Selection of Audit Procedures

Selection  of  the  appropriate  audit  procedure  is  again  a  matter of  experience  and judgment. Take extreme example of contingent liability in respect of pending suits : no entry or other records for this would be available to the auditor; verification of the estimate of the liability  would become difficult for lack of basis. In such cases it would be more reasonable for the auditor to get the estimate confirmed by the solicitors of the company. In addition, he should  examine the correspondence pertaining to the case and should discuss the matter with the  company’s officials. If the company was involved in a similar suit in the past, by going through the records thereof; the auditor would be able to pull out relevant considerations for estimating the liability. In any case the auditor is not precluded from making his own estimate on the basis of similar cases reported in the law journals.

The  normal  procedure  for  verification  of  cash  balance  is  counting  but  this  is  not practicablein respect of the cash-in-transit. The auditor has to think in advance about the possibilities of departure from the normal procedure and the areas likely to be affected thereby. The procedure should provide for such situations in the programme.

It has been emphasised earlier that all available evidence should be used by the auditor but it is not intended to stretch it too far. Sometimes evidence collection becomes costly both in terms of  money and time involved. If you are checking the cost of a building constructed by the client in addition to having recourse to all internal evidence, you may have  the  temptation  of  getting  an  independent  valuation  certificate  by  a  professional valuer. This would be an unwise course in the absence of any suspicious circumstances- it would cost the company a lot of money for procuring that evidence for the satisfaction of the auditor; it may also give rise to an unwarranted feeling suspicion about the bonafide of the  management, though there was no evidence available with the auditor to suggest it. The auditor must be cautious and reasonable in his attitude. If, however, the situation was otherwise, i.e., the evidence normally made available to the auditor failed to provide him with satisfactory evidence about the cost incurred, it may be absolutely necessary for him to insist on an independent valuation.

While collecting audit evidence through an audit procedure, the auditor collects the same by employing  different  techniques.  In  order  to  verify  a  particular  item  in  financial statements, say, cash, he may have to collect audit evidence from different sources. For instance, in case of cash at bank, reference may be made to bank column in cash book, reference to bank reconciliation        statement followed by examination of bank statement/bank pass book. Further, the auditor may like to obtain confirmation from the client’s  asset. During all this process, the auditor would have to see that audit evidence obtained from  different sources does not contradict each other and the cost of obtaining more  and  more  audit  evidence is  justified by  the  benefit flowing from  obtaining such evidence.

Possibility of fraud and error is ruled out while framing the audit programme. The auditor should   prescribe  procedures  and  techniques  keeping  this  possibility  in  view.  If  he undertakes a  review and testing of internal controls and checks before or while drawing up the programme, he  would reasonably be in a position to focus his attention on the matters where this possibility is  rather great. The consideration of the auditor should be specifically directed to provide for the discovery of serious errors and frauds, the potential of  which  is  great.  The  possibility  of  other  errors  which  are  generally  not  of  great consequence can be left open to be observed and  discovered in the course of normal evidence collection process.

Co-ordination of the procedures : Knowledge about accounting may be conveniently used in assembling the procedures in the most rational and natural manner. Fixed assets, like plant and machinery or buildings are directly linked with charges for repairs, maintenance and depreciation;  purchase is linked with inward freight and sales with outward freight, sales  tax  and  excise  duty;  earnings  from  investments  bear  a  relationship  with  the investments. Hence, in assembling the procedures and methods, if the related items are grouped  together,  the  programme  becomes  cohesive,  comprehensive, purposeful  and easy to  coordinate; the work can also he conveniently distributed amongst assistants on the basis of the groupings so that, say the assistant assigned the work in connection with plant and machinery  would be responsible for carrying out also the related work, e.g., repairs and depreciation. This  would help easy flow of work with the least possibility of any information gap to the assistant concerned.

Steps involved in the process of Audit

The scheme of auditing process involves the following :

1.    Formulating audit programme on the basis of knowledge of client’s business.

2.    Determination of the extent of checking on the basis of compliance procedures.

3.    Carrying out the steps  in the  procedure on the  basis of  programme and the extent  of 

        substantive checking that may be required.

4.    Keeping a record of notes and inquiries and maintenance of working papers.

5.    Formulation  of  opinion  about   financial   statements  and   review  with   reference   to  

accounting standards.

