Introduction to Auditing


Sardar Asim Hassan Khan

Page 1

Internal Control systems of the company (efficiency of management) Audit: Audit is independent examination and expression of opinion on the financial statements of the company.Introduction to Auditing Auditors are independent Stakeholders 1. For Example 1. 2. Positive and Negative Assurance: 1.Accuracy of financial statements Checking of financial statements Go deep into the figures Dig out the problems concealed from the public.Negative assurance is given. e.Internal control system of the company are strong 3. Past performance of the company 2.Forecasting is correct 2.Future Forecasting (Going concern issues) 3.g True and fair Net cuurent assets = current assets – current liability 2 m – 1. For Example: 1.Forecasting doesn’t seen to be unreasonable 2.9 m = 100. when the auditor states that nothing wrong was found.An internal control system of the company doesn’t seen to be weak.000/Account reconciliation letter by the auditor to the person who receive this payment. Company is able to clear all its liability Or Sardar Asim Hassan Khan Page 2 .Positive assurance is given by the auditor when he thinks things are fine.Account show true and fair view.

Work level Do no go for personal dinner Do not accept gifts b.Introduction to Auditing Company assets are capable to clear all its liabilities 2 m is true BUT NOT FAIR IF STOCK is stuck due to change of legislations. 2. technical change etc.Objectivity: Without biasness No favoritism Only based on facts (decision) 3.Has the management provided enough evidence that was required by the auditor? May be some information is not provided. 1. If it is true then it must be practically possible.Confidentiality: Auditor has the excess to see all the particular confidential information. The stock has been entered correctly at cost but lost its worth due to internal or external factors.Did the auditor put enough effort to find out the problem? 2. 5. Ethics: According to ACCA Conduct of auditor Personality of auditor 1.Integrity in Auditor: It means straight forward and honest to its profession.Advertisement Level Show your strengths Do not defame other Sardar Asim Hassan Khan Page 3 .Professional Competence: Qualification Understanding the industry 4. If negative assurance is given by the auditor then two things are possible.Professional Behavior: a. Honestly and straight forwardly quoted the facts.

Business Relationship: a.Low Balling: It is a practice of quoting a very low audit fees in the hope that profits would be made from some work awarded by the company. again it would be difficult for the auditor to annoy the bank as after unfavorable report the bank might call back the loans or withdraw the guarantee.If you have worked in that company. 3.Contingent Fees: It is an agreement between the auditor and the company that higher fees would be paid. it will be threat for the auditor to issue unfavorable report as after that he might no be able to recover it. 6. because after that share price might go down and he suffer loss and difficult to issue unbiased report.Loans and Guarantees: If your audit client is a bank and if you have obtained loans from the bank or the bank extended some guarantee on your behalf. 7.Overdue fees: If there has been a overdue fess that has to be recovered by the auditor. Sardar Asim Hassan Khan Page 4 .Brother b.Uncle 4. 2. 5.Financial Interests: If the auditor have shares of particular company then he is not like to issue unfavorable audit report. if favorable report is issued or vice versa.g. if you maintained supplier or buyer relationship.Introduction to Auditing Type 1: Self Threats to professional Ethics: Such circumstances ethics should be threatened 1.Family Relationship: Such as a.If you have business relationship. e. then you have affiliation with the company. b.

the danger is if members of the staff recruited by the auditor then subsequently auditor would be reluctant to criticize the performance of people recruited by him.Black mailing 3. 4.Physical intimidation Concept of Materiality: The matter is material if its omission or misstatement would influence the decision of stakeholders. 3. Type 4: Intimidation Threats: 1. 2.Paragraph 2: Auditor’s responsibilities are just to express our opinion on just the evidence. Here. thereafter. Thereafter.Internal Audit Services: Sometimes the auditor prepares the financial statement or extends the internal services audit for the client. the unfavorable audit report might serve as evidence against that particular case. he would be reluctant to criticize the work he himself performed.Introduction to Auditing Type 2: 1. Type 3: Advocacy Threat: Sometime.Paragraph 4: Sardar Asim Hassan Khan Page 5 .Recruitment for the client: Recruitment of staff on behalf of client should not be done.Litigation 2. which auditing standards will be follow. Audit Report: Independent Audit Report: 1. the audit firm supports the company in some form of dispute in a court of law. 2.Paragraph 3: Auditing standards.Paragraph 1: Defines financial statements reviews by auditor.

When financial statements need modification 1.Evidence : Auditor has unable to obtain sufficient evidence. 2. True and fair and free from material misstatement. 6789Signature Date Address Contact Numbers Types of Audit Report: 1. Sardar Asim Hassan Khan Page 6 .Modified Audit Report: iMatters that do affect the auditor’s opinion. There are some errors.Errors: There are errors in financial statements. There might be something in financial statements that need to be emphasized so that the user of the audit report does not miss it.Unmodified Audit Report: It is favorable audit report. issues in audit report due to which auditor’s opinion are affected. A/P situation Do not meet with bank manager Qualified opinion iiMatters that do not affect the auditor’s opinion. There are not modified changes required in financial statements. Unqualified Decision: o It does not qualify for errors.Paragraph 5: Other requirements such as according to State Bank requirements to review additional statements. 2.Introduction to Auditing Opinion paragraph Favorable Report: True and fair Free from material misstatements 5.

