Auditing and Investigation Final SP

Acknowl e dg e me n t ii
Acknowledgement
We grat efully acknowl edge per mi ssi on to quot e from past exami nat i on
paper s of the following bodi es: Kenya Account s and Secre t ari e s
Nati onal Exami nat i on Board (KASNEB); Chart er e d Insti t ut e o
!anag e me n t Account a nt s (CI!A); Chart er e d Ass oci at i on o
Certi i ed Account a nt s (ACCA)
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
iii
Instruct i ons or St ude nt s

Instructions or Students
This study guide is int ended to assi st dist ance- learni ng student s in their
independe nt st udi es. In addi tion, it is only for the personal use of the
purchas er , see copyri ght clause. The course has been broken down into
ine lessons each of which shoul d be consi der ed as approxi mat el y one
week of study for a full time student . !ol"e the reinforceme nt probl ems
"erifying your answer with the sugges t ed solution cont ai ned at the back
of the dist ance learni ng pack. When the lesson is compl et ed, repeat the
same procedur e for each of the following lessons.
#t the end of lessons $, %, & and ' ther e is a compr ehensi "e assi gnme nt
that you shoul d compl et e and submi t for marki ng to the dist ance
learni ng admi ni st r at or .
Su,mi s s i on +roce dur e
(. #fter you ha"e compl et ed a compr ehe nsi "e assi gnme nt clearl y
identify each questi on and number your pages.
$. If you do not under st and a portion of the course cont ent or an
assi gnme nt questi on indicat e this in your answer so that your
marker can respond to your probl em areas. )e as specific as
possi bl e.
*. #rrange the order of your pages by questi on number and fix them
secur el y to the dat a sheet pro"ided. #dequat e post age must be
affixed to the en"el ope.
%. While waiting for your assi gnme nt to be marked and ret urned to
you, continue to work through the next two lessons and the
correspondi ng reinforceme nt probl ems and compr ehensi "e
assi gnme nt .
+n the compl eti on of the last compr ehensi "e assi gnme nt a two- week
period of re"ision shoul d be carri ed out of the whol e course using the
mat eri al in the re"ision section of the st udy pack. #t the compl et i on of
this period the final ,ock -xami nat i on paper shoul d be compl et ed under
exami nat i on conditions. This shoul d be sent to the dist ance- learni ng
admi ni st r at or to arri"e in airobi at least fi"e weeks before the dat e of
your sitting the .#!-) -xami nat i ons. This paper will be marked and
post ed back to you within two weeks of recei pt by the /ist ance 0earni ng
#dminist r at or.
A&*I"IN- AN* IN'ES"I-A"I%N

i"
Contents
.
Acknowl e d g e me n t ///////////////////////////////////////////////////////////////////////////////ii
Instruct i ons or Stude nt s ///////////////////////////////////////////////////////////////iii
Cont ent s ///////////////////////////////////////////////////////////////////////////////////////////////////i0
Audi ti ng and In0es t i gat i on s Cours e *es cri 1t i on //////////////0
Audi ti ng and In0es t i gat i on s Index ///////////////////////////////////////////0i
2ESS%N %NE////////////////////////////////////////////////////////////////////////////////////////////.
Introducti on to #uditing ........................................................(
2ESS%N "3%////////////////////////////////////////////////////////////////////////////////////////44
#ccounti ng and Internal 1ontrol !yst ems: Theory
and 2ractice ............................................................................**
2ESS%N "$#EE//////////////////////////////////////////////////////////////////////////////////.56
The #udit 2rocess: 2lanni ng and 3uality 1ontrol ...(4$
2ESS%N 7%&#////////////////////////////////////////////////////////////////////////////////////.68
#udit -"idence and /ocument a t i on ............................($5
2ESS%N 7I'E//////////////////////////////////////////////////////////////////////////////////////.85
The #udit process: 6erification of #sset s and
0iabilities ................................................................................(54
2ESS%N SI9/////////////////////////////////////////////////////////////////////////////////////////6.:
The #udit 2rocess: 7inal 8e"iew of #udit of 7inanci al
!tat e me nt s ...........................................................................$(&
0-!!+ !-6-....................................................................$$9
!peci ali:ed #udit !ituations ...........................................$$9
2ESS%N EI-$"///////////////////////////////////////////////////////////////////////////////////6;<
-;T-8#0 #</IT+8! 8-2+8T! #/ +T=-8
8-2+8T!................................................................................$%'
2ESS%N NINE/////////////////////////////////////////////////////////////////////////////////////6<;
#udit In"esti gati ons, 8ecei"er shi ps, 0iquidations and
1urrent Issues in #uditing ...............................................$'%
2ESS%N "EN///////////////////////////////////////////////////////////////////////////////////////44:
8e"ision aid ..........................................................................**&
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
v Audi ti ng and In0es t i g at i o n
Cours e *es cri 1t i on
Auditing and In0estigations Course *escri1tion
>The course ai ms at de"el opi ng the candi dat es? appr eci ati on of the
professi onal and legal en"ironme nt in which audi ti ng is practiced and the
ability to execut e all types of gener al and speci ali:ed audi t s.
The syllabus ai ms at ensuri ng that the candi dat e has compet ence in the
audi ti ng of public and pri"at e instit uti ons and to carry out audit
in"esti gat i ons.

The core areas of the syllabus include int ernal cont rol syst e ms desi gn,
"erificati on of asset s and liabilities, audi t report s, in"esti gat i ons.
+ther assur ance assi gnme nt s under t aken by audi t or s are also being
exami ned and the student s are expect ed to under st and the changi ng
commer ci al en"ironme nt which has creat ed the demand for thes e
ser"ices.
7raud cases especi ally in the <nited !tat es and <nited .ingdom ha"e
lead to the most topical debat es and the issuance of new audi ti ng
st andar ds. The student is expect ed to be abl e to discuss these issues in
det ail.
The student has continuous opport uni t y to test his under st andi ng by
compl eti ng the reinforci ng questi ons and checki ng his answer s with
those gi"en in the re"ision secti on.
Audi ti ng and In0es t i g at i o ns Index
vi
Auditing and In0estigations Index
0esson +ne Introducti on
8einforcing 3uesti ons
0esson Two Internal 1ontrol !yst e m
1ompr ehe nsi "e #ssignment (
0esson Three #udit 2lanni ng and 3uality
0esson 7our #udit -"idence
1ompr ehe nsi "e #ssignment $
0esson 7i"e 6erification of asset s and liabilities
0esson !ix 7inal 8e"iew
1ompr ehe nsi "e #ssignment *
0esson !e"en !peci ali:ed #udit situat i ons
0esson -ight #uditors 8eport s
0esson ine In"esti gat i ons, recei"er shi ps, liquidati ons and
current issues
1ompr ehe nsi "e 0esson #ssignme nt %
0esson Ten .#!-) !yllabus. ,odel answer s to reinforcing
questi ons. !elect ed past paper s with model answer s.
Work through model @ answer s ensuri ng they are
under st ood. +n compl et i on submi t final assi gnme nt
to !trat hmor e <ni"ersi t y.
7INA2 ASSI-N!EN"
!ock Exami nat i on
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2es s on %ne .
2ESS%N %NE
Introduction to Auditing
%B=EC"I'ES
When you ha"e studi ed this lesson you should be able to:
-xplain and discuss the nat ur e of auditing
/escribe and discuss the regul at ory framework for auditing and
relat ed ser"ices internati onally and in .enya
/escribe the pro"isions of the #ccount ant s #ct, 1ap 5*( in relation to
professi onal misconduct .
C%N"EN"S
/efinition of auditing and the gener al principles go"erni ng an audit of
financi al st at eme nt s. AI!# $44B
The 1oncept of 8easonabl e #ssurance
The 1ost )enefit #nalysis of an #udit: #d"ant ages and /isad"ant ages
Types of #udits
The 8egul ation of the #ccount ancy 2rofession in .enya
/uties, 8ight s, 2owers and 3ualifications for #ppoint ment
#ppoint ment , 8emuner at i on, /ismissalC8emo"al and 8esignati on
The -ngage me nt AI!# $(4B
Typical !et- up in an accounti ng firm
Impact of Internati onal !tandar ds on #uditing AI!#sB , Internati onal
7inanci al 8eporting !tandar ds AI78!B
2rofessional responsi bility and the 0egal 0iability of auditors
INS"#&C"I%NS
8ead the study Text
1ompl et e answer s to reinforcing questions at the end of the lesson
without reference to the model answer s.
1heck your answer s with those gi"en in 0esson (4 of the !tudy 2ack.
6
Introduct i on to Audi ti ng
./ 5 *ei ni ti on o audi ti ng
#ccordi ng to the Int ernat i onal !t andar d on #uditing AI!#B o. $44
Objecti ve and General Principles Governi ng an Audit of Financial
Stat e me nt s , the obDecti"e of an audi t of financi al st at e me nt s is to
enabl e the audi t or to expr es s an opinion whet her the financi al
st at e me nt s are prepar ed, in all mat eri al respect s, in accordance
with an identified financi al reporti ng framewor k.
The phras es used to expr es s the audit or?s opinion are Egi"e a true
and fair "iewF or Epres ent fairly, in all mat eri al respect s, F which are
equi"al ent ter ms. # si mil ar obDecti"e appli es to the audit of financi al
or other infor mat i on prepar ed in accordance with appropri at e
crit eri a.
The Institut e of 1ertified 2ublic #ccount ant s of .enya AI12#.B defines
as the independent exami nat i on of and expressi on of opinion on, the
financi al stat e me nt s of an ent er pri se by an appoint ed audit or in
pursuance of that appoi nt ment and in compli ance with any rele"ant
stat ut ory obligation:
./ . #el at e d Ser0i c e s
In addition to audi t ser"ices, audi t or s pro"ide other ser"ices. These can
be classified as:
Ass uranc e enga g e me n t s
#udits
8e"iews
Non> as s uranc e Engag e me n t s
#greed upon 2rocedur es
1ompil ati ons
./ ./ . #e0i e ws
The obDecti"e of a re"i ew of financi al st at e me nt s is to enabl e an audi t or
to st at e whet he r ? on the ,asi s o 1roc e dur e s whi ch do not
1ro0i de all the e0i de nc e that woul d ,e re@ui re d in an audi t ?
anyt hi ng has come to the audi t orA s att e nt i on that caus e s the
audi t or to ,el i e0 e that the inanci al st at e me nt s are not
1re1ar e d? in all mat eri al respect s, in accordance with an identified
financi al reporti ng framewor k. # si mil ar obDecti"e appli es to the re"iew of
financi al or other
Informat i on prepar ed in accor dance with appropri at e crit eri a.
# re"iew compri ses inquiry and anal ytical procedur es, which are
desi gned to re"iew the reliability of an asser ti on that is the responsi bility
of one part y for use by anot her part y. While a re"i ew in"ol"es the
applicati on of audi t skills and techni ques and the gat heri ng of e"idence,
it does not ordinarily in"ol"e an asses s me nt of account i ng and int ernal
cont rol syst e ms , test s of records and of respons es to inquiri es by
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obt ai ni ng corrobor at i ng e"idence through inspecti on, obser"at i on,
confir mat i on and comput at i on, which are procedur es ordinarily
perfor med during an audit .
#lthough the audit or att e mpt s to become awar e of all significant mat t er s,
the procedur es of a re"iew make the achi e"e me nt of this obDecti"e less
likely than in an audit engage me nt , thus the le"el of assur ance pro"ided
in a re"iew report is correspondi ngl y less than that gi"en in an audit
report .
./ ./ 6 Agre e d> u1on +roce dur e s
In an engage me nt to perfor m agr eed- upon procedur es, an audit or is
engaged to carry out those procedur es of an audi t nat ur e to which the
audi t or and the entit y and any appropri at e third 1arti e s ha0e agr eed
and to report on fact ual findings. The recipi ent s of the report must form
their own conclusi ons from the report by the audit or. The report is
rest rict ed to those parti es that ha"e agr eed to the procedur es to be
perfor med since other s, unawar e of the reasons
for the procedur es, may misi nt er pr et the resul t s.
./ ./ 4 Com1i l at i ons
In a compil ati on engage me nt , the account ant is engaged to use
account i ng exper ti se as opposed to auditing exper ti se to collect, classify
and summari :e financi al infor mat i on. This ordinarily ent ails reduci ng
det ail ed dat a to a manage a bl e and under st anda bl e form without a
requireme nt to test the asser ti ons underl yi ng that infor mat i on. The
procedur es empl oyed are not desi gned and do not enabl e the account ant
to expr ess any assur ance on the financi al infor mat i on. =owe"er, user s of
the compil ed financi al infor mat i on deri"e some benefi t as a resul t of the
account ant ?s in"ol"eme nt becaus e the ser"ice has been perfor med with
due professi onal skill and care.
./ 6 "he Nee d or an Audi t
If you take an exampl e of a moder n large liability company, we can clearly
distingui sh bet ween the pro"ider s of funds and those who control those
funds. The pro"ider s of funds are the shar ehol der s, credit ors, and other
third parties who ha"e gi"en loans to the company. Those charged with
the responsi bility of controlling those funds are usually called direct ors
and manage me nt . We can also clearly see that the company has
resources, Aasset sB, and clai ms against those resources, A0iabilities and
capit al.B
!ince the pro"ider s of funds are di"orced from the control of those funds it
would seem logical that the controllers shoul d on a regul ar basis gi"e a
report to the pro"ider s of the funds on changes in the resources and
clai ms. This report of the controllers or direct ors accordi ng to the .enya
1ompani es #ct shoul d be in the form of annual account s which consist of
the balance sheet and the profit and loss account . The accounti ng
professi on has ext ended the account s by requiring that a 1ash 7low
!tat ement be also appended to the account s as part of the account s.
;
"he re1ort o the direct or s in the orm o account s lacks
credi ,i l i t y? in that B
aB It may cont ai n errors@
bB It may fail to disclose frauds@
cB It could be misl eadi ng inad"ert ent l y@
dB It could be misl eadi ng deliber at el y@
eB It may fail to disclose all rele"ant informat i on.
# further point to not e is that moder n compani es can be "ery large with
multi- national acti"ities. 2repari ng account s for such a group becomes a
"ery compl ex operation that could in"ol"e bringing toget her and
summari si ng the account s of subsidi ari es with differing accounti ng
syst ems. #ll account s are required to confor m to "ery det ailed and
compl ex requirement s of the 1ompani es #ct A1#2 %9&B and also to the
requirement s of the many Internati onal 7inanci al 8eporting !tandar ds
AI78!sB. Taking these point s into consider at i on ther efore, it becomes
necess ar y that to gi"e credibility to the account s an independent qualified
expert be appoi nt ed to obDecti"ely in"esti gat e the account s and then
report his findings to all interest ed parties, pri marily the shar ehol der s as
required by the 1ompani es #ct, but also to other pro"iders of funds and
rele"ant regul at or y aut horities.
"hi s inde1e nde nt ex1ert is call ed the audi t or . =is in"esti gati ons
constit ut e an audit and the report of his in"esti gati ons an audit report .
#part from resol"ing the probl ems of credibility an audit is essenti al to
ensur e that the requirement s of the 1ompani es #ct and the Internati onal
7inanci al 8eporting !tandar ds ha"e been complied with. The account s are
referred to as financi al stat e me nt s. To summari se, we can identify the
following parti es as being interest ed in the financi al st at eme nt s.
aB The direct ors who produce them@
bB The shar ehol der s to whom traditionally they are address ed@
cB 0enders and debent ur e holders@
dB 2otenti al in"est ors@
eB -mployees@
fB 1ust omer s@
gB !uppliers@
hB #ccount ant s@
iB !tock- brokers@
DB 1redit rating agenci es@
kB 7inanci al Gournalist s@
lB Trade <nions@
mB !tatisticians@
nB 1ompeti t ors@
oB The Ho"ernment , including the Tax #uthorities and the@
pB ,inistry of 7inance for -conomi c 2olicy /ecisions@
qB The gener al public.
#ll these peopl e must be sure that the financi al st at eme nt s can be relied
upon.
It should be not ed that :
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2es s on %ne 8
(. The audit or himself must be independent to ha"e credibility.
$. =e must ha"e the pri mar y obDecti"e of produci ng a report of his
opinion on the trut h and fairness of the account s, so that any
person readi ng and using them can belie"e in them.
*. !ubsidiary obDecti"es can be seen to be the det ecti on of errors
and fraud, the pre"enti on of errors and fraud by the det err ent
and moral effect of the audit and the ability to pro"ide other
benefit s to his client s such as:
I #ssist ance with accounti ng@
I !yst ems@
I Taxation@
I 7inanci al and other problems.
The 1ompani es #ct was designed to prot ect shar ehol der s from direct ors
hence the need for an audit as cont ai ned in the 1ompani es #ct mai nly
relat es to limited liability compani es, but as we shall see any organi:ati on
can benefit from an audit.
./ 4 "y1es o audi t s
Introduct i on
!o far we ha"e tended to think in ter ms of the audit of limit ed compani es,
and indeed, the emphasi s throughout this text will be on such compani es
incorpor at ed under the 1ompani es #ct ('&$, not least becaus e this type
of audit situati on is at the heart of the "ast maDorit y of auditing
exami nati on questi ons. =owe"er, it might be con"eni ent at this stage to
briefly indicat e the main classes of audit which are undert aken in practice.
Stat ut ory Audi t s and Non> Stat ut ory Audi t s
Stat ut ory Audi t s
#udits are compul sory under stat ut e in the case of a large number of
undert aki ngs including the following:
&ndert aki ng +rinci 1al Act
0imited 1ompani es
)uilding !ocieti es
ding !ociet y #ct ('&$
)anking and 7inanci al
Institutions )anking #ct
('9'
Insurance 1ompani es
Insurance #ct ('9%
1o- oper ati"e !ocieti es
1o- operati"e !ocieti es #ct
1ompani es #ct ('&$
)uilding !ociet y #ct ('&$
)anking #ct ('9'
Insurance #ct ('9%
1o- oper ati"e !ocieti es #ct
Non> stat ut ory Audi t s
on- stat ut ory audit s are perfor med by independent audit ors becaus e the
owners, propri et or s, member s, trust ees, professional and go"erni ng
bodies or other interest ed parti es desire them, not becaus e the law
requires them.
In consequence, auditing may and will ext end to e"ery type of
undert aki ng which produces account s, and will include therefor e:
:
aB 1lubs@
bB 1harities Aassumi ng an audit is not in any e"ent st at ut or yB@
cB !ole trader s@ and
dB 2art ner shi ps
It may also ext end to forms of financi al stat e ment other than the annual
report ed figures where those responsi bl e for the stat e ment , or those to
whom the stat e ment is made, wish an independent opinion to be
express ed as to whet her it gi"es a true and fair "iew. -xampl es would
include:
aB !ummari es of sales in support of a st at eme nt of royalti es?
payabl e where goods are sold under licence@
bB !tat eme nt s of expendi t ur e in support of applications for
regional de"elopment or other go"ernment s grant s@ and
cB The circulation figures of a newspaper or maga:i ne, used when
soliciting ad"erti sing.
In all such audit s the audit or must ha"e regard to any regul ations
concerni ng financi al stat e me nt s which are cont ai ned in the internal rules
or constit ution of the undert aki ng. -xampl es of the regul ations which
would be essent i al reference mat eri al for the audit or in such assignment s
would include:
aB The 8ules of 1lubs, !ocieti es and 1harities
bB 2art ner shi p agree me nt s.
Audi t o +art ners hi 1s
Ad0ant a g e s o an audi t to a 1art ners hi 1
The audit of a part ner shi p is not nor mally required by stat ut e and so the
auditor must agree with the client what his right s and duti es are going to
be. The audit or must obt ain writt en confirmat i on of his ter ms of
engage me nt and must take care to clearly distingui sh bet ween audit and
account ancy work and ensur e that the client appr eci at es such distinction.
In addition to the ad"ant ages common to all forms of audit, namel y, the
"erification of account s and the possibl e det ecti on of errors and fraud, the
audit of the account s of a part ner shi p may also be seen to ha"e the
following ad"ant ages:
aB It will pro"ide a con"eni ent means of set tling account s bet ween
the part ner s, thus a"oiding the possi bility of future disput es.
bB The audit or may be able to make useful comment s on the firmJ s
accounti ng and control syst ems, wher e necess ar y making
recomme ndat i ons as to how areas of weakness could be
eliminat ed.
cB The set tl ement or adDust ment of account s bet ween part ner s on
the occasi on of any change in the part ner shi p struct ur e will be
facilitat ed wher e audit ed account s are a"ailabl e.
dB Where audit ed account s are a"ailabl e this will perhaps
make them more readily accept abl e to the income tax
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2es s on %ne C
aut horities? inland re"enue when it comes to agreei ng an
indi"idual?s part ner J s liability to tax. The part ner s may
well wish to take ad"ant age of the audit orJ s ser"ices in the
additional role of tax ad"isor.
eB The sale of the business or the negoti ati on of loan or o"erdr aft
facilities may well be facilitat ed if the firm is able to produce
properly prepar ed and audit ed account s.
fB #n audit on behalf of a J sleepi ng part ner J is highly ad"isabl e
since gener ally such a person will ha"e little other means of
checking the account s of the business, or confirming the scal e
of profits due to them.
#part from the ad"ant ages discuss ed abo"e, which would be peculiar to a
part ner shi p, similar ad"ant ages may be found in the audit of the account s
of a sole trader, club or charit y. What e"er the nat ur e of the business, the
auditor will find himself concer ned with compli ance with #uditing
!tandar ds.
Interi m and 7inal Audi t s
Whereas the split bet ween the syst ems and balance sheet audit s is
concerned with the type of work co"ered, that bet ween the interi m and
final audit s is concerned with timing. The interi m audit will nor mally take
place approxi mat el y three- quart er s of the way throughout the financi al
year.
There is an element of similarity bet ween syst emsC bal ance sheet work and
interi mCfinal audit s in as much as the maDority of the syst ems work will be
carried out during the interi m audit and the maDorit y of the balance- sheet
work during the final audit. =owe"er, it will be necess ar y to compl et e
some syst ems work during the final audit so that transacti ons bet ween the
time of the interi m and final audit s do not escape the auditorJ s att enti on.
!imilarly, some subst ant i "e testing is "ery likely to be carried out during
the interi m Ae.g. "erifying fixed asset s additions to dat eB.
With "ery small audit s, it is someti mes consider ed unneces s ar y to carry
out an interi m audit. This means that, as a mat t er of con"eni ence, all the
audit work will be carried out in a single phase commenci ng typically, a
short time before the year- end and continui ng into the post balance sheet
period.
#t the other extreme, with large compani es it is someti mes necess ar y to
carry out mor e than one interi m audit or, alternat i"el y adopt a continuous
auditing approach. In the case of a continuous audit the audit orJ s staff will
either make se"er al "isits to the client spread throughout the year or, as
in the case of "ery large compani es, some of the audit staff will be present
at the clientJ s premi ses "irtually all the time.
Ad0ant a g e s and *isad0ant a g e s o a Conti nuous Audi t
AaB Ad0ant a g e s
I. The continual or regul ar att endance of the audit or may act
as a det err ent to fraud@
ii. Weakness es in the client J s syst ems are noticed earlier and,
if they exist, errors and fraud may be disco"er ed more
quickly@
iii. It is someti mes possi bl e to start the balance sheet work
before the year end. This will lead to swifter financi al
D
reporting@
i". The audit orJ s work is spread more e"enl y throughout the
year. This will help to relie"e the pressur es on st aff that
arise for many audit firms during the first few mont hs of
each year.
AbB *isad0ant a g e s
I. #udit staff who spend much of their time working on one
client may find their independence ad"er sel y affect ed@
ii. The auditorJ s frequent Aand somet i mes unexpect edB "isits
may cause incon"eni ence to the client@
iii. It is possibl e that figures may be alter ed Ainnocentl y or
fraudul entl yB aft er they ha"e been checked@
i". It may be found that outst andi ng point s and queri es raised
at one "isit are forgot t en and not followed up at a later
st age. !trict control is needed to ensur e that this does not
happen particul arly wher e the st aff assigned to the audit
ha"e changed.
./ ; "he Audi t or and the Kenya Com1ani e s Act? .<:6? Ca1 ;D:
*uti e s
,ake a report to the member s on all account s laid before the
member s in gener al meet i ng during his tenur e of office:
I The report must cont ai n mat t er s menti oned in the Kth !chedul e to
the #ct. !ection (&$A(B.
I This ther efor e means the auditor has to include in the report
st at eme nt s on the account s i.e.
i. 1ompliance with the 1ompani es #ct@
ii. Truth and fairness of the balance sheet and profit and loss
account .
The auditor also has to in"esti gat e and report whet her or not:
i. 2roper books of account ha"e been kept@
ii. 2roper returns ha"e been recei"ed from branches not "isited by
the audit or.
iii. The account s are in agree me nt with the books of account s.
The auditor has also to report whet her or not he has obt ained all the
informat i on and expl anati ons which to the best of their knowl edge
and belief were necess ar y for the purposes of their audit.
#ight s
(. 8ight to ha"e his report read before the 1ompany. A!ection
(&$A$B.
$. 8ight of access at all times to the books, account s and "oucher s
of the company.
*. 8ight to require from offices of the company such informat i on
and explanat i on as he thinks necess ar y for the perfor mance of
the duties of the audit or. A!ection (&$A*B.
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on %ne <
%. 8ight to recei"e notice of and att end meeti ngs and report on
any mat t er s that concer n him as auditor. A!ection (&$A%B.
5. 8ight to report to the member s on his findings including failure
by the direct ors and employees of the company to suppl y him
with all the informati on and explanat i ons which he deemed
necess ar y. A!ection (&$A(B and Kth !chedul e company.
A!ections (&(A*B.
+owers
The right s may be consider ed to be powers but the 1ompani es #ct does
not gi"e the auditor any legal powers to assist him in his work.
The direct ors can refuse to gi"e any informati on he want s and they can
refuse to publish his report and can deny him access to the records and
also fail to ser"e him with notice of meeti ngs and ther e is +T=IH T=-
#</IT+8 1# /+L
The 1ompani es #ct does not gi"e the audit or any legal powers.
Eualii cat i ons 7or A11oi nt me nt As Audi t or
,ust be a holder of a practi sing certificat e issued pursuant to !ection $(
of the #ccount ant s #ct. A!ection (&(A(B. !hould not be an officer or
ser"ant of the company. A!ection (&(A$aBAiB.
!hall not be a part ner of or in the empl oyment of an officer or ser"ant of
the company. A!ection (&( A$aBAiiB.
!hould not be a body corpor at e. A!ection (&( A$aBAiiiB.
If an auditor is disqualified from appoi nt ment as an auditor of the
companyJ s subsi di ary company or holding company or any other "ent ur e
which if it were a company would be a subsidi ary or holding.
2lease not e that references to officer or ser"ant shoul d not be const rued
to mean audit or Aalthough the audit or =+0/! +77I1-B. A!ection (&(A$BAbB.
./ 8 "he Audi t ors and the Kenya Com1ani e s Act? .<:6? Ca1 ;D:
A11oi nt me nt
-"ery company must appoi nt an audit orC audi t or s at each annual gener al
meeti ng. To hold office from the conclusion of that, until the conclusion of
the next annual gener al meeti ng.
8etiring auditor is deemed to be reappoi nt ed without passi ng a resolution
at an #H, unless:
I =e is not qualified for reappoi nt ment @
I 8esolution is passed at the #H, appointing somebody inst ead of
him or pro"iding expressl y that he should not be reappoi nt ed.
I =e has gi"en notice in writing of his unwillingness to be
reappoi nt ed !ection (5'A$Ba, b, c.
If at the #H, no auditorCAsB isCare appoi nt ed or deemed reappoi nt ed, the
registrar may appoint a person to fill the "acancy. !ection (5'A*B. The
direct ors can appoi nt the first audit ors at any time before the first #H, to
.5
hold office till that #H,. The direct ors can fill a casual "acancy in the
office of auditor. !ection (5'A&B.
#emunerat i on
7ixed by whoe"er appoi nt s the audit orC s. !ection (5' AKB AaB.
8emuner at i on includes any expens es of the audit orC s paid by the
company. !ection (5' AKB AbB.
*ismi s s al F #e mo 0 al
#n auditor can be dismi ssed at any time before the end of his tenur e of
office. This is despit e any agree me nt bet ween him and the company.
This remo"al is by ordinary resolution at a meeti ng with speci al notice A$9
clear daysB ha"ing been ser"ed. +nly the member s in a properly
constit ut ed meet i ng can remo"e an auditor from office.
When an auditor is remo"ed before expiry of his tenur e of office, then the
company must within fourt een days gi"e notice of this fact to the
8egistrar. The auditor must be informed of all att empt s to dismi ss or
remo"e him, from office. =e is allowed to make represent at i ons to the
member s if he feels the direct ors want to remo"e him unfairly. The
direct ors ha"e to circulat e the repres ent at i ons to the member s.
#esi gnat i on
#uditors in .enya cannot under the 1ompani es #ct resign before the end
of their tenur e of office. The closest they can come to resigning is gi"ing
notice in writing to the company that they are unwilling to be reappoi nt ed.
!ection (5'A$BAcB.
./ : "he New Engag e me nt
Background
8eiterati on of the I12#. definition of an audit highlight s the probl ems of
the new audit.
#n audit is the independent exami nat i on of, and expressi on of opinion on,
the financi al st at eme nt s of an ent erpri se by an appoi nt ed auditor in
pursuance of that appoint ment and in compli ance with any rele"ant
stat ut ory obligation: If we take the exampl e of a limit ed company audit,
then we can immedi at el y appreci at e that Abefore a new audit client is
accept ed, the auditor concerned must ensur e that there are no
independence or other ethical problems likely to cause conflict with the
ethical code. 7urther mor e, it is import ant for the new auditor to ensur e
that he has been appoi nt ed in a proper and legal manner - it will be
appr eci at ed that one auditorJ s appoi nt ment is nor mally anot her auditorJ s
remo"al or resignati onB. -ssenti ally, the initial procedur es to be obser"ed
can be consider ed in $ stages:
aB 2rocedur es before accepti ng nomi nati on@ and
bB 2rocedur es after accepti ng nomi nati on.
+rocedur e s ,e ore acce1t i ng nomi nat i on
The nomi nee auditor must take the following steps:
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on %ne ..
aB -nsure that he is professionally qualified to act i.e. is not
disqualified on any legal or ethical grounds.
bB -nsure that the firmJ s existing resources are adequat e to
ser"ice the needs of the new client. This will raise questi ons of
st aff and time a"ailability and the firmJ s technical experti se.
cB !eek references in respect of the new client company, it may
be, as is often the case, that the direct ors of the company are
already personally known to the firm, if not, independent
enquiries should be made concerni ng the st at us of the company
and its direct ors.
dB 1ommuni cat e with the retiring audit or:
+rocedur e s at er acce 1t i ng nomi nat i on
AaB -nsure that the outgoi ng audit orJ s remo"al or resignati on has
been properly conduct ed in accordance with the 1ompani es #ct
('&$.
The new auditor should see a "alid notice of the out going
auditorJ s resignati on, or confirm that the out going audit or was
properl y remo"ed at a gener al meet i ng of the company.
AbB -nsure that the new audit orJ s appoi nt ment is "alid.
The new auditor should obt ain a copy of the
resolution passed at the gener al meet i ng appoi nti ng
him as the companyJ s auditor.
AcB !et up and submi t a lett er of engage me nt to the direct ors of the
company.
This import ant procedur e is consider ed immedi at el y below.
"he engag e me n t let t er
+ur1os e
We ha"e est ablished that the direct ors and auditors of a limit ed company
ha"e "ery precise legal duti es, we are also awar e that moder n
account ancy firms thri"e on their ability to pro"ide a wide range of
professi onal ser"ices in addition to audit.
It is the purpose of an engag e me n t let t er to define clearly the ext ent of
the audit orJ s responsi bilities and so mini mi se the possibility of any
misunder st andi ng bet ween the client and the auditor. 7urther, the
engage me nt lett er pro"ides writt en confirmati on of the auditorJ s
accept ance of the appoint ment , the scope of the audit, the form of his
report and scope of any non audit ser"ices. If an engage me nt lett er is not
sent to client s - both new and existing - ther e is scope for argument about
the precise ext ent of the respecti"e obligations of the client and its
direct ors and the audit or. The cont ent s of an engage me nt lett er shoul d be
discussed and agreed with manage me nt before it is sent and preferabl y
prior to the audit appoi nt ment B.
"ii. The engage me nt lett er is a well est ablished audit techni que and I!#
$(4 "erms o Audi t Engag e me nt s pro"ides guidance in this area.
#egul at i on o the Account i ng +ro es s i on in Kenya
.6
The broad regul ations that go"ern the #ccounti ng professi on in .enya are
set out in the #ccount ant s #ct, 1hapt er 5*( of the 0aws of .enya.
The act est ablishes "arious bodies to regul at e the profession in .enya.
These are det ailed below with their maDor respecti"e functions
summari sed.
(. Kenya Account ant s and Secret ari e s Nati onal Exami nat i on
Board (KASNEB) (Sect i on .C) /
7unctions: I 2repar e syllabus es for accounti ng exami nati ons@
I ,ake rules with respect to exami nat i ons@
I #rrange and conduct exami nat i ons@
I Issue certificat es to candi dat es who ha"e satisfied
exami nati on requirement s@
I 2romot e recognition of its exami nat i ons in foreign
count ri es.
$. #egi s t rat i on o Account ant s Board (#AB)
7unctions: I 8egist er account ant s who are effecti"ely graduat es of I#! C
I78!-) exami nat i ons or hold qualifications
recogni sed by 8#) A!ection $* M $%B.
I Issue of 2ractising 1ertificat es A!ection $(B.
*. Insti t ut e o Certii ed +u,li c Account ant s o Kenya (IC+AK)
7unctions: I To promot e standar ds of professi onal compet ence
and practice amongst member s@
I 2romot e research into the subD ect s of account ancy
and finance and relat ed mat t er s, publication of books,
periodical s, Dournal s and articles@
I 2romot e the internati onal recogni tion of the institut e@
I #d"ise the .#!-) on mat t er s relating to
exami nati on st andar ds and policies.
%. *isci 1l i nary Commi t t e e
,ember shi p to be det er mi ned by 1ouncil of I12#.. Where the
Institut e 1ouncil has reason to belie"e that a member may be
guilty of professional misconduct it shall refer the mat t er to the
/isciplinary 1ommi t t ee which will inquire into the mat t er.
#fter its inquiry the 1ommi t t ee can recomme nd: -
aB o further action be taken agai nst the member @
bB The member be repri manded@
cB The member be repri manded with publication of the repri mand
in the Ha:et t e@
dB 8egistration be cancelled@
eB 2ractising certificat e be suspended.
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on %ne .4
!ection $9 of the #ccount ant s #ct det ails what constit ut es
professi onal misconduct .
%rgani s at i on in an Audi ti ng 7irm
The organi sati on adopt ed by most of the large firms in .enya
in"ol"es a pyrami d struct ur e that is usually made up as follows:
2art ner
,anager
#ccount ant in 1harge
#udit #ssist ant s, Trainees, Duniors
The part ner would be responsi bl e for the o"erall audit and he would sign
the final account s although most firms ha"e a second part ner with whom
the first part ner will consult particul arly on mat t er s of qualification in
report s. In addition, the part ner has to appro"e the det ailed plan of work
and gi"e his aut horit y before work can begin. =e will carry out a final
re"iew of the work once it has been done before signing the account s. It
is his dut y to ensur e that up- to- dat e ser"ices and ad"ice on all
professi onal mat t er s are pro"ided to the client. =e has to ensur e
continuit y in the relationshi p which can be absent lower down the
pyrami d. With difficult client s he is also charged with negoti ati ng the
audit fees. =e can be sued on behalf of the firm.
The manager is appoi nt ed for e"ery Dob and he is responsi bl e to a part ner
for satisfact ory compl etion of that assignment . =is initial responsi bility
usually in"ol"es prepari ng pro"isional timings and costing for the audit
and to agree the timings with the client. =e has to ensur e that there are
sufficient staffs at the right grade to co"er the client J s requirement s. 7rom
the appropri at e staff, he has to select the proper account ant in charge and
to brief him on what needs to be done. =e will also re"iew the audit plan
and the relat ed budget which may be prepar ed by the account ant in
charge and he will monit or the progr ess of the Dob const antl y to ensur e
that target s are achi e"ed. =e has to re"iew the working paper s in det ail
before they are submi t t ed to the part ner for his final re"iew. The manager
is a crucial person in the audit assignment . =e has to ensur e that the
proposed report is properl y drawn up. =e has to ensur e that the deadlines
are met @ he has to ensur e that the account s compl y with all regul ations in
e"ery way.
The account ant in charge is somet i mes referred to as a super"i sor or audit
senior. =is Dob is to control the day to day operation of the audit.
=owe"er, his degree of aut onomy depends "ery much on a particul ar
firmJ s policy, the personaliti es of the manager s and the account ant J s own
experi ence and ability. =is typical responsi bilities include:
aB The collection of det ail ed informati on for the prepar at i on of the
audit plan.
bB The delegat i on of specific areas of work to the audit assist ant s
or trainees.
.;
cB The planning and super"i sion of the day to day running of the
audit.
dB The const ant re"iew of progress by compari son of act ual time spent
agai nst budget .
eB -nsuring that the working paper s ha"e been thoroughl y prepar ed
and are present ed in an orderly manner to the manager and the
part ner for re"iew.
If we look at his position, we find that of the whole audit team he is
best placed to disco"er errors and irregul ariti es. #lso if the client is
not a client of integrit y, the account ant in charge is the easi est
person to influence. =e is also the easi est person to lose to client s
who are looking for young energeti c account ant s to Doin their
organi sati ons.
#udit #ssist ant s or trainees are responsi bl e to the account ant in
charge for the det ail ed work of the audit. They are expect ed to
produce working paper s set out in accordance with the firmJ s quality
control procedur es.
"y1i cal Set > &1 in a +ro e s s i o nal 7irmB %nl y +ro e s s i o nal
St a
-radi ngF *e 1art me nt B Seni or +art ner > Euali i ed Account ant B
+"erall in charge of the practice and co- ordinat es the functions and
relationshi ps of all depart me nt s, and is usually the primary liaison
with the internati onal firm Aif anyB.
Audi t *e1art me nt B #udit 2artner s - constit ut e a maDor part of the
part ner shi p as auditing is usually the core of securing business for
the practice.
"ax *e1art me nt B Tax 2artner - usually one part ner, at the same le"el as
the audit part ner s, concent r at es on running the tax depart ment for bot h
corpor at e and personal taxation.
Com1any Secret ari al *e1art me nt B <sually a company regist er ed
under the 1ompani es #ct with all the part ner s as direct ors. +ne part ner
may be assigned the responsi bility of o"erseei ng the acti"ities of this
depart me nt usually run by a qualified 1ompany !ecret ar y who is a
manager le"el empl oyee but not a part ner. 1hanges brought about by the
new act on 1ompany !ecret ari es will require that this empl oyee be made
a direct or as corporat e bodi es can no longer be 1ompany !ecret ari es.
S1eci al Ser0i ceB 2ro"iding bookkeepi ng and account ancy ser"ices this
depart me nt is usually headed by a person of Dunior manager grade with
se"er al clerks as support st aff.
Insol 0e nc y *e1art me nt B +ne audit part ner can doubl e up as insol"ency
part ner when "olume of business is small otherwi se a full part ner will be in
charge of this depar t ment with se"er al key support staff, that would
include manager s.
!anage me nt Cons ul t anc yB <sually headed by a /irector who is same
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on %ne .8
le"el as a part ner but is not necess arily a qualified account ant . ,ost in-
fact possess es other skills in consult ancy. Informat i on Technology is a
maDor ,1! in"ol"ement , 8ecruit ment ser"ices, ,anage me nt Training,
,anage me nt 1onsult ancy are the other areas of in"ol"ement .
!upport st affs are called consult ant s and ha"e grading such as:
!enior 1onsult ant N #udit -qui"al ent N !enior
,anager
1onsult ant N #udit -qui"al ent N
,anager
Gunior 1onsult ant N #udit -qui"al ent N
!uper"isor
"he Euali ti e s o an Audi t or or +ro es s i onal Account ant
Euali t y Euali t y Ex1l ai ne d
./ Com1e t e nc e (.( "he 1ro e s s i onal account ant mus t ,e
ully con0ers ant wit h
I #ccounti ng and )ook- .eeping@
I #uditing@
I Taxation 0aw and 2ractice@
I Internal 1ontrol and #ccounti ng
!yst ems@
I 1ompany 0aw@
I Informat i on Technology@
I ,anage me nt and 7inanci al 1onsult ancy@
I 6aluation@
I 0iquidation, 8ecei"ershi ps and
)ankrupt cy proceedi ngs@
I -conomi c en"ironment , policies and
trends.
(.$ A,ility to communi c at e ,ot h orall y
and in writi ng
I To his staff in gi"ing instructions and
directions@
I To the manage me nt and employees in
obt ai ning e"idence@
I To shar ehol der s in reporting his findings@
I To other third parti es in reporting his
findings and obt ai ning e"idence.
(.* =udge me nt
The account ant must be able to make
sound Dudgement s, not only in professi onal
mat t er s but also of peopl e.
=e must ther efor e not only possess the
.:
skill and ha"e the experi ence but he must
also ha"e imagi nation and the ability to
differenti at e bet ween mat eri al and non-
mat eri al items and to recogni se appar ent
inconsi st enci es and abnor mali ti es.
$. Int egri t y The account ant must be and be seen to be
honest , a follower of the ethical code of the
institut e, a person of discretion and tact
and a person awar e of his or her wider
responi bility to the communi t y at large.
The synonyms for integrit y include
honest y, upright nes s, probity, rectitude,
mor al soundnes s.
When an account ant has ethical difficulties
or is unsur e of what course of conduct to
follow, he must consult the institut e or
seek legal ad"ice.
*. Inde1e nde nc e The account ant J s Oreason to beO is
independence. # dependant account ant is
a contradi ction in ter ms. The rule is that
the account ant must approach e"ery
assignment with obDecti"ity. =e must
approach his work in a spirit of
independence of mind. #gain not only
must he be independent , he must be seen
to be independent . #ny interest which
might diminish an account ant sJ obDecti"ity
of approach or which might appear to do so
must be a"oided.
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on %ne .C
3hat the 1ro e s s i on does to
secur e the @ual i ti e s in the
account ant
Board res1ons i ,l e or
de0el o1me nt F ac t i on
8equirement to pass compr ehensi "e
exami nati ons for entry into the
professi on
.#!-)
8equirement s of a good gener al
educati on before registration as
student
.#!-)
8equirement of a mini mum period of
practical experi ence in a firm of
1ertified 2ublic #ccount ant s of .enya
before a practi sing certificat e is gi"en
Aan account ant cannot be an auditor
without a practi sing certificat eB
8#)
8equirement of registration with the
8egistrati on of #ccount ant s )oard of
.enya on qualification as an
account ant
8#)
/et er mi nati on of the financi al
reporti ng framework
I12#.
=olding of semi nar s, Issue of
maga:i nes and other technical
literat ur e
I12#.
-xist ence of the disciplinary commi t t ee The 1ouncil of I12#.
Int ernat i onal ? Assuranc e Audi ti ng? Standards Board (IAASB)
The preface to the Int ernat i onal !t andar ds on 3ualit y 1ontrol, #uditing,
#ssurance and 8elat ed !er"ices AInt ernat i onal !t andar ds or I##!)?s
!t andar dsB is issued to facilitat e under st andi ng of the obDecti"es and
oper at i ng procedur es of the Internat i onal #uditing and #ssur ance
!t andar ds )oard AI##!)B and the scope and aut hori t y of the
pronounce me nt s it issues, as set forth in the I##!)?s Int eri m Terms of
8eference.
The mi ssi on of the Internat i onal 7eder at i on of #ccount ant s AI7#1B, as set
out in its consti t uti on, is Ethe worldwi de de"el opme nt and enhance me nt
of an account ancy professi on with har moni :ed st andar ds, abl e to pro"ide
ser"ices of consi st ent l y high qualit y in the public int er est . F
In pursui ng this mission, the I7#1 )oard has est abli shed the I##!) to
de"el op and issue, under its own aut hori t y, high qualit y st andar ds on
audi ti ng, assur ance and relat ed ser"ices engage me nt s AI##!)?s
-ngage me nt !t andar ds, as defined in paragr aph (%B,
relat ed 2ractice !t at e me nt s and qualit y cont rol st andar ds for use around
the world.
.D
The I##!)?s pronounce me nt s go"er n audit , assur ance and relat ed
ser"ices engage me nt s that are conduct ed in accor dance with
Internat i onal !tandar ds.
They do not o"erride the local laws or regul ati ons that go"er n the audi t
of hist orical financi al st at e me nt s or assur ance engage me nt s on other
infor mat i on in a particul ar count r y required to be followed in accordance
with that count r y?s national st andar ds. In the e"ent that local laws or
regul ati ons differ from, or conflict with, the I##!)?s !t andar ds on a
particul ar subD ect , an
engage me nt conduct ed in accor dance with local laws or regul ati ons will
not aut omat i call y compl y with them. # professi onal account ant shoul d
not repr es ent compli ance with the I##!)?s -ngage me nt !t andar ds unl ess
the professi onal account ant has compli ed fully with all of those rele"ant
to the engage me nt .
The I##!) is commi t t ed to the goal of de"el opi ng a set of Int ernat i onal
!t andar ds gener all y accept ed worldwi de. To furt her this goal, the I##!)
works cooper at i "el y with national st andar d set t er s, and takes a lead role
in Doint proDect s with them, to promot e con"er gence bet ween national
and int ernat i onal st andar ds and achi e"e accept anc e of I##!)?s
!t andar ds.
"he Int ernat i onal Audi ti ng and Assuranc e Standards Board
The I##!) is a )oard est abli shed by I7#1. The member s of the I##!) are
appoi nt ed by the I7#1 )oard to ser"e on the I##!).
I##!) member s act in the common int er est of the public at large and the
worldwi de account ancy professi on. This could resul t in their taking a
position on a mat t er that is not in
accor dance with current practice in their count ry or firm or not in
accor dance with the position taken by those who put them forwar d for
member s hi p of the I##!). -ach I##!) member has the right to appoi nt
one techni cal ad"i sor who may participat e in the discussi ons at I##!)
meet i ngs.
I##!) meet i ngs to discuss the de"el opme nt and to appro"e the issuance
of Internat i onal !t andar ds, 2ractice !t at e me nt s or other paper s are open
to the public. #genda paper s, includi ng minut es of the meet i ngs of the
I##!), are published on the I##!)?s websi t e.
"he Authori t y Attachi ng to Int ernat i onal Standards Issued ,y the
Int ernat i onal Audi ti ng and Assuranc e Standards Board
Internat i onal !t andar ds on #uditing AI!#sB are to be applied in the audit
of hist orical financi al infor mat i on.
Int ernat i onal St andar ds on #e0i e w Engag e me n t s (IS#Es) are to be
applied in the re"i ew of hist orical financi al infor mat i on.
Int ernat i onal St andards on Assuranc e Engag e me n t s (ISAEs) are
to be applied in assur ance engage me nt s dealing with subD ect mat t er s
other than hist orical financi al infor mat i on.
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on %ne .<
Int ernat i onal St andar ds on #el at e d Ser0i c e s (IS#Ss) are to be
applied to compil ati on engage me nt s , engage me nt s to appl y agr eed upon
procedur es to infor mat i on and other relat ed ser"ices engage me nt s as
specified by the I##!).
I!#s, I!8-s, I!#-s and I!8!s are collecti"el y referr ed to as the IAASBA s
Engag e me n t St andar ds /
Int ernat i onal St andar ds on Eual i t y Control (ISECs) are to be
applied for all ser"ices falling under the I##!)?s -ngage me nt !t andar ds.
The I##!)?s !tandar ds cont ai n basic principl es and essent i al procedur es
Aidentified in bold type lett eri ngB toget her with relat ed guidance in the
form of expl anat or y and other mat eri al, includi ng appendi ces. The basic
principl es and essent i al procedur es are to be under st ood and appli ed in
the cont ext of the expl anat or y and other mat eri al that pro"ide guidance
for their applicati on. It is ther efor e neces s ar y to consi der the whol e text
of a !t andar d to under st and and appl y the basic principl es and essent i al
procedur es.
The nat ur e of the I##!)?s !t andar ds requir es professi onal account ant s to
exerci se professi onal Dudgment in appl yi ng them. In except i onal
circums t anc es , a professi onal account ant may Dudge it necess ar y to
depar t from a basic principl e or essent i al procedur e of an -ngage me nt
!t andar d to achi e"e mor e effecti"el y the obDecti"e of the engage me nt .
When such a situati on arises, the professi onal account ant shoul d be
prepar ed to Dustify the depar t ur e.
#ny limit ati on of the applicability of a specific Internat i onal !t andar d is
made clear in the st andar d.
"he Aut hori t y Att achi ng to +ract i c e St at e me n t s Issue d ,y the
Int ernat i onal Audi ti ng and Ass uranc e St andards Board
Internat i onal #uditing 2ractice !t at e me nt s AI#2!sB are issued to pro"ide
int erpr et i "e guidance and practi cal assi st ance to professi onal
account ant s in impl ement i ng I!#s and to promot e good practi ce.
Internat i onal 8e"iew -ngage me nt 2ractice !tat e me nt s AI8-2!sB,
Internat i onal #ssur ance
-ngage me nt 2ractice !tat e me nt s AI#-2!sB and Internat i onal 8elat ed
!er"ices
2ractice !t at e me nt s AI8!2!sB are issued to ser"e the same purpos e for
impl eme nt at i on of I!8-s, I!#-s and I!8!s respect i "el y.
2rofessi onal account ant s shoul d be awar e of and consi der 2ractice
!t at e me nt s applicabl e to the engage me nt . # professi onal account ant
who does not consi der and appl y the guidance included in a rele"ant
2ractice !t at e me nt shoul d be prepar ed to expl ai n how the basic
principl es and essent i al procedur es in the I##!)?s -ngage me nt
!t andar dA sB addr es s ed by the 2ractice !t at e me nt ha"e been compli ed
with .
IAASBs St andar ds and Aut hori t at i 0e *ocume nt s whi ch are whi ch
are Exami na,l eB
65
ISA No "itl e
Hlossar y of ter ms 2reface to I!#s and 8!s
(44 #ssurance -ngage me nt s
($4 7ramewor k of I!#s
$44 +bDecti"e and Hener al 2rincipl es Ho"erni ng an #udit
of 7inanci al !t at e me nt s
$(4 Terms of #udit -ngage me nt
$$4 3ualit y cont rol for #udit Work
$*4 /ocument at i on
$%4 The #uditor?s responsi bilit y to 1onsi der 7raud and
-rror in the #udit of 7inanci al !tat e me nt s
$54 1onsider at i on of 0aws and 8egul ati ons in an #udit of
7inanci al !tat e me nt s
$&4 1ommuni cat i on of #udit ,att er s with those charged
with Ho"er nance
*44 2lanni ng
*(4 .nowledge of the )usiness
*$4 #udit mat eri alit y
%44 8isk #ssess me nt s and Int ernal 1ontrol
%4( #uditing in a 1omput er Infor mat i on !yst ems
-n"ironment
%4$ #udit 1onsider at i ons 8elati ng to -ntities <sing
!er"ice +rgani :at i ons
544 #udit -"idence
54( #udit e"idence P #dditional 1onsi der at i on for !pecific
Items
545 -xt ernal 1onfirmat i ons
5(4 Initial -ngage me nt s P +peni ng )alances
5$4 #nalytical procedur es
5*4 #udit !ampli ng and +ther !electi"e Testing
2rocedur es
5%4 #udit of #ccounti ng -sti mat es
5%5 #uditing 7air 6alue ,easur e me nt s and /isclosur es
554 8elat ed 2arti es
5&4 !ubsequent -"ent s
5K4 Hoing 1oncer n
594 ,anage me nt repr es ent at i ons
&44 <sing the Work of anot her #uditor
&(4 1onsideri ng the Work of Int ernal #uditing
&$4 <sing the Work of an -xpert
K44 The #uditor?s 8eport on 7inanci al !tat e me nt s
K(4 1ompar at i "es
K$4 +ther Informat i on in /ocument s 1ont ai n #udit ed
944 The #uditor?s report on !peci al 2urpos e #udit
-ngage me nt s
9(4 The -xami nat i on of 2rospect i "e 7inanci al Infor mat i on
'(4 -ngage me nt to 8e"iew 7inanci al !t at e me nt s
'$4 -ngage me nt s to 2erfor m #greed <pon 2rocedur es
8egar di ng 7inanci al Informat i on
'*4 -ngage me nt to 1ompil e 7inanci al Informat i on
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on %ne 6.
o Title
I#2! (445 The !peci al 1onsider at i ons in the #udit of !mall -ntities
I#2! (4(4 The 1onsi der at i on of -n"ironment al ,att er s in the #udit of
I#2! (4(* -lectronic 1ommer ce -ffect on the #udit of 7inanci al
!t at e me nt s
+ne of the requirement s of I#! K44 the audit or must specifically menti on
in his report that the audit has been carried out in accordance with
appro"ed auditing standar ds. This is also required by I#2!. The auditing
standar ds and guidelines prescri be best practice in auditing but in no way
inhibit the audit or from exercising his Dudgment in particul ar situations.
2rofessional Dudgement is still required in interpr eti ng the standar ds in
particul ar areas, det er mi ni ng the sufficiency and type of e"idence needed,
areas where no standar d or guideline has yet been pronounced on.
#uditing standar ds therefore raise the requirement s for professi onal
Dudgement and an effecti"e and economi cal audit can only be achie"ed
with a great deal of thought at all stages. Therefore though mandat or y,
they are not designed to inhibit professional Dudgement .
