1. Accounting vs Auditing ACCOUNTING: process that creates F/S andother financial info. for mgt (decision making)purposes. AUDITING: enhance the credibility of F/S throughthe audit process (gathering & evaluatingaccounting records & supporting documents) inproviding basis of opinion of auditors report.Main distinguishing factor: Auditor must possess accounting knowledge & expertise to accumulate & analyse audit evidence.1

2. THE DEMAND FOR AUDITING Greek, Egyptian & Islamic civilisations Why do organizations request an audit?The existence of principal and agentrelationship that causes: Conflict of interests Information asymmetry Manipulation of records and reports Audit acts as a cost-effective monitoring devicefor contractual relationship conform tocontracts? 2 3. The objective & definition To enable auditors to express an opinion onwhether the F/S are prepared, in all materialrespects, in accordance with an identifiedfinancial reporting framework. TFV? AUDITING (broadly defined) is a systematicprocess of objectively obtaining & evaluatingevidence regarding assertions about economicactions and events to ascertain the degree ofcorrespondence between those assertions &established criteria & communicating the resultsto interested parties. AUDITING (narrowly defined) is a written report 3on the examinations of F/S for a client. 4. ASSURANCE SERVICES Assure = to remove doubt / feel confident(Wilkipedia) ASSURANCE services are independentprofessional services that improve the quality ofinformation for decision makers. Analogy (House inspection) Desirable characteristics Independence & the appearance of independence4 5. OVERVIEW OF THE AUDIT PROCESS (Major Phases) preliminary Engagement activities obtain Understanding of the entity establish Materiality & assess Risks Planning: set overall strategy & set audit plan Tests of control & audit business processes Complete the audit Evaluate results & issues Audit Report5 6. AUDIT OF F/SAuditors responsibilities opinion on compliance with accounting regulation (based on auditing standards) .: Accounting stds vs. Auditing stds Only reasonable assurance (not a guarantee)that F/S do not contain material misstatements Why only reasonable assurance? Use of testing sampling Inherent limitations of internal control Audit evidence is persuasive not conclusive documents assumed true unless suspected to be false Use of judgement6 7. FINANCIAL REPORTINGFRAMEWORK APPROVED ACCOUNTING STANDARDS (in Malaysia) approved by MASB FINANCIAL REPORTING STANDARDS (FRS) PRIVATE ENTITY REPORTING STANDARDS (PERS) Other regulation: Co.s Act 1965, Banking Act (specific industries) Auditors check to see if F/S comply with the above &substance over form*2-7 8. Auditing Standards Measure the quality of auditors performance. In conducting audit, auditors are required to rely ona codified set of auditing standards issued bynational accounting authority professional stillneeded In Malaysia, relevant national standards arereferred to as the approved standards on auditing: the International Auditing & Assurance StandardsBoard (IAASB) under the International Federationof Accountants (IFAC) issues the International2-8Standards on Auditing (ISA) 9. Main Categoriesof Audit Reports Unqualified Qualified / Modified 10. Parts of the StandardUnqualified Audit Report1. Report title2. Audit report address3. Introductory paragraph4. Scope paragraph5. Opinion paragraph6. Name of CPA firm7. Audit report date10 11. AUDITORS REPORT Report title TO THE MEMBERS OF ABC Co. Audit report address We have audited the F/S: B/S, I/S & CFS These F/S are the responsibility of the directors. Our responsibility is to express an opinion onthese F/S based on our audit. Introductoryparagraph We conducted our audit in accordance withInternational Standards on Auditing . What an audit entails We believe that our audit provides a reasonablebasis for our opinion. Scope paragraph 11 12. In our opinion, the financial statements give a trueand fair view of, in all material respects, the financialposition of the Company as of December31, 20X1 and of the results of its operations andits cash flows for the year then ended in accordance with financial reportingframework Opinion paragraph Name of CPA firm Audit report date 12 13. Statutory requirements relating tofinancial statements audit Section 169 of Company Act 1965- requires co.the directors to present the audited F/S at itsAGM Directors responsible for F/S Section 174 (2) of the Act requires auditor toreport to the members of the company at theAGM Section 174 (3) of the Act requires Auditor toform an opinion.Appointment of Auditors& Disqualification of Auditors13 14. Corporate Governance (CG) Is the corporate framework or structure that an entity appliesto direct & manage it business & affairs. System, units that govern (monitor) the corporation.