Audt Notes & Qstns Kce

AUDITING
LAWS THAT GOVERN AUDITING PRACTICE
1. Companys Act e.g.

 Appointment of auditors
 Remuneration of auditors
 Objectives of an audit
2. International Standards on Auditing (ISA) – They explain the audit procedures to be
followed in audit work e.g.
– Planning of audit ISA 300
– Recording of audit IAS 230
– Controlling of audit IAS 220
– Audit Reporting IAS 700
– Audit evidence IAS 500
3. International Standards on Accounting (IAS)
4. International Financial Reporting Standards (IFRS)
TOPIC ONE:
NATURE, PURPOSE AND SCOPE OF AUDIT
Definitions:
AUDITING
Auditing is an independent examination of the books of accounts, vouchers of the entity and the
records of the business by an appointed auditor with a view to forming an opinion as to whether:
- Proper books of accounts have been kept

- Accounts are in agreement with the books of accounts
- Sound accounting policies have been followed in the presentation and preparation of the
financial statements.
- The financial statements prepared i.e. balance sheet, profit and loss account and cashflow
statements reveal a true and fair view of the state of affairs of the company as at the year
end and of its profit or loss as of the year ended and that they do comply with the
company’s Act Cap 486
Examples of books of accounts
1 Passion for Excellence

 Ledgers
 Cash books
 The day books /Journals
Examples of vouchers
 Invoices
 Receipts
 Suppliers statements
 Local purchase order
 Delivery notes
 Cheque books
 Log book
 Title deed
 Share certificates
 Premium bonds
 Treasury bills
 Debit not
 Credit note etc.
Examples of records
 Minutes book
 Registers e.g. shareholders register and fixed asset register
EXPLANATIONS
a) Proper books of accounts
It means:
i. The receipts and payments included in the cash book are accurately stated and actually
incurred during the period.
ii. All legal books, records and documents are kept.
iii. There are no errors and frauds
b) Accounts are in agreement with the books of accounts
It means that account balances are in agreement with the figures from the vouchers or source
documents.
c) Accounts do comply with the company’s Act Cap 486

It means that accounting policies followed in the preparation and presentation of the financial
statements are in agreement with the Generally Accepted Accounting Principles (GAAP).
d) True and fair view
It means that the accounts are accurate, exact, reasonable and factual. According to the
company’s Act True and fair view means:
i. That proper books of accounts have been kept.

ii. That the accounts are in agreement with the books of accounts.
iii. That sound accounting policies have been followed in the preparation of financial statements
and that the financial statements prepared comply with the company Acts requirements.
Auditor
Its defined as;
a) Professionally qualified accountant i.e. (CPA) finalist, Association of chartered Certified

Accountants (ACCA) or Certified Financial Analyst (CFA).
b) Registered accountants with the Registration of Accountants Board (RAB).
c) Practicing accountants who is holding a valid practicing certificate issued by RAB in
accordance to Section 21 of the accountants Act Cap 531.
In practice an auditor may be an individual or a firm of practicing accountants. An individual

auditor is the one who practices alone at all times in the professional field.
A firm of practicing accountants may operate as:
i. Sole proprietorship i.e. only one person is professionally qualified, registered and practicing.
ii. Partnership i.e. more than one person is professionally qualified, registered and practicing
iii. Company i.e. all partners are professionally qualified, registered and practicing.
NB: All audit firms are registered under the partnership Act. The services provided by practicing
firms of accountants include:
a. Taxation services
b. Accountancy services
c. Auditing services
d. Consultancy services
e. Management services
f. Technical services.
Work done in each of the services rendered include:
a. Accountancy services
- Writing up the books of accounts on behalf of the clients
- Balancing the accounts
- Preparation of the final accounts
- Assisting the accountant in compiling reports.
b. Taxation services
- Computing tax liability on behalf of a client
- Assisting the client in lodging tax appeals to the tax department
- Assisting the company secretary to file tax returns due to the tax department
- Advising the client on tax implications on profits.
- Educating the client on VAT regulations.
c. Auditing services
- Planning for the audit of new and existing clients
- Carrying out audit procedures on transactions and financial statements.
- Completing the audit and signing the audit report.
d. Consultancy services
- Provide advise on the accounting system and internal control system of the client.
- Provide advise on changes in the systems e.g. from manual to computerized accounting
systems within the entity.
e. Management services
- Organizing seminars and training workshops for the top management.
- Assisting in recruitment of senior personnel for the client entity.
f. Technical services
- Provide advise on the effect of economy on business operations.

Structure of a firm of practicing accountants
ABC & CO
AUDIT PARTNER
AUDIT MANAGER
ACCOUNTANT IN CHARGE
AUDIT STAFF
ASSISTANT CLERK TRAINEE

Responsibilities
i. Audit partner
1. Prepares and signs the engagement letter for new clients accepted
2. Organizes for the audit field visits of the client audits.
3. Plans and draws program of time, cost and usage budgets of the clients audits.
4. Writes and signs the audit reports.
5. Accepts or declines an appointment based on the qualification of the firms.
ii. Audit manager

1. Directs and controls the audit work.
2. Documents the working papers for evidence purposes
3. Review and supervises the audit work.
4. Performs investigation for suspected areas of fraud.
iii. Accountant in charge

1. Invoices the clients for completed audit work.
2. Prepares accounts for the firm
3. Receives, banks and pays cheques.
4. Determines whether an assignment for an audit is economical or not.
iv. Supervisor
1. Assits the manager to ensure efficiency in the audits
2. Performs progress review of the audit work
3. Directs, control and supervises individual audit assignment

4. Implements audit programs.
5. Train the junior staff
v. Audit staff
They take a direct part in the audit and they are assigned duties by the manager.
They are the ones who perform the actual audit work i.e examining the accounts and financial
statements
AUDIT
Its defined as an independent examination of and expression of an opinion on the financial

statements of the reporting entity by an appointed auditor in accordance to his appointment and
in compliance with any other statutory obligation or requirements.
The objective of an audit of the financial statements is to enable the auditor express an opinion,
whether the financial statements are in all material respect, in accordance with an applicable
financial reporting framework. I.e. IAS and IFRS.
NEED FOR AN AUDIT
1. Stewardship accounting
2. True and fair view
3. Separation of powers and control of business (Audit Divorce)
Stewardship accounting
Stewardship means the management of resources by a group of persons on behalf of another

group in the most profitable manner.
Accounts prepared by the directors on behalf of the shareholders are considered to be

stewardship accounts and because their credibility is doubted, there need for an external auditor
on such accounts.
2. True and Fairview
It’s a requirement of the company’s act that accounts prepared by the directors should give a true
and fair view. Through an external audit, the auditor is able confirm that accounts give a true and
fair value which means;
a. That proper books of accounts are kept.

b. Accounts are in agreement with the books of accounts
c. Accounts do comply with the company’s acts.
3. Separation of powers and control of the business

The shareholders have divorced themselves from running the affairs of the business and as a
result they have entrusted the management and control of business affairs in the hands of
directors.
Arising from these responsibilities there’s need for external audit because the shareholders do
suspect that the directors may be in a position mis-management the business in their absence.
OBJECTIVES OF AN AUDIT
1. Main / statutory / primary objectives company’s act.
These are objectives arising from statutory requirements. The objective of an audit of financial
statements is to enable to auditor to report to shareholders and express an opinion on whether
the financial statements are prepared in all material respect, in accordance with an identified
financial reporting framework. The phrases used to express the auditors opinions are “give a true
and fair view” or “present fairly in all material respects” which are equivalent terms.
These should be read together with the matters contained in the 7 th schedule of the company’s
Act. These matters are:
a) Whether they have obtained all information and explanations which to the best of their
knowledge and believe were necessary for the purposes of their audit.
b) Whether in their opinion proper books of accounts have been kept by the company so far as it
appears from their examination of those books.
c) Whether proper returns adequate for their purpose of audit have been received from
branches not visited by them.
d) Whether the company’s balance sheet and income statement dealt with by the report or in
statement annexed (attached) thereto i.e. cash flow statement are in agreement with the
books of accounts and returns.
e) Whether in their opinion and to the best of their information and according to the
explanations given to them, the said accounts give the information required by the company’s
Acts. In the manner so required and give a true and fair view.
i) In the case of the Balance Sheet, of the state of affairs of the company as at the end of
its financial year.
ii) In the case of the income statement, of the profits or loss for its financial year.
2. Incidental / professional body/ secondary objectives
The Institute of Certified Public Accountants of Kenya (ICPAK), also puts to the Auditors shoulder
to achieve the following incidental objectives:
a) Detect errors and frauds and assist in their prevention.

b) Provide advise to the management through the management letter on the weaknesses of
internal control system, adequacy of staff and client computerized system.

The stated objectives can be achieved by the auditor through;
i. Planning for the audit of the clients

ii. Preparing and maintaining working papers
iii. Understanding the clients accounting system and the internal controls system
iv. Obtaining quality evidence
v. Discussing the accounts with the directors
vi. Vouching and verification
vii. Analytical review procedures.
Changes in audit objectives over the years
A change is brought about by circumstances surrounding the audit practice. Audit objectives
have changed over the years due to the following reasons:
a) Changes in the legal framework governing audit practice.

b) Changes in the auditing standards and guidelines adopted by auditors
c) Change in the structure of business, size and volume of transactions.
d) Development of IT affecting the accounting function
e) Pressure from the clients to keep audit fee low while maintaining the quality of audit work.
The above reasons have made the objectives of an audit to change as follows:
i) In early auditing the auditor was expected to prove for the true and correct view of the
financial statements while in modern auditing the auditor is called upon to prove for the true
and fair view. This is because financial statements contains provisions which are estimates
making the figures not to be correct and instead only fair.
ii) In early auditing the auditor’s main duty was to detect errors and frauds while in modern
auditing this duty is an incidental objective to the proving of the true and fair view.
iii) In early auditing, the auditor could be appointed to carry out both accounting and auditing
under the same engagement which in modern auditing is not possible due to the concept of
professional independence.
iv) In early auditing, the auditor’s main areas of work were determined by the management
while currently they are established by the statute.
v) In early auditing the findings of the auditor were included in the auditors reports and were
addressed to the management of the company while in modern auditing auditors findings are
divided into two. i.e.
i. A statutory report to the shareholders reporting on the true and fair view of financial
statement,
ii. A report to the management that highlights weakness in the company ICS.

PROBLEMS ENCOUNTERED BY AUDITORS IN ACHIEVING AUDIT OBJECTIVES
In as much as the auditor would want to achieve the objectives in the audit he or she would come
across the following problems;
i. The set up of the business enterprise may be technical or complicated for the auditor to
understand and operate.
ii. The management knowing that the auditor has come to evaluate their work and report this
to the shareholders will not cooperate with the auditor and hence he will not be able to
obtain any information from them.
iii. Due to high cost of external audit the management may decide to limit the checkings the
auditor is expected to carry out. This makes it difficult for the auditor to reach the objectives.
iv. Where the management have colluded with third parties to commit fraud it may be difficult
for the auditor to discover this.
v. Most of the audit partners do rely on the work of audit juniors and it may be possible that in
the course of audit an audit junior may exercise negligence resulting from a material
omission which may make it impossible to achieve the objectives.
Types of audit
AUDIT
External Audit Internal Audit
Public / Private / non

Statutory Audit Statutory Audit
1. External Audit
This is a type of audit which is conducted at the end of financial period. It is conducted by an
external auditor (independent Auditor). It is classified into two:
a) Public / statutory audit
This is audit that is legally required to be conducted. The auditors scope of work and
responsibility is defined by the companies Act provisions. The management of the company can
only increase the auditor’s work but cannot reduce or suspend the work all together.
A statutory audit is conducted by the following business:
 Limited companies
 Banks and financial institutions
 Insurance companies
 Co-operative societies
 Building societies etc.
Where the business is governed by any other law apart from the companies Act such as insurance
and banking Acts the auditor would incorporate the relevant Acts when reporting on the
b) Private / non statutory audit
This audit is not legally required to be conducted. It is carried out due to the willingness of
owners or management.
Under this audit the auditor’s scope of work and responsibility is defined by an agreement
between the management and the auditor. Such an agreement is important because;
i. It defines the auditor’s scope of work and responsibilities for the audit.
ii. It minimizes any misunderstanding between the auditor and management in future.
iii. It confirms in writing all verbal communication done between the auditor and the
management of the company.
iv. Provides the basis of charging the audit fee.
v. It enables the auditor to create a contractual obligation with the management of the
company.
Under the private audit the auditor’s duties can be increased, reduced or suspended by the
management.
This type of audit is ideal for the following businesses:
 Sole proprietorship
 Partnership
 Trade unions
 Trusts
 NGOs
 Clubs etc.

2. Internal Audit
This is a recent development in the accounting field. It is a department on its own within the
entity.

It is set up by the management to assist them carry out the following:
i. Operate the business in an orderly and efficient manner

ii. Ensure for the safeguarding of the company’s assets
iii. Ensure adherence with the company’s policies
iv. Ensure for accuracy and reliability of the company’s records
v. Ensure compliance with the statutory requirements
Internal audit department is headed by the chief internal auditor who is appointed by the
management. His scope of work and responsibility is defined by the management.
Functions of Internal audit department
1. Acts as consulting department to all other departments on matters of control and company
policies.
2. Review the company’s activities to ensure that they are in line with the statutory requirement
and company policies.
3. Serve to detect and prevent errors and fraud through constant review of accounts and
procedures.
4. Conduct special investigations where fraud or error is suspected, where policies are out of
hand or where targets are not achieved.
5. Act as a feed back to management regarding the success or failure of operations.
6. Performs routine verification of assets and liabilities constantly checking accuracy of the
accounts.
Similarities of external and internal audit
i) Both are interested in the strength or weakness of internal control system and will evaluate
the system to ensure efficiency.
ii) Both carry out independent reviews of the company’s operations and activities to ensure that
they are running according to the companies policies and statutory requirements.
iii) Both have to determine whether proper books of accounts have been kept by the company
and are in accordance with the requirements of the companies Act.
iv) Both are concerned with the safety of the company’s assets.
v) Both are concerned with the detection and prevention of errors and frauds.
Differences between internal and external audit
External Internal
1. Conducted on behalf of the shareholders 1. Conducted on behalf of the management
2. Conducted by a qualified personnel 2. May be conducted by any competent
approved to act as such by the companies accountant.
Act

3. Conducted by an independent party 3. It is conducted by an employee of the
company
4. It is a requirement of the companies Act for 4. It is not regulated by the provisions of the
all registered companies companies Act.
5. It is meant to determine the true and fair 5. It is meant to strengthen the companies
view of the financial statement internal control system
6. Auditors scope of work is determined by the 6. Auditors scope of work is determined by
statute the management.
7. External auditor is appointed by 7. Internal auditor is appointed by
shareholders and reports to them management and reports to them.
TIMINGS OF AN AUDIT
1. Continuous audit
2. Interim audit
3. Final / completed audit
(1) Continuous audit
This is detailed examination of the books of accounts on a regular basis. It is normally conducted
by very large organizations where the clients daily transactions are many and cannot be audited
completely at the final audit.
This audit involves
a) Regular examination of the company’s records to discover any material misstatement arising
from an error or fraud.
b) Review of the company’s internal control system to determine its effectiveness and
accounting system to determine its adequacy.
c) Conducting analytical review procedures on transactions and financial statements.
d) Examination of financial statement items.
e) Completing the audit and providing the audit report to the management.
Conditions under which continuous audit is ideal
1. Banking organizations where transactions involve cash which is at a high risk.

2. Manufacturing and large scale company’s where the volume of transaction is large that they
cannot be audited in a single session.
3. Business organizations where the internal control system is weak in which case they cannot
be audited at the end of the financial period as errors and frauds in such organization will
have reached high proportions.
4. Companies with branches and subsidiaries in which case accounts in all branches cannot be
audited at year end.

Merits of a continuous audit
1. It speeds up completion of the final audit.

2. Enables the auditor to detect and fraud at an early stage.
3. The audit senior is able to understand the clients accounting system, their forms of control
and internal operations.
4. Acts as a boost to the morals of accounting staff who will keep their records upto date.
5. Facilitate preparation of management letter as he auditor by virtue of his almost constant
presence in the organization will be able to understand such a business properly and by
extension give advice to the situation facing the company.
Demerits
1. It’s expensive due to the long hours taken by the auditor and his staff in the client business.
2. It disrupts and dislocates the accounting work due to frequent visits by the auditor.
3. It involves a tedious note taking exercise throughout the audit period and as a result it may
not be liked by inefficient staff.
4. It is not ideal for small businesses with small volume of transactions.
5. Figures already audited maybe altered after the audit by the company’s staff.
Solutions to the above problems
1. The auditor should instruct the client’s staff not to initiate any alterations without the
auditors consent.
2. The auditor should take note of questions raised so that these can be answered after later
with the assistance of the clients.
3. During the next audit visit the auditor should ensure that he glances over the totals he had
noted earlier in order to detect fraudulent changes.
4. The auditor should always visit the client on a surprise basis to ensure that fraudulent
alterations are easily detected.
(2) Interim audit
This kind of audit is conducted in two ways;
a) As part of the final audit where the auditors conducts such an audit after a given part of the
financial period and then leaves the other entries to be audited in the final audit.
b) To ascertain the companies interim performance for purpose of paying interim dividends
particularly where the companies legal provisions empowers such a company to declare
interim dividend and then a final dividend.
The work carried out in the interim audit includes;
1. Reviewing of accounting system and internal control system for adequacy and effectiveness.
2. Examining the transactions and agreeing them to the source documents.
3. Analytical review procedures on the interim financial statements.
4. Concluding on the true and fair view of the matters included in the interim financial
statements.
5. Issuing a report for the true profits of the business to be used as a basis for payment of
interim dividends.
Conditions under which interim audit is ideal
1. Where the company is empowered by the legal provision to pay interim dividends in which
case the auditor will ascertain the companies interim performance for the purpose.
2. Where the company by law is required to publish its interim performance for interest of the
stakeholders e.g. shareholders, banks, customers, suppliers, government etc.
3. Where an organization is operating in a volatile market and the owners wish to keep track of
the companies performance on an interim basis.
Advantages of interim Audit
1. Errors and frauds may be prevented and detected.

2. Provides the basis for the payment of interim dividend.
3. Facilitates completion of the final audit.
4. It is less costly than a continuous audit.
5. It is useful for the preparation of interim reports which is necessary for managerial decision
making process.
6. This audit is used to assess the strength or weakness of clients internal control system which
is necessary for carrying out the final audit as it is on the basis of controls existing during the
interim audit that the audit test can be designed for the final audit.
7. This audit entails less disruption in the accounting work compared to a continuous audit as it
is conducted halfway through financial period.
Disadvantages
1. Figures already audited maybe altered by the client staff through fraudulent manipulation or
they may be done so by the company management to portray a better performance of the
company in a bid to influence the level of interim dividends.
2. Errors and frauds detected at this point of the financial period will have reached advanced
stages such that their detection no longer assists the company as loses have already been
incurred.
3. This audit is ideal for large companies with large volume of transactions and thus may not be
used by small companies.
Solutions to the above problems

1. Alterations of figures should be done using journal entries which should then be listed for
auditor’s attention.
2. In case the audit is carried out as part of the final audit the auditor should caution the clients
not to alter any figure without his consent.
3. The client should be advised to boost its ICS or to have an internal auditor to minimize
occurrence of errors and frauds.
(3) Final / Completed Audit
This audit is conducted in two ways;
i. It can be conducted at the end of the financial period in one session. It is ideal for small
businesses whose transactions can be audited in one session.
ii. It may be preceded by continuous audit or interim audit or both. In such a case the preceding
audit will have been conducted to minimize the work load at the end of the financial period.
Final audit is important because:
a) For a limited company it fulfills the statutory requirement i.e. the auditor has to state that at
each and every AGM the accounts of the company and the auditor’s report were laid down
before the members and were debated upon by the members.
b) Annual report is required by the company which can only be possible through a final audit.
c) The tax department would want to ascertain the tax liability the company which can only be
possible through a final audit.
Advantages of a final audit.
a) It eliminates tedious note taking exercise especially when it is done in one session.
b) It is less expensive compared to a continuous audit as its less time consuming.
c) It is easier to plan and execute as it takes place at the end of financial period and in one
session.
d) It eliminates possibility of alteration of figures.
e) More evidence is available for the audit.
f) It does not interupt the accounting work since the books of accounts have been balanced and
closed down.
Disadvantages of a final audit
a) It may leave some errors and frauds undetected at the completion of the audit or may be
detected when it is too late.
b) It may be difficult to conduct such an audit in large organizations which have large volume of
transactions.
c) Due to the time constraints the auditor may not undertake a thorough examination and this
may lead to a biased audit report.

Advantages / Significance / Importance of an External Audit
a) To the limited liability companies.

i. An audit provides assurance and credibility to the accounts which are relied upon by the
interested parties.
ii. It provides protection to 3rd parties who are not directly involved in running the affairs of the
business.
iii. It acts as a detective and preventive measure against errors and frauds.
iv. An auditor gives advice to management for the purpose of planning and operating the internal
control system.
v. If a business is to be sold as a going concern the price is determined based on the audited
accounts.
vi. Audited accounts are used as a basis of obtaining short term and long term loans from the
financial institutions.
vii. Audited accounts provide the basis of settling insurance claims in case of any loss.
viii. An audit allows for the correct computation of tax liability by the government.
ix. Audited accounts serve as a basis of declaring dividends.
b) To partnership
i. Independently audited accounts by a firm of practicing accountants minimize any disputes
among the partners on profit sharing retirement or admission of partners.
ii. Through an external audit the dormant or sleeping partner is able to understand the financial
progress of the partnership.
iii. During the audit the external auditor would be useful to the partnership in determining and
advising on the nature of the firms controls.
c) To the sole proprietor

i. Errors and frauds would be detected and prevented.
ii. The accounting staff would be made to become more vigilant and up to date in their records.
iii. The audited accounts would provide the basis of borrowing short and long term loans from
financial institutions.
iv. Insurance companies would make compensation on the basis of audited financial statements.
v. The proprietor would get free advice on the accounting function general management and
control of the firm.
vi. The audited accounts are generally acceptable by the tax department for ascertainment of tax
liability.
Disadvantages of an External Audit

1. Financial leakages to competitors. The audit report prepared and signed by the auditor
confirms the picture portrayed by the financial statements of the company. As a result of this
the competitors are able to understand the trading result of the company check notes.

2. High operation cost: of late the fee charged by auditors are drastically high and therefore
results to high operation cost of the business.
3. Lack of independence: Even though the auditor is required to remain independent throughout
the audit practically this may not be possible because he has more time with the directors
than he has with the shareholders and as a result the directors may have his independence
compromised.
4. Lack of credibility in auditor’s report. Reports given by the auditors are not liked by all users
because some of the scope of reporting, are not convincing to the investors,do contain false
information and in some cases incomplete.
DISTINCTION BETWEEN AUDITING AND ACCOUNTING
Accountancy is the art of collecting, arranging, classifying, analyzing, recording, processing

and presentation of accounting information to provide a meaningful data or useful data to
assist the management in Decision making.
Auditing in accountancy is concerned in determining whether the recorded information

reflects the economic events that occurred during the accounting period. Therefore an auditor
must be an expert in accounting to attain his objective.
DIFFERENCES
Auditing Accounting
i. It’s the examination of the books of i. It is the preparation of the books of
accounts with to view of forming an accounts as an aid to managerial
opinion on the true and fair view of the decision making.
ii. Its carried out independently of all ii. No independence is required accounts
parties are prepared by employees.
iii. It’s a statutory requirement for all iii. It’s essential for all business regardless
limited companies to have their of their size.
accounts audited.
iv. Its conditioned on prepared financial iv. It’s not conditioned to any prepared
statements financial statements.
v. Its conducted at year end v. It’s a continuous process throughout
the accounting period.
vi. An auditor receives audit fees. vii. An accountant receives a salary

DISTINCTION BETWEEN AUDITING AND INVESTIGATIONS
Investigation is defined as a commission set up to carry out the probing of suspected fraud. An
investigator may or may not be the auditor. Investigation may go beyond the accounting
books and may take longer than the duration of audit.
The report provided by the investigator is submitted to the clients to take the necessary
action.
Common types of investigations include:

1. Investigation for fraud.
2. Investigation for acquisition of shares of a company.
3. Investigation for mergers, takeovers and amalgamations.
4. Investigation for liquidation and receivership.
5. Investigation for credit worthiness for loans.
Differences
Auiting covers the accounts of the entity, the vouchers supporting the transactions and the
accounting policies followed by the entity. Investigations proceeds beyond auditing and do
call for further investigations or searching for inquiry with the outsiders who have adequate
knowledge about the business and may go beyond the financial records of the company.
Auditing is carried out in accordance to the Company Act provisions, Auditing standards and
guidelines and the current practice by audit firms. While investigations, are carried out in
accordance to the instructions given by the clients in respect to such investigations.
USERS OF AUDITED FINANCIAL STATEMENTS AND AUDITORS REPORTS AND THEIR

INFORMATION NEEDS.
a) Potential investors
The providers of capital and their advisors are concerned with the risk inherent in and the
return provided by the investment. They need information to help them determine whether
they should buy, hold or sell their investment.
b) Employees
Employees and their representative groups are interested in information about the stability
and profitability of their employers. They need information which enables them to assess the
ability of the enterprise to provide retirement benefits and employment opportunities.
c) Lenders/ Banks
They are interested in information that enables them determine whether their loans and
interests attaching to them will be paid when.
d) Suppliers and trade creditors:
They are interested in information that enables them determine whether the amount
owing to them will be paid when due.
e) Customers :
They are interested in information about the continuity of the enterprise especially when
they have a long term involvement with or are dependent on the enterprise for supply of
goods and services.
f) Government and their agencies

They are interested in allocation of resources and therefore the activities of the enterprise.
They need information in order to regulate the activities of the business and determine the
taxation policies.
g) Management
It requires information that will help in decision making.
Audit strategies / Approaches

An audit approach is a methodology that can be used in auditing the financial statements of a
company. They usage of an approach depends on the circumstances and the risk assessments of
the clients. Some of the approaches include;
1. System based audit approach / compliance audit.
2. Substantive audit approach.
3. Analytical review procedure approach
4. Business audit approach
RISK BASED AUDIT APPROACH
1. System based audit approach

This is the evaluation of the design and effectiveness of the accounting system, internal control
system and concluding whether they are working as expected. The following stages or steps are
followed in a system based audit.
a) Obtain an understanding of the business environment in order to assess whether the

accounting system and Internal Control Systems is appropriate to the client.
b) Ascertain the completeness of the accounting system and the Internal Control Systems by
form of inquiry into:
i. How major transactions are initiated and completed.
ii. The major accounting records produced or maintained by the accounting system.
Ascertaining the system can be done to determine whether the systems are effective or
not.
c) Record the accounting system and Internal Control Systems through narrative notes flow
charts answers to internal control questionnaire and organizational charts.
d) Perform a walk through audit test by tracing transactions through the accounting records to
ascertain the correctness of the description of the system.
e) Perform a preliminary evaluation of the system using internal control evaluation
questionnaire.
f) If the auditor intends to obtain reliance on the accounting system and Internal Control System
he must design appropriate compliance test e.g. inspection and observation of procedures.
However if the system is strong the control risk will be assessed as being low and therefore
the auditor can rely on the Internal Control System in order to gather evidence on the
financial statements. If the system is weak the control risk will be assessed as being high and
therefore the auditor cannot rely on Internal Control System he should adopt a substantive
audit approach.
N.B
Control risk is the inability of the accounting system and Internal Control System to detect and
prevent material errors and fraud on timely basis.
2. Substantive Audit Approach
This is a detailed examination of financial statements and accounting records with an

intention of detecting material errors and fraud. It involves testing the account balances
transactions and records in order to gather evidence on the accuracy validity and
completeness of the transactions.
It is usually adopted if the auditor suspects that the financial statement might be containing
material mis-statement and the accounting systems and Internal Control System not existing
or they are existing but weak.
3. Analytical Review Procedures:
This refers to the analysis of significant accounting ratios trend performance and investigation of
variances or relationships that deviates from predictable in order to obtain an understanding of;
a) Clients business through trend analysis.

b) To identify potential risk areas in the business.

Analytical review procedures are appropriate when the auditors have audited the financial
statements for more than 2 years. Analytical review procedures can be applied in different
stages of an audit.
i. Audit planning to provide evidence on the risky areas where audit procedures are
required.
ii. During execution of the audit process to provide evidence on the nature, timing and extend
of the internal control system and audit procedures.
iii. Completion of an audit to provide evidence on the true and fair view of the financial
statement.
RISK BASED AUDIT APPROACH
These audit strategy is based on the definition of audit risk and its analysis in to 3 distinct
components of inherent, control and detection risk.
 Auditor’s assessment of inherent risk impacts on the nature and extent of the audit test and
other procedures which are necessary to reduce the overall audit risk to an acceptable low
level.
 Under this approach the auditor identifies the organization’s activities and objectives and
then determines the risk facing the clients.
Based on this knowledge the auditor designs his audit test and procedures in such a way that
high risk areas are given more attention, introducing the concept of audit by exception.
The increased use of risk based audit is due to two factors;
a) Growing complexity of the business environments increasing the risk of fraud and mis-
statement.
b) Pressure from the client on the auditor to keep audit fee low while improving the quality of
the audit.
Advantages of Risk Based Audit Approach
i. It increases the auditor’s chance of detecting material errors and fraud.

ii. It enables the auditor to provide value for money audits.
iii. It leads to low engagement risk i.e. reduce chances of giving wrong opinions.
iv. There is effective use of audit resources.
Disadvantages of Risk Based Approach
i. It is expensive because of the resources employed.

ii. It requires highly skilled and competent audit staff.
iii. Inherent risk is difficult to assess because it is affected by behavioral characteristics of the
controlled environment.

BALANCE SHEET AUDIT APPROACH
This is the examination of the balance sheet item from the balance sheet and tracing them to their
supporting accounting documentation.
Unlike the system based audit, the accounting system which provides the financial information is
largely ignored. The following may be identified as the reasons why the balance sheet audit
cannot be sufficient in forming an opinion on the financial statements.
i. The appropriate valuation of assets under the historical cost convention is largely dependent
on reliable accounting records.
ii. Balance sheet audit largely ignores income statement items thus ignoring the fact that users of
audited F/S in addition to their concern with solvency, directed their attention to achieved
earnings and the income earning potential of the company.
iii. Generally accepted auditing standards today require that there should be a proper study and
evaluation of the internal control system as a basis of reliance there on and for determination
of the extent to which audit test are to be applied.
 Balance sheet audit is ideal in the following circumstances
i. When the client audit under review is large in size.
ii. If the entity has a highly computerized accounting system and the internal control
system (ICS) is effective in operation.
 This audit falls under partial audits and as such may lead to a biased report because only a
few entries are examined which may not be a representative of the client’s audits.
AUDIT AS AN ASSURANCE ENGAGEMENT

A professional accountant can provide 2 general types of services.
i. Assurance / engagement
ii. Non-assurance services /engagement.
i. Assurance engagement
It is an engagement where a professional accountant evaluates or measures a subject matter that
is the responsibility of another party against identified suitable criteria and expresses a
conclusion that provides the intended user with a level of assurance about the subject matter.
Assurance engagement performed by professional accountants are intended to enhance the
credibility of information about a subject matter by evaluating whether the subject matter
conforms in all material respects with suitable criteria; thereby; improving the likelihood that the
information will meet the needs of an intended user.
In this regard, the level of assurance provided by the professional accountant’s conclusion
conveys the degree of confidence that the intended user may place in the credibility of the subject
matter.

TYPES OF ASSURANCE
An assurance engagement can either by attestation or direct reporting.
Assurance engagement is said to be attestation if an accountant is expected to confirm / Dispel

assertions made by management i.e.
i. Existence
ii. Rights and obligations
iii. Occurrence
iv. Completeness
v. Valuation
vi. Measurement /cut off
vii. Presentation and disclosure.
 The auditor declares whether the subject matter comply/Don’t comply with the criteria
e.g. An audit
On the other hand, a direct reporting engagement is where the auditor says whether anything has
come to his or her attention during evaluation that makes him or her believe that financial
statements are mis-stated.
Examples of Assurance Engagements / Services
1. Audit engagement
 An audit engagement is an attestation engagement where a professional accountant carries
out an independent examination of the financial statement and expresses an opinion on the
financial statements of an entity pursuant to that appointment and in a compliance with any
other relevant statutory and professional requirements.
 Auditors provide a high but not absolute level of assurance and as is technically said to be
reporting positively.
Objectives of an audit engagement (see previous notes on main and incidental objectives of an
audit)
2. Review Engagement
This is where an auditor states whether on the basis of the procedures required in an audit ,
nothing has come to his attention to make him believe that the financial statement have not
been prepared in accordance with an identified financial reporting framework i.e. IAS, IFRS.
Review engagement are-extremely similar to an audit engagement in that similar work is
under taken and the key difference between them is that a review engagement is designed to
give less assurance than audit on similar issue.
In a review engagement the auditor gives a negative assurance i.e. the auditor gives an
assurance that nothing has come to his attention to indicate that financial statements have not
been prepared in accordance with an identified financial reporting framework. A review
engagement involves direct reporting.

ii. Non-assurance engagement /services
Not all services offered by professional accountants are assurance services. The following are
other key services and engagements performed by auditors but do not constitute an
assurance engagement.
a) Agreed upon procedures
b) Compilation engagements
c) Preparation and submission of tax returns
d) Management consulting
e) Other advisory services
a) Agreed upon procedures

This is where an auditor carries out procedures of an audit nature to which the auditor and
the client have agreed in advance. The auditor simply provides a report of factual findings of
agreed upon procedures, expresses no opinion and provides zero level of assurance.
The users of the report assess for themselves the procedures and findings reported by the
auditor and draw their conclusion from the auditors work.
Independence is not a requirement for agreed upon procedures.
b) Compilation engagements
This is where the accountant is engaged to use his accounting knowledge as opposed to his
auditing expertise to collect, classify and summarize financial statements information.
A compilation engagement would include the preparation of financial statements (which may
not or may be a complete set of financial statements) but may also include the collection,
classification and summarization of other information. Independence is not a requirement of a
compilation engagement.
N.B The auditor does not carry out an audit on the financial statements they have prepared or
compiled.
Elements of an assurance engagement
Whether a particular engagement is an assurance engagement will depend on whether it

exhibits the following elements.
1. A 3 party relationship must exist i.e. professional accountant, a responsible party and the
intended user.
The responsible party must be a company or government department where as the
intended user are members of the public or other stakeholders interested with the
assurance report.

2. Subject matter i.e. what is being examined or evaluated e.g. environmental reports, tax
reports, prospective financial information. (Budgets or forecasts) financial statements or
internal controls.
3. Suitable criteria –a criteria is a standard or a benchmark that is used to evaluate the
subject matter of assurance engagement for instance. For the financial statements to
determine whether they are prepared in accordance with IAS and IFRS so as to give a true
and fair view.
 Suitable criteria must exhibit the following characteristics
a) Relevance –relevant criteria contribute to conclusions that assist decision making by

the intended users.
b) Completeness –criteria are sufficiently complete when the relevant factors that could
affect the conclusions in the context of engagement circumstances are not omitted.
c) Reliability- Neutral criteria contribute to conclusions that are free from bias
d) Understandability –understable criteria, contributes to conclusions that are clear,
comprehensive and not subject to different interpretations.
4. An engagement process- it involves agreeing the terms of engagement, scope of work,
deciding the methods to use for gathering evidence, evaluation and measurement to
support conclusions reached. The evidence gathered by the auditor must be sufficient and
appropriate.
5. Conclusion and assurance report- this is where the practitioner should express his
assurance opinion regarding how the subject matter was prepared. The practitioner
provides a written report containing a conclusion that conveys the assurance obtained
about the subject matter information.
Auditing standards establish the basis elements for assurance reports. In addition, the
practitioner considers other reporting responsibilities including communicating with
management when it is appropriate to do so.
Therefore, an audit engagement is an assurance engagement in that other than confirming

management assertion, it also exhibits all the elements of an assurance engagement as
illustrated below.
i. 3 party relationship - Practitioner –external auditor

- Responsible party- management / directors of the company
- Intended user –shareholders and other stakeholders i.e.
government, bank, employee.
ii. Subject matter- financial statements of the company

iii. Suitable criteria – IAS, IFRS, Company’s Act requirements.
iv. Engagement process- Audit process
v. Conclusion and Assurance report- Audit opinion and positive assurance.

Engagement Acceptance
A practitioner accepts an assurance engagement only where the practitioner’s preliminary

knowledge of the engagement circumstances indicates that;
i. Relevant ethical requirements such as independence and competence will be satisfied.

ii. The engagement exhibits all of the following characteristics.
a) The subject matter is appropriate
b) The criteria to be used are suitable and are available to the intended users/.
iii. The practitioner has access to sufficient appropriate evidence to support the practitioner’s
conclusion.
iv. The practitioner is satisfied that there is a rational purpose scope of the practitioner’s
work. It may be unlikely that the engagement has a rational purpose.
Problems encountered in providing assurance services.

i. There could be disagreements between the auditor and the clients’ concerning information
to be collected, about the subject matter and suitable criteria.
ii. The auditor may be unable to obtain sufficient appropriate evidence because of limitation
of scope in his work.
iii. Litigation threats by managers may make the auditor comprise his independence.
iv. Some aspects of the subject matter may not be inconformity with the suitable criteria.
Types of assurance reports.
a) Positive / Reasonable assurance- In an audit engagement, the conclusion is expressed in the

positive form e.g. “in our opinion the subject matter conforms in all material respects with
identifiable criteria”.
This form of expression conveys reasonable assurance which indicates that given the level of
the practitioners, evidence gathering procedures and the characteristics of the subject matter,
the practitioner has obtained sufficient and appropriate evidence to reduce assurance
engagement risk to an acceptable low level.
Reasonable assurance obtained in an audit engagement is less than absolute assurance

because reducing assurance engagement risk to zero is not attainable.
Reasons why absolute level of assurance is not possible
a) Use of selective testing/ sampling procedures

b) Inherent limitations to the accounting system and ICS.
c) The fact that much of audit evidence is persuasive rather than conclusive in nature.
d) The use of judgment in gathering evaluating evidence and forming a conclusion.
e) Inherent limitation of audit report.

b) Negative Assurance / Limited assurance- In a review engagement (forecasted financial
information) the conclusion is expressed in the negative form e.g. “nothing has come to our
attention that causes us to believe that the subject matter does not conform in all material
respects with identifiable criteria.” This form of expression conveys limited assurance which
indicates that given the level of the accountants evidence gathering procedures and the
characteristics of the subject matter, the accountant has obtained sufficient and appropriate
evidence to reduce assurance engagement risk to a moderate level.
Assurance Engagement Risk
It is the risk that the practitioner expresses in appropriate conclusion when the subject matter
information is materially mis-stated.
Expectation Gap
This is the difference in perception between what users of financial statements think that
auditors do and what auditors as trained professional actually do. It arises because many users
do not understand the role of the auditor in an audit. E.g.
i. Users think the auditor’s main duty is detecting errors and frauds whereas this is the work of
the management.
ii. Users think that auditor’s report to the management whereas auditor’s report to the
shareholders.
iii. Most users think that the auditors work is defined by the management but it is actually
defined by the statute.
iv. Users also think that modified report is better than unmodified report.
v. Users expect auditors to assist directors in preparing financial statements.
Elements of Expectation Gap: Standard, Performance, Liability
1. Standard gap- it arises because users do not understand the auditing standard and thus they
do not understand the audit.
2. Performance Gap- It arises where the users feel that the auditor has performed below the
standards and have not offered value for their money.
3. Liability Gap- This is where users do not understand to who the auditors are legally liable.
Most users think that auditors are liable to managers whereas they are liable to all the
shareholders.
The following are the main causes of expectation gap
i. Mis-understanding on the part of the user as to what is the role of the auditor.
ii. The quality of audit work.
 The accountancy profession has accepted that it is their responsibility to narrow this gap.
Measures to bridge the expectation Gap

i. On the issue of misunderstanding – this arises due or lack of or poor communication. And
therefore, to address this issue the accountancy profession has improved communication with
the users. The auditing standards (ISA 700) on auditor’s report have been expanded to
include the following additional information.
a) The auditor must identify the financial statement audited.

b) The auditor must clarify the responsibilities of the directors and that of the auditor towards
the financial statement.
c) The auditor must stress on the limited nature of auditing i.e. it is undertaken on a test basis
and therefore 100% completeness and accuracy cannot be guaranteed.
d) The auditor cannot be relied upon to detect errors and frauds.
ii. On the issue of quality of audit work. To deal with the quality of auditor’s work, auditing
standards were introduced to establish the framework within which auditing is conducted.
The auditing standards were established to address specific problems which included.
a) ISA 300, Planning – it demands that the auditor prepares an audit plan before he undertakes
the audit exercise.
b) ISA 240, Errors and Frauds – it demands that auditors pay a particular attention to the
possibility of fraud and errors.
c) ISA 400, Risk assessment and internal control system. It demands that auditors should assess
the control risk by obtaining an understanding of the controls.
d) ISA 500, Audit Evidence- It demands that auditors obtain sufficient and appropriate audit
evidence to draw reasonable conclusion there from.

TOPIC 2: LEGAL AND PROFESSIONAL REQUIREMENT OF AN AUDITOR
A. LEGAL FRAMEWORK
It is a legal requirement for each and every limited company to undertake the following:-
i. Appoint a company auditor at each and every AGM conducted by the company members.
ii. To have the company accounts audited by such an auditor.
iii. To have the auditor report on the accounts prepared by the management.
iv. To have the audited accounts and the auditors reports laid down before the members at
each and every AGM for inspection, agreement and approval.
Purpose of Law to auditors
1. To define the scope of work and responsibilities of the auditor on the audit
2. Provide certain rights and privileges to the auditor to enable him carry out his duties.
3. To protect/control the auditor’s removal or resignation from office.
4. To provide the procedures of appointing the company auditor.
Qualities of an auditor
1. Integrity
He should be straightforward, honest, sincere and have fair dealings with the company
under audit.
2. Independence
He should and must demonstrate that he is independent from the management of the
company shareholders and 3 rd parties. There must be proper evidence that the auditor is
free from any interest in the company which may interfere with the audit work.
3. Confidentiality
He must be a person who maintains a high degree of top secrecy on the matters relating to
the clients except where consent has been obtained.
4. Competence
He must possess adequate skills and competence necessary in the audit work. This must be
supported by professional qualification, training, experience and knowledge in the
accountancy field, auditing economics, finance, law and commerce.
5. Objectivity
A professional accountant should be fair and should not allow prejudice or bias, conflict of
interest or influence by others to override objectivity.
6. Professional behavior
An auditor must be a person who is able to:-
a. Meet the professional requirements in practice
b. Observe the professional guidelines issued by the professional body e.g. ICPAK.
c. Abide by the rules of the institute during practice.

