OXFORD UNIVERSITY PRESS SOUTHERN AFRICA

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1 AUDITING FUNDAMENTALS IN A SOUTH AFRICAN CONTEXT Editors: Pieter von Wielligh Frans Prinsloo Gerrit Penning Rika Butler Dana Nathan (Josset) Rolien Kunz Vincent Motholo Graeme O'Reilly Riaan Rudman Henriette Scholtz OXFORD UNIVERSITY PRESS SOUTHERN AFRICA

2 CONTENTS CONTENTS IN BRIEF i" ACKNOWLEDGEMENTS PREFACE LIST OF AUTHORS ABOUT THE BOOK NTSIMBI PIPING COMPANY PROFILE xiii xiv xvi xviii xix PART A: THE CONTEXT WITHIN WHICH THE EXTERNA! AUDITOR OPERATES 1 CHAPTER 1 Introduction 5 Learning outcomes 5 Reference list Background What is the purpose of and need for accounting records? Purpose of accounting records Examples of accounting records What is the objective of and need for flnancial statements? The objective of flnancial statements Responsibility for accounting records and flnancial statements The assertions made by the (flnancial Statement) preparers Companies Act requirements for accounting records and flnancial statements Why are externa! auditors needed and what is the purpose of an external audit? The need for external auditors Thehistoryofauditing The history of the external auditing profession in South Africa The purpose of an external (flnancial Statement) audit Providing assurance The definition of an external audit Auditing postulates Types of auditors What are examples of major corporate accounting scandals in recent years? International corporate accounting scandals South African corporate accounting Standards What are the structures of the accounting and auditing professions? Professional bodies International accounting bodies Structure of the accounting and auditing professions in South Africa 30 Assessment questions 32 CHAPTER 2 Ethics 34 Learning outcomes 34 Reference list What is the nature of ethics? Why do professions have codes of ethics? Background to codes of ethics of professions Rules-based versus principles-based codes of ethics Examples of ethical misconduct by auditors What are the ethical codes and rules applicable to external auditors In South Africa? What constitutes prohibited actions for the external auditor? IRBA Rules Regarding Improper Conduct 39

3 CONTENTS SAICA's punishable offences How do the SAICA and IRBA disciplinary processes work? SAICA disciplinary process IRBA disciplinary process Examples of SAICA and IRBA disciplinary processes What is the content of the SAICA and IRBA Codes of Professional Conduct? Background to the SAICA and IRBA Codes of Professional Conduct Difference between SAICA and IRBA Codes of Professional Conduct The SAICA Code of Professional Conduct How do ethics fit into the audit process? 74 Assessment questions 75 CHARTER 3 Legal responsibilities of the auditor 77 Learning outcomes 78 Reference list Introduction Legislation and regulations governing the audit function Legislation and regulations with which the auditor has to be familiar What are the statutory and regulatory requirements for an audit? Companies that have to be audited What if a Company does not have to be audited? How does the statutory appointment, removal and rotation of the auditor work and what are his or her rights? Requirements to be met by the auditor in order to be appointed First appointment of the auditor Resignation of the auditor Dismissal of the auditor Appointment of a replacement auditor Rotation of auditors Statutory rights and functions of the auditor What are the statutory requirements to practise as an auditor? The requirements to become a 'Registered Auditor' Firms as Registered Auditors Limitations to what an auditor may do Statutory duties of auditors Inspections of auditors Liability of auditors for losses suffered by the dient and/or third parties What does the auditor s statutory responsibility to identify and respond to Reportable Irregularities entail? Definition of a Reportable Irregularity The auditor's reporting duties with regard to Reportable Irregularities The implications of a Reportable Irregularity for the auditee How is auditing in the public sector different from auditlng in the private sector? Background to auditing in the public sector Who performs public sector audits? To what Standards are these public sector audits conducted? What other legislation and regulations may impact on the scope of the audit function? The Johannesburg Stock Exchange (JSE) Listings Requirements What special qualifications are required to audit an Company listed on the JSE? What are the specific responsibilities of auditing firms and individual authors conducting audits of companies listed on the JSE? The Sarbanes-Oxley Act of What role can the auditor play to aid good corporate governance? The combined assurance model The concept of 'combined assurance' The role of the audit committee with regards to the audit function 103 Assessment questions 104

