Department of Professional Studies

AUDITING – I (COC332)

Bachelor of Commerce
(Finance and Accountancy)

Christ (Deemed to be University),

Bangalore Central Campus
Karnataka, India
www.christuniversity.in

Compiled By –
CA Luv Madur
 Unit 2: Basic Concepts in Auditing & Preparation for an Audit

1) Independence of Auditors

Independence enhances the auditor’s ability to act with integrity, to be objective and to maintain an
attitude of professional skepticism. Independence implies that the judgement of a person is not
subordinate to the wishes or direction of another person who might have engaged him.

It is not possible to define “independence” precisely. Rules of professional conduct dealing with
independence are framed primarily with a certain objective. The rules themselves cannot create or
ensure the existence of independence. Independence is a condition of mind as well as personal
character. It should not be confused with the superficial and visible standards of independence which
are sometimes imposed by law.

There are two interlinked perspectives of independence of auditors,

 independence of mind; and

 independence in appearance.

The Code of Ethics for Professional Accountants issued by International Federation of Accountants
(IFAC) defines the term ‘Independence’ as follows:

“Independence is: (a) Independence of mind – the state of mind that permits the

 provision of an opinion without being affected by influences

 allowing an individual to act with
o integrity, and
o exercise objectivity and
o professional skepticism; and

(b) Independence in appearance –

 the avoidance of facts and circumstances

 that are so significant
 that a third party would reasonably conclude
 an auditor’s integrity, objectivity or professional skepticism had been compromised.”

Independence of the auditor has not only to exist in fact, but also appear to so exist to all reasonable
persons.

2) Threats to Independence

The Code of Ethics for Professional Accountants, prepared by the International Federation of
Accountants (IFAC) identifies five types of threats. These are:

Self-interest threats

Occur when an auditing firm, its partner or associate could benefit from a financial interest in an
audit client. Examples include

● direct financial interest or materially significant indirect financial interest in a client,

● loan or guarantee to or from the concerned client,

● undue dependence on a client’s fees and, hence, concerns about losing the engagement,
● close business relationship with an audit client,

● potential employment with the client, and

● Contingent fees for the audit engagement.

Self-review threats

Where non-audit work (non-audit services include any professional services provided, other than
audit or review of F.S. These include management services, internal audit, investment advisory
service, design and implementation of information technology systems etc.) is provided to an audit
client and is then subject to audit, the auditor will be unlikely to admit to errors in their own work, or
may not identify the errors in their own work.

or when a member of the audit team was previously a director or senior employee of the client.

Instances where such threats come into play are

(i) when an auditor having recently been a director or senior officer of the company, and

(ii) when auditors perform services that are themselves subject matters of audit.

Advocacy threats

Promoting the position of a client or representing them in some way would mean the audit firm is
seen to be 'taking sides' with the client.

In such situations, auditor can be perceived as backing and championing causes of auditee clients
and it may lead to belief that the auditor is not acting and working objectively.

Example - when an auditor

(i) deals with shares or securities of the audited company, or

(ii) becomes the client’s advocate in litigation and third-party disputes.

Remember that auditor has not only to be independent but also appear to be acting so.

Familiarity threats

Familiarity threats are self-evident, and occur when auditors form relationships with the client where
they end up being too sympathetic to the client’s interests.

This can occur in many ways

● close relative of the audit team working in a senior position in the client company,

● former partner of the audit firm being a director or senior employee of the client,

● long association between specific auditors and their specific client counterparts, and

● acceptance of significant gifts or hospitality from the client company, its directors or employees.

Intimidation threats

Intimidation threats, which occur when auditors are deterred from acting objectively with an
adequate degree of professional skepticism. Basically, these could happen because of

 threat of replacement over disagreements with the application of accounting principles, or

 pressure to disproportionately reduce work in response to reduced audit fees or
 being threatened with litigation.

Such threats attempt to intimidate auditors to deter them from acting objectively.

3) Safeguards to Independence
The Chartered Accountant has a responsibility to remain independent by taking into account the
context in which they practice, the threats to independence and the safeguards available to
eliminate the threats.

The following are the guiding principles in this regard: -

1. For the public to have confidence in the quality of audit, it is essential that auditors should always
be and appear to be independent of the entities that they are auditing.

2. In the case of audit, the key fundamental principles are integrity, objectivity and professional
skepticism, which necessarily require the auditor to be independent.

3. Before taking on any work, an auditor must conscientiously consider whether it involves threats to
his independence.

4. When such threats exist, the auditor should either desist from the task or put in place safeguards
that eliminate them.

