THIS IS YOUR BRAIN ON
ACCOUNTING
Handouts
APRIL 3, 2022
MRG
Anonymous Group
, TABLE OF CONTENTS
FUNDAMENTALS OF AUDITING (AN INTRODUCTION) ..............................................................................................1
AUDITOR’S REPORT .............................................................................................................................................................. 3
ADVANTAGES & DISADVANTAGES OF AUDITING......................................................................................................... 7
OBJECTIVES & GENERAL PRINCIPLES OF FINANCIAL STATEMENT'S AUDIT..................................................... 9
REASONABLE ASSURANCE.................................................................................................................................................13
LEGAL CONSIDERATIONS REGARDING AUDITING....................................................................................................15
RIGHTS, DUTIES AND LIABILITIES OF AUDITOR ........................................................................................................19
LIABILITIES OF AN AUDITOR............................................................................................................................................21
BOOKS OF ACCOUNTS & FINANCIAL STATEMENTS...................................................................................................23
STATUTORY REQUIREMENTS REGARDING COMPANY ACCOUNTS ......................................................................36
UNDERSTANDING ENTITY, ITS ENVIRONMENT & RISKS OF MATERIAL MISSTATEMENT ...........................42
UNDERSTANDING ENTITY, ITS ENVIRONMENT & RISKS OF MATERIAL MISSTATEMENT (CONT) ............44
UNDERSTANDING ENTITY, ITS ENVIRONMENT & RISKS OF MATERIAL MISSTATEMENT (CONT.) ...........47
UNDERSTANDING ENTITY, ITS ENVIRONMENT & RISKS OF MATERIAL MISSTATEMENT (CONT..) ..........50
UNDERSTANDING ENTITY, ITS ENVIRONMENT & RISKS OF MATERIAL MISSTATEMENT (CONT...) .........52
ASSIGNMENT .........................................................................................................................................................................57
DOCUMENTING THE INTERNAL CONTROL SYSTEM................................................................................................58
EVALUATING THE INTERNAL CONTROL SYSTEM .....................................................................................................63
INTERNAL CONTROL QUESTIONNAIRE .......................................................................................................................68
AUDIT TESTS ..........................................................................................................................................................................74
SUBSTANTIVE PROCEDURES.............................................................................................................................................78
AUDIT EVIDENCE.................................................................................................................................................................82
SUFFICIENT APPROPRIATE AUDIT EVIDENCE............................................................................................................85
TESTING THE SALES SYSTEM............................................................................................................................................89
TESTING THE PURCHASES SYSTEM................................................................................................................................91
TESTING THE PURCHASES SYSTEM (CONTINUED) ...................................................................................................93
TESTING THE PAYROLL SYSTEM .....................................................................................................................................95
TESTING THE CASH SYSTEM.............................................................................................................................................97
TESTING THE CASH SYSTEM (CONTINUED) ................................................................................................................99
TESTING OTHER SYSTEMS .............................................................................................................................................. 101
TESTING THE NON-CURRENT ASSETS ........................................................................................................................103
VERIFICATION APPROACH OF AUDIT ..........................................................................................................................104
VERIFICATION OF ASSETS................................................................................................................................................108
LETTER OF REPRESENTATION (VERIFICATION OF LIABILITIES) .......................................................................111
VERIFICATION OF EQUITY.............................................................................................................................................. 115
VERIFICATION OF BANK BALANCES............................................................................................................................. 116
VERIFICATION OF STOCK IN TRADE AND STORE & SPARES .................................................................................120
,AUDIT SAMPLING................................................................................................................................................................122
STATISTICAL SAMPLING ...................................................................................................................................................125
INTERNAL AUDITING .......................................................................................................................................................128
AUDIT PLANNING............................................................................................................................................................... 131
PLANNING AN AUDIT OF FINANCIAL STATEMENTS...............................................................................................134
AUDIT PLANNING (ESTABLISHING OVERALL AUDIT STRATEGY) .......................................................................137
AUDITOR’S REPORT ON A COMPLETE SET OF GENERAL PURPOSE FINANCIAL STATEMENTS .................140
MODIFIED AUDITOR’S REPORT......................................................................................................................................146
, Fundamentals of Auditing –ACC
FUNDAMENTALS OF AUDITING
AN INTRODUCTION
What is an Audit?
Audit is an independent examination of financial statements of an entity that enables an auditor to express
an opinion whether the financial statements are prepared (in all material respects) in accordance with an
identified and acceptable financial reporting framework (e.g. international or local accounting standards and
national legislations)
This view of audit is presented by ISA 200 Objective and General Principles Governing an Audit of Financial
Statements.