"$E IN"E#NA"I%NA2 7INANCIA2 #E+%#"IN- S"AN*A#*S
Internati onal 7inanci al 8eporting !tandar ds are of great import ance to an
auditor. # det ail ed re"iew of those so far issued belongs to an accounti ng
text and for this reason it is assumed that the student s ha"e knowl edge of
their requirement s. =owe"er, elsewher e in this text the maDor auditing
point s with regar d to each current I#! C I78! are re"iewed under the
accounti ng st andar ds checklist. The I#! C I78! issued to dat e are as
follows:
Exami na,l e Authori t at i 0e docume nt s
Int ernat i onal 7inanci al #e1orti ng Standards (IASsFI7#S)
o Title Issue
dat e
2reface to !t at e me nt s of I#!s
I#! ( 2resent at i on of 7inanci al !t at e me nt s A8e"isedB
#ug (''K
I#! $ In"ent ori es /ec
(''*
I#! K 1ash 7low !t at e me nt s A!ee ot e $B
/ec (''$
I#! 9 et 2rofits or 0oss for the 2eriod, 7unda me nt al -rrors
#nd 1hanges in #ccounti ng 2olicies
/ec (''*
66
I#! (4 -"ent s aft er the )alance !heet /at e A8e"isedB
,ay ('''
I#! (( 1onst ructi on 1ontract s /ec
(''*
I#! ($ A8e"isedB Income Taxes +ct
(''&
I#! (% A8e"isedB segment 8eporti ng
#ug (''K
I#! (5 Informat i on reflecti ng The -ffect s of 1hangi ng 2rices
/ec (''*
I#! (& 2roperti es, 2lant and -quipment A8e"isedB
!ep (''9
I#! (K #ccounti ng for 0eases A8e"isedB
o" (''K
I#! (9 8e"enue /ec
(''*
I#! $4 #ccounti ng for Ho"er nme nt Hrant s and /isclosur e
+f Ho"ernme nt #ssist ance
Gan (''5
I#! $$ )usiness 1ombi nat i ons A8e"isedB
!ep (''9
I#! $* )orrowing 1ost s /ec
(''*
I#! $% 8elat ed 2art y /isclosur es Gan (''5
I#! $K 1onsolidat ed 7inanci al !t at e me nt s and #ccounti ng
7or In"est me nt s in !ubsi di ari es
Gan (''5
I#! $9 #ccounti ng for In"est me nt s in #ssoci at es A8e"isedB
!ep (''9
IAS 30
I#! *( 7inanci al 8eporti ng of Inter est s in Goint 6ent ur es
A8e"isedB !ep
(''9
I#! *$ 7inanci al Instrume nt s: 8ecogni ti on and ,easur e me nt
A8e"isedB A!ee ot e *B
Gune (''5
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on %ne 64
I#! ** -arni ngs per !har e 7eb
(''K
I#! *% Interi m 7inanci al 8eporti ng
7eb (''9
I#! *5 /iscount i ng +per ati ons
Gun (''9
I#! *& Impair ment of #sset s
Gune (''9
I#! *K 2ro"isions, 1ontingent 0iabilities
and 1ontingent #sset s
!ep (''9
I#! *9 Intangi bl e #sset s !ep
(''9
I#! *' 7inanci al Instrume nt s: /isclosur e and
2resent at i on A!ee ot e *B /ec
(''9
I#! %4 In"est me nt 2ropert y
,ar $444
I#! %( #gricult ur e 7eb
$44(
I78! ( !hare )ased 2ayment s
I78! $ 7irst Time #pplication of I78!s
I78! * !hare )ased 2ayment s
I78! % )usiness 1ombi nations
I78! 5. on 1urrent #sset s =eld for !ale and /isconti nued +perati ons
#E2E'ANCE %7 IAS F I7#S "% A&*I"IN-
#uditors must include in their report their opinion on whet her the financi al
stat e ment s they report on gi"e a true and fair "iew. It is gener ally felt
that in order for account s to show a true and fair "iew ther e must be
compliance with the I#! C I78!. There may be situati ons wher e
compliance with I#! C I78! may result in a true and fair "iew not being
gi"en but this is rare. !o effecti"ely, the auditor is being asked to gi"e an
opinion on whet her all I#! C I78! ha"e been complied with in the
prepar at i on of the account s he is auditing. The audit or therefore must
know and under st and the I#! C I78! in det ail. #uditing student s are also
expect ed to know the I#! C I78! in det ail becaus e in"ari abl y, there will be
an exami nati on questi on that requires this knowledge and student s are
ad"ised to quot e from the I#! C I78! and st at e which of the I#! C I78! is
6;
rele"ant to their answer.
Internati onal 7inanci al 8eporting !tandar ds are intended to be applied to
all financi al stat e me nt s which show a true and fair "iew. They set out the
main assumpt i ons underlying stat e ment s and they prescri be which
accounti ng policy shoul d be used when more than one are possibl e. They
also specify disclosur e requirement s in many areas including the
disclosur e of accounti ng policies. #gain they are not intended to be a
compr ehensi "e code of rigid rules. It is recogni sed that such a code
sufficiently elabor at e to cat er for all business situati on and circumst ances
and for e"ery excepti onal and mar gi nal case is impossi bl e. The benefit s of
I#! C I78! are:
(. They lead to a degr ee of uniformit y and compar ability among
account s.
$. They assist underst andi ng by pro"iding reader s of the account s
great er informat i on about the prepar ati ons of the account s.
*. They assist account ant s and audit ors by aiding in the process of
det er mi ni ng what is a true and fair "iew. They therefor e help
refine the meani ng of true and fair "iew.
%. They describe a met hod of accounti ng and or disclosur e
requirement appro"ed by the institut e.
5. ,ember s of the institut e are obliged to secur e adher ence to
I#! C I78! whene"er they are concerned with financi al
st at eme nt s be they direct ors, account ant s, company
secret ari es, auditors or in any other role.
Negl i ge nc e in -eneral
There is no recorded case in .enya against audit ors and this makes it
difficult to be precise as to where the audit or?s legal liability falls. We
need ther efor e to refer to decided cased in other count ri es. )ut e"en in
those count ri es ther e are in fact "ery few decided cases agai nst auditors.
In those count ri es, the "ast maDority of actions against audit ors are set tl ed
out of court. This sa"es what could otherwi se be "ery expensi "e court
cost s. It is also significant to not e that this sa"es draggi ng the
professi onal firmJ s name through the court s and most likely through the
newspaper s. 7irms are of course anxious to a"oid such bad publicity.
It is howe"er gener ally known that the auditorJ s liability falls under three
specific headi ngs:
AaB To his client s under contract law@
AbB To third parti es under the law of tort@
AcB 1i"il and criminal liability under st at ut e law
and we will deal with each in turn:
"o hi s cli ent sB The audit or is under duty to report to the member s
in gener al meet i ngs on all account s exami ned by him and laid before
them. =is contract is ther efor e with the company as a whole and not
with indi"idual shar ehol der s. The auditor can therefore be accused
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on %ne 68
of negligence if:
AaB he fails to det ect fraud or error which he should reasonabl y
ha"e det ect ed@
AbB if he fails to compl y with gener ally accept ed auditing st andar ds
and practices.
=owe"er, it is also gener ally held that for an auditor to suffer act ual
financi al loss, the following conditions must be met .
i. he must be pro"ed to ha"e been negligent @
ii. the compl ai nant must ha"e suffered a loss@
iii. the loss must be as a direct consequence of his reliance on the
audit orJ s report and the audit ors negligence.
Therefore if the auditor fails to det ect a fraud which is immat eri al to
the account s and unless there are suspicious circumst ances which he
had noticed or shoul d reasonabl y ha"e noticed, it is unlikely that he
will be held negligent .
-"en if the fraud was mat eri al to the account s, he may still escape
liability if det ecti on could not reasonabl y ha"e been achi e"ed using
normal audit procedur es. It must be admi t t ed howe"er this is a "ery
dubious area of law.
The audit or has no duty to indi"idual shar ehol der s. # shar ehol der
who makes an in"est ment decision by relying on the audit orJ s report
and suffers loss cannot clai m under the law of contract . +nly if the
company as a whole has suffered, can the whole body of
sharehol der s clai m from the auditor.
In a number of cases it appear s that clai ms ha"e arisen as a result of
some misunder st andi ng as to the degree of responsi bility which the
account ant was expect ed to take in gi"ing ad"ice or expressi ng an
opinion. It is therefor e import ant , to distingui sh bet ween disput es
arising from misunder st andi ng regar di ng the duties assumed, and
negligence in carrying out agreed ter ms.
"he &se o Engag e me nt 2ett ers
There is a contract ual relationshi p bet ween an account ant and his client.
The account ant should therefore ensur e that at the time he agreed to
perfor m cert ai n work for the client, the scope of his responsi bilities is
made clear preferabl y in writing, in that the ter ms of his contract with his
client are properly defined. Where possi bl e a lett er of engage me nt shoul d
be prepar ed set ting out in det ail the act ual ser"ices to be perfor med, and
the ter ms of engage me nt should be accept ed by the client so as to
mini mi se the risk of disput es regar di ng the duties assumed.
2ia,ili ty to third 1arti es
7or a long time liability to third parti es exist ed only in respect to physical
inDury. 0iability for financi al loss is a recent de"elopment . -xampl es of
occasions when an account ant may run the risk of insuring a liability to
third parties may include the following:
6:
AaB 2repari ng financi al stat e ment s or report s for a client when it is
known or ought to be known that they are intended to be shown
to and relied upon by a third part y e"en if the identit y of the
third part y is not disclosed.
AbB Hi"ing references regardi ng a client J s credit wort hiness or an
assur ance as to his capacit y to carry out the ter ms of a contract
or gi"ing any other reference on behalf of the client.
#gain, it must be shown that the account ant was negligent , third parti es
suffered a financi al loss, the financi al loss occurred as a result of the
account ant J s negligence and that the account ant knew the purpose for
which his report or account s were to be used.
2ia,ili ty under st at ut e
Ci0il lia,ili t yB !ection $4& of the 1ompani es #ct pro"ides that
officers of the company and for these purposes auditors are
consider ed as officers, may be liable for financi al damages in respect
of the ci"il offences of misfeas ance and breach of trust. This section
which is only rele"ant to winding up refers to a situation where
officers ha"e misused their position of aut horit y for the purposes of
personal gain.
Crimi nal lia,ili t yB !ection %& of the 1ompani es #ct stat es that an
auditor shall be criminally liable if he wilfully makes a mat eri ally false
stat e ment in any report, certificat e, financi al stat e me nt etc. Wilfully
implies fraudul entl y and can be difficult to pro"e. Whereby, it is
held that wher e an officer of a body corporat e with intent to decei"e
member s or creditors, publishes or concurs in publishing a writt en
stat e ment of account which to his knowledge is or may be
misleadi ng, false or decepti "e in a mat eri al particul ar he shall on
con"iction be liable to imprisonment for a ter m not exceedi ng K
years.
%ther rel e0ant issue s to ,e consi der e d under thi s sect i on incl udeB
I The auditor with errors and irregul arities@
I The auditor with illegal act s by client or client J s st aff@
I 3uestionabl e payment s@
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on %ne 6C
I22E-A2 AC"S
#uditors may unco"er criminal offences commi t t ed by a client or an
empl oyee of the client. This put s them in a difficult position, but the
auditor shoul d act carefully and correctl y and if necess ar y, take legal
ad"ice. The auditor must not commi t a criminal offence himself. It is felt
that he would ha"e commi t t ed a criminal offence if:
AaB =e ad"ises his client to commi t a criminal offence@
AbB #ids the client in de"ising or exami ni ng a crime@
AcB If he agrees with a client to conceal or dest roy e"idence or
mislead the police with false st at eme nt s@
AdB If he knows that his client has commi t t ed an arrest able offence
and tries to impede his arrest and prosecuti on. Impede does
not include refusing to answer questi ons or refusing to produce
document s without the client J s consent @
AeB If he knows that his client has commi t t ed an offence and agreed
to accept consider at i on to withhold informati on@
AfB If he knows that the client has commi t t ed treason and fails to
report the offence to the proper aut horit y.
*isco0ery o unl aw ul act s
When an auditor disco"er s unlawful act s, usually he is not expect ed to
disclose to the police or other aut horiti es unless:
i. The client aut horises disclosur e@
ii. That disclosur e is compell ed by process of law for exampl e, a
court order@
iii. That disclosur e is required in the audit orJ s own defence@
i". The circumst ances are such that the audit or has a public dut y to
disclose, for exampl e, when the client has commi t t ed a serious
crime or his act is treasonabl e.
Therefore to summari se, the audit or on disco"ery of an unlawful act
shoul d do not hing positi"ely to assist in the offence or to pre"ent its
disclosur e. =e must bring all offences of empl oyees to the notice of his
client s. If the offence is such that its non- disclosur e means that the
account s are not showing a true and fair "iew, then the audit or must insist
on disclosur e or qualify his audit report. /isco"ery of mat eri al defect s in
pre"ious account s shoul d be point ed out to the client with
recomme nda t i on for disclosur e.
6D
Eues t i ona,l e +ayme nt s
In some count ri es, business is often gained by bribing minist ers or public
officials or officers of compani es or firms with whom one wishes to do
business. Indeed bribery and corruption are a way of life in some business
communi ti es. This is the gener al area of questionabl e payment s, which
may include Ocommi ssi ons, usually based on the amount of business
placedO. When an audit or disco"er s such payment s, he has to consider
what course of action to take. In gener al, the following conduct by the
auditor is accept abl e.
AaB =e should satisfy himself that the payment is as stat ed and that
he has been told the whole story@
AbB =e should satisfy himself that the payment s were genui nel y
made in further ance of the client J s business@
AcB =e has to satisfy himself that all direct ors of the company were
awar e of the payment and its purposes@
AdB =e has to obt ain a lett er of represent at i on, signed by all the
direct ors to confirm AcB@
AeB If the client is a subsi di ary, then he has to ensur e that the
holding company and the pri mar y auditors are awar e of the
payment and@
AfB =e has to consider whet her disclosur e is required. Hener ally
disclosur e is not necess ar y becaus e such payment s are rarely
mat eri al in the cont ext of the companyJ account s as a whole
and usually a true and fair "iew is gi"en without disclosur e.
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on %ne 6<
#EIN7%#CIN- E&ES"I%NS
E&ES"I%N %NE
The direct ors of .. 0imited, a newly formed company, ha"e writt en to you
with a "iew to securing your ser"ices as auditor. Within their lett er you
not e the following comment s.
OQour duti es and right s as audit or will be det er mi ned by the board of our
company. In the mai n these duties are in line with the requirement s of
the 1ompani es #ct ('&$ but in the e"ent of conflict or exclusion we will
indemnify you against any legal action brought as a consequence of the
position adopt ed. The board also ret ai ns the right to dismi ss you at any
time without necess arily disclosing the reasons for their actionO.
#e@ui red
AaB /escribe what is your under st andi ng of your duti es as audit or of
.. 0imited.
AbB What is your relationshi p as the audit or to the direct ors of ..
0imitedR
AcB +utline your right s under the 1ompani es #ct as audit or of a
limited company.
AdB Would you agree with the direct ors that they ha"e the aut horit y
to dismi ss youR
AeB What st eps would you take prior to accepti ng the appoint ment
as audit or to the companyR
E&ES"I%N "3%
It has been suggest ed that the most import ant mat t er affecting the
credibility of the audit or is that of >IndependenceJ .
#e@ui red
AaB /iscuss gi"ing exampl es, mat t er s other than independence,
which might be rele"ant in relation to the credibility of the
audit or and st eps that the accounti ng professi on has taken or
might take in relation to them.
AbB 1omment on the following situations in the cont ext of the
independence of the auditor, showing clearly the principles
in"ol"ed:-
i. The audit manager in charge of the audit assignment of
#ndrew holds (,444 S( ordinary shar es in the company
Atot al shar es in issue - (44, 444B. The audit part ner holds
no shar es.
ii. #n audit part ner of a firm of 1ertified 2ublic #ccount ant s is
a personal friend of the chief account ant of Games 0td. The
chief account ant is not a direct or of the company and the
audit part ner is not responsi bl e for the Games 0imited audit
work.
iii. The audit fee recei"abl e from Ganet 0td is S(44, 444. The
45
tot al fee income of the #udit firm is SK44, 444.
i". The audit senior in charge of the audit of ,argot )ank 0td
has a personal loan from the bank of S$, 444 on which she
is currentl y paying (*T interest .
". The audit part ner is responsi bl e for two audit assignment s,
=arry 0imited and Gean 0imited. =arry 0imited has
recentl y tender ed for a contract with Gean 0imited for the
suppl y of mat eri al quanti ti es of goods o"er a number of
years. =arry 0imited has asked the audit part ner to ad"ise
on the mat t er.
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E&ES"I%N "$#EE
AaB What shoul d an account ant do about commi ssi onsR
AbB -numer at e the areas wher e conflict of interest may occurR
AcB What restrictions are there on ad"ertisingR
AdB =ow can an account ant obt ai n publicity in an ethical mannerR
AeB ,ay an account ant send a "ideo, showing how he could assist a
pot enti al company client, direct to that companyR
AfB What are the rules on account ant sJ remuner at i onR
E&ES"I%N 7%&#
+nyango, .amau and ,akokha are part ner s in a small firm of
engineer s oper ati ng in road const ruction. !ince commenci ng
business $4 mont hs ago they ha"e been quit e successful. The
accounti ng records ha"e been kept by +nyango who att ended
7inance for on- #ccount ant s !emi nar some two years back.
+nyango has also prepar ed the first years account s.
+n re"iew of the account s the three part ner s notice that the account s
show a profit in excess of drawings. .amau and ,akokha suggest
that they shoul d di"ide the excess amongst thems el "es immedi at el y
but +nyango counsel s caution, talking about working capit al needs
which confuses the others.
,akokha questi ons +nyango on his interpr et at i on of the part ner shi p
agree me nt which is a "ery complicat ed document and suggest s that
they should pay to ha"e the account s audit ed. +nyango becomes
heat ed and says that would be a wast e of time and money as he is
perfectly capabl e of producing the account s and makes no charge to
his part ner s for this work.
#e@ui red
What benefit s would the part ner s deri"e from empl oyi ng an
independent audit orR
It is common practice for audit ors to send a lett er of engage me nt to
new client s and increasi ngl y to existing client s. !et out below are
mat t er s usually included in such lett ers.
i. /efinition and scope of audit
ii. 7raud and irregul ariti es
iii. #ccounting, taxati on and other ser"ices
i". 7ees
#e@ui red
AaB -xplain why a lett er of engage me nt is desirabl e for the audit or
AbB In the case of each mat t er referred to abo"e show what point s
will be included.
(.8 !arks)
46
E&ES"I%N 7I'E
7or many years the law had adopt ed an approach wher eby no action for
negligence could be brought if the parti es concer ned had no contract ual
relationshi p with each other, unless the negligent act caused physical
inDury or was fraudul ent misrepr es ent at i on. Thus, the auditor had a
contract ual relationshi p with his client or client sJ shar ehol der s only and
owed a dut y of care to them alone. =owe"er, the court s ha"e increasi ngl y
sought to ext end the liability of the audit or to other Ae"en pot enti alB users
of financi al stat e me nt s. The "iew of the Dudiciary appear s to be that the
time is ripe for the auditing profession to assume a great er responsi bility
for its actions. The risk att ached to users of audit ed financi al st at eme nt s
has been reduced and, at the same time, there has been an increas e in
the risk carried by the auditing profession.
(ou are re@ui red to
AaB /escribe the Dudicial decisions, which ha"e alter ed the range of
the audit orsJ duty of care to third parti es.
AbB -xplain how the auditor can ensur e that the risk att achi ng to an
audit is reduced to a mini mum.
AcB 1omment on the "iew that much of the litigation and allegati ons
of negligence direct ed against the audit ors may be more
appropri at el y ai med at the direct ors of a company.
Check your ans wer s with thos e gi 0en in 2ess on .5
o the Study +ack
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44
2ESS%N "3%
Accounting and Internal Control SystemsB "heory and +ractice
%B=EC"I'ES
When you ha"e studi ed this lesson, you should be able to:
/efine and describe the obDecti"es of internal control syst ems and
the responsi bility
for internal control syst ems in the cont ext of organi sati onal
obDecti"es
/escribe the import ance of internal controls to audit ors
/escribe and illustrat e the limit ations of internal control syst ems in
the cont ext of fraud and error
!tat e the types of controls
!ummari se the met hods used to ascert ai n and to record syst ems
/iscuss whet her reliance should be placed on the syst ems to reduce
the tot al amount of testing
/esign appropri at e accounti ng and internal control syst ems
-xplain and discuss the impact of de"el opment in IT.
C%N"EN"S
(B The #ccounti ng !yst em
$B Internal 1ontrols syst ems
*B -rrors and 7raud
%B Internal #uditing
5B The Impact of de"elopment s in Informati on Technology
INS"#&C"I%NS
(. #ssigned reading
a. I#! %44 8isk #ssess ment s and Internal 1ontrol
b. I!# $%4 The #uditor?s responsi bilit y to 1onsider 7raud and
-rror in the #udit of 7inanci al !tat e me nt s
c. I!# &(4 1onsi deri ng the work of int ernal #uditing
$. 1ompl et el y answer the reinforci ng questi ons at the end of this
lesson without refer ence to the model answer s
*. 1ompar e your answer s with those gi"en in lesson (4 of the study
pack.
A&*I"IN-
4; Account i ng and
Int ernal Control Sys t e m
6/ 5 "he Account i ng Syst e m
*ei ni ti on
ISA 400 Ris Assess me nt and Internal !ontrol account i ng sys t e m is
the seri e s o tas ks and records o an ent i t y ,y whi ch
trans ac t i ons are 1roc e s s e d as a means o mai nt ai ni ng inanci al
records / Such sys t e ms ident i y? as s e m,l e ? anal yG e ? cal cul at e ?
cl as s i y? record? summari G e and re1ort trans ac t i ons and ot her
e0e nt s /
ISA ;55 8isk #ssess me nt s and Internal 1ontrol s st at es that the audi t or
shoul d obt ai n an under st andi ng of the account i ng and int ernal cont rol
syst e ms sufficient to plan the audit and de"el op an effecti"e audi t
approach. The audi t or shoul d use professi onal Dudgment to asses s audit
risk and to desi gn audi t procedur es to ensur e it is reduced to an
accept abl y low le"el.
"he Com1ani e s Act Ca1 ;D: places a duty upon the auditor in
prepari ng his report to carry
out in"estigations that will enabl e him form an opinion on the financi al
stat e ment s in accordance
with the se"ent h schedul e to the 1ompani es #ct 1ap %9&
"he o,H ect i 0e o the account i ng syst e m is to ens ur e that all
trans ac t i ons are com1l e t e l y and accurat el y 1roce s s e d and
recorde d and that the resul t i ng account i ng entri e s are 0ali d/
!anage me nt s int ere s t in the account i ng syst e m
,anage me nt needs compl et e and accurat e books of account s
becaus e:
i. There is no other way the business can be controlled@
ii. 8ecords of debt or s and credit ors are indispens abl e@
iii. The best way to safeguar d asset s is to ha"e a proper record of
them@
i". #ccount s can only be prepar ed if proper primary books exist@
". The 1ompani es #ct has specific requirement s on keepi ng of
proper books of account s@
"i. The "arious act s co"ering !!7, =I7, 2#Q-, 6#T, 0-6Q require
proper books.
What constit ut es an adequat e syst em of accounti ng depends on the
circumst ances. The import ant thing is that the syst em should
pro"ide for the orderly assembl y of accounti ng informati on to enabl e
account s to be prepar ed. # syst em of accounti ng cannot succeed in
compl et el y and accurat el y processi ng and recordi ng all transacti ons,
unless internal arrange me nt s set up by the manage me nt known as
Int ernal Control s are built into the syst em.
6/ . Internal Control Syst e ms
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I!# %44: EInt ernal cont rol sys t e m F means all the policies and
procedur es Aint ernal cont rol sB adopt ed by the manage me nt of an entit y
to assi st in achi e"i ng manage me nt ? s obDecti"e of ensuri ng, as far as
practicabl e, the orderl y and efficient conduct of its busi ness, including
adher ence to manage me nt policies, the safeguar di ng of asset s, the
pre"ent i on and det ect i on of fraud and error, the accur acy and
compl et enes s of the account i ng records, and the timel y prepar at i on of
reliabl e financi al infor mat i on. The int er nal cont rol syst e m ext ends
beyond those mat t er s which relat e directl y to the functions of the
account i ng syst e m and compri ses:
AaB E"he cont rol en0i ronme nt I
Which means the o"er all at tit ude, awar enes s and actions of direct or s
and manage me nt regar di ng the int er nal cont rol syst e m and its
import ance in the entit y. The cont rol en"ironme nt has an effect on the
effecti"enes s of the specific cont rol procedur es. # strong cont rol
en"ironment , for exampl e, one with tight budget ar y cont rol s and an
effecti"e int ernal audit function, can significantl y compl eme nt specific
cont rol procedur es. =owe"er, a strong en"ironme nt does not, by itself,
ensur e the effecti"enes s of the int ernal cont rol syst e m. 7act ors reflect ed
in the cont rol en"ironme nt include:
The function of the board of direct or s and its commi t t e es .
,anage me nt ? s philosophy and oper at i ng styl e.
The entit y?s organi :ati onal struct ur e and met hods of assi gni ng
aut hori t y and responsi bility.
,anage me nt ? s cont rol syst e m includi ng the int ernal audit
function, personnel policies and procedur es and segr egat i on of
duti es.
AbB EControl 1roc e dur e s F which means those policies and procedur es
in addi tion to the cont rol en"ironment which manage me nt has
est abli shed to achi e"e the entit y?s specific obDecti"es. !pecific cont rol
procedur es include:
8eporti ng, re"iewi ng and appro"i ng reconciliations.
1hecking the arit hmet i cal accur acy of the recor ds.
1ontrolling applicati ons and en"ironme nt of comput er
infor mat i on syst e ms , for exampl e, by est abli shi ng cont rol s o"er
changes to comput er progr a ms
#ccess to dat a files.
,aint ai ni ng and re"iewi ng cont rol account s and trial bal ances.
#ppro"i ng and cont rolling of document s .
1ompari ng int ernal dat a with ext er nal sources of infor mat i on.
1ompari ng the result s of cash, securi t y and in"ent or y count s
with account i ng records.
0imiting direct physi cal access to asset s and records.
1ompari ng and anal y:i ng the financi al result s with budget ed
amount s.
#</ITIH
Exam 7ocus
This is a fertile area for exami ner s. In"ariabl y in e"ery exami nat i on paper
set on auditing ther e
A&*I"IN-
4: Account i ng and
will always be a questi on on internal controls.
We will consider the definition, the theory, the practice and its impact on
the account ant being
audit ed and the account ant who is doing the auditing.
The manage me nt is concerned that errors and irregul ariti es shoul d
not occur becaus e if they did occur they would result either in the
loss of asset s or the production of accounti ng records that are
unreliabl e in that they will fail to disclose a true and fair "iew of the
financi al position and the result s from oper ati ons of the entit y
concerned.
!eani ng o the dei ni ti on
aB %rderl y and ei ci ent mannerB #n organi:ati on that is run in
an orderly and efficient manner is able to satisfy the needs of its
manager s, shar ehol der s, audit ors, cust omer s, suppliers and
anybody else interest ed in the operations of the entit y. It will
be able to satisfy the needs of its producti on facilities. The
result s of orderliness include the timel y producti on of
informati on that is reliabl e, they also include the cooper ati on of
all parti es concer ned. #n organi:ati on that is run in a disorderl y
and inefficient manner will soon degener at e into chaos and
would probabl y ha"e to close down sooner or later. This is
import ant to the audit or in that where the organi:ation is well
run he will expect reliabl e informat i on timel y recei"ed or
pro"ided and he will recei"e the cooper ati on of the
manage me nt , the st aff and other third parti es from whom he
may seek repres ent at i ons. This reduces the amount of det ailed
work the audit or has to do.
bB -nsure adher e nc e to manag e me nt 1oli cy : -"ery
organi:ati on must ha"e ai ms or obDecti"es. 7or a company
these are usually to be found in its ,emorandum and
#rticles of #ssociation. The manage me nt is charged with
the responsi bility of designi ng policies that will enabl e the
organi:ati onJ s obDecti"es to be achi e"ed. !o the
manage me nt must set policies that ha"e to be followed or
adher ed to, to achie"e the obDecti"es of the organi:ation.
To do this, manage me nt identifies broad policies such as:
the indust ry in which to oper at e, the product s to produce,
where the factory is to be locat ed and which market its
product s are aimed at. ,anage me nt also set s det ailed
policies such as the number of account s clerks to be
employed and their remuner at i on. 7or the auditor
adher ence to manage me nt policy places the whole
organi:ati on in perspect i"e. +nly if the audit or
underst ands the organi:ationJ s obDecti"es and the policies
adopt ed by the manage me nt to achi e"e those obDecti"es
will he be able to det er mi ne whet her meas ur ed against
those obDecti"es, the account s gi"e a true and fair "iew.
The policies adopt ed particul arly in det er mi ni ng the "alues
att ached to asset s and liabilities and the amount s to be
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charged as re"enue or expendi t ur e in the profit and loss
account must be in accordance with gener ally accept ed
accounti ng principles.
cB Sa e guar d the ass e t s B The asset s are the resources of the
organi:ati ons. They must ther efore be prot ect ed from loss.
This prot ection can be done directly i.e. physically locking the
asset s under lock and key and trying to pre"ent their
det eriorati on or safeguar di ng can be done indirectly through
records and document at i on. !afeguar di ng the asset s means
restricting access to the asset s. Indirect restriction means that
access to the asset s should be through aut hori sed
document at i on. 7or the audit or, the account s cannot gi"e a
true and fair "iew if he cannot confirm that the asset s
concer ned act ually exist and ha"e the "alue attribut ed to them.
dB Secure as ar as 1os si ,l e the com1l e t e n e s s and accuracy
o the records . It is difficult to control any business unless you
ha"e got reliabl e and accurat e records. )usiness decisions
cannot be made unless all the transacti ons ha"e been
compl et el y and accur at el y process ed and recorded. The
1ompani es #ct requires proper records being kept for all the
companyJ s transacti ons and acti"ities. It further requires that
these records shoul d be such that account s that gi"e a true and
fair "iew can be extract ed from them. Therefore, the
organi:ati on must keep reliabl e records and ther efore the
manage me nt must take the appropri at e steps to ensur e that it
secur es as far as possibl e the compl et enes s and accuracy of the
records. 7or an audit or, his interest s in this element of internal
control arises out of his st at ut ory responsi bility to in"esti gat e
and report whet her proper books of account s ha"e been kept ,
whet her the account s he is exami ni ng are in agreeme nt with
those books, and whet her the 1ompani es #ct requirement s
ha"e been complied with in all mat eri al respect s. =e therefore
has a direct interest in compl et e and accur at e records.
6/ 6 7raud and Error
I!# $%4 The #uditor?s 8esponsi bilit y to 1onsider 7raud #nd -rror st at es
that when planni ng and perfor mi ng audit procedur es and e"al uat i ng and
reporti ng the result s ther eof, the audi t or shoul d consi der the risk of
,at eri al misst at e me nt s in the financi al st at e me nt s resul ti ng from fraud
or error.
,isst at e me nt s in the financi al st at e me nt s can arise from fraud or error.
The ter m Eerror F refers to an unint ent i onal misst at e me nt in financi al
st at e me nt s , including the omi ssi on of an amount or a disclosur e, such as
the following:
# mist ake in gat heri ng or proces si ng dat a from which
financi al st at e me nt s are prepar ed.
#n incorr ect account i ng esti mat e arising from o"ersi ght or
mi sint er pr et at i on of fact s.
A&*I"IN-
4D Account i ng and
# mist ake in the applicati on of account i ng principl es relati ng
to meas ur e me nt , recogni tion, classificati on, present at i on, or
disclosur e.
The ter m Eraud F refers to an int enti onal act by one or mor e indi"idual s
among manage me nt , those charged with go"er nance, empl oyees, or
third parti es, in"ol"ing the use of decept i on to obt ai n an unDust or illegal
ad"ant age.
#lthough fraud is a broad legal concept , the audi t or is concer ned with
fraudul ent act s that caus e a mat eri al mi sst at e me nt in the financi al
st at e me nt s . ,isst at e me nt of the financi al st at e me nt s may not be the
obDecti"e of some frauds. #uditors do not make legal det er mi nat i ons of
whet her fraud has act uall y occurr ed. 7raud in"ol"ing one or mor e
member s of manage me nt or those charged with go"er nance is referr ed
to as mana g e me n t raud @F fraud in"ol"ing only empl oyees of the entit y
is referr ed to as Jem1l oy e e raud .F In either case, ther e may be
collusion with third parti es out si de the entit y.
Two types of int enti onal mi sst at e me nt s are rele"ant to the audi t or?s
consi der at i on of fraud P misst at e me nt s resul ting from fraudul ent financi al
reporti ng and mi sst at e me nt s resul ti ng from mi sappr opri at i on of asset s.
7raudul e nt inanci al re1ort i ng in"ol"es int enti onal mi sst at e me nt s or
omi ssi ons of amount s or disclosur es in financi al st at e me nt s to decei"e
financi al st at e me nt user s. 7raudul ent financi al reporti ng may in"ol"e the
following:
/ecepti on such as mani pul at i on, falsification, or alt er ati on
of account i ng
records or supporti ng docume nt s from which the financi al
st at e me nt s are
prepar ed.
,isrepr es ent at i on in, or int enti onal omi ssi on from, the
financi al
st at e me nt s of e"ent s, trans act i ons or other significant
infor mat i on.
Intenti onal misapplicat i on of account i ng principl es relati ng
to
meas ur e me nt , recogni ti on, classification, present at i on, or
disclosur e.
The distingui shi ng fact or bet ween fraud and error is whet her the
underl yi ng action that resul t s in the misst at e me nt in the financi al
st at e me nt s is int enti onal or unint ent i onal . <nlike error, fraud is
int enti onal and usually in"ol"es deliber at e conceal ment of the fact s.
While the audi t or may be abl e to identify pot ent i al opport uni ti es for fraud
to be perpet r at ed, it is difficult, if not impossi bl e, for the audit or to
det er mi ne int ent , particul arl y in mat t er s in"ol"ing manage me nt
Dudgment , such as account i ng esti mat es and the appropri at e applicati on
of account i ng principl es.
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#es 1ons i ,i l i t y o "hos e Charge d 3ith -o0ernanc e and o
!anag e me n t
The pri mar y responsi bility for the pre"ent i on and det ect i on of fraud and
error rest s with bot h those charged with the go"er nance and the
manage me nt of an entit y. The respect i "e responsi bilities of those
charged with go"er nance and manage me nt may "ary by entit y and from
count r y to count r y. ,anage me nt , with the o"ersi ght of those char ged
with go"er nance, needs to set the proper tone, creat e and mai nt ai n a
cultur e of honest y and high et hics, and est abli sh appropri at e cont rol s to
pre"ent and det ect fraud and error within the entit y. This responsi bility
arise out of the contract ual relationshi p bet ween the direct ors, manager s
and the company
8ecent 2ronounce me nt s on corpor at e go"er nance ha"e reinforced this
responsi bility
#es 1ons i ,i l i t i e s o the Audi t or
The #uditor ha no responsi bilit y for the pre"ent i on and det ect i on of fraud
and error although the annual audi t may act as a det err ent .
#s descri bed in I!# $44, E+bDecti"e and Hener al 2rincipl es Ho"er ni ng an
#udit of 7inanci al !t at e me nt s , F the obDecti"e of an audi t of financi al
st at e me nt s is to enabl e the audi t or to expr ess an opinion whet her the
financi al st at e me nt s are prepar ed, in all mat eri al respect s, in accor dance
with an identified financi al reporti ng framewor k. #n audi t conduct ed in
accor dance with I!#s is desi gned to pro"ide reasonabl e assur ance that
the financi al
st at e me nt s taken as a whol e are free from mat eri al misst at e me nt ,
whet her caus ed by fraud or error. The fact that an audit is carri ed out
may act as a det err ent , but the audi t or is not and cannot be held
responsi bl e for the pre"ent i on of fraud and error.
#n audi t does not guar ant e e all mat eri al mi sst at e me nt s will be det ect ed
becaus e of such fact ors as the use of Dudgment , the use of testi ng, the
inher ent limit ati ons of int ernal cont rol and the fact that much of the
e"idence a"ail abl e to the audi t or is persuasi "e rat her than
conclusi"e in nat ur e. 7or these reasons, the audit or is abl e to obt ai n only
reasonabl e assur ance that mat eri al mi sst at e me nt s in the financi al
st at e me nt s will be det ect ed.
In planni ng the audi t, the audit or shoul d discuss with other member s of
the audi t team the suscept i bility of the entit y to mat eri al misst at e me nt s
in the financi al st at e me nt s resul ting from fraud or error. The audi t or
shoul d make inquiries of manage me nt :
AaB To obt ai n an under st andi ng of:
AiB ,anage me nt ? s asses s me nt of the risk that the financi al
st at e me nt s may be
mat eri all y misst at ed as a resul t of fraud@ and
AiiB The account i ng and int ernal cont rol syst e ms manage me nt
has put in place to addr es s such risk@
AbB To obt ai n knowl edge of manage me nt ? s under st andi ng regar di ng
the account i ng and
int ernal cont rol syst e ms in place to pre"ent and det ect error@
A&*I"IN-
;5 Account i ng and
AcB To det er mi ne whet her manage me nt is awar e of any known fraud
that has affect ed the entit y or suspect ed fraud that the entit y is
in"esti gat i ng@ and
AdB To det er mi ne whet her manage me nt has disco"er ed any mat eri al
errors.
+roc e dur e s 3hen 7raud is sus 1e c t e d
When the audit or encount er s circumst a nc es that may indicat e that ther e
is a mat eri al misst at e me nt in the financi al st at e me nt s resul ting from
fraud or error, the audit or shoul d perfor m procedur es to det er mi ne
whet her the financi al st at e me nt s are mat eri ally mi sst at ed.
When the audit or identifies a misst at e me nt , the audi t or shoul d consi der
whet her such a misst at e me nt may be indicati"e of fraud and if ther e is
such an indication, the audit or shoul d consi der the implications of the
mi sst at e me nt in relati on to other aspect s of the audit , particul arl y the
reliability of manage me nt repr es ent at i ons /
E0al uat i on and *i s1os i t i on o !iss t at e me n t s ? and the Eect on
the Audi t orA s #e1ort
When the audit or confir ms that , or is unabl e to conclude whet her , the
financi al st at e me nt s are mat eri ally misst at ed as a resul t of fraud or
error, the audi t or shoul d consi der the implicati ons for the audi t.
.
*ocume nt a t i o n
The audi t or shoul d docume nt fraud risk fact ors identified as being
present during the audi t or?s asses s me nt process and docume nt the
audi t or?s respons e to any such fact or s. If
during the perfor manc e of the audit , fraud risk fact ors are identified that
cause the audit or to belie"e that addi tional audit procedur es are
neces s ar y, the audi t or shoul d document the pres ence of such risk fact ors
and the audit or?s respons e to them.
Communi c at i o n
When the audit or identifies a misst at e me nt resulting from fraud, or a
suspect ed fraud, or error, the audi t or shoul d consi der the audit or?s
responsi bility to communi cat e that infor mat i on to manage me nt , those
charged with go"er nance and, in some circums t anc es , to regul at or y and
enforce me nt aut hori ti es.
Communi c at i o n o !isst at e me n t s #es ul t i ng 7rom Error to
!anag e me n t and
to "hos e Charge d 3ith -o0ernanc e
If the audi t or has identified a mat eri al misst at e me nt resul ting from error,
the audi t or shoul d communi cat e the misst at e me nt to the appropri at e
le"el of manage me nt on a ti mel y basi s, and consi der the need to report
it to those char ged with go"er nance in accordance with I!# $&4,
J Communi c at i o n o Audi t !at t ers 3ith "hos e Charge d 3ith
-o0ernanc e / I
The audi t or shoul d infor m those charged with go"er nance of those
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uncorr ect ed misst at e me nt s aggr egat ed by the audi t or during the audi t
that wer e det er mi ned by manage me nt to be immat eri al , bot h
indi"idually and in the aggr egat e, to the financi al st at e me nt s taken as a
whol e.
Communi c at i o n o !isst at e me n t s #es ul t i ng 7rom 7raud to
!anag e me n t and
to "hos e Charge d 3ith -o0ernanc e
If the audi t or has:
AaB Identified a fraud, whet her or not it resul t s in a mat eri al
mi sst at e me nt in the financi al
st at e me nt s @ or
AbB +bt ai ned e"idence that indicat es that fraud may exist Ae"en if the
pot ent i al effect on the financi al st at e me nt s would not be mat eri alB@
the audi t or shoul d communi cat e thes e mat t er s to the appropri at e
le"el of manage me nt on a ti mel y basi s, and consi der the need to
report such mat t er s to those charged with go"er nance in
accor dance with I!# $&4.
Communi c at i o ns to #egul at ory and Enorce me nt Aut hori t i e s
The audi t or?s professi onal dut y to mai nt ai n the confidenti alit y of client
infor mat i on ordinarily precl udes reporti ng fraud and error to a part y
out si de the client entit y. The audi t or consi der s seeki ng legal ad"ice in
such circumst a nc es .
-rrors can be described as an intentional mist ake and they can occur at
any st age in a business transacti on and they can be of any type. #uditors
would primarily be interest ed in the pre"enti on, det ection and disclosur e
of errors for the following reasons:
AaB -xist ence of errors may indicat e that accounti ng records are
unreliabl e and are ther efor e not a satisfact ory basis from which
to prepar e financi al st at eme nt s. The audit or could ther efore
conclude that proper books of account s ha"e not been kept
where there are too many mat eri al errors. This is a ground for
qualification of an audit orJ s report .
AbB Too many errors may also indicat e that the syst em of internal
control is not reliabl e, and ther efor e the audit or wishing to place
any reliance on a syst em of internal control may not be able to
do so.
AcB If errors are of sufficient magni t ude, they may be sufficient to
affect the true and fair "iew gi"en by the account s.
Irregul ari ti e s
Irregul arities can be described as intentional distortions of financi al
stat e ment s for what e"er purpose and also as misappropri ation of
asset s whet her or not a company by distortions of financi al
stat e ment s. The auditorJ s responsi bility towards fraud and other
irregul arities is exactl y the same as that of errors.
A&*I"IN-
;6 Account i ng and
!at eri al i t y
If the auditor knows or suspect s that an error or irregul arit y has
occurred or exist s, then he cannot apply mat eri ality consider at i on
until he has sufficient e"idence of the ext ent of the error or
irregul arit y
Indi cati on o irregul ari ti e s
2ossibl e indications of irregul arities include:
AaB ,issing document s or "oucher s, these could ha"e been
deliber at el y dest royed to conceal an irregul arit y@
AbB -"idence of altered document s: alter ati ons can take place aft er
the transacti on has been appro"ed@
AcB <nsati sfact or y expl anati on: these are expl anati ons that are
"ague and are unsuppor t ed@
AdB -"idence of disput es@
AeB -xist ence of suspens e account s or unexpl ained differences on
reconciliations@
AfB -"idence that internal control is not operati ng as it is intended
to@
AgB <nduly la"ish life styles of employees and officers@
AhB 7igures not agreei ng with expect at i ons.
#e1orti ng
"o the me m,er s : unless the errors and irregul arities result in the
account s not gi"ing a true and fair "iew, or do not confor m to st at ut e,
or proper books ha"e not been kept, then ther e is no need to report .
To the top manage me nt : if the auditor suspect s that manage me nt
are in"ol"ed in irregul arities, then he shoul d report to the mai n board
or to the audit commi t t ee. To manage me nt : all act ual or pot enti al
irregul arities shoul d be report ed with recomme ndat i ons for changes.
To third parti es: the audit or shoul d take legal ad"ice or ad"ice from
his professional body to ensur e the account s gi"e a true and fair
"iew, but only disclose those mat t er s wher e he has a clear public
duty to disclose for exampl e, if a serious crime has been commi t t ed.
"(+ES %7 IN"E#NA2 C%N"#%2
(. %rgani Gat i onB -nterpri ses shoul d ha"e a plan of their
organi:ati on defining and allocati ng responsi bilities and
identifies lines of reporting for all aspect s of the ent er pri sesJ
operation, including the controls. The delegat i on of aut horit y
and responsi bility should be clearly specified.
$. Segr e g a t i on o duti es B +ne of the pri me means of control is
the separ at i on of those responsi bilities or duties which would if
combi ned enabl e one indi"idual to record and process a
compl et e transact i on. !egregat i on reduces the risk of
intentional mani pul ation and error and increas es the element of
checking. 7unctions which should be separ at ed include those of
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aut hori:ation, executi on, cust ody, recordi ng and in the case of a
comput er based accounti ng syst em, syst ems de"elopment and
daily operations.
*. +hysi cal B These are concer ned mai nly with the cust ody of
asset s and in"ol"e procedur es and securit y meas ur es designed
to ensur e that access to asset s is limit ed to aut horised
personnel . This includes both direct access and indirect access
through document at i on. These controls assumes import ance in
the case of "aluabl e, port abl e, exchange abl e or desirabl e
asset s.
%. Authori Gat i on and a11ro0al B #ll transacti ons should require
aut hori:ation or appro"al by an appropri at e responsi bl e person.
The limits for this aut hori:ation should be specified.
5. Arithme t i c al and account i ngB These are the controls within
the recording function which check that the transacti ons to be
recorded and process ed ha"e been aut horised, that they are all
included and that they are correctl y recorded and accurat el y
process ed. !uch controls include: the checking of the
arithmet i cal accur acy of the records, the maint enance and
checking of tot al s, reconciliations, control account s and trial
balances and accounti ng for document s.
&. +ers onne l B There should be procedur es to ensur e that
personnel ha"e capabilities commens ur at e with their
responsi bilities. Ine"it abl y, the proper functioning of any
syst em depends on the compet ence and integrit y of those
operati ng it. The qualifications, selection and training as well as
the innat e personal charact eri stics of the personnel in"ol"ed are
import ant feat ur es to be consider ed in set ting up any control
syst em.
K. Su1er0i si onB #ny syst em of internal control shoul d include the
super"i sion by responsi bl e officials of day to day transacti ons
and the recording thereof.
9. !anag e me nt control sB These are the controls exercised by
the manage me nt out side the day to day routine of the syst em.
They include: the o"erall super"i sory controls, exercised by
manage me nt , the re"iew of manage me nt account s, and
compari son thereof with budget s, the internal audit functions
and any speci al re"iew procedur es.
Qou should reme mber the key internal control obDecti"es in relation
to recordi ng and processi ng@ A"alidity, compl et enes s, accuracy,
independenceB .
"y1es o control s ex1l ai ne dB
To expl ain the abo"e types of controls we will const antl y refer to
purchas e of raw mat eri al s.
%rgani Gat i onB The ent erpri se should creat e proper depar t ment s that will
achi e"e an efficient and orderly working en"ironment . In the areas of
purchas es one would expect the organi:ation to ha"e a stores depart me nt
which is charged with the responsi bility of monit oring stock le"els so that
when the stock of raw mat eri al s reaches the reorder le"el they will raise a
requisition for new supplies. We would expect that a clerk in the stores
depart me nt has been charged with this responsi bility and that he does his
A&*I"IN-
;; Account i ng and
Dob. =e knows what is expect ed of him, he knows whom he report s to, he
knows whom he can delegat e his work to and he knows the limits of his
aut horit y. We would also expect a purchasi ng depar t ment charged with
the responsi bility of recei"ing the requisition from the stores. Their
function is once they recei"ed the requisition they will exami ne it for
necessi t y and they will select the most appropri at e supplier who has been
appro"ed by the entit y. They will raise the 02+, check the det ails on the
02+, get it appro"ed, and despat ch it to the supplier. Qou shoul d not e that
organi:ation relat es to ha"ing proper depart ment s within the company
and within those depart me nt s to ha"e indi"idual s with clearly specified Dob
descriptions.
Segre g at i on o duti e sB 7or e"ery transacti on, we can identify the
following stages: initiation, aut hori:ation, execution, cust ody of the
result ant asset s and the recording of the whole process. #s much as
possibl e, these stages should be separ at ed as far as the indi"idual s who
carry them out are concerned. In the case of raw mat eri al s, the initiation
began in the stores depar t ment when the goods were request ed. 2art of
the execution is carried out by the purchasi ng depart me nt when they
exami ne the requisition and raise the 02+. #uthori:ation of the 02+ will
ha"e to be done by an independent person. We can already see that two
depart me nt s ha"e been in"ol"ed, the stores and the purchasi ng
depart me nt . These controls co"er what used to be originally called
internal check. This archai c ter m used to refer to a situation wher eby the
work of one person was subD ect to independent re"iew by anot her person
or was compli ment ar y to the work of anot her person. It also co"ers
rot ation of duti es whereby no one person is kept in the same position for
an indefinit ely long period of time. It includes the requirement that peopl e
shoul d take regul ar lea"e so that other peopl e can ha"e the opport uni t y to
carry out their functions.
+hysi cal B The store- man should know the condition under which the raw
mat eri al s should be stored to ensur e that they do not det eriorat e. =e has
also to ensur e that the raw mat eri al s are secur el y kept in a warehous e
that is well prot ect ed so that no one can Dust walk in and steal the raw
mat eri al s. We will also expect the organi:ation to ha"e raw mat eri al s
requisition not es so that they ha"e to be properly aut horised for raw
mat eri al s to be mo"ed from the warehous e to the production section.
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Authori Gat i on and a11ro0al B #s we saw under organi:ation the
purchasi ng depart me nt will raise the 02+@ the 02+ commi t s the
organi:ation to use its resources. These commi t me nt s require to be
appro"ed at the appropri at e le"els hence you will find that before the 02+
becomes a "alid contract , it must be appro"ed in accordance with the
appro"ed delegati on of aut horit y. The reason for this is that as it forms a
basis of a contract bet ween the organi:ation and the supplier it needs to
be checked for grammat i cal mist akes and the commi t ment of funds.
Arithme t i c al and account i ngB Transactions ha"e to be recorded in
monet ar y ter ms, or wher e necess ar y in physical quantiti es. The entity
must ther efor e ha"e adequat e records to record all transacti ons and
adequat e document s to pro"ide e"idence and an audit trail of the
transact i ons from aut hori:ation up to recordi ng. In the case of our raw
mat eri al s, we would ther efor e expect that when the raw mat eri al arri"es
at the warehous e, somebody shoul d check it for quanti t y and quality to
ensur e that what we are recei"ing is what we order ed, these would mean
compari ng with the orders. # document must be raised to acknowl edge
recei pt of the goods and the checking of their quality and quanti t y with
the orders. # copy of the document acknowl edgi ng receipt should be sent
to the account s depart ment for them to be able to mat ch it with the
suppliers in"oice when it is recei"ed to ensur e that we are being charged
for goods that we order ed and recei"ed. The suppliers in"oice will ha"e to
be ent er ed into the purchas es day book, the purchas es ledger and into the
creditors control account .
+ers onnel B 2ersonnel controls are negl ect ed in many organi:ati ons much
to the regret of the organi:ation concerned. 2ersonnel in"ol"es allocati ng
the human resources in the most efficient and cost effecti"e manner .
-"ery indi"idual shoul d be gi"en a Dob that he is compet ent of doing, he
shoul d be properly remuner at ed for that Dob, he should be moti"at ed to do
the Dob, he should see a clear career pat h. #lso the integrit y of the st aff
in"ol"ed has to be est ablished. This in"ol"es obt aining references of key
staff before the organi:ation engages them and const ant counselling to
ensur e that they ha"e not lost their integrit y. When the raw mat eri al
reaches the warehous e, we would expect that the store man knows
exactl y what kind of mat eri al it is, how it should be stored to prot ect it
from det eriorati on and how it should be used. We would expect that he
could see pot enti al for de"elopment within the organi:ation and that his
salary or remuner at i on is commens ur at e with his responsi bilities.
Su1er0i si onB -"erybodyJ s work should be subDect to super"ision. !o the
clerk who raises the requisition in the stores has his superior super"ising
his acti"ities to ensur e that he does not Dust raise requi sitions without
confirming that in fact the reorder le"el has been reached.
!anage me nt control sB These are exercised by manage me nt by
ensuri ng compliance with the broad policyJ s of the organi:ation. In the
case we are looking at, we can en"isage the managi ng direct or being
gi"en a schedul e of purchas es for the whole mont h, he then re"iews this
schedul e and tries to det er mi ne whet her the mat eri al we bought was in
the quantit y and amount that the organi:ati on should be using, whet her
we are within budget and whet her we are being profitabl e or not.
A&*I"IN-
;: Account i ng and
The aim of a syst em of internal control we said was to mini mi se the
incident s of errors and irregul arities. !o as we mo"e on to the practice of
internal control we will be consideri ng the pot enti al errors and
irregul arities that can occur and the meas ur es the organi:ation takes to
ensur e that they do not occur and if they occur they are det ect ed within
reasonabl e time so that future occurrences are pre"ent ed.
"$E +#AC"ICE %7 IN"E#NA2 C%N"#%2
The traditional classification of oper ati on for internal control purposes
was:
aB 1ash and cheques recei"ed including cash and bank balances@
bB 1ash and cheque payment s@
cB !alaries and wages@
dB 2urchas es and trade creditors@
eB !ales and trade debt ors@
fB !tocks including work- in- progress@
gB 7ixed asset s and in"est ment s.
=owe"er, it is more usual now to classify transact i ons in accordance with
their relat ed cycles. These cycles are recogni:ed in a typical
manuf act uri ng organi:ation as: sales cycles, purchas es cycle, wages cycle
and con"ersion cycle.
"he Sal es Cycl e
./ +ot ent i al error or irregul ari t yB
Hoods being despat ched or lea"ing the premi ses without being in"oiced,
ser"ices being render ed without being in"oiced, goods on consignment or
in transit to other branches not being recogni sed in the books.
Im1li cat i ons
<nderst at e me nt of sales, wrong manage me nt account s, loss of asset s of
the company and account s that will not gi"e a true and fair "iew as sales
and debt ors are underst at ed.
+re0e nt i 0e meas ur e s
The sales depart ment shoul d acknowl edge orders recei"ed. This can be
done by the organi:ati on ensuri ng that all cust omer sJ orders are
transcri bed their own internal sales orders which shoul d be prenumber ed.
The obDecti"e is to initiat e the accounti ng trail and reduce the possibility of
disput es with the cust omer s. The sales depart me nt shoul d also be
responsi bl e for fixing selling prices and deli"ery dat es and any speci al
discount s shoul d be appro"ed by a responsi bl e official. )efore the order is
process ed further, it is passed on to the credit control depart ment , they
check the credit worthiness of the cust omer and if he is an existing
cust omer they ha"e to check that the new order will not exceed the credit
limit. If the cust omer has not dealt with the company pre"iously, then
bank and trade references shoul d be obt ained. The credit control
depart me nt if it is satisfied that this is a cust omer who should be supplied
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with the goods will then check with the stores to confirm the a"ailability of
the stock items. They will then appro"e the sales order and pass it on to
stores to despat ch the goods. !tores should despat ch the goods ensuring
what they are despat chi ng is in accordance with what the cust omer
order ed and what has been appro"ed by the credit control depar t ment .
They should raise document at i on to e"idence the despat ch of goods. This
shoul d be a prenumber ed document and is usually called a despat ch not e
or a goods deli"ery not e. They should be issued numeri cally in sequence.
1opies of the despat ch not e should be sent with the goods. +ne copy as
ad"ice to the cust omer and a second copy to be signed by the cust omer
and returned to the company as proof of deli"ery. To ensur e that all
goods lea"ing the premi ses are in"oiced the deli"ery not e sequence
shoul d be checked prior to raising in"oices and each deli"ery not e should
be checked to ensur e that an in"oice is raised.
