Fira Firmanila & Lyanda Pasadhini

COMPREHENSIVE
EXAMINATION
AUDITING References: Rick Stephan Hayes , Mr. Sururi (GAAs
and ISAs)
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AUDITING
Definition
The financial statement audit is a systematic process of objectively obtaining and evaluating
evidence regarding assertions about economic actions and events to ascertain the degree
of correspondence between these assertions and established criteria and communicating
the results to interested users.

Systematic approach
The audit follows a structured, documented plan (audit plan). The audit must be planned and
structured in such a way that those carrying out the audit can fully examine and analyze all important
evidence.

Objectively
Auditors are fair and do not allow prejudice or bias to override their objectivity. They maintain an
impartial attitude.

Obtains and evaluates evidence

The auditor assesses the reliability and sufficiency of the information contained in the underlying
accounting records and other source data by:

- Studying and evaluating accounting systems and internal controls.

- Carrying out such other tests, inquiries and other verification procedures of accounting
transactions and account balances.
Ascertains the degree of correspondence
between assertions and established criteria. The audit program tests most assertions by examining
the physical evidence of documents, confirmation, inquiry, and observation.

Communicating the results to interested users

The audit is conducted with the aim of expressing an informed and credible opinion in
a written report.

The communication of the auditor’s opinion is called attestation, or the attest function.

Management assertions
Representations by management about classes of transactions (e.g. sales transactions) and related
accounts (e.g. revenue, accounts receivable) in the financial statements.

An example of a management assertion

 That “the company’s financial statements are prepared based on international accounting standards”.
This assertion is one of presentation and disclosure. The auditor must obtain sufficient evidence that
this assertion is materially true. He must gather evidence that accounts are classified correctly and
the proper disclosures have been made based on international standards.

Assertions about classes of transactions and events for the period under audit
 Occurrence
 Completeness
 Accuracy
 Cutoff
 Classification

Assertions about account balances at the period end

 Existence

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 Rights and obligations

 Completeness
 Valuation and allocation

Assertions about presentation and disclosure

 Occurrence and rights and obligations
 Completeness
 Classification and understandability
 Accuracy and valuation

Objectives of financial statement audit

To express opinion of whether the financial statement

1. Is presented fairly in all material respect and

2. Confirm with the framework of financial statement

Types of audit
Audit of financial statements
Examine financial statements, determine if they give a true and fair view or fairly present the financial
statements.

Operational Audit
A study of a specific unit of an organization for the purpose of measuring its performance.

Compliance Audit
A review of an organization’s procedures and financial records performed to determine whether the
organization is following specific procedures, rules, or regulations set out by some higher authority.

For example:
Audit by the tax authority, the government internal auditing arm, or audit of a bank by banking regulators.

Forensic Audit/ Audit with specific purpose

An audit that done by a request, as a result of finding done by the financial statement auditor.

Information system audit

An audit to review the IS/IT whether IT controls protect corporate assets, ensure data integrity and are
aligned with the business’ overall goals
Types of Auditor
Internal auditor
Employed by individual companies to investigate and appraise the effectiveness of company operations
for management.

External auditor
Typically certified either by a professional organization or government agency.

Auditing Standards (PCAOB) are as follows:

a. General standards, is standards about (1) the qualification requirements of auditor, (2) the
independency requirements of auditor, (3) and the requirements of implementation the due
professional care.
b. Field work standards, is standards about (1) the requirement of audit planning and the supervision
to junior auditors, (2) the requirement of understanding as well as testing the ICS (Internal Control
Systems), and (3) the requirement of obtaining the competence or the appropriateness of the audit
evidences through the implementation of standardized auditing procedures.
c. Reporting standards, is standards about the elements of audit report, such as (1) the statement
about the conformity of the report with the underlying accounting standards, (2) the statement about
the consistency of the implementation of accounting standards, (3) the statement about the
sufficiency of financial statement’s disclosures, if any, and lastly (4) the statement about the auditor
opinion to the financial statements as a whole.