5. If the auditor is unable to fully implement credible and adequate safeguards, then he must not
accept the work.

Example - Mr. S and Mr. W are partners in SW and Associates, a Partnership Firm of Chartered
Accountants. During the financial year 2020-21, SW and Associates were appointed as auditors of
Capable and Composed Limited. The brother of Mr. W was involved in the management of Capable
and Composed Limited. Mr. S being aware of the whole situation, on behalf of SW and Associates did
not accept the appointment as auditors of Capable and Composed Limited as it would act as a threat
(familiarity threat) and affect independence of auditors.

4) Materiality

The general meaning of Material Items

● The items, the knowledge which might influence the decisions of the user of the financial
statements.

● An item may be material because of its size or because of its nature.

● Thus, we can say that materiality can be quantitative or qualitative.

● It is not practicable to design audit procedures to detect misstatements that could be material
solely because of their nature.

● Materiality forms the basis for determination of audit scope and the levels of testing the
transactions.

● Sometimes materiality in terms of quantity is also defined in law and regulations. For example
○ A company should disclose by way of notes additional information regarding any item of income
or expenditure which exceeds 1% of the revenue from operations or Rs. 1,00,000 whichever is
 higher (Refer general Instructions for preparation of Statement of Profit and Loss in Schedule
III to the Companies Act, 2013).

○ A company should disclose in Notes to Accounts, shares in the company held by each
shareholder holding more than 5% shares specifying the number of shares held.

Materiality from auditing point of view

● Auditor is concerned with material misstatements in the financial statements.

● Auditor will apply the concept of materiality while planning and performing the audit, he will also
use it in evaluating the effect of identified misstatements on the audit and of the uncorrected
misstatements, if any, on the financial statements and in forming the opinion in the auditor’s report.

● If materiality is defined or discussed in the financial reporting framework, the auditor will take it as
a point of reference to determine materiality level for the audit.

● Different Financial reporting frameworks may discuss materiality in different terms, the common
points which are generally emphasized are as follows.

1. Misstatements are material if expected to influence the economic decisions of users taken on
the basis of the financial statements

Misstatements, including omissions, are considered to be material if they, individually or in the

aggregate, could reasonably be expected to influence the economic decisions of users taken on the
basis of the financial statements;

2. Judgments about materiality are affected by the size or nature of a misstatement

Judgments about materiality are made in the light of surrounding circumstances, and are affected by
the size or nature of a misstatement, or a combination of both; and

3. Judgments about matters that are material are based on a consideration of the common
financial information needs of users as a group

Judgments about matters that are material to users of the financial statements are based on a
consideration of the common financial information needs of users as a group. The possible effect of
misstatements on specific individual users, whose needs may vary widely, is not considered.

The auditor’s determination of materiality is a matter of professional judgment.

The auditor’s determination of materiality is a matter of professional judgment, and is affected by

the auditor’s perception of the financial information needs of users of the financial statements. In
this context, it is reasonable for the auditor to assume that users:

a. Have a reasonable knowledge of business and economic activities and accounting and a
willingness to study the information in the financial statements with reasonable diligence;
b. Understand that financial statements are prepared, presented and audited to levels of
materiality;

c. Recognize the uncertainties inherent in the measurement of amounts based on the use of
estimates, judgment and the consideration of future events; and

d. Make reasonable economic decisions on the basis of the information in the financial
statements.
Benchmarking

Benchmarking is one recognized method through which an Auditor determines the materiality level.
Under this method, a percentage is often applied to a chosen benchmark, as a starting point in
determining materiality for the Financial Statements as a whole.

The auditor has to apply his professional judgement in determining materiality, choosing appropriate
benchmark and determining level of benchmark.

Factors: Factors that may affect the identification of an appropriate benchmark include –

a. Elements of the Financial Statement (e.g., Assets, Liabilities, Equity, Revenue, Expenses)

b. Whether there are items on which the attention of the users of the particulars Entity’s Financial
Statement tends to be focused (e.g., profit, revenue or net assets)

c. Nature of the Entity, where the Entity is at in its life cycle, and the industry and economic
environment in which the Entity operates

d. Ownership Structure and Financial Pattern (e.g., if an entity is financed more by Debt rather than
Equity, users may put more emphasis on Assets, and claims on them, than on the Entity’s Earning)
and

e. The relative volatility of the benchmark.

Examples of benchmarks that may be appropriate, include categories of reported income such as
PBT, Total Revenue, Gross Profit and Total Expenses, Total Equity or Net Asset Value.

a. Profit Before Tax from continuing operations is often used for profit-oriented entities. In this
regard if Profit Before Tax from continuing operations is volatile, another benchmark may be more
appropriate.

b. In an audit of the entities doing public utility programs/projects, Total Cost or Net Cost
(Expenses less Revenues) may be appropriate benchmarks for that particular program/project
activity.

c. Where an entity has custody of the assets, assets may be an appropriate benchmark.
 5) Concept of true and fair view

The phrase “true and fair” in the auditor’s report signifies that the auditor is required to express his
opinion as to whether the state of affairs and the results of the entity as ascertained by him in the
course of his audit are truly and fairly represented in the accounts under audit.

