Auditing

Q1 Explain briefly the key differences between the following types of audits: Financial

Statements Audit; Compliance Audit; and Operational Audit

To start with, its involving of accumulation and evaluation of evidence about which

information to qualify and report on the degree of interaction between the information and set-up

data are the common factors among financial statement audits, operational audits and compliance

audits. What differentiates each type of audit from each other is the information being used to

examine and the data established for the information evaluation. The annual audit of IBM

Corporation where its financial statements are examined by the external auditors for the

determination of the degree of interaction between these financial statements and commonly

used accounting principles is a good example of financial statement. Meanwhile, the company’s

computerized payroll-processing system could also be audited by an internal auditor to check if

the system is in efficient and effective operation, is the example of operational audit. An instance

of a compliance audit is the examination of an entity’s federal tax return to decide the degree of

compliance with the Intenal Revenue Code by an IRS auditor.

Q2 Distinguish between: Auditing and Accounting as well as Internal and External

Auditing

Auditing and accounting play two different financial processes and respectively serve

different purposes for small transactions. Accounting is to prepare the works, Auditing is to

process the evaluation and examination of the work that had been prepared. To be straight, the

daily update duties to maintain the accounts, the implementation of the board financial strategy,

if any, is the main scope of work of accountants. By the end of the period, Financial Statement, a

summary report of the financial performance would be implemented by accountant. Meanwhile,

auditor would implement the checking if the financial statements are accurate, to ensure the

financial statement prepared would see no misstatement issue.

The thorough scope of the audit helps to differentiate the internal and external audit. The

complete conduct of business is covered by the potential scope of an internal audit, whilst a

financial and compliance audit confines the external audit to match the satisfaction of the

external auditor’s statutory responsibilities, in which the accounts needs to be examined and a

view as to whether a ‘true and fair picture’ is provided by the financial statements or not. There

are two differences classified here as below: (1) Meeting: Shareholders choose external auditors

who must not be members of the company, meanwhile this is in contrast to internal auditors who

are often dependent on the company; (2) Liability: Owners are the ones who manage external

auditors, while internal auditors are supervised by their senior management; (3) Targets: While

management is what internal auditors are set, external auditors on the other hand, are controlled

by statute. In short, what parts of the company or what systems internal auditors will be looking

at and what type of internal audit they need to carry out depends on the decision of management.

Q3 State the social purpose of auditing and how this relates to the postulates and

concepts of auditing. List 4 postulates and 4 concepts of auditing

In order to measure, understand, report and completely improve the performance of an

organization’s society and ethics, a social audit is required. This implementation helps to make

the gaps between target and actual performance, between efficiency and effectiveness, smaller. It

is also for the understanding, measurement, verification, report for the improvement of the

performance of the society/organization. Targets of social audit: (1) For the assessment of the

physical and financial gaps between demands and sources which are avail for local

improvement; (2) For the awareness creation between suppliers and users of local social and

productive services; (3) For the increase of developing local programmes more efficiently and

more effectively; (4) The carefulness examination of different methods of policy decisions,

continuing caring for stakeholder interests and priorities, especially in rural areas; (5) To

estimate the opportunity cost if stakeholders don’t access to public services punctually.

Q4 a) State who may, or who may, not be appointed as an auditor of a company; b) List

those parties who may appoint the auditor or remove the auditor from office

A company must not appoint or choose the auditor of its company unless: (1) This is a

chartered accountant; or (2) this is a licensed auditor; or (3) this person belongs to an

organization of accountants outside New Zealand where (a) the Registrar approves for the target

of this section of where the organization is situated, by notice in the Gazette, for the present; and

(b) it is not against the law for the person to work as an auditor in the country, state, or territory

where the organization is located; or (4) the person is not the one that paragraph (3) indicates, but

who is (a) not against the law to work as an auditor in a country, State, or territory outside New

Zealand; and (b) to get approval at present for the targets of this section. Nevertheless, if the

issuer is a company, only when a person is a licensed auditor must they be appointed or could act

as an auditor of that company.

These following persons may not be chosen to work as auditor of a company: (1) the member

of a family, both director and employees; (2) A partner, or in the employment – a director or

employee of the company; (3) a liquidator or a person who receives in respect of the company’s

asset; (4) a body corporate; and (5) a person who, according to paragraph (1) or paragraph (2),

can’t become the auditor of a related company.

An auditor or auditors may be appointed any time by the directors within the first period

when the company appoints auditors or, an auditor hasn’t presented at the company for a

duration, at any time when the next auditors are appointed or a casual vacancy is filled. An

auditor or auditors could also be chosen by the shareholders through the passing the typical

decision within the duration for choosing auditors, or in case there was a failure of the company

to choose an auditor or auditors within a duration for choosing auditors, or in which the directors

had power to choose an auditor or auditors (as per the description in the above paragraph) but

haven’t been successful in making a meeting.

An auditor may be removed from office or decided not to be re-chosen for a longer term

whenever during their employment with the company by the shareholders of the company.

However, this decision – the removing the auditor, or choosing someone else must be given

within a 28-day notice in advance in a general meeting. The auditor must be received a copy of

the notice of the intended decision and they will serve the right to respond in written and request

this must be sent to the company’s employees.

