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TOPIC 1

 NATURE AND PURPOSE OF AN AUDIT

Nature of an audit

According to General Guidelines on Internal Auditing issued by the ICAI, “Auditing is defined as a systematic and independent examination of data, statements, records, operations and performances (financial or otherwise) of an enterprise for a stated purpose. In any auditing situation, the auditor perceives and recognises the propositions before him for examination, collects evidence, evaluates the same and on this basis formulates his judgement which is communicated through his audit report.”

The nature of the propositions which an auditor is called upon to review varies. Thus an auditor may review the financial statements of an enterprise to ascertain whether they reflect a true and fair view of its state of affairs and of its working results. In another situation, he may analyse the operations of an enterprise to appraise their cost-effectiveness and in still another, he may seek evidence to review the managerial performances in an enterprise. In yet another type of audit, the auditor may examine

whether the transactions of an enterprise have been executed within the framework of certain standards of financial propriety. However, the variations in the propositions do not change the basic philosophy of auditing, though the process of collection and evaluation of evidence and that of formulating a judgment thereon may have to be suitably modified.

According to AAS-1 on “Basic Principles Governing an Audit”, “An audit is independent examination of financial information of any entity, whether profit oriented or not, and irrespective of its size or legal form, when such an examination is conducted with a view to expressing an opinion thereon.” The person conducting this process should perform his work with knowledge of the use of the accounting statements discussed above and should take particular care to ensure that nothing contained in the statements will ordinarily mislead anybody. This he can do honestly by satisfying himself that:

• The accounts have been drawn up with reference to entries in the books of account;
• The entries in the books of account are adequately supported by underlying papers and documents and by other evidence;
• None of the entries in the books of account has been omitted in the process of compilation and nothing which is not in the books of account has found place in the statements;
• The information conveyed by the statements is clear and unambiguous;
• The financial statement amounts are properly classified, described and disclosed in conformity with accounting standards; and
• The statement of accounts taken as an integrated whole, present a true and fair picture of the operational results and of the assets and liabilities.

The aforesaid definition is very authoritative. It makes clear that the basic objective of auditing, i.e., expression of opinion on financial statements does not change with reference to nature, size or form of an entity. The definition given in AAS-1 is restrictive since it covers financial information aspect only.

However, the scope of auditing is not restricted to financial information only but, today, it extends to variety of non-financial areas as well. That is how various expressions like marketing audit, personnel audit, efficiency audit, production audit, etc. came into existence. Students may note that study material deals with various aspects of financial audit only unless otherwise specified.

 

The auditor: The person conducting audit is known as the auditor; he makes a report to the person appointing him after due examination of the accounting records and the accounting statement in the form of an opinion on the financial statements. The opinion that he is called upon to express is whether the financial statement reflect a true and fair view. Auditing, especially of companies and for public purposes has become the preserve of persons having recognised professional training and qualification.

Objectives of an audit: The objective of an assurance engagement will depend on the level of assurance given. First we will consider a reasonable assurance engagement, where a high, but not absolute, level of assurance is given.

ISAE 3000 (Revised) Assurance engagements other than audits or reviews of historical financial information was revised in September 2013 and applies to assurance reports dated on or after 15 December 2015. The revised ISAE distinguishes between two forms of assurance engagements:

• Reasonable assurance engagements
• Limited assurance engagements

The objective of a reasonable assurance engagement is a reduction in assurance engagement risk to an acceptably low level in the circumstances of the engagement as the basis for the assurance practitioner’s conclusion. The conclusion would usually be expressed in a positive form.

In order to give reasonable assurance, a significant amount of testing and evaluation is required to support the conclusion.

Limited assurance is a lower level of assurance. The nature, timing and extent of the procedures carried out by the practitioner in a limited assurance engagement would be limited compared with what is required in a reasonable assurance engagement. Nevertheless, the procedures performed should be planned to obtain a level of assurance which is meaningful, in the practitioner’s professional judgement.

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For a limited assurance engagement, the conclusion conveys whether, based on the procedures performed and evidence obtained, a matter(s) has come to the practitioner’s attention to cause the practitioner to believe the subject matter information is materially misstated. This would usually be expressed in a negative form of words.

For both reasonable and assurance engagements, the revised ISAE requires the practitioner to provide a summary of the procedures undertaken within the assurance report.

