| Audit Procedures/Processes |
| Audit procedures are an important area of the syllabus, though candidates often use inappropriate audit procedures to answer questions. The following tips will help you to understand the concepts and write appropriate audit procedures. Every procedure must state: • the assertion tested • the audit procedure • the reason for the procedure. Each of these points is explained below. STEP 1 – IDENTIFY THE ASSERTION TESTED Audit procedures are performed in order to test financial statement assertions. Therefore, the first step in explaining an audit procedure is to identify the assertion that needs to be tested. The assertions embodied in the financial statements, as used by the auditor to consider the different types of potential misstatements that may occur, may take the following forms: Transactions and events • Occurrence • Completeness • Accuracy • Cutoff • Classification Account balances at the period-end • Existence • Rights and obligations • Completeness • Valuation and allocation Presentation and disclosure • Occurrence and rights and obligations • Completeness • Classification and understandability • Accuracy and valuation A brief explanation of the various assertions is as follows: Completeness This means that all transactions have been recorded in the financial statements – ie all assets, liabilities, equity interests (capital and reserves) and other disclosures have been included in the financial statements. Occurrence This assertion means that transactions and events and other matters that have been recorded actually took place – and relate to this organisation. Valuation and allocation This means that all items have been included in the financial statements at appropriate amounts according to company policy and the relevant financial reporting framework. Furthermore, any allocations or valuation adjustments required (like impairment) have been made and financial and other information is disclosed fairly and at appropriate amounts. Classification and understandability Financial information is appropriately presented and disclosed, and disclosures are clearly expressed so as to make them understandable to the users. For this, the disclosures should use simple language and state matters clearly and concisely. Accuracy Accuracy means that amounts and other data relating to transactions and events have been recorded at the correct amounts – ie at the amounts appearing in the source documents. Rights and obligations This means that the entity has a right to its assets – ie it is free to use or dispose of the assets as it sees fit. Furthermore, the entity is obliged to pay off the liabilities that are shown in the statement of financial position. Existence This means that assets, liabilities and equity interests (capital and reserves) are physically present/belong to the entity on the reporting date. Cutoff This means that transactions and events have been recorded in the correct accounting period – for example, if goods are delivered prior to year end, they are included in the cost of goods sold, not inventory. |
Definition:
Audit procedures are the processes and methods that auditors perform to obtain audit evidence which enables them to make a conclusion on the set audit objective and express their opinion. Sometimes we call audit procedures as audit programs.
These two are the same thing. Auditors normally prepare audit procedures at the planning stages once they identified audit objective, audit scope, audit approach, and risks.
Auditors design audit procedures to detect all kind of risks that they identified and ensuring that the required audit evidence is obtained sufficiently and appropriately.
Normally, audit partners need to approve on audit plan and audit procedures before the audit team could perform their testing. This is to make sure that all concern or risks are address in the procedures.
Audit procedures might be different from client to client, and period to period. This is because internal control over financial reporting is different from one client to another and the control might be change from time to time.
The auditor might need to update audit procedures from time to time event thought current financial statements had been audited by its firm or team.
Typically, there are five audit procedures that normally use by auditors to obtain audit evidence. Those five audit procedures include Analytical review, inquiry, observation, inspection, and recalculation.
List of Five Types of Procedures:
Analytical Review:
Analytical review is not the procedure that uses to obtain audit evidence, but it is the procedure used to assess the unusual transactions or event as the principle or basic to perform other procedures.
For example, when auditor found there is unusual transactions or event as the result of using analytical review, then the auditor will use other procedures that are applicable to obtain evidence.
The analytical procedure could be used for the types of transactions or event that occur regularly or have a connection with others transaction or event.
For example, we can use the analytical procedure to assess the reasonableness of depreciation that records in the financial statements. The main reason is that depreciation expenses are calculated systematically and occur regularly.
Inquiry:
Auditors inquire accountant and related management to gather information and obtain an explanation on the mater that found by auditors.
Sometimes auditors inquire management about the business process and the ways how financial transactions are recording as well as the major control on business transactions. The inquiry is also one of the most important audit procedures and it could be used in different stage.
For example, the auditor might inquire management at the planning stage and auditor could also inquire management to confirm the consignment liabilities at the end of the audit work.