This requires that the auditor should examine the accounts with a view to

● verify that all assets, liabilities, income and expenses are stated at amounts

○ which are in accordance with accounting principles and policies which are relevant.

● and no material amount, item or transaction has been omitted.

What constitutes a ‘true and fair’ view is a matter of an auditor’s judgment in the particular
circumstances of a case.

In more specific terms, to ensure true and fair view, an auditor has to see:

1. That the assets are neither undervalued or overvalued, according to the applicable accounting
principles,

2. No material asset is omitted;

3. The charge, if any, on assets are disclosed;

4. Material liabilities should not be omitted;

5. The profit and loss account and balance sheet discloses all the matters required to be disclosed;

6. Accounting policies have been followed consistently; and

7. All unusual, exceptional or non-recurring items have been disclosed separately.

6) SA 300 “Planning an Audit of Financial Statements”

Scope

This Standard on Auditing (SA) deals with the auditor’s responsibility to plan an audit of financial
statements.

Objective

The objective of the auditor is to plan the audit so that it will be performed in an effective manner.

Involvement of Key Engagement Team Members

The engagement partner and other key members of the engagement team shall be involved in
planning the audit, including planning and participating in the discussion among engagement team
members. The involvement of the engagement partner and other key members of the engagement
team in planning the audit draws on their experience and insight, thereby enhancing the
effectiveness and efficiency of the planning process.

Audit Plan to Conduct an Effective Audit

Plans should be made to cover, among other things:

(a) acquiring knowledge of the client’s accounting systems, policies and internal control procedures;
(b) establishing the expected degree of reliance to be placed on internal control;

(c) determining and programming the NTE of the audit procedures to be performed; and

(d) coordinating the work to be performed.

Plans should be further developed and revised as necessary during the course of the audit.

Benefits of Planning in the Audit of Financial Statements

Adequate planning benefits the audit of financial statements in several ways, including the following:

1. Helping the auditor to devote appropriate attention to important areas of the audit

2. Helping the auditor identify and resolve potential problems on a timely basis.

3. Helping the auditor properly organize and manage the audit engagement so that it is performed in
an effective and efficient manner.

4. Assisting in the selection of engagement team members with appropriate levels of capabilities and
competence to respond to anticipated risks, and the proper assignment of work to them.

5. Facilitating the direction and supervision of engagement team members and the review of their
work.

6. Assisting, where applicable, in coordination of work done by auditors of components and experts.

7) Audit Strategy

What is Audit Strategy

Overall audit strategy sets the scope, timing and direction of the audit, and guides the development
of the more detailed audit plan.

Establishment of Overall Audit Strategy

In establishing the overall audit strategy, the auditor shall:

a. Identify the characteristics of the engagement that define its scope;

Example –
• The expected audit coverage, including the number and locations of components to be included.
• The nature of the business segments to be audited, including the need for specialized knowledge.
• The expected use of audit evidence obtained in previous audits, for example, audit evidence
related to risk assessment procedures and tests of controls.

b. Ascertain the reporting objectives of the engagement to plan the timing of the audit and the
nature of communications required.

Example –

 The entity’s timetable for reporting, such as at interim and final stages.
 The organization of meetings with management and those charged with governance to
discuss the nature, timing and extent of the audit work.
 The discussion with management and those charged with governance regarding the
expected type and timing of reports to be issued and other communications, both written
 and oral, including the auditor’s report, management letters and communications to those
charged with governance.
 The discussion with management regarding the expected communications on the status of
audit work throughout the engagement.

c. Consider factors that, in the auditor’s professional judgment, are significant in directing the
engagement team’s efforts;
d. Consider results of preliminary engagement activities and, where applicable, whether knowledge
gained on other engagements performed by the engagement partner for the entity is relevant; and

Example –

• Preliminary identification of areas where there may be a higher risk of material misstatement.
• Results of previous audits that involved evaluating the operating effectiveness of internal control,
including the nature of identified deficiencies and action taken to address them.
• Volume of transactions, which may determine whether it is more efficient for the auditor to rely on
internal control.

e. Ascertain the nature, timing and extent of resources necessary to perform the engagement.

Example –

• The selection of engagement team and the assignment of audit work to the team members,
including the assignment of appropriately experienced team members to areas where there may be
higher risks of material misstatement.
• Engagement budgeting, including considering the appropriate amount of time to set aside for
areas where there may be higher risks of material misstatement.

8) Audit Plan

Description of Audit Plan

As per SA 300 “Planning an Audit of Financial Statement” the audit plan shall be include a description
of

❖ The nature, timing and extent of planned risk assessment procedures, as determined under SA
315.

