auditing solved assignment

8/18/2019 Auditing Solved Assignment

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Auditing Solved Assignment

Labels: Auditing

What is the importance of Auditing for the business profession?

Financial statements of companies are very useful in business profession and the following people or group of

people are likely to want to see and use these:

• Actual or Potentially owners or shareholders, lenders or debenture holders, employees, customers

and suppliers

• People who advise the above accountants! stockbrokers! credit rating agencies! financial "ournalists!

trade unions! statisticians• Competitors and people interested in mergers, amalgamations and takeovers

• The government , including the ta# authorities, departments concerned with price control, consumer

protection, and the control and regulation of business

• The public , including those who are interested in consumer protection, environmental protection, and

political and other pressure groups

• Regulatory organizations

All these people must be sure that the financial statements can be relied upon $he problem, which has alwayse#isted when managers report to owners is %&an the owners believe the report?

$he report may

• &ontain errors

• 'ot disclose fraud

• (e inadvertently misleading

• (e deliberately misleading

• Fail to disclose relevant information

• Fail to conform to regulations

$he solution to this problem of credibility in reports and accounts lies in appointing an independent person

called an auditor to investigate the report and report on his findings

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A further point is that modern companies can be very large with multi)national activities $he preparation of

the accounts of such groups is a very comple# operation involving the bringing together and summari*ing of

accounts of subsidiaries with differing conventions, legal systems and accounting and control systems $he

e#amination of such accounts by independent e#perts trained in the assessment of financial information is of

benefit to those who control and operate such organi*ations as well as to owners and outsiders

+any financial statements must conform to statutory or other re uirements $he most notable is that all

company accounts have to conform to the re uirements of the &ompanies -rdinance, ./01

$he primary aim of auditing is to enable the auditor to say, %these accounts show a true and fair view2 or, of

course, to say that they do not $he ob"ects of an auditing are:

Primary

$o produce a report by the auditor of his opinion of the truth and fairness of financial statements so that any

person reading and using them can have belief in them

Subsidiary

• $o detect errors and fraud

• $o prevent errors and fraud by the deterrent and moral effect of the audit

• $o provide spin)off effects $he auditor will be able to assist his clients with accounting, systems,

ta#ation, financial, and other problems

What factors are considered by an auditor in developing an audit plan? 3#plain

4t is of great importance that an audit is planned in advance because:

• $he intended means of achieving the audit ob"ectives must be established!

•

$he audit can be controlled and directed• Attention can be focused on the critical and high risk areas!

• $he work can then be completed economically and to time scale re uirements

$he following are the matters to be taken into account and the preparation of an audit plan:


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Matters to take into account

• $he work to be performed in addition to the audit

• 5eviewing last year6s working papers

• &hanges in legislation or auditing or accounting practice

• Analytical review of management accounts, consulting with management

• &hanges in the business or its management or ownership

• &hanges in systems or accounting procedures

• $iming measurements

• 3#tent of preparation by the client of analyses and summaries

• 7se of internal audit

• 8egree of reliance on internal controls• 9oint auditors if any

• 5otational) testing

• Liaison with the audit committee

$he general strategy will be directed toward the following matters:

• Terms of engagement Work to be done ) audit, precise accounting work to be done for client, ta#

3tc , letters to be sent ) letter of weakness etc, reports to third parties e g regulatory authorities!

• The client and its background istory, products, locations, especially noting factors like a new

managing director, a new computer, a new product

• !mportant figures and ratios From previous years and if available, from management and draft

accounts

• Audit risk areas $ hese might include stock, work in progress, or dealings with a company under

common ownership

• The effect of information technology on the audit

• "#tent of involvement of internal audit

• Re$uirement for involvement of specialists $ hese may be from within the audit firm e g computer

audit or rarely e#ternal specialists

• Setting of materiality levels

• Client assistance Assistance from the client may be re uired in providing documents and analyses,

providing computer time, arranging visits to branches


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• The audit approach $ he e#tent of reliance on internal control, the use of substantive tests and

analytical review procedures

• Timetable 8 ates of interim, year end and final audits and of dead lines to meet e g A;+ of company