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Audit Process Model

Phase I - Client Acceptance
Determine both acceptance of a client and acceptance by a client. Phase I, involves deciding whether to
accept a new client or continue with an existing one.

Procedures:
1. Evaluate the client's background and reasons for the audit.
New Client Investigation
Before accepting a new client, the auditor will review publicly available information, past company
financial statements, reports to stockholders, publicly available government financial reports (e.g., U.S.
10K report), tour the company premises, and have discussions with the previous auditor.
Continuing Clients
The continuance of the relationship would depend on:
a. if fees due from a client for professional services remain unpaid for an extended period of time.
b. If the auditor feels excessive risk is involved, e.g., regulatory conflict or the high risk industry.
c. If the client is involved in litigation with the auditor
For continuing engagements, the auditor would update and reevaluate information gathered previously,
including information in the prior years working papers.

2. Determine whether the auditor is able to meet the ethical requirements regarding the client.
3. Determine need for other professionals.
Situations where an auditor might use an expert are valuations of certain types of assets; actuarial
valuation; value of contracts in progress; and legal opinions.

4. Communicate with predecessor auditor;

a. IFAC Code of Ethics for Professional Accountants requires the new auditor to communicate directly
with the previous auditor.
b. When the previous accountant receives the communication of the newly proposed auditor, he should
reply, preferably in writing, advising of any reasons why the proposed accountant should not accept the
appointment.

5. Prepare client proposal.

a. nature of the audit services to be performed,
b. the timing of those services,
c. the expected fees,
d. audit team,
e. audit approach,
f. audit quality,
 g. use of client’s internal
h. auditors,
i. The transition needs.

6. Select staff to perform the audit, and

7. Obtain an engagement letter.
An engagement letter is an agreement between the accounting firm and the client for the conduct of the
audit and related services.

a. Scope
b. Responsibility
c. Limitation.

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Phase II – Planning
Determine the amount and type of evidence and review required to give the auditor assurance that there is no
material misstatement of the financial statements.

Procedures
1. Perform audit procedures to understand the entity and its environment, including the entity’s internal
control;
Information about the client company not already discovered in the Client Acceptance phase may be
obtained by reviewing minutes of meetings of stockholders, board of directors and important
committees; from internal financial management reports for current and previous periods; and from
previous year's audit working papers and other relevant files.

Methods for Obtaining Controls Audit Evidence:

a. Inquiries of management = discussions with the client’s management about its objectives and
expectations, and its plans for achieving these goals.
b. Analytical procedures = analysis of significant ratios and trends including the resulting
investigation of fluctuations and relationships that are inconsistent with other relevant information
or deviate from predictable amounts.
During the planning stage, analytical procedures are usually focused on account balances
aggregated at the financial statement level and relationships between account balances.
Objectives : to determine whether account balances or other data appear reasonable.
Types :
i. Trend Analysis ; analysis of changes in an account balance over time.
ii. Ratio Analysis : comparison of relationships between financial accounts, the comparation
of an account with finanacial data, or the comparation of relationships between firms in an
industry.
Example: relationship between sales and account receivables; liquidity, solvency,
profitability, activity ratio.
iii. Statisical and Data Mining Analysis : to examine large volumes of data with the objective of
indicating hidden or unexpected information or patterns.
iv. Reasonables Test : analysis of account balances or changes in account balances within an
accounting period in terms of their ‘reasonable’ in light of expected relationships between
account.
Gampangnya : apakah presented account balance make sanse or not.
Using the number of employees hired and terminated, the timing of pay changes, and the
effect of vacation and sick days, the model could predict the change in payroll expense
from the previous year to the current balance within a fairly narrow dollar range.
 c. Observation and inspections
i. Observation of entity core activities
ii. Reading of management reports/ICS manuals to the inspesction of documents.
iii. Viewing facilities to identify some internal controls safe guards
iv. Seeing production process to assess the inventory movement and the use of fixed asset.

