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AUDITING
External Audit Independent Statutory (Law fixes it)
Internal Audit Not so independent, an employee of the firm (Chapter 18) Compulsory for Berhad (PLC)
Opinion
True & Fair (T & F) If T & F means 95% confidence opinion is correct. But they could also mean there is a 5% chance the opinion is wrong.
Audit Report
Unmodified Report -Good News. -Unqualified. -Also means without reservations of any doubt. (Keraguan) ie. No need to say anything.
Main Product
Audit Report required by companies Act 2007. to form an opinion.
By Product (after finish audit) - Management letter / letter of weakness (these are weakness found in A/C System & solution). - Good or bad still give management letter.
Agency Theory
Principal (shareholders)
Auditor (another agent) These agent will be appointed by principal shareholder to check the other agent.
Agent (Directors) (these agent run the business for shareholders (principal)) These agent could run the business in a way that could maximise Agents (Directors) benefit or they could make mistakes. @ Principal (shareholder) would want someone to check.
Information Hypothesis
Audits gives assurance to third party on the validity of the financial statements prepared by directors. Third parties could refer to Banks, Government Bodies, Creditors etc.
Form of an Insurance
When Audits are done, Audit Report will be provided starting the True & Fair opinion of the auditors. Shareholder / potential shareholders who make investment decision can sue the auditor if their investment turn out to be a bad investment.
System
Jan 04 (Interim Audit)
Dec
Interim Audit
Basically looking at Income Statement (P/L) * B/S only audit / or being looked at the Eg. Sales / Purchases / Wages end of the year, 9 months will be tested therefore during Note : Asset / Liabilities will not be tested interim audit, the B/S at Interim. is not important.
Final
Its more on B/S Audit. Asset & Liabilities. P/L items will not be tested if during Interim these was tested and found to be satisfactory. However during final by testing Asset / Liabilities, P/L items are indirectly tested.
Chapter 2 Independence
Auditor lend credibility. Therefore to be credible auditor must act ethically (professionally). In order to be credible auditors must be:(i)
Confidentiality (ii) Objectivity (iii) Competence (iv) Professional Behaviour (v) Integrity (vi) Technical Standards
Confidentiality
Auditor must make sure of the 3 things: (i) Act for client only if client willing to disclose all information. (ii) Auditors must not use for personal benefit (client information). (iii) If want to disclose to third parties. Auditors must get consent.
Objectivity
Auditor must approach an audit objectively. Must be in a clear state of mind.. Must not have any conflict of interest, as having interest will not make the approach objective. Eg. Auditing your wifes company (in this case auditor cannot be objective).
Competence
Auditor must be able to handle any audit task. There should not be any doubts. Must make sure only accept audit appointment when capable of doing.
Professional Behaviour
Auditor must behave professionally with (i) Client Staff (ii) Former Auditor (OLD) (iii) Incoming Auditor (NEW)
Integrity
Auditor must always be honest.
Technical Standards
Auditors must always keep up to date (in Accounts & Audit Standards).
Independent
An audit gives credibility for the users who look at the financial statement. Auditors therefore must not be pressured (bullied) by anyone. They must be independent & seen to be independent.
Threats to Independence
Advocacy Familiarity Intimidation Self Review Self Interest
Advocacy Threat
Company Advocate Auditor X
X When you are auditor you cannot be representing as a lawyer for that firm. Choose other one whether become the lawyer or auditor. Cannot be lawyer & auditor at the same time.
Familiarity
When auditor becomes too familiar with the client, it could pose a threat. Eg. Friends / girl friend. Safeguard (leave the team) ask another partner to audit.
Intimidation
Client bullies or takes advantage of weak auditor (financially) (by telling will not reappoint them). Safeguard be rich & powerful auditor. be selective ie. Dont audit big companies.
Self Review
Doing other job eg. Accounts & then auditing the A/Cs done. It is like checking your own work. Safeguard 2 teams one person do A/C & the other audit.
Self Interest
Losing engagement Money Issue. Make sure not over due dependent on the client fee rule 10% & 15%. lose job.
Area of Risk
Loan Auditors are not suppose to give or take loan to / from client. Reason client might use this to put pressure on auditors. Overdue fees Once there is overdue fees & if it starts to accumulate, it may look like a loan. Here again client might use this to put pressure on auditors.
Situation
If fee approaches very near 15% or 10%. eg. 14.6% for private Ltd Company then auditors should apply safeguard.
Safeguard
Try to get more client. (ie. Increase client Base will make auditors not to rely on a single client). Get more seniors in the team. Independent partner review. Rotation of partner.