4 vi AUDITING FUNDAMENTALS PART B: THE AUDITEE'S RESP0NS1BIL1TY FOR FINANCIAL INFORMATION 107 CHAPTER 4 Basic concepts of governance and internal control 110 Learning outcomes HO Reference list HO 4.1 What is 'governance'? What is the relationship between governance and internal control? Risks within a business III Risk management III 4.3 What is 'internal control'? A system of internal control Components of a system of internal control Inherent limitations of a system of internal control Impact when the system of internal control does not operate as intended How does one design a system of internal control? Step 1: Identify the risks Step 2: Formulate control objectives Step 3: Design a system of appropriate internal controls 128 Assessment questions 13 CHAPTER 5 Introduction to risks and internal controls in a computerised environment 133 Learning outcomes Introduction How has Information Technology evolved? How and why do companies have to govern their Computer Information systems? What is the impact of upgrading a manual accounting system to an electronic accounting system? What are the key components of a Computer Information system? How does a computerised accounting system operate? How are Computer controls classified? How are general controls classified? Organisational controls and personnel practices System development and change controls Access controls Business continuity controls Operating controls and system maintenance controls Which controls relate to the computerised processing of business transactions? Background Manual versus Computer controls Overview of application controls How are controls identifled in advanced technologies? Electronic commerce, electronic funds transfers and other data communication Service organisations, outsourcing and data warehousing 177 Assessment questions 178 Appendix: Electronic fund transfer controls 180 CHAPTER 6 Revenue and receipts cycle 183 Learning outcomes 184 Reference list What are the nature, purpose and accounting implications of the cycle? Nature and purpose Forms of revenue from sale of goods and rendering of services The varied nature of the cycle How transactions in the cycle are triggered (initiated) Major accounts affected by the cycle 188

5 CONTENTS vii IAS 18 and the treatment of revenue for financial reporting purposes What functional areas exist in the cycle? Description of the functional areas Summary of functional areas by department What Information system is used in the cycle? Accounting for revenue and receipt transactions Supporting documents, Journals and ledgers Databases and masterfiles (computerised systems only) Reports Reconciliations Illustration: Transaction flow in the revenue and receipts cycle What could go wrong (risks) in the cycle? Financial reporting risks Misappropriation risks What Computer technologies are used in the cycle? Point-of-sale systems and barcode scanning Electronic funds transfer Internet-based (web) sales What are the control objectives in the cycle? Control objectives in the cycle Achievement of the control objectives in the cycle Link between the control objectives in the cycle and management's assertions What are the controls in the cycle (manual and computerised)? Internal control activities in the cycle Internal control tables Cycle Illustration: The revenue and receipts cycle at Ntsimbi Piping Credit management Receiving Orders from customers Authorisation of sales orders Picking of goods from warehouse Despatch and delivery of goods to customers Invoicing Recording of sales in the accounting records Receipt of cash from customers Recording of receipts in the accounting records Processing and recording of returns and other sales adjustments 249 Assessment questions 250 CHARTER 7 Rurchases and payments cycle 254 Learning outcomes What are the nature, purpose and accounting implications of the cycle? Nature and purpose Forms of purchases The varied nature of the cycle How transactions in the cycle are triggered (initiated) Example of a typical transaction in the purchases and payments cycle Major accounts affected by the cycle Accounting treatment of certain specific transactions in the cycle What functional areas exist in the cycle? Description of functional areas Summary of functional areas by department What Information system is used in the cycle? Accounting for purchases and payments transactions Supporting documents, journals and ledgers Databases and masterfiles (computerised systems only) Reports Reconciliations 268