*et ect i 0e meas ur e s
This in"ol"es an independent clerk mat chi ng all the deli"ery not es or
despat ch not es with the in"oices and the in"estigati on of any
unmat ched deli"ery not es.
$. +ot e nt i al error or irregul ari t y
Hoods being sent to bad credit risk:
Im1li cat i ons B incident s of bad debt s, loss of asset s.
,easur es are: the est ablishment of a credit control depar t ment that
exami nes all the orders recei"ed by the sales depart me nt and
est ablishes the credit wort hiness of the cust omer before aut hori sing
stores to despat ch the goods. # re"iew of long outst andi ng debt s
and in"esti gati ons as to why payment is not being recei"ed.
*. +ot e nt i al error or irregul ari t y
+"erdue account s escapi ng follow- up:
Im1li cat i ons B increased incident s of bad debt s.
!eas ur e s B the production of an aged debt ors list. The ageing must
be checked for correct nes s. The credit control depart me nt should
re"iew this listing regul arly and ensur e that o"erdue account s are
const ant l y followed up. The company can institut e a stop ser"ice list
wher e all delinquent s are placed and this list distribut ed within the
organi:ation to ensur e that any transacti ons with the concerned
parti es are closel y monitored.
%. +ot e nt i al errors or irregul ari ti e s
In"oicing errors occurring: that is sales in"oiced but not recorded,
sales in"oiced incorrectl y.
Im1li cat i ons B misst at eme nt s in sales and debt ors either up or
A&*I"IN-
;D Account i ng and
down. 0oss to the organi:ati on as money will not be recei"ed for
sales made and increas ed disput es with cust omer s due to errors in
in"oicing.
!eas ur e s B the use of prenumber ed sales in"oices and the
requirement s that they be issued in sequence. The exist ence of
proper Dournal s - that is the sales Dournal and the debt ors ledger. The
checking of the in"oices raised by an independent clerk of the
arithmet i cal accuracy, the pricing, the discount s allowed, the coding
and the cross referenci ng to the cust omer J s order. !endi ng
stat e ment s to cust omer s on a regul ar basis, quantit y reconciliations
compar ed with act ual document at i on.
5. +ot e nt i al errors and irregul ari ti e s
The receipt of cash or cheques not being banked including teemi ng
and lading.
Im1li cat i ons B misappr opri ati on of cash and hence loss to the
organi:ation. Increas ed interest expens e due to late banking.
-xposur e to theft by burgl ars.
!eas ur e s B the requirement that mail should be opened by the managi ng
direct orJ s secret ar y in the presence of some mess enger . !he shoul d then
prepar e a pre- list of all cheques recei"ed by mail. 1ross all cheques and
pass them on to the cashi er prompt l y for his banking. The organi:ation
shoul d use prenumber ed recei pt s and ha"e a requirement that for all
money recei"ed, a receipt must be raised. The recei pt s shoul d be
promptl y ent er ed in the cash book and pay- in-slips prepar ed accordingl y.
There should be a requirement that all receipt s be banked prompt l y and
intact thus if we ha"e recei"ed cash, cash should be banked and if
cheques ha"e been recei"ed, then cheques should be banked and no
substit ution should be allowed. 8egul ar bank reconciliation shoul d be
prepar ed, checked and appro"ed by a responsi bl e official. #n independent
clerk should on a regul ar basis compar e the pre- list prepar ed by the
secret ar y to the pay- in- slip and on to the bank stat e me nt .
&. +ot ent i al errors and irregul ari ti e s
1ash sales being improperl y dealt with by persons initially recei"ing
cash and persons handling cash from initial receipt to final banking.
Im1li cat i ons B misappropri ation of asset s as cash is the most readily
realisabl e asset s.
!eas ur e s B use of prenumber ed cash sales recei pt s, restricting the
number of peopl e who can handl eC recei "e cash, requiring that
returns be filed on a daily basis, quantit y reconciliation, close
super"ision of the cash handl ers, encour agi ng cust omer s to pay by
either cheque or credit card, surprise cash count s and reconciliation
with the supporti ng records.
K. +ot ent i al errors and irregul ari ti e s
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/ebtors account s being improperl y credit ed. # debt or s account s can
be credit ed either by recei pt of cash or by the issue of a credit not e.
Im1li cat i ons B unreliabl e records, increased incident s of bad debt s,
disput es with cust omer s, loss for the organi:ati on.
!eas ur e s B coding of cust omer s. #n independent clerk selecti ng
credit entries in cust omer s account and mat chi ng those to their initial
recei pt s or credit not es.
%ther mat t ers to consi der
Sal es ledger de1art me nt
The sales ledger depar t ment will be responsi bl e for recording
in"oices agai nst the appropri at e debt or. To ensur e that all the
in"oices are included the document at i on should be serially number ed
and the sequence should be checked prior to recording.
"he account s de1art me nt
The ledger s shoul d be balanced mont hl y and agreed with an
independent l y held debt or s control account . +nce account s are
reconciled, then st at eme nt s should be sent to cust omer s as they pro"ide
an independent check on the o"erst at e me nt of debt s or the
under st at e me nt of moni es recei"ed. This would ther efor e require the
stat e ment s being sent out by a senior official after he has checked the
balances on the st at eme nt to the ledger. #ny cust omer s query shoul d be
dealt with by staff other than those who maint ai n the ledger s. The writing
off of bad debt s and the appro"al of credit not es shoul d be done by a
senior official. These will include the requirement of an appropri at e
supporting document at i on and properl y raised and appro"ed
document at i on. We may ther efor e require seeing lawyers?
correspondence as far as bad debt s are concerned and goods returned
not es as far as credit not es are concerned.
In the absence of the abo"e controls, the following are exampl es of the
types of fraud that may become possibl e:
(. 1ollusion bet ween cust omer s and sales in"oicing depar t ment . If
such a collusion occurs, in"oices may not be raised, or they may be
raised only for reduced amount s. !uch a fraud can in"ol"e
subst ant i al sums of money but can be pre"ent ed by proper
sequenti al control o"er deli"ery not es and the subsequent
independent check of despat ch document at i on to in"oices.
$. 7ailure to raise despat ch document at i on. If goods are allowed out of
the premi ses without deli"ery not es being raised the mat t er may
ne"er be disco"er ed. !o the best way to pre"ent these from
happeni ng is to ha"e the mini mum number of entr ances to the
premi ses with a guard at each entrance checking document at i on in
respect of all goods lea"ing.
*. Improperl y raised credit not es. 7ictitious credit not es can be used to
co"er up the misappr opri ati on of cash or to reduce a cust omer J s
debt , particul arly if the member of staff in"ol"ed is in collusion with
the cust omer . The false writing off of bad debt s can be used in the
A&*I"IN-
85 Account i ng and
same way.
%. 1ashi ers. The cashi ers function must be kept strictly separ at e from
any of the sales procedur es in order to ensur e that teemi ng and
lading does not take place. The cashi er shoul d record all the moni es
recei"ed and shoul d bank them daily to a"oid ha"ing large amount s
on the premi ses. The bank pay- in-slip shoul d be prepar ed at least in
duplicat e. +ne copy for the bank and the other one to be st amped
by the bank and returned as proof of deposi t. The person who makes
out the pay- in-slip should not take the money to the bank.
"$E +&#C$ASES C(C2E
./ +ot e nt i al errors and irregul ari ti e s
0iabilities being set up for goods or ser"ices which are either not
aut horised or not recei"ed.
Im1li cat i ons B <nreliabl e records as they do not show the true
position of liabilities, ther e may cause loss due to paying for goods or
ser"ices ne"er recei"ed.
!eas ur e s B If suppliers are in collusion with employees,
fictitious charges can be appro"ed for payment with a shar e subsequent l y
going to the empl oyee. This can most easily occur at the goods inwards
stage and is particul arly possi bl e if the inspection procedur es are
inadequat e. 7alse in"oices can be introduced at any st age in the
processi ng and false supporti ng document at i on can be produced as well
and this type of fraud is difficult to pre"ent . Therefore, the purchas es
function should be such that only specified employees ha"e the power to
requisition goods and then only up to an aut hori sed limit. !uch limits
increasi ng with the le"el of seniorit y. The requisitions shoul d be serially
number ed and should be sent to the buying depart ment . The buying
depart me nt will be charged with the responsi bility of negoti ati ng the best
prices and deli"ery dat es from suppliers and ensuri ng that quality goods
are recei"ed. 1entral buying has some ad"ant ages such as: ability to buy
in bulk and ther efor e reduce the "olume of small orders, knowl edge of the
most reliabl e suppliers and being able to plan opti mum reorder times and
quanti ti es. The exist ence of a separ at e purchasi ng depart ment
consider abl y strengt hens internal control becaus e it pre"ent s user
depart me nt s from ordering goods without the order being subDect ed to
independent check. #t the same time the user depar t ment checks on the
buying depart me nt . When the order is raised, it should cont ai n
informat i on about price and deli"ery dat es requirement . # deli"ery
addr ess should be quot ed. !e"er al copies of the order are usually
required. +ne for the supplier, one for the buying depart me nt , one for the
account s depart me nt , one for the requi sitioned to ad"ise him, that the
mat t er is recei"ing att enti on and one to the stores to inform them of what
to expect . These 02+J s should be prenumber ed. When goods are
recei"ed, they should be recei"ed in areas speci ally designed for receipt of
goods. Hoods recei"ed not es should be raised, they should be pre-
number ed and issued sequent i ally. umberi ng strengt hens internal
control and reduces the possibility of fake document s. 7or a goods
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recei"ed not e this is "ery import ant becaus e it is the pri me supporti ng
document for the supplierJ s in"oice. # copy of the goods recei"ed not e
shoul d ther efore go straight to the account s depart ment for this purpose.
# copy shoul d be sent to the buying depart me nt for mat chi ng off in the
order file. #ny short ages should immedi at el y be notified to the buying
depart me nt so that appropri at e credit can be clai med. The account s
depart me nt on recei"ing the in"oices should stamp them, they should
then collect all the rele"ant supporti ng document s such as goods recei"ed
not es, copy orders etc. and on this basis should appro"e the in"oice for
payment . There should exist a purchas es Dournal, purchas es ledger, and a
creditors control account .
)efore in"oices are aut horised for payment , they should be checked
and the syst em should require that they shoul d all be present ed with
their supporti ng document at i on for appro"al.
$. +ot e nt i al errors and irregul ari ti e s
0iabilities being incurred but not recorded:
Im1li cat i ons B <nderst at e me nt of liabilities hence disput es with
suppliers.
!eas ur e s B The use of prenumber ed goods recei"ed not es, the
mat chi ng of the goods recei"ed not es with suppliers st at eme nt s
and in"oices, the use of prenumber ed purchas e orders and
their subsequent mat chi ng with goods recei"ed not es,
in"esti gati on of unmat ched goods recei"ed not es, regul ar
reconciliations bet ween the credit ors ledger and the suppliers
st at eme nt s, ha"ing a list of appro"ed suppliers.
*. +ot e nt i al errors and irregul ari ti e s
,aking payment s without proper document at i on and proper
aut hori:ation e.g. incompl et e document at i on, forged or fraudul ent
document at i on and duplicat e payment s.
A&*I"IN-
86 Account i ng and
Im1li cat i ons B 2aying for ser"ices and goods not recei"ed.
+"erst at e me nt of purchas es and expens es.
!eas ur e s B # requirement that before any payment is made all in"oices
must be originals and they must be support ed with proper and compl et e
document at i on. +nce payment has been made on a set of document s,
they should be clearly marked that they ha"e been paid to pre"ent their
represent at i on.
%. +ot e nt i al errors and irregul ari ti e s
,isallocation of charges to the wrong gener al ledger account s.
Im1li cat i ons B ,is-stat e me nt of "arious expens es and account s not
gi"ing a true and fair "iew.
!eas ur e s B 1oding of all expens es and credit ors account s. +n
recei pt of an in"oice, it shoul d be coded and the coding should be
checked by an independent clerk. <se of budget ar y control
meas ur es.
5. +ot e nt i al errors and irregul ari ti e s
Hoods being returned to suppliers without being recorded in their
records. 1redit not es not being raised or recorded for short
deli"eri es.
Im1li cat i ons B +"erst at e me nt of purchas es and loss of receipt s due
to the company.
!eas ur e s B #ll goods ret urned should ha"e a despat ch
document at i on raised for them. # copy of the despat ch
document at i on concerned should be passed o"er to the account s
depart me nt and the purchasi ng depar t ment for them to liaise with
the supplier and follow up the recei pt of a credit not e. #ll clai ms
shoul d be subDect to numerical control.
%ther mat t ers to ,e consi der e d
<nless a document at i on is cancell ed at the time the cheque is
signed, it is possi bl e for a genui ne in"oice to be represent ed for a
second payment . This usually in"ol"es collusion bet ween an
empl oyee and the supplier and the company can lose subst ant i al
sums of money in this way. 1heque payment s shoul d be aut hori sed
on the basis of "alidly appro"ed document at i on. The cashi er
normally draws the cheque which should be crossed account payee.
The cheque shoul d then go to the first cheque signat ory for signing.
There should be a second cheque signat or y to act as a check on the
first signat or y. 0imits should be imposed on the signat ory and all
supporting document at i on should be cancelled at the time of signing.
When the cheques ha"e been signed they shoul d immedi at el y be
despat ched to the payee. They shoul d ne"er be returned to anyone
who has had anyt hi ng to do with their prepar at i on or aut hori:ati on
especi ally not to the cashi er for in the right hands, signed cheques
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are as good as cash as it only takes little skill to be able to alt er the
name or amount on the cheque.
The cashi er should record the payment s in the cash book and regul ar
bank reconciliations should be prepar ed. Where suppliers send
stat e ment , reconciliations should also be prepar ed. !uppliers?
stat e ment s should ne"er be used as the sole document at i on
supporting a cheque payment .
Cash 1ayme nt s
The best syst em to mai nt ai n for cash payment s is the imprest
syst em. In this syst em a fixed sum or imprest is assigned to the
pet t y cashi er and more cash is only obt ainabl e on the producti on of
"oucher s that ha"e been paid. The ad"ant ages of this syst em are:
aB The fixed balance pre"ent s escal ation of the amount held, so
the amount at risk can be kept small.
bB The syst em is self checking becaus e each time a
rei mbur s e me nt is required the pet t y cashi er must present his
records to the official responsi bl e for exami nati on.
cB 8econciliation of pet t y cash book is made easi er. The amount
of the imprest shoul d be as low as possi bl e and the number of
float s in use should be kept to a mini mum. I+< should not be
allowed nor should st aff cheques be cashed out of pet t y cash.
o other receipt s should go into the pet t y cash. #t the time of
the rei mbur s e me nt , the responsi bl e official should check the
pet t y cash book with the supporti ng "oucher s and should sign it
accordi ngly. 8egul ar surprise cash count s can usefully be
made. The account ant has to be on the look out for use of
falsified "oucher s and the repres ent at i on of used "oucher s. #
properly run imprest syst em is reasonabl y well prot ect ed from
mat eri al fraud.
Bank and cas h ,al anc e s
,oney in all forms is highly suscept i bl e to misappr opri ati on. 7or this
reason regul ar bank reconciliations should be carried out by senior
independent officials. +utst andi ng items should be in"estigat ed,
particul arly if they are long out st andi ng.
A&*I"IN-
8; Account i ng and
"$E 3A-ES C(C2E
(. +ot ent i al errors and irregul ari ti e s
1an persons other than genui ne employees be paid through the
payrollR This includes consider ati on of fraudul ent doubl e
payment for lea"er s.
Im1li cat i ons B +"er"al uati on of stocks by using wrong labour
cost s, loss to the organi:ation by paying for ser"ices ne"er
recei"ed.
!eas ur e s B The personnel depart ment is responsi bl e for hiring
and firing personnel . They are also responsi bl e for aut horising
alter ations in rat es of pay as a result of promoti ons or gener al
pay increas es. When we ha"e a separ at e depart me nt in
exist ence for personnel mat t er s, then an independent record
can be maint ai ned of all personnel in empl oyment and this can
pro"ide a "ery useful check on the work of the wages
depar t ment . #ll changes should be notified to the wages
depar t ment through the use of serially number ed change
document s. +n the time keepi ng side, clock card or time sheet s
are nor mally used to record the hours worked. In either case
the amount s shown by the empl oyee should be "erified
independent l y. The clocking in process should be obser"ed by
ha"ing a time keeper at the gat e. This syst em can be abused
and the organi:ation should be alert to this possi bility.
Time sheet s shoul d be appro"ed by the empl oyees immedi at e superior
and if possibl e reconciled to production records. The appro"ed clock cards
or time sheet s are sent to the wages depar t ment for them to produce the
payroll. /ifferent clerks in the wages depar t ment shoul d check the hours
worked as calcul at ed by the foreman. 1alculat e the gross pay by
reference to the employeeJ s personal card showing his wage rat e, check
the calculation of gross pay, calcul at e net pay by reference to tax tables
and empl oyeeJ s personal records, check the net pay calculations, check
the cast s and cross cast s of the payment s. The payroll should be
appro"ed by a senior member of the manage me nt team. In most
organi:ations this is done by the chief account ant , the personnel manager
and the managi ng direct or. )efore appro"al, the official can carry out a
useful re"iew by casting and cross casting the payroll, scanni ng the
payroll for duplicat ed names or unusually high payment s, check the
number of empl oyees on the payroll to personnel records, carry out a
mont h to mont h reconciliation in bot h number s and amount s taking into
account lea"ers and Doiners and when they act ually left or Doined.
+nce the payroll is appro"ed the cheque can then be drawn. There shoul d
be at least two cheque signat ori es. 2referabl y the person who appro"ed
the payroll should not be one of the signat ori es. The money can now be
collect ed from the bank and distribut ed.
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"he oll owi ng stag e s shoul d ,e oll owe d
/rawing the cheque - the cashi er
1ollecting the money from the bank - securit y firm
7illing the pay en"elopes - independent empl oyees
/istributi ng the cash to the employees - other independent employees
and the foreman.
The employees who fill the en"elopes should ha"e had no pre"ious
dealings with the prepar at i on of the payroll. They should count the money
before beginni ng their work. The exact amount of the payroll shoul d be
withdr awn from the bank. +nce the en"elopes are filled, they shoul d be
count ed and gi"en to a second bat ch of independent empl oyees who
shoul d check the number of packet s handed o"er before distributing them
to employees. The foreman should accompany the pay out in order to
identify the correct employee. Where the employee is not present , their
pay packet should not be gi"en out to anot her employee.
$. +ot ent i al errors and irregul ari ti e s
-mployees being paid for work not done or unclai med wages
being misappropri at ed.
Im1li cat i ons B +"erst at e me nt of stock "alues due to using
wrong labour rat es. 2ay to an employee whose salary may
ha"e been misappropri at ed by anot her employee or thief.
!eas ur e s B These ha"e been co"ered adequat el y under A(B
abo"e under clock cards and time sheet s.
*. +ot ent i al errors and irregul ari ti e s
The occurrence of payroll errors: start er s, lea"er s, rat e changes.
Im1li cat i ons B ,is-st at eme nt s of "arious expens e account s, wrong stock
"aluations.
!eas ur e s B ,onthly reconciliations, agreeme nt of payroll records with
personnel records, independent clerk checking the calculations of the
payroll, re"iew of the payroll by depart ment heads, and budget ar y control
mat t er s.
%. +ot ent i al errors and irregul ari ti e s
Improper deducti ons being made or being misappropri at ed.
Im1li cat i ons B =a"ing to make doubl e payment s to the
aut horities where the deductions ha"e been misappr opri at ed,
compl ai nt s by employees.
!eas ur e s B 8equirement that all deductions be document ed
and the document at i on be appro"ed. The document at i on
should be checked agai nst the payroll to ensur e agree me nt .
A&*I"IN-
8: Account i ng and
5. +ot ent i al errors and irregul ari ti e s
Inflation of the payroll in other ways.
Im1li cat i ons B <nreliabl e records, mis- stat e ment s of expens es
and stock cost s.
!eas ur e s B ,onthly reconciliations, checking the payroll by an
independent clerk and the re"iew mentioned under A(B abo"e
done by the appro"er of the payroll.
%ther mat t er s to ,e consi der e d
If a proper independent record of empl oyees is not mai nt ai ned,
it becomes possi bl e to insert dummy employees on the payroll.
7ictitious names can be in"ent ed or employees who ha"e
retired or left empl oyment may be ret ained on the payroll. This
type of fraud is usually perpet r at ed by the wages officer.
+"erst at e me nt of gross pay can also occur when ther e is
collusion bet ween an employee and the wages officer so that he
is deliberat el y o"erpai d. +"erst ati ng the payroll can also occur
but can easily be pre"ent ed by casting the payroll at the time of
appro"al.
%ther Areas
(. Hener al cash: the worry here is miscell aneous recei pt s being
omitt ed, non trading or pet t y cash payment s being made and
not aut hori sed and the possibility of misappropri ation and
improper use of cash balances.
$. Hener al ledger: the processi ng of unaut hori sed Dournal entries
and the maki ng of errors in subsi di ary ledgers.
*. !tocks: the loss or pilferage of stocks, the consumpt i on or
wast age without proper recordi ng of stocks, the o"erst at e me nt
or underst at e me nt of work- in-progr ess and
%. 7ixed asset s: the acqui sition or disposal of fixed asset s without
proper aut horit y or recordi ng.
In the area of stocks and fixed asset s the control requirement s
are pri marily concerned with cust ody procedur es. 1ustody
procedur es are of great import ance becaus e all fraud in"ol"es
misappr opri ati on of asset s. The things to not e are:
(. ,aint enance of stock records: this shoul d be perfor med by a
person who has not access to the physical stocks and has no
responsi bility for sales or purchas e records.
$. 1ust ody procedur es: this can be achi e"ed by using segr egat ed
lockabl e areas under the control of a store man who can be held
account abl e by means of stock records.
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*. 8econciliation of physical quantiti es to stock records: these
reconciliations are "ital for the pre"enti onC det ect i on of fraud
and to ensur e that the stock figure in the account s show a true
and fair "iew. Internal auditors are the appropri at e officials to
control the stock count and a subsequent reconciliation.
/iscrepanci es should be referred to the highest le"el of
aut horit y and should be in"estigat ed immedi at el y.
%. Writing off damaged, obsol et e and slow mo"ing stocks: it is
essent i al that aut horit y for writing off these stocks should come
from a senior independent official and only on the basis of
appropri at e document ar y e"idence. !uch stocks are re"eal ed
by periodic stock checks or they come to light during the
ordinary course of business.
5. !crap and wast e product s: wast e product s and scraps can ha"e
consider abl e "alue in cert ai n types of indust ry. )ut their control
can be difficult. It becomes necess ar y therefor e to ha"e
calcul ations of esti mat ed scrap and wast e and this should be
compar ed regul arly with act ual amount s. !ignificant differences
to be in"esti gat ed immedi at el y.
&. 1onceal ment of theft by write off: if those who ha"e access to
stocks also ha"e the aut horit y to make write offs in the records
for damage then theft can be "ery easily conceal ed. !imilarly
peopl e who ha"e access to stocks, if they are per mi t t ed to
record the stock records or the sales or purchas es records then
book quantiti es can be mani pul at ed so that they correspond
with the act ual quanti ti es of stock in hand.
7I9E* ASSE"S
#lthough most fixed asset s are "ery large and "ery immo"abl e Ano
one is likely to st eal the whole buildingB, some fixed asset s can be
small, highly port abl e and "ery st eal abl e. mot or cars, bulldo:er s,
power tools and e"en port abl e comput er s all spring to mind. !uch
items can be "ery "aluabl e indeed. It is essent i al that they are
adequat el y controlled.
Authori Gat i on and a11ro0al o ca1i t al ex1e ndi t ur e
This shoul d be perfor med by senior le"els of manage me nt . 0imits
shoul d be placed on the aut horit y of each manager with maDor items
of expendi t ur e requiring appro"al by the board.
Account i ng records
The accounti ng records should be maint ai ned by a person who has
no access to the fixed asset s and has no responsi bility for aut horising
purchas es or sales thereof. There should be clear distinction
bet ween capit al and re"enue items.
+lant regi s t er s
/et ailed records must be kept as to the location and "alue of
fixed asset s. ,any compani es do not mai nt ai n these records. =owe"er, if
it is maint ai ned, the clerk responsi bl e for it shoul d ha"e no in"ol"ement
with the asset s thems el "es or with the gener al ledger or with sales or
A&*I"IN-
8D Account i ng and
purchas es of fixed asset s. This way enabl es records to pro"ide
independent e"idence but the "alue increas es if the records are regul arly
checked to the asset s thems el "es and reconciled to the gener al ledger.
#s this work should be done by independent employees, internal audit ors
are quit e appropri at e.
Scra11i ng? sal e or trans er o ass e t s
The responsi bility for taking asset s out of ser"ice shoul d be reser"ed for
the highest le"el of manage me nt and then only on the basis of
document at i on that is properly appro"ed.
!mall port abl e items may simply be stolen from the premi ses. This can be
pre"ent ed by ensuri ng that someone is fully account abl e for all items of
equipment . We should also ha"e appropri at e securit y measur es at all
point s of access to the company. 8egul ar reconciliations of the plant
regist er to the physical asset s shoul d be prepar ed and expl anati ons
sought for any discrepanci es from the persons account abl e. If peopl e who
ha"e responsi bilities are also in positions to write up the accounti ng
records or the plant regist er then by altering the books, they can cancel a
misappropri ation. #n empl oyee who has physical control as well as the
responsi bility for appro"ing the scrappi ng of asset s may scrap items
premat ur el y. The audit or should also be on the lookout for sale of asset s
which are no longer required at below market "alues e"en though they
ha"e not reached their retirement age. #lso the use of company asset s
for pri"at e purposes.
IN'ES"!EN"S
)y their "ery definition, in"est ment s are "aluabl e. The issues to watch out
here for are:
(. #uthori:ation of purchas es and sales: these should be
perfor med by "ery senior le"el manage me nt and those
responsi bl e shoul d ha"e no connection with cash or the cust ody
of document s of title.
$. ,aint enance of in"est ment regist er: this should be perfor med
by a clerk who has no access to the document s of title and no
responsi bility for aut hori:ation of purchas es or sales. The
regist er requires reconciliation with the in"est ment account in
the gener al ledger. The document s of title shoul d be "ouched
regul arly. #gain some work for internal audit ors.
*. ,aint enance of records: an independent clerk should be gi"en
the dut y of compari ng contract not es with purchas e and sales
aut hori:ation and for ensuring that charges ha"e been correctl y
calcul at ed. #dditional arrange me nt s should be made for
dealing with shar e transfers for ensuri ng that shar e certificat es
are recei"ed or deli"ered and that bonuses, right s issues,
capit al repayment s and di"idends or interest s are recei"ed and
properly account ed for. The internal auditors may play an
import ant role in ensuri ng that this work is well perfor med.
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%. /ocument s of title: adequat e cust ody procedur es must be
mai nt ai ned for document s of title and two senior officials shoul d
ha"e responsi bility for them. #ccess to the document s shoul d
be by the two officials acting Dointly.
"$E A&*I"%# AN* S(S"E!S %7 C%N"#%2 AN* ACC%&N"IN-
The accounti ng syst em operat es within a syst em of internal control.
The accounti ng syst em is designed to ensur e that e"ery transacti on
is compl et e and accur at el y process ed and recorded and that it is
"alid. The syst em of internal control is a collection of internal
arrange me nt s designed by the manage me nt to ensur e that the
accounti ng syst em achie"es its obDecti"es.
Ascert ai nme nt
The audit or ascert ai ns the syst em by asking questions of knowl edgeabl e
peopl e within the organi:ation. =e can also ascert ai n a syst em by a study
of the syst ems manual prepar ed by the client. =e can also study the
document s used in the organi:ati on and he can obser"e the procedur es
being perfor med.
#ecordi ng
The audit or must record the syst em that he has ascert ai ned. This simply
means put ting it on paper. =e can record the syst em in se"er al ways:
(. arrati"e not es: narrati"e not es are probabl y the most
adapt abl e means of recording but they ha"e the disad"ant ages
that they can be cumber some to use, they are difficult to
interpr et and re"iew and they are awkwar d to change. It is also
difficult to identify if any part of the syst em has been omitt ed
plus of course the difficulty associ at ed with readi ng other
peopl es illegible hand writing. This met hod is therefore
appropri at e to small business es or to an o"erall record of
syst ems in large compani es.
$. <se of internal control questionnair es: In our re"iew of the
"arious cycles we identified measur es that an organi:ation can
take to pre"ent and det ect errors and irregul ariti es. These
measur es represent desirabl e controls than can exist in a
syst em. ow internal control questionnai r es are pre- print ed
document s asking specific questi ons about the exist ence of
desirabl e controls in the syst em. The way they are framed is
such that the questi ons can be answer ed in a >yesJ and >noJ
manner. # >noJ answer implying a weakness in control or a lack
of control. >QesJ answer s indicat e a strengt h. Internal control
questionnai r es help to ensur e that all basic control point s are
consider ed and in the cont ext of control e"aluati on they can be
extremel y useful but they are not efficient as a means of
recordi ng an accounti ng syst em becaus e Dust like narrati"e
not es they can become "ery clutt er ed hence becomi ng difficult
to interpr et .
A&*I"IN-
:5 Account i ng and
*. 7low- chart s: a flow chart is a diagr amma t i c represent at i on of
the flow of document s through an accounti ng syst em with e"ery
check or control recorded on the lines of flow and segregat i on of
duties highlight ed. This met hod of recordi ng ensur es as far as
possi bl e the compl et enes s of recording becaus e a missed st age
would result in a flow line simply stoppi ng in the middl e of a
page. It eliminat es the need for lengt hy narrati"e, it is easy to
underst and and extract the salient point s of control and any
relat ed weakness es. In addition, if the format is standar di sed
then assi mil ation is made easi er. The met hod howe"er does
not facilitat e the recordi ng of physical, personnel , super"i sion or
manage me nt controls which are usually best cont ai ned in
narrati"e not es. # flow- chart is widely regar ded as an import ant
tool in the e"aluati on of syst ems. It is pri marily designed to
re"eal the absence of essent i al accounti ng controls therefore
time should not be spent on recordi ng det ails which are
irrele"ant to this purpose. 2repari ng flow- chart s is time
consumi ng and for a professi onal firm expensi "e to prepar e.
1onsider at i on must always ther efore be gi"en to their cost
effecti"eness. In most situations it is not appropri at e to prepar e
flow- chart s at all. #ll these techni ques can be used at the same
time and are therefore not mut ually exclusi"e.
"he inormat i on re@ui red
aB #n o"erall organi:ation chart. We need a chart that will show
the principle depar t ment s of the company toget her with the
description of their functions and the number of peopl e
employed ther ei n. The titles and names of all responsi bl e
officials should be recorded along with their lines of
responsi bility within the organi:ation.
bB # list of the principal books of account s with a brief description
of how each are kept . 8ecords can be kept in many ways,
rangi ng from hand writt en ledgers through accounti ng machi nes
to the most sophi sticat ed real time comput eri sed dat a
processi ng syst ems. It is essenti al to ha"e precise det ails of the
met hods used.
cB Informati on as to accounti ng informati on flows and
controls: this is usually in the form of flow- chart s. #nyway
what e"er met hod is used it is import ant to record the
person who is responsi bl e at each stage for the
aut hori sing, the recording and the cust ody of rele"ant
asset s and records.
dB arrati"e not es on appropri at e accounti ng controls particul arly
with reference to the account ability of empl oyees in each audit
area. )y this we mean for exampl e aut horit y limits for cheque
signat ori es toget her with their speci men signat ur es and in
addition a brief description would also be included on any other
controls.
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#fter recording the syst em in whiche"er way, the auditor needs to
corrobor at e the records. 1orrobor ation means confirming that what he
has recorded is what act ually takes place. 1orrobor ati on is done by use of
a walk through test . This in"ol"es collecting sampl es on a Dudgement al
basis of one or two transacti ons and following them through the syst em as
recorded. The walk through test confirms the records and also confirms
the audit ors under st andi ng of the syst em. #fter corrobor ati on, if it is the
syst em of accounti ng, the auditor will perfor m test s and from the result s
of those test s he will assess its adequacy as a basis for the prepar ati on of
the financi al st at eme nt . To this end I refer you to the chapt er on
#ccounti ng syst ems and implications. If it is a syst em of internal control,
aft er corrobor ati on, the auditor seeks to e"aluat e those controls.
-"aluation of controls is carried out from three point s of "iew with the sole
aim of being able to est ablish whet her the syst em constit ut es a reliabl e
basis for the prepar ati on of annual account s and to det er mi ne the required
amount s of subst ant i "e testi ng. If internal control is weak it may not be
possibl e to express any opinion at all on the account s present ed. +n the
other hand, a strong syst em of internal control can mini mi se the amount
of subst ant i"e testing used in arri"ing at an opinion. The three point s of
"iew mentioned are:
(. to consider the possibility of fraud@
$. possi bility of undisco"er ed errors occurring and
*. possi bility of account s being deliber at el y distort ed
E0al uat i ons
-"aluation can be approached from the I13 point of "iew of trying to
det er mi ne if desirabl e internal controls are present in a syst em and from
the "iew of an I1-3 wher e we use key control questions to det er mi ne if
specific errors or irregul arities are possibl e. 0et us look at both
approaches:
ICEB We ha"e already met this document which is Dust a list of questions
that typically ask whet her cert ai n controls are perfor med and if so, when,
how and by whom. The I13 is usually formul at ed such that ther e is one
co"ering each of the areas discuss ed under accounti ng cycles. #n
exampl e of an I13 on the purchasi ng cycle is appended as an appendi x to
this chapt er. I13 facilitat e the orderly "aluation of the internal control.
They eliminat e the possi bility of mat t er s being o"erlooked and they
pro"ide a basis for the manager C par t ner re"iews of the opinions reached
by the st aff in the field. They pro"ide audit e"idence of the basis of audit
conclusions in the e"ent that the auditorJ s Dudgement is subsequent l y
challenged. Their maDor failings are: they concent r at e on the controls
thems el "es rather than the error or irregul arit y that the controls are
designed to pre"ent or det ect . It is also gener ally consider ed that these
I13J s can become too compl ex and clutt er ed for meani ngful e"aluati on
and that in large and compl ex organi:ati ons syst ems informati on is best
recorded in the form of flow- chart s or syst ems. It is essenti al that the
audit is conduct ed in a searchi ng and enquiring manner , always beari ng in
mind the types of problems that may arise. With I13s it is "ery easy to
forget the significance behind e"ery question and for this reason much of
their "alue is lost and most maDor firms now adopt the internal control
e"aluation questionnair e approach.
A&*I"IN-
:6 Account i ng and
ICEEsB I1-3s are char act eri sed by the use of the key control
questi ons co"ering the accounti ng cycles dealt with earlier
which are then backed up by backup questions. Where the
syst em has been recorded by the use of narrati"e not es or flow-
chart s weaknes s es are not easily appar ent as was the case
when the I13 was used. The I13 is a compr ehensi "e, all
inclusi"e met hod of ascert ai ni ng, recording and e"aluati ng a
syst em of control but where as we ha"e seen the syst em is
recorded in the other two met hods then we ha"e need for
anot her document for us to be able to e"aluat e the strengt hs
and weakness es of the syst em. The likelihood of defalcation
can be e"aluat ed by det er mi ni ng whet her the segr egat i on of
duti es is satisfact ory. The possibility of error can be consider ed
by looking at the checks present in the syst em in the light of the
"arious types of error possi bl e. The possi bility of distortion
normally by senior officials cannot be readily det er mi ned by
questi onnair e but may be re"eal ed during the course of
e"aluation procedur es by looking out for signs that the
manage me nt are under pressur e.
2imit ati ons o the e ect i 0e ne s s o int ernal control s
The auditing guidelines stress that no internal control syst em howe"er
elabor at e can by itself, guar ant ee efficient admi nist r ati on and the
compl et enes s and accuracy of the records nor can it be proof against
fraudul ent collusion, especi ally on the part of those holding positions of
aut horit y or trust . Internal controls dependi ng on segregat i on of duti es
can be a"oided by collusion. #uthori:ation controls can be abused by the
person in whom the aut horit y is "est ed. ,anage me nt is frequentl y in a
position to o"erride controls which it has set up itself. Whilst the
compet ence and integrit y of the personnel operati ng the controls may be
ensur ed by selection and training, these qualities may alter due to
pressur e exert ed both within and without the ent erpri se. =uman error
due to errors of Dudgement or interpr et at i on to misunder st andi ng
carel essnes s, fatigue or distracti on may under mi ne the effecti"e operation
of internal control.
"he audi t orA s use o int ernal control
The auditorJ s obDecti"e in e"aluati ng and testi ng internal control is to
det er mi ne the degr ee of reliance which he may place on the informati on
cont ai ned in the accounti ng records. If he obt ains reasonabl e assur ance
by means of compl et enes s and accuracy of the accounti ng records and
the "alidity of entries therei n he may limit the ext ent of his subst ant i "e
testi ng. )ecaus e of the inherent limit ations in e"en the most effecti"e
internal control syst em, it will not be possibl e for the audit or to rely solely
on its oper ati on as a basis for his opinion on the financi al st at eme nt . In
some ent erpri ses the auditor may be unabl e to det er mi ne whet her all the
transact i ons ha"e been reflect ed in the accounti ng records unless they are
effecti"e internal controls. The types of internal control on which the
auditor may seek to rely "ary widely. Where the auditorJ s pri mar y
e"aluation indicat es that ther e are controls which meet the obDecti"e
which the audit or has identified then he should design and carry out
compliance test s if he wishes to rely on those controls. =owe"er, where
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his e"aluation discloses weakness in or the absence of internal controls
such that mat eri al error or omission could arise in the accounti ng records
or financi al st at eme nt s the audit or will mo"e directly to designi ng and
carrying out subst ant i"e test s.
A&*I" "ES"IN-
The auditor is not entitled to place any reliance on internal controls based
solely on his preli minary e"aluati on. =e should carry out compliance test s
to obt ai n reasonabl e assur ance that the controls on which he wishes to
rely were functioning both properly and throughout the period.
Com1l i anc e "est s
1ompliance test s are defined as those test s which seek to pro"ide audit
e"idence that internal control procedur es are being applied as prescribed.
We ha"e seen that the auditor first ascert ai ns a syst em of internal control
through "arious means, he then records that syst em again through
"arious possi bl e means, then through the use of walkthrough test s he
seeks to corrobor at e the record. #fter corrobor ati on he must carry out an
e"aluation of the syst em to det er mi ne whet her concept ually it is reliabl e,
or has cert ai n key controls upon which he can place reliance.
If he e"aluat es the syst em and reaches the conclusion that the syst em has
controls upon which he can place reliance, then the audit or has to make a
further decision and this is whet her he should carry out compliance test s
or not. # point must be made here, it is the application of the syst em that
is being test ed not the transacti ons although the testing is through the
medi um of transacti ons. !o in carrying out his compli ance test s and as
excepti ons are not ed wher e the syst em has not been complied with in any
particul ar, then the audit or may need to re"ise his syst em description and
re- e"aluat e its effecti"enes s. =e also will need to det er mi ne if the failure
of compli ance was an isolat ed case or is sympt omat i c.
1ontrols and their exercise can lea"e a "isible trail like a signat ur e or a
stamp on a document or they may lea"e no "isible trail. 1ompliance test s
ther efor e can be carried out through inspection of document s to
det er mi ne whet her appropri at e signat ur es and e"idence of appro"al and
checking exist s, or through obser"ati on wher eby there is no e"idence that
a procedur e was carried out as expect ed. The test s carried out by
exami nati on of document s can usually be ext ended and conclusions
extrapol at ed to co"er the whole popul ation concer ned. =owe"er, for
those subD ect to obser"ati on we can only draw conclusions based on what
was act ually obser"ed and we ha"e no e"idence that the procedur e is
perfor med that way throughout the period.
In compliance test s the issue of mat eri alit y does not arise. -"ery
excepti on is mat eri al and shoul d be in"esti gat ed. If compliance test s
disclose no exceptions the auditor may reasonabl y place reliance on the
effecti"e functioning of the internal controls test ed. =e can ther efore limit
his subst ant i "e test s on the rele"ant informati on in the accounti ng
records.
A&*I"IN-
:; Account i ng and
The account ant is concer ned as far as e"ery transact i on is concer ned that
it has been recorded and process ed compl et el y and accurat el y and that it
is "alid. Internal controls are arrange me nt s est ablished by the
manage me nt to ensur e that this is so, therefore compli ance test s pro"ide
the auditor with indirect e"idence that all transact i ons ha"e been
compl et el y and accurat el y process ed and recorded. -xampl e: # key
control that the auditor wishes to rely on may be that before the payroll is
paid the chief account ant , the personnel manager , and the managi ng
direct or must sign to appro"e it. The auditor would therefore select a
sampl e of payrolls and going through them seek to confirm that the
appropri at e signat ur es ha"e been appended. ow if he finds that the
appropri at e signat ur es are act ually appended then it gi"es him some
assur ance that e"eryt hi ng relating to the payrolls was compl et el y and
accurat el y process ed and recorded and all the result ant entri es are "alid.
This is so becaus e we would not expect the chief account ant , the
personnel manager and the managi ng direct or to appro"e a payroll that is
wrong in some particul ar. Qou can see from this that the auditor has not
referred to any informat i on cont ai ned in any records or any financi al
stat e ment s and yet he has some assur ance. Therefore as a result of this,
he may limit his det ailed test s on the payroll to a mini mum.
If the compliance test s ha"e disclosed excepti ons which indicat e that the
control being test ed was not operati ng properly in practice the auditor
shoul d det er mi ne the reason for this. =e needs to assess whet her each
excepti on is only an isolat ed depart ur e or is represent at i "e of others and
whet her it indicat es the possibl e exist ence of errors in the accounti ng
records. If the expl anati on he recei"es suggest that the excepti on is only
an isolat ed depart ur e then he must confirm the "alidity of the explanat i on
for exampl e by carrying out further test s. If the explanat i on or the further
test s confirm that the control being test ed was not oper ati ng properly
throughout the period then he cannot rely on that control. In these
circumst ances, the auditor is unabl e to restrict his subst ant i "e testi ng
unless he can identify an alternati "e control on which to rely. )efore
relying on the alternati"e control he must carry out suit abl e compliance
test s on it. -xampl e: In our payroll exampl e abo"e, suppos e the auditor
picks fi"e payrolls and on further exami nat i on finds that one of them does
not ha"e the appropri at e signat ur es. This may mean that maybe
responsi bl e officials were on lea"e in which case the control was not
exercised. =e could therefor e select fi"e mor e payrolls to confirm that the
excepti on was an isolat ed one. If he finds out that the payroll is ne"er
appro"ed by the three officials as required then he cannot limit his
det ailed subst ant i "e test s and he will ha"e to look for e"idence that all the
empl oyees on the payroll were genui ne, they were paid for work done and
the recording was correctly done.
Su,s t ant i 0 e tes t s
These are defined as thos e tes t s o trans ac t i ons and ,al anc e s and
ot her 1rocedur e s such as an anal yti cal re0i ew whi ch to seek to
1ro0i de audi t e0i de nc e as to the com1l e t e n e s s ? accuracy and
0ali di t y o the inormat i on cont ai ne d in the account i ng records or
in the inanci al st at e me nt s / Qou can see from this definition that all
audit work comes within subst ant i"e test s, we howe"er use the ter m to
mean all test s other than compli ance test s. # subst ant i "e test seeks to
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pro"ide direct e"idence of the correct treat ment of a transacti on, a
balance, a liability or any item in the books or the account s.
The emphasi s here is on the informat i on cont ai ned in the records or the
financi al st at eme nt s and seeki ng e"idence to pro"e its compl et enes s,
accuracy and "alidity and not a check on the procedur es est ablished by
the manage me nt to ensur e that it is so.
!ome exampl es:
(. Transacti ons: you may find the sale of a fixed asset recorded in
the accounti ng books. The audit or would need to exami ne the
copy in"oice, the aut horit y for the transact i on, the elimination of
that item of fixed asset s from the plant regist er and other
books, the accounti ng treat me nt and he will also seek e"idence
that the price obt ained was reasonabl e.
$. )alances: a bank balance recorded in the books. The
audit or would need to obt ai n direct confirmat i on from the
bank, and compar e that confirmati on with the bank
reconciliation and the cash book.
*. #nalytical re"iew: the auditor seeks e"idence that proper cut off
has been achie"ed. =e can do this by exami ni ng the gross
profit ratio and the accounti ng treat ment of receipt s and issues
of stock items.
%. 1ompl et enes s of e"idence: the audit or can obt ai n
repres ent at i on from the companyJ s lawyer s that ther e are no
pendi ng legal cases agai nst the company that could result in
significant losses.
#%"A"I%NA2 "ES"S
In practice the audit or will carry out only compli ance test s and subst ant i"e
test s. 1ompliance test s to pro"ide him with indirect e"idence and
subst ant i "e test s - direct e"idence.
+ccasionally howe"er there is reference to rotational test s and these are
of two kinds:
(. 6isit rot ation: this is where the client has numer ous branches,
factories or locations. It may be impractical to "isit all of them
each year. In such cases the auditor "isits them in rot ation such
that each will not be "isited each year, but all will be "isited
o"er a period of time.
$. -mphasi s: ther e are times the auditor rot at es audit emphasi s.
The auditor perfor ms a syst ems audit on all areas of the client s
business e"ery year but he would select one area for speci al in
dept h testi ng. There is opinion that e"ery audit e"ery year
must co"er all areas adequat el y, howe"er, as audit ors usually
ser"e for se"er al years rotational testi ng makes sense in ter ms
of effecti"enes s and efficiency. It is "ital that rotational test s
are carried out at random so that client staff do not know which
areas or locations will be select ed in any one year.
A&*I"IN-
:: Account i ng and
"EC$NIE&ES %7 A&*I" "ES"IN-
<nder our re"iew of audit e"idence we exami ned techni ques of obt ai ning
audit e"idence and these are the techni ques for audit testing.
"imi ng o audi t tes t i ng
(. Walk through test s: their purpose is to confor m the correct
recordi ng of an accounti ng syst em and the auditorJ s
underst andi ng of that syst em and the relat ed controls. These
are therefore best perfor med:
aB #fter recording the syst em.
bB The following year if you are the audit or becaus e it is
inefficient to ascert ai n and record the syst em e"ery year.
#ll the audit or needs to do is to ask the client whet her
there has been any changes in the syst em and if ther e has
been no changes then a walk through test confirms that
the record is still appropri at e.
cB #fter an interi m audit "isit when the auditor comes in
for the final audit he can carry out walk through test s
to confirm that the syst ems ha"e not changed.
dB When the auditor did not prepar e the record of the syst em
then he carries out walkt hrough test s to confirm his
underst andi ng of the syst em.
$. 1ompliance test s: the sampl e should be represent at i "e of the
whole years transacti ons. They are usually carried out at the
interi m audit "isit and updat ed at the final "isit to ensur e that
the whole period has been co"ered.
*. !ubst anti "e test : these test s are applied to:
aB Transacti on records wher e internal controls are weak or
non- exist ent or where the syst em cannot be relied on.
bB <nusual, extraor di nar y or one off transact i on and
transacti ons which are not co"ered by the syst em.
cB #ll asset s and liabilities at the balance sheet dat e.
Therefore we can see that subst ant i"e test s are usually carried out at
any time during the audit but mostly concent r at ed at the final "isit.
"o summari s e audi t tes t i ng
The stages in audit testi ng are:
(. Internal control e"aluations which will be followed by.
$. 1ompliance testi ng which gi"es satisfaction to some ext ent on
the reliability of the records and the controls. This will be
followed by:-
*. #n o"erall analytical re"iew designed to expose appar ent
inconsi st enci es and abnor mali ti es in the financi al st at eme nt s
and the underl ying records. These three help us det er mi ne the
ext ent of subst anti "e testi ng. !ubst anti "e testing consist s of
test s that are designed to subst ant i at e the compl et enes s,
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accur acy and "alidity of informat i on cont ai ned in the accounti ng
records and financi al st at eme nt s. They consist of:
aB det ail ed analytical re"iew which is designed to help locat e
mat eri al mis- stat e ment s in the account s by compari ng
transacti ons and balances with relat ed items bot h for the
same period and for pre"ious periods.
bB test s of det ail which consist of transact i on testing and
balance testing and are designed to subst ant i at e
indi"idual items in the account s and so gain
assur ance either about the "alidity of similar
transacti ons or about the det ails that underlie the
"arious account s balances. Test of det ails consist of
transacti on testi ng which is achi e"ed by "ouching
whereby "ouchi ng is defined as pro"ing the
aut hent i cit y of a recorded transacti on, the checking
of cast s and cross cast s, checking of postings and
reconciliations. )alance testi ng is achie"ed by direct
confirmat i on and the physical inspecti on, all these
gi"e the necess ar y confidence for the audit or to
express an opinion on the account s.
"he #el ati ons hi 1 ,et we e n Ext ernal Audi ti ng and Int ernal
Audi ti ng/
Introduct i on
6ery large organi sati ons Aand some small onesB ha"e found a need
for an internal audit in addition to an ext ernal audit. Internal
audit ors are employees of the organi sati on and work exclusi"ely for
the organi sati on. Their functions partly o"erlap those of the
ext er nal audit ors but in part are quit e different .
The precise functions of ext ernal audit ors are either laid down by
st at ut e or embodi ed in a lett er of engage me nt . The functions
Awhich are rarely precisel " laid downB of internal audit ors are
det er mi ned by manage me nt and "ary greatl y from organi sati on to
organi sati on.
Internal audit can be defined as:
Oan independent apprai sal function within an organi sati on for the
re"iew of syst ems of control and the quality of perfor mance, as a
ser"ice to the organi sati on. It obDecti"el y exami nes, e"aluat es and
report s on the adequacy of internal control as a contribution to the
proper, economi c, efficient and effecti"e use of resources. O
Internal auditing is thus:
a. 1arried on by independent personnel . Internal audit ors are
employees of the firm and thus independence is not always
easy to achie"e. =owe"er it can be assist ed by:
I ha"ing the scope to arrange its own priorities and acti"ities
I ha"ing unrest rict ed access to records, asset s and
A&*I"IN-
:D Account i ng and
personnel
I freedom to report to higher manage me nt and where it
exist s to an audit commi t t ee
I =a"ing internal audit personnel with an obDecti"e frame of
mind
The I!# &(4, deal s with 8eliance by -xternal #uditors on the
work of the Internal #uditor.
I I# personnel who ha"e no conflicts of interest s or any
restrictions placed upon their work by manage me nt .
I I# personnel ha"ing no responsi bility for line work or for
new syst ems. # person cannot be obDecti"e about
somet hi ng heCshe has taken responsi bility for. +n the
other hand the I# should be consult ed on new or re"ised
syst ems
I I# personnel who ha"e no non- audit work.
!ince internal audit ors are employees it is difficult to ensur e that they are
truly independent in mind and attit ude.
b. an apprai sal function. The internal audit orJ s Dob is to appr ai se
the acti"ity of others, not to perfor m a specific part of dat a
processi ng. 7or exampl e, a person who spent his time checking
employee expens e clai ms is not perfor mi ng an internal audit
function. )ut an employee who spent time re"iewing the
syst em for checking empl oyee expens e clai ms may well be
perfor mi ng an internal audit function.
c. as a ser"ice to the organi sati on.
The manage me nt requires that :
i. Its policies are fulfilled.
ii. The informati on it requires to manage effecti"ely is reliabl e
and compl et e.
iii. The organi sati onJ s asset s are safeguar ded.
i". The internal control syst em is well designed.
". The internal control syst em works in practice.
The internal audit orJ s acti"ity will be direct ed to ensur e that
these requirement s are met . The internal auditor can be seen
as the eye of the board within the ent erpri se.
d. +ther duti es may include:
i. )eing concer ned. #n exampl e of this is in energy sa"ing.
ii. )eing concerned with the respons e to the internal control
syst em to errors and required changes to pre"ent errors.
iii. #cting as a training officer in internal control mat t er s.
i". #uditing the informati on gi"en to manage me nt particul arly
interi m account s and manage me nt accounti ng report s.
". Taking a share of the ext er nal audit orJ s responsi bility in
relation to the figures in the annual account s.
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6/ ESSEN"IA2 E2E!EN"S %7 IN"E#NA2 A&*I"
The essent i al element s of internal audit are:
a. IndependenceNs ee abo"e
b. !taffingNt he internal audit unit should be adequat el y staffed in
ter ms of number s, grades and experi ence.
c. TrainingNall internal auditors shoul d be fully trained.
d. 8elationshi psNint er nal audit ors should fost er const ructi"e
working relationshi ps and mut ual underst andi ng with
manage me nt , with ext ernal audit ors with any re"iew agenci es
Ae.g. manage me nt consult ant sB and where appropri at e with an
audit commi t t ee. ,utual under st andi ng is the goal.
e. /ue careNan internal audit or should beha"e much as an
ext ernal auditor in ter ms of skill, care and Dudgement . =e
shoul d be up to dat e technically and ha"e personal st andar ds of
knowledge, honest y, probity and integrit y much as an ext ernal
auditor. It is desirabl e that an internal audit or is qualified,
becaus e of ethical consider at i ons as much as technical
standar ds implied by member s hi p of a professi onal body.
f. 2lanning, controlling and recordingNfunda me nt all y the internal
auditors shoul d beha"e much as ext er nal audit ors in this
respect . The plan shoul d identify audit areas which may be:
i. #cti"ity Ae.g. payroll, income, stores, purchasi ng etc.B
ii. ature of the audit Ae.g. prot ecti"e, syst ems audit, "alue
for moneyB
iii. 0e"el of audit required Ae.g. degr ee of risk, frequency and
ext ent of auditB.
Internal auditors plan their work strat egi cally Atwo to fi"e years
for all areas to be co"eredB, periodically Atypically one year
when the strat egi c plan is transl at ed into a schedul e of workB
and operationally Aeach piece of work, in det ailB.
1ontrolling includes super"i sion and re"iew of internal audit
work.
Working paper s should be of a similar det ail and standar d as
those of ext er nal audit ors.
g. !yst ems controlNthe internal auditor must "erify the operations
of the syst em in much the same way as an ext ernal auditor i.e.
by in"esti gati on, recording, identification of controls and
compliance testi ng of the controls. =owe"er, the internal
auditor is also concer ned with:
I The organi sati onJ s business being conduct ed in an orderly
and efficient manner
I #dherence to manage me nt policies and directi"es
I 2romoti ng the most economi c# efficient and eff ecti ve use
of resources and achie"ing the manage me nt J s policies.
