AUDIT PLANNING AND CONTROL ANNING AND CONTROL - ICAN

401 Pages·2010·0.96 MB·English

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After studying this chapter, readers should be able to understand:
! The general concept of audit strategy.
! The Importance of audit strategy as an effective plan for an audit.
! Internal control systems, evaluation and assessment.
! Audit documentation.
! Relationship with experts.
! Audit risks and its relative importance to audit.
! Components of audit risks.
! How to assess audit risks.
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Auditing has developed over many years, but it was not until the late nineteenth
century (with the formation of joint stock companies, the predecessors to present
day limited liability companies) that auditing became widely accepted in the
United Kingdom and by extension, in other parts of the world. Individual firms
of accountants have refined their approach to auditing from time to time and
the professional accountancy bodies in various countries have published
guidelines to their members on auditing procedures.
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Audit strategy is directed to the gathering of relevant and reliable audit evidence
in order to support the expression of an opinion on the accounts. In carrying out
an audit assignment, the auditor should:
(a) Consider his responsibilities as defined in the terms of engagement;
(b) Familiarise himself with the client’s business and organisation;
(c) Obtain a preliminary understanding of the principal features of the
client’s accounting system and internal control procedures;
(d) Determine and record the audit strategy to be adopted;
(e) Where it is proposed to carry out a detailed evaluation of all or certain
internal controls with a view to placing some reliance on such controls,
obtain a more detailed description of the accounting system and internal
control procedures and review selected transactions to confirm that he
has understood and recorded the system properly;
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(f) Review critically and evaluate those aspects of the client’s accounting
system, procedures and internal controls on which he intends to place
some reliance;
(g) Discuss any weakness in the system with the client in order, inter alia,
to ascertain whether they are compensated by some other controls;
(h) Test the system to determine whether the controls on which he intends
to place reliance were operating during the period;
(i) Report apparent weakness and breakdown in internal control to the client
in a management letter; and
(j) Based on the results of the work described above, carry out a programme
of audit work to substantiate the amounts appearing in the accounts
and related notes so as to ensure that the accounts show a true and fair
view of the state of affairs and the results of the business.
The above paragraph summarises the basic procedures that an auditor should
carry out in order to express an opinion on the accounts. It should be noted,
however, that the procedures and terminology used in practice may vary, even
though, the fundamental concept may be the same. Furthermore, the extent to
which the auditor places reliance on the work of an internal audit department
may significantly affect the nature, timing and extent of his work.
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The purpose of determining an audit strategy is to enable the auditor
familiarise himself with the client’s business and organisation as well
as to obtain a preliminary understanding of the client’s accounting
system. This will entail the preliminary identification of those internal
controls on which he proposes to rely upon.
The auditor should then determine and record his audit strategy before
commencing any detailed audit work. In doing so, the auditor will need
to identify the optimum balance between, on one hand, relying on
internal controls and reducing the level of his substantive tests, and on
the other hand, placing little or no reliance on internal controls and
seeking audit satisfaction from a higher level of validation procedures.
The purpose of making this assessment is to enable the auditor to carry
out the audit in the most effective and efficient manner. Determination
of the audit strategy requires a high degree of professional judgement.
Consequently, the audit assignment should be carried out by an
experienced staff, with the involvement of the audit partner.
In particular, the determination of the audit strategy for a new client
will usually require considerably more time and effort than for existing
clients, except where the circumstances of existing clients have changed
significantly since the last audit. However, this does not mean that a
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formal determination of the audit strategy is not necessary for existing
clients whose circumstances do not change significantly from year to
year. In all cases, a formal record of the audit strategy is essential. The
overall strategy should focus on a more efficient and effective audit.
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In order to ensure a high standard of performance, it is important that
the auditor should prepare adequately for his work. Planning for an
audit, just like every human endeavour, is essential for the smooth
performance of the audit work and its successful completion. Planning
ahead for an audit work will not only guarantee a valid audit opinion
but will also help the auditor to ensure that:
(a) The audit objective is established and achieved;
(b) The audit is properly controlled and adequately directed at all
stages;
(c) High risk and critical areas of the engagement are not omitted
but that adequate attention is focused on these areas; and
(d) The work is completed economically and expeditiously, hence,
savings on audit resources.
It is important to distinguish between an audit planning memorandum.
