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STUDENT FRIENDLY MATERIAL AUDITING AND ASSURANCE

CA A.K.S. Krishnan M.Com, FCA 1

Author’s Note:

Dear Friends,

The primary aim of this book is to make FEAR FREE approach towards CA IPCC auditing. I salute your hard work and determination to pursue this course. Let me also help you in completing this course with highest mark in Auditing subject.

ICAI study material is holly book. Students shall at least go through once that book.

In this book I brought the summary of ICAI material

I CA AKS Krishnan aimed to make Auditing subject as easy as possible by presenting you this book, for students who find difficult to go through big books.

Once you purchased this book you can send message to my mobile no. 9940512888, either text message or whatsapp stating your name , city which you belong. I will store your contact. You can ask your doubts through whatsapp also.

You can also follow me in face book “Krishnan AKS” and you tube videos CA AKS Krishnan.

My advice to you to pass CA in very first attempt:

You may either do self-study or you can go class. But complete syllabus well in time. READ PRACTICE MANUAL one time before writing exam.

I am thankful to my Mother Mrs. S Banumathi who helped me to complete my CA at the age of 21.

All the very best for students wish you all success

CA AKS Krishnan



TABLE OF CONTENTS

Contents LESSON 1: NATURE OF AUDITING ........................................................................................... 3 LESSON 2: BASIC CONCEPTS OF AUDIT................................................................................ 19 LESSON 3: PREPARATION FOR AN AUDIT ........................................................................... 30 LESSON 4: INTERNAL CONTROL ............................................................................................ 48 LESSON 5: COMPANY AUDIT 1 ............................................................................................... 62 LESSON 6: COMPANY AUDIT 2 ............................................................................................... 84 LESSON 7 & 8: VOUCHING AND VERIFICATION .............................................................. 106 LESSON 9: SPECIAL AUDIT .................................................................................................... 129 Lesson 10: BANK AUDIT .......................................................................................................... 150 Lesson 11: AUDIT IN AN AUTOMATED ENVIRONMENT ................................................. 163 STANDARDS ON AUDITING .................................................................................................. 167 SA 200 “Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing” ............................................................................... 169 SA 210 on “Agreeing the Terms of Audit Engagements” ....................................................... 173 SA 220 Quality Control for an Audit of Financial Statements ................................................ 176 SA 230 “Audit Documentation” ................................................................................................ 177 SA 240, “The Auditor’s Responsibilities relating to Fraud in an Audit of Financial Statements” ................................................................................................................................. 180 SA 250, “Consideration of Laws and Regulations in an Audit of Financial Statements” ..... 183 SA 299 “Joint Audit of Financial Statements” .......................................................................... 185 SA 300 "Planning an Audit of Financial Statements" ............................................................... 188 SA 315 “Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and its Environment” ..................................................................... 190 SA 320 “Materiality in Planning and Performing an Audit” .................................................. 194 SA 500 “Audit Evidence” ........................................................................................................... 196 SA 501 “Audit Evidence- Specific consideration for selected items” ..................................... 198 SA 505 “External Confirmations”.............................................................................................. 201 SA 510 “Initial Audit Engagements – Opening Balances” ...................................................... 203 SA 520 ‘Analytical Procedures’ ................................................................................................. 204 SA 530 “Audit Sampling” .......................................................................................................... 207 SA 550 on “Related Parties”....................................................................................................... 210 SA 560 “Subsequent Events” ..................................................................................................... 212 SA 570 Going Concern ............................................................................................................... 214 SA 580 “Written Representations” ............................................................................................ 219 SA 610 “Using the Work of Internal Auditors” ........................................................................ 223 SA 700 “Forming an Opinion and Reporting on Financial Statements” ................................ 226 SA 701: Communicating Key Audit Matters in the Independent Auditor’s Report ............. 232 SA 705 “Modifications to the Opinion in the Independent Auditor’s Report” ..................... 234 SA 706 – Emphasis on Mater Paragraph and Other Mater Paragraph in Independent Auditor’s Report ......................................................................................................................... 242 SA 710 “Comparative Information - Corresponding Figures and Comparative Financial Statements” ................................................................................................................................. 243



LESSON 1: NATURE OF AUDITING In New syllabus this chapter is Nature, Objective and Scope of Audit

An audit is independent examination of financial information of any entity, whether profit oriented or not, and irrespective of its size or legal form, when such an examination is conducted with a view to expressing an opinion thereon.

An auditor may review the financial statements of an enterprise to ascertain whether they reflect a true and fair view of its state of affairs and of its working results

He may analyse the operations to review the managerial performances in an enterprise.

The auditor may examine whether the transactions is of financial propriety (unnecessary expenses to be curtailed)

Auditor should see whether

the accounts have been drawn up with reference to books of account; the entries in the books of account are adequately supported by underlying papers none of the entries in the books of account has been omitted; the information conveyed by the statements is clear and unambiguous; the financial statement are in conformity with accounting standards; and the statement of accounts present a true and fair picture of the assets and liabilities.

The basic objective of auditing, i.e., expression of opinion on financial statements.