6 viii AUDITING FUNDAMENTALS Illustration: Transactiori flow in the purchases and payments cycle What could go wrong (risks) in the cycle? Financial reporting risks Misappropriation risks What Computer technoiogies are used in the cycle? Electronic funds transfer (EFT) Electronic data interchange (EDI) What are the control objectives in the cycle? Control objectives in the cycle Achievement of the control objectives in the cycle Link between the control objectives in the cycle link and the management's assertions What are the controls in the cycle (manual and computerised)? Internal control activities in the cycle Internal control tables Cycle Illustration: The purchase and payments cycle at Ntsimbi Piping Purchase requisition Ordering goods from suppliers Receiving goods from suppliers Recording of purchases Payment preparation Paying the supplier Recording of payment Returning goods and recording a purchase return 311 Assessment questions 313 CHAPTER 8 Inventory and productlon cycle 316 Learning outcomes 317 Reference list What are the nature, purpose and accounting implications of the cycle? Nature and purpose Types of inventory and production The varied nature of the cycle The link between this cycle and the other cycles How transactions in the cycle are triggered (initiated) Example of a typical transaction in the inventory and production cycle Major accounts affected by the cycle IAS 2 and the treatment of inventory for flnancial reporting purposes What functional areas exist In the cycle? Description of the functional areas Summary of the functional areas by department What Information system is used in the cycle? Accounting for inventory and production transactions Supporting documents, journals and ledgers Databases and masterfiles (computerised systems only) Reports Reconciliations Illustration: Transaction flow in the inventory and production cycle What could go wrong (risks) in the cycle? What Computer technoiogies are used in the cycle? What are the control objectives in the cycle? Control objectives in the cycle Achievement of the control objectives in the cycle Link between the control objectives in the cycle and management's assertions What are the controls in the cycle (manual and computerised)? Internal control activities in the cycle Internal control tables Controls relating to the conducting of inventory counts 350

7 CONTENTS ix 8.8 Cycle Illustration: The inventory and production cycle at Ntsimbi Piping Background to inventory and production Inventory counts 353 Assessment questions 356 CHARTER 9 Human resources cycle 359 Learning outcomes What are the nature, purpose and accounting implications of the cycle? Nature and purpose Relationship with other cycles The varied nature of the cycle How transactions in the cycle are triggered (initiated) Major accounts affected by the cycle Applicable accounting Standards, legislation, listings requirements and corporate governance principles Executive remuneration Deductions from employees'remuneration What functional areas exist in the cycle? Description of functional areas in the cycle Summary of functional areas by department What Information system is used in this cycle? Accounting for salaries, wages and related transactions Supporting documents, Journals and ledgers Databases and masterfiles (computerised systems only) Reports Reconciliations Illustration: Transaction flow in the human resources cycle What could go wrong (risks) in the cycle? Financial reporting risks Misappropriation risks What Computer technologies are used in the cycle? Access control systems Payroll Software Electronic funds transfers What are the control objectives in the cycle? Control objectives in the cycle Achievement of control objectives in the cycle Link between the control objectives in the cycle and management's assertions What are the controls in the cycle (manual and computerised)? Internal control activities in the cycle Internal control tables Cycle Illustration: The human resources cycle at Ntsimbi Piping Background to the human resources cycle of Ntsimbi Piping Appointment of employees and personnel records Timekeeping - wage employees Calculation and recording of salaries and wages Payment preparation and payment of wages and salaries Payment of deductions Recording the salary and wage transactions in the accounting records 419 Assessment questions 420 CHARTER 10 Investment and financing cycle 423 Learning outcomes 424 Reference list What are the nature, purpose and accounting Implications of the cycle? Nature and purpose Forms of transactions and major accounts affected by the cycle 427

8 x I AUDITING FUNDAMENTALS Characteristics of the investment and financing cycle Relevant accounting Standards How transactions in the cycle are triggered (initiated) What functional areas exist in the cycle? Financing Investments What Information system is used in the cycle? Accounting for investment and financing transactions Supporting documents and Journals Illustration: Transaction flow in the investment and financing cycle What could go wrong (risks) in the cycle? Financial Statement level risks Assertion level risks What Computer technologies are used in the cycle? What are the control objectives in the cycle? Control objectives in the cycle Achievement of the control objectives in the cycle Link between the control objectives in the cycle and management's assertions What are the controls in the cycle (manual and computerised)? Cycle Illustration: The Investment and financing cycle at Ntsimbi Piping 451 Assessment questions 451 PART C: THE EXTERNAL AUDIT PROCESS 453 CHARTER 11 Overview of the audit process 455 Learning outcomes 457 Reference list Introduction What terminology is used by the auditor when performing an audit? What are the objectives of an audit? What are the International Standards on Auditing (ISAs)? How is the audit and audit evidence documented? Characteristics of audit evidence What are the stages in the audit process? Pre-engagement activities (refer to Chapter 12 for a detailed discussion) Planning (refer to Chapter 12 for a detailed discussion) Obtaining audit evidence (refer to Chapters 13 and 14 for a detailed discussion) Evaluating, concluding and reporting (refer to Chapter 15 for a detailed discussion) How do computerised environments impact on the audit process? Is there a link between the stages of the audit process and the ISAs? 469 Assessment questions 471 CHAPTER 12 Pre-engagement and planning activities 473 Learning outcomes 475 Reference list Introduction The concepts of 'Overall audit strategy', 'Audit plan' and 'Audit approach' How does the auditor perform pre-engagement activities? Requirements Application in practice How are the terms of the engagement documented? Importance of documenting the terms Contents of the engagement letter How does the auditor obtain an understanding of the entity? Aspects of the entity to be understood Method of obtaining the understanding 495

