1.0
INTRODUCTION
An audit can be
carried out on organizations, both large and small, and both new and well-established. This note focuses on the cycle or stages in
the modern audit of an established
company which is big enough to have a comprehensive system of accounting and record keeping and a
system of controls over those records.
2.0
OBJECTIVES
At the end of this note,
you should be able to:
· explain audit cycle
· outline the stages in
the audit cycle
· describe the stages
in the audit.
3.0
MAIN CONTENT
3.1
Audit Cycle and Procedures
Audit cycle refers to
the stages in the conduct of an audit from the
beginning to the end. The stages in the modern audit can be summarised as follows.
(i) Background
research;
(ii) Preparation of
the audit plan;
(iii) Accounting
system review;
(iv) Internal control
system review;
(iv) Substantive
testing;
(v) Analytical review
techniques;
(vi) Analytical
review of financial statements;
(vii) Preparation and
signing of report.
These stages will be
explained below.
3.1.1
Background Research
Before commencing the
audit proper, the auditor must discover as much
as possible:
(a) the present
condition and future prospects of the industry of which his client is a part;
(b) the past history
and the present condition and future prospects of his client;
(c) the management and key personnel of his
client and recent changes;
(d) the products and
manufacturing and trading processes of the
client and recent changes;
(e) the locations of
all his client’s operations;
(f) difficulties
encountered by the client in manufacturing, trading, expanding, contracting, labour relations or
financing;
(g) problems in
accounting or in internal control systems;
(h) problems in
accounting measurement like in stock valuation and income recognition;
(i) problems likely
to lead to audit risk like the difficulty of
assessing the value of long-term contracts in a civil engineering business;
(j) problems likely
to be met in carrying out the audit, for example, distant locations, tight timing problems, or
large staff requirements on stocktaking
attendance;
(k) changes in law or
accounting practice which may affect the
client.
This background
research will be done by reading or interviewing the
following.
(i) Previous years’
audit files;
(ii) Members of staff
of audit who have been previously engaged on
the audit;
(iii) Published
material concerning the client’s company and industry;
(iv) The company’s
interim, internal and management accounts;
(viii) The management
of the enterprise.
The auditor must
focus his audit, particularly on areas of special difficulty and risk in order to carry out a
comprehensive and effective audit which
is nevertheless efficient in terms of time spent. In addition, the evaluation of many areas in the financial
statements must entail a consideration
of the whole circumstances of the client.
3.1.2
The Audit Plan
The auditor must plan
his audit in some detail and the plan will involve preparation of an overall audit plan showing:
(a) an outline of the
audit work to be done on each area of the
client’s systems and financial statements;
(b) the staff who
will do the work;
(c) the location of
the audit;
(d) the timing of the
work to be done;
(e) a budget of time
and costs.
The plan must be made
to fit in with the client’s timing requirement and with the client’s ability to produce
necessary analyses and summaries.
3.1.3
Accounting System Review
The auditor must:
(a) ascertain by
asking questions;
(b) record on paper;
(c) corroborate his
record (confirm that the record is correct);
(d) review for
adequacy and for planning of tests;
(e) test to determine
that it always works as it is supposed to;
(f) evaluate and
(g) form a conclusion
on the adequacy of the client’s system for
documenting and recording the transactions, assets and liabilities of the client in the books of account and
other records. This is because:
(i) the Companies Act requires the auditor to
investigate and report on the company
keeping of “proper” accounting records;
(ii) the books of
account and other records form the basis for the preparation of the financial statements.
3.1.4
Internal Control System Review
Be reminded that
internal controls are procedures which ensure that all transactions, assets and liabilities are
recorded correctly.
The auditor should:
(a) ascertain;
(b) record;
(c) corroborate the
record;
(d) review;
(e) test;
(f) evaluate and
(g) form a conclusion
on the adequacy of the client’s system of
internal control.
The objectives of the
accounting systems and internal control systems
investigations are to enable the auditor to have evidence that:
(i) the client
maintains adequate books and records;
(ii) the client has a
system of internal controls over the processing
and recording of transactions such that all transactions are recorded correctly both numerically and in
principle;
(iii) the books of
account can be relied on to form a reliable basis for the preparation of the accounts.
Thus, it is not
necessary for the auditor to vouch for every transaction recorded in the books. He will rely upon the
system. If the system is satisfactory,
then he can substitute an investigation and test of the system for a detailed examination of every
entry. This is both more economical and
is more effective because it is only by examining the system that he can have evidence that all the
transactions are recorded.
However, in practice,
some areas of the firm’s internal controls may not exist or may be weak. In such cases, the
auditor cannot rely on the controls and
other evidence need to be sought for, for the completeness and accuracy of the record.
