11 Audit Procedures and sampling Flashcards
test yourself
1
Q
What are substantive procedures?
A
substantive procedures are tests to obtain audit evidence to detect material misstatements in the financial statements.
2
Q
What are the types of assertions for completeness and the typical audit tests?
A
Classes of transactions and related disclosures Account balances and related disclosures:
(a) Review of post year end items (b) Cut-off testing (c) Analytical review (d) Confirmations (e) Reconciliations to control account
3
Q
What are the types of assertions for Rights and obligations and the typical audit tests?
A
Account balances and related disclosures
Confirmations with third parties
Reviewing invoices for proof that item belows to the company
4
Q
What are the types of assertions for Accuracy, valuation and allocation and the typical audit tests?
A
Account balances and related disclosures:
valuation and allocation
Account balances and related disclosures
(a) Matching amounts to invoices (b) Recalculation (c) Confirming accounting policy is consistent and reasonable (d) Review of post year end payments and invoices (e) Expert valuation
5
Q
What are the types of assertions for Existence and the typical audit tests?
A
Account balances and related disclosures:
(a) Physical verification (b) Third-party confirmations (c) Cut-off testing
6
Q
What are the types of assertions for Occurrence and the typical audit tests?
A
Classes of transactions and related disclosures:
(a) Inspection of supporting documentation (b) Confirmation from directors that transactions relate to business (c) Inspection of items purchased
7
Q
What are the types of assertions for Accuracy and the typical audit tests?
A
Classes of transactions and related disclosures:
(a) Recalculation of correct amounts (b) Third-party confirmation (c) Analytical review
8
Q
What are the types of assertions for Classification and the typical audit tests?
A
Classes of transactions and related disclosures:
(a) Confirming compliance with law and accounting standards (b) Reviewing notes for understandability
9
Q
What are the types of assertions for Cut-off and the typical audit tests?
A
Classes of transactions and related disclosures:
(a) Cut-off testing (b) Analytical review
10
Q
Use the following model for drawing up an audit plan:
A
Agree opening balances with previous year’s working papers Review general ledger for unusual records Agree client schedules to/from accounting records to ensure completeness Carry out analytical review Test transactions in detail Test balances in detail Review presentation and disclosure in account
11
Q
What are the two types of substantive tests?
A
Analytical procedures Tests of detail of transactions, account balances and disclosures
12
Q
Whata re the two categories substantive procedures fall into?
A
Tests to discover errors (resulting in over- or understatement) Tests to discover omissions (resulting in understatement)
13
Q
Tests designed to discover errors start with…
A
tests will start with the accounting records in which the transactions are recorded to supporting documents or other evidence. Such tests should detect any overstatement and also any understatement through causes other than omission
14
Q
Tests designed to discover omissions
A
These tests must start from outside the accounting records and then matched back to those records. Understatements through omission will never be revealed by starting with the account itself, as there is clearly no chance of selecting items that have been omitted from the account
15
Q
example of Tests designed to discover errors
A
if a test is designed to ensure that sales are priced correctly, it would begin with a sales invoice selected from the sales ledger. Prices would then be checked to the official price list
16
Q
example of Tests designed to discover omissions
A
if a test is designed to discover whether all raw material purchases have been properly processed, it would start with goods received notes to be agreed to the inventory records or purchase ledger.
Exam
17
Q
What does the concept of directional testing come from?
A
The concept of directional testing derives from the principle of double-entry bookkeeping, in that for every debit there should be a corresponding credit. Therefore, any misstatement of a debit entry will result in either a corresponding misstatement of a credit entry or a misstatement in the opposite direction, of another debit entry.
18
Q
Give an example of Testing debit items (expenditure or assets) for overstatement by selecting debit entries recorded in the nominal ledger and checking value, existence and ownership
A
If a non-current asset entry in the nominal ledger of $1,000 is selected, it would be overstated if it should have been recorded at anything less than $1,000 or if the company did not own it, or indeed if it did not exist (eg it had been sold or the amount of $1,000 in fact represented a revenue expense).
19
Q
Give an example of a Test credit items (income or liabilities) for understatement by selecting items from appropriate sources independent of the nominal ledger and ensuring that they result in the correct nominal ledger entry
A
Select a goods despatched note and agree that the resultant sale has been recorded in the nominal ledger sales account. Sales would be understated if the nominal ledger did not reflect the transaction at all (completeness) or reflected it at less than full value (say, if goods valued at $1,000 were recorded in the sales account at $900, there would be an understatement of $100). `
20
Q
When are analytical procedures used?
A
Analytical procedures are used at all stages of the audit, including as substantive procedures. When using analytical procedures as substantive tests, auditors must consider the information available, assessing its availability, relevance and comparability
21
Q
What do analytical procedures include?
