Audit Strategy and Audit Program

Types of Audit TestsFive types of tests:

1. Risk assessment

2. Understanding internal control +

3. Tests of controls+

4. Analytical procedures+

5. Tests of details of balances=

Sufficient competent evidence per GAAS

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Risk Assessment• Canadian Auditing Standards (CAS)

• Identify risk of material misstatement

• Understanding of client’s business risk

• Thus part of clients risk profile:

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Procedures to Obtain an Understanding of Internal Control

• Update and evaluate the auditor’s previous experience with the entity

• Inquiries of client personnel

• Review of client’s policy and systems manuals

• Examine documents and records

• Observe entity activities and operationsAudit Strategy-4

Tests of Controls

• The purpose of test of controls

• If controls are to be relied upon then substantive evidence may be reduced.

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• Transaction-related audit objectives:

• Occurrence

• Completeness

• Accuracy

– Posting and Summarization

• Classification

• Timing (Cutoff)

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• Audit tests used for tests of controls:

• Similar to procedures used to obtain an understanding of controls

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• What are tests of controls?

• Audit procedures designed to

• Examples include:

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Methodology for Designing Tests of Controls

• Perform procedures to understand internal control

• Evaluate cost-benefit of testing controls

• Design tests of controls to meet transaction-related audit objectives

• Assess control riskAudit Strategy-9

Dual-Purpose Tests

• What is a substantive test?

• What is a dual purpose test?

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Tests of Details of Balances

• Why are substantive procedures performed?

• The fundamental substantive procedures

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• Balance-related audit objectives:

– Existence

– Rights and Obligations

– Completeness

– Valuation or realizable value

– Allocation• Accuracy of adjustment

• Adjustment to correct accounts

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• Typical audit tests:– Physical examination

– Direct communication

– Examine documentation

– Client inquiry

– Reperformance Audit Strategy-13

Which Evidence is Used for Which Type of Audit Test?

• Physical examination

• Confirmation

• Observation

• Inquiry

• Mechanical accuracy or reperformance

• Analytical procedures

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The Trade-off of Evidence Mix

• What is evidence mix?– The proportion of:

• Low cost versus high quality of the audit tests

• Auditor must use professional judgment to determine the mix of audit tests

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Presentation & Disclosure Related Audit Objectives

• Used to examine financial statements

• Seven objectives– Occurrence

– Rights and Obligations (Ownership)

– Completeness

– Accuracy

– Valuation

– Classification

– Understandability Audit Strategy-16

Designing the Audit Program

• Most audits use a combined approach:

• The audit program is normally split into three parts:

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Analytical Procedures

• Are conducted at each phase of the audit:– During knowledge of business phase

• Purpose therefore:

– Use of analytical procedures during other phases• Purpose:

• Typical procedures

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• Understand internal controls

• Control risk

• Cost benefit

• Design tests

Methodology for Designing Tests of Controls

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Tests of Controls Audit Program

• The actual tests must be based upon

• If cost-beneficial, tests of controls would be conducted for key controls

• Audit program is normally listed in a performance format

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Substantive Tests

• Consider an example of Accounts Receivable– Set audit risk

– Set materiality

– Assess inherent risk

– Assess control risk for sales and collection cycle

– Design, predict results for and conduct tests of controls and analytical procedures for sales and collection cycle

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Four Different Situations

• Situation 1:• control risk: good

• good results for analytical procedures in planning

• Situation 2:• control risk: poor

• good results for analytical procedures in planning

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• Situation: 3• control risk: good

• poor results for analytical procedures in planning. Or not performed

• Situation 4:• control risk: poor

• poor results for analytical procedures in planning. Or not performed

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Remember the audit phases

1. Plan and design an audit approach

2. Perform tests of controls

3. Perform analytical procedures and tests of details of balance

4. Complete the audit

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Problem 10-16, page 331The following are 11 audit procedures taken from an audit program:1. Add the supplier balances in the accounts payable master file, and compare the total with the general ledger.2. Examine vendors’ invoices to verify the ending balance in accounts payable.3. Compare the balance in employee benefits expense with previous years’. The comparison takes the increase in

the employee benefit rates into account.4. Discuss the duties of the cash disbursements bookkeeper with him or her, and observe whether he or she has

responsibility for handling cash or preparing the bank reconciliation.5. Confirm accounts payable balance directly with vendors.6. Use generalized audit software to run a gap test on the cheques issued during the year. (Print a list of cheque

numbers omitted from the normal cheque number sequencing.)7. Examine the treasurer’s initials on monthly bank reconciliations as an indication of whether they have been

reviewed.8. Examine vendors’ invoices and other documentation in support of recorded transactions in the acquisitions

journal.9. Multiply the commission rate by total sales, and compare the result with the commission expense.10. Examine vendors’ invoices and other supporting documents to determine whether large amounts in the repairs

and maintenance account should be capitalized.11. Examine the initials on vendors’ invoices that indicate internal verification of pricing, extending, and footing by a

clerk.Required:a. Indicate whether each procedure is a test of controls, an analytical procedure, or a test of details of balances.b. Identify the type of evidence for each procedure.

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Problem 10-21, page 332The following are audit procedures from different transaction cycles1. Use audit software to foot and cross-foot the cash disbursements journal, and trace the balance to the general

ledger.2. Select a sample of entries in the acquisitions journal, and trace each one to a related vendors’ invoice to

determine whether one exists.3. Examine documentation for acquisition transactions before and after the balance sheet date to determine

whether they are recorded in the proper period.4. Inquire of the credit manager whether each account receivable on the aged trial balance is collectible.5. Compute inventory turnover for each major product, and compare with that of previous years.6. Confirm with lenders a sample of notes payable balances, interest rates, and collateral.7. Use audit software to foot the accounts payable trial balance, and compare the balance with the general ledger.Required:a. For each audit procedure, identify the transaction cycle being audited.b. For each audit procedure , identify the type of evidence.c. For each audit procedure, identify whether it is a test of control or substantive test (indicating whether it is a test

of details of balances or an analytical procedure.)d. For each audit procedure, identify the related audit objective(s).e. Specifically assess the purpose of each audit procedure, as follows:

• For tests of control, state the risk (potential error) that is being assessed.• For analytical procedures, state a possible result that you would expect.• For tests of detail, state the type of material error that you would be quantifying.

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Problem 12-21, page 406, Canadian 11th. EditionThe following internal controls for the acquisition and payment cycle were selected from a standard internal control questionnaire:1.Vendors’ invoices are recalculated prior to payment.2.Approved price lists are used for acquisitions.3.Prenumbered receiving reports are prepared as support for purchases and are numerically accounted for.4.Dates on receiving reports are compared with vendors’ invoices before entry into the accounts payable system.5.The accounts payable system is updated, balanced, and reconciled to the general ledger monthly.6.Account classifications are reviewed by someone other than the preparer.7.All cheques are signed by the owner or the manager.8.The cheque signer compares data on the supporting documents with the cheques.9.All supporting documents are cancelled after entry.10.After they are signed, cheques are mailed by the owner or manager, or a person under his or her supervision.Required:a.For each control, state which transaction-related audit objective(s) is (are) applicable.b.For each control, write an audit procedure that could be used to test the control for effectiveness.c.For each control, identify a likely misstatement, assuming the control does not exist or is not functioning.d.For each likely misstatement, identify a substantive audit procedure to determine if the misstatement exists.

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