(governor) Malaysian Code of CG issued by the Malaysian Institute ofCG principle & best practices Board of Directors (BoD) 6 responsibilities monitor theinternal control (IC) Audit Committee = independent directors? communicationlink between management, auditors & BoD Internal audit dept. / unit 2-14 15. INTERNAL AUDITORFocus more on accounting & internal control system& providing recommendations for improvements.Prior to using internal audit works, perform apreliminary assessment of internal audit function:Organisational status IA report to higher mgmtlevelScope of responsibility relevance & usefulnessof nature & extent of auditTechnical competence adequacy of training &skillDue professional care consider adequacy ofwork plan, documentation, etc. 15 16. AUDIT COMMITTEESection 344A of Listing Requirements of KLSE requires PLCs to set up an independent audit committee.Functions & duties: Consider nomination of external auditor. Review external auditors plan, audited FS & auditreport. Review scope and findings of internal auditors.Fiduciary duties: assist board in ensuring the compliance of accountingpolicies & reporting practices. 16 17. ETHICS ANDINDEPENDENCE Ethics = system or code of conduct based onmoral duties and obligations that indicates howone should behave. Professionalism = the conduct, aims, or qualitiesthat characterize or mark a profession orprofessional person. All professions operate under some type of code of ethics/ conducts. E.g- MIA issues By-Laws (On Professional Conduct and Ethics) for auditors2-17 18. Problems faced by auditors that may affect theirprofessionalism: Low-balling decrease (initial) audit fees (lucrative management service fees) Audit fees restricted anyway. Need to maintain audit to recover costs Opinion shopping Choose auditor that agrees with accounts Threaten to change auditors2-18 19. THE AUDITORS RESPONSIBILITY FOR ERRORS,FRAUD, AND ILLEGAL ACTS To plan and perform the audit to obtain reasonable (notabsolute) assurance about whether the financialstatements are free of material misstatement whethercaused by error or fraud. To detect misstatements resulting from illegal acts is thesame as that for error or fraud. To exercise due professional care (professionalskepticism) critical & questioning mind Whistle blowing (ROC for non-compliance)2-19 20. Certified PublicAccounting Firms The legal right to perform audits is grantedto CPA firms by regulation of each state.CPA firms also provide many other services totheir clients, such as tax and consulting services. 21. The Big-4 Ernst & Young PricewaterhouseCoopers KPMG Deloitte KassimChan2-21 22. Hierarchy of a Typical CPA FirmStaff LevelExperience Typical ResponsibilitiesStaff Performs most of the0-2 yearsAssistantdetailed audit workResponsible for the audit Senior 2-5 years field work, including Auditor supervising staff work2-22 23. Hierarchy of a Typical CPA FirmStaff Level Experience Typical Responsibilities Helps the plan, manages Manager 5-10 years the audit, reviews work, and works with the client Reviews audit work andPartner 10+ years makes significant audit decisions2-23 24. Other Types of Audits Services Operational = effectiveness & efficiency of operatingprocedures Compliance = meeting / performing according to specificprocedures (set guidelines) Forensic = obtaining of legal evidence for a court case 2-24 25. Operational Audit Evaluate computerized payroll system Example for efficiency and effectivenessNumber of records processed, cost ofInformationthe department, and number of errorsEstablishedCompany standards for efficiency and Criteria effectiveness in payroll department Available Error reports, payroll records, and Evidence 2-25 payroll processing costs 26. Compliance Audit Determine whether bank requirements Examplefor loan continuation have been metInformation Company recordsEstablishedLoan agreement provisions Criteria AvailableFinancial statements and Evidence 2-26calculations by the auditor 27. Forensic AuditBusiness and Employee FraudCriminal InvestigationShareholders and Partnership disputesBusiness economic losses2-27 28. Other Activities of CPA Firms Accountingandbookkeepingservices Tax services Management consultingservices 29. TYPES OF AUDITORSExternal auditorsInternal auditorsGovernment auditorsForensic auditors2-29 30. ORGANIZATIONS THAT AFFECT FINANCIAL REPORTING & AUDITS Malaysian Accounting Standards Board regulate the accounting standards Malaysian Institute of Accountants regulate the accountants Companies Commission of Malaysia regulate the companies Securities Commission regulate securities2-30 31. EngagementCLIENT ACCEPTANCE & CONTINUANCE Prospective or new client: Identify status of the client in businesscommunity, financial stability, & relationship withprevious auditor. (background on client) Successor auditor must communicate withpredecessor auditor reason for change. (newauditor must inform / ask previous auditor)31 32. The successor auditor is interested in askingquestions related to: integrity of management; disagreements with management over accountingand auditing issues; illegal acts; internal control-related matters; and the predecessors understanding for thechange in auditors.32 33. Existing or recurring client: Should evaluate existing clients whether to retain them. Reasons: may be due to conflicts on accounting policies or auditing issues, or dispute on fees