A
Comparable information for prior periods Anticipated results of the entity, from budgets or forecasts Expectations prepared by the auditors (eg estimation of depreciation) Industry information
22
Q
What do other analytical procedures include?
A
(b) Those between elements of financial information that are expected to conform to a predicted pattern based on the entity’s experience, such as the relationship of gross profit to sales (c) Those between financial information and relevant non-financial information, such as the relationship of payroll costs to number of employees
23
Q
ISA 520 states that when using analytical procedures as substantive tests, the auditor must:
A
a) Determine the suitability of particular analytical procedures for given assertions. (b) Evaluate the reliability of data from which the auditor’s expectation of recorded amounts or ratios is developed. (c) Develop an expectation of recorded amounts or ratios and evaluate whether this is sufficiently precise to identify a misstatement that may cause the financial statements to be materially misstated. (d) Determine the amount of any difference that is acceptable without further investigation.
24
Q
When are substantive analytical procedures applicable
A
Substantive analytical procedures are usually more applicable to large volumes of transactions that tend to be predictable over time. The suitability of a particular analytical procedure will depend on the auditor’s assessment of how effective it will be in detecting material misstatements. Determining the suitability will be influenced by the nature of the assertion and the auditor’s assessment of the risk of material misstatement
25
The ISA sets out factors which influence the reliability of data: Give an example of source of information
Information may be more reliable when obtained from independent sources outside the entity.
26
The ISA sets out factors which influence the reliability of data: Give an example of Comparability of information available
Broad industry data may need to be supplemented so it is comparable to that of an entity that produces and sells specialised products.
27
The ISA sets out factors which influence the reliability of data: Give an example of Nature and relevance of the information available
Whether budgets have been set up as results to be expected rather than goals to be achieved.
28
The ISA sets out factors which influence the reliability of data: Give an example of Controls over the preparation of the information to ensure its completeness, accuracy and validity
Controls over the preparation, review and maintenance of budget
29
Give an example of the factors which need to be considered with The accuracy with which the expected results of analytical procedures can be predicted
The auditor may expect greater consistency in comparing the relationship of gross profit to sales from one period to another than in comparing discretionary expenses, such as research and advertising.
30
Give an example of the factors which need to be considered with The degree to which information can be disaggregated
Analytical procedures may be more effective when applied to financial information on individual sections of an operation or to the financial statements of components of a diversified entity than when applied to the financial statements as a whole
31
Give an example of the factors which need to be considered with The availability of the information
The auditor may consider whether financial information (eg budgets and forecasts) and non-financial information (eg number of units produced or sold) is available.
32
With practical analytical techniques rovide comparisons of ratio analysis
Ratio analysis can be a useful technique. However, ratios mean very little when used in isolation. They should be calculated for previous periods and for comparable companies
33
Examples of Other analytical techniques include:
(a) Examining related accounts in conjunction with each other. Often revenue and expense accounts are related to accounts in the statement of financial position and comparisons should be made to ensure relationships are reasonable. (b) Trend analysis. Sophisticated statistical techniques can be used to compare this period with previous periods. (c) Reasonableness test. This involves calculating the expected value of an item and comparing it with its actual value; for example, for straight-line depreciation. (Cost + Additions – Disposals) Depreciation % = Charge in statement of comprehensive income
34
Give examples of important accounting ratios
Gross profit margins, in total and by product, area and months/quarter (if possible) Operating profit margin Receivables collection period (average collection period in days) Payables payment period (average payment period in days) Inventory holding period (average number of days' inventory is held) Inventory revenue ratio (revenue divided into cost of sales) Current ratio (current assets to current liabilities) Quick or acid test ratio (liquid assets to current liabilities) Gearing ratio (debt capital to equity capital) Return on capital employed (profit before tax to total assets less current liabilities
35
What are some of the related items as examples of financial ratios
Payables and purchases Inventories and cost of sales Non-current assets and depreciation, repairs and maintenance expense Intangible assets and amortisation Loans and interest expense Investments and investment income Receivables and bad debt expense Receivables and sales
36
Give other examples of consideration?
Examine changes in products, customers and levels of returns Assess the effect of price and mix changes on the cost of sales. Consider the effect of inflation, industrial disputes, changes in production methods and changes in activity on the charge for wages
37
Give More examples of consideration?