❖ The nature, timing and extent of planned further audit procedures at the assertion level, as
determined under SA 330.

❖ Other planned audit procedures that are required to be carried out so that the engagement
complies with SAs. (Obtaining written representations from management)

Knowledge of the Client’s Business

It is one of the important principles in developing an overall audit plan. In fact, without adequate
knowledge of the client's business, a proper audit is not possible.

As per SA-315, “Identifying and Assessing the Risk of Material Misstatement through Understanding
the Entity and Its Environment”, the auditor shall obtain an understanding of the following:
1. Relevant industry, regulatory and other external factors including applicable financial reporting
framework.

Example –

• The competitive environment, including demand, capacity, product and price competition as well
as cyclical or seasonal activity.
• Supplier and customer relationships, such as types of suppliers and customers (e.g., related
parties, unified buying groups) and the related contracts with those entities.
• Technological developments, such as those related to the entity’s products
• Energy supply and cost.
• The effect of regulation on entity operations.

2. The nature of the entity, including:

a. Its operations;

b. Its ownership and governance structures;

c. The types of investments that the entity is making and plan to make: &

d. The way that the entity is structured and how it is financed.

Example –

• Understanding the sources of an entity’s earnings can help us identify risks of material
misstatement related to valuation of certain products or lines of businesses or areas that may be
more susceptible to management fraud.
• Understanding key supplier and customer relationships can help us identify potential related
parties or risks related to revenue recognition.
• An entity with components in multiple tax jurisdictions, resulting in additional risk of misstatement
in the tax accounts.
• An acquisition may result in a complex structure of holding companies to achieve benefits to the
shareholders giving rise to significant intercompany transactions which may give rise to material
misstatements due to fraud or error.
• Transactions outside the entity’s normal course of business may include: complex equity
transactions, transactions regarding the leasing of premises, or the rendering of management
services by the entity to another party, when no consideration is exchanged, transactions under
contracts with terms that change before expiration should be studied in depth.

3. The entity’s selection and application of accounting policies, including the reasons for changes
thereto.

Examples –

1. We use our understanding of the entity’s accounting principles, financial reporting policies or
disclosures to help us determine:
The need to involve a specialist to help perform audit procedures related to particular
disclosures, such as pension disclosures.
The effect on our audit of significant new or revised disclosures that may be required as a
result of changes in the entity’s environment, financial condition or activities, such as a change in
the segments for the reporting of segment information arising from a significant business
combination.
 2. Management determines that most of the entity’s competitors have adopted an accounting
policy that is different from that adopted by the entity. After evaluation, management determines
that the alternative accounting policy is generally accepted and further determines that the
alternative accounting policy preferable as it will result in greater comparability and result in
reliable and more relevant information. Management therefore decides to change the entity’s
accounting policy.

4. The entity’s objectives and strategies, and those related Business risks that may result in risks of
material Misstatement.

Example –

1. If one of management’s objectives is to grow the business, management may develop a

strategy of steady but regular growth through specific marketing campaigns and
development of new markets. Alternatively, management may develop a more aggressive,
complex strategy of acquiring competitors. Each of these strategies gives rise to differing
business risks and potentially differing risks of material misstatement.

2. Examples of potential business risks include:

Failure to keep up to date with new products, technologies or services.
Excessive reliance on a key supplier, product or individual, such as the owner.
Lack of personnel with expertise to react to changes in the industry.
Insufficient or excessive production capacity caused by inaccurate estimation of
demand.
Loss of financing due to the entity’s inability to meet financial covenants

5. The measurement and review of the entity’s financial performance.

Example –

External information such as analysts’ reports and credit rating agency reports may be useful
information for us to obtain an understanding of an entity’s performance measures. Such reports can
often be obtained from the entity.

In addition to the importance of knowledge of the client’s business in establishing the overall audit
plan, such knowledge helps the auditor to identify areas of special audit consideration, to evaluate
the reasonableness of both accounting estimates and management representations and to make
judgements regarding the appropriateness of accounting policies and disclosures.

Relationship between the overall audit strategy and the audit plan

● Audit plan is prepared after the audit strategy and is more detailed. Audit strategy gives less detail
but it forms the basis of the planning

● The auditor shall establish an overall audit strategy that sets the scope, timing and direction of the
audit, and that guides the development of the audit plan

● Detailed audit plans would include the nature, timing and extent of the audit procedures so as to
obtain sufficient appropriate audit evidence.
 9) Audit Programme

Meaning

An audit programme consists of

- a series of verification procedures

- to be applied to the financial statements and accounts of a given company

- for the purpose of obtaining sufficient evidence

- to enable the auditor to express an informed opinion on such statements.

