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Introduction to Auditing
1 .2 A U D IT IN G
Audit
is an
indep
1
2 Bestword's Auditing and Assurance CM Chap. 2
ende
nt
exam
inatio
n, Of
finan
cial
infor
matio
n,
Of any entity whether profit making or not, irrespective
of its size & legal structure, When such an examination
is conducted with a view to express an opinion thereon.
D e fin itio n as
per
IC A I
Audit has to be conducted in a proper way.
Auditor should be completely objective (unbiased) in his
Features/ Systematic & approach.
Independent He should not be influenced by the
Characteristics
Financial client.
of Audit
statement Auditor's opinion is on financial
s statements including Profit and I
account, Balance sheet & Notes to
accounts. The Preparation of
Entity financial statements is the
responsibility management of
entity.
His Opinion client can be any entity whatever
is the legal form i.e., it may bti
proprietorship, partnership, trust or company etc.
The entity may be profit oriented or a charitable one.
His opinion is on 'true & fair view' of financial
statements. For this, it is necessary that
(i)Financial statement have been prepared using
acceptable policies which are consistently
applied,
(ii)Financial statements have been prepared as per
relevant ^ regulations, &
(iii)There is appropriate disclosure of all material items.
By Whom In India, audit is to be conducted by a
professional having good accc anting &
auditing background. A chartered accountant having
certificate of practice is eligible to conduct audit.
Meaning of Independence means that the judgement of a person is not subordinate to wishes of another | person.
It requires that he should not act under any influence.
Independence
Thus, he can work in a complete unbiased manner.
Why If auditor maintains high degree of independence, credibility of financial statements is 1 enhanced.
Independent audit report will be accepted & respected by all stakeholders.
independence
Advantages of For management a)They can easily judge reasons for losses along with the reasons & try 1 to control
independent it.
b)They can ensure general reliability; of accounting system.
audit
c) For Employees a)It discourages them from committing frauds as it acts as a moral check | on them.
b)They can judge reasonableness of payments w.r.t salary, bonus etc.
introduction to/waning (a) lb)
For lenders Bankers can place reliance on audited financial statements while
14 BASIC ASPECTS TO BE COVERED BY THE AUDITOR / AUDITORS FUNCTIONS
ct audit. (a) Examination making
Of Accounting system & Internal decision
Control abouttocredit
system ensureworthiness
about theirofappropriateness.
loan applicants. ■ Even after
oach.
providing loan, the audited statements of borrower help the lender to judge
(b) Books Checking books of accounts to ensureoftheir
recoverability theirarithmetical
funds. accuracy.
ifit and loss
(c) Evidence For Computing
Examining Tax ■Audited
documentary evidencestatements
to supportenhances
the booksthe
of reliability
accounts. of computation of income earned by
nsibility
of anotherof (d) Full inclusion entity, thus helps in determining income tax.
Checking whether all entries in the books of Accounting have been taken while preparing financial statements.
it may be Auditor also checks computation of excise duty & sales tax etc.
For Owners They get real picture of profits & losses earned.
■From such statements, they come to know about their share in profit (as in
partnership firms) and can expect dividend.
For arbitrationIn case of dispute, audited statements help in settling claims.
C h a>le
p . policies
1 Introduction to Auditing
For insurer 5
In case of loss or damage to property by fire, theft etc. it helps the insurer to settle the
r relevant claim.
For prospective
On basis of past year's audited financial statements, they can devise expected profit trends
auditor's investor for deciding whether to invest in the entity or not.
i by THE of
auditor
;ments is
(e) Properness Examining whether information contained in financial statements is proper and it does not contain any
erroneous or fraudulent entry.
(f) Verification of Checking their completeness, existence, valuation & disclosure in financial statements.
Assets/
liabilities
(g) Statutory In case of audit of banks, General Insurance Companies etc., ensure compliance of financial statements with
compliance relevant statute.
(h) Disclosure Examining whether the information in financial statements is disclosed properly as per accounting principles.
(i) Truth & Cheeking whether financial statements as a whole represent true & fair view of profit /loss and of Assets &
fairness liabilities in the required from.
ins & try
(a) Integrity Auditor should be honest, sincere & straightforward while performing his professional duties.
ement
T(
He should not disclose, confidential information acquired during conduct professional a I
(j) Confidentiality +
duties, to any third party except when
■Permitted by client or
■Required by law ,
(k) Caution Whatever he does, he must do with proper skill & care.
Principles
As per accounting standards. As per auditing standards .
PrimaryTo maintain accounts & prepare financial statements
To conduct audit in an effective way is the responsibility of
responsibilit is the responsibility of management. auditor.
y
Expertise
Accounting expertise. Accounting & auditing Expertise (both).
Time of Accounts are prepared by the management prior Auditing
to get is examination of financial information, thus can't be
occurrence them audited. conducted prior to accounting.
1.8 SA-200 BASIC PRINCIPLES GOVERNING AN AUDIT
9. Audit
8 Bestword's
conclusions a)Auditor
1. Integrity, shouldAuditing and Assurance
be straightforward, CM
honest and sincere in his professional work. Chap. 2
and reporting
objectivity and b)He should be fair and must not be biased.
independence c)He should maintain impartiality. He should be free of any interest.
2. Confidentiality a)He should maintain confidentiality of information acquired during his work.
b)He should not disclose any such information to a third party without specific I permission of
client or legal or professional duty to disclose.
3. Skill and a)He should perform work with due professional care.
competence b)Audit should be performed by persons having adequate training, experience and 1 competence.
