INTRODUCTION TO AUDITINGDefinitionAuditing can be defined as a systematic process by which a competent, independent person objectively obtains and evaluates evidence regarding assertions about an economic entity or event for a purpose of forming an opinion about and reporting on the degree to which the assertion conforms to an identified set of standards.

Auditing is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between the assertions and established criteria and communicating the results to the interested users.

The History of Auditing Auditing has developed from what in the 12th century, was primarily a check of the

accounting for stocks and revenues by authorised officers of the Exchequer of England into a sophisticated professional assurance services performed by independent auditors for the interest of their clients and other users of financial statements.

The historical perspective of auditing is very important given the current shift away from traditional accounting and auditing services to a broad variety of assurance services.

The role of auditing first appeared in the United Kingdom in the 1800s.

The development of the auditing role is very much an account of Court case decisions at the end of that century.

The increasing use of the company form of business organisation led to the growth to managers who handled large sums of capital on behalf of shareholders.

In 1844 the Joint Stock Companies Act stipulated that “Directors shall cause the books of the Company to be balanced and a full and fair Balance Sheet to be made up”.

The Act then provided for appointment of auditors who were empowered to examine the accounts of the company.

In 1900 the appointment of an auditor became compulsory for all public companies to appoint an auditor and in 1948 auditors were required to have appropriate professional qualifications.

Financial AuditingThe objectives of the ordinary audit of financial statements by the independent auditor is the expression of an opinion on the fairness in which they present fairly in all material respects, financial position, results of operations and cash flows in conformity with G.A.A.P.

Risk reductionAuditing is a process of reducing to a socially acceptable level of information risk to users of financial statements.

Business risk – this is the risk, the chance that a company takes that inflation will rise, risk that customers will buy from competitors, government grant will be lost, employees will go strike

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NB- auditors do not directly influence the company’s business risk

Assurance functionThis involves the expression of written or oral conclusions or the reliability or relevance of information / information systems.

Objectives of an auditAccording to International Standard on Auditing 200 Objectives and General Principles Governing an Audit of Financial Statements , the objective of an audit “ is to enable the auditor to express an opinion whether the financial statements are prepared in all material respects in accordance with an identified financial reporting framework .

This framework might be International Financial Reporting Standards or the National Standards of a particular country.

The auditor shall make a report to the members of the accounts examined by him on every balance sheet ,income statement, and all group accounts laid before the company in general meeting during his term of office and the report shall contain the following statement :

“Whether in his opinion , the balance sheet and income statement of the company or group of companies are properly drawn up in accordance with legislation so as to give a true and fair view of the company’s affairs at the date of its balance sheet and income statement for its` financial year ended on that date.”

The primary purpose of an audit is to establish whether, in the auditor`s opinion, the financial statements are a true and fair reflection of the company’s financial position.

If he does not believe that they are, then he will decline to confirm them or issue a qualified report.

The auditor shall include in his report, statements which in his opinion are necessary if: He has not obtained all the information and explanations which to the best of his

knowledge and belief were necessary for the purpose of the audit. So far as appeared from his examination proper book of accounts have not been kept by

the company. Proper returns adequate for the purpose of the audit have not been received from the

branches not visited by him. The company’s balance sheet and income statement are not in agreement with the book of

accounts and returns from the branches.

Rights of an auditor.Every auditor of a company shall have a right of access at all times to the books, accounts, vouchers and securities of a company and shall be entitled to require from the officers of the company such information and explanations as he thinks necessary. Every auditor of a holding company shall have a right to attend a general meeting of the

company and receive all notices relating to any general meeting of the company. The auditor is entitled to be heard at any general meeting which he attends.

Legal background. The companies Act lays down the legal background to an audit that includes the

appointment of an auditor, the disqualification for appointment as auditor and the rights and duties.

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Appointment and remuneration of an auditor The first auditors of a company shall be appointed by the directors within one month of

issue of the certificate that the company is entitled to commence business in the case of a public company and other companies within one month of the issue of the certificate of incorporation.

An auditor so appointed shall hold office until the conclusion of the first Annual General meeting.

The directors shall at each AGM appoint an auditor to hold office from the conclusion of that meeting until the conclusion of the next AGM.

The directors may fill any casual vacancy in the office of auditor but while any such vacancy continues, the continuing auditor, if any, may act.

The remuneration of the auditor of a company shall be fixed by the company in general meeting, or in such manner as the company in general meeting may determine.

Any sums paid by the company in respect of the auditors` expenses shall be deemed to be included in the remuneration.

Disqualification from appointment as auditor None of the following persons shall be qualified for appointment as auditors of a

company: An officer or servant of the company A person who is a partner of a company A person who is an employer or an employee of an officer or servant of a company. A body corporate A person who is an officer or servant of a body corporate A person who by himself or his partner or his employee regularly performs the duties of

secretary or bookkeeper of the company.

Resignation and removal of the auditor Auditors may be removed from office by resolution of the company at an Annual General

Meeting for which a notice of twenty eight days is required. The company must send such a notice of the resolution to the auditor in writing. The auditor is then given an opportunity to make presentations in writing with copies of

presentations sent to all members. Auditors may be removed so as to strengthen audit independence by appointing another

auditor. Auditors who qualify their opinion on the financial statements cannot be removed by

directors for qualifying the financial statements. When resigning the auditor should notify the company in writing. The notice must be accompanied by any circumstances to be brought to the attention of

members or creditors or a statement that no such circumstances exist.

CODE OF ETHICS The auditor`s objectivity must be beyond question if he is to report as an auditor. The objectivity can only be assured if the auditor is seen to be independent. Independence may be threatened or appear to be threatened in the following

circumstances :

1 . Undue dependence on an audit client

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The auditor’s objectivity is likely to be jeopardised where the fees for audit and other recurring work paid by one client or group of clients exceeds 15% of the gross practice income or 10% of the gross practice income in the case of listed and other public interest companies.

A new practice seeking to establish itself or an established practice seeking to reduce its activities may not be able to comply with this criteria.

2 . Overdue fees The existence of significant overdue fees from an audit client or a group of connected

clients may be a threat to objectivity similar to that of a loan.

3. Actual or threatened litigation Litigation between the auditor and the client is likely to represent a breakdown in the

relationship of trust between them.

4. Family and other personal relationships Problems may arise where a practice or anyone closely connected with it has a mutual

business interest with a client, and an officer or an employee of a client or where an officer or employee is closely connected with a partner or staff member.

5. Beneficial interests in shares and other investments A practice should ensure that it should not have as an audit client a company in which a

partner or employee or anyone closely connected with a partner or employee who is a holder of a beneficial investment nor should it employ on the audit a member of staff, if that member of staff or a person closely connected with him is a beneficial holder of such investment.

6. Loans A practice or anyone closely connected with it should not, either directly or indirectly or

by way of a trust or other intermediary: Make a loan to or guarantee borrowings by a company or organisation audited by the

practice. Accept a loan from such a company or organisation. Have borrowings guaranteed by such a company or organisation This rule is not intended to preclude a loan, overdraft or home mortgage being accepted

from an audit client financial institution in the normal course of business and on normal commercial terms by a partner or staff member.

7. Goods and Services:Hospitality Goods or services should not be accepted by a practice or anyone closely connected with

it unless the value of any such benefit is modest. Acceptance of undue hospitality poses a similar threat.

8 . Provision of other services There is no objection in principle to a practice providing to a client, services additional to

the audit. However, care must be taken not to perform management functions or make management

decisions. In the case of many audit clients, it is common to provide a range of accountancy services,

which may include participation in the preparation of accounting records.

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In the case of a listed company or public interest company audit client a practice should not participate in the preparation of accounting records except in :

(a) In relation to assistance of a mechanical nature for example consolidations and tax provisions.

(b) In emergency situations.

Conflict of interests There is, on the face of it, nothing improper in having two or more clients whose interests

may be in conflict provided that the work that the auditor undertakes is not in itself, likely to be the subject of conflict between the clients.

Where the acceptance or continuance of an engagement would even with safe guards, materially prejudice the interests of a client, the appointment should not be accepted or continued.

Where the auditor becomes aware of possible conflicts between the interests of two or more clients, all reasonable steps should be taken to manage them.

These steps may include some or all of the following safeguards : The use of different partners and teams for different engagements. Standing instructions to prevent the leakage of confidential information between different

teams and sections within the audit firm. Regular review of the situation by a senior partner or compliance officer not personally

involved with either client. Advising one or both clients to seek additional independent advice.

Scope of an audit The term scope of an audit refers to the audit procedures necessary to achieve the

objective of an audit that is an audit should be conducted in accordance with International Standards on Auditing, rules of professional conduct, legislation and the terms of an audit engagement.

Responsibility for the financial statements. The auditor is responsible for forming and expressing an opinion on the financial

statements. The responsibility for preparing and presenting the financial statements rests with

management. The audit of financial statements does not relieve management of its responsibility. The auditor should comply with the code of ethics for professional accountants issued by

the International Federation of Accountants.

The principles include : (a)Independence (b)Integrity (c)Objectivity (d)Professional competence and due care (e)Confidentiality (f)Professional behaviour (g)Technical standards

The auditor should conduct an audit in accordance with International Standards on Auditing.

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

Responsibility for the detection of fraud and error The responsibility rests with management through the implementation and continued

operation of an adequate system of internal control which reduces the possibility of fraud and error.

Audit objective The objective of an audit of financial statements is to enable the auditor to express an

opinion on such financial statement. The auditor carries out procedures designed to obtain reasonable assurance that the

financial statements are properly drawn in all material respects. The auditor should therefore plan his audit so that he can have reasonable expectation or

discovery of material misstatements resulting from fraud and error

Inherent limitations of an audit. While the existence of an effective system of internal control reduces the probability of

misstatements of financial information resulting from fraud and error, there will always be some risk of internal controls failing to operate as designed.

AUDIT ENGAGEMENT LETTERSPurposes of an engagement letter. An engagement letter documents and confirms the auditor’s acceptance of engagement,

objectives and scope of the audit, the extent of the responsibility of the client and the form of any audit reports.

The engagement letter avoids misunderstanding between the auditor and the client with respect to the engagement.

An engagement letter normally contains the following matters: Objective of the audit of financial statements and managements’ responsibility for the

preparation of financial statements. Managements’ responsibility for the preparation of financial statements. Basis on which fees are computed and other billing arrangements. Provision of accounting and other services such as taxation.

Example of an engagement letter

Deloitte & ToucheKenilworth Gardens1 Kenilworth RoadHighlandsHarareZimbabwe

To the directors Old Mutual Limited

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The purpose of this letter is to set out the basis on which we are to act as auditors of the company and its subsidiaries and the respective areas of responsibility of the directors and of ourselves.

Responsibility of directors and auditors.

1. As directors of the above company, you are responsible for ensuring that the company maintains proper accounting records and for preparing financial statements which give a true and fair view and have been prepared in accordance with the Companies Act. You are also responsible for making available to us as and when required, all the company’s accounting records and all other relevant records and related information, including minutes of all management and shareholder’s meetings.2. We have a statutory responsibility to report to the members whether in our opinion the financial statements give a true and fair view of the state of the company’s affairs and of the profit or loss for the year and whether they have been properly prepared in accordance with the Companies Act. In arriving at our opinion we are required to consider the following matters, and report on any in respect of which we are not satisfied:(a) Whether proper accounting records have been kept by the company and proper returns adequate for our audit have been received from branches not visited by us;(b) whether the company`s balance sheet and income statement are in agreement with the accounting records;(c)Whether we have obtained all the information and explanations which we think necessary for the purposes of our audit; and(d) Whether the information in the director’s report is consistent with the financial statements.In addition, there are certain other matters which, according to circumstances, may need to be dealt with in our report. Where the financial statements do not give full details of the directors’ remuneration or of their transactions with the company the Companies Act requires us to disclose such matters in our report.We have a professional responsibility to report if the financial statements do not comply in any material respect with International Accounting Standards, unless in our opinion the non-compliance is justified in the circumstances.Our audit will be conducted in accordance with International Standards issued by the Auditing Practices Board, and will include such tests of transactions and of the existence, ownership and valuation of assets and liabilities as we consider necessary. We shall obtain an understanding of the accounting and internal control systems in order to assess their adequacy as a basis for the preparation of the financial statements and to establish whether proper accounting records have been maintained by the company. We shall expect to obtain such appropriate evidence as we consider sufficient to enable us to draw reasonable conclusions there from. The nature and extent of our procedures will vary according to our assessment of the company’s system and, where we wish to replace reliance on it, the internal control system, and may cover any aspect of the business’s operations. Our audit is not designed to identify all significant weaknesses in the company’s systems but, if such weaknesses come to our notice during the course of our audit which we think should be brought to your attention, we shall report them to you. Any such report may not be provided to third parties without our prior consent. Such consent will be granted only on the basis that such reports are not prepared with the interest with the interests of anyone other than the company in mind and that we accept no duty or responsibility to any other party as concerns the report.

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As part of our normal audit procedures, we may request you to provide written confirmation of oral representations which we have received from you during the course of the audit on matters having a material effect on financial statements.In order to assist us with the examination of your financial statements, we shall request sight of all documents or statements, including the chairman’s statement and directors` report which are due to be issued with the financial statements. We are also entitled to attend all general meetings of the company and to receive notices of all such meetings.The responsibility for safeguarding the assets of the company and for the prevention of fraud, error and non compliance with laws rests with yourselves. However, we shall endeavour to plan our audit so that we have a reasonable expectation of detecting material misstatements in the financial statements or accounting records, but our examination should not be relied upon to disclose all such material misstatements or frauds.9. Where appropriate we shall not be treated as having notice, for the purposes of our audit responsibilities, of information provided to members of our firm other than those engaged on the audit.10. Once we have issued our report we have no further direct responsibility in relation to the financial statements for that financial year. However we expect that you inform us of any material event occurring between the date of our report and of the Annual General Meeting which may affect the financial statements.Other services11. You have requested that we provide other services in respect of taxation. The terms under which we provide these other services are dealt with in a separate letter. We will also agree in a separate letter of engagement the provision of other servicesFees12. Our fees are computed on the basis of the time spent on your affairs by the partners and our staff and on the level of skill and responsibility involved. Unless otherwise agreed, our fees will be billed at appropriate intervals during the course of the year and will be due on presentation.Applicable law13. This engagement letter shall be governed and construed in accordance with Roman Dutch law .The Courts of Zimbabwe shall have exclusive jurisdiction relating to any claim, dispute or difference concerning the engagement and any matter arising from it Each party irrevocably waives any right it may have to object to an action brought in those Courts, to claim that the action has been brought in an inconvenient forum, or to claim that those Courts do not have jurisdiction.14. Once it has been agreed, this letter will remain effective, from one audit appointment to another, until it is replaced.We shall be grateful if you could confirm in writing your agreement to these terms by signing and returning the enclosed copy of this letter, or let us know if they are not in accordance with your understanding of our terms of engagement.

Yours faithfully

Deloitte and Touche

Recurring auditsAn auditor may decide not to send a new engagement letter each year.However, the auditor may decide to send a new engagement letter where there is: (i) any indication that the client misunderstands the scope and objective of the audit.(ii) any revised or special terms of the engagement(iii) a recent change of management

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(iv) any significant change in the nature and size of the client`s business.(v) legal requirements.

FRAUD AND ERRORFraud is intentional misrepresentation of financial information by one or more individuals among management, employees and third parties and which results in misstatement of financial information and may involve : Manipulation, falsification, or alteration of records and documents. Suppression or omission of the effects of transactions from records and documents Misappropriation of assets. Recording of transactions without substance Misapplication of accounting policies.

Error is unintentional mistake in financial statements and may involve: mathematical or clerical mistakes in accounting records oversight or misrepresentation of facts Misapplication of accounting policies.

Responsibility for the detection of fraud and error The responsibility rests with management through the implementation and continued

operation of an adequate system of internal control which reduces the possibility of fraud and error.

Inherent limitations of an audit While the existence of an effective system of internal control reduces the probability of

misstatements of financial information resulting from fraud and error, there will always be some risk of internal controls failing to operate as designed.

Any system of internal controls may be ineffective against fraud involving collusion among employees or fraud committed by management.

Conditions which increase risk of fraud and error (indicators) The following conditions may indicate the existence of fraud and error: (a) Questions with respect to the integrity or competence of management. (b) unusual pressures within the entity (c) unusual transactions (d) problems in obtaining sufficient appropriate audit evidence

Procedures where indications of fraud or error and fraud exist Consider potential effect on the financial statements(materiality) Perform additional procedures as necessary to confirm or dispel suspicion of fraud and

error If unable to obtain evidence to confirm or dispel suspicion of fraud and error, the auditor

should consider the possible effect on the financial statements or should take legal advice before rendering any report or withdrawal from the engagement.

The auditor should communicate to management on a timely basis if fraud and error is actually found to exist or if he believes fraud or error may exist even if the potential effect on the financial statements is immaterial.

PROFESSIONAL LIABILITY OF AN AUDITOR Auditors are accountable in law for their professional conduct.

