Auditing Notes

5/22/2018 Auditing Notes

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AUDITING

Auditing comes from a Greek word Audin' which means to hear, therefore auditors were

traditionally hearers. They had oral reports on how other people managed the economic

resources entrusted to them by the owners.

In Britain for eample, the !ing with the help of the "hancellor of the #che$uer used to

hear oral reports of how the !ingdom resources were managed to ascertain whether theywere properly used.

%resent auditing has roots in the Industrial reudution &()*+. The deelopment of

industries and their epansion re$uired professional management because the ownersfound it difficult to manage their own businesses. The deelopment of auditing in !enya

can be traced to the coming of colonial rule and the beginning of organi-ed money trade

in the business world.

FACTORS INFLUENCING THE GROWTH OF AUDITING IN KENYA

Industrial Revolution

The industrial reolution a conse$uent epansion of technology resulted in the increase of

business si-e hence necessitating growth or need for auditing.

%ublic wnership and %rofessional /anagement

0ue to separation of owners of business from management, the shareholders re$uired an

independed epert to report to them on their companies' financial affairs at the end of

each financial period. The auditors act as an arbitrator between the owners and themanagement hence the need for auditors to be independent.

1egislation by 2tateThe conduct of audits has been made a statutory obligation to companies registered under

the "ompanies Act "ap 3(4. "ompanies are therefore re$uired by law to hae their

financial statement audited leading to deelopment of auditing.

%ronouncement by the "ourt of 1aw

The many cases brought by court with regards to auditors has made pronouncement

which reflect the growing epectation of society from profession to improe $uality ofwork especially presentation and reprinting financial statements. "ourts are not only

making it easy to sue the auditor, but they are also demanding for establishment of

accounting principles and auditing standards hence growth of auditing.

0efine Auditing

Auditing is an independent eamination of the books of account, finance statements andouchers by the appointed auditor to ascertain whether they reflect a true and fair iew of

the company's state of affairs as at the balance sheet.


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ELEENTS OF DEFINATION

1. Independent Examination

It is a re$uirement of company Act as a professional body &i.e. I"%A"+ that theauditor should be independent. %rofessional independence means that the

auditors should be free from any influence of the management.

2. Books of Accounts

The "ompanies Act "ap 3(4 re$uires that all public limited companies should

keep proper books of the accounts i.e. cashbook ledgers.

3. Financial Statements.

5efers to the % and 1 account, balance sheet, it is a re$uirement of a "ompany Act

that they must be tabled before shareholder's AG/.

4. Vouchers

These are support documents behind any accounting transactions e.g. receipts, log

book, title deeds, che$ues

. !rue and Fair VieTrue means6 in accordance with reality or correct or a perceied standard. True

account means not false, ficticious and in accordance with the fact. The auditor

therefore should identify and ascertain that the accounts contain elements of truthespecially in the balance sheet and % and 1 account.

7airness means8 accounts should be fair to the users because they hae certain

epectation. The users epect that the accounts comply with the "ompany Act andconfirm to the generally accepted accounting principle or practices &G.A.A.%2+. If he

certifies these epectations of the users it can be said that we are fair.

It's epected that accounts will reflect the resources used in the company and claims

against resources.

De!ine an Audit

An audit is an independent eamination and epression of opinion on financial statement

of an enterprise by an appointed auditor in pursuance to that appointment and in

compliance with any releant statutory re$uirements. Audit opinion is the auditors ownprofessional 9udgement as to whether financial statement she has audited reflect a true

and fair iew.

A true audit opinion &:e+ is known as an un"uali!ied O#inionwhereas a negatie &;e +

opinion is known as a $uali!ied O#inion%

A $ualified opinion may lead to the following effects on the company8

. 7all in price of shares on the stock echange market


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=. 0ismal of Board of 0irectors by shareholders

3. 1i$uidation of the "ompany in etreme cases

0istinction Between Auditing and Accounting

AUDITING ACCOUNTING

It is an independent eamination of the books of

account, financial statement and ouchers to ascertain

whether they reflect a true and fair iew of balancesheet

Accounting is the recording,

classifying and

communication of economicinformation to assist in

decision making

< Auditing comes after accounting Accounting usually proceeds

auditing therefore books of

accounts must be prepared

= Auditing is performed by auditors who must be fully$ualified accountants

Accountancy is performed byaccountants who may either

be partially or fully $ualified

accountants

3 Auditing is performed by auditors who report to

shareholders of the company

Accountancy is performed by

accountants who usuallyreport to the management

) Auditing is conducted at the end of the year Accountancy is a continuous

process

4 Auditing is a statutory re$uirement for limited

companies

Accountancy is essential for

all businesses regardless oftheir nature and time.

> The professional body &I"%A!+ is usually igilant oerauditing process

The professional body doesnot keep igil oer the work

of accountancy

O&'ECTI(ES OF AN AUDIT

)ri*ar+ O,-e.tives

To epress all audit opinion on the financial statement prepared and presented by themanagement regarding a true and fair iew.

The following should be stated in auditor's opinions8;?hether the "ompany has kept proper books of account?hether the auditor's has receied all important information and eplanation necessary

for his audit work.

?hether ade$uate returns hae been receied from branches not isited by the auditor?hether financial statements are in agreement with the books of account

?hether the accounting policy followed is in agreement with the generally acceptable

accounting principles or practice &G.A.A.%s+ &IA2+.

=


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Se.ondar+ o,-e.tives

. %roiding adice to the clients management through the management letter on thefollowing8;


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=. They are used by firms to raise finance as they boost the forms credit rating

therefore they are used as a basis of borrowing

3. It is used by ta authorities to assess the "ompany ta liability and helps to aoidpossible disputes between the "ompany and income ta authority

). In cases where the business is to be sold as a going concern, audited accounts are

used as a basis of fiing prices4. Insurance compensation claims can only be settled on the basis of the latest

audited financial statements

>. It keeps client staff igilant and upto date all the time(. They are used to assure arious parties that the company has operated within the

proisions of the "ompany Act.

C. Its used by shareholders as the basis of sharing profits and therefore minimi-e

disputes among them.

Disadvanta/es o! an Audit

. "ompany secrets are eposed to competitors


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The auditor puts a disclaimer opinion &no opinion+ as a caution to report users that

he has only done partial audit

0ifferences between statutory and priate audits

Statutor+ Audits )rivate Audits

2tatutory audits are a re$uirement of "ompanyAct of all 1td "ompanies

%riate audits are not legallyre$uired but are perfomed at

the re$uest of the owner or

management

< 2tatutory auditors are either appointed by

directors, registrar of companies or shareholders

%riate audit , auditors are

appointed by the management

= In statutory audits, rights and duties of the auditor

are defined by the "ompany Act and cannot be

limited by management

%riate audit, rights are

defined by the owner and their

limited

3 2tatutory audits aim at proing a true and fair

iew

%riate audits aim at detecting

errors and frauds andascertainment of profit and ta

purpose

) In statutory audits, the scope of work isdetermined by the company's Act and cannot be

limited

The scope of work of thepriate auditors are limited by

the management

Internal Audits

This is an independent appraisal actiity instituted by the management to help in

achieing their desired ob9ecties.

The scope of work to be coered is defined by managementThey are not legally re$uired by the "ompany's Act but are carried out by organi-ations

to reduce the cost of eternal audits

The main ob9ecties include8;

To safeguard the fied assets of the company

To detect errors and fraud and their preention

To help in the implementation of company policies and proceduresTo ensure accuracy, alidity and completeness of records

To ensure adherence to statutory re$uirements

"B# !he$ are usuall$ concerned %ith internal control s$stems of the or&ani'ation

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According to the method of approach8;

7inal Audit"omplete Audit0etailed Audits2tatutory AuditsThis is conducted at the end of a financial year

It is carried out to completion in one continuous session

The auditor takes possession of all books of account for eamination and forms anopinion on a true and fair iew of the company's state of affairs

7inal audits facilitate commencement of the AG/

They are suitable for businesses with fewer transactions and are used as a basis ofdeclaring and approing diidends.

Advanta/es o! Final Audit

They are suitable for small businesses with small transactionsThey are economical since the auditors spend less time hence less epensie to the

"ompany

They are conened because they take place at the end of the financial year when most

actiities of the company hae come to an end and therefore, help minimi-e interactionsto the client's work

elps in the elimination of note taking because the auditors does not re$uire notes to bemade each time indicting the stages reached

They are fleible because the auditors can prepare ade$uate programs to coer all areas

of the audit.