4. Work a)The auditor can delegate work to assistants or use work performed by other auditors I and
performed by experts.
others b)But he will continue to be responsible for his opinion on financial information.
b)Working papers are maintained to demonstrate that the audit was carried out in accordance with
the basic principles.
6. Planning a)He should plan his work to conduct audit in effective and timely manner.
c)Plans should be further developed and revised during audit if circumstances require so.
7. Audit Evidence a)Auditor should obtain sufficient and appropriate audit evidence by performing compliance and
substantive procedures.
b)Evidences enable the auditor to draw reasonable conclusion.
c)Compliance procedures mean the tests designed to obtain reasonable assurance that internal
controls have been properly designed & operating effectively throughout the
year.
d)Substantive Procedures are performed to obtain evidence as to the completeness, accuracy and
validity of data produced by the accounting system.
8. Accounting system a)Internal control system ensures that the accounting system is adequate and that all the accounting
and internal information has been duly recorded.
control b)The auditor should understand the accounting system and related internal controls adopted by
the management.
c)He should study and evaluate internal controls system to determine the nature, timing and extent
of other audit procedures.
a)The auditor should review and assess the conclusions drawn from the audit evidences obtained through performance of
procedures.
b)The audit report should contain clear written expression of opinion on the financial statements.
c)His report is on whether:
■The financial information has been prepared using acceptable accounting policies which have been consistently applied;
■The financial information complies with relevant regulation and statutory requirements; and
■There is adequate disclosure of all material matters.
(d)The report should be as per legal requirement. When other than clean opinion is given, the audit report should state the reasons
thereof.
r
revealing /not self-revealing Affecting T.B
Unintentional/ Unconcealed/ /not affecting
intentional concealed T.B.
1, 1,13 A(
Self-
Meaning
T I
Error of
Three fundamen aeeountin assumptic
Error of
Compensating
Error of commission
principleomission
error Conditions which increase the risk of misstatement in financial statement
1.Weakness in internal control system.
2.Doubt about competence and integrity of management.
3.Unusual pressure within entity e.g., entity facing problems in getting finance.
4.Unusual transactions e.g., transaction with related parties.
5.Problems in obtaining sufficient & appropriate audit evidence. For example,
management deliberately n o t coperating
o with the auditor.
Disclosur
requirem
per AS-1
Chap. 1 Introduction to Auditing 11
6.
1.12 ACCOUNTING CONCEPT-DISCLOSURE OF ACCOUNTING
Meaning - POLICIES
A c c o u n policies
tin g
It refers to specific accounting principles & methods of applying those principle,
Why disclosure adopted by entity.
is needed In preparation & presentation of financial statements.
(a)There is no single list of Accounting policies that can be applicable in all situations.
(b)Management chooses the appropriate accounting policy.
(c)For e.g., depreciation can be charged as per written down value method or straight-
line method. Same ways, different polices may be adopted for following:-
■Valuation of inventory
■Treatment of expenditure during construction
■Valuation of fixed assets
■Conversion of foreign currency items
■Valuation of investments
■Treatment of research & development expenditure
■Treatment of contingent liability
(d)The profit or loss can be significantly affected by adopting different accounting
policies.
Requirement of a) (e)Thus disclosure of accounting policies followed, becomes necessary so that readers
Accounting of financial statement can properly understand the view presented.
b)
standard All
c)significant accounting policies adopted in financial statements should be disclosed; &
regarding d) Disclosure should usually be made at one place; &
disclosure of Disclosure should from part of financial statement; &
accounting Any change in Accounting policies having material effect should be disclosed along
with amount by which financial statement is affected by such change ( if amount is
policies- AS-1
ascertainable ) If amount is not ascertainable, the fact should be stated; & If any
(e) fundamental accounting assumption is not followed, the fact should be disclosed.
accounting assumption.
Chap. 1 Introduction to Auditing 13
QUESTIONS ON CHAPTER -1
time constraints and other practical problems. As he doesn't check each & every item, so it is impossible
for him to detect all fraud & errors.
(15)Disclosure of accounting policy, which is adopted in preparation of financial statements, is not required. FALSE
<=> The profit or loss can be significantly affected by adopting different accounting policies. Thus,
disclosure of accounting' policies followed becomes necessary, so that readers of financial statements can
properly understand the view presented.
(16)As per AS -1 disclosure of fundamental accounting assumptions is needed whether these are followed or not.
FALSE => If all three fundamental accounting assumptions are being followed in preparation & presentation of financial
statements, specific disclosure is not needed. Thus, disclosure is needed only in case of non-compliance
with the fundamental accounting assumption.
THEORETICAL QUESTIONS
%Nov What would be the inherent limitations of an Audit in relation to frauds and errors? % M 01 N
Write short note on Conditions or events, which increase the risk of fraud or error.
98N 0I!M Write short note on Errors of commission.
99May Distinguish between Auditing and Accounting
00May 'An opinion expressed by the auditor is neither an assurance as to the future viability of the enterprise nor the
efficiency or effectiveness with which management has conducted the affairs of the enterprise'. Comment.
01 N 03 M Do you agree with the view that there are inherent limitations of Audit? 05 N
4Nov State briefly the qualities of Auditors. 05Nov Write short
note on General Purpose Financial Statements.
5Nov Write short note on Going Concern Concept.
97May "Independence of auditor must not only exist in fact, but should also appear to exist to all reasonable persons"-
Discuss highlighting the advantages of an independent audit.