Hospitality
Criteria any large gift / hospitality dont accept.
Shares Inherited
Must be disposed at an earliest practicable date.
Operational Independent
Programming Independence Free to decide audit approach. Investigative Independence Free to collect what / how much audit evidence the auditor wants (because auditor must get sufficient appropriate audit evidence to form an opinion). Reporting Independence Auditor is free to give whatever opinion he wants based on his findings (investigations).
Other Recommendations
Audit Committee Consist of Non Executive directors Role - Selection of External Auditors. - Setting External Auditors remuneration. - Ensuring External Auditor not bullied by Board of Directors. - Ensuring fair reporting of financial statements.
Audit Court
Judgement of True & Fair given by court & not audit firm. Audit court made up of panel of judge. Judge are partners from a few audit firm (they are not the real judge you see in court). Audit firm will prepare the audit evidence based on its finding then it will pass to the Audit Court for them to make an opinion.
Restriction of Services
Dont off many services to clients. eg. Accountancy, Tax, Consultancy etc.
Peer Review
Another Audit firm review the Audit file.
Rotation - Voluntary
Eg. 2000 2004 E&Y 2005 2007 PWC 2008 2009 KPMG
Pepsi
Coke
(i) They must inform coke that pepsi is a client. (ii) Inform Pepsi that coke is going too be a client.
Fees / Remuneration
Fee Recurring
(ie. Every year have) Eg. Auditing, Accountancy % on sales / Profit (Contingency) Not allowed Must be based on work done
Non-Recurring
(One off) Eg. Consultancy Contingency basis allowed eg. loan paperwork done by auditor. They will change 1% on loan amount. Eg. Tax saved fee will be y% x Tax Saved
Client Screening
High risk client? Problematic? Can I serve him well? Profitable in long run? Will it end up damaging my reputation.
Desirable?
Look for
1. Reason for change. 2. Future Audit. 3. Audit fee. 4. Credit worth. 5. Management. 6. Engagement risk.
Ethical Clearance
Client N
Incoming Auditor
Q P
O R
Outgoing Auditor
1. Incoming Auditor gets permission from client to contact the outgoing Auditor. 2. Client gives permission. 3. Incoming contacts outgoing Auditor asking is there any professional reason why they should reject the appointment. 4. Outgoing auditors gets permission from client to contact incoming auditor. 5. Client gives permission. 6. Outgoing contacts incoming auditor.
Letter of Engagement
To Directors From External Auditor Contents Directors Responsibility External Auditors Responsibility Scope of Audit Fee calculation basis
2/4/04
Business incorporated
31/12/04
31/12/05
General Notes
Appointment on annual basis. But LOE no need to give every year.
Subsequent Auditors
Directors make recommendation but shareholders appoint. Need ordinary resolution . 50% votes in AGM.
1st Auditors
At Board Meeting.
Removal of Auditors
Reason
1. Group company wants it. 2. Expensive. 3. Incompetent. 4. Disagreement of Accounting Issue.
Stages
Board of Directors decide to Remove Auditors
Resignation
15/2 Auditors
To submit (written notice of Resignation to Board of Directors) Must deposit letter at Registered office
15/3 Directors
Shall then call for a General Meeting of company as soon as is practicable to appoint an auditor to replace
17/3 Resignation
Shall take place
Rights of Auditors
Rights During
Operational Rights (Right to work / carry out his duty of auditor) Operational Independence. (a) Programming Independence. (Right to do & how to do it) (b) Investigative Independence. (Right to ask & right to find out information) (c) Reporting Independence. (Right to make conclusion / report whatever he wants)
After Rights on Resignations Rights to receive written notice. Make written representation & request sent to every member. Right to receive a copy of resolution. After Right to attend the meeting.
Risk Based Audit Approach 1st External Auditor studies the risk in the client company. (ie. Finds out how risky they are) 2nd Then design a suitable audit approach. (How much work to do)
Audit Approach Nature Extent Timing Type of audit procedure planning How much audit evidence to collect When?