6.    Issuance of the audit report.

Audit Techniques

For  collection  and  accumulation  of  audit  evidence,  certain  methods  and  means  are available  and these are known as audit techniques. Some of the techniques commonly adopted by the auditors are the following :

1. Posting checking
2.Casting checking
3.Physical examination and count
4.Confirmation
5.Inquiry
6.Year-end scrutiny

7.Re-computation
8.Tracing in subsequent period
9.Bank Reconciliation

The  two  terms,  procedure  and  techniques,  are  often  used  interchangeably;  in  fact, however,  a distinction does exist. Procedure may comprise a number of techniques and represents the broad frame of the manner of handling the audit work; techniques stand for the methods employed for carrying out the procedure. For example, procedure requires an examination of the documentary evidence. This job is  performed by the procedure known as vouching which would  involve techniques of inspection and checking computation of documentary evidence. As per SA-500 on Audit Evidence, basically audit procedures are broadly of two types viz. compliance  procedures and tests of detail. Test of details are further comprised of  substantive audit  procedures  and  analytical  review  procedures.

Vouching is a substantive audit procedure which involves audit techniques like casting, cross-casting, checking of  posting, etc. On  the other hand, verification of  assets and liabilities  is a substantive audit procedure which involves application of audit techniques like physical examination, confirmation from third parties, etc

Audit Planning

Audit Planning

As per Auditing and Assurance Standard 1, “Basic Principles Governing an Audit”, Audit Planning is one of the basic principles.

 Accordingly, it states “The  auditor  should  plan  his  work  to  enable  him  to  conduct  an  effective  audit  in  an efficient and timely manner. Plans should be based on knowledge of the client’s business.

Plans should be made to cover, among other things :

(a)   acquiring knowledge of the client’s accounting systems, policies and internal control procedures;

(b)   establishing the expected degree of reliance to be placed on internal control;

(c)   determining and programming the nature, timing, and extent of the audit procedures to be performed; and

(d)   coordinating the work to be performed.

Plans should be further developed and revised as necessary during the course of the audit.”

SA-300 further expounds this principle. According to it, planning should be continuous throughout the engagement and involves :

     developing an overall plan for the expected scope and conduct of the audit; and

       developing  an  audit  programme  showing  the  nature,  timing  and  extent  of  audit procedures.

Changes in conditions or unexpected results of audit procedures may cause revisions of the overall plan of and the audit programme. The reasons for significant changes may be documented.

Objectives of Planning : Adequate audit planning helps to :

 ensure that appropriate attention is devoted to important areas of the audit;

     ensure that  potential problems are promptly identified;
       ensure that the work is completed expeditiously;
        utilise the assistants properly; and
       co-ordinate the work done by other auditors and experts.

In planning his audit, the auditor will consider factors such as complexity of the audit, the environment  in which the entity operates, his previous experience with the client and knowledge of the client’s business.

The auditor may wish to discuss elements of his overall plan and certain audit procedures with the  client to improve the efficiency of the audit and to coordinate audit procedures with  work  of  the  client’s personnel. The  overall audit  plan  and  the  audit programme,however, remain the auditor’s responsibility.

Audit Objective

The auditor must gather sufficient competent evidential matter as a basis for forming his opinion on :

 (a)  the truth and fairness of the accounts and also their compliance with the provisions of the related laws, rules and regulations;

(b)   the proper keeping of the accounting records, and other records and related registers of the client.

These broad objectives may be amplified as follows :

To determine whether :

(1)   all assets and liabilities are properly stated and classified on a basis consistent with that of the previous year;

(2)   proper disclosure is made of securities for  liabilities and of assets charged or secured;

(3)   the client has complied with the provisions of the applicable laws and documents created under them, loan agreements and other documents to which he is a party;

(4)   income and expenses are properly classified and disclosed and are properly matched.

They relate to the period in which they are reported and have been determined on a basis consistent with that of the previous year;

(5)   all contingencies and commitments are properly disclosed;

(6)   no material omissions have been made in the financial statements;

(7)   no material error or inaccuracy in reporting or disclosing income, expenses, assets and liabilities has been created in the financial statements;

(8)   the books and records have been properly kept in accordance with the requirements of the client.

The  expression  of  opinion  on  the  overall  balance  sheet  and  profit  and  loss  account involves initially forming an opinion on each of the balance sheet or profit and loss items; it is necessary first to decide what are the essential conditions or pre-requisites for each balance sheet or profit and loss account item in order to give a true and fair view of the particular assets or liabilities  or  item of income or expense being represented. These conditions are well established and may be illustrated by reference to the areas of sundry debtors and sales revenues.