97 Nov Briefly describe the Fundamental Accounting Assumptions.
99 May Write short note on Disclosure of Accounting Policies.
99 Nov Write short note on Fundamental Accounting Assumptions.
01 May What is the importance of having the accounts audited by independent professional auditors?
1May Write short note on Fundamental Accounting Assumptions.
1. Nov Write short note on Disclosure of Accounting Policies.
3May Write short note on Disclosure of Accounting Policies. 03 Nov
Write short note on Fundamental Accounting Assumptions.
03 , 06 Nov What are the basic principles governing an audit as laid down in SA200 (AAS 1)? Explain in briet
05 May Discuss the concept of 'True and Fair'.
Chap.J______
According to source
According to
nature
I
15
Chap. 2 Basic concepts in Auditing 16
R
Visual
Chap. 2 Basic concepts in Auditing 17
5. Analytical Review
6. Reperformance
2 .2 SA-500 -AUDIT EVIDENCE (REVISED) w.e.f. April 1, 2009
Definitions Accounting records - The records of initial accounting entries and supporting
records, such as checks and records of electronic fund transfers; invoices;
contracts;etc.
,(j>K Appropriateness (of audit evidence) - The measure of the quality of audit
evidence; that is, its relevance and its reliability in providing support for the
conclusions on which the auditor's opinion is based.
Chap. 2 Basic concepts in Auditing 19
Jpf Audit evidence - Information used by the auditor in arriving at the conclusions on
which the auditor's opinion is based. Audit evidence includes both information
contained in the accounting records underlying the financial statements and
other information.
Jtff Management's expert - An individual or organisation possessing expertise in a
field other than accounting or auditing, whose work in,that field is used by the
entity to assist the entity in preparing the financial statements.
Jpf Sufficiency (of audit evidence) - The measure of the quantity of audit evidence.
The quantity of the audit evidence needed is affected by the auditor's assessment
of the risks of material misstatement and also by the quality of such audit
Sufficient evidence.
The auditor shall design and perform audit procedures that are appropriate in the
Appropriate
circumstances for the purpose of obtaining sufficient appropriate audit evidence.
Audit Evidence Inspection
Inspection consists of examining records, documents or
tangible assets. Inspection involves examining records or
documents, whether internal or external, in paper form,
electronic form, or other media. An example of inspection
used as a test of controls is inspection of records for
evidence of authorisation.
Inspection of tangible assets may provide reliable audit
evidence with respect to their existence, but not necessarily
Inquiry and about the entity's rights and obligations or the valuation of
Confirmation Observation the assets.
Observation consists of witnessing a process or procedure being performed
by others.
For example, the auditor may observe the counting of
inventories being performed by client's personnel.
1 When designing and performing audit procedures, the auditor shall consider the relevance
and reliability of the information to be used as audit evidence. ■ The reliability of audit
evidence is increased when it is obtained from independent sources outside the entity.
Meaning "Analytical procedures" means the analysis of significant ratios and trends, including the
investigation of fluctuations.
Nature of Analytical procedures include comparisons of the entity's financial information with f following:
Analytical ■Comparable information for prior periods.
Procedures ■Anticipated results such as budgets.
■Predictive estimates prepared by the auditor, such as estimation of depreciation.
■Industrial trend.
STAGE-3 In overall He should apply analytical procedures at or near the end of the audit while concluding as to whether the
review at the end of the financial statements as a whole are consistent with his knowledge of the business.
audit In some cases, the auditor may identify areas where further procedures should be applied before
reporting.
Unusual fluctuations
When ARP identify significant fluctuations which are inconsistent' with other information, the auditor
should perform extended procedures.
Materiality Meaning ■Material items are those which may affect the judgement of users of
financial statements.
■It may be quantitative / qualitative.
Considerations by ■Auditor decides upon materiality level during planning stage which may be c h a n gduring
ed
Auditor progress of audit. It may be increased/ decreased for specific account.
■If ARP indicates misstatements, auditor should adopt other procedures to estimate it.
Aggregate Meaning *Specific misstatements identified by Auditor +
uncorrected *Uncorrected misstatements (not identified) +
misstatement *Net effect of uncorrected misstatements identified during previous
year's audit
If Auditor concludes that aggregate uncorrected misstatement are material
4 i
Materiality in the O. K. Qualified/ adverse opinion.
Context of an
Audit
This Standard on Auditing (SA) deals with the auditor's responsibility to apply the concept of
materiality in planning and performing an audit of financial statements. SA 450, explains
how materiality is applied in evaluating the effect of identified misstatements on the audit and
of uncorrected misstatements, if any, on the financial statements.
3.The auditor's determination of materiality is a matter of
professional judgment, and is affected by the auditor's
perception nf the financial information needs of users of the
financial statements. In this context, it is reasonable for the
auditor to assume that users:
(a)Have a reasonable knowledge of business and economic
activities and accounting and a willingness to study the
Chap. 2 Basic concepts in Auditing 23
Objective The objective of the auditor is to apply the concept of materiality appropriately in planning and performing the
audit.
/Definition For purposes of the SAs, performance materiality means the amount or amounts set by the auditor at less than
materiality for the financial statements as a whole to reduce to an appropriately low level the probability
that the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial
statements as a whole. If applicable, performance materiality also refers to the amount or amounts set by
the auditor at less than the materiality level or levels for particular classes of transactions, account
balances or disclosures.
