Audit UNIT 3
Audit UNIT 3
INTRODUCTION
When one considers the professional responsibility and potential legal liability involved, it
becomes obvious that auditors do not merely accept at new audit client and then arrive at the
client's premises to "start auditing." The first examination standard states:
The audit work should be adequately planned and properly executed. If assistants are
employed, they should be properly supervised.
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AUDIT PLANNING
Once the client has been obtained, the planning process intensifies as the auditors concentrate
their efforts on obtaining a detailed understanding of the client business and developing an
overall audit strategy.
Good planning helps in assigning those proper tasks to the members of the audit team,
coordinating outside experts, etc
. All members of the audit team must have an understanding of the entity's affairs.
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♣ Audit procedures should be discussed with the client's management, staff and/or audit
committee in order to coordinate audit work, including that of internal audit. However, all
audit procedures remain the responsibility of the external auditors.
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engagement. However, the process should be seen as being 'continuous and cumulative',
allowing reassessment at all stages of the audit.
Sources of Knowledge
a) previous experience of the client and its industry
b) visits to the client's premises and plant facilities
c) discussion with the client's staff and directors
d) discussion with other auditors and with legal and other advisors who have provided
services to the client or within the industry
e) Publications related to the industry (eg. Government statistics, surveys, texts, journals,
financial newspapers)
f) legislation and regulations that significantly affect the client
g) Documents produced by the client (eg. Minutes of meetings)
h) Professional literature giving industry specific guidance.
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Having obtained knowledge relating to the entity discussed above, the auditors must use it:
a) to assess risks and identify problems
b) to plan and perform the audit effectively and efficiently and
c) to evaluate audit evidence.
The audit areas subject to judgment which may be affected by knowledge of the business are
as follows.
Communication of Knowledge
Knowledge of the entity can only be used effectively if it is communicated to members of the
audit team. The audit engagement partner should ensure that the audit team obtains such
knowledge of the business of the entity being audited as many reasonably be expected to be
sufficient to enable it to carryout the audit work effectively.
Such information will usually be provided in the planning documentation, but the partner
should ensure that staff regularly shares any subsequent knowledge they have gained with the
rest of the team.
AUDIT RISK
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Key Terms
Audit risk is the risk that auditors may give an inappropriate opinion on the financial
statements.
Audit risk is the risk that the auditors give an unqualified opinion on the accounts when they
should have given a qualified opinion, or they give an opinion qualified for a particular reason
where that reason was not justified.
Auditors should
a) obtain an understanding of the accounting and internal control system sufficient to
plan the audit and develop an effective audit approach; and
b) use professional judgment to assess the components of audit risk and to design audit
procedures to ensure it is reduced to an acceptably low level.
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Determine
Acceptable Audit
Risk (Say 5%)
Calculate
Access Assess
Perfection
Inherent Risk Control Risk
Risk Reassess
Control Risk
Test Controls
Design
substantive
tests based on
detection risk
Inherent Risk
In developing their audit approach and detailed procedures,
procedures, auditors should assess inherent
risk in relation to financial statement assertions about material account balances and classes of
transactions, taking account of factors relevant both to the entity as a whole and to the specific
assertions.
Inherent risk is the risk that items will be misstated due to characteristics of those items, such
as the fact they are estimates or that they are important items in the accounts. The auditors
must use their professional judgment and all available knowledge to assess inherent risk. If no
such information or knowledge is available then the inherent risk is high.
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The result of the assessment must be properly documented and, where inherent risk is not
high, and then audit work may be reduced.
Control Risk
Control risk is the risk that client controls fail to detect material misstatements. Auditing
standard requires a preliminary assessment of control risk at the planning stage of the audit if
the auditors intend to rely on their assessment to reduce the extent of their substantive
procedures. This assessment should be supported subsequently by tests of control.
Detection Risk
Auditors should consider the assessed levels of inherent and control risk in determining the
nature, timing and extent of substantive procedures required to reduce audit risk to an
acceptable level.
Detection risk is the risk that audit procedures will fail to detect material errors.
Detection risk relates to substantive procedures and the inability of the auditors to examine all
evidence. Audit evidence is usually persuasive rather than conclusive so some detection risk
is usually present, allowing the auditors to see 'reasonable confidence.'