etc. Reevaluate the integrity of management and excessive risk relative to industry/entity. ESTABLISHING THE TERMS OF THEENGAGEMENT The auditor and the clientmust agree on the terms of the engagement,including the type, scope, and timing of theengagement.33 34. Three topics are important for establishing theterms of the engagement: (ISA 210) Engagement letter (ISA 610) Internal auditors Audit committee Engagement letter Serve as a contract Outlines both parties responsibilities Prevents misunderstandings.34 35. Principal contents of EL Objective of audit of financial statements Managements responsibility Scope of audit (pronouncement of regulations &applicable standards) Form of report Nature and inherent limitations of audit Unrestricted access in connection of auditOther components of EL Arrangements involving use of specialists Additional services to be provided relating to regulatoryrequirements 35 Others services to be provided 36. PLANNING THE AUDIT (Howwould you plan)? Audit staffing. considerations Obtain knowledge of clients business & industry(including applicable law & regulations). Consider going concern issue. Assess materiality, audit risk& control risk. Assess the possibility of illegal acts (fraud/error). Identify related parties.What are related parties?Why are they important to identify? 36 37. Audit planning (contd) Conduct preliminary analytical procedures. Develop an overall audit strategy and prepareaudit programs. Consider additional value-added services. Consider the IA functions Review audit strategy with audit committeeConsiderations on audit staffing Professional expertise vs. costs The moreexperienced & qualified the higher the rate/hour Costs vs. reputation & risk of litigation Independence of the auditor & the audit teamsign form 37 38. ASSESS A PRELIMINARY LEVELFOR CONTROL RISK In assessing a preliminary level of CR, the auditormust be concerned about the extent of IT used inprocessing accounting information, including: The extent that IT is used in each business process. The complexity of the entitys computer operations. The organizational structure of the IT activities. The availability of data. The need for IT-assisted techniques to gather andconduct audit procedures. 38 39. Assess The Possibility of Illegal Acts Indicators: Unauthorized transactions. Investigation by a governmental agency orpayment of unusual fines or penalties. Violations of laws or regulations. Large payments for unspecified services. Sales commissions or agents fees that appearexcessive. Large payments in cash or bank cashierschecks. Unexplained payments to government officials. Failure to file tax returns or pay government39duties. 40. AUDIT STRATEGYSUBSTANTIVE Stratg. RELIANCE STRATEGYAn auditor assess Control An auditor assess ControlRisk as High & extensiveRisk as Low and non-substantive testing:extensive substantive The controls aretesting:assessed as ineffective & To obtain more detailedinefficient. understanding of IC To understand IC and not To plan & perform test ofto rely on IC at all times incontrols & assess controlthe extent of audit testingrisk To document To document control riskunderstanding of IC andassessmentcontrol risk assessment. To plan extent of substantive testing 40 41. 3 FUNDAMENTAL CONCEPTS INCONDUCTING AN AUDITMATERIALITY: magnitude (size) of an omission or misstatement of accounting information that may affect F/S significantly.(ISA 320) Materiality: material if omission or misstatements could influence the decisions of F/S users very judgmental / subjective (professional judgement) it provides threshold or cut-off point. 41 42. AUDIT RISK: The risk that the auditor mayunknowingly fail to appropriately modify theopinion on F/S that are materiality misstated. Risk of giving wrong opinion(ISA 240) Audit risk: Possibility of auditor not detecting allmisstatements. Control through proper audit planning, effectiveaccounting and internal control system. 42 43. Sampling: The application of an audit procedure to lessthan 100 percent of the items (100% = population) Due to cost & time constraints, the auditor examines onlya subset of the clients data (transactions) in the records. To lower the audit risk, need to do more audit work bigger sample Audit risk vs. cost & time (balance) Sample size depends on acceptable audit risk established criteria & auditors experience.: Inverse relationship between: Sample size & materiality example Sample size & acceptable audit risk .: if materiality threshold is low, a bigger sample is collected. 43 44. EVIDENCE: Info. derived from the audit procedures in order to support the F/S, audit objectives tested and opinion of the auditors report.