Disadvanta/es o! Final Audits

0ue to limited time aailable at the end of the financial year, the auditor may take few

tests hence increasing his liability in cases of negligence.?here internal controls are weak, it may take a log time to finish hence delaying the

report and AG/They are unsuitable for organi-ations with many transactions2ince they are carried out at the end of the year when the % and 1 account and balance

sheet hae been prepared errors and frauds can only be detected when they hae

already caused aderse effects on the organi-ation?here the audit firm has seeral audit engagements it becomes difficult for it

schedule its audit staff because of similar year ends

Continuous Audits

In this audits the auditor is engaged throughout the year

Audit staff may be with the client continuously or at certain time interals

It inoles detailed eamination of the books of accountsIts suitable for large organi-ations with many transactions and where internal controls

are weak

They are suitable in banking and manufacturing sectors

Advanta/es o! Continuous Audit

They enable the auditor to carryout detailed eamination of the accounts hence

epressing a balanced audit opinion because he has enough time.

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They facilitate interim audits necessary for payment of interim diidends

They facilitate final audit because much of the work would hae been done

They help to minimi-e errors and frauds in the organi-ation0ue to regular isits by the auditor, he gets a better understanding of the clients

accounting system

The audit firm benefits because the audit staff are kept busy throughout the year

Disadvanta/es o! Continuous Audits

They are time consuming

They inconenience the clients from time to time

It inoles intensie note taking to aoid alteration after books of account hae been

auditedThe clients accounting staff may depend on the audit staff to sole their accounting

problems because the audit staff is continuously with them

They are epensie to the client

SOL(ING )RO&LES OF CONTINUOUS AUDITS

0etailed notes should be taken to aoid alteration of figures

The auditor should adopt sampling approach to sae time and the cost of the audit

The client should improe on the internal control systemThe auditor should plan his work well so that the audit can take place when the

business of the client is at a minimum leel of work

Interi* Audits

It is conducted with the accounting period and concentrates of the % and 1 account

It measures the performance of the company and is useful in the declaration ofinterim diidends as well as determining the price or alue of the company incase ofmergers

Derification of assets on the balance sheet is left until final audits are arried at.

It helps in the detection and preention of errors and frauds at their earliest stageIt also facilitates completion of final audits and helps the auditing staff to update the

clients book because they are aware that the auditor is coming

)ro.edure Audits

This is an eamination and reiew of internal procedures and records of the

organi-ation

The auditor obseres the accounting system of the client to ensure that the records arealid, accurate and complete.

These audits seek to reeal an economic procedure for correctie measures to be

takenThey are suitable where controls are not effectiely operational

They facilitate writing the management letter &1etter of Internal ?eaknesses+

(


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Advanta/es o! )ro.edure Audits

elps the management to know procedures that are not followed and why

elps the management to identify outdated and uneconomical procedures

They ensure effectie co;ordination of organi-ation actiities to boost profitability ofthe company

They form the basis of writing the management to correct all weaknesses identified

Disadvanta/es o! )ro.edure Audits

They are difficult to carry out where the organisation has many procedures

They are epensie because the auditor will take a long time to familiari-e himself

with the procedures usedThe management may frustrate the auditor by not reealing inefficiencies of

procedures leading to a biased audit opinion

ana/e*ent AuditsIt deals with management of all leels concerning their effectieness

The management is inestigated from the point of iew of profitability and efficientrunning of the business

Advanta/es o! ana/e*ent Audit

elps to improe the $uality of management of the business

elps in identifying how decisions are made

It reeals the weakness of management in running the company

It does not interrupt company operations as fewer of its books are checked

Disadvanta/es o! ana/e*ent Audit2ome top managers may not reeal their inefficiencies leading to a biased report2ometimes it kills the morale of managers instead of improing it

&alan.e S4eet Audit

This audit starts with the balance sheet backwards to the books of original entry

0ocumentary eidence &ouchers+ are also eamined

Its suitable where internal controls are effectiestrong

T4e auditor .4e.5s !or t4e !ollo6in/78

)8#resentationTo ensure that the financial statement is presented in accordance with IAs

A8aut4ori9ation

To ascertain the authority for ac$uisition of assets &minutes of a meeting and resolutions

passed are eamined+

D8Dis.losure:des.ri#tion

C


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To ensure that assets as outlined on the balance sheet are properly recorded and described

O8o6ners4i#

The auditor will eamine ouchers such as title deeds, log books etc to proe ownership

(8valuation

The auditor will compare the alue of the assets as recorded with the physical assets itself

E8e;isten.e

The auditor will physically eamine the assets to proe their real eistence

Advanta/es o! &alan.e S4eet Audits

They are not epensie because few entries are checked

They are suitable where internal controls are strongIt gies a balanced opinion because the balance sheet contains most important items

"hances of changing figures after the audit are minimal

Disadvanta/esIt's a partial audit and therefore not suitable for ltd liability companies

It is practical only for organi-ations with strong internal control systemThe auditors liability may increase because of eamining few entries

Classi!i.ation a..ordin/ to user /rou#:#ur#ose o! audit re#ort

7inancial Auditstatutory Audit

perational Audit%rocedure Audit

"ompliance Audit

Finan.ial Audit

The auditor independently eamines eidence necessary for his audit work7inancial audits ensure that the interest of shareholders are well taken care ofThey are re$uired by the companies Act &2tatutory Audits+ and the auditor gies an

opinion on a true and fair iew regarding the financial statement as at a gien date.

O#erational Audit

They seek to establish whether company policies and procedures are followed

Their report is used by internal users

The results of an operational audit is a report on the strengths and weaknesses of thesystem

5ecommendations for improement are also gien to the management

@B8 perational audits are simply procedure audits.

Co*#lian.e Audit

They are responsible for determining whether a particular set of laws or administratieprocedures are being followed

They can be performed either by internal or eternal auditors

They are mostly used by goernment agencies


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LEGAL AS)ECTS AND THE AUDITOR

The legal enironment of the auditor is goerned by the "ompanies Act "ap 3(4 and theAccountants Act "ap )=.

)ur#ose o! Le/islation

Co*#eten.e

1egislation ensures that a person meets basic re$uirements in terms of professional

$ualification before being allowed to practice as an auditor

Inde#enden.e

The auditors independence and security is enhanced by legislation e.g. in matters

concerning his appointment and dismissal

De!inition o! Dut+

The auditors duties and matters that should be coered in the audit report are definedby legislation

Ri/4ts and O,li/ations

1egislation gies the auditor the rights and obligations in the performance of his

duties.

$uali!i.ation o! Auditors

7or one to $ualify to practice as an auditor in !enya he should fulfil the following

conditions of the Accountants Act "ap )= of C>>8;

ne must be a member of a professional body &I"%A!+

ne must hae been registered by !2@#B and has passed the final leel of "%A &!+

ne must hae a post;graduate eperience in an auditing enironment &< years*/ust be a holder of a practicing certificate issued by the registration Accountants

Board &5AB+

It could be anyone authori-ed by the registrar of companies who has a degree in

accounting and eperience in an auditing enironment

Dis"uali!i.ation !ro* ,ein/ Auditors

The following parties are not legible for appointment as auditors as outlined by 2ec 4of the "ompanies Act 3(48;

An officer or serant of a company whose books are being audited%ersons who are dis$ualified as auditors of the company's subsidiary or holding

company

A person who holds more than )E of the companies authori-ed share capital

Body corporate


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A 1imited "ompany cannot be an auditor because shareholders are many and they cannot

epress a personal opinion on the financial statement.

A##oint*ent o! Auditors

The auditors appointment is done in accordance with the re$uirements of the "ompaniesAct "ap 3(4 &2ec )C+ and can be appointed in the following ways8;

A##oint*ent ,+ &oard o! Dire.tors

This is done in the following circumstances8;

Incase of the stauditor of the company before the AG/

The auditor shall be appointed =* days after the registration of the company and

should oersee the company affairs until the net AG/Incase of filling a casual acancy caused by the auditors death or incapacitation

"B# A casual (acanc$ created )$ the auditors resi&nation can onl$ )e filled )$

shareholders in the Extraordinar$ A*+ ,Ex-A*+ ,held earlier than other A*+s.

