Chapter 13 Audit Principles and Techniques – Secretarial Audit Compliance Management and Due Diligence ICSI Study Material is designed strictly as per the latest syllabus and exam pattern.
Audit Principles and Techniques – Secretarial Audit, Compliance Management and Due Diligence Study Material
Question 1.
Differentiate between Audit Plan and Audit Programme. (June 2019, 5 marks)
Answer:
Difference between Audit plan and Audit Programme can be tabulated as under:
| Audit Plan | Audit Programme |
| Audit Plan lays down the audit strategies to be followed for conducting an audit such as identifying the areas where special audit consideration and skills may be necessary, obtain the knowledge of business etc.
Plans should be made to cover the following among other things: (i) Acquiring knowledge of accounting systems, policies and internal control procedures
|
Audit Programme is an outline of how the audit is to be done, who is to do what work and within what time. It lays down the following audit procedure to be followed: (i) Evaluation process |
Question 2.
(i) What are the points for consideration in audit planning in relation to the audit engagement? (5 marks)
(ii) What precautions should be taken while adopting test checking? (June 2015, 5 marks)
Answer:
(i) Audit planning requires a high degree of discipline on the part of the auditor. In order to make the planning more meaningful, the auditor should take into consideration the following matters in relation to the audit engagement:
1. Preliminary Work to be done in addition to the real audit work: This will include such matters as stocktaking, cash count, debtors’ circularisation and review of previous year’s working papers. This will remind the auditor of those matters brought forward from the previous year and any other points to be resolved in the current year or problems anticipated.
2. Changes in legislation, accounting or any auditing standards or guidelines: The auditor should acquaint himself with all the changes that took place during the year in applicable legislation, accounting and auditing standard. This will help an auditor in carrying out the auditing assignment in a way that meets the legislative requirement.
3. Analytical review of available management accounts and other management information that relate to the accounts: This will assist in establishing valuable ratios and indicators that will guide the auditor. For instance, the computation of the gross profit percentage compared with that of the previous year will provide a good indicator to the auditor of the accuracy and reliability of sales and cost of sales.
4. Changes in the business or management: The appointment of a new finance controller and the establishment of a new business line or the creation of a new branch are significant changes in the circumstances of the company which will necessitate changes in the existing audit plans. There may be similarly changes for which change may be required in audit plan.
5. Changes in the accounting system: The introduction of computers such that when a company introduces significant changes in its operating procedures will require a review and evaluation of the system of internal control.
6. Deadlines established for the submission of audit report: Where a client has set deadlines for its statutory activities such as the annual general meeting, it is important for the auditor to work in line with such programmes.
7. Use of rotational testing and verification: In practice, the auditor may not carry out a hundred percent testing or verification of the client’s transactions or segments of the business.
(ii) While adopting the test check, the auditor must take the following precautions:
| Heading | Description |
| 1. Test checking | Entries selected for test checking must be representative of all transactions. |
| 2. Random entry | The selection of the items should be at random. |
| 3. Applicability | It cannot be adopted in case of vouching the cash book. |
| 4. Unawareness of client | Client’s Staff should not come to know of the entries selected for test checking. |
| 5. Different period | Period selected for test checking should differ from book to book and year to year. |
| 6. Audit require by law | He should not adopt test checking where the law requires thorough audit. |
| 7. First and last month | A number of entries of the first and last month of the year must be checked thoroughly. |
| 8. Test should be devised | Test should be so devised that a sizeable portion of the work done by each employee is checked. |
| 9. Control accounts | Control accounts or impersonal ledger should not be subject to test checking. |
| 10. Test Independently | Auditor should select the test independently without regard to the suggestions of the member of the client’s staff. |
| 11. Bank/Cash checked fully | Bank statement and entries for cash withdrawal and cash deposits should be checked in full. |
Question 3.
What do you mean by ‘materiality’ in auditing? As an auditor of a company, how will you comply with materiality concept in auditing (5 marks, Dec 2016)
Answer:
1. Concept: Materiality is a concept or convention within auditing and accounting relating to the importance/significance of an amount, transaction, or discrepancy. The objective of pn audit of financial statements is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, in conformity with an identified financial reporting framework such as Generally Accepted Accounting Principles (GAAP). The assessment of what is material is a matter of professional judgment.
