Procedures Flashcards
What is the audit of receivables and their risks?
What are they?
- People who owe us money (trade and loan receivables, etc.)
- People who owe us services (prepayments)
Key Risks:
- Understated bad debt provision
- Error in recording of receivables
- Error recording cash receipts
- Receivables recorded in wrong period
What are the key assertions of receivables?
Existence – the receivable actually exists
Rights and obligations – the company has rights to receive benefit from receivables
Valuation and allocation – receivables are included in the financial statements at the correct amount, including provisions for bad and doubtful debt
Completeness – all receivables relating to the period have been accounted for
Classification and understandability – receivables (Including provisions) are appropriately disclosed in the financial statements.
What is Receivables circularisations?
If successful, circularisations provide evidence directly from the receivables themselves.
Considered to be reliable because they are external, third party confirmations
Procedure
Considerations
Success depends on response rate
What is the audit of inventories and their risks?
What are they?
Assets to be sold in the course of a company’s main trading activities
Key risks
Incorrect calculation of WIP and finished goods cost
Errors recording cost
Failure to value in accordance with IAS 2
Inaccurate inventory counting
What are the key assertions of inventories?
Existence – does the inventory recorded actually exist?
Completeness – have all inventory balances been recorded?
Rights and obligations – does the company have the rights to receive the benefits from inventories?
Valuation and allocation – are inventories valued appropriately
Cut-off – are inventory movements around the year-end recorded in the correct period?
Classification and understandability – are inventories (including provisions) appropriately disclosed in the financial statements?
What is the inventory count?
Typically at year-end, although continuous possible.
Purpose is to confirm quantities of inventory recorded on the client’s system are accurate.
Whilst performed, items damaged and/or obsolete should be identified for either scrapping or sale at a discounted price.
From an audit perspective, attendance at the count helps provide evidence regarding existence, completeness and valuation of inventory balances
Inventory counting is the responsibility of the client. Auditor merely attends the count to help gather evidence to form an opinion regarding whether inventory is free from material misstatement or not.
What are continuous inventory systems?
Objective – to identify whether client’s inventory system reliably records, measures and reports inventory balances.
Advantages:
Auditor less time constrained and can pick and choose particular locations and inventory lines to count at any time to ensure the system is reliable.
Slow moving and damaged inventory should be identified and adjusted for in the client’s records on a continuous basis therefore, improving the valuation at year-end.
Disadvantages:
Auditor needs to gain sufficient evidence that system operates effectively at all times.
Additional procedures for year-end (cut-off, year-end provisions/estimates)
What is inventory held for third parties?
Auditor normally obtains confirmation of quantities, value and condition from the holder.
Holder sufficiently independent to provide relevant, reliable evidence?
Confirmation request sent by client to confirm its existence.
Reply sent directly to auditor to prevent tampering.
Problems if 3rd party uses different description, also response not guaranteed.
What are the final audit procedures for inventory?
Completeness
- Inventory list, cast and agreed to financial statements
- Inventory count
Cut-off
- GRN’s and GDN’s
Presentation and disclosure
Valuation
What is the audit of payables, accruals, provisions and contingent liabilities and their risks?
Amounts due in relation to goods and services consumed
Amounts due to lendors and lessors
Taxes owed – PAYE, VAT & Corporation Tax
Probable costs incurred in the future where there is a present obligation
Key risks:
Incomplete recording of liabilities
Recording of purchases in wrong period
Unrecognised provisions
Errors in calculation of accruals and other payables
Manipulation of provisions to distort reported profits
What are the key assertions of payables, accruals, provisions and contingent liabilities?
Existence – the payables actually exist
Rights and obligations – the company has obligations to settle all payables
Valuation and allocation – payables are included in the financial statements at the correct amount
Completeness * – all payables relating to the period have been accounted for
Classification and understandability – all payables are appropriately disclosed in the financial statements.
(* Provisions and accruals offer opportunity for creative accounting)
How can supplier statements be used?
Supplier statement reconciliation – important source of audit evidence.
Possible variances due to:
Timing differences
Errors
Auditors can inspect or reperform supplier statement reconciliations to ensure completeness, existence and valuation of payable balances.
Reliable source of evidence as independent, external sources.
How can auditors tesaccruals?
Inspect invoices received after year-end that relate to services provided before year-end. Trace to accruals made to ensure completeness and accuracy of amounts.
Obtain list of accruals from client and cast.
Agree to nominal ledger and financial statements.
Recalculate sample of accrued costs (eg loan interest)
Analytically review to PY to identify any missing balances
How can auditors test tax, overdrafts and leases?
Tax – agree to tax computations and payroll
Overdrafts, loans – agree to bank letter confirmation of outstanding amounts
Leases – agree to underlying agreements/contracts and recalculate amounts and the split between current and non-current.
How can auditors test loans?
Agree year-end loan balance to any available loan statements to confirm obligation, existence and valuation.
Agree interest payments to loan agreement and bank statements.
Analyse relevant disclosures of interest rates, amounts due (eg between current and non-current payables) to ensure complete and accurate.
