PA603 AUDITING AND ASSURANCE

PA603 AUDITING AND ASSURANCEUNIT 1 AUDIT APPROACHNIK AZIDA BINTI ABD GHANI013-9337550nikazida5@yahoo.com

Nature of Audit Nature of Audit Nature of Audit Nature of Audit Nature of Audit Types of Audit ApproachTypes of Audit ApproachTypes of Audit ApproachTypes of Audit ApproachTypes of Audit ApproachFinancial Statement Audit:Conducted to determine whether the overall financial statements are stated in accordance with specified criteria.

The auditor performs appropriate tests to determine whether the statements contain material errors or other misstatements. Types of Audit ApproachFinancial Statement Audit

Strategic systems audit approach: The auditor should identify risks associated with clients strategies by considering the clients business strategies, processes and measurement indicators for critical success factors related to the strategies.Types of Audit Approach

Uses of Flowchart in Audit ApproachFlowchart:Used to visualize complex systems involved in an organization (especially on internal accounting control).Can provide a concise overview of the clients system (analytical tool in evaluation).Aids management and auditor in identifying inadequacies by facilitating a clear understanding of how the system operates.Uses of Flowchart in Audit ApproachFlowchart:Allow an auditor to find where a problem may be, and visualize from where the problem stems.Easier to read and easier to update.May be used in replace of narrative ease of understanding by current and subsequent year auditors and relative cost of preparation.Example of an Audit Flowchart

Example of an Audit Flowchart

Types of Audit TestAudit Test:A procedure performed by either an external or internal auditor in order to assess the accuracy of various financial statement assertions. Typically are performed on a sample basis over an existing group of similar transactions. Sampling approaches - statistical or non-statistical (to obtain the most representative sample of the population before testing begins).Two common categorizations of audit tests are:substantive tests tests of internal controlsTypes of Audit TestSubstantive Audit Test:A direct test that validates a financial statement balance (often requires a large deal of recalculating, confirming, and vouching)

Internal Control Test:Focused on key controls, such as management reviews or standardized templates, that are designed to prevent and detect material misstatements. Types of Audit TestTypes of Audit Test:VouchingVerificationTest of control (compliance test)Substantive testWalk-through testDepth testWeakness testRotational test

VouchingRefers to the inspection of documentary evidence supporting and substantiating a transaction, by an auditor.Consists of:Selecting an item for testing from the accounting journals or ledgers and then examining the underlying source documents - verifying a transaction recorded in the books of account with the relevant documentary evidence (such as invoices, debit and credit notes, statements, receipts) - provide evidence that items included in the accounting journals or ledgers have occurred (are valid).Verifying the authority. Confirming that the amount mentioned in the voucher has been posted to an appropriate account included in the final statements of account.Example: vouch a sample of recorded acquisition transactions to vendors invoices and receiving reports.Objective of Vouching:To establish that the transactions recorded in the books of accounts : are in order have been properly authorized are correctly recorded. Vouching is the essence or backbone of auditing because when performing an audit, an auditor must have proof of all transactions.VouchingVouching Importance of Vouching:Due care and attention are to be given to vouching in auditingAuditor can be charged with negligence Example: Armitage v. Brewer and Knott the auditors were found to be guilty on negligence auditors did not display enough reasonable care and skill in vouching the wage sheets failed to detect fraud in manipulation of these wage records and cash vouchers). VouchingWhen vouching/examining a transaction, ensure that:The date of the voucher falls within the accounting period;Voucher/transactions therein are duly and properly authorized by the relevant signatory.The transactions being examined belongs to the entity.The transaction is recorded in the proper account and revenue or expenses is properly allocated to the accounting period.All transaction which have actually occurred have been recorded.The posting from the voucher of the amount needs to be correctly taken in the final accounts, disclosed in accordance with recognized accounting policies and procedures.Vouching Example of vouching in a commercial bank:The purpose of an audit of a commercial bank is to verify the accuracy of the existing accounting system. Through the process of vouching and verification, auditors can draft an opinion as to the accuracy and completeness of a bank's finances and records as well as ensure the over all financial health of the bank is in good standing.The inspection of documents compared to records is called the vouching procedure. A document is proof that a transaction occurred. The document is compared to the supporting record to verify a sales transaction took place.Vouching Process and Assertions

Vouching and Assertions

Verification A substantive audit procedures that deal with examining the balance sheet transactions. To establish the truth of something - involves gathering evidence that will lead to a conclusion as to whether classes of transactions, balances and disclosures reflected in the clients financial statements are properly stated (true and fair).Verification Encompasses the inquiry into the ownership/ title, existence, valuation, completeness and presentation of assets and liabilities in the balance sheet.Deals with the final balance of profit and loss - also applies to profit and loss item to check the account balances and their presentation.