Qualifications / Eligibility of an Auditor
A person to be appointed as an auditor of a company is required to hold some specific

qualifications which are given in Sec 161 of the Company’s Act. These qualifications are:-
a) One must be a professionally qualified accountant i.e. ACCA, C PA or CFA.

b) One must be a registered accountant.
c) One must be a practicing accountant possessing the following requirement:-
i. Be a member of ICPAK.
ii. Be a person who has not been disqualified from acting as an auditor of the company’s branch
or subsidiary of the company.
iii. Be professionally independent from the entity under audit.
Disqualification / Ineligibility of an auditor
1. The company’s Act specifies those persons who cannot be appointed as auditors even if they
meet the professional requirements as per the Accountants Act Cap 531. Such persons
include:-
a) An officer or servant of the company being audited.
b) A person who is a partner or an employee of an officer or servant of the company being
audited.
c) All persons who are disqualified from acting as the auditor of the company’s subsidiary or
a holding company.
d) Body corporate- A body corporate is restricted from acting as an auditor because:-
i. They have limited liability yet liability for professional services is personal and
unlimited.
ii. An auditor is required to express an opinion yet a body corporate is a legal person
incapable of expressing a personal opinion on the accounts of the company.
2. Those who cannot be appointed as auditors due to their potential loss of independence
are:
a) Any person who is indebted to the company for large amounts or who has
given guarantee or security in connection to indebtness with any party.
b) A person holding more than 5% of the company’s share capital.
c) A person earning more than 15% of his total earnings from the company
under audit.
APPOINTMENT OF AUDITORS
1. Appointment by members during the AGM

Sec 159 Sub Section 1 of the Company’s Act empowers the company’s shareholders to appoint
the company’s auditor to hold office till the next AGM. During the AGM, the members shall be
expected to exercise their voting rights and pass a resolution of simple majority of those
members present in appointing the company auditors. The same AGM shall be responsible to
discuss and agree on the auditor’s duties, rights and remuneration.
According to Sec 159 Sub section 2, a retiring auditor is deemed to be automatically re-appointed
in the auditor’s office except under the following circumstances:-
a) He/she is not qualified for re- appointment.

b) He/she has given a notice to the company of not less than 28 days requesting not to be
reappointed in the next AGM.
c) A resolution intended to remove the present auditor has been passed by the members.
2. Appointment by BOD.
Sec 159 sub section 5 and 6 empowers the BODs to appoint an auditor only by nomination under
the following circumstances:-
a) In case of the company’s first auditors, the directors are empowered to appoint an auditor
before the first AGM.
b) To fill in a casual vacancy arising in the auditors office in between the AGM. A casual
vacancy, may be caused by:-
i. Auditors sudden death
ii. Auditor’s sudden resignation
iii. Auditor’s sudden incapacitation.
3. Appointment by the registrar of companies
Section 159(3) empowers the registrar of companies to appoint the company auditor 7 days
after conclusion of the AGM where the members have not appointed an auditor and neither
of such powers has been delegated to the company’s directors.
ENGAGEMENT LETTER
This is the contract between the auditor and the client. The letter is sent by the auditor to the
client outlining the scope of audit work and underlying responsibilities.
The letter becomes effective only after it has been acknowledged and accepted by the client.
Purpose of engagement letter
1. It defines the auditor’s scope of work and responsibilities for the audit.
2. Confirms in writing any verbal agreement made between the client management and the
auditor.
3. Minimizes any misunderstanding between the auditor and client management.
4. Explains in outline, how the auditor will approach his audit work.
5. Used to emphasize to the client management their responsibilities regarding the financial
statement of the company. These responsibilities are:-

a) To keep proper books of accounts and prepare financial statement that give a true
and fair view.
b) Prevent and detect errors and frauds in the company.
c) Set up an ICS which is effective in the company.
d) Safeguard the company’s assets against misuse.
e) Prepare and avail the necessary schedules for audit purposes.
6. It creates a contractual obligation between the auditor and the management of the company.
7. Provides the basis of charging the audit fee.
Contents of an Engagement Letter
1. Must have an explanation of what an audit is to the client

2. The audit method to be used in general terms. This will include a brief explanation of how the
auditor intends to gather audit evidence.
3. A reminder to the client that the auditor shall place reliance on the ICS and therefore, he
expects in the system, strong and reliable controls.
4. A reminder that the auditor will expect a letter of representation at the end of the audit from
the client management.
5. A reminder to the client that the auditor will give a management letter outlining the
weakness in the ICS and indicating possible solutions.
6. A reminder to the clients of the management responsibility on the accounts and financial
statements.
7. A reminder to the clients of the auditors restricted responsibility on prevention and
detection of errors and frauds.
8. Specify the basis of charging the audit fee.
9. Specify other services that may be offered in course of auditing.
10. Contain a note for the clients to acknowledge and if in agreement, sign for acceptance.
Circumstances when an engagement letter may be sent

1. On or before commencement of the audit to all new clients.
2. To existing clients who have not received one before.
3. At the request of the management to the auditor.
Circumstances of sending a revised engagement letter

1. When there is a change in the accounting system.
2. After a period of 3 years.
3. When there are changes in the scope of work and responsibilities of the audit.
DUTIES OF A COMPANY AUDITOR

1. The auditor has a duty to make report to the to the members of the company and state in the
audit report whether the company has complied with matters contained in the 7 th schedule
of the Company’s Act i.e.:-
a) Whether they have obtained all information and explanations which to the best of their
knowledge and believe were necessary for the purposes of their audit.

b) Whether in their opinion, proper books of accounts have been kept by the company so far
as it appears from their examination of those books.
c) Whether proper returns adequate for purposes of their audit, have been received from
branches not visited by them.
d) Whether the company balance sheet, income statement and the cash flow statement are in
agreement with the books of accounts and returns.
e) Whether in their opinion and to the best of their information and according to the
explanations given to them, the said accounts give the information required by the
Company’s Act in the manner so required and give a true and fair view:
i. Incase of the balance sheet of the state of affairs of the company as at the end of its financial
year.
ii. Incase of income statement of its profit or loss for the year then ended.
2. Duty to call for information regarding the securities of the company and whether they cover
the loans adequately.
3. Duty to prepare and maintain working papers to assist in investigation of the company’s
affairs.
4. Duty to certify statutory reports regarding the number of shares sold, cash received in
respect of allotment made and certificate of the number of shares.
5. Duty to assist in investigation whenever required to do so by the company.
6. Duty to certify the income statement and bank statement in a prospectus.
Rights of the company auditor
1. Rights to access the books of accounts and vouchers of a business at all times and including
vouchers kept by 3rd parties on behalf of the company.
2. Right to call for information and explanations which the auditor considers necessary for the
purpose of forming an opinion.
3. Right to receive notices of and attending general meetings.
4. Right to attend the AGM regardless of whether the accounts are the subject of discussion or
not.
5. Right to indemnity- An auditor has the right to be indemnified out of the company’s assets
against any liability incurred by him in defending his name if this was tarnished by the
company in any manner
6. Right to visit branches i.e.:-
a) Right to receive information and explanations relating to the activities of branches as far as
they affect the company’s affairs.
b) Right to examine branch accounts and request for returns submitted to the headquarters.
c) Right to communicate and receive information from 3 rd parties of such branches.
d) Right to receive representation from these branches over those matters for which the
auditor did to have sufficient documentary evidence.
7. Right to be remunerated. This includes:-
a) To be paid his audit fees as and when they fall due.
b) To have his expenses re-imbursed by the client i.e. out of pocket expenses.
c) To withhold his report until his fees have been paid in full.
8. Right to sign audit report.
9. Right regarding the removal of the auditor i.e.:-
a) Right to receive a notice of intention to remove him from the office
b) Right to attend the meeting at which he is to be removed.
c) Right to speak at such meetings.
d) Right to send his representation which should be circulated to the members.
10. Right to obtain legal and technical advice from the experts provided that the advice is
interpreted from the auditors own understanding of the prevailing circumstances.
Remuneration of a company auditor
According to the Company’s Act the auditor’s remuneration is determined by the party that
appointed him in liaison with the BODs of the company. Under the Company’s Act, the auditor is
remunerated as follows:-
1. The auditor appointed by the Company’s members during the AGM, shall have his
remuneration discussed and agreed upon by the members in the AGM.
2. An auditor automatically reappointed in the AGM, shall continue receiving the same
remuneration as the previous years remuneration unless otherwise stated.
3. An auditor appointed by the registrar of company’s shall have his remuneration determined
by the registrar in consultation with the BODs.
4. An auditor appointed by the BODs, as the first auditor, of the company shall have his
remuneration discussed and agreed upon by the BODs.
5. An auditor appointed to fill in a casual vacancy shall have his remuneration determined by
the members during an extraordinary general meeting.
6. Any amount paid by the auditor in respect of expenses, shall be included in the auditor’s
remuneration and must be disclosed to the members of the company and other users in the
income statement as an expense.
VACATION OF OFFICE
Causes
i. Auditor’s removal/ Dismissal
ii. Auditor’s resignation.
iii. Casual vacancy – auditor’s sudden death
– Auditor’s sudden resignation
– Auditor’s sudden incapacitation.
i. Auditors Removal/Dismissal
This is a situation where the management and shareholders are not willing for the auditor to
continue acting as their auditor. This may be due to:-
a) Where the auditor has disagreed with the directors because he has qualified the audit
report.
b) Where the auditor has exercised carelessness or negligence to the affairs of the company.
c) Where the auditor is disqualified from acting as an auditor under sec 161(2) of the
Company’s Act.
d) Where the auditor is charging a very high audit fee.

Procedures of removal
1. The company should issue a special notice of not less than 28 days to the members of the
company and the present auditor of an intention to remove the present auditor in the next
AGM.
2. Upon receipt of the notice, the auditor should provide a written representation to the
directors which should be circulated to the members intended to discuss about his removal
The auditor should not request for the circulation if it contains defamatory information.
3. The company should then requisition for the AGM within a period of not less than 21days for
the members to discuss about the auditors removal either by votes of ordinary resolution of
simple majority of those members present.
4. The auditor has a right to attend the AGM and speak on matters affecting his removal.
ii. Auditors resignation

The auditor may resign due to:-
a. Lack of qualification under Section 161(2)

b. Disagreement with the directors about the accounts.
c. Material limitation in the scope of the auditor’s work
d. An intention to remove the auditor in the next AGM.
e. When the client has delayed the payment of audit fee contrary to the agreement.
Procedures for resigning
1. The auditor should tender his resignation letter stating the date and time he is resigning
within a period of not less than 28 days and deposit the resignation letter at the Company’s
headquarters.
2. The auditor should accompany the resignation letter with a statement of circumstances of
either:-
a) Those matters that the auditor would want to bring to the attention of the shareholders in
respect to his resignation.
b) None of such matters
3. The company upon receipt of the auditor’s resignation letter should notify the registrar of
company’s within a period of not less than 14 days. Failure to which, each of the company’s
directors shall be subjected to a fine of a reasonable amount.
4. The auditor should then requisition for an extraordinary general meeting for the members to
discuss about his resignation.
5. The company must ensure that the auditor’s resignation is accepted by votes of ordinary
resolution or a simple majority of those members present.
iii. Casual vacancy
It is filled in by the BODs using the following procedures:-
a) Issue a special notice to the deceased or resigning auditors within a period of not less than
28 days.
b) Nominate another firm of auditors who are to take over.
c) Discuss and agree with the nominated auditor on the scope of work for the audit.
d) Confirm this through an engagement letter.
e) Present the nominated auditor through an extra ordinary general meeting for approval.
AUDITORS LEGAL LIABILIY
Liability
Liability is the accusation or allegations made against the auditor as a result of negligence or lack
of care & skills in the professional work.
Users of financial statements rely on the work of the auditor in making decisions relating to the
client company therefore, the auditor clearly has a responsibility to do his work carefully and
honestly.
In London and General Bank case, Lord Lindley observed “such I take to be the duty of the
auditor, he must be honest i.e. he must not certify what he does not believe to be true and must
take reasonable care and skill before he believes that what he certifies is true. What is reasonable
care in any particular case must depend on the circumstances of that case”
Auditor’s liability falls under 3 categories:-
i.To his client under contract law.

ii.To 3rd parties under the law of Tort.
iii.Civil and criminal liability under statutory law.
i.Auditor’s liability to his clients.

The auditor is under duty to report to the shareholders in the AGM on all accounts examined by
him. The contract is with the company as a whole and not with individual shareholders.
Therefore, an individual shareholder cannot sue the auditor for negligence.
If the auditor fails to carry out his duty with due care and professional skill, he can be sued by the
company and made to pay damages. For him to be ordered to pay damages, it must be proved
that:-
i. The auditor was negligent – negligence by the auditor is hard to establish, but the auditor can
be accused of negligence if:-
a) He fails to detect material fraud and errors which he should have reasonably detected.
b) He fails to comply with the accepted auditing standards, guidelines and procedures e.g.
failure to attend a cash count.
ii. The company has suffered a quantifiable financial loss.
iii. The loss suffered is as a result of the auditors report and auditor’s negligence.
ii. Auditor’s liability to 3rd parties

– Financial statements with the auditor’s report will not only be relied upon by the person by
whom the auditor has relations but by other people referred to as 3 rd parties.
– It is possible that where the auditor is negligent and fails to discover that the account did not
show a true and fair view, that other people who relied on the accounts suffered a financial
loss.
– In the famous case of Hedley Bryne Vs Heller and Partners it was decided by the judges that
the auditor does not have a contractual obligation with a 3 rd party because a 3 rd party is a
stranger in the agreement between the auditor and the client. However, for a 3 rd party to
succeed against the auditor, he/ she must prove that:-
a) The auditor owed him a duty or care.

b) The auditor was well aware of this at the time of entering in to the contract with the client.
(c) That the auditor has breached the duty of care
(d) As a result of the breach, the 3rd party has suffered a quantifiable financial loss.
(e) The 3rd party relied on the auditor’s report to reach the decision made.
(f) That the auditor did not attach a disclaimer statement in his report to make the 3 rd party not
to rely on it.
The auditor can escape liability using the following arguments:-
1. That the 3rd party were not having any contractual obligation with the auditor.
2. That the auditors were not aware that their report would be used for investment by any
other party other than the client.
3. That the auditors included in their report, a disclaimer statement instructing the user not to
rely on the report for making investment decisions.
4. That the auditor owed no duty of care to the 3rd party therefore the breach cannot affect the
third party.
5. That the loss suffered by the 3rd party; could not be measured in quantifiable terms.
3. Auditors liability under statutory law
a) Criminal liability
An auditor shall be held criminally liable if he willfully makes a material false statement in any
report, certificate or financial statements. The company’s Act Section 19 of the theft Act states
that, where an officer of a body corporate with an intent to defraud members, creditors or
management publishes or concurs in publishing a written statement of accounts which in his
knowledge is misleading, shall be on conviction to imprisonment for a term not exceeding 7
years.
In order to hold the auditor criminally liable, the following must be proved:-
1. That the statement made was false in material facts.

2. That the auditor willfully made such a false statement.
3. That the statement complained of has been made in any written report, financial report,
certificate or any other documents required to be made under any provisions of the
company’s Act.

4. That the auditor was a party 2 carrying out a business with intention of defrauding members
or creditors.
5. That the auditor certified income statement and balance sheet in a prospectus which contains
false information.
When criminal liability are reported and discussed in courts, the auditor is faced with the
following consequences:-
a) Imprisonment
b) Fine
c) Deregistration
d) Nullification of certificates
(b) Civil liability
This arises, under the normal breach of contract where the auditor as the contractor fails to carry
out the contract as advised by the contractee. At the beginning of the contract, the auditor has a
contractual obligation with the shareholders because they pay for the audit service. As a result of
this they are concerned with how the auditor is carrying out the audit work.
The civil liability arises under the following:-
1. Where the auditor has breached a primary duty of care

2. Where as a result of the breach, the contracting parties have suffered a financial loss.
3. The loss suffered can be measured in quantifiable terms.
In some cases, civil liability call for suing the auditor for damages
Liability under published accounts
The publishing of accounts is done either after or before the audit has been conducted. When
accounts are published, they become a public record and therefore they are expected to give a
true and fair view. However, published accounts may have material misstatements either before
or after the audit.
The auditor becomes liable if such misstatements arise after the audit. This is because,
discovering material misstatements after the audit would mean:-
a) That the auditor was negligent

b) That the auditor did not exercise degree of care and skill.
Ways of minimizing auditor’s liability
1. Planning the audit adequately, controlling and recording the audit.

2. Accepting an appointment only where one is qualified to practice.

3. By carrying out the audit after consultation with the director’s previous auditors and
specialists.
4. By clearly having the scope of work and responsibility for the audit included in the
engagement letter.
5. When giving reference to attach a disclaimer of financial responsibilities.
6. By always following the accepted auditing standards, guidelines and procedures.
7. Reviewing the completed audit work performed by the juniors to minimize risk exposures.
8. Always be aware of professional and legal advice on any relevant matters.
9. Take a professional indemnity cover.
10. Register the audit firm as a limited liability partnership so that the partner responsible for
the audit is the one to bear the burden.
11. ICPAK should take disciplinary action on those members caught with negligence claims.
B. PROFESSIONAL FRAMEWORK
a. Professional ethics
Ethics is a system of discipline instituted by a profession to its members in practice to govern the
conduct and behavior of the members in the given practice.
Accountants do have professional ethics to the accountant instituted by ICPAK. Professional

ethics to the accountants touches a variety of areas of discipline including integrity, due care and
skill, objectivity, independence, confidentiality and competence.
An accountant who assumes responsibility in the public practice, would be expected to possess
the above areas of discipline in order to minimize exposures to potential risks and liabilities as
well as negligence in respect to the professional work.
Purpose of professional ethics
1. Regulate the conduct and behavior of accountants in practice.

2. Maintain discipline among the accountants in the profession.
3. Enhance independence and objectivity of the accountant.
4. Reduce the accountants exposure to risk and liabilities.
5. Help maintain interest and well behavior of the accountants with other members in other
professions.
Ethical considerations
To ensure that, the accountants are competent as far as possible when reporting on the financial
statements, true and fair view, they must observe the following:-

1. Integrity
2. Due care and skills
3. Independence
4. Competence
5. Objectivity
6. Confidentiality
7. Advertising and publicity
8. Professional fees
9. Change in professional appointments
10. Technical standards
11. Client monies
12. Obtaining professional work.
NB: No. 1, 2, 3, 4, 5 & 6 are fundamental principles.
1. Integrity
This means that a professional accountant must be a person who is honest, have fair dealings
with the client, be straight forward, upright, understandable, sincere, and not complicated in
any manner when reporting on the financial statements or when making an agreement with
the client.
The degree of integrity shouldn’t be questioned or doubted or appear to be threatened by any
party among the client management and 3rd parties to the financial statement.
2. Due care and skills

This is a question of mind and the statements within which a professional member is able to
operate, carry out practices and report on the financial statement effectively.
3. Independence
This is the backbone of all the professional ethics and without it, the rest of the ethics are
useless. Independence is exercised at 2 levels:-
a) Independence of mind/ fact

This is the state of mind that permits the provision of an audit opinion without being
affected by influence from others that may compromise the professional judgment. It
allows the individual to act with integrity and objectivity.
b) Independence in appearance / attitude

This is the avoidance of facts or circumstances that are so significant such that, if a 3 rd
party is aware that the auditor engaged himself in such circumstances, he will conclude
that his independence was compromised.

General importance of independence
1. The auditors are watchdogs for the shareholders and they need to be independent of the
directors and management who are charged with the custodianship of the resources of the
shareholders.
2. To express a true and fair view, the persons carrying out the audit, must be independent of
all interested parties.
3. Only through independence can all potential users of the financial statement rely on the
auditor’s opinion.
4. Audit independence, is a requirement of the company’s act and also the accounting
profession.
5. An audit is an independent examination process. Therefore, the persons carrying out the
audit must be professionally independent.
6. Several parties have been disqualified under the company’s acts to be appointed as
auditors due to lack of independence.
Way In which auditor’s independence may be compromised.
1. Where a small audit firm is appointed to audit a large company where they are likely to
depend on financial support from the company.
2. Beneficial, shareholding i.e. where the audit firm has acquired the shares of the company to
an aggregate value of more than 5% of the share capital.
3. Family / blood relations i.e. where the audit staff, their children or spouses has got relations
with the company under audit either at a personal level or any other level.
4. Loans to and from the clients i.e. where the audit firm has borrowed from the client or has
given guarantee or security on behalf of the client to borrow.
5. Goods and services i.e. where the audit staffs or audit partners have accepted goods and
services as part payment against the fee from the client.
6. Low balling i.e. where an audit firm charges a very low audit fee as compared to other audit
firms.
7. Non audit services. An audit firm’s independence may be threatened by the provision of non
audit services such as book keeping, recruitment, taxation and review of the design of the
account system and ICS. This implies that, the auditor has become actively involved in the
company’s affairs and may mean that, they will not be objective in auditing their own work or
decision.
Providing a service such as book keeping, may appear as if the auditors are taking
responsibility for the accounts.
Advantages of providing non audit services
1. The audit firm can increase its revenue base

2. The audit firm staffs are likely to render a better audit service because of detailed
understanding of the clients operations.
3. The auditor is likely to take less time in auditing the financial statements therefore; the client
will be charged a lower audit fee.
Disadvantages of providing non audit services
1. The auditor will be perceived as being not fully independent.

2. The auditor is likely to be biased because he cannot audit his own work.
3. Effectively, much of non audit services involves managerial functions therefore the auditor
ceases to be an auditor of the company, but he has became the manager of the company. This
is likely to create conflict of interest.
Ways in which auditors independence can be safeguarded
1. By ensuring, that their scope of work and responsibility is clearly defined.

2. The auditors should not depend on any one client for a large portion of his revenue. In this
case, the auditor is required to diversify on the number of clients or merge with other small
audit firms so as to attract a larger client base.
3. By resigning as the auditors when independence is likely to be compromised.
4. Goods and services should not be accepted on more favourable terms than could be made
available in all other circumstances.
5. Appointment should not be accepted where conflict of interest seems to occur and if it occurs
after appointment, disengagement is necessary.
6. By applying auditing standards guidelines and procedures in the audit.
7. Organizing seminars and training workshops on audit independence.
8. Audit rotation - rotating the audit staffs from one client to another in course of the audit
work.
9. On an annual basis, the audit firms should compel their staffs to sign self interest declaration
statements. These are short structured questions that require a Yes or No answer and can
take the form of:-
Do you own shares in the client company.
Do you have a personal / family relationship with the key directors or managers?
10. The audit firm should separate the audit staffs who will provide non audit services and the
ones who will audit the financial statement.
11. ICPAK should take disciplinary action against those audit firms where there’s evidence that
they have compromised their independence.
4. Competence

The accountant must possess some competence in respect to the professional work by having a
variety of knowledge in the field of accountancy competence is necessary in ensuring for
objectivity.
For the accountant to be competent, the following are necessary

– Thorough knowledge in the field of accountancy and auditing.
– Adequate practical experience in the relevant field of practice.
– General knowledge about the surroundings under which the accountant is practicing.
– Level of intelligence when handling matters with no previous connection.
The auditor should seek the assistance of an expert in performing his duties in respect to
complicated areas. Professional accountants should pursue continuing education so as to
maintain their competence level. They can do this by joining ICPAK or Institute of Internal
Auditors.
5. Confidentiality
Auditors come across sensitive information about a client when reviewing the files. They are
expected to exercise high level of secrecy and should not disclose such information without prior
consent of the client. However there are some exceptions that include:
a) When the auditor is defending himself in a court of law or the information is required in a
court process.
b) If the client is involved in illegal activities such as money laundering, drug and human
trafficking, terrorism, etc.
c) If the information is required by regulatory authorities e.g. KRA, CMA, NEEMA, NSSF, NHIF
and Banking fraud investigation departments.
d) If the auditor has a professional duty.
6. Objectivity
A professional accountant should be fair and should not allow prejudice, bias, conflict of interest
or influence by others, to override objectivity.
7. Advertising and publicity
Professional accountants are not required to advertise their services directly to their potential
clients. Ideally accountants have the same competence level and therefore, the audit firm should
not influence the client by claiming that they are better than others. The judgment should be
made by the clients through evaluation of the tenders.
Exceptions to advertising include:
a) When the audit firm has changed its physical and postal address.

b) When they are recruiting on behalf of their clients
c) When they have recruited an audit partner.
d) During a professional seminar and the key speakers are drawn from different audit firms, the
audit firm will be allowed to place an advertisement banner indicating the name of the audit
firm, services being offered and contacts.
8. Professional fees
It should be clear, at the beginning of the engagement both to the auditors and to the client
management on how the professional fees should be charged.
During the preliminary evaluation of the systems and at the background research of the entity,
the auditor will prepare time and cost budgets necessary to allow him to determine the basis of
charging the professional fees.
- The basis used by the accountants in charging the fees are:

a) The time spent by the partner and the audit staffs in the conduct of the audit at each and
every field visit.
b) The skills and competence employed by the audit senior for the successful completion of the
audit.
c) Any technical expertise and knowledge employed by the auditor from a specialist or an
independent expert necessary to allow the auditor to complete the audit work effectively.
9. Change in professional appointment.
Before an auditor takes up a public office, that was occupied by another auditor, the following
procedures are adopted.
 Nominated auditor should request the client for permission to communicate with the
previous auditor.
 The previous auditor also to request the client for consent to discuss freely with the
nominated auditor matters pertaining to the audit.
 When such permission is denied, the nominated auditor should decline the appointment.
 When the consent is denied to the previous auditor by the clients the previous auditor should
feel free to communicate this to the new auditor.
 However, when such permission and consents are granted, the previous auditor should
disclose freely those matters necessary for the new auditor to decide whether to accept or
reject the appointment.

Communication with the previous auditor
It is important because:
a) It is a requirement by the professional body i.e. the new auditors should obtain ethical
clearance from the previous auditor.
b) Acts as a basis of obtaining the previous year’s working papers by the current auditor from
the previous auditor.
c) Helps the auditor to gain an assurance about the client ICS.
d) To find out why he is no longer the auditor of the client.
e) To obtain the previous year’s copy of financial statements.
f) Obtain information about the audit fee charged by the previous auditor.
10. Technical standards

– A professional accountant should carry out professional services in accordance with the
relevant technical and professional standards.
– A professional accountant has the duty to carry out the audit work with care and skill
according to the instructions of the client in so far as they are compatible with the
requirement of integrity, objectivity and in the case of professional accountants in public
practice, independence.
– In addition, they should conform to the technical and professional standards issued by ICPAK
e.g. ISA, IAS committee, members, professional body or other regulatory bodies and relevant
legislation.
11. Obtaining professional work

– A member should not in any circumstances obtain or seek professional work for himself or
another party in any unprofessional manner.
– A practicing member should not give any commission fee or reward to a 3 rd party in return
for the introduction of a client.
12. Client monies
A member in practice is strictly accountable for all the client monies received by him. Such
monies should be kept separate from all other monies in his hands to be applied only for the
purpose of the client.
Role of ISA’s
– Auditing standards are set by International Audit and Assurance Standards Board (IAASB)
which is a subcommittee of International Federation of Accountants Council (IFAC).

– Working procedures of IAASB is to identify specific standards that require establishment of
procedures and guidelines. They will form a subcommittee which will be responsible for
preparing exposure draft concerning that area. This draft will be considered by the Board and
distributed to the members of IFAC to provide comments and suggestions. Once the
comments and suggestions have been received, the draft standard will be revised as
appropriate and issued as a new International Standard on Auditing.
ROLE OF ISA
1. To provide a framework through which auditing can be done.

2. To provide a minimum level of performance to which auditors must conform.
3. To ensure that audit work complies with certain minimum standards.
4. To improve the quality of audited accounts.
5. Standards provide a benchmark by which the quality of audit work can be measured.
6. To ensure standardization of audited accounts hence making comparisons of one company to
another possible.
7. To increase confidence of users of the accounts
8. To reduce incidents of audit failure by also reducing the levels of audit risk.
9. They guide the auditor in all ethical requirements to minimize his liability.
10. They can be used for training audit junior staff because they provide support regarding the
amount of work to be carried out in a systematic manner.
Disadvantages of auditing standards
1. They make the audit expensive for small companies because the entire standards have to
be followed irrespective of the size of the company.
2. They make the audit to take a mechanical approach and therefore they are applied for the
sake of it without considering their implication.
3. The auditor’s creativity is likely to be limited with time.

TOPIC 3
CLIENT ACCEPTANCE PROCEDURES
AUDIT CYCLE
An audit cycle is a sequence of steps followed by auditors from commencement of an audit until
the end (i.e. at production of the audit report). They include:-
1. Ensure that you are properly engaged to carry out an audit of the client especially if it is for
the first time to be engaged by the client. Ensure that you have not breached the legal and
ethical requirements.
2. Obtain background information about the business and environment of the client
3. Plan the audit procedures so that economical, efficient and effective audit can be conducted.
4. Acquire detailed understanding of the accounting system and the related ICS.
5. Design appropriate compliance tests to evaluate the accounting system and ICS.
6. Carry out substantive procedures and ARP’s on financial statements
7. Carry out the final review of the financial statement. This may include:-
a) Reviewing the audit completion check list.
b) Discussing the audit findings with client management so that any recommendations can
be implemented.
c) Ensure that the accounts have been prepared in accordance with an identified financial
reporting framework.
8. Draft the audit report, sign it and send it to the shareholders.
Matters to be considered before accepting an appointment
1. The auditor should check whether the firm is legally qualified to act as an auditor of the
client. For this purpose, ensure that the audit firm is legally registered and professionally
qualified.
2. Establish whether the firm is currently disqualified in any manner to act as an auditor of the
branch or subsidiary.
3. Consider whether, the firm is professionally independent to become the auditor of the client.
For this purpose, consider for any blood relations, audit fees and beneficial shareholding.
4. Obtain permission from the client management to communicate with the previous auditor
and ask them for any reason as to why your firm should not accept the new appointment.
5. Where such permission is denied, decline the appointment.
6. Check the integrity of the management in providing useful information to the auditor and
whether you are likely to establish a long-term beneficial relationship with the directors
during the audit.
7. Check whether, your firm has the potential resources necessary to audit the clients business.
For this purpose, check for the staffing requirement and timing for the audit field visits.

8. Consider any technical expertise and knowledge you would require for the audit of the new
client in respect to the accounting system and ICS.
9. Ensure that a discussion has been made in respect to your scope of work and responsibility
for the audit of the new client.
10. Check the risk exposure associated to the clients as regards to the audit firm reputation
11. Check the current commitment of the audit firm that may affect your ability to carry out the
audit and complete it effectively.
12. Ensure that no conflict of interest arise upon acceptance of the appointment.
13. Consider the level of audit fee to charge. It should be reasonable to provide adequate return.
Procedures after appointment
1. Obtain instructions from the clients as to the scope of work and determine whether this is in
addition to what is assigned to you by the company’s Act in which case it should be included
in a letter of engagement.
2. Ensure that the auditors removal was done legally by obtaining a copy of resolution passed
by the shareholders to remove the auditor.
3. As an incoming auditor, ensure that your appointment is valid by obtaining a copy of
resolution passed by the shareholders.
4. Draft and submit the engagement letter to directors of the company. This letter will serve the
purpose of defining the scope of work and formal acceptance of the work.
Background research/ obtaining information about the clients
The purpose of this research is to enable the auditor get a detailed knowledge of the Client
Company and industry in which it operates. This will enable the auditor carry out a
comprehensive and effective audit which is also efficient in terms of time spent.
In performing an audit of financial statement, the auditor should have or should obtain
knowledge of the business sufficient to enable him identify and understand events transactions
and practices that in the auditors judgment may have significant effect on financial statement or
on the examination of financial statement or on the audit reports.
Such knowledge is used by auditors in assessing inherent and controll risk and in determining
the nature, extent and timing of audit procedures.
Gathering information about the client covers the following areas:-
a) Present conditions and future prospect of the industry in which the client is part.
b) The past history and present conditions of the client.
c) The management and key personnel and any recent changes.
d) The service, product, manufacturing or trading process of the client.
e) The location of client operation
f) The problems in accounting and ICS

g) The problems likely to lead to audit difficulty
h) Any other problem likely to be met in carrying out the audit e.g. distant, location and timing
problems.
i) Any changes of law or accounting policies which may affect the economy.
j) General economic factors e.g. general economic activity (recession or growth, foreign
currencies rate, inflation, interest rate and government policies (taxes and trade
restrictions).
k) Important conditions affecting the client operations e.g. competition
How background research is done
1. Previous experiences with the entity and the industry.

2. Discussion with people in the entity e.g. directors and senior operating personnel
3. Discussion with internal auditor and review of the auditors report.
4. Discussion with other auditors, legal and other advisors who have provided services to the
entity or within the industry.
5. Discussion with knowledgeable people e.g. industry players, customers, suppliers,
competitors etc.
6. Review of publications related to the industry e.g. government statistics, surveys, trade
journals, report prepared by banks and security dealers, financial newspapers etc.
7. Review legislation and regulations that significantly affect the entity.
8. Visit the entity premises and plant facilities.
9. Review documents produced by the entity e.g. minutes of entity, materials sent to
shareholders or filed with regulatory authority, promotion, prior reports, budgets, internal
management reports, interim financial statements, management manual, manual of
accounting and ICS, chart of accounts, job description, marketing and sales plan.
10. Reviewing information from company website.
Using the knowledge
Knowledge of the business ensures that auditor exercises professional judgment, understanding
the business and using this knowledge appropriately in:-
1. Assessing risks and identifying problems. This will enable the auditor to budget for time and
staffs.
2. Planning and performing the audit effectively and efficiently.
3. Designing appropriate audit tests and procedures
4. Evaluating audit evidence
5. Providing better services to the client.

TOPIC 4: AUDIT PLANNING, CONTROLLING AND RECORDING
A. AUDIT PLANNING ISA 300
This is the formulation of general audit strategies that sets out the direction, scope, timing, extent
and conduct of the audit, and then provides guidance in the development of overall audit plan.
The auditor should plan the audit work so that the audit will be performed in an effective and
timely manner.
Objectives of planning
1. To ensure that an efficient, effective and economical audit is conducted.

2. To ensure that potential problems are identified such as weakness in accounting system and
ICS, the auditor will then be able to devote more attention to these areas.
3. To ensure proper allocation of audit resources and co-ordination of the work of audit staff
and involvement of experts and other auditors.
4. It assists in identification of events, transactions and practices that may have a material effect
on financial statements.
5. It assists in the development of overall audit plan.
6. It ensures that the audit work is completed expeditiously i.e. with speed, efficiency and
thoroughly.
7. To facilitate the final review
Factors to consider when planning for an Audit
1. Knowledge about the client business. This is important and enable the auditors to determine
the test and procedures to be carried out for the audit.
2. The accounting system and the I.C. This is important to enable the auditor determine the test
and procedures to be carried for the audit.
3. The type of the Engagement and the statutory requirement. This is to ensure that they are
well addressed in the audit plan.
4. Nature and the types of the report and other communication with the client. Such should be
considered and accommodated in the audit plan.
5. Accounting policies adopted by the management.
Consider the effect of new accounting / auditing pronouncement on the files or any changes
that have occurred on the same.
6. Consider any condition that may require special attention such as the indicators of material
fraud or errors.
7. Consider the presence of internal audit department and any reliance that you will place on
their worth.
8. Consider the possibilities of rotation of employees and any need to emphasise on certain
areas.
9. Consider their location of work between joint auditors if there is any
10. Consider any changes that have taken place since the previous audit especially
computerization of the system.
11. Consider the financial reporting framework used by the client to prepare files as it is likely to
affect your audit work.
Stages in Audit planning
1. Acquiring information and knowledge about the client (see previous notes)
2. Risk assessment
3. Setting materiality levels
4. Performing ARPs
5. Developing an overall audit plan.
6. Logistics
1) Acquiring information and knowledge about the client (see previous notes)
2) Risk assessment
Risk is an event, activity or action that can prevent an auditor, an individual or organization from
achieving their objective. The auditor must be aware of 2 types of risk:-
 Business risk
 Audit risk
i. Business risk - existence
These are events or risks facing the entity as a result of its existence or operations.
Business risk is made up of 3 components:-
- Financial risk
- Operational risk
- Compliance risk
Financial risk
This occurs as a result of financial activities or consequences of company operations. Examples:-
a. Changes in foreign currencies rates leading to foreign currencies losses.

b. Increase in bad and doubtful debts due to failure, by debtors to honour their obligations.
c. Inability to obtain additional funding from banking institutions.
d. Failure to pay creditors and other liabilities as and when they fall due.
ii. Operational risk
Occurs as a result of day to day activities e.g.

a. Loss of key employees without immediate replacements
b. Loss of major suppliers and customers
c. Breakdown in production facility.
iii. Compliance risk
Occurs as a result of non adherence with the relevant laws and regulations that govern the
entity:-
a. Failure to meet statutory obligations e.g. pay taxes.

b. Failure to comply with environmental regulations leading to fines and penalties
c. Failure by bankers to meet the minimum capital base leading to withdrawal of banking
license.
Management of business risk
1. The client may approach the risk by doing nothing and hoping for the best especially for
external risks.
2. Strong ICS, this will eliminate most of the internal risks and operational risks.
3. Diversification – The company should change the products it deals with by investing in new
products and researching for new markets.
4. Risk reduction – This is done by increasing staff awareness on risks and having strict
discipline in all areas to reduce inefficiency and training of staffs.
5. Risk transfer – This is through an insurance cover e.g. consequential loss policy.
Implications of Business Risk to the auditor
Business risk has an effect on the financial statement and may contribute to financial statement
risk i.e. possibility of misstatement in the financial statements.
The following are the major financial statements risks arising from business risk:
1. Possible misstatement e.g. under provision of bad debts

2. Fraud by management to gain a good audit report.
3. Concealment and suppression of liabilities
4. Inappropriate accounting policies
5. Misapplication and misinterpretation of accounting standards.
6. Shortage of operating cash flows.
NB: Business risk can also be divided into external risk and internal risk.
External risk

This is risk arising from outside the company and are beyond management control e.g. changing
legislation, foreign exchange rates, interest rates, technology, public opinion, attitude, changes in
tastes and preferences, natural hazards etc..
Internal risk
This is risk arising from within the company sometimes referred to as operation risk and are
within the management control e.g. staff turnover, cash flow problems fraud & irregularity,
computer system failure, internal control weaknesses.
Audit risk
This is the risk that the auditor gives inappropriate audit opinion in the financial statement when
they are materially misstated.
- The auditor may give a positive report when the financial statement contains errors and
frauds.
- The auditor is required at the planning stage to determine the level of risk in the company
and then appropriate design audit procedures which are meant to reduce the risk at a low
level. Audit risk has 3 components:-
 Inherent risk
 Control risk
 Detection risk
1. Inherent risk
This is the susceptibility of an accounts balance to material misstatements either individually or

when aggregated with misstatements of the other accounts balance assuming that there were no
related internal controls.
It is the risk that financial statements are materially misstated assuming that there are no ICS in
the organization.
Auditors are suspecting that the accounts balances could be misstated because of their natural
characteristics or they are important items to the financial statements e.g. stock and directors
fees.
Inherent risk occurs because of the nature of the business and it is not affected by the auditors
actions.
Inherent Risk Assessment
To be able to assess inherent risk, the auditor must use his professional judgment and also the
available knowledge about the client. Inherent risk can be assessed at two levels:-
1. At the financial statement level

2. At the individual accounts balance or transaction level
(1) At the financial statement level
The auditor should be aware of conditions that are likely to lead to material misstatements of the
financial statement taken as a whole
They include:-
i. Integrity of directors and management being questionable

ii. Domineering effect in that, the directors are at the same time the major shareholders.
iii. Nature of business and products i.e. if affected by changes in technology.
iv. If directors and management remuneration is based on the company’s performance.
v. Changes in industrial factors such as stiff competition or significant decline in customers.
vi. Unusual pressure on the management by the shareholders.
vii. The degree of judgment involved in determining account balances
(2) At the individual account balance or transaction level
Factors to consider include:-
i. Complexity of the account balance in computation e.g. WIP

ii. Assets at the risk of being stolen because they are small in size, portable and expensive e.g.
laptops, cell phones, jewellery etc.
iii. Unusual transactions of large amounts particularly if they occur once in a year e.g. bonus
payments.
iv. If the account personnel are paid poorly, then they are likely to perpetrate fraud.
2. CONTROL RISK
This is the inability of the accounting system and ICS to detect and prevent material fraud and
error either in an individual accounts balance or when aggregated with misstatements of other
account balances.
Control risk assessment
In order to assess control risk, the auditor must obtain an understanding of the accounting
system and the ICS. This understanding will help the auditor to:-
 Identify the major classes of transactions, the way they are processed and completed.
 Identify significant accounting records produced by the accounting system.
 Identify the financial reporting process.
The auditor will then proceed to evaluate the likely effectiveness of the accounting system and
ICS through compliance testing. If these results reveal that the controls are weak, then the control

risk will be assessed as being high. However, if the controls are strong, then the control risk will
be assessed as being low.
3. DETECTION RISK
 This is the inability of the auditors substantive procedures to detect a material misstatement
either individually or when aggregated with misstatements of other accounts balances.
Detection risk is directly affected by the auditors procedures
 The auditors control risk assessment together with inherent risk assessment influences the
nature, extent and timing of substantive procedures to be performed to reduce the detection
risk and therefore minimize the audit risk to an acceptable low level.
 Some detection risk would always be present even if the auditors were to examine 100% of
the accounts balance or class of transactions.
 Detection risk, has two components:
 Sampling risk
This is the risk that material errors and frauds will not be detected by the auditor because
of the accepted audit practice of examining less than the whole of the population i.e. the
auditor may select a sample that is not a representative of the population.
 Non sampling risk

This is the risk that the auditor will fail to detect material errors and frauds due to
inappropriate audit procedures, misinterpretation of audit evidence or misrepresentation
to the auditors by management or third parties.
 The auditor should use his professional judgment to assess the audit risk and to design audit
procedures to ensure that, it is reduced to an acceptable low level.
 It is advisable for the auditor to know that the following causes audit risk:
1. Over delegation of audit work to audit juniors in course of the audit.
2. Failure to follow the firms quality controls i.e. failure to give instructions, supervise the
juniors and review the work of the juniors.
3. Failure to apply auditing standards, guidelines and procedures in the audit.
Although audit risk cannot be fully eliminated in the audit, it can be minimized by
adopting the following:-
i. Accepting appointment only where one is professionally qualified to practice.
ii. Implementing as far as possible the firms quality controls in the conduct of the audit.
iii. Adopting the auditing standards guidelines and procedures in the conduct of the
audit.
iv. Carrying out alternative procedures necessary to provide assurance on the
effectiveness of the audit.

3) SETTING MATERIALITY LEVELS
Information is material if its omission or misstatement can influence the economic decision of the
users of the financial statements.
Criteria for determining materiality
When assessing whether an item is material or not material, an auditor will consider the
following:
 The nature of the item

 The value
 The Impact
a. Nature
Some transactions by their own characteristics or nature are material e.g. directors fees, stocks
and contractual payments.
b. Value
Some items will be significant in the financial statement by virtue of their size and amount e.g. if a
company bought a piece of land whose value make up ¾ of total assets, then that will be said to
be material. If it is omitted or misstated materiality is expressed in terms of percentage of assets
and profits as indicated below:-
Item Cut off point for materiality

1. Net profit before tax More than 5%
2. Net profit after tax More than 5% but less than 10%
3. Turnover / total sales More than ½% but less than 1%
4. Gross profit More than ½% but less than 1%
5. Net assets (Assets – liabilities) More than 2% but less than 5%
6. Total assets More than 1% but less than 2%
When determining materiality, the auditor must consider whether the accounts balance in
question will affect the I/S items, balance sheets or both at the same time.
c. Impact
Some items by chance have a significant effect on the financial statement e.g. a proposed journal
entry which is not material on its own but could convert profits into a loss will be considered to
be material.

Factors to consider when planning with respect to materiality
1. The quantity of the item when taken individually or when aggregated.

2. The effect on the user if the item is omitted or mis-stated.
3. The qualitative characteristic of the item and the accuracy with which it can be computed.
4. The value of the item and the effect on the files.
5. The legal consideration on materiality i.e same items by law are considered material
irrespective of the amount e.g directors remuneration.
Importance of considering materiality in an audit
1. It enhances the credibility of the files because users will know the exact parameters of the
information.
2. It results to cost efficient audit because one can concentrate on material items.
3. It becomes easier for auditors to defend themselves when faced with cases of negligence.
4. I t enables auditors to plan their work in such a way that material frauds and errors will be
detected.
5. It enables auditors to design the appropriate test and procedures to carry out for the audit.
6. It enables auditors to form an opinion on true and fair view.
Conclusions on materiality
From the above discussion, the following inferences can be drawn:-
1. A matter is material if its omission or misstatement will influence the economic decision of
the users of the financial statements.
2. Materiality is an expression of the relative importance of a specific matter on the financial
statement taken as a whole.
3. Materiality consideration during planning, are extremely important because they will help
the auditor to know:
 How many and what types of items to examine.
 What audit tests and procedures are to be performed.
 What level of error or fraud is required to qualify the audit report.
4. Materiality can be thought of in terms of the business size. It has a direct correlation with
changes in the size of the company and therefore it has to be reviewed from year to year.
5. The level of materiality must be reviewed constantly as the audit progresses. Discovery of
fraud or error might alter the level of materiality set at the planning stage.

