Slides ENGLISH FOR AUDITING

Audit of Financial StatementsDefinition: A financial statement audit is conducted to determine whether the financial statements the information being verified are stated in accordance w

CHAPTER 3:

ENGLISH FOR AUDITING

3.1 Basic Auditing

3.2 Techniques in Collecting Audit Evidence

3.3 Types of Audit Tests

3.4 Internal Control

3.5 Audit of Items in Financial Statements and Business Cycles

3.1

Basic Auditing

3.1.1 Nature of Auditing

Auditing is the accumulation and evaluation

of evidence about information to determineand report on the degree of correspondencebetween the information and established criteria

Auditing should be done by a competent,

independent person

Information and Established

Criteria

To do an audit, there must be information in a

verifiable form and some standards (criteria)

by which the auditor can evaluate the information

Criteria

Accumulating Evidence and Evaluating Evidence

Evidence is any information used by the auditor

to determine whether the information beingaudited is stated in accordance with the

established criteria

Transaction data

Client

Written and electronic Communications with outsiders

Observations

Competent, Independent Person

Independence

Evaluation of Evidence

3.1.2

Types of Audits and

Types of Auditors

Audit of Financial Statements

Definition: A financial statement audit is conducted to determine whether the financial statements (the

information being verified) are stated in accordance with specified criteria.

Audit of Financial Statements

Boeing's financial statements

Generally accepted accountingprinciples

Documents, records, and outside

Operational Audit

Definition: An Operational audit is a review of any part of an organization’s operating procedures and methods for the

purpose of evaluating efficiency and effectiveness

Operational Audit

for efficiency and effectiveness

the department, and number of errors

Compliance Audit

Definition: A compliance audit is conducted to determine whether the auditee is following specific

procedures, rules, or regulations set by some higher authority

Compliance Audit

for loan continuation have been met

Established

Criteria

Available

Loan agreement provisions

Financial statements and

Independent auditors

Independent auditors are certified public accountants or accounting firms that perform audits of commercial and non-commercial financial entities

Three Requirements for

Becoming a CPA

 Educational requirement

 Uniform CPA examination requirement

 Experience requirement

State auditors

State auditor is an auditor working for the State Audit of a nation; the State Audit reports to and is responsible solely to Congress

Internal auditors

Internal auditors are auditors employed by a company to audit for the company’s board of directors and management

Learning objectives

 Materiality and Audit risk

3.1.3 Fundamental Concepts

in Auditing

Fraud and Error

 A Student took materials (text books or mini photocopies) in examination room (Rule: Close-book exam)

Is it a fraud and an error?

Types of Fraud

 Misappropriation of assets

 Fraudulent Financial Reporting

Misappropriation of assets (“employee fraud”) involves theft of an entity’s asset.

Examples include:

 Embezzling receipts

 Stealing physical assets or intellectual property

 Assets are used with wrong purposes

 ….

Fraudulent Financial Reporting (“management fraud”)

 Earnings management

 Income smoothing

 Inadequate disclosure

 …

What is Error?

Unintentional mistakes in financial information such as:

 Errors of commission: mathematical or clerical mistakes in the recording and accounting data;

 Errors of omission: transactions, events is left out of an accounting statement by mistake.

 Errors of principle: misapplication or misunderstanding of accounting policies unintentionally Ex:

wrong allocation between different accounts, wrong valuation of assets,…

Causes of accounting errors

 Time pressure in the process of recording accounting transaction

 Working style of accountants : Careless or negligent, distract,

 Limited qualification of accountants

Materiality is the magnitude of an omission or misstatement of accounting information that, in the light

of surrounding circumstances, make it probable that the judgment of a reasonable person relying on the

information would have been changed or influenced by the omission or misstatement

Source: Financial Accounting Standards Board (FASB)

Assessment of Materiality

 Materiality is a relative rather than absolute concept

 Materiality includes both quantitative and qualitative consideration (size and nature of the misstatement)

 Quantitative materiality level

No official guidelines within auditing standards

Bases for evaluating Materiality

 Qualitative Considerations

 Amount involve fraud are usually more important than unintentional errors of equal dollar amounts