Here the emphasis of material of decision is given because this paragraph draws the attention of the reader to a particular point which has already been disclosed in financial statements but the auditor is worried that reader might miss that point while studying the financial statements. This makes the report true. The emphasis of matter decision is given here but auditor says that I want to emphasis on Note. ABC has filed a sue against the company of 5 million. Government Rules and Regulations c. Competitors 5. fair and all materials are complete. Material but not Pervasive Except for Except for Pervasive Adverse Disclaimer Errors Evidence Pervasive: Sardar Asim Hassan Khan Page 7 .Borrowing facilities not agreed by the bank 4.g. Technology change b. Our financial statement has to be closed on 31st December but supplier has filed a claim on the 25th December.Emphasis of Matter Decision: The auditor still thinks that financial statement represents fair and true and free from material misstatements. The company cannot take this claim as a liability. if the decision goes against so there will be a problem in the going concern of the company otherwise everything is fine. The proceedings will continue and decision will come out in six to seven months.Partnership Issues 3. however.Non-compliance with regulations Qualification Matrix: One type of error makes financial statement useless. e. There is a deep linkage between emphasis of matter decision and going concern issues of the company.Introduction to Auditing 1. This liability is in the notes. 1.Inability to paid suppliers in time 2.Change in the external environment of the company a.10. Contingent Liability Which decision and outcome is not conformed. 1.Negative Operating Cash Flows: Over a long period of time.

g Every thing is correct except for depreciation otherwise. Disclaimer: Auditor refuses to give any decision. it will fine. No errors he will find. Sardar Asim Hassan Khan Page 8 .Because of that issue there is a question mark(?) On the normal operations of the company Except For: e.Introduction to Auditing The issue is large enough 1. 2.Make the financial statements useless.

of branches o No. of staff required Required skills in staff member Expertise Opinion o Expert person from insurance company You need to identify the important areas Sardar Asim Hassan Khan Page 9 .Introduction to Auditing Process of Audit Plan the Audit Understand the entity Assess Risk of Material Misstatment Effective Controls Ineffective Controls Test of Controls (TOC) Substantive Testing Limited Substentive Testing Audit Report Plan the audit: To carry out any work effectively General strategy in a detailed manner o Overall layout o Where head office located o No.

Business Risk (BR) 2. Invoice process b. Business risk will be further divided into three categories.Audit Risk (AR) 1Business Risk: Business risk results from the circumstances or from the actions of management that later effect the company’s ability to achieve its objectives. • Management: o Financial risk arises from high borrowings. Inventory process Assess Risk of Material Misstatement: Risk Analysis: The auditor has analysis the total risk of the company (TR). Sardar Asim Hassan Khan Page 10 .Financial Risk (FR) 2. (Circumstances include external factors).Financial Risk: It arises from high borrowings. When company under the financial burdens Interest rate increase • Circumstances: o Financial risk rises because of interest rate that put the business under swere pressure and that can increase the going concerns of the company.Introduction to Auditing o Financial statements o A/R o Inventory Identify the problematic areas o If company shifted from manual to computer system Co-ordination with the parties (department heads) Understand the Entity: 1234Nature of business Rules and regulations Accounting policies (which policy of accounting they use) Internal control system a. Total Risk can be sub divided into two categories.Operational Risk (OR) 3. 1. 1.Compliance Risk (CR) 1.

Control Risk (CD): It is the risk that company’s own control procedures are not strong enough to locate / pick that error and then corrects it.g.Introduction to Auditing 2.Audit Risk (AR): The risk that auditor gives an in appropriate opinion on the financial statement.Internet Risk (IR): Financial statements would actually contain errors and material misstatement e. the industry is new to him and there have been some time and money pressures. Control system 2. Quality production. • Circumstances: o Due to child labor in the company • Managements: o Law breakage. too many warranty claims.Operational Risk: Operational risk arises from the operational errors e.Internet Risk (IR): 2. the planning was poor. drainage 2. this will be increased if auditor is inexperienced.Compliance Risk: Compliance risk arises from failure to comply with rules and regulations that mean business may face large penalties or they might be prevented from continuing to trade.g.Detection Risk (DR): It is basically the failure of the auditor to detect the errors from financial statements.Control Risk (CD): 3. Sardar Asim Hassan Khan Page 11 . 1. Audit Risk will be further divided into three categories. • • Circumstances: o New technology Management: o Reputational Risk (RR) 3. International Control System o AR=IR x CR = 100% * 100% = 100% 3.Detection Risk (DR): 1. products are old fashioned.

