UNIT 1 AUDIT APPROACH

NIK AZIDA BINTI ABD GHANI

013-9337550
nikazida5@yahoo.com
Description of Auditing
Auditing is the accumulation and
evaluation of evidence about
information to determine and report on
the degree of correspondence between
the information and established criteria.
Auditing should be done by a competent
and independent person.
Information and criteria
Information should be in a verifiable form.
Information is evaluated against some standards
(criteria) these criteria depend on the information
being audited. For example, for the audit of tax
returns by Inland Revenue Board, the criteria are
found in the Income Tax Act.
For subjective information, the criteria should be
agreed upon before the audit starts.

Evidence
Information used by the auditor to determine whether the
information being audited is stated in accordance with the
established criteria.
Forms of evidence:
Oral testimony of the client
Written communication with outsiders
Observations by the auditor
Electronic data about transactions
Evidence should be obtained in sufficient quality and volume
(types and amount of evidence necessary to evaluate whether
the information correspond to the established criteria.
Auditor
Must be qualified (to understand the
criteria used)
Must be competent (to know the types
and amount of evidence to accumulate)
Must have an independent mental
attitude (not biased)
Report
Audit report communication of the
auditors findings to users.
To inform users the degree of
correspondence between
information and established criteria.
Interim Audit
Conducted during the fiscal year.
Usually to minimize the work and time involved
in concluding the audit after the fiscal year.
Provide shareholders and other interested
parties with final audit data sooner than if the
final audit was commenced after the fiscal year
was completed.
An interim audit does not usually yield any
formal reports from the external auditors.
Interim Audit
Example: A corporation might have an
interim audit covering the first nine
months of the fiscal year so that at the
end of the fiscal year most of the
auditing will focus on the last three
months of the fiscal year thus allowing
for a comprehensive audit and early
completion of the audit reports.
Compliance Audit
Conducted to determine whether the
auditee is following specific
procedures, rules or regulations set by
some higher authority.
Results of compliance audit are
reported to someone within the
organizational unit rather than to a
broad spectrum of users.
Compliance Audit
Example of compliance audit:
To determine whether accounting
personnel are following the procedures
prescribed by the company controller.
Reviewing wage rate for compliance with
minimum wage rates.
Examining contractual agreement with
banker/ other lenders for compliance with
legal requirements.
Financial Statement Audit:
Conducted to determine whether the
overall financial statements are stated in
accordance with specified criteria.

The auditor performs appropriate tests to
determine whether the statements
contain material errors or other
misstatements.
Financial Statement Audit

Strategic systems audit approach:
The auditor should identify risks associated
with clients strategies by considering the
clients business strategies, processes and
measurement indicators for critical success
factors related to the strategies.
Differences between types of audit
approach - Interim Audit, Financial
Statement Audit and Compliance
Audit
Purpose
Timing
Report
Extent

Flowchart:
Used to visualize complex systems involved in
an organization (especially on internal
accounting control).
Can provide a concise overview of the clients
system (analytical tool in evaluation).
Aids management and auditor in identifying
inadequacies by facilitating a clear
understanding of how the system operates.
Flowchart:
Allow an auditor to find where a problem may
be, and visualize from where the problem
stems.
Easier to read and easier to update.
May be used in replace of narrative ease of
understanding by current and subsequent
year auditors and relative cost of preparation.
Audit Test:
A procedure performed by either an external or
internal auditor in order to assess the accuracy of
various financial statement assertions.
Typically are performed on a sample basis over
an existing group of similar transactions.
Sampling approaches - statistical or non-
statistical (to obtain the most representative
sample of the population before testing begins).
Two common categorizations of audit tests are:
substantive tests
tests of internal controls
Substantive Audit Test:
A direct test that validates a financial
statement balance (often requires a large deal
of recalculating, confirming, and vouching)

Internal Control Test:
Focused on key controls, such as management
reviews or standardized templates, that are
designed to prevent and detect material
misstatements.
Types of Audit Test:
Vouching
Verification
Test of control (compliance test)
Substantive test
Walk-through test
Depth test
Weakness test
Rotational test