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This responsibility arises under common law and statute law. Responsibility under common law may be under contract to clients or in certain

circumstances, to third parties to whom a legal duty of care may be owed. There is a growing concern that too often following a business failure and alleged

fraudulent financial reporting the plaintiffs and their legal representatives prey on the auditors regardless of degree of fault, simply because the auditors may be the only party left with sufficient financial resources to indemnify the plaintiffs’ losses.

Liability to shareholders and third parties Auditors are liable under statute and common law to the shareholders for any

negligent performance of statutory duties. Auditors are also liable for cases of fraud and defamation in the same manner as

any other citizen. Negligence if proven to be wilful may constitute a conspiracy with management to

defraud the company or other parties. Some auditors have found themselves in Court on the criminal charge of fraud

after issuing unqualified reports on financial statements subsequently found to be misleading.

In respect of the provision of auditing services auditors are liable to compensate the plaintiff if the plaintiff is able to prove that:(a) A duty of care is owed to the plaintiff(b) The audit is negligently performed or the opinion negligently given

(c) The plaintiff has suffered a quantifiable loss as a result of the auditor’s negligence.The extent of the auditor’s responsibility in performing an audit is contained in Kingston Cotton Mills Co Case of 1896.Kingston Cotton Mills Co (No2) (1996) 2 Ch 279

Facts of the Case For several years the manager of Kingston Cotton Mills had been exaggerating the

quantities and values of the company’s stocks so as to fraudulently overstate the company’s profits.

This came to light when the company was unable to pay its debts and its true financial position was revealed.

The auditor had relied on a certificate signed by the manager and ensured that the amount appearing in the accounts as being as “per manager’s certificate”.

In line with contemporary practice, the auditor did not physically observe stocks or attempt to verify the valuation of individual items.

Neither did the auditor reconcile stocks with the opening balance and purchases and sales made during the year, all of which would have alerted the auditor that something was amiss.

Judgement: As regards stocks, Justice Lindley had the following to say:“I confess that I cannot see that their omission to check his [manager’s] returns was a breach of their duty to the company. It is no part of the auditor’s duty to take stock. No –one contends that it is. He must rely on other people for details of the stock in-trade in hand. In the case of a cotton mill he must rely on some skilled person for the materials necessary to enable him to enter the stocks-in trade at its proper value in the balance sheet.In relation to the auditor’s responsibilities in general particularly the detection of fraud, the following points from the judgement of Justice Lopes are important:

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“It is the duty of an auditor to bring to bear on the work he has to perform that skill, care and caution which a reasonably competent, careful and cautious would use. What is reasonable skill, care and caution must depend on the particular circumstances of each case. An auditor is not bound to be detective, or as was said, to approach his work with suspicion or with a foregone conclusion that there is something wrong. He is a watchdog and not a bloodhound. He is justified in believing in tried servants of the company in whom confidence is placed by the company. He is entitled to assume that they are honest, and to rely upon their representations, provided he takes reasonable care. If there is anything calculated to Excite suspicion, he should probe it to the bottom but, in the absence of anything he is only bound to be reasonably cautious and careful.The duties of auditors must not be rendered too onerous. Their work is responsible and laborious, and the remuneration moderate.Auditors must not be made responsible for not tracking out ingenious and carefully laid schemes of fraud, where there is nothing to arouse their suspicion and when those frauds are perpetrated by tried servants of the company and are undetected for several years by the directors. So to hold will make the work of an auditor intolerable”.

The Kingston Cotton Mill Case laid some fundamental auditing principles such as the “watch dog”rule and the notion of reasonable skill and care.

Liability to third parties A third party (a person who has no contractual relationship with the auditor) may sue the

auditor for negligence and claim damages. The plaintiff (third party) must prove that: the auditor owes a duty of care. the defendant has breached the appropriate standard of care (has been negligent) the plaintiff has suffered loss resulting from the defendant`s breach. In Herdley Byrne vs. Heller & Partners Case [1964] it was stated that a duty of care exists

where there is a special relationship between the parties(where the auditor knew or ought to have known) that the audited accounts would be made available to and would be relied upon by a particular person or group of persons.

In Caparo Indusries vs Dickman and others [1990] case it was held that a duty of care was not owed to potential investors or take over bidders having regard to the lack of proximity between the auditor and potential investors.

Fidelity Company was taken over by Caparo Industries. Fidelity accounts had been audited by Touche Ross.Caparo alleged that the accounts

overstated profits of Fidelity PLC and that its purchases of shares and take over bid were all made in reliance on the audited accounts.

AUDIT PLANNING The auditor should plan the audit work so that the audit will be performed in an effective

manner. Planning means developing a general strategy and a detailed approach for the expected

nature, timing and extent of the audit (problem).

Purposes of planning1 .Planning helps to ensure that appropriate attention is devoted to important areas of the Audit.2. Potential problems are identified and the work is completed expeditiously.3. Planning assists in proper assignment to audit assistants.4. Planning co-ordinates work done by the auditor and other experts.5. It helps the auditor to put more attention in important areas

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Extent of planningThe extent of planning varies according to:1. The size of the entity.2. The complexity of the audit3. The auditor`s experience with the client entity.4. Knowledge of the business

Preliminary arrangements When planning the auditor may discuss audit procedures and the overall audit plan with

management, audit committee and the client`s staff in order to improve the efficiency and effectiveness of the audit.

The overall audit plan Matters to be considered in developing the overall audit plan include:

1. Knowledge of the business General economic factors and industry conditions affecting the entity`s business. Characteristics of the entity, management structure and financial performance. Management competence.

2. Understanding the accounting and internal control system Accounting policies adopted by the entity. Reliance to be placed on the tests of internal control and substantive procedures.

3. Risk and Materiality Assessment of inherent and control risks Setting of materiality levels. Possibility of misstatements Identification of complex accounting areas.

4. Nature, timing and extent of procedures Possible change of emphasis on specific audits Reliance on internal audit.

5. Co-ordination, Direction and Supervision Involvement of experts Staffing and quality control Use of another auditor

6. Other matters The possibility that going concern assumption may be subject to question Conditions requiring attention such as the existence of related parties The terms of engagement and other statutory responsibilities The nature, timing of reports or other communication where the entity is expected to

use under the engagement.

The audit can be divided into 4 specific phasesPhase 1- plan and design audit approachPhase 2- perform tests of controls and substantive tests of transactionsPhase 3- perform analytical procedures and tests of details of balances

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Phase 4- complete the audit and issue an audit report

Elements of quality control1. Independence2. Consultation3. Hiring4. Inspection5. Advancement6. Supervision7. Acceptance and continuance of cliency

1. Independence All persons must maintain independence as required by the rules and regulations in auditing

2. Consult Auditors should look for assistance to the extent to which it is required

3. Hiring This should be to provide the firm with reasonable assurance that employees possess the appropriate characteristics to enable them to perform competently

4. Inspection Internal inspection activities should be established to provide the firm with reasonable assurance that the procedures relating to other elements of quality control are being effectively applied

5. Advancement Advancement and promotion policies should provide the firm with reasonable assurance that persons selected for advancement will have the qualifications necessary to fulfil the responsibility they will be called to assume

6. Supervision The conduct and supervision of work at all org levels should provide the firm with a reasonable assurance that the work performed meets the firm’s standards of quality

7. Acceptance and continuance of client Decisions of whether to accept or continue with a client should be guided to minimize the likelihood of association with the client who lacks integrity

Audit Programme The auditor should develop and document an audit programme setting out the nature,

timing and extent of planned audit procedures required to implement the audit plan. During the course of the audit, the audit plan and audit programme should be revised

where necessary.

Example: Audit programme – Credit Sales1. - Select the names of some new customers from the sales ledger. Trace to the relevant application forms completed by the customer. Note that established credit limits are in line with the company`s criteria.

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2. - Agree invoice details to the corresponding customer orders and delivery notes for selected sales transactions.

3. -Check delivery notes for: Signature of the foreman who agreed items to be delivered with that of the order forms

and the delivery notes. Signature of the gate keeper who checked the number of parcels leaving the premises with

the delivery note. Signature of the customer accepting delivery of the goods.

4 - Check entries in the sales journal with the copies of the invoices paying particular attention to the dates, names of customers, the amounts and the nature of the sales.

5 - Check additions of the sales journal including cross additions in analysis columns

6 – Check the postings of selected invoices to customer`s accounts in the sales journal.

KNOWLEDGE OF THE BUSINESS In performing an audit of financial statements, the auditor should have or obtain

knowledge of the business sufficient to identify and understand the events, transactions and practices that in the auditor’s judgement may have a significant effect on the financial statements or the audit report.

Obtaining the knowledge (sources of information)The auditor can obtain knowledge of the industry and the entity from a number of sources that include: Previous experience with the entity. Discuss with people within the entity (directors, managers, employees). Discuss with the internal audit staff and review of internal audit reports. Discussion with other auditors and advisors of the client. Publications related to the client’s industry (govt statistics, surveys trade journals,

financial newspapers. Visit the client’s premises. Documents produced by the entity (financial statistics, minutes of board meetings,

budgets, accounting manuals). Ask the competitors

Using the knowledgeKnowledge of the business assists the auditor in the following ways: Assessing risks and identifying potential problems. Planning and performing the audit efficiently and effectively. Evaluating and assessing audit evidence including assessing conflicting information. Identifying areas where specific audit skills and or consideration may be required. Identifying related parties and related party transactions Recognising unusual transactions.

AUDIT WORKING PAPERS Documentation means the working papers prepared by or for or obtained or retained

by an auditor in connection with the performance of the audit.

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ISA 230 Documentation states that the auditor “should document matters which are important in providing evidence to support the audit opinion and evidence that the audit was carried out in accordance with International Standards on Auditing.

Working papers should be “sufficiently complete and detailed to provide an overall understanding of the audit”.

Working papers maybe be in the form of data stored on paper, electronic media, film and etc

Working papers should record:(a) Planning information

(b)The work done and when it was done (c)Results and conclusions.

The extent of working papers is a matter of professional judgement and it is neither necessary nor practical to record every matter.

Auditors are required to record all matters which are important in supporting the report and in particular on all significant matters that require the exercise of judgement. They are also there to support ISA.

Working papers should not be made available to third parties without the client’s consent and extracts from the working papers can be made available to the client entirely at the discretion of the auditor.

Appropriate procedures should be undertaken to maintain the confidentiality and safe custody of working papers and for their retention for a sufficient period to meet regulatory requirements –about six (6) years.

The auditor should record in the working papers info on planning the audit work, nature timing and extent of the audit procedures, the results therefore and the conclusion drawn from the evidence obtained.

Contents of working papers(a) Information likely to be of continuing importance on recurring audits such as the Organisation’s constitutional documents and other information concerning the legal and Organisation structure of the entity.(b) Audit planning information and time budgets.(c) Details of the internal control and accounting systems of the business including the Auditor’s evaluation and assessment of risk.(d) Details of audit work carried out, including notes of errors, action taken and conclusions drawn, including work carried out by other auditors.(e) Supporting schedules to financial statements.(f) Audit conclusions including significant and unusual matters.(g) Copies of approved financial statements and auditor’s reports, letters of representation, engagement letters, and letters of weakness.

Audit working papers are usually filed in two separate files:(a) Permanent files (b) Current file

THE PERMANENT AUDIT FILE The purposes of the permanent audit file are:

(a) To document information which is of recurring value regarding items appearing in the financial statements.(b) To document information of a permanent nature regarding the client’s business.

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(c)To give audit staff new to the audit, information regarding the client’s affairs and the nature of the audit.

Typical Permanent Audit File Contents(i) Copies of the company’s initial founding documents.(ii) Nature and history of the business.(iii) Registered office, management structure, products, industry, personnel.(iv) Details of the accounting system, accounting manuals, and statistical information.(v) Leases, title deeds, royalty agreements, stock exchange undertakings.(vi) Group structure.(vii) Other professional advisors that is lawyers, bankers, stock brokers, insurers.(viii) Letter of engagement and time budgets.(ix) Copies of management letters.(x) Control over branch and site visits.(xi) Minutes of important body

THE CURRENT AUDIT FILEThe purposes of the current audit (working) file are:

(a) To provide a record of the work planned.(b) To detail the work carried out.(c) To ensure the reporting partner reviewing the audit to satisfy himself that an

adequate examination for audit purposes have been made for the client’s affairs.

Contents of the Current File(a) A copy of the signed financial statements.(b) check list concerning compliancy to statutory (c) Copies of all reports issued to the client.(d) Letters of weakness.(e) Letters of representation.(f) Planning programme.(g) Budget and fee estimates.(h) Audit programmes.(i) Schedules showing the result of audit test carried out on transactions and balances(j) Third party confirmations and certificates.(k) Client’s trial balance.(l) Tests of control and substantive procedures carried out.(m)Extracts from members’ meetings.

Ownership and custodian of working papersThe auditor should adopt appropriate procedures for maintaining the confidentiality and safe custody of working papers and for retaining them for a period sufficient to meet the needs of the practise and in accordance of legal and professional requirement of record retention.

NB- the audit working papers are his own papers as he created them in his own independent capacity and for his own use.

INTERNAL CONTROL AND RISK ASSESSMENT One of the first tasks in an audit engagement is obtaining an understanding of the

accounting and internal control system.

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The internal control system consists of the control environment and control procedures.

The understanding must be sufficient to enable the auditor to design procedures for obtaining evidence applicable to the separate assertions.

The understanding of the accounting and internal control system should enable the auditor to make a preliminary assessment as to the probable effectiveness of internal controls.

All companies should maintain internal controls that will provide reasonable assurance that fraudulent financial reporting will be prevented or subject to early detection.

Internal control is a process, effected by an entity’s board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives.

NB- objectives of internal control(a) Reliability of financial reporting.(b) Compliance with applicable laws and regulations.(c) Effectiveness and efficiency of operations. Before commencing an audit on an entity’s financial statements, the auditor must have

a thorough understanding of the entity’s accounting system.

These are systems of control, finance and otherwise established by management in order to carry on buzz of the enterprise in an orderly and efficient manner, ensure adherence to management policies, safeguard of assets and secure as far as possible the accuracy and completeness of records.

Types of internal control1. Security checks2. Segregation of duties3. Authorisation and approval4. Security levels5. The code of conduct6. Rotation of duties7. Adequate supervision8. Management or organisational structure9. Accounting controls10. Management reviews11. Physical control of assets12. Personnel13. Internal auditor

NB-Everyone is responsible for the internal control.

Control ProceduresControl procedures are those policies and procedures in addition to the control environment that management has established to ensure as far as possible, that specific entity objectives will be achieved.(a) Information Processing Controls

Proper authorisation procedures to ensure that transactions are authorised by personnel acting within the scope of their authority.

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Authorisations may be general or specific. General controls relate to general transactions and specific authorisations apply to

non-routine transactions or routine transactions that exceed a certain limit. Authorisation controls are also important in limiting access to assets, documents and

records.(b) Segregation of Duties

Segregation of duties ensures that individuals do not perform incompatible duties. Duties are considered incompatible from a control stand point when it is possible for

an individual to commit an error or irregularity and then be in a position to conceal it in the normal course of his or her duties.

Responsibility for executing a transaction, recording the transaction and maintaining custody of the assets resulting from the transaction should be assigned to different individuals or departments.

(c ) Physical Controls Physical controls limit access to assets and important records. Direct controls include initiating measures for the safe keeping of assets, documents

and records. Indirect controls apply to the preparation or processing of documents such as sales

orders. When computers are used, passwords can be used to control access.

CONTROL ENVIRONMENT The control environment means the overall attitude, awareness and actions of

management regarding internal control and its importance in the entity. Numerous factors comprise the control environment. Amongst these are: Integrity and ethical values. Commitment to competence. Management’s philosophy and operating style. Organisational structure. Assignment of authority and responsibility. Internal Audit. Use of information technology. Human resource policies and practices. Board of directors and audit committee.

Weaknesses of internal controls1. They can be amended without notice by management2. Subject to manipulation3. Can easily be overwritten4. Control breakdowns5. Bureaucracy-delayed decision making

Limitations of Internal Controls Internal controls can provide reasonable assurance to management and the board of

directors regarding the achievement of an entity’s objectives.Reasons for limitations(a) Management Override

Management can overrule prescribed policies or procedures for illegitimate purposes such as personal gain.

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Override practices include making deliberate misrepresentations to auditors and others such as by issuing false documents to support the recording of fictitious sales transactions.

(b) Mistake in judgement Management may exercise poor judgement in making business decisions or in

performing routine duties because of inadequate information or time constraints.(c) Collusion

Individuals acting together such as employees or management may be able to perpetrate and conceal an irregularity so as to prevent its detection by the internal control system.

(d) Breakdowns Breakdowns in established controls may occur because personnel misunderstand

instructions or make errors due to carelessness or distractions. Changes in personnel or in systems or procedures may also contribute to breakdowns.

