SUMMARY: AUDITING 288
FIRST SEMESTER
________________________________________________________________
INTRODUCTION TO AUDITING
Purpose of an audit
To express an opinion on the FS that they are free of material misstatement and that they
fairly represent in all material aspects the financial position and performance of the entity, n
accordance with IFRS and the Companies Act.
What is not the purpose of an audit
- Identifying every error
- Detecting fraud
- Guaranteeing future success of the company
Inherent limitations of an AUDIT
[Don’t confuse with inherent limitations of INTERNAL CONTROL!]
- Nature of financial reporting
o Estimates and judgments are used)
- Nature of audit procedures
o Time and cost limitations
o Mgmt may not provide all info
o Mgmt can hide fraud
- Timeliness of reporting
o Cost and benefit of taking longer to audit must be balanced
- Reliability vs Cost
o Use of sampling bc everything cannot be tested
5 Postulates (“assumptions”) auditors make about a company
- FS are verifiable
- FS are free from irregularities
- What held in the past will hold in the future
- Consistent application of principles leads to fair representation
- No conflict of interest
Definition of an audit
A systematic process to gather and evaluate evidence objectively, to evaluate the assertions
made by mgmt, to determine the correlation with predetermined criteria (qualitative and
quantitative) and communicate results in writing to shareholders.
,External vs internal auditors
External auditors:
- Express an independent opinion on the whether the financial statements fairly
represent the financial position and performance of a company
- Not employed by the company
Internal Auditors
- Perform independent assignments for mgmt
- Enhances mgmt’s confidence that internal controls are working properly
- Employed by the company
___________________________________________________________________________
, INTERNAL CONTROL
Definition of internal control
A process, designed and initiated by mgmt., to provide reasonable assurance about the
achievement of the company’s objectives in terms of
- Reliability of reporting
- Effectiveness and efficiency of operations
- Compliance with laws and regulations
[Note: The auditor does not design or implement IC. It is done by mgmt. throughout the year.]
Inherent limitations of internal control
- Cost vs benefit
o It is expensive to segregate all duties. Tradeoff: only segregate some crucial
incompatible duties
- IC can become obsolete or inadequate as business changes
- Collusion by EE’s to circumvent IC and commit fraud
- Collusion by mgmt. to override IC and commit fraud
- Human error
5 Components of internal control (COSO model)
- Control environment
Entity’s governance and management functions and attitudes, awareness and
actions of those responsible for governance
- Risk assessment process
Entity’s process for identifying risks relevant to the financial reporting objectives and
how they are addressed
- Information system
Procedures and records established by entity to initiate, record, process and report
transactions (eg Pastel)
- Control activities
Policies and procedures ensure controls are in place to achieve internal control
objectives (SCRRAM)
- Monitoring of Controls
Process to assess effectiveness of internal controls over time
CONTROL ACTIVITIES CONTROL OBJECTIVES
(SCRRAM) (VAC)
Segregation of duties Do this… Validity
Control access Accuracy
Independent Review To ensure that this is Completeness
Records and docs achieved →
Authorisation
Monitoring
,Control objectives (VAC)
Validity
- Transactions are authorised i.t.o. company policy
- Events actually occurred
- Documents exist
- Transaction is legitimate (i.e. not to fictitious persons)
Completeness
- Keyword = “ALL”
- No omissions
- Pre-numbered documents are in order and all are present
- Timely recorded
Accuracy
- Right account
- Right amount
Possible exam questions
- Give:
o weaknesses (say what isn’t there),
o consequences (usually fraud or error, resulting in material misstatement) and
o recommendations (give the correct controls that you identified as missing. If
a document is missing, give all the controls around that document, i.e. the
perfect cycle. Lots of marks!)
- Give a perfect cycle. Leave out the controls that the company is already doing right.