As per SA 200 “Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing”, the purpose of an audit is to enhance the degree of confidence of intended users in the financial statements. This is achieved by the expression of an opinion by the auditor on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework.

International Auditing and Assurance Standards Board IAASB

International Federation of Accountants (IFAC) has established IAASB, which is independent standard-setting body for professionals.

Auditing and Assurance Standards Board

ICAI is member of IFAC. ICAI set up Auditing and Assurance Standards Board (AASB). So in India, they only issue standards for Auditors. They issued standards on Standards on Quality Control, Auditing, Review, Other Assurance and Related Services.

SA – standards on Auditing - to be applied in the AUDIT of historical financial information. SRE – standards on Review Engagements - to be applied in the review of historical financial information. SAE – standards on Assurance Engagement – to be applied when auditor examining Prospective financial information SRS – Standards on Related Services – when CA engaged for compiling Financial statements



Who is an auditor?

The person conducting audit is known as the auditor; he makes a report to the person appointing him after due examination in the form of an opinion on the financial statements.

What is guidance Notes?

Guidance Notes’ are primarily designed by ICAI to provide guidance to members (CA) on matters which may arise in the course of their professional work and on which they may desire assistance in resolving issues which may pose difficulty. Guidance Notes are recommendatory in nature.

What is Pronouncements?

ICAI issues various standards on accounting and auditing. Those are to be followed mandatorily.

Classification of Auditors

Internal Auditor vs. External Auditor:

External Auditor Internal Auditor CA in Practise. Qualified Professional May be professionally qualified or may not Independent that of entity May not be independent Appointed under Section 139 Appointed under Section 138 Scope given by Law Scope given by audit committee/ Board Appointed by Shareholders Appointed by audit committee/ Board

Qualities of an Auditor:

He shall be tact (skilful in handling issues), caution, firmness, good temper, integrity, discretion, industry, judgement, patience, clear headedness and reliability.

Both practical training and theoretical education are equally necessary. He must know thoroughly all accounting principles and techniques. Person of Highest integrity (honest)

Objectives of Audit

Expression of opinion

The London and General Bank Ltd. [1895] it is decided that it is duty of auditor to ascertain and state the true financial position of the company at the time of the audit.

But as per SA 200: Overall Objectives of the Independent Auditor in conducting an audit of financial statements the duty of auditors also include:

To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error,

financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework



Financial Statement means: Balance sheet, Statement of Profit and loss, cash flow statement, Explanatory notes, changes in equity.

Reporting framework means schedule III read with accounting standards.

The auditor has to obtain sufficient and appropriate audit evidence to reduce audit risk.

That is to say the risk of an auditor to expresses an inappropriate opinion when the financial statements are materially misstated.

The auditor is expected to express reasonable assurance only. Reasonable assurance is not an absolute level of assurance, because there are inherent limitations of an audit. The auditor’s opinion being persuasive rather than conclusive.

Errors and Frauds

Management is responsible for prevention of errors and frauds. While conducting audit, the auditor may come across areas where control measures have to be made better. In such instances, the auditor may provide the management with practicable suggestions for alteration or modification of the controls and checks.

In P. Catterson & Sons Ltd case it is decided even though it is not primary responsibility of auditor to detect fraud and error, in case if he finds weakness he has to intimate management.

Court will look into:

whether the auditor has exercised reasonable care and skill in carrying out his work; whether the errors and frauds were such as could have been detected in the ordinary

course of checking without the aid of any special efforts; whether the auditor had any reason to suspect the existence of the errors and frauds;

and Whether the error or fraud was so deep laid that the same might not have been

detected by the application of normal audit procedures.

The reason for error:

Ignorance, carelessness,

Types of errors.

1. Self-revealing and not self-revealing 2. Unintentional and intentional 3. Unconcealed and concealed 4. Affecting general ledger balances and not affecting general ledger balances.

Self-Revealing: Wrong totalling, Not posting entry in one ledger. Certain apparent errors balance almost automatically get caught by double entry accounting procedure.

Reason for Fraud

Concealment of fact, evade tax, project high image, personal benefit, opportunity to commit fraud is available.



Fraud is deliberate act. Fraud is the word used to mean intentional error.

The distinguishing factor between fraud and error is whether the underlying action that results in the misstatement of the financial statements is intentional or unintentional.

Two types of intentional misstatements are relevant to the auditor:

fraudulent financial reporting and Misappropriation of assets incl. Defalcation of Cash

Reason may be pressure - earnings target or financial outcome

Fraudulent financial reporting can be achieved through:

Manipulation, falsification (including forgery), or Alteration of accounting records or supporting documentation. Misrepresentation in or intentional omission from, the financial statements Recording fictitious journal entries inappropriately adjusting assumptions changing estimate Concealing, or not disclosing facts

Misappropriation of assets:

Stealing physical assets or intellectual property Embezzling receipts – actually amount received from debtor but diverted and later

write off Causing an entity to pay for goods and services not received Using an entity's assets for personal use

Intentional errors are most difficult to detect.

