Special Audit Techniques. CA Final Paper 3: Advanced Auditing & Professional Ethics Chapter 5 CA Arijit Chakraborty

Transcription

1 Special Audit Techniques CA Final Paper 3: Advanced Auditing & Professional Ethics Chapter 5 CA Arijit Chakraborty

2 2 Agenda for discussion - Special Audit Techniques Audit evidence -Confirmation, inquiry, observation, Analytical review Statistical Sampling- concept, types, technique, sampling risk, audit planning Risk Based audit

3 3 Special Audit Techniques Inquiry Observation Confirmation Analytical review Statistical sampling, risk, error Risk based audit

4 4 Learning Objectives 1. Understand the concept and purpose of special audit techniques (SAT) 2. Learn the linkage of SAT with Audit Standards

5 Auditor workflow-1 auditor accumulates and evaluates to determine correspondence between evidence management assertions established criteria

6 Auditor workflow- 2 auditor accumulates and evaluates evidence to determine correspondence between management assertions established criteria then communicates results to Users

7 Sufficient Appropriate Audit Evidence ( SAAE) SA 500 (Revised) SA 501 (Revised) SA 505 (Revised), SA 510 (Revised) SA 520 (Revised) Audit Evidence, Audit Evidence Specific Considerations for Selected Items External Confirmations Initial Audit Engagements Opening Balances Analytical Procedures

8 Sufficient Appropriate Audit Evidence ( SAAE) SA 530 (Revised) Audit Sampling SA 540 (Revised) Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures SA 550 Related Parties SA 560 (Revised) Subsequent Events SA 570 (Revised) Going Concern SA 580 (Revised) Written Representations

9 Obtaining Audit Evidence - I Inspection Inquiry Observation Analytical Procedures Confirmation Recalculation Reperformance Inquiry alone, ordinarily, does not provide SAAE

10 SA 500 : Audit Evidence Evidential matter: Any information that corroborates or refutes an assertion

11 Audit Evidence Some Relevant Terms used in SA 500: Accounting Records Appropriateness(of audit evidence) Audit Evidence Management s Expert Sufficiency(of audit evidence)

12 Types of Evidence Physical evidence Third-party representations Documentary evidence Computations Data Interrelationships Client representations Accounting records

13 Types of Evidence Physical Evidence Evidence that can actually be seen by auditors. This type of evidence is generally effective for supporting the existence assertion.

14 Types of Evidence Third Party Representations Confirmations Lawyers Letters Reports of Specialists

15 Types of Evidence Documentary Evidence Created by outside parties and transmitted directly to auditor Created by outside parties and held by client Created and held by client Electronic documents

16 Types of Evidence Computations Computations are: performed independently by auditor

17 Types of Evidence Data Interrelationships Data interrelationships (i.e., analytical procedures) rely on relationships among financial and non-financial data. Effective for testing reasonableness of certain account balances

18 Types of Evidence Oral and Written Client Representations Responses to questions and inquiries toclients during an audit constitute auditevidence.

19 Types of Evidence Accounting Records Clients accounting records (e.g. ledgers and journals) may provide worthwhile evidence in themselves. Depends on the effectiveness of internal controls

20 Audit Procedures Physical examination Observation Confirmation Tracing Vouching Inspection Reconciliation Re-performance Analytical procedures Inquiry Comparison Physical Evidence Third-Party Representations Documentary Evidence Computations Client Representations Accounting Records Data Interrelationships

21 Reliability of Certain Types of Audit Evidence RELIABILITY TYPE EXAMPLE High Physical Inventory Observation Documentary External External/Internal Internal Cutoff Bank Statement Purchase Invoice Sales Invoice Low Client Representations Management representation Letter

22 22 Statistical Sampling Special audit techniques

23 23 Statistical Sampling Provide guidance regarding the design and selection of an audit sample Guide on the use of audit sampling in the audit engagement Guidance on use of sample in risk assessment procedures and tests of controls performed by auditor

24 Scope Applies when auditor decides to use audit sampling in performing audit procedures Deals with auditor s use of statistical and non-statistical sampling when- Designing and selecting audit sample Performing tests of controls and tests of details Evaluating results from sample Complements SA 500

25 Objective Objective of Auditor when using Audit Sampling are To provide a reasonable basis To draw conclusions About population from which sample is selected

26 26 Sampling design & selection Design of Sample The auditor should consider: Specific audit objectives Population Sample size Selection of Sample Commonly used methods: Random selection and Use of CAATs Systematic selection Haphazard selection

27 Sample Design, Size and Selection of Item (A) Sample Design Purpose of audit procedure Characteristics of population To design audit sample & determine sample size Tests of controls Assessment of expected rate of deviation Tests of details Assessment of expected misstatement Decision to use statistical or non-statistical is a matter for auditor s judgment sample size is not a valid criterion

28 (B) Sample Size Auditor to determine sample size sufficient to reduce sampling risk to an acceptably low level Lower the risk auditor willing to accept, greater the sample size Sample size determined by application of Statistically based formula, or Exercise of professional judgment