(ISA 500) Evidence: Relevance = whether the evidence relates to the specific audit objective being tested. egs. $ in Bank account = RM 554,000 Reliability = the diagnosticity of the evidence; does the evidence signal the true state of the assertion or audit objective. Can you rely on it to be true?44 45. Links to Evidence Management assertions & Internal Control Materiality & Audit Risks Will determine the Nature, Extent & Timingof evidence collected In collecting the evidence: Think about what could go wrong in theaccounting process (each step): Internal controls }.: procedures to Individual transactions }test whether issues Account balances}reduced TFV45 46. Risk Assessment & Materiality Professional guidance in considering materiality& audit risk when planning & performing an auditprogram The wording of the auditors report recognizesboth these concepts due to the following terms: Reasonable assurance In all material respects46 47. AUDIT RISK What is audit risk? AUDIT RISK is the risk that the auditor mayunknowingly fail to appropriately modify the opinion onfinancial statements that are materiality misstated. Some parts of this risk can be controlled by theauditor. AUDITOR BUSINESS RISK is the exposure to loss orinjury to professional practice from litigation, adversepublicity, or other events arising in connection with F/Saudited & reported on. 47 48. More on audit risk Audit risk must be at an acceptably low level What is acceptably low? professional judgement If not low enough, need to perform more audit procedures. The auditor needs to consider risks of materialmisstatement at 2 levels: The overall f/s level The assertion level for individual a/c balances & classes of transactions 48 49. THE AUDIT RISK MODEL AR = IR x CR x DRInherent Risk (IR) = material misstatement would occur inthe absence of internal control in the business. IR may be dueto the nature of the business.Control Risk (CR) = material misstatement is not detected byinternal control on timely basis.Detection Risk (DR) = risk that auditor will not detectmaterial misstatement in financial statements= composed of sampling & non-sampling risk 49 50. Detection Risk Results from 2 types of risks or uncertainties: Sampling risks Non-sampling risks What is sampling risk and non-sampling risk? Sample may not reflect the population hence wrongconclusion drawn Mistake made by auditor by using wrong test ormisinterpreting results50 51. LIMITATIONS OF THEAUDIT RISK MODEL The model assume the components of the model(IR, CR, and DR) are independent of each other. However, in practice, dependencies exist betweenthese components [IR = f(CR)]. Auditors assessments of IR and CR may be differentfrom the actual levels of IR and CR. The audit risk model does not consider the possibilityof non-sampling risk. 51 52. Use of the Audit Risk Model 3 steps: Set a planned level of Audit Risk Assess Inherent Risk & Control Risk Determine the appropriate level of Detection Risk AR = IR x CR x DR.: DR = ARIR x CR .: if AR planned level of Audit risk (target) unqualified report52 53. AUDITORS RESPONSIBILITY Auditor needs to assess IR & CR, then determine levelof DR & what audit procedures to be performed. Auditor should document and describe: Risk factors identified Auditors response to those risk factors IR is related to clients business risk (* Not the same asAuditor Business Risk) 53 54. CLIENT BUSINESS RISK Risk that an entitys business objectives will not beattained as a result of the external & internalfactors, pressures, and forces that may affect entityssurvival and profitability.In order to properly judge the fair presentation of F/S, auditor needs to understand the entitys business strategy & risks and its ability to respond to the changing environment.54 55. ASSESSING CLIENT BUSINESSRISK Industry level: Critical industry issues Significant industry risk Structure and profitability within industry Relationship industry and economic environment Entity level: market/product positioning, strategy andmeasures in dealing with customers/competitors. May affect going concern (.: need to keep updated) 55 56. Risk assessment procedures INQUIRIES OF MANAGEMENT AND OTHERS ANALYTICAL PROCEDURES OBSERVATION AND INSPECTION These will affect the nature, timing & extent of auditprocedures 56 57. ERROR OR FRAUD ERRORS are unintentional misstatements or omissionsof amounts or disclosures and may involve: Mistakes in gathering or processing accounting data Unreasonable accounting estimates Mistakes in the application of accounting principles. FRAUD involves intentional misstatements that can beclassified into two types: fraudulent financial reporting misappropriation of assets. 57 58. ASSESS THE RISK OFMATERIAL MISSTATEMENTDUE TO ERROR OR FRAUD FRAUDULENT FINANCIAL REPORTING includes: Manipulation, falsification, or alteration of accounting records or supporting documents from which the F/S are prepared. Misrepresentation in, or intentional omission from, the F/S of events, transactions, or significant information. Intentional misapplication of accounting principles. 58 59. MISAPPROPRIATION OR DEFALCATION OFASSETS includes: Embezzling of cash receipts Stealing assets Causing the entity to pay for goods or services not received Risk factors that cause possible presence of fraud inreporting: Managements characteristics and influence over the control environment Industry conditions and economic environment. Operating characteristics and financial stability. 