Determining When establishing the overall audit strategy, the auditor shall determine materiality for the financial
Materiality and statements as a whole. If, there is one or more particular item for which misstatements of lesser amounts
Performance than the materiality for the financial statements as a whole could reasonably be expected to influence the
Materiality when economic decisions of users taken on the basis of the financial statements, the auditor shall also
determine the materiality level or levels to be applied to those particular item.
Planning the
Audit The auditor shall determine performance materiality for purposes of assessing the risks of material
misstatement and determining the nature, timing and extent of further audit procedures.
Revision as the The auditor shall revise materiality for the financial statements as a whole (and, if applicable, the
Audit materiality level or levels for particular classes of transactions, account balances or disclosures) in the
event of becoming aware of information during the audit i that would have caused the auditor to have
Progresses
determined a different amount (or amounts) initially.
If the auditor concludes that a lower materiality for the financial statements as a whole (and, if applicable,
materiality level or levels for particular classes of transactions, account balances or disclosures) than
that initially determined is appropriate, the auditor shall determine whether it is necessary to revise
performance materiality, and whether the nature, timing and extent of the further audit procedures
remain appropriate.
Documentation The audit documentation shall include the following amounts and the factors considered in their
determination:
Materiality for the financial statements as a whole ;
If applicable, the materiality level or levels for particular classes of transactions, account balances or
disclosures;
Performance materiality; and
Any revision of (a)-(c) as the audit progressed.
2.6 SA 580 (REVISED) - WRITTEN REPRESENTATIONS (W.E.F. 1ST
APRIL, 2009)
Scope of this SA This Standard on Auditing (SA) deals with the auditor's responsibility to obtain written representations
from management and TCWG.
Written ■Similar to responses to inquiries, written representations are audit evidence.
Although
Representations as written representations provide necessary audit evidence, they do not provide sufficient
appropriate audit evidence on their own about any of the matters with which they deal.
Audit Evidence
Furthermore, Other
the fact that management has provided reliable written representations does not affect the
nature or extent of other audit evidence that the auditor obtains.
Written
Representatio
Chap. 2 Basic concepts
To obtain written representations frominmanagement
Auditing 25 the
that management believes that it has fulfilled
Objectives of ns
fundamental responsibilities.
auditor
To support other
Date auditof evidence by means of written representations, if determined necessary by the
auditor or required by other SAs; and
and
To respond appropriately to written representations provided by management or absence thereof.
Period(s)
Doubt as to the
Covered
Doubt as to Written A written statement by management provided to the auditor to confirm certain matters or to support
Reliability of Written by
other audit evidence. Written representations in this context do not include financial statements, the
the Reliability representations
Representations Written
assertions therein or supporting books and records.
of Written Representations
from Whom The auditor shall request written representations from management with appropriate responsibilities
Representatio
Formstatements
for the financial ofand knowledge of the matters concerned.
ns and PreparationWritten
and written representation that mgt. has fulfilled its responsibility for the
Written
Requested Representations Presentation of the preparation and presentation of the financial statements
Representatio
Written Financial Statements
about ns
Representatio Management's
ns Not Responsibilities
Provided Information Provided Written representation that mgt. has provided the auditor with all relevant
to the Auditor information agreed in the terms of the audit engagement and that all
transactions have been recorded and are reflected in the financial statements.
Other SAs require the auditor to request written representations. If, in addition to such
required representations, the auditor determines that it is necessary to obtain one or more
written representations, the auditor shall request such other written representations.
The date of the written representations shall be as near as practicable to, but not after, the date
of the auditor's report on the financial statements. The written representations shall be for all
financial statements and period(s) referred to in the auditor's report.
The written representations shall be in the form of a representation letter addressed to the
auditor.
If law or regulation requires management to make written public statements about its
responsibilities, the relevant matters covered by such statements need not be included in
the representation letter.
If the auditor has concerns about the competence, integrity, ethical values or diligence of
management, the auditor shall determine their effect on the reliability of representations
(oral or written) and audit evidence in general. In particular, if written representations are
inconsistent with other audit evidence, the auditor shall perform audit procedures to
attempt to resolve the matter.
If the auditor concludes that the written representations are not reliable, the auditor shall
take appropriate actions, including determining the possible effect on the opinion
If management does not provide one or more of the requested representation, he shall discuss
Requested Written the matter with mgt. and re-evaluate the reliability and integrity of mgt. He shall consider its
Representations Not effect on his audit report as well.
Provided The auditor shall disclaim an opinion on the financial statements if:
(a)The auditor concludes that there is sufficient doubt about the integrity of management such
that the written representations are not reliable; or
(b)Management does not provide the written representations.
External It is the process of obtaining and evaluating audit evidence through a direct communication from a third
Confirmation- party in response to a request for information about a particular item.
Meaning
r
preparation and sending of confirmation requests and
the responses to those requests.3.2 SA-210 - TERMS
OF AUDIT ENGAGEMENT
Objective
Changes in If before completing the engagement, client requests the auditor to change
Engagement I; engagement to one, which provides a lower level of assurance, he
should consider tit 1 reasonableness of such a request.
Audit of
Component
Recurring Audits
He should consider the request from client to change the terms
I
Ppr 'f Auditor conqludes that there is
Preconditions
Scope of this SA This Standard on Auditing (SA) deals with the auditor's responsibilities in agreeing the terms of the audit
for an Audit engagement with management and, where appropriate, those charged with governance.
Effective Date This SA is effective for audits of financial statements for periods beginning on or after April 1,2010.