Defalcation of Cash

Making payments against fictitious vouchers/ amount inflated Manipulating totals of wage rolls

Teeming and Lading:

Playing with customer balances. Not entering his receipts. Un authorised debit and credit notes. Not accounting full sales, writing off balances.

Misappropriation of Goods

The goods may be removed by subordinate employees or even by persons quite higher up in the management. This can get caught by surprise physical verification.

Manipulating accounts:

inflating or suppressing purchases and expenses; inflating or suppressing sales and other items of income, inflating or deflating the value of closing inventory; failing to adjust outstanding liabilities or prepaid expenses; and



Charging items of capital expenditure to revenue or by capitalising revenue expenses.

Errors can be classified as:

Errors of omission - where a transaction has been omitted either wholly or partially Errors of commission - where a transaction has been mis-recorded either wholly or

partially Compensating errors - where there are two or more errors which exactly counter

balance each other Errors of principle - distinction not being made between capital and revenue income

or expenditure Procedural errors – not following internal control procedures

Duties of auditor with respect to Fraud and error:

An auditor conducting an audit in accordance with SAs is responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error. But owing to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements of the financial statements will not be detected, even though the audit is properly planned and performed in accordance with the SAs.

The risk of not detecting a material misstatement resulting from fraud is higher than the risk of not detecting one resulting from error. This is because fraud has the intention to deceive hence properly planned.

The auditor’s ability to detect a fraud depends on skilfulness of the perpetrator

The risk of the auditor not detecting a material misstatement resulting from management fraud is greater than for employee fraud.

Fraud Risk Factors categorised into 3 conditions:

incentives/pressures, opportunities, and Attitudes

Fraud risk factors found in Financial reporting and Mis appropriation of asset

Examples of risk factors - fraudulent financial reporting

High degree of competition Product obsolescence Significant declines in customer demand and increasing business failures Operating losses making the threat of bankruptcy Negative cash flows Need to obtain additional debt or equity financing to stay competitive Significant related party transactions Operations in tax-haven jurisdictions Many functions handled by same person



Employees turnout ratio is more Complex internal control – No one can easily understand. Use of information technology Deficiency in internal control, Management failing to remedy known significant

deficiencies in internal control on a timely basis To avoid paying taxes To win shareholders confidence

Examples of risk factors - misappropriation of assets

Large amounts of cash on hand Inventory items that are small in size, of high value Inadequate internal control over assets Inadequate record keeping with respect to assets No rotation of employees – one person is doing same job for years.

Circumstances that may indicate the possibility that the financial statements may contain a material misstatement resulting from fraud:

Transactions that are not recorded in a complete or timely manner. Unsupported or unauthorized transactions Last-minute adjustments that significantly affect financial results complaints to the auditor about alleged fraud Original not available and only photocopy made available Significant unexplained items discrepancies between the entity's records and third party confirmation Missing or non-existent cancelled cheques Denial of access to records, Unusual delays by the entity in providing requested

information Undue time pressures imposed to complete audits Unwillingness by management to permit the auditor to meet privately with those

charged with governance Frequent changes in accounting estimates

Basic Principles Governing an Audit

1. Integrity: straightforward, honest 2. Objectivity: Express true and fair opinion 3. Independence: maintain an impartial attitude and both be and appear to be free of

any interest 4. Confidentiality: not disclose any such information of client to a third party without

specific authority 5. Skills and competence: Theoretical knowledge with adequate training 6. Using Work performed by others: auditor delegates work to assistants or uses work

performed by other auditors and experts, when relying on their work, he shall exercises adequate skill. The auditor should obtain reasonable assurance that work performed by other auditor or experts is adequate for his purpose.



7. Documentation: document matters which are important in providing evidence 8. Planning: Planning helps in doing. Effective audit in an efficient and timely manner.

This requires knowledge on client business, internal control, programming the nature, timing, and extent of the audit procedures to be performed.

9. Audit Evidence: auditor should obtain sufficient appropriate audit evidence through the performance of compliance and substantive procedures.

Compliance procedures are tests designed to obtain reasonable assurance that those internal controls.

Substantive procedures are designed to obtain evidence as to the completeness, accuracy and validity of the data produced by the accounting system. Substantive test again classified into two types: Test of details of transaction (ledger scrutiny) and Analytical procedures. (Ratios)

10. Knowledge on accounting system and Internal Control: The auditor should reasonably assure himself that the accounting system is adequate

11. Audit conclusions and reporting: Auditor has to review and asses the conclusion. Whether accounting policy consistently applied, financial statement gives full disclosure, statutory requirements complied with.

Aspects to be covered in Audit:

examination of the system of accounting and internal control whether material inadequacies and weaknesses exist in the system Checking of the arithmetical accuracy of the books of account Verification of the authenticity and validity of transaction proper distinction has been made between items of capital and of revenue transactions Verification of the title, existence and value of the assets Verification of the liabilities Confirming whether the statutory requirements have been complied with.

Inherent Limitations of Audit

The auditor is not expected to, and cannot, reduce audit risk to zero. This is because there are inherent limitations of an audit.

