CONTENT Introduction................................................................................................................2 I.

II.

The duties, status and liability of the external auditor and also describe the relationship between internal and external audit...................................................2 Plan an audit with reference to scope, materiality and risk...................................3 appropriate manner as per requirements..............................................................8

III. Identify and use appropriate audit tests and also record the audit process in an

IV. Explain the purpose and content of a statutory audit report related to Jolie

Company.............................................................................................................12
V.

Explain and illustrate different types of qualification within an audit report.........13 Company.............................................................................................................14

VI. Draft suitable management letters in relation to a statutory audit for Jolie

Conclusion...............................................................................................................16 References...............................................................................................................17

Introduction I am a manager in Jen & Co, responsible for the audit of Jolie Co as their external auditor. The following audit report will show my analysis in auditting process Jolie Co accounts for the year ended 30 November 2010. I. The duties, status and liability of the external auditor and also describe the relationship between internal and external audit

Being an auditor, My rights and duties are enshrined in law. I have to check all balance sheet and profit and loss account. I have to report whether these accounts have been properly prepared in accordance with the Company Act 1985. I also have to give my opinion on the truth and fairness of these documents. In the Company Act 1985, there are some factors that an audit like me has to consider.
Proper accounting records have been kept and proper returns adequate for the

audit received from branches not visited.

The accounts agree with the accounting records and returns. All information and explanations have been received as the auditor think

necessary and they have had access at all times to Jolie Cos books, accounts and vouchers. Details of directors emoluments and other benefits have been correctly disclosed in the financial statements.
Particular of loans and other transactions in favour of directors and others have

been correctly disclosed in the financial statements.

The information given in the directors report is consistent with the accounts.

As an auditor, I also have liabilities for professional negligence. First, auditors have to face potential liability to the clients under the law of contract. The auditors have responsibility for loss which has occurred through the failure of them to carry out their duties imposed by the contract with the clients. Beside that, the auditors may have the liability under the law of tort. The effect of law of tort is to impose upon auditors a duty of care over what is imposed by statute or contract. The law of tort is more likely to be a remedy for third parties.

The relationship between internal and external audit

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The cooperation between Jolie Co (JLC) internal auditor and Jen & Co external auditor will minimize the duplication of work and encourage a wide coverage of audit issues and areas. The cooperation will be developed through: Periodic meetings to plan the overall audit to ensure adequate coverage. Periodic meetings to discuss matters of mutual interest. Mutual access to audit reports and management letters. Exchange of audit reports and management letters Common development of audit techniques, methods and terminology

The external auditor must control and assess the work of the internal auditor. Although the reliability of records and adequacy of the reporting and accounting systems are interests shared by both types of auditor. Internal audit must not be seen as a service to the external audit. The internal audit work should not be so distorted in order to fit with external audit needs that its own function is lost. The internal audit is not always a cheaper way of carrying out an external audit function because the internal role can extend into many other areas. Besides, the special position of the external auditors makes them more effective and appropriate in some cases. II. Plan an audit with reference to scope, materiality and risk Scope Jolie Co is a large company, operating in the retail industry. Most sales are made instore, but there is also a very popular catalogue, from which customers can place an order on-line, or over the phone. I am a manager in Jen & Co, responsible for the audit of Jolie Co. In this audit plan, I will focus on sales and collection department of Jolie Co. Materiality Materiality is an expression of the relative significance or importance of a particular matter in the context of financial statements as a whole, or of individual financial statements. A matter is material if its omissions or misstatement would reasonably influence the decisions of an addressee of the audits report. Materiality considerations will differ depending on the aspect of the financial statements being considered. The assessment of materiality when determining the nature, timing and extent of audit procedures should be based on the most recent and reliable financial information and will help to determine an effective and efficient audit approach. Materiality assessment in conjunction with risk assessment will help the auditors to make a number of decisions.
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+ What items to examine + Whether to use sampling techniques + What level of error is likely to lead to an opinion that the account do not give a true and fair view After observing and documenting an understanding of the sales and collection process of Jolie Co, I think auditor should concentrate on the sales and collection department. This is a important process which Jolie Co needs to control and supervise carefully. At Jolie Co most sales are made in-store, but there is also a very popular catalogue, from which customers can place an order on-line, or over the phone. The new on-line sales system has allowed overseas sales for the first time. The system for phone ordering has recently been outsourced. We can see that Jolie Co has stable development in 2009 but it changed in 2010. The number of phone and on-line orders increased from 1,316,667 (2009) to 1,700,000 (2010). However the Profit before tax of 2009 is $253 million and higher than of 2010 is $220 million. Maybe some misstatements has been occurred in sales and collection department. Because Jolie Co uses order on-line system, over the phone and the new on-line sales system has allowed overseas sales for the first time, misstatements in order process are unavoidable. Risk We should consider the level of audit risk. there are four types of risk: audit risk, inherent risk, control risk and detection risk. a) Audit risk Audit risk is the risk that auditors may give an inappropriate opinion on the financial statements. It indicates the auditors agreement to accept that the financial statements may be materially mistaken after the auditing is finished and unqualified opinion is issued. Being an auditor of Jolie Co and wanting to have a low audit risk, so I select a acceptable audit risk is 5%. b) Inherent risk Inherent risk is the risk that items will be misstated due to characteristics of those items, such as the fact they are estimates or that they are important items in the accounts. This type of risk can be reduced by increasing the extent of test of details. In Jolie co, inherent risk isnt high. Thus, I think it is 30%. c) Control risk Control risk is the risk that client controls fail to detect material misstatements. The internal control of Jolie co has just 3 members. However, there is only Lindsay who reports to the finance director. The other two internal auditors are currently studying
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for their professional examinations. The team was set up two years ago, and initially focused on introducing financial controls across all of Jolie Cos offices. It can be seen that the internal control of Jolie Co is poor and weak. Thus, I think control risk of Jolie Co will be 70%. d) Detection risk Detection risk is the risk that the auditors substantive procedures do not detect a misstatement that exists in an account balance or class of transactions that could be material, either individually or when aggregated with misstatements in other balances or classes. Base on the formula: AR = CR x IR x DR, so we will have: 5% = 70% x 30% x DR
DR =