Objective The objective of the auditor is to accept or continue an audit engagement only when the basis upon which
it is to be performed has been agreed, through:
a)Establishing whether the preconditions for an audit are present; and
Confirming that there is a common understanding between the auditor and management and, where
appropriate, those charged with governance of the terms of the audit engagement.
Definitions Preconditions for an audit - The use bv management of an acceptable financial reporting framework_in the
preparation of the financial statements and the agreement of management and, where appropriate, those
charged with governance to the premise on which an audit is conducted.
For the purposes of this SA, references to "management" should be read hereafter as "management and,
where appropriate, those charged with governance".
In order to establish whether the preconditions for an audit are present, the auditor shall: (a) Determine whether the financial
reporting framework to be applied in the preparation of the financial statements is acceptable; and
Obtain the agreement of management that it acknowledges and understands its
(b)
responsibility:
(i)For the preparation of the financial statements in accordance with the ai financial reporting framework, including
their fair presentation;
(ii)For such internal control as management determines is necessary to enable the preparation of financial statements that
are free from material misstatement, whethB due to fraud or error; and
(iii)To provide the auditor with: Access to all information such as regords. documentation and other matters; Additional
a. information that the auditor may request from management for the purpose of the audit; and
b.
c Unrestricted access to persons within the entity from whom the auditor;
. determines it necessary to obtain audit evidence.
Limitation on Scope If management or those charged with governance impose a limitation on the scope of the auditor's work in the terms of a
Prior to Audit proposed audit! engagement such that the auditor believes the limitation will result in the auditor disclaiming an opinion on
Engagement the financial statements, the auditor shall not accept such a limited engagement as an audit! engagement. _
Acceptance I
If the preconditions for an audit are not present, the auditor shall| discuss the matter with management. Unless required by law
or regulation to do so, the auditor shall not accept the proposed audit I engagement. J
Other Factors
Affecting Audit The auditor shall agree the terms of the audit engagement with management or those charged with governance, as
Engagement appropriate.
Acceptance the agreed terms of the audit engagement shall be recorded in an audit engagement letter or other suitable form of written
agreement and shall include:
(a)The objective and scope of the audit of the financial statements;
(b)The responsibilities of the auditor;
(c)The responsibilities of management;
(d)Identification of the applicable financial reporting framework for the preparation of the financial statements; and
Bestword 's Auditing and Assurance C h a p ,!
(e)Reference to the expected form and content of any reports to be issued by the auditor and a statement that there may be
circumstances in which a report may differ from its expected form and content.
If law or regulation prescribes in sufficient detail the terms of the audit engagement the auditor need not record them in a
written agreement, except for the fact that such law or regulation applies and that management acknowledges and
understands its responsibilities as above.
On recurring audits, the auditor shall assess whether circumstances require the terms of the audit engagement to be revised and
Recurring whether there is a need to remind the entity of the existing terms of the audit engagement.
Audits
Agreement on
Audit
Engagement
Terms
34 Bestword 's Auditing and Assurance
Acceptance of Thea auditor shall not agree to a change in the terms of the audit engagement where
Knowledge o'
there is no reasonable
Change in the justification for doing so. clients Busines
If, prior to completing the audit engagement, the auditor is requested to change the audit engagement to an
Terms of the
engagement that conveys a lower level of assurance, the auditor shall determine whether there is
Audit reasonable justification for doing so.
Engagement If the terms of the audit engagement are changed, the auditor and management shall agree on and record the
new terms of the engagement in an engagement letter or other suitable form of written agreement.
If the auditor is unable to agree to a change of the terms of the audit engagement and is not permitted by
management to continue the original audit engagement, the auditor shall:
(a)Withdraw from the audit engagement where possible under applicable law or regulation; and
(b)Determine whether there is any obligation, either contractual or otherwise, to report the circumstances to
other parties, such as those charged with governance, owners or regulators.
Auditor's ReportIn some cases, the law or regulation applicable to the entity prescribes the layout or
Prescribed by Law wording of the auditor's report in a form or in terms that are significantly different
or Regulation from the requirements of SAs. In these circumstances, the auditor shall evaluate:
(a)Whether users might misunderstand the assurance obtained from the
audit of the financial statements and, if so,
(b)Whether additional explanation in the auditor's report can mitigate
possible misunderstanding.
If the auditor concludes that additional explanation in the auditor's report cannot
mitigate possible misunderstanding, the auditor shall not accept the audit
engagement, unless required by law or regulation to do so. An audit conducted in
accordance with such law or regulation does not comply with SAs. Accordingly,
the auditor shall not include any reference within the auditor's report to the audit
having been conducted in accordance with SAs.
This letter will be effective for future years unless it is terminated, amended or superseded. Please s i g attached
n copy of this
letter to indicate that it is in accordance with your understanding of the a r r a n g e maudit
e n t sof
| the financial statements. XYZ & Co.
Chartered Accountants
Chap. 3 Preparation for an Audit 35
(Signature)
(Name of the Member) (Designation)
(Signature)
Name and Designation Date
In verification of Assets, mam techniques such as physical examination, inquiry and computations ! are needed.
3.6 PLANNING-BASICS
Basis
(i) Meaning
(ii) Types
3.7 SA 300 (REVISED) - PLANNING AN AUDIT OF FINANCIAL STATEMENTS (w.e,f. 1st April
2008)____________________________________________________________________________
Scope of this SA It deals with the auditor's responsibility to plan an audit of financial statements. This SA is framed in the context of recurring
audits. Additional considerations in initial audit engagements are separately identified.