I -nsuring compli ance with stat ut or y requirement s
I !ecuring as far as possibl e the compl et enes s and accuracy
A&*I"IN-
C5 Account i ng and
of the records
I !afeguar di ng the asset s
h. -"idenceNt he internal audit or has similar st andar ds for
e"idence as an ext er nal audit or, he will e"aluat e audit e"idence
in ter ms of sufficiency, rele"ance and reliability.
i. 8eportingNt he internal auditor must produce timely, accur at e
and compr ehensi "e report s to manage me nt on a regul ar basis.
These should report on the mat t er s outline in g. abo"e and with
the accuracy of informat i on gi"en to manage me nt and gi"e
recomme nda t i ons for change.
4/ E9"E#NA2 AN* IN"E#NA2 A&*I"%#S C%!+A#E* AN*
C%N"#AS"E*
Common int ere s t s
a. #n effecti"e syst em of internal control
b. 1ontinuous effecti"e operation of such syst em
c. #dequat e manage me nt informati on flow
d. #sset safeguar di ng
e. #dequat e accounti ng syst em Afor exampl e to compl y with the
1ompani es #ct 1ap %9&B
*i ere nc e s
a. Sco1e Nthe ext ent of the work undert aken. Internal audit work
is det er mi ned by manage me nt but the ext ernal auditorJ s work is
laid down stat ut e.
b. A11roach . The internal auditor may ha"e a number of ai ms in
his work including an apprai sal of the efficiency of the internal
control syst em and the manage me nt informat i on syst em. The
ext ernal auditor is interest ed pri marily in the trut h and fairness
of the account s.
c. #es1ons i ,i l i t y . The internal auditor is answer abl e only to
manage me nt . The ext ernal auditor is responsi bl e to
sharehol der s and arguabl y to an e"en wider public. bot h are of
course answer abl e to their consci ence and the ethical concept s
of their professional bodies.
Areas o work o0erl a1/ This can apply in the following areas:
a. -xami nati on of the syst em of internal control.
b. $%ami nati on of t&e accounti ng records and supporti ng
document s.
c. 6erification of asset s and liabilities.
d. +bser"ati on, enquiry and the making of st ati stical and
accounti ng ratio measur e me nt s.
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#eas ons or Co> %1erati on ,et we e n External and Int ernal Audi t ors
Internal audit is an element of the Internal 1ontrol syst em est ablished by
manage me nt . Thus as ext er nal auditors are accust omed to place reliance
on internal controls they will consider if reliance can be placed on this
element .
!ome of the obDecti"es of internal audit are the same as those of the
ext ernal audit or. 7or exampl e, the internal audit or will perfor m work on
the document at i on and e"aluation of accounti ng syst ems and internal
controls and will carry out compli ance and subst ant i "e test s. It makes
economi c sense to reduce the work of the ext er nal auditor by relying on
work done by the internal audit or.
Basi s o Co> %1erati on
The ext er nal auditor may utili:e the work of the internal auditor in two
ways:
a. )y taking into account the work done by the internal audit or@
b. )y agreei ng with the manage me nt that internal audit will render
direct assist ance to the ext er nal audit or.
Nat ure o Int ernal Audi ti ng
The scope and obDecti"es of internal audit at e set by manage me nt and
"ary widely. The areas of acti"ity may include:
a. 8e"iewing accounti ng syst ems and internal control@
b. -xami ni ng financi al and oper ati ng informat i on for manage me nt ,
including det ail ed testi ng of transacti ons and balances@
c. 8e"iewing the economy, efficiency and effecti"enes s of
oper ati ons and of the functioning of non financi al controls@
d. 8e"iew of the implement at i on of corpor at e policies, plans and
procedur es@
e. !peci al in"estigations.
!ome of these functions are directly rele"ant to the obDecti"es of the
ext ernal auditorNseeki ng e"idence of the trut h and fairness etc., of items
in the #ccount s. -"en speci al in"esti gati ons may be rele"ant . 7or
exampl e, an in"estigation into the ext ent of slow mo"ing stock is rele"ant
to the "alue of stock or an in"esti gati on into the "iability of a branch may
be e"idence as to the correct nes s of using going concern "alues for that
branchJ s asset s.
!ome of the functions are clearly not rele"ant to the ext er nal auditorJ s
obDecti"es. 7or exampl e, the cost of a control is not rele"ant , only its
effecti"enes s.
!ome internal audit work is not audit work at all but is part of internal
control. 7or exampl e internal audit in 0ocal #uthorities may scrutini:e and
appro"e expens es clai ms. !uch work is an internal control but is not
auditing.
Ass e s s me nt
)efore placing any reliance on the work of an internal audit or, the ext ernal
A&*I"IN-
C6 Account i ng and
auditor must assess the internal auditor and his work in the following
areas:
a. Inde1e nde nc e / The internal auditor may be an empl oyee of
the organi sati on, but he may be able to organi se his own
acti"ities and report his findings to a high le"el in manage me nt .
an internal audit or on whom the ext ernal auditor places reliance
must be independent and be able to communi cat e freely with
the ext ernal auditor.
b. The sco1e and o,H ect i 0e s of the internal audit function areas
such as &a. and b. are likely to be useful to the ext ernal auditor.
but c., d. and e. may also. 7or exampl e, an in"esti gati on into a
fraud may suppl y e"idence to the ext ernal audit or that the
ext ent of the fraud is not mat eri al.
c. *ue 1ro e s s i onal care/ To be useful to an ext er nal auditor
the internal auditorJ s work must be done in a professi onal
manner . That is, it must be properl y planned, controlled,
recorded and re"iewed. The auditor who arri"es in the morning
and says to himself Owhat shall I do todayO, is not much use.
d. "echni cal com1e t e nc e / ,ember shi p of a professional body
with its compet ence and ethical implications is desirabl e.
+ngoing training in speci alist areas, such as comput er s, is
useful.
e. #e1orti ng st andards / # useful internal audit or will pro"ide
high standar d report s which are act ed upon by manage me nt .
f. #esourc e a0ail a,l e/ #n internal audit depar t ment that is
star"ed of resources will not be "ery useful to the ext er nal
auditor.
The assess me nt should be thorough and fully document ed and included in
the working paper s. If the conclusion is that the internal audit depart ment
is weak or unreliabl e, then this fact shoul d be communi cat ed in the
ext ernal auditorJ s Oreport to manage me nt O.
Ext ent o #eli anc e
The ext ent of reliance depends on many factors including:
a. The mat eri al i t y of the areas or items to be test ed. 2ett y cash
expendi t ur e may probabl y be left to the internal audit or.
b. The le"el of audi t risk inherent in the areas or items. The "alue
of work in progr ess in a 1i"il -ngineeri ng company or the
pro"ision for doubtful debt s in a =ire 2urchas e company, are
high risk areas which the ext er nal audit or must see to himself.
c. The le"el of Hudge me nt required. The le"el of delay repairs in
a truck leasing company requires careful Dudgement .
d. The sufficiency of com1l e me nt ar y audit e"idence. The
internal audit may be relied upon to audit debt ors accounti ng
procedur es if the ext ernal auditor has e"idence in the form of a
debt orJ s circularisation.
e. S1eci al i s t skills possess ed by internal audit staff. In a )ank,
the internal audit depar t ment will ha"e speci alist knowl edge
and skills in the appr ai sal of the )ankJ s comput er syst em.
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*et ai l ed +lanni ng
=a"ing decided that he ma" be able to place reliance on the work of the
internal auditor, the ext er nal audit or shoul d.
a. #gree with the chief of internal audit the timing, test le"els,
sampl e selection procedur es and the form of document at i on to
be used@
b. 8ecord the fact of his intended reliance, its ext ent and the
reason for the fact and ext ent , in his working paper s@
c. 1onfirm with top manage me nt that he is doing so.
Control li ng
In order to be able ulti mat el y to place reliance on the work of the internal
auditor, the ext er nal audit or shoul d:
a. 1onsider whet her the work has been properl y staffed, planned,
super"ised, re"iewed and recorded@
b. 1ompar e the result s with other e"idence Ae. g. /ebtors
circularisati onB@
c. !atisfy himself that any unusual or Oput upon enquiryO items
ha"e been fully resol"ed@
d. -xami ned the report s made and the manage me nt J s respons e to
the report s@
e. -nsure the work is to be done in time.
#t the conclusion, the arrange me nt s should be re"iewed to make
things e"en bet t er next year.
#ecordi ng
The ext ernal auditor will ha"e a high st andar d of recordi ng in working
paper s. The internal audit orJ s work must be equally good if it is to be
relied upon.
E0idenc e
The det ailed mat eri al in this chapt er is import ant for student s, but you
shoul d not lose sight of the fact that an audit is about audit evidence . The
work of the internal auditor is e"identi al mat eri al. Whet her it is good
e"idence supplying a reasonabl e basis for conclusions to be reached, is a
mat t er of Dudgement . It may be desirabl e for the ext er nal audit or to test
the work of the internal auditor by suppl ement ar y procedur es or by re-
testi ng transacti ons or balances test ed by the internal audit or.
#e1ort to !anag e me nt
Whet her or not any work of the internal auditor is relied upon, the internal
auditor may unco"er and report on weaknes s es in internal controls. If the
internal auditor report s to manage me nt and manage me nt responds, then
the mat t er may rest ther e. If, howe"er, weakness es are mat eri al and the
respons e by the manage me nt inadequat e, then it may be desirabl e to
include the weakness es in the ext ernal audit orJ s own re1ort to
A&*I"IN-
C; Account i ng and
manag e me nt /
;/ 5 "he im1act o de0el o1me nt s in inormat i on technol o gy
Int ernal Control Consi derat i ons
7or an account ant , we can look at problems of comput eri sati on from
two angl es. Their impact on the syst em of internal control and their
implications for the audit or.
"he im1act o com1ut er s in the sys t e m o int ernal control
There are speci al char act eri stics of an -/2 syst em that the
account ant must be awar e of. Their basic differences from a manual
syst em are:
(a) E*+ syst e ms take much longer and are more dii cul t to
inst al l / Inefficient inst allation can therefore result in maDor
problems including accounti ng chaos that can lead to the
account ant being unabl e to det er mi ne the trut h and fairness of
the account s and at times can lead to the failure of the
company.
AbB E*+ syst e ms are much more com1l i cat e d and there or e
can creat e 1ro,l e m o unders t andi ng or the account ant
,e he the audi t or or Hust the com1anyK s account ant .
AcB "he nat ural di0i si on o dat a 1roce s s i ng ,et we e n 0ari ous
1art s o an organi Gat i on and its account i ng de1art me nt
is usual l y lost toge t he r wit h the unders t andi ng o the
int ere s t in dat a 1roce s s i ng whi ch manag er s ha0e/ This is
becaus e a large part of that dat a processi ng oper ati ons become
centr alised and there is concent r at i on of power in the comput er
depar t ment . This may facilitat e error and fraud and make its
disco"er y difficult.
AdB "he st e1s o 1roce s s i ng and st orag e o dat a on magne t i c
il es lea0e s no 0i si ,l e trail unl es s they are 1rint e d out .
,ost moder n syst ems rely hea"ily on direct entry of dat a "ia
key boards and the storage of dat a on discs. There is often no
print out of out put s as informat i on can be assess ed as required
on "isual display units.
AeB -eneral l y s1eaki ng? i correct dat a is 1res e nt e d to the
machi ne and aul tl e s s com1ut er 1rogramme s are used
the out 1ut shoul d ,e error ree . These howe"er reinforce
the mist aken belief that machi nes do not make mist akes. )ut
machi nes cannot be relied upon to recogni:e nonsens e dat a. #
machi ne will not think, it will do as it is told. Therefore if it has
been instruct ed incorrectl y it will always correctl y make the
same mist ake, wher eas a clerk in a manual syst em would be
expect ed to notice and query this.
AfB S1e e d/ # comput er J s pot enti al for produci ng informati on in
bot h ter ms of "olume and speed is of course "ast but its
pot enti al as "ehicles of mani pul ati on and fraud is equally great ,
and e"en if we were to lea"e aside the questi on of fraud, it is
gener ally true that when production of "ital dat a is dependent
on a comput er if things go wrong, they may go wrong on a truly
big scal e.
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#ll these differences radically alter the way in which accounti ng dat a is
recorded, the way in which such recordi ng must be controlled and
aut henti cat ed, the training needs and attit udes of the st aff responsi bl e at
both manage me nt and technical le"els and the way in which the process
and its result s must be audit ed. This may ther efore mean the introduction
of additional controls within the organi:ation to deal with the additional
probl ems.
The gener al controls that need to be incorpor at ed into the dat a processi ng
syst em are di"ided into two types of controls:
AaB -eneral control s which are further di"ided into admi nist r ati"e
controls and syst ems de"elopment s controls
AbB A11li cat i on control s
-eneral control sB Admi ni s t rat i 0e control sB
These arise from the risks implicit in the concent r at i on of power in the -/2
depart me nt , the carrying of a large number of files of import ant dat a
cent rally stored and storing dat a in a form which is highly inflammabl e
concent r at ed, sensiti"e to temper at ur e and at mospheri c conditions and
dependant for processi ng on machi ner y which is suscept i bl e to break
down. The measur es that will ha"e to be taken to mini mi se the possibility
of loss from these probl ems include:
i. 2hysical facilities such as a speci ally designed fire proof room
whose temper at ur e is properly controlled and entry is restrict ed
to only aut horised personnel .
ii. ,aint aining back up copies of all import ant programme s and
files. This includes the grand father and son configuration
whereby three files are maint ai ned at different le"els and at
different locations to enabl e reconst r uction to take place should
the need arise.
iii. =a"ing st andby arrange me nt s like unint errupt ed power supply
units to deal with power blackout s and ha"ing arrange me nt s
with other users of similar machi nes to allow processi ng of
urgent informati on should the machi nes breakdown. These
procedur es shoul d be subD ect ed to regul ar checks to confirm
that they do work in practice.
i". The maint enance of a library to ensur e that access to
programme s and files is properl y controlled.
". #dequat e di"ision of duties. The presence of comput er s does
not dispens e with the need to obser"e that fundament al aspect
of internal control i.e. the di"ision of responsi bilities in such a
way as to ensur e that:
AaB Those in a position of responsi bility do not thems el "es
become in"ol"ed in executi ng the routine of the
procedur es they ha"e aut hori sed.
AbB Those occupi ed with recordi ng functions do not ha"e
control o"er or access to the asset s whose mo"eme nt s
they are controlling and recording.
AcB That the work of one person is aut omat i cally checked for
aut horit y, accuracy, compl et enes s and procedur al
A&*I"IN-
C: Account i ng and
adher ence by anot her independent member of st aff
prefer abl y in a different depart me nt . The clerical
responsi bilities that need to be taken into consider at i on in
the user depar t ment s can be allocat ed in relation to
collection and sorting of input dat a, creation of batches
and batch tot als, ret ention of control dat a for compari son
with out put s, aut horisation of input s to be trans mi t t ed to
the -/2 depart me nt , collection and distribution of output s,
compari son of out put recei"ed e. g. schedul es, statistical
summar y, exception report s, error report s and
reprocessi ng requirement s.
Within the comput er area itself, the principles of this aspect of internal
control must be obser"ed. !yst ems de"elopment staff and progr ammer s
shoul d play no part in act ual processi ng in fact, ideally they shoul d ha"e
no access to the comput er room. This is becaus e ha"ing writt en the
progr ams they will be awar e of the controls that ha"e been writt en into
the programs and will therefore be capabl e of by- passi ng them.
/e"elopment st aff shoul d not e"en be allowed to test their programs. The
-/2 manager and his super"isors who bet ween them are responsi bl e for
all acti"ity in the -/2 area must mai nt ai n their independence of all
det ailed procedur es and they should therefore ha"e no acti"e part in day
to day routine processi ng. # suit abl e log for recordi ng the mo"eme nt of
all files, their safe cust ody when not in use, their clear identification at all
time shoul d be mai nt ai ned and this shoul d be the responsi bility of the
librari an who should ha"e no routine duties in the -/2 section. In
addition, a consol e log is needed as an import ant securit y function for
maki ng per manent records of e"ery operat or inter"enti on.
Syst e ms de0el o1me nt control s
These are intended to ensur e that we ha"e a "alid syst em of processi ng
whene"er new applications are de"ised, meet i ng the requirement s of
manage me nt and user depart me nt . These ai ms are achie"ed by:
AaB The use of st andar d document at i on@
AbB The use of st andar d procedur es whene"er possi bl e@
AcB !pecifying rigid aut horisation procedur es whene"er new
applications are en"isaged or existing progr ams amended or
ext ended@
AdB The adoption of adequat e testing routines prior to
implement at i on and@
AeB Instituting a compr ehensi "e syst em of program and document
securit y.
The stages of syst ems de"elopment may be briefly summari sed as
follows:
i. 7easi ,i l i t yB # commi t t ee which would usually include the -/2
manager and head of the user depar t ment concerned will
consider the feasibility of each proposed application from the
"iew point s of financi al "iability and technical capability. The
decision therefore rest s on the familiar cost benefit equati on.
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The benefit s of the new application must be weighed against
the cost. If the proDect is assumed feasibl e, then the next stage
is commenced. It may be ad"isabl e to inform the audit or to
obt ain his input at this stage becaus e the audit or is an expert
on syst ems of internal controls, he is also "ery knowledgeabl e
on the requirement s of the 1ompani es #cts as far as proper
books of account s are concerned. =e may also ha"e
requirement s that need to be taken into consider ati on and he
may also know the best suppliers of the equipment that would
be more suit abl e for the companyJ s needs.
ii. Syst e ms Anal ysi sB The syst ems anal yst s are highly trained
member s of the de"elopment personnel . They will consider
e"ery new application from e"ery rele"ant angl e taking into
account the needs of all those affect ed by the proposed
changes. The ext ernal audit or should be consult ed at this point
on particul ar feat ur es which he requires to be included. This
will sa"e the problem of the loss of audit trail that frequentl y
occurs. +nce all the users including the audit or ha"e been
consult ed as to their specific needs and the manner in which
their work will be affect ed by the new procedur es and
document at i on, the syst ems anal yst then set out the program
requirement s in the form of flow chart s known as block
diagr ams. These must be appro"ed before programmi ng can
begin.
iii. +rogrammi ngB 1ompar ed with syst ems analysi s which
requires a cert ai n degree of creati"it y and imaginati on,
programmi ng is a mechani cal exercise mai nly requiring strict
adher ence to the logical st eps which one by one make up the
program.
i". +rogram tes t i ngB 2rogram testing is di"ided into desk
checking which as the name suggest s takes place at the desk
rat her than on the comput er. =ere each instruct on is test ed by
the progr ammer s for logic, consist ency and accur acy with
reference to creat ed test dat a. #s each logic error is disco"er ed
the necess ar y corrections are made. This is called debuggi ng.
The use of test packs. 1reat ed dat a designed to highlight as
many problems and pot enti al logic errors as possi bl e are
punched and run on the comput er against the new program.
The output will then be closel y compar ed with pre- prepar ed
hand writt en result s and any further errors re"eal ed will be
correct ed. +il ot runni ngB In this case the new programs are
test ed against bat ches of li"e dat a co"ering the range of
possi bl e input s as compr ehensi "el y as possibl e. +nce agai n this
is compar ed with manually prepar ed result s. The chief
programmer will then inform the -/2 manager that the
program has been thoroughl y test ed and debugged and is
perfor mi ng the task it was designed for.
". +aral l el runni ngB This stage requires the new syst em and the
existing syst em to oper at e side by side for a lengt hy period
during which result s are compar ed. This is designed to ensur e
that the program responds correctly to the real processi ng
requirement of the user depart me nt in"ol"ed, that adequat e
comput er time will be a"ailabl e, that any errors remai ni ng can
A&*I"IN-
CD Account i ng and
be eliminat ed and that the user depar t ment st aff get used to
the new routines and document at i on. It may be useful to get
the auditor in to carry out a few test s to enabl e him assess the
adequacy of the controls incorpor at ed in the syst ems design.
"i. 7ile con0er si onB #ssumi ng that all the pre"ious fi"e st ages
ha"e been successful and ha"e been duly appro"ed, then all the
files need to be con"ert ed into comput er format . This is usually
a troubl esome and time consumi ng exercise and before the
manual records are dest royed, it is import ant to ensur e that the
con"ert ed files are accur at e, compl et e and up- to- dat e.
A11li cat i on Control s
#pplication controls codify the operati ng routines to be followed by the
-/2 and the user depart me nt s in their relations with each other.
#pplication controls co"er:
AaB The prepar ati on of input s and its transfer to the comput er@
AbB The processi ng of dat a within the comput er@
AcB The prepar ati on of out put s and its distribution@
AdB The mai nt enance of mast er files and the standi ng dat a
cont ai ned therei n.
We can ther efor e say that application controls are mainly concerned
with compl et enes s of input s, compl et enes s of processi ng, accuracy
of input, accur acy of processi ng, "alidity of dat a process ed and the
maint enance of dat a files.
A11li cat i on Control s
Com1l et e n e s s B In1ut
+ur1os eB #ll transacti ons are recorded, input and accept ed by the
comput er A1ontrol o"er the number s of document sB. -ach document is
process ed only once.
!ome control techni ques which may be applied by the comput er
Aprogramme d procedur esB or by the user A,anualB. #ll reDect ed dat a must
be in"estigat ed and correct ed. 1ontrol dat a, mat chi ng sequence, one for
one.
Com1l et e n e s s B +roce s s i ng
+ur1os eB #ll input and accept ed dat a updat es the mast er file. +utput
report s are compl et e.
Control techni @ue s incl ude 1ontrol tot al s, mat chi ng sequence, one for
one, summar y processi ng Aall aft er updat esB.
AccuracyB In1ut
+ur1os eB 1ontrol o"er the dat a fields to ensur e the accur acy of dat a
transcri bed from source to input- document Awhere applicabl eB and the
dat a are accurat el y con"ert ed to machi ne- readabl e form.
Control techni @ue s incl ude 1ontrol tot als mat chi ng, one for one,
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progr amme d checks Ae.g. reasonabl enes sB.
AccuracyB +roce s s i ng
+ur1os eB #ccurat e dat a are carried through processi ng to the mast er file.
1omput er gener at ed dat a are accur at e. +utput report s are accurat e.
Control techni @ue s incl ude 1ontrol Aafter updat eB one for one,
summar y processi ng, manual reconciliation of accept ed items, tot al s with
file tot al s.
!ast er 7iles and Standi ng *at aB 'ali di t y
+ur1os e +nly aut horised dat a updat es the mast er files. o changes to
the dat a are made after aut horisation.
Control techni @ue s incl ude 2rogramme d checks Ae.g aut horit y limitsB,
manual aut hori:ati on and re"iew.
!ast er 7iles and Standi ng *at aB !aint enanc e
+ur1os eB /at a on mast er files cannot be changed without aut horit y and
ther e are no long outst andi ng or unusual items on file.
Control techni @ue s incl udeB ,anual reconciliation of file tot al s with
manual control account , excepti on report s.
Test s the auditor does and all these application controls are to be found in
the #ppendix.
#uditors are bound to in"esti gat e the syst em of internal control of their
client J s organi:ati on before the execution of det ail ed audit test s. The
syst em produces the records, the records produce the final account s on
which the audit or has to report . In an -/2 syst em the nat ur e of internal
controls is strikingly different and therefore it becomes necess ar y for the
auditor to open his mind to changes which become necess ar y. In a
con"entional syst em, "isual scrutiny of e"ery function is possi bl e at e"ery
stage of recordi ng and the allocation of duti es is relati"el y straightforwar d.
"he Audi t orK s A11roach
If we look at the basic differences bet ween comput eri sed and
con"entional syst ems we will be able to appr eci at e the impact they
ha"e on the auditorJ s approach. If we re"isit these differences, we
can classify them as follows:
AaB "he com1l e xi t y o com1ut eri s e d syst e ms : <sually an
audit or can fully under st and a con"entional syst em in a
mat t er of hours at the most , whereas a comput eri sed
syst em cannot easily be compr ehended without expert
knowl edge and a great deal of time.
AbB A se1arat i on ,et we e n the com1ut er and the user
de1art me nt : The nat ur al checks on fraud and error nor mally
pro"ided by the interaction of user personnel and accounti ng
A&*I"IN-
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personnel no longer applies in a comput er en"ironment . This
leads to reluct ance on the part of the audit or to rely on internal
controls in a comput eri sed syst em.
AcB 2ack o 0i si ,l e e0i de nc e : /at a in comput er syst ems is stored
primarily on magnet i c discs. This informat i on is not easy to
exami ne. This creat es probl ems for the audit or, it must
howe"er be appr eci at ed that most comput er inst allations in
.enya produce acres of print out and the auditor may be faced
with too much record rat her than too little. #fter all the
manage me nt is also interest ed in running a business and needs
these records.
AdB !ost dat a on com1ut er il es is ret ai ne d or short
1eri ods : ,anual records can be ret ai ned for years. These
records may be kept in a manner which makes access by the
audit or difficult and time consumi ng.
AeB Com1ut er s syst e ms can ha0e 1rogramme d or aut omat i c
control sB Therefore their operation is often difficult to check by
an audit or.
AfB !ince progr ams operat e aut omat i cally without personnel being
awar e of what the program is doing, any progr am with an error
is likely to process erroneousl y for e"er.
AgB &se o out si de age nci e s : !ometi mes the client uses a
comput er bureau to maint ai n their accounti ng records. The
problems here for the audit or are in being able to exami ne
controls and syst ems when access is not a legal right.
Change s in audi t a11roac hB
Syst e ms desi gn : In con"enti onal syst ems the audit or finds out
about the client J s syst em. In a comput eri sed syst em, it is ad"isabl e for
the audit or to be ther e right from the design st age, when the syst ems are
set out.
"imi ng o audi t 0i si t sB ,ore frequent "isits may be required becaus e
ther e may be changes in syst ems and programs, print outs are often
shredded and magnet i c files o"erwritt en. 7requent changes occur in filing
order and the audit trail has to be followed while it still exist s.
Syst e ms re0i e wB This follows the normal way of using a questionnai r e
but is mor e difficult becaus e -/2 syst ems are mor e compl ex, technical
language is used, too much document at i on is a"ailabl e, many controls are
progr am controls meani ng that their e"aluation may require det ailed
study of programs which are writt en in high le"el languages or in machi ne
code, and frequent changes are made to syst ems and programs.
Audi t tes t sB These will ha"e to differ from those used in manual syst ems
to reflect the new records being exami ned.
"he Control 7ile
When auditing -/2 syst ems, it will be found that much reliance is placed
within the syst em upon st andar d forms and document at i on in gener al, as
well as upon strict adher ence to procedur es laid down. This is no surprise,
of course, since the ulti mat e const r ai ning factor in the syst em is the
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comput er J s own capability, and all users are compet i t or s for its time. It is
ther efor e import ant that an audit control file be built up as part of the
working paper s, and the audit or should ensur e that he is on the
distribution list for notifications of all new procedur es, document s and
syst ems changes in gener al. The following shoul d be included in the audit
control file.
AaB 1opies of all the forms which source document s might take, and
det ails of the checks that ha"e been carried out to ensur e their
accur acy.
AbB /et ails of physical control o"er source document s, as well as of
the nat ur e of any control tot als of number s, quantiti es or
"alues, including the names of the persons keepi ng these
controls.
AcB 7ull description of how the source document s are to be
con"ert ed into input medi a, and the checking and control
procedur es.
AdB # det ailed account of the clerical, procedur al and syst ems
de"elopment controls cont ai ned in the syst em Ae.g. separ ati on
of programmer s from oper at or s@ separ at i on of control of asset s
from records relating theret oB.
AeB The arrange me nt s for ret ai ning source document s and input
medi a for suit abl e periods. This is of great import ance, as they
may be required for reconst r ucti ng stored files in the e"ent of
error or mishap.
AfB # det ailed flow diagram of what takes place during each routine
processi ng run.
AgB /et ails of all tapes and discs in use, including their layout ,
labelling, storage and ret ention arrange me nt s .
AhB 1opies of all the forms which out put document s might
take, and det ails of their subsequent sorting and checking.
The audit orJ s own comment s on the effecti"eness of the
controls.
Audi ti ng Around the Com1ut er
When it is possi bl e to relat e on a one to one basis, the original input
to the final output or to put it anot her way, where the audit trail is always
preser"ed than the presence of the comput er has mini mal effect on the
auditorJ s work, and in that case it is possibl e to ignore what goes on in the
comput er and concent r at e audit test s on the compl et enes s, accur acy,
"alidity on the input and the out put , without paying any due concern to
how that output has been process ed. Where ther e is super abundance of
document at i on and the out put is as det ailed and compl et e as in any
manual syst em and wher e the trail from beginni ng to end is compl et e so
that all document s can be identified and "ouched and tot ally cross
referenced, then the execution of normal audit test s on records which are
comput er produced but which are ne"ert hel ess as compl et e as abo"e then
this type of auditing is called auditing around the machi ne. In this case,
the machi ne is "iewed as simpl y an instrument through which
con"entional records are produced. This approach is much criticised
becaus e:
A&*I"IN-
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i. It indicat es a lack of knowledge on the part of the audit or@
ii. It is extremel y risky to audit and gi"e an opinion on records that
ha"e been produced by a syst em that the audit or does not
underst and fully, and@
iii. # comput er has immens e ad"ant ages for the auditor and it is
inefficient to carry out an audit in this manner.
=owe"er, problems arise when it is disco"er ed that manage me nt can use
the comput er more efficiently in running the business. This is usually
done by the production of exception report s rat her than the full records.
7or exampl e, the manage me nt is interest ed in a list of delinquent debt or s,
ther efor e produci ng the whole list of debt ors means the list has to be
analy:ed again to identify delinquent debt or s and act upon them. This is
inefficient and time consumi ng as the print er is the slowest piece of
equipment in any comput eri sed syst em. 7rom the auditorJ s "iew,
excepti on report s which pro"ide him with the "ery mat eri al he requires for
his "erification work raise a serious probl em becaus e he cannot simpl e
assume that the programs which produce the exception report s are:
i. /oing so accur at el y@
ii. 2rinting all the exception which exist s@
iii. #re aut hori sed programs as opposed to dummy programs
speci ally creat ed for a fraudul ent purpose or out of dat e
programs accident ally taken from the library and@
i". That they cont ai n programs control paramet er s which do in fact
meet the companyJ s genui ne internal control requirement s.
!o although it may be reasonabl e for manage me nt to ha"e faith in their
syst ems and programs, such faith on the part of the auditor would be
compl et el y mispl aced and may reflect "ery ad"ersel y on his dut y of care.
This is the first situati on on the loss of audit trail.
The other situation wher e loss of audit trail is not ed where the comput er
gener at es, tot als, analyses and balances without printing out det ails. It
ther efor e becomes necess ar y for the auditor to find a way to audit through
the comput er rat her than around it. )ut before we go on to that, the loss
of audit train can be o"ercome as follows:
AaB We can ha"e speci al print out s for audit ors, reme mber the need
to be consult ed at the design stage.
AbB Inclusi"e audit facility: This means putting in the progr ams
speci al audit instructions that enabl e the comput er to carry out
some audit test s and produce print out s speci ally for the
audit or.
AcB 1lerical recreati on: Hi"en unli mit ed time and man power,
mai nt ai n the possi bility to recreat e manuall y the audit trail.
This would ob"iousl y be a "ery tedious exercise.
AdB Total testi ng and compari son: It is possi bl e to compar e result s
with other dat a, budget s, pre"ious periods and indust ry
a"erages.
AeB #lternati"e test s: We can perfor m stock takes, debt or s?
circularisation and exami nat i on of the condition of fixed asset s.
AfB We can use test packs to "erify program perfor mance.
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Audi ti ng "hrough the Com1ut er
There are basically two techni ques a"ailabl e to the audit or for auditing
through the comput er. These are a use of test packs and the use of
comput er audit progr ams. These met hods are ordinarily referred to as
comput er assist ed audit techni ques A1##TsB.
Test packs: These are designed to test the perfor mance of the client sJ
progr ams. What it in"ol"es is for the audit or either using dead dat a i.e.
dat a he has creat ed himself or li"e dat a i.e. the clientJ s dat a that was due
for processi ng to manually work out the expect ed output using the logic
and st eps of the progr am. This dat a is then run on the comput er using the
progr am and the result s are compar ed. # satisfact ory outcome gi"es the
auditor a degr ee of assur ance that if that programme is used continuousl y
throughout the year, then it will perfor m as required. Qou can see that
this techni que of test packs falls under compliance testi ng work.
AaB 0i"e testi ng has the following disad"ant ages:
i. If the dat a is included with nor mal dat a, separ at e test dat a
tot als cannot be obt ained. This can somet i mes be
resol"ed by the use of dummy branches or separ at e codes
to report the progr amJ s effect s on the test dat a.
ii. !ide effect s can occur. It has been known for an audit orJ s
dummy product to be included in a cat alogue.
iii. 1lient J s files and tot als are corrupt ed although this is
unlikely to be mat eri al.
i". If the audit or is testi ng procedur es such as debt follow up,
then the testi ng has to be o"er a fairly long period of time.
This can be difficult to organi se.
AbB /ead testing has the following disad"ant ages:
i. /ifficulties will be encount er ed in simul ati ng a whole
syst em or e"en a part of it.
ii. # mor e det ailed knowl edge of the syst em is required than
with the use of li"e files.
iii. There is often uncert ai nt y as to whet her oper ati onal
programs are really being used for the test .
i". The time span problem is still difficult but mor e capabl e of
resolution than with li"e testing.
Com1ut er audi t 1rograms . These consist of comput er programs used
by an auditor to read magnet i c files and to extract specified informat i on
from the files. They are also used to carry out audit work in the cont ent s
of the file. These programs are somet i mes called enquiry or interrogati on
progr ams. They can be writt en by an audit firm thems el "es or they can
be found from softwar e houses. They ha"e the ad"ant age that unskilled
staff can easily be taught to use them.
A&*I"IN-
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&ses o com1ut er audi t 1rograms B
!election of represent at i ons or randoml y chosen transact i ons or items for
audit test s, e. g. item number *& and e"ery (%4t h item ther eaft er.
!crutiny of files and selection of exceptional items for exami nati on e. g. all
wages payment s o"er .shs. ($4, or all stock lines wort h mor e than
.shs. (, 444 in tot al. 1ompari son of two files and printing out differences
e.g. payrolls at two select ed dat es. 2repar at i on of exception report s e.g.
o"erdue debt s. !tratification of dat a e.g. stock lines or debt ors@ with a
"iew to exami nat i on only of mat eri al items. 1arrying out det ail test s and
calculations. 6erifying dat a such as stock or fixed asset s at the interi m
stage and the compari ng of the exami ned file with the year end file so
that only changed items need be exami ned at the final audit Awith a small
sampl e of the other unchanged itemsB. 1ompari son of files at succeedi ng
year ends e.g. to identify changes in the composi tion of stock.
Ad0ant a g e s
(. -xami nati on of dat a is mor e rapid@
$. -xami nati on of dat a is mor e accur at e@
*. The only practical met hod of exami ni ng large amount s of dat a@
%. Hi"es the audit or practical acquai nt ance with li"e files@
5. 2ro"ides new opport uni ti es to the audit or@
&. +"ercomes in some cases a loss of audit trail@
K. 8elati"ely cheap to use once set up cost s ha"e been incurred@
*isad0ant a g e s
(. 1an be expensi"e to set up or acquire.
$. !ome technical knowl edge is required.
*. # "ariet y of programmi ng languages is used in business.
!tandar d comput er audit progr ams may not be compat i bl e.
%. /et ailed knowledge of syst ems and programs is required.
!ome auditors would disput e the need for this det ailed
knowl edge to be gained.
5. /ifficulty in obt aining comput er time especi ally for testi ng.
There can be no doubt that st andar d comput er audit program packages
will be in gener al use in the near future. <se of audit softwar e raises the
"isibility of the audit or in the eyes of the company. It makes the audit
mor e credibl e. /eficienci es in the syst em are often disco"er ed and can be
report ed to manage me nt . This also makes the audit mor e credibl e.
2ackages are not howe"er usually a"ailabl e for small machi nes.
%N> 2INE AN* #EA2 "I!E S(S"E!S
Traditional bat ch processi ng has the ad"ant ages that the dat a can be
subD ect ed to checks for "alidity, accur acy and compl et enes s before it is
process ed. )ut for organi:ati ons that need informat i on on strict time
scale, this type of processi ng is unaccept abl e. This has led to the
de"elopment of online and real- time syst ems and the number is growing
particul arly in airline offices, banks, building societi es and other financi al
institutions. The auditorJ s duties do not change but his techni ques ha"e to
change. The key feat ur es of these syst ems are that they are based on the
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use of remot e ter mi nal s which is Dust a 6/< and keyboar d typewrit er.
These ter mi nal s will be scat t er ed within the user depart me nt and they
ha"e access to the cent ral comput er store. The problem for the audit or
arises from the fact that mast er files held in the centr al comput er store
may be read and updat ed by remot e ter mi nal without an adequat e audit
trail or in some cases, any record remai ni ng. ecessar y precauti ons ha"e
to be made ther efore to ensur e that these ter mi nal s are used in a
controlled way by aut hori sed personnel only. #nd the securit y techni ques
include:
i. =ardwar e const r ai nt s e.g. necessi t ati ng the use of a key of
magnet i c- strip badge or card to engage the ter mi nal, or placing
the ter mi nal in a location to which access is carefully restrict ed,
and which is const antl y monit or ed by closed- circuit tele"ision
sur"eillance syst ems@
ii. The allocation of identification number s to aut horised ter mi nal
operat or s, with or without the use of passwords@ these are
checked by the mai nframe comput er against stored records of
aut hori sed number s and passwor ds@
iii. <sing oper at or char act eri stics such as "oice print s, hand
geomet r y Afinger lengt h ratiosB and thumb print s, as a means of
identification by the mainframe comput er@
i". 8estricting the access to particul ar progr ams or mast erfiles in
the mainframe comput er , to designat ed ter mi nal s@ this
arrange me nt may be combi ned with those indicat ed abo"e@
". In top- securit y syst ems, the aut horit y to allocat e aut horities
such as those indicat ed abo"e Ai.e. det er mi nat i on of passwor ds,
nomi nati ng select ed ter mi nal sB, will itself be restrict ed to senior
personnel , other than intended users@
"i. # speci al file may be mai nt ai ned in the centr al processor which
records e"ery occasion on which access is made by particul ar
ter mi nal s and oper at or s to centr al programs and files@ this log
will be print ed out at regul ar inter"al s e. g. the end of each day,
or on request by personnel with appropri at e aut horit y.
What differenti at es an online syst em from a real- time syst em is that the
online syst em has a buffer store where input dat a is held by the cent ral
processor before accessi ng the mast er files. This enabl es the input from
the remot e ter mi nal s to be checked by a speci al scanni ng program before
processi ng commences . With real time syst ems howe"er, action at the
ter mi nal causes an immedi at e respons e in the cent ral processi ng wher e
the ter mi nal is online. !ecurity against unaut hori sed access and input is
e"en mor e import ant in real- time syst ems becaus e the effect of the input
is that it inst ant aneousl y updat es the file held in the cent ral processor and
any edit checks on the input are likely to be under the control of the
ter mi nal oper at or s thems el "es. In "iew of these control problems, most
real time syst ems incorpor at e additional controls o"er the scrutiny of the
mast er file for exampl e, logging the cont ent s of the file before look and
aft er look.
S(S"E!S A&*I" A++#%AC$
The syst e ms audi t is based on the following:
The "olume of trans act i ons in a moder n company and the cost of
audi ti ng precl ude the exami nat i on and "erificati on of e"ery trans act i on
A&*I"IN-
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followed by the summar i :at i on of the trans act i ons into the financi al
st at e me nt s .
The "erificati on of all trans act i ons woul d not in itself be sufficient
becaus e it would not gi"e any assur ance as to the compl et enes s of
trans act i ons.
The syst e ms based audi t depends on reliance on syst e ms which pre"ent
or det ect any "ariation from correct proces si ng of docume nt s into ent ri es
in the financi al records, and hence their inclusion in the financi al
st at e me nt s . The audi t or needs to under st and the syst e m and "erify that
cont rol s are effecti"e throughout the period under re"i ew.
"he Int ernal Control Syst e m
ISA ;55 Ris Assess me nt s and Int ernal !ontrol defines the int ernal
cont rol syst e m as compri si ng the control environme nt and control
procedures . It includes all the policies and procedur es adopt ed by the
manage me nt of an entit y to assi st in their obDecti"e of achi e"i ng, as far
as practi cabl e, the orderl y and efficient conduct of the busines s,
including adher ence to manage me nt policies, the safeguar di ng of asses,
the pre"ent i on and det ect i on of fraud and error, the accur acy and
compl et enes s of the account i ng records, and the timel y prepar at i on of
reliabl e financi al infor mat i on.
Control en0i ronme nt means the o"er all attit ude, awar enes s and
actions of direct or s and manage me nt regar di ng the int ernal cont rol
syst e m and its import ance to the entit y. It encompa s s e s manage me nt
styl e, corpor at e cult ur e, "alues, philosophy and oper at i ng styl e, the
organi :at i onal struct ur e, personnel policies and procedur es.
2ersonnel policies and procedur es, for exampl e, would include those
co"eri ng recrui t ment , ret ent i on and dismi ss al . The organi:at i onal
struct ur e shoul d ha"e clear lines of reporti ng responsi bilit y and the
mai nt ena nc e of an int er nal audi t function and audi t commi t t e e
demons t r at es a commi t me nt to high le"el cont rol s. The use of
manage me nt account s for the purpos e of "ari ance anal ysi s is also a high
le"el cont rol.
The cont rol en"ironment pro"ides a backgr ound to det ail ed cont rol
procedur es. It does not itself, of course, ensur e the effecti"enes s of the
int ernal cont rol syst e m as a whol e.
1ontrol procedur es are those est abli shed to achi e"e the entit y?s specific
obDecti"es. These obDecti"es in an account i ng cont ext include the proper
aut hori:at i on, timel y and accur at e recor di ng of transact i ons in the
correct period, the safeguar di ng of asset s and ensuri ng he exist ence of
asset s recorded. They include particul ar procedur es to pre"ent , det ect
and correct errors. They differ from entit y to entit y and are affect ed by
the si:e of the entit y.
In practi ce, the choice of cont rol s may reflect a compari son of the cost of
oper at i ng indi"idual cont rol s agai nst the benefit s expect ed to be deri"ed
from them.
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,any of the int ernal cont rol s which woul d be rele"ant to the larger
ent er pri se are not practi cal, appropri at e or neces s ar y in the small
ent er pri se. ,anage me nt of small ent er pri ses ha"e less need to depend
on formal int er nal cont rol s for the reliability of the records and other
infor mat i on becaus e of their personal cont act with or in"ol"eme nt in the
oper at i on of the ent er pri se itself.
#t its si mpl est , compani es need int er nal cont rol s to stop things going
mi ssi ng and to make some sense of how the busines s is doing.
/ocument s get lost and asset s go home with the st aff e"en wher e ther e
are cont rol s in place to record e"er yt hi ng. ,anager s ha"e a gut feeling
for how the busi ness is doing, but when all they ha"e to pro"e it is three
large boxes stuffed full of in"oices and two large boxes full of expens es
Aand neit her of thes e are quit e compl et eB, they may find it difficult to
pro"e their ideas to the taxati on aut hori ti es and of course they may well
be "ery wrong.
/ocument s are bat ched and prenumber ed so that one can check they
are all ther e. If some sal e in"oices ha"e gone missi ng we may not be
collecti ng what is owed to us. This means that our cash flow suffers and
we cannot pay our debt s. It also means that our financi al st at e me nt s
may be wrong. If our financi al st at e me nt s under st at e our income we will
find it mor e difficult to obt ai n finance from the bank and if we are a list ed
company, we will appear less att r act i "e to in"est or s. If our purchas e
in"oices go missi ng, or if we do not mat ch goods recei"ed not es to
in"oices at the period end in order to arri"e at a goods recei "ed not
in"oiced figure, mat t er s are e"en worse. We think we are maki ng good
profits but we are not. We spend money that is owing to payabl es and
when they present their final demands we ha"e no cash and they
threat en to put us into liquidati on. )usiness goodwill is damage d. We
then ha"e to adDust profit s downwar ds and we are accus ed of misl eadi ng
the bank about our profit s in order to obt ai n finance.
)ut what if the amount s in"ol"ed are smallR /oes one in"oice really
mat t er R -xperi ence shows that if one in"oice has gone mi ssi ng it is
highly likely that se"er al mor e are also missi ng, and the larger the
organi :at i on get s, the bigger the number s get and the tight er the
cont rol s ha"e to be to pre"ent significant errors.
Why so many aut hori:ati on cont rol sR In order to allocat e responsi bility
and deal with e"eryday probl ems . If fifteen peopl e are in"ol"ed in the
proces si ng of one in"oice and somet hi ng is badl y wrong with it, ther e has
to be a mechani s m to show that the error occurr ed at a particul ar st age.
If we do not do this, errors conti nue to happen, no- one takes
responsi bility and the organi:at i on get s a reput at i on for inadequat e
admi ni st r at i on and inefficiency, and frauds become possi bl e. !ay for
exampl e, a clerk routi nel y aut hori:es a false purchas e in"oice raised by
friend out si de the company. The company pays the in"oice and the clerk
and his friend shar e the proceeds. This is a "ery common type of fraud.
1ontrol s to pre"ent this requir e payme nt s to be aut hori:ed only with
refer ence to purchas e in"oices that are att ached to goods recei"ed
not es, or aut hori:ati ons for the recei pt of ser"ices by manger s
compl et el y unconnect ed with the account i ng function.
A&*I"IN-
DD Account i ng and
I!# %44 st at es that int ernal cont rol s within an account i ng syst e m are
need to ensur e that :
(. Transact i ons are execut ed in accor dance with gener al or specific
aut hori t y
$. #ll trans act i ons are recorded at the correct amount in the correct
account in the proper period so as to per mi t the prepar at i on of
financi al st at e me nt s .
*. #ccess to asset s and records is aut hori:ed
%. 8ecorded asset s are compar ed with existing asset s periodically
and appropri at e action is taken with regar ds to differences.
3hy int ernal control int ere s t s the ext ernal audi t or
#t an earl y st age in his work the audi t or will ha"e to deci de he ext ent to
which he wishes to place reliance on the int er nal cont rol s of the
ent er pri se. #s the audi t proceeds, that deci sion will be kept under
re"iew and dependi ng n the resul t s of his exami nat i on he may deci de to
place mor e or less reliance on thes e cont rol s.
The principal reason why int ernal cont rol int er est s the audit or is that the
reliance on int ernal cont rol will reduce the amount of subst ant i "e testi ng
of trans act i ons and resul t ant bal ances in the ledger account s required.
The oper at i on of int ernal cont rol s shoul d ensur e the compl et ene s s and
accur acy of the account i ng records. If the audi t or is satisfied that the
int ernal cont rol syst e m is functioni ng, ther e is ther efor e a reduced risk of
error in the account i ng records.
It is "ery import ant to the audi t or ther efor e to est abli sh what int ernal
cont rol syst e m exist s and then to test that syst e m to ensur e that it is
working properl y.
#nother reason that the audit or needs to consi der the adequacy of the
account i ng syst e m is that the audit or usually has an additional
responsi bility under legisl ation to form an opinion as to whet her proper
account i ng records ha"e been kept . This implies the oper at i on of a
sound syst e m of int ernal cont rol.
)y recor di ng the account i ng syst e m and checki ng its oper at i on by test s
of cont rol, the audi t or can reduce the amount of subst ant i "e procedur es.
The tot al amount of work is reduced as a result .
S1eci i c control 1rocedur e s
These include:
(. 8eporti ng, re"iewi ng and appro"i ng reconciliations.
$. 1hecking the arit hmet i cal accur acy of the recor ds
!uch cont rol s include checki ng the cash in a purchas e in"oice, and
recal cul ati ng the sal es tax on sal es in"oices
*. 1ontrolling applicati ons and the en"ironme nt of comput er
infor mat i on
These are deal t with lat er in the text
%. ,aint ai ni ng and re"iewi ng cont rol account s and trial bal ances
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1ontrol account s include recei"abl es and payabl es ledger cont rol
account s, bank reconciliations and non- current asset regist er s.
5. #ppro"al and cont rol of docume nt s.
In a purchas e syst e m for exampl e, ther e shoul d be present
aut hori t y limits. #n order to the "alue of U(, 444 could be
appro"ed by a depar t me nt head, up to U5, 444 by anyone direct or,
and beyond this by the )oard as a whol e.
&. 1ompari ng int ernal dat a with ext er nal sources of infor mat i on.
This might include suppli er st at e me nt reconciliations.
K. 1ompari ng the result s of cash, securit y and in"ent or y count s with
the account i ng records
9. 0imiting direct physi cal access to asset s and records
#n import ant gener al principl e with respect to asset s and records
is that of segr egat i on. In particul ar ther e shoul d be a di"ision of
responsi bilities for:
AiB #uthori:ing or initiating the trans act i on
AiiB The physical cust ody and cont rol of asset s in"ol"ed
AiiiB 8ecordi ng the transact i on
o one person shoul d be in a position bot h to mi sappr opri at e an
asset and to conceal his act by falsifying the records. 7or
exampl e, in a sal es syst e m the duti es of recei"i ng money from
cust omer s and writing up the sal es ledger shoul d be separ at ed. If
not, money could be mi sappr opri at ed and the records falsified to
co"er this.
'. 1ompari ng and anal y:i ng the financi al result s with budget ed
amount s.
"he control en0i ronme nt
#uditors need to consi der the cont rol en"ironme nt of the client as it
pro"ides the backgr ound agai nst which the "arious other cont rol s are
oper at ed. =owe"er a strong cont rol en"ironment does not, by itself,
ensur e the effecti"enes s of the o"er all int er nal cont rol syst e m. 7act or s
reflect ed in the cont rol en"ironme nt include the following:
The philosophy and oper at i ng st yl e of the direct or s and
manage me nt
The entit y?s organi :ati onal struct ur e and met hods of assi gni ng
aut hori t y and responsi bility Aincludi ng segr egat i on of duti es and
super "i sor y cont rol sB
The direct or s? met hods of imposi ng cont rol, includi ng the int ernal
audi t function, the functions of the board of direct or s and
personnel policies and procedur es.
&nders t andi ng the syst e m
#s we ha"e seen befor e, I!# %44 requir es that audi t ors obt ai n and
document an under st andi ng of the account i ng syst e m and cont rol
en"ironment sufficient to det er mi ne their audit approach, whet her that
be a syst e ms based approach, or a subst ant i "e approach. It also helps
with the asses s me nt of inher ent and cont rol risk. If cont rol risk is to be
asses s ed as less than high, the Dustificati on for that asses s me nt must be
document e d.
A&*I"IN-
<5 Account i ng and
This under st andi ng can be updat ed year on year and audi t ors oft en
perfor m Vwalk through? test s, to ensur e that their under st andi ng and
document a t i on of the syst e m are correct . This si mpl y in"ol"es taking a
trans act i on through the syst e m from source to desti nat i on and can oft en
Vdoubl e? as a test of cont rol and as a subst ant i "e procedur e, dependi ng
on which element s of the trans act i ons are checked. !uch test s are
particul arl y useful wher e the audi t or is relying on the client?s
document a t i on of the syst e m.
+ro1er Account i ng #ecords
8eme mber that most compani es are under a legal obligation to keep
proper account i ng records and that audit ors are requir ed to form an
opinion as to whet her they ha"e done so. ,ost national laws require that
the account i ng records must be sufficient to show and expl ai n the
company trans act i ons and must be such as to:
AaB /isclose with reasonabl e accur acy, at any ti me, the financi al
position of the company at that time, and
AbB -nabl e the direct or s to ensur e that any bal ance sheet and income
st at e me nt compl y with the requir eme nt s of the legisl ati on as to
their form, cont ent s and otherwi se.
ational legisl ati on often prescri bes specific books and account s that
must be kept . In count ri es with a 1i"il 1ode legal tradi tion, it is common
to ha"e a V1hart of #ccount s? that all compani es are requir ed to mai nt ai n
in some form. There is also det ail ed guidance on what type of
trans act i ons shoul d be post ed to the "arious account s. 1ommon 0aw
tradi tion count ri es such as the <., the <!, 1anada and #ustrali a do not
ha"e chart s of account s. They are of course required to prepar e
account s in accor dance with specific format s laid down in legisl ati on and
account i ng st andar ds. I#! ( 2resent at i on of 7inanci al !t at e me nt s
cont ai ns pro- formas for the bal ance sheet and income st at e me nt of
financi al st at e me nt prepar ed under I#!s.
Ade@uac y o the account i ng syst e m
#n account i ng syst e m shoul d pro"ide for the orderl y asse mbl y of
account i ng infor mat i on and appropri at e anal ys es to enabl e financi al
st at e me nt s to be prepar ed. What consti t ut es an adequat e account i ng
syst e m will depend on the si:e, nat ur e and compl exi t y of the ent er pri se.
In its si mpl est form for a small busi ness dealing pri marily with cash sal es
and with only a few suppli ers the account i ng syst e m may only need to
consi st of an anal y:ed cash book and a list of unpai d in"oices. In
cont r ast , a company manuf act uri ng se"er al different product s and
oper at i ng through a number of disper s ed locations may need a compl ex
account i ng syst e m to enabl e infor mat i on required for financi al
st at e me nt s to be asse mbl ed.
*ocume nt i ng the syst e m
The "arious met hods of ascer t ai ni ng and recordi ng the syst e m may be
summari :ed as follows:
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Ascert ai ni ng #ecordi ng
AaB -xami ni ng pre"ious audi t work AaB arrati "e not es
AbB 1lient?s own docume nt at i on of the syst e m AbB
+rgani:ati on chart
AcB Int er"i ews with client?s st aff AcB Int ernal cont rol
questi onnai r es
AdB Tracing trans act i ons AI13sB or
checklist s
AeB -xami ni ng client?s docume nt s AdB 7lowchar t s
AfB +bser"at i on of client?s procedur es
Qou shoul d be familiar with these met hods of ascer t ai nme nt and
recordi ng from pre"ious st udi es.
#eli anc e on Internal Control s
0imit ations on the effecti"enes s of int ernal cont rol s
#s we ha"e seen, it is possi bl e to reduce the "olume of subst ant i "e
procedur es requir ed but not to eli mi nat e the requireme nt altoget her .
This is becaus e all syst e ms ha"e inher ent limit ati ons such as:
The need to bal ance the cost of the cont rol with its benefit s
The fact that int ernal cont rol s are appli ed to syst e ma t i c
trans act i ons, not one of year end adDust me nt s, which are often
large and subD ect to error.
The pot ent i al for human error
The possi bility of circum"ent i on of int ernal cont rol s through the
collusion of manager s or empl oyees with other parti es inside or
out si de the entit y.
The super"i sor responsi bl e for checki ng and aut hori:ing
o"erti me clai ms could collude with empl oyees , to enabl e
excess o"erti me payment s to be clai med for exampl e.