Q5 What are the auditor’s duties under (Statute of Law) the Companies Act 2006

Below are the duties of the auditor under (Statute of Law) the Companies Act 2006: (1) The

statement of the auditor on the summary financial statements; (2) The special report of the

auditor on abbreviated accounts; (3) The reports of auditors on revised accounts; (4) The

“Senior Statutory” auditor under the Companies Act 2006

Q6 What are the auditor’s duties under Common Law (Decided Cases)

A company’s auditors, as per Common Law (Decided Cases) are requested to implement such

researches during the preparation of their report, so as to enable the forming an opinion so as to

see a) if the company has kept the accounting records properly and branches not visited by them

have received proper returns enough for their audit, b) if there is compliance between the

accounting records and returns of the company’s individual accounts, and c) (in the case of

above mentioned company) if there is compliance between the auditable part of the company’s

directors’ remuneration report and the accounting records and returns.

Q7 What are the auditor’s duties under Auditing Standards

Below are the duties of the auditor in relation with fraud during the audit of financial

statements: an expansion of the area of procedures to find out fraud during implementation of

Auditing Standards will be what auditors face. The purpose of the new standard is for the

consideration of the auditor of fraud seamless blending between the audit implementation and

the continual update till the audit is completed. In Auditing Standards there is a process where

(1) the information needed is gathered for the identification of risks of material misstatement due

to fraud, 2) the assessment of these risks after the entity’s programs and controls are taken into

account and evaluated and (3) the response to the results.

Q8 Briefly explain the objectives of Compliance Procedures and Substantive

Procedures. For each of these objectives give one example of an audit process which is

designed to meet that objective.

In compliance audit, it is the process in which business functions are reviewed to check if

specific contractual, regulatory or predetermined requirements are obliged in that company. The

compliance audits can take place among a company’s employees or departments. In larger

corporations, compliance audit is used for the conduction of internal reviews so as to measure if

standard operating procedures are well operated among departments. In that company, whether

written agreements are followed or third party guidelines are met, is what contractual and

regulatory audits review.

They create substantive procedures as evidence that an auditor comes to help the confirmation

that no material misstatements incur related to the completeness, validity, and accuracy of the

financial records of an entity. Therefore, an auditor will perform the substantive procedures to

find out if any material misstatements in accounting transactions occur. Below are the general

categories of activity of substantive procedures: To test classes of transactions, account balances,

and disclosures; To agree the financial statements and accompanying notes to the underlying

accounting records; To examine material journal entries and other adjustments made while the

financial statements are made.

Q9 a) Define audit working papers; and b) List five specific purposes of audit working

papers.

In audit working papers there is information extracted from accounting and statistical records,

personal observations, the results of interviews and inquiries, and other available sources.

Besides, there are many kinds of audit working papers as contract briefs, copies of

correspondence, excerpts from corporate minutes, organization charts, copies of written policies

and procedures, and other substantiating documentation. A large measure on the nature of the

audit assignment will decide the degree and set-up of working paper files.

Audit working papers play very important roles in (1) the facilitation of effective conduct and

management of the audit assignment; (2) the provision of support for the auditor’s report; and (3)

the provision of background and the control follow-up actions taken to correct defects. There are

also other derived purposes, for example: (4) for the facilitation of third-party review and for the

aid of professional improvement; and (5) for the provision of a source of information for non-

audit purposes.

Q10 Distinguish between information contained in The permanent audit file and The

current audit file. Provide 2 examples of the information contained in each of the above

files.

Regarding recurring audits, there should be permanent audit files updated currently with

information for the continuous importance of the success of auditing, in distinction with current

audit files in which information related mainly to the audit of a single period is included. Below

information is compulsory for permanent audit working papers or permanent audit files: (1)

Copy of certificate of incorporation; (2) article and Memorandum of Association; (3)

Organisation structure; (4) Major accounting policies; (5) List of major shareholders and their

stake in the company; (6) List of professional advisers and their addresses; (7) Other legal

documents such as prospectuses, leases, sales agreement; (8) List of directors and their interest in

the business. Whereas, below information is necessary for present audit working papers or

present audit files: (1) Copy of management account being audited; (2) Schedule of major items

in the account; (3) Management letter for the accounting year; (4) Letter of representation; (5)

Reply to all circularization letters; (6) List of queries and their disposition; (7) Extract of Board

minutes of the meeting held during the year; (8) Published financial statements (current year).

Q11 Briefly explain the meaning of the term analytical procedures and outline three

ways in which these procedures are used in an audit.

On an audit, analytical procedures play an important part as of an evidence. As a matter of

fact, there is a comparison of recorded values with expectations developed by the auditor,

relating to the analytical procedures. There are the evaluations of financial information which are

created from a study of reasonable connections between both financial and nonfinancial data. For

instance, after the adjustment for any change in sales and other economic factors, we can

compare the prior-years’ balances with the present year accounts receivable balance. Below are

three kinds of analytical procedures: (1) Preliminary analytical procedures; (2) Substantive

analytical procedures; (3) Final analytical procedures.

