Planning conduct and Impact of Audit

Planning, conduct and Impact of AuditA presentation: Ram Mohan JohriPrincipal Accountant General ( Audit)Himachal Pradesh

1What are the main reasons for audit planning?- to enable the auditor to obtain sufficient appropriate evidence- to help keep audit costs reasonable- to avoid misunderstandings with the client2Audit PlanningAddresses the specifics of what, where, who, when and how:What are the audit objectives?Where will the audit be done? (i.e., scope)When will the audit(s) occur? (how long?)Who are the auditors?Who are the initial interviewees?How will the audit be done?

3 Audit Planning Planning is required for :

Selection of Audit team with suitable qualifications and experience.Assessment of need for specialists.Determination of probable time period in which audit is to be carried out for better utilisation of audit resources and coordination among constituent elements.4Audit ObjectivesTransaction-related1. Existence2. Completeness3. Accuracy4. Classification5. Timing6. Posting and summarizationBalance-related1. Existence2. Completeness3. Accuracy4. Classification5. Cutoff6. Detail tie-in7. Realizable value8. Rights and obligations9. Presentation and disclosure5 Audit process

6Stages of an Audit Process

72. Obtain an Understanding of the Client and its EnvironmentPerform risk assessment procedures, includingInquiries of management and others within the entityAnalytical proceduresObservation and inspection relating to client activities, operations, documents, reports and premises.Other procedures, such as inquiries of others outside the company (e.g., legal counsel, valuation experts) and reviewing information from external sources such as analysts, banks, rating organizations, journals.8Understanding the Clients BusinessNature of the Auditee UnitCompetitive positionOrganizational structureAccounting policies and proceduresOwnershipCapital structureProduct and service linesCritical business processesInternal control

9Understanding the Clients Business,Industry, Regulatory, and Other FactorsCompetitive environmentSupplier and customer relationshipsTechnology developmentsMajor laws and regulationsEconomic conditionsAttractiveness of the industryBarriers to entryStrength of competitorsBargaining power of suppliers of raw materials and laborBargaining power of customers

10Understanding the Clients BusinessObjectives, Strategies & Business RisksObjectivesOverall plansOperating and financial strategiesOperational actions to achieve objectivesBusiness risksThreats to achieving objectives

11Understanding the Clients BusinessMeasuring and Reviewing PerformanceBudgetsKey performance indicatorsVariance analysisSegment performance reportsBalanced scorecardExternal parties

12Understanding the Clients Business Internal ControlNeed knowledge and understanding of how a clients internal control works:What controls existsWho performs themHow various types of transactions are processed and recordedWhat accounting records and supporting documentation exist13Understanding the Clients BusinessSources of InformationInquiries of managementIndustry Accounting and Auditing GuidesIndustry Risk AlertsTrade journals and news storiesGovernment publicationsPrior company annual reports and SEC filingsPrior tax returnsElectronic sources e.g. web pages for companyTour of plant and officesAnalytical proceduresThe statement of cash flows and obtaining an understanding of the client14Transaction cyclesAuditors consideration of internal control is often organized around clients major transaction cycles (examples)Revenue cycleAcquisition cycleConversion cyclePayroll cycleInvesting cycleFinancing cycle15Determining MaterialityUse professional judgment and based on reasonable personConsiders both Quantitative and qualitative factorsMateriality used inPlanning the auditAt the overall financial statement levelAllocate to individual accountsEvaluating audit findings163. Assess the Risks of Material Misstatement and Design Further Audit ProceduresOverall approachWhat could go wrong?How likely is it that it will go wrong?What are the likely amounts involved?Particularly considerInherent risksRisks of material misstatement due to fraud (fraud risks)Design further audit procedures17Assessing Fraud Risks Identifying Fraud RisksConsiderations in identifying fraud risksType SignificanceLikelihood that it will result in a material misstatementPervasiveness

18Assessing Fraud RisksTwo typesFraudulent financial reporting (management fraud)Misappropriation of assets (defalcations)Procedures to assess fraud risksDiscussion among engagement teamInquiries of management and other personnelRisk assessment analytical procedures (to aid in planning the audit)Considering fraud risk factors IncentivesOpportunityAttitude