=> reflect on honest and reliability of management

 Misstatements that are otherwise minor may be material if there are consequences influenced related significant accounts

 Misstatements that are otherwise immaterial if they affect a trend in earning

Study Break

1 Which is the following statements is not correct about materiality:

A.The concept of materiality recognizes that some matters are important for fair presentation of FS in conformity with GAAP, whereas other matters are not important

B.An auditor considers materiality for planning purpose in term of largest aggregate level of misstatements that could be material to any one of the FS

C.Materiality judgments are made in light of surrounding circumstances and necessarily involve both quantitative and qualitative judgments

D.An auditor’s consideration of materiality is influenced by the auditor’s perception of needs of reasonable person who will rely on the FS

Accepted audit risk

 Accepted audit risk is a measure of how willing the auditor is to accept that the financial statements may

be materially misstated after the audit is completed and an inappropriate opinion has been issued

 For many audit firms, accepted audit risk is 5% or lower (1% or ½%,…)

Accepted audit risk

AAR = 5%??????????????

Same as audit assurance = 95%

Audit Risk Model

= Inherent Control Detection

Risk * Risk * Risk

Inherent Risk

 Inherent risk is the susceptibility of an account balance or class of transactions to misstatements that could be material, individually or when aggregated with misstatements in other balances or classes, assuming that there are no related internal control (ISA 400)

 Or Risk of fraud / errors arising due to nature of entity

Control Risk

Risk that a material misstatement, that could occur in an account balance or classic of transaction and that could

be material individually or when aggregated with misstatements in other balances or classes, will not be

prevented or detected on a timely basis by the company’s internal control (ISA 400)

OR Risk that controls do not prevent or detect fraud / errors

Auditors assess CR through evaluating the effectiveness of internal control system

Detection Risk

 Risk that an auditors’ substantive procedures will not detect a material misstatement that exist in an

account balance or class of transaction, individually or when aggregated with misstatements in other balances or classes (ISA 400)

OR Risk that auditor’s procedures do not detect material fraud / errors

 Auditors can control DR => have responsibility to reduce DR by performing substantive tests

Audit Risk Model

Interrelationship of the components of audit risk

AUDIT EVIDENCE

Any information used by the auditor for

determining whether the information being

audited is stated in accordance with

established criteria

Audit Evidence (AE)

AE is the information obtained by the auditor in arriving at the conclusions on which the audit opinion is based

AE is the documentations and information which is obtained by the auditor in connection with audit on which the audit opinion is based (ISA 500 para 04)

 AE includes source documents and accounting records underlying the financial report and

corroborating information from other sources

 Management Assertions

 Audit Objectives

3.1.4 Audit objectives in financial audit

Management Assertions

1. Assertions about classes of transactions and

events for the period under audit

2 Assertions about account balances at period end

3 Assertions about presentation and disclosure

Management Assertions for

Each Category of Assertions

Occurrence

Transactions and Events Account Balances Presentation and Disclosure

Existence Occurrence and rights

and obligationsCompleteness

Accuracy

Classification

Cutoff

Completeness CompletenessValuation and

allocation

Accuracy andvaluationClassification andunderstandability

Rights andobligations

Audit Objectives

General Transaction-related Audit Objectives

Occurrence

Completeness

Accuracy

Recorded transactions exist

Existing transactions are recorded

Recorded transactions are stated

at the correct amountsPosting and

summarization

Classification

Transactions are included in the masterfiles and are correctly summarized

Transactions are properly classified

Transactions are recorded on the

General Balance-related Audit Objectives

Existence

Completeness

Accuracy

Amounts included exist

Existing amounts are included

Amounts included are stated at the correct amounts

Presentation and disclosure related audit objectives

Phase I Plan and design

Perform analyticalprocedures andtests of details

of balances

Phase II

Perform tests ofcontrols andsubstantive tests

of transactions

Phase IV

Complete theaudit and issue

an audit report

3.1.5 Audit process

Phase I: Plan and design an audit approach

Accept client and perform initial planning

Understand the client’s business and industry

Assess client’s business risk

Perform preliminary analytical procedures

Set materiality and assess acceptable audit risk and inherent risk

Understand internal control and assess control risk

Gather information to assess fraud risks

Phase II: Perform tests of controls and

substantive tests of transactions

Plan to reduce assessedlevel of control risk?