A##oint*ent ,+ s4are4olders in t4e AG

The shareholders during the AG/ can appoint the auditor to oersee the affairs of the

company from that AG/ to the conclusion of the financial period to the net AG/.

The outgoing auditor should be gien a


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5ight to information and eplantions that he considers necessary for the performance of

his audit assignment and epression of opinion.

5ight to receie notice&s+ of meetings e.g.


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The letter of engagement helps to minimi-e the risk of misunderstanding between the

auditor and client during the audit assignment

Contents o! t4e En/a/e*ent Letter#planation of an Audit

2tatutory responsibilities of the auditor

%rofessional responsibilities of the auditor"onformity to auditing standards and guidelines

@eed for the letter of representation from the management

A reminder to the management that their responsibility is to preent and detect mis;

statements in the financial statementThe basis of charging audit fee

A note re$uesting the client to accept the letter

ther serices proided by the auditor e.g. taationaccountancy etc.

Cir.u*stan.es o! Sendin/ an en/a/e*ent Letter

It should )e sent to the client in the follo%in& circumstances

Ne6 Client

This is where a new client has appointed an auditor

E;istin/ Client

This is where the eisting client had not receied the engagement letter initially

C4an/es in .ir.u*stan.es

This is where material changes hae taken place in the client's company which haesignificantly changed the duties of the auditor as outlined in the original engagementletter

La#se o! ti*e

A reised engagement letter can be sent to the client after epiry of = years.

I)ORTANCE OF THE ENGAGEENT LETTER 1Need:)ur#ose2

It outlines the scope of work including the etent of the auditor's responsibilities

It helps to minimi-e misunderstanding between the auditor and the clientIt is a written confirmation of the erbal agreement between the auditor and his client

It informs the client among other matters that it is his responsibility to detect and

preent material misstatement in the financial statement and to maintain proper booksof accounts

elps to minimi-e the auditor's liability especially in priate audits by outlining his

work.


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An engagement letter if re;affirmed by the client creates a contractual obligation

between the client and the auditor

It is a professional re$uirement that an auditor should rent an engagement letter to hisclient on or before commencement of the audit assignment.

E;a*#le o! an En/a/e*ent Letter

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NAIRO&I

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NAIRO&I

0ear 2ir/adam,

RE7 ACCE)TANCE OF ENGAGEENT

The purpose of this letter is to outline the basis of which we are to act as companies

auditor. It therefore shows the areas of responsibility of the company and ourseles onthe following8;

AUDIT AND OUR STATUTORY O&LIGATIONS

?e hae the statutory obligation to report to shareholders in our opinion8;

?hether proper books of accounts hae been kept by the company?hether the company balance sheet and % and 1 account are in agreement with theaccounting records.

?hether we hae receied all the information and eplanations we consider necessary

for our audit?hether the information in the directors report is consistent with that in the audited

financial statement.

ANAGEENT RE)RESENTATIONS

As part of our audit, we shall re$uire written representations from the management which

seres as confirmation on their accuracy, alidity and completeness of the financial

statements as it is a re$uirement of the professional body &I"%A!+. The timing of thisrepresentation shall be at the completion of the audit.

)RE(ENTION OF ERRORS AND FRAUDS

This is to inform you that the responsibility of the preention and detection of errors and

frauds primarily rests with you. oweer, we shall plan our audit in such a manner that


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we hae reasonable epectation of detecting material misstatement in the financial

statements.

AUDIT FEE

ur fee shall be charged on the basis of the time spent on your affairs by the partners and

on the leel of skills and responsibility inoled. The audit fee shall be build certain timeinterals during the course of the audit and will be due on presentation.

ACCOUNTANCY AND OTHER SER(ICES

?here appropriate we shall undertake accountancy serices and taation serices to

ascertain the company's ta liability.

AGREEENT OF TERS

nce accepted, this letter will remain effectie from one period to another until replaced.

?e shall be grateful if you confirm in writing your agreement to the terms of this letter.

Hours faithfully

(alle+ O56anda

OKWENDA AND CO% CERTIFIED )U&LIC ACCOUNTANTS

Failure to Re8a!!ir* t4e En/a/e*ent Letter

5e;affirmation of the engagement is where the clientmanagement accepts, adopts orapproes and signs to the content of the engagement letter and the terms contained

therein.In cases where the client's management hae failed to re;affirm the engagement letter,the auditor should take the following actions8;

2eek for eplanations from the management for reasons of not confirming the letter5e;consider the materiality of the information contained in the letter and its

importance

2end a reminder letter to the client's management

If still not re;affirmed decline the appointment

Dis*isal o! t4e Auditor

Irrespectie of who appoints him, the auditor can only be remoed from office byshareholders.

/easons for auditors dismissal could )e#-Breach of any professional ethics issued by I"%A!

Incapability of the auditor to perform his duty as per the engagement

Technical dis$ualification under the "ompanies Act


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)ro.edure o! Dis*issin/:Re*ovin/ t4e Auditor !ro* O!!i.e%

2hareholders wishing to hae the auditor remoed from office shall gie a 3;days

notice to the companyA special notice of


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?here he is appointed by the 5egistrar of "ompanies, the registrar shall fi his

remuneration in consultation with the Board of 0irectors

If automatically re;appointed he shall continue receiing the preious remuneration

@B8 oweer in practice company auditors are usually remunerated by the Board of

0irectors working within their delegated responsibilities.

T4e !ollo6in/ !a.tors are a.tive deter*inants o! t4e audit !ee78

Time re$uiredspent in the client's businessThe degree of responsibilities inoled

/arket rate for similar serices

2kills and eperience re$uired

Technology re$uiredAudit risk inoled

Le/al Lia,ilities o! t4e Auditor

The auditor may be penali-ed for failing to applying reasonable care and skillThis could call for disciplinary action by the professional body I"%A! or it could take

ciil or criminal proceedings

!he auditor0s le&al lia)ilities can )e classified as follo%s#-

Auditors liability under priate audits2icne they are not legally re$uired the auditors scope of work is limited to the etent

of the agreement between him and client

The auditor's liability shall therefore depend on the contractual obligation based on

the agreementThe auditor shall not be held liable should he fail to ascertain accuracy, alidity and

completeness of accounts not specified in the agreement.e should therefore approach his work in a manner that shall minimi-e his eposureto chances of negligence

Should the auditor )e accused of ne&li&ence the follo%in& should )e ascertained )$ theparties accusin& him#-

That the auditor was negligent to the initial agreement

That as a result of his negligence the client suffered lossThat the financial loss was suffered by a person who had a contractual obligation with

the auditor

In his report the auditor should therefore caution that the audit should not be relied upon

by any =rdparties to make inestment decisions.

This is due to limitation of scope of the auditor's work which is a characteristic of priateaudits

Auditor


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In statutory Audits the auditor's scope of work, rights and duties are goerned by the

"ompany Act.

The auditor owes a primary duty of care to his client with whom he has a contractualobligation.

oweer, ciil liabilities against the auditor may etend to =rdparties with no contractual

obligation but to whom the auditor owes a duty of care.

!he part$ %ho suffers loss can claim from the auditor pro(ided he pro(es the follo%in-

That the auditor was negligentThat as a result of his negligence the client has suffered financial loss

That the financial loss suffered in material and can be $uantified

!hird parties could hold the auditors lia)le if the$ can pro(e#-That the statement made by the auditor was untrue

That the auditor knew that statement was untrue

That =rdparties relied on it and suffered financial loss

That the auditor gae consent for the statement to be published

!he auditor can )e lia)le to 3rdparties under the follo%in& circumstancesThat the party relied on the financial statement and suffered financial loss

?here it can be proed that the auditor did not eercise professional care and skill

?here it can be proed that the auditor was aware that the report could be relied uponby =rdparties for inestment decisions

?here the auditor did not put a disclaimer opinion to stop reliance by =rdparties

?here it can be proed that =rdparties actually relied on the statement

If the auditor finds out that there was a misstatement after signing the prospectus, he can

withdraw his consent in writing before the prospectus is issued or publishedThe auditor should hae supporting eidence as to how such a report is issuedThe auditor should attach a disclaimer that he is unable to form an opinion as caution to

report users.

e should properly document his audit work for it will act in his reference in the court oflaw

e should use reasonable duty of care and skill during the course of his work &audit+

A.tions Ta5en ,+ Individual Auditors to ini*i9e Lia,ilities

e should employ suitable and properly trained staff with re$uired competence and

skills

e should follow IAs and I2A issued by the professional body I"%A!e should ensure that an independent attitude is maintained at all times and

ob9ectiity adhered to in the course of the audit

e should record his work properly and keep all letters of representation from themanagement

e should define well his responsibilities in the engagement letter

e should seek for professional adice where necessary in areas of difficulty


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e should insure himself against audit liabilities which would reduce the financial

conse$uences of such liabilities.