In analytical procedures, financial information (data in financial statement) is compared with

with prior periods, budgets, forecasts, similar industries and so on. Here there is also

consideration of predictable relationships, for example: gross profit to sales, payroll costs to

employees, financial information and non-financial information, such as the CEO's reports and

the industry news. We can study about the client from other sources such as interim financial

information, Budgets, Management accounts, Non-Financial information, Bank and cash records,

VAT returns, Board minutes, Discussion or correspondence with the client at their year-end.

Q12 Explain briefly the circumstances in which the auditor’s desired level of audit risk is

likely to be particularly low.

Due to either error or fraud, there exists the risk that due to their failure to find out material

misstatement, unqualified report may occur with an auditor. This risk consists of inherent risk

(IR), control risk (CR) and detection risk (DR), and can be calculated as below:

AR = IR × CR × DR

Where: IR is inherent risk, CR is control risk and DR detection risk. IR refers to the risk

involved in the nature of business or transaction.

The audit risk model was developed by standard setters as a planning tool. Nevertheless,

auditors and their firms must consider the number of limitations of the model, when an audit plan

is revised or evaluated its results. In such cases, the audit risk referred by the formula is still

smaller than the actual or realistic level of audit risk. This is explicable that there is the risk of

material misstatement during the assessment of the auditor, and such defect maybe higher or

lower than the actual risk of material misstatement that the client is facing. Such incorrect

estimation could lead to a flawed determination of detection risk. Therefore, they could not really

achieve the desired level of audit risk.

Q13 Explain briefly how the auditor’s assessment of inherent risk and internal control

risk affects his or her planning of substantive procedures.

The efficiency of the audit process could be improved thanks to the ability to assess inherent

risk. At basic degree, the control procedure requiring that we should check invoice pricing

independently is considered. Such a procedure may be current, but also may be not. If being not

current, it should be supposed that they could misprice every invoice and control risk is assessed

at 100%. Actually it is a different story with experience. Even without the controlling effectively

to suggest every invoice will be mispriced would be unreasonable. Other factors should be taken

into consideration for example the capability of the invoicing clerk, the complication of invoice

calculations, or incentives on the invoicing clerk to misprice invoices such as a bonus based on

invoice value.

We refer these collectively as inherent risk which is the susceptibility of misstatements

occurring in an account balance or transaction. As a matter of fact, it can be seen that less than

20% of invoices are wrongly priced in the absence of a control and assessed inherent risk at 20%.

Therefore, the collective assessment of control risk at 100% and inherent risk at 20%, is 20%,

dramatically reduces the requested level of risk detection.

Q14 Describe the circumstances in which the auditor gives a qualified audit report.

Below are the cases that a qualification can be increased:

Uncertainty occurring as a result from both a limited number of the auditor’s work and

the incapability of achieving any proof in terms of which happen in connection with a

pending issue.

Disagreements occurring as a result from factual discrepancies, unsuitable accounting

policies, inadequate or misleading disclosures given in the financial statements or

failure to be in compliance with an accounting standard or legislation. Sometimes

these kinds of conflicts could be easily negotiated with customers so as to avoid a

qualification, such as a realistic conflict resulting in the financial statements being

corrected to show the right opinion. However, there are also more subjective conflicts

related to the suitability of an accounting policy which are very hard to find solution

for.

Q15 In relation to audit sampling, explain briefly what is meant by Precision Limits;

Sampling Risk (and levels of assurance); Tolerable errors; Stratification.

“Audit sampling” (sampling) means to apply audit procedures to be less than 100% of items

within one class of business or account balance so all sample units could be selected. This helps

for the auditor’s obtaining and evaluation of audit proof of the items chosen for the creation and

or assistant in a conclusion regarding the population where the sample is drawn. As can be seen,

there are two kinds of audit samples, statistical and non-statistical ones. Quantity of risk,

direction of risk, and quality of risk management in determining precision levels to use are what

should be done by examiners. In order to design samples, the sample size is affected by the

precision limitation; it is allowable that if the precision limits are small, the size of the sample

selected will be bigger, and the amount of exceptions are smaller. If a tolerance of a large rate of

exceptions is allowed, a precision of 20% is normally chosen. If not, a precision of 5% is

normally chosen. It’s highly recommended to avoid precision levels greater than 20%.

“Sampling risk” comes from the possibility that there may be a difference between the

auditor’s conclusion and the conclusion reached if the entire organization were subjected to the

same audit procedure. Below are two kinds of sampling risk:

The risk will be included, in case of a control test, and controls are much better than

they really are, or in case of a detail test, then in reality a material error does exist but

was not recorded. Such kind of risk results in audit effectiveness and unsuitable audit

opinion;

The risk will be included, in case of a control test, and controls are much worse than

they really are, or in the case of a detail test, that a material error exists when in fact it

does not. This kind of risk makes bad effect on audit efficiency since it would result in

extra works to create incorrect initial conclusions.

“Stratification” means dividing a population into subpopulations, each is a group of sampling

units which are similar (often monetary value). “Tolerable error” is the maximum error in a

population that the auditor could accept.

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