5% = 23.8% 70% x 30%

Because detection risk is low (23.8%) so auditors will work many things and try their best to keep this ratio. It can be seen that the internal control of Jolie Co didnt operate effectively, so audit department has to carry out many processes and tests. Plan By analysing the draft statement of comprehensive income of Jolie Co, we can find out more evidences about problems and errors in sales and collection process. The number of phone and on-line orders in 2010 is 1,700,000 and higher than of 2009 (1,316,667) but the Profit before tax of 2010 is $220 million and less than of 2009 ($253 million). To identify the complexity problems, auditors should visit each business area relevant what they have accessed above such as on-line ordering computer system, phone ordering services, collect more information about financial statements (balance sheet, income and cash-flow statements). Besides that, auditors also need to use the following techniques:
+ Questionnaires: auditor uses these questions to collection information about

sales systems of Jolie Co: a) Are supplies examined on arrival as to quantity and quality ? b) Is such an examination evidenced in some way ? c) Is the receipt of supplies recorded, perhaps by means of goods inward notes ? d) Are receipts records prepared by a person independent of those responsible for: i.Ordering functions
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ii.The processing and recording of invoices e) Are goods inward records controlled to ensure that invoices are obtained for all goods received and to enable the liability for unbilled goods to be determined ? f) Are goods inward records regularly reviewed for items for which no invoices have been received ? g) Are any such items investigated ?
h) Are these records reviewed by a person independent of those responsible for

the receipt and control of goods ? (source: financial systems and auditing course book, pg. 556)
+ Evaluating questionnaires (ICEQs): auditor use this type of questionnaire for

staffs of Jolie Co to evaluating about internal control of this company a) Sales are properly authorised ? b) Sales are made to reliable payers ? c) All goods despatched are invoiced ? d) All invoices are properly prepared ? e) All invoices are recorded ? f) Invoices are properly supported ? g) Cash and cheques received are properly recorded and deposited ? (Source: financial systems and auditing course book, pg. 557)
+ Test of control: carrying out test of control will help auditor to evaluate companys

control is effective or not. There are two aspects of the relevant parts of the accounting and internal control systems about which auditors should seek to obtain audit evidence:
a) Design: the accounting and internal control systems are designed so as to be

capable of preventing or detecting material misstatements.