 Development of audit (early audit and modern audit)

1. Early Auditing (Ancient Times to 19th Century)

• Origins in Ancient Civilizations:
  • Auditing traces back to ancient Mesopotamia, Egypt, Greece, and Rome.
  • Scribes checked records for fraud and mismanagement in tax collection and trade.
• Middle Ages (Feudal Systems):
  • Stewards (managers) maintained accounts for landowners.
  • Auditors reviewed records to detect fraud and ensure accuracy.
• Industrial Revolution Impact (18th–19th Century):
  • Growth of businesses led to separation of ownership and management.
  • Shareholders demanded independent verification of financial statements.
  • Key Development:
    • Joint-stock companies(e.g., East India Company) required audits to protect investors.

2. Modern Auditing (20th Century–Present)

• Early 20th Century:
  • Formalization of Auditing Standards:
    • Companies Acts (e.g., UK’s 1844 Joint Stock Companies Act) mandated audits.
    • Big Four accounting firm semerged (PwC, Deloitte, EY, KPMG).
  • Shift from Fraud Detection to Financial Verification:
    • Focus on ensuring financial statements were “true and fair.”
  • Late 20th Century–21st Century:
    • Technology Integration:
      • Use of CAATs (Computer-Assisted Audit Techniques)and data analytics.
    • Regulatory Changes:
      • Sarbanes-Oxley Act (2002, USA): Strengthened internal controls post-Enron scandal.
      • IFRS (International Financial Reporting Standards): Global harmonization of audits.
    • Expanded Scope:
      • Risk-based auditing, sustainability audits, and cybersecurity audits.

 

Key Differences: Early vs. Modern Audit

Aspect   Early Audit Modern Audit Purpose   Fraud detection Financial accuracy + compliance Methods   Manual ledger checks Digital tools, AI, data analytics Regulation   Minimal formal standards Strict laws (SOX, IFRS, ISA) Scope   Basic financial records Risk management, ESG, IT systems Auditor Role   Reactive (error-finding) Proactive (risk assessment)

 

Users of audited financial statements

1. Owners and investors

Stockholders of corporations need financial information to help them make decisions on what to do with their investments (shares of stock), i.e. hold, sell, or buy more.

Prospective investors need information to assess the company’s potential for success and profitability. In the same way, small business owners need financial information to determine if the business is profitable and whether to continue, improve or drop it.

 

2. Management

In small businesses, management may include the owners. In huge organizations, however, management is usually made up of hired professionals who are entrusted with the responsibility of operating the business or a part of the business. They act as agents of the owners.

The managers, whether owners or hired, regularly face economic decisions – How much supplies will we purchase? Do we have enough cash? How much did we make last year? Did we meet our targets? All those, and many other questions and business decisions, require analysis of accounting information.

 

3. Lenders

Lenders of funds such as banks, financial institutions, and bondholders, are interested in the company’s ability to pay liabilities upon maturity (solvency).

 

4. Trade creditors or suppliers

Like lenders, trade creditors or suppliers are interested in the company’s ability to pay obligations when they become due. They are nonetheless especially interested in the company’s liquidity – its ability to pay short-term obligations.

 

5. Government

Governing bodies of the state, especially the tax authorities, are interested in an entity’s financial information for taxation and regulatory purposes. Taxes are computed based on the results of operations and other tax bases. In general, the state would like to know how much the taxpayer makes to determine the tax due thereon.

 

6. Employees

Employees are interested in the company’s profitability and stability. They are after the ability of the company to pay salaries and provide employee benefits. They may also be interested in its financial position and performance to assess possibilities of company expansion, and with it, career development opportunities.

 

7. Customers

When there is a long-term involvement or contract between the company and its customers, the customers become interested in the company’s ability to continue its existence and maintain stability of operations. This need is also heightened in cases where the customers depend upon the entity.

For example, a distributor (reseller), the customer in this case, is dependent upon the manufacturing company from which it purchases the items it resells.

 

8. General Public

Anyone outside the company such as researchers, students, analysts and others could be interested in the financial statements of a company for some valid reason – be it for personal research, industry and sector analyses, school report, or simply to satisfy one’s curiosity.

 

Internal and External Users

The users may be classified into internal and external users.

Internal users refer to managers who use accounting information in making decisions related to the company’s operations.

External users, on the other hand, are not involved in the operations of the company but hold some financial interest. The external users may be classified further into users with direct financial interest – owners, investors, creditors; and users with indirect financial interest – government, employees, customers and the others.