6. Materiality is also considered at the completion of the audit stage to enable the auditor
determine the effects of misstatements on the financial statements.
4. PERFORMING ARP’s
In planning stage, ARPS are used to help the auditor understand the business and changes in the
business, to identify areas of potential risk and to plan other audit procedures.
ARPs includes comparison of financial information with prior periods, budgets, and forecasts and
with similar industries. They also include consideration of predictable relationships e.g.
relationship of gross profits to sales or payroll costs to the no. of employees.
ARPs involves:
a) Computing the accounting ratios on transactions and financial statements

b) Comparing the ratios with those of the previous period.
c) Ascertaining the actual performance based on such ratios
d) Comparing the actual performance with that of the previous year and drawing conclusion.
5. DEVELOPMENT OF OVERALL AUDIT PLAN
This is a general strategy that provides information, procedures and guidelines in respect to the
conduct of the audit relating to the clients.
– It is comprehensive because, it summarizes all the work involved in the conduct of the audit
matters likely to be included in the overall audit plan are:–
1. Planning for the interim audit

2. Planning for ARPs
3. Planning for the systems review
4. Planning for the use of work of experts
5. Planning for the attendance of the annual physical stock taking.
6. Planning for the confirmation of balances from the 3rd parties.
7. Planning for the completion of the audit, signing of the audit report and attendance of the
AGM.
The contents of the overall audit plan include:–
a) Background information about the client.

b) Risk assessment
c) Setting materiality levels.
d) Nature, extent and timing of audit procedures.
e) Coordination, direction, supervision and review.
f) Others e.g. going concern and subsequent events consideration.
g) Audit staff
h) Key deadlines

i) Time table
6. LOGISTICS
These deals with administration matters which the auditor must consider during planning some
of the matters include:–
1. Ensuring that the audit staff will be available during the audit by controlling the time they
proceed on leave.
2. The audit staff must be informed of the following deadlines:–
a) Time taken to review the financial statements including the date of completion of the
review.
b) Date of discussion of the audit findings with the audit manager.
c) Date of discussing the audit report.
d) Date of the AGM.
– If the audit staff are aware of the above deadlines, they will work expeditiously to achieve their
targets.
3. Timetable –it is important for the engagement partner to ensure that the audit is completed in
a cost effective manner. The time taken to audit each part of the financial statements will need
to be standard and a fee set accordingly.
The time budget will be influenced by the following factors:–
a) Size of the company
b) Materiality of the accounts balance
c) Risk assessment of the clients
d) Prior experience of the auditor with the clients
e) Experience and competence level of the auditor.
Procedures for planning the audit for a new client

1. Review the previous year’s audit work papers in particular the current audit file to
determine the balances for the previous period & changes that have taken place since the
previous audit.
2. Consider any materiality issues disclosed above in respect to the current audit.
3. Arrange to discuss with the client management the effect of changes on the accounting
system and changes which should be incorporated in the current audit plan.
4. Ascertain for the staffing requirement in respect to the audit.
5. Consider the timing of the field visits and ensure that the time is sufficient for the conduct
and completion of the audit.
6. Incorporate in the current plan any technicalities required for the audit, skills, competence
and related costs, e.g. use of expert and internal auditors work.
7. Prepare a comprehensive overall audit plan to accommodate all the requirements in
respect to the audit.
8. Prepare the time, usage and cost budget for the audit of the new client
9. Prepare the planning memorandum and a standard audit program to provide instructions
to the audit staffs to allow for commencement of the audit.

PLANNING MEMORANDUM
This is a means of directing the audit work by the audit senior to the audit staffs. It is a document
that highlights the overall strategy and the different procedures to be carried out when
performing the audit work. It summarizes to the audit staffs the matters covered by the audit
plan. It provides following matters:–
1. The engagement letter

2. Background research of the clients.
3. Audit risk area
4. Timetable of events
5. Staffing requirements.
6. Budget and audit fee quotation
7. Audit approach to be used in auditing the financial statements.
8. Setting of materiality levels
9. Assets, liabilities, incomes and expenses.
10. Financial position, important figures and ratios.

AUDIT PROGRAMME
It is a step by step breakdown of the audit work to be performed by the audit staffs from the
beginning until the completion of the audit.
Audit programme provides guidelines to audit assistants, clerks and trainees on how to proceed
with the conduct of the audit.
Contents of an Audit programme
1. Name and address of the audit firm.

2. Name and address of the client.
3. Date and time of the audit.
4. Financial period covered by the financial statements
5. Nature of transactions to be tested, e.g sales, purchases, wages and salaries, e.t.c
6. The audit tests or procedures to be carried out on transactions.
7. Date and time of carrying out the audit tests.
8. Initials of the audit staffs
Purpose of Audit Programmes

1. They set out the nature, timing and extent of the planned audit procedures required to
implement the overall audit plan.
2. They serve as a set of instructions to audit assistants involved in the audit.
3. They provide a means of controlling and recording the proper execution of the audit work.
4. Contains the audit objectives for each area
5. Sets out the time budgets in which hours are budgeted for various audit areas and
procedures.
Types of Audit programmes
There are two types of audit programmes i.e.
1. Standard audit programme/ pre determined /pre prepared

These are programmes commonly used by audit firms in the audit of both large and small
businesses. They are prepared in advance before the audit commences and can be applied on
subsequent audit periods.
Standard audit programmes are preferred because;
a) They are economical to the auditor.
b) They ensure efficiency in the conduct of the audit.
c) Ensures effective completion of the audit.
d) Saves the auditor time because they provide the main areas of the audit where tests and
other procedures are to be carried out.
2. Progressive Audit Programme

This is a type of audit programme which is prepared by the auditor during the actual audit and
they are allowed to be completed as the audit progresses.
They are liked because:-
a) They enable the audit staff to carry out their respective work independently.
b) They reduce supervision on the conduct of the audit.
c) They promote specialization among the audit staffs.
General Advantages of Audit Programmes
1. They facilitate effective and efficient conduct of the audit.

2. Acts as a good training ground for new audit staffs because they will guide them on what to
do, how to do it and when to do it.
3. The audit senior is able to direct and coordinate the audit work properly.
4. A standard audit programme enables the audit manager to understand the areas of the audit
and potential problems in the course of the audit.
5. They give the auditor the opportunity to apply similar programmes in subsequent audit
thereby ensuring audit uniformity.
6. They facilitate allocation of the audit work to different audit staffs based on their relative
qualification and experience.
7. Ensures that the audit staffs do not overlook any aspect of an audit, because the programme
has to specify the work to be done and has to provide evidence of all the work done.
Disadvantages of Audit Programmes
1. They are followed mechanically by the audit staff and therefore inhibit the auditor’s personal
initiative to think and plan on his own.
2. If the programs are followed mechanically, they may leave errors and frauds undetected
especially where the auditor does not apply professional skills.
3. Some audit staffs may hurry through the programs to finish on time leaving other documents
and books unchecked.
4. No single programme can be used for all areas of the audit as such areas may not be
represented in the programme especially those requiring personal judgment.
5. Some audit programmes are too rigid as they do not adjust to the changes in the
circumstances of the business.
Aspects to note when preparing Audit Programme.
1. Any defects identified in the programme should be corrected immediately because this
may lead to a defective audit.
2. The programme should be seen as a guideline of what should be done.
3. The programme should be updated from time to time to accommodate change in the
clients business.
4. An audit programme must specify the audit objective.
5. The programme should make provision for staff to take responsibility of the work done.
EXAMPLES OF AUDIT PROGRAMMES
1. Audit program of purchases and creditors
1. Standard Audit Programme on Purchases and Creditors.-: Verify the purchase requisitions
and orders ensuring that they were dully authorized.
2. Ensure that all Goods Received Notes were matched with purchase orders.

3. Verify that all invoices are supported by purchase orders and goods received notes.
4. Verify that the credit notes have been received for all goods returned.
5. Check that the payment of invoices was dully approved.
6. Check the recording of the purchase orders and credit notes into the respective subsidiary
books.
7. Check postings to the general ledger.
8. Check control accounts.
9. Reconcile creditor balances with control accounts.
10. Check reconciliation of creditors balances with the creditors statements.
2. Audit Programmes on Sales & Debtors.
1. Verify some of the order received, goods dispatch notes and invoices issued in respect of
the goods dispatched.
2. Test check calculations and additions on the sales invoices.
3. Test check a number of items sold with stock records like stock ledger to ensure that these
goods were deducted from the stock in hand.
4. Test check entries in the sales Day Book and posting in the sales ledger.
5. Verify that goods returned have been properly recorded and these returns have been
approved by a responsible officer.
6. Verify that all credit notes have been properly authorized by an official
7. Check the goods returned with stock records.
8. Test check a number of Debtors A/C in the sales ledger.
9. Examine discounts and allowances and inquire into any items which are exceptional.
10. Obtain a list of bad debts and ensure that all have been properly authorized.
11. Test check additions in the sales ledger and reconcile the totals of debtors in the sales
ledger with control A/C balances.
12. Ascertain that control accounts are regularly maintained.
13. Ensure that monthly statements are regularly to debtors.
14. Obtain confirmation of debtor balances.
3. Audit Programme on Stock & Work in Progress.
1. Verify the stock records and the supporting documents like Goods Received Note, Goods
Requisition Note and Goods Issue Note.
2. Examine the results of the physical counts as compared to stock records and establish that
they were carried out properly and by someone not from the stores department.
3. Review the stock taking system. If necessary, test check some stock items physically.
4. Verify the actual purchases, stock issues and stock balances to establish that there is no
variance.
5. Verify that stock sheets and supporting documents were signed by authorized persons.
6. Examine the method of charging stock costs to respective stock units.
7. Check the basis for the valuation of stock.
8. Examine the procedures of identifying obsolete, damaged and slow moving stock items.
9. Examine the measures taken to minimize the risk of stock damage, wastage and theft.

4. Audit Programme on Wages & Salaries.
1. Verify that payment of wages and salaries are according to the rules of the Company and to
actual employees only.
2. Check the calculation of gross wages, deductions and net wages.
3. Examine the records on the basis of which gross wages have been calculated e.g. Clock
cards, Piece work tickets and Bonus scheme basis.
4. Verify that overtime is dully authorized.
5. Check the approval of payroll by an authorized person.
6. Check that amounts deducted are accounted for and dully paid over to the respective
parties. e.g. PAYE, NSSF, NHIF
7. Examine the procedures followed in respect of unclaimed wages and ensure that this are
dealt with properly.
8. Examine the procedures of distributing wages and salaries and ensure that it operates
properly.
9. Compare the signature of employees in the payroll with those in staff cords to ensure there
are no dummy/ghost workers.
Limitations of planning
i.) Inadequate audit staff.
ii.) Conflicting timing of field visits.
iii.) Technicalities of the accounting system and I.C.S.
iv.) Complexity of the business, industry and the organization.
v.) Lack of commitment from the clients.
Reasons why auditors fail in the planning process

1. Starting the audit work before finishing planning resulting in omission, unnecessary work
and misunderstanding with the client.
2. Inadequate documentation.
3. Lack of proper understanding of the clients business.
Reasons why auditors fail in the planning process
4. Starting the audit work before finishing planning resulting in omission, unnecessary work
and misunderstanding with the client.
5. Inadequate documentation.
6. Lack of proper understanding of the clients business.

AUDIT CONTROLLING: ISA 220
– Business risks facing audit firms
1. Loss of key audit personnel to competitors
2. Litigation to audit firms that can lead to damage of reputation and consequently loss of
clients.
3. Disciplinary action by ICPAK e.g. withdrawal of practicing certificate or suspension for a
period of time because of negligence or carelessness in performance of audit work.
Due to the above risks, ISA 220 requires every audit firm to put in place quality control measures
at two levels:-
a) At the audit firm level.
b) At individual audit level.
– Audit control means the steps taken by the auditor to ensure that the actual audit is carried out
as per the audit plan.
A good audit plan is to be supplemented by good audit control.
Controlling the audit is a continuous process in the audit assignment.
Effective audit control involves the following matters:-
1. Allocation of duties to audit staffs in accordance to their qualification, training and experience.
2. Giving instructions in form of audit programs to help the audit staffs in the conduce of the
audit
3. Monitoring the progress of the audit to ensure that work is carried out in accordance to the
programmes.
4. Reviewing the completed audit work to agree these with the standards of expectation.
– Therefore, audit control can be defined as, the process by which the audit senior directs,
coordinates, delegates, supervises and reviews the audit work, to ensure efficiency in the
conduct of the work carried out.
– The scope of the audit control differs from one audit to another and from one auditor to
another depending on:-
1. The terms of engagement for the audit.
2. Nature of the audit assignment
3. Objectivity of the audit.
4. Size of the business and volume of transactions.
5. The degree of cooperation expected from the management.
a) Audit control at the audit firm level (General Quality Controls)

These are the general measures to ensure that the quality of services rendered by the audit firm
is safeguarded. They include:-
1. Professional requirements.
2. Skills and competence
3. Assignment
4. Delegation
5. Consultation
6. Acceptance and retention of clients ( client screening)
7. Monitoring

1. Professional requirement
– These are procedures that ensure that the audit staff complies with ISA, professional ethics
and Company’s Act while providing their services.
– For a large audit firm, it may be appropriate to delegate the task of ensuring compliance
with professional requirements to the HR partner.
– In case of non-compliance such a partner will take disciplinary action against the audit
staff.
2. Skills and competence

– The audit firm should recruit personnel who have desirable knowledge, skills and
experience to conduct the assignment.
The audit staff should be assisted to enhance their competence level by:-
i. Maintaining a technical library in the audit firm.
ii. Attendance of continuing professional education by paying their membership fee to join
ICPAK and Institute of Internal Auditors.
iii. Issuing technical circulars and memos on changes in the accountancy profession
iv. Audit firms should recruit professionals such as engineers, quantity surveyors, architects,
lawyers, e.t.c, who will assist the audit firm where they lack the necessary competence
level.
3. Assignment
– Work should be allocated to those who are competent to perform that work perfectly.
High risk areas should be allocated to highly qualified and experienced personnel whereas low
risk areas should be allocated to assistants and trainees.
4. Delegation
This is the process of giving work to the audit staff to do it on behalf of the engagement partner.
The engagement partner should provide direction and supervision so that the work is of good
quality. He should be answerable for any mistakes committed by the audit juniors.
5. Consultation
Where possible, the audit staffs should be encouraged to discuss with each other on use of
authoritative sources on complex matters.
Areas where consultation may be required include,
a) When auditing specialized institutions e.g. banks, insurance companies, building societies,
pension fund, e.t.c.
b) When a qualified opinion is to be issued, i.e. negative audit opinion.
c) During application of a newly pronounced ISA.
6. Acceptance and retention of clients( client screening)

Acceptance and retention of clients should be an ongoing process. Audit firms assess their
potential and existing clients and decide whether or not to accept or continue with engagement.

Factors to consider before accepting or retaining clients
a) Directors and management integrity- Integrity of those managing a company is very
important particularly if the company is run by one or a few personalities. If the integrity is
questionable, the financial statements are likely to be manipulated.
b) Risk assessment- Audit firms must categorize their clients into high and low risk clients. High
risk client, will display the following characteristics:-
– Poor financial performance
– Evidence of questionable integrity
– Weak accounting system and ICS.
Whereas, low risk clients will have the following characteristics:-
- Competent and honest management.
– Strong accounting and ICS.
When the level of risk is determined to be high, then the specific areas should be identified and
documented. It may be necessary to assign highly experienced audit personnel.
c) Engagement economies
– Audit firms should conduct a cost benefit analysis i.e the audit fee charged should reflect the
resources to be used.
d) Relationship
Most audit firms want the relationship with their clients to last for a long period of time. This is
not only to enjoy large amounts of audit fees year after year, but to allow the audit work to be
enhanced by a better understanding of the client.
e) Ability to perform the work
The audit firm should consider whether they have sufficient resources especially the audit
personnel who should be competent to carry out the audit according to the necessary
expectations.
MONITORING
This is the process of making a follow up to ensure that the quality control procedures are being
complied with. The audit file of the client should be reviewed by independent partners who will
assess whether the audit assignment has been completed and the conclusions arrived at are
reasonable.
AUDIT CONTROL AT THE INDIVIDUAL AUDIT LEVEL
This involves delegation, direction, supervision and review of the audit work.
1. Delegation
The audit manager should,
i. Decide on the no. of staff required on the audit assignment.
ii. Decide on the professional requirements of each audit staff member
iii. Consider the nature and the audit work.
iv. Prepare allocation of duties schedule.
v. Allocate the duties to each of the audit staff
2. Direction
The audit manager should
i. Evaluate the nature of the risk involved in the client.
ii. Evaluate the nature of the scope of the quality controls of the firm
iii. Consider any skills and competence required.
iv. Issue the audit programme and the planning memorandum in respect to the audit work.
3. Supervision
The audit manager should
i. Attend the place of the audit work at each and every field visit.
ii. During the field visit, monitor the progress of the work.
iii. Identify areas where programs are not followed or are followed mechanically.
iv. Order for the repeat of work where this was not done properly.
4. Audit Review
The work performed by each audit staff should be examined by appropriate personnel to ensure
that,
i. The work has been performed in accordance with auditing standards and the audit firm own
standards and applicable legal and regulatory requirements.
ii. The work performed has been adequately documented in support of the conclusion reached.
iii. Any significant matters have been resolved or are reflected in the audit conclusions.
iv. The audit objectives have been achieved and the work done and the conclusions drawn
support the opinion expressed.
v. The audit evidence obtained is sufficient and appropriate to support the auditor’s reports.
November 2010 Q1a
AUDIT RECORDING/ WORKING PAPERS –ISA 230
– The auditor should document matters important in providing evidence to support the audit
opinion and evidence that the audit work was carried out in accordance with the required
standards.
– Documentation means the materials (working papers) prepared and retained by the auditor in
connection with the performance of the audit. An auditor should be keep a record of all
important matters which he comes across during the audit.
– Working papers are the records kept by the auditor of the procedures applied, tests
performed, information obtained and pertinent conclusions reached in the engagement.
Purpose of working papers June 07 Q1 (a) (i)
1. They provide information for future reference, details of problems encountered and
conclusions drawn therefrom in arriving at the audit opinion.
2. They form a basis for planning the audit for the following year. The information contained in
the working papers allows the auditor to plan the audit adequately considering the
occurrences in the previous period.
3. Acts as evidence of work carried out. Working papers are a primary means of providing
evidence that an adequate audit was conducted. Where need arises, the auditor will be able to
demonstrate through availing working papers that the audit was well planned, adequately
supervised, evidence accumulated was reliable, relevant and sufficient and that the opinion
drawn by the auditor was proper considering the results of examination.
4. Working papers provide a source of data for determining the opinion to make. They provide an
important source of information in assisting the auditor in determining the appropriate report
to issue in a given set of circumstances.
5. It is a basis for review by supervisors and partners. They are a primary frame of reference used
by supervisors and partners to ensure that work delegated has been properly performed.
6. Working papers can be used for training new audit staffs.
Working papers may take the form of manual papers or electronic media such as a flash disk
and C.Ds. The working papers should be sufficient, complete and detailed enough to enable
another auditor, who did not take part in the audit assignment to arrive the same conclusion.
Matters to consider when documenting the working papers
1. Name of the audit firm and the client.

2. An appropriate title i.e area audited.
3. Audit objectives on why the account balance was examined.
4. Audit findings.
5. Audit conclusions.
6. Reference no.4 tracking purposes.
7. Name of the preparer, position and signature.
8. Name of the reviewer, position and signature.
9. Appropriate date i.e date the account balance was examined.
CONTENTS OF WORKING PAPERS
Working papers are conventionally sub divided into two for convenience and control.
1. Permanent Audit File.
2. Current Audit File.
Permanent Audit File
This working paper contains information or data of historical or continuous nature which will be
required by the auditor for more than one audit period.
Such information will always be referred to in subsequent audit assignment.
It must be updated at the end of each audit. It contains the following:-
1. MOA and AOA
2. A brief history of the company and the summary of accounts.
3. Description of the accounting system and the ICS.
4. The organization chart showing the top management functions and the division of
responsibilities.
5. Description of the business operations and address of its location.
6. Other important legal documents and agreements. E.g lease contracts, debenture deeds, trade
agreements, guarantees, e.t.c
7. List of accounting books and records maintained by the company.
8. Significant fixed assets and investments owned by the company and their valuation.

Current Audit File
This working paper contains all information, records and documents relating to the company, the
audit and the auditor necessary for the current year audit.
This working paper includes matters such as:-
1. A copy of the accounts being audited indicated by the directors signature

2. The annual audit programme detailing the tests to be carried out and recording of the tests
carried out.
3. The audit plan including time budgets, staffing requirements and statement of the scope and
level of tests.
4. Schedule showing the analysis of individual items in the financial statements. The schedule
should show the item at the beginning of the year, changes during the year and the balance at
the year end. E.g fixed asset register, debtors schedule, stock schedule, etc.
5. Notes of meetings and all correspondences relating to the audit including all certificates and
other 3rd party confirmations.
6. Extracts from minutes of meetings of the shareholders, directors and important committees
such as audit committees.
7. Records of detailed audit tests carried out, the timing of the tests, level of the tests and
conclusions drawn from the tests.
8. Information received from the other auditors regarding the financial statements audited by
them.
9. Records of questions raised by auditors and how such questions have been dealt with.
10. A copy of the representation letter indicating that they have supplied the auditor with all the
information and explanation relevant to the audit and that disclosed in the financial
statements are matters required by the statute and the accounting standards.
11. A copy of the management letter highlighting weaknesses in the ICS and possible solutions.
12. A review of post balance sheet events up to the date of signing the audit report.
13. Audit findings and conclusions drawn.
14. Audit reports that contains the audit opinion on the financial statement.
15. Name and initial of the audit staff.
Standardized work papers

These are pre-prepared working papers that are used by audit firms for all the engagements.
They are prepared in advance and can be used from one audit to another and from one company
to another.
Examples include:-
i. ICQ - These are short structured questions that are used to ascertain how the accounting
system and ICS is working.
ii. ICEQ - they are short structured questions that are used to evaluate the design and
effectiveness of the accounting system and ICS.
iii. Debtor’s circularization letter- these are used to confirm debtors balances from the
debtors themselves. Circularization letter can also be used for creditors.
iv. Bank Standard letter- It is used to confirm bank balances as at the balance sheet date from
the client banker.
v. Standard Audit programmes- They give the procedures to be performed from the
beginning to the end of a certain audit area.
Advantages of standardized working papers
1. They enhance uniformity/ consistency in all the audit performed by the audit firm.
2. They provide a control to ensure that important procedures are not omitted hence enhance the
quality of the audit work.
3. They are economical to the auditor.
Disadvantages
1. The set procedures may not fit well with all the clients since different clients have different
accounting systems and ICS.
2. Such working papers may make the audit take a mechanical approach i.e. the audit staffs will
be applying the procedures for the sake of it.
3. The auditor’s creativity may be limited because they are not allowed to think on their own on
the best way of auditing the financial statements.
AUTOMATED WORKING PAPERS

These are computer programmes which have been developed and makes documentation of the
audit work much easier.
Such computer programmes can assist in the analysis of the performance, preparation of
financial statements and computation of significant accounting balances.
Advantages of automated working papers

1. Work papers will be neat and easier to review because they are not manually documented.
2. They can be transmitted to the audit firm electronically as long as laptops are installed with an
email or fax bound s/w. Therefore this enhances communication and teleworking.
3. It facilitates confidentiality because laptops and the respective audit files can be password
protected.
4. Storage is enhanced because a lot of information can be condensed in an electronic media such
as flash disks, memory space of the laptop.
Disadvantages
1. It is costly to develop such working papers since the audit firms must engage a system analyst
and a computer programmer.
2. If the audit firm does not have adequate back up procedures, in the event of a disaster, the
audit firm may not recover such information.
3. If the audit staff share their passwords or the passwords are ineffective, it is easy for
unauthorized personnel to access sensitive information about the client.
OWNERSHIP & CUSTODY OF WORKING PAPERS
Working papers are the property of the auditor and they are not part of the accounting records of
the client.

The auditors at their own discretion may release some of the working papers to the clients as
long as the disclosure does not undermine the independence and integrity of the audit process.
Equally, the audit firms are expected to maintain high level of secrecy over the information about
the client. They should not disclose such information to the 3rd parties without prior permission
of the client.
According to the statute of limitation, working papers should be maintained for a minimum
period of 6years. This has been the practice audit firms have been complying with. However, as a
result of the Goldenberg scandal, ICPAK issued a circular advising their members to retain the
working papers for a minimum period of 12years.
Qualities/ Essentials of Working Papers
Whatever the format adopted, there are certain basic essentials with which work papers should
conform i.e.
1. They should be properly organized.

2. They should be fairly complete.
3. They should be clear.
4. They should be referenced.
5. They should be indexed.
6. They should bear the preparer and reviewer’s signature.
7. They should be appropriately dated.
8. They should be sufficiently complete.
9. They should be kept safely to avoid misuse.
10. They should be updated periodically.
ACCOUNTANTS LIEN
A particular lien gives the possessor the right to retain goods until a debt arising in connection
with those goods is paid in full. Accountants are considered to have a particular lien in the
following areas.
a) Lien over books of accounts and records of the company.

b) Lien over group accounts if any.
c) Lien over returns from branches not visited by the auditor.
d) Lien over information and explanations obtained by the auditor.
ACCOUNT SYSTEM AND INTERNAL CONTROL SYSTEM –ISA 315

Definition of an account system.
– This is a series of tasks and records of an entity by which transactions are processed as a
means of maintaining the financial records and eventually leads to the preparation of the f/s.
– Such an account system should identify, assemble, analyze, classify, calculate, record and
report financial transactions and other events.
– An account system will enable the accounts to :-
a) Gather data or information.
b) Analyze the performance of the company.
c) Compute account balances and classify them accordingly
d) Interprete financial information for decision making purposes.
e) Prepare the f/s.
Auditors interest in the account system and the ICS

1. The 7th schedule of the Company’s Act requires that the auditor performs the following
statutory obligations:-
a) State whether proper books of accounts have been kept by the company as per sec147 of
the Company’s Act.
b) State whether the financial statements in agreement with the books of the accounts and
whether they give a time and fair view.
c) Since the account system is the one that maintains or produces proper books of accounts,
it is important for the auditor to have an interest in the account system and ICS so that he
can discharge the above statutory obligations.

TOPIC 5: ACCOUNTING SYSTEM AND INTERNAL CONTROL SYSTEM – ISA 315
Definition of an accounting system
- This is a series of tasks and records of an entity by which transactions are processed as a
means of maintaining the financial records and eventually leads to the preparation of the
- Such an accounting system should identify, assemble, analyze, classify, calculate, record and
report financial transactions and other events.
- An accounting system will enable the accountant to:-
a. Gather data or information
b. Analyze the performance of the company
c. Compute account balances and classify them accordingly
d. Interpret financial information for decision making purposes
e. Prepare the financial statement.
Auditors interest in the accounting system and the ICS
1. The 7th schedule of the company’s Act requires that the auditor report on the following
statutory requirements:-
a) State whether proper books of accounts have been kept by the company as per Section 147 of
the company’s act.
b) State whether the financial statements are in agreement with the books of accounts and
whether they give a true and fair view.
Since the accounting system is the one that maintains or produces books of accounts,
financial statements then it’s important for the auditor to have an interest in the accounting
system and ICS so that he can discharge the above statutory obligations.
2. ISA 315 requires the auditor to obtain a detailed understanding of the accounting system and
ICS sufficient to enable him develop an effective, efficient and economical audit approach.
Management interest in Accounting System and ICS
1. To assist them in the preparation of the financial statement because such systems provide a
framework for the preparation of the accounts.
2. To assist them in safeguarding the company’s assets.
3. To assist them in effective decision making.
4. To prevent and detect material misstatements.

Nature of the accounting system and ICS
When directors and management of the entity intend to design an accounting system and ICS,
they must consider the following issues:-
1. Size of the entity – If it is large, then a complex accounting system must be implemented to
support the operating activities of the organization.
2. Materiality of the accounts balances in the context of the financial statement. For instance
a multinational company e.g. cocacola that has cross border transactions will require a
complex accounting system than a kiosk owner who might find the cash book to be
sufficient.
NB: The basic need of any accounting system is that it should provide for an orderly assembly of
accounting information to assist in the preparation of the financial statements.
3. Nature of the operating activities of the company i.e. whether manufacturing or service
oriented entities.
4. Management of the entity
5. Practicability of the accounting system and ICS.
6. Practice by other organization in the same field.
Importance of ICS in a company’s accounting system
- For any accounting system, to operate effectively, there has to be an inbuilt ICS. The accounting
system is manned by human beings and if they are incompetent, they make mistakes or errors
and if they lack integrity, they will perpetrate irregularities or fraud. To minimize errors and
irregularities including fraud, an accounting system must be built in to it, internal controls
whose purposes are:-
1. To ensure that all transactions are executed in accordance with proper, general or specific
authorization.
2. Ensure that all transactions are promptly recorded with the correct amount, in the
appropriate accounts and in the appropriate period so as to permit the preparation of the
financial statement in accordance with the company’s Acts and accounting standards.
3. Ensure that access to assets is restricted to authorized personnel only.
4. Ensure that recorded assets are compared with existing assets at reasonable intervals and
appropriate action taken with regard to any differences.
5. Ensure that errors and irregularities are avoided and made apparent if they occur.
Audit procedures as regards the accounting system and ICS
- ISA 315 suggests that the auditors procedures with regard to the accounting system and its
related ICS, will depend with the circumstances but may include:-

1. Obtaining an understanding of the enterprise as a whole in order to see the accounting
system in its proper context and thus be able to assess the systems effectiveness and
appropriateness.
2. Ascertain the complete system by some form of enquiry in order to:-
a) Identify the major classes of transactions, how they are initiated and completed.
b) The significant accounting records produced or maintained by the accounting system.
c) The financial reporting process.
3. The auditor should record the accounting system he has ascertained through narrative
notes, flow charts answers to ICQ and organization structure.
4. The auditor should perform walk through tests. This is the confirmation of the correctness
of the description of the accounting system by reviewing the accounting records.
5. The auditor should make a decision on whether he will rely on the accounting system and
ICS. If he is going to place reliance on the controls, then he must perform test of controls or
compliance tests.
6. If his test of controls reveals that the accounting system and ICS are strong, then he must
design and perform less substantive procedures but if they are weak, he should design and
perform detailed substantive procedures.
7. The auditor should then evaluate his evidence i.e. determine whether proper books of
accounts have been kept and whether the accounting system form a reliable basis for the
preparation of the financial statement.
Definition of Internal Control System (ICS)
- An ICS, can be defined as the whole system of controls, financial or non financial instituted by
the management of an entity to enable them operate the business in an orderly and efficient
manner, ensure adherence to management policies, safeguard the assets of the company,
prevent and detect errors and frauds and to secure as far as possible the accuracy and
reliability of the company’s records.
Purpose / Objectives of ICS
1. To ensure orderly and efficient conduct of the business

2. To ensure prevention and detection of errors and frauds
3. To ensure for the safeguarding of the company’s assets.
4. To ensure adherence with management policies.
5. To ensure accuracy and completeness of the accounting records including timely preparation
of the financial statements.

Explanations
1. Orderly and efficient conduct of the business
When a company is run in an orderly and efficient manner, it will display the following
characteristics:-
i. There will be smooth flow of work, resources and information

ii. Information produced for decision making purposes will be timely and reliable.
iii. The organization can satisfy the requirements of its customers, suppliers, employees and
regulatory authorities.
iv. There will be reduced wastage of resources and facilities.
- The auditor of such an organization is likely to receive the necessary co-operation from the
client, customers and suppliers.
2. Detect and prevent errors and frauds

Managers of the company are expected to institute the following controls:-
a) Preventive controls – These will deter / prevent the risk from occurring e.g. authorization
of a major transaction will prevent fraud from occurring.
b) Detective controls – These are controls that are designed to identify or unearth a risk that
could not have been prevented e.g. reconciliation and establishing an internal audit
function.
c) Corrective controls – These are controls that will address the risk that could not have
been prevented but were detected and ensure that, they do not occur again e.g. paying
adequate remuneration and having follow up procedures by the management.
3. Safeguarding the company’s assets

Assets of the company are exposed to the following risks:-
a. Theft – To guard against theft, managers should institute physical controls such as
employment of watchman, use of TV circuits, surveillance cameras, use of mbwa kali and
above all take insurance cover against theft.
b. Fire – to guard against fire employees should be trained on safety regulation measures,
occasionally conducting fire drills, installing fire extinguishers and taking an insurance
cover against fire.
c. Misuse – to safeguard against misuse, there should be proper authorization before usage
of an asset and allocating an asset to a responsible official who can be held accountable in
the event of misuse.
d. Deterioration in value – To guard against this, managers should ensure that, assets are
serviced or maintained on a periodical basis to ensure that, they are at their best condition
at all times.

4. Adherence with management policies.
Employee’s of the company are supposed to comply with the rules and procedures that will
enable them fulfill their duties as expected.
Such compliance, can occur if:-
i. Managers recruit competent personnel
ii. Undertaking periodical training that will ensure that employees performance
improves with time.
iii. Establishing an internal Audit department that will monitor the compliance with the
policies.
iv. Remunerating employees adequately.
v. Taking disciplinary action against those employees who fail to comply with the
policies.
5. Accuracy and completeness of the accounting records including timely preparation of
financial statement:
Managers need accurate and complete accounting records to enable them make effective
decisions concerning the performance of the company or operating activities. The accounting
personnel should be trained on how to gather accounting data, process the data into
information and they should be given target on when to prepare financial statement.
Elements of ICS
A good ICS must have the following elements
1. The control environment

2. The risk assessment process
3. The information system
4. The control activities
5. Monitoring of controls
a) The control environment
It refers to the overall attitude, awareness and actions of the management regarding the internal
control and its importance to the entity.
A good control environment facilitate the growth of internal control.
b) The risk assessment policies
It focuses on how well the management is able to identify and respond to various risks facing the
business. A business risk if not well managed could result to failure of business.

c) Information system
Refers to the hardware, the software and the communication channels through which the
information flows in the organization. Effective communication is a great tool for organization
survival.
d) Control activities
Control activities are the policies and procedures adopted around the control environment in
order to achieve the control objectives. They are the action taken to address the risks that
threatens achievement of objectives e.g. segregation of duties, supervision rotation of duties,
internal checks system.
e) Monitoring of controls
This involves regular evaluation of controls to check whether they are operating as intended. It
involves assessing the quality of the internal control performance over a period of time
Features / characteristics of a sound ICS
An effective ICS can operate when some specific procedures are adopted by the management.
These features are:
i. Plan of organization
ii. Authorization and approval
iii. Segregation of duties
iv. Accounting and arithmetic controls
v. Physical controls
vi. Supervision
vii. Personnel
viii. Management
1. Organizational plan
These should be organizational plan clearly defining the duties and responsibilities of employees,
senior staff, departments and sections. These must be supported by an organizational chart or
structure. A clear organizational plan ensures for the smooth flow of work and responsibilities,
discourage any conflicting duties, create good work relations and mutual understanding among
employees, managers and supervisor.
2. Authorization and approval
All transactions should require authorization and approval by appropriate personnel or the
responsible officer. This is aimed at ensuring;

a. Preventing frauds and errors
b. Safeguarding the company’s assets
c. Streamlining the flow of authority to avoid bureaucracy and conflicting duties. The person
authorizing should be at a lower level in ranking than the person approving purposely to
detect and prevent any error or fraud.
3.Segregation of duties
It involves division of responsibilities to ensure that no one person is responsible for carrying out
a complete transaction. The involvement of several people reduces the risk of intentional
manipulation, incidental errors and frauds and increases the element of checking the work
segregation of duties encourages specialization hence efficiency in the organization.
Duties that must be segregated include:
a. Authorization and approval

b. Recording of transactions
c. Execution of duties
d. Custody of company’s assets
e. Systems development for computer operations
f. Payroll preparation
4. Supervision
All actions by all levels of staff should be supervised. The supervisors must be vigilant in their
duties to ensure that work is carried out as per the laid down company policies. The supervision
should however be mane to avoid frustration of staff.
5. Accounting and arithmetic controls
These controls are aimed at ensuring the accuracy of transactions and proper recording of the
company’s transactions according to the generally accepted accounting principles. Accounting
and arithmetic controls involves the following:
a) Employing reliable and qualified personnel who will not be exposed to committing errors and
frauds.
b) Use of computers, cash registers, calculator or adding machines.
c) Setting up and maintaining strong internal check systems such that work done by one officer
is automatically checked by another for accuracy and completeness.
6. Physical controls
These concerns the safety and custody of assets and involves procedures and measures designed
to limit access to authorized personnel only e.g. employment of watchmen, strong locks and

fences, bullet proof devices, password to restrict access to several computer files, use of CCTVs,
electrifying the gates, use of security lights use of dogs and biometric controls.
7. Personnel
Companies should employ qualified, competent and motivated personnel to carry out the tasks
assigned to them. The proper functioning of a system depends on the competence and integrity of
the operating personnel. The measures to ensure this include:
a. Good remuneration
b. Promotion and recognition
c. Career development prospects e.g. training
d. Appropriate assignment of tasks
Management
These are controls exercised by management who are outside and above the day to day routine
of the system. This includes overall supervisory controls, review of management accounts by
comparing actual performance with budgets and setting the internal audit department.
Inherent limitation to the internal control system although the ICS are essential factors of any
organization, that is run in an orderly and efficient manner, it is important to recognize that the
controls may not work as intended because of the following inherent limitations.
i. Managers are usually guided by cost benefits analysis before implementing a control e.g.
most companies might fail to establish practical controls audit committee or internal audit
function because the short term costs outweigh the immediate benefit. However in the long
run, benefit exceeds the costs incurred.
ii. Changes in technology might render an internal control system obsolete hence fail to achieve
its objectives.
iii. The fall the an ICS is applied for systematic and routine transactions and not non-routine
transactions. There’s a high chance that material fraud and errors can occur in respect to
non-routine transactions.
iv. Potential human errors may lead to mis-statements in the financial statements.
v. Possibility that the people in-charge of exercising the controls may override the internal
control e.g. it is easy for directors and managers to bypass normal procedures.
vi. The possibility of collusion between employees, 3 rd parties and manager e.g. the production
manager who is responsible for authorizing overtime claims may collude with the employee
to enable excess overtime payments to be made and later share with the employee.

Inherent limitation to the internal control system
Although the ICS are essential features of any organization, that is run in an orderly and efficient
manner, it is important to recognize that the controls may not work as intended because of the
following inherent limitations:
1. Managers are usually guided by cost benefit analysis before implementing a control e.g.
most companies might fail to establish physical controls audit committee or internal audit
function because the short term costs outweigh the immediate benefit. However in the long
run, benefits exceed the costs incurred.
2. Changes in technology might render an internal control system obsolete hence fail to
achieve its objectives.
3. The fact that an ICS is applied for systematic and routine transactions and not non routine
transactions may make the management not to develop controls in respect to the non-
routine transactions. There is a high chance that material fraud and errors can occur in
respect to non-routine transactions.
4. Potential for human errors may lead to mis-statements in the financial statements.
5. Possibility that the people in charge of exercising the controls may override the internal
controls e.g. it is easy for directors and managers to bypass normal procedures.
6. The possibility of collusion between employees, 3 rd parties and managers e.g. the
production manager who is responsible for authorizing overtime claims may collude with the
employees to enable excess overtime payments to be made and later share with the
employee.
Advantages of a strong ICS
1. Minimizes chances of errors and frauds in a business through rotation of duties, compulsory
leave, surprise checks and supervision.
2. Safeguards the company’s assets through physical controls, proper authorization, arithmetic
and accounting controls.
3. Enables the management to achieve its goals as policies will be checked through budgeted
controls, managerial review and constant supervision.
4. It will boost control of work and avoid duplication of efforts through delegation of duties,
proper organizational charts and defined powers.
5. Encourages specialization through segregation of duties thus boosting efficiency.
6. Strong ICS will always lead to unqualified audit report.
7. The company will have up-to date data for managerial decision making through qualified and
competent staff, routine and surprise checks, use of machines and constant supervision.
Disadvantages of a strong ICS
1. It may lead to demoralized staff due to poor supervision and if the internal check system is
not properly instituted.

2. It can be an expensive system to install and maintain e.g. physical controls and internal audit
department.
3. Rigid segregation of duties may lead to high bureaucracy levels in the company leading to
frustration among the employees.
4. It might set unrealistic controls e.g. tight budgets which cannot be achieved by employees
thus frustrating them.
5. Management may over rely on such a system leading to compromise on supervision,
managerial reviews and delegation of duties which employees may take advantage to
perpetrate fraud.
6. The external auditor may over depend on such a system and thus relax on his audit tests
which may leave errors and frauds undetected.
RELATIONS OF INTERNAL CONTROLS “TO PURCHASE OF RAW MATERIALS
(Example from a large manufacturing company)
1. Stores department
There should be a stores department which is charged with the following responsibilities.
i) Custody of raw materials, protecting them from theft, damage and misuse.
ii) Initiate the purchases transaction by raising requisition based on re-order level. The
requisition should be pre-printed, pre-numbered, issued in numerical sequence and as a
minimum two copies.
iii) The requisition to be distributed as follows:-
- Original to the buying department
- Duplicate to remain as a book copy to update the register of requisitions.
iv) There should be a register to disclose as a minimum the following information:
- Column I: Requisition number
- Column II: Date when the requisition was raised.
- Column III: Purchase order number and the date of the purchase order
- Column IV: Goods received note number
- Column V: Date of the Goods Received Note.
v) To receive a copy of the purchase order from the buying department which should be
attached to the book copy of the requisition.
vi) When goods arrive, they should be received by the stores department which should check the
goods for quantity and quality against the purchase order.
If satisfied;
vii) Raise a Goods Received Note which should be pre printed, pre-numbered, raised in numerical
sequence and at least 3 copies which should be distributed as follows:-
- Original to the accounts department to be matched against the suppliers invoice when it is
received.

- Duplicate to be sent to the buying department where it is to be matched against the
purchase order.
- The third copy to be used by the stores department to update the register of requisition
and also to update the stock ledger which may be maintained in quantity terms.
viii) To issue to production departments upon a proper requisition note, materials to be used in
the production process.
ix) To monitor the continued existence and good condition of materials in the stores.
2. Buying department
The buying department will be charged with the following responsibilities:
a) To identify the optimum suppliers maybe through a tendering process, agree the trading
terms with the supplier, document the agreed terms in form of a trading contract then
produce a list of approved suppliers. The purchasing committee will ensure that no new
supplier is added to that list unless the committee has given its approval in writing.
The agreed list of suppliers is then sent to the accounts department who will open an account
in the creditors ledger for the supplier concerned. No account can be opened without a
recommendation from the buying department and approval by the chief finance officer.
b) To receive a requisition from the stores department, consider the necessity of the goods
being requisitioned for and if satisfied identifying the optimum supplier from the approved
list of suppliers.
c) Prepare a purchase order on a pre-printed, pre-numbered stationary that should be issued in
numerical sequence. As a minimum, 4 copies should be raised and distributed as follows after
being properly authorized;
- Original to the supplier to form the basis of the contract between the supplier and
company.
- Duplicate to the stores department to notify them that goods requisitioned for have been
ordered.
d) The third copy to the accounts department to await the receipt of the suppliers invoice
against which it is to be matched.
The 4th copy to be retained as a book copy by the buying department to be matched against
the copy of GRN so that the buying department can know the orders that have not been
supplied.
e) To deal with the supplier on such aspects as sending the original copy or purchase order to
the supplier, to communicate with the supplier to start packing the goods and to follow up
the supplier for short or delayed deliveries.
f) Regularly to produce a list for review by senior management and taking appropriate action
against unfulfilled orders.
g) The buying department can also maintain its own register and monitor the movement of the
purchase orders.

3. Authorizing department
It would be inappropriate for the head of the buying department to authorize for the purchase
transactions. Therefore, senior officials ordinarily be managing director or the chief accountant
or the BOD would be given the responsibility of committing the resources of the organization.
The purchase order once prepared by the buying department would be forwarded to the officials
to authorize the transactions. They should check the purchase order to ensure that, it is
grammatically correct, confirm that the supplier is in the approved list of suppliers, that the
anticipated expenditure is within the budget and that it is generally proper to do business with
that supplier.
4. Accounts department
The accounts department will be charged with the following responsibilities:
a) To receive all invoices from the suppliers

b) Give those invoices an internal number probably stamped in the invoice, the numbers\ being
allocated as the invoices are received.
c) They should maintain an invoice register where the details of suppliers invoices should be
entered.
d) Compare the suppliers invoices to the details in the purchase order and the GRN.
e) Send the invoice to the buying department and stores department for responsible,
independent official there to check and confirm that the invoice is genuine.
f) On receipt of the invoice, from the buying and stores department, if approved, check the
calculation on the invoice to confirm for accuracy and check other details such as name and
date and then allocate account codes on the invoice.
g) Enter the invoice details in to the purchases day book and the entry to the credit side of the
suppliers individual ledger accounts in the creditors ledger.
h) Periodically post the totals in the purchases day book to the control accounts in the general
ledger.
i) Receive details of payment from the cash book section and post the individual payments to
the debit side of the individual creditors account and the totals to the control account in the
general ledger.
j) Extract a list of balances from the individual creditors ledger account and compare that list
with the balances on the control account. If different, prepare a reconciliation.
k) Compare the details on the creditors ledger with details on the suppliers statements and
again prepare a reconciliation where there are differences.