Sundry Debtors : The audit of sundry debtors should be sufficiently comprehensive to enable the auditor to form an opinion as to whether :

(1)   The amounts shown represent bonafide receivables of the company.

(2)   The receivables are properly classified.

 (3)  Adequate provisions have been made for uncollectible receivables and for discounts and freight allowable, returns adjustments, etc.

(4)   Any receivables have been pledged, discounted, assigned or sold, and if so whether they are properly disclosed.

Sales Revenues : Specific objectives in the audit of sales revenues are to determine whether:

(1)   Sales accounting procedures are operating effectively to produce reliable sales revenue figures for the period.

(2)   Sales  revenues  have  been  recorded  in  the  proper  accounting  period  and  are  not overstated through improper credits for fictitious sales of goods neither supplied nor set aside.  Conversely, whether sales or other revenues are understated through deferring the recording  thereof to subsequent periods or omitting to record sales despatched as sales.

(3)   Allowance, returns and other sales deductions are fairly stated and properly treated in the financial statements and that adequate provisions have been made for any significant additional amount that may be anticipated to be paid but not yet finally settled.

(4)   Non-operating revenues have been segregated from sales revenues and have been appropriately treated in the profit and loss statement.

Auditing : Knowledge of the Client’s Business

It is one of the important principles in developing an overall audit plan. Infact without adequate  knowledge  of  client’s  business,  a  proper  audit  is  not  possible.  SA-310  on “Knowledge of the Business” deals in detail about the significance of such knowledge on the part of the auditor.

The auditor needs to obtain a level of knowledge of the client’s business that will enable him to  identify the events, transactions and practices that, in his judgment, may have significant effect on the financial information. Among other  things, the auditor can obtain such knowledge from :

     The client’s annual reports to shareholders.

     Minutes of meetings of shareholders, board of directors and important committees.

     Internal financial management reports for  current and previous periods, including budgets, if any.

     The previous year’s audit working papers, and other relevant files.

     Firm personnel responsible for non-audit services to the client who may be able to provide information on matters that may affect the audit.

     Discussions with client.

     The client’s policy and procedures manual.

     Relevant publications of the Institute of Chartered Accountants of India and other professional bodies, industry publications, trade journals, magazines, newspapers or text books.

     Consideration of the state of the economy and its effect on the client’s business.

     Visits to the client’s premises and plant facilities.

With respect to the previous year’s audit working papers and other relevant files, the auditor  should pay particular attention to matters that requires special consideration and decide whether they might affect the work to be done in the current year.

Discussions with the client might include such subjects as :

     Changes in management, organisational structure and activities of the client.

     Current Government legislation, rules, regulations and directives affecting the client.

     Current business developments affecting the client.

     Current or impending financial difficulties or accounting problems.

     Existence of parties in whom directors or persons who are substantial owners of the entity are interested and with whom transactions are likely.

     New or closed premises and plant facilities.

     Recent  or  impending  changes  in  technology,  type  of  products  or  services  and production or distribution methods.

     Significant matters arising from previous year’s financial statements, audit report and management letters, if any.

     Changes in the accounting practices and procedures and in the system of internal control.

     Scope and timing of the examination.

     Assistance of client personnel in data preparation.

     Relevance of any work to be carried out by the client’s internal auditors.

In addition to the importance of knowledge of the client’s business in establishing the overall  audit plan, such knowledge helps the auditor to identify areas of special audit consideration,  to   evaluate   the   reasonableness   both   of   accounting   estimates   and management  representations, and to make judgments regarding the appropriateness of accounting policies and disclosures.

Audit Programme

The auditor should prepare a written audit programme setting forth the procedures that are  needed  to  implement  the  audit  plan.  The  programme  may  also  contain  the  audit objectives for each area and should have sufficient details to serve as a set of instructions to the assistants involved in the audit and as a means to control the proper execution of the work.

In preparing the audit programme, the auditor, having an understanding of the accounting system  and  related  internal  controls,  may  wish  to  rely  on  certain  internal  controls  in determining the  nature, timing and extent of required auditing procedures. The auditor may conclude that relying  on certain internal controls is an effective and efficient way to conduct his audit. However,  the auditor may decide not to rely on internal controls when there are other more efficient ways of obtaining sufficient appropriate audit evidence. The auditor  should  also  consider  the  timing  of  the  procedures,  the  coordination  of  any assistance expected from the client, the availability of assistants, and the involvement of other auditors or experts.