The phrases used; “to express the auditor’s opinion” means that the financial statements give a true and fair
view or have been presented fairly in all material respects.
True and fair presentation means that the financial statement are prepared and presented in accordance with
the requirements of the applicable International Financial Reporting Standards (IFRS) and local
pronouncements/legislations.
What we can understand as the essential features of an audit from the above definition and explanation are
as under:
• An auditor involves in examination of financial statements, the auditor is not responsible for the
preparation of the financial statements.
• The end result of an audit is an opinion to assist the user of the financial statements. Auditing
therefore relies heavily on professional judgment, not merely on the facts.
• The auditor’s opinion makes reference to “true and fair” or “fair presentations” but “true and fair”
is again a matter of judgment. It is not precisely defined for the auditor.
• In order to make the user of the auditor’s report able to feel confident in relying on such report, the
auditor should be independent of the entity. Independent essentially means that the auditor has no
significant personal interest in the entity. This allows an objective, professional view to be taken.
You will note that this is a wide concept of an audit which can be applied to any entity, not just to limited
companies. However, in this course, we are concerned primarily with audits of limited companies (often
known as statutory or external audits). Any other audit applications will be clearly indicated for you in the
text.
Why is there a need for an audit?
The problem that has always existed at the time when the manager reports to the owners is that: whether
the owners will believe the report or not? This is because the reports may:
a. Contain errors
b. Not disclose fraud
c. Be inadvertently misleading
d. Be deliberately misleading
e. Fail to disclose relevant information
f. Fail to conform to regulations
The solution to this problem of credibility in reports and accounts lies in appointing an independent person
called an auditor to examine the financial statements and report on his findings.
A further point is that modern companies can be very large with multi-national activities. The preparation
of the accounts of such groups is a very complex operation involving the bringing together and
summarizing of accounts of subsidiaries with differing conventions, legal systems and accounting and
control systems. The examination of such accounts by independent experts who are trained in the
assessment of financial information is of benefit to those who control and operate such organizations as
well as to owners and outsiders.
Many financial statements must conform to statutory or other requirements. The most notable is that all
company accounts have to conform to the requirements of the Companies Ordinance 1984 but many other
ACCOUNTING
Handouts
APRIL 3, 2022
MRG
Anonymous Group
, TABLE OF CONTENTS
FUNDAMENTALS OF AUDITING (AN INTRODUCTION) ..............................................................................................1
AUDITOR’S REPORT .............................................................................................................................................................. 3
ADVANTAGES & DISADVANTAGES OF AUDITING......................................................................................................... 7
OBJECTIVES & GENERAL PRINCIPLES OF FINANCIAL STATEMENT'S AUDIT..................................................... 9
REASONABLE ASSURANCE.................................................................................................................................................13
LEGAL CONSIDERATIONS REGARDING AUDITING....................................................................................................15
RIGHTS, DUTIES AND LIABILITIES OF AUDITOR ........................................................................................................19
LIABILITIES OF AN AUDITOR............................................................................................................................................21
BOOKS OF ACCOUNTS & FINANCIAL STATEMENTS...................................................................................................23
STATUTORY REQUIREMENTS REGARDING COMPANY ACCOUNTS ......................................................................36
UNDERSTANDING ENTITY, ITS ENVIRONMENT & RISKS OF MATERIAL MISSTATEMENT ...........................42
UNDERSTANDING ENTITY, ITS ENVIRONMENT & RISKS OF MATERIAL MISSTATEMENT (CONT) ............44
UNDERSTANDING ENTITY, ITS ENVIRONMENT & RISKS OF MATERIAL MISSTATEMENT (CONT.) ...........47
UNDERSTANDING ENTITY, ITS ENVIRONMENT & RISKS OF MATERIAL MISSTATEMENT (CONT..) ..........50
UNDERSTANDING ENTITY, ITS ENVIRONMENT & RISKS OF MATERIAL MISSTATEMENT (CONT...) .........52
ASSIGNMENT .........................................................................................................................................................................57
DOCUMENTING THE INTERNAL CONTROL SYSTEM................................................................................................58
EVALUATING THE INTERNAL CONTROL SYSTEM .....................................................................................................63
INTERNAL CONTROL QUESTIONNAIRE .......................................................................................................................68
AUDIT TESTS ..........................................................................................................................................................................74
SUBSTANTIVE PROCEDURES.............................................................................................................................................78
AUDIT EVIDENCE.................................................................................................................................................................82
SUFFICIENT APPROPRIATE AUDIT EVIDENCE............................................................................................................85
TESTING THE SALES SYSTEM............................................................................................................................................89
TESTING THE PURCHASES SYSTEM................................................................................................................................91