5. Board of Directors
The BOD, would also establish an internal audit department which would check the activities of
different departments mentioned above independently tracing the transactions through the
system and matching independently all documents and records that need to be matched.
The BOD will also regularly compare the actual performance with budgets and institute
investigations into those aspects that do not appear to be in accordance with expectations.
INTERNAL CONTROLS IN PRACTICE
Most organization have the following internal controls:-
1. Wages and salaries

2. Purchases and creditors
3. Sales and debtors
4. Stock and Work In Progress
5. Fixed assets
6. Cash sales, payment by cheques and cash received by post
7. Petty cash etc.
The easiest way to design an ICS is to consider the following questions:-
1. What can go wrong in the absence of Internal Controls i.e. identification of risk
2. What is the impact if the matter went wrong i.e. financial, operational or compliance
3. What are the recommendations if the matter went wrong i.e. preventive, detective and
corrective controls.
1) Internal controls over wages and salaries

a) Risks associated with the payroll
1. Unauthorized payments to ghost workers or fictitious employees
2. Manipulation of authorized rates of pay and the number of hours worked leading to
overstatement of the payroll.
3. Un authorized access to the payroll system resulting to manipulation of the payroll
database.
4. Failure to pay statutory deductions, submitting incorrect returns or late payments leading
to penalties by the respective authorities.
5. Payment to starters and leavers before they commence work or leave employment
respectively.
6. Incorrect computation of gross pay resulting to discrepancies.

b) Objectives of ICS over wages and salaries
1. To ensure that, wages and salaries are only paid to actual employees at authorized rates of
pay.
2. To ensure that all wages and salaries are computed in accordance with records of work
performed whether in respect of time, output, sales made or other criteria.
3. To ensure that payroll are correctly calculated.
4. To ensure that payments are made only to genuine and correct employees
5. To ensure that statutory deductions e.g. NHIF, NSSF, PAYE are correctly accounted for and
paid over to the appropriate 3rd party.
6. To ensure that all wages and salaries are correctly recorded in the books of accounts.
c) Specific internal controls

To achieve these objectives, the company would need to put in place both preventive and
detective measures.
Preventive to ensure that, errors and irregularities including fraud do not occur and detective
to ensure that, if they cannot be prevented, then they are promptly detected and corrected.
The measures include;

a) There should be separate records kept for each employee. These records should contain
matters such as; date of engagement, age, next of kin, agreed deductions, skills
development specimen signature and certified copy of ID. These records should be kept
by separate personnel.
b) There should be procedures for and specified officials responsible for engagement
retirement, dismissal, fixing and changing the rates of pay. Procedures should be laid
down for notification of these matters to the personnel departments and payroll
preparation team.
c) Time records should be kept preferably by means of clock card records. This should be
approved and approval acknowledged. All overtime, should be authorized.
d) Output or piece work records should be properly controlled and authorized. Therefore
procedures should exist for reconciling output or piecework records with the production
records.
e) The payroll should be prepared by personnel department and connected with other
wages duties, special procedures should exist for dealing with advances, holiday pay, lay
off pay, new employees, employees leaving, sickness and other absences and bonuses.
f) The payroll should be checked by separate personnel. All work of the preparation and
checking of the payroll should be initialed. All work should be supervised and the payroll
scrutinized and approved by a senior official.
g) The net amount to be paid in cash should be drawn out on a coin analysis. Tight security
should be imposed on the security of cash both on collection from the bank and at all
times upto the receipt of envelops by the workforce.
The collection of cash from the bank should be by a recognized and adequately insured
security company.
h) Wages envelopes should be made by personnel independent of the payroll preparation
team.
i) Specified time should be laid down for the distribution of wage packets. These wage
packets should be acknowledged by the recipients
j) A surprise attendance of the payout should be made at intervals by the internal auditor or
by a senior official.
k) Any unclaimed wages should be subject to special procedures. These include, a record
being maintained of unclaimed wages, safe custody of such pay packets, a requirement for
investigation as to why the wages were unclaimed, subsequent pay out only after proper
proof of entitlement and breaking down and re-banking the remaining unclaimed wages
after a specified duration of time.
l) If wages and salaries are paid by cheque, the following controls should be exercised:-
i) Two signatories should be involved in signing the cheques.
ii) They should avoid pre-signing of blank cheques
iii) A cheque register should be maintained to capture the cheque number, amount, name
of employee, ID number, date of collection and signature.
iv) The finance manager should reconcile cheque payments to the bank statements and
ensure that, there is consistency with the payroll amounts.
m) If the wages and salaries are paid through electronic funds transfer, then the following
controls should be exercised.
i) The finance manager should be responsible for disbursing the funds and not the
accountant who prepared the payroll.
ii) The organization should communicate with the bankers on the upper limits of salaries
likely to be disbursed on a monthly basis.
iii) The IT infrastructure of the entity should have security features that will encrypt the
instructions into meaningless information. Once they reach their destination, they will
be decrypted into meaningful information.
iv) The finance manager should reconcile funds disbursed with the amount as per the
bank statement and ensure that they are consistent with the payroll.
n) Deductions such as PAYE, NSSF, NHIF and co-operative society contribution should be
subject to prompt payment over to the institution concerned. Control totals which should
be subject to frequent review should be made and comparison of such totals with records
such as tax deduction card should be performed regularly.
o) Regular independent comparison should be made between personnel records and wages
records.
p) Regular independent comparison of payroll at different dates should be made.
q) Regular independent comparison of wages with budgets should be made and variances
investigated.

r) Surprise investigation of wages records by the officials of ministry of labour should be
built into the mechanism to ensure that the company’s employment procedures are in line
with law and government regulations
NB: The accounting records that are necessary include
1. Time sheets or other performance indicators which constitutes the base documents
from which the remuneration of the employee is worked out.
2. Payroll should also be maintained to show how the relevant figures have been arrived
at for each employee.
3. Payroll should then be summarized and journalized to the general journal for posting
to the relevant nominal ledger.
2. Internal Controls over sales and debtors
The objective of a system of accounting and internal control over sales and debtors are:
a) To ensure that all customers orders are promptly executed.

b) Ensure that sales on credit are made only to bonafide good credit risk.
c) Ensure that all sales on credit are invoiced, that authorized prices are charged and before
issue all invoices are completed and checked as regards to the price, trade discounts and
V.A.T.
d) Ensure that all invoices raised are entered into the books.
e) Ensure that all customers claims are carefully investigated before credit note is raised.
f) Ensure that every effort is made to collect all debts.
g) Ensure that no unauthorized credits are made to the debtors accounts.
To achieve these objectives the following measures or controls are usually put in place
1. Customers orders: Incoming customers orders should be recorded and if necessary

acknowledged on pre-numbered forms. This procedure may call for a requirement that all
customer’s order be in writing on official letter heads. On receiving customers orders, the
staffs of the sales department will be required to transcribe the details as per the customers
order onto pre-numbered orders. The orders should be matched with invoices and lists
should be prepared at intervals of outstanding orders for management action. Sequence
checks should be made regularly by a senior official.
2. Credit control: There should be procedures laid down for verifying the credit worthiness of
all persons or institutions requesting goods on credit. For existing customers, credit
worthiness data should be kept up to date and checks made that outstanding balances plus a
new sale do not cause the preset limit to be exceeded. For new customers, investigative
techniques should be made including inquiry of credit letting agencies, referees, bankers and
even a search of the company’s file which is held by registrar of companies. A credit limit
should be established. This can be fixed at two levels with a higher level such that further
sales are not made and a lower level such that management is informed and judgment made
on granting a credit.

3. A separate sales department should be charged with the responsibility of, in conjunction with
the accounting department and senior managements prescribing the selling prices and laying
down policies on trade and cash discounts and special prices.
4. The dispatch of goods should only be made on properly evidenced authority. Goods outward
should either be recorded in a register or using a pre-numbered dispatch note. Accordingly
any unissued blank dispatch note should be safeguarded and their issue to the stores
department monitored by the use of a register. Sequence checks of dispatch notes should be
made regularly by the internal auditor or a senior official. Where appropriate
acknowledgement of receipt of goods should be made by customers on copies of dispatch
notes.
5. Invoicing should be carried out by a separate department or the sales department:
b. Invoices should be pre-numbered and the custody of unused invoices should be
controlled and recorded.
c. Regular sequence checks by internal audit or by a senior official should be made of the
invoices.
d. The missing or spoilt invoices should be investigated.
6. All invoices should be independently checked for agreement with the customer’s orders and
goods dispatched records for pricing, discount, VAT and other details. All actions should be
acknowledged by signatures or initials.
7. Accounting for sales and debtors should be segregated by employing separate staff for cash
invoicing, to register sales, to make ledger entries and to prepare monthly statements to the
debtors.
8. Sales invoices should be pre-listed before entry into the invoice register and day book and the
pre-list total should be independently compared with the total of the register.
9. Customers claim should be recorded and investigated. Credit notes should be pre-numbered
and at year end, any uncleared claims should be carefully investigated and assessed. All credit
notes should be subject to acknowledgement or approval by a senior official.
10. Control accounts should be prepared and independently checked.
11. Debtors statements should be prepared by personnel separate from the sales ledger
personnel or department. Posting should be subject to acknowledgement and safeguarding
so that no statements are intercepted before posting.
12. Procedures must exist for identifying and chasing slow players. Long overdue balances
should be brought to the attention of the senior management for legal action or other action
to be taken.
13. All balances must be reviewed regularly by an independent official to identify and investigate
overdue accounts. This investigation should cover debtors paying by installments or lump
sum amounts where payments do not match invoices.
14. Bad debts should only be written off after due investigation and acknowledged authorization
by senior management. At the end of the year an aged debtors analysis should be prepared to
e valuate the need for doubtful debt provision.

15. Also at the year end, cutoff procedures will be required and particular attention will be paid
to orders dispatched but not invoiced.
Special aspects on sales and debtors
1. The sales department mentioned above through which all customers orders should be
channeled should also perform the following additional responsibilities.
a. They have the responsibility of initiating the sales transactions.
b. They must carry out initial evaluation of the customers circumstances. The head of the
sales department must recommend in writing the supply or trading with the customer.
2. Authority for the sales transaction is given by the credit control department.
a) The credit control departments in addition to evaluating credit worthiness usually
maintain a stores service list. They also confirm with the stores departments that the
goods ordered by the customers are available and they authorize in writing the packing
and dispatch of goods.
b) They usually maintain a copy of dispatch notes signed by the customers acknowledging
receipt of goods.
c) They usually review on a monthly basis the aged debtors listing. They recommend the
debtors to be provided against or written off and initiate recovery procedures when the
debtor becomes a slow payer. These recovery procedures include; sending statements
regularly, sending reminders or instituting legal action to recover the amounts. To do
that, they must ensure that they retain sufficient evidence to support any claim by the
company.
3. Credit notes becomes necessary when either the goods have been returned by the customers
for whatever reason or there are errors in the invoice sent to the customers. Credit note must
be supported before they are raised or approved. If they are for goods returned by customers,
then a goods received note or goods returned note or a copy of the sales invoice concerned
should be attached to support the workings on the credit note. The prepared credit note
should be subjected to independent checking and approval by a responsible officer. If the
credit note is to correct errors on an invoice, then a copy of the invoice should be attached to
support the workings and it should be checked independently.
4. Authorized credit to customers or debtors accounts: a debtors account can be credited
because of :
a. Receipt of payment from the customer
b. Credit note issued to the customer
c. Bad debts written off.
A credit on the customer’s accounts indicate that there is no more claim by the company on
that debtor to the extent of the amount credited. Therefore it is important that the amount
credited on individual debtors account are genuine or valid i.e. properly authorized. An
independent official should match those credits to the supporting documents.

5. a) Documents to be maintained are customers orders, dispatch notes, invoices and credit
notes.
b) Records will be an invoice register, customer’s order register which monitors the
movement of the sales orders, then a sales day book which assembles all the invoices and
credit notes with the total being posted to the control accounts in the general ledger and the
individual entries to the individual debtors ledger accounts in the debtors ledger, a debtors
ledger where an account is maintained for every customer.
6. NB: For bad debts written off or doubtful debts being provided against, the following
procedures should be followed;
a) After credit control department has failed to record the amount owed, they should
produce a list of bad and doubtful debtors supported with evidence to consider them bad
or doubtful.
b) The senior management should then review that list and if satisfied approve the write off
or provision. Then and only then should those amounts be entered in the records.
(i) No copy of the customer’s order is sent to the credit control department inorder to evaluate
credit worthiness of the customer and authorize in writing the selling of goods to that
customer.
(ii) Invoices are not pre-numbered and this can result to transaction being supervised without a
trace.
(iii) Credit limit checking is done by the department instead of credit control department.
(iv) Invoices are not checked for arithmetical accuracy.
(v) These are no procedures laid down for dealing with unsatisfied orders.
(vi) There’s no evidence of validation of prices charged in the invoice.
(vii) No delivery or dispatch notes are raised to support goods sent to customers.
(viii) There’s no evidence to ensure that the customers signs for goods that have been collected.
(ix) Order file is not updated with details of orders dispatched to customers.
INTERNAL CONTROLS OVER PURCHASES AND CREDITORS
a) Control objectives
1. To ensure that goods and services are ordered in the quantity, of the quality and at the best
terms available after appropriate requisition and approval.
2. Ensure that goods and services are inspected and only acceptable items are accepted.
3. Ensure that all supplied items are checked against authorized orders and goods received
notes.
4. Ensure that all goods and services are invoiced and properly recorded in the books.
b) Control procedures
1) There should be a procedure for requisition of goods and services only by specified personnel
on specified forms with space for acknowledgement of performance.
2) Order forms should be pre-numbered and kept in safe custody. The issuing of blank order
forms or books to the staff of the buying department should be confirmed and recorded by
means of a stationery register.
3) Ordering procedures should include a requirement for obtaining tenders, estimates and
competitive bids.
4) There should be sequence checks on the order forms, regularly performed by a senior official.
Any missing document should be investigated.
5) All goods received should be recorded in good received notes which preferably should be
pre-numbered or recorded in a special book or register.
6) All goods received should be inspected for conditions and agreement with the order and
counted on receipt. The inspection should be acknowledged. The procedure for dealing with
rejected goods or services should include the creation of a debit note which should be pre-
numbered with subsequent, sequence checks and the follow-up of the receipt of the credit
note from the supplier.
7) At intervals, a list of unfulfilled orders should be made and investigated.
8) Invoices should be checked for arithmetical accuracy, pricing, the correct treatment of VAT
and discounts, agreement with the order and the goods inwards records. These checks should
be acknowledged by the performer preferably on the spaces marked by the rubber stamp on
the invoice.
9) Invoices from suppliers should have consecutive numbers put on them. The invoice batches
should be pre-listed.
10) Totals of the entries in the invoice register or daybook should be regularly checked with the
pre-list.
11) The responsibility for the purchase ledger entry should be vested in personnel who are
separate from the personnel responsible for ordering, receipt of goods and invoice register.
12) The purchase ledger should be subject to frequent reconciliation in totals or should be
checked by an independent senior official.
13) Ledger account balances should be regularly compared with the supplier’s statement of
accounts.
14) All goods and services procurement should be controlled by means of budgetary techniques.
Orders should be placed that are only within budget limits. There should be frequent
comparison of actual purchases with budgets and investigations into variances.
15) Cut off procedures at the end of the year are essential. These are measures designed to
ensure that for all goods received, and accepted into the stores before the year end, then a
corresponding liability is recognized or where a liability has been recognized, before the year
end, then the corresponding benefit available or actual goods received are also recognized in
purchases and if they still exist, they are recognized in stocks at the balance sheet date and
excluded from the cost of sales.
16) A proper coding system is required for the purchase of goods and services so that the correct
nominal ledger accounts are debited.

4. Internal controls over stock and work in progress
a) Control objectives
1) To ensure that stock records only include those items that belong to the organization.
2) Ensure that all movement of stock is properly authorized and recorded.
3) Ensure that valuation of stock is done in accordance with IAS 2 which requires that stock be
valued at the lower of cost and net realizable value.
4) To ensure that the level of stock held is reasonable to avoid overstoking or stock out.
5) To ensure that stock is safeguarded against loss, theft and damage.
b) Specific internal controls
1. Movement of items in and out of the organization should be properly authorized through
goods received note and goods dispatch notes respectively.
2. The bin card system should be updated regularly based on the goods received notes and
goods delivery / dispatch notes.
3. An independent physical stock count should be carried out by a person who does not work in
the stores department.
4. The organization should establish a pre-determined EOQ to prevent over-stocking or stock
out.
5. All stock items of similar nature or use should be held in the same location to avoid possible
contamination and to facilitate easy access.
6. These should be a formal procedure for identifying damaged, obsolete and slow moving item.
Any stock written off should be authorized.
7. There should be adequate security in the stores department.
8. Proper segregation of duties in respect of receiving, recording and custody of stock items
should exist.
9. Stock should be adequately insured against fire and theft
Controls During stock take
For the company to ensure that stock items are properly counted and valued, the following
measures are necessary:
a) The stores department should be closed down on the even of the exercise.
b) The stock takers should be non-participants in the stores department during the normal
working days.
c) The counting should be done in the presence of the store keeper in order to allow him defend
his job.
d) The stock takers should be grouped into two whereby one group is to count and the other is
to record.

e) No purchases or sales should be allowed during the counting.
f) Adequate stock take sheets should be used during the counting and they should provide for
the following:
- Quantities counted
- Unit price
- Identification mark
- Serial number
- Condition of the stock item i.e. whether obsolete, damaged, slow moving or fast moving
stock items
- Date and time of the count.
g) There should be sufficient arrangement whereby the stock takers are able to identify the
slow moving items, obsolete or damaged part of the stock.
h) If possible additional arrangement should be made where by the person counting does not
also count those items held by the clients for safe custody on behalf of third parties.
5. Internal controls over cheque payments
1. Cheques should be signed when evidence of properly authorized transactions is available and
supported by the relevant documents such as GRN’s, LPO’s and purchase invoices.
2. At least two signatories should sign the cheques and they should be given pre-defined
authority limit.
3. Blank cheques should be kept under key and lock by a reliable official. The accountant should
be given one cheque book at a time.
4. The organization should avoid pre-signing of blank cheque to prevent fraudulent payments.
5. The company should communicate with their bankers on the maximum amount that should
be processed whenever a cheque is presented. This is to prevent fraudulent payments
especially if the amount exceed the threshhold given.
6. Supporting documentation to cheque payments should be cancelled or stamped as having
being paid to avoid using them to raise another cheque.
6. Internal controls over cash sales
1. An organization which is highly cash oriented should maintain cash register machine that will
capture all the sales made.
2. Cash register machine should produce 2 copies of cash receipts that are pre-numbered. One
copy should be given to the customer and the second copy to be retained by the company.
3. There should be independent reconciliation between cash sales as per the receipts with cash
received. In case of material difference, this should be investigated promptly.
4. Security should be provided over cash in transit whereas cash at premises should be kept
under key and lock. It is important for a company to take insurance cover for cash in transit

and cash in premises of the organization so that in the event of theft, insurance company will
compensate.
5. The banking of cash should be done by independent person of the cashiers. There should be
reconciliation between amount deposited, deposit slip and bank statement to ensure they are
consistent with each other.
7. Internal controls over cash collected by salesmen
1. Authority to collect cash should be given to team leaders or supervisors of the sales
representatives.
2. Sales representatives should be provided with rough cash books that should capture
description, quantity and value of items sold.
3. An independent reconciliation of units sold, cash collected and balance of units surrendered
should be done on a daily or weekly basis. Incase of material inconsistency, prompt
investigation should be carried out.
4. Incase of promotional activity and significant cash is anticipated to be collected, sales
representatives should be accompanied by security personnel.
5. Reliable official should make follow up on those sales representatives who have not
surrendered cash.
6. The organization should provide subsistence allowance to sales representatives so that they
do not use cash collected from sales.
8. Internal controls over cash received by post
1. The company should safeguard against possible interception of cash between receipt and
opening of mails by restricting access to the keys of the postal rental box. At no time should
the messenger be allowed to have custody over such keys.
2. Customers should be encouraged to use telegraphic money orders that are crossed by writing
account payee. This will prevent unauthorized person to encash the money order.
3. There should be segregation of duties in respect to opening of mails, counting and recording
of cash.
4. Cash collected should be banked within reasonable time and if significant it should be banked
immediately.
9. INTERNAL CONTROLS OVER BANKING
i) There should be a policy where the company banks its daily takings immediately latest the
following morning
ii) Adequate security arrangements should be set in place during banking.
iii) The duties of cashiers and book keepers should be rotated to minimize risk of theft.
iv) The company should have an arrangement with the bank where they’re able to obtain bank
statement regularly.

v) There should be a policy of preparing reconciliation statements to agree the balances as per
the cash book and the balances as per the bank statement.
vi) There should be a policy of filing up the bank paying slips to determine how much banking
has been done.
vii) The chief accountant should also make an arrangement with the bank branch manager
whereby the certificate of existence, variation and ownership of the bank balance is
provided to the company immediately upon request.
viii) Sales ledger personnel should have no access to the cash or the preparation of the pay in
slips.
10. INTERNAL CONTROLS OVER PETTY CASH
i) The level and location of the cash floats should be laid down formally.
ii) There should be restricted access to the floats.
iii) Cash should be securely held e.g. in a locked drawer with restricted access to the keys.
iv) All expenditures should require a voucher signed by a responsible official not the petty
cashier.
v) The imprest system should be used to reimburse the floats i.e. at any time the total cash and
the value of vouchers not reimbursed equals a set amount.
vi) Vouchers should be cancelled once reimbursement has taken place.
vii) A maximum amount should be placed on the petty cash payment to discourage normal
purchase procedures being by-passed.
viii) Petty cash should be reconciled by an independent person periodically.
11. INTERNAL CONTROLS OVER FIXED / NON CURRENT ASSETS
a) Control Objectives;
i) To ensure that acquisition and disposal of non-current assets are properly authorized.
ii) To ensure that acquisition and disposal of non-current assets are made at the most
favourable price possible.
iii) Ensure that noncurrent assets are adequately secured.
iv) Ensure that noncurrent assets are properly recorded, depreciated and written down where
possible.
v) Ensure that noncurrent assets are properly insured against theft and fire and the assets are in
good condition at all times.
b) Specific Controls
i) Proposal for acquisition and disposal of noncurrent assets should be prepared and
submitted to the board for approval.
ii) The BOD should prepare a budget for capital expenditure which should be followed strictly.

iii) Acquisition and disposal of noncurrent assets should be consistent with the policy agreed or
authorized by the BOD.
iv) Fixed asset register should be maintained and should capture description of the assets, cost,
accumulated depreciation, net book value, location, depreciation rate and policy.
v) Noncurrent assets should be properly maintained and serviced periodically to ensure they
remain at their best condition.
vi) Noncurrent assets should be safeguarded against fire and theft by instituting the relevant
controls e.g. employing watchmen, electrifying the fence and taking insurance cover against
fire and theft.
vii) There should be segregation of duties in respect to purchase custody, recording and
disposal of fixed assets.
Techniques of ascertaining, recording and evaluating I.C.S
1. Internal control questionnaires

2. Flow chart
3. Internal control evaluation questionnaires
4. Narrative / system notes
5. Check list.
Audit tests
a) Compliance test
b) Substantive tests
c) Walkthrough tests
Audit checks
a) Surprise checks
b) Interim checks
c) Complete / total checks
d) Audit in depth
Internal control questionnaire
An internal control questionnaire is a set of brief questions imposed by the auditor to the client
management and employees. Its designed to ascertain and record an accounting system and its
related internal control system usually it requires to be supported by narrative notes or flow
charts which actually record the system.
To be efficient and effective the questions should be framed in such a manner that they can be
answered in the form of yes or no answers. A yes answer indicating existence of controls and a no
answer indicating weakness or lack of controls.

Advantages of internal control questionnaires
(i) It assists the auditor to know the books and, the records kept by his client and the
information contained therein.
(ii) It makes it easier to assess the strength or weakness of the I.C.S which will assist in audit
planning.
(iii) Answers to the I.C.Q serves as a basis of writing the management letter for corrective
measures against the weaknesses.
(iv) The auditors remarks do form the basis of opinion
(v) Evidence is obtained by the auditor directly.
Disadvantages of I.C.Q
i) Answers may be given mechanically without much thought.

ii) Internal control questionnaires may be standardized and yet not two similar businesses may
warrant the used of standardized I.C.Q.
iii) Management may cheat the auditor if they want to cover up a fraud.
iv) Its tedious and time consuming to prepare questions for the whole system
v) There may be lack of co-operation from the client staff at the time of asking questions.
vi) ICQ is not complete by itself because it provides evidence about the existence of controls
whereas the auditor is concerned with the effectiveness of such a system.
INTERNAL CONTROL QUESTIONNAIRE
Examples of internal control questionnaires
1. Internal control questionnaires over purchases

a) Is there a separate purchases department?
b) Are all purchases made through written purchase orders?
c) Who authorizes purchases requisition?
d) Who authorizes purchases orders?
e) Are the purchase orders serially numbered?
f) Are the purchase order books kept safely to avoid their misuse?
g) Are the duties of writing and signing purchase order properly segregated?
h) Are the local purchase order placed on the lowest quotation?
i) Who is authorized to receive goods?
j) Are the goods inspected when received?
k) Is a copy of goods received notes sent to:
 Purchasing department
 Accounting department
l) What documents are prepared on the return of goods?
m) Who is responsible to ensure the receipt of credit note regarding goods returned?
n) Are the invoices compared with original purchase orders and goods received notes?
o) Who authorizes the payment of invoices?
p) Are the invoices passed for payment, duly stamped to prevent double payment?
q) Are the incoming invoices recorded in the purchases journal?
r) Who is responsible to make postings to the ledger?
s) Is a purchase ledger control account maintained?
t) Are the ledger accounts examined by someone else other than the ledger clerk.
2. Internal controls questionnaires over sales

a) Who is responsible to receive orders?
b) What record is compiled on receipt of orders?
c) Are all orders approved before passing them for execution?
d) Who approves the dispatch of goods?
e) What records are compiled on dispatch of goods?
f) Who is responsible to prepare dispatch notes and delivery notes?
g) What records are compiled on return of goods from customers?
h) Is the issue of credit note for goods returned approved and by whom?
i) Who authorizes the selling price and sales discounts?
j) Are all invoices pre-numbered and controlled?
k) How many copies of sales invoices are made and to whom are they distributed to?
l) Are reconciliation made between sales invoices and issues from the stock?
m) Are all sales and returns recorded on the respective subsidiary books?
n) Are the sales returns posted to the ledger accounts?
o) Are control account balances reconciled with the respective sales ledger account totals?
p) Are statements sent to debtors and how often?
3. Internal control questionnaires over wages

a) Who has the authority to engage or dismiss the employees?
b) Are the staff cards kept for all employees containing items for employment and specimen
signatures?
c) Who authorizes overtime?
d) What records are maintained in respect to time records and piece work?
e) How are the piecework quantitative checked?
f) Who approves piecework, bonus and clock card payments?
g) Who prepares the payroll?
h) Is the payroll preparation divided into different stages and different persons responsible
for completing each stage?
i) Is the payroll checked with the staff records?
j) Is the payroll authorized by a responsible official once completed and before the cheques
are drawn?
k) Are the cheques drawn on the net amount of wages or gross wages?
l) If gross wages are drawn, then how is the cash regarding statutory deduction dealt with?
m) Are the persons who distribute wages different from those who prepare payroll?
4. Internal control questionnaires over cash receipts and payments

a) Does the company have a policy of banking its daily takings immediately, latest, the
following morning?
b) Are the duties of the cashiers properly segregated?
c) Who is responsible for recording and payment?
d) Is the same cashier responsible for recording and payment on behalf of the company?
e) Does the chief accountant prepare the reconciliation statements?
f) Are there additional controls which exist over cash payments?
g) Are the cashiers and other sales staff regularly rotated?
h) Is the cashbook cross examined by the chief accountant on daily basis?
2. Flow chart
It is a diagrammatic representation of the flow of documents or goods within an organization. A

flowchart has an advantage of being easy to understand fictitious documents and it is easy to
identify inadequate documentation. Considering a flow chart that deals with the flow of
documents, it is important to identify the following aspects.
a. The departments involved in the system

b. The individuals involved in the system
c. The documents that are created or prepared to support the stages of a transaction
d. The records that are updated or maintained within the system
– Because of the need of a flow chart to be logical, the preparer must identify the operations in
the system and give them numbers in a logical sequence.
Operations means matters such as:
a. Initiating a transaction
b. Preparing documents
c. Authorizing documents
d. Receiving documents
e. Updating of records.
- Accordingly, a flow chart must show for every document:-

 Its start or origin
 The procedures performed on it such as checking and authorization
 All copies of the document and their distribution
 The records involved
 The department and individuals that perform any procedure on the document
 Its destination must also be shown
- The symbols of flow charting are not standardized therefore a key must be given explaining
the symbols used in the flow charts.
For our purpose, we shall use the following symbols:-
1. N Represents a document e.g. LPO, GRN, invoice etc. if the document is

pre numbered, we will have a line cutting the top left hand corner
with an N inside
N
Represent where more than one copy of document is raised.
N 3
2.
N 2
3. Represent a record e.g. purchase ledger, sales ledger, stores

ledger etc.
4.
Represent filling
5.
Represent an action or operation e.g. initiating a transaction,
updating records or authorizing documents
6.
This represent a check
7. …………………………… This represent compared with or using details from
Considerations when drawing a flow chart.

1. It must be properly headed.
2. Should not be congested with flow lines.
3. The flow lines should either be horizontal or vertical.
4. Any symbols used in the flow chart must be explained.
Disadvantages of flow chart.

1. They are time consuming and involving.
2. Some are not simple to understand.
3. Requires technical skills and competence in order to draw them.
Examples of flow charts on purchases and sales invoicing [H/O]
3. Internal Control Evaluation Questionnaire
– ICEQ is a set of brief questions imposed by the auditor to the management and employees of
the entity. This technique is used by the auditor to record and evaluate ICS. The questions
imposed do confirm the nature of controls as expected by the auditor. The questions in this
regard include:-
a) ICEQ on Purchases
1. Is there reasonable assurance that purchases are made by a LPO?

2. Is there reasonable assurance that orders are placed on authorized requisition?
3. Is there reasonable assurance that quotations are received before the orders are written?
4. Is there reasonable assurance that all payments are properly authorized?
b) ICEQ on Sales
1. Is there reasonable assurance that sales are properly authorized?

2. Is there reasonable assurance that all goods dispatched are invoiced?
3. Is there reasonable assurance that all invoices are properly prepared, recorded and properly
supported?
Differences between ICQ & ICEQ
1. ICQ is used to ascertain and record the ICS whereas ICEQ is used to record and evaluate the
ICS.
2. ICQ provides the nature of controls practiced by the company whereas ICEQ confirms the
strength or otherwise of the controls.
3. ICQ gives evidence on the existence of controls whereas ICEQ gives evidence on the
effectiveness of the controls.
4. Check list
These are specimen questions imposed by the auditor to the client business to help determine
the nature of the ICS. The questions do require Yes answers, No answers or Not Applicable

answers. A Yes answer confirms the strength of the ICS, a No answer confirms weaknesses in the
ICS, Not Applicable answers confirm the doubted nature of the ICS.
The questions are prepared by the auditor based on a standard list according to the auditor’s past
experience with the entity. The questions are prepared in respect to the sensitive areas of the
clients operations.
5. Narrative / System Notes
A small business would always describe their internal controls in a procedural Manual. During
the audit, the auditor would make a summary of the procedures followed and maintain this in the
working papers necessary to help him understand the entity.
For a computerized accounting system, these are called system notes whereas for a manual
accounting system, these are called narrative notes where the controls are carried out as
prescribed, the ICS is concluded to be effective and where these controls are not followed, the ICS
is concluded to be weak.
6. Audit Tests
a) Compliance Tests/ Test of controls
After the system has been evaluated as being suitably designed, the auditor then plans to carry
out tests of control on the systems.
Compliance tests are procedures performed to obtain evidence about the effectiveness of the;-
a) Design of the accounting and ICS i.e. whether it is suitably designed to prevent and correct
material misstatement.
b) Operation of the Internal Controls consistently throughout the financial period.
- The auditor carries out test of controls to determine whether, these controls have worked
effectively throughout the financial period and can be relied upon to ensure complete,
accurate and reliable accounting records.
Compliance tests include:-
a) Inspection- Documents supporting transactions and other events are inspected to gain
assurance that internal controls have been operated properly.
b) Inquiry- Inquiries about the internal controls which have no audit trail need to be done e.g.
inquiring whether appropriate security measures are undertaken during payment of wages.
c) Re-performance of Internal Controls e.g. reconciliation of bank accounts to ensure client
banks reconciliation statement is accurately prepared.
d) Observation- this entails observing control procedures being performed e.g physical counting
of stock will enable the auditor confirm that the exercise is being conducted properly.

Such observation will provide evidence that a control is operating effectively as designed.
- When obtaining audit evidence about the effectiveness of Internal Controls, the auditor
considers how they were applied and the consistency with which they were applied. The
concept of effective operational controls recognizes that, some deviation from prescribed
controls may occur.
This may be due to changes in key personnel, human error, and significant changes in the volume
of transactions.
Substantive Tests/ Test of details
This is a primary audit test which seeks to provide evidence about the accuracy, validity and
completeness of the company’s records.
It is those audit tests which are carried out on transactions, records and account balances.
Substantive tests consist of:-
i. ARP’s
ii. Substantive Procedures of details
- Substantive procedures of details are all procedures other than ARP’s, which are considered
under assertion methodology i.e. those procedures performed in order to confirm for:-
1. Existence
2. Rights and obligations
3. Occurrence
4. Completeness
5. Valuation
6. Measurement
7. Presentation & Disclosure
- These audit tests are carried out throughout the audit period but more so in the final stages
of the audit in respect to the account balances, so as to provide evidence on the true and fair
view of the financial statements.
Substantive tests are performed when:-
1. The ICS is weak or non existent.

2. When there are unusual extra ordinary items or one-off items which are not covered by the
system. E.g. goodwill written off and foreign exchange gains or losses.
3. On all assets and liabilities at the balance sheet date.
4. When additional evidence is required on an item.
c) Walk through audit tests

It is necessary for the auditor to have an assurance about the strength or weakness of the clients
ICS from the general point of view. So as to determine the nature or extent of reliance he can

decide to place on such controls. To be able to do this, the auditor carries out walkthrough audit
tests. These are procedures employed by the auditor when tracing an individual transaction right
from the beginning till the completion of its records e.g. checking of the sales invoice right from
the placement of the order till receipt of payment.
7. Audit checks
a) Surprise checks
This is an audit procedure which is carried out on transactions, records or account balances
without prior warning or notice to the client staff.
They are intended to reveal a suspected fraud.
Surprise checks are conducted in the following areas:-

i. Counting of cash in hand or unused petty cash balance.
ii. The physical counting of the stock to determine quantities.
iii. Inspecting the payment of wages and salaries to casual workers.
b) Complete/ total checks

For the audit of a small company it is possible for the auditor to minimize his risk exposures
by conducting a total or complete check. This is where each and every transaction posted in
the clients books, will be examined by the auditor right from the original stage till the
completion stage purposely to detect a material error or fraud.
c) Interim checks
These are audit procedures carried out by the auditor during the interim audit. An interim
audit is carried out purposely for the payment of interim dividends.
d) Audit in depth
This is an audit procedure which is carried out during the vouching of transactions. The
modern audit is required to be cost effective and therefore time spent by the auditor should
be as minimal as possible:-
To achieve this objective, the auditor will be required to carry out an audit in depth which
involves the following:-
i. Selecting a sample of transactions in respect to certain percentage from a given
population of records, account balances and transactions.
ii. Carrying out a complete checking of the selected transactions and drawing conclusions
on the remaining unchecked balances.
Indicators of weak ICS

The auditor is continuously concerned with the nature of the clients ICS. To the auditor, the
following signals will confirm weaknesses in the client system:-
a) Questions in respect to the Integrity of Management e.g.

- Business which are operated by a single group of persons with no oversight board.
- Business whose sensitive areas are operated by relatives or friends e.g. cash operations,
stock areas and wages payments.
- Business whose management are reluctant to implement the auditors
recommendations.

b) Unusual pressure within the entity e.g.
- Where employees are expected to complete a given task within a short period of time than
the usual case.
- Too much supervision in respect of the work.
- Where targets are not achievable and the management is putting pressure on employees to
achieve them.
c) Unusual transactions in the company e.g.

1. Contingent liabilities e.g. discounted bills of exchange, legal cases against the company
insurance claims against the company claims, by employees for unfair dismissal.
2. Post balance sheet events- these are events favourable or unfavourable that occur between
the balance sheet date and the date when the financial statements are authorized for issue
e.g. changes in the rate of depreciation affecting the profits, disposal of fixed assets e.t.c.
d) Problems in gathering Audit Evidence e.g.

- Lack of cooperation from management or employees
- Technicalities in the accounting system.
- Inadequate manpower affecting the business.
- Possibilities of errors and frauds.
e) Problems unique in the Electronic Data Processing System e.g.

- Nature of programs
- Loss of audit trail over the processed data
- Possibility of computer virus affecting the data.
- Destruction of magnetic tapes and flash disks.
- Possibility of software error and computer fraud.
Action to be taken by auditor when ICS is weak

- Alert the management immediately about the situation.
- Change the audit approach from system based to vouching audit approach.
- Consider the materiality of errors and frauds detected.
- Increase the sample units for testing to allow for more discovery.
- If the weaknesses are material, qualify the audit report.
- Summarize all the weaknesses in the management letter.
MANAGEMENT LETTER
- This is also known as letter of Internal Control Weakness.
- It is written by the auditor to the management of the company. The auditor draws the
attention of the management towards the shortcomings and weaknesses in the company’s
ICS. These weaknesses are discovered by the auditor in the course of his audit work.
- The letter is normally issued after the evaluation of the ICS but before the issue of the audit
report.
Purpose of Management Letter

1. To report to the management about the nature of accounting system and ICS.
2. To provide advice to the management on how to ensure for the accuracy and reliability of the
company’s records.
3. Enable the auditor to bring to the management’s attention, areas of weaknesses that might
lead to material errors.
4. Enable the auditor to communicate matters that may have an impact on future audit.
5. Enable the management to put right matters that may otherwise have led to audit report
qualification.
6. Management letter provides the basis for planning the subsequent period audit of the client
through identification of risky areas.
Contents of Management Letter

1. Name and address of the audit firm and the client company.
2. Signature of the auditor.
3. Description of the accounting system and ICS.
4. Areas within the business where controls are lacking.
5. Areas within the business where controls are not properly followed.
6. Weaknesses in the ICS.
7. Implications of the weaknesses to the financial statements
8. Auditor’s suggested recommendations for improvement.
9. Consequences if the auditor’s recommendations are not implemented in full.
INTERNAL AUDIT- ISA 610

This is an independent appraisal of the activities within the organization by the chief internal
auditor aimed at ensuring that the management operates the business in an orderly and efficient
manner.
An internal audit department is set up and maintained by the management who appoints the
chief internal auditor to manage the department.
The management is also responsible for defining clearly the scope of work and responsibilities of
the Internal Auditor and ensures that the internal auditor is able to report to the management
regularly.
Factors to consider when setting up an Internal Audit Department

1. The size of the company should be large enough to call for the need of internal auditor.
2. The volume of transactions should also be large to justify the need for internal audit.
3. Whether the internal audit will be economical to the organization in that, the running costs
should be less than benefits derived from the departments.
4. The nature of the accounting system and related internal controls must also call for the need
of the Internal Audit.
5. The current practice by other organizations in the same field.
6. Changes in key risks. If the business is developing in new areas, an internal auditors
assessment of how effectively it is handling consequent changes in risk can be very significant.
7. Increased number of unexplained or unacceptable events. This applies not just to events that
cause problems with the accounting records but also problems that delay production or result
in inferior quality in goods/ services.
The cost of Internal Audit may need to be weighed against the possibility of lost sales.
Functions/ Work done by Internal Audit Department

1. To regularly examine the accounts and prove for their accuracy and reliability.

2. Review the company’s activities to ensure that they are in line with statutory requirements
and company policies.
3. Set up and maintain on behalf of the management adequate accounting system and effective
ICS.
4. To independently perform continuous appraisal of the company’s records to determine their
relevancy, accuracy and completeness.
5. Serves to detect and prevent errors and frauds through constant review of accounts and
procedures.
6. Conducts special investigations where errors and frauds are suspected, targets are not
achieved or where policies are out of hand.
7. Acts as a feedback to the management regarding the success or failure of operations.
8. Performs routine verification of assets and liabilities.
9. Acts as a consulting department to all other departments on matters of control and company
policies.
10. Safe guards the assets of the company against losses or misuse.
11. Assists the BOD’s in the governance process. Governance is the process by which company’s
affairs are directed and directors held accountable for their actions.
- Internal Auditors will facilitate the governance process by:-

a) Promoting ethical culture, ensuring compliance with code of conduct and be a living
example. This will give the Internal Auditor moral authority to perform independent
reviews.
b) Assist the BOD’s in the strategic direction of the company and will provide a feedback on
the implementation of the corporate plan.
c) Acts as a link between the audit committee and the external auditors.
d) They are secretaries to the audit committees and in case of any issue raised by either
party, they can provide the necessary information to the intended party.
Independence of the Internal Auditor

The Internal Audit Department and the Internal Auditors, are required to carry out their duties
and responsibilities independently. This will ensure that they are objective in their judgment.
However, the internal auditor is not independent as external auditors because:-
1. He is an employee of the company
2. The scope of the work and responsibilities of the internal auditor are defined, supervised and
reviewed by the management.
3. The internal auditor reports to the management who also appoint him.
4. The internal auditors are involved in the design, implementation and operation of the
accounting system and ICS.
5. The internal auditor may have personal interests that conflict with their role as Internal
Auditor e.g. if the Internal Auditor is engaged in fraud, then he will not be able to act
objectively in prevention and detention of fraud.
6. The internal auditor may be intimidated by management or a member of management who
may not want the internal auditor to discover something about him/ her.
7. The internal auditor authority and scope of work may be limited by management.
Differences between Internal and External Audit. [see topic I)

Internal audit External Audit
1. Conducted by an employee of the 1. Conducted by an independent
company party
2. Conducted on behalf of 2. Conducted on behalf of
management. shareholders.
3. Conducted by any competent 3. Conducted by qualified personnel
accountant. approved by Company’s Act.
4. Auditors scope of work is defined 4. Auditors scope of work
by management. determined by the statute.
5. Not a requirement of the 5. Is a requirement by Company’s
Company’s Act. Act for all registered company’s
6. Meant to strengthen ICS. 6. Meant to determine the time and
fair view
7. Appointed by management and 7. Appointed by shareholders and
reports to them. report to them.
8. He is paid a salary. 8. He is paid audit fees.
External Auditors Reliance on the Internal Auditor
Isa 610 (Considering the work of Internal Auditor) mandates the external auditor to perform an
initial assessment of the Internal Audit function, obtain an understanding of the operating
activities and conclude whether reliance can be placed on their work.
Placing reliance on the work of the Internal Audit effectively reduces the nature, timing and
extent of audit procedures to be performed by the external auditor. This reduces the time spent
in the clients business and the audit cost.
Factors to consider when placing reliance on the work of the Internal Auditor
1. Technical competence and experience – the external auditor should review whether the
Internal Audit staff possesses the knowledge, skills and experience necessary to perform the
Internal Audit work.
Other issues to consider include:-

a) Whether the internal Audit staff have any professional affiliation i.e. they are members of
ICPAK or institute of Internal Auditors.
b) Whether the lead of Internal Auditor has sufficient experience obtained as a result of working
for different organizations.
If the above matters are appropriate, the external auditor will place more reliance.
2. Scope of work- The external auditor should review whether the internal auditor has
unlimited access in reviewing the entire operating activities of the company. In case of any
restrictions placed by the management, it means that some of the departments may not be
audited and there’s a high chance of errors and frauds to occur. However, if there are no
restrictions and management acts on recommendations of Internal Auditor, then more
reliance will be placed.

