AUDIT CYCLE

By
Prof. Dr Safdar Ali Butt
Audit Cycle

Essentially an external audit takes the following course:

• Appointment of an external auditor
• The Audit File
• Assessment of Internal Controls
• Audit Programs
• Audit work and techniques
• Audit Report

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Appointment

• Mode of appointment
• Eligibility for appointment
• Initial inquiries
• Acceptance or Engagement Letter

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Mode of Appointment

• Shareholders appoint the external auditors at Annual General

Meeting.
• Auditor’s name is proposed and seconded by shareholders. If more
than one name is proposed, an election takes place.
• Before an audit firm’s name is proposed, their prior consent should
be taken by the proposer.

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Who can be appointed
an external auditor?
• Must have a practicing license. This means he should be a qualified
chartered accountant or equivalent.
• In Pakistan, most external audits of companies are performed by
auditing firms rather than individuals.
• SBP and SECP have rated/classified audit firms according to their
strength and experience, etc.

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Who cannot be appointed
an external auditor?
• An employee or director of the company.
• A person who is a spouse, partner or servant of an
employee of the company.
• A debtor or a beneficiary of the company.
• A company.
• A person who has been for any legal reason
disqualified from being the auditor of the company,
or any of its subsidiary or holding company.

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Appointment by
Partners or sole traders
• The sole trader can appoint the external auditor himself.
• In case of partnership, the majority of partners can appoint the
external auditor.

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Rights of an auditor

• Access to all books and records of the company, where ever they may
be.
• Raise queries or ask for any information needed by him and get it.
• Attend and speak at AGMs.

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Removal of Auditor

• Resignation or voluntary
• Forced removal:
• Only at General Meeting of shareholders.
• Permission of SECP
• Auditor has a right to make a representation at shareholders meeting.

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Acceptance of Appointment

• Upon passing of the resolution of his appointment, the external

auditor is notified.
• Some negotiation on terms and fees etc must take place before the
external auditor gives his preliminary consent.
• The external auditor takes certain steps before he formally accepts
the appointment.

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Initial Steps

• Study the relevant laws and statutes.

• Study the relevant legal documents like Articles and Memorandum of
the company.
• Ascertain the general nature of the company’s business.
• Get a list of all books of accounts and supporting records, manuals,
charts, etc.

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Initial Steps: continued

• Seek confirmation from previous external auditor

where applicable.
• Get a copy of published accounts, supporting
schedules and audit reports of previous few years.
• Review his own resources to handle the job.
• Having taken the above steps, the external auditor
gets into a position to decide whether or not to
accept the appointment.

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Engagement Letter

• No appointment letter is issued to an external auditor.

• Instead, the external auditor issues an Engagement Letter outlining
the scope and terms of his assignment.
• The company must accept the Engagement Letter and abide by its
provisions.

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Audit Files

• Permanent file
• Current file

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Permanent Audit File

• Statutory documents of the company e.g. articles and memorandum

of association.
• General description of the company’s business.
• List of accounting records, responsible officers, organizational chart,
etc.
• Internal control manuals
• Any other document that has long term importance to the audit.

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Current Audit File

• Engagement letter
• Current accounts, ratios and supporting schedules
• Completed ICQs
• Record of queries raised and answers obtained during the audit
• Minutes of relevant meetings
• Any other document of importance relating to current year’s audit.

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Audit Note Book

Each employee assigned to the audit is provided an Audit Note Book in

which he records whatever steps or acts he personally takes in the
course of the audit, e.g. queries raised, answers received, daily
progress, significant totals and balances, stage of audit reached at the
end of each day or week, minutes of meeting held with client’s staff,
etc.

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Audit Working Papers

• The contents of the Current File and Audit Note Books are called
Auditing Working Papers.
• They provide a detailed record and reference to audit work carried
out.
• Form basis of auditors’ fee is based on hourly charge.
• Keep track of audit staff’s performance
• Ensure comprehensive coverage.

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Assessing Internal Control

Before the audit commences, the external auditor

evaluates the internal control system of the
company. In this regard:
• The first step is to find out what internal controls
exist. This is done by preparing Internal Control
Questionnaires.
• The second step is to assess how effectively the
system is actually enforced. This is done by test
checking the answers to ICQs.

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Internal Control Questionnaires

• An ICQ is simply a list of short questions, capable of

being answered in only a few words, prepared to
find out how a company handles a particular part of
its accounting work or records. A large number of
ICQs are prepared to ensure complete coverage of
all aspects of all accounting records.
• ICQ are prepared by senior managers and answers
to the questions are completed by junior audit staff.
• Completed ICQ are reviewed by a senior manager
before Audit Programs are drawn up.

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Audit Program

An Audit Program is an actual plan of audit work. A

large number of APs are prepared to cover the
various activities of the company, as one AP covers
only one aspect. It contains:
• The list of tasks to be performed by audit workers;
• Instructions on how to perform them;
• Depth and breadth to which audit work must be
done.
• How to record the findings.

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Using Audit Programs

• AP is prepared by senior audit managers after

reviewing the findings of ICQs.
• The actual audit work is done by junior audit staff.
• Completed APs are reviewed by audit seniors and
further test checks may be made by them to ensure
their validity.
• Standard Audit Programs (SAPs) may be used for
routine, common aspects of accounting records and
tasks.

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Advantages of APs

• Clear set of instructions to audit staff.

• Comprehensive coverage of audit work.
• Work is done in organized, systematic manner.
• Record and proof of work done.
• Pin point responsibility of who did what part of the
audit work.
• Better handling of audit staff
• Training of audit staff.

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Disadvantages of APs

• Make work mechanical.

• Rigidity and inflexibility
• May inhibit efficient audit staff.
• Inefficient staff simply aim at completing the AP and hide behind it.
• If clients’ staff gets to know about contents of AP, they can rig
records.

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Detailed Audit Work

• Once APs have been prepared, actual checking work commences.

Audit staff start doing work according to APs.
• Audit senior keep reviewing the work of juniors through checks and
notes books.
• Completed APs are studied by seniors.
• If deemed necessary further checks may be carried out.

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Completion of Audit Work

Once detailed audit work has been done, the audit seniors form an
opinion on the work done. This is communicated to the client in two
ways:
• Audit Report
• Management Letter

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Audit Report

It states that:
• Auditor has gone through the financial statements and
related records
• He has obtained all necessary information needed for his
work.
• The accounting records have been kept in accordance with
relevant laws.
• Financial statements are correctly based on accounting
records.
• Financial statements reflect a true and fair view of the profit
or loss made by the company and the company’s financial
position at the balance sheet date.

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Management Letter

• Sent to Management of the Company.

• Lists weaknesses of the internal control systems.
• May also give suggestions for improvements.
• It does not absolve the auditor of his basic responsibility.

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Audit Committee

• Required by code of corporate governance.

• Formed by Board of Directors to oversee all internal and external
audit matters.
• External auditor deals with the company through the chairman of
audit committee.
• Internal auditor also reports to chairman of audit committee.

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