Verification The type(s) of technique(s) used depend on the audit objectives that the auditor is seeking to achieve.

The general objective to be achieved by audit verification work is to establish whether the financial statements present a true and fair view.Verification If the controls systems are:effective and operating as laid down, the amount of verification work will be reduced.weak or are not operating effectively, a high level of verification work will be performed.

Verification In carrying out substantive audit tests (verification work) the auditor will be looking for evidence on differentassertions at the financial statements level:Assertions about classes of transaction and event for the period under audit.Assertions about account balances at the period end.Assertions about presentation and disclosure.

Verification a) Assertions about classes of transactions and events for the period under audit;Occurrence transactions and events that have been recorded have occurred and pertain to the entity;Completeness - all transactions and events that should have been recorded have been recorded;Accuracy - amounts and other data relating to recorded transactions and events have been recorded appropriately.Cutoff - transactions and events have been recorded in the proper period.Classification - transactions and events have been recorded in the proper accounts.

Verification b) Assertions about account balances at the period end.Existence - assets, liabilities, and equity interests exist;Rights and obligations - the entity holds or controls the rights to assets, and liabilities arethe obligations of the entity;Completeness all assets, liabilities and equity interests that should have been recorded have been recorded;Valuation and allocation - assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded.

Verification c) Assertions about Presentation and DisclosureOccurrence and rights and obligations disclosed events, transactions and other matters have occurred and pertain to the entity.Completeness - all disclosures that should have been included in the financial statements have been included;Classification and understandability - financial information is appropriately presented and described, and disclosures are clearly expressed;Accuracy and valuation - financial and other information are disclosed fairly and at appropriate amounts.Management Assertions

Verification Verification means to obtain and examine evidence in respect of an item of asset that:The asset exists on a given date.The asset is legally owned by the concern.There are no unrecorded assets.The assets are disclosed, classified, and presented in accordance with recognized accounting policies and the requirement of law.Audit techniques that may be used: physical inspection, observation and confirmation.Verification of AssetsVerification of asset is an important audit technique - limited to inspection of assets and collection of information about the assets.Verification of assets is primarily the responsibility of the management: Management are expected to have a much greater knowledge of the assets of the business (condition, location etc.) than that which an outsider might be able to acquire on their inspection. Are competent to determine the values of the assets at which they should be included in the Balance Sheet. The auditor is only expected to apply his skill and expertise considering the value of each asset with a view to confirm that they are truly and fairly disclosed in the Balance Sheet.Vouching and Verification Differences between vouching and verification:Vouching is a substantive test procedure that deals with profit and loss transactions/ items.Verification is a substantive test procedure that deals with examination of balance sheet transactions/ items whether they are assets or liabilities are properly stated in the balance sheet. Vouching is the substantive testing of transactions at their point of origin whereas verification usually deals with the final balance in the balance sheet and profit and loss.VOUCHINGVERIFICATIONNature Is a substantive audit procedure which deals with examination of profit and loss transactions/items- Is a substantive audit procedure which deals with examination of balance sheet transactions/items Also applies to profit and loss item to check the account balances and their presentationDeal withVouching is the substantive testing/examination of transaction at their POINT OF ORIGIN

Deals with the FINAL BALANCE in the Final Accounts viz the balance sheet and profit and loss

Purpose whether the transactions are genuine and valid to enable the auditor to report on the financial statements Whether assets or liabilities are properly stated in the balance sheet and profit and loss item correct account balances and presentationProcessWhen vouching/examining a transaction, the essential points need to be ensured, such as The date of the voucher falls within the accounting period.

Verification process encompasses the inquiry into the ownership/ title, existence, valuation, completeness and presentation of assets and liabilities in the balance sheet.