3. Professional Due Care- External Auditor should evaluate whether the work of internal
auditor is properly planned, supervised, directed, recorded and reviewed. The existence of
audit plan, audit manuals and working papers, provide evidence that the work is carried out
in a professional manner and more reliance will be placed.
4. Reporting standards- useful Internal Audit will provide high standard reports which are
acted upon by the management.
5. Resources Available- An internal Audit Department that is constrained of resources will not
be very useful to the external auditor.
6. Independence- The Internal Auditor may be an employee of the organization but he may be
able to organize his own activities and report his findings to the management. An internal
auditor on whom the external auditor places reliance must be independent and be able to
communicate freely with the external auditor.
7. Consider the past experience with the internal auditor in terms of the degree of cooperation
received from them in the previous audit.
8. Consider efficiency of the ICS- the more efficient the system, the higher the reliability that
can be placed on the work done by internal auditor and vice versa.
- The assessment of Internal Auditor should be thorough and should be fully documented and
included in the working papers.
- If the conclusion is that, the internal auditor department is weak or unreliable, then this fact
should be communicated in the external auditors report to the management.
Special Ways of Reliance/ Extent to which external Auditor can rely on the Internal
Auditor.
1. The internal auditor may explain to the external auditor areas of weaknesses in the ICS so that
the external auditor may carry out more audit tests on those areas.
2. The E.A may use the internal auditor working papers in order to gather evidence of the
company’s operations programs or tests.
3. The internal auditor may explain to the internal auditor the technical operations and controls
used by the clients which may be beyond the external auditor understanding.
4. The internal auditor may observe the following procedures on behalf of the external auditor
a) Stock taking procedures
b) Wages payment procedures
c) Cash count procedures
d) Branch visits.
e) Follow up of the auditors correspondence with 3rd Parties.
5. The internal auditor may verify mobile assets on behalf of the external auditor if the external
auditor has not been able to do so during his visits. In such cases the internal auditor needs to
give the certificate of existence of those assets to the external auditor confirming that they
have been verified as existing.
6. The internal auditor may prepare schedules of accounts to be used by the external auditor for
their review e.g. fixed assets movement schedule, aged debtors analysis, tax payable,
movement schedule e.t.c.
7. The internal auditor will safeguard the company’s assets and ensure that the company
maintains proper books of accounts and this facilitates the work done by the external auditor.
8. The presence of the internal auditor may reduce chances of errors and frauds thereby
reducing the amount of work the external auditor has to do.
INTERNAL CHECK SYSTEM

- This is part of the ICS and it is a means by which the work done by one officer is
independently checked by another person for authority and recording.
- An internal check system is necessary for large organizations and such a check can be
practiced in the sensitive areas where frauds are common. E.g
a) cash office
b) Wages payment
c) Reconciliation section
d) Stores Department
e) Mail opening in the organization.
Purpose / Advantages of Internal Check System

1. Ensure that no single officer is allowed to carry out one operation from the beginning until the
end.
2. Help in strengthening the ICS.
3. Help detect errors and frauds committed and prevent future occurrence of errors and frauds.
4. Ensure efficiency in the accounting work.
5. Enables the organization to have accurate records due to independent checks and this will
facilitate good decision making based on accurate information.
Disadvantages of Internal Check System
1. It may reduce the morale among employees because independent, automatic and routine
checks may be viewed with suspicion.
2. It is an expensive system to operate especially in a small company.
3. It may be manipulated or abused by sensitive personnel through collusion.
4. May be over-relied upon by management which may result in relaxed supervision which staff
may take advantage to perpetrate fraud.
ASSERTION METHODOLOGY
- Management is responsible for the fair presentation of files that reflect the nature and
operations of the entity.
- In representing that the financial statements give a true & fair view, or are presented fairly in
all material respects in accordance with the applicable financial reporting framework,
management implicitly/ explicitly make assertions regarding the recognition, measurement,
presentation and disclosure of the various elements of the financial statements and related
disclosures.
- The auditor should use assertions for classes of transactions, account balances and
presentation and disclosure in sufficient details to form the basis for the assessment of risk on
material misstatement, design and performance of further audit procedures.
- The auditor uses assertions in assessing the risk by considering the different types of
procedures that are responsive to the assessed risk.
- Assertions used by the auditor fall into the following categories:-
a) Assertions about classes of transactions and events for the period under audit.(income
statement items
i. Occurrence i.e. transactions & events that have been recorded have occurred & pertain to the
entity.
ii. Completeness i.e. all transactions and events that should have been recorded have been
recorded.
iii. Accuracy i.e. amounts and other data relating to the recorded transactions and events have
been recorded appropriately.
iv. Cut-off i.e. transactions and events that have been recorded, have been recorded in the correct
accounting period.
v. Classification i.e. transactions and events have been recorded in the proper accounts.
b) Assertions about account balances at the period end ( balance sheet items)
i. Existence i.e. assets, liabilities and equity interest exist at the balance sheet date.
ii. Rights and obligations i.e. the entity holds or controls the right to the assets and liabilities
are genuine obligations of the entity.
iii. Completeness i.e. assets, liabilities and equity interest that should have been recorded have
been recorded.
iv. Valuation and allocation i.e. assets, liabilities and equity interest are included in the
financial statements at appropriate amounts and any resulting valuation or allocation
adjustments are appropriately recorded.
c) Assertions about presentation and disclosure

i.Occurrence, rights and obligation i.e. disclosed events, transactions and other matters have
occurred and pertain to the entity.
ii.Completeness i.e. all disclosures that should have been included in the financial statements
have been included.
iii.Classification and understandability i.e. financial information is appropriately presented and
described and disclosures are clearly expressed.
iv.Accuracy and valuation i.e. financial and other information are disclosed fairly and at
appropriate amounts.
The auditor may use the assertions as described above or may express them differently provided
all aspects described above have been covered e.g. the auditor may choose to combine the that
assertions about transactions and events with the assertions about the account balances.
The assertions can be summarized as follows:-

1. Existence
2. Rights and obligations
3. Occurrence
4. Valuation /accuracy/ allocation

5. Completeness
6. Measurement/cut off
7. Presentation & Disclosure/ classification
a) Thus, for the auditor, financial statements are said to give a true and fair view when the
auditor can reach an affirmative/ positive conclusion on all the above assertions. Hence
financial statements are said to give a true and fair view if:-
1. Assets and liabilities that are shown in the balance sheet are in existence at the balance sheet
date.
2. That the said assets are the right of the entity and the said liabilities genuine obligations of the
entity at the balance sheet date.
3. That the recorded transactions and events actually took place and relate to the entity.
4. That in the recording, processing and preparation of the financial statements, within the
constraints of materiality, there are no unrecorded assets, liabilities, transactions, events or
undisclosed items.
5. That in arriving at the carrying value of assets and liabilities, the overall valuation basis used
is appropriately considered and applied the underlying assumptions of going concern and
accruals and that suitable accounting policies were applied which in their selection and
application, due consideration was given to the qualitative characteristics of prudence,
materiality and substance over form.
6. That in recognizing a transaction as resulting into either an asset, liability income or an
expense, the transactions were appropriately measured and if it constitutes revenue or
expense, it was allocated in the proper accounting period.
7. That in the presentation and disclosure of the items in the financial statements, due
consideration was given to the disclosure requirements of the Company’s Act, other
regulations like the IAS such that, in the classification, description and categorization, all the
relevant information was given without bias and the financial statements display the
qualitative characteristics of reliability, relevance, materiality and comparability.

TOPIC FOUR
ERRORS, FRAUDS AND OTHER IRREGULARITIES- ISA 240
 ERRORS
They can be described as unintentional mistakes. They can occur at any stage in the processing
and recording of transactions. This can be at the occurrence stage, documentation stage,
recording of prime entry stage, double entry stage, during the summarizing stage or during the
production of financial statement.
Errors can be of different types i.e.

i) Arithmetic or clerical errors.
ii) Error in the application of accounting policies i.e. error of principle e.g. recording a
revenue expenditure as capital expenditure or conducting stock valuation against the
principles of accounting. This error can be detected through critically analyzing different
accounts over a given period and investigating changes in such figures.
iii) Error of commission i.e. posting an entry to an account other than the one it should have
been posted to but the correct amount and to the right side. The idea behind this error is
fraudulent or misappropriation of cash between one or two members of the accounting
staff. To detect this error:
a) The auditor should compute ratios e.g. Gross Profit ratio, debtors and creditors
turnover ratio and major differences be investigated.
b) Circularization of debtors
c) Detailed vouching of the books of accounts.
iv) Error of omission it occurs when an entry is partly or wholly omitted from being recorded
in the books of accounts. It may be innocent or intentional. It’s difficult to detect this error
because it doesn’t affect the trial balance. To detect it, the auditor should compare current
transactions with previous year similar transactions and inquire into differences. He can
also undertake a detailed vouching of the entries from the original to the final stage.
v) They can be compensating errors i.e. error counter balanced with another error.
vi) They can be errors in the interpretation of facts.
From an auditing point of view, errors are committed by incompetent persons, persons given
wrong job assignments, overworked persons, inadequate trained persons.

 IRREGULARITIES
An irregularity is the deliberate manipulation or distortion of information or records and the
related misappropriation of assets. An irregularity becomes a fraud when it involves criminal
deception i.e. seeking unfair advantage over another person.
 FRAUD
It’s a form of Economic crime. It refers to an intentional act by one or more individuals among
management, employees or 3rd parties which may result in misrepresentation of financial
statements. Fraud may involve:
a) Manipulation, falsification or alteration of records and documents.
b) Misappropriation of assets.
c) Suppression or omission of the effects of transactions from records or documents.
d) Recording of transactions without substance
e) Misapplication of accounting policies.
Types of frauds
1. Teeming and lading

Also known as carry over fraud. It’s usually designed to misappropriate cash received by the
cashier from debtors. The cashier receives cash from debtor. A misappropriates the amount
and when Debtor B pays his amount, it’s used to credit debtor As account and so on. This
continues until the cashier decides to repay back the misappropriated amount or even write it
off. It’s more prevalent where:
i. There’s insufficient segregation of duties
ii. Failure to rotate duties of the cashiers and book keepers
iii. Lack of internal check system and supervision.
Preventive measures / internal controls to prevent teeming and lading fraud
1. Have proper segregation of duties between the cashier and the book keepers.
2. Regularly rotate the duties of the cashier and the book keepers.
3. Debtors should be advised to pay the amount directly to the bank accounts.
4. Ensure adequate supervision and internal check system.
5. Employ people of integrity and remunerate them well.
6. Have pre-numbered receipts for control purposes.
7. Authorize discounts and write-off at all times.
8. Enforce immediate receipting and banking of cash.
9. Have regular independent reconciliation of the cash book and bank statements by a
responsible person.
10. Send monthly statements to customers by a person who should not be connected with
cashier and the bookkeepers.
11. There should be compulsory leave for the cashier and the book-keepers.

Detective measures
1. Test the internal control system in particular internal check for receipts which should ensure
that the cashier should never have access to the debtors’ ledger.
2. Test-check the sales ledger of the current year with the previous year and note customers
who previously paid promptly and now are in arrears.
3. Check accounts with block payments which were previously paid in installments.
4. Check the pay-in slips with the cash book for agreements of entries and ascertain items
omitted and check for short banking.
5. Agree-dates in the cash book and counterfoils of the cash receipts.
6. Undertake circularization of debtors to see if dates and amounts agree or disagree with dates
in the debtors’ ledger.
7. Perform bank reconciliation.
2. Dummy / ghost workers

In this fraud, the company’s payroll is inflated with non-existing staff and the proceeds
misappropriated. It usually occurs where:
a) Retired employees aren’t removed from the payroll
b) Deceased employees aren’t removed from the payroll
c) Dummy names are inserted in the payroll
3. Window dressing
At the end of the financial period, the management may wish to please the shareholders that
they are operating profitably by committing the window dressing, fraud. Window dressing is
the process of leaving the books open at the end of the year awaiting the post balance sheet
transactions which are posted in the current period in disregard of the cut off procedures. This
may be accompanied by distribution of dividends, payment of taxes and transfer to reserves.
This is recovered during good periods. This process is also known as kitting.
Audit procedures to detect window dressing fraud

1) Obtain representation letters from management confirming their current financial position.
2) Perform Post Balance Sheet review; and
3) Examine bank statement to determine large amount deposited at year end as this may be
used for window dressing purposes
4. Misappropriation of cash.
5. Misappropriation of goods.
People who perpetrate fraud and other irregularities are very competent persons, they know
what they are doing but they lack integrity. For a successful fraud to take place, two conditions
must be present:
1. There must be opportunity

2. There must be motive

Opportunity is governed by the factors of time, access and skills. Motive is governed by the
factors of need, justification and challenge.
The auditors responsibility towards errors is the same with auditor’s responsibility towards
frauds. However practice dictates that errors being, accidental or unintentional are easy to
detect and in most cases they will conceal each other out.
Irregularities including fraud, invariably are more difficult to detect because the fraudster would
have taken steps to conceal the irregularity or fraud.
Implications of errors and frauds in the financial statement.
The existence of errors and frauds has the following implications for the auditor and for the audit
of the company’s financial statements.
i) They may indicate that proper books of accounts have not been kept, thus the financial
position and operating results may not be disclosed with reasonable accuracy and
completeness. This may raise doubt as to whether the accounting system is a reliable basis
for the preparation of the financial statements that show a true and fair view. The auditor
may have to conclude that proper books of accounts may not have been kept a ground for
qualifying the audit report.
ii) The system of internal control is not working as its intended to that it cannot prevent, detect,
correct and appropriately disclose errors including fraud. The auditor may therefore be
unable to place any reliance on the ICS thereby increasing detailed substantive procedures
and doing away with compliance procedures consequently leading to a more expensive audit.
iii) If they are of sufficient magnitude, they may prevent the financial statements from showing a
true and fair view and complying with the company’s act disclosure requirement, e.g. (a) theft
of stock by employees and the public from a supermarket chain is a common cause
occurrence and the users of the financial statements will presume that some theft has
occurred provided that they are within normal tolerances. The financial statements do not
need to disclose the facts and the amount of such theft. However, a material theft of cash
concealed by suppression of copy invoices on one particular year by the company accountant
could need to be dissolved in the accounts otherwise the users will have a wrong view of the
annual profits.
The inclusion in the accounts of debts which are known by the directors to be bad will lead to
wrong view being given to the users of the accounts regarding the profit and the capital of the
company. If the accounts do not show a true and fair view, the auditor must state that fact in
his report.

Issue of materiality with regard to errors and fraud
A true and fair view way be given by the financial statements of Huge ltd with or without the
disclosure of a minor defalcation on the other hand theft by employees of Shs. 1,000,000 from
Ndogo Ndogo Ltd will have to be disclosed if the profits were for example Shs. 900,000. The
latter is material to the accounts but the former is not.
If the auditor knows or suspects that an error or irregularities have occurred/exists he cannot
apply materiality consideration until he has sufficient evidence of the nature and extent of the
error/irregularity. Consequently investigations may need to be made by the auditor and by the
client into all errors and irregularities so that the auditor can have evidence on the materiality of
the matter concerned.
The respective responsibilities for the detection and prevention of errors and frauds
ISA 240 fraud and error is categorical that the primary responsibility rests with the management.
This responsibility arises out of the contractual relationship between management and the
company. The management has a duty of care and they act in a stewardship capacity with regard
to the resources entrusted to them by the shareholders or owners of the company. How they
exercise this duty of care is up to them but in most cases they will be taken to have discharged
their responsibility by instituting and maintaining a strong I.C.S.
There are many ways the directors and management can discharge the duty towards the
prevention and detection of errors and frauds such as:
i. Establishing I.C.S and monitoring its continued effectiveness

ii.Establishing an internal audit function
iii.
Having an audit committee
iv.Developing a code of conduct, monitoring compliance with that code and taking action
against breaches.
v. Establishing a compliance function i.e. a separate department of an enterprise specifically
charged with ensuring compliance with all sorts of regulations.
The external auditor is not required or expected to assist the directors in carrying out their
responsibilities. The auditor should remind the directors of their responsibilities and the need to
have a system of internal control to act as a deterrent to errors and irregularities.
If we look at the auditor’s responsibilities, it’s obvious that the auditors must obtain relevant and
reliable audit evidence to support his opinion. Therefore, with regard to errors and irregularities,
the auditor should have sufficient evidence that no material errors and irregularities have
occurred and if they’ve occurred then they would either be corrected or disclosed in financial
statements.

The auditors responsibility is to properly plan, perform and evaluate his work so as to have
reasonable expectation of detecting material misstatement in the financial statements. Whether
they are caused by frauds, other irregularities or errors.
Impact of errors and frauds on the audit plan
Before preparing the audit plan, the auditor should assess the risk that material errors and
irregularities may have taken place. The factors to take into account may include:
a) The situation facing the clients such as financial difficulties.

b) The known problems with the internal controls.
This is because the whole approach to the audit may radically be changed by the risks involved.
The following matters need to be considered in details:
I. Nature of the business; its services or products which are susceptible to misappropriation e.g.
organizations which involves cash takings such as those which operates retail business and
organizations which involves easily portable and valuable assets such as jewellery are at a
high risk. Similarly organizations where assets are held in a fiduciary capacity such as lawyers
who hold the clients money before handing them onto the appropriate person.
II. Circumstances which might induce the management to understate the profits e.g. impact of
taxation on the profits.
III. Circumstances which might induce the management to understate losses or overstATE profits
e.g. to retain the confidence of banks, investors or creditors or to increase profit related
remuneration or reduce the trend of insolvency proceedings.
IV. The known strength, quality and effectiveness of the management.
V. The internal control environment including the degree of management involvement,
supervision and the degree of segregation of duties and where excessive authority is vested in
one senior officer.
VI. The existence and effectiveness of the internal audit.
VII. Ability of the management to over-ride otherwise effective controls.
In particular accounts, areas and matters to consider would include the susceptibility of an area
to irregularity e.g. cash sales, portable and valuable stock items, the exclusion of liabilities
unusual transactions, related party transactions and materiality. The information on matters
outlined above will come from past experience and the annual review of the business and the
environment.
Weight will be given depending on;
a) The type of error or irregularity that may have occurred or is known to have occurred.
b) The relative risk of occurrence
c) Materiality
d) Relative effectiveness of different types of audit tests available.

Audit tests and irregularities
The primary purpose of an audit test is to simply obtain audit evidence. They may however
unearth irregularities e.g. compliance test of controls are designed to seek evidence that t he
controls upon which the auditor may desire to place reliance are effective in design and
application but those test of controls may reveal actual or possible irregularities. Substantive
procedures are designed to obtain audit evidence about the accuracy, completeness and validity
of the transactions. Again irregularities may be revealed as a by-product of the test.
Some audit tests are designed to detect irregularities in addition to obtaining audit evidence e.g.
those tests designed to reveal understatement of liabilities or overstatement of assets such as
stock and debtors.
NB: In general, “an auditor is a watchdog and not a blood haunt” and therefore tests designed
specifically and uniquely to detect fraud will be performed only when the auditors suspicion is
aroused.
Role of Internal controls in the area of errors and frauds
As stated earlier, internal controls are designed partly to prevent and detect errors and
irregularities and partly to ensure for the orderly and efficient conduct of the business entity. The
auditor has a duty to ascertain the entire system of recording and processing of transactions and
assess its adequacy as a basis for the preparation of the financial statements. To respond to this
duty, the auditor will invariably also examine the internal controls. Since the controls are built
into the system of recording and processing.
An auditor who may wish to place some reliance on some internal controls must ascertain those
controls and perform test of controls which includes evaluating the controls and checking
whether the controls have been complied with. Thus the auditor is likely to acquire a very
extensive knowledge of the existence and effectiveness of the internal controls. This review of the
internal control environment may indicate potential or actual instances of errors and frauds
which may then lead to auditor determining by audit test if errors have taken place and if so to
what extent.
In any event, the auditor should inform the client of potential fraud or error in the management
letter.
Indicators of errors and frauds
1. Missing vouchers and documents – They may have been deliberately destroyed to conceal
irregularity.
2. Evidence of altered or falsified documents: The alteration may have taken place after the
documents have been authorized.

3. Unsatisfactory explanations.
4. Unexplained items on reconciliation or existence of a suspense account.
5. Evidence of disputes
6. Evidence that the internal controls are not operating as intended to. Thus explanations that
short cuts may have been made to achieve greater efficiency.
7. Evidence of unduly lavish lifestyle by officers and employees although other explanations may
be possible such as inheritance, suspicion is in order.
8. Failure of figures to agree with expectations produced by analytical review e.g. unexpectedly
low gross profits ratio or a surprisingly high breakage rate in a glass factory may hide a
defalcation.
9. Investigations by the government or police department
10. Substantial fees, commission or other payments which are larger or smaller than is usual and
are paid to consultants for unspecified services.
11. Payment made to the officials of the government
Action to be taken by auditors on discovery of potential errors and irregularities
i) Consider materiality – if the matter is not material or may not be material in the context of the
accounts then take no further action apart from informing the management.
ii) If the matter may be material then perform appropriate additional audit procedures.
iii) If it appears material consider the effects on the financial statement ensure that they’ve been
prepared with such adjustments or amendments as may be required.
iv) If further investigations are required and accounts cannot be delayed, then the audit report
may have to be qualified on limitation of scope.
v) In the event where errors or irregularities have occurred, ensure that top management are
aware of such events.
vi) Any weakness in the accounting system and I.C.S which may give or may have given rise to
errors or irregularities should be fully discussed and reported to the management.
Reporting with regard to errors and irregularities
1. To shareholders
Errors and irregularities need not to be reported to the members as such but if the financial
statements or any part of them do not or may not give a true and fair view or conform to statute
or if proper books of accounts have not been kept, then the auditor has his statutory duty as
given by the company’s act to report to the members.
2. To the top management
In the event of the auditor suspecting that management are involved in irregularities, then a
report the main board or committee may be necessary.

3. To the operational management
All actual or potential irregularities discovered should be in the management letter with
recommendations for change.
4. To third parties
The auditor is required to take the following action:
a. Seek legal and professional advice from ICPAK

b. Ensure that the accounts give a true and fair view
c. Disclose to 3rd parties such as police only those matters where the auditor has a clear
public duty to disclose such as when there is a serious crime contemplated.
d. Consider possible ways of ending the engagement although this is the state of the last
resort.
Conclusions on errors and irregularities
ISA 240 has a number of specific requirements:
a) Auditor should plan and perform his audit work and evaluate evidence and report the results
thereof recognizing that fraud or error may materially affect the financial statements.
b) When planning the audit, the auditor should assess the risk that errors or frauds may cause the
financial statements to contain material misstatements.
c) Based on their risk assessment, the auditor should design audit procedures so as to have
reasonable expectation of detecting misstatements arising from error or fraud which are
material to the financial statements.
d) When the auditor becomes aware of information which indicates that errors or frauds exist,
they should obtain an understanding of the nature of events and circumstances in which they
have occurred and sufficient other evidence to evaluate the possible effects on the financial
statements. If the auditor believes that the indicated fraud or error could have a material effect
on the financial statement then he should perform appropriate, modified or additional audit
procedures.
e) When the auditor becomes aware or suspects that there may be instances of errors and frauds,
they should document their findings and subject to any requirement report them direct to a
third party and discuss with the appropriate level of management.
f) The auditor should consider the implication of suspected or actual errors or fraudulent
conduct in relation to other aspects particularly the reliability of management representations.
g) The auditor should as soon as possible communicate their findings to the appropriate level of
management or board of directors or the audit committee if:
 He suspects or discovers fraud even if the potential effect on the financial statements is
immaterial.
 A material fraud is actually found to exist.

AUDIT EVIDENCE ISA500
 Nature and source of Audit Evidence

ISA 500 recommends that the auditor should obtain sufficient and appropriate audit evidence
to be able to draw conclusions on which to base his audit opinion. Audit evidence means the
information obtained by the auditor in arriving at conclusions from which he bases his
opinion. Audit evidence comprises of source documents, accounting records underlying
financial statements, evidence from 3rd parties and from the client management.
Evidence provided to the auditor may be oral, visual or documentary. The evidence obtained
must represent the qualities of sufficiency relevancy and reliability. The evidence obtained by
the auditor will differ from one audit to another, one management to another and from one
engagement to another. This is because evidence is affected by:-
1. Nature and source
2. Time and cost
3. Materiality and risk involved
4. Objective and purpose of the audit
5. Qualification and experience of the auditor
Sources of Audit Evidence
Audit evidence may be obtained from:
a) Source document and underlying accounting records

b) Accounting system and the internal control system
c) Management and employees of the company
d) Tangible assets
e) 3rd parties e.g. customers and suppliers
The above sources do provide the following evidence;
a) Evidence on the accuracy and reliability of source document

b) Evidence on the agreement of accounts with the books of accounts
c) Evidence about the effectiveness of the Internal Control System.
d) Evidence about the adequacy of the accounting system
e) Evidence about the reliability and competence of management and employees
f) Evidence in respect to the debtors and creditors balance.
Types of Audit Evidence
There are 4 types of audit evidence namely:
1. Primary Audit Evidence

2. Secondary audit evidence

3. Circumstantial audit evidence
4. Hearsay audit evidence.
Primary audit evidence
This is evidence gathered from within the client entity i.e. from the accounting records,
accounting system and internal controls. This evidence is obtained through computation,
comparing of performance, physical inspection and examination, observation etc.
Secondary Audit Evidence
This is evidence from sources outside the clients business i.e. from 3 rd parties e.g. reply to
circularization of debtors and creditors, Evidence from the bank, lawyers and trustees. This type
of evidence is more reliable because it’s documented except that where 3 rd parties have relations
with the company they may collude and give biased information.
Circumstantial evidence
This is evidence from circumstances prevailing within the clients business at the time of the
audit. It’s obtained through observation of procedures or happening of activities. It’s obtained in
respect to the following areas
1. The physical counting of stock in trade

2. The suprise check of petty cash balance
3. The payment of wages to casual workers
4. Opening of incoming mail to the organization.
Hearsay Evidences
This evidence is gathered from interviews, questionnaires and discussions with the management
and other parties related to the clients. It’s not documentarily supported and thus its carefully
evaluated by the auditor in respect to the audit.
QUALITIES OF AUDIT EVIDENCE
Audit evidence should possess 3 qualities i.e.
1. Sufficiency
2. Relevancy
3. Reliability
 Sufficiency
The auditor seeks to obtain audit evidence that relevant financial statements are fairly stated or
aren’t materially misstated. The concept of professional skeptism would suggest that the auditor

must have an element of “doubt” as to whether the financial information is fairly stated. The
degree of doubt will depend on the possibilities of errors and irregularities including fraud.
Audit evidence becomes sufficient when it removes the element of doubt or the auditor is able to
conclude one way or another.
Sufficiency is measure of the quantity of audit evidence. The auditor’s judgement as to what is
sufficient audit evidence is influenced by factors such as:
i) Auditor’s assessment of the nature and level of inherent risk at both the financial
statement level at the account balance or class of transactions level.
ii) Nature of the accounting system and internal control system and the assessment of control
risk.
iii) Materiality of the item being examined.
iv) Experience gained during the previous audit.
v) Result of audit procedures including fraud or error which may have been found.
vi) Source and reliability of information available.
Professional skeptism: Implies an attitude that includes a questioning mind and a critical
assessment of audit evidence without being obsessively suspicious or skeptical. Such an attitude
results for example in the auditor asking more questions than usual and more probing questions.
Critically analyzing these answers and their company this analysis with other evidence gathered.
When an auditor adopts such an attitude, he evaluates evidence bearing in mind that th e
evidence may be misleading, incomplete, person providing evidence may be incompetent and
there may be possibility of fraud.
 Relevancy
When management operates a system of accounting and internal controls they make certain
assertions that:
- The controls exist

- The controls are effective
- They are effective continuously
If the auditor is intending to place some reliance on some internal controls, then he must seek for
evidence to confirm those management assertions. Evidence is relevant when it confirms
management assertions.
1. The nature of the item e.g cash has a greater degree of misstatement than fixed assets
2. Nature and size of business being audited
3. Financial position of the company

 Reliability
It refers to the degree of confidence that the auditor can derive from a source of audit evidence.
It’s influenced by its nature and source. The sources of audit evidence can be internal or external.
 From the auditors point of view because internal evidence can easily be manipulated, it’s
less reliable than evidence from external sources who are independent from internal
sources. Therefore, generally it’s held that; external evidence is more reliable than internal
evidence.
 If management are able to establish and maintain a satisfactory system of controls which
can effectively prevent and detect errors and frauds then it enhances the reliability of
internal evidence. Hence, again it’s stated that generally, internal evidence becomes more
reliable when the related internal controls are satisfactory.
 Some audit evidence of necessity must be generated by the auditor himself including
seeking independent confirmation from 3rd parties. From the auditors point of view, the
evidence he has generated himself must of necessity be the most reliable. Hence again it’s
stated that generally, evidence obtained by the auditors himself is more reliable than that
obtained from management of the entity.
 The other characteristic of audit evidence is its nature which can be visual documentary or
oral. What the auditor has examined with his own eyes creates a very reliable evidence
particularly concerning its existence. Information available in the form of documents or
record can be referred to at any time and thereby resolve any dispute. On the other hand
information obtained orally can’t be referred to. It follows that oral evidence is the least
reliable evidence. Again its stated that evidence in the form of document or written
representation is more reliable than oral representation.
Techniques/ways/methods/procedures of obtaining/gathering audit evidence

There are 5 main techniques of obtaining audit evidence i.e.
1. Inspection
2. Observation
3. Computations
4. Inquiry and confirmation
5. Analytical review procedures.
1. Inspection
It’s the process of physically checking or examining records to determine for their accuracy. It
can also be carried out over tangible assets to confirm for their existence and conditions.

2. Observation
In this method the auditor witnesses the happening of activities or transactions being
undertaken by the clients. The evidence obtained by the auditor is recorded and used to form the
auditors evidence. Observation of procedures can be performed in the following areas.
i. Wages payment to casual workers

ii. Physical counting of stock in trade
iii. Opening of incoming mails to the organization.
iv. Physical counting of cash in hand
3. Computations
This involves checking the arithmetical accuracy of records, transactions and account balances.
Computation is carried out by the auditor when checking the source documents, verification of
assets and liabilities, examination of the cash book and confirmation of balances with 3 rd parties.
4. Inquiry and confirmation

Inquiry involves conducting interviews and questionnaires in order to obtain some evidence.
The auditor can conduct interviews and questionnaires with the 3 rd parties, management and
employees.
Confirmation is where the auditor writes to 3 rd parties requesting them to confirm the balances
in respect to transactions undertaken. Confirmation may be done from the debtors through the
debtors circularization or from the bank through the bank standard letter.
Bank standard letter

The auditor can confirm the balance at bank using the bank standard letter. The procedures
involved are:
i. Obtain a written authority from the client management to confirm the bank balance.
ii. Write a bank standard letter in the clients letter head signed by the client.
iii. Receive written confirmation of the bank balance from the clients bank manager.
iv. Obtain a certificate of existence of the bank balance signed by the clients bank manager.
v. Where the client operates different accounts confirm the balances from each branch.
Debtors circularization
This is the process by which the auditor writes to the debtors at the balance sheet date
requesting them to confirm the agreement or disagreement with the stated balance in the
circular. This kind of evidence is more reliable because it’s from external sources and is
documentarily supported. It’s also obtained by the auditor himself.
Purpose of debtors circularization

1. Determine the nature of the I.C.S over trade debtors and credit sales
2. Detect incidences of teeming and lading
3. Confirm the existence and valuation of trade debtors in the balance sheet.
4. Confirm for the accuracy of the sales ledger and sales invoices.
5. Observe the cut-off procedures over credit sales and debtors.
6. Determine the rightful authority and approval of discount and write-offs.
The auditors procedures with regard to circularization

1. Obtain permission from the management of circularize the debtors
2. Obtain an aged debtors listing prepared as at the date he wishes to circularize. The auditor
should check that listing, cast and cross cast, test check the aging, test check the extraction
of the balances and agree the totals as per the listing to the control accounts or the
reconciliation with the control accounts.
3. The auditor should select a sample to circularize and agree with the management.
4. Prepare the circular which should be typed in the clients letterhead and signed on behalf
of the company by a senior officer.
5. Fill in the details in the circulars
6. Post the circulars
7. Send reminders to non-replies
8. Analyze the replies
9. Perform alternative procedures incase of non-replies
10. Conclude on whether the objectives of the circularization have been achieved.
Debtors circularization can either be negative or positive circularization.
Positive circularization
The debtor is required by the auditor to reply to the circular confirming their agreement or
disagreement with the stated balance. If they agree, they should reply, if they disagree they
should also reply. It’s the preferred method of circularization. It should be sent when:
1. The debtor isn’t well known by the auditor;
2. When the auditor suspects fraud;
3. There’s a weak I.C.S.
Negative circularization
The debtor isn’t expected to reply to the circular unless he disagrees with the contents of the
circular. The major drawback of a negative circularization is that, should the debtor fail to
receive the circular and therefore not reply the auditor may wrongly conclude that the debtor is
in agreement. It’s therefore used when:-
1. The client has a very strong I.C.S
2. There are a lot of other evidence upon which the auditor can rely on.

Selecting a sample for circularization
Although debtors circularization can be used as a compliance test, its main use is as a substantive
procedure of details and therefore the sample selected tends to be biased towards those accounts
which it mis-stated would result into a misleading view being given by the debtors figures.
Therefore the following accounts would be included in the sample selected;
1. All material balances – After the materiality level for debtors have been established, all
the debtor balances in excess of that amount would be selected.
2. Debtor accounts with credit balances
Debtor systems should produce debit balances therefore when it produces a credit
balance, there’s need to confirm that this is a genuine balance.
3. Account balances which are small or Nil but that happens at the year end suggesting
that during the rest of the year the accounts were very active. This may have been used for
window dressing purposes
4. Those customers who have exceeded their credit limit in terms of time and amount.
5. Those customers who are paying the current invoices but the old invoices are still
outstanding.
6. Those customers paying lump sum amount or amount on accounts rather than clearing
specific invoices.
7. Any other account that puts the auditor upon enquiry such as accounts with related
parties, customers’ enjoying favourable terms compared to others e.t.c
The circular
It’s drafted by the auditor but it’s actually addressed to the company customers as if its from the
company therefore it‘ll be typed in the company’s letterhead. It should however request that any
replies be sent direct to the auditors whose address is given in the circular. To encourage more
customers to reply, the circular would usually indicate that its not a request for payment. The
circular should be posted by the auditor himself to minimize the risk of it being intercepted. The
details can be filled in by the client staff.
5. Analytical Review Procedures (ARP)

It refers to the computation of accounting ratios, comparison of financial information with
anticipated results or similar information related to other periods or business enterprises. It
involves investigation of changes in trend so as to determine unusual fluctuation in the
performance that may require additional explanations or investigations. Analytical Review
Procedures are performed in 3 stages i.e.
(a) At the planning stage-in this stage analytical review procedures provide evidence in
respect to the areas of risk where more audit tests or procedures would be required. The
result of the analysis in the planning stage will enable the auditor to design appropriate
substantive procedures of details.

(b) During the audit – at this stage analytical review procedures provides evidence to the
auditor in respect to the nature, extent and timing of clients Internal Control System.
(c) At the completion of the audit – they’ll provide evidence about the true and fair view of the
Steps/stages of analytical review procedures

a) The auditor would compute accounting ratios using fundamental formulas under the ratio
analysis e.g
i) Fixed assets – There will be

Fixed assets turnover ratio = sales
Book value of assets
To measure the utilization of the available capacity
Global Depreciation Ration = Book value of Asset

Depreciation charge for the year
This ratio seeks to determine whether on average, the estimated useful life of asset is reasonable
in that it computes how many years it’ll take to write off the fixed assets at the current rate of
depreciation.
ii) Stocks, there will be;

 Percentage change in the value of stock which is compared with percentage
change in purchases. The reason being, that an increase in purchases should lead
to a corresponding increase in stocks.
 Stocks turnover ratio which is = cost of sales

Average stock
iii) Debtors, there’ll be;

 Percentage change in debtors which will be compared with percentage change in
sales or turnover.
 Number of days sales in debtors = Debtors
Average sales per day.
It measures the effectiveness of the credit control procedures of the organization.

iv) Creditors, there will be;
 Percentage change in creditors which will be compared with percentage change
in purchases.
 Number of days sales in Creditors = Creditors
Average purchases per day.
It measures how quick the company is taking to pay its creditors.
v) Liquidity ratios
E.g. The Current ratio or the Acid Test Ratio
vi) Profitability ratios

E.g. The Gross Profit Margin.
b) Compare the current ratios with the previous year’s ratios.

c) Using the current ratios, compute the actual performance.
d) Compare the actual performance with the previous year performance.
e) Compute the variance and compare with other periods.
f) Compare the same variance with those of other firms in the same industry and perform
investigations incase of unusual variances.
g) Reach a conclusion.
Limitation in gathering audit evidence

1. Lack of co-operation from the client management to provide useful information to the
auditor
2. Where evidence is obtained from 3rd parties, they may refuse to reply to the auditor’s
letters or 3rd parties may collude with the management to give biased information.
3. Where ARPs are used to gather evidence in some cases it may not be possible to apply
ratios and other analysis especially if there have been changes in the economic
circumstances and accounting policies.
4. Incase of large clients where vouching is used as a means of gathering evidence, the
sampling procedures maybe such that , they leave out voucher with errors and frauds or
there may be loss of audit trail where voucher have been misplaced.
5. Where volume of transactions is large, examination of vouchers becomes tedious and time
consuming.
6. If the Internal Control System is weak, the auditor may not be able to gather sufficient
evidence because information will usually be lacking either due to incomplete of records
or lack of documents.
7. Where observation is to be used and especially where the auditor makes known his
intended visits, the client staff may attempt to give the auditor the impression that the
procedures are actually followed when they are not.
8. The auditors attempt to gather evidence may be limited by the technical nature of the
clients business. An auditor may have to rely on another party who knows and
understands the client’s business.
9. Where personal judgement is used, wrong conclusions may be made through wrong
judgement, since personal judgement is influenced by individual bias.
How the auditor uses the gathered evidence

Normally evidence obtained by the auditor is used in informing an opinion on the true and Fair
view of the financial statements. However to some extent evidence can be used in the following
ways:
1. To assess and evaluate the nature of the Internal Control System.
2. To determine the accuracy and reliability of accounting records.
3. Defend the auditor incase of accusation or allegations made by the client due to negligence.
4. Plan optimally for the future audit of the clients
AUDIT SAMPLING ISA530

It’s the application of a compliance or substantive test to a less than 100% of the items within an
account balance or a class of transaction in order to obtain evidence that describes the general
characteristic of the population. The evidence obtained will represent the whole population.
Reasons for sampling

1. Sampling is fruitful, the auditor can draw conclusion about an account balance, class of
transactions or system of controls by way of sampling procedures.
2. Its economical both in terms of time and cost.
3. Sampling is practical because users of accounting information don’t require 100%
accuracy, their concern is material items.
4. Compete or total check leads to boredom of audit assistants hence their work become
vulnerable to errors.
Where sampling is applied

1. When auditing a large company with large volumes of transactions.
2. When performing a system based audit.
3. When proving the true and fair view of the financial statements.
4. When determining the degree of risk exposures.
5. When the population is homogenous.

Exceptions to audit sampling
1. When items of examination are few and material e.g fixed assets
2. Items of special importance where materiality doesn’t apply e.g. directors remuneration
and their loans
3. Items put on enquiry e.g. presence of a suspense account.
4. Extra ordinary items i.e. activities out of the normal operations of the business e.g.
intangible assets written off or income from sale of a subsidiary.
5. Exceptional items i.e. items abnormal in nature, size, characteristic or significance.
6. High risk areas e.g. cash, stock and wages.
7. When the audit area does not consist of items of the same kind i.e. heterogeneous.
Factors to consider when determining the size of a sample

1. Population
The population should be large enough to call for sampling. The larger the population the
larger the sample size so as to give every item an equal chance of being selected. Sampling
should not be applied where there are few transactions in the population.
2. Nature of transactions
The transactions should be similar thought to enable the auditor to use the same audit test.
The transactions selected should enable the auditor to draw conclusions on the whole
population.
3. Method of sampling
Selection should be done randomly to give each item an equal chance of being selected.
4. Audit objective
That is whether it’s for errors and frauds or for the true and fair view of the F/Ss e.g. when the
objective is to defeat errors or frauds, a large sample would be selected.
5. Level of materiality and risk exposures

Sample selected should be for material items which if materially mis stated would lead to a
wrong view being given by the accounts. Items exposed to a high risk should also be selected
incase of a high risk, a large sample needs to be used for examination.
6. The confidence level

The difference between the actual error and expected errors rate from a given population.
7. Time and cost involved in carrying out the sampling

A sample should be selected that would minimize the time as much as possible hence
reducing the cost of the audit.

8. Accounting system and related forms of controls
For a weak Internal Control System, sample size will be large.
9. Expected error
10. Tolerable error
11. Stratification
Stages of audit sampling

1. Designing or planning the sample
2. Selecting the sample size
3. Performing audit procedures on the sample
4. Evaluating the results of the sample
1. Designing and planning the sample

a) The auditor should state the audit objective i.e. why is this test being carried out. He
should then determine the population from which he draws the sample for the specific
audit objective.
b) The auditor needs to define error or deviation i.e. what he wants to test. Before performing
tests on the sample the auditor should determine the results of the tests and conditions
that would be considered error or deviation e.g.:-
i) To test that duplicate sales invoices are approved, lack of proper initials will
indicate lack of approval.
ii) To test whether delivery notes are attached to duplicate sales invoices. The
deviation is the delivery note, not accompanying the sales invoices
c) Determine the sample size. This will be affected by assurance and risk in planning. The
auditor needs to determine the level of audit risk i.e. probability that an auditor will draw
wrong conclusions from the procedures. In addition to the 3 components of risk, i.e.
inherent, control and detection risk, there’s also sampling risk and non-sampling risk.
 Sampling risk
It’s the risk of obtaining a sample that is not a representative of the whole population. A sample
cannot be 100% representative of the population but a large sample gives a higher assurance.
 Non-sampling risk
It arises when the auditor uses inappropriate procedures or might mis-interpret evidence and
thus might fail to recognize an error.
d) Defining the tolerable error

It’s the maximum error in the population that the auditor is willing to accept and still concludes
that the results from the sample have achieved the audit objective. Establishing tolerable error

requires professional judgment, if the tolerable error is high, the sample size should be smaller
and if the tolerable error is low, the sample size should be large.
e) Defining the expected error

If the auditor expect errors to be present e.g. due to past experience he would have to plan to
examine a large sample
f) Stratification of the sample

It’s the process of dividing the population into sub-populations. It enables the auditor to direct
his effort towards the items he considers to have greater monetary error. The more efficient the
stratification the smaller will be the size of the sample
2. Selecting the sample size

Sample items should be selected in such a way that the sample can be expected to be a
representative of the population. This requires that all items in the population are given an equal
opportunity of being selected. There are 2 main methods of selecting the sample i.e.
i. Judgemental method
ii. Statistical method
i. Judgemental method
This is on the basis of the auditors own judgement. The auditor selects the transactions
randomly, tests them and uses his own judgement to reach a conclusion. The success of its
application depends mainly on the auditors experience, knowledge and skills of judgement. Its
therefore used when the internal control system is strong and above all the auditor is well
conversant with the system and the procedures of the business under audit. The auditor will
have to use professional judgement in the following cases:
a) In deciding which tests need to be applied or carried out.

b) In deciding on the reliance to be placed on the system of internal controls.
c) When deciding what is material or immaterial on the sample results.
Advantages of judgemental method

1. The method is well understood and is refined by experience, since the method has been in
use for many years.
2. The auditor can bring judgement and expertise into use
3. No special knowledge of statistics is required
4. No time is wasted on mathematics thus enough time is spent on the audit.