EXAMPLEYour firm is the auditor of Lintorn textiles. You have been asked to suggest the audit work which should be carried out on the sales system. Lintorn textiles sales textile clothing to shops. Most of the sales are made on credit but some customers who do not have accounts can collect their purchases and pay in cash. The procedures of the cash sales are as follows:

1. The customer order the item from the sales department which raises a pre-numbered multi-copied advice note

2. The dispatch department makes up the order and gives it to the customer with a copy advise note

3. The customer gives the advice note to the cashier who prepares a sales invoice4. The customer pays the cashier by cheque or cash5. The cashier records and banks the cash

Required:Suggest ways in which the internal control systems can be improved [30]

UNDERSTANDING AND DOCUMENTING THE INTERNAL CONTROL SYSTEM The auditor should understand and document the internal control system. Relevant documents and records of the entity should be inspected including

organisation charts, policy manual, and charts of accounts, journals and source documents.

To reinforce the understanding of internal control system the auditor should perform walk through tests (start of the process to the end).

The documentation is done through current working audit file A few transactions within each major class of transactions is traced through the

transaction trail and the related control policies and procedures are identified and observed.

Documentation in the working papers may take the form of completed questionnaires, flow charts and narrative memoranda.

Questionnaires An internal control questionnaire consists of a series of questions about accounting

and control policies and procedures which the auditor considers necessary to prevent material misstatements in the financial statements.

The questions are usually phrased so that either a “Yes” or “No” or N/A answer results, with a “Yes” answer indicating a favourable condition.

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Example: Internal Control Questionnaires

Client: Genesis Investment Bank Balance Sheet Date: 31 December 2005

Completed By:HPG Reviewed By: FKDDate: 16 January 2006 Date: 21 January 2006

Internal Control Questionnaire Component: Control Environment

Question Yes, No, N/A CommentIntegrity and ethical values:

1. Does management set the “tone Yes Management is conscious at the top” by demonstrating a of setting an example. commitment to integrity and ethics Entity does not have a through both its words and actions? formal code of conduct.2. Have appropriate entity policies Yes Expectations of employees regarding acceptable business practices, included in a policy conflicts of interest and conduct been manual distributed to all established and adequately communicated? employees.

3. Have incentives and temptations that Yes Profit sharing plan might lead to unethical behaviour been monitored by audit reduced or eliminated? committee.

Board of directors and audit committee:

1. Are there regular meetings of the board Yes Board has nine board and are minutes of the board prepared on members three of whom a timely basis? serve on the audit

committee.2. Do board members have sufficient Yes knowledge, experience and time to serve efficiently. 3. Is there any audit committee composed of Yes experienced non executive directors?Management’s philosophy and operatingstyle1. Are business risks carefully considered and Yes Management is adequately monitored? conservative about

business risk.

2. Is management’s selection of accounting Yes principles and development of accounting estimates consistent with objective and fair reporting?

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3. Has management demonstrated a willingness Yes to adjust the financial statements for material misstatements?

Human resources policies and practices

1. Does existing personnel policies and procedures Yes Formal job descriptions result in the recruitment or development of are provided for all competent and trustworthy employees needed to positions. Normal labour support an effective internal control structure? “ turnover”.

2. Does personnel understand the duties and Yes procedures applicable to their jobs?

3. Is the turnover of personnel in key positions Yes at an acceptable level?

Example: Internal Control Questionnaire - Control Procedures

CLIENT: Independence Gold Mining BALANCE SHEET DATE 30 April 2006

Completed By: STM Reviewed By DMSDate: 18 February 2006 Date : 26 February 2006

Internal Control Questionnaire Component: Cash Payments

Question Yes, No, N/A Comment

Cash Payment Transactions:

1. Is there an approved payment voucher Yes with supporting documents for each cheque prepared?

2. Are pre-numbered cheques used and Yes accounted for?

3. Are unused cheques stored in a secure place? Yes Safe in accountant’soffice.

4. Are only authorised personnel permitted to Yes Only treasurer and sign cheques? Finance Manager can sign.

5. Do cheque signers verify agreement details Yes of cheque and payment vouchers before signing?

6. Are vouchers and supporting documents Yes Vouchers and all 21

cancelled after payment? supporting documents arestamped “paid”.

7. Is there segregation of duties for:

(a) Approving payments and signing cheques? Yes (b) Signing and recording cheques? Yes

8. Are there periodic independent reconciliations Yes Performed by of cheque accounts? assistant controller.

9. Is there an independent check of agreement of No Comparison now made daily summary of cheques issued with entry by assistant treasurer, will to cash payments? recommend it to be done

by assistant controller.

AUDIT RISK

Audit risk is the risk that the auditor will get the audit opinion wrong on the financial statements.

Audit risk has 3 components1. Inherent risk2. Detection risk3. Control risk

In practice, this nearly always means that the auditor will fail to qualify an audit report that he should have qualified.

In order for this situation to arise, there needs to be a material error in the accounting records or the financial statements which was not corrected before the financial statements were published and which the auditor did not refer to in the audit report.

Audit risk model

Audit risk is the product of inherent risk, control risk and detection risk.

1. Inherent risk Inherent risk is the susceptibility of an assertion to error which individually or when

aggregated with other errors could material to the financial statements before considering the effect, if any, of related internal controls e.g.:

integrity of management competence and commitment of staff time pressure as a result of unrealistic deadlines being set for reporting dates.

It is risk that is derived from the characteristics of the entity to be audited or the circumstances of the audit. The audit cannot prevent or control it e.g.

1. A company operating in a high technology industry is regarded as a risky organisation for the audit because of the need for specialization.

2. A new client is considered as high risk22

3. The business management style4. Tight reporting deadlines for the auditor5. Complex structures in transactions6. A cash based business7. Frequent changes in auditors8. Frequent changes in management

Inherent risk is assessed as high if the integrity of management is questionable or the competence of staff is questionable.

2. Control risk Control risk is the risk that an error which could occur and which individually or when

aggregated with others could be material to the financial statements will be prevented or detected on a timely basis with the internal controls.

This is the risk that material misstatement could occur and not be prevented or detected on timely basis by the internal control systems.

It is affected by the following factors History of errors found by the auditor. Management attitude and dominance Incompetent or inexperienced staff Lack of segregation of duties Size of the entity and its accounting systems

Control risks arises because the accounting systems lacks in built internal controls to prevent inaccurate, incomplete and invalid transaction recording or due to the intrinsic limitations of internal controls such as collusion among employees or management overriding controls.

The auditor’s assessment of control risk involves two phases namely:

A preliminary assessment of control risk once the auditor has enquired into the accounting system and has identified controls on which it might be effective and efficient to rely in conducting the audit.

A final assessment of control risk after the performance of compliance test aimed at determining whether or not controls to be relied upon by the auditor were performed adequately as they were designed and they were applied throughout the whole period of intended reliance.

The auditor would assess control risk as high if internal controls are insufficient to prevent or timely detect errors.

Detection risk Detection risk is the risk that the auditor’s substantive procedures will fail to detect

material misstatements which, individually or when aggregated with others could be material to the financial statements due to the following:

1. Time pressures because of unrealistic budgets2. Lack of competence and application.

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3. Failure to consult with senior staff when in doubt.4. Lack of commitment.

The level of detection risk the auditor can accept is influenced by the assessment of inherent and control risks together.

The lower the auditor’s combined assessment of inherent and control risk, the higher the detection risk and vice versa.

The auditor needs to assess the types of risks in an org and plan his audit in a manner that will reduce their effectThe auditor may respond by varying the nature, timing and extent of audit work.Control is for the client, detection is for the auditor and inherent is for client

Use of the model

In order to make use of the model it is important to realise that only some elements of the model are within the auditor’s control.

In particular the auditor can do little about inherent risks and control risks. The auditor can however make detection risk as low as possible.

The auditor will need to do less substantive testing if inherent risk or control risks are low. If the system of internal control is good then control risk will be low leading to less

substantive testing.

On the other hand the auditor might decide to take no comfort from inherent or control factors and to base the audit opinion purely on substantive procedures including analytical reviews.

ISA 230 - AUDIT MATERIALITY

Materiality can be described as an expression of relevant significance or importance of a matter in the context of financial statements as a whole.

The auditor should consider materiality and its relationship with audit risk when conducting an audit.

Information (a matter) is material if its omission or misstatement would reasonably influence the economic decisions of its users taken on the basis of the financial statements.

Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement.

It is the effect of information on an opinion of decision, degree of substance, degree of significance.In looking at materiality, the auditor will consider the following:

a. The size of the item in relation to the totalb. The nature of the item

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There are certain items in accounts that are capable of precise determination - any error of an item that is capable of precise determination, however small should be consider material and adjusted.

For example:An errors on the directors remuneration is always material as it is considered deliberate.

c. Likely influence of the material to the users e.g. when the internal auditor is reporting directly to the management.

Materiality should be considered when the auditor id determining the nature, timing and extent of audit procedures and when evaluating effects of misstatements.

Materiality

The objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are prepared in all material respects, in accordance with an applicable financial reporting frame work.

The assessment of what is material is a matter of professional judgement.

In designing the audit plan the auditor establishes an acceptable materiality level so as to detect qualitatively material misstatements.

However, both the amount (quantity) and nature (quality) of misstatements need to be considered for example failure to disclose the breach of regulatory requirements when it is likely that the imposition of regulatory restrictions will significantly impair operating capability.

The auditor needs to consider the possibility of misstatements of relatively small amounts that cumulatively could have a material effect on financial statements.

The auditor considers materiality at both the overall financial statement level and in relation to classes of transactions, accounting balances and disclosures.

Materiality should be considered by the auditor when determining the nature, timing and extent of audit procedures, and evaluating the effects of misstatements.

Evaluating the effects of misstatements

The auditor should assess whether the aggregate of uncorrected misstatements that had been identified during the audit is material.

The aggregate of uncorrected misstatements comprises:

Specific misstatements identified by the auditor.

The auditor’s best estimate of other misstatements which cannot be specifically identified.

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If the auditor concludes that the misstatement may be material, the auditor needs to consider reducing audit risk by extending audit procedures or requesting management to adjust the financial statements.

If management refuses to adjust the financial statements and the results of extended audit procedures do not enable the auditor to conclude that the aggregate of uncorrected misstatement is not material, the auditor should consider appropriate modification of the auditor’s report.

Relationship between materiality and audit risk.

There is an inverse relationship between materiality and the level of audit risk. The higher the materiality level the lower the audit risk and vice versa. When planning for specific audit procedures, if the auditor determines that the acceptable

materiality level is lower, audit risk is increased.

The auditor would compensate for this by:(a) Reducing the assessed risk of material misstatement by carrying out extended or additional tests of control or

(b) Reducing detection risk by modifying the nature, timing and extent of planned substantive procedures.

AUDIT EVIDENCE

Audit evidence means the information obtained by the auditor in arriving at the conclusions on which the audit opinion is based.

Sufficient appropriate audit evidence

Sufficiency is a measure of quality of audit evidence and appropriateness is the measure of quality of audit evidence.

The auditor’s judgement as to what constitutes appropriate audit evidence is influenced by factors such as: nature of the accounting and internal control systems and control risk materiality of the item being examined experience gained during previous audits Source and reliability of information available.

The aspects of accounting and internal control systems which the auditor would obtain audit evidence are:

Design - whether the accounting and internal control systems are suitably designed to prevent and or detect and correct material misstatements.

Operation- whether the systems exist and have operated effectively throughout the period.

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Nature and reliability of audit evidencea. The source, b. accuracy of info, c. authenticity of the documents being used, d. nature of the info, e. size of the sample used,f. timing of the info

The reliability of audit evidence is influenced by its source and by its nature and is dependent on the individual circumstances under which it was obtained.

Audit evidence is more reliable when it is obtained from independent sources outside the entity.

Audit evidence that is generated internally is more reliable where the related internal controls are effectives.

Audit evidence obtained directly by the auditor is more reliable than audit evidence obtained indirectly.

Documentary audit evidence is more reliable than oral audit evidence. Audit evidence obtained from original documents is more reliable than evidence provided

by facsimiles.

Procedures of obtaining audit evidence

1. Physical examination-This refers to assets2. Confirmation, matching - things to be verified

3. Inspection (physical checks)- This consist of the examination of supporting documents, records, or tangible assets for example the inspection of plant and machinery against the asset register.

4. Vouching (authentication of source credibility)5. Tracing6. Re-performance (redoing the transaction)7. Scanning (looking through)8. Enquiry (investigation in anticipation of response9. Observation (witnessing, scrutinizing)10. Analytical procedures (use of previous info for analysis)11. Verification (prove or establish if certain to satisfaction)12. Recalculation

Observation

This consists of looking at a process or procedure being performed by others for example the observation of a stock count by personnel.

Enquiry and confirmationThis consists of the response to an enquiry to corroborate information contained in the accounting records for example debtor’s circularisation.NB- response to enquiry may provide the auditor with info not previously possessed.

Physical counting27

This is the inspection of tangible assets

InspectionIt consists of examining documents and records whether internal or external in paper form, electronically and other media. Inspection provide varying degree of reliability depending on the nature or source

ConfirmationIt is the process of obtaining a representation of information and of an existing condition directly from a third party e.g. an auditor may confirm the trade receivable by directly contacting the

RecalculationConsist of verifying the mathematical accuracy of documents or records

Re-performanceThis is the auditors independent execution of procedures or controls that were og performed as part of the entity’s internal control

ComputationThis consists of checking the arithmetic accuracy of documents and accounting records or performing independent calculations for example performing a bank reconciliation.

Analytical procedures

This consists of evaluation of fin info made by a study of plausible relationships amongst fin and non-fin dataThis consists of the analysis of ratios, trends and relationships and the investigation of fluctuations that are inconsistent with other relevant info or deviate significantly from predicted amounts.They are used for risk assessment tools or procedures to obtain and understanding of the entity and its environment.Financial information is compared with prior periods, budgets and forecasts and industry averages.Relationships are considered between elements of financial and non-financial information.

ANALYTICAL PROCEDURES

The auditor should apply analytical procedures as risk assessment procedures to obtain an understanding of the entity and its environment.

Analytical procedures means evaluation of financial information made by a study of plausible relationship among both financial and non financial data.

Analytical procedures also encompass both investigation of identified fluctuations and relationships that are inconsistent with other relevant information or deviate significantly from predicted amounts.

Nature and purpose of analytical procedures28

Analytical procedures include the consideration of comparison of the entity` financial information with for example;

comparable information for prior periods. anticipated results of the entity such as budgets of forecasts. similar industry information such as a comparison f the entity’s ratio of sales to accounts

receivable with industry averages or with other entities of comparable size in the entity`s industry.

Analytical procedures also include consideration of relationships: Amongst elements of financial information that will be expected to conform to a

predictable pattern based on the entity’s experience such as gross margin percentage.

Between financial information and relevant non-financial information such as payroll costs to number of employees.

Analytical procedures are used for the following purposes:As risk assessment procedures to obtain an understanding of the entity and it’s environmentAs substantive procedures when their use can be more efficient and effective than tests of details in reducing the risk of material misstatements at the assertion level to an acceptably low level.As an overall review of the financial statements at the end of the audit.

Extent of use

Factors determining the extent of use of substantive procedures include:

The closeness of relationships between the items of data. Analytical procedures are more appropriate when relations are plausible and predictable

for example commission and sales revenue. The availability and reliability of financial data. the relevance of information available The comparability of the available information.

Extent of reliance

Factors determining the extent of reliance on substantive analytical procedures include:

The risk that analytical procedures will fail to identify a material misstatement. The less significant of an account balance or class of transactions, the more reliance

can be placed on analytical procedures. A reduction in the extent of tests of detail will be justified where significant fluctuations

and inconsistencies have been corroborated.Income and expenditure accounts tend to be more predictable than balance sheet items.

13. Non-recurring accounting entries such as asset revaluations do not lend themselves to effective analytical procedures.

14. If control risk is high more reliance on tests of details for drawing conclusions may be required.

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Investigating unusual items

When analytical procedures identify significant fluctuations or relationships that are inconsistent with other relevant information or that deviate from predicted amounts, the auditor should investigate and obtain adequate explanation and appropriate corroborative audit evidence.

The investigation of unusual fluctuations and relationships ordinarily begins with enquiries of management followed by: Comparing management’s responses with the auditor’s understanding of the entity and

other audit evidence obtained during the course of the audit. Consideration of the need to apply procedures based on the results of such enquiries if

management is not able to provide an explanation or if the explanation is not considered adequate.

AUDIT CONTROLDuring the plan of an audit, the auditor assesses the internal control system of a client in order to determine the level of examination of an accounting record as a basis of forming an opinion.

Types of testsThe basis of classification of audit tests depends on the auditor purpose in applying the tests.The basic purposes of audit tests are:

1. Tests of control

Types of tests controlsa. Tests of controls are directed towards effectiveness of the design on the policies or

procedures and whether they are placed in operationb. Tests of controls directed towards the operating effectiveness of the policies and

procedures and how they are applied, the consistency to which they are applied, by whom they are applied throughout the period under audit.

The overall purpose of tests of control is to evaluate the effectiveness of the design and operation of internal controls.