Audit plan relates to preparations made by the auditor for one
specific audit engagement. While audit planning memorandum is a
standing arrangement made by the auditor for the continuing
engagement of a particular client. Hence, an audit plan for the audit of
one client for one year while audit planning memorandu is a standing
plan for the continuing audit of a client from year to year.
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Audit planning requires a high degree of discipline on the part of the
auditor. In order to make the planning more meaningful, the auditor
shouldtake into consideration the following matters in relation to the
audit engagement:
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This will include such matters as stocktaking, cash count,
debtors’circularisation and review of previous year’s working
papers. This will remind the auditor of those matters brought
forward from the previous year and any other points to be
resolved in the current year or problems anticipated.
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The promulgation of the Companies and Allied Matters Act, Cap.
C 20, LFN 2004, brought with it a lot of changes in accounting
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and auditing requirements of companies. Such legislations
whether in respect of all companies or particular industrial group,
must be reviewed ahead of the engagement in order to deter-
mine their effects on the operations or reporting requirements of
the enterprise.
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This will assist in establishing valuable ratios and indicators
that will guide the auditor. For instance, the computation of the
gross profit percentage compared with that of the previous year
will provide a good indicator to the auditor of the accuracy and
reliability of sales and cost of sales.
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The appointment of a new Finance Controller and the establishment
of a new business line or the creation of a new branch are
significant changes in the circumstances of the company which
will necessitate changes in the existing audit plans.
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The introduction of computers such that when a company
introduces significant changes in its operating procedures will
require a review and evaluation of the system of internal control.
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Where a client has set deadlines for its statutory activities such
as the annual general meeting, it is important for the auditor to
work in line with such programmes.
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In practice, the auditor may not carry out a hundred percent
testing or verification of the client’s transactions or segments of
the business. Where rotational testing or verification is adopted,
it will be necessary for the auditor to determine ahead of the
date of the engagement which aspects of the business should be
selected for testing or verification. An example of rotational
testing could be applied on the client’s branches to be visited.
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Audit planning memorandum should cover the following standing
matters which are designed to achieve the desired audit objectives:
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In the case of a new audit engagement, a letter of engagement
should be prepared as part of the overall plan of the audit. Even
in subsequent visits,the letter of engagement should be reviewed
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in the light of current circumstances to ensure that all aspects of
the work undertaken for the client are covered in the letter
especially as they relate to taxation, accountancy, staff
development and executive search.
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The auditor should critically review all the areas of high risk in
order to ensure that the planned procedures adequately cover
such areas and that competent staff have been assigned to these
areas. High risk areas may relate to the nature of the items, such
as cash for a retail establishment with numerous collection points
and outdoor disbursement locations. Risk may also relate to a
high probability of error as in the case of stocks whose quantities
are subject to estimation and are susceptible to pilferage. The
risk may also relate to the structure of the organisation
especially in cases of joint ownership of an organisation, where
the owners are not equally represented in the management. There
is therefore the risk of withholding key information from some of
the directors.
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These will require detailed plans since they are of continuing
relevance to the financial statements of many years and the
relevant vouchers may not be readily accessible. The plans
relating to assets should clearly disclose their history such that
current movements may easily be ascertained and adequately
verified. These will apply mainly to plant and long term loans.
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Wherever an internal auditor exists in an organisation, the audi-
tor should develop suitable plans to review the technical compe-
tence of the internal auditor, his degree of independence and scope
and quality of his work in order to determine the extent of reli-
ance to be placed on his work and to identify the areas of work
overlap.
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The auditor should determine ahead of his visit those aspects of
the work that may require the services of specialists. This may
be internal or external specialists as relates to stocks, specialist
valuation for insurance or computer applications.
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Based on the review of the system of internal control, the auditor
should be able to decide on the audit approach to adopt. This
will be based on the extent of reliance to be placed on the system
of internal control.
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A critical aspect of the audit is the timetable. The auditor should
establish plans to ensure that for each year, the audit is completed
within any stated deadline for submission of the report.
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The auditor should plan for adequate number of staff with the
required skill for the audit. The training of audit staff is a long
term process which will require that even from the initial
appointment of the auditor, he should take steps to train suitable
staff in sufficient number to handle the audit of the client.