Audit involves judgements The Nature of Financial Reporting: Managements uses estimates. Like taxes,

warranties, depreciation Nature of Audit Procedures : the completeness information may not be available. audit procedures used may be ineffective for detecting an intentional misstatement –

fraud audit is not an official investigation Evidences are persuasive and not conclusive

Auditing and Investigation

Auditing is distinct from investigation. For example if fraud is suspected and an accountant is called upon to check the accounts to whether fraud really exists and if so, the amount involved, the character of the enquiry changes into investigation.



For auditing on the other hand, the general objective is to find out whether the accounts show a true and fair view. Audit never undertakes discovery of specific happenings and is never started with a pre- conceived notion.

Even though auditor is not expected to find all frauds, in case during the course of audit, if he finds, he shall disclose in his report.

Types of Audit

Audit is not legally obligatory for all types of business organisations.

In some form of business - Audit is required under law:

a. companies registered under Companies Act, 2013; b. banking companies governed by the Banking Regulation Act, 1949; c. electricity supply companies governed by the Electricity Supply Act, 1948; d. co-operative societies registered under the Co-operative Societies Act, 1912; e. public and charitable trusts registered under various Religious and Endowment Acts; f. body corporates set up under an Act of Parliament g. Specified entities under various sections of the Income-tax Act, 1961

In other form of business like proprietary entities, partnership firms, Hindu undivided families, etc audit is not mandatory. But they do audit for purposes like sanction of grants, loans, etc.

Advantages of an Independent Audit

a. It safeguards the financial interest partners or shareholders. b. It acts as a moral check on the employees c. Audited statements of account are helpful in settling liability for taxes, negotiating

loans d. These are also useful for settling trade disputes for increase of wages or bonus,

insurance claims e. Help in the detection of wastages and inadequacy of internal checks or internal control

measures. f. Audited accounts are of great help in the settlement of accounts at the time of

admission or death of partner. g. Government may require audited statement for issuing a license. h. Helps in filing Income tax returns i. To claim insurance

Relationship of Auditing With Other Disciplines Auditing and Accounting: Auditor should have a thorough and sound knowledge of generally accepted principles of accounting before he can review the financial statements. Auditing starts where the accounting ends. Auditing and Law:



It is necessary that the auditor shall have knowledge of business laws affecting the entity. Company law, contract, Tax laws etc. Auditing and Economics From the auditing view point, the auditors are more concerned with Micro economics rather than with the Macro economics. Auditor is expected to be familiar with the overall economic environment in which his client is operating. Auditing and Behavioural Science Auditing includes review of both financial and non financial data. So auditors shall have some knowledge in the field in which he do audit. Auditor is required to interact with a lot of people in the organisation. That too internal auditor or a management auditor is expected to deal with human beings rather than financial figures. Auditing and Statistics & Mathematics: Test check procedures (sampling technique) in auditing have become part of generally accepted auditing procedures. The knowledge of mathematics is also required on the part of auditor particularly at the time of selection of samples. Auditing and Data Processing

Many organisations are carrying out their financial accounting activities with the help of computers. The auditor should have good knowledge of the system and in fact, EDP auditing become separate opportunity.

Auditing and Financial Management

The financial services sector occupies a dominant place in our system, like such as working capital management, funds flow, ratio analysis, capital budgeting etc. The auditor is also expected to have a fair knowledge in these areas.

Auditing and Production

Auditor shall have knowledge on accounting for by-products; joint- products more particularly in case of an internal auditor also understanding the cost system in operation in the factory and assessing whether the same is adequate for the particular company.

AFTER READING THIS CHAPTER - READ STANDARDS ON AUDITING – last chapter in this book.

UNLESS AND UNTIL YOU READ STANDARDS ON AUDITING YOU CANNOT ANSWER PRACTICE MANUAL QUESTIONS.

TEST YOUR KNOWLEDGE:

1. Detection of fraud - after completion of statutory audit. 2. Risk under statutory audit – factors which causes the risk 3. Error of commission



4. Condition which increases risk of fraud or error 5. Operational audit 6. Effect of subsequent event 7. Auditor responsibility for detection of fraud and error 8. Qualities of an auditor 9. Verification of inventory 10. Travelling expenses 11. Vouching -Trade receivables 12. General purpose of financial statements 13. Going concern concept 14. Formation of opinion on accounts 15. Audit vs. investigation 16. Basic principles governing an audit 17. Inherent limitation of an audit 18. Advantage of Independent audit 19. Types of audits 20. Engagement standards 21. What is Arms length transactions 22. Communication of findings with TCWG 23. Factors affecting form content and extent of audit 24. Risk factor while applying sampling techniques 25. Auditor responsibilities in respect of corresponding figures 26. Identification of significant transaction – outside business 27. Self revealing errors and illustrations 28. Examples about Non compliance of Laws and regulations by management 29. Guidance note of ICAI – whether mandatory or recommendatory 30. Inquiry from management – auditor to evaluate subsequent event 31. Discipline of behavioural science linked with auditing 32. Written representation – if management not provided – how to deal as an auditor 33. Going concern indicators – Operating 34. Professional scepticism 35. Defalcation of cash with example 36. Auditor continuance with client – 4 factors 37. Significant difficulty encountered during audit 38. Identification of significant risk 39. Function and objective of auditing and assurance board 40. Advantage of Independent audit 41. Objective of audit will not change with respect to nature, size and form of an entity. 42. Detection of Fraud and error – duty of an auditor 43. Short notes on fraudulent financial reporting 44. Factors affecting identification of an appropriate bench mark in determining