29 (C) Selection of Items for Testing Auditor to select representative sample Each sampling unit in the population has a chance of selection Statistical Sampling each unit has known probability of being selected Non-statistical Sampling judgment is used to select items

30 Methods of selecting sample Random selection Systematic selection Monetary unit sampling Haphazard selection Block selection Applied through random generators, e.g., random number tables Number of sampling units/sample size = sampling interval Type of value weighted selection sample size, evaluation results in monetary amounts Selection without following structured technique Selection of blocks of contiguous items from within the population

31 Nature & Cause of Deviations and Misstatements Investigate nature & cause of any deviations/ misstatements Evaluate their possible effect on -Purpose of audit procedure -Other areas of audit If common feature then identify all such items in a population & extend audit procedures to those items

32 Projecting Misstatements Tests of details project misstatements to population Gives broad view of scale of misstatement but insufficient to determine amount to be recorded Consider effect of uncorrected misstatement Tests of controls - no explicit projection necessary Sample deviation rate is also projected deviation rate

33 Evaluating Results of Audit Sampling Tests of controls unexpectedly high sample deviation Tests of details unexpectedly high sample misstatement May lead to an increase in assessed risk of material misstatement May cause to believe that class of transactions/ account balance is misstated Unless further evidence substantiating initial assessment Is obtained Unless there is absence of further evidence that there is no misstatement

34 Evaluation of Sample Results Analyse the nature and cause of any errors detected in the sample; Project the errors found in the sample to the population; Reassess the sampling risk; and Consider their possible effect on the particular audit objective and on other areas of the audit engagement. Risk may be reduced if additional audit evidence is obtained

35 35 Analytical Review Procedures Special audit techniques

36 Analytical Procedures, SA 520 Applied At planning stage to understand business and identify potential risks Near end of audit to conclude whether FSs correspond to knowledge of business When analytical procedures identify significant variances or inconsistent relationships further investigation / explanations / corroborative evidence needed

37 Analytical Procedures: Overview Provide guidance regarding the application of analytical procedures during audit Deals with the aspects such as: the nature and purpose of analytical procedures, analytical procedures as risk assessment procedures and planning the audit Analytical procedures as substantive procedures Analytical procedures in the overall review at the end of audit Extent of reliance on analytical procedures

38 Extent of Usage of the Analytical Procedures The significance of the area being examined. The adequacy of the system of internal control. The availability and reliability of financial information. The precision with which the results of analytical procedures can be predicted. The availability and comparability of information regarding the industry in which the organization operates. The extent to which other auditing procedures provide support for audit results.

39 39 Analytical Review - stages Analytical Procedures as Risk Assessment Procedures and in Planning the Audit to obtain an understanding of the business, the entity and its environment and in identifying areas of potential risk. Analytical Procedures as Substantive Procedures procedures to reduce detection risk relating to specific financial statement assertions Analytical Procedures in the Overall Review at the End of the Audit forming an overall conclusion as to whether the systems, processes and controls as a whole are robust, operating effectively and are consistent with the auditor's knowledge of the business.

40 40 Risk Based Audit Special audit techniques

41 41 Risk Based Audit Learning objective Applying risk based framework to audit, understanding audit risk Prioritizing high risk areas in the audit plan

42 Audit Risk Audit accepts the risk that the audit conclusion may be wrong and that Audit may have allowed material error to remain undetected in the account. Only a very small degree of audit risk would be acceptable as otherwise the audit process may lose its purpose. A very high level of assurance (or confidence) is required when expressing the audit opinion.

43 Relationship between materiality and audit risk To calculate the level of assurance (or confidence) required from substantive audit tests, risk model is employed.

44 Risk Model Analytical tool for planning and execution. Detects high-risk areas for concentrated audit efforts. Audit can thus focus on areas which are likely to generate better assurance instead of sampling and testing of larger but low risk areas. Structures the audit procedures and reorganizes the audit work in terms of risk perception

45 Audit Risk Risk of Material Risk that the Auditors Audit Risk = Misstatement * Fail to Detect the Misstatement = Inherent Control Detection Risk * Risk * Risk

46 Inherent Risk The risk of a material misstatement occurring in an assertion assuming no related internal controls.

47 Control Risk Risk that a material misstatement in an assertion will not be prevented or detected on a timely basis by the company s internal control.

48 Detection Risk Risk that the auditors procedures will lead them to conclude that a material misstatement does not exist in an assertion when in fact such misstatement does exist. Detection risk restricted by performing substantive tests

49 Audit Risk Formula AR = IR x CR x DR AR = Audit risk IR = Inherent risk CR = Control risk DR = Detection risk

50 Illustration of Audit Risk

51 Audit Risk Formula Solving for Detection Risk DR = AR IR CR Implications Assuming constant, sufficiently low AR, detection risk is inversely related to IR and CR combined IR and CR allowed DR substantive evidence

52 Risk exposure Risk exposure (likelihood of occurrence) to be assessed on a scale of 1-10 (10 being most likely). Risk based Audit Understand client s business, operations, industry, legal regulations Document possible risks which can impact account balance, class of transaction and Financial Statements Prioritize risk exposure High, Medium, Low Conduct audit as per risk priority Risk exposure is product of probability of occurrence and financial impact