Features of audits

• Auditing is a systematic process. It is a logical and scientific procedure to examine the accounts of an organization for their accuracy. There are rules and procedures to follow.
• The audit is always done by an independent authority or a body of persons with the necessary qualifications. They have to be independent so their views and opinions can be totally unbiased.
• Once again, an audit is the examination of all the books of accounts and financial information of the company. So it is essentially a verification of the final accounts of the organization, i.e. the profit and loss statement and the balance sheet at the end of the financial year.
• Auditing is not only the review of the books of accounts but also the internal systems and internal control of the organization.
• To conduct the audit we need the help of various sources of information. This includes vouchers, documents, certificates, questionnaires, explanations etc. He may scrutinize any other documents he sees fit like Memorandum of Association, Articles of Associations, vouchers, minute books, shareholders register etc.
• The auditor must completely satisfy himself with the accuracy and authenticity of the financial statements. Only then can he give the opinion that they are true and fair statements.

 

Purpose of an Audit

The main purpose of an audit is to provide

1. An objective and independent examination of the financial statements
2. To enhance the credibility of the financial statements prepared by the organisation
3. To increase the confidence of users in the financial statements
4. To reduce risk to investors

Thus, the basic purpose of an audit can be described as:

1. To assess whether or not the financial statements are in conformity with Generally Accepted Accounting Principles (GAAP) and the prescribed accounting standards.
2. To provide assurance about the accuracy of financials.
3. To ensure compliance with established internal control procedures by examining
   records, reports, operating practices and documentation.
4. To certify the assets and liabilities by comparing same to available documentation.
5. To verify compliance, conformance or performance.
6. To follow-up on the completed/contemplated corrective action plan of an

 

Distinction between auditing and accounting

Accounting	Auditing
Definition
Accounting is referred to as the process of recording, classifying, summarising and interpreting the financial transactions, statements to determine the financial position of an organisation	Auditing is referred to as the process of examining the financial records such as transactions and statements of an organisation in order to find any discrepancies during the process of recording of the transactions and also to verify the accuracy of the records
Purpose
Accounting is done with the purpose of showing the position, profitability and performance of the business entity or organisation	Auditing is done to verify the accuracy of data presented by accounting. It is done with the purpose of revealing to what extent the true and fair view of records is maintained in the transactions
Objective
To determine profit and loss of the organisation or the financial position of an organisation for a period	To determine the correctness of all the recorded transactions
Mode of operation
Accounting is done on a daily basis, as transactions happen on a daily basis for any business	It is a periodical assessment and is done monthly, quarterly or yearly
Performed by
Accounting is done by accountants	Auditing is done by auditors
Sequence
Accounting starts at the end of bookkeeping	Auditing starts at the end of accounting

 

Different types of audit

As a brief recap, an audit examines your financial records and transactions to verify they are accurate. Typically, audits look at your financial statements and accounting books to compare information.

You or your employees may conduct audits. Or, you might have a third party audit your information (e.g., IRS audits).

Many business owners have routine audits, such as once per year. If you are not organized or don’t keep thorough records, your audits might take more time to complete.

Types of auditing can vary from business to business. For example, a construction business might conduct an audit to analyze how much they spent on a specific project (e.g., costs for contractors or supplies).

Overall, audits help ensure your business is operating smoothly. So, what are the various types of audit?

 

1. Internal audit

Internal audits take place within your business. As the business owner, you initiate the audit while someone else in your business conducts it.

Businesses that have shareholders or board members may use internal audits as a way to update them on their business’s finances. And, internal audits are a good way to check in on financial goals.

Although there are many reasons you may conduct an internal audit, some common reasons include to:

• Propose improvements
• Monitor effectiveness
• Make sure your business is compliant with laws and regulations
• Review and verify financial information
• Evaluate risk management policies and procedures
• Examine operation processes

 

Pros of internal auditing

When supported by well-organized data and skilled auditors, internal auditing can bring specific advantages to an organization.

• Enhance decision-making: Internal audits can define specific problems and give decision-makers data to help inform their strategies and assess solutions.
• Improve operations and efficiency: Internal audits can identify operational problems and inefficiencies. Because audits look at specific areas in-depth, they provide insights into the source of the issue. After the company makes changes, they can run another internal audit to see if the new practices and procedures have delivered the desired results.
• Define and mitigate risks: Internal audits can look at the consequences of potential events and the odds that such an event will take place. Once decision-makers are aware of the risk, they can take steps to mitigate it, lower the odds of it taking place, and reduce the potential consequences.
• Ensure compliance and success in external audits: Internal audits can mimic the process of external audits and find issues with reporting or compliance. By finding these problems and making corrections, a company can avoid potential penalties or punishments.

 

Cons of internal auditing

August 2024 Question One A

Internal auditing brings advantages, but there are also some drawbacks to consider.