59 60. Risk factors that cause possible presence ofmisappropriation of assets: Susceptibility of assets to misappropriation. Controls. Similar to indication of material misstatement due tofraud Fraud Risk factors Incentives / pressure to commit fraud Opportunity to carry out fraud Attitude / rationalism to justify fraud60 61. Response to Risk of MaterialMisstatement due to Fraud Overall response Response at assertion level Response to management override ofcontrols* Documentation of risk assessment & response61 62. MATERIALITYISA 320 (Para 3): Materiality is the magnitude ofan omission or misstatement of accountinginformation that could influence the economicdecisions taken by users of financial statements.It sets the threshold and cut off point indetermining the size of error or misstatements. 62 63. STEPS IN APPLYING MATERIALITY Step 1: Establish a preliminary judgment about themateriality. The max. amount by which the auditorbelieves the F/S could be misstated but stillnot affect the decisions of reasonable users. Set materiality at f/s level: i) 5% of GP after depreciation ii) 3-5% of PBT iii) % of Revenues/ Sales iv) % of Total Assets v) 1% of equity63 64. FACTORS THAT AFFECT PRELIMINARY JUDGMENT ABOUT MATERIALITYThe above was the quantitative aspectsModify for qualitative aspects: Nature of business operations Size of the company and volume of business transactions Prior clients history To determine the base of the judgmenti.e PBT, Total Assets,Total Equity, Total Revenues 64 65. Step 2: Allocate the preliminary judgment to accountbalances (BS) or class-of transactions (PL). Purpose- to plan audit procedures Once allocated, it is referred to as tolerable amount of error or misstatement (ISA 530) Small amount of materiality allocated, the more evidence to be gathered. Step 3: Estimate the likely misstatement and compare tototal preliminary judgment If likely misstatement is less than the preliminary judgment, auditor can conclude that the F/S is fairly presented (unqualified report). Otherwise, auditor should request the client to adjust the F/S. If client refuses, auditor could issue qualified/adverse audit opinion.65 66. Factors that should be considered in allocating materiality to accountsbalances The magnitude of the account relative to the F/Se.g the larger the account balance, the greater theamount of materiality can be allocated. The expectations of errore.g if auditor expect that little or no misstatement in anaccount, they can allocate larger amount of materiality. The relative cost to audite.g if an account is very expensive to audit (largeinventory, AR and AP), auditor allocate more materialityto be cost effective. 66 67. How materiality affects the auditreport?1. Given any misstatements or error that occurred, auditor need to evaluate and consider whether the misstatements/ error are immaterial (not affect the overall picture of F/S) or highly material (requires adjustment). These will affect the appropriate audit report to be issued.2. Any violations against the standards of financial reporting, materiality of violation influences whether an unqualified or qualified report should be issued. 67 68. Management Assertions Statements that management assert (claim to be true) 3 categories Transactions Account balances Presentation & disclosure2-68 69. MANAGEMENT ASSERTIONS BYCATEGORY Assertions about class Assertions about accountof transactions balances Existence/ Existence/ occurrence occurrence Accuracy Ownership/ Rights andObligation Completeness Completeness Cut-off Valuation Classification2-69 70. MANAGEMENT ASSERTIONS BYCATEGORY Assertions about presentation and disclosure Occurrence and rights and obligation Accuracy & valuation Completeness Classification2-70 71. FINANCIAL STATEMENTS:MANAGEMENT ASSERTIONS AND AUDIT OBJECTIVES Management assertionsAudit objectives Existence Validity Occurrence Rights and obligations Ownership Completeness Completeness Cutoff Valuation Valuation (Measurement) Accuracy Presentation and disclosure Classification (Classification & understandability) Disclosure 71 72. AUDIT PROCEDURES AUDIT PROCEDURES are specific actsperformed by the auditor to gather evidence todetermine if specific audit objectives are beingmet. steps taken to collect audit evidence based onaudit objectives A set of audit procedures prepared to test auditobjectives for a specific component of the financialstatements is referred to as an AUDITPROGRAM. 