Obtain explanations for all major variances analysed using a standard costing system. Particular attention should be paid to those relating to the over- or under-absorption of overheads since these may, inter alia, affect inventory valuations Compare trends in production and sales and assess the effect on any provisions for obsolete inventory Ensure that changes in the percentage labour or overhead content of production costs are also reflected in the inventory valuation
38
Give examples of review of other expenditure
Review other expenditure, comparing: – Rent with annual rent per rental agreement – Rates with previous year and known rates increases – Interest payable on loans with outstanding balance and interest rate per loan agreement – Hire or leasing charges with annual rate per agreements – Vehicle running expenses with those expected for the company's vehicles – Other items related to activity level with general price increase and change in relevant level of activity (for example telephone expenditure will increase disproportionately if export or import business increases) – Other items not related to activity level with general price increases (or specific increases if known)
Review statement of comprehensive income for items which may have been omitted (eg scrap sales, training levy, special contributions to pension fund, provisions for dilapidation)
39
How do yo Ensure expected variations arising from the following have occurred:
– Industry or local trends – Known disturbances of the trading pattern (for example strikes, depot closures, failure of suppliers)
40
The working papers must contain the completed results of analytical procedures. They should include
The outline programme of the work The summary of significant figures and relationships for the period A summary of comparisons made with budgets and with previous years Details of all significant fluctuations or unexpected relationships considered Details of the results of investigations into such fluctuations/relationships The audit conclusions reached Information considered necessary for assisting in the planning of subsequent audits
41
Substantive analytical procedures help auditors to test for a wide range of financial statement assertions. Generally, analytical procedures can provide evidence on
Financial statement assertion tested
all financial statement assertions relating to classes of transactions and related disclosures all financial statement assertions relating to account balances and related disclosures except for rights and obligations
42
In Classes of transactions and related disclosures: Compare the current year gross profit margin with the prior year gross profit margin and with industry trends
Financial statement assertion tested
Occurrence and completeness of revenue Cut-off of revenue Accuracy of revenue Occurrence and completeness of cost of sales Accuracy of cost of sales Classification of cost of sales
43
In Classes of transactions and related disclosures: Compare the current year effective tax charge with the applicable rate of corporation tax for the period
Financial statement assertion tested
the applicable rate of corporation tax for the period
Accuracy of tax expense Completeness of tax expense and disclosures
44
In Classes of transactions and related disclosures: Perform a proof-in-total of payroll (based on number of employees multiplied by average wage)
Financial statement assertion tested
| Occurrence and completeness of payroll expenses Accuracy of payroll expenses Cut-off of payroll expense
45
In Account balances and related disclosures:
| Compare the current year receivables collection period to that of the prior year
Financial statement assertion tested
Existence and completeness of trade receivables Accuracy, valuation and allocation of trade receivables Accuracy, valuation and allocation of provision for irrecoverable receivables
46
In Account balances and related disclosures:
| Calculate the current year current ratio and compare with that of the prior year
Financial statement assertion tested
Existence and completeness of current assets Accuracy, valuation and allocation of current assets Existence and completeness of current liabilities Accuracy, valuation and allocation of current assets Presentation of going concern disclosures
47
in Both classes of transactions and account balances:
Calculate the effective rate of interest on borrowings and compare it to the applicable rate stated in the relevant loan agreements
Financial statement assertion tested
| Accuracy of interest expense Completeness of interest expense Accuracy, valuation and allocation of borrowings
48
ISA 520 states that where analytical procedures identify fluctuations or relationships that are inconsistent with other relevant information or that differ significantly from the expected results, the auditor shall investigate by:
Enquiries of management and obtaining appropriate audit evidence relevant to management's responses Performing other audit procedures if necessary (eg if management cannot provide an explanation or the explanation is not adequate)
49
When auditing accounting estimates, auditors must:
Test the management process Use an independent estimate Review subsequent events In order to assess whether the estimates are reasonable.
50
What is the auditors objective in obtain appropriate audit evidence about accounting estimate
The auditor's objective is to obtain sufficient appropriate audit evidence about whether accounting estimates are reasonable and related disclosures are adequate.
51
Define:accounting estimate; Estimation uncertainty; Management's point estimate; Auditor's point estimate or auditor's range
An accounting estimate is an approximation of a monetary amount in the absence of a precise means of measurement. Estimation uncertainty is the susceptibility of an accounting estimate and related disclosures to an inherent lack of precision in its measurement. Management's point estimate is the amount selected by management for recognition or disclosure in the financial statements as an accounting estimate. Auditor's point estimate or auditor's range is the amount, or range of amounts, respectively, derived from audit evidence for use in evaluating management's point estimate
52
Give examples of accounting estimate:
Allowance for doubtful accounts Inventory obsolescence Warranty obligations Depreciation method or asset useful life Outcome of long-term contracts Costs arising from litigation settlements and judgements Provision against the carrying amount of an investment where there is uncertainty regarding its recoverability
53
ISA 540 states that the auditor shall obtain an understanding of the following to provide a basis for the identification and assessment of the risks of material misstatement for accounting estimates:
The requirements of the applicable financial reporting framework How management identifies those transactions, events and conditions that may give rise to the need for accounting estimates How management makes the accounting estimates and an understanding of the data on which they are based, including: – Method – Relevant controls – Assumptions – Whether change from prior period in method used – Whether management has assessed the effect of estimation uncertainty The ISA also states that the auditor shall review the outcome of accounting estimates included in the prior period.