- Identify the control activities relating to some given controls (SCRRAM)
o E.g. “The manager locks the petty cash box in a safe” = ACCESS CONTROL
- Formulate control objectives (start with ‘to ensure that… ‘)
o E.g. “Formulate the control objectives for the validity of credit sales”
Answer: To ensure that…
• All debtors are approved and authorised i.t.o. company policy
• Credit sales actually occurred
• Invoices are generated for credit sales
• Credit sales are legitimate (i.e. only sales to approved debtors)
, PERFECT CYCLES OF INTERNAL CONTROL
Exam technique: generic template that applies to almost every document
[Document name] should be pre-numbered and pre-printed
Prepared by [clerk/storeman] and signed to assign responsibility
[Number of copies] - for client, as evidence of occurrence If in doubt,
- for accounting dept, for recording 4 copies.
- for same dept, for evidence of occurrence Say why
- for next dept, to agree documents each copy
Reviewed by [sales/purchases/warehouse] manager for details: needed
o Reperform calculations
o Check date
o Check quantity and price
o Agree to previous docs
Reviewer signs to authorise in terms of company policy (e.g. approving a debtor)
Reviewer checks number sequence and follows up outstanding items (say this for every
single doc)
Blank documents must be safeguarded
+ Additional controls specific to each cycle
Perfect Cycles below:
- Sales and Receipts
- Purchases and Payments
- Inventory
- Bank and Cash
- Investments and Financing (not likely in test)
- Salaries and Wages (often asked!)
, SALES AND RECEIPTS CYCLE
“What could go wrong?”
Sales
Risk Control Objective
Fictitious sales Validity
Received orders are not processed Completeness
Credit granted to un-creditworthy client Validity
Dispatch goods that were not ordered Validity
Ordered goods are not dispatched Completeness
Incorrect dispatchment Accuracy
Client not invoiced Completeness
Client incorrectly invoiced – amount Accuracy
Client incorrectly invoiced - debtor Accuracy
Transaction recorded in wrong period Completeness
Cash Receipts
Risk Control Objective
Receipts stolen Validity
Payment recorded but never actually occurred Validity
Incorrect amount received / recorded Accuracy
Received cash not banked Completeness
Returns
Risk Control Objective
Refund granted but goods not actually Validity
returned
Incorrect discount / credit Accuracy
Credit note recorded incorrectly Accuracy
Provision for Bad Debts
Risk Control Objective
Debt doubtful, but no provision made Completeness
Incorrect calculation/ judgement Accuracy
Incorrect recording Accuracy
Write-off Bad debts
Risk Control Objective
Write-off debt that is recoverable Validity & Authorisation
Incorrect recording Accuracy
, Sales order form
Pre-numbered and pre-printed
Prepared by sales clerk
Confirm stock availability before allowing order to be placed
Details – purchaser, goods description, quantity
4 copies:
- customer → evidence of order
- own records of sales dept → history of sales
- warehouse → check for availability of goods and prepare goods
- invoicing → used to draw up invoice
Authorised and signed by sales/credit manager, if credit sale
Sales invoice
Pre-numbered and pre-printed
Prepared by sales clerk from sales order
Confirm stock availability before allowing invoice to be generated
Agree signed DN with sales order and invoice
Sales manager reviews for:
Details – purchaser, sales transaction, amount owing, payment conditions
Prices agreed to approved price list i.to. company policy
Mger checks prices, VAT and discount calculations, customer details → signs to auth.
2 Copies:
- customer → to inform of amount owing
- own records of invoicing dept → record of invoices issued
Delivery Note
Pre-numbered and pre-printed
Prepared by storeman from invoice
Details - date, description and quantity of goods
Goods detailed in DN must match sales order – the storeman agrees physical goods to the
DN
5 copies:
- 2x copies goes in vehicle to customer → evidence of delivery, 1x copy signed by
customer is returned
- inventory records → update inventory balance
- sales dept → proof that order has been delivered
- own records of warehouse → record of stock on hand
Authorised and signed by warehouse manager/foreman
Before leaving premises, agree sales order, DN and physical goods to ensure correct stock is
dispatched, by person different to person compiling any of the documents.