• Cost: Internal auditing costs money. The most efficient auditing departments only cost their companies. However, expenses can be high if you aren’t careful.
• Disruptions to operations: Sometimes, audits may disrupt business processes. Work stoppages due to audits can harm a company’s bottom line.
• Negative employee reactions: Employees may feel that an audit is unjust, that their department is being unfairly singled out, or that the review focuses on their performance rather than the department’s overall efficiency.
• Poor use of digital accounting systems: Internal audits may be inaccurate or time-consuming because of poor record-keeping, a lack of an automated accounting system, and disorganized financial data.

Factors necessitating growth in Internal Audit

The growth and evolution of Internal Audit (IA) functions are driven by several key factors, including regulatory changes, organizational complexity, technological advancements, and increasing stakeholder expectations. Below are the primary factors necessitating growth in Internal Audit:

1. Increasing Regulatory and Compliance Requirements

• Stricter laws (e.g., IIA, GDPR, Basel III, CCPA) demand stronger internal controls.
• Regulators expect IA to provide assurance on compliance and risk management.
• Emerging ESG (Environmental, Social, and Governance) reporting requirements.

2. Growing Organizational Complexity

• Expansion into new markets, mergers & acquisitions (M&A), and diversified business models.
• Complex supply chains and third-party risks requiring deeper audit scrutiny.
• Decentralized operations (remote/hybrid work) increasing cybersecurity and fraud risks.

3. Technological Advancements & Digital Transformation

• Adoption of AI, blockchain, cloud computing, and automation introduces new risks.
• Need for IT Audits(cybersecurity, data privacy, system integrity).
• Use of Data Analytics & AI in Auditing(predictive analytics, continuous monitoring).

4. Rising Cybersecurity & Fraud Risks

• Increased cyber threats (ransomware, phishing, data breaches).
• Fraud detection and forensic auditing becoming critical.
• IA must assess IT controls and incident response plans.

5. Stakeholder & Board Expectations

• Investors and regulators demand greater transparency and accountability.
• IA must provide strategic insights beyond compliance (value-added auditing).
• Focus on Enterprise Risk Management (ERM)and operational resilience.

6. Globalization & Geopolitical Risks

• Cross-border operations introduce regulatory, currency, and political risks.
• IA must assess risks in different legal and cultural environments.

7. Focus on Operational Efficiency & Cost Optimization

• Businesses demand IA to identify inefficiencies and cost-saving opportunities.
• Shift from traditional audits to risk-based and agile auditing.

8. Talent & Skill Development

• Need for auditors with expertise in data analytics, cybersecurity, and AI.
• Upskilling to align with evolving business risks.

9. Reputation & Trust Management

• High-profile corporate scandals increase demand for strong IA functions.
• IA helps protect brand reputation by ensuring ethical practices.

2. External audit

An external audit is conducted by a third party, such as an accountant, the IRS, or a tax agency. The external auditor has no connection to your business (e.g., not an employee). And, external auditors must follow generally accepted auditing standards (GAAS).

Like internal audits, the main objective of an external audit is to determine the accuracy of accounting records.

Investors and lenders typically require external audits to ensure the business’s financial information and data is accurate and fair.

Audit reports

When your business is audited, external auditors usually give you an audit report. Audit reports include details of the audit process and what was found. And, the report includes whether your financial records are accurate, missing information, or inaccurate.

 

December 2024 Question One B

Discuss FOUR differences between “internal audits” and “external audits”.     (8 marks)

 

Using the work of internal audit

International Standard on Auditing (ISA) 610, Using the Work of Internal Auditors was revised and published in 2013. This standard focuses on whether the external auditor can use the work of the internal audit function for purposes of audit, and the revised version of the standard, clarified whether the internal auditors could be used to provide direct assistance to the external auditor.

Internal auditors are the employees of the entity, which could result in threats to independence (either in fact or perceived) if direct assistance is provided by the internal auditors. On the other hand, the following benefits relating to provision of direct assistance by the internal auditors cannot be ignored:

• There will be a strengthened relationship between the external and internal auditors through a more effective dialogue
• With the knowledgeof the internal auditors, the external auditor can gain additional insights into the entity
• The external auditor can use internal auditors who may have relevant expertisein particular areas, and
• The external audit team can focus on the more significant audit issues.

 

The external auditors need to evaluate and perform audit procedures on the work done by internal auditors that they might be able to use, in order to determine its adequacy.