54
The auditor shall also evaluate the degree of estimation uncertainty associated with an accounting estimate. Where estimation uncertainty is assessed as high, the auditor shall determine whether this gives rise to significant risks. True /false
True
55
The ISA requires the auditor to perform one or more of the following:
Determine whether events occurring up to the date of the auditor's report provide audit evidence regarding the accounting estimate.
(b) Test how management made the accounting estimate and the data on which it is based. (c) Test the operating effectiveness of controls over how the accounting estimate was made. (d) Develop a point estimate or a range to evaluate management's point estimate.
56
Where the auditor judges that the accounting estimate gives rise to a significant risk, they shall evaluate the following in accordance with ISA 540.
How management has considered alternative assumptions and why these have been rejected Whether the assumptions used are reasonable Management's intent to carry out specific courses of action and its ability to do so
57
ISA 540 requires the auditor to do the following:
Evaluate whether the accounting estimates are either reasonable or misstated Obtain sufficient appropriate audit evidence about whether disclosures are correct For accounting estimates that give rise to significant risks, evaluate the adequacy of disclosure of their estimation uncertainty Review the judgements and decisions of management in making the accounting estimates to identify if there are indications of possible management bias Obtain written representations from management as to whether management believes significant assumptions used are reasonable
58
ISA 500 introduces three methods of selecting items for testing:
Testing 100% of items in a population Testing all items with a certain characteristic, as selection is not representative Audit sampling
59
When sampling, auditors may focus on:
(a) High value or key items. The auditor may select high value items or items that appear suspicious, unusual or prone to error. (b) All items over a certain amount. Selecting items this way may mean a large proportion of the population can be verified by testing a few items. (c) Items to obtain information. This could be information about the client's business, the nature of transactions, or the client's accounting and control systems. (d) Items to test procedures. This is to see whether particular procedures are being performed.
60
What is audit sampling designed to do?
Audit sampling is designed to enable the auditor to draw conclusions about an entire population, on the basis of testing a sample drawn from it.
61
Define: audit sampling and population
Audit sampling is the application of audit procedures to less than 100% of items within a population of audit relevance such that all sampling units have a chance of selection in order to provide the auditor with a reasonable basis on which to draw conclusions about the entire population. The population is the entire set of data from which a sample is selected and about which the auditor wishes to draw conclusions.
62
What is statistical sampling and non statistical sampling
Statistical sampling is an approach to sampling that has the following characteristics: (i) Random selection of the sample items; and (ii) The use of probability theory to evaluate sample results, including measurement of sampling risk. Non-statistical sampling is a sampling approach that does not have these characteristics.
63
Whats the difference between statistical sampling and non statistical sampling
The difference between the two types of sampling is that, with statistical sampling, the sampling risk can be measured and controlled (we look at sampling risk in Section 3.2). With non-statistical sampling it cannot be measured.
64
```
Define:
Sampling risk
Non-sampling risk
Sampling unit
Stratification
```
Sampling risk is the risk that the auditor's conclusion based on a sample may be different from the conclusion that would be reached if the entire population were subjected to the same audit procedure. Non-sampling risk is the risk that the auditor reaches an erroneous conclusion for any reason not related to sampling risk; for example, the use of inappropriate audit procedures, or misinterpretation of audit evidence and failure to recognise a misstatement or deviation. Sampling unit is the individual items constituting a population. It may be a physical item (eg credit entries on bank statements, sales invoices, receivables' balances) or a monetary unit. Stratification is the process of dividing a population into sub-populations, each of which is a group of sampling units which have similar characteristics, often monetary value.
65
When designing an audit sample what are some of the things to consider:
purpose of the audit procedure
characteristics of the population
that stratification or value-weighted selection is appropriate
a sample size sufficient to reduce sampling risk to an acceptably low level.
66
What are the main methods of selecting samples
random selection, systematic selection and haphazard selection
67
Explain Random selection
Random selection ensures that all items in the population have an equal chance of selection, eg by use of random number tables or random number generators.
68
Explain Systematic selection
Systematic selection involves selecting items using a constant interval between selections, the first interval having a random start. When using systematic selection auditors must ensure that the population is not structured in such a manner that the sampling interval corresponds with a particular pattern in the population.