Refers to the inspection of documentary evidence supporting
and substantiating a transaction, by an auditor.
Consists of:
Selecting an item for testing from the accounting journals or
ledgers and then examining the underlying source documents -
verifying a transaction recorded in the books of account with the
relevant documentary evidence (such as invoices, debit and credit
notes, statements, receipts) - provide evidence that items included
in the accounting journals or ledgers have occurred (are valid).
Verifying the authority.
Confirming that the amount mentioned in the voucher has been
posted to an appropriate account included in the final statements
of account.
Example: vouch a sample of recorded acquisition transactions
to vendors invoices and receiving reports.
Objective of Vouching:
To establish that the transactions
recorded in the books of accounts :
are in order
have been properly authorized
are correctly recorded.
Vouching is the essence or backbone of
auditing because when performing an
audit, an auditor must have proof of all
transactions.
Importance of Vouching:
Due care and attention are to be given to
vouching in auditing
Auditor can be charged with negligence
Example: Armitage v. Brewer and Knott
the auditors were found to be guilty on
negligence
auditors did not display enough reasonable care
and skill in vouching the wage sheets failed to
detect fraud in manipulation of these wage
records and cash vouchers).
When vouching/examining a transaction, ensure that:
The date of the voucher falls within the accounting period;
Voucher/transactions therein are duly and properly authorized
by the relevant signatory.
The transactions being examined belongs to the entity.
The transaction is recorded in the proper account and revenue
or expenses is properly allocated to the accounting period.
All transaction which have actually occurred have been
recorded.
The posting from the voucher of the amount needs to be
correctly taken in the final accounts, disclosed in accordance
with recognized accounting policies and procedures.
Example of vouching in a commercial bank:
The purpose of an audit of a commercial bank is to verify
the accuracy of the existing accounting system.
Through the process of vouching and verification,
auditors can draft an opinion as to the accuracy and
completeness of a bank's finances and records as well as
ensure the over all financial health of the bank is in good
standing.
The inspection of documents compared to records is
called the vouching procedure. A document is proof that
a transaction occurred. The document is compared to
the supporting record to verify a sales transaction took
place.
A substantive audit procedures that deal
with examining the balance sheet
transactions.
To establish the truth of something -
involves gathering evidence that will lead to
a conclusion as to whether classes of
transactions, balances and disclosures
reflected in the clients financial statements
are properly stated (true and fair).
Encompasses the inquiry into the
ownership/ title, existence, valuation,
completeness and presentation of assets
and liabilities in the balance sheet.
Deals with the final balance of profit and
loss - also applies to profit and loss item to
check the account balances and their
presentation.

The type(s) of technique(s) used depend on
the audit objectives that the auditor is seeking
to achieve.

The general objective to be achieved by audit
verification work is to establish whether the
financial statements present a true and fair
view.
If the controls systems are:
effective and operating as laid down, the amount
of verification work will be reduced.
weak or are not operating effectively, a high level of
verification work will be performed.

In carrying out substantive audit tests
(verification work) the auditor will be
looking for evidence on different
assertions at the financial statements level:
Assertions about classes of transaction and
event for the period under audit.
Assertions about account balances at the period
end.
Assertions about presentation and disclosure.

a) Assertions about classes of transactions and events
for the period under audit;
Occurrence transactions and events that have been
recorded have occurred and pertain to the entity;
Completeness - all transactions and events that
should have been recorded have been recorded;
Accuracy - amounts and other data relating to
recorded transactions and events have been
recorded appropriately.
Cutoff - transactions and events have been recorded
in the proper period.
Classification - transactions and events have been
recorded in the proper accounts.

b) Assertions about account balances at the period end.
Existence - assets, liabilities, and equity interests exist;
Rights and obligations - the entity holds or controls the
rights to assets, and liabilities are
the obligations of the entity;
Completeness all assets, liabilities and equity interests
that should have been recorded have been recorded;
Valuation and allocation - assets, liabilities, and equity
interests 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
Occurrence and rights and obligations disclosed events,
transactions and other matters have occurred and pertain
to the entity.
Completeness - all disclosures that should have been
included in the financial statements have been included;
Classification and understandability - financial
information is appropriately presented and described, and
disclosures are clearly expressed;
Accuracy and valuation - financial and other information
are disclosed fairly and at appropriate amounts.
Verification means to obtain and examine evidence
in respect of an item of asset that:
The asset exists on a given date.
The asset is legally owned by the concern.
There are no unrecorded assets.
The assets are disclosed, classified, and
presented in accordance with recognized
accounting policies and the requirement of law.
Audit techniques that may be used: physical
inspection, observation and confirmation.
Verification of asset is an important audit technique -
limited to inspection of assets and collection of
information about the assets.
Verification of assets is primarily the responsibility of the
management:
Management are expected to have a much greater
knowledge of the assets of the business (condition, location
etc.) than that which an outsider might be able to acquire on
their inspection.
Are competent to determine the values of the assets at
which they should be included in the Balance Sheet.
The auditor is only expected to apply his skill and
expertise considering the value of each asset with a view
to confirm that they are truly and fairly disclosed in the
Balance Sheet.
Differences between vouching and verification:
Vouching is a substantive test procedure that deals with profit
and loss transactions/ items.
Verification is a substantive test procedure that deals with
examination of balance sheet transactions/ items whether they
are assets or liabilities are properly stated in the balance sheet.
Vouching is the substantive testing of transactions at their
point of origin whereas verification usually deals with the final
balance in the balance sheet and profit and loss.
VOUCHING VERIFICATION
Nature Is a substantive audit procedure
which deals with examination of
profit and loss transactions/items
- Is a substantive audit procedure which
deals with examination of balance sheet
transactions/items Also applies to profit
and loss item to check the account
balances and their presentation
Deal
with
Vouching is the substantive
testing/examination of transaction
at their POINT OF ORIGIN