b) Operation: the systems exist and have operated effectively throughout the

relevant period (Source: financial systems and auditing course book, pg. 564) As we can see that, junior audits opinion is internal control has a lot of deficiencies. The internal audit team of Jolie Co has just three member. In fact, company has only Lindsay who works and reports to the finance director; the remaining two members are currently studying for their professional examinations. Thus, the internal audit team didnt have enough time to finish their task and Lindsay finds many instances
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of management policies not being adhered to, and the managers of each location are generally reluctant to introduce controls as they want to avoid bureaucracy and paperwork. As a result, Lindsays recommendations are often ignored. It can be seen that Jolie Co has problem about sales and collection, especially in cash-flow. Maybe they sell goods on credit and collect their debtors too slow or there are a lot of bad debt. Besides that, the financial costs is $25 million in 2010 and more than in 2009 ($22 million). Thus, the profit of Jolie will be decreased. If Jolie Co wants to improve its cash-flow, company should collect all debtor as soon as possible.
+ Substantive test: auditor should use substantive test to obtain audit evidence to

detect material misstatements in sales and collection, especially analytical review method and the following assertions:
a) Existence: an sales exists b) Rights and obligations: an sales belongs to the client c) Occurence: a transaction or event took place which relates to the client d) Completeness: all relevant sales, transactions and events are recorded, and

there are no undisclosed items

e) Valuation: an sales is recorded at an appropriate value f) Measurement: a transaction or event is measured at a proper amount and

allocated to the proper period

g) Presentation and disclosured: an item is disclosed, classified and described

in accordance with the applicate reporting framework. Accuracy: that all sales, transactions and events are recorded accurately. (Source: financial systems and auditing course book, pg. 565). Examples for analytical review method: Documents Sale ledger Sale invoice Sale order .... Tested area Check the balance of the account whether clients account has accounting code. Check whether the sale invoice is numbered evidence of matching sale invoice, sale order. Check whether orders are pre numbered in a sequence, so completeness and validity are easy to confirm. ....

After using types of questionnaires, test of control and substantive test; auditor needs to evaluate, check how the company report. It is true or false ? After that, auditor summarize and draw conclusions and ways to solve misstatements or problems if it happens. III. Identify and use appropriate audit tests and also record the audit process in an appropriate manner as per requirements Audit test is a procedure applied to a sample within a population the purpose of an audit test is to assure that no material exceptions are included in the sample Decision about the nature of audit test is related to the auditors choices about the type of evidence that they collect to support an opinion. There are three common types of audit procedures:
Risks assessment procedures that are designed to help the auditor assess the

risk of material misstatement in an assertion, whether performed early in the audit engagement or in the response to new information. Recall that the auditor uses risk assessment procedures to obtain evidence about inherent risks and the risk of fraud.
Test of Control that is designed to provide evidence about the operating

effectiveness of various aspect of internal control. Tests of control provide evidence to support control risk assessment below the maximum.
Substantive test that are designed to provide evidence about to fair presentation

of management's assertions in the financial statements. To seek for audit evidence from tests of control, auditors should consider the sufficiency and appropriateness of the audit evidence to support the assessed level of control risk. Test of control Tests of control are tests to obtain audit evidence about the effective operation of the accounting and control systems that properly designed controls identified in the preliminary assessment of control risk exist in fact and have operated throughout the relevant period. Test of control are sometimes called compliance tests. (Source: auditing 8th edition course book, pg. 105) Two points must be made on inspection and control:
1) It is the application of the system being tested is not traded, although testing is

through the medium of transaction.

2) If the discovery is made that the system did not follow a particular way then: He may need to review the description of his system and reevaluate its

effectiveness.
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 He will need to determine whether the failure of compliance is an isolated or a

symptom. Base on scenario, we can calculate the following ratios: Income over sale ratio of 2009 = Profit before tax x 100% 253 x 100% = = 16.48% 1,535 Sales 220 x 100% Profit before tax x 100% = = 15.12% 1,455 Sales

Income over sale ratio of 2010 =

Operating expense over sales ratio of 2009 =

Operating expense x 100% Sales 1,260 x 100% 82.1% 1,535 Operating expense x 100% Sales 1,210 x 100% 83.2% 1,455