FIRST SEMESTER
________________________________________________________________
INTRODUCTION TO AUDITING
Purpose of an audit
To express an opinion on the FS that they are free of material misstatement and that they
fairly represent in all material aspects the financial position and performance of the entity, n
accordance with IFRS and the Companies Act.
What is not the purpose of an audit
- Identifying every error
- Detecting fraud
- Guaranteeing future success of the company
Inherent limitations of an AUDIT
[Don’t confuse with inherent limitations of INTERNAL CONTROL!]
- Nature of financial reporting
o Estimates and judgments are used)
- Nature of audit procedures
o Time and cost limitations
o Mgmt may not provide all info
o Mgmt can hide fraud
- Timeliness of reporting
o Cost and benefit of taking longer to audit must be balanced
- Reliability vs Cost
o Use of sampling bc everything cannot be tested
5 Postulates (“assumptions”) auditors make about a company
- FS are verifiable
- FS are free from irregularities
- What held in the past will hold in the future
- Consistent application of principles leads to fair representation
- No conflict of interest
Definition of an audit
A systematic process to gather and evaluate evidence objectively, to evaluate the assertions
made by mgmt, to determine the correlation with predetermined criteria (qualitative and
quantitative) and communicate results in writing to shareholders.
,External vs internal auditors
External auditors:
- Express an independent opinion on the whether the financial statements fairly
represent the financial position and performance of a company
- Not employed by the company
Internal Auditors
- Perform independent assignments for mgmt
- Enhances mgmt’s confidence that internal controls are working properly
- Employed by the company
___________________________________________________________________________
, INTERNAL CONTROL
Definition of internal control
A process, designed and initiated by mgmt., to provide reasonable assurance about the
achievement of the company’s objectives in terms of
- Reliability of reporting
- Effectiveness and efficiency of operations
- Compliance with laws and regulations
[Note: The auditor does not design or implement IC. It is done by mgmt. throughout the year.]
Inherent limitations of internal control
- Cost vs benefit
o It is expensive to segregate all duties. Tradeoff: only segregate some crucial
incompatible duties
- IC can become obsolete or inadequate as business changes
- Collusion by EE’s to circumvent IC and commit fraud
- Collusion by mgmt. to override IC and commit fraud
- Human error
5 Components of internal control (COSO model)
- Control environment
Entity’s governance and management functions and attitudes, awareness and
actions of those responsible for governance
- Risk assessment process
Entity’s process for identifying risks relevant to the financial reporting objectives and
how they are addressed
- Information system
Procedures and records established by entity to initiate, record, process and report
transactions (eg Pastel)
- Control activities
Policies and procedures ensure controls are in place to achieve internal control
objectives (SCRRAM)
- Monitoring of Controls
Process to assess effectiveness of internal controls over time
CONTROL ACTIVITIES CONTROL OBJECTIVES
(SCRRAM) (VAC)
Segregation of duties Do this… Validity
Control access Accuracy
Independent Review To ensure that this is Completeness
Records and docs achieved →
Authorisation
Monitoring
,Control objectives (VAC)
Validity
- Transactions are authorised i.t.o. company policy
- Events actually occurred
- Documents exist
- Transaction is legitimate (i.e. not to fictitious persons)
Completeness
- Keyword = “ALL”
- No omissions
- Pre-numbered documents are in order and all are present
- Timely recorded
Accuracy
- Right account
- Right amount
Possible exam questions
- Give:
o weaknesses (say what isn’t there),
o consequences (usually fraud or error, resulting in material misstatement) and
o recommendations (give the correct controls that you identified as missing. If
a document is missing, give all the controls around that document, i.e. the
perfect cycle. Lots of marks!)
- Give a perfect cycle. Leave out the controls that the company is already doing right.