The  auditor  normally  has  flexibility  in  deciding  when  to  perform  audit  procedures. However,  in some cases, the auditor may have no discretion as to timing, for example, when observing the taking of inventories by client personnel or verifying the securities and cash balances at the year-end.

The audit planning ideally commences at the conclusion of the previous year’s audit, and along with the related programme, it should be reconsidered for modification as the audit progresses. Such consideration is based on the auditor’s review of the internal control, his preliminary   evaluation   thereof,  and  the  results  of  his  compliance  and  substantive procedures.

It is desirable that in respect of each audit and more particularly for bigger audits an audit programme should be drawn up. Audit programme is nothing but a list of examination and verification steps to be applied set out in such a way that the inter-relationship of one step to  another  is clearly shown and designed, keeping in view the assertions discernible in the  statements  of  account  produced  for  audit  or  on  the  basis  of  an  appraisal  of  the accounting records of the client. In other words, an audit programme is a detailed plan of applying  the  audit   procedures  in  the  given  circumstances  with  instructions  for  the appropriate techniques to be  adopted for accomplishing the audit objectives. Businesses vary in nature, size and composition; work which is suitable to one business may not be suitable to others; efficiency and operation of internal controls and the exact nature of the service to be rendered by the auditor are the other  factors that vary from assignment to assignment. Because of such variations, evolving one audit  programme applicable to all business under all circumstances is not practicable. However it  becomes a necessity to specify in detail in the audit programme the nature of work to be done so that no time will be wasted on matters not pertinent to the engagement and any special matter  or any specific situation can be taken care of.

To start with, an auditor having regard to the nature, size and composition of the business and the dependability of the internal control and the given scope of work, should frame a programme  which should aim at providing for a minimum essential work which may be termed as a  standard  programme. As experience is gained by actually carrying out the work,  the  programme  may  be  altered  to  take  care  of  situations  which  were  left  out originally, but are found relevant for the particular concern. Similarly, if any work originally provided for proves beyond doubt to be unnecessary or irrelevant, it may be dropped. The assistant engaged in the job should be encouraged to keep an open mind beyond the programme given to him. He should be instructed to note and report significant matters coming to his notice, to his seniors or to the partners or proprietor of the firm engaged for doing the audit.

There should be periodic review of the audit programme to assess whether the same continues  to  be  adequate  for  obtaining  requisite  knowledge  and  evidence  about  the transactions. Unless this is done, any change in the business policy of the client may not be adequately known, and consequently, audit work may be carried on, on the basis of an obsolete programme and, for this negligence, the whole audit may be held as negligently conducted and the auditor may have to face legal consequences. For example, if the audit programme for the audit  of a branch of a financing house, drawn up a number of years ago, fails to take into consideration that the previous policy of financing of a vehicle has been  changed  to  financing   of  real  estate  acquisition,  the  whole  audit  conducted thereunder would be entirely  misdirected  and may even result into nothing more than a farce. [Pacific Acceptance Corporation Ltd. v. Forsyth and Others.]

The utility of the audit programme can be retained and enhanced only by keeping the programme as also the client’s operations and internal control under periodic review so that  inadequacies or redundancies of the programme may be removed. However, as a basic feature, audit programme not only lists the tasks to be carried out but also contains a few relevant instructions, like the extent of checking, the sampling plan, etc. So long as the programme is not  officially changed by the principal, every assistant deputed on the job should unfailingly carry out  the detailed work according to the instructions governing the  work.  Many  persons  believe  that  this  brings  an  element  of  rigidity  in  the  audit programme. This is not true provided the periodic review mentioned earlier is undertaken to keep  the programme as up-to-date as possible and by encouraging the assistants on the job to observe all salient features of the various accounting functions of the client.

An audit programme consists of a series of verification procedures to be applied to the financial  statements  and  accounts  of  a  given  company  for  the  purpose  of  obtaining sufficient  evidence  to enable the auditor to express an informed opinion on such statements. For the purpose of programme construction, the following points should be kept in view :

1.    Stay within the scope and limitation of the assignment.

2.    Determine the evidence reasonably available and identify the best evidence for deriving the necessary satisfaction.

3.    Apply only these steps and procedures which are useful in accomplishing the verification purpose in the specific situation.

4.    Consider all possibilities of error.

5.    Co-ordinate the procedures to be applied to related items.

Amplification is not necessary of the above points except the one under evidence : that is the  very basis for formulation of opinion and an audit programme is designed to provide for that by  prescribing procedures and techniques. What is best evidence for testing the accuracy  of any  assertion  is  a  matter of  expert  knowledge  and  evidence.  This  is  the primary task before the auditor when he draws up the audit programme. Transactions are varied in nature and impact;  procedures to be prescribed depend on prior knowledge of what evidence is reasonably available in respect of each transaction.