2. Definition Materiality can be defined as the magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.
3. Materiality in Planning and Performing an Audit: SA 320 “Materiality in Planning and Performing an Audit”, establishes standards on the concept of materiality and the relationship with audit risk while conducting an audit. Hence, the auditor requires more reliable evidence in support of material items. SA 320 defines material items as relatively important and relevant items, i.e., items the knowledge of which would influence the decision of the user of financial statements.
4. Disclosure in Financial Statement: The auditor has to ensure that material items are properly and distinctly disclosed in the financial statements. The concept of materiality is fundamental to the process of accounting. It covers all the stages from recording to classification and presentation. It is very important for the auditor who has constantly to judge whether a particular item is material or not. There is an inverse relationship between materiality and the degree of audit risk. The higher the materiality level, the lower the audit risk and vice versa. For example, the risk that a particular account balance or class of transactions could be misstated by an extremely large amount might be very low but the risk that it could be misstated by an extremely small amount might be very high.
Question 4.
List out five factors that influence the reliability of audit evidence as per SA 500. (Dec 2016, 5 marks)
Answer:
| Heading | Description |
| 1. Evidence obtained from outside of entity | Audit evidence obtained from independent source outside the entity is more reliable. |
| 2. Effective internal control | Audit evidence that is generated internally is more reliable when the related internal controls are effective. |
| 3. Obtained directly by auditor | Audit evidence obtained directly by auditor is more reliable than evidence obtained indirectly or by inference. |
| 4. Documentary form | Audit evidence is more reliable when it exits in documentary form. |
| 5. Original Document | Audit evidence of original document is more reliable than photo or scanned copies. |
Question 5.
Why is there a need of external experts’ opinion on various technical matters to auditors ? (June 2019, 5 marks)
Answer:
An auditor may take external expert’s opinion on various technical matters which forms the audit evidence. The auditor has to place reliance on the opinion expressed by the external expert considering his reliability, competency, consistency with data and information and independence. s In case of an external expert it shall be ensured that the interests and relationship of the external expert does not constitute a threat to that expert’s objectivity. The auditor shall evaluate adequacy of expert’s work having regard to the following:
- Relevance and reasonableness of expert’s findings /conclusions and consistency thereof with other audit evidence.
- Relevance and reasonableness of assumptions and methods used in the expert’s work.
- Relevance, reasonableness, accuracy and completeness of source data (if any) used in the expert’s work provided such data are significant for the expert’s Work.
- Agreement with the expert on the nature and extent of further work by the expert in case expert’s work is found to be inadequate for audit purpose.
- Performance of additional, appropriate audit procedures in case expert’s work is found to be inadequate for audit purpose.
Question 6.
What is materiality concept in auditing ? Explain. (Dec 2019, 3 marks)
Answer:
Material means important and essential. The disclosure of important matters helps the users in taking business decisions. There should be neither suppression of vital facts nor miss-statements.
- The concept of the materiality draws the whole process of the audit, the user of the audit report does not require the absolute accuracy to make informed decision, accordingly a matter is considered material if its omission or misstatement would reasonably influence the decision of an intended user of the audit report.
- The concept of materiality should be considered by the auditor while determining the nature, timing and extent of audit procedures and evaluating the effect of the misstatements.
- The concept of materiality is used both at the planning stage of the audit, when deciding what and how much work need to be done and in evaluating the result of the audit, which is generally known as planning materiality and reporting materiality.
- The Auditor has to report the errors which he judges to be material, the audit work can be planned in the knowledge that it need to detect errors that are material.
In accessing materiality, the prime consideration is the total value of the error, However, the values is not the sole consideration, the nature of the error or the context in which the transaction occurs are sometimes more important and the auditor must always consider these factors, as well as the value, when deciding whether an error is material.