The engagement partner and other key members of the engagement team shall be involved in planning the audit.
Involvement of Key
Engagement Team
Members
Chap. 3 Preparation for an Audit 37
Preliminary
Engagement The auditor shall undertake the following activities at the beginning of the curratp engagement:
Activities a)Performing procedures required by SA 220 regarding the continuance of tht§ relationship;
b)Evaluating compliance with ethical requirements, including independent! required by SA 220; and
^Preliminary
c)Establishing an understanding of the terms of the engagement, as required biB 210. Engagement
Activities, „
The auditor shall establish an overall audit strategy that sets the scope, tiraii direction of the
audit, and that guides the development of the audit plan. In establishing the overall audit
Planning Activities strategy, the auditor shall: U)
Planning
(a)[Tdentify ^e characteristics^ the engagement that define its scope;
(b)Ascertain the reporting objectives of the engagement to plan the timingofi audit and the nature of the communications
required; Str
(c)Consider the factors that are significant in directing the engagement
efforts; a
(d)Consider the results of preliminary engagement activities and, where apf whether knowledge
Use gained on
other engagements performed by the engagf partner for the entity is relevant; and ol
(e)Ascertain the NTE of procedures. Char
The auditor shall develop an audit plan that shall include a description of: a
audit
(a)The nature, timing and extent of planned risk assessment procedui determined under SA 315.
(b)The nature, timing and extent of planned further audit procedures at the assertion! level,
Dir as determined
under SA 330 .
ec
(c)Other planned audit procedures that are required to be carried out so that the $ NT engagement
complies with SAs. E
(iii)Upda deK
The auditor shall update and change the overall audit strategy and the audit plan as t necessary
Documentation during the course of the audit te e
The auditor shall plan the nature, timing and extent of direction and supervision of \ + ReN engagement
team members and the review of their work. po
I. Se\
The auditor shall document: (^The overall audit strategy; tyyf 5 e >
The audit plan; and .
AssV
2 f
[pf Any significant changes made during the audit engagement to the overall audit strategy or the
and the reasons for such changes.
. Ins audit plan,
sta
The auditor shall undertake the following activities prior to starting an initial audit:
(a)Performing procedures required by SA 220 regarding the acceptance of the client relationship and the specific audit
engagement; and
(b)Communicating with the predecessor auditor, where there has been a change of auditors, in compliance with relevant ethical
requirements.
Additional 6
Considerations in
Initial Audit
Engagements .
.
38 Bestword's Auditing and Assurance Chap.: Chap. 1
SUMMARY OF SA 300
Audit
Recurring
(i) Preliminary Continuance (Q.C.)
Engagement
Activities
Ethics (Q.C.)
Terms
1
j (ii) Planning Activities
Initial
Acceptance
(
Q
.
C
.)
+
Commu
nicate
with
previou
s
auditor
+ Strategy
Use of Knowledge
Characteristics of
audit
Direction required
NTE (Broad
determination)
Plan Report (timing
etc)
315-
330-
Other
Plan
315-
330-
Other
(iii)
Updatio
ns, if
required
Chap. 3 Preparation for an Audit 39
3.8
ADVA
NTAG
ES OF
AUDI
T
PROG
RAM
3. Ready check list It provides ready checklist of all the procedures and techniques to be adopted.
4. No ignorance or Due to properly written program, there is no chance of forgetting /overlooking some important
overlooking matter.
5. Responsibility Program clearly set out as to who is required to do a particular work. Thus responsibility can be
fixation fixed.
6. Progress of work The progress of work can be determined on the basis of entries on the program.
done
8. Timely completion Time to time, compliance with program is checked so as to complete the work on timely basis.
9. Basis for reporting Program easily sets out procedure - evidence - conclusions chain, to enable the auditor f to
express opinion.
10. Future Audits It serves as a guide for audits to be carried out in succeeding years.
11. Safeguard for auditor In case, auditor faces some case for negligence, he can defend himself by showing it.
1. Mechanical Approach Assistants may carry out work mechanically without understanding the whole concept. '
2. Inflexibility The program often becomes rigid & inflexible. Assistants are not able to change it as per
requirements of specific case. .
3. Lack of initiative Hard & fast program hurts the initiative & judgmental skills of hard working assistants.
4. Monotonous Talented & efficient staff becomes frustrated due to anonymity in programs.
5. Shelter for inefficient They think that it contains exhaustive matters. They don't even think of any unusual matter,
assistants which is not listed in program even if its presence can change audit approach.
40 Bestword's Auditing and Assurance Chap.: Chap. 1
2. Record of time If arrival & departure time of assistants are recorded, it will act as a moral check for them.
4. Documentation Working papers should be maintained regarding all the work done.
5. Confidentiality Audit staff should not discuss the client's affairs with outsiders.
7. Colour Colored pen/pencils & different ticks should be used to indicate different audit procedures.
differentiation
8. Supervision Audit team manager must periodically review & supervise the work done.
9. Regular During audit, there should be continuous interaction among the members of audit team to discuss
meetings latest findings.