One Audit Programme – Not Practicable for All Businesses

● All businesses are not same

● They vary in nature, size, capital raised and on other parameters also

● Some might have a formal and working internal control, while some may not have internal control
at all.

● Applicability of different laws and regulation also differentiate the scope of services to be given by
auditor

● Because of the reasons for variations mentioned above it is not possible to develop one audit
program applicable to all businesses under all circumstances.

● Every audit programme must have details of the nature of work to be done as per the nature, size
and other parameters of the business. This will help in saving time and special matters and situations
will not be overlooked.

Periodic Review of The Audit Programme

Audit programme must be periodically reviewed, to check its effectiveness in the light of changing
circumstances.

Constructing an Audit Programme

While developing an audit programme, the auditor may conclude that relying on certain internal
controls is an effective and efficient way to conduct his audit.

However, the auditor may decide not to rely on internal controls when there are other more efficient
ways of obtaining sufficient appropriate audit evidence.

The auditor should also consider

● the timing of the procedures,

● the coordination of any assistance expected from the client,

● the availability of assistants, and the involvement of other auditors or experts.

Further, the auditor normally has flexibility in deciding when to perform audit procedures.

However, in some cases, the auditor may have no discretion as to timing,

- for example, when observing the taking of inventories by client personnel or verifying the securities
and cash balances at the year-end.

For the purpose of programme construction, the following points should be kept in mind:

1. Stay within the scope and limitation of the assignment.

2. Prepare a written audit programme setting forth the procedures that are needed to implement
the audit plan.

3. Determine the evidence reasonably available and identify the best evidence for deriving the
necessary satisfaction.

4. Apply only those steps and procedures which are useful in accomplishing the verification purpose
in the specific situation.

5. Include the audit objectives for each area and sufficient details which serve as a set of
instructions for the assistants involved in audit and help in controlling the proper execution of the
work.

6. Consider all possibilities of error.

7. Co-ordinate the procedures to be applied to related items.

Audit Programme To provide Audit Evidence

Audit programme is designed to provide for Audit evidence by prescribing procedures and technique.

The best evidence for testing accuracy of an assertion is a matter of professional judgement of the
auditor.

Auditor through his training, knowledge and experience Will design the audit program in such a
manner that it will provide the best possible audit evidence for the given assertions.

For example, the best evidence for cash in hand can be obtained through counting the cash.

For something which is pledged with the bank the banker’s certificate will be the best audit
evidence.

Variety of fields for Audit Evidence

An auditor picks up evidence from a variety of fields and it is generally of the following broad types:

a. Documentary examination,

b. Physical examination,

c. Statements and explanation of management, officials and employees,

d. Statements and explanations of third parties,

e. Arithmetical calculations by the auditor,

f. State of internal controls and internal checks,

g. Inter-relationship of the various accounting data,

h. Subsidiary and memorandum records,

i. Minutes,

j. Subsequent action by the client and by others.

Example –

1. For cash in hand, the best evidence is ‘count’

2. For investment pledged with a bank, the banker’s certificate.
3. For verifying assertions about book debts, the client’s ledger invoices, debit notes, credit notes,
monthly accounts statement sent to the customers are all evidence: some of these are corroborative,
other being complementary. In addition, balance confirmation procedure is often resorted to,
to obtain greater satisfaction about the reliability of the assertion.

Quality Control for Audit Work Delegation and Supervision of Audit Work

An audit is a complex task involving number of people at different levels.

Auditor will have to depend on

● Assistants

● Technical Experts

● Other auditors

In the case of assistants, the auditor has to direct, supervise and review the work delegated to them.

In the case of other auditors and expert auditor has to obtain reasonable assurance that the work
performed by them is adequate for the purpose of the auditor.

The objective of the auditor is to implement quality control procedures at the engagement level that
provides the auditor with reasonable assurance that

● The audit complies with the professional standards and the regulatory and legal requirements

● The Auditor’s report is issued as appropriate in the circumstance.

The responsibility to express an opinion on financial statements and it’s accountability will always be
of the auditor.

10) SA 230 – Audit Documentation

Objectives of the Auditor

The objective of the auditor is to prepare documentation that provides:

(a) A sufficient and appropriate record of the basis for the auditor’s report; and

(b) Evidence that the audit was planned and performed in accordance with SAs and applicable legal
and regulatory requirements.

Nature and Purposes of Audit Documentation

Audit documentation that meets the requirements of this SA and the specific documentation
requirements of other relevant SAs provides:

a. Evidence of the achievement of the overall objectives of the auditor; and

b. Evidence that the audit was planned and performed in accordance with SAs and applicable legal
and regulatory requirements.

Audit documentation serves a number of additional purposes, including the following:

1. Assisting the engagement team to plan and perform the audit.

2. Assisting members of the engagement team responsible for supervision to direct and supervise
the audit work, and to discharge their review responsibilities.