Sampling is applicable only in testing the operation of controls when there is a trail of documentary evidence of the performance of control procedures.

Each sample tested will have one of two attributes either that the control has been properly performed or not.

The outcome of testing is known as a deviation rate, representing the proportion of transaction tested which have not been processed according to laid down procedures.

2. Substantive tests

Types of substantives testsa. Analytical procedures: trend analysis, ratio analysis,

b. Tests of detail : test of transactions and tests of balances

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Substantive testing refers to details testing either to obtain evidence that an account balance is not materially misstated or to make an independent estimate of some amount for example to value stock where there are no records.

A transaction may be tested from the book of original entry to the ledger and finally to the financial statements.

In carrying out substantive tests, transactions should be traced to supporting documentation.

Audit tests are generally in 3 forms:a. Substantive testsb. Compliance testsc. Walk through tests

A. Substantive tests These are detailed procedures carried out by the auditor to tests the operating effectiveness of the accounting system. Substantive procedures are used to detect material misstatement in transactions. They are usually in two forms:

a. Tests of details of classes of transactions, which test for errors, fraud or accuracy of the records. [Capital and revenue expenditure]

b. Substantive analytical procedures which involve the comparison of recorded values with the trend. These tests include trend analysis and use of accounting ratiosNB- the auditor now concentrate on exceptional figure which fall out of trend

B. Compliance tests: observing transactions in detail These are tests made to check whether the operations of the buzz where done in

accordance with regulations stated by management. Compliance tests are done where the auditor wishes to rely on some system of internal

control. The purpose of compliance tests is to obtain reasonable assurance that internal controls functions both properly and consistent. The auditor will observe transactions as they pass through the various control procedures e.g. security checks at the gate.

The auditor uses compliance test to see whether the control procedures are being observed as recorded. Where the auditor is satisfied by level of compliance, he will limit out the carrying out of detailed tests of transactions.

C. Walk through tests This is where the auditor picks some transactions and follows them from start to end. They are performed to tests the effectiveness of controls in preventing or detecting

material misstatements. They are done when the auditor assessment of the risk includes an expectation of the

effectiveness of controls and when substantive procedures alone do not provide sufficient audit evidence.

They include enquiries, observation of specific controls and inspection of the client records.

AUDIT OF FINANCIAL POSITION ITEMS

Auditing non-current assets

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Assets constitute a significant item in the fin stats. Due to their value, it is imperative that an auditor gives them a lot of attention. The purpose of an audit is to enable an auditor to form an opinion on whether the fin stats agree with the underlying records and give a true and fair view of the operations of the business. The auditor needs to consider the following:

i. Reliability of the internal accounting system of the clientii. Materiality of the amounts involved

iii. Current professional practisesiv. Risk or absence of suspicious circumstancesv. Legal requirements relevant to the client

The auditor’s objectives of verification of assets can be summarised as follows:

1. Cost- is it fair, is it consistent with the cost of such an asset2. Authorisation-was the acquisition properly authorised, was use authorised,was

disposal authorised3. Valuation – is it properly valued in the financial statements (impairment, depreciation,

revaluation, other improvements to the asset)4. Existence – is the asset physically present, can it be easily identified,5. Beneficial –is the asset being used for the benefit of the entity, it should be for its

intended use.6. Ownership - who owns the asset, in whose name is it, the owner should benefit7. Presentation (disclosure) – is the asset properly classified in the financial statement.

PROCEDURES FOR VERIFICATION OF NON CURRENT ASSETSCost This is done for assets acquired during the year under audit. The auditor examines the

purchasing document and purchasing procedures to see if they are transparent The auditor inspects if there was objective selection of suppliers and if the quality of the

product was consistent with price. The auditor also examine s if the purchase was properly accounted for as capital expenditure and not revenue expenditure.

The auditor also (examines/verifies if the correct asset cost has been calculated for example, hire purchase cost include current and future payments

Authorisation The auditor is there to observe authority levels e.g. when purchasing certain items of a

higher costs, a certain number of signatures of people in certain higher levels in the organisation are used as authorisation.

The auditor examines how acquisition, use and disposal was authorised

Valuation The auditor must satisfy himself that the asset is disclosed in the fair value in the fin stats.

Fair value may be different from original cost but the auditor must satisfy himself that value disclosed is justified

The auditor must also satisfy himself that any other considerations affecting asset value must be taken onto account e.g. impairment, obsolescence, improvements, location, market value, consistent application of adopted principles

Existence The auditor should rely upon physical identification of the asset.

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Physical identification will help to determine the state of the asset, location and any other improvements

Beneficiary and ownership The auditor has to ensure that the assets are owned by the organisation and are being used

for the legitimate purpose of the business or entity They should be reference to:

1. Title deeds in terms of building2. Registration book in terms of motor vehicles3. Serial number of other assets

If the use of the asset gives rise to benefit or expense, the vouching of the benefits or expense will provide sufficient evidence of both ownership, beneficiary and existence. An asset should have verifiable income regularly remitted and identifiable expenses for the general upkeep

Ownership and benefit from asset should be attached to the benefit enjoyed as well as expenses incurred in the use of the asset

Presentation The auditor needs to verify the disclosure of the assets in the financial statements to

ensure that the disclosure is in accordance IAS. Presentation should show a fair view and should be consistent from year to year

TANGIBLE ASSETS

A tangible asset is an asset intended for continuing use within a business.

Audit Objectives

The majority of the testing being undertaken will be for overstatement. There is a concern that the value of the assets incorporated within the balance sheet

will be overstated. The specific objectives that should be addressed when auditing fixed assets are:

(a) To ensure that the assets exist at the balance sheet date.(b) To ensure that the assets are owned by the client.(c) To ensure that assets are completely and accurately recorded at cost.(d) To ensure that all re-valued assets are supported by proper valuations and that

the basis is acceptable.(e) To ensure that disposals are accounted for correctly.(f) To ensure that depreciation is correctly calculated and that the rates applied are

adequate to write the cost of the assets less estimated residual value.(g) To ensure that there is adequate consideration for impairment.

Audit Procedures

The auditor should determine the most appropriate procedures for the particular circumstances of the particular client.

The auditor should select a sample of fixed assets from the fixed asset register or any record of assets maintained including additions during the year.

Property

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The auditor should inspect title deeds to ensure that the client’s name is shown on deeds.

The description of land should be the same as shown on the balance sheet. Where property is mortgaged the auditor should verify the deeds with the lender. The auditor should write to the lender asking for specific details of the mortgaged

property and confirm that the client is the registered owner of the property. The auditor should ensure that finance leases are capitalised and shown as assets in the

balance sheets. The auditor should review loan agreements to determine if any assets have been

pledged as security. If costs brought forward from earlier years have been audited, the auditor should

concentrate on purchases during the current year. The auditor should ensure that additions are audited only if they are material.

The following procedures should be followed:(a) Obtain invoices for purchases of assets.(b) Agree details to the fixed asset register.(c) Ensure that the property was delivered during the period.(d) Consider whether any item should be re-classified as repairs or maintenance and

so be eligible for full tax relief.(e) Consider whether VAT has been capitalised.(f) The auditor should review board minutes to confirm that the purchases for capital

expenditure purposes were authorised.

The auditor should ensure that the client has claimed capital allowances on capital expenditure.

The purchase invoices should be traced to entries in the ledger accounts. The existence of the tangible non-current assets should be verified by the auditor. The auditor should examine a sample of assets to test the existence of such assets. Where physical verification is not possible because an asset is not available or is

inaccessible, the auditor should confirm with third parties for example insurers.

Revaluation

Where assets have been re-valued the auditor should consider whether the revaluation has been performed by a third party.

The auditor should consider :

(i) whether the valuer is professionally qualified and independent of the client. (ii) whether any assets were excluded. (iii) whether the basis of the valuation comply with IAS 16 Property , Plant and

Equipment that is at the current cost or at market value at the balance sheet date. (iv) whether the useful economic life of the asset should be revised. (v) whether the disclosures are adequate. (vi) whether the valuers were given all relevant facts. (vii) whether the valuation is reasonable compared to the auditor’s knowledge of the

client.

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Where a revaluation has occurred the auditor should ensure that any revaluation surplus or deficit is correctly treated.

The increase or decrease should be reflected in the revaluation reserve. If this results in a reserve with a deficit then the balance should be written off or

charged to the profit and loss account. The auditor should consider whether any events have occurred after the date of

valuation that are likely to affect the value and whether any adjustment is required. The auditor should ensure that historical cost information is kept to allow disclosure of

the historical cost equivalent of re-valued assets.

Depreciation

The auditor should assess the reasonableness of depreciation charges for categories of fixed assets when compared to the accounting policy and previous audit experience with the client.

Ensure or consider whether depreciation policy has been consistently applied.

Procedures

Calculate the depreciation charge for fixed assets. Verify calculations with the client’s own calculations. Review accounting policies and consider whether the policies have been adopted

consistently. Consider whether depreciation rates are consistent across similar clients in the same

industry. Review gains or losses on disposal. This could indicate the use of inappropriate rates of depreciation. The auditor should consider whether there are a number of fully depreciated assets

which are still in use, which could suggest that assets have been written off too quickly.

Land has an unlimited life so should not be depreciated.

Analytical Procedures

Calculate depreciation as a percentage of fixed assets. Compare fixed assets net book value to fixed assets at original cost.

INVESTMENTS

Long term investments should be included in the balance sheet at cost, less any impairment, or at market value.

Valuation can be either market value or the directors’ own valuation. Short-term investments should be valued at the lower of cost or net realisable value

and should be classified as current assets.

Audit Objectives

The primary tests will be in respect of overstatement. The objectives are as follows:

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(a) To ensure that investments exist at the balance sheet date and are owned by the client.

(b) To ensure that investments are properly stated at cost or revaluation.(c) To ensure that any profits or losses on disposal are correctly accounted for.(d) To ensure that that investment income is accounted for in full.(e) To ensure that investments are correctly classified as either long term or current

assets and that the treatment is consistent.(f) To ensure that there is adequate provision for any permanent loss in value.

Audit Procedures

The auditor should inspect documents of title where these are held by the client or obtain confirmation from third parties that they are holding such documents on the client’s behalf.

Details of the investments should agree to the client’s records and it should be clearly shown that the client is the beneficial owner.

All rights issues or conversions should be correctly accounted fro and reflected in share certificates.

The auditor should obtain details of any investments that have been pledged as security via discussions with management, reviewing bank letters or similar documents.

Examine details for dividends and interest income received. The auditor should ensure that any holdings are properly classified as subsidiaries or

as associates where appropriate. If the client is a parent undertaking the auditor should ensure that consolidated

financial statements are prepared. The auditor should review contract notes and purchase agreements.

All purchase transactions should be authorised. Where investments are carried at market value the auditor should agree details of

listed investments to the Stock Exchange. The auditor should also consider the possibility of post balance sheet valuation. For unlisted investments the auditor should review the methods of valuation adopted

by the directors to value the investments and consider whether they are reasonable. The auditor should also review the available accounts and any reports used by the

directors in reaching their valuation.

The auditor should agree details of any disposals to the contract note or other relevant documentary evidence.

All disposals should be properly authorised. The auditor should test for the updating of the nominal ledger after the disposal of

investments. The nominal ledger should be credited after the sale of an investment. If there are any doubts regarding the independence of the broker the auditor should

consider if the selling price for unlisted investments is reasonable. The auditor should ensure that all related income has been properly recorded. This can be achieved by comparing expected income on fixed rate investments with

actual income reported.

Analytical Reviews36

Compare investments held during the current period with investments held during the previous financial year.

Compare expected income with actual income from investments.

AUDITING CASH AND BANK BALANCES

Cash and bank balances are the most liquid assets and are therefore subject to a high risk of misappropriation.

The auditor should ensure that the audit procedures minimise the risk of this occurring undetected.

Audit Objectives

The objectives are :(a) to establish that all bank balances and overdrafts are owned, exist and have

been included at the correct amount.(b) to ensure that only genuine items are included in the reconciliation.(c) to ensure that cash sales are not overstated.(d) to ensure that no window dressing has taken place.

Procedures

The auditor should obtain a bank letter from all banks at which accounts were open at any time during the year.

This procedure should be followed even if the client has changed their bank during the year and closed old accounts.

Bank letters should be checked against other audit evidence, to ensure that they are consistent.

Where there is any inconsistency, either in respect of a balance or in respect of other information, the bank should be approached again to confirm the information contained in the bank letter.

Letters should be sent to the banks at least two weeks in advance of the date of confirmation.

The auditor should obtain and prepare bank reconciliations from all accounts and complete the following audit tests:

The bank balances should be checked to the bank statement and bank letter. The cash book balance should be checked to the nominal ledger. Uncleared items should be checked to after date bank statements noting the dates

items cleared. Any item that have taken longer to clear should be followed up. The auditor should obtain explanations and substantiate all adjustments on the bank reconciliation. Cut off testing should be undertaken by reviewing the paying-in book and Cheque stubs to ensure that receipts and payments have been recorded in the correct period.

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Where the client receives cash income the auditor should ensure that un banked takings before and after the year end have been accounted for in the correct period.

All cash should be promptly banked.

Cash count

Where the client has material cash balances the auditor should carry out a cash count. The following procedures should be undertaken: Cash should be counted in the presence of a member of the client’s staff who is responsible for cash and all cash balances should be counted at the same time. The member of staff should be asked to sign to confirm the amount counted. The cash balance should be agreed to the nominal ledger. Explanations should be obtained for any material differences. Cash count should be undertaken at the year end at the same time when a stock take is

undertaken.

Internal Control

The duties of the person writing up the Cash Book should be separated from the person responsible for making payments or handling receipts and checking bank reconciliations.

Opening of a new bank account should only be possible with the authorisation of the board of directors.

There should be adequate security over blank cheques and under no circumstances should signed cheques be kept.

Cash book balances should be regularly reconciled to the nominal ledger. Cheques should be dispatched immediately after signature and not returned to the

person who prepared them. A senior member of staff should independently check bank reconciliations. Cash counts should be undertaken on a regular basis. Petty cash vouchers should be authorised.

Procedures to test for window dressing

The auditor should review material receipts and payments in the final month of the year and for a reasonable period after the year end to assess whether they appear unusual.

Investigate delays in banking receipts. The auditor should investigate delays in the presentation of cheques and this may

indicate that cheques are being held back.

Common methods of window dressing

Including cash received after the balance sheet date. Using bank borrowing facilities immediately before year end to place cash on deposit

thereby improving liquidity or transferring cash to other group companies. Sending cheques to creditors before the balance sheet date but not entering them in the

cash book until the following month.

Risks38

15. Cash and bank are financial assets and there is a primary risk of financial loss because of:

Fraudulent activity or misappropriation of funds, particularly where large amounts of cash are involved or where there are developed authorities for activities surrounding cash and banking.

Inappropriate or inadequate banking arrangements for the area under review resulting in financial loss.

Inappropriate or inadequate banking arrangements for the area under review resulting in loss or overdraft.

Excessive banking charges resulting in financial loss.

Bank reconciliations

16. Bank reconciliations should be prepared at least monthly.17. The person responsible for preparation should be independent of the receipts and

payments function or alternatively an independent person should check the reconciliation.

18. If the reconciliation is prepared by an independent person he should obtain bank statements directly from the bank and hold them until the reconciliation is completed.

19. The preparation should preferably include a check of at least a sample of receipts and payments against items on the bank statement.

Verification

20. There are two stages of verification: Confirmation from the bank. Examination of the bank reconciliation. The reconciliation should establish that: Differences between the bank and the client’s records can be specifically identified. The differences are differences of timing. No very old differences are outstanding. All major differences are cleared in the post balance sheet period.

AUDITING SALARIES AND WAGES

Wages and salaries expenditure is often substantial and material to the financial statements.

Wages and salaries is a debit balance and therefore the auditor should ensure that the expense item is not overstated.

Objectives

(a) To ensure that wages costs are not overstated in the financial statements.(b) To ensure that all paid employees exist and work for the client company.

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(c) To ensure that payroll costs are accurately stated.(d) To ensure that regulations relating to PAYE and National Insurance have been

complied with.

Risks associated with the payroll

(a) Fraudulent employees on the payroll.(b) Delay in payment of wages resulting in de-motivation of employees.(c) Incorrect calculation resulting in under or overstatement of profits and loss of cash.(d) Employees may manipulate the payroll if they gain access to the computer system.(e) Delays in preparing PAYE resulting in huge fines from the tax authorities.(f) Unauthorised changes to the rates of pay resulting in overpayments to employees.

Internal Controls

The payroll should be independently approved for accuracy. Each employee should have a personal file kept by an independent department. The personnel department should maintain a written record of notification of changes

in rates of pay. Calculations for salaries and wages should be independently checked especially for

staff working within the payroll department. Unclaimed wages should be immediately re- banked. Overtime should be authorised by departmental managers or other senior employees. Employees should sign for their wages on collection. Each employee should collect his or he own wages.

