An audit – general overview

Hello fellow forum readers. I sometimes find things easier if I ‘say them out loud’, so I thought I would come on here and talk myself through an audit to make sure I understand the bigger picture. I’d like you to add things I have missed out or correct things I have gotten wrong as appropriate. I don’t expect to have remembered everything, but I’m hoping to cover the major points.

I won’t lie, it’s long winded – so make yourselves comfortable and perhaps get yourselves a hot beverage.

Start

A client asks me to carry out an audit on their draft financial statements (FS). I will first consider if there is already an auditor, and if so that they are have been removed correctly. I will also make sure that I have no threats to my independence, and then set out the terms of my appointment in an engagement letter.

An example of a FS is the statement of financial position (SOFP). The SOFP contains various items, such as non-current assets, and let’s take the example of a factory building for illustration. The inclusion of the factory building on the SOFP has certain implied assertions. These include valuation, existence, rights & obligations etc. and in order to provide reasonable assurance that the FS show a true and fair view, as auditor I must obtain sufficient appropriate audit evidence to support these assertions.

So I begin to plan my audit. I must seek to gain an understanding of the entity and carry out a risk assessment in order to determine the risk of material misstatement in the FS. In terms of gaining an understanding, I can make inquiries with management as to their feelings towards going concern and other matters. It may be at this point that I feel I will need an auditor’s expert if the entity is a special case (such as investment company, for example). Through my risk assessment I will determine the nature of the control environment, the controls the entity has (do they have an internal audit department?) and how effective they are. Is it a new company, with lots of complex transactions and a large volume of fast moving inventory? I will also carry out analytical procedures (such as ratio analysis, comparing the draft FS with those of previous years and budgets) to try to identify significant changes and highlight areas at greater risk of material misstatement. I will also set a materiality and performance materiality level, using professional judgement. The former is for the FS as a whole, and the latter is a lower level for individual items to ensure that their aggregate effects do not exceed the overall level.

During

My conclusions during the planning stage will determine the timing, extent and nature of the procedures I carry out. Let’s take two different scenarios:

a) The entity has a strong control environment and apparently good internal controls, and further, my analytical procedures have not identified anything serious. From here I will carry out tests of controls to determine their effectiveness. I can do this by observation, inquiry & re-performance. Do certain transactions require authorisation? Is there adequate segregation of duties? If these are satisfactory it means I can use less substantive testing.

b) The entity has poor internal controls. I will communicate any deficiencies that I find to management and those charged with governance in a timely manner. Furthermore I will have to carry out full substantive testing.

I now need to carry out substantive tests, their extent based one either a) or b) above. In order to do this I will use sampling techniques, (probably random and stratified) and base my sample size on the risk of material misstatement using professional judgement. I will probably use computer assisted auditing techniques to help me. These substantive tests could include, for example, following a sale through the entity’s accounts. I may start with a goods despatched note (GDN) and trace the original sales order and subsequent invoice. Has the invoice been posted to the correct customer account? Does the sales ledger reconcile with the debtor’s control account? Has the customer paid, or are they likely to be a bad debt? Depending on my findings, I may need to perform further tests or amend the materiality level as appropriate.

Overview

By now the evidence I have been obtaining will all be kept in an audit file. It will soon be time for me to generate an audit report. I need to consider if the evidence obtained supports my original assessment and understanding of the entity or not. Do I need to obtain written representations from management about any specific issues other than those required by ISA’s?

Is there something I feel should be changed in the FS? Have I found that there is a significant amount of inventory valued at cost, but really should be written down to its NRV based on the fact that it is six months old? Or is it obsolete and should be written off completely? Do management agree?

Report

My audit report will be determined by the evidence I have obtained:

1) I have managed to obtain sufficient appropriate audit evidence to provide reasonable assurance that the FS are free from material misstatement and give a true and fair view. This is an unmodified opinion.

2) If the above is not the case, then I must give a modified opinion, which depending on the circumstances will fall into one of the following categories:

i) If I believe there is a misstatement, or that there might be but I can’t obtain sufficient appropriate audit evidence, as long as I do not consider it to be pervasive I give a qualified opinion.

ii) I believe there is a misstatement and it is pervasive, I give an adverse opinion.

iii) I cannot obtain sufficient appropriate audit evidence, but I believe that there may be a material misstatement and it may be pervasive, I give a disclaimer of opinion.

If I am giving a modified opinion I must communicate this to those charged with governance to give them the opportunity to provide further explanation. If I have given an unmodified opinion I can use an emphasis of matter paragraph after the opinion paragraph if I need to draw a user’s attention to something fundament to their understanding of the audit.

Other

Up to the date that I sign the report, I have an active duty to obtain evidence about any subsequent events that would cause and adjustment to the FS. If there is an event after I signed the report, but before the FS are published my report may need to be amended.

END

So, what have I missed? All help appreciated.