10. Flexibility If need arises, audit program should be revised during the course of audit.
3.11 CLASSIFICATION
OF AUDIT
ACCORDING TO TIME
OF ASSURANCE
Chap. 3 Preparation for an Audit 41
Final/ periodical/ i Audit that begins after the books have been closed at end of accounting period &
Meaning thereafter carried on continually till completion.
completed Audit
Advantages i)Work is carried out in single continuous sitting.
ii)Suitable for small client.
iii)No manipulation in accounts, once closed.
iv)No interruption in regular workflow of client.
vi) Precautions to i)Work should be completed up to definite stage during each visit.
avoid ii)Important balances should be noted down at end of each visit & compared at
limitations next visit so that any alteration can be detected.
iii)Visits should be on random basis (surprise visits).
iv)Special attention should be given to altered figures, if any.
v)Auditor should try at his level best not to interfere in client's day to day work.
>Documentation refers to
working papers kept
by the auditor in
connection with f
performance of his
audit work.
>It is the record of planning,
procedure performed, evidence
42 Bestword's Auditing and Assurance Chap.: Chap. 1
organised according to
standardised form.
(iii)Documentation should be
signed.
documented.
(v)As per ICAI,
documentation is the
property of auditor &
he should maintain it
at least upto 7 years
from date of signing of
audit report,
(previously it was 10
years)
(vi)If it is in electronic
/magnetic media, he should take
proper care for its storage &
retrieval.
(vii)He should maintain
confidentiality ( should not
show his W.P. to outsiders).
Working
paper files In
case of
1.
Permanent
audit file
Inf
or
ma
tio
n
reg
ard
ing
the
leg
al
an
d
org
ani
zat
ion
al
str
uct
ure
of
the
ent
ity.
Fo
r
e.g
. in
cas
e
of
Co
mp
an
y,
thi
s
inc
lud
es
M
O
A
&
A
O
A.
Legal
docum
ents,
agreem
ents
44 Bestword's Auditing and Assurance Chap.: Chap. 1
and
minute
relevan
t to the
audit.
record
of the
study
and the
evaluat
ion of
the
internal
control
s.
Copies
of
audited
financi
al
stateme
nts, for
previou
s years.
Analysi
s of
signific
ant
ratios
and
trends.
Chap. 3 Preparation for an Audit 45
Copies
of
manage
ment
letters
issued
by the
auditor,
if any.
Record
of
commu
nicatio
n with
the
retiring
auditor.
Notes
regardi
ng
signific
ant
account
ing
policies
.
46 Bestword's Auditing and Assurance Chap.: Chap. 1
Significant 2. Current It contains matters relating to audit of single period. Its contests are as
audit audit file follows:-
observations ■Correspondence relating to acceptance of annual reappointment.
3.12 AUDIT WORKING PAPERS (DOCUMENTATION)
of earlier ■Important matters in the minutes of Board Meetings and General Meetings as
relevant to audit.
years.
Meaning ■Evidence of the planning process of the audit and audit programme.
■Analysis of transactions and balances.
■A record of the nature, timing and extent of auditing procedures.
■Evidence that the work performed by assistants was supervised and reviewed.
■Copies of communication with other auditors, experts and third parties.
Basic
■Letters of representation or confirmation received from the client.
requirements
■Conclusions reached by the auditor concerning significant aspects of the audit.
* Copies of the financial information being reported on and the related audit reports.
Audit note Meaning It is generally a bound book which records large variety of matters observed during
Book audit. ,
Examples of Audit queries not solved immediately. Irregularities observed during audit.
contents
(iUjrImportant information regarding entity not appearing in accounts, (jy)f
Important matters for future reference.
Features / i)It is permanent record of auditor, which can be referred to later on.
usefulness
ii)It contains all details of work carried out. This work can be linked, if concerned
assistant is away.
iii)It contains all workflow of audit in detail.
iv)It can be important defence for auditor if action for negligence is brought against
him subsequently.
v)It shows, weakness in clients system, thus helpful in formulating audit programs in
future.
vi)It helps in follow up of work done.
Chap. 3 Preparation for an Audit 47
working papers No, otherwise it will violate rule of (ii)But auditor may, at his discretion, show s o rncomplete W.P. to client.
to (iii)If he shows W.P. to client itself, rule i confidentially does not arise at all.
Scope of this SA Other SA and Laws or regulations may establish additional documentation requirements.
Nature and (b)Evidence that the audit was planned and performed in accordance with. S A s a napplicable d legal and
Purposes of Audit regulatory requirements. .
Audit documentation serves a number of additional purposes, including the following:
Documentation 1.Assisting the engagement team to plan and perform the audit.
2.Assisting members of the engagement team responsible for supervision to di r e c t a supervise
nd the audit work.
3.Enabling the engagement team to be accountable for its woyk.
4.Retaining a record of matters of continuing significance to future audits.
5.Enabling the conduct of quality control reviews and inspections.
6.Enabling the conduct of external inspections in accordance with applicable l e g a lregulatory, or other
requirements
(a)Audit documentation - The record of audit procedures performed, relevant a u d ievidence t obtained, and
conclusions the auditor reached (terms such as " w o r k ipapers"
ng or "workpapers" are also sometimes used).
(b)Audit file - One or more folders or other storage media, in physical or e le c tr o nform,
ic containing the records
that comprise the audit documentation for a s p e c ific
engagement.
(c)Experienced auditor - An individual (whether internal or external to the fir m ) w has h o practical audit
Definitions experience, and a reasonable understanding of:
Audit documentation
provides: (i)Audit processes;
(a)F.virlence of the auditor's (ii)SAs and applicable legal and regulatory requirements;
basis for audit report;
and (iii)The business environment in which the entity operates; and
(iv)Auditing and financial reporting issues.
