AUDITING AND ASSURANCE Dec 2013

QUESTION ONE

 

• In order to conduct an audit effectively and efficiently, an auditor should properly plan for the assignment

 

• Explain the matters that an auditor should take into account at the planning stage of       an audit exercise             (8 marks)
• Outline the ways in which an auditor acquires knowledge about the client‘s business and industry      (4 marks)

 

• The final stage of an audit includes an overall review of the financial statements.

Explain the procedures that the auditor should adopt for the final review. (4 marks)

• Highlight the qualities required of the final accounts prepared by a client company.

(4 marks)

(Total: 20 marks)

CPA

 

 

 

QUESTION ONE

 

•  In order to conduct an audit effectively and efficiently, an auditor should properly plan for the assignment.

 

•       Matters to be considered at the planning stage of the audit.

ISA 300 – Planning an audit of financial statements states that the auditor should plan the audit so that the engagement will be performed in an effective manner. Planning the overall audit strategy for the engagement and developing an audit plan

 

Matters to be considered;

Knowledge of business

• • General economic factors and including conditions affecting the entity‘s

business

• Important characteristics of entity, its business, its financial performance and its reporting requirements including changes since date of prior audit
• General level of competence of management

• Accounting policies adopted by the entity and changes in those policies
• Effect on new accounting and auditing pronouncements
• Auditing cumulative knowledge of accounting and internal control systems is the relative emphasis expected to be placed on tests of control and

substantive procedures   Risk and materiality

• The expected assessment of inherent and control risks and the identification of significant audit areas
• The setting of materiality levels for audit purposes
• Possibility of material misstatement, including experience of past periods or

fraud

• Identification of complex accounting areas including those involving

accounting estimates

• , timing and extent of procedures
  • Possible change of emphasis on specific audit areas
  • Effect of information technology on the audit
  • Work of internal auditing and its expected effect on external audit procedures
• ^ü Co-ordination, Direction, Supervision and Preview
  • Involvement of other auditors in audit of components e.g subsidiaries, branches and divisions
  • Involvement of experts
  • Number of locations
  • Staffing requirements

 

Other matters;

• Possibility that going concern assumption may be put to question

 

 

• Conditions requiring special attention, such as the existence of related parties
• Terms of engagement and any statutory responsibilities
• Nature, timing of reports or other communication with the entity that are expected under the engagement

 

Ways of acquiring knowledge of business and industry

            According to ISA 310 – Knowledge of business, such methods are;

• Previous experience with entity and industry
• Discussion with the people of the entity e.g. directors, senior operating

personnel

• Discussion with internal audit personnel and review of internal audit reports
• Discussion with other auditors and with legal and other advisors who have provided services to entity or within the industry
• Discussion with knowledgeable people in the entity e.g. industry economists, industry regulators, customers, suppliers and competitors
• Publications related to industry e.g. government statistics, surveys, texts, trade journals, reports prepared by banks and security dealers, financial newspapers

etc

• Legislation and regulations that significantly afect the entity
• Visits to entity‘s premises and plant facilities
• Documents produced by entity e.g.ü ü

Minutes of meetings      Material

sent to shareholdersü               ü

Material filed with regulatory authorities

Promotional literatureü               ü

Prior years annual and financial reports

Budgetsü         ü

Interim financial reports

Management policy manual

ü

Manuals of accounting and internal control systems

The auditor can also consider;

• General economic factors such as;
  • General economic activity
  • Interest rates and availability of financing
  • Inflation, currency revaluation
  • Government policies
  • Monetary
  • Taxation
  • Tariffs, trade restrictions
  • Fiscal
  • Financial incentives

 

• Industry – Important conditions affecting client‘s business
  • Market and competition
  • Cyclical or seasonal activity
  • Changes in product technology
  • Business risk
  • Adverse conditions as declining demand
  • Key ratios and operating statistics
  • Specific accounting practices and problems
  • Environmental requirements and problems

 

Revision Questions and Answers

 

• Regulatory framework
• Energy supply and cost

 

Before forming an opinion on the financial statements and deciding on the wording of

      the audit report, the auditor should conduct an overall review of statements

Audit procedures for final review

 

• Accounting policies

Consider if they;

 