53 RISK STATEMENTS Risk prioritization examples S. N o Risk statement Seve rity Risk Detectab Ility Imp act Risk expo sure Heat zone 1 Invoice may be raised without effecting physical delivery of the goods from depot/ plant 2 Sales order may not be executed in time and in full 3 Debit / credit notes sent to customers may not contain adequate details R Y G2

54 RISK STATEMENTS Examples S. N o Risk statement Seve rity Risk DetectabI lity Imp act Risk Risk expos ure Heat zone 1 Depreciation rates may have been incorrectly set up 2 Vendors account may not have been reconciled/ confirmed as per laid down frequency 3 Line items (individual entries) clearing may not have been carried out in vendor accounts R Y G2

55 55 Lesson Summary 1. We have learnt the meaning and purpose of special audit techniques 2. We had also seen the classification of special audit techniques and discussed the techniques 3. We had discussed the concept and usage of Risk based audit

56 56 Testing time Special audit techniques- Multiple Choice Questions

57 Multiple Choice Questions 57

58 58 Question 1 Which of the following analytical procedures is most applicable to inventory? a. Comparison of sales of current and prior years. b. Comparison of gross profit ratios of current and prior years. c. Comparison of marketing expense with budget. d. Comparison of ratios of sales to accounts receivable of current and prior years. Solution b Reason Because the amount shown for inventory affects cost of sale and the gross profit ratio, fluctuations in this ratio are investigated in connection with the audit inventory.

59 59 Question 2 The inventory observation provides least evidence of a. Presentation c. Valuation b. Existence d. Rights Solution A Reason Observation of inventory on hand provides little evidence about the classification of inventory.

60 60 Question 3 The observation of inventories is a(n) a. Generally accepted auditing standard. b. Generally accepted auditing procedure c. Alternative auditing procedure. d. Optional auditing procedure. Solution b Reason Observation of inventories is a procedure, i.e., an act to be performed.

61 61 Question.4 During an inventory observation auditors normally record certainty of their test counts to a. Be used in compiling the client s inventory. b. Check the accuracy of the client s account. c. Compare with the final inventory listing. d. Test the client s counting procedure. Solution c Reason Recorded test counts are compared with the client s final inventory listing to provide assurance that the client s counts were not changed between the time they were made and the time the final inventory listing was prepared.

62 62 Question.5 During an inventory observation an auditor may detect obsolete items by all of following except a. Observing unusual amounts of rust or dust. b. Observing items with prior year inventory tags. c. Computing gross profit ratios. d. Inquiry of plants personnel. Solution C Reason The gross profit ratio will not detect obsolete goods in inventory although other ratios such as inventory turnover will.

63 63 Question.6 To test the receiving cut off auditors record the last several numbers of documents used prior to the taking of the inventory. These documents are a. Vendor invoices. b. Purchase orders. c. Receiving reports. d. Purchase requisition Solution c Reason Receiving reports are used to test the receiving cut off.

64 64 Question.8 In which of the following types of inventories would an auditor be least likely to need the assistance of a specialist to determine existence? a. Baked goods b. Coal Pile c. Precious gems d. Art work Solution a Reason The auditor could evaluate baked goods, but would need a surveyor for the coal pile and appraisers for the gems and art work.

65 65 Question.9 The most important objective in the audit of current liabilities is a. Existence b. Completeness c. Valuation d. Presentation and disclosure. Solution c Reason Unrecorded items constitute the auditor s main risk when auditing current liabilities.

66 66 Question.10 In determining which accounts payable to select for confirmation, an auditor is most likely to pick a. Accounts with the largest balances to obtain dollar coverage. b. Major vendors and suppliers regardless of the amount of the balances. c. Accounts with debit balances. d. Any account with zero balance. Solution b Reason Because the auditor is primarily concerned with the completeness assertion, he or she sends confirmations to vendors that should have large balances (the major vendors).

67 True and False 67

68 68 True and False.1 The taking of an accurate physical inventory is a generally accepted auditing procedure. F The observation of the physical inventory is a generally accepted auditing procedure.

69 69 True and False.2 Before the start of the inventory, the auditor should review the client s inventory instructions. T

70 70 True and False.3 The test of inventory pricing in a job-order cost system usually involves a review of the flow and accumulation of costs by cost centre for the major products. F

71 71 True and False.4 The objective of a receiving cut off test is to determine whether items that are received near the end of the year and included in inventory also are recorded as purchases and accounts payable. T

72 72 True and False.5 The auditor tests a client s inventory cut off to determine that physical items and their related costs are treated in a consistent manner. T

73 73 CA Final question ( May 2009) What are the considerations to be kept in mind while performing analytical procedures on date prepared by the client? Solution outline Refer SA 520 Analytical Procedures Factors 1. accuracy with which expected results of substantive analytical procedures can be predicted. 2. degree to which information can be segregated 3. availability of financial and non-financial information

74 Thank You 74