LIA&ILITY OF THE AUDITOR UNDER CRIINAL LAW

Case Stud+7 Re; (s% K+lsant and oorland 0=>0 1UK2

"riminal proceedings were brought against the auditor in this particular case.The chairman and auditor were accused of8;

That the chairman had issued a false annual report to shareholders with the intentionto deceie not only shareholders but also other stakeholders

The auditor was also accused of being guilty of abetting and auditing the issuance of

a false report. Both the chairman and the auditor were ac$uitted of charges but the

chairman on further charge was found guilty of publishing a prospectus which heknew was false in material terms. "onse$uently, the auditor's criminal liabilities were

defined to arise out of the following8;

If the auditor alters, falsifies, mutilates or destroys or is priy to allegations offalsification, mutilation or destruction of any books of accounts, ouchers or statements

If he makes a statement which is false in material terms knowing it to be falseIf he makes or is priing to making of fraudulent entries in the companies accounts,

ouchers or registers.

If the auditor willfully contraenes any proisions of the "ompanies Act which undernormal circumstances he is supposed to follow in the course of his audit work e.g.

If he fails to re$uest for returns intentionally

If he does not use professional skill and care

If he is aware of a material statement that has been omitted in the report or een in theprospectus but does not reeal this fact

"B# In the a)o(e circumstances the auditor ma$ )e fined or imprisoned for a term notexceedin& ,se(en $ears or )oth and after such a term his certificate ma$ )e nullified

and expelled from the profession alto&ether.

Cir.u*stan.es7 7ined

Imprisoned for > years

@ullification of "ertificate

#pulsion from the profession

STE)S TAKEN &Y THE )ROFESSION TO REDUCE AUDITORS RISK

Issue of accounting standards and guidelinesThis proides the auditor with the rules of measurement and disclosures aimed at

reducing error 9udgement

Issue of Auditing 2tandards and guidelines to enable the auditor practice according tostandards of Auditing

Issue of Guidelines on #thical "onduct and Independence

se of 0isciplinary "ommittees


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"ontrol of issuing practicing certificates to make sure that only those who meet

minimum re$uirements are allowed to practice

se of continuous professional education to help the auditors maintain theircompetence all the time

)ro!essional As#e.ts and t4e Auditor

)ro!essional Et4i.s

This is a set of rules and regulations imposed by a professional body to its members to

goern their practice

To the practicing accountants, the rules and regulations are imposed by I"%A!A member of a profession owes duty to the public industry those that hae employed him

e also owes a duty to the profession itself

This duties may at times be contrary to his personal self;interests

The professional ethics help to regulate the conduct of members in order to behae asprofessionals who act aboe personal interests

I*#ortan.e o! )ro!essional Et4i.s

5egulation of behaiour and conduct of members

%rofessional #thics enables members in public practice to behae in a manneracceptable to that profession

0iscipline

#thics are meant to distill discipline among members of the profession to enhance

the image of the professionAchieement of b9ecties

In the absence of professional ethics the auditor in public practice may engage inactiities that are against achieement of audit ob9ecties#thics therefore helps to keep the auditor focussed in approach to his audit work

%roduction of /embers

#thics protect members of a profession from accusations of members of the publicThe auditor who does not contraene of be in breach of professional ethics is not

likely to face accusations from members of the public including his client

It is a professional re$uirement that each profession should hae rules to goern

its practice hence enabling the professional body to take disciplinary actionsagainst its members who are found guilty of professional misconduct.

niformity

%rofessional ethics enhance uniformity in reporting0ifferent auditors gien the same information from a client are epected to

produce similar reports as long as they adhere to professional ethics

%ublic image1ike any other profession, accountancy takes public criticism should members of that

profession behae in a manner that negatiely reflects on the profession.

The image of the professional body is also tainted


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In order to safeguard its image, its important for a professional body to hae ethics

acceptable to that profession.

ETHICAL STATEENTS )U&LISHED &Y )ROFESSIONAL &ODY IC)AK

An auditor should not misrepresent facts knowingly

e should not surbodinate his 9udgements to otherse should not accept an engagement which he cannot complete with competence

e should not allow his name to be associated with financial statements which he

has not audited in such a manner as to imply that he has conducted such an auditwhile he has not.

e should neer epress an opinion that financial statements agree with the

G.A.A%s when they are not.

e shall neer undertake a serice for free or at a fee which will depend upon agien finding or results of his audit

An auditor should not pay commission to obtain clients

The auditor should not commit an act that discredits the profession

INTEGRITYAn auditor should be honest, sincere and straight forward, in his approach to

professional work by aoiding actual and apparent conflicts of interests.*. CONFIDENTIALITY

The auditor should maintain top secrecy in regard to his clients affairs

The auditor is under legal obligation not to disclose any information in the courseof professional work.

?hen he discoers unlawful acts, usually he is not epected to disclose them to

the police or other authorities unless8;

The client authori-es the disclosure

nless the disclosure is completed by a process of law &court order+nless the disclosure is re$uired in the auditor's own defensenless the circumstances are such that the auditor has a public duty to disclose

If non;disclosure will affect true and fair iew, then insist on disclosure or $ualify the

audit report

NB: pon discoering by an auditor of any unlawful acts, he should do nothing positie

to assist in the offence or to preent its disclosure.

CO)ETENCE

The auditor's degree of competence to perform his duty should not be doubted

In cases where the auditor has inade$uate knowledge pertaining to some matters in thecourse of his audit, he should consult an epert

O&'ECTI(ITY

The auditor should communicate the information fairly and ob9ectiely by disclosing all

releant information that could reasonably influence the users understanding of the

financial statement.


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The auditor should therefore approach his work with a iew of being free from bias in his

report

AD(ERTISING AND )U&LICITY

A firm of practicing accountants is not allowed to adertise publicly to obtain clients.oweer, adertising can be done under the following circumstances8;

?hen seeking for employees

?hen informing the clients or the public in the conduct address?hen opening or closing down a branch

?hen in need of epert adiceepertise knowledge

?hen adertising for their clients

CHANGE IN )ROFESSIONAL A))OINTENT

The incoming auditor should seek for permission from the client to communicate with the

outgoing auditor. ?here permission is granted, the incoming auditor should write to the

outgoing auditor re$uesting him of any necessary informationThe obtained information enables the incoming auditor to consider whether or not to

accept the appointmentBefore replying to the incoming auditor, the outgoing auditor should also seek for

permission from the client and where such a permission is denied, decline the

appointment

INDE)ENDENCE

Independence in the contet of auditing means free from the influence of the

managementIndependence is the central pillar in auditing

Fa.tors I*#airin/:Destru.tin/ t4e Auditor


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If the audit appointment is rotated eery after a few years to aoid oer;

familiari-ation with the client

If the audit process is reiewed for $uality by an outside agencyIf the auditor limits the proision of other serices to the clients to aoid conflict of

interests

If auditing techni$ues are sufficiently deeloped to deal with the client's hightechnology system

If the audit firm is sufficiently large to the etent that loss of any indiidual client

would not be material to the audit firm

Need !or auditor


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)ROFESSIONAL ISCONDUCT

%rofessional misconduct is a breach of professional ethics issued by the professional body

I"%A!.

The accountants Act "ap )= of the 1aws of !enya deals with such breaches as follows8;2ec. =* proides that I"%A! should in$uire into a members failure to obsere the

professional ethics

2ec.= proides that the council of the institute should refer such a member to adisciplinary committee to ascertain the nature of punishment to be accorded to the

member who is guilty of breaching the professional ethics.

