Lecture - Chapter – 1

10 “Standards on Auditing”
(5) SA – 505 “External Confirmations”

(a) Meaning of External confirmation:

Audit Evidence obtained as a direct written response to the auditor, from a third

party (confirming Party) in paper, electronic or other form.

(b) Areas where external confirmations may be used:

(i) Bank balance and Other confirmation from bankers

(ii) Account Receivable/Account Payable Balances

(iii) Stock Lying with Third Parties

(iv) Property Title Deed held by third parties

(v) Investments Purchased but delivery not taken.

(vi) Loan from Lenders

(vii) Terms of agreement or Transaction with Third Parties

(c) Types of confirmation requests:

(I) Positive Request: A request that confirming party respond to the auditor

indicating

- whether it agree or disagree with the info. requested

or

- providing the information.

(II) Negative Request: A request that confirming party will respond to auditor

only when it disagrees with the requested information.

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(d) Effects of +ve and – ve requests:

- Response to a +ve request may be considered as sufficient appropriate audit

evidence on which auditor may draw the conclusion unless the doubt arises.

- Negative requests provides a less persuasive audit evidence as compared to +ve

request. Hence, limited use of -ve request is recommended and should be used

used only when below mentioned conditions are satisfied:)

(a) Lower Risk of Material Misstatement.

(b) Population comprises of large no. of transactions of homogenous nature

of small amounts.

(c) Expected deviation rate is low.

(d) Auditor is not aware of any circumstance that 3rd party will disregard

the request.

(e) Steps to be followed:

Step – 1: Determine the information to be confirmed

Step – 2: Select the Confirming Party

Step – 3: Designing of Confirmation request

Step – 4: Sending the request including follow-up

Factors to be considered in designing a confirmation request:

(i) Assertion being addressed.

(ii) Specific identified RMM.

(iii) Layout & presentation of request.

(iv) Prior experience on the audit of similar engagements.

(v) Method of communication.

(vi) Management authorisation / encouragement to Confirming Party to respond to

auditor.

(vii) Ability of Confirming Party to provide/confirm requested info.

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(f) Special Situations:

Auditor ask management for E.C.

(A) Management refuses (B) Management Agree

Inquire the reasons Reply not received Reply received

and

collect Evidences as to Perform alternate audit Procedures

validity and reasonableness

of management reasons SAAE not obtained

Modify the opinion

Reasons Satisfactory Non Satisfactory

Perform Alternate – Communicate to TCWG

Audit Procedure - Evaluate its effect on Audit

and Audit opinion

3rd party 3rd party Doubtful Non Reliable

disagree agree reply reply

(Exception arises)

Inquire further Consider it as Perform Evaluate its

to identity SAAE (unless additional effect on audit

instances of doubt arises) procedures to and audit opinion

misstatement (if any) resolve doubts

DO Practice – Questions on SA 505

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(6) SA – 520 “Analytical Procedures”
(a) Scope of SA – 520: SA – 520 deals with the use of Analytical procedures as

Substantive Analytical Procedures (SAP).

Note: - Application of Analytical Procedures as RAP are covered in SA 315.

- Use of SAP as sole Substantive Procedures is generally not advisable. SAP

should be used in combination with ToD (i.e. Vouching & Verification.

(b) Meaning and Nature of AP: Analytical procedures may be defined as

- Procedures used to evaluate financial information, by

establishing relationship among financial and non – financial data,

and

- also includes investigation of identified fluctuations.

Analytical procedures comprise of:

(i) Consideration of Comparison: of entity financial information with

(i) Prior period information; or

(ii) Budgeted (anticipated) information; or

(iii) Industry averages

(ii) Consideration of relationship: among

(i) Elements of financial information.

(ii) Elements of financial & Non–Financial info.

(c) Audit Procedures while applying Analytical Procedures:

Step -1: Determine the suitability of Particular SAP:

SAPs are generally more suitable for large volume of transactions that

can be predicted over a time period.