The abuse of aut hori t y and o"erride of cont rol s
#buse of aut hori t y might in"ol"e orderi ng personal goods
through the firm. It is "ery easy for direct or s and manager s of
organi :at i ons of any si:e to instruct st aff to bypass nor mal
procedur es such as the requireme nt for aut hori:at i on for
payment s .
The obsol escence of cont rol s
Control o,H ect i 0e s ? 1roce dur e s ? and tes t o control
It is not practi cal to go into det ail about the exact reason for e"ery
cont rol that is commonl y used. #s you go through this secti on, try and
think of reasons why the cont rol is in oper at i on, think about what might
happen if the cont rol were not ther e, what asset s could be lost, what
records would be incorrect and how the busines s would be damage d or
made inefficient and unprofit abl e.
Qou must distingui sh carefully bet ween cont rol obDecti"es, cont rol
procedur es Abot h of which are the responsi bility of the clientB and test s of
cont rol Awhich are the responsi bility of the audi t orB. They are not the
same thingL
A&*I"IN-
<6 Account i ng and
Control %,Hecti 0e s
8eme mber that cont rol obDecti"es for all syst e ms are, in outline, as
follows
AaB That only aut hori:ed trans act i ons are prompt l y recorded at the
correct amount is the
appropri at e account s in the proper account i ng period,
AbB That acces s to asset s is only in accor dance with proper
aut hori:at i on and
AcB That recor ded asset s are compar ed with existi ng asset s.
Control +roce dur e s
/et ail ed cont rol procedur es are often si milar across sal es, purchas es and
other areas and include, for exampl e@
!equent i al numberi ng of document s with subs eque nt checki ng
of the sequence for compl et enes s
The mai nt ena nc e of bat ch and other cont rol tot al s at the input
st age with subseque nt checki ng to out put for compl et enes s
and accur acy
The mai nt ena nc e of cont rol account s which are checked to
ensur e that they reconcil e to the ledger s
#uthori:ati on, e"idenced by the signat ur e of responsi bl e
officials? for the raising, input and distributi on of docume nt s.
"est s o control
Test s of cont rol Aalso known as compli ance test sB by the audit or in"ol"e
audi t or s ensuri ng that the procedur es abo"e ha"e been applied, by
looking for e"idence of, for exampl e, the checki ng of sequence s, and
creat i on of bat ch tot al s, cont rol account reconciliations and
aut hori:at i on. +ften the audit or is si mpl y looking for a signat ur e, to
show that the cont rol procedur e has been perfor med. =e will also
somet i mes reperfor m the cont rol by, for exampl e, checki ng that the
reconciliation has been perfor med correctl y or checki ng that all of the
document s within a sequence are act ually ther e, with no omi ssi ons or
duplicati ons, in order to pro"e to hi mself that the cont rol has act uall y
been perfor med, rat her than the document si mpl y ha"i ng been signed.
8eperfor mance of a cont rol procedur e will often also ser"e as a
subst ant i "e procedur e.
"he #e0enue ? ex1e ndi t ur e and other cycl e s a11roac h
# tradi tional approach to audi ti ng is the di"ision of trans act i on
proces si ng into cycl es. -xampl es of cycl es include sal es and recei"abl es
cycl e, purchas es and payabl es cycl e, wages and sal ari es cycl e, pet t y
cash cycle, the in"ent ori es recordi ng cycl e and the con"er si on cycle for a
manuf act ur er . -ach cycle recei "ed has its own section of the audit
progr amme and the audi t team would nor mall y be di"ided into sub
groups and allocat ed a particul ar cycl e.
The rational e behi nd this met hod is that for each cycl e the dat a capt ur e,
proces si ng and out put and the int er nal cont rol s, will be specific. In turn
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the nat ur e and le"el of testi ng for each cycle can be planned accordi ngl y.
The met hod effecti"el y encompa s s e s all the items in a set of financi al
st at e me nt s except one- off trans act i ons. 7or exampl e the sal es and
recei "abl es cycl e incorpor at ed turno"er, its anal yst s into segme nt s,
recei "abl es and relat ed writ e offs and pro"isions.
<sed in isolation this approach is now seen as unneces s aril y det ail ed and
hence top expensi "e.
#s exampl es of the cycl e approach we shall consi der the sal es and
recei "abl es and the purchas es and payabl es cycl es.
Sal es and #ecei 0a,l e s Cycl e
Control %,Hecti 0e s
=ow do the cont rol@ obD ecti"es not ed abo"e transl at e into Vreal life?
obDecti"es for sal esR
7or many busi ness es , sal es are made on credit and thus the sal es cycl e
includes cont rol obDecti"es for recei"abl es. These cont rol obDecti"es
include:
1ust omer s? order s shoul d be aut hori:ed, cont roll ed and recor ded
in order to execut e them prompt l y and det er mi ne any allowance
required for losses arising from unfulfilled commi t me nt s .
Hoods shipped and work compl et ed shoul d be cont roll ed to ensur e
that in"oices are issued and re"enue recorded for all sal es.
Hoods ret ur ned and clai ms by cust omer s shoul d be cont roll ed in
order to det er mi ne the liability for goods ret ur ned and clai ms
recei "ed but not ent er ed in the account i ng records.
In"oices and credit s shoul d be appropri at el y checked as being
accur at e and aut hori:ed befor e being ent er ed in the account i ng
records
6alidat ed recei "abl es trans act i ons, and only those transact i ons,
shoul d be accur at el y ent er ed in the account i ng records.
There shoul d be procedur es to ensur e that sal es in"oices are
subseque nt l y paid and that doubtful amount s are identified in
order to det er mi ne any allowances requir ed.
Achi e0e me nt o %,Hect i 0e s
In order to achi e"e these obDecti"es ther e shoul d be good segr egat i on of
duti es. There are three distinct proces s es in the sal es syst e m which
shoul d be segr egat ed and perfor med by different st aff in order to
est abli sh effecti"e int ernal cont rol s. They are:
Accepti ng !ust omer s' Orders : !equence- cont rolled docume nt s
shoul d be used to acknowl edge all order s recei"ed. #ny
uncompl et ed order s shoul d be regul arl y re"iewed.
1redit limits shoul d be checked by the credit cont rol
depar t me nt . !elling prices, speci al discount s and deli"ery
dat es shoul d be fixed by seni or member s of the depar t me nt P
ne"er by the account s st aff.
(espat c& depart me nt : !equence- cont roll ed document s shoul d
be used Agoods out war ds or dispat ch not esB for all goods
lea"i ng the premi ses. These shoul d be compl et ed by the
A&*I"IN-
<; Account i ng and
gat ekee per or the dispat ch depar t me nt Pne"er by the account s
st aff.
Invoicing t&e goods : !equence cont roll ed in"oices shoul d be
raised by the sal es depar t me nt and then passed to the
account s depar t me nt for recordi ng. Independe nt checks
shoul d be made to ensur e that in"oices ha"e been raised for all
goods out war ds not es.
In addition strict cont rol of credi t not es is essent i al to ensur e that they
are raised by proper aut hori t y in the sal es depar t me nt agai nst goods
recei "ed not es. It is not uncommon for credit not es to be raised to Vhide?
what are in fact bad debt s or to conceal theft of cash recei pt s. 1redit
not es can also be used to cancel out fictitious sal es in"oices which ha"e
been raised in order to boost sal es figures artificially.
Control 1rocedur e s o0er sal es and recei 0a,l e s
There are a large number of cont rol s that may be requir ed in the sal es
cycl e due to the import ance of this area in any busines s and the possi bl e
opport uni ti es that exist for di"erti ng sal es away from the busines s and
other persons benefiting.
(a) %rders
The order s shoul d be checked agai nst the cust omer?s account @ this
shoul d be e"idenced by initialing. #ny new cust omer shoul d be
referr ed to the credit cont rol depar t me nt before the order is
accept ed.
-xisting cust omer s shoul d be allocat ed to a credi t limit and it
shoul d be ascer t ai ned whet her this limit is to be exceede d if the
new order is accept ed. If so the mat t er shoul d be referr ed to credit
cont rol.
#ll order s recei"ed shoul d be recorded on prenumber ed sal es
order document s .
#ll order s shoul d be aut hori:ed before any goods are dispat ched
The sal es order shoul d be used to produce a despat ch not e for the
goods out war ds depar t me nt . o goods may be dispat ched
without a dispat ch not e.
(,) *es 1at c h
/espat ch not es shoul d be prenumber ed and a regi st er kept of
them to relat e to sal es in"oices and order s
Hoods dispat ch not es shoul d be aut hori:ed as goods lea"e and
checked periodically to ensur e they are compl et e and that all ha"e
been in"oiced.
(c) In0oi ci ng and credi t not e s
!ales in"oices shoul d be aut hori:ed by a responsi bl e official and
refer enced to the original aut hori:ed order and dispat ch not e.
#ll in"oices and credi t not es shoul d be ent er ed in sal es day book
records, the account s recei"abl e ledger, and account s recei"abl e
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ledger cont rol account . )atch tot al s shoul d be mai nt ai ned for his
purpos e.
!ales in"oices and credit not es shoul d be checked for prices, cost s
and calcul ati ons by a person other than one prepari ng the in"oice.
#ll in"oices and credit not es shoul d be seri ally prenumber ed and
regul ar sequence checks shoul d be carri ed out.
1redit not es shoul d be aut hori:ed by someone unconnect ed with
despat ch or account s recei"abl e ledger functions.
1opies of cancell ed in"oices shoul d be ret ai ned.
#ny in"oices cancell ati on shoul d lead to a cancell ati on of the
appropri at e despat ch not e.
1ancell ed and free of charge in"oices shoul d be signed by a
responsi bl e official.
-ach in"oice shoul d distingui sh bet ween different types of sal es
and nay sal es taxes. #ny coding of in"oices shoul d be periodically
checked independent l y.
(d) #eturns
AiB #ny goods ret urned by the cust omer shoul d be checked for
ob"ious damage and, when accept ed, a document shoul d be
raised.
AiiB #ll goods ret urned shoul d be used to prepar e appropri at e
credi t not es.
(e) #ecei 0a,l e s
AiB # recei"abl es ledger cont rol account shoul d be prepar ed
regul arl y and checked to indi"idual sal es ledger bal ances by
an independe nt official.
AiiB 8ecei"abl es ledger personnel shoul d be independe nt of
despat ch and cash recei pt functions
AiiiB !t at e me nt s shoul d be sent regul arl y to cust omer s.
A&*I"IN-
<: Account i ng and
E&ES"I%N %NE
1omput er securit y is of "ital import ance not only to the account ant in
indust ry but also to the account ant in practice who may be ad"ising his
client as to suit abl e securit y controls or who may be auditing a comput er
syst em. !ecurity is the means by which losses are controlled and
ther efor e in"ol"es the identification of risks and the institution of
meas ur es to either pre"ent such risks entirely or to reduce their impact .
AaB !tat e four areas of risk which may arise in relation to a
comput er syst em and in each case explain one factor which
could lead to the syst em being exposed to such risk.
AbB /escribe the different forms of control which should be
institut ed to safeguar d agai nst comput er securit y risks.
E&ES"I%N "3%
When auditing informati on produced by -/2 equipment , it is necess ar y to
take into account the checks and controls built into the syst em itself. In
connecti on with routine processi ng, expl ain how each of the following
constit ut es an import ant control:
AaB 2arity check@
AbB 7ile prot ection ring@
AcB Tape labelling@
AdB 8ecord count @
AeB 1ontrol tot al.
E&ES"I%N "$#EE
Internal control is defined in the Internati onal !tandar ds on #uditing
AI!# %44B as:
OThe whole syst em of controls, financi al and otherwi se, est ablished
by the manage me nt in order to:
i. 1arry on the business of the ent er pri se in an orderly and
efficient manner
ii. -nsure adher ence to manage me nt policies
iii. !afeguar d the asset s, and
i". !ecur e as far as possi bl e the compet ence and accuracy of the
recordsO.
#e@ui red
In respect of manage me nt obDecti"es AiB to Ai"B abo"e, explain their
meani ng and the rele"ance of each to the auditor gi"ing an opinion on
financi al st at eme nt s.
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E&ES"I%N 7%&#
#udit risk is a combi nati on of the risk that the financi al stat e ment s being
audit ed may cont ai n mat eri al errors and that these errors may not be
det ect ed by the auditorJ s testi ng procedur es. 8isk can be cat egori sed as
>nor mal riskJ or >higher than nor mal riskJ , and is e"aluat ed during the
planni ng stage of an audit. The auditor shoul d de"ot e att enti on to the
critical areas of the financi al st at eme nt s by consideri ng and e"aluati ng
mat eri alit y and risks specific to the company. ,ateriality limits should be
set at the planni ng stage of the audit to act as a guideline for deciding
whet her adDust ment shoul d be made to the financi al st at eme nt s.
AaB )riefly describe what you underst and by the ter ms >inher ent
risk,J >cont rol riskJ and >det ecti on riskJ .
AbB 0ist the factors which the audit or would bear in mind when
assessi ng the audit risk of a company.
Qou should set out your answer under the headi ngs >inher ent
riskJ and >cont rol riskJ .
AcB /iscuss the consider at i ons which would det er mi ne whet her an
item was mat eri al in relation to the financi al stat e me nt s.
AdB /iscuss the "alidity of the stat e ment that mat eri ality limits
should be set at the planning stage of the audit and should be
rigidly adher ed to throughout the audit.
E&ES"I%N 7I'E
OThere are those who put forward the theory that an auditor should not in
any circumst ances become in"ol"ed, e"en as an ad"iser, in the
manage me nt function of decision- maki ng within a business. I do not
subscribe to this "iew, and indeed in my opinion it is the audit orsJ duty to
point out weaknes s es, to offer const ructi"e ad"ice, and to help the
business in e"ery possi bl e way that he canO.
/iscuss this stat e me nt . (65 !arks)
o the Study +ack
A&*I"IN-
<D Account i ng and
C%!+#E$ENSI'E ASSI-N!EN" N%/ .
"% BE S&B!I""E* A7"E# 2ESS%N 6
"o ,e carri ed out under exami nat i on condi t i ons and sent to the
*ist anc e 2earni ng Admi ni s t rat i on or marki ng ,y the &ni 0ersi t y/
E9A!INA"I%N +A+E#B "I!E A22%3E*B 4 $#S/ ANS3E# A22
E&ES"I%NS/
Answer A22 Eues t i ons "ime AllowedB 4 $ours
E&ES"I%N %NE
The audi t or s of !treet wi se ha"e recentl y been dismi ssed by the
company. The direct or s of !treet wi se ha"e approached you to act as
their audi t or s and ha"e st at ed that they are prepar ed to pay U(44, 444 as
an audi t fee. 2lus a bonus f (T of the profits aft er taxati on. The
company manuf act ur es and ret ails window frames. The direct or s ha"e a
poor reput at i on as regar ds empl oyee welfare and ther e is a "ery high
turno"er of empl oyees . # go"er nme nt depar t me nt has pre"iousl y
in"esti gat ed the busines s practi ces adopt ed by the company but no
action was subs eque nt l y taken agai nst the direct or s or the company.
#e@ui re d
AaB /escri be the st eps the audit or must take before deciding whet her to
accept the nomi nat i on as audi t or.
A9 marksB
AbB !tat e with reasons, whet her the audit or may accept the met hod of
remuner at i on as propos ed by the direct or s
A5 marksB
AcB 1omment on the "iew that wher e the audi t fee is fixed by the
negoti ati on bet ween the direct or s and the audi t or, the confidence of
the shar ehol der s in the independe nc e of the audi t or may be affect ed.
AK marksB
("ot al B 65
marks )
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on "wo
<<
E&ES"I%N "3%
Qour firm of 1ertified #ccount ant s, in common with many other firms of
account ant s and audi t or s, issues to its st aff an audi t manual which
cont ai ns, amongs t other mat t er s, recomme nde d procedur es to be
adopt ed in carryi ng out audi t s. # number of these recomme nde d
procedur es relat e to physi cal obser"at i on of stock count s and re"iew of
stockt aki ng instructi ons. +wing to pressur e of work, you negl ect ed to
arrange for the physical obser"at i on of stocks at the premi ses of
0ees moor 0imit ed at *( ,arch $44*, but your re"iew of stockt aki ng
instructi ons indicat ed that company procedur es appear ed to be in order.
Qou deci ded to accept the amount at which stock was st at ed in the
financi al st at e me nt s at *( ,arch $44* on the grounds that :
i. The stockt aki ng instructions appear ed to be satisfact ory@
ii. o problems had arisen in det er mi ni ng physical stock quanti ti es
in pre"ious years@ and
iii. The figures in the financi al stat e me nt s gener ally >made senseJ .
Qou issued your unqualified audit report on $9 ,ay $44* and
unbeknown to you 0eesmoor used the financi al stat e ment s and the
audit report for the purpose of obt aining mat eri al additional finance
from a third part y in the form of an unsecur ed long- ter m loan.
<nfortunat el y, in +ctober $44* the company ran into financi al
difficulties and was forced into liquidation as a result of which the
long- ter m loan holder lost the amount of his loan. /uring the
liquidation proceedi ngs it became clear that stock quanti ti es at *(
,arch $44* had been consider abl y o"erst at ed.
#e@ui red
AaB -xplain the probabl e legal position of your firm in respect of the
abo"e mat t er comment i ng specifically on the following:
i. The possi bility of demonst r at i ng your firm were negligent @
ii. The fact that the stocks figure in the financi al st at eme nt s
appar ent l y >made senseJ @
iii. The fact that you were not informed that the financi al
st at eme nt s and your audit report were to be used to
obt ain additional finance.

A(% ,arksB
AbB /escribe the reasonabl e st eps your firm shoul d take to a"oid a
recurr ence of a mat t er such as that described abo"e.
A& ,arksB
("ot al B 65 marks )
A&*I"IN-
.55 Account i ng and
E&ES"I%N "$#EE
7oolhardy 0imited, a small merchandi si ng company, acquired a hard- disk
microcomput er syst em, and purchas ed a standar d spreads he et package in
order to mai nt ai n its financi al records. The financi al controller of the
company const ruct ed, by using this package, a seri es of comput er model s
in order to record the basic accounti ng transacti ons of the business, but
did not incorpor at e any accounti ng controls within these model s. The
nomi nal ledger, cash book and sales and debt ors ledger s were all
maint ai ned by means of the spreadshe et syst em. The direct ors of the
company were quit e impress ed by the speed and flexibility of the new
accounti ng syst em.
The audit ors of 7oolhardy 0imited, during their final audit, were not at all
impress ed by the new accounti ng syst em and when they commenced
their audit test s they found discrepanci es in the debt or and bank balances.
7or exampl e, the debt ors circularisation seemed to indicat e that the
financi al controller had not recorded all of the cash recei"ed from debt ors,
and the bank st at eme nt balance could not be reconciled to the balance in
the comput eri sed cash book. It appear ed to the audit ors that the financi al
controller had been defraudi ng the company and they are now considering
their next course of action.
AaB -xplain the actions which the auditor should take if, as indicat ed
abo"e, during the course of his work he obt ains informati on
which indicat es the possi bility of irregul ariti es in the financi al
records of 7oolhardy 0imited. AK ,arksB
AbB -xplain the reasons why the spreads heet package should not
ha"e been used to mai nt ai n the financi al records of 7oolhardy
0imited. AK ,arksB
AcB 0ist the ways in which a spreads heet package could assist the
manage me nt of 7oolhardy 0imited to impro"e the flow of
accounti ng informati on within the business.
A& ,arksB

("ot al B 65 !arks)
E&ES"I%N 7%&#
. The proliferation of #ccounti ng !tandar ds and the introduction of
#uditing !tandar ds and Huidelines ha"e reduced the function of
auditing to a mer e application of technical skills to the detri ment of
professi onal Dudgement .
/iscuss.
("ot al B 65 !arks)
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on "wo
.5.
E&ES"I%N 7I'E
AaB !ummari se the pro"isions of the Internati onal !tandar d on #uditing
with regard to the
responsi bility of det ecti ng fraud and error.
AK ,arksB
AbB /iscuss the "arious factors which an audit or should consider when
appr ai si ng the risk of
mat eri al error and fraud during an audit.
A9 ,arksB
AcB While carrying out an audit, an auditor may somet i mes
encount er circumst ances
that cause him to suspect or confirm that fraud or error has
occurred.
#e@ui redB +utline the action which the auditor should take in such
a case. A5 ,arksB

("ot al B 65 !arks)
End o Com1rehe ns i 0e Assi gnme nt No/ .
Now Send (our Answer s to the *i st anc e 2earni ng
Centre or !arki ng
A&*I"IN-
.56 " he Audi t +roc e s s B +l anni ng
and @ual i t y Control
2ESS%N "$#EE
"he Audit +rocessB +lanning and Euality Control
%B=EC"I'ES
2lan and Dustify audit strat egy
/iscuss and apply the concept of mat eri ality and audit risk to the
audit process
-xplain how personal comput er s can help audit ors In their work
/iscuss and explain the speci al problems of auditing wher e a client
has a 1omput eri sed
!yst em.
C%N"EN"S
!tages of a moder n audit
/efinition of planni ng
The need for audit planni ng
8isk #ssess ment and ,anageme nt
#udit #pproaches
3uality 1ontrol in 2ractice ,anageme nt
The concept of mat eri alit y in audit planning
INS"#&C"I%NS
#ssigned 8eadi ng:
I!#s
($4 7ramewor k of I!#s
$44 +bDecti"e and Hener al 2rincipl es Ho"erni ng an #udit of
$$4 3ualit y cont rol for #udit Work
$*4 /ocument at i on
$54 1onsider at i on of 0aws and 8egul ati ons in an #udit of
*44 2lanni ng Afull title on the new I!#B
*$4 #udit mat eri alit y
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on "hree
.54
*.( The Stage s o a !odern Audi t
The mai n feat ur es of an audit are as follows, with a brief not e on the
procedur es to use:
i/ Ascert ai nme nt of the nat ur e and constit ution of the client J s
business and how it is carried on. 2rocedur es would include
"isits to the client J s premi ses, discussions with officers, study of
document s such as past account s, prospect us es, audit files, etc.
ii. +lanni ng and su,s e @u e nt l y control l i ng the audi t .
2rocedur es would include prepar ati on of an Oaudit
memor andumO set ting out work to be done and timing and st aff
requirement s. # preli minary re"iew of the client J s manage me nt
account s and pre"ious audit files would also ha"e been
required.
iii. Ascert ai ni ng? e0al uat i ng and tes t i ng the cli entK s
account i ng syst e ms and int ernal control s . There are
se"er al ways of dealing with this. # moder n way is to ascert ai n
by asking >grass root sJ st aff@ recordi ng the fact s by means of
flow chart s etc. and e"aluati ng by the use of the >keyJ questi ons
and criteri a questi ons using a hypot het i cal or nor mat i "e model
of the appropri at e syst ems.
i". Carryi ng out test s on the syst e ms to det er mi ne i they
are e ect i 0e and are consi s t e nt l y a11li ed at all rel e0ant
ti me s . This is done by means of OcomplianceO test s prefer abl y
operat ed on a st ati stically "alid basis.
". 'eriyi ng the exi st e nc e ? titl e and amount s incl ude d in
the ,al anc e she e t in res1e c t o ass e t s ? lia,ili ti e s and
ca1i t al / This is done by a "ariet y of means including
assess me nt of internal control procedur es and by means of
Osubst ant i "eO test s which gi"e direct e"idence of the items to
the audit or, e.g. bank lett er, and debt or s circularisation.
"i. Checki ng the inanci al st at e me nt wi th the account i ng
records . This is a requirement of the Kth !chedul e of the
1ompani es #ct and is achie"ed by simply making such a
compari son.
"ii. Exami ni ng the income st at e me nt to conirm that it
rel ect s the resul t s o the o1erat i ons o the ent er1ri s e /
This is achi e"ed by assess me nt of internal control procedur es
and the quality of the records, by seeki ng direct e"idence, and
by seeki ng out and probing anomali es or differences from
expect ati ons.
"iii. Exami ni ng the inanci al st at e me nt s or con or mi t y wi th
acce1t a,l e account i ng 1racti c e s and or com1l i anc e wi th
legal and ot her di scl os ur e re@ui re me nt s . This is achie"ed
by the use of check lists.
ix. Consi deri ng the inanci al stat e me nt s as a whol e and
re0i e wi ng the audi t work and concl us i ons drawn there
rom in order to det er mi ne whet her such st at e me nt s
gi 0e a true and air 0i ew . This is achie"ed by a re"iew
conduct ed by experi enced personnel consideri ng the audit
working paper s, any re"eal ed anomali es and any uncert ai nti es
and any disagr ee me nt s with direct ors or other parti es
responsi bl e for the prepar ati on of the account s.
A&*I"IN-
.5; " he Audi t +roc e s s B +l anni ng
x. "he drati ng o an audi t orK s re1ort gi 0i ng the audi t orK s
o1i ni on on the trut h and airne s s and com1l i anc e wi th
st at ut e o the account s . The wording of the report will
depend on the conclusion drawn by the auditor from his audit,
and the report may be qualified or unqualified.
4/ 6 Introduct i on to +l anni ng
The primary obDecti"e of an audit is the expressi on of an expert and
independent opinion on the trut h and fairness of the informati on cont ai ned
in the annual financi al stat e ment s express ed in the audit report and the
ascert ai nment and e"aluati on of the accounti ng syst ems as the basis for
the prepar at i on of financi al st at eme nt s.
It is for he audit or to decide the ext end of audit work he consider s
necess ar y in order to support his opinion.
ISA )00 Objectives and General Principles governi ng an audit of financial
stat e me nt s st at es that the auditor should carry out an audit in accordance
with I!#s and ethical principles to pro"ide reasonabl e assur ance that the
financi al st at eme nt s are free from mat eri al misst at e me nt .
"he audi t or shoul d 1l an the audi t work so that the audi t will ,e
1er orme d in an e ec t i 0 e manner/
J +l anni ng F means de"el opi ng a gener al strat egy and a det ail ed
approach for the expect ed nat ur e, ti mi ng and ext ent of the audit . The
audi t or plans to perfor m the audi t in an efficient and ti mel y manner .
Internati onal Standard on Auditing *ISA+ 300 Planni ng est abli shes
st andar ds and pro"ides guidance on planni ng an audit of financi al
st at e me nt s .
#n audit is an assignment . To compl et e the assignment efficiently and
effecti"ely in an
economi cal and cost effecti"e manner then it must be planned for in some
det ail before
commence me nt and the strat egy const ant l y re"iewed as the audit
progress es. 2lanning consist s
of det er mi ni ng what is to be done, det er mi ni ng when it is to be done,
det er mi ni ng who is to do
it@ and det er mi ni ng what it will cost in ter ms of hours and money.
Audi t +l anni ng !emor andu m
2lanning must be formalised in a writt en document ordinarily called an
#udit 2lanning
,emorandum A#2,B.
In practice, such a plan includes the following infor mat i on:
(. Sect i on . can be a summar y of the ter ms of engage me nt ,
basically summari :i ng the expect ed scope of the
assi gnme nt and the report s or other communi cat i ons called
for under the ter ms of engage me nt .
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on "hree
.58
$. Sect i on 6 woul d consi st of the hist ory or a brief
background of the client and any maD or changes that ha"e
taken place since the pre"ious audit "isit. #ccordingl y, this
par agr aph will co"er such mat t er s as the kind of busi ness
the client is in, the product s, the spread of the company?s
product s, the location from which the client oper at es,
changes in key personnel , account i ng policies and
procedur es, legisl ati on and e"en changes in the indust r y
struct ur e.
If the company is a part of a group, then a summar y of the
relati onshi p with other compani es in the group may also be
pro"ided.
*. Sect i on 4 woul d summari :e those areas with high inher ent
risk. These are those areas wher eby becaus e of the nat ur e
of the busines s en"ironme nt in which the client oper at es,
ther e is a high chance of mi sst at e me nt or mi sr epor ti ng
those are areas wher e the audi t or could reach a wrong
conclusi on unless speci al audi t procedur es are adopt ed.
%. Sect i on ; could summar i :e the financi al position and
resul t s. This nor mall y in"ol"es summari :i ng the bal ance
sheet and the profit and loss account for the last audit ed
year and ha"i ng alongsi de those figures the lat est a
manage me nt account s figures as well as the budget ed
figures. The audi t or then carri es out a ratio anal ysi s on the
financi al infor mat i on to identify other audi t risk areas or
areas wher e appar ent l y ther e ha"e been new de"el opme nt s
or significant changes that requir e in"esti gat i on and
expl anat i ons.
5. Sect i on 8 could consi st of a listing of incomes , expens es,
asset s and liabilities i.e. the significant component s of the
financi al st at e me nt s and a brief descri ption of the met hods
to be adapt ed to "erify them. W
&. Sect i on : is mat eri alit y le"els, which would be set for e"ery
mat eri al component of the financi al st at e me nt s and the
relat ed audi t approach.
K. An outl i ne o the 1ro1os e d audi t approach. The aspect s
that woul d be co"er ed here include:
The expect ed client st aff assi st ance in the
prepar at i on of supporti ng schedul es
The expect ed reliance on the Internal 1ontrol
!yst e ms AI1!B
The int ended use of int ernal audi t or?s work
The int ended use of exper t s or speci alist s
This secti on would also highlight the expect ed le"els of assur ance to
be deri"ed from:
- test s of cont rol
- anal ytical re"iew procedur es
- subst ant i "e procedur es of det ail s
9. Sect i on D could consi st of a ti met abl e on timing of key
e"ent s or acti"ities such as the propos ed dat e of the #H,,
the dat e of audi t clear ance, the dat e of the stock take and
the dat e of the "arious audi t unit s.
A&*I"IN-
.5: " he Audi t +roc e s s B +l anni ng
'. Sect i on < could deal with the st affing arrange me nt s ,
identifying the part ner responsi bl e for the audit , the
manger , the account ant in char ge and the audit assi st ant s.
(4. Sect i on .5 could be for the budget and a fee quot at i on.
This would show for e"er y st aff me mber , the number of man
hour as well as the cost of throe hours.
ot e that the plan must be appro"ed by the part ner in writing
before the audi t comme nc e s .
4/ 4 Im1ort anc e o Audi t +l anni ng
#dequat e planni ng of the audi t work helps to ensur e:
That appropri at e at t ent i on is de"ot ed to import ant areas of the
audi t,
That pot ent i al probl ems are identified
That work is compl et ed expedi ti ousl y.
2roper assi gnme nt of work to assi st ant s
1oordinat i on of work done by other audi t or s and exper t s.
The ext ent of planni ng will "ary accordi ng to the si:e of the entit y, the
compl exi t y of the audit and the audi t or?s experi ence with the entit y and
knowl edge of the busi nes s.
+bt ai ni ng knowl edge of the busi ness is an import ant part of planni ng the
work.
The audit or?s knowl edge of the busi ness assi st s in the identification of
e"ent s, trans act i ons and practi ces which may ha"e a mat eri al effect on
the financi al st at e me nt s .
The audi t or may wish to discuss element s of the o"er all audi t plan and
cert ai n audit procedur es with the entit y?s audi t commi t t ee, manage me nt
and st aff to impro"e the effecti"enes s and efficiency of the audi t and to
coordi nat e audi t procedur es with work of the entit y?s personnel .
The o"er all audit plan and the audi t progr a m@ howe"er, remai n the
audi t or?s responsi bility.
Control l i ng
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on "hree
.5C
The auditor carries out his work using different le"els of staff. To achi e"e
the plan requires
control at all stages. The element s of control are:
AaB /irecting or /irection: !taff must ha"e the instructions to follow.
This could be
formalised audit programme s clearly set ting out
what the st aff
must do.
AbB !uper"ision: -"ery member of the audit team shoul d be
subDect to super"i sion
by his superior to ensur e that the plan is being
carried out as
expect ed and all necess ar y work is being done.
AcB 8e"iewing: The work done would be re"iewed at all le"els
and e"idence of
this re"iew should be a"ailabl e.
AdB 8ecording: The entire audit process must be properl y
document ed in the form
of working paper s.
4/ ; "he %0eral l Audi t +l an
The audi t or shoul d de"el op and docume nt an o0eral l audi t 1l an
descri bi ng the expect ed scope and conduct of the audi t. While the record
of the o"er all audi t plan will need to be sufficientl y det ail ed to guide the
de"el opme nt of the audit progr am, its preci se form and cont ent will "ary
dependi ng on the si:e of the entit y, the compl exi t y of the audi t and the
specific met hodol ogy and technol ogy used by the audit or.
,att er s to be consi der ed by the audit or in de"el opi ng the o"er all audit
plan
include the following:
Knowl e dg e o the Busi ne s s
I Hener al economi c fact ors and indust r y conditions affecti ng the
entit y?s busi ness.
I Import ant char act eri sti cs of the entit y, its busines s, its financi al
perfor manc e and its reporti ng requireme nt s includi ng changes
since the dat e of the prior audit .
I The gener al le"el of compet ence of manage me nt .
&nders t andi ng the Account i ng and Int ernal Control Sys t e ms
I The account i ng policies adopt ed by the entit y and changes in
those policies.
I The effect of new account i ng or audi ti ng pronounce me nt s .
I The audi t or?s cumul at i "e knowl edge of the account i ng and
int ernal cont rol syst e ms and the relati"e emphasi s expect ed to be
placed on test s of cont rol and subst ant i "e procedur es.
#isk and !at eri al i t y
I The expect ed asses s me nt s of inher ent and cont rol risks and the
identificati on of significant audit areas.
I The set ti ng of mat eri alit y le"el s for audit purpos es.
A&*I"IN-
.5D " he Audi t +roc e s s B +l anni ng
I The possi bility of mat eri al misst at e me nt , including the
experi ence of past periods, or fraud.
I The identificati on of compl ex account i ng areas including those
in"ol"ing account i ng esti mat e s.
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on "hree
.5<
Nat ur e? "imi ng and Ext ent o +roce dur e s
I 2ossi bl e change of emphasi s on specific audit areas.
I The effect of infor mat i on technol ogy on the audi t.
I The work of int er nal audi ti ng and its expect ed effect on ext er nal
audi t procedur es.
Coordi nat i on? *irect i on? Su1er0i s i on and #e0i e w
I The in"ol"eme nt of other audit ors in the audit of component s ,
for
exampl e, subsi di ari es, branches and di"isions.
I The in"ol"eme nt of exper t s.
I The number of locations.
I !t affing requireme nt s .
#</ITIH
%ther !att er s
I The possi bility that the going concer n assumpt i on may be
subD ect to questi on.
I 1onditions requiring speci al at t ent i on, such as the exist ence of
relat ed parti es.
I The ter ms of the engage me nt and any st at ut or y responsi bilities.
I The nat ur e and ti mi ng of report s or other communi cat i on with
the entit y that are expect ed under the engage me nt .
4/ 8 "he Audi t +rogram
"he audi t or shoul d de0el o1 and docume nt an audi t 1rogram
set t i ng out the nat ure ? ti mi ng and ext e nt o 1l anne d audi t
1roc e dur e s re@ui re d to im1l e me nt the o0eral l audi t 1l an/
The audi t progr a m ser"es as a set of instructi ons to assi st ant s in"ol"ed
in the audi t and as a means to cont rol and record the proper execut i on of
the work. The audit progr a m may also cont ai n the audi t obDecti"es for
each area and a ti me budget in which hours are budget ed for the "arious
audi t areas or procedur es.
In prepari ng the audi t progr am, the audi t or woul d consi der the specific
asses s me nt s of inher ent and cont rol risks and the required le"el of
assur ance to be pro"ided by subst ant i "e procedur es. The audi t or woul d
also consi der the ti mi ng of test s of cont rol s and subst ant i "e procedur es,
the coordi nat i on of any assi st ance expect ed from the entit y, the
a"ailability of assi st ant s and the in"ol"ement of other audit ors or
exper t s.
Chang e s to the %0eral l Audi t +l an and Audi t +rogram
The o"er all audit plan and the audi t progr a m shoul d be re"ised as
neces s ar y during the course of the audit . 2lanni ng is conti nuous
throughout the engage me nt becaus e of changes in condi tions or
unexpect ed resul t s of audi t procedur es. The reasons for significant
changes would be recorded.

4/ : Audi t A11roac he s
(. !ubst anti "e procedur es
$. )alance sheet #pproach
*. #udit 8isk #pproach
A&*I"IN-
..5 " he Audi t +roc e s s B +l anni ng
%. )usiness 8isk #pproach
5. !yst ems )ased #udit approach
&. /irectional Testing
K. #nalytical 2rocedur es
4/ :. Su,s t ant i 0 e 1roc e dur e s
This in"ol"es creati ng and using audit programs for mat eri al account
balances and transact i ons. The two cat egori es of subst ant i "e testi ng
include test s of det ail of transacti ons and balances and analytical
procedur es.
4/ :6 Bal anc e she e t A11roac h
This approach is based on the assumpt i on that the balance sheet is the
most import ant aspect of the financi al stat e ment s and therefor e if the
balance sheet is correct , the other stat e me nt s must be correct . It is
suit abl e for small compani es and larger propert y compani es. It
concent r at es audit testing on the account balances with limited testing
of the profit and loss account .
4/ :4 Audi t #isk A11roac h
A&*I" #ISK
#s we ha"e seen many parti es rely on the audit opinion to make decisions,
and therefore it is now a well est ablished fact that if the audit or gi"es an
audit opinion that is wrong in some particul ar then they stand a chance of
suffering some damage.
#udit risk therefor e could be defined as the chance of damage to the audit
firm as a result of gi"ing an opinion that is wrong in some particul ar. +r
put anot her way, it could be expl ained as the possi bility that financi al
stat e ment s cont ai n mat eri al mis- stat e ment s which had escaped det ecti on
by both an internal control on which the auditor has relied and on the
auditorJ s own subst anti "e test s and other work.
It could be looked at also as: the possibility that the auditor may be
required to pay damages to the client or other persons as a consequence
of:
(. The financi al stat e me nt s cont ai ni ng a misst at eme nt @
$. The compl ai ni ng part y suffering a loss as a direct consequence
of relying on the financi al st at eme nt and
*. egligence by the audit or in not det ecti ng any reporting on the
mis- stat e me nt which can be demonst r at ed.
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on "hree
...
/amage to the audit firm or the audit or may be in the form of monet ar y
damages paid to the compl ai nant as compens at i on or simpl y damage to
their reput ati on with a client or the business communi t y.
#ll audit s in"ol"e an element of risk such that howe"er strong the audit
e"idence and howe"er careful the auditor, ther e is always a possibility of
an error or a fraud going undet ect ed. It is gener ally known that the
auditor who organi ses his office and st aff in a compet ent manner and
follows auditing standar ds and guidelines is unlikely to be found negligent
and to pay damages as a consequence of fraud or error not being
disco"er ed by him.
#udit risk can be either normal or higher than normal .
Normal audi t risk
Indications that an audit is a normal risk audit are:
AaB The client ha"ing manage me nt and staff who are compet ent
and ha"e integrit y@
AbB Where the client has an accounti ng syst em that is well
designed, works and is subDect to strong internal controls@
AcB Where the client has no speci al financi al probl ems@
AdB The audit orJ s past experi ence@
AeB Where the client is old, well est ablished and the business of the
entity is not subDect to rapid change@
AfB If the clientJ s board of direct ors are acti"ely engaged in the
company and they pro"ide control and leader shi p of a good
quality@
AgB If the board of direct ors has compet ent non- executi"e direct ors@
AhB If the organi:ati on has an audit commi t t ee.
When the audit or is faced with the nor mal audit risk, the audit
approach adopt ed is usually one of reliance on key controls
support ed by subst ant i"e test s, compliance test s and anal ytical
re"iew.
$igher than normal risk
!e"er al audit assignment s in"ol"e high audit risk and usually in any client
ther e will always be at least one high risk area. Indications that an audit
has an element of higher than normal audit risk include:
AaB 2oor manage me nt with lack of control and poor bookkeepi ng@
AbB 0iquidity probl ems and high gearing@
AcB The opposit e of all the factors mentioned in the normal risk
abo"e@
AdB 8ecent changes in ownershi p, control or key st aff@
AeB 1hanges in accounti ng policies or procedur es@
AfB 7uture plans to seek quot ation on the airobi !tock -xchange@
AgB +"er- reliance on a few product s, cust omer s, suppliers and
in"est ment s in new "ent ur es or product s@
AhB 2roblems inher ent in the nat ur e of the business for exampl e
difficulties in stock counti ng or "aluation, difficulties in
A&*I"IN-
..6 " he Audi t +roc e s s B +l anni ng
det er mi ni ng the ext ent of clai ms and pro"isions and cutoff
problems@
AiB The exist ence of put upon enquiry situations, domi nance by the
singl e person and lack of in"ol"ement of direct ors or
propriet or s. In such a situation, the auditor approaches his
audit in a manner that is:
I !ceptical, relying on high calibre staff
I 1ollection of audit e"idence in each area from a wide range
of sources
I Taking extreme care in the prepar ati on of audit working
paper s
I In"esti gati ng thoroughl y high risk and problemat i c areas
I -xercising extreme care in drafting the audit report
In addition to normal risk and higher than normal risk discussed abo"e,
the auditor can also be exposed by subst andar d work such as:
i. =is failure to recogni se put upon enquiry situation
ii. =is failure to draw correct inferences from audit e"idence and
the anal ytical re"iew
iii. =is use of wrong procedur es in a particul ar situation
i". =is failure to perfor m necess ar y audit work becaus e of time and
cost consider ati on
". =is failure to det ect errors or fraud becaus e of poor sampling
met hods or the selection of inadequat e sampl e si:es
It is essent i al that an audit firm shoul d organi:e itself in such a way
that it can mini mi se the risk of suffering any damage. We can look at
these measur es from two point s of "iew. )road meas ur es taken by
the professi on as a whole and meas ur es to be taken by the indi"idual
auditor in mini mi sing this audit risk.
"he !eas ur e s "aken By the +ro e s s i o n As A 3hol e
These ha"e been adequat el y co"er ed under the section on independence
in lesson ( and qualities of an audit or whereby we consider ed the st eps
taken by the professi on to secur e the qualities of compet ence, Dudgement ,
obDecti"ity and integrit y in an auditor.
!eas ur e s "o Be "aken By the Indi 0i dual Audi t or
AaB 2roper recruit ment and training of all staff@
AbB #llocating staff to particul ar audit s wher e they ha"e the
appropri at e skills@
AcB 2lanning the Dobs well in ad"ance so that it can be approached
in a relaxed but disciplined manner and any timing problems
can be accommodat e d@
AdB <se of audit manual s that confor m to audit standar ds and
guidelines@
AeB <se of up- to- dat e lett ers of engage me nt s @
AfB 3uality control meas ur es that ensur e re"iew at e"ery st age of
the audit@
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on "hree
..4
AgB Hood briefing of auditing staff so that they can recogni se put
upon enquiry situation@
AhB -mphasi si ng on mat eri ality and use of adequat e sampl e si:es
+roc e dur e s the Audi t or Ado1t s
The auditors procedur es will include:
aB Hetting an underst andi ng of the entity as a whole in order to
see the accounti ng syst em in proper perspect i"e and thus be
able to assess how effecti"e and appropri at e the syst em is@
bB )y use of enquiry or internal control questi onnai r es or readi ng
manual s ascert ai n the compl et e syst em@
cB 8ecord the syst em that he has ascert ai ned either in the form of
narrati"e not es, flow chart s, check lists or answer s to the I13@
dB If the audit or intends to rely on the internal control then he
further has to record the syst em of controls in det ail@
eB If the syst emJ s record was pro"ided by the client or was
obt ained through reading manual s, then the audit or must
perfor m walk through test s to confirm the correct nes s of the
record and also his own underst andi ng of the syst em@
fB The audit or then perfor ms a preli minary assess me nt of the
syst em, and if he is relying on controls then he perfor ms a
preli mi nar y e"aluation of those controls@
gB If the syst em of controls and accounti ng seems adequat e and
the audit or feels that he can rely upon the controls he then
designs and perfor ms compli ance test s. =owe"er, if he does
not wish to rely on the controls then he perfor ms subst anti "e
test s on the records@
hB =e has to e"aluat e his e"idence and form an opinion on whet her
proper books of account s ha"e been kept and whet her the
books of account s form a reliable basis for the prepar at i on of
the financi al stat e me nt s.
A&*I"IN-
..; " he Audi t +roc e s s B +l anni ng
4/ :; Busi ne s s #isk A11roac h
This approach requires the auditor to det er mi ne what are the "ery
import ant business risks which the client faces. This line of approach bot h
helps the client and also enabl es the audit or to appreci at e and underst and
his client s business and appr eci at e all aspect s of the business acti"ities. It
is then for the audit or to det er mi ne where the risks are likely or unlikely
and whet her the risks are likely to produce serious consequences. This
enabl e the audit to be focussed on those mat t er s where there is a
possibility of misst at e me nt . This is the basis of re"ised auditing standar ds.
The big firms ha"e largel y adopt ed this approach within their audi t
met hodol ogy.
The hist ory of audi ti ng shows a gradual change o"er time as det ail ed
testi ng of trans act i ons mo"ed to syst e m audi t s. The next de"el opme nt
was the audi t risk model which focuses the audit and the ext ent of audi t
procedur es on to the areas of an audi t wher e the audi t or was most at
risk of gi"ing an inappropri at e opinion.
=ere we consi der concept of risk from the "iew point of the busi ness as a
whol e:
4/ :;/ . "he Busi ne s s #isk A11roac h to Audi ti ng
In recent year s the broader concept of busi ness risk ha"e been
de"el oped by the larger firms. It was the subD ect of the I1#-W auditing
road show VTomorrow?s audit today? in the lat e (''4s in the <.. The
concept has not been fully refined but its mai n principl es are now well
est abli shed.
Busi ne s s risk is the threat that an e0e nt or acti on will ad0er s e l y
a ect a ,usi ne s s A s a,i li t y to achi e0 e its ongoi ng o,H ect i 0 e / It
can ,e s1l i t ,et we e n ext er nal and int ernal act ors ,
The busi ness risk approach to auditing in"ol"es exami ni ng the busi ness
in it?s entirel y and e"al uat i ng the "arious risks to which it is exposed.
The busines s risks are fact ors which affect the company? s ability to meet
its goal s. The risks may be cont roll abl e Ato some ext ent B or
uncont r oll abl e Afor exampl e, ext er nal fact orsB. It may be possi bl e to
trade- off some risks Ae. g. insuranceB . The audit or is concer ned about
those risks which may impact upon the financi al st at e me nt s and
ther efor e needs a full under st andi ng of the busines s and its risks in order
to do this. The audi t or will then plan the audi t strat egy with these
busi ness risks clearly focused in mind.
4/ :;/ 6 "he Eect s o the Busi ne s s #isk A11roac h
There are some gener al point s which can be made about the busines s
risk approach and the effect it has had on the audi ti ng process.
This Vtop down? approach to the audit , begi nni ng with busines s risk
and endi ng with the financi al st at e me nt s
There is still a lack of clarity in the relationshi p bet ween busi ness
risk and audit risk
The ideas of inher ent risk and cont rol risk ha"e tended to mer ge
into the larger concept of busi ness risk.
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on "hree
..8
The ideas of inher ent risk and cont rol risk can be called resi dual
risk which has to be mini mi :ed by audit action. #n audit action
carri es with it det ect i on risk.
The approach is "ery much a high le"el approach and shoul d
include consi der at i on of all mat t er s which are critical to the
busi ness. 7or exampl e, Vcould the client lose the ;QX franchi se
and what would be the possi bl e conseque nc es for the company
and its financi al st at e me nt s R?
)ecaus e of the high le"el of under st andi ng required of a client?s
busi ness it is possi bl e to use anal ytical procedur es mor e
frequent l y as a procedur e for "erification of financi al st at e me nt
asser t i ons
It is an aid to the firm?s accept anc e and conti nuat i on procedur es
for client s Ado we want this client RB
)usiness failure risk is an import ant aspect of o"er all busi ness risk.
The asses s me nt of busi ness failure risk will assi st the audit or when
consi deri ng the going concer n st at us of the client s busi ness.
The audit needs to be tailor made and a gener ali:ed approach to
audi t s is neit her producti "e nor economi cal
#uditors need mor e under st andi ng of busines s and to that end the
larger firms set up larger dat abas e s of infor mat i on about the
economy and the busines s world
The concept implies a conti nui ng relati onshi p with the client rat her
than a oine off "iew with each year being separ at e.
#s shoul d be e"ident from this summar y the busi ness risk approach is a
mor e holistic approach to the audit . The busines s risk approach st art s at
a st age back from the tradi tional audi t risk model and offers mor e
benefit to audi t or s and client s alike.
)usiness acti"it y infor mat i on financi al
st at e me nt s
Wher eas the audit risk model encompa s s e s the last two aspect s the
busi ness risk approach st art s with exami ni ng the busi ness acti"it y and
identifies the risk relati ng to it, before exami ni ng the risks of the
infor mat i on and subsequent l y the financi al st at e me nt s bei ng misst at ed.
The consequence s of the busi ness risk approach shoul d be a mor e
efficient and focused perfor med by a mor e knowl edge abl e audi t or
resul ti ng in a bet t er audi t or P client relationshi p. 7or exampl e, the audi t
will ha"e less emphasi s on trans act i ons. The audi t or may well pro"ide
other benefit to the client gi"en this great er under st andi ng of the
busi ness and its risk profile.
4/ :;/ 4 Ad0ant a g e s o the Busi ne s s #isk A11roac h
The ad"ant ages of the busi ness risk approach are as follows:
8esear ch showed that proces si ng errors wer e rarel y a cause of
audi t probl ems
,aDor audit probl ems Ae. g. compani es going bust shortl y aft er a
clean audi t report B typically arise out of issues such as going
concer n, maD or fraud by top manage me nt , larger scal e syst e ms
breakdown etc.
A&*I"IN-
..: " he Audi t +roc e s s B +l anni ng
In"esti gat i on of busi ness risk enabl es the audit or to ha"e a
profound knowl edge of the busi ness Aas required by I!# *(4
knowl edge of the busi nes sB.
The approach focuses the audit on to the high risk areas which are
mat eri al to the busi nes s.
The approach adds "alue to the audit and enabl es the audi t or to
offer some commer ci al benefi t s to the audi t.
The pre"ious emphasi s on trans act i ons and syst e ms was
expensi "e and uneconomi c
The pace of change in busi ness and in comput i ng and
communi cat i ons means that compani es are much mor e at risk of
failure than e"er befor e.
#uditing needs to be awar e of such changes
#udit firms wish to be in "an of inno"at i on to att r act client s.
#udit firms are anxious to show product differenti ati on to pot ent i al
client s
The busi ness en"ironment and corpor at e go"er nance issues, and
the nat ur e of manage me nt cont rol are all now mor e significant for
and transl at e mor e quickly into the financi al st at e me nt s
The approach tends to in"ol"e part ner s and seni or manger s much
mor e in the planni ng st ages of an audi t
The busi ness risk re"iew may show up areas wher e the audi t or can
sugges t that its highly paid ser"ices can be offered to the client .
4/ :;/ ; *i sad0a nt a g e s o the Busi ne s s #isk A11roac h
There are some disad"ant age s to the approach, as follows:
,ore highly qualified and compet ent st aff are requir ed
The added "alue idea does tend to oppos e the notion of
independe nc e
4/ :;/ 8 Busi ne s s #isk Anal ysi s
)usiness risk can be anal y:ed bet ween ext er nal and int ernal risks
Ext ernal risks
1hangi ng legisl ati on Ae. g. mini mum wageB
1hangi ng int er est rat es Aespeci ally with highly gear ed compani esB
1hangi ng exchange rat es
2ublic opinion, at tit udes, fashions Ae. g. en"ironme nt al fact orsB
2rice wars initiat ed by compet i t or s Ae. g. super mar ket sB
Import compet i ti on Ae. g. the textile tradeB
<ntri ed technol ogi es and ideas Ae. g. dot. com trader sB
at ur al ha:ar ds Ae. g. fire or flood or effect s of global war mi ngB
)ad debt s
0itigation
-n"ironment al mat t er s
Inflation
2olitical fact or s
Int ernal #isks
Internal risks can also damage the company. These include:
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on "hree
..C
7ailure to moder ni :e product s, process es , labour elations,
market i ng resul ting in loss of compet i ti "e edge
-mployees Ae. g. ineffecti"e recruit ment or training policiesB
)oard member s Ae. g. ineffecti"e corpor at e go"er nanceB
The proces s of dealing with suppli ers or cust omer s
-xcessi"e reliance on a domi nance chief execut i "e Ather eby
weakeni ng int ernal cont rolB
Inadequat e cash flow and the risk of corpor at e failure
Inappr opri at e geari ng Aresul ti ng in a lack of financi al efficiencyB
8elat ed parti es resti ng in inappr opri at e ter ms of tradi ng
Inappr opri at e acqui sitions and poor future prospect s
+"ert r adi ng resul ti ng in cash short ages
-xcessi"e reliance on one of a few product s, cust omer s, suppli ers
Internal cont rol weaknes s e s
1omput er syst e ms failure and loss of records
7raud
4/ :;/ : Com1ani e s A !ode s o %1erat i on
!ome compani es Aespeci ally small onesB oper at e without any o"ertl y
expr es s ed plan and si mpl y carry out the busi ness as always, respondi ng
to market changes as they happen. !uch compani es are often "ery
adapt abl e and sur"i"e well.
0arge compani es nor mall y plan their acti"iti es in a hierarchal way, as
follows:
,ission st at e me nt
!trat egi c plan
)udget s
)usiness es are at risk if their busi ness obDecti"es are not achi e"ed. It is
ther efor e desirabl e for the manage me nt to identify all busi ness risks and
if necess ar y to amend the plan to accommoda t e the risks or make
conti ngency plans to sur"i"e.
7or exampl e, a company which has o"er reliance on one cust omer mi ght
decide acti"el y to seek new cust omer s or market s, perhaps by
acqui si tion. #nother exampl e would be a company which is tot ally
reliant on is comput er syst e m shoul d ha"e backup facilities.
4/ :;/ C Clas si i cat i on o Indi 0i dual Busi ne s s #isk
Indi"idual busines s risk can be low or high impact and low or high
likelihood. =ere are some exampl es for a satirical maga:i ne.
=igh 0ikelihood 0ow 0ikelihood
=igh impact 0egal action for libel.
!uch a scenari o is
import ant as the going
concer n of the
maga:i ne may be
threat ened
V#ct of Hod? such as
fire or flood. !uch
risks are often ignor ed
or disast er reco"er y
conti ngency plans
made if the cost is not
too high.