• Staffing re$uirement

• %udget and fee

• The operating style rofessional independence is e#ceedingly important $his is very much an attitude of mind rather than

a set of rules

• 4ntegrity is vital Synonyms for integrity include honesty, uprightness, probity, rectitude, and moral

soundness

• Accountants must not only be people of integrity and independence! they must also be seen to be so

Any interest


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• $he ethical codes are in some areas mandatory

• 4n some areas they give guidance only For e#ample in the independence ethical guide, the .@ fees

rule is for guidance only client giving .B of gross fees may influence an auditor who fears the loss of

income if he loses the client

• 4n all these ethical matters an accountant must not only behave correctly, he must also be seen to be

behaving correctly

• $hese matters are occasionally tested

• 3thics are taken very seriously by professional accountants

• >rofessional accountants are not allowed to give investment advice or conduct investment business

unless they are authori*ed to do so

• Auditors become privy to all sorts of information in the course of their work Auditor and their staff

must regard all such information as totally privileged and not disclose it to third parties e#cept in

circumstances where there is a legal right or duty to disclose it $hey may not also use suchinformation for personal gain, e g by insider trading

• >artners and staff of audit firms can become so familiar with the management or staff of a client

company that they lose their ob"ectivity $his must be avoided perhaps by rotating the partners and

staff involved

• 4ndependence is a big, issue at the time of writing and the practice of audit firms performing other

services for their audit clients has come into some criticism Warnings are made in the, ethical guides

of the professional bodies of the risks to ob"ectivity in performing these services but these all fall a

long way short of prohibition $he real uestion is whether an audit firm can offer a totally

dispassionate opinion if it andCor an associated firm are supplying services like:

• (ookkeeping

• >reparing the annual accounts

• $a#ation

• Advice on company secretarial matters

• +anagement consultancy

• -btaining staff

•

Selecting computer systems• Litigation support

• &orporate financial advice e g on capital raising or takeovers

• 4n a particular situation an auditor may well feel, that he or she is a professional person and is uite

capable of giving an independent audit opinion even though:

• $he fee for the opinion is fi#ed by the directors


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• $he directors can engineer a change of auditor if they wish the senior conducting the audit prepared

the final accounts the firm advised the firm on the choice of a computer firm for the supply of new

hardware and software

• $he firm investigated a company which the client company purchased the firm advised the client on a

comple# scheme for ta# avoidance

What are the ob"ectives of internal control? 3#plain various types of internalcontrol

4nternal control is defined as the whole system of controls, financial and otherwise, established by the

management in order to carry on the business of the enterprise in an orderly and efficient manner, ensure

adherence to management policies, safeguard the assets and secure as far as possible the completeness and

accuracy of the records

'%("CT!)"S '* !+T"R+A, C'+TR',

4f we look into the definition of the internal control, it will find out that the following are ob"ectives of

internal control

!nternal control generally

• $o carry on the business in an orderly and efficient manner, to ensure adherence to managementpolicies, safeguard its assets, and secure the accuracy and reliability of the records

Cash and che$ues received by post

• $o ensure that all cash and che ues received by post are accounted for and accurately recorded in the

books

• $o ensure all such receipts are promptly and instantly deposited in the bank

Cash sales and collections

• $o ensure that all cash, to which the enterprise is entitled, is received

• $o ensure that all such cash is properly accounted for and entered in the records

• $o ensure that all such cash is promptly and instantly deposited


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Payments into bank

• $o ensure that all cash and che ues received are banked intact

• $o ensure that all cash and che ues received are banked without delay at prescribed intervals,

preferably daily

• $o ensure that all cash and che ues received are accounted for and recorded accurately

Cash balances

• $o prevent misappropriation of cash balances

• $o prevent unauthori*ed cash payments

%ank balances

• $o prevent misappropriation of bank balances

• $o prevent teeming and lading

Che$ue payments

• $o prevent unauthori*ed payments being made from bank accounts

-ages and salaries

• $o ensure that wages and salaries are paid only to actual employees at authori*ed rates of pay