Internal Control

Internal control is a “process.” Internal control is not one event or circumstance, but a series
of actions that permeate an entity’s activities.
Internal control is effected by people. A board of directors, management, and other personnel
in an entity effect internal control. The people of an organization accomplish it, by what they
do and say. People establish the entity’s objectives and put control mechanisms in place.
Internal control can be expected to provide only reasonable assurance, not absolute
assurance, to an entity’s management and board that the company’s objectives are achieved.
The likelihood of achievement is affected by limitations inherent in all internal control systems.
Internal control is geared to the achievement of objectives of:
1 Operation
2 Financial Reporting
3 Compliance
4 Safeguarding of assets.
Components of Internal Control

 the control environment;

 the entity’s risk assessment process;

 the information system and related business processes relevant to financial reporting and
communication;

 control procedures;

 monitoring of controls.

Why internal control matters to the auditor?

If the auditor is able to assess the quality of accounting and internal control systems and to verify
their proper operation throughout the year under audit, the auditor might be able to rely heavily
on these systems for sufficient audit evidence.

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2. Assess the risks of material misstatements of the financial statements.

Audit procedures to obtain and understanding because some of the result may be used by the
auditor as audit evidence to support the assessment of the risk of material misstatement of financial
statement.
Sources of audit evidence :
a. Transactions
b. Account balances
c. Disclosures
d. Operating effectiveness of controls

Audit Risk = IR x CR x DR

Audit risk is a risk by an auditor gives an inappropriate opinion when the financial statement are
materially misstated.

a. Inherent risk : susceptibility of an account balance or class of transactions to misstatement that

could be material, assuming that there were related internal controls.
1. At the Financial Statement Level:
- The integrity of management.
- Pressures on management to report certain financial results.
2. At the Account Balance and Class of Transaction Level:
- The complexity of the underlying transactions and other events which might require
using the work of an expert.
- The degree of judgment involved in determining account balances.
- Susceptibility of assets to loss or misappropriation, for example, assets which are highly
desirable and movable such as cash.
b. Control risk : a misstatement that could occur in an account balance or class of transactions
and that could be material, will be not be detected and corrected on a timely basis by accounting
and ICS. (resiko yang akan tetap muncul karena internal control punya limitation)
c. Detection Risk : a risk that an auditor’s substantive procedures will not detect a misstatement
that exist in an account balance or class of transaction that could be material.
For example, if the internal control structure is effective in preventing and/or detecting errors (i.e.
control risk is low), the auditor is able to perform less effective substantive tests (detection risk is
high). Alternatively, if the account balance is more susceptible to misstatement (inherent risk is
higher), the auditor must apply more effective substantive testing procedures (detection risk is
lower).
In short, the higher the assessment of inherent and control risk, the more audit evidence the auditor
should obtain from the performance of substantive procedures.
 3. Determine materiality
Information is material if its omission or misstatement could influence the economic decisions of users
taken on the basis of the financial statements.
Level of materiality:
 The lower the materiality, the more costly is the audit. (if any error of whatever small size needs
to be found in the audit, the auditor would spend significantly more time than when a certain
level of higher materiality level is considered acceptable).

Focus on substantive test

Jumlah bukti akan semakin banyak untuk akun yang material.

At the planning stage, the level of materiality is determined based on the prediction of potential error
and fraud as a result of the assessed level of inherent and control risks at the planning stage.

At the conclusion stage the level of materiality is determined based on the reality or the result of
audit process. Therefore the level of materiality at the planning stage and at at the conclusion stage
may different.