Disadvantages of judgemental method
1. It is unscientific and the auditor cannot determine the degree of risk exposure from the
sample.
2. Personal bias cannot be avoided.
3. No quantitative results are obtained.
ii. Statistical method

It’s a mathematical approach to sampling where figures are computed analyzed and concluded
on, by the auditor under statistical methods there are:
a) Random selection method
b) Interval selection method
c) Haphazard selection method
d) Stratified selection method
e) Clustered selection method
(a) Random selection method

Items in the population have or are given numbers. These numbers are then selected in such a
way as to give every item in the population an equal chance of being selected. This is done by
random number or computer generated numbers.
(b) Interval selection method

It involves selecting items using constant interval between selections. The first interval has a
random start. The interval may be based on a certain number of items e.g. every 10th voucher or
every Shs.20, 000.
(c) Haphazard selection method

It involves drawing a representative sample from the entire population with no intention to
include or exclude specific items. When using this method, the auditor should take care against
taking selection that is biased.
(d) Stratified selection method

It involves dividing population into sub populations called strata. A sample is picked from every
strata and then the items picked form the entire sample.
(e) Clustered selection method

This is used when the data is maintained in clusters, groups or bunches e.g wages records in
months or sales invoices in weeks. A cluster is randomly selected and all items in the cluster are
examined.
Advantages of statistical sampling

1. Sample size is objectively determined having in mind the degree of risk exposures
2. It’s possible to use smaller sample size, thus saving time and cost.
3. The results of the tests can be expressed in mathematical terms.
4. Bias is eliminated
5. It helps the auditor reduce his risk exposures.
Disadvantages of statistical sampling.

1. The methods are difficult to understand.
2. Time is wasted on mathematics rather than on the audit.
3. Unsuspected bias on the sample selection may invalidate the conclusions.
3. Performing audit procedures on the sample

This could be compliance or substantive testing whereby compliance testing is testing the
effectiveness of the internal control system. While substantive testing is testing figures in the
accounts balance or transactions to determine the accuracy, completeness and validity.
4. Evaluating the results of the sample

After carrying out the audit procedures that are appropriate to a particular audit objective, the
auditor should :-
a) Analyze any errors detected in the sample
b) Project the errors found in the sample to the population
c) Assess the risk that the actual error may exceed the tolerable error.
d) Conclude on whether the audit objectives have been achieved.
REPRESENTATION LETTER ISA 580

The auditor needs to obtain a letter of representation from the management, addressed to him
confirming any representation given to the auditor by the management. Representation for this
purpose means, the oral statements made by the management to convey their opining on various
matters of the accounts.
Such matters are statements stated on the accounts which concern questions of facts or
judgement which are difficult for the auditor to confirm with objectivity.
Role of the representation letter

1. The auditor is required and therefore entitled to obtain from the officers of the company
all information and explanations as he deems fit and necessary for the performance of his
work.
2. It makes the officers of the company liable for any false or misleading information made by
them to the auditor.
3. It ensures that the directors fully appreciate their responsibility for the matters contained
in the financial statements.
 The letter of representation is necessary where objectivity cannot be achieved by the
auditor e.g a representation on contingent liabilities.
 A letter of representation is not necessary to verify the amount of bank balance or debtors
balance as this can be objectively determined by direct confirmation from the bank or the
debtors.
Basic contents o the representation letter

1. Confirmation of the responsibility for and approval of financial statements
2. Confirmation that all accounting records and explanations have been availed
3. Confirmation of expected outcome of pending litigation
4. Confirmation of the entity’s compliance with statutory and other regulatory requirements
5. Confirmation that all liabilities and provisions have been disclosed
6. Confirmation of the company’s plans in relation to certain tax provisions
7. Confirmation of completeness or disclosure of related party transaction.
8. Confirmation of review of subsequent events on post balance sheet events.
In some cases the management may be reluctant to sign the representation letter such cases may
be due to:
i) Where management have reservations about an aspect of the accounts
ii) Where management have reservations about accounts as a whole
iii) Where management refuses to cooperate on principle
iv) Where the management don’t seem to understand what they are required to sign and why
v) Where the management remain uncertain about a given matter.
vi) Where the management do not seem to appreciate their responsibility in relation to the
accounts.
Where there’s such reluctance by management to sign the letter the auditor may end up with the
following procedures.
i) Emphasize to the management that accounts are primarily their responsibility and that the
representation are just to be signed to confirm matters in the accounts.
ii) The auditor should prepare a statement, stating the principles of representation and
requesting the management to acknowledge and sign. He needs to give all necessary
explanations until an understanding is reached
iii) The auditor should try to establish the reasons of the reluctance to sign the letter. This
may give the auditor information about matters not disclosed to him.
iv) When the refusal persists, the auditor should carryout extra work to discover the nature of
such reservations and where they relate to material aspects the auditor may qualify his
audit report on the basis of disclaimer of opinion stating that they are unable to express
their opinion because they’ve not received all the necessary information and explanations.
The letter of representation should be signed and approved as late as possible probably after the
analysis of analytical review but before the audit report is prepared. This is because it constitutes
evidence which must be considered and may determine the nature of the report given.

WORK OF EXPERTS – ISA 620
Under ISA 620, the auditor should obtain sufficient and appropriate audit evidence that such
work is adequate for the purpose of the audit. An expert means a person or a firm possessing
special skills, knowledge and experience in a particular field other than auditing and accounting.
An expert may be engaged or employed by the company or by the audit firm.
Examples of situations where an auditor may wish to rely upon an expert

1. Valuation of certain types of assets e.g. land and buildings, plant and machinery, work of arts,
precious stones etc.
2. Determining quantities or physical condition of assets e.g. minerals, petroleum reserves and
determining the remaining useful life of plant or machinery.
3. Determination of amount using specialized techniques e.g. actuarial valuation. Measurement
of work completed to work to be completed in work in progress.
4. Legal opinions concerning interpretation of statutes and regulations.
5. When auditing a complex IT system.
When deciding whether to use the work of an expert the auditor should consider (NEED)
i. The engagement team knowledge and previous experience of the matter of hand
ii. The materiality of the financial statement items being considered.
iii. The risk of material mis-statement based on the nature, complexity of the matter being
considered.
iv. Quality and quantity of other evidence expected to be available.
Factors to consider before relying on the work of an expert.

1. Qualification, competence and experience of the expert. When planning to use the work of an
expert the auditor should assess the professional competence of the expert. This will involve
considering the expert.
(a) Professional certification, licensing by or membership to a professional body.
(b) Experience and reputation in the field in which the auditor is seeking audit evidence.
2. Objectivity and independence of the expert. This can be assessed by ensuring that the expert
does not have any relationship with the client e.g. family relation, shareholding and financial
assistance from the client.
3. Scope of the expert’s work - this refers to the ability of the expert to perform his procedures
in given circumstances. To assess the scope of work the auditor should perform the
following procedures:
(a) Review the terms of reference especially if the expert is employed by the client.
(b) Review the methods used by the experts and confirm whether they are consistent
with Industry’s best practices.

(c) Check whether the expert was able to assess the supporting record pertaining to
the account balances under examination.
4. Time and cost involved in using of the work of an expert.
Assessing the work of expert

The auditor assesses the appropriateness of expert work as audit evidence regarding the
financial statement assertion being considered. Factors to be considered include:
1. Source of data used: if the source of data can be regarded as reliable then the auditor can
reasonably use the expert work as audit evidence.
2. Assumptions and methods used and their consistency with prior periods.
3. Result of the expert work.
Reference to an expert in an Auditing Report

When issuing unqualified audit report (+ve) the auditor should not refer to the work of an expert
but if as a result of expert’s work the auditor decides to issue a qualified report (-ve), in some
cases it may be appropriate in explaining nature of qualification to refer to an expert or describe
their work including the identity of expert and extent of their involvement. In such
circumstances the auditor would obtain the consent of the expert before making such reference.

AUDIT OF FINANCIAL STATEMENT ITEM: (Vouching and verification)
VOUCHING
A voucher is documentary evidence used to support the transaction in the books of account.
Vouching is the examination of vouchers to ensure that:
1. They are properly authorized ;
2. They are properly recorded;
3. They are for the business; and
4. They are for the current financial period.
Vouching is the process of matching documentary evidence with the details recorded in the
accounting records and provides evidence as to the accuracy, completeness and validity of
account balances or class of transactions. All profit or loss account items are vouched while
balance shelf items are verified.
Examples of voucher include:
 Supplies invoices and statement

 customers’ orders
 sales invoice
 purchase order
 cancelled cheques
 payment vouchers
 sales contract
 lease agreement
 depreciation schedule
 impairment schedule
 loan agreement
 confirmation letter from lawyers
 bank standard letter
 Reply from debtors circulation.
The work done during vouching includes:

a) Decide on the audit test and audit check to be carried out. An audit test is a procedure that
aims at providing evidence on the accuracy, validity and completeness of the records. There
are two types of audit tests i.e.
i) Primary audit test which include compliance test and substantive test.
ii) Secondary audit test which includes walk through test, rotational or surprise tests, audit
in depth, and evaluation audit test.

Furthermore, an audit check is a procedure that provides evidence about the occurrence of an
error or fraud. These checks are: complete or total check, interim check, surprise check and test
check
b) Decide on the reasons of performing the audit test or the audit check.
c) Carry out vouching of the transaction to confirm for authority, recording, date, amount or the
name.
d) Draw conclusions on the truth of the profit and loss account items.
Rotational or surprise test

Where the company has branches or subsidiaries, the accounts are kept at different locations and
each must be examined by the auditors. When checking the accounts of each continuously and
going to the other branch to check for errors and frauds, this is called rotational testing. The
purpose of a rotational test is to ensure that borrowing is not done from one branch to another to
cover up a fraud or losses are not transferred from one branch to another. It is done without
prior notice of the client.
Evaluation audit tests
These are audit procedures which are carried out by the auditor to provide evidence about the
strength weaknesses of the ICS. They include the internal control evaluation questionnaire.
Test check
This is where only few transactions are checked from the beginning till the end. It is carried out
to help the auditor to obtain the general view about the accuracy and reliability of the records. It
is carried out on those transactions or account balances which the auditor suspects to have error
or frauds.
Why the auditor would examine a voucher

1. To check whether the voucher is properly authorized with the rightful authority.
2. Check whether the voucher is properly recorded in the books of accounts.
3. Confirm whether the voucher is in the name of the business.
4. Check whether the dates in the voucher agree with the current financial period under audit.
5. Confirm whether the amounts in the voucher are in agreement both in words and in figures.
6. Detect any alterations, falsification or cancellation of documents.
7. Confirm whether the expenditure or cost incurred in the voucher fall within the ordinary
activities and financial limitation of the client.
8. Ensure that any additions or subtractions in the voucher are arithmetically correct.
9. Confirm whether the vouchers are serially numbered and filed accordingly.
NB: Any voucher that does not meet the above requirement is referred to as irregular vouchers.
Vouching therefore involves tracing a transaction from the initial stages through the books of
prime entry to the financial statements.

The degree of vouching will be determined by:
1. Size of the organization and volume of transactions.
2. Strength of the ICS.
3. Audit risk involved.
4. Auditor’s past experience with the client.
5. Materiality of the item involved.
Vouchers that should not be accepted by the auditor

1. Duplicate vouchers.
2. In case the date is wrong i.e. it does not correspond with the dates in the records.
3. If the voucher is in personal name because it is benefiting the individual named therein and
not the company.
4. Vouchers that have not been authorized or passed by a responsible officer it could be a
fraudulent voucher.
5. A cancelled voucher as it may represent double transaction.
6. If the amount differs in words and in figures. It will not be possible to know which one is
correct.
What to bear in mind when vouching

1. All vouchers must be serially numbered and filed properly.
2. The auditor must pay attention to:
a) The date of the voucher which must be for the current financial year.
b) The party to the voucher.
c) Amount in the voucher with should be reasonable and authorized.
3. Accepted vouchers must be cancelled using a big tick or stamped across the voucher.
4. Attention should be paid to vouchers in personal names of the company officer if so, the
accounts should be debited.
5. Attention should be paid to the amount in words and in figures which should tally.
6. Duplicate of missing vouchers should only be accepted with a reason from a responsible
officer and this should be mentioned in the representation letter.
Advantages of vouching
1. Enable the auditor to obtain evidence in respect to the source document.
2. Through vouching, the auditor is able to apply audit tests and procedures.
3. It facilitates completion of the final audit and the signing of the audit reports.
4. Enables the auditor detect errors and frauds.
5. Through vouching, the auditor can identify weaknesses in the ICS.
6. It helps the auditor to minimize exposures to the audit risk.
Disadvantages of vouching
1. Consumes the auditor’s time hence expensive to the clients.
2. Some of the vouchers may not have been properly filed.
3. Some vouchers may be missing as a way to cover up fraud.

4. Client employees may fail to co-operate during vouching.
5. It is not possible for the auditor to vouch all transactions therefore vouching is not
standardized.
Why it is not possible for the auditor to vouch all the transactions
1. Vouching depends on the nature of the ICS i.e. when it is weak, the auditor will have to do
detailed vouching while when it is strong the auditor will use system based approach.
2. Some of the financial statement items do require verification and not vouching.
3. The main objective of the audit is to prove for the true and fair view and therefore vouching
can only be carried out as a subsidiary procedure in detecting fraud.
VOUCHING OF PROFIT AND LOSS ACCOUNT ITEMS

1) Vouching of purchases
1. Check the internal control system and pay attention to internal check on ordering,
receiving and recording of purchases through ICQ, flow charts and compliance tests.
2. Select a number of invoices and check their signing and note the amounts on the invoices.
3. Trace the invoice to goods received notes and goods retuned notes to ensure for
agreement.
4. Check computations and extensions of the invoices and agree this with the goods received
notes.
5. Ensure that the invoice have been entered into the purchases day book and trace the
costing to the purchases ledger or to control accounts.
6. Trace the invoices to orders and requisitions notes to ensure that purchases were genuine.
7. Trace the items in the inventory records and ensure that they’re up to date and properly
recorded.
8. Ensure proper allocation of capital and revenue expenditure.
9. Check the invoices with monthly reconciliation of control accounts and compare with the
balance on the list of purchases and investigate any differences.
2) Vouching of sales
1. Test for approval of credit sales by someone responsible.
2. Test the prices with those on the price list or quotations.
3. Test check details on the delivery notes with order forms and inventories.
4. Check computations on the delivery notes and invoices.
5. Test a number of items in the stock records to ensure proper deductions.
6. Check sales analysis to detect the sale of assets treated as an ordinary sale.
7. Test check postings to the sales day book, journals, ledgers and control etc.
8. Reconcile debtors’ ledger with the debtors control account.
9. Check for the ICS on sales in respect to authorization and approval, segregation of duties
and supervision.
10. Check additions and calculations on the credit notes and invoices.
11. Perform an independent check on:
a) Recording returns.
b) Preparation of invoices and credit notes.
c) Maintaining of the sales ledger account.

d) Reconciliation of sales ledger and control accounts.
12. Check for authority of credit to customers by a responsible officer.
3) Vouching of wages and salaries

1. Test the ICS in particular the internal check on wages and salaries.
2. Examine the salaries book with payment vouchers for net salaries.
3. Check for increment, promotions and allowances and ensure that they were authorized.
4. Increment must be checked with engagement letters to see if the increments have been
effected when they are due and ensure that they are genuine.
5. Ensure that any allowance or special increments have been authorized by the board or
someone responsible.
6. Check statutory deductions and ensure that they are properly recorded and confirm that
they were submitted to the relevant authorities on time.
7. Counter check the cheques paid with the bank statement.
8. The auditor should verify salaries paid with returns to domestic taxes departments which
should agree in all respects.
9. Confirm the cheques drawn in favour of the employees and ensure that the amounts
therein are consistent with the amounts in the payroll.
10. The auditor should prepare to visit the company on the payday to observe the payment of
wages to casual workers purposely to detect dummy or ghost workers.
Ways of identifying dummy workers

1. They do not count their money.
2. They are shy when receiving wages.
3. They are not sociable with other workers during the pay day.
4. Dummy workers do hesitate in their signatures.
Detection of dummy workers

1. Compare the personnel records with the wages sheet for consistency.
2. Request for ID cards from the casual workers and determine whether there are dummy
workers.
3. Check signatures for different periods for consistency. Dummy workers signatures will not be
consistent.
4. Check the wages sheet for different periods and when some names don’t appear in different
wages sheet these must be investigated.
5. Obtain a list of retired, dead, or employees who have left the company and ensure that their
names don’t appear on the wages sheet.
6. Pay a surprise visit on pay day and observe the payment of wages to ensure that it is made on
production of ID cards.
7. Take a sample of ID cards compare the names on them with those on the wages sheet.
8. Compare actual wages with budgeted wages and obtain explanations for any variance.
9. Examine the employment procedures to see if they can give room for dummy workers.
10. Ensure that the name of a given employee don’t appear on the unpaid wages more than once.

4) Vouching of rent and rates
1. Check for the company’s policy to do with payment of rent and rates i.e. is it monthly,
quarterly or yearly and ensure that the policy is consistently followed.
2. Obtain the schedule of rent and rates prepared by the company and examine this for
disclosures and materiality.
3. Examine vouchers used for payment of rent and rates and check for authority and
recording.
4. Write to third parties to whom the rent has been paid to confirm directly from them how
much was paid.
5. Obtain the counterfoils of the cheque paid and ensure that it is in the name of the payee.
5) Vouching of electricity and water bills

1. Check the company’s policy to do with payments of electricity and water bills and ensure
that the policy is consistently followed.
2. Obtain electricity and water bills vouchers and examine these for authority, recording,
dates, name and amounts.
3. Confirm for any changes in respect to the current bills with the previous bills. Confirm
mater reading/consumption to determine any unusual variance that may call for
investigations.
4. Write to KPLC and NCC water department (or Nairobi Water and Sewerage Services)
directly the total amounts owing in respect to the clients.
6) Vouching postage and stationery

1. Confirm the company’s policy to do with the above payments.
2. Obtain the schedule of postage and stationery and examine these for materiality in
disclosures.
3. Obtain the cheque book used for payment to confirm these for authority, recording, name,
date and amounts.
7) Vouching of rent received

1. Obtain the rent agreement between the landlord and the tenants to confirm the following:
i) Amounts of rent receivable.
ii) Due dates.
iii) Interest for late payments.
iv) Terms and conditions of the agreement.
2. Examine the cash book for the total rent received.
3. Agree the receipts for dates and amounts with bank statement records.
4. Check the ledger for proper entry of these items in particular the period for which it was
due.
5. The auditor should set to examine the rent earning asset by physical inspection.
6. In case rent is received by an agent, check the agent’s accounts with the company and any
corresponding between the company and the agent.
7. For rent outstanding for some time, write to the tenant and request him to confirm his
position.

8) Vouching interest paid on loans
1. Examine the loan agreement to ascertain:
i) The rate of interest charged.
ii) The date when it is due.
2. Compute the interest and ensure it is correct.
3. Check the recording of this interest on the ledger.
4. Obtain the counter-foil of the cheque paying this interest. Confirm dates, names, amounts
and authority.
5. Check the item in the bank statement.
9) Vouching item in the bank statement

1. Check the company’s policy to do with the above and ensure that such a policy is practiced
consistently.
2. Examine the schedule of accruals and prepayments and consider these for materiality and
disclosures.
3. Obtain the vouchers in support to the accrued and prepaid expenses and examine this for
dates, names, and amounts.
4. Confirm with third parties whose names are included in the vouchers to agree this for
dates and amounts.
10) Vouching depreciation

1. Obtain the companies policy on depreciation and confirm that it is consistently applied.
2. Obtain the fixed assets register and vouch for additions, disposals and scrap and treatment
of profits or loss on disposal.
3. Confirm arithmetic accuracy of depreciation for the year and carry out analytical review of
comparison provision for depreciation for various periods.
11) Vouching directors fees

1. Examine the policy governing directors’ fees for consistency.
2. Examine the legal documents to ascertain that the fee payable to the directors is paid in
the amounts and manner provide for.
3. Examine minutes of meeting of shareholders and/or directors for authorization.
4. Check the attendance register for directors to ensure that they receive their fee as a result
of attending meetings.
5. Examine disclosure of directors’ fees in the financial statements.
6. Confirm that the director’s fees are paid net of tax from supporting documents.
7. Ascertaining whether the payments have been properly approved in accordance with the
legal framework of the company and that they are not prohibited by the Companies Act.
8. Confirm that all money payable and benefits in relation to the current account have been
properly accounted for.
9. Consider whether the most common types of benefits e.g. company cars have been
omitted.
10. Review directors service contracts by inspecting copies of the service contracts and ensure
that they are kept at:
i) Registered office.
ii) Principle place of business.
iii) The place where the register of members is kept if not the register office.
11. Review the company’s procedures to ensure that all directors advise the board of all
disclosable emoluments.
12. Review the procedures for ensuring that any payments made to the former directors of the
company are identified and properly disclosed.
13. Verify that long term service contracts i.e. lasting for more than five years have been
approved in the general meetings.
VERIFICATION OF ASSETS AND LIABILITIES
Verification is defined as the confirmation of some truth about assets and liabilities at the balance
sheet date. This means that the auditor will require evidence with regard to the following matters
in respect to the assets and liabilities.
1. Materiality in the disclosures.
2. Their legal ownership.
3. Their fairness in valuation.
4. Their physical existence and condition at the balance sheet date.
5. Their authority and completeness in processing and recording.
Verification can be achieved through

1. Vouching which means proving of the authenticity of the recorded transactions.
2. Balance testing which refers to the other audit procedures concerned with the balance sheet
items i.e. existence, rights and obligations, completeness, valuation, presentation or
disclosures.
Verification of assets
General Audit procedures
For any asset, the steps of verification are the same and usually include:
1) Ascertain, record, evaluate and if appropriate compliance tests the system of the accounting
and ICS over that asset.
2) Vouch the resulting accounting entries to the original or primary books of accounts and the
supporting documents to determine whether proper books of accounts have been kept and
the accounting system is adequate as a basis for the preparation of the financial statement.
3) Obtain or prepare a schedule showing the make-up of the balances e.g. FAMS, stock movement
schedule, debtor analysis.
(i) Cast and cross-cast the schedule to determine their arithmetical accuracy, agree the
totals of the schedule to the draft accounts, to the schedule and to the general ledger.
(ii) Check the reconciliation between the listing as per the schedule and the control account
in the general ledger if different, ensuring that the reconciling items are genuine.
(iii) Check the extraction of balances from the subsidiary ledger by selecting a few names
from the subsidiary ledger and tracing the details to the schedule and selecting a few
names from the schedule and tracing them to the subsidiary ledger.
4) Perform appropriate existence tests.
5) Perform appropriate rights or ownership tests.
6) Perform valuation tests.
7) Perform completeness tests.
8) Perform analytical review tests if not carried out above.
9) Review the adequacy of presentation and disclosure using appropriate check list e.g. the
Companies’ Act and the relevant accounting standards.
10) Conclude on whether assets give a fair view as at balance sheet date.
Verification of Dove (Description and Disclosure, Ownership, Valuation, Existence)

Technically, DOVE refers to
a) Description or disclosure
b) Ownership or title
c) Valuation or pricing
d) Existence or condition
Description and disclosure

1. Obtain the asset register/ledger and examine these for materiality in disclosures.
2. Agree the details in the ledger with those in the asset schedule.
3. Agree such disclosures with the relevant accounting standards requirements.
4. Check for the company’s policy to do with the disclosure of the asset and ensure that such a
policy has been practiced consistently.
5. Consider the importance of the asset to the true and fair view i.e. assets should be disclosed
as either non-current or current assets.
Ownership/title
1. Inspect the ownership documents and ensure that they are in the clients name e.g. title deed,
certificate of ownership, agreement and contracts, log books etc.
2. Agree the details in the ownership documents with those in the records e.g. in the asset
register.
3. Confirm for the ownership of the assets with the source documents supporting the accounts.
4. Check for the authority and approval for the purchase and disposal of the assets from the
minutes of meetings of the directors and shareholders.
5. If assets are held by third parties for safe custody, obtain a certificate from those third parties
and ensure that they are holding the asset for good reasons i.e. not as security for loans.
Valuation/pricing
1. Take costs less accumulated deprecation to date allowing in for additions or disposals during
the year all of which must be reasonable to arrive at the net book value.
2. Where the asset is too technical to value, engage an expert to provide for a fair value in
respect to the asset.
3. Agree the valuation policy with the Generally Accepted Account Principle (i.e. the provisions
of IAS 16, property, Plant and equipment).
4. Ensure that the value of the asset is fairly stated and reasonable.
Existence/condition
1. Visit the client premises at the balance sheet date and inspect the asset physically.

2. Ensure that the asset exists and are in good condition.
3. Agree the physical condition of the asset with those given in the records.
4. For assets which are held by third parties, obtain a certificate of existence.
5. Obtain a letter of representation for assets which were not available for physical verification.
Assets to be verified:
1. Freehold property and leasehold property.
2. Plant and machinery
3. Motor vehicles
4. Intangible assets.
5. Debtors
6. Cash in hand and cash at bank.
7. Stocks
1. Verification of freehold property

1. Examine the authorization if the acquisition for these assets if it is for the first audit. For this
purpose examine the minutes book.
2. Read through the correspondence between the seller and the buyer to ascertain the price and
its reasonableness.
3. The price must be reasonable and for this purpose compare with offers from different sellers
to ensure that the lowest price was paid.
4. In case it is a newly constructed building, obtain the architect’s certificate to ascertain its cost.
5. Inspect the document of ownership i.e. the title deed and ensure that they are in the name of
the client.
6. In case it has been mortgaged, obtain authority for this charge.
7. The auditor should obtain a certificate from the companies lawyer regarding the validity of
the title deed.
8. If the asset has appreciated in value, the auditor should ensure that the appreciated value is
reasonable.
9. For land, its value must be ascertained by engaging a valuer who should give a certificate to
this effect.
NB: Land is valued at cost or revaluation.
10. Ensure that the asset is physically present through inspection
11. Ensure its proper recording and description in the accounts and the asset register.
12. Obtain the land and building register and examine this for materiality in disclosures and agree
this with the accounting policies in respect to the disclosures.
2. Verification of leasehold property

1. Examine the authority for leasing the property by reading through the minutes of directors
and shareholders for the authorization of the lease.
2. Obtain the lease agreement and ascertain
a) Value of the leased property
b) Duration of the lease
c) Whether the lease is renewable
d) When it expires

e) Amount of lease charges.
3. Verification of plant and machinery

1. Examine the authority for acquisition of plant and machinery and for this reason read
through the minutes of meetings of meetings of directors or shareholders authorizing this
expenditure.
2. Inspect the documents of acquisition of these assets e.g. invoices and receipts which
should be in the company’s name.
3. Obtain the asset register and ascertain the following:
a) Name of the machine
b) Its serial number
c) Date when purchased
d) Depreciation rate and method
e) Cost of the asset.
4. The assets should be physically inspected to ensure that it exists and cross check its
physical value with documentary value, check also for details in point 3 above physically
i.e. with the physical asset.
5. For ownership, the auditor should obtain receipts, agreements and contracts and the
insurance policy which should be in client’s name.
6. For valuation, the asset should be valued by taking the purchase price plus incidental costs
less depreciation upto date.
7. Check the recording to ensure that it is properly recorded in the ledger accounts and
balance sheet.
8. Ensure that depreciation policy is consistent with the previous year and it is reasonable.
9. For disposal of plant and machinery, ensure that this was authorized and ascertain
whether the value of disposal is reasonable.
10. Ensure the proper recording of sales proceeds and their consequent balancing in the
assets account.
11. Where plant and machinery are held by 3 rd parties, obtain a certificate of ownership,
valuation and existence from these 3rd parties.
4. Verification of motor vehicles

1. Examine the motor vehicles register and ascertain
a) The make of the vehicle
b) Year of acquisition
c) Registration number
d) Engine number
e) Year of manufacture
2. Obtain authority for the purchase of the vehicles from the board minutes or shareholder’s
minutes book.
3. Inspect the vehicles physically and cross-check the entries with those in the log book
4. Ensure that the logbook is in the client’s name.
5. For valuation take cost less accumulated depreciation allowing in for additions and
disposals.
6. Obtain a schedule for the use of the motor vehicles and ensure that they are properly
utilized.

7. Also for more proof of ownership, the auditor should cross-check the log-book with the
insurance policy which should be comprehensive and ensure that it is in the client’s name
and upto date.
8. Check the recording of these assets in the respective ledger.
Role of the fixed asset register

Because fixed assets are used over many account periods, their continued existence is of
paramount importance, if the accounts are to show a true and fair view. The ledger accounts t hat
record fixed assets additions, are cumulative in nature and every progressive year, the auditor
needs an assurance that these cumulative balances represent fixed assets that are still in
existence.
For a large manufacturing company, assets in the category of plant, machinery and equipment,
motor vehicles as well as furniture, fittings and fixtures, may display some of the following
characteristics:-
a. They are numerous

b. They are movable from one place to another.
This will suggest that keeping track of those fixed assets would be difficult unless, an
independent records concerned with their physical /// is maintained. For many organization
such records, are in the form of fixed asset register which can usefully contain the following
information:
1. The description of the fixed assets

2. The normal location of that asset
3. A unique identification number of the asset.
4. The official who has primary responsibility over the asset
5. The date of purchase of that asset
6. Cost of the asset
7. Date of valuation if it has been revalued
8. Amount of revaluation
9. Estimated useful life
10. The rate or method of depreciation
11. Accumulated depreciation at the end of the year
12. Depreciation charge for the year
13. Accumulated depreciation at the beginning of the year.
14. Net book value of the assets at the beginning of the year
15. Net book value at the assets at the end of the year.
16. Date of disposal if disposed off
17. Disposal proceeds
18. Wear and tear allowance information and other types of capital allowances.
The management can then build into place the following additional measures:
a) On a regular basis, the staff of the internal audit department can select a number of items
from the fixed asset register, go to the location where the asset is supposed to be, identify it
using its unique identification and description to confirm that it exists. They can also select a
number of items from the floor and trace the items to the register. The program can be
arranged such that, by the end of the year, every item has been inspected at least once.
b) The financial information from the fixed asset register i.e. number 6, 8, 11, 12, 13, 14, 15 and
17 can then be summarized, totaled up and the totals agreed to the general ledger and control
accounts. This would confirm that the general ledger control account reflects fixed assets that
are in existence.
c) The external auditor, would carry out similar tests as those performed by the internal auditor
except that, the external auditors coverage is slightly smaller and would not involve monthly
visits.
Purpose of the Fixed Asset register

1. It is used as part of the verification process of fixed assets in the business.
2. It facilitates identification of assets during a physical check.
3. It forms an important part of system of internal control
4. It helps in the reconciliation of values with those in the financial records.
5. It helps to work out depreciation amounts on the assets as full details assets are available.
Suitability of depreciation policies

d) In accordance with provisions of IAS 16, depreciation should be provided for on a rational
basis on all fixed assets with a finite useful life.
e) Rational basis means, allocating the residue value of fixed assets over its estimated useful life
using a method that gives the best approximation to the usage or consumption of that fixed
asset and results in an amount to be charged against the income statements. The methods
commonly found in practice are:
1. The usage method

Theoretically, this is the most rational method and therefore where consumption or usage
can be determined accurately, it should be the preferred method.
2. Straight line method

There are certain fixed assets e.g. buildings for which there is no rational basis for
determining their usage. In such cases, the straight line method is the ideal method to use.
Thus, for property such as freehold buildings, it is justified to assume, that every period
receives or uses an equal amount of the assets.
3. Reducing balance method

Some fixed assets decline in efficiency as they are used. Mostly, plant and machinery and
motor vehicles fall in this category. Therefore for such assets, it is justified to use the
reducing balance method.
The other aspect of depreciation is the period the asset is used. This again must be
considered:-
i. Test check a number of calculations: - This is a recomputation exercise, whereby the
auditor confirms, whether the calculations have been done correctly.
ii. Consider the effect of technological changes. When the estimated useful life is
established, it is then used to calculate the residue value of the asset and therefore, the
depreciation to be charged on an annual basis. It assumes that the fixed assets will be
used for the entire period of the estimated useful life but changes that may be brought
about by technological advances could render the fixed asset obsolete or could extend
its estimated useful life. The auditor must therefore, exercise professional judgement to
determine whether, the remaining estimated useful life is reasonable or not.
NB: Freehold land does not usually have a finite useful life. Therefore, there is no rational basis
on which to charge depreciation. It is therefore not usually depreciated. The buildings on the
freehold land, have a finite useful life and therefore, their cost or valuation must be separated
from that of the freehold land and it should be depreciated over its estimated useful life.
AUDITOR PROCEDURES WITH REGARD TO DEPRECIATION
1. The auditor should check the policy of depreciating the assets and ensure that this policy is
suitable and it is followed consistently.
2. He should check for the reasonableness of the useful life of the fixed asset and
appropriateness of the rate of depreciation used.
3. Where there’s a revision of the estimated useful life of an asset following regular review, the
undepreciated cost should be charged over the revised remaining useful economic life.
4. Where the assets are revalued the provision for depreciation should be based on the revalued
amounts and the current estimated useful life with disclosures of the year of change and effect
of revaluation if material.
5. For each class of asset depreciated, ensure that disclosures are made in respect to the method
of depreciation used, useful life of the asset, the rate of depreciation used, total depreciation
for the year and accumulated depreciation.
6. Confirm the arithmetical accuracy of depreciation through recomputation of figures.
Revaluation of non-current asset

Assets are usually valued using historical cost accounting. Quite often the value attributable to
these assets has no relationship at all with the market conditions existing. The values therefore
begin to appear unreasonable and can be said to distort the view given by the balance sheet.
The auditor will perform the following procedures in respect of revaluation:
1. Determine whether the company has a policy for revaluation and whether it is consistently
followed.
2. Review the B.O.D minutes to confirm authorization for revaluation.
3. If a professional valuer was engaged, assess the competence of the valuer by finding out if he
is professionality qualified and registered valuer.
4. Incase the board of directors are the ones who undertook the revaluation, assess their
competence level in carrying out the revaluation.
5. Assess the expertise of the valuer in valuing similar properties.
6. Assess also the reputation and independence of the valuer, consideration being given to any
relationship between the valuer and the key directors.
7. Consider the value arrived at by the professional valuer and ensure that it is reasonable in
light of the latest selling price of similar properties in the region.
8. Ensure that depreciation is charged on the revalued amount and not the cost.

5. Verification of intangible asset (IAS 38 IFRS 3)
IAS 38 defines intangible assets as an identifiable, non monetary asset that lacks physical
substance. For an asset to be recognized as an intangible asset, it must satisfy the following
criteria;
a) It is controlled by the business as a result of events which took place in the past.
b) The business expects future economic benefits to flow to the organization as a result of
holding the asset.
Examples of intangible assets
1. Goodwill
2. Trademark
3. Patents
4. Copyrights
5. Computer software licences
Goodwill
Accounting treatment for good will IFRS 3
IFRS 3 states the following:
1. Good will should never be amortised but should be tested for impairment. Any impairment
should be written off to the income statement.
2. Negative goodwill should be recognized immediately in the income statement.
Audit procedures for goodwill

1. Confirm the consideration price to the company’s books, bank statements and Board of
Directors minutes.
2. Ensure that purchased goodwill has been computed correctly by ensuring that it should
reflect the difference between the purchase price and the fair value of the net assets acquired.
3. Confirm the realization of the purchase price and net assets and ensure that they are
reasonable.
4. Ensure compliance with IFRS in respect to disclosures.
5. Check that internally generated goodwill has not been recognized in the financial statements.
Audit procedures of other intangible assets

1. Review the Board of Directors minutes and the fixed asset register to obtain a confirmation of
other intangible assets the company could be holding.
2. Verify the payment of annual fee to the institute of intellectual properties by reviewing the
cash book, invoices and receipts.
3. Circularize the owners of intellectual properties to confirm that the intangible assets are
owned by the client.
4. Verify the amount capitalized for patent rights developed by the company to the supporting
documentation.
5. For acquisition and disposal of intangible assets, review the board of directors minutes to
confirm that authorization was granted and proceeds received and payment made properly
recorded.
6. Verification of cash in hand:
(1) If possible, the auditor should visit the clients at the balance sheet date or the following
day and count cash at hand to date and compare this with the cash book entries.

(2) If the company has different cash collection centres, cash in all the centres must be
counted simultaneously to avoid a shortage in one centre being made up with balance
from other centres.
(3) All counting should be done in the presence of the cashier responsible for their centres so
that if there’s any shortage the auditor can request a certificate of shortage from the
cashier concerned.
(4) The auditor should discourage the client from keeping large sums of cash in hand because
this will not only make it difficult for him to count but also chances of embezzlement are
high.
(5) For cash at hand in branches, the auditor should obtain certificate from this branch
auditors in this respect.
(6) The auditor should never accept I.O.U’s makeup for shortages except where these have
been certified by a responsible office. He should discourage the use of I.O.U’s as they may
be used to conceal fraud in cash shortages.
(7) Incase the auditor cannot visit the clients at the balance sheet dates, he should instruct a
responsible person to deposit cash at hand in the bank and retain the pay in slips as
evidence of the balance of cash at hand.
7. Verification of cash at bank

1) The auditor should set to examine the ICS regarding the banking operations of the
company in particular its internal check.
2) The auditor with the consent of the client should write to the bank and obtain a bank
statement from the bank.
3) Compare the entries in the pay in slips with those in the statements and the cash book
which should agree in amount and date of entries.
4) Perform a reconciliation of the bank statement with the cash book.
5) When examining the bank statement ensure that large amounts deposited at the end of
the year are investigated as they may be used for window dressing whereby money is
borrowed, banked and later withdrawn after the audit.
6) If the company has several bank accounts, these should be verified simultaneously up to
the same date to avoid withdrawals from one account to make up for a deficit in another
account.
7) Ensure there’s proper disclosure of all cash balances i.e. what is classified as cash is really
cash e.g. cash held in closed banks or foreign banks may not be easily convertible.
8. Verification of debtors
General audit procedures
1) Obtain a schedule of debtors from the ledger accounts
2) The auditor will validate the records and internal controls over sales and debtors through
a selected sample for compliance and substantive testing. The auditor will evaluate the ICS
and the system should ensure that:
a. Debtors are brought into existence by a bonafide sale
b. All sales are recorded
c. All sales are made to approved customers
d. Ensure that once debtors are recorded, the only way in which they are removed from
the books is by receipt of payment from them or authority from a responsible officer.
e. Ensure that debts are collected on time so that debtors do not exceed their credit limit.
f. Ensure that aging process is conducted regularly and that follow-up is made on debtors
who have exceeded their credit period and if necessary adequate provision for bad and
doubtful debts is made.
3) The auditor should cast the schedule to determine for arithmetical accuracy.
4) The auditor should compare balances on the ledger accounts to the schedule. All the
amount in the ledger should be reflected in the schedule.
5) The auditor should check control accounts to ensure that all entries are properly recorded.
6) The auditor should inquire into credit balances which should be due to overpayments or
overcharging of the debtors.
7) The auditor should conduct analytical reviews by comparing debtors ratios with those of
the previous years.
8) The auditor should ensure that accounts are settled from time to time by tracing the
receipts of payment.
Valuation of debtors
Debtors like any other current assets are valued at the lower of cost and net realizable value.
Where NRV realizable value is equal to cost – (less) provision for bad and doubtful debts. The
auditor’s main concern is the adequacy of the provision of bad and doubtful debts. To determine
this adequacy, the auditor must consider the following factors.
1) The adequacy of the system of internal control to the approval of credit sales and follow up of
bad debts.
2) The auditor will consider the credit allowed and taken by the debtor
3) Whether the balances have been settled by the date of the audit.
4) Whether an account is within the maximum credit period approved.
5) Any legal proceedings and legal status of the debtor e.g. bankruptcy.
6) Evidence of any dispute between the company and the debtor
7) Consider if any debts have been regarded as bad previously.
Existence of debtors
It is verified by debtors circularization or direct confirmation from the debtors (refer to previous
notes on debtors circularization).
9. Verification of stock
General considerations
In a large manufacturing company, the auditor will invariably discover that there’s no other
item in the balance sheet that presents verification problems to the auditor to the extent that
stock does. The reasons for this include:
1) In the balance sheet, stock will invariably be the single largest item i.e. they are always
material meaning that a small error in stock in percentage terms could have a material
effect on reported results and financial position.
2) Unlike all other balances in the financial statements, and books of accounts, unless the
client maintains an integrated accounting system, the figures for stock do not result from
the normal double entry system i.e. stock is not subjected to the normal routine of balances
as debtors, creditors or bank balance. Stock is counted at year end, then valued and any
differences disappear in the cost of sales account.

3) Stock consists of many different items at different stages of production and of very many
diverse classifications. This creates problems of controlling the existence and the condition
of the stock items.
4) Stock items are portable and valuable. They are therefore very attractive to both staff and
customers opening themselves to misappropriation.
5) There are many different acceptable methods that can be applied for costing or valuing
stocks each of which could result in significant differences in value for the same item.
Suitability of methods and consistency of application of that method requires serious
auditor consideration.
6) There’s a significant amount of subjective judgment involved in the area of stocks and
because stocks have a one for one effect on the reported profit, management and auditors
can easily disagree on this area of subjectivity. Most of this argument arises in the area of
valuation rather than costing because determining the net realizable value is a highly
subjective area.
Existence of stocks
The auditor must be satisfied that the quantities used to arrive at the value of stock for balance
sheet purposes are correctly determined. This can be through:
1) Reliance on the perpetual inventory record maintained by the client.
2) Through the client organizing a stock take exercise at year end or at any other time and using
the records of issues and receipts in the intervening period to compute the physical quantities
at the balance sheet date.
If reliance is to be placed on the quantities generated by the system rather than complete
stock take, then the system must possess the following qualities:
1. It must be a perpetual inventory stock system whereby pre-numbered goods received
notes are used to record the receipts of stock items and update the stock records and pre-
numbered dispatch notes are also used to record any stocks leaving the company
premises. For every stock item there must be a stock card that at any given moment
reflects the opening balance in quantity terms, the goods received, goods issued and
closing balance in quantities.
2. There must be in operation a system that regularly monitors the movement of the stock
items and agrees or reconciles the physical quantities present to the quantities reflected by
the stock records. This independent competent staff such as from internal audit should
regularly select a number of stock items and count them on a rotational basis making a full
record of the count that they have carried out, then investigation of variances ensuring
that the stock records are adjusted to reflect the physical quantities counted. The selecting
of items should be such that all the items will be counted atleast once during the year but
the high value and the fast moving items will be counted more than once during the year.
3. If these regular counts do not reflect significant variances between the physical and the
records then the external auditor can also carry out sample tests such as during the
interim audit and the records can be relied upon at the end of the year for extracting the
quantities which are then valued and incorporated in the financial statements.
The use of stock-take to determine quantities

Many organizations have no faith in the perpetual inventory system and would rather carry out a
comprehensive stock take of all items at one period or time preferably at the end of the year. If
that be the case, the auditor’s duties regarding the stock-take can be classified into:
(1) Before the stock take
(2) During the stock take
(3) After the stock take
1. Auditor’s duties before the stock take

(1) The auditor and the management should incorporate their plans to ensure that a stock
take that the auditor can rely upon would be carried out. Therefore the management must
prepare a documented plan for the stock take in the form of stock-take instructions. The
auditor must thoroughly inspect these stock take instructions to be satisfied that they are
adequate or else the auditor should make recommendations for improvement.
(2) The auditor should review the previous year’s working papers and familiarize himself with
the locations from which the client operates, the nature and volume of the clients stock
items and the potential difficulties in measuring or weighing the stock items. He will also
be able to ascertain the ICS over the stock and changes if any.
(3) The auditor should plan for the visit to attend the stock take and observe. Sometimes this
planning calls for a visit to the client premises well before the stock take takes place.
(4) The auditor should select and incorporate into the audit programme the high value and
fast moving items to test count.
(5) The auditor should identify the 3rd parties who may be holding some of the clients stocks
and arrange to write confirmation letter to them so that replies can be received in good
time for the final audit visit.
(6) If the client has many locations, and effective internal audit function, the auditor should
consider coordinating attendance with the internal auditors so that they can minimize
duplication of efforts in that the internal auditor can visit some locations and the external
auditor can visit other locations.
Qualities of good or adequate stock-take instructions

i) The instructions should identify the overall coordinator of the exercise who ideally should be
the head of finance but not the head of the stores department.
ii) The instructions should identify the count teams. In an ideal situation, every count team
should have 3 persons: one from the stores department and the other two from another
department. The one from the stores department will identify the products, one of the other
two will count the quantity and the other one will re-count and record the quantity. No team
should be composed entirely of persons from the stores department.
iii) The instructions should call for adequate prior preparation such that the stores personnel
should ensure that all similar items are identified and arranged in one location, that if
weighing and measuring instruments are required, they are obtained well in advance.
iv) The instructions should provide for the mode of counting and recording the stock items. Thus
pre-printed, pre-numbered, rough-stock take sheets identifying all known stock items should
be prepared so that the quantities counted would just be filled in. The count teams can then
be allocated specific location well in advance and the markings to be used to indicate when
an item has been counted can also be determined well in advance to ensure there’s no
omission or duplication.
v) The instructions should deal with arrangements for identifying and isolating slow moving
damaged and obsolete stock items which may not have a value that equals to the cost.
vi) The instructions should provide for the closing down of the stores for the stock take so that
there is minimum movement of goods again to reduce chances of omission or duplication.
vii) The instructions must deal with the mode of collecting the cut-off information which is
basically the last numbers of all accountable pre-numbered documents such as goods
received notes, the invoice, dispatch notes, debit notes, credit notes etc.
viii)They should also provide for pre-stock take brief meeting which would usually be held a few
days before the actual stock-take and this will be equivalent to a rehearsal for the real thing.
2. Auditor’s duties during the stock take

The auditor should attend the stock take and:
(i) Observe whether the staffs are following the instructions if not the auditor should
discuss the short-comings with the overall co-ordinator who should take the necessary
action.
(ii) The auditor should perform test count of the items previously selected by him i.e. fast
moving and high value items plus other items selected from the floor. The auditor in
doing this should ensure that the client personnel are present, they agree with his
identification of the product, agree with the quantity counted by both of them and they
confirm that there are no other items elsewhere.
(iii) Test check the client procedures for identifying and isolating damaged, obsolete and slow
moving items.
(iv) Test check the client cut-off procedures independently documenting the last numbers of
stock movement records.
(v) Form a mental impression of the quantity of stock to be compared with the final values
for purposes of assessing its reasonableness. This is because it is not practicable for the
auditor to record the entire stock take.
(vi) Take appropriate notes of how the entire exercise has been carried out, the number of
stock-take sheets used and the number of stock-take sheets prepared but not used. This
is to ensure that no additional items are included when they were not in existence. The
auditor may have to take photocopies of selected rough stock take sheets to confirm at
the final audit that there were no alterations.
(vii) The auditor must conclude as to whether a reliable stock take was carried out which can
form the basis of determining quantities for incorporation in the final value stock sheets.
3. Auditors duties after the stock take

This is mainly a follow up exercise checking to ensure that the quantities determined by the
stock take have been completely and correctly transferred to the final value stock sheets.
Therefore the auditor performs the following tests:
(i) He traces the test counts that he had carried out to the final value stock sheets.
(ii) He inspects all the rough stock take sheet to ensure that they are all present, they have not
been altered without proper authority and justifiable reasons and on a sample basis
traces the quantities therein to the final value stock sheets.
(iii) He ensures that adequate cut-off have been effected in that no additional items or
documents were raised after the stock take and processed through the records as if they
took place before the stock take.