The evaluation includes the following:

• Whether the work was done by internal auditors having adequate technical training and proficiency
• Whether the work was properly supervised, reviewed and documented
• Whether adequate audit evidence was obtained to allow the internal auditors to draw reasonable conclusions
• Whether the conclusions reached are appropriate and any reports are consistent with the results of the work done
• Whether any exceptions or unusual matters disclosed are properly resolved

The nature, timing and extent of the audit procedures performed on specific work of the internal auditors will depend upon the external auditor’s assessment of the risk of material misstatement of the area concerned, the evaluation of internal audit and the evaluation of the specific work of the internal auditors.

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

 

Pros of external auditing

When a company is required to have an external audit, it can enjoy certain advantages.

• Improved transparency: An outside auditor gives a company a chance to prove their finances are in order and their statements are accurate. This extra proof is necessary for shareholders, but lenders and people who want to support honest, transparent businesses will also appreciate it.
• Stronger internal controls: A business can establish strong internal policies and practices to ensure a positive outcome of an external audit. These policies can also help with accounting, record-keeping and overall efficiency within the company.
• Increased credibility: Whether public or private, a company can increase its credibility by letting a third party examine its financial records. The audit can show that the firm is operating honestly and not trying to manipulate its finances or engage in any unscrupulous practices.

 

Cons of external auditing

External audits can also come with drawbacks, some of which can be significant if you aren’t prepared for them.

• Increased costs: The cost of an external audit depends on the size of a company and the details of its financial records.
• Negative publicity: If your audit produces negative results, it could generate damaging stories in the media. This could be disastrous for public companies, which could lose shareholders. Even smaller firms could suffer if the audit turns up financial reporting or compliance issues.
• Compliance concerns: An impending external audit could lead to concerns about meeting regulatory requirements. Companies may worry about accounting practices or systems missing necessary data or reports not complying with industry requirements. 

 

Limitations of the external audit:

– Not all items in the financial statements are tested.

– Judgement is required.

– There are limitations in the accounting and control systems.

– The audit report is issued a while after the balance sheet date.

 

Similarities between internal audit and external audit

External audits and internal audits, though serving distinct purposes, share common goals and methodologies. The following are examples:

• Both strive to deliver accurate and reliable information.
• They also uphold professional standards and maintain independence.
• Their primary role involves assessing the effectiveness of internal controls and pinpointing areas for improvement

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AUDITING AND ASSURANCE NOTES

CONTENT

1. Nature and purpose of an audit

• Nature and objectives of an audit
• Development of audit (early audit and modern audit)
• Users of audited financial statements
• Features of audits
• Distinction between auditing and accounting
• Types and classification of audits
• Situations when different audits are performed (interim, continuous, final, operational)
• Advantages and disadvantages of various types of audits
• Nature of work done for different audits
• Inherent limitations of an audit

 

2. Assurance and non- assurance engagements

• Definition and objectives of assurance engagements
• Audit as an assurance engagement
• Elements of an assurance engagement
• Types of assurance engagements (Audit, Review assignments)
• Differences between audit and review engagements
• International Standard on Assurance Engagement-ISAE 3000
• Accepting appointment to perform assurance engagement
• Review of interim financial information – ISRE 2410
• Levels of assurance and reports issued on assurance engagements
• Non-assurance engagements (Agreed upon procedures engagement -ISRS 4400 and compilation assignments-ISRS 4410
• Attestation and direct reporting engagements

 

3. Legal and professional framework

• Regulatory framework for external audits
  1. Appointment of the auditors
  2. Qualifications and disqualifications of auditors
  3. Removal and resignation of auditors
  4. Remuneration of the auditors
  5. Rights and duties of auditors
  6. Mechanisms of regulations of auditors-role of professional bodies, Audit committee, rotation of audit firms
• Professional ethics/code of ethics for professional accountants

• Importance of the professional ethics
• Basic/fundamental principles for Code of Ethics for accountants
• Other professional guidelines on audit fees, conflict of interest, advertising  and publicity and opinion shopping by clients
• Auditors independence /objectivity and its importance
• Threats to independence and safeguards.

• Threats on adherence to other fundamental principles and safeguards to the threats
• Development and status of ISAs in execution of audits
• Relationship between International Standards of Auditing and National Auditing Standards
• Purposes/importance of adoption of ISA in the audit.