- Identify the control activities relating to some given controls (SCRRAM)
o E.g. “The manager locks the petty cash box in a safe” = ACCESS CONTROL
- Formulate control objectives (start with ‘to ensure that… ‘)
o E.g. “Formulate the control objectives for the validity of credit sales”
Answer: To ensure that…
• All debtors are approved and authorised i.t.o. company policy
• Credit sales actually occurred
• Invoices are generated for credit sales
• Credit sales are legitimate (i.e. only sales to approved debtors)
, PERFECT CYCLES OF INTERNAL CONTROL
Exam technique: generic template that applies to almost every document
[Document name] should be pre-numbered and pre-printed
Prepared by [clerk/storeman] and signed to assign responsibility
[Number of copies] - for client, as evidence of occurrence If in doubt,
- for accounting dept, for recording 4 copies.
- for same dept, for evidence of occurrence Say why
- for next dept, to agree documents each copy
Reviewed by [sales/purchases/warehouse] manager for details: needed
o Reperform calculations
o Check date
o Check quantity and price
o Agree to previous docs
Reviewer signs to authorise in terms of company policy (e.g. approving a debtor)
Reviewer checks number sequence and follows up outstanding items (say this for every
single doc)
Blank documents must be safeguarded
+ Additional controls specific to each cycle
Perfect Cycles below:
- Sales and Receipts
- Purchases and Payments
- Inventory
- Bank and Cash
- Investments and Financing (not likely in test)
- Salaries and Wages (often asked!)
, SALES AND RECEIPTS CYCLE
“What could go wrong?”
Sales
Risk Control Objective
Fictitious sales Validity
Received orders are not processed Completeness
Credit granted to un-creditworthy client Validity
Dispatch goods that were not ordered Validity
Ordered goods are not dispatched Completeness
Incorrect dispatchment Accuracy
Client not invoiced Completeness
Client incorrectly invoiced – amount Accuracy
Client incorrectly invoiced - debtor Accuracy
Transaction recorded in wrong period Completeness
Cash Receipts
Risk Control Objective
Receipts stolen Validity
Payment recorded but never actually occurred Validity
Incorrect amount received / recorded Accuracy
Received cash not banked Completeness
Returns
Risk Control Objective
Refund granted but goods not actually Validity
returned
Incorrect discount / credit Accuracy
Credit note recorded incorrectly Accuracy
Provision for Bad Debts
Risk Control Objective
Debt doubtful, but no provision made Completeness
Incorrect calculation/ judgement Accuracy
Incorrect recording Accuracy
Write-off Bad debts
Risk Control Objective
Write-off debt that is recoverable Validity & Authorisation
Incorrect recording Accuracy
, Sales order form
Pre-numbered and pre-printed
Prepared by sales clerk
Confirm stock availability before allowing order to be placed
Details – purchaser, goods description, quantity
4 copies:
- customer → evidence of order
- own records of sales dept → history of sales
- warehouse → check for availability of goods and prepare goods
- invoicing → used to draw up invoice
Authorised and signed by sales/credit manager, if credit sale
Sales invoice
Pre-numbered and pre-printed
Prepared by sales clerk from sales order
Confirm stock availability before allowing invoice to be generated
Agree signed DN with sales order and invoice
Sales manager reviews for:
Details – purchaser, sales transaction, amount owing, payment conditions
Prices agreed to approved price list i.to. company policy
Mger checks prices, VAT and discount calculations, customer details → signs to auth.
2 Copies:
- customer → to inform of amount owing
- own records of invoicing dept → record of invoices issued
Delivery Note
Pre-numbered and pre-printed
Prepared by storeman from invoice
Details - date, description and quantity of goods
Goods detailed in DN must match sales order – the storeman agrees physical goods to the
DN
5 copies:
- 2x copies goes in vehicle to customer → evidence of delivery, 1x copy signed by
customer is returned
- inventory records → update inventory balance
- sales dept → proof that order has been delivered
- own records of warehouse → record of stock on hand
Authorised and signed by warehouse manager/foreman
Before leaving premises, agree sales order, DN and physical goods to ensure correct stock is
dispatched, by person different to person compiling any of the documents.