4. Prepare the planning memorandum and audit program, containing the auditor’s response to the
identified risks.
a. Planning memorandum
An audit planning memorandum is a memo detailing the planned audit approach and budget.
b. Audit plan
Includes the details of the nature, timing and extend of planned audit procedure for material
classes of transaction, account balance, disclosure, and performance of risk assessment
procedures.
How much evidence is required: The ‘demand’ for audit evidence can be derived from the
planning stage.
How much audit evidence is provided by a given procedure?
What should the timing of audit procedures be: In planning the timing of audit work, crucial
procedures should be performed first.

Audit procedure: procedure that will provide reasonable assurance to auditor that material error will
be detected and removed from the Financial Statements.

In general, audit procedures can be classified into procedures of:

a. Accepting the audit engagements
b. Preparing the audit engagement letter
c. Understanding the industry
d. Understanding the business

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e. Understanding the Internal Control Systems

f. Tests of control
g. Substantive tests, which can be further breakdowned into: (1) initial procedures, (2)
analytical procedures, (3) procedures tests detail of transactions, (4) procedures of tests
detail of account balances, (5) procedures of testing the accounting estimate, and (6)
procedures evaluation of the presentation and disclosures.
In detail, audit procedures can be further classified into the following procedures:
a. Analytical e. Observing i. Reperforming
b. Inspection f. Enquiring j. Counting
c. Vouching g. Confirming k. Computer assisted audit techniques (CAAT)
d. Tracing h. Matemathic
Phase III - Testing and Evidence
Test for evidence supporting internal controls and the fairness of the financial statements.

Procedures:
1. Tests of controls;
Is a audit procedur to test the effectiveness of control policies and procedure to support the reduced
control risk

Auditor must determine the nature, timing, and extend of procedur to test of control.

Types of test of controls:

a. Inquiry of client personnel (based on interviews concerning the effectiveness of controls)

1. Direct inquires: asking questions to the person who performed control procedures or
monitoring activities directly.
2. Indirect inquires: asking questions to person in knowing whether the IC perform operating
effectively but they don’t perform control procedures themselves.
b. Observations: looking at the procedures/process performed by others.
c. Inspections: examining records, documents, or tangible assets.
d. Re-performance: perform tasks done by an employee to verify the result of the transactions.
e. Confirmation: consists of the response to an inquiry of a third party to corroborate information
contained in the accounting records.
1. To confirm the existence of accounts receivable and accounts payable
2. To confirm existence, quantity and condition of inventory held by third parties (e.g. public
warehouse consignee) on behalf of the entity.
3. To verify bank balances with banks
4. Cash surrender value of life insurance or insurance coverage with insurers;
5. Notes payable with lenders or bondholders
6. Shares outstanding with stock transfer agents
7. Liabilities with creditors
8. Contracts terms with customers, suppliers, and creditors.

Cons:
costly, time-consuming, and an inconvenience to those asked to supply them

ISA 505 identifies two forms of confirmations: positive and negative confirmation.

1. Positive confirmation asks the recipient (debtor, creditor, or other third party) to confirm
agreement or by asking the respondent to fill in information.

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The positive form is preferred when inherent or control risk is assessed as high because
with the negative form no reply may be due to causes other than agreement with the
recorded balance.
2. Negative confirmation request asks the respondent to reply only in the event of
disagreement with the information provided in the request.

If the auditor does not accept the validity of management’s request and is prevented from
carrying out the confirmations, there has been a limitation on the scope of the auditor’s work and
he should consider the impact of this limitation on the auditor’s report.

2. Substantive tests of transactions;

Are tests performed to obtain audit evidence to detect material misstatements in Financial
Statements.
a. Test of details of transactions and balances
b. Analytical procedures

3. Analytical procedures:
In substantive testing, analytical procedures focus on underlying factors that affect those account
balances through the development of an expectation of how the recorded balance should look.
Pros and Cons:
 Indirect evidence based on relationships (less reliable then TOD. Cannot be performed alone
when risks are significant)
 Not time consuming (less effort involved, less costs due to less time)
 Identifies only general unusual fluctuations which would then require further investigation
Example:
Entity A has rent expense of 12,500 in its income statement. The auditor would select the first month
and agree this to the rent invoice or lease contract to agree that the monthly rent is say $1,000. Then
the auditor would predict that the rent for the full year should be 12,000 (1,000 x 12 months).
The actual balance would then be compared to the predicted amount which would indicate a
difference of $500. The auditor would then be required to investigate this variance of $500. If
management explains that it was for hiring out an extra room for a conference, the auditor would
need to inspect corroborating evidence to support this explanation. Once done, the rent amount has
been audited even though only one month was actually tested.