materiality

HINT ANSWER TO THESE QUESTIONS

Chap – 1 – Nature of Auditing



1. As per SA-240 “The auditor’s responsibilities relating to fraud in an audit of financial statements”– Managements primary responsibility in detecting fraud: Auditor is not responsible unless he has obtained reasonable assurance. Auditor could not find fraud or error in the ordinary course of Audit. The risk of fraud is higher than the risk of error because fraud is done with

intention to deceive, error is unintentional

2. Auditor must express an opinion that Financial Statement are prepared in all material respects. But there are certain inherent limitations Audit involves Judgment Audit involves Sampling Evidences are Persuasive and not conclusive Nature of financial reporting Balance should be achieved between benefit and cost

3. The Error of commission are :

Error of Posting Error of casting Carry forward Extract of balance

4. In planning & performing the audit, auditor should take into consideration the material

respects. Conditions which increase risk are:

Poor internal control Inadequate evidence Non-compliance with control procedures etc.

5. Operational Audit

Audit of operating items is called operational audit Operational audit is an extension of internal audit. Auditing all operations and activities of the entity Check Whether standards of efficiency and economy are maintained Formulation of plan with respect to manufacturing, production, marketing etc.

6. Effects of Subsequent Events:

Understand Subsequent events. Classify whether it is in the nature of adjusting or non adjusting. Obtain the understanding – how the management identify subsequent events. Whether events affect the financial statements, and recoverability of assets. Read minutes, read next year’s interim financial statements, discuss with entity’s

legal counsel.

7. In P. Catterson and Sons Ltd it was held that The Auditor is not primarily liable for detection of fraud and error. As he is expected to give only reasonable assurance fraud and error cannot be detected in the ordinary course of checking If the auditor proved that he is not grossly negligent, he cannot be held liable.

8. Various Qualities of an Auditor are :



Clear headness Straight forward, integrity Good tempered Professional behavior / Professional Skepticism Reliability

9. Verification of Inventory:

Object of auditor in respect of opening balances obtain sufficient appropriate evidence

Whether material misstatements exists in opening balances Whether accounting policies are consistently applied.

10. Travelling Expenses –

whether expense has been actually incurred Whether it is within the accounting period Whether it relates to business Whether there is a supporting evidence i.e. voucher [internal evidence] Whether this expense (revenue exp) is charged to statement of P & L Whether the amount is disclosed correctly.

11. Trade receivables –

Whether they are shown in the assets side of the Balance sheet Whether they are recorded properly It includes all sales transaction occurred during the year Whether there is a Promissory note received from debtors

12. General Purpose of Financial Statements :-

a. Prepared in accordance with General Purpose framework b. It includes Balance Sheet, statement of Profit and Loss, cash flow statements,

statement of changes in equity if any, Explanatory notes does not include boards’ report etc.,

13. Going concern – SA 570 – Fundamental Accounting Assumptions Assumption that Entity operates for foreseeable future Entity can realize its assets and discharge its liabilities If it is unjustified, going concern is affected, Fact must be disclosed Auditor shall express adverse opinion

14. Formation of opinion on account

Financial Statement reflects true and fair view FS are free from material misstatements arising due to fraud or error Financial statement are prepared in accordance with financial reporting

framework. Reliability, arithmetical accuracy Authenticity & validity of transaction

15. Audit vs. Investigation:-

Auditing is distinct from investigation. For auditing on the other hand, the general objectives to find out whether the accounts show a true and fair view. Audit never undertakes discovery of specific happenings and is never started with a pre conceived notion.



Even though auditor is not expected to find all frauds, in case during the course of audit, if he finds, he shall disclose in his report.

16. Basic Principle governing an audit: Integrity Objectivity Independence Confidentiality Skill and competence Using the work of others Documentation Planning Audit Evidence Account system, Internal control Reporting

17. Inherent Limitations of an audit are:

Audit involves Judgment Evidence are persuasive and not conclusive Audit involves Sampling Events that affect entity’s going concern Noncompliance with laws and regulations There may be fraud

18. Advantages of Independent audit:

Moral check on employees Safeguards financial interests of shareholders Detection of wastages, adequacy of Internal checks (or) Internal measures Calculation of good will, Share of profits, Settlement of accounts at the

time of admission or death of partners

19. Types of Audit i. Company Audit

ii. Bank Audit iii. Insurance company audit iv. Co-operative Societies Audit v. Audit under Electricity act

20. Engagement standards

SA – standards on Auditing SRE – standards on Assurance Engagements SAE – standards on related services SRS – Standards on Related Services

21. Arm’s length transactions Transaction between knowledgeable, unrelated willing buyer & willing seller Price is the sole consideration

22. Communication of finding with TCWG:

SA260 – Communication with TCWG when the auditor cannot proceed with the audit, he must obtain written

representation as evidence



He must communicate it to right person having authority He must communicate at regular intervals

23. Factors affecting form, content and extent of audit.

Size and complexity of entity nature of audit procedures risk of material misstatement significant of audit

24. Risk factor while applying sampling techniques

Sampling test check based on professional judgment which maynot be always correct.It is an inherent limitation

Selection of wrong samples Risk of expressing inappropriate opinion due to selection of samples from given

range of population.