72 73. The Purpose of Audit Procedures RISK ASSESSMENT TEST OF CONTROLS SUBSTANTIVE PROCEDURES Test of Controls Evaluates whether controls have been properlydesigned to prevent or detect and correct materialmisstatements. (timely manner) Test the operational effectiveness of the control:- How it is applied- Consistency of its application- By whom it is applied 73 74. TESTS OF CONTROLSPart of audit procedures in test of controls: Inquiries of appropriate management, supervisory, andstaff personnel. Inspection of documents, reports, and electronic files. Observation of the application of specific internalcontrols. Walk-through test. Reperformance of the application of the control by theauditor.74 75. SUBSTANTIVE TESTS Concentrate on detecting misstatements in accountbalances, individual transactions and disclosurecomponents Substantive tests of transactions (IS)-test of errors or fraud in individual transactions-example: examine purchase transactions that containmaterial value Analytical procedures (AP) Tests of account balances (BS)-concentrate on details of amounts contained in accountbalances-test whether material misstatement is included in theaccount balances 75 76. TYPES OF AUDIT PROCEDURES (purpose: risk assessment, test of control, substantive tests) Physical examination Documentation inspection Confirmation Analytical procedures Inquiries of client personnel or management Observation Computation and Re-performance Scanning76 77. RELIABILITY OF EVIDENCE BASED ON PROCEDURESLevel of Reliability Type of proceduresHighPhysical examinationReperformanceMediumDocumentationConfirmationAnalytical proceduresLow Inquiries of client personnel ormanagementObservation77 78. ANALYTICAL PROCEDURES ISA 520: analysis of significant ratios and trendsincluding results from investigation of fluctuations andrelationships that are inconsistent with other relevantinformation or deviate from predicted amounts. Evaluations of financial information made by a study ofplausible relationships among both financial and non-financial data. Range from the use of simple comparisons to the useof complex models. 78 79. TYPES OF ANALYTICAL PROCEDURES (AP) Compare current-year with prior year figure Preliminary AP. Compare current-year with budgets, projections &forecasts Variance analysis. Relationships among elements of financial informationwithin the current period egs. loan terms & interest. Compare clients figure with industry data. Ratioanalysis. Relationship of financial information to non-financialinformation. # of employees, sales commission. 79 80. PURPOSES OF AP Assist in planning the nature, timing, and extent of other auditprocedures Understanding the overall picture of thebusiness, indicates unusual cases As a substantive test to obtain evidence (to support a/cbalance or class of transactions) Computation of prediction against actual Detailed analysis of trends (ratio analysis) As an overall review of the financial info. in the audit finalreview stage (completion) Assess conclusions, evaluate overall FS presentation & recheck for non-investigation. 80 81. The effectiveness & efficiency of AP inidentifying material misstatementdepend on: The nature of the assertion or audit objective AP test all objectives except ownership & mostly effective in completeness. The plausibility and predictability of the relationship. Predictability of relationships (sales & commission). The availability & reliability of the data used. Depends on competency of audit evidence. The precision of the expectation. Accurate estimation. 81 82. Substantive Analytical DecisionProcess Develop expectations (based on last years figure, mostof the time) Define tolerable differences: Rule of thumb- difference of less than 10% or difference of less than RM50,000. Compare the expectation to the recorded amount Investigate differences if greater than tolerabledifferences82 83. FINANCIAL RATIOS USEFULAS AP Short-term liquidity ratios Activity ratios Profitability ratios Coverage ratios83 84. Audit Procedures & Audit evidence In carrying out your audit procedures, youneed to collect audit evidenceAudit evidence: Information obtained by the auditor inarriving at the conclusions on which theaudit opinion are based. (ISA 500) It is obtained to support F/S assertion. Comprise of source of documents andaccounting records. 84 85. Concepts of Audit Evidence Nature accounting records, corroborating evidenceincluding written or electronic form(invoices, contracts, bank statement) Competence (Appropriateness) - quality of evidence(reliability and relevance) Sufficiency - quantity of evidence (due to cost of auditand nature of evidence) Evaluation - persuasive / unbiased (critically analyzed) thorough 85 86. The Competence (appropriateness)of Evidential MatterEvidence is considered COMPETENT when it is RELEVANT - it refers to whether the evidence relates tothe specific audit objective being tested. Egs. ofrelevance of audit procedure in collecting evidence RELIABLE - it refers to the diagnosticity of the evidence;does the evidence signal the true state of the assertionor audit objective.86 87. General factors for assessingreliability Independence of the source of the evidence. Effectiveness of internal control. Auditors direct personal knowledge. Documentation (internal or external).87 88. A MODEL OF BUSINESS PROCESSES Financing capital, invest in FA, loans payback Purchasing goods & others, payback creditors Human Resource Management employees (pay) Inventory Management stock / goods Revenue sales & a/cs receivables* AIS & IC must capture these auditor must audit each of these.2-88 89. DOCUMENTATIONISA 230 - Documentation of work done & evidence accumulated in supporting the opinion in auditors reportFunctions of working paper (WP):1. Aid planning and performance of audit Contain evidence that document auditors work- comply to the auditing standards2. Assist supervision and review of audit workEvaluate the sufficiency of work done by subordinates3. Provide support and evidence to opinion of auditors report89 90. The Importance of Working Papers1. Basis of planning an audit for subsequent year, as reference of prior working papers2. To provide record of evidence accumulated and conclusions indicating that adequate procedures have been performed & to demonstrate that sufficient and competent evidence accumulated by indicating proper x-ref, clients name, period covered etc3. To support proper type of audit report based on the sufficient data accumulated.4. Basis for review by manager or partner to evaluate sufficient and competent evidence accumulated and support final audit opinion. 