0ow impact The launch of a new
newspaper P the
-"ent s out si de the
field of medi a and
A&*I"IN-
..D " he Audi t +roc e s s B +l anni ng
maga:i ne?s reader s hi p
tends to be drawn
from the reader s of
broadshe e t s . The
maga:i ne woul d be
largel y unaffect ed
politics which do not
affect the maga:i ne?s
st akehol der s or cost s
What can manage me nt do about risks once they are identifiedR 1learly
what to do depends on the risk and ther e are an infinit e "ari et y of risks.
+ne possi bl e classificati on of pot ent i al reacti ons by manage me nt is as
follows:
/o not hi ng and hope for the best
/e"el op int ernal cont rol s
/e"el op qualit y cont rol s o"er producti on of goods, product i on of
ser"ices, st aff recruit ment
Goin in go"er nme nt sche me s like 7ami ne 8elief or 2o"ert y
8educti on
Train st aff
/i"ersify P acqui si tion, new product s, mul ti pl e sourci ng, addi ng to
cust omer base perhaps by exporti ng
8isk reducti on P raising st aff awar enes s of risk, tight er discipline in
all areas, physi cal meas ur es such as sprinkl ers. /i"ersified
comput er syst e ms inst ead of one compl ex one
Transf er of risk P by insur ance, subcont r act i ng, out sour ci ng
#"oidance P e. g. lea"ing a market such as the <!# to a"oi d
product liability
In the end, the busines s of the ent r epr eneur is risk raking and all risk
cannot be remo"ed. The basi c economi c truism is that ther e is a
correl ati on bet ween risk and ret urn and high ret urns are not possi bl e
without risk.
4/ :;/ D Audi t #isk and Busi ne s s #isk
We saw in earlier studi es that audit risk is oft en cat egori:ed as the
product of inher ent risk, cont rol risk and det ecti on risk
#uditors shoul d consi der busi nes s risk in three ways:
)y enquiri ng into and asses si ng busines s risk, ther eby gaining an
excell ent knowl edge of the busi ness. This is a basic requireme nt
in all audit engage me nt s .
)y helpi ng their client s to recogni :e, asses s and respond to risk P
by welcomi ng it, ignoring it, managi ng it, eliminati ng it, de"el opi ng
a reco"er y plan, insuring agai nst it etc. This can be a lucrati"e
source of fees. They may also hel p to eli minat e or mange risk,
which reduces audit risk in the futur e.
)y seei ng the connect i on bet ween audi t risk and busines s risk and
the risk of misst at e me nt in the financi al st at e me nt s , which focuses
the audi t or risks likely to lead to possi bl e mi sst at e me nt .
4/ :;/ < "he Im1li cat i ons o Busi ne s s #isk or the Audi t
)elow is a checklist of the possi bl e planni ng implicati ons for the audit of
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on "hree
..<
busi ness risk
Is the cont rol en"ironment goodR
/oes the manage me nt manage risk effecti"el yR
Is the account i ng syst e m adequat eR
/o any risks threat en the going concer n st at us of the companyR
/o any of the risks ha"e implications for cash flowR
Is ther e a high risk of fraud P e. g. poor cont rol s, manage me nt
o"erride, o"erwhel mi ng ambi tion and arrogance in the chief
execut i "eR
#re ther e relat ed parti es with different agendas R
Is the busi nes s under threat of being taken o"er, with the risk of
manage me nt misst at i ng financi al st at e me nt s R
Is ther e a risk of litigati on agai nst the companyR
Is ther e any risk of withdr awal of suppor t by loan or trade
payabl esR
<ltimat el y many of the audi t risks come down to the following fact ors or
a combi nat i on of them.
2ossi bl e misst at e me nt s due to lack of cont rol s. 8ecent company
failures Aoft en shortly aft er clean audit report sB ha"e been caus ed
by o"er"al uat i on of in"ent or y under allowance for bad debt or s et c.
Working capit al short age leadi ng to cash flow difficulties and
techni cal insol"ency, oft en due to expansi on which has been rapi d.
Inappr opri at e account i ng policies. These can oft en lead to
o"erst at e me nt of asset s or under st at e me nt of liabilities.
!uppr es si on of liabilities
7raud by manage me nt
8elat ed parti es? trans act i ons or acti"iti es
Hoing concer n appropri at ene s s
1omput er failures
0itigation or regul at or y probl ems
"est (our &nders t a ndi ng
#s manager responsi bl e for prospect i "e new client s you ha"e "isit ed
=ard bridge 0orry 1omponent 0td which suppli es a small range of
component s for lorry manuf act ur er s. The chief execut i "e and maD orit y
shar ehol der is ,r. #lfred and he has asked your firm to make a propos al
for the company? s audi t and other ser"ices.
/uring the initial meet i ng you ha"e ascer t ai ned the following
infor mat i on:
The company? s turno"er has increas ed by about *4T a year for
the last three year s
,r. #lfred is a domi nat i ng personali t y who seems tirel ess and has
limitl ess ambi tion
The company has two maD or cust omer s and a few small ones
The largest cust omer has recent l y announced maD or expansi on
plans and =arbri dge ha"e already purchas ed addi tional land and
ha"e signed a cont r act for mor e building to increas e producti on.
Qou ha"e read in -&e (ail" -i mes that the cust omer?s expansi on
plans are "iewed with some skepti cis m by the city which seems to
doubt the company? s "iability.
=arbridge has borrowed hea"ily from its bank and a maD or
repayme nt of the loan is due shortl y. The company is already on
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its o"erdr aft limit and has yet to fund the new building
const r ucti on. ,r. #lfred is in negoti at i on with a ,iddle -ast er n
bank for furt her finance.
,any of the company? s part s are sourced in a count ry with an
exchange rat e which is "ery fa"our abl e to the <.. The financi al
press has lat ely sugges t ed that this rat e may change in the near
futur e.
The company recent l y purchas ed a "ery large and "ery compl ex
comput er syst e m to cont rol all its affairs. ,r. #lfred admi t s that
his admi n st aff Aheaded by his brot her, who has recent l y ret ur ned
from fi"e year s back packing abroadB does not really ha"e the
compet e nc e to run it properl y.
The company recent l y purchas ed a company Det aircraft which ,r.
#lfred says he finds essent i al for "isiting cust omer s and suppli ers.
,r. #lfred pilot s the aircraft hi mself. =e has Dust been to ,iami
wher e ther e are neit her cust omer s nor suppli er s.
,r. #lfred admi t t ed that the company had recentl y been issued
with writs alleging that the company had breached a pat ent in one
of its "ital proces s es and that the company had failed to pay the
sum due to a suppli er. ,r. #lfred did not consi der this as serious
and said that failure to pay was becaus e the new comput er syst e m
had not agreed the amount due with the suppli er?s st at e me nt
The company has no formal manage me nt account i ng syst e m. The
new comput er syst e m is suppos ed to remedy that but not hi ng has
been done as yet .
,r. #lfred has plans to float the company in the near futur e.
#e@ui re d
AaB Identify and descri be the principal busi ness risks rel ati ng to =arbridge
0orry 1omponent s ltd.
AbB Gustify an appropri at e audit strat egy for the first audit of =arbri dge
0orry 1omponent s 0td.
AcB !uggest some procedur es that =arbridge could impl ement
immedi at el y to impro"e is account i ng procedur es and financi al cont rol s.
)usiness risk is the risk that the audit ed entit y will fail to achi e"e its
obDecti"es. This approach is said to offer a top down, rational, "alue
added, focused and economi cal audi t with good co"er age of audit work.
The busines s risk approach is to be preferr ed becaus e it shoul d resul t in
a mor e efficient and focused audi t perfor mance by a mor e
knowl edge abl e audi t or resul ting in a bet t er audi t or client relati onshi p.
4/ :8 Sys t e ms Bas e d audi t a11roac h
The basis of I#! %44, 8isk #ssess me nt and Internal 1ontrol
The ter m syst ems audit refers to the typical audit approach to medi um
and large compani es and is based on the assumpt i on that such compani es
ha"e internal control syst ems which will hopefully constit ut e a reliabl e
base for the prepar ati on of the account s. In other words, the
charact eri stic of a syst ems audit is an exami nati on of internal control.
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.6.
We ha"e already est ablished that many small compani es cannot achi e"e
satisfact ory internal control and it is hence clearly futile for the audit or to
seek to rely on controls if they donJ t exist or are pat entl y unreliabl e. 7or
such ent er pri ses the audit or has no alt ernat i"e but to carry out a so called
J subst ant i "e auditJ in"ol"ing ext ensi"e "erification of transacti ons followed
by a det ail ed exami nat i on of the balance sheet A"erification of asset s and
liabilities and re"iew of the financi al stat e ment sB.
The cont empor ar y audit approach to reasonabl y sophi sticat ed compani es
is therefor e to carry out a syst em- based audit during the course of the
accounti ng year, followed by a balance sheet audit at the year end - if the
syst ems audit work is successful, i.e. the controls pro"e reliabl e, the
auditor can use his Dudgement to reduce the ext ent of the balance sheet
work Ain no circumst ances will the balance sheet work be eliminat ed
entirelyLB.
4/ :: *irect i onal "esti ng
The concept of directional testing recogni ses that it is the purpose of the
audit test which will det er mi ne the direction of the test .
4/ :C Anal yt i cal +roc e dur e s
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E&ES"I%N %NE
AaB Why is planning the audit in ad"ance consider ed to be so import ant R
A5 ,arksB
AbB What mat t er s should be taken into account in formul ati ng the audit
planR A(4 ,arksB
E&ES"I%N "3%
AaB What is an audit planni ng memor andum and what might it cont ai nR
A(5 ,arksB
A bB Why is it essenti al to fully underst and the client sJ indust ry, business
and
organi
:ationR
A*,ark
sB
AcB !uggest practical problems which could be encount er ed in the
implement at i on
of audit planning and how you would endea"our to mini mi se theseR
A9 ,arksB
E&ES"I%N "$#EE
What quality control procedur es are required to ensur e that audit s are
perfor medR
AaB In accordance with appro"ed auditing st andar ds
AbB In confor mi t y with stat ut ory and contract ual requirement s
AcB In confor mi t y with personal AethicalB st andar ds
AdB In confor mi t y with any professi onal st andar ds set by the firm itself
AeB -conomi cally and to time schedul es
AfB With mini mum riskR
(65 !arks)
E&ES"I%N 7%&#
The need for the planni ng, controlling and recordi ng of work is an
essenti al aspect of all types of ent er pri se, including account ancy firms. It
is of particul ar import ance in the perfor mance of the audit of a client who
is a limit ed company.
#e@ui re d
aB -xplain why the need exist s and what benefit s are to be deri"ed from
adopti ng such an approach
bB What st eps would you take prior to the commence me nt of the audit
of a limit ed company which has been a client for a number of yearsR
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.64
A&*I"IN-
.6; " he Audi t +roc e s s B +l anni ng
E&ES"I%N 7I'E
8oss and 1o. 1hart er ed 1ertified #ccount ant s are audi t or s to !el ene -os,
a manuf act uri ng group built up on take- o"er of numer ous small <.
manuf act ur er s. The foundi ng direct or is the "ery ent r epr ene uri al but
aut ocr at i c 2aul =elius, who has a good financi al and IT team with hi m.
The group is "ery highly gear ed and has recentl y taken o"er a list ed
company buy a cont est ed bid which city anal ysi s say was too expensi "e.
+ne large member of the group is emean which manuf act ur es anti-
personnel mines and anot her large member of the group, /er m is facing
clai ms from cust omer s who ha"e bought its skin prepar at i on and ha"e
allegedl y de"el oped skin diseas es from it.
#e@ui re d
AaB !ummar i :e the ad"ant age s of a busines s risk approach to this audi t
A9 marksB
AbB 1arry out a busi nes s risk asses s me nt of !elene -os and suggest how
they
may influence the audi t proces s
A($ marksB
("ot al B 65
marks )
C$ECK (%&# ANS3E#S 3I"$ "$%SE IN "$E 2ESS%N .5 %7 "$E
S"&*( +ACK
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Audi t E0i denc e and *ocume nt a t i o n
.68
2ESS%N 7%&#
Audit E0idence and *ocumentation
%B=EC"I'ES
-xplain the nat ur e and import ance of audit e"idence
-xplain the import ance of working paper s and their re"iew
-xplain the sources, sufficiency appropri at enes s and others issues on
audit e"idence.
C%N"EN"S
The topics co"er ed under this lesson are:
AiB The 1oncept of #udit -"idence
AiiB The use of asserti ons in obt aining audit e"idence
AiiiB #udit !ampling
Ai"B 0ett ers of 8epresent at i on
A"B 8ecording the #udit 2rocess
A"iB 8elat ed 2arties
INS"#&C"I%NS
#ssigned 8eading
Int ernat i onal st andards on audi ti ng
544 #udit -"idence
5*4 #udit !ampli ng and +ther !electi"e Testi ng 2rocedur es
594 ,anage me nt repr es ent at i ons
&44 <sing the Work of anot her #uditor
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.6:
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;/ 5 "he Conce 1t o Audi t E0idenc e
#uditing is an e"idence gat heri ng exercise. It is an exercise carried out to
confirm the assertions made by the manage me nt in carrying out the
manage me nt duties and in producing account s meant to gi"e a true and
fair "iew. The aut horit ati"e document is the ISA 855 Audi t E0i denc e
.
The auditor proceeds by:
aB Identifying the asser ti ons made by the direct ors express ed
or implied for e"ery item in the account s@
bB The e"aluati on of e"ery assertion for relati"e import ance so as
to assess the quantit y and quality of audit e"idence required@
cB <sing bot h compli ance and subst anti "e procedur es to collect
informati on and e"idence to support the amount at which items
ha"e been disclosed and the nat ur e of that disclosur e@
dB The e"aluation of the e"idence collect ed to ensur e that it is
rele"ant , reliabl e and sufficient@
eB to formul at e a Dudgement on the trut h and fair present at i on of
the items.
=a"ing formul at ed the Dudgement on each item included or
excluded from the account s, the auditor then formul at es a
Dudgement on the trut h and fairness of the account s taken as a
whole. To do this he will find that he needs other e"idence in
addition to the Dudgement he made on the indi"idual items.
;/ . *ei ni t i on
E#udit e"idenceF is all the infor mat i on used by the audi t or in arri"ing at
the concl usi ons on which the audit opinion is based, and includes the
infor mat i on cont ai ned in the account i ng records underl yi ng the financi al
st at e me nt s and other infor mat i on. #uditors are not expect ed to addr es s
all infor mat i on that may exist . #udit e"idence, which is cumul at i "e in
nat ur e, includes audit e"idence obt ai ned from audi t procedur es
perfor med during the course of the
audi t and may include audit e"idence obt ai ned from other sources such
as pre"ious audit s and a firm?s qualit y cont rol procedur es for client
accept anc e and conti nuance.
;/ 6 Sourc e s o e0i de nc e
The I!# identifies sources of e"idence as being the accounti ng syst ems
and the underlying document at i on, the tangi bl e asset s, the manage me nt ,
the employees, cust omer s, suppliers and other third parti es who ha"e
dealings with or knowledge of the entity or its business.
;/ 6. "he nat ure o audi t e0i de nc e
The nat ur e of audit e"idence can be: "isual, document ar y or oral.
;/ 66 Sui ci e nc y
The audit e"idence should in tot al enabl e the auditor to form an opinion on
the financi al st at eme nt s. !ufficiency is a measur e of the quantit y of
e"idence obt ai ned. =ow much e"idence to obt ain, what source to use,
and the form the e"idence should take is an issue left to the auditor to
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.6C
exercise his Dudgement in the light of the opinion called for under the
ter ms of his engage me nt . +f crucial import ance howe"er, he will be
influenced by the mat eri alit y of the mat t er being exami ned, the rele"ance
and reliability of e"idence a"ailabl e from each source and the cost and
time in"ol"ed in obt aining it. 3uite often the audit or obt ains e"idence
from se"er al sources which when put toget her gi"es him the necess ar y
assur ance. 7actors that affect sufficiency are usually dict at ed by the
degr ee of risk of misst at e me nt . The risk itself is affect ed by the nat ur e of
the item, the adequacy of internal control, the nat ur e of the business
carried on by the entity, situations which may exact an unusual influence
on manage me nt , the financi al position of the entity, the mat eri alit y of the
item in relation to the financi al stat e ment s taken as a whole, the auditorJ s
experi ence as to the reliability of the manage me nt staff of the ent er pri se
and its records, the result s of auditing procedur es including fraud or error
which may ha"e been found and the type of informat i on a"ailabl e.
;/ 64 #el e0anc e
The audit or obt ains e"idence either through compli ance testi ng of the
internal controls or through subst ant i"e test s of the informati on cont ai ned
in the financi al stat e ment s and the underl ying records. When
manage me nt est ablish a syst em of internal control they make cert ai n
assertions. #s far as internal controls are concer ned, these assertions are:
i. -xist ence: that the controls exist s@
ii. -ffecti"eness: that not only does the control exist but that it is
effecti"e@
iii. 1ontinuit y: not only does it exist and is effecti"e but the control
operat es throughout the period of intended reliance. !o when
the auditor is carrying out the compli ance test s, any e"idence to
confirm these assertions is rele"ant .
The rele"ance of audit e"idence has to be consider ed in relation to
the o"erall obDecti"e of forming an opinion and reporti ng on the
financi al st at eme nt s. To achi e"e this obDecti"e, the audit or needs
e"idence to enabl e him to draw reasonabl e conclusions. 1ompliance
test s alone cannot pro"ide him with this e"idence. =e ther efore has
to use subst ant i "e test s. =ere also ther e are cert ai n asser ti ons that
the manage me nt is maki ng and the audit or seeks e"idence to
confirm this.
aB Exi st e nc eB do the recorded asset s and liabilities exist at the
balance sheet dat e.
bB #ight s and o,li gat i ons : are the asset s owned by the
ent erpri se and are the liabilities properly those of the
ent erpri se.
cB %ccurrenc eB did the recorded transacti ons in fact occur and do
they relat e to the ent erpri se.
dB Com1l et e ne s s : ha"e all the asset s and liabilities been
recorded. =a"e all income and expens es been recorded.
eB 'aluat i onB ha"e the amount s attribut ed to the asset s and
liabilities been arri"ed at in accordance with st at ed accounti ng
policies on an accept abl e and consist ent basis.
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.6D
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fB !eas ur e me nt B =a"e the income and expens es been
measur ed in accordance with stat ed accounti ng policies on an
accept abl e and consist ent basis.
gB +res e nt at i on and di scl os ur e : ha"e the asset s, liabilities,
capit al and reser"es been properl y disclosed. =a"e income and
expens es been properl y disclosed wher e appropri at e.
#nswers to these questions pro"ided by audit e"idence obt ai ned are
rele"ant in confirming the assertions made by the manage me nt .
8emember that audit e"idence obt ained in confirming one asser ti on
cannot compens at e for failure to obt ai n e"idence to confirm anot her
assertion.
;/ 6; #eli a,i l i t y
8eliability of audit e"idence is influenced by its source and its nat ur e and
although it is dependant upon the particul ar circumst ances, we can make
some gener ali:ations:
aB #udit e"idence is mor e reliabl e when it is obt ai ned from
independe nt sources out si de the entit y.
bB #udit e"idence that is gener at ed int ernally is mor e reliabl e
when the rel at ed cont rol s imposed by the entit y are effecti"e.
cB #udit e"idence obt ai ned directl y by the audi t or Afor exampl e,
obser"at i on of the applicati on of a cont rolB is mor e reliabl e than
audi t e"idence obt ai ned indirectl y or by inference Afor exampl e,
inquiry about the applicati on of a cont rolB.
dB #udit e"idence is mor e reliabl e when it exist s in docume nt ar y
form, whet her paper, elect roni c, or other medi um Afor exampl e,
a cont empor ane ousl y writt en record of a meet i ng is mor e
reliabl e than a subseque nt oral repr es ent at i on of the mat t er s
discuss edB .
eB #udit e"idence pro"ided by original document s is mor e reliabl e
than audit e"idence pro"ided by phot ocopi es or facsi mil es.
;/ 4 "echni @ue s o o,t ai ni ng e0i de nc e
I!# 544 mentions them as:
aB Inspection of records or document s ,
bB Inspection of tangibl e asset s,
cB +bser"ati on,
dB Inquiry,
eB 1onfirmati on,
fB 8ecalcul ation,
gB 8eperfor mance and
hB #nalytical procedur es.
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.6<
These can be further anal y:ed as follows:
aB The physical exami nati on of tangi bl e asset s and counting them@
bB 1onfirmati on. These shoul d be in writing, ext ernal sources being
preferabl e to internal sources@
cB -xami nati on of original document s. 6ouching should be carried
out that is compari ng original document s with entries in the
books@
dB 8ecomput at i on: This in"ol"es carrying out additions,
calculations, extracti ng balances, rechecki ng postings and
summari es.
eB !canni ng: This is useful in seeking the unusual or extra- ordinary
item. It in"ol"es Dust flipping through the records and document s
looking out for the odd items.
fB Inquiry: This is asking questions of knowl edgeabl e persons
within and out side the entit y. It is a necess ar y and "alid
techni que. #uditors howe"er, prefer confirmati on to oral
answer s.
gB 1orrelation: This is seeki ng consist ency in the records and in the
account s and using e"idence obt ai ned in other areas to pro"ide
additional assur ance in other areas.
hB +bser"ati on: 6isual e"idence is more satisfact or y therefore,
obser"i ng a procedur e being perfor med is the best possibl e
confirmati on. =owe"er, obser"ati on has the draw back that you
can only rely on it at the time you are obser"ing. Qou can ne"er be
sure that the procedur e is carried out that way all the time.
;/ ; 7orms o e0i de nc e
aB +bser"ati on, is usually witnessi ng internal control and book-
keepi ng procedur es. It includes att endance at wages pay out.
+bser"ati on of stock- take, opening of mail and receipting and
issuing procedur es at the stores warehous e.
bB Inspection: exami ni ng of physical asset s to confirm their
exist ence and their condition as an aid in det er mi ni ng their
"alue for account s purposes. It includes exami ni ng the
records to ensur e that bookkeepi ng and internal control
procedur es ha"e been carried out.
cB Testi mony from independent third parti es. These are obt ai ning
bank lett ers, debt or s circularisati on, lawyer s lett ers etc.
dB 8e"iew of aut horit ati"e document s: e. g title deeds, share and
loan certificat es, leases, contract , supplierJ s in"oices, minut es of
board meet i ngs, internal sales in"oices.
eB Testi mony from manage me nt and empl oyees: This can be
formal for exampl e a lett er of represent at i on or informal
for exampl e replies to questi ons in questionnai r es.
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2es s on 7our
fB !atisfact ory internal control: Where the "olume of
transacti on is large for exampl e sales, purchas es, wages
and salari es, recei pt s and payment s, this may be the most
useful e"idence.
gB 1alculations perfor med by the audit or: These gi"e him e"idence
of the correct nes s of many figures.
hB 8e"iew of post balance sheet e"ent s: In most cases the final
audit is perfor med well after the end of the year and since the
present is a function of the future many assertions can be
"erified by reference to subsequent e"ent s.
iB 8elationshi p e"idence: -"idence confirmi ng trut h about one
item may confirm the trut h about anot her, for exampl e "erifying
the expens e rat es confirms to some ext ent exist ence and
owner shi p of the propert y.
DB #greement with expect at i on: 1omput at i on and compari son of
ratios and absolut e magni t ude with those achi e"ed in the past,
by other compani es, or budget ed can assist in "erification. #lso
inconsi st enci es, unusual , abnor mal or unexpect ed items can
alert the auditor.
kB -xternal e"ent s: The audit or must consider ext ernal e"ent s in
using his knowl edge of current e"ent s to assist him in the
assess me nt of a companyJ s account s. =e must therefor e
consider pre"ailing economi c circumst ances that affect his
client@ he must also consider the political situation and
legislation.
;/ 8 2imi t at i ons o audi t e0i de nc e
The quality and quantit y of e"idence is const r ai ned by the following
factors:

aB #bsolut e proof is not possi bl e@
bB !ome asser ti ons are not mat eri al@
cB Time and cost must be consider ed as account s must be
produced within cert ai n time scal es and the audit or may
ha"e to do with less than perfection, and ideal e"idence
may be too expensi"e to obt ain.
dB !ensiti"ity: some items are of great er import ance than others or
are capabl e of great er "ariations.
"o summari s eB the audit ors degree of assur ance is great er when
e"idence obt ained from different sources is consist ent with each other.
=owe"er, when e"idence from one source is inconsist ent with that
obt ai ned from anot her then further procedur es may ha"e to be perfor med
to resol"e the inconsist ency.
;/ : "he &se o Ass ert i ons in %,t ai ni ng Audi t E0idenc e
,anage me nt is responsi bl e for the fair present at i on of financi al
st at e me nt s that reflect the nat ur e and oper at i ons of the entit y. In
repr es ent i ng that the financi al st at e me nt s gi"e a true and fair "iew Aor
are present e d fairly, in all mat eri al respect sB in accordance with the
applicabl e financi al reporti ng framewor k, manage me nt implicitly or
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explicitly makes asser t i ons regar di ng the recogni ti on, meas ur e me nt ,
present at i on and disclosur e of the "arious element s of financi al
st at e me nt s and relat ed disclosur es.
"he audi t or shoul d us e as s er t i ons or cl as s e s o trans ac t i ons ?
account ,al anc e s ? and 1res e nt a t i o n and di scl os ur e s in su i ci e nt
det ai l to orm a ,asi s or the as s e s s me n t o risks o mat eri al
mi s s t at e me n t and the desi gn and 1er or manc e o urt her audi t
1roc e dur e s / The audit or uses asser t i ons in asses si ng risks by
consi deri ng the different types of pot ent i al misst at e me nt s that may
occur, and ther eby desi gni ng audi t procedur es that are responsi "e to the
asses s ed risks. +ther I!#s discuss specific situati ons wher e the audit or is
required to obt ai n audi t e"idence at the asser t i on le"el.
#ssertions used by the audit or fall into the following cat egori es
;/ :. Ass ert i ons a,out cl as s e s o trans ac t i ons and e0e nt s or the
1eri od under audi t B
aB %ccurrenc e Ntrans act i ons and e"ent s that ha"e been recorded
ha"e occurr ed and pert ai n to the entit y.
bB Com1l e t e n e s s Nall trans act i ons and e"ent s that shoul d ha"e
been recor ded ha"e been recorded.
cB Accuracy Namount s and other dat a rel ati ng to recorded
trans act i ons and e"ent s ha"e been recor ded appropri at el y.
dB Cut o Ntrans act i ons and e"ent s ha"e been recorded in the
correct account i ng period.
eB Clas si i cat i on Ntransact i ons and e"ent s ha"e been recorded in
the proper account s.
;/ :6 Ass ert i ons a,out account ,al anc e s at the 1eri od endB
aB Exi st e nc e Nasset s, liabilities, and equi t y int er est s exist .
bB #ight s and o,l i gat i ons Nthe entit y holds or cont rol s the right s to
asset s, and liabilities are the obligati ons of the entit y.
cB Com1l e t e n e s s L all asset s, liabilities and equi t y int er est s that
shoul d ha"e been recorded ha"e been recor ded.
dB 'al uat i on and all ocat i on Nasset s, liabilities, and equi t y int er est s
are included in the financi al st at e me nt s at appropri at e amount s
and any resul ti ng "aluati on or allocati on adDust me nt s are
appropri at el y recorded.
;/ :4 Ass ert i ons a,out 1res e nt a t i o n and di scl os ur eB
aB %ccurrenc e and right s and o,li gat i ons Ndisclosed e"ent s,
trans act i ons, and other mat t er s ha"e occurr ed and pert ai n to the
entit y.
bB Com1l e t e n e s s Nall disclosur es that shoul d ha"e been included in
the financi al st at e me nt s ha"e been included.
cB Clas si i cat i on and under s t anda ,i l i t y Nfinanci al infor mat i on is
appropri at el y present ed and descri bed, and disclosur es are clearly
expr es s ed.
dB Accuracy and 0al uat i on Nfinanci al and other infor mat i on are
disclosed fairly and at appropri at e amount s.
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2es s on 7our
The audi t or may use the asser t i ons as descri bed abo"e or may expr ess
them different l y pro"ided all aspect s descri bed abo"e ha"e been
co"er ed. 7or exampl e, the audi t or may choose to combi ne the asser ti ons
about transact i ons and e"ent s with the asser t i ons about account
bal ances. #s anot her exampl e, ther e may not be a separ at e asser t i on
relat ed to cut off of trans act i ons and e"ent s when the occurr ence and
compl et enes s asser ti ons include appropri at e
consi der at i on of recordi ng trans act i ons in the correct account i ng period.
;/ C Ex1ert s as a sourc e o Audi t E0idenc e
<sually the auditorJ s work on e"idence obt ai ned from within the entit y
support ed by confirmat i ons from third parti es will gi"e him enough reliable
e"idence that can enabl e him to gi"e an unqualified opinion. There are
howe"er, cert ai n circumst ances when his knowl edge is insufficient and he
may see the need to rely on the opinion of other expert s to help him form
his own opinion.
The aut horit ati"e document on this subD ect ISA :65B &si ng the
work o an ex1ert . It defines an expert or a speci alist as a person
or a firm possessi ng speci al skills, knowl edge and experi ence in a
particul ar field other than accounti ng and auditing. The expert may
be engaged by the client or by the auditor@ he may be employed by
the client or by audit or.
-xampl es of speci alist s or expert s whose work may be relied upon
include:
aB 7or "aluations such as land and buildings, plant and machi ner y,
works of art and precious stones N"aluers@
bB 7or the det er mi nat i on of quantiti es of physical condition of
asset s for exampl e: miner al s stores in stock piles, under ground
miner al s and petrol eum reser"es - geologist s@
cB /et er mi nat i on of amount s using speci alised techni ques or
met hods for exampl e: an act uari al "aluation - #ctuari es, on the
liability to be included for pension scheme liabilities@
dB The measur e me nt of work compl et ed and to be compl et ed on
long ter m contract s in progress for the purpose of re"enue
recognition - 3uantit y !ur"eyor s.
eB 0egal opinions concer ni ng interpr et at i ons of agree me nt s, laws
and regul ations - 0awyers.
fB /et er mi ni ng the "alue of stock exchange securiti es - !tock
)rokers.
When det er mi ni ng whet her to use the work of an expert the auditor
shoul d consider the mat eri ality of the financi al st at eme nt item being
consider ed, the risk of misst at e me nt based on the nat ur e and
compl exit y of the item being consider ed and the quanti t y and quality
of other audit e"idence.
;/ C. "he skill s and com1e t e nc e o the ex1ert
When planni ng to use the work of an expert , the audit or should
assess the professi onal compet ence of the expert .
The auditor should satisfy himself as to the expert J s skills, experi ence
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
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and compet ence by consideri ng the professi onal qualifications, the
licence or member s hi p of an appropri at e professional body,
experi ence and reput ati on in the field in which the audit or is seeki ng
e"idence.
;/ C6 %,Hect i 0i t y o the ex1ert
"he audi t or shoul d as s e s s the o,H ect i 0i t y o the ex1ert / =ust
like in hi s own cas e? wher e ,y hi s obDecti"ity has to be Dealously
guarded the audit or must consider the obDecti"ity of the expert . The
expert J s obDecti"ity can be impaired where the expert is employed by
the client or is relat ed in some other manner to the client for
exampl e being financi ally dependent upon or ha"ing an in"est ment
in the client. The audit or may ha"e to perfor m more ext ensi "e
procedur es than would otherwi se ha"e been planned, or he shoul d
consider engagi ng anot her expert .
;/ C4 Communi c at i o n wi t h the ex1ert
If the auditor intends to use the work of an expert then he must
communi cat e with the expert well in ad"ance to confirm the ter ms of
engage me nt and also to co"er other mat t er s such as:
aB The obDecti"es and scope of work@
bB #n outline of the specific items the auditor expect s to be
co"ered in the report@
cB The intended use by the auditor of the expert J s work including
possi bl e communi cat i on with third parti es as to the expert J s
identit y and ext ent of in"ol"ement .
dB -xtent of access to appropri at e records and files by the expert .
eB 1larification of the expert s relationshi p with the client@
fB 1onfidenti ality of the client J s informat i on@
gB The assumpt i ons and met hods intended to be used by the
expert and how consist ent they are with those used in the past@
hB The recordi ng of any further informati on required as audit
e"idence.
;/ C; Sco1e o the Ex1ert s work
The audit or shoul d obt ai n sufficient appropri at e audit e"idence that
the scope of the expert s work is adequat e for the purpose of the
audit.
;/ C8 +roc e dur e s in e0al uat i ng the work o the ex1ert B
The auditor must obt ai n reasonabl e assur ance that the expert J s work
constit ut es appropri at e audit e"idence in support of the financi al
informat i on. =e must ther efor e consider the source dat a used and
whet her it is appropri at e in the circumst ances, the assumpt i ons and
met hod used and their consist ency with prior periods and the result s of
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the expert J s work in the light of the audit orJ s o"erall knowledge of the
business and the result s of his other audit procedur es. =e should satisfy
himself that the subst ance of the expert J s finding is properl y reflect ed in
the financi al informati on. =ow appropri at e, reasonabl e the assumpt i ons
and met hods used are and how they ha"e been applied is the expert J s
responsi bility. The auditor does not ha"e the same experti se so he cannot
always challenge the expert J s assumpt i ons and met hods. #lthough the
auditor is not an expert on the expert J s field of speci ality, the audit or must
be able to det er mi ne what is reasonabl e and what is not. Therefore he
must obt ai n an underst andi ng of the assumpt i ons and the met hods to
det er mi ne that they are reasonabl e. There are times when the work of
the expert does not support the relat ed represent at i ons in the financi al
stat e ment s then the auditor shoul d att empt to resol"e the inconsist ency
by holding discussi ons with the client and the expert . =e may need to
engage anot her expert in resol"ing the inconsi st ency.
I at er 1er or mi ng all the s e 1roc e dur e s the audi t or concl ude s
that B
i. The work of the expert is inconsist ent with the informat i on in
the financi al stat e me nt or that
ii. The work of the expert does not constit ut e sufficient appropri at e
audit e"idence, then he should@
iii. -xpress a qualified opinion, a disclai mer of opinion or an
ad"erse opinion as appropri at e.
;/ C: #e er e nc e to an ex1ert in the audi t ors re1ort /
When issuing an unmodified auditors report , the auditor should not refer
to the work of the expert . This is becaus e such a reference might be
misunder st ood to be a qualification of the auditorJ s opinion or a di"ision of
responsi bility neither of which is intended.
+ccasionally the audit or may feel that e"en though he is expressi ng an
unqualified opinion it may benefit the reader of the account s if he refers to
the work of the expert then the audit or must obt ain the per mi ssion of the
expert . If per mi ssi on is refused and the auditor belie"es that such a
reference is necess ar y he should seek legal ad"ice.
;/ D !anag e me n t #e1re s e nt a t i o ns as a Sourc e o Audi t
E0idenc e
Internat i onal !tandar d on #uditing (ISA) 8D5 !anag e me n t
#e1re s e nt a t i o ns pro"ides st andar ds and guidance on the use of
manage me nt repr es ent at i ons as audit e"idence, the procedur es to be
applied in e"al uati ng and docume nt i ng manage me nt repr es ent at i ons and
the action to be taken if manage me nt refuses to pro"ide appropri at e
repr es ent at i ons.
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The audi t or shoul d obt ai n appropri at e repr es ent at i ons from manage me nt
The audi t or shoul d obt ai n e"idence that manage me nt acknowl edges its
responsi bility for the fair present at i on of the financi al st at e me nt s in
accor dance with the rele"ant financi al reporti ng framewor k, and has
appro"ed the financi al st at e me nt s . The audit or can obt ai n e"idence of
manage me nt ? s acknowl edgme nt of such responsi bilit y and appro"al from
rele"ant mi nut es of meet i ngs of the board of direct or s or si mil ar body or
by obt ai ni ng a writt en repr es ent at i on from manage me nt or a signed copy
of the financi al st at e me nt s .
The thing to not e is that during the course of the audit the auditor obt ai ns
"arious represent at i ons
from the manage me nt which can be cat egori sed into three types:
aB ot mat eri al to the financi al st at eme nt s. -xampl es being
queri es on missing document s or errors in bookkeepi ng or
bB 1apabl e of being corrobor at ed by other e"idence or
cB Where the knowledge of the fact s is confined to the
manage me nt . 7or exampl e, the manage me nt J s intention
to close down a maDor branch and wher e the mat t er is
principally one of Dudgement and opinion for exampl e the
reali:ability of obsol et e stock.
In AaB and AbB, there is no need for the audit or to obt ain separ at e
writt en repres ent at i ons by the manage me nt . In AcB howe"er, the
auditor should:
i. -nsure that ther e is no conflicting e"idence
ii. If he is unabl e to obt ain corrobor ati ng e"idence, then the
audit or should obt ai n a writt en confirmati on from the
manage me nt of any repres ent at i ons made.
iii. The audit or must decide for himself whet her the tot al of other
e"idence and the manage me nt J s writt en repres ent at i on are
sufficient for him to form an unqualified opinion.
The procedur es adopt ed are clearly stat ed in I!# 594. The lett er
shoul d not include routine mat t er s but only mat t er s which are
mat eri al to the financi al stat e ment s and the auditor cannot obt ain
independent corrobor ati ng e"idence. 2lease not e that the lett er of
represent at i on is simply one more piece of e"idence and the audit or
shoul d not rely on it rashly but ther e are times it is the only source of
e"idence open to the auditor.
If a repr es ent at i on by manage me nt is cont r adi ct ed by other audi t
e"idence, the audi t or shoul d in"esti gat e the circums t anc es and,
when necess ar y, reconsi der the reliability of other repr es ent at i ons
made by manage me nt .
;/ D. *ocume nt a t i o n o #e1re s e nt a t i o ns ,y !anag e me n t
The audi t or would ordinarily include in audi t working paper s e"idence of
manage me nt ? s repr es ent at i ons in the form of a summar y of oral
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discussi ons with manage me nt or writt en repr es ent at i ons from
manage me nt .
# writt en repr es ent at i on is bet t er audit e"idence than an oral
repr es ent at i on and can take the form of:
AaB # repr es ent at i on lett er from manage me nt @
AbB # lett er from the audi t or outlining the audi t or?s under st andi ng of
manage me nt ? s repr es ent at i ons, duly acknowl edged and confir med
by manage me nt @ or
AcB 8ele"ant mi nut es of meet i ngs of the board of direct or s or si mil ar
body or a signed copy of the financi al st at e me nt s .
;/ D6 Basi c Eleme nt s o a !anag e me n t #e1re s e nt a t i o n 2ett er
When request i ng a manage me nt repr es ent at i on lett er, the audi t or woul d
reques t that it be addr es s ed to the audi t or, cont ai n specified infor mat i on
and be appropri at el y dat ed and signed.
# manage me nt repr es ent at i on lett er woul d ordinarily be dat ed the same
dat e as the audi t or?s report . =owe"er, in cert ai n circumst ance s , a
separ at e repr es ent at i on lett er regar di ng specific trans act i ons or other
e"ent s may also be obt ai ned during the course of the audit or at a dat e
aft er the dat e of the audit or?s report , for exampl e, on the dat e of a public
offering.
# manage me nt repr es ent at i on lett er woul d ordinarily be signed by the
member s of manage me nt who ha"e pri mar y responsi bilit y for the entit y
and its financi al aspect s Aordinarily the seni or executi "e officer and the
seni or financi al officerB based on the best of their knowl edge and belief.
In cert ai n circums t anc es , the audi t or may wish to obt ai n repr es ent at i on
lett er s from other me mber s of manage me nt . 7or exampl e, the audit or
may wish to obt ai n a writt en repr es ent at i on about the compl et ene s s of
all minut es of the meet i ngs of
shar ehol der s, the board of direct or s and import ant commi t t e es from the
indi"idual responsi bl e for keepi ng such mi nut es.
;/ D4 Acti on i !anag e me n t #eus e s to +ro0i de #e1re s e nt a t i o ns
If manage me nt refuses to pro"ide a repr es ent at i on that the audi t or
consi der s neces s ar y, this consti t ut es a scope limit ati on and the audit or
shoul d expr ess a qualified opinion or a discl ai mer of opinion. In such
circums t anc es , the audi t or would e"al uat e any reliance placed on other
repr es ent at i ons made by manage me nt during the course of the audi t and
consi der if the other implicati ons of the refusal may ha"e any addi tional
effect on the audi t or?s report .
;/ < Audi t Sam1l i ng
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ISA .30 Audit Sampling and Ot&er Selective -esting Procedures defines
Audi t sam1l i ng is the application of a compliance or subst ant i "e
procedur e to less than (44T of the items within an account balance or
class of transacti ons such that all sampling units ha"e a chance of
selection. to enabl e the auditor to obt ai n and e"aluat e e"idence of some
charact eri stics of the balance or class and to form or assist in forming a
conclusion concerni ng the popul ation from which the sampl e is drawn. .
There are two approaches to sampling in auditing:
i. Gudgement sampling Aor non st ati sticalB
ii. !tatistical sampling
;/ <. =udgme nt al Sam1l i ng
Gudgement sampling is where the auditor using his own experi ence and
knowledge of the client J s business and circumst ances select s the sampl e
to be test ed without use of any mat he mat i cal or statistical tools.
!tatistical sampling is the drawing of inferences about a large "olume of
dat a by an exami nati on of a sampl e using statistical met hods in its
selection.
"he ad0ant a g e s o Hudge me nt sam1l i ng
aB The approach is well under st ood and has been refined by
experi ence o"er many years@
bB The audit or is gi"en an opport uni t y to bring his Dudgement and
experti se into play. #fter all auditing is an exercise in
professional Dudgement @
cB o speci al knowl edge of st ati stics is required@
dB o time is wast ed playing with mat he mat i cs@
Its di s ad0a nt a g e s are
aB It is unsci entific@
bB It is wast eful and usually too large sampl es are select ed@
cB Qou cannot extrapol at e the result s to the popul ation as a whole
as the sampl es are not repres ent at i "e@
dB 2ersonal bias in selecting the sampl e is una"oidabl e@
eB There is no logic to the selection of the sampl e or its si:e@
fB The sampl e selection is so erratic that it cannot be said to ha"e
applied to all items in the year@
gB the conclusions reached are usually "ague.
Gudgement sampling is still the preferr ed met hod by the maDorit y of
auditors and this is defended on the grounds that the auditor is
weighing se"er al pieces of e"idence and is in"esti gati ng se"er al
things at the same time that the whole process is too compl ex to be
reduced to simpl e formul as.
;/ <6 St at i s t i c al sam1l i ng > Ad0ant a g e s
aB It is scientific and defensi bl e@
bB It pro"ides a precise mat he ma t i cal stat e ment about
probabilities of being correct @
cB It is efficient as o"er large sampl es are not taken@
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dB It tends to cause unifor m st andar ds among different auditing
firms@
eB It can be used by lower grade st aff who due to lack of
experi ence may be lacking the necess ar y Dudgement needed by
the Dudgement sampling.
7actors to be taken into consider ati on before adopti ng st ati stical
techni ques:
aB The number of client s to whom it is appropri at e becaus e set up
cost s and training can be "ery high@
bB 0arge popul ations must exist as statistics is the science of large
number s@
cB #dequat e controls must exist and the obDecti"e being to test
them it is ob"ious that wher e no control exist then you cannot
apply statistical sampling@
dB The popul ations being test ed must be homogenous in
mat eri ality. They must also be homogenous in that the same
syst em and controls must apply to each one of them. In other
words they must be subDect to the same treat ment .
eB Too many "ariabl es cannot be test ed at once@
fB Items must be separ at el y identifiabl e, ther efor e sequent i al
numberi ng is essent i al@
gB The error must be defined@
hB ,ateri ality: the auditor must consider the tot al "alue of the
popul ation and any "ariances from it@
iB The risk factor: some items ha"e more risk than other s@
DB The a"ailability of other e"idence. If e"idence can be obt ai ned
through other means, then statistical sampling may only be a
top up.
;/ .5/ . #el at e d +arti e s
I#! $% prescri bes the disclosur es neces s ar y to draw att ent i on to the
possi bility that the
financi al position and profit or loss of an entit y may ha"e been affect ed
by the exist ence of
relat ed parti es and by trans act i ons and out st andi ng bal ances with such
parti es.
/efinitions of relat ed part y and relat ed part y trans act i ons from I#! $%,
E8elat ed 2art y /isclosur esF are as follows:
#el at e d 1art yLparti es are consi der ed to be rel at ed if one part y has the
ability to cont rol the other part y or exerci se significant influence o"er the
other part y in maki ng financi al and oper at i ng deci sions.
#el at e d 1art y trans ac t i ons Na transf er of resour ces or obligati ons
bet ween relat ed parti es, regar dl ess of whet her a price is charged.
# part y is rel at ed to an entit y if it:
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
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/irectly or indirectl y, cont rol s, is cont rolled by, or is under
common cont rol with,
The entit y@
=as significant influence o"er the entit y@
has Doint cont rol o"er the entit y@
Is a close member of the family of any indi"idual who cont rol s, or
has significant
Influence or Doint cont rol o"er, the entit y@
Is an associ at e of the entit y@
Is a Doint "ent ur e in which the entit y is a "ent ur er @
Is a member of the key manage me nt personnel of the entit y or its
par ent @
Is a close me mber of the family of any of the aforeme nt i oned key
manage me nt
2ersonnel @
Is an entit y that is cont roll ed, Dointly cont rolled or significantl y
influenced by, or
7or which significant "oting power in such entit y resides with, any
of the key
,anage me nt personnel or their close family member s @
Is a post- empl oyme nt benefit plan for the benefit of empl oyees of
the entit y, or of
#ny of its relat ed parti es.
I#! $% requires the following relat ed part y disclosur es:
at ur e of relati onshi ps bet ween par ent s and subsi di ari es, e"en if
ther e wer e no transact i ons bet ween those relat ed parti es@
The name of the entit y?s parent and, if different , the ulti mat e
cont rolling part y@
1ompens at i on of key manage me nt personnel @
If ther e ha"e been trans act i ons bet ween rel at ed parti es, the
nat ur e of the relati onshi p and infor mat i on about the trans act i ons
and out st andi ng bal ances with relat ed parti es. !uch disclosur es
are made separ at el y for each of the following cat egori es: the
par ent @ entiti es with Doint cont rol or significant influence o"er the
entit y@ subsi di ari es@ associ at es@ Doint "ent ur es in which the entit y is
a "ent ur er@ key manage me nt personnel @ and other relat ed parti es.
;/ .5/ 6 Im1ort anc e o #el at e d +art y "rans ac t i ons
While the exist ence of relat ed parti es and trans act i ons bet ween such
parti es are consi der ed ordinar y feat ur es of busi ness, the audi t or nee ds
to ,e aware o the m ,ecaus e :
aB The financi al reporti ng framewor k may requir e disclosur e in the
financi al st at e me nt s of cert ai n relat ed part y relationshi ps and
trans act i ons, such as those requir ed by I#! $%@
bB The exist ence of relat ed parti es or relat ed part y transact i ons may
affect the financi al st at e me nt s . 7or exampl e, the entit y?s tax
liability and expens e may be affect ed by the tax laws in "arious
Durisdictions which requir e speci al consi der at i on when relat ed
parti es exist@
cB The source of audit e"idence affect s the audi t or?s asses s me nt of
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its reliability. # great er degr ee of reliance may be placed on audi t
e"idence that is obt ai ned from or creat ed by unrel at ed third
parti es@ and
dB # relat ed part y trans act i on may be moti"at ed by other than
ordinar y busines s consi der at i ons, for exampl e, profit shari ng or
e"en fraud.
Transactions with relat ed parti es are import ant for se"er al reasons:
AaB !e"er al financi al scandal s in"ol"ing relat ed parti es frequent l y
appear in the headlines@
AbB # true and fair "iew of the entit yJ s affairs may not be gi"en
unless full disclosur e is made@
AcB !tat ut ory requirement s must be compiled with e.g. loans to
direct ors.
There are basically two types of transacti ons that arise bet ween a
company and a relat ed part y:
AaB Those ent er ed into in the ordinary course of business. It is
usual for member s of a group to trade with each other.
AbB Those not engaged into in the ordinary course of business or
which may in"ol"e misl eadi ng present at i on of the account s or
fraud on the company, its member s or creditors.
Type AaB gener ally deser"es no speci al audit att enti on. The auditor
must howe"er ensur e that they act ually arise in the ordinary course
of business at arms lengt h.
Type AbB is wher e problems may arise and where scandal s ha"e
occurred.
The 1ompani es #ct prohibit s loans to direct ors and where they occur
requires full disclosur e. The law prohibits the gi"ing of financi al assist ance
for the purchas e of or subscri ption for a companyJ s own shar es. The law
restrict s the right s of direct ors to acquire non- cash asset s from the
company or for the company to acquire non- cash asset s from its direct ors.
!ignificant shar ehol ding of mor e than 5T must be notified to the company
within se"en days.
;/ .5/ 4 Audi t ors #es 1ons i ,i l i t i e s wi t h regard to rel at e d
1arti e s /
ISA ..0 Relat ed Parties st at es that the audi t or shoul d perfor m audi t
procedur es desi gned to obt ai n sufficient appropri at e audi t e"idence
regar di ng the identificati on and disclosur e by
,anage me nt of relat ed parti es and the effect of rel at ed part y
trans act i ons that are mat eri al to the financi al st at e me nt s . =owe"er, an
audi t cannot be expect ed to det ect all rel at ed part y trans act i ons.
The #udit 2rocedur es can be summari sed as follows:
St e1 .B Ident i yi ng the rel at e d 1arti e s /
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
.;.
The audit or shoul d re"iew infor mat i on pro"ided by the direct or s and
manage me nt identifying the names of all known rel at ed parti es and
shoul d perfor m the following procedur es in respect of the compl et enes s
of this infor mat i on:
aB 8e"iew prior year working paper s for names of known relat ed
parti es@
bB 8e"iew the entit y?s procedur es for identification of relat ed parti es@
Inquire as to the affiliation of direct or s and officers with other
entiti es@
cB 8e"iew shar ehol der records to det er mi ne the names of principal
shar ehol der s or, if appropri at e, obt ai n a listing of principal
shar ehol der s from the shar e regi st er@
dB 8e"iew minut es of the meet i ngs of shar ehol der s and the board of
direct or s and other rele"ant st at ut or y records such as the regist er
of direct or s? int er est s@
eB Inquire of other audi t or s current l y in"ol"ed in the audi t, or
predeces s or audit ors, as to their knowl edge of addi tional relat ed
parti es@ and
fB 8e"iew the entit y?s income tax ret urns and other infor mat i on
suppli ed to regul at or y agenci es.
If, in the audi t or?s Dudgment , the risk of significant rel at ed parti es
remai ni ng undet ect ed is low, these procedur es may be modified as
appropri at e.
Wher e the financi al reporti ng framewor k requires disclosur e of relat ed
part y relationshi ps Asuch as I#! $%B, the audi t or shoul d be satisfied that
the disclosur e is adequat e.
St e1 6B *i stri ,ut e the list to audi t st a re@ue s t i ng the m to
ens ur e that any trans ac t i on
wi t h rel at e d 1arti e s o whi ch they come acros s shoul d ,e
looke d at care ul l y/
St e1 4B Seek out trans ac t i ons wi th the rel at e d 1arti e s . /uring
the course of the audi t, the audit or carri es out procedur es which may
identify the exist ence of transact i ons with relat ed parti es. -xampl es
aB 2erfor mi ng det ail ed test s of trans act i ons and bal ances.
bB 8e"iewi ng minut es of meet i ngs of shar ehol der s and direct or s.
cB 8e"iewi ng account i ng records for large or unusual trans act i ons or
bal ances, payi ng particul ar att ent i on to trans act i ons recogni:ed at
or near the end of the reporti ng period.
dB 8e"iewi ng confirmat i ons of loans recei"abl e and payabl e and
confir mat i ons from banks. !uch a re"i ew may indicat e guar ant or
relati onshi p and other rel at ed part y trans act i ons.
eB 8e"iewi ng in"est me nt trans act i ons, for exampl e, purchas e or sal e
of an equit y int er est in a Doint "ent ur e or other entit y.
/uring the course of the audit , the audi t or needs to be alert for
trans act i ons which appear unusual in the circumst ance s and may
indicat e the exist ence of pre"iousl y unident ifi ed relat ed parti es.
-xampl es include the following:
aB Transact i ons which ha"e abnor mal ter ms of trade, such as unusual
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prices, int er est rat es, guar ant e e s , and repayme nt ter ms.
bB Transact i ons which lack an appar ent logical busines s reason for
their occurr ence.
cB Transact i ons in which subst ance differs from form.
dB Transact i ons process ed in an unusual manner .
eB =igh "olume or significant trans act i ons with cert ai n cust omer s or
suppli ers as compar ed with other s.
fB <nrecor ded trans act i ons such as the recei pt or pro"ision of
manage me nt ser"ices at no charge.
Exami ni ng Ident i i e d #el at e d +art y "rans ac t i ons
In exami ni ng the identified relat ed part y trans act i ons, the audi t or shoul d
obt ai n sufficient appropri at e audit e"idence as to whet her these
trans act i ons ha"e been properl y recorded and disclosed.
!anag e me n t #e1re s e nt a t i o ns
The audi t or shoul d obt ai n a writt en repr es ent at i on from manage me nt
concer ni ng:
aB The compl et ene s s of infor mat i on pro"ided regar di ng the
identificati on of rel at ed parti es@ and
bB The adequacy of relat ed part y disclosur es in the financi al
st at e me nt s .
;/ .5/ ; Audi t Concl usi ons and #e1ort i ng
If the audi t or is unabl e to obt ai n sufficient appropri at e audi t e"idence
concer ni ng rel at ed parti es and transact i ons with such parti es or
concludes that their disclosur e in the financi al st at e me nt s is not
adequat e, the audi t or shoul d modify the audit or?s report appropri at el y.
;/ .. #EC%#*IN- "$E A&*I"B ISA 645
+ur1os e o worki ng 1a1er s
It is essent i al that all audit work is document ed - the working paper s
are the tangi bl e e"idence of the work done in support of the audit
opinion.
The I!# identifies the reasons for prepari ng audit working as follow:
aB The reporting part ner needs to be able to satisfy himself that
work delegat ed by him has been properly perfor med. The
reporting part ner can gener ally only do this by ha"ing a"ailabl e
to him det ail ed working paper s prepar ed by the audit staff who
perfor med the work.
bB Working paper s pro"ide for future reference, det ails of probl ems
encount er ed, toget her with e"idence of work perfor med and
conclusions drawn there from in arri"ing at the audit opinion.
cB The prepar at i on of working paper s encour ages the audit or to
adopt a met hodi cal approach.
The exact form that working paper s should take cannot be prescri bed
each firm will ha"e its own disciplines. What e"er form the paper s
take, howe"er, they must achie"e the mai n obDecti"es set out abo"e.
