Auditing Principles

Auditing Standards
Auditing Standards & Professional code of conduct are of major importance in determining the responsibilities and duties of auditors in all types of audit engagements Auditing Standards outline the basic principles of audit methods and performance see pg 35 AUS202- AUS904

Auditing Standards
Auditing Standards outline the basic principle of audit methods and performance and provide guidance on a wide range of issues that occur in practice AUS202 Objectives and General principles Governing an Audit of a Financial Report AUS204 Terms of the engagement AUS206 Quality Control for Audit Work AUS208 Documentation AUS 210 Irregularities, Including Fraud, Other Illegal Acts And Errors AUS 402 Risk Assessment and Internal Controls AUS 808 Planning Performance Audits

Role of AUS202 The objectives and General Principles Governing the Audit of a Financial Report
Objective of an audit to enable an auditor to express an opinion on an entitys financial statements in order to ad credibility to the financial representations of management Audit should cover all aspects of the entity necessary to form an opinion on whether:
The financial information has been prepared in accordance with applicable accounting standards The financial information complies with relevant regulations and statutory requirements The view presented by the financial information as a whole is consistent with the auditors knowledge of the business entity; and There is adequate disclosure of all material matters necessary to give a true & fair view

AUS 202 also requires audits to be carried out in accordance with auditing standards, and that the auditor remains objective and critical throughout the audit

Scope of an Audit
Refers to the audit procedures that are necessary to achieve the objective of the audit Many audits are based on sampling approach in which representative samples of transactions and balances, as well as internal controls, are examined Regard must be given to requirements of auditing standards, legislation, regulations and terms of the audit engagement and reporting requirements

Reasonable Assurance
An audit performed in accordance with audit standards should provide reasonable assurance as to whether the financial report is free from material misstatement. Reasonable assurance relates to the whole audit process accumulation of audit evidence and the drawing of conclusions based on that evidence

Audit Objectives
Overall objective is to provide an opinion as to whether the financial statements are fairly resented in accordance with accounting standards Objectives include:
Completeness (no unrecorded transactions, assets or liabilities) Accuracy ( transactions and balances are accurate) Validity (all transactions are authorised) Safeguarding of assets (assets are kept safe) Security ( security is present in accounting systems) Accountability (client staff are accountable for their positions) Existence (assets and liabilities exist) Occurrence (transactions have actually occurred) Valuation (assets and liabilities are valued appropriately) Measurement (measurement of transactions is consistent) Cut Offs (transactions are recorded in the correct accounting period) Rights and obligations (ownership rights and liabilities are considered) Presentation (formats are in accordance with legal requirements) Disclosure (necessary disclosures are made)

Audit process

Stage 1 - Acceptance of New Audit

Client acceptance
ensure independence, gaining knowledge of the entity and the industry evaluate integrity of client communication with outgoing auditor

Audit tender cost and resources required

Stage 2 -Engagement letter AUS 204 agreement & scope of the audit Engagement letter should address the following:
Objective of audit Managements responsibility for financial statements Scope of audit Form of reports and letters arising from engagement Extent to which an audit can be relied upon to detect material misstatements (reasonable assurances) Unrestricted aces to records, documentation and accounting systems Arrangements for planning the audit Need for management to prepare letters of representation about certain issues Request for the client to accept terms of engagement by acknowledging receipt of the engagement letter Basis on which audit fees are calculated Arrangements re: involvement of others & outgoing auditor

Stage 3 - Planning the Audit AUS 302

Ensures that appropriate evidence is accumulated through relevant audit tests so that audit can be carried out efficiently 1. Knowledge of business AUS 304: economic influences Recession & growth Interest rates and availability of financing Inflation, government policies Industry conditions Market & competition Cyclical or seasonal activity Changes in technology Business risk technological market volatility Key ratios Characteristics of the client, its businesses, Corporate structure Related parties managements' objectives Internal control structures inherent risks Nature of businesses and logistics Competence levels of management financial performance and reporting requirements Key ratios & trends Reporting environment Legislation Users of financial statements

Stage 4 Study of internal controls & evaluation thereof

Study Internal Controls so that audit can be planned effectively by inspection, observation & enquiry
Reliance on internal control Identify & document all internal controls present or absent using analytical procedures such as ratio analysis Identify & document weaknesses in internal controls List internal controls found in each subsystem:
Sales or accounts receivable Purchases or accounts payable Cash Inventory Intangible assets Payroll Fixed Assets Shareholders funds Investments Deferred liabilities

Evaluation of the level of control risk for the system risk that a material fraud or error in a transaction or balance will remain undetected

Assessment of materiality size and significance of an item in the financial statements. An item is material if its omission or misstatement could mislead the users of the financial statements.

Inverse relationship b/w risk and materiality. If materiality is increased the audit is more rigorous and audit risk is lowered

Stage 5 Compliance testing

Test of internal control systems for each subsystem to measure effectiveness of internal controls and to assess control risk for each subsystem Compliance tests includes gathering a range of evidences using a number of techniques: Enquiry of staff inspection of documents Observation of procedures Re-performance of procedures Compliance tests will assess: Existence of internal controls Continuity of the internal control Effectiveness of the internal control Compliance test results may be communicated to management if problems are detected

Stage 6 Substantive testing

Concerned with transactions and balances contained in the financial statements 3 Types:
Test of transactions
Validity Completeness Accuracy of transactions E.g. a sales invoice is traced to the accounting records to check accuracy of journals and ledgers

Test of Balances
Accuracy Validity Completeness of account balances E.g. a stock take to check that stock on hand agrees with the record balance

Analytical review
Review of relationships between figures and to highlight unusual trends E.g. identify the trend in gross profit ratio over previous 5 years

Greater the control risk of a subsystem greater the substantive testing required

Stage 7 Completion of Audit

Check for contingent liability (depends on a future event i.e. legal action) and review events subsequent to balance date Obtain any necessary representations from management as well as review going concern assumption Review suggested adjusting entries given to client Evaluation of audit evidence gathered as a basis for the audit conclusion

Stage 7 Audit Report

Made up of a number of elements
Addressee Scope of the audit Qualification section (if required) Emphasis of matter section (if required) Signature Date

Audit opinion is either qualified or unqualified Unqualified- financial statements are properly drawn up in accordance with accounting standards Qualified
Except for qualification (effect on reports is material)
Except for the qualified aspects (deficiency, weakness or limit on scope) the statements are presented fairly

Adverse qualification (effect on reports is highly material)

Statements are not fairly presented misleading and minimal information value to users

Inability to form an opinion (lack of evidence is very material)

Auditor unable to give an opinion due to limitations on the audit process