• Are in accordance with generally accepted accounting principles and comply with fundamental accounting concepts as going concern, accruals, consistency and prudence.
• Are acceptable to particular circumstances
• Are commonly adopted in a particular industry
• Are consistently applied over the years
• Are consistently applied throughout the enterprise
• Comply with all relevant accounting standards

 

• Circumstances of enterprise

 

• Consider if the accounts are consistent with the auditor‘s knowledge of underlying circumstances of the business and information.
• Review information in the accounts to determine if there are any abnormalities or inconsistencies

 

Presentation and disclosure

• • Consider in any conclusion that a reader might draw from his reading of the accounts would be justified and is consistent with the circumstances of the

enterprise

• Consider if the substance of any transactions or activities is disclosed and not

merely their form

• Consider if the presentation might have been unduly influenced by management‘s desire to present facts in a favourable light
• Consider if the review has indicated that there are few factors which might alter the policies used or the presentation of the accounts, and special attention needs to be paid to going concern difficulties.

 

•  Qualities of final accounts
•  That they use acceptable accounting principles which have been consistently

applied and are appropriate to business ii) The results of operations; income statement, state of affairs; Balance sheets and all other information included in financial statements are compatible with each other

and with auditor‘s knowledge of enterprise

There is adequate disclosure of all appropriate matters and the information contained in financial statements is suitably classified and presented e.g. a loan to

            subsidiary should not be described as cash at bank  

There is compliance with statutory requirements e.g. the Companies Act

•  There is compliance with other relevant regulations e.g. stock exchange regulations.
•         There is compliance with accounting standards.

 

QUESTION TWO

 

• The auditor must exercise due care and skill before he certifies that the financial statements show a true and fair view.

 

Explain the ways in which an auditor can minimize his potential liability for professional  negligence.        (10 marks)

• Highlight the possible defences available to an auditor in a court of law who has been

sued for failure to detect fraud in client‘s company.            (5 marks) c) In the context of the Companies Act, state the duties of an auditor.          (5 marks)

(Total: 20 marks)

 QUESTION TWO

Ways of minimizing auditor‘s potential liability for professional negligence. -Stating in audit report the purpose of the report and that it may not be relied upon for any other purpose

 

–        Advising the client in the engagement letter of the need to obtain permission to use  the name of the accountant and withholding permissions in appropriate cases –        By limiting or excluding liability by a term in the engagement letter or third liabilities  by a disclaimer in a report. –        By agreeing the duties and responsibilities in an engagement letter. This should specify the specific tasks to be undertaken and exclude specifically those that are not to be undertaken by the client and specify and limitations on the work to be undertaken –        By defining in their report the precise work undertaken, work not undertaken, any limitations to the work. This is so that any third party will have knowledge of the responsibility accepted by the auditor for the work done –        Identifying the authorized recipients of reports in the engagement letter or to third  parties, by a disclaimer in the report –        Defining the scope of professional competence. The auditor should not undertake work that they are not competent to carry out –        By obtaining a professional indemnity insurance.   b) Defense available to an auditor in a court of law in case he has been sued for failure to
	detect fraud in client‘s company. – Breach of contract may occur when there is non-performance of a contractual duty. Causes for action against the auditor for breach of contract may include but are not
	limited to the following
 	•        Violating client confidentiality •        Failing to provide audit report on time •        Failing to discover a material misstatement
	–     Remedies for breach of contract include requiring specific performance
	•        Specific performance of contract agreement. •        Providing for recovery of amounts lost as a result of breach. When specific performance or on injuction is not appropriate, the client is entitled to recover compensatory damages.
	The auditor can use the following defenses against breach of contract –        The auditor proofs that the exercised dues professional care and skill in accordance
	with the contract. –                 Contributory negligence was present i.e. both the client and the auditor were
	involved in negligence – The client losses were not caused by the breach i.e. the client did not suffer financial loss as a result of auditor‘s negligence.
c)	Duties of an auditor – To report to the shareholders or directors on whether the financial statements of the company or group show a true and fair view or ―present fairly‖ and
	have been properly prepared in accordance with legislation. –       To consider whether the information in the management report included within the
	annual report is consistent with the audited financial statements.
	–     To form an opinion as to whether
	•        Proper accounting records have been kept by the company •        Such information and explanation as the auditors think necessary for the
	performance of their duties have been received from company‘s officers.
	    Report on any violation of law or company‘s constitution.