25. Auditors responsibility in relation to corresponding figures SA710 – comparative information corresponding figures comparative financial statements Corresponding figures are those figures which is are relating to previous year

and that forms part of Financial Statement Auditor should adopt procedures to verify corresponding information The accounting policy are consistently applied If there is change in policy whether proper adjustment has been made He must follow requirement of standards on auditing Auditor should obtain written representations if he observes any material

misstatement. 26. Identification of significant transaction outside business

i. Obtain appropriate audit evidence ii. Terms of transaction in consistent with managements explanation

iii. Accounted and disclosed as per Financial Reporting framework.

Tools to assess risk:

SA 315 –

Checklist Narrative records Flowchart ICQ (Internal control Questionnaire)

27. Self-Revealing errors:

Errors which becomes apparent in the process of compilation of Accounts E.g.: Omission – posting, Trial Balance will not tally Omission to enter in bank a/c - BRS will show error

By double entry accounting procedures, error can be easily identified.

28. Non-compliance of laws and regulations: SA250 – Consideration of laws and regulations in the audit of Financial Statement. Payment of fines, penalties to government departments Inconsistent accounting policies Non-compliance with SA’s



Litigation Charging revenue exp to Balance Sheet i.e. Treating Revenue Expenditure as

capital Expenditure and vice versa.

29. Statements and Guidance note issued by ICAI- Recommendatory (or) Mandatory?

Statements were mandatory Duty of members (CA) to ensure that statements and followed and complied with

30. Inquiry from Management to Evaluate subsequent events:-

Whether new commitments, borrowings, guarantee have entered into Whether sale or purchase of asset have occurred or are planned Whether any increase in capital Whether assets got destroyed Recent developments on contingencies

31. Professional Skepticism Professional behavior Questioning mind, proper reasoning Reponses to inquiries Obtain sufficient and appropriate audit evidence

32. Auditing and behavioral science:

Auditing includes review of both financial and non-financial data Auditor has to make lot of interaction with many people in the organization He shall be competent and honest.

33. Written representations:

SA580 – written representations Discuss with management Re-evaluate the integrity of management Shall issue a disclaimer opinion if management does not provide written

representations

34. Going concern indications: Lock out Shortage of import supplies Management in the process of liquidation (or) leasing the operations Lack of market, license, principle suppliers stop supplying Loss of KMP Natural Disaster

35. Defalcation of cash:

Manipulating cash payments

E.g. Cash payments against fictitious vouchers

36. Auditor’s continuance with client: SA220 – quality control for Audit of Financial Statement The integrity of key management, principals owners TCWG with governance of

entity



Whether engagement team is competent Compliance with ethical requirements Leadership quality Human resource Management Continuance of client

37. Significant difficulty encountered during the audit:

Significant delays in management providing required information Unavailability of expected information Restrictions imposed on auditor by management

38. Identification of Significant risk:

Fraud Changes in laws and regulations Complexity of transaction Related party transaction risk

39. Functions and objectives of Auditing & Assurance standards board

Review and examine existing accounting practices Formulate engagement standards, SQC, SA Review existing SAs Develop guidance notes for specific or in generic issue

40. Same as question 18

41. Audit is an independent examination of Financial information of any entity whether it is profit oriented or not irrespective of its size and legal form with a view to express an opinion. Therefore objective of an audit will not change with respect to size, nature or form of an entity

43. Fraudulent financial reporting can be achieved through:

Concealing or not disclosing facts Alteration of accounting records Manipulation or falsification Recording fictitious journal entries

44. Bench Marking for fixing Materiality:

Size, Complexity depend on industry Items which affects the users of Financial Statement Nature of entity and its business cycle Ownership structure



LESSON 2: BASIC CONCEPTS OF AUDIT

In New syllabus this chapter is Audit Documentation and evidence

Professional Behaviour:

CA shall act in a manner consistent with the good reputation of the profession and refrain from any conduct which might bring discredit to the profession.

While discharging his duties he shall comply with Standards on Auditing.

Only so long as the auditor maintains a high standard of independence and impartiality, the audit reports will continue to be accepted and respected by business, financial institutions, Government and investors. Professional integrity and independence are essential characteristics of all the learned professions.

Independence is utmost necessary for auditor. He shall be un biased. In company audit chapter we will study more about disqualification of auditors.

Audit Evidence

An auditor is called upon to give an expert opinion about the truth and fairness of such accounts.

He needs evidence to obtain information for arriving at his judgment.

Audit evidence includes both information contained in the accounting records underlying the financial statements and other information.