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Based on plans already established in terms of time, staff and
materials, the auditor should plan for his fees to cover staff sala-
ries, overhead costs and leave a sufficient margin for the part-
ners’ share of profit and pension scheme. The planned fees must
be discussed with the client, if not already agreed.
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The extent of the knowledge gained of the client’s industry and business
organisation greatly facilitates the performance of the engagement staff.
It is essential therefore that all staff engaged in the audit are
encouraged to gain an understanding of the client’s business
operations. Such understanding, in addition to enhancing the overall
audit performance, also facilitates communication with client’s staff
and in assessing the reliability of representations from management
and making judgement regarding the appropriateness of the
accounting policies adopted and their disclosure.
The auditor may obtain knowledge of the client’s business by:
(a) Personal visits to the client’s premises and operating bases and
holding discussions with key officials of the company;
(b) Reading minutes of meetings and correspondence with the
client;
(c) Reading internal audit report;
(d) Reading previous year’s audit files and permanent audit files;
(e) Reading other materials from within the firm, e.g. management
consultancy reports and feasibility reports; and
(f) Reading relevant materials relating to the business e.g. trade
journals, investment analysis and stockbroker’s report.
Other significant factors which should be considered by the auditor to
determine the audit strategy are as follows:
(a) The auditor’s responsibilities in accordance with the terms of the
engagement;
(b) The nature of the client’s business;
(c) The nature and significance of items in the year’s accounts; and
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(d) The principal features of the client’s accounting system and the
extent and effectiveness of the related internal accounting
controls, which may be gained from a preliminary understanding
of the system.
Consideration of the above factors should enable the auditor determine
an appropriate audit strategy which should be set out in writing, in an
audit strategy memorandum, which should be approved by the audit
partner.
However, the auditor should recognise that this strategy may, if
necessary as a result of changing factors, be reviewed and revised as
the audit progresses. For existing clients, the auditor should have much
of the information he needs to determine his audit strategy in his audit
files.
Nevertheless, he should still discuss with the clients management
whether there have been any changes in the company’s circumstances
that might affect his audit approach.
The external auditor is appointed to carry out audit in accordance with
specific regulatory or statutory requirements, such as the Companies
and Allied Matters Act or in accordance with generally accepted auditing
standards within the country concerned. In these circumstances, the terms
and conditions will not call for any special consideration when
determining the audit strategy. The auditor should, however, consider
whether additional responsibilities arise from request by the client’s
management or because the client is required to conform to special
regulatory or other requirements.
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The auditor needs reasonable knowledge of both the business of the client and
the industry in which the client operates, how and in what places its activities
are carried on, in addition to the basic financial information which will be
obtained for the audit in order to understand and interpret the financial
statements on which he is reporting.
In order to familiarise himself with the business and organisation of a new
client, the auditor would normally:
(a) Examine publications emanating from:
(i) The client, such as annual reports or interim financial statements;
(ii) Others, regarding the client’s industry or business;
(b) Have meetings with the client’s management, in order to identify the
major types of transactions entered into by the client; and
(c) Examine the client’s important internal documents, such as:
(i) procedure manuals;
(ii) legal documents, i.e. memorandum and articles of association,
contracts; lease and loan agreements;
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(iii) minutes of meetings of the Board/AGM (and/or any important
Committees thereof);
(iv) policy statements; and
(v) internal management accounts.
The auditor should also tour the client’s principal places of business, such as
plants, factories, shops and offices.
The auditor of a manufacturing concern, for instance should undertake a tour
of the company’s factory in order to familiarise himself with the production
process, to see the types of scrap items and the manner of their disposal and
the form of the finished products. In all other concerns, the auditor should make
himself familiar with the market in which the business operates and with its
methods of marketing.
Having adequate knowledge and background of the business will make the
auditor to determine whether the system of accounting and internal control
disclosed by his detailed review is appropriate for the business and properly
records all its transactions. Such knowledge will also give the auditor an
awareness of the physical realities behind the accounting records and financial
statements which he examines and will enable him consider their significance
more intelligently.
The auditor’s task of familiarising himself with the client’s business and
organisation will often involve his spending additional time on the first audit
of a new client.
In contrast, the need for him to spend additional time for this purpose on the
audit for the second and subsequent years may be fairly limited, as he may
only need to have brief meetings with key members of the client’s staff to
consider any changes in the client’s circumstances and systems since the
previous year.