Meaning
Why it is
Example
may
suitable
Chap. enable an experienced auditor to understand:
3
y acc ess audit (a)The nature, timing, and extent of the audit procedures;
(b)The results of the audit procedures performed, and the audit evidence
D o c u m e n t a t io n o f
Chap. 3 Preparation for an Audit 49
u,r
- ThusTJlT t h e A u d it
P roced u res obtained; and
P e r f o r m e d a n d show some/ (c)Significant matters arising during the audit and the conclusions
A u d it E v id e n c e reached thereon.
hernial nmtteT
O b t a in e d
,lf
> rule of Auditor shall also record:
Form, Contain (a)The identifying characteristics of the specific items or matters
and Extent of tested;
Aud.:t (b)Who performed the audit work and the date such work was
isclose The auditor shall completed; and
prepare audit (c)Who reviewed the audit work performed and the date and extent of
documentation that such review.
onfidentialit is sufficient to If the auditor identified inconsistent information, the auditor shall
document how the auditor addressed the inconsistency.
If, in exceptional circumstances, the departs from SA, the auditor shall document the reasons for the departure and alternative procedures
performed.
Departure from a
Relevant If, in exceptional circumstances, the auditor performs new or additional audit procedures or draws new conclusions after the date of the auditor's
Requirement report, the auditor shall document:
1. The circumstances encountered;
sments.
Matters Arising 2. The new or additional audit procedures performed, audit evidence obtained, and conclusions
after the Date of reached, and their effect on the auditor's report; and
the Auditor's 3. When and by whom the changes to audit documentation were made and reviewed.
Report
Assembly of the
SAs The auditor shall assemble the audit documentation in an audit file and complete the administrative process of assembling the final audit file on a
FinnI Audit File timely basis after the date of the auditor's report. After the assembly, the auditor shall not delete audit documentation before the end of its
and ng: retention period.
"ect and
J
egal,
3.14 TEST CHECKING / SAMPLING - BASICS
audit
king
)
nic
ific
Cho
50 Bestword's Auditing and Assurance CM Chap. 2
Meaning Test checking means examining less then 100% of items in the population. T)
St
Why it is required i)Auditor usually doesn't have enough time for detailed 100% examination.
ii)Number of transactions / Balances are generally very high.
iii)Mostly items are identical.
iv)If, on basis of compliance procedures, it is concluded that internal control system is very effective,
there is no need for detailed 100% examination.
Examples where it i)Cheking bank reconciliation statement.
may not be suitable
ii)Few transactions, very high in amount.
Precautions (i)
while Thorough study of The flow of transactions should be completely studied bdl adopting
conducting test accounting system sampling.
cheeking (how to
make sampling
Meaning
Type-I effective)
Judgmental (ii) Thorough study of I.C. Proper study of internal control system helps the auditor to de^i^E
sampling System. further test check plans.
Example (iii) Areas not suitable for Auditor should take care to ensure that detailed complete chedifl is
sampling done for required items (as above).
Advantages (iv) Proper planning Proper plan for test cheking should be devised & explained® audit
staff.
, (v) Classification Transactions & Balances should be classified & statiM,®
The
(vi) number of items in a sample should be appropitj
Sample size
determined.
required.
(vii) No
Sample should bias be chosen in unbiased way.
(viii) Analysis of
Errors found in sample misstatement should be analysed properly.
2.Expected
M eth o d -I Meaning i)All items have equal chances of selection. Error
ii)It may involve use of random number table. 3.Samplin
R andom
Risk
iii)It can be of two types i.e. simple random or stratified random.
S a m p lin g
iv) (1) Simple Random i)Each item of population (for Eg. :- each debtor) has equal chance of
Sampling selection.
ii)It can be chosen by
use of random number table, help of computer.
Picking up number in a random way.
iii)Suitable for Homogeneous population (population having similar items).
For example:- Debtors ranging from Rs. 5,000 to 15,000.
D C
3,00,001 -5,00,000 1,00,001 -3,00,000
(1) Block
Sampling
In
Comp
(2) Cluster
sampling In
Substi
Effect
54 Bestword 's Auditing and Assurance
(5)
Nu 316
factq^F^CTIN^IZ^^^MP^
i)Tolerable Error
into ii)Expected Error F a c to rs
iii)Sampling Risk
1.
T o le r a b le
can E r r o r => Maximum Error in population that auditor is ready to
accept for a given sample size. => If smaller tolerable
error, big sample size is needed.
In compliance procedure Maximum rate of deviation from
I E x p e c te destablished procedure of I.C.
E r r o r I In substantive procedure j Maximum monetae error.
S a m p lin g => If auditor expects possibility of error in population,
R is k larger sample size is required. If population is expected to
be free of misstatement, smaller sample size is needed.
1.It arise from possibility that
=> Auditor's conclusion based upon sample,
=> May be different from,
=> Conclusion that would have been reached,
=> If same audit procedures were applied on entire population.
2.It is always in sampling.
3.If acceptable sampling risk is low, large sample is needed.
4.It arises in both compliance procedures & substantive procedure.
In Risk of under Based upon sample, auditor concludes that I.C. system is not
compliance reliance adequate, however actually it is not so.
procedure
Risk of over Based upon sample, auditor concludes that I.C. are very effective &
reliance thus decides to rely on them, however it is not so in reality.
In Risk of incorrect Based upon sample, auditor concludes that transactions/ balances are
substantive Rejection materially misstated, whereas in fact these are not.
procedure
Risk of incorrect Based upon sample auditor concludes that transactions/ balances are
Acceptance not materially misstated while in fact these are misstated.
lead to
erroneous