Information contained in the accounting records means accounting entries and supporting records, invoices, contracts, computations, reconciliations and disclosures.

Other Information: Minutes of the meetings, written confirmations from trade receivables and trade payables, manuals containing details of internal control etc.

Sufficiency and Appropriateness of Audit Evidence

Audit Procedures to Obtain Audit Evidence

1. Risk assessment procedures Understanding of the entity and its environment, including the entity’s internal control, to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial statement and assertion levels.

2. Further audit procedures a) Tests of controls and b) Substantive procedures:

Inspection, observation, External confirmation, recalculation, re-performance and analytical procedures

Sufficiency of Audit Evidence:



Sufficiency is the measure of the quantity of audit evidence. Higher the assessed risks, the more audit evidence is likely to be required.

Sufficiency depends on:

Materiality Risk of material misstatement

(a) Inherent Risk (b) Control Risk

Size and characteristics of the population

In classes of transactions, account balances and presentation and disclosures.

Appropriateness of Audit Evidence

Appropriateness is the measure of the quality of audit evidence. (the higher the quality, the less may be required). SA 330 requires the auditor to report whether sufficient appropriate audit evidence has been obtained to reduce audit risk to an acceptably low level.

Nature and Timing of the Audit Procedures

Nature: Some evidence / documents may be available only in physical form / some of them is available only in electronic form. Certain electronic information may not be retrievable after a specified period of time

Audit Procedures to obtain audit evidence:

Inspection:

Physical examination of an asset. Inspection of tangible assets may provide reliable audit evidence with respect to their existence, but not necessarily about the entity’s rights and obligations or the valuation of the assets.

Observation:

Looking at a process or procedure being performed by others, for example, the auditor's observation of inventory counting by the entity’s personnel.

External Confirmation

Direct written response to the auditor from a third party (the confirming party), in paper form, or by electronic or other medium. Example: Creditor/ debtor confirmation. More to be studied in SA 505.

Recalculation:

Recalculation consists of checking the mathematical accuracy of documents or records. classic example - Depreciation, Inventory valuation.

Re-performance:

Auditor will re perform few process to check the entity’s internal control effectiveness.



Analytical Procedures

Relationships among both financial and non-financial data. Ratio analysis, trend analysis etc.,

Inquiry:

Inquiry consists of seeking information of knowledgeable persons. Inquiries may range from formal written inquiries to informal oral inquiries.

TEST OF CONTROLS:

Test of controls may be defined as an audit procedure designed to evaluate the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the assertion level. Substantive procedure may be defined as an audit procedure designed to detect material misstatements at the assertion level.

(a) Type of control – Manual or automated (b) Operating effectiveness of controls including IT controls (c) The frequency of the performance of the control (d) The expected rate of deviation from a control (e) The relevance and reliability (f) Whether controls are adaptable to changing circumstances

Substantive Procedure:

Substantive procedure may be defined as an audit procedure designed to detect material misstatements.

Substantive procedures comprise:

(i) Tests of details – (applied in classes of transactions, account balances, and disclosures), and

(ii) Substantive analytical procedures. More to be studied in SA 520.

Assertions used by the auditor to consider the different types of potential misstatements:

(a) Assertions about classes of transactions Occurrence—transactions that have been recorded have occurred and pertain to the

entity. Completeness—all transactions have been recorded. Accuracy—amounts relating to recorded transactions recorded appropriately. Cut-off—transactions pertaining to relevant accounting period. Classification—transactions and events have been recorded in the proper accounts.

(b) Assertions about account balances at the period end:

Existence—assets, liabilities, and equity interests exist. Rights and obligations—the entity holds or controls the rights to assets, and liabilities

are the obligations of the entity. Completeness—all assets, liabilities and equity interests that should have been

recorded have been recorded.



Valuation and allocation—assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded

(c) Assertions about presentation and disclosure:

Occurrence and rights and obligations—Disclosed items are happened and pertaining to the company.

Completeness—all disclosures that should have been included in the financial statements have been included.

Classification and understandability —financial information is appropriately presented and described, and disclosures are clearly expressed.

Accuracy and valuation—financial and other information are disclosed fairly and at appropriate amounts

Types of Audit Evidence:

Internal evidence: Evidence which originates within the organisation being audited is internal evidence. Example-sales Invoice, debit and credit notes, etc

External evidence: originates outside the clients organisation; for example, purchase Invoice, debit notes and credit notes coming from parties, quotations, confirmations.

The external evidence is generally considered to be more reliable as they come from third parties who are not normally interested in manipulation.

As an ordinary rule the auditor should try to match internal and external evidence as far as practicable

Where external evidence is not readily available to match, the auditor should see as to what extent the various internal evidence corroborate each other.

Relevance and Reliability

Relevance: The quality of all audit evidence is affected by the relevance and reliability of the information. What kind of techniques to be used to check the evidence.

Reliability: audit evidence itself is influenced by its source and its nature, and the circumstances under which it is obtained. Example: The reliability of audit evidence is increased when it is obtained from independent sources outside the entity. If internal controls are very effective, then internal evidence can also be reliable. If external confirmation obtained by auditor directly is more reliable. Written is more reliable than oral.