Materiality consists of both quantitative and qualitative factors. Materiality is often considered in terms of monetary value but the- inherent nature or characteristics of an item or group of items may also render a matter material. Materiality is a matter of professional judgment and depends on the auditor’s interpretation of the users’ needs. A matter can be judged material if knowledge of it is likely to influence the decisions of the intended users. Materiality should be considered by auditor while determining the nature, timing and extent of audit procedures and while the evaluating the effect of misstatement.
During the planning process, information is gathered about the entity in order to assess risk and establish materiality levels for designing audit procedures. Issues that may be considered material even if the monetary value is not significant would include the following:
- Material by value
- Material by nature
- Material by context
Question 7.
What is Audit Trail and why there is a need of creation of Audit Trails? (Dec 2019, 5 marks)
Answer:
Audit Trail is a repository of administrative and operational documentation relating to audit process. It is established and maintained to aid in audit planning and to centralize available documentation and information not included in the individual audit files. Information included in the permanent files should only be information that cannot be feasibly included in the working papers due to volume or format or because the information will be applicable on an on going basis to the current audit or future audits. Permanent files should be filed with all audit and follow-up working papers supporting the audit. The contents of permanent files are dependent on the needs of the audit. An index should be developed and placed in the front of the permanent file indicating the documents contained, date included in file and auditor’s initials.
The auditor should prepare and maintain working papers, the form and content of which should be designed to meet the circumstances of a particular engagement. The information contained in working papers constitutes the principal record of the work that the auditor has done and the conclusions that he has reached concerning significant matters. Working papers serve mainly to
1. Provide the principal support for the auditor’s report, including his representation regarding observance of the standards of field work, which is implicit in the reference in his report to generally, accepted auditing standards.
2. Aid the auditor in the conduct and supervision of the audit. Working papers are records kept by the auditor of the procedures applied, the tests performed, the information obtained, and the pertinent conclusions reached in the engagement. Examples of working papers are audit programs, analyses, memorandum, letters of confirmation and representation, abstracts of company documents, and schedules or commentaries prepared or obtained by the auditor. Working papers also may be in the form of data stored on tapes, films, or other media.
The quantity, type, and content of working papers vary with the circumstances, but they should be sufficient to show that the records agree or reconcile with the statements or other information reported on and that the applicable standards of field work have been observed.
Working papers ordinarily should include documentation showing thatThe work has been adequately planned and supervised, indicating observance of the first standard of field work.
- A sufficient understanding of internal control has been obtained to plan the audit and to determine the nature, timing, and extent of tests to be performed.
- The audit Evidence obtained, the auditing procedures applied, and the testing performed have provided sufficient competent evidential matter to afford a reasonable basis for an opinion, indicating observance of the third standard of field work.
Working papers are the property of the auditor. The auditor’s rights of ownership, however, are subject to ethical limitations relating to the confidential relationship with clients.
The auditor’s working papers may sometimes serve as a useful reference source for his client, but the working papers should not be regarded as a part of, or a substitute for, the client’s accounting of other records.
The auditor should adopt reasonable procedures for safe custody of his working papers and should retain them for a period sufficient to meet the needs of his practice and to satisfy any pertinent legal requirements of records retention.
Audit working papers provide evidence of audit coverage and documentation of audit trails, they should be properly filed and stored. In addition, there should be a standardized format for working papers, adequate cross-referencing to identify the audit working papers created as well as a system for filing and retrieving working papers.
Question 8.
Describe auditing risk and its components. (Dec 2020, 5 marks)
Answer:
Auditing risk means that an auditor accepts/presumes some level of uncertainty in performing the audit work, which means that the auditor accepts the risk that the audit opinion given by the auditor might be wrong. Only a very small degree of audit risk would be acceptable as otherwise the audit process may lose its purpose.
The audit risk has three components:
- Inherent Risk
- Control Risk
- Detection Risk
Question 9.
Raj. the Secretarial Auditor of Netcap Ltd. wants to seek external confirmations. Guide Raj about the steps involved in obtaining external confirmations. (Aug 2021, 3 marks)
Answer:
External confirmation means Audit evidence obtained as a direct written response to the auditor from a third party (confirming party) on paper or electronic media or in any other form. External confirmation seeking steps are:
- Determine information to be confirmed / requested.