Deals with the FINAL BALANCE in the Final
Accounts viz the balance sheet and profit
and loss

Purpose whether the transactions are
genuine and valid to enable the
auditor to report on the financial
statements
Whether assets or liabilities are properly
stated in the balance sheet and profit and
loss item correct account balances and
presentation
Process When vouching/examining a
transaction, the essential points
need to be ensured, such as
The date of the voucher falls within
the accounting period.

Verification process encompasses the
inquiry into the ownership/ title,
existence, valuation, completeness and
presentation of assets and liabilities in the
balance sheet.

Test of Control (compliance test):
Purpose: procedures to test effectiveness of
controls in support of reduced assessed control
risk.
Assessing control risk consider the design and
operation of controls to evaluate whether they will
likely to be effective in meeting transaction-
related audit objectives (worth relying upon).
If the auditor is not satisfied with the test of
control, substantive test (comprehensive) will be
carried out.
Assessing control risk:
Auditor needs to obtain understanding of
internal control: design and operation.
Preliminary assessment of control risk made:
Whether the entity is auditable (integrity of
management and adequacy of accounting records).
For each transaction-related audit objective for each
major types of transaction in each transaction cycle.
Example: in the sales and collection cycle, the types of
transactions usually involve sales, sales returns and
allowances, cash receipts, and the provision for and
write-off of uncollectible accounts.
Identifying
transaction-
related
audit
objective
may involve
the usage
of control
risk matrix
Identify transaction-related audit
objectives
Identify existing controls
Associate controls with transaction-
related audit objectives
Identify and evaluate:
control deficiencies,
significant deficiencies and
material weaknesses
Transaction-
related
Existence
Completeness
Accuracy
Classification
Timing
Posting and
Summarization
Balance-
related
Existence
Completeness
Accuracy
Classification
Cutoff
Detail tie-in
Realisable value
Rights and obligation
Presentation and
disclosure
AUDIT
OBJECTIVES
exist if the design or operation of control does not permit prevention or
detection of misstatements on a timely basis.
Control deficiencies
exist if one or more control deficiencies exist that, more than remotely
(slight chance of occurrence), adversely affect companys ability to
initiate, authorize, record, process or report external financial statement
reliably such that there is more than a remote likelihood that a
misstatement that is more than inconsequential (a reasonable person
would conclude that the misstatement would clearly be immaterial to the
financial statement) will not be prevented or detected.
Significant deficiencies
exist if a significant deficiency or a combination with other deficiencies,
results in more that remote likelihood that internal control will not
prevent or detect material financial statement misstatement.
Material weaknesses
Substantive Test
are performed in order
to detect material
misstatements at the
assertion level (Like;
occurrence,
completeness, accuracy,
valuation, existence,
rights and control)
include tests of details of
classes of transactions,
account balances and
disclosures and
substantive analytical
procedures.

3 types of
substantive test
Substantive test
of transactions
Analytical
procedures
Test of details of
balances
Substantive test of transactions:
Purpose: to determine whether transaction-
related audit objectives have been satisfied
(Existence, Completeness, Accuracy,
Classification, Timing, and Posting and
Summarization).
May be done simultaneously with tests of
control since both tests are performed for
transactions in the cycle and not the ending
account balances.