 

4. Planning and Risk Assessment

Obtaining, accepting and retention of an audit engagement

• Matters to consider before and after acceptance of nomination
• Pre-conditions of an audit
• Engagement letter, procedure of sending letter, purposes and contents of the letter-ISA 210
• Circumstances for revision of engagement terms
• Understanding the entity and its environment
• Background information about the entity or client.
• Ways of gathering knowledge about the business
• Reasons/importance of information gathered about the client
• Reasons of review of previous audit files and communication with previous auditors
• Overview of audit process

 

5. Audit risk assessment

• Components of audit risk (Inherent, Control and Inherent risks)
• Assessment of different types of audit risks
• Factors leading to increase or decrease of inherent, control and detection Risks
• Adoption of risk based audit, reasons and procedure
• Advantages and Disadvantages of the approach
• Evaluating and prioritising risk and control factors
• Mechanisms to minimise the risks associated with client audits.

 

6. Audit planning
   • Purpose and challenges in audit planning
   • Planning for new and existing clients
   • Development of the overall audit strategy
   • Contents of audit planning memorandum/ overall plan
   • Relationship between audit strategy and audit plan
   • Design of audit programs, importance and problems of the programs
   • Impact of material misstatements on audit strategy and degree of work done
   • Influence of interim audit work on the year end/final audit.

 

7. Audit documentation

• Reasons and importance of audit documentation
• Sources, features and purposes of working papers
• Storage of working papers-permanent audit file and current audit file, auditors note book or diary
• Lien or custody on working papers
• Standardisation of working papers – advantages and disadvantages
• Safe custody and retention of working papers
• Form and content of working papers
• Automated working papers
• Quality control policies and procedures implemented by audit firm
• Objectives of quality controls to the audit firm/ auditors
• Peer review and its objectives

 

8. Internal control systems and Internal Audit Function

           Internal control systems (ICS)

• Objectives of internal control system
• Component of internal control system
• Features of Internal control system
• Designing of internal control system.
• Auditors and management responsibility over ICS
• Advantages and disadvantages /inherent limitations of ICS
• Indicators of weaknesses in ICS and actions taken by management
• The evaluation of internal control systems by auditors using Internal Control Questionnaire, Flow charts and narrative notes
• Tests of controls on specific control environments
• Internal controls theory and practice-sales and debtors, purchases and creditors, inventories and work in progress, fixed assets, salaries and wages
• Communication of improvements on ICS weaknesses/ risks associated – Management letter.

 

9. Internal Audit Function

• Scope and objectives of internal audit
• Criteria of using internal audit work
• Areas of support on external auditors’ work
• Internal audit review reports and actions by management and those charged with governance
• Design of risk based internal audit plan
• Internal audit key performance indicators
• Managing and monitoring follow up of audit recommendations made to board/ management.
• Outsourcing internal audit function-advantages and disadvantages.
• Audit committee-functions, merits and demerits.
• Internal check systems-scope, features, advantages and disadvantages
• Information technology threats and control
• Auditors duty on compliance with laws and regulations.

 

10. Overview of Forensic Accounting, Errors, Frauds and Irregularities

Overview of forensic accounting

• Nature, purpose and scope of forensic accounting
• Types of forensic investigations: corruption, asset misappropriation, financial statement fraud, others
• Asset Recovery process and legal framework

 

11. Errors, Frauds and Irregularities
    • Differences between error and frauds
    • Types of errors-omission, commission, principle, reversal of entries
    • Types of Frauds-Teeming and lading, ghost employees, window dressing, misappropriation of goods and fraudulent financial reporting
    • Causes of frauds and fraud triangle
    • Indicators of errors and frauds
    • Detection and prevention of errors and frauds and deterrence-role of internal audit
    • Materiality and Implications of errors and frauds in the financial statements
    • Impact of errors and frauds on the audit plan
    • Reporting on error and frauds
    • External auditors and Management responsibility on error and frauds
    • Auditors professional skepticism.

 

12. Audit evidence

• Financial statement assertions and audit evidence
• Types and features of audit evidence (sufficiency, reliability and relevance)
• Audit evidence gathering procedures/ techniques
• Materiality and limitations of audit evidence
• Financial statement assertions and audit evidence
• Audit sampling techniques – statistical and non-statistical
• Analytical reviews procedures- nature, objectives, timing and extent of support evidence
• Types of analytical Procedures-Variance analysis, reasonableness tests, trend analysis
• Using the work of experts- areas of support and considerations
• Using management representations (importance, procedures adopted and matters covered).