- Select appropriate confirming party.
- Design/format confirmation request.
- Send the request with follow up.
Question 10.
You have made a presentation to the Risk Management Committee of your company about the various risks and the mitigation plans thereof. The committee has asked you to formulate the action plan to address the identified risks. Explain the points to be considered while formulating the action plan. (Aug 2021, 5 marks)
Answer:
Once risks are identified, industry members must make a proper assessment of the issues that would arise if incidents occur, and take proportionate steps to minimise the likelihood of such issues resulting in consumer harm. Steps taken need not involve significant resources in advance.
Good process planning and/or staff training may have a positive impact on a company’s ability to respond effectively when incidents do occur. Even matters that are perceived to be unlikely or appear minor can pose long term difficulties if businesses are under prepared to respond to matters that do arise.
The formulation of an action plan could be based on the following:
- To periodically test and/or monitor certain ‘risks’ that would normally be associated to a particular service category (e.g., for a subscription service, it may be prudent to test the clarity of promotions, whether reminder messages have been sent, with delivery confirmation noted, and that ‘STOP’ commands have been properly processed);
- The frequency of such testing should reflect the risk posed by both the client and the service type. For example, a client with no breach history, or where none of the directors are linked to other companies with breaches, and low-risk service types (such as football score updates), would require far less monitoring than a client with an extensive breach history that provides a high- risk category of service (e.g., a subscription-based lottery alerts system with a joining fee);
- ‘Mystery shopper’ testing could be used as, and when, appropriate;
- Internal mechanisms to enable ‘whistle-blowing’ by staff, where appropriate;
- Putting in place internal checks that correlate with unusual patterns of activity which may indicate consumer harm (e.g., spikes in traffic and/or consumer complaints made directly to the provider about one specific service);
- Having a procedure to alter and address instances of non-compliant behaviour;
- Monitoring of the client’s service to ensure that any directions given by the Phone-paid Services Authority have been complied with;
- Producing a compliance file, comprising of a written record of the assessment, the subsequent action plan and evidence of any monitoring and/or testing required by the plan having taken place. This record does not necessarily need to be lengthy (although this will depend on the client and the actions taken under the plan), but should be made available to the Phone-paid Services Authority upon request.
Question 11.
“The audit checklist assists auditors in conducting a thorough, systematic and consistent audit” Briefly highlight the benefits of checklist. (Aug 2021, 5 marks)
Answer:
The audit checklist assists auditors in conducting a thorough, systematic and consistent audit. The checklists are used to guide and help the auditor to assess whether evidence meets audit criteria.
It is important to remember that checklists are used to guide the auditor’s and do not rigidly dictate exactly what is to be audited as in various event the auditor need to check beyond the checklist and the compliance requirement is different according to the nature and business of the company. – Accordingly, the audit checklists support the audit process in identification of the various compliance requirements and have their own benefits for the performance of the audit. Though for all organization a uniform checklist can be considered but same need to be customized as per the organization and the scope of the audit.
The benefits of the audit checklists are as under:
- Promote planning for the audit.
- Ensure a consistent audit approach.
- Act as a sampling plan and time manager.
- Serve as a memory aid.
- Provide a repository for notes collected during the audit process (audit field notes)
- Audit checklists provide assistance to the audit process.
- Auditors need to be trained in the use of a particular checklist and be shown how to use it to obtain maximum information by using good questioning techniques.
- Checklists assist an auditor to perform better during the audit process.
- Checklists help to ensure that the audit is conducted in a systematic and comprehensive manner and adequate evidence is obtained.
- Checklists provide the structure and continuity to the audit and ensure that the audit scope is being followed.
- Checklists provide a means of communication and a place to record data for use for future reference.
- A completed checklist provides objective evidence that the audit was performed.
- A checklist provides a record.
- Checklists can be used as an information base for planning future audits.
- Checklists can be provided to the auditee ahead of the onsite audit.
Question 12.