     Make a ―statement of circumstances‖ when they cease to hold office

for any reason.

 

QUESTION THREE

 

• Briefly explain how the auditor can use each of the following methods of sample selection when carrying out his audit assignment;
•  Stratified sampling (2 marks)
•  Cluster sampling     (2 marks)
• Haphazard sampling           (2 marks)
•  Block sampling      (2 marks)
• Explain the reasons why an auditor is not required to carry out a complete check of all

the transactions and balances of a business                                           (4 marks)

• Identify the cases where an auditor is required to conduct a complete check of all the transactions and balances of a business.(4 marks)
• Explain two reasons why an auditor should consider materiality when selecting a sample            (4 marks)                                   (Total: 20 marks)

QUESTION THREE

• The auditor can use each of the following methods of sample selection when carrying out his audit assignment as follows

 

• Stratified sampling

Stratification is used to reduce the degree of variation between items within a population and enables auditor to direct attention to those areas where there is the greatest potential monetary error. It has the effect of reducing sample sizes. Where auditors are concerned with discovery of overstatement errors and consider that the largest monetary errors are likely to occur in the largest individual populations, they will stratify population by value They may direct major part of their audit effort to

those items with highest individual value.

Example;

 

	Number of items	Value of	Test
Value	in stratum	Stratum	size
Above Ksh.1m	10	Shs.36 million	10
Shs.250,000 to Shs.1m	150	Shs.95 million	50
Shs.50,000 to Shs.250,000	1000	Shs.93 million	50
Shs.10,000 to Shs.50,000	3000	Shs.60 million	35
Less than Shs.10,000	7000	Shs.15 million	15

 

1. Cluster Sampling

It is useful when data is maintained in clusters (groups or bunches) as wage records are kept in weeks or safes in months. The idea is to select a cluster randomly and then to examine all the items in the cluster. The problem with the method is that the sample may not be representative.

 

 

• Horizontal sampling

It is simply choosing items subjectively but avoiding bias. Bias might come in by tendering to favour items in a particular location or in an accessible file or conversely in picking items because they appear unusual. The method is acceptable for non-statistical sampling but is insufficiently rigorous for statistical sampling.

 

 

1. Block sampling

It is simply choosing at random one block of items e.g. all June invoices. It consists of selecting a number of adjacent transactions or items e.g. all sales in a particular week or all credit customers with a name beginning with a particular letter. It is not an appropriate selection method since populations might be expected to be structured in such a way that items in a sequence have similar characteristics to each other but different characteristics to items elsewhere in the population.

 

 

1. An auditor is not required to carry out a complete check of all transactions and balances;
   1. Economic

The cost in terms of expensive audit resources would be prohibitive which will inflate audit fees

 

1. Time

The complete check would take so long that the client may receive audit reports on matters which are outdated

 

• Practical reasons

Users of accounts do not expect 100% accuracy. The auditor will only focus on material areas.

 

• Psychological
  • complete check would be tiresome to audit staff who may then not carry out an effective and efficient audit

 

• Fruitless/End results
  • complete check would not add much to worth of figures if as would be normal a few amounts were discovered. This emphasis in auditing should be on the completeness of record and true and fair view.

 

• Large volume of transactions

For large business with voluminous transactions, it is necessary for auditor to sample since not all transactions can be audited. Full testing would not achieve the specified audit objectives for an area e.g. full testing on sales invoices would not verify all sales are recorded (it may not demonstrate completeness) nor would it deal with human error on the part of the auditor.

 

• Cases where an auditor is required to conduct a complete check of all transactions and balances
  • Categories which are few in number but of great importance e.g. land and buildings
  • Categories with special importance where materiality does not apply e.g. director‘s emoluments and director‘s loans and any other such benefits.
  • Unusual, one-off or exceptional items
  • Any area where the auditor is put upon enquiry
  • High risk area
  • Audit area does not consist of items of the same kind, i.e. there is nonhomogeneous population.

 

• Importance of considering materiality in selecting sample size

 

• • An auditor is not required to have confidence that all items in a set of accounts are 100% correct. His duty is to give an opinion on the truth and fairness of the accounts. Errors can exist to accounts and yet accounts still give a true and fair view. The maximum error that any particular magnitude can obtain without marring true and fair view is tolerable error. Tolerable error is auditing materiality.
  • In his audit planning, the auditor needs to determine the amount of tolerable error in any given population and to carry out tests to provide evidence that the actual errors in the population are less that tolerable error.