Walk-through Test:
A combination of observation, documentation and
inquiry in the form of a transaction walkthrough.
The auditor selects one or a few documents for the
initiation of a transaction type and traces them (step-
by-step) through the entire accounting process to
learn how a process works.
The auditor is required to perform at least one
walkthrough for each major class of transactions.
Purpose: to establish reliability of clients accounting
and internal control procedures and to reveal system
deficiencies and material weakness that need to be
rectified at the earliest.
Depth Test:
aka cradle-to-grave tests
Involves taking a transaction or a number of transactions and
following them through the accounting system from start to finish
or vice versa
Purposes/Objectives:
To provide audit evidence to assist the auditor in arriving at his
opinion where the auditor is still unable to form an opinion from
the results of the walk-through test.
To confirm the accuracy of clients accounting system (walk-
through checks) - involve only a small number of transactions.
To perform compliance test (the auditor may use a number of
transactions, testing the control in depth at each stage). Such tests
will provide evidence as to whether or not he may rely upon that
control in planning later audit work.
To provide evidence of a substantive nature (to check that
transactions have been properly recorded in the accounting
records or in the financial statements.
Weakness Test:
If the compliance test reveal weaknesses in the
application of the system, additional tests
(weakness test) that may be necessary to
establish the extent of the weaknesses and their
effect on the reliability of the accounting records.
Only carried out in areas where material error
could occur.
Purpose: to establish whether material errors
have in fact occurred (if they have, an extended
program of work on the verification of associated
asset will be carried out).
Rotational Test:
To improve audit approach efficiency, some firms rely to varying
degrees on controls tested in previous engagements. Controls are
therefore tested on a rotation basis.
If the auditor plans to use audit evidence about the operating
effectiveness of controls obtained in prior audits, the auditor should
obtain audit evidence about whether changes in those specific
controls have occurred subsequent to the prior audit (by performing
enquiry in combination with observation or inspection to confirm
the understanding of those specific controls).
All controls should be tested at least once every third audit.
May be applied as long as the controls identified have not changed
since they were last tested and the assessed risk of material
misstatement at the assertion level is not significant.
Audit procedures:
Detailed instructions for the collection of a type of audit
evidence that is to be obtained at some time during the
audit.
Use specific terms to permit their use as instructions
during the audit.
Example: obtain the cash disbursements journal and
compare the payee name, amount and date on the
cancelled check with the cash disbursements journal.
The audit procedures to be followed on an engagement
are indicated in the audit program (Typically, it
specifies the name of the auditor responsible for a given
job including the estimated time to conduct the audit
task. The audit program guides and controls the work of
staff assistants.). The work paper indicate what has
been done on the audit.

Audit techniques - Methods used to obtain
audit evidence:
Inspection
Observation
Inquiry
Confirmation
Computation
Analytical review
Audit techniques may change depending on
circumstances (verification of cash differs from
verification of debtors) or nature of
organization (manufacturing, trading or
professional).

Audit Procedures Audit Techniques
Steps taken to obtain audit
evidence.
Methods used to obtain audit evidence.

Broadly classified into
compliance procedures and
substantive procedures.
Examples are posting checking, casting
checking, physical examination and count,
confirmation, inquiry, year-end scrutiny, re-
computation, tracing in subsequent period and
bank reconciliation.
Procedures may comprise a
number of techniques and
represents the broad frame of
the manner of handling the audit
work.
Techniques stands for the methods employed
to carry out the procedure.
Example: substantive procedure
requires an examination of the
documentary evidence.
This job is performed by the procedure known
as vouching which involve techniques of
inspection and checking computation of
documentary evidence.
Audit Procedures Audit Techniques
Offer detailed audit steps which are
to be performed during the audit
fieldwork.
Offer a range of choice of
methods to obtain the
evidence.

Provide detailed steps to be
followed in order to achieve the
explicit audit objectives.
Methods to obtain
evidence must take into
consideration the
circumstances and nature
of organization.