2ec.=< proides that the disciplinary committee should refer such a mattermember to the

5egistration of Accountants Board &5AB+ for the implementation of actionsrecommended by the disciplinary committee

T4e !ollo6in/ a.tions .an ,e ta5en a/ainst a *e*,er78

?ithdrawal of a practicing license@ullification of the professional certificate of a member

0e;registration of the member from the board

$UALITIES OF AN AUDITOR

The auditor should neer pass a transaction unless it is correcte should neer be influenced directly or indirectly by others in the attempt to change his

opinion

e must be well ast with all branches of accounting e.g 7A, costing, and /anagement

AccountingThe auditor should be willing to resign instead of signing a wrong balance sheet which

will epose him to liabilitiese must be accurate, igilant and methodical in the course of the audit assignmente should be prepared to hear arguments as a source of audit eidence which will

strengthen his opinion

e should hae professional common sense in his obserations, interiews and allaspects that affect his opinion

e must be familiar with commercial and company law

e should be honest or should be a person of un$uestionable integrity and should not

certify as true what he does not beliee to be true

STAGES OF AN AUDIT

GENERAL A))ROACH TO AN AUDIT2pecific procedures for conducting an audit ary from audit to audit

oweer, all audits show a common approach

T4e !ive /eneral ste#s:sta/es o! an audit are78

!nowledge of the "lient and Audit 2ituation

7or proper audit eamination the auditor must hae good knowledge of the client

&auditee+


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e must also understand the clients industry

This knowledge enables the auditor8;

To know how the industry operatesTo know what types of assets and actiities to epect

To know what leel of profitability is epected

To know specific laws or accounting principles

nderstanding of the audit situation helps the auditor to know8

?hether the business is newly opened or well establishedTo know if the client has many or few competitors

To know if the client operates in a high or low income community

oweer, much of the information about the client are obtained by reiewing the auditworking papers of the preious periods that are in the possession of the outgoing auditor

Ot4er sour.es o! /ainin/ an understandin/ o! t4e .lient in.lude78

5eading client's stories in trade 9ournalsmaga-ines5eading industry publications written about the industry

Taking formal courses about the industry"ommunicating with preious auditors of the client

Interiewing the client's management and employees

Touring the clients operations for personal obseration

Assess*ent o! Ris5 and aterialit+

In larger organi-ations, it is possible for the auditor to erify each transaction for this

would be epensie and time consumingAlso, an audit report loses its alue if it is not timely

The auditor should therefore focus on areas of great risk and of greatest importance toreport users2uch areas are where most problems are likely to be found and which are likely to be

material to =rdparties.

)lannin/ t4e nature? e;tent and ti*in/ o! tests

@ature of tests refers to specific procedures to be performed by the auditor

They usually ary with the nature of the industry

#tent of tests refers to the amount of testing to be performed or how far the auditorshould go &scope of work to be coered+

Timing to tests refers to the period far from close to the AG/

The auditor should therefore deote time on the nature, etent and timing of tests.The auditor's usually write their audit plan in step by step listing called Audit

%rograms

Gat4erin/ o! Eviden.e

#idence is gathered by performing the procedures in the audit program

The procedures could6 counting of stock, erification of assets and accuracy of

calculations


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"ollected eidence should be recorded in audit working papers

The work of the audit staff should be reiewed by the audit seniors or superisors

If necessary, the


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*atherin& Audit E(idence

It inoles termination of the leel and si-e of system ealuation

The ealuation could include8 statistical test, physical counts &erification+ and =rdpartyen$uiries.

Revie6in/ t4e Finan.ial State*ents

This inoles testing of indiidual items in the financial statements which could also

inole carry out of analytical reiew procedures.

/eportin& Audit pinion to Shareholders

This inoles weighing audit eidence against the statutory re$uirements and auditing

standards.An opinion on a true and fair iew is drawn on the financial statement

AUDIT RISK A))ROACH

An audit report is relied upon by many parties to make inestment decisions.

Therefore, if the auditor gies an audit opinion which is wrong then both the auditor andthe user stand a chance of the auditor suffering damages as a result of giing wrong

resultsopinion or8;

It is the possibility that the financial statements contain material misstatement which hadescaped detection by both internal controls which the auditor relied on and the auditor's

own substantie tests.

It can also be looked at as the possibility that the auditor may be re$uired to pay damages

to the client and other parties as a result of87inancial statements containing misstatements

The complaining party suffering loss as a direct conse$uence of relying of the financialstatementAs a result of negligence by the auditor for not detecting and at the same time not

reporting misstatements identified.

All audits inoles and element of risk irrespectie of how strong the controls are and the

nature of audit eidence obtained. There is always a possibility of error or fraud going

undetected howeer careful the auditor may be.

TY)ES OF AUDIT RISK

I% NORAL AUDIT RISKAudit risk can either e normal or higher than normal

The following indicators show a normal audit risk6

The client haing management and staff who are competent and who haeintegrity

?here the client has an accounting system that is sub9ect to the strong internal

controls

?here the client has no financial problems


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?here Board of 0irectors are actiely inoled in proiding $uality leadership

?here the clients business is firmly established and not sub9ected to fre$uent

changesIf the organi-ation has an audit committee

?here the auditor is faced with normal audit risk, the audit approach adopted is usually

one of reliance of key controls supported by subsistence tests

AUDIT COITTEE

It is a sub;committee of the Board of 0irectors consisting of ma9ority of independent,

non;eistence directors

It assists the directors to fulfill their responsibilities effectiely concerning financial

reportingcontrol.

O,-e.tives o! Audit Co**ittee

To promote the accuracy, reliability, credibility of the companies financial

reportingTo ensure that proper accounting and internal control procedures are maintained

to protect the "o. assets.To deal with any other responsibilities assigned to it by the #ecutie of

0irectors.

Advanta/es o! Audit Co**ittee

It enhances the independence of internal audit department

It improes the $uality of work done to enhance eternal auditors reliance on the

work done by internal auditors.It promotes communication between directors, internal auditors, management

It helps in the improement of controls in the companyIt reiews the financial statement the financial statement ob9ecties effectielyinorder to improe the $uality of financial reporting and public confidence in the

financial statements

It enables non;eecutie directors to become deeply inoled in the "ompanyaffairs.

Disadvanta/es

It creates conflicts within the "ompanyIt may split the Board of 0irectors of 0irectors

If encroaches on management responsibilities

%reparation of financial statements may delayIts epensie in terms of time and cost

They don't hae real power and therefore their recommendations may be ignored

/ost organi-ations do not hae non;eecutie directors

II% HIGHER THAN NORAL AUDIT RISK

/ost audit assignments inole higher than normal audit risk and in any client's work

there is always atleast one area haing higher than normal audit risk


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Indicators that an audit has an element of higher than normal audit risk include8

%oor management with lack of controls and poor book;keeping?here the organi-ation faces many financial problems

?here there are fre$uent changes in the controls and key staff

?here there are fre$uent changes in the accounting procedures@o new innoations

er;reliance on few productscustomerssuppliers

In the aboe situations the auditor should approach his work by8;

5elying on high calibre staff

"ollection of audit eidence in each area from a wide range of sources

Taking etreme care in the in the preparation of audit working papersInestigating thoroughly high risk and problematic areas

#ercising etreme care in drafting the audit report

It is important therefore that the audit firm should organi-e itself in such a way as tominimi-e the risk of suffering damages.

The auditor can take the following measures8;

%roper recruitment and training of all stuff

Allocating responsibilities to the audit staff in areas where they can handlewithout problems

%lanning the audit well in adance so that it can be approached in a relaed and

disciplined manner

se of audit manuals that conform to audit standards and guidelinesse of updated letters of engagement

#ffectie briefing of the audit staff before starting the assignment#mphasi-ing on materiality and use of ade$uate sample si-e5eiew the work done properly at eery stage of the audit.

INHERENT RISK

This is the risk that occurs within the entity and its enironment before establishment of

internal controls

CONTROL RISK

This is the risk that the errors will not be preented or detected by the implemented

internal controls of the client.

DETECTION

This is the risk that material errors which hae not been detected by the establishedinternal controls systems will still not be detected by the auditors substantie tests.

ANALYTICAL RISK

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This is the risk that analytical reiew procedures used by the auditor will not detect

material errors.