Operating expense over sales ratio of 2010 =

= Substantive tests

Substantive procedures are tests to obtain audit evidence to detect material misstatement in the financial statements. There are generally of two types: a. Analytical procedure b. Other substantive procedures, such as test of details of transactions and balances, reviews of minutes of directors meeting and enquiry. (Source: auditing 8th edition course book, pg. 106) Both types of tests are used in external and internal audits in order to reach established audit objectives, as can be outlined in audit checklists or determined based on the results of audit questionnaires. Audit tests typically are performed on a sample basis over an existing group of similar transactions. Sampling approaches can either be statistical or non-statistical, with the ultimate goal being to obtain the most representative sample of the population before testing begins. In Jolie Co, some audit tests are required to provide reassurance that sales are recorded accurately and debts are collectable. To control the sales are recorded accurately, the following test could be carried out:
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 Check whether cash received was recorded. Prepare proof of cash receipts. Check to discover lapping of accounts receivable. To control the debt collection, the following test should be conducted: Check for proper authorization of the write-off of uncollectible accounts Verification of accounts written off Check that orders are only accepted from customers who are within their credit terms and credit limits Check that all new account on the sales ledger have been authorized by senior staff Record the audit process in an appropriate manner as per requirements Client Auditor Audit activities

Transaction

Audit planning

Continuously obtaining information about the clients business Continuous update of knowledge and understanding of clients internal control structure including control environment and activities Designing of audit strategy including applying audit risk model and preliminary audit programs

Accounting information system

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Internal control

Consideration of internal control structure

Continuous understanding and evaluation of internal control structure Performing electronic tests of controls Modifying audit programs

Process transaction

Substantive tests of detail transaction

Selecting appropriate electronic audit tools and techniques Performing audit procedures Ensuring reliable means of obtaining competent and sufficient audit evidence

General ledgers

Substantive test of account balances

Gathering sufficient and competent audit evidence Evaluating the and reliability evidence timeliness of audit

Monitoring continuous audit approach

Financial statements

Audit report

Issuing audit report Improving continuous audit approach Deciding whether to accept or continue a continuous audit engagement

IV. Explain the purpose and content of a statutory audit report related to Jolie Company
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The audit report is the means which the external auditors express their opinion on the truth and fairness of a companys financial statements. This is for the benefit of the shareholders and others users. Therefore, audit reports are always kept on public record with the financial statements. An audit report is the only output of the auditors work, which people outside the Internal Audit function get to see. It is a formal document summarizing the work done and reports the findings and recommendations. It is a means of communicating all of the auditor's work to management. The report must concisely present the total essence of the audit effort. Findings must be supported by sufficient evidence and be within the audit's scope and objectives. Each recommendation must fit the facts of the finding and materially reduce the potential risk as indicated by the facts of the finding. Each finding must be provable. It is not important what an auditor believes; the important thing is what the auditor can prove. Auditor beliefs, without proper documentation will not be carried to the report. An audit report should include:
a) Title: the report is addressed to the members of the company; the auditor is under

a statutory duty to report to the members of the company.

b) Scope: The purpose of this paragraph is to ensure that the elements of the

financial statements which are subject to audit are identified (by reference to the relevant page numbers in the annual report). The following financial statements needs to be identified: The Balance Sheet. The Profit and Loss Account. The Cash Flow Statement.
c) The basis of the opinion: this part show that the audit is conducted in

accordance with auditing standards, this gives a benchmark against which the quality of the audit may subsequently be judged in the event of any external scrutiny of the auditors work. The opinion: the auditor will give opinion on the financial statements give a true and fair view ; the financial statements have been prepared in accordance with the Companies Act 1985. Signature and date: the audit report must have signature and specific date. V. Explain and illustrate different types of qualification within an audit report
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There are three following types of qualification within an audit report:

Qualified opinions

Qualifications with respect to an auditor's opinion may be broadly classified into two categories; those qualifications which relate to the scope of the examination, and those qualifications with respect to the fairness of presentation in accordance with generally accepted accounting principles consistently applied. A qualified opinion restricts the auditors' responsibility for fair presentation in some areas of the financial statements. The opinion states that except for the effects of some deficiency in the financial statements, or some limitation in the scope of the auditors' examination, the financial statements are presented fairly. All qualified reports include a separate explanatory paragraph before the opinion paragraph disclosing the reasons for the qualification. The auditor finds 1 of 2 types of situations that don't comply with GAAP. The auditor determines the financial statements are presented fairly except for. Reasons: Single deviation from GAAP - occurs when one or more areas of the financial statements don't conform to GAAP, but don't affect the rest of the financial statements from being fairly presented when taken as a whole. Scope of limitation - occurs when the auditor couldnt audit one or more areas of the financial statements, and even though they couldnt be verified, the rest of the financial statements were audited and they conform GAAP.
Adverse opinions