4. Tests of details of balances

Are substantive tests that provide either reasonable assurance of the validity of a general ledger
balance or identify a misstatement in the account. When testing balances the auditor is concerned
with overstatement or understatement of the line item in the financial statement.
Pros and Cons:
  Obtains direct evidence for a sample (thus more reliance placed on this. Required to be performed
when risks are assessed as significant)
 Time consuming (a lot of effort. Higher costs for the client)
 Identifies specific errors or misstatements
Example:

If accounts receivable total $1,500,000 at the end of the year, tests of details may be made of the
individual components of the total account. Assume that the accounts receivable control account
balance of $1,500,000 is the total of 300 individual customer accounts. As a test of balances, an
auditor might decide to confirm a sample of these 300 accounts. Based on an analysis of internal
controls, the auditor may decide that the proper sample size should be 100 accounts that should be
tested by confirmation.

5. Search for unrecorded liabilities.

To search for unrecorded liabilities, the auditor reviews disbursements made by the
client for a period after the balance sheet date.
Example:
Vouching a January electricity payment to an unaccounted December bill will indicate that the payment
relates to the period of December, prior to year-end. This would result in an unrecorded liability for
which the auditor may propose an adjusting entry, if it is material.

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Evidence

Evidence is anything that can make a person believe that a fact, proposition, or assertion is true or false.
The evidence-gathering procedures in order of cost from most costly to least costly are in general:
confirmation (most costly), inspection, recalculation, re-performance, observation, analytical procedures,
inquiry (least costly).

The auditor should conclude whether sufficient appropriate audit evidence has been obtained to reduce to an
acceptably low level the risk of material misstatement in the financial statements.

Criteria of audit evidence:

Relevance
Of evidence is the appropriateness (pertinence) of the evidence to the audit objective being tested.

Reliability
Is the quality of information when it is free from material error and bias and can be depended upon by users
to represent faithfully that which it either purports to represent or could reasonably be expected to
represent?

Sufficiency
Is the measure of the quantity (amount) of audit evidence?
 Appropriateness
Is the measure of the quality of audit evidence; that is, its relevance and its reliability in providing support for,
or detecting misstatements in, the classes of transactions, account balances, and disclosures and related
assertions.
Audit evidence provides reasonable assurance.

The two category of audit evidences:

a. Accounting records, includes:
1. Checks and records or electronic fund tansfers.
2. Invoices
3. Contracts
4. The subsidiary and general ledgers
5. Journal entries and other adjustments to the financial statement that are not reflected in
formal journal entries
6. Records such as worksheets and spreadsheets supporting cost allocations, computations,
and reconciliations
7. Disclosures
b. Other information (corroborating information), includes:
1. Minutes of meetings
2. Confirmation from third parties
3. Analysts’ reports
4. Comparable data about competitors (benchmarking)
5. Internal control manuals
6. Information obtained through audit procedures such as inquiry, observation, or inspection
of records or ducuments
7. Information developed by the auditor that permits the auditor to reach a conclusion
through valid logical reasoning
The audit evidences can be classified as follows:
a. Documentary evidence
b. Physical evidence
c. Analytical evidence
d. Mathematical evidence
e. Confirmation evidence
f. Written representation evidence
g. Electronic evidence
h. Observation evidence
i. Re-performing evidence

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The relationship between the control risk, materiality, detection risk, audit risk, and audit evidence.
The higher the control risk (the higher the potential misstatements), the lower the materiality, the lower the
detection risk, the lower the audit risk, and the larger the need of the audit evidences, and vice versa.
Phase IV - Evaluation and Reporting
Procedures:
1. Evaluate Governance Evidence
2. Perform procedures to identify subsequent events:
Subsequent events are transactions and other pertinent events that occurred after the balance sheet
date and which affect the fair presentation or disclosure of the statements being audited.