Inherent Risk
Risk that exist in the nature of business. Nothing can be done. Eg 1) Size of organisation - large - branches 2) Style of trading - Aggressive trading - Growing fast - Over trading (too much commitment) (tight cash flows) 3) Pressure by management - Tight datelines to finish the audit - Too little time given could result in not enough evidence collected & too short the post balance sheet period (IAS10)
4) Management experience & integrity - If last year A/C qualified (then this year must be careful) - Aggressive directors - Breaking law directors - Creative accountants 5) Regulations Many rules to follow (eg. certain business) 6) Account Balance Level Items eg. Stk / Cash easy for misappropriation 7) Degree of estimation - Subjective items eg. 1) Evaluation of Fixed Assets, Stocks, W.I.P 2) Tax estimation 3) Provision for bad debts / contingent losses
Control Risk
Risk that Internal Control System will not pick up errors in timely basis. Assessing Control Risk * Preliminary assessment of control risk. 4 steps: Ascertain (find out) Record Confirm Make preliminary assessment
Audit Risk =
IR x CR
x DR
More Audit Procedure Required to make Detection Risk low
IR x CR
Inherent Risk High High Low Low Control Risk High Low High Low Likelihood of Material Error High Medium Medium Low Detection Risk
Auditor must do a lot of things to bring DR low
Detection Risk
Auditors procedures will not pick up errors. If audit procedures heavy risk is low. Detection risk is due to sampling risk. Sampling risk The risk because you choose to sample (Is the difference in conclusion of sample results compared to the population results). How to eliminate sampling risk 100% audit (but going to be difficult & costly)
Low Risk
High Risk
Conclusion A 90%
Conclusion 90%
Both gives the same conclusion. But amount of work done more in the High Risk.
Audit Materiality
Material Amount Is any large & important items. Critical in the understanding of financial statement. eg. Material omission of information. Material misstatement of Information.
Material Level Cut of point or threshold level eg. Invoice amount 1) 2) 3) 4) 300 400 20 60 5) 6) 7) 8) 80 120 110 120 9) 100 10) 70 11) 12 12) 30 Material level 90 No of sample will be 6
Chapter 4 Question
Date line (year ended) : 31 May 2003 - When is the date line from year end. - It depends on the management of the company. Tight date line would make it more risky. Principal Activity Distribution of leather foods by nature it takes time to be out of date.
One supplier - All leather goods purchased for resale are imported. - Overseas supplier: There is currency risk because company pays in Euros dollar. They pay Euros dollar one month from purchased. Company would be afraid that the Euros dollar will become stronger. There is also a risk of translation. i.e recording todays Euros dollar into RM. We could use the wrong exchange rate for recording purposes.
Fall in gross profit margin resulted in turnover increase. Further increase in debtors period 38 days to 70 days resulted an increase sales. It is not that the company has experience high rapid growth. Because of debtor cash flow are thigh up. Company needs to funds the business and might manipulate results to obtain funds. Risk of bad debts. Debtors would be overstated. 31 July 2003 is the date line. Thigh date line is possible to make errors and have a short post balance sheet period. Negative cash flow. Urgent payments to pay. Risk of not having money. ie. Risk of bankruptcy. Bank loan repayment. Risk of shortage of cash.
During Planning
Auditor during Interim look at Internal environment + External Environment. Eg. Look at economic, political, merger, strikes, new regulations, growth rates, any change in directors, new connection. Why? to see client risky or not.
Eg. Gearing Ratio Going concern assessment. Overdraft limit high now. @ need new source of finance Bank will not increase overdraft limit as currently high gearing. Client may do off B/S financing. Eg. Finance lease dont record Note: To identify areas of potential Audit Risk Compare ratio in line with Industry & previous years / Trends.
Documentation
Introduction Auditor should document which are important in providing evidence to support the audit opinion & evidence that the audit was carried out in accordance with International Standards on Auditing. Documentation (working papers) can be in paper, film or electronic media. Working paper:a) Assist in the planning & performance of the audit. b) Assist in the supervision & review of the audit work & c) Record the audit evidence resulting from Audit work performed to support the auditors opinion.
The form and content of working papers are affected by matters such as the . Nature of the engagement. Form of the Auditors report. Nature & complexity of business. Nature & condition of business Accounting & Internal Control System. Needs in particular circumstances for direction, supervision & review of work performed by assistants.
Working papers are designed & organised to meet the circumstance and the auditors needs for each audit. Auditors should would include the current & permanent audit files. Auditors should adopt appropriate procedures for maintaining the confidentially & safe custody of working papers and for retaining them for a period sufficient to meet the needs of the practice & in accordance with legal & professional requirement.
Generally a) Auditors should maintain the confidentiality & safe custody of working papers. b) Working papers should be retained for a period sufficient to meet the needs of the audit practice & in accordance with legal & professional requirement. c) Working papers are property of auditors and clients have no rights to demand access. d) In Malaysia, working papers must be retained for 7 years. e) Security of working papers locked fire proof cabinets or rooms & use keys & logical passwords. f) Electronic documentation should be backed up.