69
Explain Haphazard selection
Haphazard selection may be an alternative to random selection provided auditors are satisfied that the sample is representative of the entire population. This method requires care to guard against making a selection which is biased, for example towards items which are easily located, as they may not be representative. It should not be used if auditors are carrying out statistical sampling.
70
Explain Block selection
Block selection may be used to check whether certain items have particular characteristics. For example, an auditor may use a sample of 50 consecutive cheques to test whether cheques are signed by authorised signatories rather than picking 50 single cheques throughout the year. However, block sampling may produce samples that are not representative of the population as a whole, particularly if errors only occurred during a certain part of the period, and therefore the errors found cannot be projected onto the rest of the population.
71
Explain Monetary unit sampling
Monetary unit sampling is a type of value-weighted selection in which sample size, selection and evaluation results in a conclusion in monetary amounts.
72
Explain an anomaly
An anomaly is a misstatement or deviation that is demonstrably not representative of misstatements or deviations in a population.
73
Explain a test of details
For tests of details, the auditor shall project misstatements found in the sample onto the population to obtain a broad view of the scale of the misstatement but this may not be enough to determine an amount to be recorded
74
Explain a test for controls
ISA 530 states that for tests of controls, no explicit projection of errors is necessary because the sample deviation rate is also the projected deviation rate for the population as a whole. So for example, if in a sample of 75, four errors are discovered, the projected deviation rate is 4/75, ie 5%
75
Explain Tolerable misstatement
Tolerable misstatement is a monetary amount set by the auditor in respect of which the auditor seeks to obtain an appropriate level of assurance that the monetary amount set by the auditor is not exceeded by the actual misstatement in the population
76
Explain Tolerable rate of deviation
Tolerable rate of deviation is a rate of deviation from prescribed internal control procedures set by the auditor in respect of which the auditor seeks to obtain an appropriate level of assurance that the rate of deviation set by the auditor is not exceeded by the actual rate of deviation in the population.
77
What are the key summaries of the sampling process are as follows
Determining objectives and characteristics of the population Determining sample size Choosing method of sample selection Projecting errors and evaluating the results
78
What are Computer-assisted audit techniques ?
Computer-assisted audit techniques (CAATs) are applications of auditing procedures using the computer as an audit tool.
79
How can CAAT be used?
Tests of details of transactions and balances Analytical review procedures Tests of computer information system controls
80
Whata re the advantages of CAAT?
(a) Auditors can test program controls as well as general internal controls associated with computers. (b) Auditors can test a greater number of items more quickly and accurately than would be the case otherwise. (c) Auditors can test transactions rather than paper records of transactions that could be incorrect. (d) CAATs are cost effective in the long term if the client does not change its systems. (e) Results from CAATs can be compared with results from traditional testing – if the results correlate, overall confidence is increased.
81
Disadvantages of CAAT?
Setting up the software needed for CAATs can be time consuming and expensive. Audit staff will need to be trained so they have a sufficient level of IT knowledge to apply CAATs. Not all client systems will be compatible with the software used with CAATs. There is a risk that live client data is corrupted and lost during the use of CAATs.
82
The major steps to be undertaken by the auditors in the application of a CAAT are as follows:
Set the objective of the CAAT application Determine the content and accessibility of the entity's files Define the transaction types to be tested Define the procedures to be performed on the data Define the output requirements Identify the audit and computer personnel who may participate in the design and application of the CAAT Refine the estimates of costs and benefits Ensure that the use of the CAAT is properly controlled and documented Arrange the administrative activities, including the necessary skills and computer facilities Execute the CAAT application Evaluate the results
83
the two types of CAAT are
audit software and test data
84
Define audit software:
Audit software consists of computer programs used by the auditors, as part of their auditing procedures, to process data of audit significance from the entity's accounting system. It may consist of generalised audit software or custom audit software. Audit software is used for substantive procedures
85
What are the two types of audit software:
Generalised audit software allows auditors to perform tests on computer files and databases, such as reading and extracting data from a client's systems for further testing, selecting data that meets certain criteria, performing arithmetic calculations on data, facilitating audit sampling and producing documents and reports. Examples of generalised audit software are ACT and IDEA. Custom audit software is written by auditors for specific tasks when generalised audit software cannot be used.
86
Give examples of the use of audit software in the course of an audit:
Perform calculations and comparisons in analytical procedures Sampling programs to extract data for audit testing, eg select a sample of receivables for confirmation Scan a file to ensure that all documents in a series have been accounted for or to search for large and unusual items Compare data elements in different files for agreement (eg prices on sales invoices to authorised prices in master file) Reperform calculations eg totalling sales ledger Prepare documents and reports eg produce receivables' confirmation letters and monthly statements
87
What are the Benefits of using audit software?