• $o ensure that all wages and salaries are computed in accordance with records of work performed

whether in respect of time, output, sales made or other criteria

• $o ensure that payrolls are correctly calculated

• $o ensure that payments are made only to the correct employees

• $o ensure that payrolls deductions are correctly accounted for and paid over to the appropriate third

parities• $o ensure that all transactions are correctly recorded in the books of account

Purchases and trade creditors


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• $o ensure that goods and services are only ordered in the uantity, of the uality, and at the best

terms available after appropriate re uisition and approval

T." T/P"S '* !+T"R+A, C'+TR', !+C,01"

'rganization

An enterprise should have a plan of organi*ation which should define and allocate responsibilities, every

function should be in the charge of a specified person who might be called the responsible official $hus the

keeping of petty cash should be entrusted to a particular person who is then responsible for that function

Segregation of duties

'o one person should be responsible for the recording and processing of a complete transaction

Physical controls

$his concerns physical custody of assets and involves procedures designed to limit access to authori*ed

personnel only

Authorization and Approval

All transactions should re uire authori*ation or approval by an appropriate person $he limits to these

authori*ations should be specified

Arithmetic and Accounting

$his check that the transactions have been authori*ed, that they are all included and that they are correctly

recorded and accurately processed

Personnel

>rocedure should be designed to ensure that personnel operating a system are competent and motivated to

carry out the tasks assigned to them, as the proper functioning of a system depends upon the competence and

integrity of the operating personnel


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Supervision

All actions by all levels of staff should be supervised $he responsibility for supervision should be clearly laid

down and communicated to the person being supervised

Management controls

$hese are controls, e#ercised by management which are outside and over and able the day to day routine of

the system

Acknowledgement of performance

>ersons performing data processing operations should acknowledge their activities by means of signatures,initials, rubber stamps, etc

%udgeting

A common techni ue used in business is the use of budgets, which can be defined as uantitative plans of

action (udgets having been agreed, can be compared with actual turn out and differences investigated

8ifferentiate between internal control and internal audit

!+T"R+A, C'+TR',

4nternal control is defined as the whole system of controls, financial and otherwise, established by the

management in order to carry on the business of the enterprise in an orderly and efficient manner, ensure

adherence to management policies, safeguard the assets and secure as far as possible the completeness and

accuracy of the records

$he control environment is a new concept in auditing 4nternal controls have limitations

,imitations of internal control


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• 4nternal controls are essential features of any organi*ation that is run efficiently owever it is

important to reali*e


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• 8etermine the control ob"ectives


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• -rder forms should be pre)numbered and kept, in safe custody 4ssue of blank order form, books

should be controlled and recorded

• -rder procedures should include re uirements for obtaining tenders, estimates or competitive bids

• Se uence checks of order forms should be performed regularly by a senior official and missing items

investigated

• All goods received should be recorded on goods received notes rocedures for dealing with re"ected goods or services should

include the creation of debit notes


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$he auditor, in considering a particular population, has to consider how to obtain assurance about it Sampling

may be the solution Factors which may be taken into account in considering whether or not to sample include:

• +ateriality >etty cash e#penditure may be so small that no conceivable error may affect the true and

fair view of the accounts as a whole• $he number of items in the population 4f these are few


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0 Stratification 4t may be desirable to stratify the population into sub)populations and sample them

separately or in some cases, such as high value items, do a hundred per cent check

/ Selection of the items to be tested

.B Testing the items

.. "valuating the results $his should also be done in stages: Analy*e the errorsC deviations detected in

relation to the planning definitions

.H Statistical and other sampling methods

.I 0se the errors3deviations detected to estimate the total error in the population $his is called

pro"ection of the errors from the sample to the population

.1 Assess the risk of an incorrect solution $his will be related to the amount of pro"ection of error

compared with the tolerable error and the availability of alternative evidence

(01&"M"+T SAMP,!+& 4 S","CT!'+ 5 ")A,0AT!'+

4n auditing, a sample should be:

• 5andom ) a random sample is one where each item of the population has an e ual


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• 4t is defensible

• 4t provides precise mathematical statements about probabilities of being correct