 

QUESTION FOUR

 

• Explain the purpose of an internal control questionnaire to an auditor. (4 marks)

 

• Explain the factors an auditor should consider when determining the adequacy of a client‘s internal control system.(6 marks)

 

• Kenya Cans Ltd. Manufactures cans which are stamped from sheets of metal moulded and supplied to Selmont Ltd for packing fruits. After stamping the sheets of metal, scrap metal is produced as residue. During the year 2004, revenue from scrap metal amounted to Sh.500,000.

 

The company has established the following system to monitor the sale of scrap metal;

 

• i) Scrap metal is placed by employees in a large bin outside the workshop ii) At the of the week a local scrap dealer collects the scrap metal leaving the bin

empty

• The scrap dealer takes the scrap metal to the gatekeeper who measures and

records the weight in a register before it exits the factory.

• The scrap dealer sends a cheques the following week with a statement showing the weight collected, price and cheques amount. The company‘s cashier on receiving the cheques, compares it with the statement to ensure that they both agree with the gatekeeper‘s registers.

 

Required;

•  Explain the weaknesses of the above system. (4 marks)
•  Suggest recommendations to improve on the above system.           (6 marks)

(Total: 20 marks)

QUESTION FOUR

 

• Purpose of internal control questionnaire to an auditor

It is a form of recording internal control system. It is regarded as document for evaluating rather than recording the system. It consists of objective questions which focus on some specific controls and information obtained in completing the Internal Control Questionnaire used to answer relevant internal control evaluation questions.

 

      Objectives/uses of internal control questionnaires

• Ascertain a client‘s system of accounting and internal control
• To record client‘s system
• Identify controls or absence of controls

 

Revision Questions and Answers

 

• Assist the evaluation of the system
• Enable the auditor to review and assess adequacy of system
• Enable auditor to design a series of tests hence draw up the audit programme
• Enable audit staff to familiarize themselves with the system quickly and comprehensively

 

• Factors to consider when determining adequacy of the internal control system
  • Segregation of duties

 

• No one person should be responsible for recording and processing of a complete transaction. There should be different staff for recording,

processing, authorisation and approval of the transactions.

• Involvement of several people reduces risk of intentional manipulation of accidental error and increases the element of checking of work

 

• Physical control

Concerns physical custody of assets and involves procedures designed to limit access to authorized personnel only

 

• Authorisation and approval All transactions should require authorisation or approval by an appropriate person. Limits to authorisation should be specified.

 

• Organisation controls An enterprise should have
  • Plan of organisation that defines and allocates responsibly.
  • Every function should be in charge of a specified person – the responsible official

 

• Delegation of authority and responsibility clearly defined. An employee should always know the precise powers delegated to him, the extent of his authority and to whom he should report to.

 

All actions by all levels of staff should be supervised. The responsibility for supervision should be clearly laid down and communicated to person being supervised.

 

• Management

These are controls exercised by management which are outside and over and above the day to day routine of the system. They include overall supervisory controls, review of management accounts, internal audit and budgeting.

 

• Control of Documents

Sensitive documents i.e. receipts, local purchase orders etc should be handled by reliable person. They should be pre-numbered to ensure control.

 

• Personnel
• Company should employ qualified and experienced people
• Arithmetic and accounting accuracy
• This ensures that accuracy of transactions through paper recording by use of calculators and computers. These are controls in recording function which check that the transactions have been authorized, that they are all included and that they are correctly recorded and accurately processed.
• Kenya Cans Ltd.
• Weaknesses in the system -Lack of supervision.
• There is no authorized employee to monitor and supervise the employees as they place scrap metal in large bins outside the workshop. The scrap metal is therefore prone to theft by staff
• Lack of authorisation controls

There is no staff to authorize the local scrap dealer when collecting the scrap metal from the bin.

 

• Incomplete recording system

There is no staff recording the scrap metal on being collected by local scrap dealer.

Company is prone to losing income from scrap metal

 

• Collusion between gate keeper and scrap metal dealer

There is not staff to monitor the gatekeeper while weighing the scrap before it leaves the factory. The dealer is likely to collude with the dealer to conceal some income and defraud the company.