Test of Control (Compliance Test) Test of Control (compliance test):Purpose: procedures to test effectiveness of controls in support of reduced assessed control risk.Assessing control risk consider the design and operation of controls to evaluate whether they will likely to be effective in meeting transaction-related audit objectives (worth relying upon).If the auditor is not satisfied with the test of control, substantive test (comprehensive) will be carried out.Test of Control (Compliance Test) Assessing control risk:Auditor needs to obtain understanding of internal control: design and operation.Preliminary assessment of control risk made:Whether the entity is auditable (integrity of management and adequacy of accounting records).For each transaction-related audit objective for each major types of transaction in each transaction cycle. Example: in the sales and collection cycle, the types of transactions usually involve sales, sales returns and allowances, cash receipts, and the provision for and write-off of uncollectible accounts.Test of Control (Compliance Test) AUDIT OBJECTIVES AUDIT OBJECTIVESDeficiencies and Weaknesses Substantive Test Substantive Test Substantive Test Substantive test of transactions:Purpose: to determine whether transaction-related audit objectives have been satisfied (Existence, Completeness, Accuracy, Classification, Timing, and Posting and Summarization).May be done simultaneously with tests of control since both tests are performed for transactions in the cycle and not the ending account balances.

Walk-through TestWalk-through Test:A combination of observation, documentation and inquiry in the form of a transaction walkthrough.The auditor selects one or a few documents for the initiation of a transaction type and traces them (step-by-step) through the entire accounting process to learn how a process works.The auditor is required to perform at least one walkthrough for each major class of transactions.Purpose: to establish reliability of clients accounting and internal control procedures and to reveal system deficiencies and material weakness that need to be rectified at the earliest.Depth TestDepth Test:aka cradle-to-grave testsInvolves taking a transaction or a number of transactions and following them through the accounting system from start to finish or vice versa Purposes/Objectives:To provide audit evidence to assist the auditor in arriving at his opinion where the auditor is still unable to form an opinion from the results of the walk-through test. To confirm the accuracy of clients accounting system (walk-through checks) - involve only a small number of transactions.To perform compliance test (the auditor may use a number of transactions, testing the control in depth at each stage). Such tests will provide evidence as to whether or not he may rely upon that control in planning later audit work. To provide evidence of a substantive nature (to check that transactions have been properly recorded in the accounting records or in the financial statements.Weakness TestWeakness Test:If the compliance test reveal weaknesses in the application of the system, additional tests (weakness test) that may be necessary to establish the extent of the weaknesses and their effect on the reliability of the accounting records.Only carried out in areas where material error could occur.Purpose: to establish whether material errors have in fact occurred (if they have, an extended program of work on the verification of associated asset will be carried out).Rotational TestRotational Test:To improve audit approach efficiency, some firms rely to varying degrees on controls tested in previous engagements. Controls are therefore tested on a rotation basis. If the auditor plans to use audit evidence about the operating effectiveness of controls obtained in prior audits, the auditor should obtain audit evidence about whether changes in those specific controls have occurred subsequent to the prior audit (by performing enquiry in combination with observation or inspection to confirm the understanding of those specific controls).All controls should be tested at least once every third audit. May be applied as long as the controls identified have not changed since they were last tested and the assessed risk of material misstatement at the assertion level is not significant.Audit Procedures Audit procedures:Detailed instructions for the collection of a type of audit evidence that is to be obtained at some time during the audit.Use specific terms to permit their use as instructions during the audit.Example: obtain the cash disbursements journal and compare the payee name, amount and date on the cancelled check with the cash disbursements journal.The audit procedures to be followed on an engagement are indicated in the audit program (Typically, it specifies the name of the auditor responsible for a given job including the estimated time to conduct the audit task. The audit program guides and controls the work of staff assistants.). The work paper indicate what has been done on the audit.

Audit TechniquesAudit techniques - Methods used to obtain audit evidence:Inspection Observation InquiryConfirmation Computation Analytical reviewAudit techniques may change depending on circumstances (verification of cash differs from verification of debtors) or nature of organization (manufacturing, trading or professional).

Differences between Audit Procedures & TechniquesAudit ProceduresAudit TechniquesSteps taken to obtain audit evidence.Methods used to obtain audit evidence.