Types of subsequent events:

A. Types of Events After the Balance Sheet

1. Those that provide further evidence of conditions that existed at period end

requires adjustment to the financial statements.

Events relating to assets and liabilities conditions that existed at period end may require
adjustment of the financial statements.

- adjustments may be made for a loss on a trade receivable account that is

confirmed by the bankruptcy of a customer that occurs after the balance sheet
date.
- sale of investments at a price below recorded cost.
2. Those that are indicative of conditions that arose subsequent to period end.

If material, requires disclosure.

those that do not affect the condition of assets or liabilities at the balance sheet date, but
are of such importance that nondisclosure would affect the ability of the users of the
financial statements to make proper evaluations and decisions, should be disclosed.
- a decline in the market value of securities held for temporary investment or
resale;
- issuance of bonds or equity securities;

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B. Events Up to The Date of the Auditor's Report.

C. Events Between the Balance Sheet Date and The Issuance of the Statements.
D. Discovery of Facts After the Financial Statements Have Been Issued
3. Review Financial Statements and Other Report Material
4. Perform wrap-up procedures
Include: supervisory review, final analytical procedures, working paper review, evaluating audit
findings for material misstatements, client approval of adjusting entries, review of laws and
regulation, and evaluation of the company as a going concern.

5. Prepare Matters for Attention of Partners

Is a report by audit managers to the partner or director detailing the audit decisions reached and the
reasons for those decisions?

6. Reports to The Board of Directors

7. Prepare Audit Report
Types of Reports Expressing Audit Opinions
Unqualified Opinion
when the auditor concludes that the financial statements give a true and fair view (or present fairly, in all
material respects) in accordance with the identified financial reporting framework.

Criteria of fairly presentation:

a. The financial statements being presented objectively, conform with the underlying source documents
b. The financial statements conform with the objective facts
c. The financial statements being disclosed sufficiently.
d. The financial statements conform with the framework of financial statements, or conform with
accounting standards and other applicable regulation and law.
There are at least two circumstances where the auditor may not be able to express an unqualified
opinion:

1. a limitation in scope;
2. a disagreement with management regarding the acceptability of the accounting policies
selected, the method of their application or the adequacy of financial statement
disclosures.

Scope limitation:
The scope limitation is a situation when auditor unable to obtain the representative audit evidences
which are needed to test the management assertion. The scope limitation can occure due to the very
weak of Internal Control Systems or due the refusal of managament to provide the evidences to the
auditor.
Qualified Opinion
When the auditor concludes that an unqualified opinion cannot be expressed but that the effect of any
disagreement with management, or limitation in scope, is not so material as to require an adverse opinion or
a disclaimer of opinion.

Adverse Opinion
When the effect of a disagreement is so material and pervasive to the financial statements that the auditor
concludes that a qualification of his report is not adequate to disclose the misleading or incomplete nature of
the financial statements.

Disclaimer of Opinion
When the possible effect of a limitation on scope is so material and pervasive that the auditor has not been
able to obtain sufficient appropriate audit evidence and therefore is unable to express an opinion on the
financial statements.

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Working Paper
Audit working papers are documents which are obtained or developed by auditor during the audit process. What
are the functions of audit working papers.
The functions of audit working paper are as a means of:
a. Planning the audit
b. Coordinating the audit
c. Controling the audit process
d. Documenting the legal evidences of audit work
e. Documenting the supporting evidences of the audit conclusion