Audit Procedures

The auditor should select a sample for testing from the payroll. Where the number of employees is small the auditor should test all transactions in a

particular month or week. Prepare a summary of wages and salaries giving details of the wages and salaries and

the number of employees month or week by week. Trace the totals from the payroll to the nominal ledger. Trace the net to the cash book. Trace a sample of payments made and agree the details back to the personnel records.

For starters the auditor should ensure that wages have only been paid from the actual starting date.

For leavers the auditor should ensure that wages were paid up to the date of leaving. The auditor should enquire on any unclaimed wages and verify their reasonableness. Re-perform the wages calculations for a sample of employees including starters and

leavers. Ensure that proper authorisation has been obtained for any deductions other than

PAYE, Pension and National Insurance. Where applicable the auditor should check hours to time records. The auditor should ensure that all overtime has been authorised. Examine directors’ emoluments paid and payable including benefits in kind to ensure

that they have been accounted for correctly and full payment has been made for any liability in respect of PAYE.

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The auditor should check the system to ensure that all relevant forms have been completed and submitted to tax authorities.

Ensure PAYE has been applied to all employees including payment to casual employees, part time employees and commission.

Analytical Procedures

Complete weekly or monthly analysis of wages and salaries. The list should also include details of gross wages, deductions, net wages and national

insurance. Ascertain the average number of employees and calculate average wages. Compare annual wage bill with budget. Analyse wages according to departments.

AUDITING PURCHASES AND EXPENDITURE

Expenditure

21. The audit objectives when auditing expenditure are to ensure that expenditure is correctly

classified, authorised and accurately disclosed.

Procedures

22. The auditor should select samples for testing from the nominal ledger.23. The details of the samples should then be traced to supporting documentation

checking the following: that the payment of the invoice is properly authorised. that the invoice is correctly classified. that the totals on the invoice are correct. that the details on the invoice have been agreed to the goods received notes and orders. that the invoice has been paid. that the paid cheque is made out to the company specified on the invoice, and is signed by

an authorised signatory.

Controls

24. The following controls are expected to exist in an expenditure system: Purchase invoices should be pre numbered. Purchase invoices should be matched with pre numbered goods received notes and authorised orders. Invoices should be marked when they are paid to prevent them from being entered into the system again. Cheques should be sent to the supplier by personnel independent of preparing the payment. All invoices should be authorised before payment. For cash expenditure the auditor should select a sample of cash purchases from the

nominal ledger and the cash book. Details of the payments should be traced to supporting documentation.

Purchases41

25. The objectives are to ensure that: Purchased goods or services are ordered under proper authorities and procedures. Purchased goods or services are only ordered as necessary for the proper conduct of the

business operations and are ordered from suitable suppliers. Goods received are effectively inspected for quality, quantity and condition. Invoices and related documentation are properly checked and approved. All valid transactions relating to purchases are accurately recorded in the accounting

records.

Risks associated with purchases

26. Fraudulent purchases resulting in financial loss.27. Inappropriate or expensive goods being purchased resulting in missed budgets.28. Failure to purchase goods at the right time and therefore failure to meet customer

orders.29. Poor quality goods received and despatched resulting in claims against the company

and damage to reputation.

30. Failure to meet regulatory requirements for goods purchased.

Internal controls over purchases

Orders

31. Requisition notes for purchases should be authorised.32. All orders should be authorised by a responsible official.33. Major items for capital expenditure must be authorised by the board of directors.34. All orders should be recorded on official documents showing the supplier’s name,

quantities ordered and price.

35. Copies of orders should be retained.36. Re-order levels and quantities should be pre-set and preferably recorded in advance.

Receipt of goods

37. All goods received should be checked for quality and quantity.38. Goods received notes should be raised for all goods accepted.39. The Goods received notes should be signed by a responsible official.40. Goods received notes should be checked against purchase orders and procedures

should exist to notify the supplier of over or under deliveries.41. Goods received notes should be sequentially numbered and checked for completeness.

Invoicing and Returns

42. Purchase invoices received should be stamped.43. Purchase invoices should be matched with goods received notes and should not be

processed before this is done.44. The invoice should be checked against the order and the Goods Received Note.

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45. The invoices should be signed as approved for payment by a responsible official independent of the ordering and receipt of goods.

46. A record of goods returned should be kept and checked to the credit notes received from

suppliers.47. Details of credit notes should be agreed to the supplier’s invoices.48. All returns should be posted to the purchases returns ledger.

Tests of control

49. Tests of control should be drawn up so as to check that control procedures are being applied.

50. The auditor should list the documents in a transaction cycle and generate appropriate tests

of control for each document:

1. Purchase order

51. Select a sample of purchase orders and test for: Evidence of sequence. Evidence of approval. Adherence to authority limits.

2. Purchase Invoice

52. Select a sample of purchase invoices and check for: Evidence of sequence. Evidence of matching of purchase invoices with goods received notes and purchase orders. Approval of purchase invoices for processing. Stamping of processed invoices.

Substantive procedures

53. Check additions on purchase invoices.54. Trace all orders to invoices55. Scrutinise the records for large and unusual transactions and trace these items for

posting to the ledger.

56. Check calculations and additions on credit notes.57. Trace purchases to inventory records.

AUDITING CREDITORS AND ACCRUALS

58. Purchases can be made on credit and thus the purchases cycle includes control objectives for

payables.

Internal control over trade payables43

59. Internal controls over payables are designed to ensure that: Purchased goods or services are ordered under proper authorities and procedures. Purchased goods or services are only ordered as necessary for the proper conduct of the

business operations and are ordered from reputable suppliers. Goods or services received are effectively inspected for quality, quantity and condition. Invoices and related documentation are properly checked and approved as being valid

before entered as trade payables. All valid transactions relating to trade payables should be accurately recorded in the

accounting records.

Audit objectives

(a) To ensure that creditors have been fully disclosed.(b)To ensure that creditors pertain to the client’s actual activities.(c) To ensure that proper cut-off has been applied.(d)To ensure that creditors have been properly classified.

Audit Procedures

60. The auditor should select a sample of creditors from the creditors’ ledger.61. The auditor should select accounts with a lot of activities during the financial year.62. The sample should also include accounts with nil balances.63. The supplier should be asked to confirm the balance outstanding giving details of the

invoices still outstanding.64. The auditor should review creditors’ reconciliations 65. Creditors’ reconciliation should be agreed to supplier’s statements.66. If suppliers statements are not available the auditor should agree the balances to the

confirmations from creditors.67. Balances on the suppliers’ accounts should be traced to the purchases account and the

purchases ledger.68. The auditor should review invoices received and amounts paid after the year end to

verify if any represent creditors that should have been included in the current financial year.

69. Select accounts with debit balances in the control account before the year end and review

evidence of payments, purchases returns and other supporting documentation.70. Review transactions recorded in the next month after the year end to identify any

material returns which should be adjusted for within the financial statements.

Analytical Procedures

Calculate creditors’ settlement days ratio that is

Average Creditors X 365Credit Purchases

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A reduction in creditors settlement days figure may indicate a potential understatement of creditors or alternatively that creditors are being paid too quickly which may signal cash flow problems.

A significant increase in the ratio may indicate potential solvency problems. The auditor should discuss the creditors settlement period with directors taking

particular note of the settlement days that the auditor expected the business to have. The client may understate creditors by recording creditors in a later accounting period. Review monthly payments for purchases payments to creditors and creditor balances. A significant increase in trade creditors after the year end could indicate a potential cut

off problem. Compare individual creditor balances to previous accounting periods.

Accruals

Any material accruals should be traced to supporting documentation. Accruals should be reviewed for completeness by comparing the auditor’s expectation

and last year’s list of accruals. The auditor should ensure that the level of any uncharged bank or loan interest is

correctly stated. The corporation tax and VAT accruals should be agreed to the financial statements

and other evidence. Any inter company balances should be agreed to direct confirmations with the

companies involved. Any terms of repayment should be reviewed and the auditor should ensure that the

liability has been recorded as being payable in the correct period.

AUDITING REVENUE

71. The objective when auditing income is to ensure that income from all sources have been

fully recorded that is the income of the entity has not been under or overstated.72. The auditor should ensure that all items are processed in the correct period.

Audit procedures

73. The auditor should first ascertain all the major sources of income, how they are recorded

and their respective importance in the accounting system.74. Where any other material source of income has been identified this should be traced to

supporting documentation.75. The auditor should then check that no changes have been made to the system and that

there are no new sources of revenue.

76. Detailed tests should be used and the auditor should ensure that a sample is selected from

the earliest stage in the recording process.77. Records examined need to be complete and the auditor should extend procedures by

examining records independent of the sales recording system.

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78. Such records include despatch notes, customer orders and transfers of goods from stock.

79. Details should be traced from the source document through to the sales invoices.80. Invoices should be agreed through to the day books, nominal ledger, sales ledger and

the system of recording debtors.

81. The auditor should ensure that the items are being accounted for in the correct period.82. Where pre-numbered invoices are used the auditor should check the sequence and

investigate missing items.83. Where the client deals in cash the auditor should ensure that cash sales are banked

regularly and in accordance with the entity’s procedures.

84. Where there are material cash sales a cash account should be prepared.85. The auditor should also select a sample of till rolls or sales invoices and trace them to

supporting documentation.

86. The procedures will include: Checking additions. Checking the numerical sequence and investigating any missing items. Checking the pricing. Checking the total cash sales to the cash book.

87. The auditor should review sales returns and where material, select a sample and trace them

to supporting documentation.88. If the client wants to suppress the level of sales then this could be achieved by

cancelling genuine sales.

89. Supporting documentation will include tests on the following:90. Making sure that the details of credit notes agree to the original invoice.91. Checking the quantity and the description on the credit note to a goods returned note

or other documentary proof of receipts of the product.

92. Tracing the posting to the sales ledger93. Ascertaining the reason for the return and considering whether this is within the

entity’s policy.

94. Where any other material source of income has been identified this should be traced to supporting documentation to ensure that it is correctly described and fully accounted for.

95. The following types of income could be material in the client’s financial statements: rental income – the auditor should trace to lease agreements interest on overdue accounts income from insurance claims investment income

96. The auditor should consider whether there are any factors which could result in turnover not

being recognised in the correct period for example: the date when title of goods pass.

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the date that the goods leave the client’s premises.

Internal Controls

97. Controls are very important in a sales system to ensure that all sales are fully recorded.98. The types of internal controls that may exist are as follows:

(a) pre-printed and sequentially numbered invoices.(b) invoices being raised in a department separate from the sales department.(c) goods should only be allowed to leave premises with a valid despatch note.(d) access to the despatch area is restricted to those staff working within the department.(e) regular stock takes to ensure that the records agree to goods despatched notes.(f ) despatch notes are independently checked to invoices.(g) customer orders are controlled and unfulfilled items followed up.

99. The auditor should identify the controls in existence and design tests to ensure that they are operating effectively before reducing the level of detailed testing.

Analytical procedures

100. It is possible to use analytical review procedures by developing an expected turnover figure

and comparing it with the actual figure recorded.101. Expected figures can be computed based on last year’s results.102. Comparisons can also be made with entities of the same size in the same

industry.

AUDITING SHARE CAPITAL AND RESERVES

Share Capital

Classes of Share Capital

103. There are many distinct types of shares of limited companies, but capital is most often

divided into preferred and ordinary shares.104. The rights of the respective shareholders are governed by legislation, contract

and the company’s constitution.

105. Preference shares are entitled to a fixed dividend out of profits.106. The surplus profits after such payments belong to the ordinary shareholders.

Reserves and Share capital

107. Share capital represents part of the capital invested in the company by its shareholders.

108. Reserves represent the balance of net assets accruing to the shareholders and may include

part of past issues of share capital (share premium), retained earnings and revaluation gains on the revaluation of non-current assets.

Auditing procedures47

109. Sampling would not be appropriate when auditing share capital and reserves.110. Check authorised capital limit to legislation and company constitutional

documents.111. Check changes to issued capital in the year and agree to board minutes.112. Changes in share capital are likely to be a material transaction which is subject

to special legal requirements.

113. Trace all transactions involving cash to the cash book and bank statement.114. Ensure that any necessary registrations have been made and that the company’s

register of members has been updated.

115. Ensure disclosure as either debt or equity.116. Ensure that all transactions are legal and share premium has been accounted

for properly.

117. The treatment of reserves can be affected by both legislation and the company’s

constitution.118. Possible categories of reserves include, share premium account, revaluation

reserve and retained income.

119. The audit of the revaluation reserve will involve: assessment of the reason for revaluation, the basis of valuation and its reasonableness in light of the auditor’s knowledge of the business and the position of the property market. evaluation of the experience qualification and independence of the valuer. ensuring that adequate disclosures are made.

120. Revenue reserves represents accumulated retained profits of the business. 121. Revenue reserves represents accumulated retained profits of the business.

122. The auditors should prepare a schedule of retained reserves showing movements in the year.

123. Check material movements and ensure compliance with legal regulations.124. Ensure all gains and losses have been included in the income statement or

other reserves as appropriate

AUDITING PROVISIONS FOR LIABILITIES, CHARGES AND CONTINGENT LIABILITIES

A contingent asset or liability is “a possible asset or liability that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future event not wholly within the entity’s control”.

The auditor should not only examine items that need to be recognised or provided for within the financial statements, but also any possible contingent assets or liabilities that have been identified during the course of the audit.

The financial commitments include a number of potential liabilities such as:48

Contractual obligations to acquire fixed assets. An obligation to sell or buy items outside of the normal activities of the business. An obligation to buy or sell currency under forward contracts. An obligation to provide for pensions.

Audit Objectives.

The main objectives when auditing contingent liabilities is to identify unrecorded or under recorded liabilities.

The objective is to identify matters that have not been incorporated within the accounting records and which may not be backed up by any formal paperwork such as an invoice.

The auditor should ensure that full provision has been made for all liabilities. Where an entity has a present obligation as a result of past events, it is probable that a

transfer of economic benefits will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation.

To ensure that all contingent assets and liabilities have been identified and adequate disclosure made.

Audit Procedures

Review the current funding of any provision schemes and ensure that adequate provision has been made in the financial statements for any liabilities.

Obtain details of any other liabilities and charges to ensure that adequate provision has been made where necessary.

The auditor can obtain such information by discussion with employees of the entity. Review minutes of the board or other management meetings. Review terms and conditions of any major contracts and agreements. The auditor should consider whether it is appropriate to send a letter to the client’s

lawyers requesting details of all contingent liabilities noted. The reply from the lawyers should be reviewed against the disclosures made in the

financial statements. The auditor should prepare or obtain a schedule of the major insurance policies

maintained.

The schedule should state the amount insured, the premium payable, the period covered and the date of the last renewal.

The auditor should assess whether the client is adequately insured. If the client is under insured losses can be suffered as a result of underinsurance. The auditor should determine whether the entity has complied with all the relevant

laws and regulations.

Controls

The auditor should consider what controls are in place to ensure that the entity complies with all relevant laws and regulations.

This may involve that there is a member of senior management responsible for such compliance who ensures that compliance is maintained.

AUDITING INVENTORIES49

Inventories consist of goods acquired for resale.In a manufacturing entity, inventories can be categorised in three classes that is: Raw materials Work in progress Finished goods

Large entities maintain comprehensive stock records.These records may be used for determining both the quantity and value of stock at balance sheet date.The auditor must perform extensive tests of control over the recording of stock transactions and maintenance of stock records.Physical existence audit can be obtained by physical observation.The auditor may observe a number of stock counts during the year as part of its control procedures over stocks.Where the entity determines stock by physical count at the year end, the auditor should attend such a stock take.The auditor should verify both the cost and net realisable value of stocks and determine which basis is relevant for each item of stock.

Audit objectives

1. Stocks included in the balance sheet physically exist.2. Stocks include all materials and products on hand at the balance sheet date.3. The entity has rights to the stocks included in the balance sheet.4. Stocks are properly stated at the lower of cost or net realisable value in accordance with IAS 2.5. Stocks are properly identified and classified in the financial statements.6. Disclosure pertaining to the classification basis of valuation and the pledging of stocks are adequate.

For entities that rely entirely on stock take at or near balance sheet date, the auditor will adopt a predominantly substantive approach in obtaining evidence as to the existence and completion assertions.

The auditor should understand the accounting and internal control system relating to the recording of stock transactions.

Reliance should be placed only on records of purchases in obtaining evidence as to valuation.

For manufacturing entities it will be necessary to obtain an understanding of the procedures for determining recording costs of production.

Manufacturing entities need to keep records of stocks of raw materials, work in progress and finished goods.

Internal Controls

1.Adequate stock records should be maintained detailing purchases and issues of stocks. Use of a computer system in recording stocks will enable automatic updating of stock records after receipts and issues. 2.All stock purchases should be authorised and made on an official purchase order . Purchase orders should be signed and sequentially numbered.3.On receipt of goods a Goods Received Note should be raised.