What do you mean by Audit Sampling? (Dec 2021, 3 marks)
Answer:
Audit Sampling
Application of audit procedures to less than 100% of the population of documents/ items relevant for audit such that all sampling units have a chance for selection (for applying audit procedure thereon) so as to provide the auditor a reasonable basis on which conclusion about the entire population can be drawn.
However, the sample design, size & selection of items for testing should meet the following:
- Purpose of the audit procedure and population characteristics shall be considered for designing an audit sample.
- Sample size shall be so chosen as to reduce sampling risk to an acceptable low value.
- Random sampling, whenever practicable, shall be considered so that each sampling unit shall have reasonable chance of selection.
- For sampling, use of stratification and value-weighted selection will increase audit efficiency.
Question 13.
Enumerate the process of the audit planning.
Answer:
The process of audit planning should include the following elements:
- The purpose and objectives
- Legal framework under which the audit is being conducted
- Significant areas and issues involved
- Process and technique to be adopted
- Check points, activities
- Allocation of work contents amongst the staff
- Time schedules for completion of various tasks/ phases
- Determining time lines for submission of Draft Report, discussion thereon with the auditee and submission of final report
- Areas to be classified on “Risk” criteria to allocate suitable resources
- Determining the extent of detailed examination and coverage in terms of volume
- Evaluation of internal controls and professional work carried out by other agencies / experts and placing reliance thereon
- Materiality considerations and determining the threshold therefore
- Structure, contents of the report.
Question 14.
Auditing risk means that an auditor accepts / presumes some level of uncertainty in performing the audit work, which means that the auditor accepts the risk that the audit opinion given by the auditor might be wrong. Comment.
Answer:
Auditing risk means that an auditor accepts / presumes some level of uncertainty in performing the audit work, which means that the auditor accepts the risk that the audit opinion given by the auditor might be wrong. Only a very small degree of audit risk would be acceptable as otherwise the audit process may lose its purpose.
The Audit risk has three components:
Inherent Risk: Inherent risk is the susceptibility of a class of transaction to misstatement that could be material, individually or when aggregated with misstatements in other transaction, assuming that there were no related internal controls. For example, Genuineness of the related party transactions.
Control Risk: Control Risk is the risk that a misstatement that could occur in an class of transactions and that could be material individually or when aggregated with misstatement on other transaction, will not be prevented or detected and corrected on a timely basis by the internal control systems. For example, delay in the filing of forms.
Detection Risk: Detection Risk is the risk that an auditor’s substantive audit procedures will not detect a misstatement that exist in class of transactions that could be material, individually or when aggregated with misstatement on other transaction. For example, while certification of e-form, the auditor has overlooked the compliance of the Secretarial Standards.
The auditor should maintain the high level of the assurance/confidence while expressing the audit opinion, and this is the most important steps in the audit planning to ensure that the audit team will gather competent, relevant and reasonable audit evidence at minimum cost.
There is an inverse relationship between materiality and the’ level of audit risk, that is, the higher the materiality level, the lower the audit risk and vice versa, Auditor should take note of the inverse relationship between materiality and audit risk when determining the nature, timing and extent of audit procedures.
Question 15.
What are the benefits of the Audit Checklists?
Answer:
The benefits of the Audit checklists are as under:
- Ensure a consistent audit approach.
- Act as a sampling plan and time manager.
- Serve as a memory aid.
- Provide a repository for notes collected during the audit process (audit field notes)
- Audit checklists provide assistance to the audit process.
- Checklists assist an auditor to perform better during the audit process.
- Checklists help to ensure that the audit is conducted in a systematic and comprehensive manner and adequate evidence is obtained.
- Checklists provide the structure and continuity to the audit and ensure that the audit scope is being followed.
- Checklists provide a means of communication and a place to record data for use for future reference.
- A completed checklist provides objective evidence that the audit was performed.
- Checklists can be used as an information base for planning future audits.
Question 16.
Material means important and essential. Comment
Answer:
Material means important and essential. The disclosure of important matters helps the users in taking business decisions. There should be neither suppression of vital facts nor mis-statements.