Audit procedures through:
Test of control to test effectiveness of
controls.
Analytical procedures to understand clients
industry and business, assess going concern,
indicate possible misstatements and reduce
detailed tests
Substantive procedures - to detect material
misstatements at the assertion level.
Make inquiries of appropriate client personnel.
Examine documents, records and reports (a trail of
documentary evidence) ensure that they are complete,
properly matched and authorized.
Observe control-related activities (which do not have a
trail of documentary evidence) example: separation of
duties.
Re-perform client procedures (for control-related
activities that do have related documents and records
but the content is insufficient for audit purpose of
assessing whether controls are operating effectively
example: price on sales invoices to be traced to the
authorized price list in effect at the date of transaction).
Procedures of Test of Control
Control-related Activities
Accountability for time and costs
Accuracy of computations
Supporting documentation
Followup action
Segregation of duties
Accountability for authorization
Depends on preliminary assessed control
risk.
For lower assessed control risk more
extensive tests of controls are applied
(number of controls tested and extent of
tests for each control). Example: larger
sample size for documentation, observation
and re-performance procedures.
May rely on evidence from the prior years
audit if key control was operating
effectively and still in place, the extent of
tests of control may be reduced in the
current year.
Testing less than the entire audit period
depend on nature of control and the
frequency that they are performed.
Extent of
Procedures of
Tests of Control
Are applied only when the assessed
control risk has not been satisfied by the
procedures to obtain an understanding.
Performed on larger samples of
transactions and observations are made
at more than one point in time.
Tests of control
Procedures are applied to all controls
identified during that phase.
Only performed on one or a few
transactions or at a single point in time
(for observations).
Procedures to
obtain an
understanding
Definition of Analytical Procedures:
Analysis of significant ratios and trends including the
resulting investigation of fluctuations and relationship
that are inconsistent with other relevant information or
which deviate from predicted amounts.
Analytical Procedures:
Uses comparisons and relationship to assess account
balances or other data appear reasonable.
Example: comparison of current years recorded
commission to total recorded sales multiplied by
average commission rate (to test the overall
reasonableness of recorded commission).
industry data
similar prior-period
data
client-determined
expected results
auditor-determined
expected results
expected results,
using non-financial
data
compare client
data with
Purposes of Analytical Procedures:
Understand clients industry and
business.
Assess going concern (likelihood of
financial failure).
Indicate possible misstatements
(attention directing).
Reduce detailed tests.
Compare client data with industry data
Aid understanding of clients business.
As indication of likelihood of financial failure
(also strength of clients capital structure,
borrowing capacity).
Weakness:
nature of clients financial information may differ
from the other firm that form the industrys total.
Difference in accounting methods may affect
comparability of data.
To overcome the weakness: compare the
clients data to one or more benchmark firms
in the industry.

Compare client data with similar prior-period data
Compare the current years balance with that of the
preceding year (identify cause of significant change
errors, misstatements, or need more attention).
Compare the detail of a total balance with similar detail
for the preceding year (comparison of details over time or
at a point in time).
Compute ratios and percentage relationships for
comparison with previous year (take into consideration
the growth or decline in business activities and
relationship of data to other data). Examples of ratio
analysis:
Raw material turnover (for manufacturing company).
Sales commission divided by net sales.
Individual manufacturing expenses as a percentage of total
manufacturing expense.
Compare client data with client-determined
expected results
Pay attention to significant areas in which
differences exist between budgeted and actual
results (may indicate potential misstatements).
Auditor needs to evaluate whether the budgets
were realistic (discussion of budget
procedures).
Auditor needs to check the possibility that
current financial information was changed to
conform to the budget (assess control risk and
perform detailed audit tests of actual data).
Compare client data with auditor-determined
expected results
Auditor estimates the expected balance by:
Relating to other balance sheet/ income statement
account/accounts (example: calculation of interest
expense on long-term notes payable by multiplying
ending balance by the average monthly interest
rate).
Making projection based on some historical trend
(example: using moving average of the allowance for
uncollectible accounts receivable as a percentage of
gross accounts receivable at the end of the audit
year).
Compare client data with expected results
using nonfinancial data
Auditor estimates the expected balance by:
Taking into consideration the nonfinancial data
such as the number of rooms, room rate for each
room and occupancy rate.
Consider also the accuracy of the data (example:
occupancy rate may be more difficult to be
evaluated on accuracy).
Cash ratio, Quick ratio or Current ratio
Short-term debt paying ability
Account receivable turnover, Inventory turnover or Days to sell
inventory
Liquidity activity ratios
Debt to equity ratio or Times interest earned
Ability to meet long-term debt obligations
EPS, Gross profit percent, Profit margin or ROA
Profitability ratios
Substantive Procedures:
Substantive procedures are performed in order to detect
material misstatements at the assertion level and include
tests of details of classes of transactions, account balances
and disclosures and substantive analytical procedures.
If a high level of assurance is obtained from the tests of
control and substantive analytical procedure, the extent of
the substantive test of details can be reduced.
When the auditor has determined that an assessed risk of
material misstatement at the assertion level is a
significant risk, the auditor should perform substantive
procedures that are specifically responsive to that
risk.


Substantive
procedures
Substantive
analytical
procedures
Trend analysis
Ratio analysis
Reasonableness
testing
Tests of details
Entire population
Specific item testing
Substantive sampling
Substantive Procedures involve :
Agreeing the financial statements to the
underlying accounting records;
Examining material journal entries and
other adjustments made during the course
of preparing
the financial statements.