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Cont e nt s o worki ng 1a1er s
The I!# $*4 o.* stresses that audit working paper s should always be
sufficiently compl et e and det ailed to enabl e an experi enced auditor with
no pre"ious connection with the audit to ascert ai n from them what work
was perfor med and to support the conclusions reached. It also
emphasi :es the speci al care needed to record difficult questions of
principle or of Dudgment . The audit or shoul d record all rele"ant
informat i on known to him at the time, the conclusions to be reached
based on that informat i on and the "iews of the manage me nt .
#lthough the guideline does not att empt to define precisel y the form of
working paper s it does indicat e what might physically be cont ai ned
ther ei n as follows:
aB Informati on which will be of continui ng import ance to the audit
Ae. g. ,emor andum and #rticles of #ssociationB@
bB #udit planning informat i on@
cB The auditorJ s assess me nt of the ent er pri seJ s accounti ng syst em
and, if appropri at e, his re"iew and e"aluation of its internal
controls@
dB /et ails of the audit work carried out, not es of errors or
exceptions found and action taken thereon, toget her with
the conclusions, drawn by the audit st aff who perfor med
the "arious sections of the work@
eB -"idence that the work of the audit st aff has been properl y
re"iewed@
fB 8ecords of rele"ant balances and other financi al informat i on
including anal ysi s and summari es supporting the financi al
st at eme nt s@
gB # summar y of significant point s affecting the financi al
st at eme nt s and the audit
report , showing how these point s were dealt with.
Working paper s are con"enti onally subdi"ided into current and per manent
files for con"eni ence and control. The charact eri stic of current working
paper s is that they relat e specifically to the audit of a particul ar set of
account s whereas per manent paper s comprise mat t er s of continuing
import ance affecting the client. =ence items AaB and AcB abo"e are
typically ret ai ned on the per manent file.
+ermane nt Audi t 7il e
The per manent audit file might include, inter alia:
aB # copy of the ent er pri seJ s stat ut es and other legal or stat ut ory
document s go"erni ng the ent er pri seJ s exist ence@
bB +ther import ant legal document s and agree me nt s@
cB /escription of the business, its operations, toget her with the
address of its locations. This section might also include det ails
of specific mat t er s relating to the indust ry or acti"ity in which
the ent erpri se is in"ol"ed and which might affect the audit@
dB #n organi:ation chart showing the AtopB manage me nt functions
and the di"ision of responsi bilities@
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eB /et ails of the syst em of accounti ng, including, wher e applicabl e,
det ails of comput er applications@
fB #n internal control questionnair e, memor andum or other means
of assessi ng the adequacy of the internal control syst em,
including those areas wher e informati on is process ed by means
of a comput er@
gB a lett er of engage me nt defining the audit orJ s under st andi ng of
the work to be perfor med and his responsi bilities, toget her with
confirmat i on from the client that the lett er set out the position
as the client also under st ands it@
hB 1orrespondence, or not es of discussi ons with the client on
internal control mat t er s@
iB In the case of group compani es det ails of all compani es in the
group including names and address es of the audit ors of the
subsi di ari es@ this section might also cont ai n a record of all
informati on concerni ng other audit ors on whose work reliance is
placed for the purpose of the audit of group account s@
DB The principal accounti ng policies followed, key ratios, history of
capit al, profits and reser"es@
kB # reasoned description of the audit approach adopt ed@
lB /et ails of import ant mat t er s arising from each audit, and a
record of what decisions were taken and how they were arri"ed
at.
Current Audi t 7il e
The current audit file might include inter alia:
aB # copy of the audit ed financi al st at eme nt s and any report
prepar ed as a result of audit work carried out@
bB #n annual audit progr amme det ailing the audit steps to be
taken and recording the audit st eps carried out@
cB /et ails of the audit plan, including time budget s, st affing and
st at eme nt of the scope and le"el of test s@
dB !chedul es showing an anal ysi s of the indi"idual items in the
financi al st at eme nt s, the not es ther et o and the manage me nt J s
report @ the schedul es should also show compar at i "e figures and
st at e how the audit or has "erified the exist ence, ownershi p and
the amount s and fairness of the present at i on of items in the
financi al st at eme nt s has been consider ed. These schedul es
should cont ai n the audit orJ s conclusions, and should be cross
referenced to supporti ng schedul es and ext ernal document ar y
e"idence, as appropri at e@
eB otes of meeti ngs and all correspondence relating to the audit,
including all certificat es and other third part y audit
confirmat i ons@
fB -xtract s from meeti ngs of shar ehol der s, manage me nt , direct ors
and other rele"ant bodi es@
gB 8ecords of det ailed audit test s carried out, the reasons for the
timing and le"el of the test, toget her with the conclusions drawn
from those test s@
hB the informati on recei"ed from the other audit ors regardi ng the
financi al stat e me nt s audit ed by them@
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iB 8ecords of queri es raised by the auditors and how such queri es
ha"e been dealt with@
DB a lett er or a st at eme nt from the manage me nt repres ent i ng that
they ha"e supplied the audit ors with all the informati on and
explanat i ons rele"ant to the audit and disclosed in the financi al
st at eme nt all mat t er s required by st at ut e and accounti ng
st andar ds@
kB # re"iew of post balance sheet dat e e"ent s up to the dat e of
signing the audit report@
lB ames and initials of the audit st aff@
St andar di s at i o n o worki ng 1a1er s
"he IC+AK gui del i ne st at e s that the use of standar di:ed working
paper s may impro"e the efficiency with which they are prepar ed and
re"iewed. <sed properl y they help to instruct audit st aff and facilitat e the
delegati on of work while pro"iding a means to control its quality.
=owe"er, despit e the ad"ant ages of st andar di si ng the routine
document at i on of the audit Ae.g. checklist s, speci men lett ers, standar d
organi:ation of the working paper sB it is ne"er appropri at e to follow
mechani cally a >st andar dJ approach to the conduct and document at i on of
the audit without regard to the need to exercise professi onal Dudgement .
+n balance, ther e should be a degree of st andar di:ation of working paper s
and practically all firms recogni se this need. 7inally, it should be not ed
that working paper s are the propert y of the audit or and he should adopt
procedur es to ensur e their safe cust ody and confidenti alityNlea"ing them
on the bus or mat at u should therefore be a"oided.
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E&ES"I%N %NE
/uring your audit of )actor 0td, the following e"identi al mat t er had been
included in your working paper s:
i. 7lowchart s of the companyJ s payroll routine prepar ed by your
audit assist ant backed up by compli ance test s.
ii. #n oral st at eme nt by the production direct or that the expect ed
working life of plant acquired in Ganuary ('99 is (4 years.
iii. # newspaper report to the effect that the new technology is
expect ed to ha"e ad"erse effect on the sales of product s
repres ent i ng $4T of the companyJ s turno"er.
i". # lett er to the managi ng direct or from the companyJ s bank
manager indicati ng that the bank intends to ext end o"erdr aft
facilities for a period of one year.
". # list of items of stock count ed by a member of your firm of
1ertified 2ublic #ccount ant s during obser"ati on of the
companyJ s stock count.
"i. # lett er from a debt or to your firm in reply to a confirmati on
request indicating agree me nt with the balance as recorded in
the books of )actor 0td.
#e@ui re d
In respect of each of the abo"e e"identi al mat t er s:
AaB -xplain its rele"ance to the o"erall audit obDecti"e of forming an
opinion and reporting on the financi al st at eme nt s
AbB !tat e, gi"ing reasons, how reliabl e you Dudge the e"idence to be
AcB /escribe one additional item of audit e"idence you would seek
to support the mat t er described.
E&ES"I%N "3%
Qou are about to comme nc e the final audi t of Higgl ane !port swear
0imit ed, a distribut or of sport s equipment and clothing. The internal
auditor informs you that he has carried out a positi"e debt orJ s
circularisati on without your prior knowledge, utilising the following
procedur es:
i. +bt ained a list of out st andi ng debt or s balances Atot al .shs.
*K&, 444B at *( +ctober $44%.
ii. !elect ed e"ery third debt or for circularisation resulting in a
sampl e of *4 debt or s tot alling .shs. 54, 444.
iii. 2repar ed and signed the circularisati on lett er himself. The
lett er request ed the debt or to write the balance due to
Higglance 0imited on the reply slip and to return the reply to
the chief account ant .
i". 2repar ed a summar y list of all replies recei"ed for submi ssi on to
the ext er nal audit or.
+nly eight replies A"alue .shs(4, 544B had been recei"ed to dat e.
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The internal auditor is a little dist urbed at the fact that you intend to
re- circularise debt ors as he feels that it is a duplication of effort and
that the replies recei"ed are reliable audit e"idence.
(ou are re@ui re d to
AaB /escribe the work which you perfor m before you can make
use of any of the work undert aken by the internal audit or.
AbB -xplain to the internal auditor the reasons why you wish to re-
circularise debt or s, comment i ng upon the procedur e adopt ed by
the internal audit or.
AcB /escribe the techni ques which you could adopt to increas e the
respons e rat e of the second debt or s circulation made by you.
AdB -xplain the possi bl e limit ations of positi"e debt or s circulation.
E&ES"I%N "$#EE
It has been your practice for some years to obt ain lett ers of represent at i on
from the manage me nt of audit client compani es. The newly appoi nt ed
managi ng direct or of a client company has, howe"er, express ed
reluct ance to sign a lett er of repres ent at i on, a suggest ed draft of which
you sent him, and he makes the following obser"ati ons in his reply to your
request for such a lett er.
i. The company employs se"er al qualified account ant s who are
responsi bl e for prepari ng accur at e account s which compl y
with the 1ompani es #cts and st at eme nt s of st andar d
accounti ng practice. It is his under st andi ng that it is the
responsi bility of the audit ors Awho recei"e a subst ant i al fee
for their ser"icesB and not his responsi bility to "ouch for the
accuracy of the account s and the auditors ha"e access to all
accounti ng records, direct orsJ minut es, correspondence and
internal audit depar t ment report s, etc and e"en aut horit y to
approach third parties to enabl e them to draw their own
conclusions.
ii. =e is not an account ant or lawyer and is not qualified to
comment on some mat t er s cont ai ned in the lett er.
iii. =e and a fellow direct or will be signing the balance sheet
before the report is signed.
#e@ui re d
/raft your reply to the managi ng direct or
E&ES"I%N 7%&#
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Qour firm has been appoint ed audit ors of 1ompa 8ing 0td in successi on to
anot her firm of 1ertified 2ublic #ccount ant s. The first financi al stat e ment s
on which you are required to express an opinion are for the year ended
*4t h !ept ember $44*
(ou are re@ui red to det ai l
AaB Qour responsi bilities in respect of prior period financi al informati on,
including compar at i "es, and
AbB The procedur es you would adopt in order to discharge your
responsi bilities.
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E&ES"I%N 7I'E
The moder n approach to >risk- based auditingJ is a most welcome
de"elopment .
#e@ui red
AaB -xplain what you underst and by risk- based auditing.
AbB 0ist our factors which could indicat e pot enti al high risk areas
on a particul ar audit. Qou should gi"e reasons in your answer.
AcB -xplain why there has been an increas ed use of a risk- based
auditing approach in recent years and what ad"ant ages arise
for the audit or from the adopti ng of such an approach.
AdB 8isk- based auditing is often associ at ed with the use of st ati stical
sampling techni ques in auditing. -xplain why the two are
associ at ed, gi"ing an illustration of the circumst ances when
st ati stical sampling techni ques are, and when they are not,
appropri at e in this cont ext .
AeB !tat e what you under st and by >confidence le"elJ in relation to
st ati stical sampling.
Check your ans wer s wit h thos e gi 0en in 2es s on .5
o the Study +ack
A&*I"IN-
.85 "he Audi t +roc e s s B 'eri i cat i on
o Ass e t s and 2ia,ili ti e s
2ESS%N 7I'E
"he Audit 1rocessB 'eriication o Assets and 2ia,ilities
%B=EC"I'ES
-xplain the nat ur e and import ance of "erification of asset s and
liabilities
-xplain the import ance and purpose of subst ant i "e procedur es in
relation to financi al stat e ment asserti ons concer ni ng asset s and
liabilities.
-xplain the sources, sufficiency appropri at enes s and others issues on
audit e"idence.
C%N"EN"S
The topics co"er ed under this lesson are:
AiB ature of "erification and the asser ti on met hodol ogy
AiiB 6erification of asset s
AiiiB 6erification of liabilities
Ai"B The #udit of #ccounti ng -sti mat es
A"B on current asset s held for sale and discontinued operations
INS"#&C"I%NS
#ssigned 8eading
Int ernat i onal Account i ng Standards F Internat i onal 7inanci al
#e1orti ng Standards
Int ernat i onal st andards on audi ti ng
I!#s
544 #udit -"idence
54( #udit e"idence P #dditional 1onsi der at i on for !pecific Items
545 -xt ernal 1onfirmat i ons
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8/ 5 Introduct i on
/espit e any reliance on any controls, the auditor must subst ant i at e the
subst ance of the account s. =e must obt ai n e"idence that the account s
gi"e a true and fair "iew. To do that he has to "erify the amount s
att ached to asset s and liabilities in the account s.
'erii cati on is dei ne d as 1ro0i ng the aut he nt i ci t y o the recorde d
amount s o ass e t s and lia,ili ti e s / 'erii cat i on is achi e0e d ,y
conirmi ng cert ai n act ors a,out an ass e t or a lia,ili t y ,al anc e /
Whilst you st udy this lesson you shoul d ha"e in mind at all time the
obDecti"e of the audi t or and the purpos e of the e"idence being sought .
ISA .00 Audit $vidence was introduced in lesson % in which we
est abli shed the financi al st at e me nt asser t i ons of:
aB -xist ence
bB 8ight and obligati ons
cB +ccurr ence
dB 1ompl et ene s s
eB 6aluation
fB ,easur e me nt
gB 2resent at i on and disclosur e.
The audi t or needs to subst ant i at e thes e asser ti ons with subst ant i "e
procedur es.
Qou shoul d keep in mind the audi t testi ng techni ques A#nalytical
procedur es, -nquiry, Inspect i on, +bser"at i on, and 1omput at i onB.
8eme mber that audi t e"idence shoul d be sufficient and appropri at e.
Qou will also need to ha"e a thorough knowl edge of the account i ng
st andar d requireme nt from your financi al account i ng studi es Afor
exampl e, financi al account i ng III and I6B. 2lease also not e that the det ail
of the account i ng st andar d requir eme nt s I! +T repeat ed in this
text book.
#rmed with these Vtools? and common sens e approach you shoul d be
abl e to desi gn an audi t progr amme to deal with all areas of the financi al
st at e me nt . Qou shoul d bear in mind also that most of the following
mat t er s ha"e a si milar theme. They are likely to ha"e some or all of the
following condi tions in common:
aB )e a critical area of the financi al st at e me nt s
bB The subD ect of an account i ng st andar d which has specifics
disclosur e requireme nt s and recogni tion and meas ur e me nt
principl es.
cB # cont ent i ous or subD ecti"e account i ng area which has alt er nat i "e
treat me nt s
dB # high risk mat t er
eB #n area in"ol"ing high degr ee of Dudgment
fB #n area wher e the mai n source of e"idence is that from
manage me nt .
The exami ner is likely to ask questi ons on areas of the financi al
st at e me nt s which requir e st udent s to demons t r at e that they can appl y
an effecti"e audit strat egy to them.
A&*I"IN-
.86 "he Audi t +roc e s s B 'eri i cat i on
Ass ert i ons
6erification has obDecti"es "ery similar to the obDecti"es of subst ant i"e
test s that we co"ered under audit e"idence and these are:
8/ .. CostB This repres ent s the original monet ar y amount at
which an asset was acquired or a liability was
incurred. It is crucial to det er mi ne cost becaus e for
most asset s under the historical cost accounti ng
con"ention "aluation is a function of cost.
8/ .6 Authori Gat i onB This is to ensur e that ther e is proper aut horit y to
acquire the asset or incur the liability. Thus e"ery
transacti on that result s into an asset or a liability
must be aut horised at the appropri at e le"el.
8/ .4 'aluat i onB #sset s and liabilities should be disclosed at the
appropri at e carrying amount . #sset s are usually
"alued at cost less a pro"ision thus, fixed asset s are
"alued at cost less depr eci ation. !tocks are "alued at
cost less pro"ision for obsol escence, debt or s are
"alued at cost less pro"ision for bad and doubtful
debt s. 7ixed asset s can also be "alued at a "aluation
less depr eci ation based on that "aluation. 0iabilities
are normally "alued at cost unless they in"ol"e
interest for late payment s or foreign exchange
transacti ons.
8/ .; Exi st e nc eB ot only should asset s and liabilities ha"e a cost and
a "alue ther e has to be e"idence that they act ually
exist, becaus e asset s could ha"e been lost, stolen or
otherwi se det eriorat ed.
8/ .8 Bene i ci al %wner s hi 1 (#i ght s and %,li gat i on)
This is exactl y the same as right s and obligations
under audit e"idence. The asset s may exist, they
may ha"e a "alue, the company may e"en ha"e paid
for them but does a company own themR !o we want
to ensur e that asset s and the right s of the entit y and
liabilities are obligations of the entity. We ha"e to
consider here also subst ance o"er form. !ubst ance
o"er form requires consider at i on of the financi al and
commer ci al reality of transact i ons and not mer el y
their legal form.
8/ .: +res e nt a t i onB
2resent at i on in the account s shoul d be clear and
unambi guous, appropri at e to the nat ur e of the
business, in accordance with rele"ant accounti ng
standar ds, in accordance with rele"ant legislation and
consist ent with pre"ious years. ,ateri ality must be
consider ed in all these mat t er s so that tri"ial mat t er s
are not gi"en undue promi nence in the classification,
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.84
description and cat egori sati on of account s balances.
Exami nat i on 1a1ers will in"ariably cont ai n a question on "erification of
asset s and liabilities. Therefore the student must reme mber these se"en
import ant words menti oned abo"e, becaus e their knowledge can be
applied to any question on "erification and the student can achie"e a good
result.
aB 1ost,
bB #uthori:ation,
cB 6aluation,
dB -xist ence,
eB )eneficial ownershi p and
fB 2resent at i on.
8/ 6 S1eci i c Consi der at i ons and +roce dur e s
8/ 6. Cost and Aut hori Gat i on
1ost and aut hori:ation can be "ouched to appropri at e document at i on
such as in"oices, cash book, agree me nt s, local purchas e orders,
direct or?s minut es. #nother import ant factor to consider under cost
is the distinction bet ween capit al and re"enue expendi t ur e. # check
has to be made to ensur e that all appropri at e items of capit al
expendi t ur e ha"e been capit alised.
8/ 66 'al uat i on and all ocat i on
#s we saw asset s are usually "alued at cost or a "aluation less a
pro"ision for usage or loss of "alue. We ha"e to ensur e therefore
that the accounti ng policy adopt ed in det er mi ni ng the amount of
pro"ision to be writt en off in any one year is in accordance with the
rele"ant I#! or gener ally accept ed accounti ng principles or
1ompani es #cts requirement s. The I#! often allows se"er al
accounti ng policies in a gi"en set of circumst ances. !o the question
can often arise as to whet her the particul ar accounti ng policy chosen
is appropri at e. +ften it falls on the audit or to decide on this
appropri at enes s. To do so, he has to consider the gener al practice in
the indust ry, the pre"ious practice in the company and the
requirement s of the true and fair "iew. !ometi mes the requirement s
of appropri at enes s will o"erride those of the I#! itself. # policy used
for "aluation apart from being appropri at e and accept abl e, must be
consist ent l y applied within the indust ry, within the entity and from
period to period and must be in accordance with I#!.
0iabilities as we said are usually "alued at cost, howe"er wher e they
in"ol"e esti mati on or they are pro"isions for specific liabilities then
they too must be in accordance with clearly st at ed accounti ng
policies. #ll these "alues must be det er mi ned on a historical cost
basis and not repl acement cost.
8/ 64 Exi st e nc e
In the case of tangi bl e asset s exist ence is "erified by the auditor
"isually, seeing the asset concerned and exami ni ng its condition.
This is import ant in that "isual e"idence gi"es the auditor a good idea
A&*I"IN-
.8; "he Audi t +roc e s s B 'eri i cat i on
as to the reasonabl enes s of the "alue att ached to the asset . Where it
is not possibl e to "isually see the asset concerned, then we ha"e to
look for relat ed e"idence for exampl e, if a company clai ms to own
land payment of rat es to the appropri at e local aut horit y is e"idence
that the plot of land exist s. 7or asset s that cannot be physically
exami ned, independent confirmat i on from third parti es would suffice.
We ha"e to take into account cut off arrange me nt s to ensur e that
exist ence is at the balance sheet dat e and not at any other time.
8/ 6; Bene i ci al owner s hi 1 B( #ight s and o,l i gat i ons )
=ere we ha"e to exami ne document s of title, e. g. title deeds, mot or
"ehicles log books. Where howe"er there are no titles, implied
ownershi p can suffice, for exampl e stock items may ha"e no title
document s but the fact that we order ed them, we paid for them, we
recei"ed them, they are in our warehous e, nobody else is laying
clai m on them, then it follows by implication that they are ours. This
also in"ol"es subst ance o"er form transacti ons. If the commer ci al
reality of a transacti on is that the rewards and risks of owner shi p
reside in the user then there is strong e"idence that the user for all
practical purposes is the owner of the asset and shoul d recogni se it
as such despit e contrar y indications due to legal arrange me nt s in
exist ence.
8/ 68 +res e nt a t i on and di scl os ur e
2roper present at i on includes present at i on in accordance with the
appropri at e I78!CI#! or Internati onal #ccounti ng !tandar ds. #doption
of accounti ng policies which are appropri at e to the circumst ances of
the company and are adequat el y stat ed. 1onsist ent application of
accounti ng policies and wher e change in policy is deemed necess ar y
with 1ompani es #cts, airobi stock exchange and I#! requirement s
and taking into account mat eri alit y.
8/ 4 Audi t o Ass e t s
on current asset s ha"e the fundament al charact eri stic that they are
held for use in the business and not for resal e. IAS / Present ation of
financial stat e me nt s defines current asset s as those asset s which are
expect ed to be sold or consumed in the course of the operati ng cycle
or asset s which are held pri marily for short ter m trading purposes
and are expect ed to be realised with in ($ mont hs of the reporting
dat e or cash and cash equi"al ent s / #ll other asset s are classified as
non current asset s which are also described as long ter m asset s or
fixed asset s.
8/ 4. Non Current Ass et s (7i xed Ass e t s )
In most count ri es, non current asset s are gener ally classified as:
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aB Intangi bl e asset s
2at ent s
0icences
/e"elopment 1ost s
Hoodwill
bB Tangible #sset s
0and and buildings
2lant and -quipment
7urniture, fixtures and fittings
cB In"est ment s
0oans
!hares
8/ 46 "angi ,l e Non Current Ass et s
The "erification approach is essent i ally similar in all these. -xtensi"e
disclosur e is required in most count ri es and IAS /0 Propert " Plant
and $1uipment # IAS 30 Impairment of Asset s and I78! 5 on 1urrent
#sset s held for !ale and /isconti nued +perati ons are the
aut horit ati"e accounti ng document at i ons. A#lso IAS 2B
(a) 2and and ,uil di ngs > 7reehol d
Account i ng +rinci 1l e s
'erii cati on +roce dur e s
Cost and aut hori Gat i on
The cost of land and building acquired during the year shoul d be "ouched
to appropri at e document at i on.
These are contract of sale, sur"eyorJ s certificat es, solicitors
correspondence, cash book and in the case where a loan was obt ai ned
correspondence with the bank. The audit or must det er mi ne what the
client considers to be cost. Where the buildings ha"e been const ruct ed by
the client, then the auditor must re"iew compl etion certificat es and
costing sheet s with regar d to internal labour and mat eri al s expended on
the building as these are often o"erlooked. 7or aut hori:ation, the auditor
shoul d look to the direct ors minut es and to confirm that the companyJ s
seal was used to seal the agree me nt of purchas e.
'al uat i on
I#! (& requires that all asset s for use by the business shoul d be "alued on
the basis of depr eci at ed historic cost s with one excepti on. I#! (& st at es
that freehol d land should not be depreci at ed except in the e"ent that the
reduction in "alue is due to depl etion through for exampl e mining or due
to changed economi c circumst ances. The reason for not depreci ati ng
freehol d land is quit e appar ent when one looks at the definition of
depr eci ation. /epreci ation is the allocation of historic cost s o"er the
useful life of the asset . #s freehol d land has no finite useful life, there is
no basis for calcul ating depr eci ation. 7reehol d buildings shoul d be
depr eci at ed and the auditor must check that the esti mat ed useful life is
reasonabl e and that the calculations ha"e been correctl y made. The split
A&*I"IN-
.8: "he Audi t +roc e s s B 'eri i cat i on
ther efor e bet ween freehol d land and the buildings on that land must be
est ablished to be reasonabl e.
Exi st e nc e
-xist ence of 0and and buildings is not difficult to pro"e. Qou may e"en be
sitting in the building. =owe"er, the auditor needs to be sure that the land
and buildings that he is seei ng are the act ual land and buildings referred
to in the account s. =e may ther efore need e"idence from a map of the
area concerned.
Bene i ci al owner s hi 1
Title deeds would usually be a"ailabl e for freehol d land and they must be
exami ned to ensur e that they are "alidly in the name of the company.
0and is often subDect to mort gage so the audit or must be careful to ensur e
that such charges are correctl y disclosed in the account s. !uch charges
shoul d also be recorded in the companyJ s regist er of charges. Title deeds
shoul d be exami ned aut omat i cally on e"ery audit. There is no title deed
to a building therefor e beneficial ownershi p is implied, that is the building
is on our land we paid for it, the title deed of the land is in our name, we
occupy that building, it follows that the building is also ours.
+res e nt a t i on
2resent at i on will be co"er ed when all other fixed asset s ha"e also been
consider ed.
8/ 44 2eas e hol d 1ro1ert y
-xactly the same procedur es are adopt ed for leasehol d land and buildings
as applied to freehol d land and buildings except in the issue of
depr eci ation. There is no split bet ween land and buildings when it is
leasehol d. In this case the land and buildings are amorti sed o"er the life
of the lease e"en though the buildings may ha"e an economi c life longer
than that of the lease. The argument for this is that the landlord aft er the
end of the lease can comfort abl y ask you to take your building and go and
he want s his land back. The ter m used is amorti sati on not depreci ati on.
"he aut hori t at i 0e docume nt is IAS .C 2eas e s
The appropri at e met hod of depreci ati on or amorti sati on to use in the case
of freehol d buildings and leasehol d propert y is straight- line. This is
becaus e ther e is no obDecti"e basis of det er mi ni ng whet her one year has
benefit ed mor e from the use of the land and building than any other year.
The mai n probl em in the audit of leased asset s in the books of the user
of the asset is to ensur e that a proper split has been made bet ween
asset s under an oper at i ng lease and asset s under a finance lease. It
shoul d be recogni:ed that ther e may be a high risk in this area due to
the client preferri ng the asset to be recogni:ed as an oper at i ng lease as
this will keep the asset and the liability off the bal ance sheet .
The definition of a finance lease Aone under which subst ant i ally all risks
and regar ds of owner shi p are transf err ed to the lesseeB is not easy to
appl y in practice.
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The calcul ati ons used to det er mi ne whet her a lease is a finance lease
can be quit e compl ex and thus the audi t or must ensur e that he
under st ands the principal s behi nd the calcul ati ons and that the
assumpt i ons used Ae. g. the implicit rat e of int er est B are reasonabl e.
=a"ing under st ood the principl es, a sampl e of the calcul ati ons need to be
checked for all leases i.e. includi ng those which the client has desi gnat ed
as oper at i ng leases.
7or the leases which ha"e been classified as finance leases, a sampl e
needs to be checked for the following mat t er s:
AiB 1heck met hod used to split int er est and capit al
AiiB 1heck the met hod is correctl y applied to lease payment s
AiiiB 1heck depr eci at i on is based on the short er of the lease ter m
and the useful life of the asset to the lessee.
In addition Vnor mal? audit test s appl y to "erification of the asset as for
any other non current asset .
If the lease has been classified as an oper at i ng lease, then a check is
required of the manner in which the rent al s ha"e been char ged to the
income st at e me nt . # check shoul d also be made on the physi cal
exist ence of the asset if at the time of the audit the lease is still in
exist ence.
7inally regar d shoul d be made to the possi bility of asset s being held
under leases also being shown in nor mal non current asset s in the
bal ance sheet . This is particul arl y rel e"ant to oper at i ng leases wher e the
exist ence of a physi cal asset at the bal ance sheet dat e may be used to
suppor t the inclusion of the asset in the non current asset account .
8/ 4; +l ant and machi nery
Cost and aut hori Gat i on
!ignificant plant and machi ner y acquired during the year is "ouched to
supporting document at i on such as supplier?s in"oices, cash books,
appro"ed budget s, local purchas e orders etc. The audit or shoul d ensur e
that the relat ed expendi t ur e such as carriage inwards, inst allation charges
ha"e been included as appropri at e.
A&*I"IN-
.8D "he Audi t +roc e s s B 'eri i cat i on
'al uat i on
6alued at depreci at ed historic cost s. #uditor?s responsi bility is to ensur e
that the accounti ng policy for depreci ati on is appropri at e. 7or exampl e if
the diminution in "alue of an asset is relat ed largely to time it would not
be appropri at e to use a reduci ng balance met hod but rat her straight- line
met hod should be used. The audit or has to ensur e that the accounti ng
policy is in accordance with I#! (&. =e has to consider whet her the useful
li"es of the asset s are appropri at e and he has to check that the
calculations are correctly made.
Exi st e nc e
This shoul d nor mally be checked by physical inspecti on, howe"er a
probl em arises. Items of plant and machi ner y can be mobile, numer ous,
port abl e and "aluabl e. It becomes difficult ther efor e for the auditor to be
assur ed that the "alue att ached to plant and machi ner y repres ent s plant
and machi ner y that act ually exist s at the balance sheet dat e. We shall
ther efor e digress a little and consider a record that is crucial in ensuri ng
the exist ence of fixed asset s under this cat egory and this is the ixed
ass e t s regi s t er/
The fixed asset regist er is an import ant independent regist er which
auditors in"ari abl y encour age their client s to maint ai n. 7or it to be a truly
independent regist er the person mai nt ai ni ng it must ha"e no responsi bility
for:
aB +rdering or aut horising the purchas e of fixed asset s.
bB The cust ody of the fixed asset s.
cB #uthorising the disposal of fixed asset s.
dB ,aint aining gener al ledger account s.
eB 1ust ody of readily realisabl e asset s.
If the regist er is properl y maint ai ned then it has the following
ad"ant ages for the audit or:
aB The internal control o"er fixed asset s is strengt hened and ther e
is an independent record of all fixed asset s showing particul arly
their location. This record can be independent l y checked to the
asset s thems el "es on a periodic basis.
bB #ccurat e depr eci ation records can be mai nt ai ned for e"ery
asset .
cB it assist s the auditor in checking the compl et enes s and
exist ence of the asset s, it would be al most impossi bl e to do this
from the gener al ledger.
dB it pro"ides a good record for tax purposes in calcul ations of
wear and tear.
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The regist er can usefully cont ai n the following informati on:
i. 7ixed asset number .
ii. 7ixed asset location and responsi bility for cust ody.
iii. ature and description of the asset .
i". The cost and the dat e of purchas e.
". the esti mat ed useful life and the residual "alue.
"i. The accounti ng policy for depr eci ation.
"ii. The accumul at ed depreci ati on and net book "alue.
"iii. The gain or loss on disposal.
ix. 1apit al allowances.
When the fixed regist er is reconciled to the gener al ledger the auditor can
check the asset for physical exist ence by reference to the number s and
locations recorded.
7or plant and machi ner y usually implied and unless ther e is clear e"idence
to the contrary, proof of purchas e and possessi on will suffice as e"idence
of owner shi p.
8/ 48 !ot or 0ehi cl e s
!imilar consider ati ons go"ern the audit of mot or "ehicles as to those
relating to plant and machi ner y. The only issue of consider ati on here is
exist ence and owner shi p. ,otor "ehicles being mobile may not be
a"ailabl e for the auditor to physically "erify when he pays his "isit.
8elat ed e"idence can suffice howe"er to pro"e exist ence for exampl e if we
own the mot or "ehicle we expect that if it is being used it will incur cost s
such as insurance, repairs and maint enance, and fuel. The engine and
chassi s number s shoul d be checked against the log book to ensur e that it
is the same "ehicle that we are looking at as client s ha"e been known to
change the registration number plat es from one "ehicle to anot her.
-nsure that the log book is in your client J s name.
8/ 4: 7urni t ure? ixt ure s and itti ngs
The only issue here to not e is the depr eci ation of fixtures and fittings.
)ecause of their nat ur e, this is usually done on replacement basis rather
than calcul at ed and charged on an annual basis. In other words the initial
cost is capit alised and any subsequent replacement are charged to the
profit and loss account as they are incurred. 7urniture is depreci at ed Dust
like plant and machi ner y.
8/ 4C *i s1os al o Non> current Ass et s
The issue here is aut hori:ation for disposal and the eliminati on of the
asset s concerned from the records. The auditor also tries to ensur e that
the "alue obt ai ned was reasonabl e either by looking at "aluations
obt ai ned independent l y from professional "aluers before the disposal and
looking at the book "alue of the asset and relat ed "alues for asset s of that
nat ur e.
A&*I"IN-
.:5 "he Audi t +roc e s s B 'eri i cat i on
8/ 4D +res e nt a t i on and *i scl os ur e ("he re@ui re me nt s o
Int ernat i onal Account i ng St andards / )
I#! (& pro"ides exclusi"e disclosur e requirement s.
7ixed asset s should be split into appropri at e classes and the following
shoul d be disclosed:
aB The depreci ati on met hods used
bB The useful li"es or the rat es of depreci ati on used
cB The tot al depreci ati on for the period and
dB The gross amount of depreci abl e asset s and the relat ed
accumul at ed depreci ati on
The split bet ween freehol d and leasehol d land must be shown
toget her with the split bet ween long and short ter m leases.
2resent l y wher e the client has fully depreci at ed asset s which are
mat eri al their cost and notional depr eci ation charge are also
disclosed. Where fixed asset s ha"e been re"al ued and incorpor at ed
in the account s then also the name of the "aluer, the qualification of
the "aluer, the addr ess of the "aluer and the dat e of "aluation must
also be disclosed. In this case, the modification of the historical cost
account s must also be disclosed as a not e to the account s.
IAS 65 Account i ng or go0er nme nt grant s and di scl os ur e s o
go0ernme nt as si s t a nc e
The audit or needs to "erify the grant s ha"e been properl y identified as
relat ed to income and capit al expendi t ur e in the account i ng period. In
particul ar, the audit or shoul d ensur e that the condi tions of the grant are
being met @ they may be repayabl e under cert ai n circumst a nc es .
It is also neces s ar y to confirm that the grant s ha"e been account ed for in
accor dance with I#! $4. 7or exampl e that capit al grant s are recogni:ed
o"er the expect ed useful life of the relat ed asset and re"enue grant s are
mat ched agai nst the relat ed expendi t ur e.
There are two accept abl e met hods of account i ng for capit al grant s. They
can either be net t ed of agai nst the asset Aand the net cost of the asset is
then depr eci at edB or the grant can be treat ed as deferr ed income and
then allocat ed to the income st at e me nt on the same basi s as
depr eci at i on is char ged on the rel at ed asset . 8e- perfor manc e and
accur acy test s shoul d be perfor med by the audit or.
The audi t or shoul d ensur e that the account i ng policy is appropri at e in
accor dance with the st andar d and properl y discuss ed.
Intangi ,l e Ass e t s
-oodwi l l and Busi ne s s Com,i nat i ons
-oodwi l l is the mos t strange of all asset s becaus e it cannot be
distingui shed from the business. It cannot be sold on its own as asset . It
is the most difficult to ascribe a "alue to. There is no reliabl e basis for
det er mi ni ng the "alue of this asset .
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The problem with internally gener at ed goodwill is trying to quantify the
asset . Therefore, internally gener at ed goodwill should not be recogni sed
as an asset in account s meant to gi"e a true and fair "iew. Therefore if
the audit or finds a set of account s wher e internally gener at ed goodwill has
been recogni sed as an asset in the balance sheet then, he should be
awar e that this treat me nt is against the requirement s of I#! and should
accordingl y qualify his report .
Account i ng +ri nci 1l e s
I78! * prescri bes the financi al reporti ng by an entit y when it under t akes
a busi ness combi nat i on. # busines s combi nat i on is the bringing toget her
of separ at e entiti es or busines s es into one reporti ng entit y.
#ll busi ness combi nat i ons are account ed for by appl yi ng the purchas e
met hod, which
"iews the busi ness combi nat i on from the perspect i "e of the acquir er. The
acquirer is
the combi ni ng entit y that obt ai ns cont rol of the other combi ni ng entiti es
or busi ness es
Athe acquireeB
.
The acquir er meas ur es the cost of a busines s combi nat i on as the
aggr egat e of:
The fair "alues, at the dat e of exchange, of asset s gi"en, liabilities
incurred or assume d, and equit y instrument s issued by the
acquirer, in exchange for cont rol of the acquiree@ plus
#ny cost s directl y att ri but abl e to the busines s combi nat i on.
#ny adDust me nt to the cost of the combi nat i on, that is contingent on
futur e e"ent s, is
included in the cost of the combi nat i on at the acqui si tion dat e if the
adDust me nt is
probabl e and can be meas ur ed reliabl y.
The acquir er allocat es the cost of the busi ness combi nat i on by
recogni :i ng the acquir ee?s identifiabl e asset s, liabilities and contingent
liabilities at their fair "alue at the dat e of acqui si tion, except for non-
current asset s that are classified as held for sal e in accor dance with I78!
5 3on4 !urrent Asset s 5eld for Sal e and (isconti nued Operations . !uch
asset s held for sal e are recogni:ed at fair "alue less cost s to sell.
-oodwi l l , being the excess of the cost o"er the acquirer?s int er est in the
net fair "alue of the identifiabl e asset s, liabilities and conti ngent
liabilities, is recogni :ed as an asset .
Hoodwill is subseque nt l y carri ed at cost less any accumul at ed
impai r ment losses in accordance with I#! *& Impairment of Asset s . If the
acquirer?s int er est in the net fair "alue of the identifiabl e asset s,
liabilities and contingent liabilities exceeds the cost of the combi nat i on,
the acquirer:
A&*I"IN-
.:6 "he Audi t +roc e s s B 'eri i cat i on
8eass es s e s the identification and meas ur e me nt of the acquir ee?s
identifiabl e asset s, liabilities and conti ngent liabilities and the
meas ur e me nt of the cost of the combi nat i on@ and
8ecogni :es immedi at el y in profit or loss any excess remai ni ng
aft er that reass es s me nt .
I78! * specifies the account i ng treat me nt :
7or busi nes s combi nat i ons that are achi e"ed in st ages@
Wher e fair "alues can only be det er mi ned pro"isionall y in the
period of acqui si tion@
Wher e deferr ed tax asset s are recogni:ed aft er the account i ng for
the acqui si tion is compl et e@ and
7or pre"iousl y recogni :ed goodwill, negat i "e goodwill and
int angi bl e asset s.
*i scl os ur e #e@ui re me nt s
I78! * also specifies disclosur es about busines s combi nat i ons and any
relat ed
goodwill.
Audi t +roce dur e s
The auditor?s procedur es as far as goodwill is concer ned would include:
aB 6ouching for det ails as per the purchas e agree me nt of the "alues
attribut ed to the asset s purchas ed and whet her the price obt ai ned
was reasonabl e consideri ng similar business es.
bB 8e"iew of the account s of the business concer ned and
det er mi ni ng whet her the business is profit abl e and can ther efor e
Dustify the continued recognition of goodwill as an asset .
cB 1onsider impair ment test s in accordance with I#! *&. ATop down
and bott om up test s under I#! *& Impair ment of #sset sB
dB 1onsider the requirement s of I!# 5%5 #uditing 7air 6alue
meas ur e me nt s
8/ ;6 #es e arc h and *e0el o1me nt
Introduct i on
=istory of business is littered with cases of compani es that ha"e collapsed
as a result of o"er indulgence in resear ch and de"elopment on product s
that ha"e pro"ed tot ally unprofit abl e. <nfort unat el y most of these could
not ha"e been easily seen from the precedi ng financi al stat e me nt s. # lot
of compani es simply capit ali:ed resear ch and auditors made little att empt
to find out whet her the "alues attribut ed to this asset were realistic.
8esearch is a necess ar y expens e in earni ng re"enue and can Dustifiably be
mat ched against it. =owe"er, when resear ch and de"elopment
expendi t ur e is incurred now, ther e is no telling when and if the associ at ed
re"enue will mat eri alise. The concept of prudence would dict at e that such
expendi t ur e be writt en off as it is incurred.
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The aut horit ati"e document on resear ch and de"elopment is Internati onal
#ccounti ng !tandar d o.*9 Intangi bl e #sset s ,
I#! *9 Intangi bl e Asset s was issued in ,arch $44% and is appli ed to the
account i ng for int angi bl e asset s acquir ed in busi nes s combi nat i ons aft er
*( ,arch $44%, and to all other int angi bl e asset s for annual periods
begi nni ng on or aft er *( ,arch $44%.
I#! *9 prescri bes the account i ng treat me nt for int angi bl e asset s, except :
aB Intangi bl e asset s that are within the scope of anot her !t andar d.
7or exampl e, I#! $ Invent ori es applies to int angi bl e asset s held for
sal e in the ordinar y course of busines s@
bB ,ineral right s and expendi t ur e on explor ati on for, or de"el opme nt
and extr acti on of non- regener at i "e resources.
#n int angi bl e asset is initially recogni :ed at cost if all of the following
crit eri a are met :
aB The asset meet s the definition of an int angi bl e asset i.e. it is
identifiabl e and cont roll ed by the entit y@
bB It is probabl e that futur e economi c benefit s that are att ri but abl e to
the asset will flow to the entit y@ and
cB The cost of the asset can be meas ur ed reliably.
Internally gener at ed goodwill, brands, mast he a ds , publishi ng titles,
cust omer lists and si mil ar items are not recogni:ed as asset s.
-xpendi t ur e on resear ch is recogni :ed as an expens e. There is no
recogni tion of an int angi bl e asset arising from resear ch. #n int angi bl e
asset arising from de"el opme nt is recogni:ed only if specified crit eri a are
met .
If an int angi bl e item des not meet the crit eri a for recogni ti on as an asset ,
the expendi t ur e is recogni sed as an expens e when incurred. -xpendi t ur e
that was initially recogni sed as an expens e is not included in the cost of
an int angi bl e asset at a lat er dat e.
!ubsequent to initial recogni tion, an int angi bl e asset is carri ed at:
aB 1ost, less any accumul at ed amor ti :at i on and any accumul at ed
impai r ment losses@
or
bB 8e"al ued amount , less any subs equent accumul at ed amor ti :ati on
and any accumul at ed impair ment losses. The re"al ued amount is
fair "alue at the dat e of re"al uat i on and is det er mi ned by
refer ence to an acti"e market .
#n int angi bl e asset can only be carri ed at re"al ued amount if ther e is an
acti"e market for the asset . #ny re"al uat i on increas e is credi t ed directl y
to equit y as re"al uat i on surpl us, unl ess it re"er ses a re"al uat i on
decr eas e of the same asset pre"iousl y recogni sed in profit or loss. #ny
re"al uat i on decr eas e is recogni sed in profit or loss. =owe"er, the
decr eas e is debit ed directl y to the re"al uat i on surpl us in equit y to the
ext ent of any credi t bal ance in re"al uat i on surpl us in respect of that
asset .
A&*I"IN-
.:; "he Audi t +roc e s s B 'eri i cat i on
#n entit y asses s es whet her the useful life of an int angi bl e asset is finite
or indefinit e@ the useful life is indefinit e if ther e is no foreseea bl e limit to
the period o"er which the asset is expect ed to gener at e net cash flows.
The depr eci abl e amount of an int angi bl e asset with a finit e life is
amor ti sed on a syst e ma t i c basi s o"er its useful life.
#n int angi bl e asset with an indefinit e useful life is not amor ti :ed, but is
test ed for impai r ment at least annuall y. Impair ment of int angi bl e asset s
is recogni sed in accordance with I#! *& Impairment of Asset s .
The gain or loss on derecogni :i ng of an int angi bl e asset is the difference
bet ween the net disposal proceeds, if any, and the carryi ng amount of
the item. The gain or loss is recogni sed in profit or loss.
*i scl os ur e #e@ui re me nt s /
I#! *9 specifies disclosur es about int angi bl e asset s.
Audi t +roce dur e s
The auditor should ensur e that :
aB #ny cost s incurred in the purchas e of fixed asset s in order to
pro"ide facilities for resear ch and de"elopment o"er a number
of accounti ng years are to be capit alised and writt en off o"er
their useful li"es@
bB -xpendi t ur e on researc& should be writt en off as it is incurred@
cB /e"elopment expendi t ur e should also be writt en off as it is
incurred except in the "ery speci al circumst ances
mentioned abo"e. If de"elopment cost s are as defined,
they should be amorti sed on the basis of sales or use of
the product or process. The amount deferr ed shoul d be
re"iewed each year and if there are any doubt s as to its
reco"er ability, it should be writt en off immedi at el y. +nce
writt en off, resear ch and de"elopment expendi t ur e should
not be reinst at ed@
dB ,o"ement s and balances of deferred de"elopment cost s
should be fully disclosed in the account s as a separ at e
item and not included in current asset s. The accounti ng
policy adopt ed shoul d be fully explained. The mo"eme nt s
that need to be disclosed are: the balance at the beginni ng
of the year, additional expendi t ur e during the year, less
expendi t ur e writt en off during the year and the amount
carried forward.
The two key issues in the audi t of int angi bl e asset s are:
(a) #ecogni t i on o int angi ,l e as s e t s
The audi t probl em her e is to ensur e that all the requir eme nt s of I#! *9
are net before int angi bl e asset s are recogni:ed. The identificati on,
meas ur e me nt and distincti on bet ween Vresear ch? and Vde"el opme nt ?
expendi t ur e are pot ent i ally difficult areas for the audi t or.
(,) !eas ur e me nt at er ini ti al recogni t i on
Intangi bl e may only be re"al ued upwar ds Aalthough in practi ce this may
be rareB if an acti"e market in them exist s. If an acti"e market does
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exist e"idence of "aluati on will be a"ailabl e. #cti"e market s are typical
in many indust ri es. 7or exampl e fishing quot as in the fishing indust r y
may be purchas ed by a company at .shs. per tonne. This increas e can
be reflect ed in the financi al st at e me nt s by the company pro"ided that it
is "erifiabl e from obser"ed acti"it y of buyi ng and selling of quot as on the
market and the "erification of price e"idence.
The st andar d defines resear ch and de"el opme nt as follows:
(a) 8esear ch P original and planned in"esti gat i on under t aken with the
prospect of gaini ng new scientific or techni cal knowl edge and
under st andi ng.
(,) /e"elopme nt P the applicati on of resear ch findings or other
knowl edge o a plan or desi gn for the producti on of new or subst ant i all y
impro"ed mat eri al s, product s de"ices et c. prior to the comme nc e me nt of
commer ci al producti on or use.
8esear ch cost s shoul d be expens ed in the period in which they are
incurred
-nt er pri ses cost s shoul d be expens es in the period in which they are
incurred
-nt er pri se shoul d writ e off all de"el opme nt cost s, unless they can
demons t r at e AaB to AfB below, in which case the cost shoul d be recogni :ed
as an asset .
AaB The techni cal feasi bility of compl eti ng the int angi bl e asset and use or
sell it
AbB The int enti on to compl et e the int angi bl e asset and use or sell it
AcB The ability to use or sell the int angi bl e asset
AdB =ow the int angi bl e asset will gener at e probabl e future economi c
benefit s. #mong other this, the
ent er pri se shoul d demons t r at e the exist ence of a market for the
out put of the int angi bl e asset pr the int angi bl e asset itself or if
it is to be used int er nally the useful nes s of the int angi bl e asset .
AeB The a"ailability of adequat e techni cal , financi al and other resources
to compl et e the de"el opme nt and to use or sell the
int angi bl e asset , and
AfB The ability to meas ur e the expendi t ur e att ri but abl e to the int angi bl e
asset during its de"el opme nt
reliably.
1ost s which wer e originally recogni :ed as expens es cannot be
recogni :ed as asset s in subsequent periods.
Amort i Gat i on P capit ali:ed cost s shoul d be amor ti sed to reflect the
pat t er n in which the relat ed economi c benefi t s are recogni:ed.
+nce commer ci al producti on has comme nc e d de"el opme nt cost s shoul d
be amor ti sed o"er the period of producti on that has benefit ed from the
de"el opme nt expendi t ur e. This may be done on a time basi s or using a
Vunit producti on? met hod.
Im1ai rme nt P deferr ed de"el opme nt expendi t ur e shoul d be re"i ewed at
A&*I"IN-
.:: "he Audi t +roc e s s B 'eri i cat i on
the end of each account i ng period and wher e the circums t ance s which
ha"e Dustified the deferr al of the expendi t ur e no longer appl y, the
expendi t ur e shoul d be writt en off immedi at el y.
The mai n procedur es in audi t work to "erify compli ance with I#! *9 are
to check that the conditions not ed abo"e for recogni ti on of de"el opme nt
cost s ha"e been compli ed with.
8/ ;4 "rade marks and 1at e nt
Trade marks and pat ent s may be capit ali:ed and then writt en off o"er
their useful li"es with any renewal fees being charged to re"enue. If a
trade mark or pat ent is abandoned then the net book amount shoul d be
writt en off immedi at el y. ormall y the company shoul d keep a regist er of
all mat eri al items which shoul d be checked agai nst the agree me nt s , the
account i ng records, and third part y confir mat i on from the pat ent agent
of the exist ence and company? s title to the asset s. #uditors will need to
consi der the "aluati on of the asset s. This will include a re"iew of the
futur e income arising from the trade mark and pat ent to see whet her it
Dustifies the "alue placed on it. In asses si ng the future income it will be
neces s ar y to consi der the possi bility that income will not arise due for
exampl e to expiry or changes in the client?s busi nes s.
Qou shoul d also recall from your account i ng knowl edge that the goodwill
impai r ment could be det er mi ned using Vtop- down? or Vbot t om- up? test s.
The Vbott om- up? test in"ol"es identifying the goodwill in the bal ance
sheet that can be allocat ed on a reasonabl e basi s to the cash gener at i ng
unit.
The Vtop- down? test in"ol"es identifying the small est cash gener at i ng unit
which the goodwill belongs and then appor ti oni ng any unallocat ed
goodwill on a reasonabl e basi s to the cash gener at i ng unit.
In each case abo"e, impai r ment has occurr ed wher e the reco"er abl e
amount of the cash gener at i ng unit is less than the carryi ng amount of
the asset s plus the allocat ed goodwill.
Qou shoul d recall from your earlier studi es that the Vtop- down? test is
required wher e ther e is no reasonabl e basi s for carryi ng out a Vbot t om
up? test .
,anage me nt ? s Dustification of the proces s of carryi ng out the impair ment
re"iew must be carefully exami ned. The audi t or shoul d consi der the
sufficiency and reliability of the e"idence a"ail abl e. When exami ni ng
Veconomi c "alue? or V"alue- in- use? e"idence will be requir ed to suppor t
Afor exampl eB futur e cash flow proD ections, int er est rat es growt h rat es,
product life cycles, future product i on cost s et c. These are subD ecti "e
areas wher eas det er mi ni ng the Vnet selling proceeds? is mor e easily
"erifiabl e by refer ence to e"idence from current market acti"it y.
It is particul arl y import ant that the audi t or re"iews the not es to the
financi al st at e me nt s to ensur e that the disclosur es in respect of the
account i ng policy and treat me nt is sufficient and appropri at e.
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-oodwi l l and air 0al ue
The mai n point s the audit or needs to "erify for any goodwill arising in the
account i ng period are as follows:
AiB -xami ne the met hods used to det er mi ne the fair "alue of the
consi der at i on gi"en to purchas e the shar es of the subsi di ary
and the fair "alue of the net asset s in the subsi di ar y at the dat e
of acqui si tion. The usual "erificati on procedur es shoul d be
used, alt hough the audi t or shoul d consi der the need for an
exper t "aluati on.
AiiB The account i ng treat me nt of the goodwill once it has been
quantifi ed needs to be checked to ensur e it is being account ed
for incompli ance with I78! *
AiiiB # check is required that the det ail ed disclosur e requireme nt s of
I78! * are compli ed with.
8/ ;; Brand name s
!ome compani es in recent year s ha"e placed "aluati ons on the brand
names of the goods that they sell. The "aluati on is shown on the
bal ance sheet . The reason for doing this is that the brand name is
"aluabl e to the company in that it hel ps to sell the company? s goods. 7or
exampl e, may peopl e woul d rat her buy a Vbranded? tin of soap powder,
rat her than the Vown make? offered by a super mar ket . I#! *9 prohi bit s
recogni tion of int ernally gener at ed brands.
7or purchas ed brands, the audit or must consi der:
AiB Is the brand name "alued accordi ng to an accept abl e met hod,
and not Dust Vguess ed? by the direct or sR
AiiB Is the "alue bei ng amor ti:ed o"er an accept abl e ti me period
which rel at es to the futur e sal es of the brandR
AiiiB =as the credit ent ry for the debi t been adequat el y shown as a
non- distribut abl e reser"e on the bal ance sheet
Ai"B Is ther e adequat e disclosur e of the account i ng policy in the
financi al st at e me nt s R
IAS 4: Im1ai rme nt o as s e t s
It is import ant for the audit or to check the client?s procedur es for
det er mi ni ng and account i ng for impair ment s . <nder I#! *&,
Vimpai r ment ? has occurr ed wher e reco"er abl e amount has fallen below
the asset ?s carryi ng "alue. The reco"er abl e amount is higher of net
reali:abl e "alue and "alue in use Aeconomi c "alueB.
The st ages of the audi t in this area could be:
AiB 1onfirm whet her the ent er pri se has carri ed out any impair ment
checks and re"i ew the "alidit y of the concl usi ons reached as to
whet her further in"esti gat i on of impai r ment was neces s ar y.
AiiB If the client has concluded that no further work is requir ed and
the audi t or concur s, no mor e audi t work is needed. If, howe"er ,
the audi t disagr ees and consi der s that the "alue of some asset s
has been impai red, it is necess ar y to discuss the mat t er with
manage me nt . If no further action is taken by manage me nt it
A&*I"IN-
.:D "he Audi t +roc e s s B 'eri i cat i on
may be necess ar y to issue a modified audi t report gi"ing a
qualified opinion based on the disagr ee me nt with manage me nt
and det ailing the caus e of the disagr ee me nt . +f course, in
maD orit y of cases further action will be taken by manage me nt
and a modified report will not be required if the audi t or is
sati sfi ed with that further action.