By  evidence  we  mean  the  material,  documentary  or  otherwise,  available  to  prove  or disprove  the assertions made in the statement of accounts through the entries in the books of account. For example sales is evidenced by :

i.           invoices raised by the client;

ii.          price list;

(iv)  stock-issue records;

 (iv)  stock-issue records;

(v)   sales managers’ advice to the stock section;

(vi)   acknowledgements of the receipt of goods by the customers, and

(vii)  collection of money against sales by the client.

In  most  of  the  assertions  much  of  the  evidence  be  drawn  and  each  one  should  be considered and weighed to ascertain its weight to prove or disprove the assertion. In this process, an auditor would be in a position to identify the evidence that brings the highest satisfaction to him about the appropriateness or otherwise of the assertion.

You may recall from chapter 2 on basic concepts in auditing that an auditor picks up evidence from a variety of fields and it is generally of the following broad types :

(a)   Documentary examination

(b)   Physical examination

(c)   Statements and explanation of management, officials and employees

(d)   Statements and explanations of third parties

(e)   Arithmetical calculations by the auditor

(f)    State of internal controls and internal checks

(g)   Inter-relationship of the various accounting data

(h)   Subsidiary and memorandum records

(i)    Minutes

(j)    Subsequent action by the client and by others.

By “good evidence” we mean a highly satisfactory evidence available without any special effort or  cost. For cash in hand the best evidence is ‘count’; in respect of investment pledged with a  bank, the banker’s certificate. For verifying assertions about book debts, the client’s ledger invoices, debit notes, credit notes, monthly accounts statement sent to the customers are all evidence : some of these are corroborative, other being complemen- tary. In addition, balance  confirmation procedure is often resorted to, to obtain greater satisfaction  about  the  reliability  of  the  assertion.  The  auditor,  however,  has  to  place appropriate  weight  on  each  piece  of  evidence  and  accordingly  should  prescribe  the priority of verification. It is true that in all cases one procedure may not bring the highest satisfaction and it may be dangerous for the auditor to ignore any evidence that is available. By the word “available” we do not mean that the evidence available with the client is the only available evidence. The auditor should know what normally should be available in the context of the transaction having regard to the circumstances and usage. For testing the authenticity of the client as regards amount lying with bank, the auditor  adopts the following procedure :

1.    Examination of the counterfoils of cheques and paying-in-slips and comparing them with the entries in the concerned ledger account of the client.

2.    Checking the castings, carry over and balances of the ledger account.

 3.    Comparison of the entries in the ledger with the bank statement (this is the reproduction of the ledger account maintained by the bank for recording the transactions with the cli- ent).

4.    Examination of the bank reconciliation statement to know the items that explain the difference, if any, between the balance shown by client’s ledger and the bank statement.

5.    Scrutiny of the subsequent period’s bank statement to ensure that items entering for reconciliation have been duly entered by the bank on clearance or presentation.

6.    Verification of official confirmation of the balance by the bank.

If you analyse these procedures, you will see that each provides the auditor with some evidence  which by itself is not adequate even if the result is satisfactory. The first one proves that the entries conform to the underlying records, but the prima facie authenticity of the underlying record is corroborated by a checking of the bank statement. The second provides evidence of the arithmetical accuracy. Procedure under step four, screens the items of difference between the two records and the bonafide of that statement is proved by step five. Sixth and the last step is most significant because the reliability of the bank statement is much enhanced by confirmation of the balance on a specified date made by a responsible  official  of  the  bank.  But  all  these  cannot  give  the  auditor  a  degree  of confidence or conclusiveness because he has no access to the bank’s books and records. Therefore,  he  must  be  contended   with  the  best  available  evidence  to  arrive  at  a reasonable opinion.

At times, the available evidence on a single assertion may be found to be contradictory. For  example,  sales  in  quantity and  value,  as  evidenced  by  some  of  the  procedures enumerated  above, may not be corroborated by a quantitative analysis of the opening stock, production, sales and closing stock. In such a situation, it would be the duty of the auditor to call for the explanation of the management before he accepts or rejects any of the contradictory evidence for  the purpose of formulation of his opinion on the particular matter. Only by properly considering  and evaluating the explanation of the management, the auditor is in such a situation as would  enable him to accept or reject any of the evidence.