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The Goods Received Note provides the source of entry of the quantity and cost of the stock.4.When issuing goods, a requisition, or despatch note should be raised and serves as the basis for authorising release of the goods from stock and for entry into the stock records deducting the quantity on hand. In retail stores the use of bar codes scanned at the cash register provides data for reducing recorded stock.5.Stocks records should be compared with physical stock at regular intervals through a stock count.

Valuation of inventories

Inventories should be measured at the lower of cost or net realisable value.Cost comprises all costs of purchase and conversion and other costs incurred in bringing the inventories to their present location and condition.Costs of purchase include import duties and other taxes, transport and handling costs.Conversion costs include direct costs such as labour and a systematic allocation of fixed and variable production overheads incurred in converting materials into finished goods.Net realisable value is estimated selling price in the ordinary course of business less the estimated costs of completion and further estimated costs necessary to make the sale.Valuation methods permitted are First In First Out, Weighted Average Cost, Standard cost and the retail method.

Risks associated with inventory

125. Risks associated with inventory include:

126. Inadequate or inappropriate inventory held to meet the demands of sales and production.

127. High inventory levels resulting in poor cash flows and financial loss.

128. Inaccurate or incomplete recording of inventory movements resulting in lack of awareness of the actual inventory position.

129. Lack of security over inventory resulting in loss, theft or misappropriation.

130. Inventory inappropriately stored resulting in loss, theft or depreciation.

131. Inappropriate or unsatisfactory inventory write off or disposals resulting in financial loss or damage to reputation.

132. Obsolete inventory held or incorrectly supplied to customers resulting in financial loss and damage to reputation.

Attendance at inventory count

133. It is not the responsibility of the auditor to count inventory but the client’s.

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134. Where the count is not attended on the date planned due to unforeseen circumstances, the auditor should take or observe some physical counts on an alternative date if possible.

135. Where attendance is impracticable, due to the nature or location of the inventories, auditors should consider whether sufficient evidence is available to avoid a qualification of the audit report.

136. The auditor should familiarise himself with the nature, volume and location of inventories and consider the timing of the inventory count.

137. The auditor should arrange third party confirmation of inventories held by third parties.

138.AUDITING ACCOUNTS RECEIVABLE

139. When the accounts receivable are material to the financial statements and when it is reasonable to expect debtors to respond, the auditor should plan to obtain direct confirmation of account balances of individual entries in an account balance.

140. Direct confirmation provides reliable audit evidence as to the existence of debtors and the accuracy of account balances but does not ordinarily provide evidence as to the collectability of balances or as to the existence of unrecorded balances.

141. When it is expected that debtors will not respond, the auditor should plan to perform alternative procedures.

Internal controls over receivables

1. The objectives of internal controls over receivables are to ensure:2. All goods despatched are invoiced at the correct price.3. Goods are only despatched on credit to approved customers.4. Invoices are recorded and related to subsequent cash receipts.5. Debtors are controlled and bad debts pursued.6. Credit notes are approved.7. The possibility of any falsification of receivables should be eliminated.8. The cashier should not have access to the sales ledger and sales ledger personnel

should not have access to cash received.9. The auditor should obtain a list of the receivables balances in the accounts

receivable ledger and agree the total with the control account.

Audit Procedures

1. The auditor should carry out the following audit procedures:2. Checking that the balances are made up of specific invoices relating to recent

transactions and enquiring on balances which appear to be old.3. Checking the authority of bad debts written off.4. Direct confirmation of debtors balances.5. Review the individual accounts of major customers and those that appear irregular

either by nature, composition or size of the balances or transactions therein.6. Review the year end cut off procedures for sales.

Analytical procedures

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1. A comparison of debtor days with prior years.2. A comparison of the proportion of the debts in different age bands to prior years.3. There should be strict internal controls over returns inwards and credit notes issued

to prevent the fraudulent cancellation of debts or to hide bad debts.4. From an audit point of view the major problem is likely to be the issue of a

substantial volume of credit notes after the year end to cancel false sales made before the year end.

5. This is called window dressing.6. For this reason both the system and the post balance sheet events, should be

examined.

Confirmation of accounts receivable

One of the most effective methods for confirming receivable balances is by the auditor communicating directly with the customers of the client to seek direct confirmation of the amounts outstanding.

This provides reliable evidence as to the existence of receivables and the accuracy of recorded balances.

Letters are sent by the auditor and customers are requested to reply directly to the auditor.

The letter contains management’s authorisation to disclose the necessary information.

When management requests the auditor not to contact a customer the auditor should consider whether there are valid grounds for such a request.

This can arise where there are disputes between the client and the customer and requests for confirmation may aggravate sensitive negotiations.

Auditors should examine evidence available to support management explanations.

If no other evidence is available, the auditor might have to consider qualifying the audit opinion.

Forms of confirmation.

142. The circularisation of debtors should be carried out at the year end as this provides evidence of the balance sheet figure.

143. There are two types of confirmation: Positive confirmation – a customer is asked to confirm to the auditor directly or

indirectly if he agrees or disagrees with the balance. Negative - customer only asked to respond if he disagrees.144. This method may be appropriate where there are a large number of small

balances and the system is well controlled.

145. Positive confirmation provides more reliable evidence than negative confirmation.

146. The choice depends on the auditor’s assessment of risk.147. The positive form is preferred when control risk is high.

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148. Customers to be circularised should be selected by the auditor from a sales ledger listing agreed to the general ledger control accounts.

149. Particular attention should be given to: old accounts. accounts written off during the period under review. accounts with credit balances. accounts with nil balances. accounts which have been paid by the date of examination.

Example of request for third party confirmation

Old Mutual LimitedMutual Gardens100 The Chase (West)Emerald HillHarare

To: Genesis Investment Bank Limited

30 April 2006

Dear Sirs

Confirmation of indebtedness

As part of their normal audit procedures we have been requested by our auditors, Ernest and Young, to ask you to confirm directly to them the balance on your account with us as at 31 March 2005. We enclose a statement of your account up to that date.

If you are in agreement with the balance shown please sign this letter in the space provided below and return it direct to Ernest and Young.

If you disagree with the balance, please send this letter to our auditors showing details of the items making up the difference in the space provided below.

Please note that this request is made for audit purposes only, and remittance should be made to us in the normal way.

Yours faithfully

I.T. Ruvando

Group Financial Director

AUDIT SAMPLING Sampling is an example of selective testing procedure i.e. examining less than 100% of

items in a population The distinguishing feature of sampling is that the process is carried in order to reach some

conclusions about the characteristics of a population54

Other selective testing procedures do not have this objective e.g. a walk through tests.

A complete check of all the transactions and balances is not required of the auditor since he can just implement sampling because:a. of the costb. The complete check would take long, so by the end the auditor is finished, the accounts

are ancient history.c. Users of accounts do not require 100% accuracyd. A complete check would be boring to the auditorse. A complete check would not add much to the worthiness of the figures

In some circumstances, a 100% check is necessary e.g. a. in high risk areasb. categories with fewer numbersc. areas where the auditor has to rely upon enquiryd. exceptional transactionse. categories of special importance e.g. directors remuneration,

Audit sampling means “the application of audit procedures to less than 100% of the items within an account balance or class of transactions to enable auditors to obtain and evaluate audit evidence about some characteristic of the items selected in order to form or assist in forming a conclusion concerning the population which makes up the account balance or class of transactions”.

Sampling risk

Sampling risk relates to the possibility that a properly drawn sample may, by chance, not be representative of the population.

It is the risk that the auditor’s conclusion about internal controls or the details of transactions and balances based on a sample may be different from the conclusion that would result from an examination of the entire population.

Non – Sampling Risk

Non – sampling risk refers to the component of audit risk that is not due to examining only a portion of the data.

Sources of sampling risk include failing to recognise errors in documents and relying on erroneous information received from third parties.

Non sampling risk can never be mathematically measured.

Population

Refers to all the transactions from which the auditor wishes to take samples. The population should consist of consist of homogenous items so that all items will

have an equal chance of being selected. For tests of control the auditor must consider the possibility that the apparent

population may not be homogenous with respect to the design of the internal control system.

Audit efficiency is improved by only testing very small samples of low value items and larger samples from high value items.

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Sampling Unit

The sampling unit within a population can be a transaction, an invoice or payment, a monetary unit or a balance.

Two approaches to sampling in auditinga. statistical samplingb. judgemental/ non statistical sampling

Statistical SamplingIt involves the random selection of a sample followed by the use of probability theory to evaluate the sample results

Advantages of statisticala. It is scientificb. It provides precise mathematical statement about probabilities of being correct.c. It is efficient over large numbers and sizesd. It tends to create uniform standards among different audit firmse. It can be used by lower grade staff who would be unable to apply judgement needed

by judgemental sampling

In statistical sampling probability theory is used to determine sample size and to interpret results.

Statistical sampling provides a decision model within which the auditor’s judgement as to the acceptable level of detection risk, materiality and other variables are inputs.

Non Statistical SamplingN.B.-any sampling approach that does not involve both the random selection of a sample and the use of probability theory to evaluate the results is called non statistical sampling.

Non statistical sampling means selecting a sample of appropriate size on the basis of the auditors’ judgement of what is suitable

In non-statistical sampling, the auditors use judgement both to determine sample size and to interpret results against the audit objective.

The choice of non-statistical or statistical sampling does not affect the selection of auditing procedures to be applied to a sample.

Advantagesa. The approach has been used for many years so the auditor have a well understanding

of the approachb. The auditor can bring his judgement and expertise into playc. No special knowledge of statistics is neededd. No time is spent on playing with mathematics

Disadvantages a. It is not scientificb. It is wasteful if sample sizes are largec. No quantitative results are obtainedd. Personal bias is unavoidable

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e. There may be no real logic to the selectionf. The sample selection may be slanted to the auditor’s needs

ISA 530- AUDIT SAMPLING AND OTHER SELECTIVE TESTING PROCEDURES In obtaining evidence, sampling risk can arise due to the possibility that the auditors

conclusions based on a sample may be different from the conclusion reached if the entire population was tested.

In obtaining audit evidence, the auditor should use professional judgement to assess audit risk and design audit procedure to ensure this risk is reduced to an acceptably low levels.

When designing an audit sample, the auditor should consider the objective of the tests and the attributes of the population from which the sample would be drawn

In determining the sample size, the auditor should consider whether the sampling risk is reduced to an acceptably low level

The auditor should select the item of the sample with the expectation that all sampling units in the population has a chance of selection.

The auditor should evaluate the sample results to determine whether the preliminary assessment of the relevant characteristics of the population is confirmed or need to be revised

Discipline of sampling plans

Any sampling that u carry out should be carefully planned and executed as follows1. identifying the population ( which must be homogeneous for the theory to be valid)2. identifying the sampling unit ( the individual items constituting a population)3. selecting the sample using an appropriate method such as random number usage,

interval selection4. identifying error5. quantifying error6. assessing risk( sampling risk and the auditor’s risk)

Planning the sampleThe auditor should consider the following

1. Audit objectives The auditor should determine the nature of the evidence he is seeking in order to define the population and the conditions that would be regarded as error or deviation.Error are under or overstatement of monetary values and will be detected by substantive tests. Deviations are failure of internal controls which are detected by compliance test

2. Population and sampling unit To ensure that the tests covers all items about which the auditor wishes to draw a conclusion, the population should be carefully identified. The population is made up of individual sampling units. In substantive test, each sampling unit will be an individual balance or underlying transaction. In test of controls, it is the unit upon which the control is based

3. Determining the sample size The sample size may be affected by the following 4 related factors:

a. assurance requiredb. tolerable deviation or errorc. expected deviation or errord. stratification

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a. Assurance required The auditor should consider sampling risk when deciding on the level of assurance required. The degree of assurance the auditor plans to obtained from the results of the sample has a direct effect on the sample size, the greater the degree of assurance required, the larger the sample size would be

b. Tolerable deviation or error This is the maximum error or deviation that the auditor is prepared to accept in the population and conclude that his audit objective has been achieved

c. Expected deviation or error Where errors are expected to occur, a larger sample size is required in in order to be able to draw a conclusion which falls within tolerable error

d. Stratification It the process of dividing a population into sus-populations so that the items within each sub population can be expected to have similar characteristics in certain respects

Selection of items to be tested The main concern when selecting a sample is to ensure that it is representative of the

population as a whole. The aim of selection techniques is to ensure that within each stratum, all sampling

units should have a quantifiable chance of being selected. Representative selection methods include:

1. Randomly2. Value weighted (larger items having a greater chance of being selected )3. Systematic (select every nth item)4. Haphazard (selecting items using the auditors judgements)

Testing the items Having selected the sample items, the auditor should carry out the predetermined audit

tests for each item. If this is not possible for particular sample items, alternative procedures which provide

equivalent evidence should be carried out on the same collected items. If it is not possible to carry out alternative procedures for those items, the auditor

should consider the effect on his conclusions of assuming his items to be in error. The auditor may eventually have to accept that the test was inconclusive if sufficient

evidence cannot be found, in each case he will seek alternative audit evidence from other tests

Evaluating the results of the tests1. Analysis of error or deviations

The auditor should consider the following: The nature and cause of all errors and deviations founds Their possible impact on the financial statements and his planned audit approach

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2. Projections of errors The auditor should estimate the expected error or deviation rate in the whole

population by projecting the results of the sample to the population from which it was selected.

The purpose of this exercise is to compare the potential error with the tolerable error and not to determine the actual error precisely.

3. Assessing the risk of an incorrect conclusion Actual error may be greater or smaller than the projected error identified. The auditor should consider the likelihood that the actual error may exceed tolerable

error

Summarising the resultsThe auditor should consider the total estimated unadjusted error arising from all his audit procedure with reference to all his materiality levels and consider whether he has obtained sufficient audit evidence for:

1. Each account balance or class of transactions2. Fin stats as a whole

Controlling and recording The auditor should adequately control and record the work involved in planning,

selecting, testing and evaluating audit samples. The work should be carried out or supervised by audit staff who have appropriate

training, experience and proficiency in audit sampling.

In particular, the working papers should record :1. The audit objectives2. The definition of the population and sampling units3. The definition of error or deviation4. The means of determining the sample size5. The selection method used6. Details of items selected7. The tests carried out8. The errors or deviations noted and the explanations as to their causes9. The projections of errors or deviations10. The auditors assessment of the assurance obtained as to the possible size of actual

error or deviation rate11. The nature and detailed of the conclusions drawn from the sample results12. Details of further action taken where required

Sampling Methods

The test objectives and sample size will be determined in the audit programme. The audit staff members involved in the audit will then be required to select the

required number of individual samples of the population for testing, perform the test and evaluate the result.

Each transaction should have an equal chance of being selected. The methods which can be used to select samples for testing are:

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(a) Random Selection

All transactions should have the same chance of selection. The sample will therefore be representative of the population as a whole. Items are selected from random numbers either by use of a computer programme using

random numbers or from random tables. Random sampling requires populations that are individually and uniquely numbered

within a reasonably consistent sequence.

The random numbers drawn from the table are not in sequence, which makes drawing a sample from a sequentially ordered file a time consuming task.

(b) Money Unit Sampling

Money unit sampling involves using the amount rather than the items as the sampling population.

Money unit sampling takes each $1 of the population as the sampling unit and then tests whether it is correctly stated.

Each individual currency unit in the population is given an equal chance of selection. If a sample of 100 $1m is required from a population of 10 000 $1millions it is taken

systematically by taking each 100th $1m. The audit test is then applied to the item such as an invoice containing that $1m. This technique is also referred to as the “ probability proportionate to size sampling,

referring to the fact that the more $1m an invoice contains the more likely it is that one of the $1m will be selected for sampling.

Advantages of money unit sampling.

(b) It is mathematically simple, therefore easy to apply especially in a computerised accounting system.

(c) Individually material items are automatically selected for sampling.(d) It is easy to determine sample sizes.

Disadvantages

(a) It is unsuitable for detecting errors or misstatements in small amounts since smallerItems are less likely to be sampled.

(b) If detected errors exceed those expected when drawing a sample plan, the auditor is likely to be forced to conclude that the whole population is materially misstated and has to conduct further audit work.

(c) The required cumulative addition of the population for purposes of drawing the sample might not be convenient.

(c) Systematic selection

Systematic selection is a sampling method whereby the population is divided by the sample size.

It is the most widely used sample selection technique in auditing. For example a population of 8200 invoices may be divided by a sample size of 40 so

that the sampling interval of 205 will result in every 205th item being selected.60

Selection can start from any point where the auditor wishes for example, if invoice number 1 is selected the next invoice number will be 205.

A criticism of systematic sampling is that the population may have a fixed pattern such that section of a certain interval may not be possible or may result in a selection of specific items.

For example employee numbers of supervisors may always be a multiple of twenty, so that when the when the auditor chooses a sampling interval of twenty, only supervisors will be selected.

In certain instances the population may not be divisible by the sampling intervals so that no specific items can be selected.

(d) Block Selection

Block selection consists of selecting a number of adjacent transactions or items for example all invoices in a particular week or all credit customers starting with a particular letter of the alphabet.

Block selection is an easy sampling method and may facilitate the integration of other substantive tests.