 

13. Auditing in the public sector
    • Introduction to auditing in the public sector and regulatory provisions
    • Objective and scope of public sector audit (compliance, performance, financial, value for money)
    • Establishment, mandate and functions of public sector auditors
    • The parties to audit in public sector-auditor, responsible party and intended users
    • Role of internal audit function in public entities
    • Relationship between external and internal auditors in the public sector
    • Audit reports by office of Auditor General.
    • Functions of audit advisory board and executive committee in Auditor General office.

 

14. Auditors Reports
    • Purposes of auditors’ report and concept of true and fair view
    • Legal /Statutory provisions on audit reports
    • Basic elements contents of audit reports
    • Emphasis of the matter paragraph and key audit matters
    • Types and Consequences of different types of audit reports issued.
    • Features of unqualified and qualified audit reports
    • Reasons for qualifications of audit reports (Limitation of scope, inherent uncertainties, disagreements)
    • Types of qualifications-disclaimer, except for and adverse opinions.
    • Overall audit review and finalisation
    • Subsequent events/Post balance sheet events review (adjusting and non – adjusting events, auditor’s responsibility and audit procedures)
    • Going concern review (Auditors and management responsibility, indicators of going concern difficulties, audit procedures, mitigation plans and reporting)
    • Management representations on contentious matters affecting financial statements like guarantees made, capital commitments, borrowings, unusual accounting adjustments.
    • Review of compliance with accounting policies, opening balances, prior period audits by other auditors
    • Format for presentation of independent auditor’s report.

 

15. Auditing in a computerised system

• Audit objectives in computerised systems
• Differences between computerised and manual systems
• Benefits and drawbacks of computerised accounting systems
• Types of controls in computerised systems (Administrative, system development, processing controls, application controls, master files and standing data
• Auditors use of computers in the course of audit
• Planning the audit in computerised systems
• Audit approaches – audit around, with and through the computer and circumstances when each is applied
• Loss of audit trail, causes and measures to mitigate the loss of audit trail
• Computer Assisted Audit Techniques (CAATS) – Audit software and test data
• Types of audit software and functions and types of test data
• Factors considered before using CAATS and steps in CAATS application
• Advantages and disadvantages of CAATS
• Use of embedded audit modules and integrated test facilities
  • Information security controls (Encryption, Firewalls, Passwords, Antivirus)

 

16. Contemporary and emerging issues in audit
    • E- commerce auditing
    • Cloud documentation
    • Use of data analytics tools in audit (Anomaly detection, diagnostic analysis, predictive analysis.

 

 

 

 

 

CONTENT                                                                                                                      PAGE

 

 

Topic 1: Nature and purpose of an audit ……………….….….……………………………..8

Topic 2: Assurance and non- assurance engagements …………………………………..…33

Topic 3: Legal and professional framework ……………….……….…….…………………48

Topic 4: Planning and Risk Assessment ……………………………………………………89

Topic 5: Audit risk assessment ……………………………………………………………..97

Topic 6: Audit planning ……………………………………………….…….…………….131

Topic 7: Audit documentation …………………………………………………………….145

Topic 8: Internal control systems and Internal Audit Function Internal control systems (ICS) ………….……………………………………………………………………………………157

Topic 9: Internal Audit Function …………………………………………….….…………175

Topic 10: Overview of Forensic Accounting, Errors, Frauds and Irregularities ………….194

Topic 11: Errors, Frauds and Irregularities ………………………….………….………….205

Topic 12: Audit evidence………………………………………………………………….216

Topic 13: Auditing in the public sector…………………………………………………….270

Topic 14: Auditors Reports…………………………………………………………….….285

Topic 15: Auditing in a computerised system……………………………………………..320

Topic 16: Contemporary and emerging issues in audit……………………………………332

 

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TOPIC 1

 NATURE AND PURPOSE OF AN AUDIT

 

 

NATURE AND OBJECTIVES

 

Definition of an Audit:

An audit is the examination of the financial report of an organisation – as presented in the annual report – by someone independent of that organisation. The financial report includes a balance sheet, an income statement, a statement of changes in equity, a cash flow statement, and notes comprising a summary of significant accounting policies and other explanatory notes.

The purpose of an audit is to form a view on whether the information presented in the financial report, taken as a whole, reflects the financial position of the organisation at a given date, for example:

• Are details of what is owned and what the organisation owes properly recorded in the balance sheet?
• Are profits or losses properly assessed?

When examining the financial report, auditors must follow auditing standards which are set by a government body. Once auditors have completed their work, they write an audit report, explaining what they have done and giving an opinion drawn from their work. Generally, all listed companies and limited liability companies are subject to an audit each year. Other organisations may require or request an audit depending on their structure and ownership.