However, the importance to the auditor of updating his knowledge and
understanding of the client’s system in this way, before carrying out any audit
test, cannot be over-emphasised.
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Normally, the most important factor in the determination of the audit
strategy will be a review of recent accounts and other available
financial information in order to assess the relative significance of items
appearing in the balance sheet and the profit and loss account.
The auditor should obtain information on the nature and approximate
volume of transactions, which result in significant account balances.
The assessment will need to take into account any audit risks identified
when analysing the clients business. Those account balances, which
are considered to be insignificant, can be subjected thereafter to only
limited audit procedures.
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In order to evaluate the potential for reliance on internal control in respect
of all significant items in the financial statements, the auditor should
gain a preliminary understanding of the principal features of the client’s
accounting system giving rise to these items, together with the related
internal control procedures. This involves a consideration of the methods
of and control over, processing and the principal accounting records
maintained for each significant transaction type.
This preliminary understanding and evaluation of the potential for
reliance on internal control should be documented, normally by way of
overview flow charts. However, this preliminary evaluation, which is
made for the purpose of determining the audit strategy, should be
distinguished from the detailed evaluation using the internal control
questionnaire.
Nevertheless, apparent weakness in internal control, which comes to
the auditor’s attention in the course of the preliminary evaluation, should
be brought to the client’s attention.
The record of the accounting system prepared for the purpose of
determining the audit strategy may need to be supplemented by a more
detailed description of the accounting system if the auditor intends to
carry out a detailed evaluation of internal controls.
However, it should, generally, prove adequate for the purpose of planning
and performing substantive tests.
During the course of the auditor’s preliminary review of the accounting
system and controls, he should be able to identify those items in the
accounts which because of the limited volume of transactions or other
factors, can be audited more efficiently through the application of
substantive tests rather than reliance on internal controls. Examples of
such account balances are share capital, long term debts and related
interest expense, investments and related income (except when a large
portfolio of investments is held). In a similar vein, he may decide to
ignore internal controls entirely, either for reasons of efficiency or because
the controls are not operating properly, and carry out extended validation
for all balance sheet and profit and loss account items.
The auditor should identify any procedures the client applied to
significant items in preparing the financial statements because they
will influence the extent of the detailed evaluation of internal controls.
Examples of such procedures are the counting of stocks, the reconciliation
of bank balances and the establishment of provisions against doubtful
debts.
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It will normally be desirable to document the audit strategy in a
memorandum, which together with the necessary supporting
documentation, should be prepared in the first year of an engagement
and revised annually thereafter. The auditor can obtain information as
to changes that may be required as a result of the experience gained
from using the audit strategy adopted in the previous year.
The auditor may find it helpful to discuss the planned audit strategy
with the client, for example, to inform him of a proposed reduction in
the extent to which the audit will involve the evaluation of internal control
procedures. In some cases, the client may wish such an evaluation to
take place and the auditor will need to explain that, while he would be
glad to comply, it is likely to have the effect of increasing cost.
The matters set out below are those which will normally be relevant
and material in determining the audit approach and which should be
addressed by the audit strategy memorandum. Other matters will almost
certainly be relevant to particular audit clients and will need to be
incorporated in the memorandum:
(a) Whether the terms of the engagement vary from the requirements
of the Companies and Allied Matters Act and approved auditing
standards and guidelines;
(b) Whether the report and accounts will include any supplementary
information, and, if so, whether an audit opinion is to be given
on it;
(c) Particular risk factors or problem areas;
(d) The number of accounting locations and the audit approach in
respect of each, that is, whether to be covered by full audit or not
to be visited with reasons for the decision. Where there are a
number of accounting locations, certain elements of the strategy
may have to be determined and recorded for each location;
(e) Balance sheet amounts and those likely to be:
(i) Insignificant; and
(ii) Significant.
(f) Types and volume of transactions that contribute to material
balance sheet amounts;
(g) Assessment of the potential for reliance on the internal controls
over the transactions, in particular, whether the audit of
significant items in the balance sheet are to be based:
(i) Principally on reliance on internal controls with limited
substantive tests; or
(ii) Principally or entirely on substantive tests with reasons
for the decision.
(h) The control objectives to be evaluated (specifying whether a
computer or manual will be adopted);
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