• 4t is efficient ) overlarge sample si*es are not taken

• 4t tends to cause uniform standards among different audit firms

• 4t can be used by lower grade staff who would be unable, to apply the "udgment needed by "udgment

sampling

• $here are some disadvantages:

• As a techni ue it is not always fully understood so that false conclusions may be drawn from the

results

• $ime is spent playing with mathematics which might better be spent on auditing

• Audit "udgment takes second place to precise, mathematics

•

4t is infle#ible• -ften several attributes of transactions or documents are tested at the same time Statistics does

not easily incorporate this

• >rove +ost Successful

• comple# check of all the transactions and balances of a business is no longer re uired of an auditor

$he reasons for this are:

Economic – the complete check would take so long that accounts would be ancient.

Time – the complete check would take so long that accounts would be ancient

them.

Practical – u sers o f accounts d o not expect or require 1 00% accuracy. M ateriality is ve ry important in

accounting as well as auditing.

Psychological – a co mplete ch eck w ould so bore t he audit staff that their work would become ineffective an d

errors would be missed.

Fruitfulness – a complete check would not add much to the worth of gures if, as would be normal, few

errors were d iscovered. T he em phasis in auditing s hould be on the completeness o f record and the true an d

fair vi ew.

3#plain the application of Stratified and cluster sampling in audit practice

$here are several methods available to an auditor for selecting items

STRAT!*!"1 SAMP,!+&


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Stratified this means dividing the population into sub populations


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T"C.+!60"S !+)',)"1 !+ )'0C.!+&

$he auditor should e#amine the books in which the purchase invoices are recorded and the file of purchase

invoices 3ach invoice will be e#amined and the following points must be borne in mind:

• $he invoice should be addressed to the firm

• 4t should at least appear to be an authentic invoice from the supplier

• $he goods should be of a nature relating to the business carried on

• $he invoice should bear the signature or initials of the clerk deputed to check them

• $he invoice should have attached to it a docket signed by the gate)keeper acknowledging receipt of

the goods or bear reference to a goods inwards book or some other evidence that the goods have

actually been received

• $he entry should be e#tended into the correct column in the purchase daybook or be otherwise

correctly coded so that it ends up in the right place in the final accounts >articular attention should

be paid to goods of a capital nature

• $he detail relating to GA$ and discounts should also be checked

• &alculations and e#tensions should be checked

• $he date should fall in the accounting period

• 4f the invoice date and the date of supply of the goods or services fall in different periods, the

auditor must see that the correct treatment has been given to the item in the final accounts

3#plain how your would vouch the Following

Recovery of %ad 1ebts -ritten 'ff

4n vouching audit it is ensured that all bad debts should only be written off after due investigation and

acknowledged authori*ation by senior management For this purpose the following procedure is adopted:

• $o see the yearly ageing schedule of accounts receivable

• >ast history of recovery from the debtors

• $he period of credit allowed and taken

• >revious provisions of bad debts

• &orrespondence with the relevant debtors

• >roperly written off to the >rofit and Loss Accounts


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Refund of !nsurance Premium made

• $his will be done in the following way:

• 3#amine the actual policy to ascertain its total premium

• &heck up the demand note of insurance company

• See the official receipt of the insurance company

• Actual payment made to the insurance company

• 4s any refund was due? -n what basis

• 5eceipt of refund paid

1iscounted %ill 1ishonored

4t is re uired to e#amine if dishonored bills are dishonored:

• Accounts of bills receivables

• 8iscounting of the bill

• >resenting of bill in the bank

• Serving of a notice

• (ank statement! or

• 5eceipt from the 'otary public

8istinguish between a positive and negative confirmation of accounts receivableand state the circumstances when each could be used

A practice that is becoming very common in the verification of debtors is to circulari*e the debtors or some of

them for direct confirmation $he advantages of this techni ue are:

• 8irect e#ternal evidence is available for the e#istence and ownership of an asset

•

4t provides confirmation of the effectiveness of the system of internal control• 4t assists in the auditor s evaluation of cut)off procedures

• 4t provides evidence of items in dispute

$here are two methods, which can also be used together:


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+egative

$he customer is asked to communicate only if he does not agree the balance $his method is mostly where

internal control is very strong

Positive

&ustomer is asked to reply whether he agrees the balance or not or is asked to supply the balance himself

$his method is used where there is:

. Weak internal control

H Suspicion of irregularities

I 'umerous bookkeeping errors

$he approach is as follows:

• -btain the co)operation of the client ) only he can ask third parties to divulge information

• Select method ) positive, negative, or a combination of the two

• Select a sample All customers can be circulari*ed but this is unusual

• 8o not omit ) 'il balances ) &redit balances ) Accounts written off in the period• ;ive weight to overdue or disputed balances

• 7se stratified samples, e g all large balances and only some small ones

• $he letter should be from the client

• 4t should re uest a reply direct to the auditor

• 4t may contain a stamped, addressed, envelope or a pre)paid reply envelope

• 4t must be dispatched by the auditor

• 5eceive and evaluate replies

• Follow up when replies are not received $his is the ma"or problem

• &irculari*ation is sometimes carried out at dates other than the year)end $his will occur only when

internal control is very strong

8iscuss the specific points which you will keep in view during verification of thefollowing:


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1"*"RR"1 C'ST

As the deferred cost is a heavy e#penditure in the nature of revenue incurred and the benefit of which is

likely to e#tend beyond the financial year in which it takes place For verification purposes, it is verify that

this is temporarily capitali*ed and to be spread e ually over number of years for which it is anticipated that

benefit would be reaped by the business

P'ST %A,A+C" S.""T ")"+TS

3vent occurring after the date of the balance sheet may assist in the assessment of the position, as it e#isted

on that date in respect of some of the item appearing in the balance sheet $hese are stated as under:

•

,iabilities O to determine the amount of contingent liabilities, etc• Provision for ta#ation O for its correctly calculation

• *i#ed assets O for showing settled amount

• 1ebtors O to determine the correct amount and accounting it

• Stock4in4trade O to establish the reali*able value

!+)"STM"+TS

•

(efore making any investment, it is re uired to take proper approval of the authority that should bewithin the ob"ectives provided in the +emorandum of Association $o verify the investments, the

following work is carried out:

• 4nvestments certificates are in the name of owners, and their value is up to investment and comparing

it with its ledger

• &hecking the market value with the uotation list at the date of the balance sheet

• Scrutini*e each individual investment account to ensure that all interest has either been received or

accrued in books

• 4n case of the limited companies, en uire into the uestion of dividend income

• Any amount of uncalled capital relating to shares held as investments and give a foot)note of it in the

balance sheet

• 3n uire into the speculative transaction with particular reference to short)term purchases and sales

ow would you ascertain the ade uacy of the provision for doubtful debts in theaccounts of a large manufacturing concern?


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$he valuation of debtors is really a consideration of the ade uacy of the provision for bad and doubtful debts

$he auditor should consider the following matters:

• $he ade uacy of the system of internal control relating to the approval of credit and following up of

poor payers• $he period of credit allowed and taken

• Whether balances have been settled by the date of the audit

• Whether an account is made up of specific items or not

• Whether an account is within the ma#imum credit approved

• 5eports on each debtor from collectors, trade associations, etc

• >resent value and reliability of securities, if any, lodged as collateral

• Puestions of set)off

• $he state of legal proceedings and the legal status of the debtor eg in li uidation or bankruptcy

• 3ffect, if any, of the Statute of Limitations

• &omparison of debtors to sales with comparison of the ratio with those of previous periods and those

achieved by other companies

• 3vidence of any debt in dispute e g for non)delivery, breakages, poor uality etc

+ote that7

• 8ebts, which are considered irrecoverable, should be written off to the profit and loss account• >rovisions for doubtful debts should be set up against debts, which are considered doubtful

Some companies make round)sum or percentage provisions against doubtful debts $his practice is generally

unacceptable to an auditor unless based on good statistical evidence, which may come from past e#perience or

may come from data about other similar undertakings which is obtainable from trade associations or which is

publicly available

auditing solved assignment

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