Complete: All account receivables should be included. Qualities of Figures: Figures appearing in financial statement are making some assertions.Accurate e. Audit Risk has to be reduced at two levels 1. whatever the figures are appearing they are claiming something.Financial Statement Level: Figure appearing in the financial statements can be time but overall effect of financial statement can be misleading. It might not show true and fairview 2. where the IR is high and CR is also high .Assertion Level: Claim level.g. the auditor will have to work harder. claiming something and these figures should be (ACCACOVER) Accurate Complete Cut of his correct Allocated Classified Occurrence Valuation Existence Rights and obligations 123456789- 1. 3. A/R Value should not be overstated Provision of bad debt also deducted 2.Cut of his correct: Inventory Cash/AR+ Sardar Asim Hassan Khan Page 12 .Introduction to Auditing AR=IR x CR x DR = 100% * 100% * 0 = 0 o Note: To decrease the detection risk in this case.

6.Analytical Procedures: It is basically calculating the ratios and then comparing it with last year results.Recalculation: Recalculating the figures to check its accuracy and re-performance of the activities to check if final results are accurate or not. 5.Classified: The transaction should be recorded into proper account with proper amount. budget and industry standard.Allocated: Expense item should be allocated in the proper account. 9. 3. 4.Existence: Exist accurate and completely. Audit Evidence: There are five sources of audit evidence (AEIOU) 12345Analytical Procedures Enquiry Inspection Observation Recalculation 1. 8.Occurrence: Should occur in the same account.Introduction to Auditing 4. 5. 2. 7. 4. Sardar Asim Hassan Khan Page 13 .Valuation: Should be value properly.Test of Controls (TOC): To check that controls are implemented properly and they have been followed.Inspection: Physical inspection of goods and inventions.Observation: Observing the departments whether the control are being followed or not.Rights and Obligations: You should have legal right on that asset. Any dramatic change can give rise to a question of its existence.Enquiry (Enquiry and Conformation): Ask the internal staff and the third parties to conform the actual situation.

2.Invoices are checked and reconciled to GRN (Good Received Note) and then with the contract to ensure that quantity. 4.Hours worked are accurately recorded. e. 3.Goods should be ordered from the authorized supplier.Employees are hired when necessary. quantity and condition.Sales System: 1. 2.The goods are properly dispatched (Out Word Gate Pass) 3. Here the auditor would check if the company is preparing age listings. 3.Orders should be accepted from the credit worthy system.The auditor will check the system by reconciling contracts with OGPs.They should be ordered at competitive prices in required quantity and except able quantity. 2. quality and rate is correct.Limited Substantive Testing High volume Testing Audit Internal Control Systems: 1. 7.Payment should be made properly to the supplier.Employees are paid competitive rates. Invoices are entered into receivable ledger 4. 2. 5.Credit control procedures have been properly implemented. 1. 6.Wage System: A good internal control system of wages and salaries should ensure.g.Introduction to Auditing 5. Sardar Asim Hassan Khan Page 14 .Purchase system: A good purchase system will ensure 1. Buyer name Age – listing Quantity Overdue days Date Rate Total amount OGP 5. 3. Credit control 6. The goods are received on correct time.Payment is received when due.The goods are booked into inventory. Invoices and receivable ledgers.Invoices are entered into payable ledger with the correct amount.Goods are ordered when they are needed.The delivery would be invoiced properly and accurate.

The auditor will look at the board minutes and will attend the board meetings. o No provision is required but disclosure is required by way of a note. 6. Payable Collection period: The auditor will calculate day sales outstanding ratio and then compare with industry standards. then the provision is recognized and disclosure is required.Payments are made accurate to employees.Net pay and detection are properly calculated. 2. Audit of Receivables: 1234Individual ledger balances will be reconciled with the control accounts.Correspondence with suppliers the auditor will write a letter to the creditors of the company to conform the balances.Correspondence with customers the auditor will write a letter to the debtors of the company to conform the balances. Sardar Asim Hassan Khan Page 15 .Introduction to Auditing 4. 6.Wait for the payment: The auditor should wait for the payments against sales that have been at the end of the year. 5.Wait for the payment. the auditor should wait for the payments against sales that have been at the end of the year. Contingent Assets and Liabilities: 1.Contingent liabilities: 1. Correspondence of company with suppliers will scrutinized. The auditor will look at the board minutes and will attend the board meetings.Remote Situation: o If the chances for outflow of the resources is remote then no provision and no disclosure is required. 3.Probable Situation: o If the present obligation probably requires the outflow of resources.Concept of leavers and joiners. 5. 6. Audit of Payables: 1234Individual ledger balances will be reconciled with the control accounts. Collection period: The auditor will calculate day sales outstanding ratio and then compare with industry standards. Correspondence of company with customs will scrutinized. 5.Possible Situation: o Possible obligation means the present obligation will not require the outflow of resources.

Introduction to Auditing 2. Sardar Asim Hassan Khan Page 16 .Remote Situation: o No disclosure and no provision is required.Contingent Assets: 1. 2.Probable Situation: o If the inflow of benefit is certain.Possible/ Up Probable Situation: o When there are more chances of getting economic benefit but you are not certain so not shown in financial statement but you have to disclosure with the help of a note. It is a real asset and should be shown in the financial statements. then asset is not contingent. 3.