Valuation of stock IAS 2
The auditor’s duties can be summarized as follows:
1) Ascertaining the companies policy adopted for valuing stocks. These are both for costing
purposes and for purposes of determining the provision for obsolete, damaged and slow
moving items so as to write the stock items down to the lower of cost and NRV. The guiding
standard is IAS 2. The auditor has 2 consider the suitability of the policies selected by the
organization in the light of the accounting standard.
a) Under IAS 2 the lower of cost and NRV is obligatory. The standard discourages the use of:
 Replacement costing
 Base stock method
 Lifo method
b) This is because under the historical cost convention the resultant cost of sales figure
produced when these methods are used is not a reflection of the cost prevailing during the
accounting period.
c) The cost should be where appropriate include a proportion of production overhead
whether or not they vary on a timely basis.
d) Where identical items are purchased or made at different times and therefore have
differing or varying cost the method of arriving at cost should either be:
 FIFO method
 Moving weighted average method
 Adjusted standard cost
 Adjusted selling price
 Unit or job costing
If any method other than these methods is used e.g. the 3 methods discouraged above, the
financial statements must disclose in a note the difference between the cost arrived at using
that other method and the value the same item would have had, had the appropriate method
from among the 5 used.
e) The auditor should test check the stock sheets or the continous stock records with the
relevant documents e.g. invoices or costing records to determine that the cost has been
arrived at correctly.
f) He must examine and test the treatment of overhead.
g) He must test the treatment and examine the available evidence for items valued at the net
realizable value.
h) The auditor must check the arithmetical accuracy of the calculations made.
i) The auditor must test and confirm the consistency with which the amounts have been
computed.
j) He must consider the adequacy of the description used in the accounts and the disclosure of
the accounting policy adopted.
Auditor’s procedures on the final value stock sheets:

Description Quantity Unit cost Total cost Net realizable Final value
value taken to f/s
Fanta 1000 200 200000 220,000 200,000
Coke 2000 150 300000 280,000 280,000
Novida 5000 100 500000 600,000 500,000
Sprite 1500 200 300000 200,000 200,000
Krest 500 100 50000 80,000 50,000
Closing stock 1,230,000
After obtaining the final value stock sheets, the auditor would perform the following procedures
on the final value stock sheet:
1. For quantities column, agree the quantities to the test counts performed by the auditor and
to the tested rough stock take sheet.
2. For the unit cost column, the auditor will
a. Determine the method or accounting policy used to arrive at cost.
b. If suitable test the application the audit tests the application by comparing the unit cost
either to the suppliers invoices or to the costing sheet and accumulation of cost where
goods to be valued were received in different lots and at different prices.
3. The total cost column is basically an arithmetical exercise of just selecting a number of items
and multiplying the quantity by the unit cost.
4. The net realizable value column: IAS 2 recommends that stock be valued at the lower of cost
and net realizable value where the net realizable value is described as the amount that could
be realizable in the open market in the normal course of business, less cost of putting the
item into a sealable condition less the cost of sales. It is upto the auditor to ensure that the
net realized value. Where the net realizable value is described as the amount that could be
realized in the open market in the normal course of business, less cost of putting the item
into a saleable condition less the cost of sales. It is upto the auditor the ensure that the net
realizable value is correctly assessed and the calculation between the cost and net realizable
value is proper and is in accordance with IAS 2 which requires that comparison ideally
should be by individual units of stock or categories of stock. Comparison cannot be on the
basis of the total cost of all stocks and the net realizable value.
Stock is reduced to the lower of cost and net realizable value by a provision for obsolete, slow
moving and damaged stock items. (NRV =cost of stock – provision for obsolete, slow moving
and damaged stock items).
This is a potential area of disagreement between the auditor and the management because it
is subject to subjective judgement. The auditor’s concern is to ensure that the provision is
neither inadequate nor in excess. To determine this adequacy, the auditor is guided by
factors such as the consideration of:
(i) The age of the stock item: The older the item, the less likely that it will be sold therefore
the lower the net realizable value.

(ii) Its rate of turnover. An adverse or declining rate raising doubt about the realizability of
the stock item.
(iii) Its condition
(iv) The technological advances in the industry concerned: In a volatile industry e.g.
production of computer parts, new inventions can render products obsolete. Therefore
in such industries, the net realizable value should be lower.
(v) The nature of the stock item: some stock items are perishable and others may be
approaching their expiry date. The closer to the expiry date, the lower the net realizable
value.
(vi) Economic conditions e.g. recent selling prices, demand for the product or performance
of competing products.
(vii) Quantity of stock held: The larger the quantity of stock, the more likely that some of the
items will not be sold therefore the lower the net realizable value.
All these factors gives the auditor a good indication whether the provision is adequate or not.
VERIFICATION OF LIABILITIES
The auditor’s duties with regard to liabilities can be summarized as:
(1) To verify the existence of liabilities included in the balance sheet.
(2) To verify the correctness of the money amount of such liabilities i.e. if they are all completely
accounted for and properly valued.
(3) To verify that the description given to the liabilities in the financial statements is appropriate
and the disclosure is adequate.
(4) Verify that all existing liabilities actually occurred and they have been properly included in
the accounts.
General verification procedures

1) Obtain or prepare a schedule for every class of liability. This would usually show the
makeup of the liability with the opening balances, changes if any and the closing balance.
2) Cut-off: The auditor would usually verify cut off by ensuring that where a service has been
received by the year end, then the corresponding liability has been set-up or the
corresponding benefits have been received.
3) Review of reasonableness: The auditor must consider the reasonableness of a liability
ensuring that there are no circumstance which may put him upon enquiry.
4) Review of internal control: The auditor should determine, evaluate and test the internal
control procedures surrounding that liability.
5) Previous year’s liabilities: The auditor should consider the liability at the previous year
end and determine whether they have been properly cleared or still applicable bearing in
mind the statute of limitation.

6) Terms and conditions: The auditor should review all the terms and conditions agreed
upon when accepting the liability between his client and the creditor. He should then ensure
that the agreement is being complied with.
7) Authorization: Authority for all liabilities should be sought. This can be found in the
company’s minutes of meetings of directors and shareholders.
8) Disclosure and description: The auditor must ensure that the description in the accounts
is adequate.
9) Inspection of documents: The auditor has to examine all the relevant documents which in
the case liabilities include invoices, correspondences, debenture deeds, loan agreements,
purchase orders etc.
10) Security: Most liabilities are secured in one way or the other. Therefore the auditor should
inquire into this and ensure that where necessary they have been registered.
11) Confirmation: The creation of any liability should not only be vouched but the related
external confirmation should be obtained.
12) Accounting policies: The auditor needs to satisfy himself that appropriate and acceptable
accounting policies are adopted and consistently applied in arriving at value of liabilities.
13) Related evidence: The review of related evidence can assist in confirming the liability e.g.
the existence of a loan can be confirmed by interest payments.
14) The materiality of the matter has to be taken into consideration
15) The review of post balance sheet events is a very important area and this must be carried
out for all liabilities.
16) Obtain a letter of representation from the management indicating that besides the
liabilities recorded in the books, there are no other liabilities existing.
Verification of contingent liabilities

In distortion of financial information, directors tend to include nonexistent assets or exclude
liabilities. Thus whereas with assets we are very much concerned with existence, valuation and
ownership of the asset, with liabilities the major concern is with completeness. It is not enough to
be satisfied that all liabilities recorded in the books are correct and incorporated in the financial
statements. The auditor must be satisfied that there are no other liabilities in existence which for
one reason or another are not included in the books of accounts and in the financial statements.
Examples of such liabilities include:

a. Claims by employees for injury at work which should be covered by workman’s compensation
b. Claims by ex-employees for unfair dismissal
c. Underfunded pension liabilities
d. Bonuses under profit sharing arrangements
e. Returnable containers or packages
f. Penalties for VAT or other taxes
g. Warranties and guarantees
h. Discounted bills

i. Pending litigation (cases in court)
j. Losses on forward contracts
k. Penalties for breach of contract.
It is important that the auditor realizes that such liabilities can exist. He should take reasonable
steps to discover them if they exist. These procedures are:
a) Inquiry of directors and other knowledgeable persons e.g., lawyers.
b) Obtaining a letter of representation from the directors confirming their position with regard
to these liabilities.
c) Reviewing the minutes of meetings of directors where the existence of unrecorded liabilities
may be mentioned.
d) Post balance sheet events review including the inspection of purchase invoices and payment
made after the balance sheet date.
e) Reviewing the previous year’s working papers to determine whether any liabilities existing
then have been included.
f) Being constantly alert of possibility of occurrence of such liabilities e.g. where goods are
subject to warrant period this should alert the auditor immediately of outstanding liability.
Verification of tax
The tax payable is computed using the income tax rules as per the Income Tax Act. These rules
differ significantly from the Generally Acceptable Accounting Principles. From the auditors point
of view, these differences in rules are only relevant in the computation of tax payable liability.
Therefore the auditor’s procedures are:
1) Obtain a tax computation from the client: The auditor should ensure that tax computation is
arithmetically correct such that items disclosed as allowable are supported by evidence. Items
such as wear and tear allowance would have to be checked that they are properly computed
in accordance with income tax requirements.
2) Review correspondence with Domestic Taxes Department of KRA paying particular attention
to questions raised and how they have been resolved, determine outstanding issues and their
current state.
3) Compare payments made with the actual receipts issued by the Domestic Taxes Department
acknowledging receipt of money paid.
4) Obtain a schedule summarizing the tax liabilities: It should reflect the balance to be charged to
the income statement and the amount to be shown as a current liability in the balance sheet
Tax payable movement schedule

Year Balance b/f Pain in the year Charge to I/S a/c Balance c/f

a) The individual payments would be agreed to the cashbook and receipts from the tax
departments and the total of that column to the cash flow statements.
b) The charge to the income statement, the individual over or under provision would be checked
into their computation in conjunction with the tax authority. The totals of that column being
agreed to the charge in the income statement.
c) The balance carried forward for which the total is agreeing to the balance sheet where it
should be reflected as a current liability.
d) The auditor should ensure that disclosure of tax position is in accordance with the Income Tax
Act, company’s act and IAS 12. The company’s act and IAS 12 requires that tax charged be
disclosed separately in the income statement and the tax payable be reflected in the balance
sheet under current liabilities and a note to the accounts should explain the basis of providing
for taxation.
Verification of share capital

The auditor’s approach will depend on whether share capital was issued during the year or not.
Where the share capital have been issued during a given year, the auditor should:-
4. Ensure that the issue is within the limits authorized.
5. Ensure that the issue is subject to directors minutes.
6. He should ascertain and evaluate the systems of control over the issue. The auditor should
verify that the system have been properly operated. This involves examining the prospectus
application and allotment sheets. The auditor should also verify the share register, cash
received, share certificate, counter-foils and repayments to unsuccessful applicants.
7. Where the issue was dependent upon permission received from the stock exchange, the
auditor should ensure that:
a. The permission has been obtained, if not all the money received is refunded
b. All the money received is maintained in a separate bank account until all conditions are
satisfied
c. The minimum subscription have been received if not all the amount is refundable.
d. Where the issue is not for cash, e.g. bonus or rights issue, the auditor should verify that the
agreement is appropriate and all entries are properly made.
e. The auditor should verify the payment for underwriting commission and other fees.
Where there was no issue made during the year, the auditor should:
i) Determine the total of shares for every class expected in the balance sheet and obtain a list of
shareholding which in total should agree with the balance sheet total.
ii) Obtain the share register and where it is maintained by an independent firm, the auditor
should obtain a certificate from them and the certificate should state the balance on the share
register which should agree with the issued capital at the balance sheet date.

Verification of trade creditors
Audit objectives
The auditor seeks to ascertain:
1. The completeness and accuracy of the creditors balances
2. That all creditors exist and are genuine liabilities of the entity.
3. Creditors are properly presented and disclosed in the financial statement.
Audit procedures
1. Obtain a creditors listing and verify that the total as per the listing agrees with the total as
per the creditors ledger.
2. From the listing, select a sample of creditors and carry out the following procedures:
a. Obtain or prepare a reconciliation of the creditors balance as per the ledger to the
suppliers statements.
b. Obtain explanations for all the reconciling items and where appropriate, ensure that, the
reconciling items have been adjusted in the books of accounts.
The reconciling items, will mainly include suppliers invoices not posted in the clients ledger
or payments not reflected in the suppliers statements.
3. Obtain a sample of payments made to suppliers after the year end and verify that all the
invoices that related to the period under review have been accrued for.
4. Obtain all the pending invoices and verify that, these have been accrued for.
5. Circularize creditors to confirm their existence, obligation and valuation.
6. Perform ARPs in respect of creditors balances.
Verification of long term liabilities

f) Long term liabilities, mainly include term loans and debentures repayable within a period of
more than one year. Such liabilities are usually evidenced by an agreement called a debenture.
They may be secured by a fixed charge over a specific asset or secured by a floating charge on
all the assets or they may be unsecured in which case they are called naked debentures.
Audit objectives
To ascertain that:-
1. All long term liabilities are included in the financial statements i.e. completeness and
valuation.
2. All long term liabilities are genuine obligations of the entity
3. All long term liabilities are properly presented and disclosed in the financial statement all
information that is relevant such as terms of the facilities, should be disclosed.
Audit procedures
1) Obtain a schedule detailing the sums due at the beginning of the year, additions and
redemptions and the sum due at the end of the year.

2) Obtain the terms and conditions of the loans as evidenced in the debenture deed. This
includes, amount lent, maturity date, repayment terms, interest payable etc.
3) Agree the opening balances with the previous years accounts and working papers.
4) If any new loans have been received, verify that this was authorized by inspecting the
minutes of the board meetings.
5) Repayments should be vouched through the cash book and the register of debentures
holders and charges.
6) Interest payments should be vouched through the cash book and any outstanding amounts
should be correctly accounted for.
7) If the loans are secured, confirm that the charge is registered at the registrar of companies.
8) Agree total amount outstanding with the register of debenture holders or the lender.
9) Review restrictive terms of the contract and provisions relating to default in repayment of
capital and interest if the company defaults, determine the effect on the financial statement,
such as the need to provide for penalties. In extreme cases, the company could be put under
receivership.
10) If the facility was acquired for a specified purpose, verify that it was actually applied for that
intended purpose.
11) Ensure that disclosure is in accordance with the company’s act requirement clearly stating
the date of redemption of the debentures.

AUDITING
AUDITORS REPORT ISA 700
This is the final product on the audit engagement which provide the auditor with an avenue to
communicate his opinion on the financial statements to the users. The auditor should review and
assess the conclusion drawn from the audit evidence obtained as the basis of the expression of an
opinion on the financial statements. This review and assessment involves considering whether
the financial statements have been prepared, in accordance with an acceptable financial
reporting framework being either I.A.S or relevant practices. It may also be necessary to consider
whether the financial statements comply with statutory requirements. The auditors report
should contain a clear written expression of opinion on the financial statement taken a whole. An
audit report is a written statement by the auditor containing his independent opinion about the
truth and fairness of the financial statements.
PURPOSE OF AUDIT REPORT
1. It enables the auditor to express an audit opinion on the true and fair view of the financial
statements.
2. Statutory audit report confirms the status or the financial position of the entity whose
accounts have been verified or checked by the auditor.
3. The potential users and the management are able to make decisions about the entity in
respect to investment through the audit report.
4. Statutory report is a legal requirement for the limited company.
5. Auditors report allows the management to publish the accounts which makes them a public
record.
CONTENTS AND THE FORMAT OF THE AUDIT REPORT
The company’s Act doesn’t prescribe a format for a suitable audit report, the auditors therefore
consider the 7th schedule basically as giving the minimum contents of the auditors report or as
providing guidance on the contents of the auditors reports issued as a result of an audit
performed by an independent auditor. The auditors report should expressly state the matters
prescribed by the 7th schedule of the company Act i.e. whether in his opinion
i) Proper books of accounts have been kept so far as it appears from the examination of those
books.
ii) Financial statements agree with the books of accounts
iii) All information and explanation necessary for their audit purposes have been received.
iv) Whether the account do comply with the company Act requirement.
v) Whether adequate returns from branches not visited by him have been received.

vi) Whether the financial statements prepared do reveal a true and fair value view of the
company’s state of affairs as at the balance sheet date and of its profit or loss as of the year
then ended.
BASIC ELEMENTS OF AUDITORS REPORT
1. Appropriate title - the most common term used for the title is the “independent auditors
report”. It distinguishes the auditors report from other reports that might be issued by other
parties e.g. officers of the company.
2. Addressee – it’s normally addressed to the company members or shareholders whose
financial statements have been audited.
3. Opening / introductory paragraph.
- It should identify the financial statements of the entity being audited including the date
and period covered by the financial statements. It should include the management
responsibility i.e. to prepare financial statements that give a true and fair view and
auditors responsibility to express an opinion of the financial statements based on the
audit.
4. Scope paragraph – the auditors report should describe the scope of the audit by stating how
the audit was conducted. The auditor should:-
a) Make a reference to the ISA or relevant practices.
b) Give a description of the work that the auditor performed. The auditors report should
describe the audit as including:-
i) Examining on a test basis evidence to support the financial statements, amounts and
disclosures.
ii) Assessing the accounting principles used in the preparation of financial statements.
iii) Assessing the significant estimates made by the management in the preparation of the
iv) Evaluating the overall financial statements presentation.
The report should include a statement by the auditor that the audit provides a reasonable
basis for the opinion.
5. Opinion paragraph – the opinion paragraph of the auditors report should:

a) Clearly indicate the financial reporting framework used to prepare the financial
statements.
b) State the auditors opinion as to whether the financial statements do give a true and fair
view in accordance with that financial reporting framework
c) Where appropriate whether the financial statements comply with statutory requirements.
The terms used to express the auditors opinion are, “give a true and fair view” or “present
fairly in all material aspects”.
6. Date of report

The auditor should date the report as of the completion date of auditing the financial statements.
This informs the reader that the auditor has considered the effect on the financial statements and
on the report of events and transactions of which the auditor became aware and that occurred up
to that date.
7. Auditors address
The report should have a specific location which is ordinarily the city where the auditor
maintains the office that has the responsibility for the audit.
8. Auditors signature
The report should be signed in the name of the audit firm, the personal name of auditor or both
as appropriate. The auditors report is ordinarily signed in the name of the firm because the firm
assumes responsibility for the audit.
TYPES OF AUDIT REPORTS

OPINION
STANDARD OPINION MODIFIED
Unqualified/unmodified
Matters that affect the Matters that do not affect auditor’s
auditors opinion opinion (Emphasis of the matter
Limitation on work Disagreement with

scope management
Material Material but Material & Material but

pervasive not so material pervasive not pervasive
[Disclaimer] & pervasive (Adverse) [Qualified]

Modified opinion matrix
Nature of Material & Material & not

circumstance pervasive pervasive
Limitation of disclaimer Qualified except
scope for
Disagreement Adverse opinion Qualified except
for
Unqualified report / opinion
- Unqualified in auditing does not mean that it has failed the test rather it means that the
auditor does not have any reservations or remarks on the 7 th schedule provisions.
- When the auditor issues unqualified opinion it means that he is affirmative:
i. That he has received all information and explanations deemed necessary in order for him to
form an opinion.
ii. In his opinion proper books of account have been kept in accordance with the company’s
act.
iii. Proper returns adequate for their audit have been received from branches not visited by
them.
iv. The balance sheet and profit and loss account are in agreement with the accounting books
and returns.
v. In the auditors opinion the company has complied with company’s act requirement in
relation to the disclosure requirements.
vi. The financial statement reflects true and fair view of the company’s state of affairs.
Example of the unqualified audit report
INDEPENDENT AUDITOR REPORT TO THE MEMBERS OF ABC LTD.
Report on the financial statements
We have audited the accompanying financial statement of ABC Co as of 31/12/2010 and the
related cash flows for the year then ended.
Director’s responsibility for the financial statement
These financial statements are the responsibility of the company’s management. The
management is responsible for the preparation and fair presentation of these financial
statements in accordance with I.F.R.S and with the requirement of company’s act. These
responsibilities include designing, implementing and maintaining internal controls relevant to
the preparation and fair presentation of financial statement that are free from material

misstatement whether due to fraud or error, selecting a appropriate accounting policies and
making accounting estimates that are reasonable to the circumstances.
Our responsibility is to express an opinion on the financial statements based on our audit. We
conducted our audit in accordance with the ISA’S. Those standards require that we comply with
ethical requirement and we plan and perform our audit to obtain reasonable assurance that the
financial statements are free from material misstatement.
SCOPE
An audit involves performing procedures to obtain audit evidence about amounts and
disclosures in the financial statements. The procedures selected depend on the auditor judgment
including the assessment of the risk of material misstatement of the financial statements,
whether due to fraud or errors.
In making those risks assessment the auditor considers internal controls relevant to the entities
preparation and fair presentation of the financial statements in order to design audit procedures
that are appropriate to the circumstances but not for the purpose of expressing an opinion of
effectiveness of the entities internal control.
An audit also includes evaluating the appropriateness of accounting policies used and the
reasonableness of accounting estimates made by the directors as well as evaluating the overall
presentation of financial statements. We believe that the audit evidence we have obtained is
sufficient and appropriate to provide a basis for our opinion.
In our opinion the accompanying financial statements give a true and fair view of the state of the
financial affairs of the company’s as at 31/ 12/ 2010 and the profit and cash flow of the company
for the 12 months period then ended in accordance with I.F.R.S and any other company’s
requirements.
Report on other legal requirements

The Kenyan Company Act requires that in carrying out our audit we consider to report to you in
the following matter, we confirm that:
i. We have obtained all the information and explanation which to the best of our knowledge and
believe were necessary for the purposes of our audit.
ii. In our opinion proper books of account have been kept by so far as it appears from the
examination of those books
iii. The company’s balance sheet is in agreement with the books of accounts
X& Y ASSOCIATES
C.P.A NAIROBI
04/04/2023

MODIFIED REPORTS
The wording of auditors report is modified in the following situations:
a) Matters that do affect the auditor’s opinion. In this case the modification can be:
 Qualified opinion
 Disclaimer opinion
 Adverse opinion
b) Matters that do not affect the auditors opinion i.e. Emphasis of matters
4) MATTERS THAT DO NOT AFFECT THE AUDITORS OPINION
-An auditor may not be able to express an unqualified opinion when either of the following
circumstances exist and in the auditors judgment the effect of the matter may be material to the
i. There is a limitation on the scope of auditor’s work.

ii. There is a disagreement with management regarding the acceptability of accounting policies
selected, the method of their application or the adequacy of the financial statements
disclosure.
i) Limitation of scope
Limitation of scope can arise due to two factors i.e.
 Those imposed by the entity
A limitation on the scope of the auditors work can be imposed by the entity e.g. when the terms
of the engagement specify that the auditor will not carry out an audit procedure that the auditor
believes is necessary. However when the limitation is in the terms of engagement, the auditor
would ordinarily not accept such an engagement unless required by statute.
Also a statutory auditor would not accept such an audit engagement when the limitation
infringes on the auditors statutory duties.
 Those imposed by circumstances

When the timing of auditors appointment is such that the auditor is unable to observe the
counting of physical inventory. It may also arise when in the opinion of the auditor the entities
accounting records are inadequate or when unable to carry out desirable audit procedures.
In this circumstances the auditor attempts to carry out reasonable alternative procedures to
obtain sufficient appropriate audit evidence to support opinion.
N.B Other factors that may result to limitations of scope include

₋ Hostility and lack of management cooperation
₋ Destruction of records due to a catastrophy

₋ When an auditor is given an engagement in which limitations are placed on the extent of
the work they are to perform.
₋ When the management denies auditors the permission to perform audit procedures
considered necessary and by using other procedures the auditor cannot reach a conclusion
on the matter.
 The two types of opinion arising from limitation on scope include:
1. A disclaimer of opinion
This should be expressed when the possible effect is so material and pervasive that the auditor
cannot be able to obtain sufficient appropriate audit evidence and is accordingly unable to
express an opinion on the financial statements.
The auditor’s wording should include “we were not able to form an opinion because of the
limitations placed on the scope of our work by the company.”
2. Qualified opinion
Should be expressed when the auditor concludes that an unqualified opinion cannot be
expressed but the effect on any limitation on scope is not so material and pervasive as to require
a disclaimer of opinion. A qualified opinion should be expressed as being “except for the effects of
the matter which the qualification relates e.g. “in our opinion except for the effect of adjustments
in the financial statements disclosed above, the financial statements give a true and fair view.
ii) DISAGREEMENT
Unlike limitation of scope in case of disagreement the auditor is able to reach a conclusion. He
has obtained all information and explanation but his conclusion is at variance with the conclusion
arrived at by the management.
The auditor and management can disagree on a number of matters which include:
– Acceptability of an accounting policy selected.

– The method of their application (accounting policy)
– The adequacy of disclosures in the financial statements
– Disagreement on facts and misrepresentation
– Disagreement of amounts and figures
– On the interpretation of the accounting standards.
If such disagreements are material to the financial statements the auditor should express a
qualified or adverse opinion

1. Adverse opinion
Should be expressed when the effect of a disagreement is so material and pervasive to the
financial statements that the auditor concludes that a qualification of the report is not adequate
to disclose the misleading or incomplete nature of the financial statements. The auditors wording
should include “in our opinion financial statements do not give a true and fair view and do not
comply with company’s Act requirement”.
2. Qualified opinion
Should be expressed when the auditor concludes that an unqualified opinion cannot be
expressed but that the effect on any disagreement with management is not so material and
pervasive as to require an adverse opinion.
A qualified opinion should be expressed as being: as discussed in note x to the financial

statements, no depreciation has been provided in the financial statements which practice in our
opinion is not in accordance with I.F.R.S. In our opinion except for the effect on the financial
statements of the matter referred to in the preceding paragraph the financial statements give a
true and fair view.
b) Matter that do not affect auditor’s opinion
(Emphasis of matter)
In certain circumstances an auditor’s report may be modified by adding an emphasis of matter

paragraph to highlight a matter affecting the financial statements which is included in the notes
to the financial statements that more extensively discusses the matter.
The addition of such an emphasis of matter paragraph does not affect the auditor’s opinion. The
paragraph would be included after the paragraph containing the auditors opinion but before the
section of any other reporting responsibilities. The emphasis of matter paragraph would
ordinarily refer to the fact that the auditor’s opinion is not qualified in this respect.
Examples of matters that may result to an emphasis of matter include:
₋ When highlighting matters relating to going concern

₋ If there is a significant uncertainty on an event i.e.an event is dependent on future actions
or event not under direct control of the entity.
₋ To draw attention to an inconsistence or a misleading presentation.
Where there are additional statutory reporting responsibilities.
An emphasis of matter paragraph relating to going concern would be worded as” without
qualifying our opinion we draw attention to a note” F” in the financial statements which indicates

that the company incurred a net loss of Sh. 500million ended 31/12/2010 and as of that date, the
company’s current liabilities exceeded it total assets by 1.5 B. These conditions indicate existence
of the material uncertainty which may cast significant doubt about the company’s ability to
continue as going concern”
Consequences of a qualified report
1. Removal of directors and their replacement with new ones.

2. Inability of the company to borrow or obtain credit from lenders.
3. A loss of the share prices in the stock exchange market where the company’s shares are
quoted.
4. Appointment of investigators to look into financial affairs of the company.
5. May lead to liquidation or receivership of the company.
FEATURES OF A GOOD AUDIT REPORT
Inherent uncertainties
Inherent uncertainties result from circumstances in which it is impossible for the auditor to
reach any objective conclusion as to the outcome of a situation due to the circumstances
themselves rather than a limitation of scope of the audit. Such uncertainties are only resolved
through the passage of time e.g. to wait for the outcome of a litigation. However, time is a great
constraint and financial statements must be prepared within the required time. The auditor
should form an opinion on the adequacy of the accounting treatment of such uncertainties. This
will involve consideration of:
1. The appropriateness of any accounting policies adopted by the management in treating the
effect of such uncertainties.
2. The reasonableness of the estimates included in the financial statements.
3. The adequacy of disclosure of the uncertainties.
Some inherent uncertainties are fundamental. These are uncertainties where the degree of
uncertainty and its potential impact on the view given by the financial statements may be very
great. In determining whether an uncertainty is fundamental, the auditor considers the following:
a. The risk of the estimate included in the balance sheet being subject to change.
b. The range of possible outcomes.
c. The consequences of those outcomes on the view given by the financial statements.
Inherent uncertainties are considered fundamental when they involve a significant level of
concern about the validity of the going concern assumption or other matters whose potential
effect on the financial statements is usually great.

Features of a good audit report
A report is a medium of expressing an opinion to the persons concerned in order to give a clear
and summarized information based on collected facts and figures. The essentials / features of an
audit report include;
1. Simplicity – It should be as clear and understandable. The auditor should avoid ambiguous
terms and facts at all times.
2. Clarity – means it should be clear and should not conceal material information that need to be
used by the share holders.
3. Brevity i.e. repetition should be avoided to control the length of the report.
4. Constructive – it should offer constructive criticism and timely suggestion for management
progress
5. Objectivity – should be based on objective evidence and consistent financial statement.
6. Firmness – should clearly indicate scope of work to be done.
7. Disclosure principle – it should be unbiased and should disclose all the facts and
8. Acceptable principles- it should be based upon facts and figures prepared with accordance
with generally accepted accounting principles.

AUDITING IN COMPUTERIZED ACCOUNTING SYSTEM (CAS)
An accounting system has various objectives and the main objective is to ensure completeness
and accuracy of transactions in processing and recording. A computer is just a large tool in the
processing and recording of transactions therefore accounting system. System objectives remain
the same even though the system of recording has changed. The audit objectives and duties of the
auditor also remain the same whatever the data processing system used. The only difference is
the internal controls instituted and the auditor’s approach.
Advantages of a computerized accounting system
1. A computerized system provides more analysed statistical information about all aspects of a
business.
2. It eliminates tedious work e.g. posting entries to the ledger accounts. It can do all the posting
at once.
3. It saves time due to extra-ordinary speed in complicated calculations.
4. There is greater accuracy in that a computer cannot produce wrong information except where
there is wrong input data or use of the wrong program.
5. Allows better centralized management control due to centralized control of data processing.
6. Improves the audit by helping the auditor to perform certain audit procedures e.g. quick
processing and examination of accounting data.
Disadvantages
1. It will require the client staff to be computer literate which increases the cost of staff training.
2. It is expensive to install and maintain, hence only large organizations can enjoy the service.
3. It forces the auditor to require computer specialists since it’s a technical area outside the
accounting field.
4. The computer uses prime / source documents e.g. invoices and receipts for posting to the
ledger accounts. These eliminates the intermediate records e.g. purchases and sales journal.
These brings a problem of cross referencing especially when the source documents are
misplaced.
5. There’s less segregation of duties due to centralized data processing, instead of different
people handling processing of transactions, these activities are done in a computer
department operated by a few individuals who may not have the essential knowledge of
accounting.
6. There are increased chances of fraud since the data is stored in a form that is invisible. Any
manipulation of data cannot be easily noticed.

Features of a computerized accounting system
The features require that adequate controls are built into the system to ensure that the
accounting system can be relied upon for complete and accurate accounting records. These
features are;
1. Consistency of operations
If properly programmed, computers will process data and transactions accurately.
2. Concentration of functions and controls
Due to the use of computers, a few people are used / utilised in the processing of financial
information many control procedures are concentrated in one individual.
3. Programmes and the data can be held together increasing the potential of unauthorized
access and alterations.
4. Computer information systems are designed to limit the use of paper work. This results in less
visible evidence. The data is entered directly into the computer system without supporting
documents.
5. There is loss of audit trail i.e. inability to trace the transactions through the systems i.e. from
the source documents to financial statements.
The data is stored in magnetic files which are overwritten over time.
6. There is ease of access to the data and computer programmes where there are no proper
controls over access to the computer and the remote terminals. This increases the chances of
access which may cause fraud/manipulation of accounting records.
7. There is programmed controls aimed at protecting the data against unauthorized access by
use of passwords containing limit checks.
8. A single input to the accounting system may automatically update all the records associated
with the transaction.
9. There is lack of visible output in processing of the transactions. Only the summary data are
printed, other data can only be accessed through the computer programmes.
Auditors use of computer
1. Preparation of working papers

Automated working papers packages have been developed to aid in the preparation of
working papers movement schedule, trail balance, control accounts and even the financial
statement themselves. They’re automatically cross-referenced, adjusted and balanced by the
computer.
2. Statistical sampling
Audit statistical sampling software packages have been developed to aid the auditor in sample
selection, determine the sample size, generating random numbers, testing the sample and
assisting the auditor in making reference about the population.

3. Analytical review procedures
The auditor may make use of sophisticated programmes to conduct significant analysis of
financial statement information.
4. Use of standard software

E.g. Ms. word/excel to perform audit procedures and this will mean faster, accurate and
reliable procedures.
5. Flow charting
6. Evaluation of audit risk
7. Compilation of data base i.e. the auditor can compile database about a client financial and
audit history than can be used as a training tool for audit assistants to familiarize themselves
with the client’s business.
8. Communication
Auditors can communicate with members of the audit team e.g. audit assistants laptops have
embedded email software hence can communicate with the audit senior through email in
case of doubt in an audit process.
9. Resources
Computer will be able to store a library of tools e.g. audit check list, audit programmes, ICQ’s,
accounting and auditing standards and hence be able to access them when required during
the audit assignment.
10. Computer can be used to store and print standardized letters such as bank standard letters,
debtors and creditor’s circularization letters therefore saving time.
INTERNAL CONTROLS IN A COMPUTERIZED ACCOUNTING SYSTEM
The computer system will require new controls to be introduced. These are:-
1. General controls i.e.

a) Administrative controls e.g. access controls, organizational and management controls,
library controls, logical controls etc.
b) System development controls.
2. Application controls: i.e.
a) Controls over input data
b) Controls over processing of data
c) Controls over outputs.
d) Controls over master files and standing data
1. Administrative controls

These controls arise out of the risk that is indicated on the accounting system by the following
characteristics of computerized system.
1) The concentration of power in the electronic data processing department.
2) A large number of files of important data are centrally stored.
3) The mode of storage being highly inflammable, highly concentrated and sensitive to
atmospheric and temperature conditions.
4) Computers can break down.
The internal controls to minimize the above risks include;
i) There should be physical security e.g. some designed fire proof roofs, air conditioned
rooms to control temperatures and restricted entry to authorized personnel only
through use of electric fences, TV circuits, security personnel, identification badge and
even use of Mbwa Kali.
ii) There should be maintained back-up copies of all important data and programmes i.e at
different levels and locations to allow recovery of data.
iii) Making arrangements for uninterrupted power supply to deal with blackouts.
iv) Adapt user machines to be used in processing important data should the computer
break down.
v) Have a library to ensure that access to programmes and files is properly controlled.
vi) Have adequate segregation of duties in the user departments and electronic data
processing department.
vii) The operations of the company should be different from the actual processing of data.
The manually maintained records should not be accessible to computer personnel to
reduce manipulation of data.
viii) Have use of specific password for terminals or particular applications where access
is through terminals passwords should be changed regularly and access to password
data should be subject to strict controls.
ix) Have two operators per shift and this is to prevent some types of fraud unless there’s
collusion
x) Encrypting the data before transmission over communication lines. This will make it
more difficult for someone with access to data to understand or modify the contents.
xi) Automatic log off i.e. disconnection of inactive data terminals may prevent the viewing
of sensitive data on an unattended data terminal.
xii) There should exist systems access log to record all attempts to use the system. This
will record the dates, time, mode of access and data involved. Logs of computer and
programme usage should be maintained and periodically reviewed.
xiii) There should be adequate virus protection e.g. establish a formal security policy that
requires only clean and certified software to be installed, install antivirus soft ware
and maintenance of clean backups.

2. System development controls
The system or programmes put into operation will continue being in use for a long time. There’s
need to ensure that the systems installed are adequate to maintain complete and accurate
records. Inadequate system can cause large loss or even corporate failure. To prevent inadequate
system from being used, standards must be prescribed for the designed development, testing and
implementation of the systems programmes and amendments to them.
System development controls are designed to ensure:
(1) Valid system of processing whenever new applications are introduced.

(2) Ensure that the system meets the requirements of management and user departments.
The internal controls in system development include:
a) Periodic reviews to ensure that the project conform to the laid down time schedules and
that resources are not excessively used.
b) The team carrying out the system development should include representatives from user
departments, accounts department and internal audit. This is to ensure that the user needs
are identified and proper consideration given to the need for adequate internal controls. It
is important to carryout a feasibility study on the new system to be developed.
c) Ensure a high degree of coordination between users and system development staff to
ensure that a workable system is subsequently implemented.
d) Each proposed system should have written specifications that are approved by
management and the user department. Such specifications will outline the user needs and
identify how the new system can meet these needs.
e) Control access to data base by use of passwords only authorized persons should gain
access to specific files.
f) Implement the system with minimum disruption to the existing operations. Continue
parallel running until the computerized system attains its level of performance and meets
its defined purpose.
g) Have adequate system documentation during development to potray the status of the
system and provide continuity of development projects
h) Check accounting records after converting data to magnetic file media to ensure that they
contain the correct information.
i) Have adequate testing of the system by the user department, accounts department,
computer department and the external auditor.
j) Have adequate controls during conversion and change over to prevent data theft or
corruption.
k) Review every stage of the system development and approve all activities.
l) Any programme changes should be authorized and subject to strict control.

3. Application controls
The objective of application controls which may be manual or programmed, is to ensure

completeness and accuracy of accounting records and the validity of transactions processed.
Applications controls are therefore important in providing assurance that all transactions are
recorded on a timely basis and that only valid transactions are captured by the system.
Application controls are divided into:-
1. Input controls
2. Processing controls
3. Output controls
4. Controls over master files and standing data
- However, some of the controls management implement, would apply to the four categories
mentioned above e.g. some edit checks could provide control over the completeness and
accuracy of the input data, the way the data is processed and output information obtained
and also provide protection over standing data.
(a) Input controls
- Most errors in data processed by computerized information systems, can be traced to errors
made when the data was being input into the system. Controls over input, fulfill the following
objectives:-
1. Completeness of input – this ensures that all transactions that took place have been
processed.
2. Accuracy – this ensures that the recorded transactions, have been captured accurately.
3. Validity – this ensures that, only valid or genuine transactions appropriately authorized
have been recorded. It also ensures credibility and reliability of recorded transactions.
To achieve the above objectives, the most common types of input controls that
management can implement are called edit controls and examples include:
i) Field checks – These control checks that, all data fields required to process the
transactions have been filled with correct information. The controls also ensure
accuracy of the processed data and its completeness because transactions cannot be
properly processed if necessary data is missing.
ii) Valid character checks – These checks that data fields are filled with data of the correct
type e.g. that amounts column is filled with numerical variables. This also ensures
correctness of input data.
iii) Reasonableness / limit checks – These verify that data falls within predetermined
reasonable limits e.g. if the authorized discount is 10%, the system would seek to
verify, that no customer is awarded discounts beyond this limit without approval. This
control, ensures accuracy and validity of the input data.
iv) Master file checks – These verify that the codes used in processing transactions, match
with those from the master files e.g. that customer identification code keyed in,

matches with what is on sales master file. These controls ensure that data is processed
against the correct master file.
v) Document count – this agrees the number of input records with what is expected as
per the batch control. This control ensures that all transactions are processed.
vi) Sign checks – This ensures that, data has been keyed in with correct arithmetic sign e.g.
a positive sign for debit entry and a negative sign for credit entry. The objective is to
check validity and accuracy of the processed data.
vii) Zero balance checks – These verify that for every transaction processed, debit entries
equal credit entries and any mismatches found are reported through an exception
report. This control ensures accuracy of input data.
Other input controls include:-
d. Generation of exception reports to capture transactions that have been rejected for
failing various control checks.
e. Measures to ensure that the reasons behind rejected transactions are investigated
and corrective action taken.
f. There may be need for manual controls e.g. a check to reveal that all purchases
orders have been properly authorized before a transaction is submitted for
processing.
(b) Processing controls
- These controls seek to ensure that, transactions are processed by the right programs and
against the correct master files. They also seek to ensure that, data is not lost, duplicated or
altered during processing and that errors are identified and corrected.
- Some of the controls under input controls above could help in meeting the above objectives of
processing controls. In addition to those, processing controls include:
(i) Physical file identification procedures – This is in form of labels which are physically
attached to files or diskettes to ensure that the right files are used during processing of
transactions.
(ii) Sequence tests over pre-numbered documents – this ensures that, all transactions are
being processed.
(iii)Comparing the contents in files before and after processing results have been achieved.
(iv) Zero balance checks that add up debits and credits of the transactions posted to ensure
that the result is zero as an indication that double entry has been completed.
(v) An audit trash should be created through use of inputs and output control logs and
maintenance of transaction listing. This trash will facilitate an attempt to trace a
transaction as a way of verifying that it has been correctly processed.
(c) Output controls
These are necessary to ensure that:-
g. Expected reports are received from input data processed.

h. Results of processing are accurate
i. Output is distributed to appropriate users promptly
Controls over output include;
a. Matching and agreeing output information to the input data.

b. Noting distribution of all output information to verify that this information is accessible to
and is distributed to the list of authorised users only.
c. Error listing or exception reports should be generated on a daily basis and reviewed by an
independent person to ensure that the transactions summarized in these reports are
investigated and where appropriate, resubmitted for processing.
(d) Controls over master files and standing data
- Standing data, refers to the data that is required during processing of the transactions but
which does not vary or change with every transaction although they are required in
processing every transaction e.g. customer details such as name and address
- Master files contain the standing data e.g. ledgers and personnel files.
- Controls over master files and standing data, are aimed at ensuring completeness, accuracy
and credibility of the information maintained. These controls include:-
1.) Restrictive access to standing data and ensuring that only a few individuals have the user
rights within the system to make adjustments to the standing data.
2.) Before any changes are made to the standing data, appropriate authorization should be
obtained.
3.) Once amendments have been made on standing data, a print out should be obtained from
the system such that, an independent person can verify that correct amendments have
been made.
4.) Where necessary, the organization should print out all the standing data and an
independent check carried out to verify that this data is accurate and complete.
5.) An exception report, should be generated on a regular basis providing details on any
unauthorized amendments made on standing data.
Planning in a computerized environment
When planning for an audit in a computerized system, the following factors must be considered.
1. Auditor’s need to be involved in computerized system at the planning, development and

implementation stage. Knowledge of the system gained at this stage will enable the auditor to
plan the audit with an understanding of the system.
2. Timing of the audit field visits is more important in computerized environment than in
manual environment because of the need of the auditor to be present when the data and files
are available. More frequent visits to the client may be required.