 

• Lack of accounting documentation

There is no recording system over scrap metals collected by dealer. The dealer is likely to deflate the cheques sent thereby defrauding the company of the income from sales.

 

• Collusion between scrap metal dealer and company cashier

There is no approval, authorisation and monitoring controls over the amounts received from dealer. Cashier is likely to collude with dealer to defraud company income.

 

Recommendations

• An efficient recording system to ensure proper documentation and scrap metal sales
• An upto date report on scrap metals sales on a monthly or weekly basis
• A specific qualified competent accountant positioned at the gate to monitor processing of the weighing and recording of scrap metal safes
• An upto date technology to be implemented for recording and weighing scrap metal
• A proper supervisory control system to ensure that gatekeeper, scrap metal dealer and cashier are supervised.
• Segregation of duties. There should be different staff for weighing scrap metal, recording and receiving cheques

Confirming amount and recording in cheques

 

QUESTION FIVE

 

Your audit senior has assigned you the responsibility of auditing the stock of your client, XYZ Supermarket Ltd. for the year ending 31 December 2005.

 

The company‘s stock take is carried out once a year in the month of Novembersimultaneously for all the retail outlets.

 

Required:

• State the audit assurances you would seek to obtain in the audit of stock. (4 marks)

 

• Describe the audit procedures that you would perform in order to be satisfied as to the validity of the amount attributed to stock in the balance sheet of XYZ Supermarket Ltd.

(12 marks) c) Define the word ―bar coding‖ and explain         its importance to XYZ Supermarket Ltd.

(4 marks)

(Total: 20 marks)

QUESTION FIVE

 

Audit assurances in the audit of stock

 

• Whether a continuous inventory is maintained. There should be at least annual stock take
• Control over stock documents. Documentation should be considered by use of prenumbered forms with regular sequence checks
• Controls over receipt of goods
• Storage conditions for stock
• Safeguarding of stock against loss, fire, deterioration due to poor storage
• Recording system. Stock records should be continuously compared with actual stocks held by independent officials
• Valuation per IAS 2 i.e. lower of cost and not realizable value
• Existence of stock
• Completeness of stock records

Revision Questions and Answers

 

• Presentation and disclosure of stock in financial statements.
• Whether the company has rights and obligation over stock recorded.

 

1. Audit procedures for stock balances in Balance Sheet

 

• Enquire into what costs are included, how these have been established and ensure that overhead addition is based on normal costs and is reasonable in relation to

information disclosed by draft financial statements.

• Test check price on inventory, lists with official sales list bearing in mind any trade discounts which are normally granted off the list prices – Ensure that inventories are valued at net realizable value if this is less than cost. Check if the relevant party processed inventories and raw materials have also been  written down
• Following up any items which inventory records show are more than say 6 months in inventory. Enquire into the reasons for this and ascertain the possible realizable value of such items.
• Follow up any inventories which at the time of selling of product lines at less than usual selling prices e.g. due to completion, or substitute products on the market
• Follow up valuation of all ―second‖ items and ensure that they are valued at reasonable estimated net realizable value is less than cost
• Check re-order levels, check whether all stock items are subjected to a maximum or minimum stock levels
• Compare actual stocks held by independent officials with the stock records. All differences should be corrected and investigated
• Check on storage conditions which deter deterioration due to physical access e.g. heat, cold, microbial action.
• Check whether a continuous inventory is maintained. There should be at least an annual stock take
• Check procedures established for stock take
• Check procedures for identifying damaged, slow moving and obsolete stock and cut off procedures
• Check the purchases records to ensure completeness of stock records
• Check whether stock has been valued at lower of cost and net realizable value as per

IAS 2

• Physically inspect stock in premises to ensure that closing stock figure actually exists.

 

Bar coding

 

It is a form of identification for all the products in the supermarket. Each product has a bar code number to identify it from other products. The product bar code number is read by the bar code reader so as to identify the product and its price.

 

Importance of bar coding

• To identify each specific product
• To identify the price of each product
• To save supermarket on costs of attaching price tags to each product.

 

QUESTION SIX

 

• Your audit firm, Kimani and Associates has been contracted by the government to audit the procurement system followed by the government.