3. Enabling the engagement team to be accountable for its work.

4. Retaining a record of matters of continuing significance to future audits.

5. Enabling the conduct of quality control reviews and inspections.

6. Enabling the conduct of external inspections in accordance with applicable legal, regulatory or
other requirements.

Form, Content and Extent of Audit Documentation

The form, content and extent of audit documentation depend on factors such as:
(i) The size and complexity of the entity
(ii) The nature of the audit procedures to be performed
(iii) The identified ROMM’s
(iv) The significance of the audit evidence obtained
(v) The nature and extent of exceptions identified
(vi) Basis of conclusions
(vii) The audit methodology and tools used

1. The auditor shall prepare audit documentation that is sufficient to enable an experienced auditor
to understand.

a) The nature, timing and extent of the audit procedures:

b) The results of the audit procedures performed, and the audit evidence obtained; and

c) Significant matters arising during the audit and the conclusions reached thereon, significant
professional judgements made in reaching those conclusions

2. In documenting the nature, timing and extent of audit procedures performed, the auditor of shall
record:

● The identifying characteristics of the specific items or matters tested. (Assertions tested)

● Who performed the audit work and the date such work was completed; and

● Who reviewed the audit work performed and the date and extent of such review.

3. The auditor shall document discussions of significant matters with management, those charged
with governance, and others, including the nature of the significant matters discussed and when and
with whom the discussions took place.

4. If the auditor identified information that is inconsistent with the auditor's final conclusion
regarding a significant matter, the auditor shall document how the auditor addressed the
inconsistency
Examples of Audit Documentation

● Audit Documentation include:

○ Audit programmes.

○ Analyses.

○ Issues memoranda.

○ Summaries of significant matters.

○ Letters of confirmation and representation.

○ Checklists.

○ Correspondence (including e-mail) concerning significant matters.

Audit documentation is not a substitute for the entity’s accounting records.

The auditor may include copies of the entity’s records (for example, significant and specific contracts
and agreements) as part of audit documentation.

The auditor need not include in audit documentation

● superseded drafts of working papers and financial statements,

● notes that reflect incomplete or preliminary thinking,

● previous copies of documents corrected for typographical or other errors, and duplicates of
documents.

Ownership of Audit Documentation

Standard on Quality Control (SQC) 1 provides that,

● unless otherwise specified by law or regulation,

● Audit documentation is the property of the auditor.

The auditor should adopt reasonable procedures for custody and confidentiality of his working
papers.

He may at his discretion,

● make portions of, or extracts from, audit documentation available to clients,

● provided such disclosure does not undermine the validity of the work performed, or,

● in the case of assurance engagements, the independence of the auditor or of his personnel.

In the case of a company, the main auditor has to consider the report of the branch auditor and has a
right to seek clarification and to visit the branch but cannot ask for the copy of working paper and
therefore, the branch auditor is under no compulsion to give photocopies of his working paper to the
principal auditor.

Retention
SQC 1 requires firms to establish policies and procedures for the retention of engagement
documentation. The retention period for audit engagements ordinarily is no shorter than seven
years from the date of the auditor’s report, or, if later, the date of the group auditor’s report.

11) SA 500 – Audit Evidence

Information contained in the accounting records include

● the records of initial accounting entries and supporting records, such as checks and records of
electronic fund transfers;

● Invoices;

● Contracts

● the ledgers, journal entries and other adjustments to the financial statements.

● records such as worksheets and spreadsheets supporting cost allocations, computations,

reconciliations and disclosures.

Other information

Other information that authenticates the accounting records and also supports the auditor’s
rationale behind the true and fair presentation of the financial statements:

Other information which the auditor may use as audit evidence includes, for example

● minutes of the meetings,

● written confirmations from trade receivables and trade payables,

● manuals containing details of internal control etc.

A combination of tests of accounting records and other information is generally used by the
auditor to support his opinion on the financial statements.

Other Points related to Audit Evidence and Its Nature.

It is cumulative in nature

Primarily obtained from audit procedures performed during the course of the audit.

It may, however, also include information obtained from other sources such as previous audits.

Audit evidence comprises both

● information that supports and corroborates management’s assertions, and

● any information that contradicts such assertions.

The absence of information (for example, management’s refusal to provide a requested

representation) also constitutes audit evidence.

Relation of Audit Evidence and Opinion of the Auditor

There exists a very important relationship between Audit Evidence and the opinion of the Auditor.

While conducting an audit of a company,

● the auditor obtains audit evidence and

● With the help of that audit evidence obtained, the auditor forms an audit opinion on the financial
statements of that company.

Audit evidence is necessary to support the auditor’s opinion and report.

