flows

Inability to pay suppliers in time

Operating losses

Borrowing facilities not agreed

Loss of key staff members

Loss of key customers

Technology change

Legislative changes

Non compliance with regulations


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Case Study

You are in charge of the audit firm. The audit manager has completed the audit for thefinancial year and has given you the draft financial statements for the period 1 Jan 2209 to 31st

Dec 2009 and audit fie containing all the working papers. You are conducting your final review

prior to signing the audit report and have identified that company has borrowings of Rs 10

million which are due for the repayment on 25thJan 2010 but it is trying to currently extend

the due date; in addition it also has an overdraft of Rs 250,000 which is 50,000 over the

authorized limit; this was not identified as the cause of concern by the audit manager.

Required:

Discuss ten issues that you think the audit manager should have considered whether or not a

company is a going concern.


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GoingConcern

Effect on audit report when going concern is in doubt

If disclosed---------Emphasis of matter

If not disclosed---------Disclaimer, adverse, limitation in scope


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Audit Planning

Plan audit workso as to do the work in an effective manner

General strategy and detailed approach

Planning objectives are

1. Appropriate attention to important areas

2. Identify potential problems

3. Work completed expeditiously

4. Proper staffing and work assignment

5. Coordination with other parties

6. Facilitate review


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Gaining an understanding of the Entity

Nature of the entity

Industry, regulator

A

ccounting policies Objectives and strategies

Internal controls

Control environment

How entity identifies business risks

Measurement of financial performance


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The concepts of risk

What is reasonable assurance

Managers need to put in place control strategies which will offer the best chances

of identifying and correcting errors at a

reasonable cost.

To do this, they need to understand risk


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The different types of risk

Inherent risk (the risk linked to the activity itself)

Control risk (the risk that controls will not prevent, detect and correct errors)

Residual risk (the product of inherent risk and control risk)

RR=IRXCR


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Put another way

Inherent risk x control risk = residual risk

OR

The risk linked to the activity, less the amount of error detected by controls = The

amount of error likely to remain undetected


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What is inherent risk?

Definition: Inherent risk is the risk related to the nature of the activities Relevant factors (complex rules, ambiguous claim forms, lack of

Guidance, new staff, recently shifted to computerised systems.)

In simple terms it is risk that company's financial statements will contain an error

What is control risk?

Definition: Control risk is the threat that errors or irregularities in the underlying

transactions will not be prevented, detected and corrected

by the internal control systems at the spot.


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What is residual risk?

The risk remaining after the controls put in place to mitigate the inherent risk.

Remember the formula:

Inherent risk x control risk = residual risk


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Conclusion

zero risk in any activity is not achievable; therefore

the residual risk, after controls, has to be defined by management;

management may decide or not to reduce residual risk further

the additional benefit of extra controls must be weighed against its cost


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Sources of Evidence

Analytical Procedures

Enquiry and Confirmation

Inspection

Observation

Recalculation and Re performance


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HowMuch Evidence

Sufficient appropriate audit evidence to be able to draw reasonable

conclusion on which to base an audit opinion.

Sufficient= Quantity

Appropriate= Relevant and Reliability

External better than entity's records

Direct evidence is better than indirect evidenceWritten is better than oral

Original better than photocopies


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The Use of Assertions

Accurate

Complete

Cutoff

Allocation

Classification and Understandability

Occurrence

Valuation

Existence

Rights and Obligations


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Types of Sampling

Random selection

Systematic selection

Haphazard selection

Stratification

Monetary Unit Sampling


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Hasnain constructions are a construction company employing a large number of workers on

various construction sites. The internal audit department is reviewing cash wages systems in

the company.

The following information is available.

Hours worked are recorded using a clocking in/out system. On arriving for work and at the

end of each days work each workers enters their unique employees number on a key pad.

Workers on each site are controlled by a foreman. The foreman has record of all the

employees numbers and can issue temporary numbers for new employees.

A

ny overtime is calculated by the computerized wage system and added to the standard pay.The two staff in the wages department makes amendments to the computerized wages

system in respect of employee holidays, illness as well as setting up and maintaining all

employees records.

The computerized wage system calculates deductions from the gross pay, such as employees

taxes and net pay. Finally the list of net cash payments for each employee is produced.

Cash is delivered to the wage office by secure courier.The two staff place cash into wages packets for each employee along with a hand written note

of gross pay, deductions and net pay. The packets are given to the foreman for distribution to

the individual employees.

Required

Weakness in the system

Suggest an internal control


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RECEIVABLES

Write to selected debtors and ask for the confirmation of

Amounts owing

Two types

Positive: want a reply everyone written to

Negative: want a reply only if balance out of agreement

Reply should go directly to auditors office

Can stratify as samples so that large percentage is covered

Ask about old debts

Balances haven't moved for sometimes


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Other work regarding receivables

y Reconcile ledger to control accounts

y Aged listings

yCorrespondence

y Board minutes

y Collection period

y Receipts after year end


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Payables

y Reconcile ledger to control accounts

y Correspondence ( Contingent Liability)

y Board minutes

yPayable period

y Statement reconciliation

y Payments after year end


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Contingent Liability

Present obligation probably requiring outflow of resources:

Provision recognized and disclosure required

Possible obligation, or present obligation that will Probably not

Require outflow of resources: No provision but disclosure

Possible obligation , or present obligation where likelihood of an outflow

Is remote: No provision, no disclosure

Contingent liability: Possible liability arising from pat events.existence

Confirmed by future events


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Contingent Assets

Contingent asset: possible asset arising from past events.existence confirmed

By future events

Inflow of economic benefits is certain: asset is not contingent

Inflow of benefits is probable but not certain: No asset is recognized but disclosure

Is made

Inflow is not certain: No asset recognized and no disclosure


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Inventory counts

Inventory is difficult to audit: Quantity, description, ownership,

Condition, value

1. Plan in advance

2. Identify damaged and third party inventories3. Pre number the locations

4. Issue pre numbered sheets

5. Sign off the location counted

6. Check Inventory Sheets

7. Account for all inventory sheets

8. Check price: Re perform the calculations


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Audit Chapter 11

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