 

      Required:

• Identify the likely risk areas that your firm may encounter in the audit.(5 marks)

 

 

Revision Questions and Answers

 

• Suggest possible  measures  the  government  can  implement  to  strengthen  the internal control system on procurements. (5 marks)

 

• Outline the  audit  procedures  an  audit  firm  should  follow  in  the  verification  of  a

manufacturing company‘s liabilities.                                                   (10 marks)

(Total: 20 marks)

 QUESTION SIX

• Kimani and associates
• i) Key risk areas in government procurement system
  • Fraudulent payments to suppliers
  • Excessive fees for goods and services procured
  • Inaccurate payments for goods and services
  • Delays in paying for purchases resulting in damage to government reputation
  • Breach of regulations, legal or company requirements

 

 

 

• Collusion between government procurement officers and suppliers for fictitious
• Inflated prices for goods and services through collusion between suppliers and government procurement officers
• Payment for goods that were never ordered and delivered
• Non-compliance to procurement processes and procedures
• Lack of clearing defined procurement policies, processes and procedures
• Complex procedures not communicated to relevant procurement officers

 

• Possible measures to improve procurement system.          –             Establish policy and procedures for procurement

• Policies, procedures for procurement properly communicated at all levels of             management
• Set authorisation and approval procedures for procurement with different levels covering different cost levels
• Procedures for negotiating the best deals in the market place for a place for specific bulk purchased
• Set up of a dedicated procurement section in which case all procurement requests should be made through this unit to maximize the benefit of any negotiated deals -Have an approved list of suppliers, ensuring that no purchases made outside of that list without authorisation
• Effective payment procedures
• Exception reports showing where transactions have not been authorized, where they fall outside of the established procedures.

 

• b) Audit procedures for audit of liabilities

 

• Obtain a schedule of payables, with appropriate age analysis and check this with the control account and purchase ledger
• Separate debit and credit balances, debit balances being included in receivables. This is called grossing up
• Review the individual accounts with the largest throughput of transactions during the period – not necessarily the largest balances at the end of the year
• Review year end cut off procedures for purchases – Review internal control over purchase system which ensures that all goods received are properly recognized as liabilities of the company
• Select a sample of supplier balances which should be based on the reciprocal of purchases turnover in which case monetary sampling unit should be used.
• Check whether all the liability balances are made up of specifications outstanding within a reasonable period
• Check whether all items have been authorized for payment
• Agree the liability amounts, reconcile with supplier statements
• Consider the need to perform a circularization of accounts payable, seeking direct confirmation of amounts due
• Review payments to payables and other liabilities just after the year end
• Perform analytical procedures on payables, comparing age analysis with previous periods and payable days.

 

= payables x 365 cost of sales

 

QUESTION SEVEN

 

• An auditor should form an opinion on the adequacy of the accounting treatment of an inherent uncertainty disclosed in the financial statements of a company.

 

• What is meant by the term “inherent uncertainty”? (2 marks)
• Explain the treatment of inherent uncertainties in the auditor‘s report. (6 marks)

 

• Summarise the principal contents of a statement  of directors‘ responsibilities to be included in financial statements. (8 marks)

 

• Explain the steps an auditor should take if he concludes that the client has made a departure from an accounting standard in the preparation of the financial statements.

(4 marks)

(Total: 20 marks)

QUESTION SEVEN

 

• An auditor should form an opinion on the adequacy of the accounting treatment of an inherent uncertainty disclosed in the financial statements of a company.

Revision Questions and Answers

 

• Inherent uncertainty

A limitation in (or on) scope gives rise to doubt i.e. uncertainty about the ―true and fair view‖ because it necessarily means that there is insufficient relevant and reliable evidence on which to base the audit opinion. However, this has nothing to do with ―inherent uncertainty,‖ this is quite contrary.

 

There are some matters for which the auditor will have all necessary i.e. sufficient and appropriate i.e. relevant and reliable, information that can be reasonably expected to be available yet still be unable to form an opinion on it because the  nature of the matter is inherently uncertain i.e., it concerns future outcomes. Hence, going concern and ‗pending litigation‘ are the classic examples of inherent uncertainty, the auditor cannot reasonably expect to know what the verdict of a jury might be in a court case to be held months or fears into the future.

 

• Treatment of inherent uncertainty in audit

Uncertainty applies to the outcome of a financial statement item that is not susceptible to reasonable estimation prior to the balance sheet date. It is another way of saying that notwithstanding the procedures carried out, the auditor cannot obtain reasonable assurance as to how fairly stated an item is. This is usually the case as regards the outcome of court case awards or a client who is heavily reliant on obtaining a key contract or renewal of financing to continue operating as a going concern.