9 CONTENTS xi 12.5 How does the auditor assess the risk of material misstatement? Conceptual aspects of risk assessment The need to consider risk arising from going concern issues The need to consider the risk of fraud Identification of risks that require special audit consideration ('significant risks') Risks for which substantive procedures alone do not provide sufficient appropriate audit evidence How can the auditor respond to identified risks of material misstatement? Responding to detection risk at the financial Statement level What options are available to the auditor to achieve desired changes to the level of detection risk at the financial institutions/disclosure level? Responding to detection risk at an account balance/class of transactions/disclosure level The implications of combined testing versus substantive testing Updating the audit approach and plan throughout the audit What is 'planning materiality' and how is it calculated? Definition Calculating planning materiality 530 Assessment questions 537 CHAPTER 13 Audit procedures: Essential concepts 542 Learning outcomes 544 Reference list Where do audit procedures fit into the audit process? What are'audit objectives'? What is the nature' of audit procedures? Determinants of the nature of audit procedures Tests of controls Substantive procedures Dual purpose audit procedures Recap What is the 'timing' of audit procedures? Determinants of the timing of audit procedures Interim tests of controls Interim substantive procedures Relying on audit evidence obtained in prior audits What is the'extent'of audit procedures? Audit sampling 582 Assessment questions 586 CHAPTER 14 Audit procedures: Specific considerations 589 Learning outcomes 591 Reference list Introduction How do we formulate the nature of audit procedures for specific classes of transactions or account balances? Wages: Attendance of a wage payout Cash and bank Inventory: Attendance of inventory counts Creditors: Creditors' reconciliations What are the requirements of International Standards on Auditing for dealing with specific complexities that may be encountered when performing audit procedures? External confirmations Management's written representations Accounting estimates Use ofother parties in the audit What are Computer Assisted Audit Techniques (CAATs)? The basics of CAATs 627

10 xii I AUDITING FUNDAMENTALS The auditor's use of Computer Software to assist in the audit Reasons for the use of CAATs in the audit process Application of CAATs in the audit process Steps in planning and performing CAATs 641 Assessment questions 644 Appendix: CAATs example 646 CHAPTER 15 Completion of the audit 649 Learning outcomes 651 Reference list Introduction What is the auditor's responsibility regarding subsequent events? Introduction Various periods pertaining to subsequent events Auditor's responsibility What is the auditor's responsibility regarding the going concern assumption? Introduction Managemente responsibility Auditor's responsibility Business rescue and its impact on the audit How does the auditor deal with uncorrected misstatements in the financia! Statements? Misstatements identified during an audit 'Final' materiality Evaluating the materiality of uncorrected misstatements Impact of uncorrected misstatements on the financial statements and audit report How does the auditor draft the audit report? Introduction Contents of the audit report Types of audit opinions Other paragraphs in the audit report Impact of going concern on the audit report 674 Assessment questions 676 CHAPTER 16 The independent revlew 679 Learning outcomes 680 Reference list What is an independent review? Nature of an independent review Differences between independent reviews and audits What are the statutory and regulatory requirements surrounding an independent review? Applicability of independent reviews Persons eligible to perform independent reviews Reportable Irregularities discovered during an independent review The scope of an independent review How does one conduct an independent review? Activities prior to, and during, the acceptance of the engagement Planning the engagement Performing the engagement Finalising the engagement Reporting on the engagement Documenting the engagement 691 Assessment questions 691 APPENDIX: Examples of cycle documentation related to the business cycles 693 BIBLIOGRAPHY 733 INDEX 736

Endunamoo BCTA Support Course (BCTA2018)

Endunamoo BCTA Support Course (BCTA2018) AUE3702: Formulating Substantive Procedures: Cycles Khanyisile Mthethwa Introduction The Code of Professional Conduct, By-Laws and rules regarding improper conduct