19Responding to Fraud RisksOverall responseProfessional skepticism and audit evidenceAssigning personnel and supervisionAccounting principlesPredictability of auditing proceduresAlterations in audit proceduresMore reliable evidenceShifting timing to year endIncreasing sample sizesResponse to the possibility of management overrideExamining journal entriesReview accounting estimates for biasesEvaluating the business rationale for significant unusual transactions

20Consideration of Fraud Throughout the AuditEvaluating the results of audit testsDiscovery of fraudCommunication to appropriate level of managementIf fraud involves senior management or material misstatement communicate to audit committee

21Audit ProgramSystems portionDeals with clients internal controlEvidence of test of controls and assessing control riskSubstantive test portionDeals with financial statement account balancesIndirect and direct verification of income statement accounts

22Audit ProgramTests of controls and substantive tests of transactionsAnalytical proceduresTests of details and balancesIt is convenient to think of the audit program as consisting of the three major classes of tests:2323Summary of the Audit ProcessPhase IPlan and designan audit approach.Phase IIPerform tests ofcontrols andsubstantive testsof transactions.Phase IIIPerform analyticalprocedures andtests of detailsof balances.Phase IVComplete theaudit and issuean audit report.24Summary of the Audit Process:Phase IPerform initial planning.Understand the clients business and industry.Assess clients business risk.Perform preliminary analytical procedures.25Summary of the Audit Process:Phase ISet materiality and assess acceptableaudit risk and inherent risk.Understand internal control and assess control risk.Gather information to assess fraud risks.Develop overall audit plan and audit program.26Summary of the Audit Process:Phase IIPerform substantive tests of transactions.NoYesPerform tests of controls.Assess likelihood of misstatements infinancial statements.Plan to reduceassessed levelof control risk?27Summary of the Audit Process:Phase IIIPerform analytical procedures.Perform tests of key items.Perform additional tests of detailsof balances.LowMediumHigh orunknown28Summary of the Audit Process:Phase IVReview for contingent liabilities.Review for subsequent events.Accumulate final evidence.Evaluate results.Issue audit report.Communicate with auditcommittee and management.29Relationship Between Types of Tests and Evidence Type of TestProcedures for I/CTests of controlsSubstantive T.O.T.Analytical proceduresTests of detailsPhysicalexaminationConfirmationDocumentationObservationType of EvidenceInquiries ofthe clientReperformanceAnalytical3030Design Further Audit ProceduresFurther audit procedures should includeSubstantive procedures for all relevant assertionsTests of controls when the auditors risk assessment includes an expectation that controls are operating effectively, or when substantive procedures alone are not sufficientProcedures should be linked with the assessed risks of material misstatement at the relevant assertion levelOverall responses when assessed risks of material misstatement are highHeightened professional skepticismAssigning more experienced staffAssigning staff with specialized skillsProviding more supervision

31Audit TrailA trail of evidence that links source documents, journal entries and ledger entriesAuditor may follow the audit trail in either of two directions related to the direction of testingTest for existence or occurrenceTest for completeness32Direction of Audit Testing

33Impact of Information Technology on Audit TestingComputer assisted audit techniques (CAATS)may be used to test automated controls or data.Reports produced by IT may be used to testthe effectiveness of IT general controls.Program change controlsAccess controls3434Variations in Evidence Mix

35An Example :Objectives of Substantive Programs for Asset AccountsEstablish the existence of assetsEstablish that the company has rights to the assetsEstablish the completeness of recorded assetsVerify the cutoff of transactionsDetermine the appropriate valuation of the assets and accuracy of related transactionsDetermine the appropriate financial statement presentation and disclosure of the assets3674Relationships among Audit Objectives, Risks of Material Misstatement, and Audit Procedures

37What are working papers?proceduresappliedinformationobtainedconclusionsreachedtestsperformedauditor records of:38Working papersWorking papers also provide:- a basis for planning the audit- a record of the evidence accumulated and the results of tests- data supporting the audit reportTheir objective is to aid the auditor in providing reasonable assurance that anadequate audit was conducted inaccordance with GAAS.39Impact of AuditIt is carried out after a period of 3 to 5 years of the conduct of audit.It is done to know whether remedial action has been taken in respect of the deficiencies pointed out in audit.It is done to know the extent to which recommendations have been implemented.It gives useful data about the areas of focus in subsequent audit exercises.Complete the audit exercise and helps to access the extent to which it is meaningful.40Thank You41