A weakness of this technique is that a block sample is less likely to be representative of the population and larger sample sizes may be necessary.

The sample may provide unreliable evidence as to the whole population.

(e) Haphazard Selection

Haphazard selection is a selection process in which the auditor attempts to give all items in a population a chance of being selected by choosing items haphazardly.

Sometimes this is the only practical method where the population is not ordered in any numerical sequence.

The auditor must take care to avoid any bias as avoiding the first or last entry on each page of the ledger.

A tendency to favour items that appear to be easy should also be avoided. The method is not recommended where other methods are available because the

absence of bias cannot be subsequently evidenced.

COMPUTERS IN AUDITING

Auditing computer accounting systemsThe auditor should be familiar with the following components of a computer system: Computer hardware. Computer software. Data organisation and processing.

Use of a computer in auditing(a) Writing the audit programme.(b) Preparing audit working papers.(c) Evaluating audit risk.(d) Analytical procedures- a spread sheet can be used to calculate key accounting ratios.

Internal Controls61

The use of computers to process information and generate much of the output is likely to affect the entity’s internal control system.

The overall audit objective in a computer information system environment however, does not change.

The existence of a computer will affect the client’s inherent and control risk. The auditor should consider whether specialised computer information system skills

are required in the audit. Internal controls may be divided into:

(a) General Controls

(i) Access to the computer room should be restricted to specific personnel.(ii) Developing back up and disaster recovery plans.(iii) Employment of suitably qualified personnel.(iv) Use of manuals for programmes.(v) Use of passwords - a programme that operate through passwords will prevent

access to data to any user who is not aware of the password.(vi) Systems maintenance and development procedures.(vii) Physical protection of computers against environmental hazards.

(b) Application Controls

Application controls are designed and implemented to detect errors before, during and after processing.

These controls are designed to provide reasonable assurance that the recording, processing and reporting of data by the computer system are properly and accurately performed.

The auditor must consider these controls separately for each significant application such as invoicing customers and preparing payroll cheques.

Input controls are of vital importance because most errors occur at this point. Data received for processing should be properly authorised and complete.

Incorrect data should be rejected by the computer and resubmitted after correction. Individual transactions may be authorised in the form of a signature or stamp on the

source document. The system should produce control totals known as batch totals at the end of each day

of processing. This control includes calculation of record totals that is the number of documents

processed and financial totals computed from the source document. Management should design controls to ascertain that input data have not been lost,

added, duplicated, or changed during the processing or between departments. Data should be checked for sequence if possible, for example consistency of receipt

numbers. Processing controls are designed to provide reasonable assurance that computer

processing has been performed as intended for the particular application. Processing errors should be identified and corrected on a timely basis. Reports from the computer should be obtained before and after processing of

transactions for comparison. Processed data should be printed for visual inspection to determine if processing is

correct.62

Only authorised personnel should be able to obtain the output from the computer after processing.

Output totals that are generated by the computer programs should be reconciled to input and processing totals.

Source documents should be compared to processed information.

Computer Assisted Audit Techniques (CAATs)

The auditor should have a thorough understanding of Computer Assisted Audit Techniques and know where and when to apply them.

CAATs are a significant tool for auditors to gather information independently. CAATs provide a means to gain access to and analyse data for a predetermined audit

objective and to report the audit findings and recommendations. Computer Assisted Audit Techniques refers to audit software, test data on line

auditing and application software. The auditor should have a thorough understanding of CAATs and know where and

when to apply them. Audit software such as Audit Command Language (ACL) and IDEA provides an

independent means to gain access to data for analysis. Test data involves the auditor using a sample of data to assess whether logic errors

exist in a program. The review of application software will provide information about internal controls

built in the system.

During the audit the auditor should obtain sufficient, relevant and useful evidence to achieve the audit objectives effectively.

With systems having different hardware and software environments, different data structures, record formats and processing functions, it is almost impossible for the auditor to collect evidence without a software tool to collect and analyse the records.

Computer Assisted Audit Techniques facilitate data collection, analysis and sampling.

Advantages of Computer Assisted Audit Techniques

(a) Reduce over reliance of client’s participation(b) Reduced level of audit risk.(c) Greater independence of the auditor.(d) Broader and more consistent audit coverage.(e) Enhanced sampling.(f) Improved exception identification.(g) Simplify the audit process(h) Greater opportunity for quantification of internal control weaknesses.(i) Faster availability of information and efficient.(j) Cost saving over time (cost effective).

Disadvantages of Computer Assisted Audit Techniques . (a) Specialised knowledge and skills are required.(b) Possible disruption of the entity’s computer operations while the auditors use the

computer files and programs.(c) Substantial set up costs in using audit software.(d) Audit software may not be suitable for use on mini computers.

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Electronic Data Interchange

Electronic data interchange enables entities to transmit standard business documents over data communication channels.

Examples of documents usually exchanged include sales invoices, purchase orders, payment advices.

The exchange of documents can take place between different systems and between different hardware and software configurations.

Given the advantages of EDI more and more businesses are now using EDI. However this places more problems to the audit because electronic transactions take

more time to verify.

Risks Associated With EDI

(a) Interdependence and Vulnerability The use of EDI leads to a closer economic integration of trading entities. Serious systems problems in one entity can have a devastating effect on other entities

within the business cycle. This increases exposure risk.

(b) Auditability The use of EDI alters the traditional audit trails. Source documents and associated paper based reports such as purchase orders,

invoices, cheques and goods received notes may be eliminated. Evidence of authorisation of orders such as a signature or initials will no longer exist. Unauthorised individuals may initiate transactions or modify audit trails. There is a possible loss or contamination of data since records are kept in magnetic

media. Messages may be read by unauthorised persons.

(c ) Application failures. Application failures expose clients to potential material losses. Contingent plans are needed to provide for quick recovery and reduce the effects of

power failures.(d) Potential disclosure of confidential information to unauthorised parties.(e) Erroneous or deliberate invoicing for services not rendered.(f) Loss of audit trail as messages are transmitted from one network to another.(g) Loss of transactions either en route to client entity or due to disruption of data

processing at the third party site.

Controls over EDI

Segregation of duties between initiation, authorisation, recording and reconciliation of EDI transactions.

Review of quality assurance and changeover procedures of software should be undertaken.

Sufficient testing of message acknowledgement, editing and encryption of data. Encryption protects the confidentiality of messages. Data can only be reviewed in its original form by the sender and receiver who have

knowledge of the cryptographic key.64

Installation of virus protection for transaction software. Verification of sequence numbers and translation software. Verification of sequence numbers and transaction numbers for uniqueness and

continuity. Establishment of error logging procedures and review of inconsistencies. Use of operator identification codes, passwords, message authenticity and

authorisation profiles. Recovery of failed communication. Maintaining a register of software. Establish procedures for reporting security violations.

Auditing Around The Computer

This is an auditing approach where the auditor ignores the data processing functions and focuses attention on source documents, which form the basis for input into the computer and printouts produced by the computer.

The computer is accepted as a “black box” that accepts and produces output.

Auditing Through the Computer

This is an audit approach where the auditor focuses attention on all phases of the electronic data processing functions.

The auditor studies and evaluates the overall control environment in which computerised accounting applications are developed, operated and maintained as well as the specific application controls to ensure that only authorised transactions are processed.

Computer Hardware

Hardware is the physical equipment associated with the system.The basic hardware configuration consists of the Central Processing Unit and its peripherals, which include various input and output devices and secondary storage devices.It is also very common to find computers connected to each other via some sort of network either a local area network (LAN), an intranet or even the internet.

The CPU comprises the control unit, an internal storage unit and an arithmetic logic unit.The control unit is usually the “processor” and it directs and co-ordinates the entire computer system.The arithmetic logic unit performs the required calculations (additions, subtractions, multiplication and division).

Data Input DevicesData input devices can be classified into three main groupings:

Keying Devices (keyboards, point of sale systems, touch screens), pointing devices (touch pads track balls, the mouse) and other devices such as (optical character recognition, bar code readers, magnetic ink character readers and voice recognition devices.

Point of sale systems

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P.O.S systems help capture data at the sales terminal.The data are transmitted directly to a computer and verified for accuracy, reasonableness and completeness before being stored for later processing.P.O.S. systems eliminate the need for source documents.

Bar code readers

Bar code readers are connected to a computer that records the data, prepares a document and stores information.Bar code readers are commonly used to record the movement of goods in and out of stock.They are also incorporated into cash registers or point of sale computers connected to price files stored on the computer.

Computer Software

Software falls into two categories: systems software and application software.

Systems software

Systems software supervises the overall operation of a computer system, including tasks such as accepting user inputs or data from various input devices, executing programmes, providing feedback to users via output devices and allocating memory to data and programs.

Examples of systems software are Microsoft Windows, UNIX and MS DOS. Systems software is usually purchased from software companies suppliers and is then

adapted to suit individual needs.

Application software

Application software contains instructions that enable the computer to perform specific data processing tasks for the user.

Application programmes may be developed by the user or purchased from software suppliers.

Transaction files

These are the equivalent of journals such as a sales journal. This eliminates the need to price each item individually.

Magnetic Ink Character Readers

A magnetic ink character reader is a particular type of magnetically encoded paper. Magnetic Ink Character Readers are commonly used by banks for printing account

numbers and cheque numbers on cheques. A Magnetic Ink Character Reader is usually a document that is prepared by the entity,

sent to the customer and then returned to the entity for further processing. The use of Magnetic Ink Character Reader documents reduces the number of input

errors.

Data Storage Devices66

1. Floppy disks

Are removable and useful for archiving, off site storage and for software distribution.

2. Magnetic tape

It is an inexpensive storage medium and is often used as a back up medium.

3. Compact Disk

Is a removable medium and has a much larger storage capability than a floppy disk. Transaction files contain details of individual transactions which affect a master file,

for example credit sales transactions affect the debtors master file.

Transaction files are created for control purposes primarily for back up in case of error or computer malfunction.

Master files

These are the equivalent of ledgers. Transaction files are used to update the master file. An example is the debtors master file.

MANAGEMENT REPRESENTATIONS

The auditor should obtain appropriate representations from management.The auditor should obtain evidence that management acknowledges its responsibility for the fair presentation of the financial information in the financial statements in accordance with the relevant financial reporting framework, and has approved the financial statements.

150. The auditor can obtain evidence of management’s acknowledgement of such responsibility

and approval from relevant minutes of the meetings of the board of directors, or a similar body or by obtaining a written representation from management.

151. The auditor should obtain written representations from management on matters material to

the financial statements when other sufficient appropriate audit evidence cannot reasonably be expected to exist.

152.The possibility of misunderstandings between the auditor and management is reduced when

oral representations are confirmed by management in writing.153. Written representations requested from management may be limited to matters that

are considered either individually or collectively to be material to the financial statements.

154. During the course of an audit, management makes many representations to the auditor.

155. When such representations relate to matters that are material to the financial statements, the

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auditor will need to: seek corroborative audit evidence from sources inside or outside the entity. evaluate whether or not the representations made by management appear reasonable and

consistent with other audit evidence obtained, including other representations. consider whether or not the individuals making the representations can be fully expected

to be sufficiently well informed on the particular matters.

156. Representations by management cannot be a substitute for other audit evidence that the

auditor could reasonably expect to be available.157. If the auditor is unable to obtain sufficient appropriate audit evidence regarding a

matter that has, or may have, a material effect on financial statements, and such evidence is expected to be available, this will constitute a limitation in the scope of the audit, even if a representation from management has been received on the matter.

158. In certain instances a representation by management may be the only audit evidence that can

reasonably be expected to be available.159.If a representation by management is contradicted by other audit evidence, the auditor

should investigate the circumstances and where necessary reconsider the reliability of other presentations made by management.

160. A written representation is better audit evidence than an oral representation and can take the

form of: a representation letter from management. a letter from the auditor outlining the auditor’s understanding of management’s

representations duly acknowledged and confirmed by management. relevant minutes of meetings of the board of directors or similar body.

161. A management representation letter would ordinarily be signed by the members of

management that have primary responsibility for the entity and it’s financial aspects.162. In certain circumstances, the auditor may wish to obtain representations letters

from other members of management.

Action if management refuses to provide representations

163. If management refuses to provide any representation that the auditor considers necessary in order to provide sufficient, appropriate audit evidence, this constitutes a scope limitation and the auditor should express a qualified opinion or a disclaimer of opinion.

164. In such circumstances, the auditor would evaluate any reliance placed on other representations made by management during the course of the audit, and consider if the other implications of the refusal may have any additional effects.

EVENTS AFTER THE BALANCE SHEET DATE

165.A post balance sheet event is an event both favourable or unfavourable which occurs between the balance sheet date and the date on which the financial statements are approved by directors.

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166. It is an event which warrants an adjustment to the financial statements or an event which

need disclosure in the financial statements but may not result in an adjustment to the financial statements.

167. Adjusting events would include such items as:

the valuation of an investment which provides evidence of a permanent loss in value the insolvency of a debtor. the discovery of an error that shows that there were errors in the previous year’s financial statements.

168. The following are examples of non adjusting post balance sheet events: The issue of new shares or debentures. Loss of fixed assets as a result of a disaster such as a flood or fire. Opening a new trading activity. A merger or an acquisition.

169. The audit objective when reviewing post balance sheet events is to ensure that material

adjusting and non adjusting post balance sheet events are identified and correctly treated and disclosed in the financial statements.

170.The initial post balance sheet events review should be one of the last exercises that is undertaken during the audit.

171.The procedures undertaken during a post balance sheet events review, require review and enquiry in respect of events that have occurred since the balance sheet date.

172. The following audit procedures should be undertaken:

The auditor should review the Cash Book, invoices and bank statements, minutes of meetings and major contracts to ensure that nothing has occurred since the year end which should be disclosed or provided for within the financial statements. The auditor should discuss the situation with management to ensure that all material

items have been identified. The auditor should consider whether the client has effective procedures to ensure that

all adjusting and non adjusting events have been identified. The auditor should read the management minutes of meetings held since the year end

and enquire about matters discussed at meetings for which minutes are not yet available.

173. Before the audit report is signed the auditor should specifically enquire in respect of the

following:

Whether any new commitments, borrowing or guarantees have been entered into. Whether sales of assets have occurred or are planned. Whether there has been an issue of new shares or debentures or an agreement to

liquidate has been made. Whether any events have occurred or are likely to occur which might bring into

question the completeness of the financial statements.

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GOING CONCERN

174. The going concern concept is defined as the assumption that the enterprise will continue

in operational existence in the foreseeable future.175. This means that the income statement and balance sheet assume no intention or

necessity to liquidate or curtail significantly the scale of operations.

176. If financial statements are not prepared on a going concern basis, that fact should disclosed,

together with the reasons for such a treatment.177. When preparing financial statements, management must make an assessment of the

enterprise’s ability to continue as a going concern.The auditor will then consider management’s assessment.Management should generally look ahead at least one year from the balance sheet date, in assessing the validity of the going concern basis, but there are circumstances in which it is appropriate to look further ahead.This depends on the nature of the business and the associated risks.

178.In the absence of a clear note to the contrary, there is a presumption that the financial statements have been prepared on a going concern basis.

Indicators of problems

179. Events or conditions which individually or collectively may cast significant doubt about

going concern are:

(1) Financial

Net liability or net current liability position.Fixed term borrowings approaching maturity without prospects of renewal or repayment.Excessive reliance on short term borrowings to finance long term assets.Indications of withdrawals of financial support by lenders.Net cash outflows.Adverse financial ratios.Substantial operating losses. Deterioration in the value of assets used to generate cash flows.Arrears or discontinuance of dividends.Inability to pay payables on due dates.

(2) Operating

Loss of key management without replacement.180. Loss of major markets, franchise, licence or principal supplier.181. Labour difficulties or shortage of important supplies.

(3) Other

182. Non compliance with capital or other statutory requirements.183. Pending legal or regulatory proceedings against the entity which if successful, result

in claims that are unlikely to be satisfied.

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184. Changes in legislation or government policy extended to adversely affect the entity.

The auditor’s responsibility

185. In planning the audit, the auditor should consider whether there are events or conditions

which may cast significant doubt on the entity’s ability to continue as a going concern.186.The auditor should remain alert of evidence or conditions which may cast significant

doubt on the entity’s ability to continue as a going concern throughout the audit.

187. If such events or conditions are identified, the auditor should, in addition to performing the

procedures, consider whether they affect the auditor’s assessment of audit risk.188.The auditor should evaluate management ’s assessment of the ability to continue as a

going concern.

189. The auditor does not have a responsibility to design procedures other than enquiries of

management to test for indications of problems beyond the period of at least twelve months assessed by management.

Additional audit procedures when events or conditions are identified

190.Where events or conditions have been identified which may cast significant doubt on the

entity’s ability’s to continue as a going concern, the auditor should: Review management’s plans for future actions based on it’s going concern

assessment. Gather appropriate audit evidence to confirm or dispel whether or not a material

uncertainty exists through carrying out additional or extended audit procedures considered necessary by the auditor.

Seeking written representations from management regarding it’s plans for future action.