As explained in SA 200, “Overall Objectives of the Independent Auditor and the Conduct of an Audit
in Accordance with Standards on Auditing”, reasonable assurance is obtained when the auditor has
obtained sufficient appropriate audit evidence to reduce audit risk to an acceptably low level.

Sufficiency of Audit Evidence

● Sufficiency is the measure of the quantity of audit evidence.

● The quantity of audit evidence needed is affected by the auditor’s assessment of the risks of
misstatement (the higher the assessed risks, the more audit evidence is likely to be required) and

● also, by the quality of such audit evidence (the higher the quality, the less may be required).

● Obtaining more audit evidence, however, may not compensate for its poor quality.

Factors to determine Sufficiency

(a) Materiality

It may be defined as the significance of classes of transactions, account balances and presentation
and disclosures to the users of the financial statements.

Less evidence would be required in case assertions are less material to users of the financial
statements.

But on the other hand, if assertions are more material to the users of the financial statements, more
evidence would be required.

(b) Risk of material misstatement

It may be defined as the risk that the financial statements are materially misstated prior to audit.
Less evidence would be required in case assertions that have a lower risk of material misstatement.
But on the other hand, if assertions have a higher risk of material misstatement, more evidence
would be required.

(c) Size of a population

It refers to the number of items included in the population.

Less evidence would be required in case of smaller, more homogeneous population but on the other
hand in case of larger, more heterogeneous populations, more evidence would be required.

(d) Appropriateness of Audit Evidence

Appropriateness is the measure of the quality of audit evidence; that is, its relevance and its
reliability in providing support for the conclusions on which the auditor’s opinion is based.

(e) Relevance

Relevance means the relationship of the evidence with audit procedure and the assertion being
checked.

A given set of audit procedures may provide audit evidence that is relevant to certain assertions, but
not others.

For example, confirmation of balance from a customer is relevant evidence as regards existence of
receivable, but it may not be relevant as regards collectability of the balance due from customer.

Also, physical observation of inventories is relevant evidence relating to existence, but is not
appropriate evidence to ensure that the entity owns the inventories.

Reliability of Audit Evidence

As per SA 500 "Audit Evidence", the reliability of information to be used as audit evidence, and
therefore of the audit evidence itself, is influenced by its

● source and

● its nature, (Direct, indirect, oral, written or original, photocopies) and

● the circumstances under which it is obtained,

● including the controls over its preparation and maintenance where relevant.

For example, information obtained from an independent external source may not be reliable if the
source is not knowledgeable, or a management's expert may lack objectivity.

While recognising that exceptions may exist, the following generalisations about the reliability of
audit evidence may be useful:

1. The reliability of audit evidence is increased when it is obtained from independent sources outside
the entity.

2. The reliability of audit evidence that is generated internally is increased when the related controls,

including those over its preparation and maintenance, imposed by the entity are effective.
3. Audit evidence obtained directly by the auditor (for example, observation of the application of a
control) is more reliable than audit evidence obtained indirectly or by inference (for example, inquiry
about the application of a control).

4. Audit evidence in documentary form, whether paper, electronic, or other medium, is more reliable
than evidence obtained orally (for example, a contemporaneously written record of a meeting is
more reliable than a subsequent oral representation of the matters discussed).

5. Audit evidence provided by original documents is more reliable than audit evidence provided by
photocopies or facsimiles, or documents that have been filmed, digitised or otherwise transformed
into electronic form, the reliability of which may depend on the controls over their preparation and
maintenance.

6. Circumstances prevailing in the organisation can have a severe impact on the reliability of the
audit evidence.

Sources of Audit Evidence

Some audit evidence is obtained by performing audit procedures to test the accounting records.
Through the performance of such audit procedures, the auditor may determine that the accounting
records are internally consistent and agree to the financial statements.
More assurance is ordinarily obtained from consistent audit evidence obtained from different
sources or of a different nature than from items of audit evidence considered individually.

Information from sources independent of the entity that the auditor may use as audit evidence may
include confirmations from third parties, analysts’ reports, and comparable data about competitors.

Audit Procedures to Obtain Audit Evidence

Audit evidence to draw reasonable conclusions on which to base the auditor’s opinion is obtained by
performing

➔ Risk assessment procedures; and

➔ Further audit procedures, which comprise:

◆ Tests of controls, when required by the SAs or when the auditor has chosen to do so; and

◆ Substantive procedures, including tests of details and substantive analytical procedures.

➔ The audit procedures described below may be used as

◆ risk assessment procedures,

◆ tests of controls or

◆ substantive procedures,

● Depending on the context in which they are applied by the auditor.

Audit procedures to obtain audit evidence can include

1. Inspection

2. Observation
3. External Confirmation

4. Recalculation

5. Reperformance

6. Analytical Procedure

7. Enquiry

Inspection

● examining records or documents,

○ whether internal or external,

○ in paper form, electronic form, or other media, or

● a physical examination of an asset.