(a) Audit software can perform calculations and comparisons more quickly than those done manually. (b) Audit software makes it possible to test more transactions than when simply manually scanning printouts. For example, audit software may facilitate searches for exceptions, such as negative or very high quantities when auditing inventory listings. The additional information will give the auditor increased comfort that the figure being audited is reasonably stated. (c) Audit software may allow the actual computer files (the source files) to be tested from the originating program, rather than printouts from spool or previewed files which are dependent on other software (and therefore could contain errors or could have been tampered with following export). (d) Using audit software is likely to be cost-effective in the long term if the client does not change its systems
88
What are the Difficulties of using audit software?
a) The costs of designing tests using audit software can be substantial, as a great deal of planning time will be needed in order to gain an in-depth understanding of the client's systems so that appropriate software can be produced. (b) The audit costs in general may increase because experienced and specially trained staff will be required to design the software, perform the testing and review the results of the testing. (c) If errors are made in the design of the audit software, audit time, and therefore costs, can be wasted in investigating anomalies that have arisen because of flaws in how the software was put together rather than by errors in the client's processing. (d) If audit software has been designed to carry out procedures during live running of the client's system, there is a risk that this disrupts the client's systems. If the procedures are to be run when the system is not live, extra costs will be incurred by carrying out procedures to verify that the version of the system being tested is identical to that used by the client in live situations.
89
Define Test data
Test data techniques are used in conducting audit procedures by entering data (eg a sample of transactions) into an entity's computer system, and comparing the results obtained with pre-determined results. Test data is used for tests of controls.
90
Give examples of Test data
Test data used to test specific controls in computer programs, such as online password and data access controls. (b) Test transactions selected from previously processed transactions or created by the auditors to test specific processing characteristics of an entity's computer system. Such transactions are generally processed separately from the entity's normal processing. Test data can for example be used to check the controls that prevent the processing of invalid data by entering data with, say, a non-existent customer code or worth an unreasonable amount, or a transaction which may if processed break customer credit limits(c) Test transactions used in an integrated test facility. This is where a 'dummy' unit (eg a department or employee) is established, and to which test transactions are posted during the normal processing cycle
91
main benefits of using test data techniques are:
a) Test data provides evidence that the software or computer system used by the client are working effectively by testing the program controls and in some cases there may be no other way to test some program controls. (b) Once the basic test data have been designed, the level of ongoing time needed and costs incurred is likely to be relatively low until the client's systems change.
92
However, there are some problems with using test data.
(a) A significant problem with test data is that any resulting corruption of data files has to be corrected. This is difficult with modern real-time systems, which often have built-in (and highly desirable) controls to ensure that data entered cannot be easily removed without leaving a mark. (b) Test data only tests the operation of the system at a single point of time and therefore the results do not prove that the program was in use throughout the period under review. (c) Initial computer time and costs can be high and the client may change its programs in subsequent years
93
Define auditor's expert
An auditor's expert is an individual or organisation possessing expertise in a field other than auditing or accounting, whose work in that field is used by the auditor to assist the auditor in obtaining sufficient appropriate audit evidence. An auditor's expert may be either an auditor's internal expert (who is a partner or staff, including temporary staff, of the auditor's firm or a network firm) or an auditor's external expert.
94
Define management expert
Management's expert is an individual or organisation possessing expertise in a field other than accounting or auditing, whose work in that field is used by the entity to assist the entity in preparing the financial statements.