An adverse opinion is the opposite of an unqualified opinion; it is an opinion that the financial statements do not present fairly the financial position, results of operations, and cash flows of the company, in conformity with generally accepted accounting principles. The auditors should express an adverse opinion if the statements are so lacking in fairness that a qualified opinion would not be warning enough. Whenever the auditors issue an adverse opinion, they should disclose in a separate paragraph of the report the reasons for the adverse opinion and the principal effects on the financial statements of the matters causing the adverse opinion. Adverse opinions are used when an auditor determines the financial statements are materially misstated, or as a whole don't conform with GAAP (Generally Accepted Accounting Principles)
Disclaimer of opinion

A disclaimer of opinion is no opinion. In an audit engagement, a disclaimer is required when substantial scope restricts or other conditions preclude the auditors' compliance with generally accepted auditing standards.
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Auditee means the person who was or is being audited. Reasons: A lack of independence, or material conflict(s) of interest, exist between the auditor and the auditee. There are significant scope limitations, whether intentional or not, which hinder the auditor's work in obtaining evidence and performing procedures There is a substantial doubt about the auditee's ability to continue as a going concern or, in other words, continue operating. There are significant uncertainties within the auditee. VI. Draft suitable management letters in relation to a statutory audit for Jolie Company Management Letter Jen & Co The Board of Directors, Jolie Co June 15th, 2011 Member of the board, Financial statements for the year ended 31 October 2007 In accordance with our normal practice, we set out in this letter certain matters which arose as a result of our review of the accounting systems and procedures operated by your company during our recent audit. We would point out that the matters dealt with in this letter came to our notice during the conduct of our normal audit procedures which are designed primarily for the purpose of expressing our opinion on the financial statement of your company. In consequence our work did not encompass a detail review of all aspects of the system and cannot be relied on necessarily to disclose defalcations or other irregular or to include all possible improvement in internal control 1. Inventory Present system The sales order form is passed to the warehouse where the goods are selected and packed and ready for despatch. The sales order form is then passed to the invoice
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typing section in the sales office, and sales invoices are prepared in triplicate with no serial numbers. Implication There is no serial number for the triplicate sales invoices. This would be hard for reconciliation Recommendation Put serial number in each invoice 2. Human Resources Present system The internal audit team has three members, including Lindsay who report to CFO. Other internal auditors are studying for their professional exams. Implication The internal audit department has not sufficient resources to work so they can't make an effective internal audit. Nine months ago, CFO guided the team to focus on the introduction of control activities to achieve cost savings from a cash flow problem is with the company. The team did not have time to do more testing financial control or operation. Recommendation Company needs to recruit staffs that have professional skills in accounting. When the internal audit department has enough staff, they will work efficiently and reduce the pressure. This will help Jolie Co to avoid financial risks. 3. The relationship between internal audit team and the managers Present system In the course of her work, Lindsay finds many instances of management policies not being adhered to, and the managers of each location are generally reluctant to introduce controls as they want to avoid bureaucracy and paperwork. As a result, Lindsays recommendations are often ignored. (Source: scenario) Implication The relationship between the internal audit team and the managers of each branch isn't good. The manager of each branch are generally reluctant to introduce control when they want to avoid bureaucracy and paperwork. This will directly affect the operation of Jolie Co.
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 Recommendation They often need to share ideas, information with member of the company and listen ideals of employees for working better. Our appreciations have been discussed with your CFO and chief accountant, we will consider these problems during the future audit. We will looking forward to receiving your reply on the points made. If Jolie Co needs more information or explanation, please contact us immediately. This letter has been written for the sole use of your company. It hasn't been disclosed for third party. We should take this opportunity to thank for your staff because of their cooperation and helping for our audit process. Yours faithfully Jen & Co

Conclusion In general, the above report shows our analysis and appreciation about finance and trading operation situation of Jolie Co. We provide a statistical analysis on the clarity and effectiveness of the accounting policies put in place by the company. Jolie Co should consider and change for trading better. References Edexcel HNC/HND business (2004) Finance specialist units 9 12, supporting foundation degrees course book. London: BPP Professional Education Aldine house, Aldine place. Continuum (2002) Auditing 8th edititon course book. 11 York Road, London SE1 7NX. Scenario. Businessdictionary, Auditee, available from http://www.businessdictionary.com/definition/auditee.html accessed on June 15th, 2011.

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