● Inspection of records and documents provides audit evidence

○ of varying degrees of reliability,

○ depending on their nature and source and,

● Example - Documentation related to authorisation

Observation

● Observation consists of witnessing a process or procedure being performed by others.

● For example, the auditor may observe the counting of inventories being performed by client's
personnel.

External Confirmation

An external confirmation represents audit evidence obtained by the auditor as a direct written
response to the auditor from a third party ( the confirming party), in paper form, or by electronic or
other medium.

External confirmation procedures frequently are relevant when addressing assertions associated
with certain account balances and their elements. However, external confirmations need not be
restricted to account balances only.

External confirmation procedures also are used to obtain audit evidence about the absence of
certain conditions.

Recalculation

Recalculation consists of checking the mathematical accuracy of documents or records. Recalculation

may be performed manually or electronically.

Re-performance

Re-performance involves the auditor’s independent execution of procedures or controls that were
originally performed as part of the entity’s internal control.

Analytical Procedures
● Analytical procedures consist of evaluations of financial information by a study of relationships
among both financial and non- financial data.

● Analytical Procedures refers to studying significant ratios and trends and investigating unusual
fluctuations.

Inquiry

12) SA 530 – Audit Sampling

Meaning of Sampling

According to SA 530 - Audit sampling (sampling)

- The application of audit procedures

- to less than 100% of items within a population of audit relevance

- such that all sampling units have a chance of selection in order

- to provide the auditor with a

- reasonable basis

- on which to draw conclusions about the entire population.

This Standard on Auditing (SA) applies when the auditor has

- decided to use audit sampling in performing audit procedures.

It deals with the auditor’s

- use of statistical and non-statistical sampling when

- designing and selecting the audit sample,

- performing tests of controls and tests of details, and

- evaluating the results from the sample.

We can also say that sampling is one of the means to select samples for testing.

Sampling is also known as test check

APPROACHES TO SAMPLING

Statistical Sampling

Probability Theory

Statistical sampling is an approach to sampling that has the

- random selection of the sample units;

- and the use of probability theory

- in determining the appropriate sample size

- In Sample selection
 - to evaluate sample results,

- including measurement of sampling risk characteristics.

Mathematical and statistical methods

Sample is chosen by applying certain mathematical and statistical methods.

More Scientific

Statistical Sampling- More Scientific

Probability theory, a branch of mathematics concerned with the analysis of random phenomena.
The outcome of a random event cannot be determined before it occurs, but it may be any one of
several possible outcomes. The actual outcome is considered to be determined by chance.
(https://www.britannica.com/science/probability-theory)

Large number of similar items

Widely used where a population to be tested consists of a large number of similar items and more in
the case of transactions involving compliance testing, trade receivables’ confirmation, payroll
checking, vouching of invoices and petty cash vouchers.

No personal bias

There Is no personal bias of the auditor in the case of statistical sampling.

Projection more reliable

Since it is scientific, the results of the sample can be evaluated and projected on the whole
population in a more reliable manner.

For Example: An auditor while verifying the Purchases during the year realised that the purchase
transactions in that year are more than 95000 in number, then in such case, statistical sampling will
be highly recommended in the audit program.

Advantages of Statistical Sampling

1. The amount of testing (sample size) does not increase in proportion to the increase in the size of
the area (universe) tested. (Smaller sample size gives a better representation of the population, in
judgemental or non-statistical sampling sample size is large still it does not give a fair representation
of the population)

2. The sample selection is more objective and thereby more defensible.

3. The method provides a means of estimating the

● minimum sample size associated with a specified risk. (Basically helps in determining the sample
size depending upon audit risk)

4. It provides a means for deriving a “calculated risk” (sampling error) i.e. the probable difference in
result due to the use of a sample in lieu of examining all the records in the group (universe), using
the same audit procedures.

5. It may provide a better description of a large mass of data when compared to a non-statistical
approach of sampling.
6. Results of sampling can be evaluated and projected in a better way

13) SA 210 – Agreeing the Terms of Audit Engagement

Pre- Conditions for an audit

In order to establish whether the preconditions for an audit are present, the auditor shall:

● Determine whether the financial reporting framework is acceptable; and

● Obtain the agreement of management that it acknowledges and understands its responsibility:

○ For the preparation of the financial statements in accordance with the applicable financial
reporting framework;

○ For the internal control as management considers necessary; and

○ To provide the auditor with:

■ Access to all information such as records, documentation and other matters;

■ Additional information that the auditor may request from management for the purpose of the
audit; and

■ Unrestricted access to persons within the entity from whom the auditor determines it
necessary to obtain audit evidence.