 

The objective of an audit is to enable the auditor express an opinion whether financial statements show a true and fair view of the company state of affairs in accordance with an identified financial reporting framework.

 

The purpose of an audit is not to provide additional information but rather it is intended to provide the users of the accounts with assurance that the information provided to then by directors is reliable. However, the users should not assume the auditor’s opinion is one to efficiency with which management has conducted the affairs of the entity.

 

Financial statement: According to the Companies Act, the company accounts refers to the balance sheet and the profit and loss account but due to development in business practice and shareholders information needs, these are inadequate as to the information regarding financial position and performance of the company. Since most balance sheets and profit and loss accounts are summarized statements amplified by notes to the statements, the business community and the accountancy profession require that a cash flow statement as well as a statement of changes in equity be prepared. The terms company accounts and financial statements have the same meaning.

 

Financial Reporting framework: According to International Auditing Standards (ISA 200, the framework of international standards of auditing), financial statements are usually prepared and presented annually and are directed at common informational needs of a wide range of users.

 

Many of the users rely on the financial statements as their major source of additional information to meet their specific information needs. Therefore financial statements need to be prepared in accordance with one or combination of:

• International Financial Reporting Standards (IFRS)or IASs
• National accounting standards
• Any other authoritative and comprehensive financial reporting framework designed for use in financial reporting and is identified in the financial statements. In Kenya the financial reporting framework adopted is as prescribed by IFRS.

 

Scope of-the Audit

 

• The auditor’s opinion on the financial statements deals with whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework: Such an opinion is common to all audits of financial statements.
• The auditor’s opinion therefore does not assure, for example, the future viability of the entity nor the efficiency or effectiveness with which management has conducted the affairs of the entity. In some jurisdictions, however, applicable law or regulation may require auditors to provide opinions on other-specific matters, such as the effectiveness of internal control, or the consistency of a separate management report with the financial statements.
• While the ISAs include requirements and guidance_ in relation to such matters to the extent that they are relevant to forming an opinion on the financial statements, the auditor would be required to undertake further work if the auditor had additional responsibilities to provide such opinions.

 

STAGES OF AN AUDIT

The suggested audit approach is designed to gather sufficient and reliable evidence to support the audit opinion in the most efficient and effective way and to enable the engagement team to fully understand the client’s business. There is no difference between an audit of a large and a small entity except that the procedures adopted may differ depending on the particular circumstances of each audit

1. Preliminary Engagement Activities
2. Planning
3. Execution
4. Review and Completion

 

Preliminary Engagement Activities

At the Pre-planning stage, the engagement partner ensures that:

• The client acceptance and continuation procedures have been carried out;
• The terms of engagement have been agreed in writing;
• The quality control aspects for the assignment have been reviewed including review of the competency of the team to carry out the assignment, review of compliance with the ethical requirements, including review of the independence requirements.

 

Planning

 Planning is an essential component in focusing the audit efforts. The key components of

Identifying the scope of the assignment

Developing an audit strategy taking into consideration the scope of the engagement; the business and the regulatory environment in which the entity operates; entity specific issues including reliance on the work of internal audit; reporting objectives, timing of the audit and the nature of communication required; matters affecting the direction of the audit including preliminary setting of materiality levels, preliminary review of risk including fraud risk, preliminary review of internal control including the control environment, the process adopted by the entity to identify, measure, monitor and control risks.

 

• Developing, based on the above, the overall audit plan detailing the nature, timing and extent of the audit procedures to be performed in order to reduce the audit risk to an acceptably low level; the nature of tests to be adopted; procedures to be adopted at the assertion level; and tailoring the audit programmes.
• Ascertaining the nature and the extent of the resources required to perform the audit.

 

iii) Execution

• The key components of the execution stage are:
• Carrying out the test of controls and substantive tests on transactions and balances including substantive analytical procedures to obtain sufficient and appropriate audit evidence to enable the engagement team to draw reasonable conclusions on which to base the audit opinion.
• Evaluating significant assumptions used in fair value measurement to determine the reasonableness of the basis used and the disclosures.
• Identification of related parties and obtaining sufficient and appropriate audit evidence in respect of measurement and disclosure of related party transactions.
• Documenting the nature, timing and extent of the audit procedures performed and the results and conclusions drawn from the audit evidence obtained

While pre-printed forms and programmes are available in the Manual, the extent and the timing of the tests should be tailored to the specific assignment. Different tests and different levels will be appropriate for each assignment. The control of the audit at this stage must be maintained by a senior team member with the appropriate experience and expertise.

 

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