Recalculate interest accrual to ensure arithmetical accuracy.
How can auditors test provisions and contingencies?
Form of payable where the amount or timing of payment is uncertain.
Where likelihood of payment is only possible, rather than probable, no amounts will be entered in the accounts. However, the matter (contingent liability) must be adequately disclosed.
Discuss matter to verify whether obligation exists.
Obtain confirmation from clients lawyers as to possible outcome, probability of payment.
Review subsequent events
Obtain a letter of representation from client.
Recalculate provision if possible.
What is the audit of bank and cash and their risks?
Positive bank accounts
Bank overdrafts
Related interest payments and receipts
Key risks:
Theft of cash
Timing differences due to unreconciled payments and receipts
Concealment of accounts from auditor
Incorrect calculation of related interest
What are the key assertions of bank and cash?
Existence – cash and bank balances actually exist
Rights and obligations – the company has rights to receive the benefit from those balances
Valuation and allocation – balances are included in the financial statements at the correct amount
Completeness – all balances have been accounted for
Classification and understandability – balances are appropriately disclosed in the financial statements?
What is the bank letter?
Direct confirmation of bank balances from bank – independent 3rd party evidence
Format standard and agreed between banking and auditing professions
Issues covered?
Auditor needs client to give bank authorisation to disclose necessary information.
Ensure all banks with client dealings are circularised.
Balances for each account should be agreed to relevant bank reconciliation at the year end.
Loans should be agreed to disclosure as current/non-current
What are other evidences forms for bank and cash?
Obtain a list of all bank accounts, cash balances and bank loans and overdrafts and agree totals to figures included in current assets and current liabilities in the financial statements.
Obtain copy of client’s bank reconciliation, cast and agree to cash book and bank letter.
Trace all outstanding lodgements and unpresented cheques to pre-year-end cash book and post-year-end bank statements
Ensure all accounts included in financial statements
Ensure no off-setting of loans and overdrafts
Count petty cash and agree to financial statements
What is the audit of tangible and NCA’s and their risks?
Land and Buildings
Plant and machinery
Motor vehicles
Fixtures and fittings
Key risks:
Damage to assets
Failure to record additions at correct value
Inappropriate revaluation
Incorrect depreciation calculation
Disposals not accounted for correctly
What are the key assertions of tangible and NCA’s?
Existence – assets actually exist
Rights and obligations – the company has rights to receive the benefit from those assets
Valuation and allocation – assets are included in the financial statements at the correct amount.
Completeness – all assets have been accounted for
Classification and understandability – assets are appropriately disclosed in the financial statements?
What is the audit of share capital, reserves and directors emoluments and their risks?
Share capital and premium
Profit and revaluation reserves
Disclosures relating to directors’ remuneration and transactions
Key risks:
Missclassification of share capital and share premium
Lack of disclosures relating to new share issues
Reserves brought forward incorrectly
Failure to disclose related party transactions
Incomplete disclosure of directors’ emoluments
What are the key assertions of share capital, reserves and directors emoluments?
Existence – do share capital balances and reserves actually exist
Rights and obligations – the company has obligations regarding equity balances
Valuation and allocation – equity included in the financial statements at the correct amount
Completeness – all equity balances, directors’ emoluments and other transactions with directors have been accounted for.
Classification and understandability – relevant disclosures have been made in the financial statements, particularly with regard to directors’ emoluments.
How would an auditor test share capital?
Agree authorised share capital to shareholding agreements such as company memorandum, articles of association and lists of registered members
Inspect cash book for receipts from share issues
Inspect terms of share certificates and reconcile to cash receipts and new share capital totals
Inspect board minutes to identify any dividends declared prior to year end
How would an auditor test directors’ emoluments?
Reconcile reported directors’ salaries to payroll records
Inspect board minutes for bonus announcements
Reconcile directors’ bonuses to cash payments in cash book
Inspect board minutes for approval of related party transactions
Obtain written representation from directors that they have disclosed all related party transactions and director remunerations to the auditor
How would an auditor test for reserves?
Reconcile closing profit reserves to: opening reserves, profit for the year and dividend paid and proposed during the year
Compare opening reserves to closing reserves reported in the prior year’s financial statements
Reconcile movements in revaluation reserves to the non-current asset register
Corroborate revaluations by comparing to independently produced reports
Why might auditors rely on the work of others (expert)?
May be effective and efficient to do so where the auditor lacks technical knowledge and skills to gather evidence about transactions, balances and disclosures:
Property valuation
Construction work in progress
Assessment of oil reserves
Specialist inventory – livestock, food and drink in the restaurant trade, jewellery
Actuarial valuations of pension schemes
What must an auditor consider when using the work of an external expert?
ISA 620 Using the Work of an Auditor’s Expert – auditor should obtain sufficient and appropriate evidence that the work of the expert is adequate for the purpose of the audit.
Auditor must assess the expert’s independence, objectivity and competence (qualifications, memberships of professional bodies and experience).