95
Examples include:
Valuations of land and buildings Valuation of inventory or work in progress, including the determination of the physical condition of inventory Legal opinions, including expert opinions on the possible outcomes of litigation or disputes
96
An auditor's expert could be employed by the auditor to assist in:
Obtaining an understanding of the entity and its environment, including its internal control Identifying and assessing the risks of material misstatement Determining and implementing overall responses to assessed risks at the financial statement level Designing and performing further audit procedures to respond to assessed risks at the assertion level Evaluating the sufficiency and appropriateness of audit evidence obtained in forming an opinion on the financial statements
97
Information on these areas may come from the following sources:
Personal experience with previous work done by the expert Discussions with the expert Discussions with other people who are familiar with the expert's work Knowledge of the expert's qualifications, membership of a professional body or industry association, licence to practise etc Published papers or books by the expert The auditor's firm's quality control policies and procedures
98
In Obtaining an understanding of the field of expertise. ISA 620 requires the auditor to agree in writing the following with the auditor's expert:
Nature, scope and objectives of the work Respective roles and responsibilities of the auditor and the auditor's expert Nature, timing and extent of communication between the auditor and the auditor's expert, including the form of any report Confidentiality requirements
99
In Evaluating the work of the auditor's expert. The auditor shall evaluate the adequacy of the auditor's expert's work, which will include the following:
The relevance and reasonableness of the expert's work and consistency with other audit evidence The relevance and reasonableness of any assumptions and methods used The relevance, completeness and accuracy of any source data used
100
The auditor must not refer to the work of an auditor's expert in the auditor's report containing an unmodified opinion (unless required by law or regulation). If the auditor makes reference to the work of an auditor's expert in the auditor's report because it is relevant to understanding a modification to the opinion, the auditor must state in the auditor's report that this reference does not reduce the auditor's responsibility for the opinion. True or false
True
101
The objectives of the auditor (as stated in ISA 610) are:
(a) To determine whether the work of the internal audit function or direct assistance from internal auditors can be used and, if so, in which areas and to what extent (b) If using the work of the internal audit function, to determine whether that work is appropriate for the purposes of the audit (c) If using internal auditors to provide direct assistance, to appropriately direct, supervise and review their work
102
Define the internal audit function and the direct assistance
Internal audit function is defined in the ISAs as a function of an entity that performs assurance and consulting activities designed to evaluate and improve the effectiveness of the entity's governance, risk management and internal control processes. Direct assistance refers to the use of internal auditors to perform audit procedures under the direction, supervision and review of the external auditor.
103
Give examples of where internal audit operates:
Monitoring of internal control Examination of financial and operating information Review of operating activities Review of compliance with laws and regulations Risk management Governance
104
When can the work of the internal audit function be used?
An effective internal audit function may reduce, modify or alter the timing of external audit procedures, but it can never eliminate them entirely. Even where the internal audit function is deemed ineffective, it may still be useful to be aware of the conclusions formed. The effectiveness of internal audit will have a great impact on how the external auditors assess the whole control system and the assessment of audit risk
105
The external auditor will need to determine whether the work of the internal audit function can be used for the audit and, if so, establish the nature and extent of work that can be used
Determining whether the work of the internal audit function can be used The following criteria must first be considered by the external auditors when determining whether the work of the internal audit function can be used.
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What are some of the criteria and considerations of EVALUATING THE INTERNAL AUDIT FUNCTION in The extent to which its objectivity is supported by its organisational status, relevant policies and procedures
Consider the status of the internal audit function, to whom it reports, any conflicting responsibilities, any constraints or restrictions, whether those charged with governance oversee employment decisions regarding internal auditors, whether management acts on recommendations made, whether internal auditors are members of professional bodies and obligated to comply with their requirements for objectivity.
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What are some of the criteria and considerations of EVALUATING THE INTERNAL AUDIT FUNCTION in the level of competence of the function
Consider whether the internal audit function is adequately resourced, whether internal auditors are members of relevant professional bodies, have adequate technical training and proficiency, whether there are established policies for hiring and training, whether internal auditors possess the required knowledge of financial reporting / the applicable financial reporting framework.
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What are some of the criteria and considerations of Whether the internal audit function applies a systematic and disciplined approach (including quality control)
Consider whether internal audit activities include a systematic and disciplined approach to planning, supervising, reviewing and documenting assignments, whether the function has appropriate quality control procedures, the existence of audit manuals, work programmes and internal audit documentation
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When determining the areas and the extent to which the work of the internal audit function can be used, the auditor must consider:
The nature and scope of specific work performed or to be performed The relevance of that work to the audit strategy and audit plan The degree of judgement involved in evaluation of audit evidence gathered by internal auditor
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Therefore, the external auditor must plan to use the work of the internal audit function less (and therefore perform more of the work directly) in any areas which might involve significant judgements being made. These will be areas where:
More judgement is needed in planning/performing procedures and evaluating evidence The risk of material misstatement is high, including where risks are assessed as significant The internal audit function's organisational status and relevant policies/procedures are not as robust in supporting the internal audit function's objectivity The internal audit function is less competent
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Before using the work of internal audit, the external auditors need to evaluate and perform audit procedures on the entirety of the work that they plan to use, in order to determine its adequacy for the purposes of the audit. The evaluation includes the following:
Whether the work was properly planned, performed, supervised, reviewed and documented Whether sufficient appropriate evidence was obtained to allow the internal auditors to draw reasonable conclusions Whether the conclusions reached are appropriate in the circumstances and the reports prepared are consistent with the results of the work done
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As we have already seen above, the nature and extent of the audit procedures performed on specific work of the internal auditors will depend on the external auditor's assessment of
The amount of judgement involved The assessed risk of material misstatement How well the audit function's organisational status and relevant policies and procedures support the objectivity of the internal auditors The level of competence of the function
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Note that ISA 610 (Revised) requires the external auditor's procedures to include reperformance of some of the internal audit work used. Audit procedures might include:
Examination of items already examined by the internal auditors Examination of other similar items Observation of procedures performed by the internal auditors
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If external auditors are prohibited by law or regulation from obtaining direct assistance from internal auditors then it should not be used. If direct assistance is not prohibited by law, the external auditor should evaluate the following.