- The concept of the materiality draw the whole process of the audit, the user of the audit report does not require the absolute accuracy to make informed decision, accordingly a matter is considered material if its omission or misstatement would reasonably influence the decision of an intended under of the audit report.
- The concept of materiality should be considered by the auditor while determining the nature, timing and extent of audit procedures and evaluating the effect of the misstatements.
- The concept of materiality is used both at the planning stage of the audit, when deciding what and how much work need to be done and in evaluating the result of the audit, which is generally known as planning materiality and reporting materiality.
- The Auditor has to report the errors which he judges to be material, the audit work can be planned in the knowledge that it need to detect errors that are material.
- In accessing materiality, the prime consideration is the total value of the error, Howevef, the values is not the sole consideration, the nature of the error or the context in which the transaction occurs are sometimes more important and the auditor must always consider these factors, as well as the value, when deciding whether an error is material.
Materiality consists of both quantitative and qualitative factors. Materiality is often considered in terms of monetary value but the inherent nature or characteristics of an item or group of items may also render a matter material. Materiality is a matter of professional judgment and depends on the auditor’s interpretation of the users’ needs. A matter can be judged material if knowledge of it is likely to influence the decisions of the intended users.
In formulating audit opinion or report, the auditor should inter-alia give due regard to the materiality of the matter keeping in view the amount, nature and context. Materiality is determined for:
- Planning purposes
- Purposes of evaluating the evidence obtained and the effect of identified instances of mis-statement or non-compliance: and
- Purposes of reporting the results of the audit work.
Audit Principles and Techniques Notes
Auditing Techniques
The Audit Techniques stand for the methods that are adopted by an auditor to obtain audit evidence and performance of the Audit as per the scope of the audit. An Auditor can apply various techniques of auditing which may be applied by the auditor under different circumstances of audit. The various Techniques of the audit are summarised as under:
- Inspection of the Documents and Records
- Observation
- Inquiry and Confirmation
- Computation
- Analytical Procedures
Audit Planning:
The Audit plan, describes the processes and activities that are to be carried out in connection with a particular audit and for the improving the quality of audit. Accordingly, an auditor should plan an audit so that it is performed in an effective manner within the defined scope. The Audit Planning should also include overall audit strategy for the audit.
Inherent Risk:
Inherent Risk is the susceptibility of a class of transaction to misstatement that could be material, individually or when aggregated with misstatements in other transaction, assuming that there were no related internal controls. For example, Genuineness of the related party transactions.
Control Risk:
Control Risk is the risk that a misstatement that could occur in an class of transactions and that could be material individually or when aggregated with misstatement on other transaction, will not be prevented or detected and corrected on a timely basis by the internal control systems. For example, delay in the filing of forms.
Detection Risk:
Detection Risk is the risk that an auditor’s substantive audit procedures will not detect a misstatement that exist in class of transactions that could be material, individually or when aggregated with misstatement.on other transaction. For example, while certification of e-form, the auditor has overlooked the compliance of the Secretarial Standards.
Audit Sampling:
Application of audit procedures to less than 100% of the population of documents/items relevant for audit such that all sampling units have a chance for selection (for applying audit procedure thereon) so as to provide the auditor a reasonable basis on which conclusion about the entire population can be drawn.
Substantive Checking:
Substantive checking is the technique use by auditor to obtain the audit evidence in order to support auditor opinion. Substantive checking is part of substantive audit approach and it is performing at the execution stage of audit. It is different to test of control. The number of sample in substantive checking is depending on many factors.
For example, the audit approach considered by auditor depends upon whether they decided to use systematic approach, substantive audit approach or else. Normally, if audit approach to be used is substantive, then the volume of samples to be reviewed are higher than systematic approach.
External Confirmation:
External Confirmation means Audit evidence obtained as a direct written response to the auditor from a third party (confirming party) on paper or electronic media or in any other form. External confirmation seeking steps are:
- Determine information to be confirmed/ requested.
- Select appropriate confirming party.
- Design/format confirmation request.
- Send the request with follow up.
Audit Evidence:
Audit Evidence means information collected and used by the auditor in arriving at the conclusions on the basis of which his opinion is based.