O(ER(IEWING OF THE AUDIT )ROCESS

@egotiation with client

"ommunication with preiousoutgoing auditor

#ngagement letter

2election of method of approach

Inestigation of internal control system

/anagement 1etter

"ompare 7inal Accounts with 5ecords

Ascertain a true and fair iew

btain 5epresentations 1etter

0raft and 2ign 5eport

COUNICATION WITH )RE(IOUS OR OUTGOING AUDITOR

5easons for "ommunication

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To know the reasons why the preious auditor is no longer the client's auditor

To obtain information on areas of weakness

To get assistance for returns from branches isited by the outgoing auditorIt is a professional re$uirement to do so

Its an act of courtesy to do so

ACCE)TANCE OF A))OINTENT 1NEW CLIENT2

There are seeral factors to be considered or steps to follow before accepting anappointment from a new client8;

T4e .a#a.it+ o! t4e .lient

This helps the auditor to ascertain whether the client has resources enough for the auditassignment

Co**uni.ation 6it4 t4e out/oin/ auditor

This enables the auditor to obtain more information inorder to understand the client andwhere permission is denied by the client decline the appointment.

Statutor+ Re"uire*ents

The auditor should ascertain whether his appointment meets the re$uirements of the

"ompanies Act.

Relations4i# 6it4 t4e Client

The auditor should ascertain whether the audit firm is related to the client in terms of

blood relations with the management, financial relations, or ac$uisition of shares by theauditor from the clients company

Co**uni.ation 6it4 t4e .lient

The auditor should then communicate with the client officially by sending an engagement

letter.

Client


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In cases where the client informs the auditor that the internal control system is ery

strong, the auditor should obtain a written representations to that effect.

Fillin/ o! (ou.4ers

The auditor should inform the client to file all ouchers in order of their occurrence.

E;a*ination o! e*orandu* and Arti.les o! Asso.iation

These documents help the auditor to know whether company operations are in agreement

with the purpose of incorporationIncase of the stAudit the auditor should inestigate the prospectus and obtain a note

from the promoters

)re#aration o! Audit )ro/ra*

The auditor should then prepare the audit programplan and commence his audit

assignment.

ACCE)TANCE OFA))OINTENT 1E@ISTING CLIENT2

The following matters should be considered before an auditor accepts appointment from

an eisting client8;

/atters arising since the preious audit

The auditor should ascertain matters pertaining to changes affecting the client since

the preious audit, he should therefore discuss such matters with the responsible

officers of the company.The auditor should ascertain whether the client has material changes in respect of

industrial and economic deelopment.In cases where there are material changes, the auditor should sign as reisedengagement letter before commencement of an audit assignment

The auditor should ascertain whether there are changes in accounting auditing

standards affecting his client as a result of new changes instituted by the management.The auditor should then ascertain staff re$uirements to cope with the changes if any.

It also helps the auditor to know whether to know whether to reduce or increase audit

staff in comparison with the preious audit.

The auditor should plan his work to accommodate the changes that hae taken placesince the preious audit.

AUDIT )LANNINGThe auditor's operational standards that, JThe auditor should ade$uately plan, control and

record his workJ this is done to ensure that an audit is carried out effectiely and

efficiently.The need to plan, control and record the audit eists irrespectie of the si-e of the

business.

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Audit planning is an adance organi-ation of policies, procedures and the audit staff by

the audit manager in respect of the audit work before commencement of the audit

assignment.

7or effectie planning, the audit 9uniors should be proided with an audit planning

memorandum. An audit planning memorandum is a written notification of the auditprogress from the audit manager to the audit staff.

It seres the following purposes8;

It informs the audit staff on the nature, etent and timing of the audit assignment

It's a basis of maintaining the auditors note book

It is a way of recordingdocumenting of the audit workThe audit planning /emorandum contains the following information8

7ied assets of the company

2tock in trade and work in progressAccounting policies used by the client

Ade$uacy of the client's internal control system

AUDIT )ROGRAE

An audit programme is a step by step breakdown of the audit work to be performed bythe audit staff from the beginning until the end of the audit assignment. Audit programs

proide guidance to the audit work.

There are three types of audit programmes8

)RE8DETERINED AUDIT )ROGRAESThey are prepared for all clients whether small or large businessesThey coer all areas of an audit

)ROGRESSI(E AUDIT )ROGRAES

They are prepared by managers and audit assistants in charge of the audit

They usually progress as the work progresses and they coer only some areas of the

audit.

INDI(IDUAL AUDIT )ROGRAES

They are prepared by eperienced audit staff and are limited to areas of eperience for a

particular audit assignment.

AUDIT )LANNING )ROCEDURE

RE(IEW

5ead through the preious year files and ascertain the nature of work coered and the

problem areas identified.

CONSULTATION

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The auditor should then consult the management on any significant matterschanges

affecting the client since the preious audit.

COR)ORATION FRO ANAGEENT

The auditor should then ascertain the degree of corporation epected from management

and internal audit staff.

IDENTIFICATION OF AUDIT STAFF

The auditor should then identify audit staff to be engaged in the assignment. This should

be done considering the numbers leel of skills and eperience of the audit assistant

&RIEFING

The audit staff should be briefed on particular areas of the audit e.g. work to be coered,

likely problems to be encountered during the audit as indicated in the audit planning

memorandum of the outgoing auditor.Audit staff are also allowed to make their contribution.

%reparation of a comprehensie audit planning memorandum which should contain all

areas of the audit and a summary of what is to be done by each member of audit team.

NEED:I)ORTANCE OF AUDIT )LANNING

Achieement of b9ecties

#ffectie planning enables the auditor to achiee the ob9ecties of the audit

0irection and control%lanning helps the auditor in determining the direction that the audit will take and

controlling of the workThis enables the auditor to minimi-e his eposure to audit risksIt helps to ensure that the auditor gies attention to critical aspects of the audit

Ade$uate planning facilitates conclusion of the audit work since all areas are

accommodated in the audit planIt is a professional re$uirement that the auditor should plan, control and record his

work in accordance with the auditor's operational standards

LIITATIONS OF AUDIT )LANNING

1ack of corporation from the clients management and other responsible officers of the

company6 may lead to failure of getting necessary information re$uired by the auditor

for proper audit planning.Audit firms usually hae a high staff turnoer due to moement of employees from

such firms as a result of poor remuneration hence adersely affecting audit planning.

"ompleity of the client's business2ome of the businesses and operations of the client could be so complicated that the

auditor may fail to ade$uately plan audit procedures which may epose him to risks.

2imilar year ends

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In cases where the audit firm engages different clients who prepare accounts on

similar year ends. The auditor may fail to ade$uately plan for all clients.

"hanges in the client's business may affect audit planning especially if the audit teamis not competent enough to deal with the new changes instituted by the

managementclient.

AUDIT CONTROLLING

Audit controlling is the process by which the superisormanager

delegatesdirectssuperisesreiews and documentsrecords the audit work during theaudit assignment

It is the duty of the audit manager to ensure that work is being performed to acceptable

standards

Audit controlling therefore inoles the directions and superision of audit staff in orderto ensure compliance with the firm's $uality controls.

AUDIT CONTROLLING )ROCEDURE

7or effectie controlling of the audit work the following procedures should be adopted bythe auditor.

Dele/ation o! t4e Audit Wor5

0elegation is the process by which the audit manager allocates the audit work to the audit

staff.The manager should therefore ascertain the number of personal re$uired for a particular

assignment.

7or proper delegation the audit manager should match the releant audit work with

$ualification and eperience of audit 9uniors.

N&7 0elegation is basically allocation of work

Dire.tion o! Wor5

This is the process by which audit manager gies proper instructions to audit 9uniors on

how to effectiely perform the audit assignment.

7or effectie direction, the auditor should proide releant, reliable and sufficient audit

instructions to the audit staff.

The auditor should also make aailable the audit planning memorandum to the audit staffduring the direction or instructions phase.

NB: 5irection is )asicall$ &i(in& of instructions

Su#ervision o! Wor5

This is where the audit manager monitors the performance of the audit staff7or proper superision, the auditor should compare the work being performed with the

audit programs and instructions gien

2uperision if properly done helps the auditor identify deiations from the epected and

correctie measures can be taken.

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@B8 2uperision is simply monitoring performance

Revie6 o! 6or5 done

This is where the audit manager analyses and interprets the work done before it is

recorded and documented.7or effectie reiewing the auditor should thoroughly compare work done with standards

of $uality and the audit program used.

Any material differences in the performance should be ascertained and eplained5eiewing helps the auditor to ensure that work was ade$uately performed.

@B8 5eiewing is simply measuring the $uality of work done in relation to $uality

standards.

Do.u*entation o! 6or5 done

This is where the auditor records the audit work after it has been superised and properly

reiewed.0ocumentation helps the auditor in epressing a balanced audit opinion on the financial

statements0ocumentation is simply recording of work done.