For Example: Room rent in case of a hotel can be predicted as:

No. of rooms X Occupancy X 365 days X Tariff

In a category Ratio per day

For Example: Employee salary can be predicted as:

No. of employees X Avg. salary p.m. X 12 Months

of a grade scale

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- Different types of SAPs will provide different levels of assurance to

the auditor.

For Example: In a particular circumstance, comparison of one financial

information with other period information may be

considered more suitable than comparison with industry

averages or budgeted information.

- Suitability of SAP may ne considered on the basis of extent of tests

of details performed on the same assertion.

Step -2: Evaluate the reliability of data:

Reliability of data depends upon the following factors:

(a) Source of information available.

(b) Comparability of information.

(c) Nature and relevance of information,

(d) Controls over the preparation of information.

Step – 3: Develop an expectation of Recorded Amount / data:

Expected amount can be determined by applying the selected SAP over

the data.

Step – 4: Determine the tolerable range of Misstatement for which no further

investigation is required:

Difference of actual recorded amount with expected amount should not

exceed tolerable range.

Step – 5: Investigation of identified fluctuations:

If differences arises beyond tolerable range of misstatement, auditor

shall -

(a) Inquire the management and obtain SAAE for their replies.

(b) Perform other audit procedures as seems appropriate.

DO Practice – Questions on SA 520

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(7) SA – 530 “Audit Sampling”

(a) Meaning of Sampling:

Application of audit procedures over less than 100% of population

so as to frame conclusion on entire population

Sampling is of two types: (a) Statistical Sampling

(b) Non statistical Sampling

Sampling which uses the probability theory and random

selection of samples is known as Statistical Sampling.

(b) Sampling Risk:

- Risk that opinion expressed by auditor on the basis of samples may differ from

the opinion, if entire population was subject to audit procedures.

- Sampling risk may be classified as risk of over reliance and risk of under

reliance.

Risk In relation to ToC In relation to Tod Impact

Auditor may Auditor may conclude It affects audit

conclude that I.C. that no effectiveness due to

Over
are effective when misstatements exist, wrong conclusions.
Reliance
actually they are but actually,

not. misstatement exist.

Auditor may Auditor may conclude It affects audit

conclude that I.C. that misstatements efficiency to

Under are not effective exists, when actually conclude that initial

Reliance when actually they they do not exist. conclusions were

are. wrong.

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(c) Stratification, tolerable misstatement and tolerable range of deviation:

Stratification: to convert heterogenous population into homogenous

groups.

Tolerable Misstatement: Auditor’s range of acceptability of misstatement, i.e.

misstatement below performance materiality.

Tolerable rate of deviation: acceptable level of weakness identified during evaluation

of internal controls.

(d) Auditor’s considerations while applying sampling:

Step – 1: Sample design, size and selection:

- Population should be appropriately designed to ensure that

samples selected represent the entire population.

For this purpose, stratification may be applied.

- Size of the samples to be selected should be sufficient enough

so as to reduce the audit risk to an appropriate level.

- Selection of samples should be made in such a way that no

no biasness entered into selection and every transaction has an

equal chance of selection.

- Selection methods that can be applied are:

(1) Random selection

(2) Systematic selection

(3) Haphazard selection

(4) Block selection

(5) Monetary Value selection

Step – 2: Perform audit procedures over selected items:

- Auditor should perform designed procedures over the selected

items.

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- If designed audit procedure cannot be applied over the selected

items, auditor shall

(a) Perform designed AND (b) Perform Alternate

audit procedure audit procedures

over replacement samples over Original Samples

Step – 3: Evaluating the results of procedures performed over the samples on

entire population:

- Evaluate the result of sampling to conclude that whether results

of examination of sample can be applied to entire population.

- If no, determine the other procedures to be performed over

remaining population.

(e) Factors affecting determination of sample size: ---- Self Study from Book ----

Do Practice – Questions on SA 530

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