90 91. WORKING PAPER Types of files: Organisation of Permanent file (PAF) Current file (CAF) working paper: Lead schedule Format of WP: X-ref between WP Heading Located in respective Indexing & x-refsection Audit ticks Ownership of working Types of working paper: Audit programspaper: Property of auditor Trial balance Including prepared by Account analysis/listings client at auditors Audit memoranda request Adjustment/Reclassificati 91 on entries 92. AUDIT SAMPLING: AN APPLICATIONTO TESTS OF CONTROLS & SUBSTANTIVE TESTINGSWhat is Sampling?AUDIT SAMPLING is the application of an auditprocedure to less than 100 percent of the itemswithin an account balance or class oftransactions for the purpose of evaluating somecharacteristic of the balance or transaction (ISA530) Applying audit procedure (testing) to less than100% of the items92 93. The importance of Sampling Timing, cost, extent and scope of audit To provide reasonable (based on sample) notabsolute (population) assurance Sufficient evidence to support conclusions andaudit opinion Appropriate means in gathering and evaluatingaudit evidence since it is impractical to do 100% oftransactions in accounts. 93 94. AUDIT RISK SAMPLING RISK Samples taken may not be representative of thepopulation tested. Overcome: to increase number or sample size. NON-SAMPLING RISK Error in conclusion not due to sample size but to natureof evidence that is persuasive rather than conclusive. i.e.inappropriate audit procedures, misinterpret evidence, orfailure in recognizing the error. Overcome: by proper planning, supervision and review. 94 95. TYPE I AND TYPE II RISK TEST OF CONTROL Type I Risk = The risk auditor will conclude that the control risk is higher than it actually is (assessed CR too high) Type II Risk= The risk of assessing control risk too low SUBSTANTIVE TESTING Type I Risk = Risk auditor will conclude that material error exists when in fact it does not. Type II Risk = Risk auditor conclude that material error does not exists when in fact it does exist. 95 96. AUDIT PROCEDURESTHAT DO NOT INVOLVEAUDIT SAMPLING Inquiry and observation Analytical procedures Procedures applied to every item inthe population (100% examination) Classes of transactions or accountbalances not tested96 97. TYPES OF AUDIT SAMPLINGNon-statistical versus statistical sampling Non-statistical (or judgmental): use of professionaljudgment in designing the sample size. Statistical: selection at random or use of law ofprobability theory Advantages: 1. Design efficient sample 2. Sufficient evidence obtained 3. Quantify sampling risk Disadvantage 1. Additional costs incurred for training on propersampling techniques 97 98. Non-statistical SampleSelection MethodsItem selection based on auditor judgmental criteriaSelecting 100% items from population Test entire population Constitute large number of large value itemsDirected Sample Selection Items most likely to contain misstatements Items containing selected population characteristics Large dollar coverage 98 99. Types of Statistical SamplingTechniques Attribute Sampling- to estimate proportion of population that havespecified characteristics (egs. non-compliance battery). Monetary Unit Sampling- to estimate the amount (in RM) of misstatementfor a class of transaction or accounts balances Classical Variable Sampling-use of typical statistical method in makingestimates 99 100. ATTRIBUTE SAMPLINGAPPLIED TO TESTS OF CONTROLS Attribute sampling is a statistical method used toestimate the proportion of a characteristic in apopulation. The auditor is normally attempting to determinethe operating effectiveness of a controlprocedure in terms of deviations from theprescribed internal control policy. 