TESTING THE PURCHASES SYSTEM (CONTINUED) ...................................................................................................93
TESTING THE PAYROLL SYSTEM .....................................................................................................................................95
TESTING THE CASH SYSTEM.............................................................................................................................................97
TESTING THE CASH SYSTEM (CONTINUED) ................................................................................................................99
TESTING OTHER SYSTEMS .............................................................................................................................................. 101
TESTING THE NON-CURRENT ASSETS ........................................................................................................................103
VERIFICATION APPROACH OF AUDIT ..........................................................................................................................104
VERIFICATION OF ASSETS................................................................................................................................................108
LETTER OF REPRESENTATION (VERIFICATION OF LIABILITIES) .......................................................................111
VERIFICATION OF EQUITY.............................................................................................................................................. 115
VERIFICATION OF BANK BALANCES............................................................................................................................. 116
VERIFICATION OF STOCK IN TRADE AND STORE & SPARES .................................................................................120
,AUDIT SAMPLING................................................................................................................................................................122
STATISTICAL SAMPLING ...................................................................................................................................................125
INTERNAL AUDITING .......................................................................................................................................................128
AUDIT PLANNING............................................................................................................................................................... 131
PLANNING AN AUDIT OF FINANCIAL STATEMENTS...............................................................................................134
AUDIT PLANNING (ESTABLISHING OVERALL AUDIT STRATEGY) .......................................................................137
AUDITOR’S REPORT ON A COMPLETE SET OF GENERAL PURPOSE FINANCIAL STATEMENTS .................140
MODIFIED AUDITOR’S REPORT......................................................................................................................................146
, Fundamentals of Auditing –ACC
FUNDAMENTALS OF AUDITING
AN INTRODUCTION
What is an Audit?
Audit is an independent examination of financial statements of an entity that enables an auditor to express
an opinion whether the financial statements are prepared (in all material respects) in accordance with an
identified and acceptable financial reporting framework (e.g. international or local accounting standards and
national legislations)
This view of audit is presented by ISA 200 Objective and General Principles Governing an Audit of Financial
Statements.
The phrases used; “to express the auditor’s opinion” means that the financial statements give a true and fair
view or have been presented fairly in all material respects.
True and fair presentation means that the financial statement are prepared and presented in accordance with
the requirements of the applicable International Financial Reporting Standards (IFRS) and local
pronouncements/legislations.
What we can understand as the essential features of an audit from the above definition and explanation are
as under:
• An auditor involves in examination of financial statements, the auditor is not responsible for the
preparation of the financial statements.
• The end result of an audit is an opinion to assist the user of the financial statements. Auditing
therefore relies heavily on professional judgment, not merely on the facts.
• The auditor’s opinion makes reference to “true and fair” or “fair presentations” but “true and fair”
is again a matter of judgment. It is not precisely defined for the auditor.
• In order to make the user of the auditor’s report able to feel confident in relying on such report, the
auditor should be independent of the entity. Independent essentially means that the auditor has no
significant personal interest in the entity. This allows an objective, professional view to be taken.
You will note that this is a wide concept of an audit which can be applied to any entity, not just to limited
companies. However, in this course, we are concerned primarily with audits of limited companies (often
known as statutory or external audits). Any other audit applications will be clearly indicated for you in the
text.
Why is there a need for an audit?
The problem that has always existed at the time when the manager reports to the owners is that: whether
the owners will believe the report or not? This is because the reports may:
a. Contain errors
b. Not disclose fraud
c. Be inadvertently misleading
d. Be deliberately misleading
e. Fail to disclose relevant information
f. Fail to conform to regulations
The solution to this problem of credibility in reports and accounts lies in appointing an independent person
called an auditor to examine the financial statements and report on his findings.
A further point is that modern companies can be very large with multi-national activities. The preparation
of the accounts of such groups is a very complex operation involving the bringing together and
summarizing of accounts of subsidiaries with differing conventions, legal systems and accounting and
control systems. The examination of such accounts by independent experts who are trained in the
assessment of financial information is of benefit to those who control and operate such organizations as
well as to owners and outsiders.
Many financial statements must conform to statutory or other requirements. The most notable is that all
company accounts have to conform to the requirements of the Companies Ordinance 1984 but many other