Files
Administration Files (i) Correspondence File One file to last for the whole duration the client is with the audit firm. (ii) Billing File One file to last for the whole duration the client is with the audit firm.
Working Papers
Permanent File One file to last for the whole duration the client is with the audit firm & its updated annually. Extracts of copies of company document that are of continuing importance. Eg. Rental agreement, M & A Board minutes. Analyses from previous years accounts that have continuing importance to the auditor. Eg. Debtors Address, Accounting Policies, bank A/C. Information relating to the understanding of Internal Control & assessment of control risk. - Organisation chart - Flow charts - Questionaires
Staff scheduling Audit Timetables Audit Planning Memorandum Knowledge of client business Audit Programme Permanent file update Sales - test of control - Account Receivable (debtor) Production - test of control - Inventories - Fixed Assets - Account payable (creditor) Finance - test of control - cash & bank
Accounting System
- Means records. - Enables auditors to identify, analyze, calculate, classify, record, summarize etc.
Control environment
- Overall attitude, awareness & actions of directors & Management regarding Internal Control System. eg. Tight budgeting control, effective internal audit function.
Control procedures
- Policies & procedures in addition to the control environment which management has established to achieve the entitys specific objectives.
Recording the Accounting Systems & Internal Control Methods of recording a) Internal Control Questionnaire (ICQ) A Yes means Good A No means possible weakness) - If strengths identified auditor perform in relevant areas. - If weakness identified he will ask. 1) Are there counter controls? 2) If there are no counter controls, what errors / irregularities could happen. 3) Could such errors / irregularities material & accounts. 4) What substantive procedure will enable such errors or irregularities to be discovered & quantified.
Flow Charts
- A diagram using standardised symbols, inter connecting flow lines. - Advantages * Enable system recorded in such a way that could be understood by new staff coming to the audit, team leaders, managers & partners the same. * Can see the whole picture of system. * Is a consistent system of recording in that symbols are fixed. * Disiplined method of recording. * Weakness are easier to spot.
Narrative Notes
- Written comments that reflect the auditors consideration of accounting system. - May be used to supplement other forms of documentation by summarising the auditors overall understanding of the accounting system or specific control policies or procedures. - Advantages * Narrative notes useful when describing a procedure that does not involve flow of documents.
It indicates that the It indicates that there system has not been have been changes to recorded correctly & the system since the last audit this must be put right before any audit
Making The Preliminary Assessment of Control Risk Method of making Preliminary Assessment
- Process of evaluating the effectiveness of an entitys accounting & internal control systems in preventing or detecting & correcting material misstatements. - Stages 1) Identify & evaluate weakness (using ICER). 2) Identify existing controls. 3) Determine which are absent & whether counter control exist. 4) Consider points made in last year management letter & whether client has acted on them. 5) Determine potential material misstatement that could result.
Designing the audit Programme for the Interim & Final Visit
Interim Preliminary Assessment of CR is low Test of Control Final Minima substantive Procedure of transaction and balance Preliminary assessment of CR is high Detailed substantive procedures of test only Detailed substantive procedure on Transaction & Balance
Test of Control
Examination of evidence of management review Inspection of a document Observation of Internal control functions Corroborative inquiries - check authorisiation - review, initial - checking if documents prenumbered - stock take - mail opening - wages payout - Inquiries to confirm certain procedures especially those that leave no audit trail - Reconciliation of Bank A/C done again - Checking calculation - Checking posting
Types of Circularisation
Positive Circularisation Debtor must reply Agree / not agree Negative Circularisation Reply only if you dont agree. Negative can only use if a) Debtor will actually receive the letter. b) If debtor not yet receive the letter. c) If debtor will give serious attention to the letter. d) he will reply if he disagrees.
@ Sampling allowed Sampling Risk possible that conclusion would be different if auditor looks at whole population.
sample 100%
Sampling risk = 0
Sampling Steps
1) Sample size 2) Need a confidence level (ie Assurance required)
Test of Control
Result a error < Tolerable error Accepts (means sample representative of population) Reject
Risk that the auditors will conclude that ::Error Reject Accept
Test of control - Control risk is higher than it is actually - It will lead to additional work - It affects audit efficiency
Substantive Procedure
- Material error exist - Control risk is - Material error does when in fact it doesnt lower than it is not exist when in fact actually it does Internal control low, substantive must be high It will lead to in appropriate opinion of population
Attribute Sampling
Test of control see whether controls are working properly. not checking monetary value. ie. values are irrelevant
Steps: 1) Find the random number let say 2 2) Calculate the sampling interval let say 3
1 11 1 1 1 1 1