NEED:I)ORTANCE OF AUDIT CONTROLLING

Allocation of work

"ontrolling enables the auditor to allocate work to the audit staff with appropriate

training and eperience.

"ontrolling enables the audit staff to understand their responsibilities through giingof instructions

Ade$uate audit recording enhances effectie recording of work done through auditworking papers"ontrolling is necessary for reiewing of work done by the audit staff

"ontrolling facilitates successful completion of audit assignment

"ontrolling promotes the $uality of work carried out through proper superision.2pecial attention

The final stages of an audit are usually stressing to the auditor this is because some

critical areas re$uire special attention.

"ontrolling therefore ensures that mistakes do not occur and that special areas aregien attention.

AUDIT CONTROLLING AND $UALITY CONTROLSuality controls are the policies and procedures established by the audit firms to

proide assurance that the audit work is performed in accordance with the auditor's

operational standards and guidelines.uality controls helps the audit firm to minimi-e its eposure to audit risks

The auditing guidelines on $uality controls proidesstates that8

#ach audit firm should establish $uality controls appropriate to its circumstances

which should be communicated to all partners and releant staff

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There should be procedures in the firm to ensure that all members adhere to principles

of independence, integrity, ob9ectiity, and confidentiality as proided by the

professional body I"%A!.The audit firm should hae staff who hae the skills and competence re$uired to fulfil

their responsibilities.

NB: uality controls enables the audit firm to determine, the nature etent and timing of

audit tests to be performed.

Y)ES OF $UALITY CONTROLS

)ersonal $ualities

The audit firm should engage persons with independence, integrity, ob9ectiity andconfidentiality.

They help the firm in the implementation of $uality controls

Before Acceptance of another client, considerations should be gien by the audit firm to

ensure that the new client does not adersely affect the eisting client.

Dire.tion and Su#ervision

The audit manager should ade$uately control the audit work by use of audit programs

timetables and instructions gien should be comprehensie enough to enable the staff to

perform their work ade$uately.

Ins#e.tion

The audit staff should where possible inspect the clients, assets and other balances to

ascertain presentation, authori-ation, disclosure, ownership, aluations, eistence.The audit firm should engage people that hae ade$uate knowledge, skills and eperience

re$uired to undertake a gien audit assignment to enable the auditors obsere dueprofessional cared.

AUDIT RECORDING

The Auditor's perational 2tandards re$uires the auditors to plan, control and record theirwork ade$uately.

Audit recording is the process of documenting the audit work that has already been

planned and controlled by the audit manager to enable the epression of a balanced audit

opinion on the financial statement.5ecording enables the auditor to keep records on important matters coered during the

audit assignment.

Audit recording is done in audit working papers.

Def: Audit working papers are records kept by the auditor on the procedures applied,

information obtained and conclusions arried at during the audit assignment. Theyshould always be sufficiently complete to proide eidence of work performed to support

conclusions reached.

SOURCES OF AUDIT WORKING )A)ERS

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%hotocopies of financial statements under the Audit and other documents of the client's

company such as /;A K A..A.Taking notes on arrears of weaknesses in internal controls especially where the auditor

cannot get ade$uate eplanations.

7illing of eidence from =rd

parties e.g. the client's bank, debtors, etc.Auditor's opinion

The auditors would file their own eidence according personal obseration and 9udgment.

Internal control $uestionnairesInformation on audit working papers would also be obtained from tools of ealuating

internal controls e.g. internal control $uestionnaires, flow charts etc.

I)ORTANCE OF AUDIT WORKING )A)ERS

The outgoing auditors work can be used by the incoming auditor to assess the clients

preious performance

?orking papers help future auditors in understanding the problems encountered by

preious auditors.%reparation of working papers enables the auditor to approach his work in a

methodical manner hence reducing his eposure to risks.In cases where the auditor is sued for negligence, audit working papers may proide

eidence that he approached his work professionally i.e. they proide eidence for

work done.?here the company is under inestigation by goernment agencies, audit working

papers are important to the person inestigating

#pression of opinion

Audit working papers if properly recorded facilitates epression of a balanced auditopinion on the financial statements.

It's a professional re$uirement of the Auditor's perational 2tandards.That the audit should plan, control and record work.

CURRENT AUDIT FILES

This is a file which relates to the current auditA new audit file is opened eery year

"urrent audit files are usualy closed at the end of the current financial period

"urrent audit files if need be should be destroyed after ) years.

Contents o! Current Audit File

A copy of the engagement letter

Audit programmes and dates when different actiities were carried outA copy of the management letter highlighting weaknesses in internal controls

A list of audit ob9ecties or statutory re$uirements

A record of $uestions asked and answers obtained either from employees ofmanagement

"orrespondences between the auditors and other parties e.g. debtors, creditors, etc

A copy of the current financial statement being audited

A schedule of items in the balance sheet

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A copy of shareholders and directors' minutes

)ERANENT AUDIT FILE

This is a file that contains information that is useful to the auditor beyond a financial

period and i.e that information is permanent in nature and should be updated at each

annual audit.

Contents o! a )er*anent Audit File

/emorandum and Articles of Association of the client's companyrgani-ational charts of the company

"opies of the last years accounts

istory of the client in terms of growth

A list of company propertiesA copy of accounting and auditing standards

A list of company adisors e.g lawyers, stock;brokers etc

0etails of a computer system in operation

Address of the registered office

LIEN O(ER AUDIT WORKING )A)ERS

riginally, it was belieed that audit working papers belonged to the client

This belief was based on the following claims8

That the auditor obtained his papers from the client's books and financial statements

That the auditor is simply an agent of the client and as such is bound by the law of

agency to hand them oer to the principal &client+That the working papers contain secrets of the client and as such should be kept by the

owner to presere the secrets.That after paying his fee, the client has a right not only oer the working papers but alsoany other information that the auditor may hae obtained by irtue of his appointment

n the other hand the auditor claims o%nership of %orkin& papers on the follo%in&&rounds#-

That working papers will act as a defense in case he is sued by the client in future

That the outgoing auditor has a professional duty to hand oer these papers to theincoming auditor to enable him to understand his client better

That they are used for future reference to facilitate future audits

That the auditor has infact gathered such papers himself and little if any is hisoriginal documents of the client

That the auditor has iew oer working papers especially his audit report in cases

he is not paid his fee in which case he has a right to retain the report and otherworking papers. ntil such a fee is paid.

@eertheless, the ownership of working papers has been resoled through legal and

professional channels as follows8;

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In the case of 2tokinky Ds Bright Graham &! C=(+, the court gae the ruling in faour

of the auditors or the bonified of the working papers on grounds that the auditor is an

independent contractor not agents of the clients but adhere discression, the auditors maygie their clients some papers such as income ta returns, correspondence between him

and =rdparties etc.

The IA2 no.


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"hanges in the clients business may render working papers obsolete.

INTERNAL CONTROL SYSTE

I.".2 is defined by the auditing guidelines on internal controls as JThe whole system of

controls established by the management in order to carry on the business of the enterprise

in an order and efficient manner, to ensure adherence to management policies, safeguardthe assets as secure as possible and completeness and accuracy of records.J

"ontrols are indiidual components of an internal control system

O&'ECTI(ES OF INTERNAL CONTROLS

To ensure adherence to management policies

To safeguard the assets of the company

To secure the accuracy, alidity and completeness of recordsTo preent and detect occurrence of errors and frauds

To ensure that management does its work in an orderly and efficient manner

To ensure that the ob9ecties of the company are achieed

To establish standards of performanceTo monitor and reward performance

To create responsible centers in an organi-ationTo enhance reliance on internal controls and internal audits by an eternal auditor

TY)ES OF INTERNAL CONTROLS

AUTHORISATION CONTROLS

A sound internal control system should hae the following controls8

Aut4orisation Cotrols

These are controls that are instituted by the management to ensure that only necessarytransactions are processed, fraudulent transactions are preented and to ensure noatteration on already processed documents.

E;a*#les in.lude7

Approal only by responsible officers

se of special ink for signing purposes

2etting authorisation limits e.g. a che$ue of oer !shs.**,***L to be authori-ed by

the chief financial officer and no other personse of official company seal

"oding of information

se of serial numbers"hecking the authenticity of signatures

Douching of documents

!eeping already authori-ed documents under key and lock

RECORDING CONTROLS

These are controls to ensure that all authorised transactions are recorded in the financial

records.