3.1.5
Substantive Testing
Substantive testing
is defined as:
…those tests of
transactions and balances, and other procedures such as analytical review, which seek to provide
audit evidence as to the completeness,
accuracy and validity of the information contained in the accounting records or in the financial
statements. You have seen that the
reliability of the records is established by the auditor, by his investigating the system.
However, not all data can be verified in
this indirect way. Thus, some transactions, balances and items in the financial statements must be
verified by direct evidence. In
particular, substantive tests are applied to the followings.
(a) Transaction
records where internal controls are weak or nonexistent and where the system cannot be relied on.
(b) Unusual,
extraordinary or one-off transactions and transactions which are not covered by a system. For
example, if the client sold a part of
its premises, this transaction is clearly rare and the client will not have a system for dealing
with it, and thus, the auditor must seek
evidence that the transaction was fully and
accurately recorded and was carried out with proper authority.
(c) All assets and
liabilities at the balance sheet date. For some
assets (e.g. debtors and creditors) the system will provide good audit evidence, but additional audit evidence
is always sought.
In practice, an
auditor has to consider on grounds of effectiveness and cost, whether to rely on systems controls or
whether to carry out substantive tests
in each area of audit. In some areas, sufficient evidence can be obtained by analytical
review. In many areas, a combination of
internal control reliance, substantive testing and analytical review provide the necessary audit
evidence.
3.1.6
Analytical Review Techniques
This is defined as:
…the study of
relationships between elements of financial information expected to conform to a predictable pattern
based on the organization’s experience
and between financial and non-financial information. Information is compared with compatible
information for a prior period or periods,
with anticipated results and with information relating to similar organizations.
In general, audit
evidence is gained from internal control, from
substantive tests and increasingly from analytical review.
3.1.7
Analytical Review of Financial Statements
At the conclusion of
the detailed work of the audit, when all the systems testing and substantive testing has been
done, the auditor will have audit evidence
that:
(a) proper books of
account have been kept which form a reliable
basis for the preparation of accounts;
(b) the accounts have
been properly drawn up from those books;
(c) all assets,
liabilities and transactions, balances and items in the account have been confirmed indirectly by
systems investigation and /or directly
by substantive testing.
Nonetheless, the
auditor will then subject the financial statements to an overall final analytical review to determine
whether:
(i) acceptable,
consistent and appropriate accounting policies have been applied. For example, the accounts would
not show a true and fair view if the
depreciation policy had been changed from
straight line to reducing balance without this being disclosed.
(ii) all the
information in the financial statements is compatible with all other information. For example, an
industrial firm using straight line
depreciation may have items of plant which have
been fully depreciated. However, in determining product cost for valuing work in progress and finished goods,
notional depreciation on fully
depreciated plant may have been taken.
(iii) all items in
the accounts are compatible with the auditor’s
knowledge of the enterprise and its circumstances. For example, the auditor may have read in the press that
new processes have been invented in a
client’s industry which makes some of the
client’s plant obsolete.
(iv) there is adequate disclosure of all items
requesting disclosure.
Numerous disclosure
requirements are in the Companies Act and
also some items may require special disclosure for proper understanding of the accounts.
(v) the accounting
requirements of the Companies Act and other
regulations have been complied with.
(vi) overall, the
auditor has sufficient evidence to enable him to give an opinion on the truth and fairness of the
accounts.
3.1.8
Preparation and Signing of Report
The ultimate aim of
an audit is the report by the auditor to his client.
This is a formal
statement giving:
(a) a title
identifying the persons to whom the report is addressed (e.g. Auditors’ report to the members of the
ABC Plc.).
(b) an introductory
paragraph identifying the financial statements
audited (e.g., Profit and Loss Account, Balance Sheet, etc.).
(c) separate
sections, appropriately headed, dealing with:
(i) respective responsibilities of directors and auditors;
(ii) the basis of the auditors’ opinion (We conducted our audit in accordance with Auditing Standards …..);
(iii) the auditors’ opinion (e.g., the financial statements give a
true and fair view …..).
(d) the manuscript or
printed signature of the auditors.
(e) the date of the
report.
4.0
CONCLUSION
You must have learnt
from the study of this note that:
a. although the
stages in conducting the modern audit have been
described, the audit is not done all at one time, but it is spread out over a period of time.
b. the modern audit
is concerned largely with a search for evidence.
Evidence can be of
several kinds including;
c. internal control
reliance:
i. substantive
testing;
ii. analytical
review.
5.0
SUMMARY
In this note, you
have learnt that modern audit has the following stages:
· Background research
into the client’s place in the economy generally
and its industry in particular, the clients’ constitution, history, operations and personnel;
· Preparation of an
audit plan;
· Accounting system
review;
· Internal control
system review;
· Substantive testing
including analytical review techniques;
· Analytical review of
financial statements;
· Preparation and
signing of the auditor’s report.
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