Broadly classified into compliance procedures and substantive procedures.Examples are posting checking, casting checking, physical examination and count, confirmation, inquiry, year-end scrutiny, re-computation, tracing in subsequent period and bank reconciliation. Procedures may comprise a number of techniques and represents the broad frame of the manner of handling the audit work.Techniques stands for the methods employed to carry out the procedure.Example: substantive procedure requires an examination of the documentary evidence.This job is performed by the procedure known as vouching which involve techniques of inspection and checking computation of documentary evidence.Needs of Audit Procedures & TechniquesAudit ProceduresAudit TechniquesOffer detailed audit steps which are to be performed during the audit fieldwork. Offer a range of choice of methods to obtain the evidence.

Provide detailed steps to be followed in order to achieve the explicit audit objectives.Methods to obtain evidence must take into consideration the circumstances and nature of organization.

Audit ProceduresAudit procedures through:Test of control to test effectiveness of controls.Analytical procedures to understand clients industry and business, assess going concern, indicate possible misstatements and reduce detailed testsSubstantive procedures - to detect material misstatements at the assertion level. Test of Control Test of Control Control-related ActivitiesAccountability for time and costsAccuracy of computationsSupporting documentationFollowup actionSegregation of dutiesAccountability for authorizationTest of Control Differences between Test of Control and Procedures to Obtain an UnderstandingAnalytical ProceduresDefinition of Analytical Procedures:Analysis of significant ratios and trends including the resulting investigation of fluctuations and relationship that are inconsistent with other relevant information or which deviate from predicted amounts.Analytical Procedures:Uses comparisons and relationship to assess account balances or other data appear reasonable.Example: comparison of current years recorded commission to total recorded sales multiplied by average commission rate (to test the overall reasonableness of recorded commission).Major Types of Analytical ProceduresAnalytical ProceduresPurposes of Analytical Procedures:Understand clients industry and business.Assess going concern (likelihood of financial failure).Indicate possible misstatements (attention directing).Reduce detailed tests.Analytical ProceduresCompare client data with industry dataAid understanding of clients business.As indication of likelihood of financial failure (also strength of clients capital structure, borrowing capacity).Weakness:nature of clients financial information may differ from the other firm that form the industrys total. Difference in accounting methods may affect comparability of data.To overcome the weakness: compare the clients data to one or more benchmark firms in the industry.

Analytical ProceduresCompare client data with similar prior-period dataCompare the current years balance with that of the preceding year (identify cause of significant change errors, misstatements, or need more attention).Compare the detail of a total balance with similar detail for the preceding year (comparison of details over time or at a point in time).Compute ratios and percentage relationships for comparison with previous year (take into consideration the growth or decline in business activities and relationship of data to other data). Examples of ratio analysis:Raw material turnover (for manufacturing company).Sales commission divided by net sales.Individual manufacturing expenses as a percentage of total manufacturing expense. Analytical ProceduresCompare client data with client-determined expected resultsPay attention to significant areas in which differences exist between budgeted and actual results (may indicate potential misstatements).Auditor needs to evaluate whether the budgets were realistic (discussion of budget procedures).Auditor needs to check the possibility that current financial information was changed to conform to the budget (assess control risk and perform detailed audit tests of actual data).Analytical ProceduresCompare client data with auditor-determined expected resultsAuditor estimates the expected balance by: Relating to other balance sheet/ income statement account/accounts (example: calculation of interest expense on long-term notes payable by multiplying ending balance by the average monthly interest rate).Making projection based on some historical trend (example: using moving average of the allowance for uncollectible accounts receivable as a percentage of gross accounts receivable at the end of the audit year).Analytical ProceduresCompare client data with expected results using nonfinancial dataAuditor estimates the expected balance by: Taking into consideration the nonfinancial data such as the number of rooms, room rate for each room and occupancy rate. Consider also the accuracy of the data (example: occupancy rate may be more difficult to be evaluated on accuracy).Analytical ProceduresSubstantive ProceduresSubstantive Procedures:Substantive procedures are performed in order to detect material misstatements at the assertion level and include tests of details of classes of transactions, account balances and disclosures and substantive analytical procedures.If a high level of assurance is obtained from the tests of control and substantive analytical procedure, the extent of the substantive test of details can be reduced.When the auditor has determined that an assessed risk of material misstatement at the assertion level is asignificant risk, the auditor should perform substantive procedures that are specifically responsive to thatrisk.

Substantive ProceduresSubstantive ProceduresSubstantive Procedures involve :Agreeing the financial statements to the underlying accounting records; Examining material journal entries and other adjustments made during the course of preparingthe financial statements.