3. Recording methods may be different. Recent development including use of portable laptops to
aid in preparing working papers enables the auditor to download data files onto their own
personal computers.
4. The allocation of suitably qualified staff to the audit. Thus audit firms now use the computer
department staff on some parts of the audit and therefore allow the general audit staff to have
some computer experience.
5. The extent to which computer assisted audit techniques i.e. CAAT’s can be used. These
techniques require considerable planning in advance.
AUDIT APPROACH
- As a result of failure of a computerized information system the auditor will need to serve an
appropriate audit approach.
- There are two main approaches that can be used to audit CIS
1. auditing around the computer
2. Auditing through the computer.
1. Auditing Around the computer

- This approach assumes that there is appropriate output and the processing operations are
done appropriately. The auditor treats the computer as a black box.
- This type of auditing pays little or no attention to the control procedures within the IT
system.
- Generally it’s not an effective approach to auditing a computerized environment.
- In this approach the auditor concentrates on the input data and output data but ignores
what goes on in between the system.
- This approach is adopted for small applications where there is adequate documentation of
the transactions such that the auditor is able to trace the beginning of the transactions to
the final recording without the need to review how the data is processed by the computer.
- Auditing around the computer is only suitable where:
a) Audit trail is complete and visible
b) Processing is simple
c) Complete documentation of transactions is available.
This approach is much criticized because:
1. It’s extremely risky to audit and give an opinion on financial statements that have been
produced by a system that the auditor doesn’t understand fully.
2. A computer has immense advantages for the auditor and its inefficient to carry out an audit in
this manner.

2. Auditing through the computer
There are basically two techniques available to the auditor for auditing through the computer.
These are 1; Use of test data
2. Use of computer audit programmes / Audit software
- These methods are ordinarily referred to computer assisted audit techniques(CAATs)
CAATs refer to any automated audit techniques such as:
1) Audit software
2) Test data
CAATS are ways in which the computers may be used by the auditor in a computerized
information system to gather or assist in gathering audit evidence.
A. Audit software
- Refers to software that has the capability to directly read and access data from various
data base plat forms.
- The software is able to carry out mathematical computations, statistical analysis, sequence
checks and recomputations.
- Using this software the auditor can directly access the data stored in a computer and
perform types of mathematical computations and statistical analysis.
Types of audit software
1. Generalized Audit Software

This comes in a variety of forms. It may either be a software package available commercially
or one developed by an audit firm.
The software is designed to perform a variety of functions such as reading computer files,
selecting data manipulating data, sorting data, performing calculations, selecting samples and
printing reports or letters in a format specified by the auditor.
- This type of software may be used to gather evidence in relation to both the effectiveness
of operations of a programmed internal control procedure e.g. system control and review
file (SCARF) and the extent of misstatement in account balances and underlying classes of
transactions (e.g.) tagging and tracing or an integrated test facility
- In other words, generalized audit software may be used as either a compliance test or a
substantive procedure.
2. Utility programmes / software
Are programmes which are generally not designed for audit purposes but can be used by the
auditor to perform common data processing functions i.e. sorting, creating, and printing files.
Example: commercial software like Ms Excel or WordPerfect which may be used by auditor for
analyzing data imported from the client files.
3. Purpose /specially written software
Are programmes specially written by the auditor or by the programmer to suit the auditor’s
specific circumstances e.g. parallel simulation.
They can only perform a specific audit procedure e.g. ARP, compliance test or substantive test
and they can only be used for one particular client.
B. TEST DATA
Test data techniques are used in evaluating the ICS over the computerized system.
The auditor can use the following types of test data:
1. Live data / valid

2. Dead data / invalid
1. Dead / invalid data.
This means erroneous data or data that doesn’t exist or can’t be recognized by the accounting
software. The auditor can capture the name and salary of a fictitious employee which he knows
very well that it will be rejected.
However, he wants to find out whether the payroll software can process such data. If it does, this
implies that the payroll system can accept dummy workers names or can facilitate perpetration
of fraud. However, if rejected it remains that the controls are strong and working as expected.
2. Live/ valid data.
This is whereby the auditor uses correct, authorized and existing data and checks whether it will
be processed correctly, for instance the auditor can key in the customers names and authorized
credit limits and check whether the invoice will be processed correctly.
USES OF AUDIT SOFTWARE
Although audit software may be used for both compliance and substantive testing it’s more
suited for carrying out substantive testing. The following functions can be performed using audit
software.
1. File re-organisation. i.e. it allows file indexing, sorting, merging and linking with other files.
2. Data selection.
3. File access
4. Arithmetic function
5. Summarizing data
6. Selecting samples or items for testing
7. Printing reports / letters in a format specified by the auditor.
8. Detection of violation of systems limits i.e. a sales ledger can be checked to ensure that no
customers have a balance above the authorized credit limit.
9. Testing reasonableness i.e. ensuring the value of purchases isn’t greater than the value of
stock received.
Advantages of CAATS
1. Examination of data is more rapid /faster

2. Examination of data is more accurate
3. It’s the only practical method of examining large amounts of data.
4. It overcomes in some cases loss of audit trial
5. It is relatively cheap to use once the setup cost has been incurred.
Disadvantages of CAATS
1. It can be expensive to acquire, set up and maintain.

2. Some technical knowledge is required
3. A variety of programming languages are used in business thus standard computer audit
programmes may not be compatible with a clients system.
4. Detailed knowledge of systems and programmes is required an undertaking many auditors
are reluctant to embark on.
5. Difficult in obtaining computer time particularly if the auditor has to use the clients
machine.
Factors to consider when using CAATS
1. Computer knowledge and experience of the auditor – the auditor should have sufficient
knowledge, to apply and to evaluate results of a particular CAATS used.
2. Availability of suitable CAATS and IT facilities.
3. Efficiency and effectiveness of using CAATS over manual techniques.
4. Impracticability of manual tests – many computers systems process data without leaving
any visible evidence of the processing carried out. In addition most of the controls are
programmed such that manual procedures can’t be applied for audit testing. In such
circumstances use of CAATS is the only way to perform the audit test.
5. Integrity of the client IT system and environment
6. Level of audit risk.
7. Time constraint
Audit trail
It’s the ability of the auditor to trace the transactions as recorded in the system from the initial
stages to the preparation of the financial statements. It’s the means by which the individual
transactions can be traced through the whole system from the source to competition and its loss
will mean that the normal audit technique will breakdown.

An audit trail should be provided so that every transactions on the file contains a unique
reference back to the original source of inputs.
Example:
The sales system transaction records should hold a reference to the customer order, delivery
note and invoices.
- Loss of audit trail is the inability to trace transactions from the initial stages to the final
accounts or the inability to trace transactions through the whole system of accounting.
Causes of loss of Audit trail
1. Use of magnetic files where data can’t be directly inspected.

2. Deletion of past data to create storage space hence only most current transactions are
maintained.
3. The computers will skip some stages in the accounting cycle e.g. daybook stage which brings a
problem of cross referencing.
4. Use of code numbers instead of names and descriptions, this makes it difficult for the auditor
to trace a transaction and he may have to use code list to get to know what different code
stand for.
Overcoming loss of audit trail
1. Having special print outs for the auditor

2. Carrying out alternative tests e.g. physical stock counting.
3. Use of CAATs.
4. Use of programmed interrogation facilities which interrogates all stages of a transaction
from source to completion.
5. Manual testing and comparison with other data available i.e. budgets or previous records.

GOING CONCERN ASSUMPTION IAS I
This is the assumption that the entry will continue in operation and existence for the forseeable
future and it has no intention to liquidate or curtail materially the scale of its operations.
Foreseeable future – the accounting and auditing standards do not define the word foreseeable
future, however, ISA 570 recognizes that any consideration about future events involves making
a judgment about those events that are inherently uncertain. In practice foreseeable future is
considered to be one years after the financial statements have been approved by the Board of
directors and the audit report has been issued.
The objectives of the auditor in respect of going concern are:
1. To obtain sufficient appropriate audit evidence regarding the appropriateness of

management’s use of the going concern assumption.
2. To consider whether a material uncertainty exists related to events or conditions that may
cast significant doubt on the entity’s ability to continue as a going concern.
3. To determine the implications on the auditors reports.
- If the going concern of the company is questionable or not appropriate, the financial
statements should be prepared on another bans.
1. The fixed assets will be classified as current assets and valued at this net realisable value
and not the net book value. This is like telling the shareholders that in the event the
company collapses, this is the much they can fetch form disposing the assets.
2. The long term liabilities could crystallize and become payable immediately. They would
also be classified as current liabilities.
3. Stocks will no longer be valued at the lower of cost and net realizable value but they will be
valued at their market values.
4. Intangible assets and advance related payments will simply disappear or have no value
left.
5. New liabilities will arise requiring to be provided for. E.g. lay off cost and winding up costs.
INDICATORS OF GOING CONCERN PROBLEMS
They are classified into 3:
a) Financial indicator e.g.

a) Inability to pay current liabilities as and when they fall due.
b) Inability to pay salaries and wages on a monthly basis.
c) Inability to pay long–term maturing obligations and there are no realistic prospects of
renewing the loans by the lenders.
d) Substantial operating losses for a number of years.
e) Discontinuation of major operations e.g. closing of branches or abandoning production of a
particular line- of products.
f) Inability to obtain additional capital from bankers or capital markets to finance expansion.
g) Change from credit to cash on delivery transactions with the suppliers.
h) Adverse key financial ratios.
i) Net current liability position.
j) Arrears of dividends and taxes.
b) Operational indicator
a) High turnovers of managing directors or C.E.O
b) Loss of key management without their immediate replacement.
c) Loss of major customer
d) Loss of major suppliers
e) Loss of major market, license of franchise.
c) Other indicators
a) Changes in government and policies.
b) Pending legal proceedings against the company which if successful may result to liabilities
and conditions that the company cannot meet.
c) Occurrence of material subsequent events that can have adverse effects on the company’s
operations.
Audit procedures when going concern is questionable
When doubt arises regarding the appropriateness of the going concern assumption, the auditor
should gather sufficient and appropriate evidence to resolve the satisfaction whether the
company can continue in operation for the foreseeable future.
Audit procedures will include:
i) Analyze and discuss the cash flow and profit forecast with the directors to determine
whether the company generates sufficient cash flows to finance its operations.
ii) Inquire from management whether these are any material subsequent events that
could have occurred and could worsen the company’s ability to continue as a going
concern.
iii) Inquire from the company’s lawyers regarding litigations against the company and
whether it is probable that the company will be liable and their ability to discharge
such a liability.
iv) Analyse and discuss the client’s latest available interim financial statements to
ascertain if the company is generating sufficient funds.
v) Review minutes of meetings of the board of directors and the shareholders resolution
to obtain evidence on how they will resolve the going concern problem.
vi) Confirm the existence, legality and enforcement of arrangements to provide financial
support with related 3 rd parties. Inquire from such parties this ability to provide
additional finance.

Management plan and mitigating circumstances
When the above procedures confirm to the auditor that the going concern is not appropriate or is
questionable, the auditor will need to discuss this situation with the management. It is likely that
the management will claim to have measures to overcome the difficulties or will identify
mitigating circumstances to reduce the impact of the problem. The auditor will need to obtain
evidence as to the viability of the plans existence of mitigating circumstances. Possible situations
are as follows:
1. Where the management have plans to resolve the cash flow deficit through disposal of assets,
the auditor will:
a) Obtain independent evidence as to the marketability of the assets earmarked for disposal.
b) Consider the effects of continuing operations i.e. ensure that management do not dispose
initial assets.
2. Where management have obtained independent advice as to future plans or financial
strategies franchise arrangement, the auditor will:
a) Evaluate the financial viability of the plan
b) Obtain experts advice as to the technical and commercial feasibility of the strategy.
3. Where management has arranged additional borrowing facility with their bankers circularize
the banker to improve the ability and willingness to provide financial support required.
4. Where financial support is claimed to be available from the parent company incase the
subsidiary is experiencing going concern problems, the auditor will:
i) Assess the ability of the parent company to provide finance.
ii) Confirm that the arrangement is legally binding and it is not just an expression of interest.
5. Where the value package has been negotiated with 3 rd parties, the auditor will need to:
a) Circularize the 3rd party to confirm the arrangements and agreements on such a
package.
b) Seek legal advice to understand the commercial effects of such a rescue package.
Impact of going concern problem on the auditor’s report
1. If the auditor is satisfied that the company is able to continue as a going concern, then he
should issue unqualified audit report.
2. If there is doubt about going concern, and directors have disclosed the nature of the going
concern, how they will resolve the problem, the auditor should express unqualified opinion
with emphasis of matter paragraph.
Emphasis of matter paragraph: This is a paragraph included in the auditor’s report that draws
the attention of the users of the financial statements to the unusual conditions that would
have accounting in the company so that they can reach a better understanding of the financial
statements.

3. If the auditor is aware that the company will not be a going concern and the directors have
not disclosed this in the accounts, then issue adverse opinion by stating that the financial
statements do not reflect a true and fair view.
Solutions to going concern
1. Retrench some of the employees but in a procedural manner to avoid litigation.

2. Consider floating rights.
3. Dispose off some of the fixed assets.
4. Negotiate with creditors to give you more time to pay
5. Concert long term liabilities into equity of the company.
6. Convert short-term debts into long term liabilities.
7. Merging of subsidiaries, branches, departments e.t.c

AUDITING
QUESTION ONE
a) State the measures that a company could put in place in order to prevent errors in the
financial statements. (6 marks)
b) Summarise the possible indicators of the existence of irregularities in the financial

statements of a client. (6 marks)
c) You are a member of the team auditing the financial statements of Salama Ltd for the
financial year ended 30 April 2009. During the course of your audit, you suspect that the
company’s finance manager is authorizing payments to creditors for goods that were never
supplied to the company.
Required
Highlight the audit procedures you would adopt to detect the above fraud. (8 marks)
(Total: 20 marks)
QUESTION TWO
a) In large manufacturing companies, the value of inventory is considered to be material and is

usually susceptible to misstatements due to errors and frauds.
Required
Highlight the errors and fraud that may be detected in the inventory disclosed in the financial
statements of a large manufacturing company. (8 marks)
b) Describe the steps an auditor should take on the discovery of material errors in a client’s
financial statements. (12 marks)
(Total: 20 marks)
QUESTION THREE
a) You are a member of an audit team engaged in the audit of Ukweli Retail Stores Ltd, for the
financial year ending 31 December 2007. In the course of the system’s audit, you notice a
discrepancy between the value of goods dispatched to customers and the sales figure. You
suspect that the company’s dispatch clerks are misappropriating goods by sending goods to
fictitious customers.

Required
i) Outline the audit procedures you would perform to detect whether there is
misappropriation of goods by the dispatch clerks. (8 marks)
ii) Suggest the appropriate internal control measures that should be put in place to prevent
misappropriation of goods by employees. (6 marks)
b) Explain the ways in which management could discharge their duties towards the prevention
and detection of fraud in an organization. (6 marks)
(Total: 20 marks)
QUESTION FOUR
a) You are a member of the audit team which has been assigned the task of auditing the
accounts receivable of Bidii Ltd. During the course of the auditing, you discover that a
number of transactions in the sales ledger are irregular.
You suspect that the company’s employees are committing fraud though teeming and lading.
Required
i) Explain the term “teeming and lading” (2 marks)
ii) Outline the audit procedures you would perform to detect teeming and lading in the
company. (6 marks)
iii) Suggest appropriate internal control measures that would prevent teeming and lading in
the company. (6 marks)
b) Summarise the matters an auditor should consider at the planning stage with regard to fraud
and other irregularities. (6 marks)
(Total: 20 marks)

AUDITING EVIDENCE
QUESTION ONE
a) In the context of International Standard of Auditing (ISA) 500 (Auditing Evidence):

i) Define the term “circumstantial audit evidence”. (2 marks)
ii) Highlight the steps an auditor should take when circularizing the debtors to obtain
sufficient evidence from internal sources. (6 marks)
iii) Give four examples of internal sources of audit evidence. (4 marks)
b) “An auditor is required to use assertions for classes of transactions, account balances and
presentation and disclosure in sufficient detail in order to form a basis for the assessment of
risks of material misstatement and the design and performance of further audit procedures”.
Required
Identify the assertions used by auditors in the following categories:-
i) Assertions about account balances at the period end. (4 marks)
ii) Assertions about presentation and disclosure. (4 marks)
(Total: 20 marks)
QUESTION TWO
An auditor should obtain sufficient and appropriate audit evidence to be able to draw reasonable
conclusions on which to base his audit opinion.
Required
a) Describe the criteria used by an auditor when evaluating the reliability of audit evidence.
(8 marks)
b) Briefly explain the factors considered in determining sufficiency of audit evidence. (6 marks)
c) Briefly explain the limitations that an auditor may experience when collecting audit evidence.
(6 marks)
QUESTION THREE
a) “Auditor should obtain sufficient, relevant and reliable audit evidence to enable him to draw
reasonable conclusions therefrom”.

Required:
i) List and briefly explain five techniques used by an auditor to obtain audit evidence.
(5 marks)
ii) State how each of the techniques in (a) (i) above could be used in the audit of a client’s
stock. (5 marks)
b) i) Distinguish between positive and negative circularization of debtors. (4 marks)
ii) Outline the purpose of circularization of debtors. (6 marks)
(Total: 20 marks)
QUESTION FOUR
Audit sampling is the application of audit procedures to less than 100% of the items in a
population in order to extrapolate a conclusion about the population.
Required
a) Identify the situations in which an auditor should not use sampling approach in his audit
assignment. (6 marks)
b) State the factors that an auditor should consider when determining the size of a sample.
(4 marks)
c) List the steps followed by an auditor when using sampling approach in his audit assignment.
(4 marks)
d) Briefly explain the advantages of statistical sampling. (6 marks)

(Total: 20 marks)
QUESTION FIVE
International Standard of Auditing (ISA) 580 (Management Representations) requires an auditor

to obtain a letter of representation from management before issuing an audit report.
Required:
a) What is meant by “letter of representation”? (2 marks)

b) Explain the importance of a letter of representation to an auditor. (6 marks)
c) Describe the types of representations that may be obtained from the management by an
auditor. (12 marks)
(Total: 20 marks)
QUESTION SIX
a) During the course of the audit of your client Zedtec Insurance Ltd, you have established that
you need the services of an actuary to provide expert advice.
Briefly explain the factors that you would consider before appointing an actuary.
(10 marks)
b) Under what circumstances does an auditor rely on substantive tests in his audit work?
(6 marks)
c) Briefly explain the meaning of cut off procedures. (4 marks)

(Total: 20 marks)

AUDITING
AUDIT OF FINANCIAL STATEMENT ITEMS
QUESTION ONE
Gitamba Ltd, is a wholesale company engaged in the sale of clothing materials to supermarkets in
Nairobi. The company purchases the materials from various suppliers on credit. As an audit
assistant in Mutua and Associates (Certified Public Accountants), you have been assigned the task
of auditing the company’s purchases and trade creditors for the financial year ended 31 July
2009.
Required:
a) Identify the objectives of an audit of the company’s purchases and trade creditors
(6marks)
b) Outline six internal control measures that should be put in place in the purchases and
trade creditors system of the company. (6marks)
c) Describe four substantive procedures that you would carry out when verifying the trade
creditors balance in the accounting of the company for the year ended 31 July 2009.
(8marks)
(Total: 20marks)
QUESTION TWO
Fairwell ltd is a manufacturing company engaged in the production of soft drinks. The company’s
employees turnover is very high. Most of the employees engaged in production are hired as
casual workers while the management staff are hired on a permanent basis. The financial
statements of the company for the year ended 31 October 2009 show that the expenditure on
salaries and wages amounted to Shs.20 million. You are an audit assistant currently engaged in
the audit of the company’s salaries and wages.
Required:
(a) Outline the audit procedures you would carry out to verify:
(i) That salaries and wages were paid to genuine employees of the company. (8marks)
(ii) That casual workers were paid for actual work done. (4marks)
(iii) The statutory deductions made from the employees by the company (4marks)
(b) Briefly explain how you would carry out a starters test and leavers test with respect to the
company’s employees (4marks)
(Total: 20marks)
QUESTION THREE
Investment in the shares of other companies may represent a substantial portion of the total
assets of a company or may merely reflect incidental aspects of the company’s operations.
However, for an auditor, investments in shares represents assets with a high inherent audit risk.
Required:
(a) Describe four audit objectives sought by the auditor when examining a company ‘s
investments in the shares of other companies (8marks)
(b) Explain the audit procedures that an auditor would carry out when verifying the existence
and ownership of a company’s investments in shares. (6marks)
(c) Describe how an auditor would determine that all investment income from shares has
been properly recorded in the books of account of the company. (6marks)
(Total: 20marks)
QUESTION FOUR
Kiatu Ltd. Is a shoe manufacturing company based in industrial area. As an audit assistant in
Kiplagat and Associates (Certified Public Accountants), you have been assigned the task of
auditing the company’s inventory for the financial year ending 31 March 2010.
Required:
(a) Identify and explain four inherent risks associated with a company’s inventory and work-
in-progress. (8marks)
(b) List four audit objectives of an auditor attending a client’s physical inventory count.
(4marks)
(c) Outline the audit procedures you would carry out during the company’s physical inventory
count. (8marks)
QUESTION FIVE
(a) Define the term “low balling” in relation to audit fees. (2marks)
(b) Identify and briefly explain four factors that an auditor should consider when determining
the professional fees to charge a client. (8marks)
(c) You are the audit partner in charge of XYZ Ltd., one of the continuing clients of your audit
firm. During the routine annual review of your firm’s clients, aimed at determining which
clients to continue with in the current year, two issues have emerged relating to XYZ Ltd:
1. For the last five years, your firm has been receiving 40% of its total audit from XYZ Ltd.
2. XYZ Ltd. Has not paid your firm the audit fees for the past two years.
Required:
Explain the impact that these two issues will have on your firm’s decision as to whether to
continue being the auditors’ of XYZ Ltd.

(d) Your audit firm has recently been reappointed the auditor of Matopeni Commercial Ltd.
The company has recently been structured with a new management. The new managing
director Mr. Josephat Kamau has indicated to your firm that two new branches in Eldoret
and Kisumu have been opened by the company to facilitate efficient distribution of the
company’s products.
Required:
Explain the reasons why it is necessary for your audit firm to review the engagement letter.
(4marks)
(Total: 20marks)

AUDITING
MODEL PAPER I
QUESTION ONE
a) Differentiate between “accounting and auditing”. (4 marks)

b) Outline the benefits of an audit to a public limited company. (6 marks)
c) Distinguish between “primary objectives” and “ secondary objectives” of an audit.(4 marks)
d) State three primary objectives and three secondary objectives of an audit. (6 marks)
(Total: 20 marks)
QUESTION TWO
a) With respect to the provisions of the Companies Act. Briefly explain:

i. Procedures of appointing a company’s auditor. (4 marks)
ii. Ineligibility of a company’s auditor (4 marks)
iii. Removal of an auditor (4 marks)
b) Explain the fundamental principles of ethics that auditors must comply with when
conducting an audit and five threats to be fundamental principles. (8 marks)
(Total: 20 marks)
QUESTION THREE
a) Explain the matters considered by an auditor before and after accepting an appointment of a
new client (10 marks)
b) “if an auditor fails in his duty to protect the interest of the various users of the financial
statements or if he does not carry out his work with due care and skill then various parties
can bring action against the auditor for negligence”.
Required
i. Briefly explain the circumstances under which an auditor could be held criminally liable
under the Companies Act. (4 marks)
ii. Summarise the steps an auditor could take to minimize potential liabilities in the course
of his audit work. (6 marks)
(Total: 20 marks)
QUESTION FOUR
“Planning is very important in auditing if the audit objectives are to be met economically,
efficiently and within time constraints”.
Required:
a) Define the following terms:

i. Audit plan (2 marks)
ii. Audit program (2 marks)
iii. Planning memorandum (2 marks)
b) Describe the matters taken into consideration by an auditor during audit planning.
c) State two reasons why an audit plan may fail to achieve its objectives.
QUESTION FIVE
a) Outline the quality control procedures that an audit firm should put in place in order to
minimize its liability. (10 marks)
b) Explain the importance of working and highlight the contents of current audit file.
(10 marks)
(Total: 20 marks)
QUESTION SIX
a) Outline the audit procedures on auditor would carry out in relation to a clients accounting
system (8 marks)
b) Corm Ltd is a small company located in Landi Mawe, industrial are. The company deals in the
importation of threads for sale in the domestic market. The threads are sold directly to
retailers on credit terms. You are an audit assistant currently engaged in the audit of the
company sales and debtors.
Required
i. Describe the main internal controls that you would expect to find in operation with regard to
the company’s sales and debtors (6 marks)
ii. Briefly explain the inherent limitations that might hinder the effective operation of an internal
control system over sales and debtors in the company. (6 marks)
QUESTION SEVEN
a) Identify and explain the functions of the internal audit department in an organisation.
(4marks)
b) Outline and briefly explain the procedures that the internal auditor can conduct on behalf of
the external auditor should consider before placing reliance on the work of the internal
auditor. (5marks)
c) State the factors that the external auditor should consist before placing reliance on the work
of the internal auditor. (5marks)
d) Briefly explain the methods which an auditor might use to ascertain a clients internal control
system. (5marks)

QUESTION EIGHT
a) State the measures that a company could put in place in order to prevent errors in the
financial statements. (6marks)
b) Summarise the possible indicators of the existence of irregularities in the financial statements
of a client. (6marks)
c) You are a member of the team auditing the financial statements of Salama ltd for the financial
year ended 30th April 2008. During the course of your audit, you suspect that the company’s
finance manager is authorizing payments to creditors for goods that were never supplied to
the company.
Required:
Highlight the audit procedures you would adopt to detect the above fraud. (8marks)
QUESTION NINE
a) In respect of the going concern concept:

i) Define ‘going concern’ and state two situations in which it should not be applied in the
preparation of financial statements. (4marks)
ii) Explain the director’s responsibilities and the auditors responsibilities regarding
financial statements prepared on the going concern principle. (6marks)
b) List the audit procedures that should be carried out to determine whether or not the going
concern basis of a company is appropriate. (6marks)
c) What form of audit opinion would you give if you concluded that the client company was
experiencing going concern problems and:
i) You have established that the financial statements give sufficient disclosure of the going
concern problems. (2marks)
ii) You have established that there is no disclosure of the going concern problems in the
(Total: 20marks)

AUDIT AND ASSURANCE
MODEL PAPER
QUESTION ONE
a) List and briefly explain the main threats to independence and objectivity as identified by
the professional body. (3marks)
b) Briefly explain the fundamental principle of confidentiality and list the circumstances in
which the auditor may disclose confidential information about the client. (8marks)
c) Explain the role of the professional bodies in the regulation of auditors (5marks)
(Total: 20marks)
QUESTION TWO
Fairwell ltd is a manufacturing company engaged in the production of soft drinks. The company’s
employees turnover is very high. Most of the employees engaged in production are hired as
casual workers while the management staff are hired on a permanent basis. The financial
statements of the company for the year ended 31 October 2009 show that the expenditure on
salaries and wages amounted to Shs.20 million. You are an audit assistant currently engaged in
the audit of the company’s salaries and wages.
Required:
(a) Outline the audit procedures you would carry out to verify:
(iv) That salaries and wages were paid to genuine employees of the company. (8marks)
(v) That casual workers were paid for actual work done. (4marks)
(vi) The statutory deductions made from the employees by the company (4marks)
(b) Briefly explain how you would carry out a starters test and leavers test with respect to the
company’s employees (4marks)
(Total: 20marks)
QUESTION THREE
Your firm is the auditor of Springfield Nurseries, a company operating three large garden centre
which sell plants, shrubs and trees, garden furniture and gardening equipment (such as
lawnmowers and sprinklers) to the general public. You are involved in the audit of the company’s
non-current assets. The main categories of non-current assets are as follows:
i) Land and buildings (all of which are owned outright by the company, none of which are
leased)
ii) Computers (on which an integrated inventory control and sales systems is operated)
iii) A number of large and small motor vehicles, mostly used for the delivery of inventory
to customers

iv) Equipment for packaging and pricing products.
The depreciation rates used are as follows:
i) Buildings 5% each year on cost

ii) Computers and motor vehicles 20% each year on the reducing basis
iii) Equipment 15% each year on cost
You are concerned that these depreciation rates may be inappropriate.
Required:
a) List and explain the main financial statements assertions tested for in the audit of non-
current assets. (5marks)
b) Explain the main risks associated with the assertions relating to non-current assets.
(4marks)
c) List the sources of evidence available to you in verifying the ownership and cost of
i) The land and buildings
ii) The computers and motor vehicles. (10marks)
d) List the audit procedures you would perform to check the appropriateness of the
depreciation rates on each of the three categories of non-current asset. (6marks)
e) Describe the action you would take if you disagreed with any of the depreciation rates
used and explain the potential effect of the disagreement on your audit report.
(5marks)
(Total: 30marks)
QUESTION FOUR
Some organizations conduct inventory counts once a year and external auditors attend those
counts. Other organizations have perpetual systems (continuous inventory counting) and do not
conduct a year-end count.
Snu is a family –owned company which retails bed, mattresses and other bedroom furniture
items. The company’s year-end is 31 December 2008. The only full inventory count takes place at
the year –end. The company maintains up-to date computerized inventory records.
Where the company delivers goods to customers, a deposit is taken from the customer and
customers are invoiced for the balance after the delivery. Some goods that are in inventory at the
year end and have already been paid for in full –customers who collect goods themselves pay by
cash or credit card.
Staff at the company’s warehouse and shop will conduct the year-end count. The shop and
warehouse are open seven days a week except for two important public holidays during the year,
one of which is 1 January. The company is very busy in the week prior to the inventory count but

the shops will close at 15.00 hours on 31 December and staff will work until 17.00 hours to
prepare the inventory for counting. The company has a high turnover of staff. The following
inventory counting instructions have been provided to staff at SNU.
i) The inventory count will take place on 1 January 2009 commencing at 09.00 hours. No
movement of inventory will take place on that day.
ii) The count will be supervised by Mr. Sneg, the inventory controller. All staff will be
provided with pre-printed, pre-numbered inventory counting sheets that are produced
by the computerized system. Mr. Sneg will ensure that all sheets are issued, and that all
are collected at the end of the count.
iii) Counters will work on their own, because there is insufficient staff for them to work in
pairs, but they will be supervised by Mr. Sneg and Mrs Zapad an experienced shop
manager who will make checks on the work performed by counters. Staff will count
inventory with which they are most familiar in order to ensure that the count is
completed as quickly and efficiently as possible.
iv) Any inventory that is known to be old, slow –moving or already sold will be highlighted
on the sheets. Staffs are required to highlight any inventory that appears to be soiled or
damaged.
v) All inventory items counted will have a piece of paper attached to them that will show
that they have been counted.
vi) All inventory that has been delivered to customers but that has not yet been paid for in
full will be added back to the inventory quantities by Mr. Sneg.
Required:
a) Explain why year-end inventory counting is important to the auditors of organizations that
do not have perpetual inventory systems. (5marks)
b) Describe audit procedures you would perform in order to rely on a perpetual inventory
system in a large dispersed organization. (6marks)
c) Briefly describe the principal risks associated with the financial statements relating to
inventory. (4marks)
d) Describe the weaknesses in the Snu’s inventory counting instructions and explain why
these weaknesses are difficult to overcome. (15marks)
(Total: 30marks)
QUESTION FIVE
An auditor should plan and perform the audit to reduce audit risk to an acceptability low level
that is consistent with the objective of an audit.
Required:

a) Explain four factors taken into consideration by an auditor when assessing the level of
inherent risk in an organization. (6marks)
b) List the possible indicators of existence of high audit risk in an organization. (6marks)
c) Summarise the benefits and limitations to an auditor of the audit risk approach to auditing.
(8marks)
(Total: 20marks)
QUESTION SIX
a) In a computer based system, the auditor should regularly review and test the programmed
controls so that he can obtain adequate evidence regarding the functioning of the controls
during the whole period.
Required:
i) Highlight the objectives of programmed controls in a computer based system.

(4marks)
ii) Identify and explain the types of programmed controls that are designed in a computer
based system. (8marks)
iii) Explain the ways in which an auditor uses a computer to assist in carrying out has audit
work. (8marks)
(Total: 20marks)
QUESTION SEVEN
a) An auditors report should contain a clear expression of opinion on the financial statements.
For each of the following situations, briefly explain the type of opinion that should be
expressed in the auditors report:
i) Kosgei and Associates (Certified Public Accountants) are appointed as auditors of C Ltd,
midway through the financial year of the company. Consequently, they are unable to
carry out audit procedures necessary to obtain adequate assurance regarding the
quantity and condition of stock and work in progress appearing the balance sheet. Any
adjustments to this figure would have a significant effect on the profit for the year.
(2marks)
ii) A client company has made no provision for losses expected to arise on a long term
contract currently in progress as the directors of the company are of the view that such
losses should be offset against amount recoverable on other long term contracts of the
company. Recognition of the losses would have a significant effect on the profit for the
year. (2marks)
iii) The consolidated financial statements of XYZ Ltd, have disclosed an ongoing court case
brought against ABC Ltd, a wholly owned subsidiary of the company, for an alleged

breach of environmental regulations. The future settlement of this court case could lead
to additional liabilities and the winding up of ABC Ltd, resulting in a substantial
negative effect on the consolidated financial statements. (2marks)
QUESTION EIGHT
You are a member of an audit team involved in the audit of CBM Ltd for the financial year
ended 30 April 2008. During the course of the audit, you discover that cheques are signed as
creditors invoices become due, but these cheques are delayed for five weeks before being
mailed to the creditors due to shortage in working capital. The company’s clerk has informed
you that presently, the unmailed cheques amount to a total of sh.640,000.
Required:
a) Outline the audit tests you would perform to verify the bank balance in the company’s
b) Highlight the audit tests you would perform in examining the creditors balance in the
company’s financial statements. (6marks)
c) Suggest appropriate internal control measures that should be instituted by the company to
prevent the delayed mailing of cheques to creditors. (8marks)
(Total: 20marks)
QUESTION NINE
a) Computerized information systems have unique features when compared to manual systems,
which require adequate controls to be in-built into the systems.
Outline two objectives of each of the following controls:
i. Input controls. (4marks)
ii. Processing controls. (4 marks)
iii. Output controls (4marks)
b) Summarise the difficulties encountered by auditors when using computer audit programs in
their audit assignments. (8 marks)
(Total: 20 marks)

AUDITING
MODEL PAPER ONE
QUESTION ONE

iii) Define ‘going concern’ and state two situations in which it should not be applied in the
iv) Explain the director’s responsibilities and the auditors responsibilities regarding
iii) You have established that the financial statements give sufficient disclosure of the going
iv) You have established that there is no disclosure of the going concern problems in the
(Total: 20marks)
QUESTION TWO
a) ISA 560 Subsequent Events explains the audit work required in connection with subsequent
events.
Required:
List the audit procedures that can be used prior to the auditor’s report being signed to identify
events that may require adjustment or disclosure in the financial statements. (5marks)
b) You are the auditor of Oil Rakers, a limited liability company which extracts, refines and sells
oil and petroleum related products.
The audit of Oil Rakers for the year ended 30 June 2009 had the following events:
Date Event
15 August 2009 Bankruptcy of major customer representing 11% of the trade
receivable on the statement of financial position.
21 September 2009 Financial statements approved by director’s.
22 September 2009 Audit work completed and auditor’s report signed.
1 November 2009 Accidental release of toxic chemicals into the sea from the company’s
oil refinery resulting in severe damage to the environment.

Management has amended and made adequate disclosure of the event
23 November 2009 financial statements issued to members of Oil Rakers.
30 November 2009 A fire at one point of the company’s oil wells completely destroys the
well. Drilling a new well will take ten months with a consequent loss in
oil production during this time.
Required:
For each of the following three dates
- 15th August 2009
- 1 November 2009 and
- 30 November 2009
i) State whether the events occurring on those dates are adjusting or non-adjusting
according to IAS 10 Events after the reporting period, giving reasons for your decision.
(6marks)
ii) Explain the auditor’s responsibility and the audit procedures that should be carried out.
(9Marks)
(Total: 20marks)
QUESTION THREE
Investments in the shares of other companies may represent a substantial portion of the total
Required
a) Describe four audit objectives sought by the auditor when examining a company’s
investments in the shares of other companies. (8 marks)
b) Explain the audit procedures that an auditor would carry out when verifying the existence
and ownership of a company’s investments in shares
QUESTION FOUR
a) (i) Define the term “materiality” and briefly explain the two stages in which an auditor
considers materiality in the course of his audit work. (4marks)
(ii) Describe how an auditor assesses an item’s materiality in the clients financial statements.
(6 marks)
b) (i) Define the term “inherent uncertainty”. (2 marks)
(ii) Describe the matters on auditor takes into consideration when forming an opinion on the
financial statements of a company where inherent uncertainty exists. (8 marks)
(Total: 20marks)

QUESTION FIVE
During the course of the audit, the auditor may need to consider audit evidence in the form of
reports, opinions, valuations or statements from specialists.
Required:
a) Discuss examples of situations where an auditor may wish to rely upon the work of a
specialist (5marks)
b) Describe the principles or factors which the auditor should consider when placing reliance
on audit evidence provided by specialists. (8marks)
c) Briefly explain the auditor’s procedures in respect of contingent liabilities. (7marks)
(Total: 20marks)
QUESTION SIX
Inspection and monitoring of quality control by a firm of auditor’s involves both in house and
external procedures.
Required:
a) Explain the purpose of audit review (5marks)
b) In relation to audit review explain the following.
i) Hot review (2marks)
ii) Cold review (2marks)
iii) Peer review (2marks)
c) What are the advantages and disadvantages of peer review? (5marks)
d) Explain the purpose of general quality controls and briefly discuss the types of general
quality controls. (4marks)
(Total: 20marks)
QUESTION SEVEN
a) What are the auditor’s objectives in his audit of fixed assets of a company? (5marks)
b) Outline the audit procedures which the auditor’s follow in the audit of fixed assets.
(8marks)
c) Describe sound internal controls which could be designed to safeguard movable and
immovable fixed assets in a large organization. (7marks)
(Total: 20marks)

AUDITING
MODEL PAPER ONE
QUESTION ONE

i) Define ‘going concern’ and state two situations in which it should not be applied in the
ii) Explain the director’s responsibilities and the auditors responsibilities regarding
i) You have established that the financial statements give sufficient disclosure of the going
ii) You have established that there is no disclosure of the going concern problems in the
(Total: 20marks)
QUESTION TWO
c) ISA 560 Subsequent Events explains the audit work required in connection with
subsequent events.
Required:
a) You are the auditor of Oil Rakers, a limited liability company which extracts, refines and sells
Date Event
22 September 2009 Audit work completed and auditor’s report signed.

Required:
- 15th August 2009
- 30 November 2009
i) State whether the events occurring on those dates are adjusting or non-adjusting according
to IAS 10 Events after the reporting period, giving reasons for your decision. (6marks)
(9Marks)
(Total: 20marks)
QUESTION THREE
Required
and ownership of a company’s investments in shares
QUESTION FOUR
(ii) Describe how an auditor assesses an item’s materiality in the clients financial statements.
(6 marks)

(Total: 20marks)

QUESTION FIVE
Required:
specialist (5marks)
b) Describe the principles or factors which the auditor should consider when placing reliance
on audit evidence provided by specialists. (8marks)
(Total: 20marks)
QUESTION SIX
Required:
iv) Hot review (2marks)
v) Cold review (2marks)
vi) Peer review (2marks)
(Total: 20marks)
QUESTION SEVEN
b) Outline the audit procedures which the auditor’s follow in the audit of fixed assets.
(8marks)
(Total: 20marks)

AUDITING
MODEL PAPER ONE
QUESTION ONE

iii) Define ‘going concern’ and state two situations in which it should not be applied in the
iv) Explain the director’s responsibilities and the auditors responsibilities regarding
iii) You have established that the financial statements give sufficient disclosure of the going
iv) You have established that there is no disclosure of the going concern problems in the
(Total: 20marks)
QUESTION TWO
a) ISA 560 Subsequent Events explains the audit work required in connection with subsequent
events.
Required:
b) You are the auditor of OilRakers, a limited liability company which extracts, refines and sells
Date Event

22 September Audit work completed and auditor’s report signed.
Required:
- 15th August 2009
- 30 November 2009
i) State whether the events occurring on those dates are adjusting or non-adjusting according
to IAS 10 Events after the reporting period, giving reasons for your decision. (6marks)
(9Marks)
(Total: 20marks)
QUESTION THREE
Required
and ownership of a company’s investments in shares. (6 marks)
c) Describe how an auditor would determine that all investment income from shares has been
properly recorded in the books of account of the company. (6 marks)
(Total: 20 marks)
QUESTION FOUR
(ii) Describe how an auditor assesses an item’s materiality in the client’s financial statements.
(6 marks)

(Total: 20marks)
QUESTION FIVE
Required:
specialist (5marks)
b) Describe the principles or factors which the auditor should consider when placing reliance on
audit evidence provided by specialists. (8marks)

(Total: 20marks)
QUESTION SIX
Required:
vii) Hot review (2marks)
viii) Cold review (2marks)
ix) Peer review (2marks)
(Total: 20marks)

QUESTION SEVEN
b) Outline the audit procedures which the auditor’s follow in the audit of fixed assets. (8marks)
(Total: 20marks)

Audt Notes &amp; Qstns Kce

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AUDITING

LAWS THAT GOVERN AUDITING PRACTICE

1. Companys Act e.g.

NATURE, PURPOSE AND SCOPE OF AUDIT

- Proper books of accounts have been kept

Examples of books of accounts

1 Passion for Excellence

a) Proper books of accounts

b) Accounts are in agreement with the books of accounts

c) Accounts do comply with the company’s Act Cap 486

2 Passion for Excellence

d) True and fair view

i. That proper books of accounts have been kept.

Its defined as;

a) Professionally qualified accountant i.e. (CPA) finalist, Association of chartered Certified

In practice an auditor may be an individual or a firm of practicing accountants. An individual

A firm of practicing accountants may operate as:

Work done in each of the services rendered include:

4 Passion for Excellence

ASSISTANT CLERK TRAINEE

ii. Audit manager

iii. Accountant in charge

5 Passion for Excellence

Its defined as an independent examination of and expression of an opinion on the financial

NEED FOR AN AUDIT

Stewardship means the management of resources by a group of persons on behalf of another

Accounts prepared by the directors on behalf of the shareholders are considered to be

2. True and Fairview

a. That proper books of accounts are kept.

3. Separation of powers and control of the business

6 Passion for Excellence

1. Main / statutory / primary objectives company’s act.

2. Incidental / professional body/ secondary objectives

a) Detect errors and frauds and assist in their prevention.

7 Passion for Excellence

i. Planning for the audit of the clients

Changes in audit objectives over the years

a) Changes in the legal framework governing audit practice.

8 Passion for Excellence

External Audit Internal Audit

Public / Private / non

a) Public / statutory audit

A statutory audit is conducted by the following business:

b) Private / non statutory audit

This type of audit is ideal for the following businesses:

10 Passion for Excellence

i. Operate the business in an orderly and efficient manner

Functions of Internal audit department

Similarities of external and internal audit

Differences between internal and external audit

11 Passion for Excellence

(1) Continuous audit

This audit involves

Conditions under which continuous audit is ideal

1. Banking organizations where transactions involve cash which is at a high risk.

12 Passion for Excellence

1. It speeds up completion of the final audit.

Solutions to the above problems

(2) Interim audit

This kind of audit is conducted in two ways;

The work carried out in the interim audit includes;

Conditions under which interim audit is ideal

Advantages of interim Audit

1. Errors and frauds may be prevented and detected.

Audt Notes & Qstns Kce

Audt Notes & Qstns Kce