Concept of Materiality

Items the knowledge of which would influence the decisions of the users of the financial statements.

Materiality is a relative term, what may be material in one circumstance may not be material in another.

Materiality shall depend upon the judgment of preparers of the financial statements. In many circumstances even small amount may be considered material if there is a

statutory requirement example: disclosure of amount paid as sitting fee to directors,



Transaction of abnormal or non-recurring nature is also considered material even though the amount involved may not be significant.

Concept of True and Fair

The concept of true and fair is a fundamental concept in auditing.

Audit requires auditor to express an opinion, whether the state of affairs and the results of the entity as ascertained by him in the course of his audit are truly and fairly represented in the accounts under audit.

This requires that the auditor should examine the accounts with a view to verify that all assets, liabilities, income and expenses are stated as amounts which are in accordance with accounting principles and policies which are relevant and no material amount, item or transaction has been omitted.

More about true and fair will be studied in Sec. 128,129,143 in company audit chapter.

128 requires management to keep books of accounts in true and fair manner

129 require financial statement prepared to represent true and fair financial position

143 requires the auditor to express whether Balance sheet, Statement of profit and loss, cash flow statement shows true and fair view of financial position.

What constitutes a ‘true and fair’ view is a matter of an auditor’s.

In more specific terms, to ensure true and fair view, an auditor has to see:

that the assets are neither undervalued or overvalued no material asset is omitted; the charge, if any, on assets are disclosed; material liabilities should not be omitted; the profit and loss account discloses all the matters required to be disclosed by Part II

of Schedule III and the balance sheet has been prepared in accordance with Part I of Schedule III;

accounting policies have been followed consistently; and all unusual, exceptional or non-recurring items have been disclosed separately.

Disclosure of Accounting Policies

Nature of Accounting Policies

It is an Accounting principles adopted by the enterprise in the preparation and presentation of financial statements.

Selection of accounting policy is duty of the management and it involves judgements.

Areas in which Different Accounting Policies are encountered



Methods of depreciation, depletion and amortisation Valuation of inventories Treatment of goodwill Valuation of investments Treatment of retirement benefits Valuation of fixed assets

Disclosure of Accounting Policies

Accounting policy differs from enterprise to enterprise. Hence it is required for each enterprise to state the accounting policy which they followed in preparation of FS. This facilitate meaningful comparison between financial statements of different enterprises. To ensure proper understanding of financial statements, It is necessary that all significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed. Any change in an accounting policy which has a material effect should be disclosed.

Fundamental Accounting Assumptions

Going Concern, Consistency, Accrual.

TEST YOUR KNOWLEDGE

1. Importance of accounts audited by auditor 2. Short notes on fundamental accounting assumption 3. Audit evidence 4. Various audit procedure to obtain audit evidence 5. Reliability of audit evidence 6. Advantage of audit working papers 7. Short notes of disclosure of accounting policy 8. How to check mis appropriation of cash in trading concern 9. Audit working papers – Importance 10. Test of controls and substantive procedure 11. Concept of true and fair 12. Relevant standard on auditing – appropriateness of going concern 13. Accounting estimate as per SA 540 14. Auditor’s Independence 15. Analytical procedures and its help 16. Materiality 17. External confirmation 18. Areas where Accounting policy encountered 19. Assertion while audit 20. Difference between internal and external evidence 21. Risk of material misstatement at assertion level for class of transaction, account

balances and disclosures 22. Responsibility of joint auditors 23. Substantive procedures 24. Audit working papers



25. Sufficient and appropriate audit evidence 26. Reliability of audit evidence 27. Inquiry as audit evidence 28. Whether Teaming and lading is one of the technique of inflating cash payments 29. Test of control

ANSWER TO QUESTIONS

1. IMPORTANCE OF ACCOUNTS AUDITED BY AUDITOR

a. It influences the decisions of the Shareholders b. Irrespective of the fact whether audit is compulsory it is important to every type

of organization c. It helps management for decision making purposes d. Tax implications e. Investors for Investment decisions

2. FUNDAMENTAL ACCOUNTING ASSUMPTION:

Going concern – entity should foresee its future Consistency – Consistent accounting policies Accrual – Recognized when earned or incurred and not when paid or received If they are not followed – it has to be disclosed.

3. AUDIT EVIDENCE – SA500

Information used to arrive at the conclusion on which auditors opinion is based on two types of evidence:

o Internal evidence o External evidence

4. AUDIT PROCEDURE TO OBTAIN AUDIT EVIDENCE

Inquiry Inspection Observation Recalculation Reperformance External confirmation Analytical procedure

5. RELIABILITY OF AUDIT EVIDENCE – SA500

Reliability is increased when it is obtained from independent source i.e. 3rd party confirmation

Reliability in internal evidence when internal controls are strong Directly obtaining audit evidence by auditor Written evidence than oral evidence Original copies than photocopies

6. ADVANTAGES OF AUDIT WORKING PAPERS:

Evidence for the work he has done Planning & performance of audit

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