Audit inquiry is sometimes used by the auditor to obtain the audit evidence and sometimes is used to obtain an understanding for some nature of business or accounting transactions in order to gain enough knowledge to design and perform testing.
However, information from inquiry sometimes hard to be used as audit evidence. The audit evidence that you found as the result of your testing after an inquiry in strongly to be used as audit evidence rather than information from inquiry itself.
Observation:
Observation is one of the audit procedures that auditors use to obtain an understanding and gather audit evidence mainly to the real process or the ways how clients have done some specific business process.
This kind audit procedure is mainly to confirm the process that client told, physical confirmation, or some time used to obtain audit evidence in order to make their own projection which will be used for comparison with client figure.
For example, auditor joins client stock take at the year-end and observe whether the way that they count are in the correct procedures or not.
In this procedure, the audit is not confirmed whether the client counts their inventories correct or not, but it confirms whether clients counting procedure is correct or not is one thing. Another thing is auditor try to confirm whether the counting has really existed.
However, in practice, sometime auditor is not only observed how the client count, but they also jointly perform counting inventories.
Sometime auditor using observation is not only for observing in counting fixed assets or inventories but also using to test the reasonableness of revenue. Here is how,
For example, the auditor performs the reasonableness testing of revenue recording in the restaurant and based on the accounting record fact check with their understanding, the revenue seems not completely records.
In this case, the auditor might perform one week or two weeks observe in the restaurant and then make their own estimate whether or not the revenue is reasonable.
Inspection:
Inspection refers to verification or vouching documents. This is one of the most important and it can be 60% of audit work involve with the inspection of documents. For example, the auditor examines the sales invoices that record in financial reports.
The auditor might examine whether the invoice issued by the client is really based on the goods that receive. And the goods that received is actually the one the company makes an order.
The auditor might also examine the payments voucher against the authority that approves on the payments vouchers. The auditor might also inspect the supporting documents recording the inventories movement during the year. This is including the documents related to purchasing raw material.
Recalculation:
Recalculation is the type of audit procedure that normally done by re-performing the works performed by the client in the purpose of assessing if there any difference between the audit’s work and client’s work.
For example, the auditor might re-perform depreciation calculation and assess if there any difference between auditor calculation and its client’s calculation.
The auditor might also perform the recalculation on monthly salaries expenses that prepare by payroll and finance department to ensure that the net salaries that paid to the employee are correct. Recalculation is the procedure that use to confirm the accuracy of transaction that involves calculation.
Financial Assertion and Audit Procedures:
Audit procedures above normally designed to confirm the financial assertion of transactions or event in the financial statements.
For example, the auditor may test the occurrence of sales revenues that records in the income statement for the period. This test is to confirm whether those transactions have really occurred or not.
The auditor might also test whether the sales revenues that recording is completely records or not by testing the completeness.
Understand about financial statements assertion could help the auditor to not only tailor actionable and effective audit procedures but also help to perform their testing more efficiently. This will also help them to redesign audit procedures when the existing procedures are not practical.
The following is the list of the financial assertions that auditors normally test:
Transactions and events: ( in P&L)
- Occurrence
- Completeness
- Accuracy
- Cutoff
- Classification
Account balances (BS items)
- Existence
- Rights and obligations
- Completeness
- Valuation and allocation
Presentation and disclosure
- Occurrence
- Rights and obligations
- Completeness
- Classification and
- Understand-ability
- Accuracy and valuation
How to design the audit procedure?
Audit procedure normally design by auditors based on the characteristic of target transactions or event risks that associate and the approach that auditor respond to those risks. Risk assessment contributes significantly to auditors to design the right audit procedures.
Right audit procedures do not only help the auditor to perform their work more effectively but also contribute to the auditor in minimizing audit risks (detection risk).
When designing the audit procedure, the auditor must make sure that all of that procedure contain and address three important things.
- The assertion that auditor want to confirm
- Procedure to test that assertion
- Reason to perform the procedure
After performing a risks assessment, the auditor will be identified that risks that they think might happen to financial statements. For example, the auditor might things the inventories that reporting in the financial statement might not exist. In this case, existence is the assertion that auditor wants to test.
Therefore, inventories observation is the procedure that should be included in the inventories’ audit procedure. The way how to perform, the number of inventories to be observed need to be stated clearly to make sure that auditor in charge for this cycle could understand.