Perform tests of controls

Perform substantive tests of transactions

Assess likelihood of misstatements in

No

Yes

Phase III: Perform analytical procedures

and tests of details of balances

Low

Perform analytical procedures

unknown

Perform tests of key items

Perform additional tests

Phase IV: Complete the audit and

issue an audit report

Perform additional tests forpresentation and disclosure

Accumulate final evidence

Evaluate results

Issue audit report

Communicate with auditcommittee and management

The audit report is the only thing that most users

see in the audit process and the consequences of

issuing an inappropriate report can be severe

Issue an Audit Report

Types of Audit Report

3.2

Techniques in Collecting Audit

Evidence

Types of Audit Evidence

Physical Examination

Audit Evidence

Physical Examination

It is the inspection or count by the

auditor of a tangible asset.

This type of evidence is most oftenassociated with inventory and cash

Definition: describes the receipt of a written or oral response from an independent

third party examining the accuracy of information that was requested by the auditor

Information often Confirmed

It is the auditor’s examination of the

client’s documents and records.

Internaldocuments

Externaldocuments

Analytical Procedures

 Understand the client’s industry and business

 Assess the entity’s ability to continue as a

going concern

 Indicate the presence of possible misstatements

in the financial statements

Inquiries of the Client

It is the obtaining of written or oral

information from the client in response to

questions from the auditor

Involves rechecking a sample of calculations

made by the client

The auditor’s independent tests of clientaccounting procedures or controls thatwere originally done as part of the entity’s accounting and internal control system

 Use one’s senses to assess

client activities

 Tour plant to obtain a general

impression of client’s facilities

 Observation is rarely sufficient

by itself

 Often need to corroborate

Appropriateness of Types of Evidence

Case study

For each of following audit procedures, indicate which type of evidence is being gathered:

1. Sending a written request to the client’s customers requesting that they report the amoung owned to the client.

2. Examining large sales invoices for period of two days before and after year- end to determine sales recorded in the proper

period

3. Agreeing the total of account receivable subsidiary ledger to account receivable gerneral ledger account

4. Comparing the current year gross profit percentage with the gross profit percentage for the last year

5. Watching the client’s warehouse personel count of the raw material inventory

6. Peforming test count of the warehouse personel count the raw material inventory

3.3

Types of Audit tests in Financial

Audit

Types of Audit Tests

Types of substantive tests

Analytical procedures: involve the study and comparison of relationships between accounting data and related

information

Tests of details: obtaining evidence on the items (or details) included in an account balance or class of

transactions:

Substantive tests of transactions (used to determine whether all six transaction related audit objectives

have been satisfied for each class of transactions)

Tests of details of balances (focus on the ending general ledger balances for both balance sheet and

income statement accounts)

3.4

Internal Control

Five Components of Internal

Control

Control environment

Includes governance and management’s overall attitude, awareness and actions regarding IC and its importance in the entity (ASA/ISA 315.A65)

Auditors should consider:

 Communication and enforcement of integrity and ethical values

 Commitment to competence

 Participation by those charged with governance

 Management’s philosophy and operating style

 Organisational structure

 Assignment of authority and responsibility

 Human resource policies and practices

Entity’s risk assessment process

Entity’s way of identifying and responding to business risks

Once risks are identified, management needs to consider their significance and how they should be managed Management may introduce plans to address specific risks or it may accept a risk on a cost-benefit basis

Information system

An effective information system establishes the records and the methods that:

 Identify and record all valid transactions

 Transfer information from transaction processing systems to the general ledger

 Capture information relevant to financial reporting for events and conditions other than

transactions; and

 Present the transactions and related disclosures properly in the financial report

Control activities

Policies and procedures established by management to ensure its directives are carried out

Can pertain to:

 Information processing, in an information technology (IT) environment comprising general IT

controls and application controls (discussed later this chapter)

 Physical controls (e.g locked storerooms for inventory)

 Segregation of duties (the most basic of which is to

have different individuals responsible for handling of assets and the keeping of records relating to those assets)