 

Uncertainties differ from accounting estimates in that accounting estimates are capable of reasonable estimation by management in the preparation of financial statements. An uncertainty may relate to the outcome of a lawsuit, the results of tax authorities audit, serious deficiencies in working capital, or failure to comply with the terms of a loan agreement.

 

In determining whether the financial statements are presented fairly, the auditor should evaluate the materiality of reasonably possible losses, both individually and in the aggregate, upon the resolution of the uncertainties. The auditors‘ consideration of materiality is a matter of professional judgement and such judgement and such judgement is made in the light of surrounding circumstances. In some cases, uncertainties relate primarily to financial position, whereas others more closely pertain to results of operations.

 

Emphasis of matter with an unqualified opinion

 

Any uncertainty may result in adding an emphasis of matter to the standard report

when;

• There is a probable chance of material loss and management has not made an accrual in the financial statements
• There is a reasonable possibility of a material loss and
  • The amount of the possible loss exceeds the auditor‘s judgement about materiality, and
  • The likelihood of occurrence is closer to probable than remote

 

The explanatory paragraph should describe the uncertainty and indicate that its outcome cannot be determined because it depends on future events. As shown below, the explanatory paragraph should follow the opinion paragraph. In this example, the explanatory paragraph is shortened by reference to the note in the financial statements. There is no mention of the uncertainty in the other paragraphs of the report.

 

Independent auditors report(First three paragraphs same as the standard report)

 

 

 

As discussed in Note X to the financial statements, the company is a defendant in a lawsuit alleging infringement of certain patent rights and claiming royalties and punitive damages. The company has filed a counteraction, and preliminary hearings and discovery proceedings on both actions are I progress. The ultimate outcome of the litigation cannot presently be determined. Accordingly, no provision for any liability that may result upon adjudication has been made in the accompanying financial statements.

 

Other types of opinion

Uncertainties will result in expressing other than an unqualified opinion when there is a scope limitation. A scope occurs when sufficient evidential matter does (or did) exist during the audit to support management‘s assertions about the uncertainties. However, such evidence was not availed to the auditor because of management‘s record retention policies or a client imposed restriction. For a scope limitation, the auditor should express a qualified opinion or a disclaimer of opinion. The departures from the standard report are the same as described earlier for other scope limitations.

 

Contents of directors responsibilities

• • Ensuring that proper books of accounts are maintained by company
  • Ensuring that the financial statements as income statement, Balance sheet and cashflow statements have been prepared in accordance with identified relevant

reporting framework e.g. international Accounting Statements. -Timely preparation of financial statements

• Designing an internal control system
• Implementing internal control system
• Ensuring accuracy, completeness of financial statements
• Designing appropriate accounting policies and procedures e.g. for depreciation
• Ensure that accounting policies adopted are consistently applied from period to

period

• Ensure that any departure from reporting framework is properly reflected, disclosed in financial statements
• Ensure uniformity in application of International Accounting Standards and accounting policies
• Ensure that they inform the shareholders of the contents in financial statements. They should interpret the policies adopted and other technical financial matters.
• Implementing an internal control system that ensures errors and frauds are
• Ensuring preventive measures are instituted to ensure errors and frauds do not

occur

• Where errors and frauds have occurred, ensure that controls are in place to correct such
• Ensure controls are in place to detect errors and frauds in financial statements

 

Steps taken by the auditor where client has departed from accounting standard.

 

• Consider materiality of item. Consider the item in comparison with total of all class of items it relates to
• Consider the impact of departure in financial statements
• Check wither the departure has been properly disclosed and presented by ways of a note to financial statements
• Confirm whether the directors have the intention of correcting the departure by ensuring compliance in subsequent financial statements
• Consider reasons for departure from directors
• Consider whether the reasons for departure are justified

 

 

Revision Questions and Answers

 

• Consider the possibility of the directors preparing revised financial statements with the correct financial statements i.e. statements that have complied with all the standards
• If the matter is material and the directors fail to do-operate to either revise the statements or disclose by way of note, the auditor should consider qualifying the audit report.