The auditors' inherent and control risk assessments influence the nature, timing and extent of
substantive procedures required to reduce detection risk and thereby audit risk. Misstatements
discovered in substantive procedures may cause the auditors to modify their previous
assessment of control risk.
Regardless of the assessed levels of inherent and control risks, auditors should perform some
substantive procedures for financial statement assertions of material account balances and
transaction classes.
Substantive procedures can never be assessed at a low enough level, although substantive
procedures may be restricted to analytical procedures if appropriate.
Where the auditors' assessment of the components of audit risk changes during the audit, they
should modify the planned substantive procedures based on the revised risk levels.
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When both inherent and control risks are assessed as high, the auditors should consider
whether substantive procedures can provide sufficient appropriate audit evidence to reduce
detection risk, and therefore audit risk, to an acceptably low level. For example, they may not
be able to obtain sufficient evidence about the completeness of income in the absence of some
internal controls.
When auditors determine that detection risk regarding a material financial statement assertion
cannot be reduced to an acceptably low level, they should consider the implications for their
report.
MATERIALITY
Key Term
Materiality is an expression of the relative significance or importance of a particular matter
in the context of financial statement as a whole.
A matter is material if its omission or misstatement would reasonably influence the decisions
of users of the auditors' report.
Materiality may also be considered in the context of any individual primary statement within
the financial statements or of individual item included in them.
Materiality is not capable of general mathematical definition as it has both qualitative and
quantitative aspects.
The concept of 'true and fair' is linked with the concept of materiality , which is
fundamental to the whole process of financial accounting. The auditors' task is to decide
whether accounts show a true and fair view.
The auditors are not responsible for establishing whether the accounts are
correct in every particular for the following reasons.
a) It can take a great deal of time and trouble to check the correctness of even a very
small transaction and the resulting benefit may not justify the effort.
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b) Financial accounting inevitably involves a degree of estimation, which means that
financial statements can never be completely precise.
Auditors should consider materiality and its relationship with audit risk when conducting an
audit. Auditors plan and perform the audit to be able to provide reasonable assurance that the
financial statements are free of material misstatement and give a true and fair view. The
assessment of what is material is a matter of professional judgment and includes consideration
of both the amount (quantity), and the nature (quality) of misstatements.
Auditors should consider materiality when determining the nature, timing and extent of audit
procedures.
Materiality considerations during audit planning are extremely important. The assessment of
materiality at this stage should be based on the most recent and reliable financial information
and will help to determine effective and efficient audit approach. Materiality assessment will
help the auditors to decide:
a) how many and what items to examine
b) whether to use sampling techniques
c) What level of error is likely to lead to a qualified audit opinion and other such matters.
The resulting combination of audit procedures should help to reduce audit risk to an
appropriately low level. Materiality assessment when evaluating the results of audit
procedures may differ from that during audit planning because of:
a) a change in circumstances; or
b) Change in the auditors' knowledge as a result of the audit (i.e., actual results are
different from expected results).
If any factors arise which cause the auditors to revise their initial assessment of materiality,
then the nature, timing and extent of all audit procedures may be modified.
AUDIT PROGRAMMES
An audit programme is a set of instructions to the audit team that sets out the audit
procedures the auditors intend to adopt and may include references to other matters
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such as the audit objectives, timing, sample size, and basis of selection for each area. It
also serves as a means to control and record the proper execution of the work.
Auditors should develop and document the nature, timing and extent of planned audit
procedures required to implement the overall audit plan.
The auditors must, when developing the audit plan, consider the risks of error as well as the
necessary audit evidence required to fulfill the procedures. Other considerations include:
a) coordination of audit work with any work on preparing the financial statements
b) timing of tests of controls and substantive procedures
c) coordination of any assistance expected from the entity
d) the composition of the audit team; and
e) The involvement of other auditors or experts.
The audit programme may contain references to other matters such as the audit objectives,
timing, sample size and basis of selection for each area. It serves as a set of instructions to the
audit team and as a means to control and record the proper execution of the work.
The level of detail and complexity depends not only on the complexity and size of the audit,
but also the experience of the members of the audit team and the extent of other
documentation.
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