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They include8

Internal check system

This is where work of an employee is automatically checked by another to ensurethat there are no errors

"ut off procedures to ensure that transactions are recorded in the accounting

period to which they relate%reparation of reconciliation statements

5outine checkssurprise checks etc to ensure accuracy, alidity and completeness

in recordingse of $ualified personnel to minimi-e negligence in recording

#ffectie superision of the recording procedure

se of serial numbers on eery document

se of computation machines

CUSTODY CONTROLS

These are controls to ensure that assets of the business as record in the accounts are free

from mis;appropriation, theft, negligenceThis controls include8;

se of security person, fencing, security clock &principal control+!eeping sensitie assets under key and lock

se of public lyck drier instructed not to carry unauthori-ed persons, no through

pass beyond this pointse of passwords and secret codes for users of computer

2igning of work tickets before ehicles leae the company

SEGREGATION CONTROL

These ensure that no single officer initiates a transaction and deelops it to its conclusion

If properly done segregation helps to minimi-e occurrence of errors and frauds and theirpreention.

(OCATION AND ROTATION

"ompulsory leae should be gien to accounting staff to enable the company to ascertaintheir efficiency and that of other officers replacing them

5otation of duties helps to ensure that an officer does not oer;familiari-e himself in

some areas.

ATTERS TO CONSIDER WHEN DE(ELO)ING SOUND


5eason for failure of earlier controls2i-e of the organi-ation

"ostaailability of resources

The personnel to implement the controlsb9ecties or purpose of controls

7leibility of the system and epected efficiency

INDICATORS OF A WEAK INTERNAL CONTROL SYSTE

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?here staff of the client are unwilling to take up annual leae

?here relaties are employed in related nature of work

?here the integrity of the management and their competency is $uestionable?here auditors and legal eperts are checked fre$uently

?here the company depends on or few customers

?here auditors and legal eperts are highly remunerated

LIITATIONS OF INTERNAL CONTROLS

Irrespectie of how strong the internal controls are, they hae the following limitations8;/anagement are in position to oer;ride their own controls. This is because they don't

want particular controls to apply to them hence, by;passing them.

Internal controls could be abused by the responsible officers to whom they are entrusted

through collusion"ontrols are implemented at a cost, i.e. its ery epensie to instal and maintain a strong

internal control system

A strong Internal "ontrol 2ystem could also be rigid and i.e. not fleible enough to meet

the purpose for which they were designed.er;reliance by management

?here internal controls are strong management are likely to oer;rely on controls hence,their responsibility of superision is compromised

er;reliance by the auditor

The auditor is likely to be tempted to oer;rely on a strong I.".2 hence, performinginade$uate tests which cannot detect errors and frauds

There is always a possibility of human error either by using wrong figures or due to

fatigue

ANAGEENT RES)ONSI&ILITY UNDER I%C%S

The auditing guidelines on internal controls states that, JIf the auditor wishes to placereliance on any internal controls, he should ascertain and ealuate these controls andperform compliance tests on their operations.J oweer it's the responsibility of

management to decide on the etent of internal controls which are appropriate to the

business or company.

This will depend on the following8

2i-e, nature and olume of transactions

The degree of control which the management team is able to eercise personallyThe geographical distribution of the enterprise.

AUDITORS RES)ONSI&ILITY O(ER I%C%SThe auditors ob9ectie in eluating and testing of internal controls is to determine the

degree of reliance which he may place on the information contained in the financial

statement. oweer, the auditor should not solely rely on internal controls as a basis ofepressing his opinions on the financial statement.

This is because there is no internal control system that can guarantee effectie

administration. Therefore if the auditor wishes to place reliance on any internal controls,

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he should ascertain and ealuate those controls and perform compliance tests on their

operations.

ASCERTAINING THE ACCOUNTING SYSTE

An accounting system refers to a series of tasks that produce accounting information to

make possible the preparation of financial statements.Accounting system therefore constitutes internal controls that deal with accounting

information.

The system ensures that only authorised transactions are processed and recorded.It also ensures that transactions of accounting nature are accurate, alid, complete and

that sensitie documents are kept by financial officers who are responsible under key and

lock

Ascertaining the system refers to gathering of information by the auditor on how theinternal controls operate.

5ecording of system refers to the implementation of the I.".2 by way of flow charts,

narratie notes, internal control ealuation, $uestionnaires etc.

ETHODS USED IN ASCERTAINING THE CLIENTS ACCOUNTING SYSTE

se of procedure manuals which show day to day actiities.Audit working papers prepared by the auditor for preious years to gain an understanding

of the system

The auditor may establish the facts about the system by interiewing the clientsmanagement and employees.

sing work of internal auditors on how the system operates

%ersonal obseration of procedures as undertaken by employees

Internal "ontrol #ample

)URCHASES and CREDITORS2uppliers should be approed before purchase orders are placedThe purchasing department should maintain a list of authori-ed suppliers which should be

continuously reised

%urchase order's should be properly approedAn indiidual ability to authori-e purchase orders should be kept within certain limits

after which further authori-ation is re$uired for approal

The purchasing department should be centrali-ed in order to obtain economy efficiency

in orderingThere should only area of reiewing goods

This helps to minimi-e inspection and storage costs as well as loses

There should be a policy to ensure that goods receied should only be accepted againstauthorised purchase orders a copy of which should be sent to the department receiing

goods.

Goods receied should be properly inspected before being accepted. nce receiedaccurate recording should be done.

Goods returned to suppliers should be recorded and a re9ection note raised at the deliery

point

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Goods receied and returned records should be monitored and controlled to ensure that

all inoices and credit notes are properly receied.

TECHNI$UES:ETHODS:TOOLS OF RECORDING AND E(ALUATING AND


FLOW CHART

These and diagrammatic representations of the companies accounting systems and

procedures"harts use hori-ontal lines to indicate the moement of items, across departments and

ertical flow lines to indicate moement of items within the same department

"harts are used by the auditor to identify ma9or functional areas where he wants to place

reliance.The following points should be considered when drawing flow charts &$ualities of a good

flow chart+

se the organi-ation chart as the basis of preparing the flow chart

It must be simple and clear to understandIt should not contain any writing

"harts should not be congested with flow lines which sere no purposese hori-ontal or ertical flow lines when preparing a flow chart

7low chart goods and documents separately

se serial numbers not words in the flow chartThe flow chart should be cross referenced to internal control $uestionnaires and

letter of internal weaknesses

"harts must show the origin of each document, se$uence of operation and the

officer who performs the taskThe specimen of the document should be attached to the flow charts.

%urchasing 0epartment 5eceiing 0epartment 2tores 0epartment Accounts 0epartmen

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!#H

/oement of an item across departments

/oement of records within and across departments

"ontinuous flow lines represent strong internal controls

Gaps in flow lines represent weakness in I.".2

Advanta/es

They enable the auditor to get the entire picture of internal controls in a particularorganisation

They highlight the relationship between parts of internal controls in a systematicmanner

It shows weaknesses in the internal controls which can be spotted clearly through

gaps in the flow linesThey form a consistent method of recording internal control system in an

organi-ation.

Li*itations

nless eplained they may be difficult to follow

The don't contain all the information and therefore notes may hae to be taken aswellThey are time consuming and difficult to prepare

They may not ideal for small business with few transactions

2ymbols used in the low chart may not be inform and therefore may causeproblems in understanding by other parties.

INTERNAL CONTROL $UESTIONNAIRES

This is a set of $uestions prepared by the auditor and which should be answered by the

client in the presence of the auditor

These $uestions re$uire short answers like8H#2, @, @ot Applicable where H#2indicates strengths in the internal control and @ or @T Applicable answer indicate

weaknesses in I.".2.

Advanta/es

It assists the auditor to know the books of the client accounts kept and the information

remained in the books.

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sing answers of internal $uestionnaires, the auditor is able to assess the strength and

weakness of I.".2. more easily to facilitate audit planning

They discuss or indicate which official to consultThey sere as a basis of writing the management letter as they show weakness in I.".2

They assist the auditor in drawing up audit programs as they will show areas where the

auditor should concentrate moreInternal control $uestionnaires are used for future reference and as a means of preparing

future audit programs

Disadvanta/es o! Internal Control $uestionnaires

They may be answered impulsiely without giing thought to the $uestions leading to a

biased opinionThey may ignore changes in the clients business if they are poorly prepared

If they are poorly prep

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