100 101. Attributes SamplingExample: Audit test on how often a credit check is not performed on customer orders before shipment - sampling unit = customer order forms how often an invoice is not sent after shipment is made - sampling unit = invoice or shipping documents?Common use of attribute sampling test of controls 101 102. Monetary-unit Sampling (MUS) MUS uses attribute sampling theory and techniquesto estimate the amount (in RM or other currency unit) of misstatement for a class of transactions or anaccount balance.Sampling unit = in monetary terms Focus on monetary value ratherthan rate of occurrences. To test overstatement (high valueitems).102 103. Audit Sample Selection- continue Statistical SamplingSimple Random Sample (random numbertable/audit software)Systematic Sample Selection (random/stratifiedrandom)Random Select every nth elements in thesampleStratified the population is divided intostrata, then sample is drawn from each strata.103 104. NEEDS FOR SAMPLING SUBSTANTIVE TESTINGS To estimate the characteristic in a population. Attempting to determine the deviations from theprescribed accounting system in ensuring the auditobjectives are achieved. To provide reasonable assurance. Sufficient evidence to support conclusion & auditopinion. Means of gathering and evaluating evidence. 104 105. PHASES IN SAMPLINGAPPLICATION Planning Performance Evaluation105 106. SPECIAL SITUATIONS INPERFORMING THE AUDITPROCEDURES Voided documents. Unused or inapplicable documents. Missing documents. Stopping the test before completion. Egs. List of invoices from creditors tosee if the accounts are paid.106 107. Non-statistical sampling for Test of Accounts Balances Identify individually significant items-These items will be tested 100%-The remaining items which insignificant is subjected tosampling. Determine the sample size = Population Book Value* x Assurance Factor Tolerable Misstatement*** Exclude 100% test ** estimated during audit planning Calculate the sample results. 107 108. NONSTATISTICAL SAMPLING: DETERMINING SAMPLE SIZE Population Book Value Sam ple Size = x Assurance FactorTolerable M isstatem ent C om b in e d R is k th a t O th e r S u b s tan ti ve P r oc e d u re s w i ll F a ilA s s e s s m e n t ofto D e te c t M a te ri al M is s ta te m e n ts C o n tr o l R is k a n d I n h e re n tM a xi m u mS li gh tlyM o d e ra teS u b s ta n tia l R is k b e lo w m a xi m u mM a xi m u m 3.02 .7 2 .32 .0S li gh tly b e lo wm a xi m u m 2.72 .4 2 .01 .6M o d e ra te2.32 .1 1 .61 .2Low2.01 .6 1 .21 .0108 109. NONSTATISTICAL SAMPLING:CALCULATING SAMPLE RESULTS The AICPAs guidance describes two acceptablemethods for projecting the amount of misstatementfound in a nonstatistical sample: Project the amount of misstatement by dividing theamount of misstatement by the percentage of thedollars of the population included in the sample. Project the average misstatement found in thesample to the population. 109 110. NONSTATISTICAL SAMPLINGAN EXAMPLE - CALABRO Th e se nio r in c h a rge o f th e a u d it, D o n Jo n e s, h a s d e c id e d to d e sign an o n sta tistic a l sa m plin g a p p lic a tio n to e xa m in e th e a c c o u n ts re c e iva ble b a la n c e o fC a la b ro , In c . a t D e c e m b e r 3 1 , 2 0 0 0 . A s o f D e c e m b e r 3 1 , th e re w e re 1 1 ,8 0 0a c c o u n ts re c e iva ble a c c o u n ts w ith a b ala n c e o f $ 3 ,7 1 7 ,9 0 0 a n d th e p o p u latio n isc o m p o se d o f th e fo llo w in g stra ta:N um b e r a n d Si ze o f A c c o un ts B o o k V al u e o f Str a ta1 5 a c c o u n ts > $ 2 5 ,0 00 $ 5 5 0 ,0 0 02 50 a c c o u n ts > 3 ,0 0 08 5 0 ,0 0 01 1 ,5 3 5 a c c o u n ts < $ 3 ,0 0 0 2 ,3 1 7 ,4 0 0110 111. NONSTATISTICAL SAMPLING - CALABROJones has made the following decisions: Based the results of the tests of controls, a lowassessment is made for inherent & control risk. Tolerable misstatement allocated to accountsreceivable is $40,000. The expected amount ofmisstatement is $15,000. There is moderate risk that other auditing procedureswill fail to detect material misstatements. All customer account balances greater than $25,000are to be audited.111 112. NONSTATISTICAL SAMPLING: DETERMINING SAMPLE SIZEPopulation Book ValueSam ple Size =x Assurance Factor Tolerable M isstatem ent C om b in e d R is k th a t O th e r S u b s tan ti ve P r oc e d u re s w i ll F a ilA s s e s s m e n t ofto D e te c t M a te ri al M is s ta te m e n ts C o n tr o l R is k a n d I n h e re n tM a xi m u mS li gh tlyM o d e ra teS u b s ta n tia l R is k b e lo w m a xi m u mM a xi m u m 3.02 .7 2 .32 .0S li gh tly b e lo wm a xi m u m 2.72 .4 2 .01 .6M o d e ra te2.32 .1 1 .61 .2Low2.01 .6 1 .21 .0112 113. NONSTATISTICAL SAMPLING AN EXAMPLE - CALABROSample Size = ($3,167,900/$40,000) x 1.2 = 95** Allocation of the 95 to the 2 strata (BV/Pop BV x SS) ResultsSt ra ta B o ok V a lueB o ok V alu e A u dit V alu e A m ou n t of o f St ra ta o f S am ple o f Sa m ple O ve rst ate m e nt> $ 2 5 ,00 0$ 5 5 0,0 0 0$ 5 5 0,0 0 0 $ 5 49 ,5 00$ 500> $ 3 ,0 00 8 5 0,5 0 04 2 5,0 0 04 23 ,0 002,0 0 0< $ 3 ,0 002,3 1 7,4 0 09 2,0 0 091 ,7 50 250113 114. Projected MisstatementSt ra taA m ou n t of P ercen ta ge o f P ro jecte d M isstatem ent S trat a S a m pled M issta tem en t> $ 2 5,0 0 0$ 50 01 0 0%$ 5 00> $ 3 ,00 0 2 ,00 0 4 2 5,0 0 0 85 0 ,5 00 = .504 ,0 00< $ 3 ,00 0 25 09 2 ,00 0 2 ,31 7 ,4 00 = .07 3 6 ,2 50T o tal Pr o jected M isstatem ent1 0 ,7 50 114 115. CONCLUSION If projected misstatements > tolerablemisstatement, conclusion: there is unacceptablyhigh risk that the account is misstated. If projected misstatements is considerably expectedmisstatements, conclusion: there is unacceptablyhigh risk that true misstatement exceeds tolerablemisstatements. 115