Possible procedures

191. Analysing and discussing cash flows and profit forecasts with management.192. Analysing the entity’s latest available financial statements after the balance sheet

date.193. Enquiring from the entity’s lawyers regarding the existence of litigation and claims

and the reasonableness of management’s assessment of their outcome and the estimate of their financial implications.

Audit conclusions and reporting

On completion of the detailed audit testing the auditor must now consider whether or not the organisation is a going concern.If it is considered that the organisation is not a going concern or that there is some doubt then the auditor needs to discuss the issues with the organisation’s management to determine how the financial statements are best prepared.

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The auditor should report going concern problems and if material the auditor may qualify the audit report.

THE WORK OF INTERNAL AUDIT

Internal audit is an independent activity established by management to examine and evaluate the organisation’s risk management processes and systems of control and to make recommendations for the improvement of achieving company objectives.Internal auditors are required to demonstrate honesty, objectivity and diligence.Internal auditors should be independent and objective and avoid any activity that will compromise independence and objectivity.In order to meet the requirements for integrity and objectivity internal auditors should exercise the highest standard of professional behaviour.Internal auditors are also required to maintain confidentiality and should not use confidential information for personal gain nor in a manner which is contrary to law.

Internal audit may also provide a number of other activities:

Examination and evaluation of financial and operating information within an organisation.Review of the economy, efficiency and the effectiveness of operations.Review of compliance with external laws and regulations, internal policy and procedures.Review and advice on the development of key development systems and on the implementation of major change.

Risk management and internal audit

Risk is the probability that an event or action may adversely affect the organisation or activity under audit.Risk management is the process of evaluating and controlling risk to ensure that the organisation is managed as effectively as possible.Risk management functions can exist within the organisation to identify, monitor and measure risk and publish risk management policies.Internal audit can ensure that it best adds value by using a risk based internal audit approach that maximises the benefits to the organisation and uses language that line management can understand.This means explaining why controls are important on the basis of how they can minimise the impact of risk materialising.

Risk based internal auditing

Risk based internal auditing involves:

Working with line management to understand the risks within the activity or organisation.Identifying in a systematic way the types of risks and the significant and likelihood of risks materialising.Assessing controls to manage risk, including those expected against those in place.Testing controls to ensure that they operate and that they provide effective management of risk.

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Making recommendations to line management for improving the operation, indicating the type and level of risk exposure.

Outsourcing of internal audit

There is an increasing trend in the outsourcing of internal audit either wholly or in part.The pressures to provide best value, and to provide competitive tendering have resulted in internal audit department facing challenges to the provision of an in house service.

Advantages of outsourcing of internal audit

Greater focus on cost and efficiency of the internal audit function.Internal audit staff used from a broader source of expertise.Less subject to high labour turnover or loss of staff from the internal audit department.Useful for providing specialist, expensive skills such as IT or treasury that an in house department may find difficult to recruit or retain.Skills required for only a short time each year can be provided without incurring excessive costs of maintaining an in house expertise.

Disadvantages of outsourcing internal audit work

194. Conflict of interest if the outsourced internal audit service is provided by external auditors.

195. Pressure on independence arising from the cost associated with the provision of internal audit.

196. The outsourced department may receive pressure from management either with the threat on renewal of the service or for retention of costs.

197. Lack of knowledge or awareness of the organisational objectives, culture or business.

198. Increased cost of an outsourced service, with less time spent on internal audit.199. Increasingly there is a partnership approach where specialist skills are provided

by consultants or are outsourced, whilst the core internal audit department remains in house.

Scope of internal audit work

200. The internal audit function is responsible for evaluating and commenting on the effectiveness of risk management, control and corporate governance processes.

201. However management remains responsible for identifying and managing risk, reporting on risk and ensuring that the right policies are in place.

202. An internal audit charter approved by the board of directors, and the audit committee should be put in place setting out the objectives, scope and authority of internal audit.

203. This should include a statement requiring access to everywhere in the organisation.

204. Internal audit is part of the overall control framework of the organisation.

Limitations of the internal audit function

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Internal audit should be an independent and objective function. However, this independence can be compromised, particularly where reporting lines

are through operational areas upon which they are required to review and report.

Relationship between internal and external audit

205. Internal and external auditors should work closely together with reliance by external auditors on the work of internal audit.

206. This is dependent on the two functions having a common understanding of the organisation’s needs.

Internal Audit and Corporate Governance

Corporate governance is the system by which business corporations are directed and controlled.

It is concerned with holding the balance between economic and social goals and between individual and communal goals. The corporate governance structure specifies the distribution of rights and

responsibilities among different participants in the corporation, such as the board, managers, shareholders, and other stakeholders and spells out the rules and procedures for making decisions on corporate affairs.

By doing this, it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance.

Corporate governance set a yardstick by which all companies should seek to be measured. The code of corporate practices and conduct is based on principles of openness, integrity and accountability. Internal audit is thus there to assist the company in measuring their compliance to governance issues.

Role of internal audit in corporate governance.

Review of general control environment. Process evaluation and performance auditing. Risk assessment, risk based audits and business monitoring Performance auditing Due diligence on internal and external reporting. Financial control, health, performance auditing and self-assessment.

Internal Audit assists the Audit committee to perform its duties without limitations and provides a valuable service by helping as follows:

Provide the audit committee with orientation, training, and support regarding the committee’s charter, operations, roles and responsibilities.

Allow reasonable amount of time for the audit committee to hear about control systems from both external and internal auditors.

Provide the audit committee with leading-edge information on new laws, new resources, and other developments that affect the governance process as well as the organization as a whole.

Making recommendations concerning risk management and governance process.

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In essence therefore, Internal Audit should be seen as ‘the eye of the Board’ confirming to the Board that:

The systems and procedures of internal control are adequate, well designed and work in practice to safeguard and secure the assets and resources of the organization.

The board is informed about, and has considered, all relevant risks. The board receives all the information relevant to its role and that the information is

accurate, reliable and complete.

AUDIT REPORTINGAuditing can be defined as a systematic process by which a competent, independent person objectively obtains and evaluates evidence regarding assertions about an economic action or event for the purpose of forming an opinion about and reporting on the degree to which the assertions conforms to an identified set of standards

What is audit reporting?The purpose of an audit is to form a view on whether the information presented in the financial report, taken as a whole, reflects the true and fair view of the financial position of the organisation at a closing date e.g.

details of what is owed and what the organisation owes properly recorded in the financial statements,,,,

are profits and loses properly disclosed,,, are inflows and outflows properly evaluated and assessed

Purpose of an audit reportThe purpose of an independent audit report is to provide an opinion as to whether or not the annual accounts give a true and fair view of the entity’s financial position

Elements of an audit report1. Title

The auditor’s report shall have a title that clearly indicates that it is a report of an independent auditor. The title distinguishes the report from any other.

2. Addressee The auditor’s report shall be addressed as required by the circumstances of the engagement, it is determined by law or regulation but usually to the shareholders.

3. Introductory paragraph The intro paragraph in the auditor’s report shall identify the financial statements whose entity they are audited, state that the financial statements had been audited, identify the title of each statement that comprises the financial statement, refer to the summary of significant accounting policies and other explanatory information and specify the dates or period covered by each financial statement.

4. Management’s responsibility of the financial statements This section of the auditor’s report describes the responsibilities of those in the organisation that are responsible for the preparation of the financial statements. The description shall include an explanation that management is responsibility for the preparation of financial statements in accordance with the applicable financial reporting frameworks.

5. Auditor’s responsibility 75

The clause shall state that the responsibility of the auditor is to express an opinion on the financial statements based on the audit. And the audit was conducted in accordance with I.S.A. and ethical requirements. It also states that the auditor planned and performs the audit to obtain reasonable assurance about whether the financial statements are free from material misstatements.

6. Opinion paragraph When expressing an unmodified (unqualified) opinion, the auditor’s opinion shall state either that the financial statements presents fairly or give a true and fair view of the financial statement in accordance to applicable financial reporting framework.

7. Other reporting responsibilities If the auditor addresses other reporting responsibilities in the auditor’s report, this shall be addressed in a separate section of the auditor’s report

8. Signature of the auditor The signature of the auditor must be contained in all his audit reports. This is usually the personal name of the auditor or if a partner is signing on behalf of the audit firm, then the signature is the name of the firm.

9. Date of the auditor’s report The auditor’s report shall be dated no earlier than the date on which the auditor has obtained sufficient appropriate audit evidence on which to base the auditors’ opinion on the financial statements

10. Auditor’s address The auditor’s report shall name the location where the auditor practices.

EXTERNAL AUDIT REPORTS

The final audit report should normally be drafted by the audit manager and signed by the audit partner.

Auditors’ reports on financial statements should contain a clear expression of an opinion, based on the review and assessment of the conclusions drawn from the evidence obtained in the course of the audit.

Contents of the auditor’s report on the financial statements.

The auditor’s report should contain the following matters: A title identifying the person or persons to whom the report is addressed. An introductory paragraph identifying the financial statements audited. Separate sections, appropriately dealing with: Respective responsibilities of directors and auditors. the basis of the auditor’s opinion and The auditor’s opinion on the financial statements. The date of the auditor’s report. The term independent auditors should be used in the title of the audit report to

better distinguish it from any other reports prepared by officers of the company.

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Statement of responsibilities and basis of opinion Auditors should distinguish between their responsibilities and those of the directors by

including the following in their report:(i) A statement that the financial statements are a responsibility of the directors.(ii) A reference to a description of those responsibilities when set out in the financial statements.

(iii) A statement that the auditor’s responsibility is to express an opinion on the financial statements.

Where the financial statements or accompanying information do not include an adequate description of directors’ responsibilities, the auditor’s report should include a description of those responsibilities.

The directors are required to prepare financial statements for each financial year which give a true and fair view of the state of affairs of the company and of the profit or loss of the company for that period.

In preparing financial statements, the directors are required to :(a) Select suitable accounting policies and then apply them consistently.(b) Make judgements and estimates that are reasonable and prudent.

(c) State whether applicable accounting standards have been followed subject to any material departures disclosed and explained in the financial statements.

(d) Prepare the financial statements on the going concern basis unless it is inappropriate to presume that the company will continue in business.

The directors are responsible for keeping proper accounting records which disclose with reasonable accuracy at any time, the financial position of the company to enable them to ensure that the financial statements comply with the Companies Act and relevant legislation.

Directors are responsible for safeguarding the assets of the company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.

Basis of opinionAuditors should explain the basis of their opinion by including in their report:

(a) A statement as to the basis of their compliance with International Standards on Auditing, together with the reasons for any departure there from.

(b) A statement that the audit process includes: (i) Examining on a test basis, evidence relevant to the amounts and disclosures.

(ii) Assessing the significant estimates and judgements made by the reporting entity’s directors in preparing financial statements.

(iii) Considering whether the accounting policies are appropriate to the reporting entity’s circumstances, consistently applied and adequately disclosed.

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(c) A statement that they planned and performed the audit so as to obtain reasonable assurance that the financial statements are free from material misstatements, and that they have evaluated the overall presentation of financial statements.

Expression of an opinion

An unqualified audit opinion arises where the auditor concludes that:(i) the financial statements have been prepared using appropriate accounting

policies which have been consistently applied. (ii) The financial statement have been prepared in accordance with relevant legislation, regulations or applicable financial reporting framework, and (iii) There is adequate disclosure of all information relevant to the proper understanding of the financial statements.

TYPES OF OPINIONS

Unqualified (unmodified) opinionThis is the most favourable

It is often called the clean opinion. An unqualified opinion is an audit report that id issued when the auditor determines that each of the financial statements recorded and provided by the business are free from any misrepresentation.

An unqualified opinion is the case that fin stats have been maintained and prepared in accordance with the standards e.g. GAAP. IFRS. IAS

This is the best type of a report that a business can receive. Typically an unqualified report consists a title that includes the word independent. This is done to illustrate that the audit report was prepared by an unbiased third party. The title is followed by the main body made up of three paragraphs which are: management (directors) responsibility, the auditor’s responsibility and other reporting responsibilities.

The main body highlights the responsibility of the auditor, the purpose of the audit and the audit findings. The auditor then signs and dates the documents including his address

Qualified / modified audit opinions In situations where the company’s fin records have not been maintained and prepared in

accordance with GAAP (or any) but no misrepresentation are identified, the auditor will issue a qualified opinion.

The writing of a qualified opinion is extremely similar to that of an unqualified opinion. The qualified opinion however will include an additional paragraph that highlights the reasons why the audit report is not unqualified.

A qualified opinion should be expressed when the auditor concludes that an unqualified opinion cannot be expressed but that the effect of a disagreement with management is not so material and pervasive and to require an adverse opinion, or limitation on scope is not material and pervasive to require a disclaimer of opinion.

High materialityNATURE MATERIAL MATERIAL AND PERVASIVEDisagreement (misstatement) Except for (qualified) Adverse

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Limitation of scope (insufficient, appropriate evidence)

Except for (qualified) Disclaimer

A qualified opinion is issued when either of the following circumstances exists: There is a limitation on the scope of the auditor’s examination, or The auditor disagrees with the treatment or disclosure of a matter in the financial

statements, and in either case In the auditor’s judgement the effect of the matter is or may be material to the

financial statements and therefore those financial statement may not or do not show a true and fair view.

Adverse Opinion An adverse opinion is should be issued when the effect of a disagreement is so

material or pervasive that the auditor concludes that the qualification financial statements is inadequate to disclose the misleading or incomplete nature of the financial statements.

An adverse opinion is expressed by stating that the financial statements do not show a true and fair view.

This is the worst type of an opinion that can be issued by an auditor. This indicates that the firm’s fin records do not conform to GAAP, IAS, IFRS and any

other financial reporting frameworks. In certain circumstances an adverse report can be issued due to occurrence of error but

it is a high indication of fraud. When this type of report is issued, a company must correct its financial statements and

have it re-audited as investors, lenders and other relating parties will generally not accept it.

Disclaimer of opinion A disclaimer of opinion should be expressed when the possible effect of a limitation

on scope is so material and pervasive that the auditor have not been able to obtain sufficient, appropriate audit evidence and accordingly is unable to express an opinion on the financial statements.

It is issued in occasion when the auditor is unable to complete an accurate audit report. This may occur for a variety of reasons such as absence of financial records, limited audit engagement time. When this happens, the auditor issues a disclaimer of opinion stating that an opinion of the firm financial statements could not be determined.

Where the auditor concludes that the possible effect of the limitation is not as significant as to require a disclaimer, the auditor issues a qualified opinion by stating that the financial statements give a true and fair view except for the effects of any adjustments that might have been found necessary had the limitation not affected the evidence available to them.

Departure from an accounting standard would, where material, result in a qualified audit report unless the departure can be and is justified.

(iii) Limitation of audit scope

Where there has been a limitation on the scope of the auditor’s work that prevents him from obtaining sufficient evidence to express an unqualified opinion: (a) The auditor’s report should include a description of the factors leading to the limitation on the scope.

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(b) The auditor should issue a disclaimer of opinion when the possible effect of a limitation on scope is so material or pervasive that they are unable to express an opinion on the financial statements.

(c) a qualified opinion should be issued when the effect of the limitation is not so material or pervasive as to require a disclaimer and the wording of the opinion should indicate that it is qualified as to the possible adjustments to the financial statements that might have been determined to be necessary had the limitation not existed.

A description of factors leading to a limitation enables the reader to understand the reasons for the limitation.

(IV) Disagreement on an accounting treatment or disclosure

Where the auditor disagrees with the accounting treatment or disclosure of a matter in the financial statements and in the auditor’s opinion the effect of that disagreement is material to the financial statements, the auditor should include in the opinion section of his report, a description of all substantive factors giving rise to the disagreement and their implications for the financial statements.

When the auditor concludes that the effect of the matter giving rise to disagreement is so material or pervasive that the financial statements are seriously misleading, they should issue an adverse opinion.

Date and signature of the auditor’s report

The auditor should not express an opinion on financial statements until those financial statements and other financial information contained in a report of which the audited financial statements form part, have been approved by the directors and the auditor have considered all necessary available evidence.

The date of an auditor’s report on a client’s financial statements is the date on which the auditor signed the report expressing an opinion on those statements.

The auditor should sign the audit report after completion of all procedures necessary to form an opinion on the financial statements including a review of post balance sheet events.

Example of an unqualified audit report

Deloitte and ToucheKenilworth Gardens1 Kenilworth RoadHighlandsHarare

Report of the Independent Auditors

To the members of Africa Banking Corporation Limited

We have audited the accompanying balance sheet, income statement, and cash flow statements of Africa Banking Corporation Limited as of 31 December 2005. These financial statements are the responsibility of the company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

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We conducted our audit in accordance with International Standards on Auditing. Those standards require that we plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material misstatements. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall financial statement presentation.

In our opinion, the financial statements give a true and fair view of the financial position of the company as at 31 December 2005 and of the results of its operations and its cash flows for the year then ended and comply with the Banking Act.

Deloitte and Touche 28 February 2006

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