The internal auditors' objectivity (existence and significance of any threats) The internal auditors' competence
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Determining the nature and extent of work that can be assigned to internal auditors The external auditor will need to determine the nature and extent of the work that may be assigned to internal auditors. As part of this, it will be necessary to consider the direction, supervision and review that would be needed. Three key areas must be considered
(a) The amount of judgement involved in planning and performing the relevant audit procedures, and in evaluating the audit evidence gathered (b) The assessed risk of material misstatement (c) The external auditor's evaluation of the existence and significance of threats to the objectivity and the level of competence of the internal auditors
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ISA 610 (Revised) prohibits the use of internal auditors to provide direct assistance to perform procedures that
(a) Involve making significant judgements in the audit (b) Relate to higher assessed risks of material misstatement where more than a limited degree of judgement is required: for example, in assessing the valuation of accounts receivable, internal auditors may be assigned to check the accuracy of receivables ageing, but they must not be involved in evaluating the adequacy of the provision for irrecoverable receivables (c) Relate to work with which the internal auditors have been involved (d) Relate to decisions the external auditor makes regarding the internal audit function and the use of its work or direct assistance
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Communicating with those charged with governance regarding the use of direct assistance
they must communicate the nature and extent of the planned use of direct assistance to those charged with governance. The external auditors and those charged with governance must reach a mutual understanding that the use of direct assistance is not excessive in the circumstances of the audit engagement.
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Before using internal auditors to provide direct assistance, written agreement must be obtained stating:
(a) From an authorised representative of the entity (confirming that the internal auditors will be allowed to follow the external auditor's instructions, and that the entity will not intervene in the work that the internal auditor performs for the external auditor) (b) From the internal auditors (confirming that they will keep specific matters confidential as instructed by the external auditor, and inform the external auditor of any threat to their objectivity)
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Where the work of the internal audit function has been used, ISA 610 (Revised) requires the external auditors to document:
(a) The evaluation of whether the function's organisational status and relevant policies/procedures support its independence adequately, the level of competence of the function and whether it is disciplined and systematic in its approach (b) The nature and extent of the work used and the reasons for deciding on that approach (c) The audit procedures performed by the external auditor to evaluate the adequacy of the internal audit function's work
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Where the external auditors have used direct assistance from the internal auditors, ISA 610 (Revised) requires the following to be documented.
(a) The evaluation of the existence and significance of threats to the objectivity of the internal auditors, and the level of competence of the internal auditors used (b) The basis for the decision regarding the nature and extent of the work performed by the internal auditors (c) Who reviewed the work performed and the date and extent of that review
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Define service organisation; user entity; user auditor; service auditor
A service organisation is a third-party organisation that provides services to user entities that are part of those entities' information systems relevant to financial reporting. A user entity is an entity that uses a service organisation and whose financial statements are being audited. A user auditor is an auditor who audits and reports on the financial statements of a user entity. A service auditor is an auditor who, at the request of the service organisation, provides an assurance report on the controls of a service organisation.
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User auditors must obtain an understanding of the services provided by the service organisation in accordance with ISA 315. This understanding must include the following:
Nature of services provided and the significance of these to the user entity, including effect on user entity's internal control Nature and materiality of transactions processed or financial reporting processes affected Degree of interaction Nature of relationship including contractual terms
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If the user auditor cannot get this understanding from the user entity, the understanding needs to be obtained from one or more of the following procedures:
Obtaining a type 1 report (report on description and design of controls at a service organisation) or type 2 report (report on the description, design and operating effectiveness of controls at a service organisation) from a service auditor, if available Contacting the service organisation through the user entity Visiting the service organisation and performing necessary procedures Using another auditor to perform necessary procedures
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In Responding to the assessed risks of material misstatement In responding to the assessed risks in accordance with ISA 330, the user auditor must:
(a) Determine whether sufficient appropriate audit evidence concerning the relevant financial statement assertions is available from records held at the user entity; and if not (b) Perform further audit procedures to obtain sufficient appropriate audit evidence or use another auditor to perform those procedures at the service organisation on the user auditor's behalf.
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The user auditor is never solely responsible for the auditor's opinion T/F
True