Before work undertaken, auditor should agree in writing:
- Nature, scope and objectives of expert’s work
- Roles and responsibilities of auditor and expert
- Nature, timing and extent of communication
- Need for expert to observe confidentiality
Once the work has been completed, auditor must assess it to ensure appropriate for purposes of audit. Involves consideration of:
The consistency of the findings with other evidence
The significant assumptions made
The use and accuracy of source data
What must be considered when using the work of an internal audit function?
Internal audit part of client’s system of internal control. If effective may reduce control risk (and reduce need for detailed substantive testing).
Additionally, auditors may co-operate with IA and place reliance on their procedures in place of performing their own.
ISA 610 Using the Work of Internal Auditors – auditor must determine whether work is adequate. Evaluate:
- Objectivity
- Technical competence
- IA function carried out with due professional care
- Whether effective communication likely
Auditor needs to plan adequate time to review work of IA to evaluate:
-Work performed by people with adequate technical training and proficiency
- Work properly supervised, reviewed and documented
- Sufficient and appropriate evidence has been obtained to draw reasonable conclusions
- Conclusions reached are appropriate in circumstances
- Any usual matters properly resolved
What are service organisations?
Client may outsource certain functions to another company – a service organisation:
- Payroll
- Receivables collection
- Entire finance function
- Internal audit
What are the advantages of service organisations?
- Independence may increase reliability
- Specialist skills – more reliable at processing information
- Auditor may be able to place high degree of reliance on their reports as a result
What are the disadvantages of service organisations?
- Auditor may not be able to obtain information
- Auditor may not be allowed to test controls
- Leads to difficulties in assessing accuracy and reliability
- Could lead to a lack of sufficient appropriate evidence and modified audit report
Should the audit reference the work of others in their report?
Auditor’s responsibility to obtain sufficient and appropriate audit evidence in order to arrive at audit opinion.
NO reference should be made in audit report regarding the use of others during the audit.
It may be seen as some form of modifying statement, deflecting responsibility from auditor to a third party.
What are accounting estimates?
May not be any physical evidence to support them
Prone to inaccuracy
Subjective, prone to management bias – manipulation of accounts.
ISA 540 Auditing Accounting Estimates – auditors need understanding of:
- How management identifies transactions, events and conditions that give rise to need for estimates.
- How management actually make estimates, including control procedures to minimise misstatement risk.
Auditors should perform further procedures:
- Review of outcome of estimates made in prior period
- Consider events after reporting date that provide additional evidence about estimates made at year-end
- Test basis and data upon which management made estimate (eg review mathematical methods)
- Test operating effectiveness of controls over how estimates are made
- Develop independent estimate to use as a point of comparison
- Consider whether specialist skills/knowledge are required (eg lawyer)
What are CAATS?
Computer assisted audit techniques
What is audit software?
Used to interrogate client’s system.
Packaged (off-the-shelf) or purpose written to work on a client’s system.
Main advantage – used to scrutinise large volumes of data (inefficient manually)
Programs can then present the results to be investigated
Specific procedures:
- Extracting samples according to a specific criteria
- Calculating ratios and benchmarking
- Check arithmetical accuracy
- Preparing reports
- Stratification of data
- Tracing transactions
What is test data?
‘Dummy’ data into client’s system to ensure that system correctly processes it and prevents/detects and corrects misstatements.
Objective – test operation of application controls within the system.
To be successful test data should include both data with errors built into it and data without errors.
Examples of errors include:
- Codes that do not exist (customer, supplier, employee)
- Transactions above pre-determined amounts
- Invoices with arithmetical errors
- Submitting data with incorrect batch control
What is live testing?
Data processed during a normal operational cycle
Could interfere with operation of system or corrupt master files/standing data
What is dead testing?
Data processed at a point in time outside normal operational cycle.
Only gives assurance that system works when not operating live. May not be reflective of strains system put under in normal conditions.
What are integrated test facilities?
Creation of dummy ledgers and records to which test data is sent.
Enables more frequent and efficient test data procedures to be performed live and the information can simply be ignored by client when printing out internal records
What is embedded audit software?
Requires purpose written audit programme to be embedded into client’s accounting system.
Programme designed to perform certain tasks, advantage that it can be turned on and off at auditor’s wish throughout year. Can identify peculiarities for final audit.
What are the practical implications of CAATs?
Planning and Risk Assessment
Efficient but limited in terms of cost and availability of resources.
Software has to be purchased or designed.
Accountancy firm needs individuals with IT expertise to perform tests.
Client permission.
Use must be considered at planning phase
Primary function – test IT application controls.
Results of this – assess control risk and design further audit procedures.
Further Audit Procedures (1)
Selecting sample selections. For example, identification of:
Receivable, payable or inventory balances over certain age
Individually material assets and liabilities
Transactions over agreed limits
Changes to standing data
Credit balances within receivables and debit balances in payables
Non-current asset purchases over certain amount
Further Audit Procedures (2)
CAAT’s can also be used to perform certain substantive procedures:
Ratio calculations
Re-calculation of depreciation
Recalculation of employee payroll data
Confirmation of batch totals to individual records
Casting of ledger balances.