 

QUESTION EIGHT

 

• The computerization of business operations has posed many challenges to the auditor. Explain the difficulties experienced by an auditor in each of the following situations:

 

• In the use of test packs. (4 marks) ii) In on-line systems. (4 marks) iii) When auditing the output of a complex computerized system.          (6 marks)

 

• Briefly explain how an auditor verifies the following items in a computerized system.

 

• Standing data in a master file (3 marks)ii)Alterations made in the computer programs.(3 marks)

(Total: 20 marks)

QUESTION EIGHT

 

• a) The computerization of business operations has posed many challenges to the I. Difficulties experienced by the auditor in the use of test packs

Audit test data consists of data submitted by the auditor for processing by the client‘s computer based accounting system. It may be processed during a normal production run (running test data live) or during a special run at a point in time outside normal cycle

(running test data dead). Approaches to test data are;

• ü Using live data
• ü Using dummy data in a normal production run

ü

• Using dummy data in a special

run Difficulties

• Costs

There may be considerable costs involved in ascertaining the relevant controls and in constructing test data from scratch

 

• Objectives of the set

Test data is likely to be confined to tests of controls and may therefore be less valuable in audit terms than using audit software.

 

• Dangers of using live testing

Careful planning and control is needed to check test data from records

 

• Dangers of testing during a special runIf special test runs are used, an artificial testing environment is created. Assurance is needed that the normal program and files have been used.

 

                      v) Recording

Use of test packs does not necessarily provide visible evidence of the audit work performed. Working papers should therefore include details of the controls to be tested, an explanation of how they are tested, details of the transactions and files used, details of predicted results, actual results and evidence of the predicted and actual results having been compared.

 

• Difficulties experienced by auditor in on-line system

Online computer systems are those that enable users to access data and programs directly through terminal devices. The risks in using real time systems is increased where terminal devices are dispersed and particularly where public as opposed to private telecommunication links are used. Unauthorised access may be deterred by use of protocols, encryption and call back procedures. Where on-line processing is interrupted, where telecommunication links are used, there is increased loss or corruption of data

 

The auditor must ensure that he understands the operation of such systems. He should test the operation of access controls such as passwords. He should test transaction logs where they exist for authorisation, completeness and accuracy.

 

The auditor may also reprocess transactions either as a test of control or as substantive procedure.

 

 

 

 

• Difficulties experienced by auditor when auditing complex computerized system

 

     Inherent risk

Due to a complex computerized environment, account balances are likely to be susceptible to material misstatement irrespective of related internal controls. This may lead to auditor expressing an inappropriate opinion on the financial statements.

 

     Control risk

It is the risk that material misstatement could occur in an accrual balance which would not be detected or prevented by the accounting and internal control systems. This occurs in a complex computer environment which will increase audit risk

 

     Detection risk

In a complex computerized environment, the auditor‘s substantive procedures may not detect material misstatement in account balances

 

     Cost/Resources

A computerized environment will result to auditor applying Computer Audit Assisted Techniques which may be costly.

 

Need for technical skills

The auditor has to empty competent, skilled and experienced staff in information technology. This will be costly and will lead to an increase in audit fees.

 

Effect in audit planning

In planning the positions of the audit which may be affected by the client‘s environment.The auditor should obtain an understanding of the significance and complexity of the computer information system activities and the availability of data for use in the audit

 

     Security threats

A complex computer system is likely to have security threats due to unauthorised access to information through hacking. This will have an effect of the application programs and audit software used.

 

•  How the auditor verifies the following;
•  Standing data in a master file
• Check that all codes match those on master files e.g. employees number matches on employee number on the personnel file. The objective is to ensure that data is processed against the correct master file.
• Check on completeness to ensure that all transactions are recorded
• For validity check to ensure that only actual transactions have been properly authorized and recorded
•  Alterations made in computer programs
• Check for authorisation to ensure that the staff who altered the program is different from the one who authorized.
• Check whether strict controls have been instituted to the changes
• Check whether a written request for an application program change has been

made by use department

• Check whether the alterations have been authorized by a designated manager or

committee

• Check whether documentation has been revised once the program has been redesigned.

 

Revision Questions and Answers

 

• Check whether the changes in the program has been tested by the user and a systems employees who was not involved in designing the change
• Check whether approval of documented changes and results of testing should be given a systems manager
• Check if the proposed changes have been tested with incorrect or incomplete data as well as actual data to determine if controls have been properly implemented in the program