AiiiB If the client has concluded that impai r ment checks are needed,
the audi t or will re"i ew the st ages of the impair ment
in"esti gat i on, payi ng particul ar att ent i on to:
AaB The "alidit y of the ent er pri se?s work in arri"ing at net selling
price
AbB The "alidity of the ent er pri se?s work in calcul ati ng "alue in
use, with particul ar refer ence to the accept abilit y of the
basi s for esti mat i ng future cash flows and of discount i ng rat e
adopt ed.
AcB The "alidit y of the client?s procedur es in appl yi ng the
impai r ment re"iew proces s to cash- gener at i ng unit s.
AdB 1ompli ance with rele"ant disclosur e requireme nt s .
8/ ;8 IN'ES"!EN"S
Not eB Aut hori t at i 0e docume nt s B
I#! %4, I#! %(, *$, *', $K, $9, *4, I78! *, 5
8equirement s of the 1ompani es #ct with respect to In"est ment s and
2roperti es.
8equirement s of I!# 5%5
Introduct i on
#n in"est me nt is held for weal t h gener at i on Asuch as di"idends and
int er est on shar es and loan not esB and capit al growt h. 1urrent
in"est me nt s are readily reali:abl e and are int ended to be held for no
mor e than one year. #ll other in"est me nt s are long ter m in"est me nt s.
In"est me nt s in subsi di ari es, associ at es and Doint "ent ur es requir e speci al
account i ng procedur es for the prepar at i on of additional financi al
st at e me nt s P group account s, otherwi se known as consolidat ed account s.
7rom your earli er st udi es you shoul d be familiar with the definitions
relati ng to group account s. 7or exampl e, a subsi di ary, broadl y, is mor e
than 54T cont rolled, and an associ at ed company is one o"er which an
entit y has a Vsignficant influence? as e"idenced by at least a $4T holding.
0ong ter m in"est me nt s may be carri ed at cost, re"al ued amount s, or the
lower of cost and market "alue det er mi ned on a portfolio basi s deci ded
by the direct or.
The carryi ng amount of a long ter m in"est me nt shoul d be reduced to
recogni :e impai r ment s in "alue.
Wher e long ter m in"est me nt s are carri ed at market "alue a consi st ent
policy shoul d be adopt ed wher eby increas es or decr eas e s in the carryi ng
amount shoul d either go through the income st at e me nt , or, to a
re"al uat i on account in equi t y. To the ext ent that ther e is no re"al uat i on
surpl us relati ng to a particul ar asset , any deficit shoul d be charged to
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income.
When asset s carri ed at market "alue are disposed of the company shoul d
adopt a policy of crediting out st andi ng re"al uat i on surpl us es to eit her
income, or ret ai ned earni ngs.
1urrent in"est me nt s may be carri ed at market "alue or the lower cost or
market "alue.
*i scl os ur e re@ui re me nt s
In gener al ter ms, the following items shoul d be disclosed in relati on to all
in"est me nt s:
AaB The account i ng policies for:
AiB The det er mi nat i on of carryi ng amount of in"est me nt s
AiiB The treat me nt of changes in market "alue of current in"est me nt s
carri ed at market "alue
AiiiB The treat me nt of a re"al uat i on surpl us on the sal e of a re"al ued
in"est me nt
AbB The significant amount s included in income for
AiB Inter est , royal ti es, di"idends and rent al s on long ter m and
current in"est me nt s
AiiB 2rofits and losses on dispos al s of current in"est me nt s
AiiiB 1hanges in "alue of such in"est me nt s
AcB The market "alue of market abl e in"est me nt s if they are not carri ed at
market "alue
AdB The fair "alue of in"est me nt proper ti es if they are account ed for as
long ter m in"est me nt s and not
carri ed at fair "alue
AeB !ignificant rest rictions on the feasi bility of in"est me nt s or the
remi t t ance of income and proceeds of disposal
AfB 7or long ter m in"est me nt s st at ed at re"al ued amount s
AiB The policy for the frequency of re"al uat i ons
AiiB The dat e of the lat est re"al uat i on
AiiiB The basi s of re"al uat i on and whet her an ext er nal "alue was
in"ol"ed
AgB The mo"e me nt s for the period in re"al uat i on surpl us and the nat ur e
of such mo"e me nt s
AhB 7or ent er pri ses whose mai n busi ness is the holding of in"est me nt s an
anal ysi s of the portfolio of
In"est me nt s
Int ernal Control
Wher e a tradi ng concer n holds only a few in"est me nt s, ther e is unlikel y
to be any syst e ma t i c int ernal cont rol syst e ms specifically for those
in"est me nt s.
With a larger in"est me nt portfolio, ther e shoul d be a syst e m of int ernal
cont rol which will include:
A&*I"IN-
.C5 "he Audi t +roc e s s B 'eri i cat i on
AiB #uthori:ati on procedur es for purchas es and sal es
AiiB 8egist er reconcil ed with cont rol account s
AiiiB 1ontrol o"er di"idendCi nt er es t recei pt s
Ai"B 2roper di"ision of responsi bilit y and super"i sion
'eri i cat i on +roce dur e s
6erification procedur es shoul d follow the gener al approach outlined for
tangi bl e non current asset s. =owe"er, the following specific point s
shoul d be not ed.
ISA .0/ Audit $vidence 6 Additional !onsiderati on for Specifi ed Items
st at es that audi t procedur es relati ng to long ter m in"est me nt s nor mall y
include consi deri ng e"idence as to whet her the entit y has the ability to
conti nue to hold the in"est me nt s on a long ter m basi s, discussi ng the
mat t er with manage me nt and obt ai ni ng writt en repr es ent at i ons to that
effect . +ther procedur es would include the following:
(a) Exi st e nc e and owner s hi 1
-st ablishme nt of title and benefici al owner shi p of in"est me nt s is not
conclusi"el y possi bl e. =owe"er, e"idence is a"ail abl e in the form of:
AiB !har e certificat es, corresponde nc e with nomi nee et c
AiiB 2ayment s for securiti es, broker s,? bought not es? or Vcont r act
not es?
AiiiB /i"idendsCi nt er es t from securiti es, di"idends Vwarr ant s?.
Ai"B Internal cont rol procedur es.
(,) 'al uat i on
6aluation of list ed securi ti es is easily confor med with appropri at ed
financi al publicati ons. /irect or s? "aluati on of unlist ed securi ti es is
somet hi ng on which the audit ors report , and the basi s of the
calcul ati ons, must ther efor e be exami ned. The audi t or must also
consi der whet her any writ e downs for impai r ment in "alue are adequat e,
which may mean exami ni ng copi es of account s of compani es in which
in"est me nt s are hel d.
(c) Income
Income from securi ti es can be "erified with known int er est rat es for fixed
int er est securi ti es, and a shar e infor mat i on ser"ice for list ed shar es.
<nlist ed shar e income must be "erified with copi es of the account s.
8/ ;: IAS ;5 In0es t me nt +ro1ert i e s
#udit work common to all types of land and building will be required to
est abli sh owner shi p, exist ence and "alue.
I#! %4 requires that compani es may adopt the cost based approach or
the fair "alue policy for the treat me nt of in"est me nt proper t i es.
If the cost based approach is used, the account i ng treat me nt is as for the
benchmar k treat me nt under I#! (& A1ost less accumul at ed depr eci at i on
and impair ment lossesB and you shoul d be familiar with the audit
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procedur es nor mall y carri ed out.
If the fair "alue policy is adopt ed, the company is required to re"al ue the
proper t y each year taking gai ns and losses to the income st at e me nt .
7air "alue will nor mall y be "erifiabl e by refer ence to current prices on an
acti"e market . In the absence of an acti"e market , the audi t or may need
to consi der e"idence of "aluati ons from si mil ar market s Asuit abl y
adDust edB or discount ed cash flow proDecti ons. 2oint s peculi ar to
in"est me nt proper ti es for the audi t or to re"iew ther efor e include:
AiB 1onfirmi ng that the fair "alue policy is appropri at e Afor exampl e
it is rent ed to a non group companyB
AiiB #ssessi ng the reliability of the e"idence on which fair "alue is
based especi ally when no acti"e market exist s
AiiiB 1orrect nes s of account i ng for transf er s bet ween classification
to for from in"est me nt proper ti es wher e Aand only wher eB a
change of use has occurr ed. AQou shoul d re- familiari:e yourself
with the account i ng treat me nt wher e transf er s bet ween
component s are madeB .
Ai"B 1ompl et ene s s of disclosur e requireme nt s .
Typical audi t e"idence might include:
2hysical inspecti on of the locati on and condi tion of the
in"est me nt proper t y and confirmat i on that it is not owner
occupi ed.
6aluer?s report Awhet her ext er nal or int ernal B including the
dat eA sB of "aluati on@ base used Ai.e. open market B,
assumpt i ons made Ae. g. full occupancyB , etc
The qualificati ons, experi ence and obDecti"it y of the
"aluerAsB
The calcul ati ons of indi"idual gainsCl oss es on proper ti es
dispos ed of.
8epr es ent at i ons fromC enqui ri es of manage me nt in respect
of the treat me nt of in"est me nt proper t i es
8e"iew of pre"ious infor mat i on for consi st ency Ae. g.
financi al st at e me nt s from pre"ious year sB
,anage me nt ? s impair ment re"iew, if any
The propos ed not e disclosur e reflecti ng the true and fair
o"erride.
Account i ng re@ui re me nt s
I#! %4 prescri bes the account i ng treat me nt for in"est me nt proper t y and
relat ed disclosur e requireme nt s .

In"est me nt proper t y is initially recogni:ed at cost . !ubsequent to initial
recogni tion,
in"est me nt proper t y is carri ed either at:
A&*I"IN-
.C6 "he Audi t +roc e s s B 'eri i cat i on
1ost, less accumul at ed depr eci ati on and any accumul at ed
impai r ment losses, as
prescri bed by I#! (& Propert "# Plant and $1uipme nt , or
7air "alue. 7air "alue is the price at which the proper t y could be
exchanged
bet ween knowl edgea bl e, willing parti es in an ar m?s lengt h
trans act i on.
,o"ement s in fair "alue are recogni :ed immedi at el y in profit or loss.
The meas ur e me nt model is appli ed consi st ent l y to all in"est me nt
proper t y. =owe"er, an entit y may choos e eit her the air 0al ue model or
the cos t model for in"est me nt proper t y backing liabilities that pay a
ret urn linked directl y to the fair "alue of specified asset s including that
in"est me nt proper t y, regar dl es s of the model chosen for all other
in"est me nt proper t y.
Transf er s to, or from, the in"est me nt proper t y classificati on are made
only when ther e
is e"idence of a change in use.
The gain or loss on derecogni ti on of an item of in"est me nt proper t y is
the difference
bet ween the net disposal proceeds, if any, and the carryi ng amount of
the item. The
gain or loss is included in profit or loss.
8/ ;C 7inanci al Instrume nt s (IAS 46 and IAS 4<)
I#! *$ and I#! *' are exami nabl e to the ext ent that they deal with the
present at i on and meas ur e me nt of equi t y, debt and con"erti bl e debt . The
typical audi t approach will include:
6erification of the anal ysi s bet ween equi t y and debt and
appropri at e desi gnat i on to capit al and reser"es or liabilities
2erfor mi ng test s for arit hmet i cal accur acy
-nsuring that the discount rat es used are realistic
-nsuring that other base dat a in the allocati on is correct Ae. g. the
correct con"er si on dat e has been usedB
-nsuring that the det ail ed disclosur es requir eme nt s are met .
8/ 8 Audi t o Current Ass e t s
8/ 8. 'eri i cat i on o St ocks and 3ork In +rogre s s
#uthorit ati"e document s: I#! $CI!# 544C 54(
I#! ( 2repar ati on of financi al stat e me nt s requires in"ent ori es to be
disclosed separ at el y and the accounti ng policy adopt ed to be disclosed.
I#! $ in"ent ori es prescri bes the account i ng treat me nt for in"ent ori es,
except :
Work in progr es s arising under const r ucti on cont r act s AI#! ((
!onstructi on !ontract s B@
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7inanci al instrument s AI#! *' Financial Instrument s B@ and
)iological asset s relat ed to agricult ur al acti"it y and agricult ur al
produce at the point of har"est AI#! %( Agricult ure B.
!ummar y of I#! $
In"ent ori es are meas ur ed at the lower of cost and net reali:abl e "alue.
et reali:abl e "alue is the esti mat ed selling price in the ordinar y course
of busi ness less the esti mat ed cost s of compl et i on and the esti mat e d
cost s necess ar y to make the sal e.
1ost includes all cost s of purchas e, cost s of con"er si on and other cost s
incurred in bringing the in"ent ori es to their present locati on and
condi tion. The cost of in"ent ori es, other than those for which specific
identificati on of cost s are appropri at e, is assi gned by using the first- in,
first- out A7I7+B or weight ed a"er age cost formul a.
When in"ent ori es are sold, the carryi ng amount of those in"ent ori es is
recogni sed as an expens e in the same period as the re"enue.
The amount of any writ e- down of in"ent ori es to net realisabl e "alue is
recogni sed as an expens e in the period the writ e- down or loss occurs.
The amount of any re"er sal of a writ e- down of in"ent ori es is recogni sed
as a reducti on in the amount of in"ent ori es recogni sed as an expens e in
the period in which the re"er sal occurs.
I#! $ specifies disclosur es about in"ent ori es.
In a large manuf act uri ng company, no item in the balance sheet present s
"erification problems to auditors to the ext ent that stocks do. The reasons
for this gener ally are:
aB The amount s in"ol"ed are mat eri al@
bB !tock has a one for one impact on the report ed profits. In other
words an increase of stock by one shilling increas es the
report ed profits by one shilling. It therefore opens itself easily
to distortion by the manage me nt @
cB !tock does not deri"e from the nor mal doubl e entry syst em, it is
usually a figure arri"ed at by a stock taking exercise held at the
end of the year, "alued and incorpor at ed into the profit and loss
account and balance sheet , any differences being writt en off to
cost of sales.
dB !tocks are port abl e and "aluabl e openi ng thems el "es to
pilferage and det erior ation either intentional or accident al .
eB The number of items in"ol"ed is usually numer ous creati ng
"erification probl ems as far as exist ence and condition is
concer ned.
fB #lthough stocks are "alued at the lower of cost and net
realisabl e "alue, what constit ut es cost can "ary from one
manage me nt to anot her and the basis of det er mi ni ng that cost
can be subD ect to so many different met hods all resulting in
different "alues for the same items.
gB It is an area that is suscept i bl e to mani pul ation by manage me nt
as apart from problems of arri"ing at cost, the pro"ision for
obsol escence, slow mo"ing and damaged stocks is a questi on of
Dudgement ther efore it is easy for the auditor and the
manage me nt to disagr ee.
A&*I"IN-
.C; "he Audi t +roc e s s B 'eri i cat i on
hB !tock is usually not one item but many different items, for
exampl e@ finished goods, work in progress, raw mat eri al s, goods
in transi t, spares, consumabl es etc. #ll these can be "alued on
a different basis and amal gamat e d and described as stocks.
8/ 86 "he audi t or s duti e s can ,e summari s e d as oll ows B
aB #scert ai ni ng the accounti ng policies adopt ed by the entity for
"aluing stocks@
bB #s the guiding standar d on stocks is I#! $ in"ent ori es, the
audit or has to consider the suit ability of the policies select ed by
the organi:ati on. Qou must not e that under I#! $:
i. The lower of cost and net realisabl e "alue is obligat ory.
7I7+ or weight ed a"er age cost is used to allocat e cost s.
ii. The cost should wher e appropri at e include a proportion of
production o"erheads whet her or not they "ary on a time
basis. The proportion included must be based upon the
nor mal le"el of acti"ity.
iii. Where identical items are purchas ed or made at different
times and ther efor e ha"e differing cost s the met hod of
arri"ing at cost should be 7I7+, weight ed a"er age
cB The auditor shoul d test check the stock sheet s or the
continuous stock records with rele"ant document s such as
in"oices and costing records to det er mi ne if cost has been
correctly arri"ed at.
dB The audit or must exami ne and test the treat ment of o"erheads.
eB The auditor must test the treat ment and exami ne the a"ailabl e
e"idence for items "alued at net realisabl e "alue.
fB The audit or must check the arithmet i cal accur acy of the
calcul ations made.
gB The auditor must check and confirm the consist ency with
which the amount s ha"e been comput ed.
hB The audit or must consider the adequacy of the description used
in the account s and the disclosur e of the accounti ng policies
adopt ed.
8/ 84 *et ai l work on st ocks is im1erat i 0 e in an audi t ? howe 0 e r
ther e are ot her re0i e w tes t s that are e@ual l y im1ort ant
and the s e incl udeB
aB 3uantit y reconciliation of changes in stocks at successi"e period
ends with records of mo"ement s i.e. receipt s and issues.
bB 1ompari son of quanti ti es of e"ery kind of stock held at one year
end with those held at a pre"ious year end and the relat ed
receipt s and issues.
cB The gross profit ratio is compar ed to that of the pre"ious year,
other compani es and budget .
dB 8e"iew of rat e of stock turno"er with pre"ious year.
eB 1ompari son of stock figures and budget s for stocks, sales and
purchas es.
fB 1onsider at i on of st andar d costing records, the treat ment of
"ariances in the "aluation of stocks and work in progress.
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8/ 8; *et ai l e d audi t o st ock
a/ Cost
7or the audit or this is rest rict ed usually to det er mi ni ng the
met hods adopt ed by the organi:ation in costing stocks. The
audit or weighs the accept ability and appropri at enes s of the
policies adopt ed. The rest of the exercise is a mechani cal
exercise of testi ng to confirm that the met hods adopt ed ha"e
been correctl y applied.
,/ Aut hori Gat i on
The purchas es cycle produces stocks, ther efor e audit work of compli ance
test s, analytical re"iews and subst ant i "e test s in the area of purchas es
usually pro"ide the audit or with adequat e e"idence as to aut hori:ation
procedur es in obt ai ning stocks.
c/ 'al uat i on
I#! $ prescribes that stock be "alued at the lower of cost and net
realisabl e "alue, It is up to the audit or to ensur e that net realisabl e "alue
is correctly assess ed and that the choice bet ween the cost and net
realisabl e "alue is properly done and is in accordance with I#! $. I#! $
stat es that compari sons shoul d be by indi"idual units of stocks or
cat egori es. 1ompari son cannot be simply on a basis of the tot al cost of all
stocks and the tot al net realisabl e "alue. !tocks is reduced to lower of
cost and net realisabl e "alue by a pro"ision for obsol et e, slow mo"ing and
damaged stocks. This is a pot enti al area of disagr ee me nt bet ween the
auditor and the manage me nt becaus e it is subDect to Dudgement . The
auditorJ s concern is to ensur e that the pro"ision is neither inadequat e nor
excessi "e. To det er mi ne this adequacy, the auditor is guided by such
factors as the consider at i on of:
i. The age of the stock@
ii. Its turno"er@
iii. Its condition@
i". Technological ad"ances in the indust ry concer ned@
". The nat ur e of the stock, it could be perishabl e or it could be
subDect to a "olatile market @
"i. -conomi c conditions i.e. recent selling prices, demand for the
product , the perfor mance of compet i ng product s@
"ii. The quanti t y of the stocks held@
"iii. The accounti ng policies in"ol"ed@
ix. !ubsequent e"ent s
#ll these factors gi"e the auditor a good indication of whet her the
pro"ision is adequat e or not.
et realisabl e "alue based on selling prices relat es to the selling prices
pre"ailing at the balance sheet dat e. +ccasionally we re"iew the selling
prices aft er the balance sheet dat e but the purpose of this is to obt ain
additional informati on about conditions existing at the balance sheet dat e.
A&*I"IN-
.C: "he Audi t +roc e s s B 'eri i cat i on
Tempor ar y fluctuations must be ignored. )y tempor ar y we mean
fluctuations of less than one mont h.
d/ Exi st e nc e
In the past the auditor accept ed a direct ors certificat e as to the exist ence
of stocks. <ntil se"er al cases particul arly in the <nited !tat es of #merica
were decided agai nst audit ors for their failure to obt ai n adequat e
independent e"idence that the stocks concerned were in exist ence. +n
se"er al occasions, audit ors certified account s as gi"ing a true and fair
"iew when the stocks concer ned were non- exist ent . The unfa"our abl e
decisions against the auditor ha"e result ed in the profession making it
obligat ory that wher e the stocks are a significant figure in the account s
the auditor must "erify exist ence.
A8efer to I!# 54(B This is achi e"ed chiefly through the client arrangi ng for
a stock take and the auditor att endi ng to obser"e the stock take.
I is not the audi t orK s dut y to take st ock/ =e must howe"er satisfy
himself as to the "alidity of the amount attribut ed to stocks in the
account s that are the subDect of his audit. In det er mi ni ng the nat ur e and
ext ent of the audit st eps necess ar y for this purpose the auditors must
exami ne the syst em of internal control in order to assess its effecti"enes s
relati"e to the ascert ai nment and e"aluati on of stocks and work in
progr ess. While it will not nor mally be necess ar y for the auditor to
obser"e the entire stock take or "isit all locations their test s should co"er
a repres ent at i "e section of the stock. Where stocks is held at a number of
locations the selection of the location to be "isited shoul d be planned so
as to co"er all significant locations o"er a period of years.
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The amount at which stock is st at ed in the account s may be based upon a
physical stock taking at the year end or upon informati on taken from stock
records. When stock is based on records these must be subst ant i at ed by
continuous or periodical physical stock takings. The procedur es should
ensur e:
aB #dequat e stock records are kept up to dat e.
bB -ach cat egor y of stock is checked at least once a year and
a record of checks mai nt ai ned.
cB If the checking is continuous, it is done syst emat i cally o"er
the years or if periodic at suit abl e times, such as when
stocks are low or ha"e reached a specific reorder point.
dB #ll differences are properly in"estigat ed and the records
amended accordi ngly. There should be mai nt ai ned
schedul es of differences with det ails of the action that was
taken.
8/ 88 S"%CK "AKIN-
The procedur es for carrying out physical stock taking "ary in det ail
according to the si:e and circumst ances of the business and the nat ur e of
its stock records. =owe"er, definit e instructions preferabl y in writing
shoul d be issued in all cases for the guidance of those who will be
engaged in the act ual stock taking. The stock taking instructions shoul d
as a bare mini mum cont ai n:
aB Identification of the articles and their ownershi p.
bB 1ounting, weighing or measuri ng.
cB 8eporting of stocks which are damaged or otherwise defecti"e.
dB =ow the stock take is to be recorded.
!tock taking should be planned well in ad"ance and carried out carefully
and syst emat i cally by persons fully informed of the duti es in"ol"ed. Those
taking part shoul d include persons familiar with the "arious sections of
stock and where practicabl e super"isors and checker s should be drawn
from depar t ment s which ha"e no control o"er the usual cust ody or
mo"ement of stocks. Where speci alised knowl edge is necess ar y to
identify the nat ur e or quality of items of stock the client should ensur e
that personnel properl y qualified for this purpose are a"ailabl e at the stock
take. Arrange me nt s shoul d ,e made to ens ur e a 1ro1er cut> o/
This means that despat ch document at i on should ha"e been originat ed for
all goods despat ched before stock taking and if still on hand, for all goods
in which the propert y has passed to the cust omer . The latt er should not
be included as stock when the count is made. The procedur es should
ensur e that the appropri at e sales in"oices are recorded in the correct
financi al period. #lso liabilities should be set up for all goods recei"ed and
included in stock and for all goods purchas ed the propert y which has been
passed to the client. This shoul d be included in the stock e"en though
they are not yet on the companyJ s premi ses. #rrange me nt s should be
made to ensur e that goods held in safe cust ody for other s are not
recorded as part of the client J s stock. #rrangeme nt s should be made to
confirm and record in the stock sheet s det ails of goods held for the
company by outside parti es and arrange me nt should be made to identify
slow mo"ing, obsol et e or damaged stock.
A&*I"IN-
.CD "he Audi t +roc e s s B 'eri i cat i on
The stock taking instructions shoul d also call for the following
informat i on which shoul d be a"ailabl e to the audit ors during and at
the conclusion of the stock take.
aB /et ails of stock mo"eme nt during the count .
bB The last number s of goods inward and outwar d records.
cB The det ails of the numberi ng of stock sheet s issued of those
compl et ed and of those cancell ed and unused.
Audi t ors +roce dur e s
The audit ors procedur es are co"ered under three stages, before, during
and after.
(a) Be or e
(B !tudy of the client s stock taking instructions and
recomme ndat i ons for changes or impro"ement s if the
audit or consider s them inadequat e.
$B 7amiliarisati on with the location of the stocks and the
opport uni t y to plan for the work to be undert aken.
*B 7amiliarisati on with the nat ur e and "olume of stocks and
especi ally with high "alue items.
%B 8e"iew of pre"ious years working paper s and discussi ons with
the manager s of any significant changes from the pre"ious
year.
5B 1onsider at i on of the location of stocks and likely point s of
difficulty e.g. cutoff.
&B 1onsider at i on of any in"ol"ement of the internal audit
depar t ment and the ext ent of reliance to be placed upon their
work.
KB #rranging to obt ain from third parties confirmat i on of stocks
held by them.
9B -stablishing whet her expert ad"ice may be needed.
(,) *uri ng
The main task during stock taking is to ascert ai n whet her the client J s
empl oyees are carrying out their instructions properl y. It is usually
ad"isabl e for the audit or to test the efficiency of the counting by counti ng
select ed items. In this case the audit or should select items for counti ng
from the records and from the factory flow. The auditor shoul d make
not es for follow up purposes of items count ed in his presence, det ails of
defecti"e, damaged, obsol et e or slow mo"ing items. Incidence of stock
taking instructions not being followed. /et ails of items for cut off
purposes. =e must enquire into, obser"e and discuss with the store
keepi ng staff the procedur es for identifying damaged, obsol et e and slow
mo"ing stocks. =e shoul d enquire and test the cut off arrange me nt s.
7orm a ment al impressi on of the quanti t y of stock held for compari son
with the account s. 8ecord fully the work done and his impressi on of the
stock take exercise. =e must form a conclusion as to whet her the stock
take can be relied upon. =e should take phot ocopi es of the rough stock
sheet s. =e shoul d take det ails of the sequence of the stock sheet s. =e
shoul d pay speci al att enti on to high "alue items.
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(c) At er
It is mai nly a follow up exercise and it in"ol"es:
(B 1hecking the cut off with the det ails of last number s of stock
mo"eme nt forms and goods inward and goods outward not es
during the year and aft er the year end.
$B -nsuring that the final stock sheet s ha"e been properl y
prepar ed from the count records. =e must particul arly check
that all the forms issued were returned.
*B =e should check the final stock sheet s for pricing, ext ensi ons,
casting, summari sat i on and the necess ar y impro"eme nt .
%B 7ollow up any not es made and the att endance.
5B Inform the manage me nt of any problems in the stock taking
exercise so that they can act accordi ngly.
Non> Att enda nc e at St ock "akes
If the auditor is unabl e to att end a stock take, becaus e he has numer ous
client s with the same accounti ng dat e, or stock is locat ed at remot e
locations, the audit or must still certify himself on the stock take. This can
be done by:
(B #rranging for the stock take to be done at an earlier dat e.
$B #ppointing agent s.
*B -xami ning perpet ual in"ent ory records more thoroughl y.
%B Intensifying other "erification records and
5B <sing rot ational met hods.
!tock takes need not take place at the end of the year. If the client has a
good syst em of
internal control and satisfact or y stock records, which clearly identify
openi ng quantiti es,
recei pt s, issues and closing quanti ti es then the auditor can rely on a stock
take carried out
before or aft er the year end. #ll he has to do is to exami ne the
mo"eme nt s in the
inter"eni ng periods and subst ant i at e them. A2erpet ual in"ent ory
techni quesB
Bene i ci al %wner s hi 1 or "itl e
In Ganuary ('K& the famous case of #luminium Indust ri es 6aasen ) 6 ".
8omal pa #luminium 0td radically alt ered the law with regard to nor mal
trading practices. 1ommer ci al law st at es that title to goods passes to the
buyer once they are deli"ered on a "alid contract , ther efore if the buying
company went into liquidation then the seller company most probabl y
would lose the stocks and money. This was accept ed business practice for
cent uri es. The 8omal pa case rules that transacti ons can be made subDect
to reser"ati on of title until such a time as the buying company makes
payment . The case further ruled that such a reser"ati on should be clearly
stat ed in the appropri at e sales document at i on and that the right s of the
selling company o"er unpai d for stocks can e"en ext end to goods
produced from the store and the sale proceeds ther e from. In the strict
legal sense, stocks subD ect to such a reser"ati on clause shoul d be included
A&*I"IN-
.D5 "he Audi t +roc e s s B 'eri i cat i on
in the buying companyJ s account s until they are paid for. #ccounti ng
treat me nt acknowl edges the concept of subst ance o"er form and as a
result the amount s are shown as sales by the selling company and as
purchas es and stocks by the buying company. This assumes a situation
wher e the buying company is a going concern. If the financi al position of
the buying company is in doubt then the amount s in question shoul d be
remo"ed from both stocks and creditors in the buying companyJ s books.
In the e"ent that the commer ci al basis of present at i on is adopt ed and the
amount s in"ol"ed are extremel y significant , then it may be necess ar y to
re"eal in a not e to the account s that credit ors of the appropri at e amount
are secur ed by a specific stock.
*ISC2%S&#E AN* +#ESEN"A"I%N
Buyers
These cases are only rele"ant if credit ors include a mat eri al amount owed
to suppliers who ha"e sold goods subD ect to reser"ati on of titles.
-ffecti"ely such credit ors are secur e. The 1ompani es #ct and the
present at i on of a true and fair "iew require disclosur e of secur ed creditors
e"en though it is not clear whet her the credit ors secur ed in this way are
co"er ed by the 1ompani es #ct. <nder normal trading conditions wher e
the buyer is a going concern, it is doubtful that the seller would reprocess
their goods. In a liquidation howe"er, the sellers may ha"e a right to their
goods. #ccount s are drawn up on the going concer n assumpt i on.
/isclosur e of mat t er s which are rele"ant only in liquidation seems
necess ar y. It is cust omar y howe"er to disclose the amount of credit ors
who are secur ed in this way. The problems this creat es are:
(B 2urchas es and credit ors subD ect to reser"ati on of title are not
nor mally separ at el y identifiabl e from other creditors and
purchas er s.
$B It is not always clear if a particul ar purchas e subD ect to this
restriction will stand up in a court of law as ordinarily the law
requires that any creditors secur ed on a companyJ s asset s
should be regist er ed.
Sel l ers
!o far as sellers are concer ned, the issue is only rele"ant in impro"ing the
collect ability of debt s. Therefore, when re"iewing the pro"ision for bad
and doubtful debt s, the account ant needs to consider these point s:
An exam1l e o a sui t a,l e not e to the account s B
EThe company purchas es goods from cert ai n suppliers subDect to
reser"ati on of title. This gi"es the suppliers the right to clai m the goods if
they are not paid for. The tot al of such supplies included in credit ors in
the balance sheet was .enya !hillings ;F.
Audi t ors +roce dur e s
(B #scert ai n what st eps the client takes to identify suppliers,
selling on ter ms which reser"e title by enquiry of those
responsi bl e for purchasi ng and of the board.
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$B #scert ai n what st eps are taken to quantify the liability to such
suppliers for balance sheet purposes, including liabilities not yet
reflect ed in the creditors ledger.
*B Where ther e are mat eri al liabilities to such suppliers:
aB If the liabilities are quantified in the account s, re"iew and
test the procedur es by which the amount s disclosed ha"e
been comput ed.
bB If the direct ors consider that quantification is impracticabl e
but ha"e either esti mat ed the liabilities or indicat ed their
exist ence re"iew and test the informati on upon which their
disclosur e is based.
cB 1onsider the adequacy of the informat i on disclosed in the
account s.
dB -nsure that the basis on which the charge for taxation is
comput ed takes account of the accounti ng treat ment
adopt ed and where necess ar y is adequat el y disclosed.
%B Where liabilities to such suppliers are said not to exist or to be
immat eri al, re"iew the ter ms of sale of maDor suppliers to
confirm that this is so.
5B +bt ain formal writt en repres ent at i on from the direct ors
either that ther e are no mat eri al liabilities of this nat ur e to
be disclosed or that the informat i on disclosed is in their
"iew as accur at e as it is reasonabl y possibl e to achie"e.
+wnershi p or title to stocks before the ad"ent of the 8omal pa case was
implied in that if we order ed the goods, ha"e paid for them or ha"e set up
a liability for them, ha"e recei"ed them, they are in our possessi on, we are
using them for trading, nobody is laying clai m to them, then they are ours.
The student shoul d not ed that 8omal pa sales do not co"er goods sold on
consignment or goods sold on sale or ret urn wher e a sale will only be
made on fulfilment of some agreed e"ent such as the resal e of the goods
by the consignee.
+res e nt a t i on
+n the face of a balance sheet or in the not es to the account s, stocks and
work in progress should be classified or sub- classified in a manner which is
appropri at e to the business and so as to indicat e the amount s held in each
of the mai n cat egori es. The accounti ng policy in respect of stocks must be
disclosed and if ther e are changes ther ei n, their impact must also be
disclosed.
A&*I"IN-
.D6 "he Audi t +roc e s s B 'eri i cat i on
8/ 8: 3ork In +rogr e s s
What applies to goods for resal e applies equally to work in progr ess e"en
though the items present s great er problems of ascert ai nment and
"aluation to the direct ors and to the audit or. The auditors in"esti gati ons
will include:
aB -nquiry into the costing syst em from which work in progress is
ascert ai ned.
bB -nquiry into how reliabl e the costing syst em is. # costing
syst em integr at ed with the financi al syst em will be more
reliabl e becaus e of the discipline of doubl e entry and the
inherent checks imposed by ext er nal dat a such as credit ors
st at eme nt .
cB -nquiry into checks that are made as part of the syst em on
st ati stical dat a concer ni ng input s of mat eri al s and out put s of
product s and expect ati ons.
dB -nquiry into the syst em of inspecti ng and reporting on work
done so that allowance is made for scrappi ng and rectification
work.
eB /et er mi ni ng the basis on which o"erheads are included in cost s
and ensuring that this is based on I#! $.
fB ,aking enquiry into the basis on which any profit element s are
dealt with. 2rofit should be eliminat ed from work in progress.
gB Where the organi sati on const ruct s internally some of its own
fixed asset s, the audit or must make sure that such items as are
under const ruction at the year end are not account ed for twice
i.e. in fixed asset s and in work in progr ess.
8/ : 2%N- "E#! C%N"#AC"S
The aut horit ati"e document with reference to long ter m contract s is I#!
((: 1onstruction
1ontract s and I#! (9: 8e"enue 8ecognition, and I!# &44 8eliance on the
Work of other
#uditor
IAS .. Cons t ruc t i on Contract s
# const r uct i on cont r act is a cont r act specifically negoti at ed for the
const r ucti on of an asset or combi nat i on of asset s that are closel y
int err el at ed or int erdepe nde nt in ter ms of their desi gn, technol ogy and
function or their ulti mat e purpos e or use.
!uch cont r act s oft en span mor e than one account i ng period. This gi"es
rise to a number of account i ng and ther efor e audi ti ng issues.
The audit or must exami ne a schedul e of all the const r ucti on cont r act s
that the ent er pri se is current l y engaged in, and reach an opinion as to
whet her at tribut abl e profits and losses ha"e been sati sfact orily
calcul at ed. 7urt her mor e the present at i on of cont r act s in the financi al
st at e me nt s must accord with the I#!. #lthough the audi t or shoul d ha"e
a working knowl edge to be abl e to deal with many aspect s of long ter m
cont r act s, it may be necess ar y to cont act ext er nal exper t s to seek
assur ance in speci alist areas wher e the audi t or has insufficient exper ti se
hi mself. 7or exampl e, det er mi nat i on of the st age of compl eti on of a
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building in the course of const r ucti on.
Whilst the audi t process will requir e "erificati on work Ae. g. exami nat i on
of costi ng records, "erification and allocati on of mat eri al s, labour and
o"erhead cost s to suppor ti ng document a t i on, et cB the mor e sensi ti"e
audi t issues are disclosur e, recogni ti on and meas ur e me nt of profit s and
re"enues and "aluati on mat t er s.
1ontract re"enue shoul d be recogni:ed in the account i ng period in
which the work is perfor med
1ontract cost s shoul d be recogni :ed agai nst the re"enue to which
they relat e
-xpect ed excess es of tot al cont r act cost shoul d be recogni:ed
immedi at el y
1ost s which relat e to futur e acti"it y Acont r act work in progr essB
shoul d be carri ed forwar d as an asset Apro"i ded they are
reco"er abl eB
Irreco"er abl e amount s recei"abl e from recogni :ed cont r act
re"enue shoul d be recogni :ed as an expens e.
0ong- ter m contract s are those for which the esti mat ed li"es is longer
than one accounti ng period. 2eriodic account s artificially break down
the life of company into specific periods and the need for the
mat chi ng concept s to be followed makes it necess ar y to ascribe a
proportion of the profit on a contract for each of the accounti ng
periods that it co"ers. This is in conflict with the prudence concept
which would require that cost s be accumul at ed until the compl etion
of the contract , or can be reasonabl y foreseen through esti mat es to
compl et e. Hener ally, when there is conflict bet ween the prudence
concept and the mat chi ng concept the prudence concept pre"ails.
(a) Cost and Aut hori Gat i on
The cost incurred to dat e on a contract can be checked by routine
"ouchi ng to in"oices and suppliers st at eme nt s.
(,) 'al uat i on
The basis of "aluation shoul d be cost plus attribut abl e profit less
foreseeabl e losses and progress payment s bot h recei"ed and
recei"abl e. It becomes necess ar y to det er mi ne the appropri at e
amount of profit that can be taken on a contract . This appropri at e
attribut abl e profits is arri"ed as follows:
"otal cost s to *at e x Anti ci 1at e d x Allowanc e
M Attri ,ut a,l e
"otal anti ci 1at e d tot al 1roi t or 1rudenc e
1roi t
cost s on the contract
This formul a deri"es the tot al profit that can be taken on the contract
to dat e. This profit aft er it had been worked out must be reduced by
any profits taken in pre"ious years to det er mi ne the attribut abl e
profit for the year. 7or the audit or, the following point s must be
not ed:
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.D; "he Audi t +roc e s s B 'eri i cat i on
(B Total cost s are deri"ed from the current esti mat ed tot al cost s
for the contract
$B Total profits is deri"ed from the contract price less tot al
esti mat ed cost s
*B 2rudence must be taken into account when det er mi ni ng the
amount of attribut abl e profits. )y prudence in this case we
mean you must take into account the likelihood of the profit
figure being achie"ed and this is a function of
aB Time: that is the longer a contract has to run the mor e
difficult it is to det er mi ne the profit.
bB 1onsider the companyJ s ability to esti mat e its cost s
accur at el y.
cB 1onsider the nat ur e of the contract : a fixed price contract
is far more risky than one which allows cost s escal ation:
thus a cost plus contract carries "ery little risk at all.
Qou will notice that this exercise is wholly dependant on the
company esti mati ng its future cost s. This is where the audit or
has to be extra careful becaus e the direct ors can distort the
account s by using unrealistic esti mat es. 1on"enti onal, historic
cost s techni ques are ther efor e inappropri at e and alternati"e
met hods must be adopt ed. They may include:
(B -xami nati on of the companyJ s budget s and budget ar y
syst em. #re they a reliable basis for det er mi ni ng future
cost s or do the figures appear to be pure guess work.
$B 1ompari son of the cost s to dat e on the contract with the
original budget . If they relat e reasonabl y, then it will gi"e
some confidence that the future cost s are also reasonabl y
st at ed.
*B 1ompari son of the result s of pre"ious contract s compl et ed
with the original budget to det er mi ne the companyJ s
ability at forecasti ng.
%B 2erfor m det ail ed test s to subst anti at e the future cost s by
reference to technical dat a and report s from any
independent personnel .
5B 8e"iew the progress of contract s in relation to any penal t y
clauses for lat e deli"ery. If the audit or is satisfied that the
future cost s are fairly stat ed, he should check the
calcul ation of attribut abl e profits, taking into account the
issue of prudence on the basis of the point s raised earlier
on. If it becomes appar ent that on compl etion of a
contract a loss will be made, then such a loss shoul d be
charged against income in the year it is foreseen. If any
profits ha"e already been taken in the past years they
should be writt en back along with the tot al loss.
8/ C. *e,t or s
1onsideri ng what we ha"e gone through on the other asset s the audit
work to "erify the figure of trade debt or s would be as follows:
(B +bt ain a schedul e of debt ors, prefer abl y aged.
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$B 6alidat e the records and controls o"er sales and debt ors
through a select ed sampl e of compliance testi ng and
subst ant i"e testing.
*B /et ailed exami nat i on of the control account including re"iew of
the reconciliation bet ween the control account and the debt or?s
ledger.
%B 1ircularisation of a sampl e of debt or s strictly to confirm
exist ence.
5B 1arrying out cut off test to ensur e that sales and stocks ha"e
been account ed for in the correct period.
&B #nalytical re"iew by compari ng salesC debt or s ratio with pre"ious
years.
KB 0ooking for e"idence to confirm that balances attribut ed to
indi"idual debt ors are compos ed of specific items.
9B -"idence that all included items are bona fide trade
debt ors.
'B 8e"iew of credit not es issued aft er dat e to ensur e that
they do not cancel debt or s balances.
(4B -xami nati on of debt or s for collect ability.
((B -nsuring that each account is set tl ed from time to time and also
enquiring into credit balances.
($B +n the schedul e that is obt ained, the audit or test s balances on
ledger account s to the schedul e and "ice "ersa, he also test s
the cast of the schedul es and ensur es that the tot al s agree to
the balance of the control account s.
(*B The auditor test s the effecti"enes s of the syst em of internal
control but before he does that he has to det er mi ne what the
syst em is, and a good syst em for debt ors should ensur e that :
aB +nly bona fide sales bring debt or s into being@
bB #ll such sales are to appro"ed cust omer s@
cB #ll such sales are properl y recorded@
dB +nce they ha"e been recorded the dat es are only
eliminat ed by receipt of cash or on the aut horit y of a
responsi bl e official@
eB /ebt s are collect ed promptl y@
fB )alances are regul arly re"iewed and aged. # proper
syst em for follow up exist s and if necess ar y adequat e
pro"ision for bad and doubtful debt s are made.
<nder debt ors the crucial issues for the audit or are the
"aluation of debt or s and the exist ence of debt or s
8/ C6 'al uat i on o de,t or s
/ebtors are "alued Dust like other asset s at the lower of cost and net
realisabl e "alue. 6aluation of debt ors is really a consider at i on of whet her
the pro"ision for bad and doubtful debt s is adequat e or not. The auditor
must therefore consider the following mat t er s:
i. =ow adequat e is the syst em of internal control as far as
appro"al of credit and follow up of poor payer s is
concer ned@
ii. The period of credit allowed and taken@
iii. Whet her balances ha"e subsequent l y been set tl ed by the
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.D: "he Audi t +roc e s s B 'eri i cat i on
dat e of the audit
i". Whet her an account is made up of specific items or not@
". Whet her an account is within the maxi mum credit allowed@
"i. The market "alues of any securities if any that ha"e been
lodged as collat er al@
"ii. Hener al informat i on about debt or s from collect ors, trade
associ ations or other publications@
"iii. The issue of set off@
ix. Whet her there are any legal proceedi ngs, the st at e of
those proceedi ngs and the legal st at us of any debt or@
x. The effect s of the stat ut e of limit ations@
xi. 1ompari ng of debt or s to sales this year with pre"ious
periods, budget s and other compani es@
xii. -"idence that any debt is in disput e for non deli"ery,
breakages or poor quality.
It should be not ed that any debt s which are consider ed bad
should be writt en off to the profit and loss account .
2ro"isions for doubtful debt s should be set up agai nst debt s
which are consider ed doubtful.
!ome compani es ha"e the habit of making round sums or
percent age pro"isions for doubtful debt s. This practice is
gener ally unaccept abl e to an auditor unless it is based on good
st ati stical e"idence which may come from past experi ence or
may come from dat a about other similar undert aki ngs which is
obt ainabl e from trade associ ations or which is publicly a"ailabl e.
8/ C4 Exi st e nc e o de,t or s /
The easi est way to est ablish the exist ence of a debt or is to ask the debt or
whet her he exist s. This is done by use of a practice known as debt or?s
circularisati on which is basically a direct confirmati on from the debt ors.
#d"ant ages or reasons for circularising debt or s are:
(B To obt ain confirmat or y direct ext er nal e"idence of the exist ence
and beneficial owner shi p of the asset debt or s.
$B To gi"e e"idence that the figure in the account s for debt ors is a
true and fair one.
*B To pro"ide confirmat or y e"idence that the syst em of recording
and document i ng sales and debt or s and the controls ther e on
can be relied upon to produce an accur at e figure for debt or s.
ormally, test s which are designed to obt ain e"idence of the
reliability of the syst em are called compli ance test s.
1ircularisation ther efor e is useful bot h for subst anti "e and
compli ance test s.
%B To pro"ide e"idence as to the correct nes s of cut off. 1ut off is
the technical ter m used to ensur e that in computi ng profits
sales are accurat el y compar ed with the cost s of the goods sold.
1ut off test s can be subst ant i "e i.e. exami ni ng last number s of
document s or compli ance that is, if controls exist s their
application can be test ed.
5B To pro"ide e"idence on the exist ence of disput ed items.
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"he Audi t A11roac h/
The auditor:
(B ,ust obt ai n the cooper at i on of the client, as only the client can
aut hori se third parti es to communi cat e with the audit or.
$B !elect the met hod to use, this can be positi"e, negati"e or a
combi nati on of both.
*B !elect a sampl e. #ll cust omer s can be circularised but this is
unusual.
%B /raft the circular, but ensur e that it is writt en out on the client
lett er head and that it requires a reply to be sent direct to the
audit or.
5B 7ill in the det ails.
&B /espat ch the lett er himself.
KB 8ecei"e and e"aluat e replies.
9B 7ollow up when replies are not recei"ed.
Com1ari s on o the "wo !et hods
Negat i 0 e
<nder this met hod of circularisati on, the cust omer is asked to
communi cat e only if he does not agree with the balance. -ffecti"ely the
cust omer is told that if no reply is recei"ed from them then the auditor will
conclude that the debt or is in agree me nt with all the ter ms in the circular.
The maDor draw back of this met hod is that if the debt or does not recei"e
the circular, he will not respond, and this could be misconst r ued to mean
that the debt or recei"ed the circular when in fact it was ne"er recei"ed
and consider ed. 7rom this st andpoi nt , this met hod is unreliabl e and
shoul d only be used where there is strong internal control.
+osi t i 0e
<nder the positi"e met hod, the cust omer is asked to reply whet her he
agrees the balance or not or is asked to suppl y the balance himself. This
met hod is used wher e there is weak internal control, suspicion of
irregul arities or items in disput e and numer ous bookkeepi ng errors.
Sel ect i on o a Sam1l e
The following account s must be included in debt or s circularisation:
(B 0arge balances becaus e they are large and the more you can
subst ant i at e of the debt ors figure, the mor e assur ed you are.
$B #ll unpai d account s becaus e ther e may be fictitious balances
designed to conceal defalcati ons or ther e may be a genui ne
disput e bot h of which can cause o"erst at e me nt .
*B #ccount s with round sum payment s: this may indicat e teemi ng
and lading or that the debt or cannot pay the full amount .
%B #ccount s with I0 balances: this is becaus e acti"e debt or s
through the year may be used to conceal window dressi ng
techni ques.
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.DD "he Audi t +roc e s s B 'eri i cat i on
5B 1redit balances: a sales syst em shoul d produce debit balances
therefore, if it produces credit balances, they need to be
in"esti gat ed to ensur e that they were properly set up. The
client may be reluct ant to allow you to ad"ise his cust omer s of
credit balances in case they ha"e been o"erlooked and the
cust omer now asks for payment . We resol"e such obDections by
omitting the balance figure from the circular.
&B #ccount s wher e credit s or discount s seem excessi "e or wher e
credit periods are regul arly exceeded without follow up.
KB +ther account s that must be consider ed for circularisation are:
account s not compos ed of specific items, small balances which
are usually large, account s with relat ed parti es and account s
which the auditor feels put him upon enquiry.
What if the debt or does not replyR
(B !end a remi nder. !till no respons e, then the following
alternati"e auditing procedur es should be adopt ed.
aB /et ailed "ouching of all entri es in the debt ors account s.
bB -xami ning post balance e"ent s e. g. set tl ement s.
cB -xami ning the debt or s remit t ance ad"ice.
dB #warenes s of the possi bility of unusual items or mis-
st at eme nt s.
eB 8e"iewing correspondence if any with the debt or.
2lease not e, a debt or s circularisati on is an auditing procedur e
ther efor e, the auditor must make it clear to its client that the auditor
has to control the circularisati on. 1ircularisation should not be used
by the client for his own purposes.
If the client refuses to allow the auditor to circularise debt ors, then
the audit or has to consider whet her he has a"ailabl e other audit
e"idence, if not he would ha"e to consider qualifying his report on
grounds of limitation of scope.
# debt or circularisati on is "ery reliabl e e"idence in confirmi ng the
exist ence of the debt or and the title to the asset debt or, but is not
designed for est ablishing the "alue of debt or s. # debt or may confirm
exist ence but that is not proof that the debt or can pay.
8/ D +re1ay me nt s
2repayme nt s like accrual s are not usually checked by the doubl e
entry syst em. This makes them suscept i bl e to error. The audit or?s
procedur es include:
(. That last yearJ s prepayme nt s are writt en back.
$. -xami ning last yearJ s prepayme nt s to get an appreci ati on of the
kind of prepayme nt s to expect the organi:ation to ha"e.
*. 1ompari son of last yearJ s listing with the current listing as
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prepayme nt s do not change much from year to year, any items
missing or subst ant i ally great er or less than last yearJ s require
in"esti gati on. +f course in the first year of trading such a
compari son is not possi bl e.
%. 8eliance on his knowl edge of the account s which frequentl y
cont ai n prepayme nt s such as rent, rat es, insurance, ad"ertising,
etc. The audit or must exami ne such account s to det er mi ne
whet her prepayme nt s ha"e been under st at ed.
5. 6ouch the listing to support document at i on to est ablish the
aut hent i cit y of prepayme nt s
8/ < Cash and Bank Bal anc e s
8/ <. Bank
The mai n concern in this area is to est ablish the exist ence of the balances
and mor e recentl y due to failures in se"er al financi al institutions in .enya
"aluation of these balances. The client will produce a reconciliation of the
cash book and the bank stat e ment . These are checked by the auditor
paying particul ar att enti on to the reconciling items. These should be
genui ne reconciling items. <npresent ed cheques and unclear ed
lodgement s should appear on the bank st at eme nt s early in the new year,
say within two weeks of the year end. If they do not appear, then these
shoul d be in"esti gat ed as mani pul ati on or fraud could be indicat ed.
,aterial unpresent ed cheques could indicat e that the bank balance is
being distort ed for balance sheet purposes as a high balance is indicat ed
of poor utilisation of cash and may reflect ad"ersel y upon the direct ors.
<nclear ed lodgement s present a mor e serious threat of fraud or distortion.
)anks normally clear lodgement s within a week, ther efor e if aft er a week
we ha"e uncl ear ed lodgement s that are not up count ry, cheques, then the
position displayed may be probabl y fictitious. They could ha"e been
insert ed by manage me nt to conceal a shaky liquidity position or by an
empl oyee to conceal a misappr opri ati on elsewher e.
# bank reconciliation is a routine mat t er, what remai ns is for the auditor to
obt ai n direct confirmati on from the bank confirmi ng the balances at the
year end. The main purpose of this bank certificat e is to confirm that the
bank st at eme nt s are not fraudul ent . The bank request a copy of which is
gi"en as an appendi x at the end of this chapt er must be made by the
client for the auditor has no right to obt ai n this informati on from the
client J s banker s. The reply must howe"er go directly to the auditors. The
normal procedur es is in fact for the client to write to the bank aut hori sing
the bank to pro"ide the audit or with any informat i on that the audit or may
require. With this aut horit y, the auditor then writes to the bank.
'al uati onB Till recentl y, "aluation of banks and cash balances was taken
for grant ed until se"er al financi al institutions start ed to fail and this
brought into question the "alue of balances mai nt ai ned with mar gi nal
banking institutions. Therefore as a further test, the auditor must
est ablish that the balances are maint ai ned in a reput abl e bank that is still
a going concer n.
+et t y> cashB 2ett y- cash balances are usually not mat eri al. They are
usually count ed by the auditor but this is Dust becaus e most organi:ati ons
hold the "iew that a cash count is an integr al part of auditing. #s far as
A&*I"IN-
.<5 "he Audi t +roc e s s B 'eri i cat i on
possibl e all cash balances should be count ed at the same time to pre"ent
the possibility of substit ution. The count must be perfor med in the
presence of the pet t y- cashi er who should be asked to sign the count-
sheet , and the count- sheet should also be signed, dat ed by the audit or.
The pet t y- cashi erJ s presence is import ant as the audit or could later be
held responsi bl e for any short ages. This area is simplified when the client
maint ai ns an imprest syst em. The audit or shoul d obt ai n a certificat e from
the cashi er.
8/ .5 Sundry *e,t ors and 2oansB
!undry debt ors and loans are not usually mat eri al asset s of compani es
other than those compani es whose business is to make loans. We shall
consider two types of sundry debt ors and loans:
aB /ealings with others other than direct ors: The "erification
work will in"ol"e:
i. /et er mi ni ng, e"aluati ng and testi ng the syst ems of
internal control. 2articular att enti on being paid to
aut hori:ation.
ii. +bt aining a schedul e of the debt or s and testing it for
accur acy and compl et enes s.
iii. +bt aining certificat es direct from the debt or s concerned.
i". 8e"iew of agree me nt s and ensuri ng that the ter ms are
being followed.
". The debt may be secur ed in which case, the securit y is
exami ned and consider at i on gi"en to its "alue and
reali:ability.
"i. The loan may be guar ant eed, in which case the st at us of
the guar ant or must be exami ned.
"ii. 2ro"isions for bad debt s must be re"iewed for adequacy.
Where loans ha"e been made to employees, they usually
become bad if the employee lea"es before repayment is
compl et ed.
bB /ealings with direct ors and other relat ed parti es: The auditorJ s
duties are as follows:
i. The re"iew of all loans made to direct ors and connect ed
persons out st andi ng at any time during the year.
,ateri ality does not apply. #ll loans must be re"iewed.
ii. 1ertificat es of confirmati on should be obt ai ned from the
direct ors concer ned.
iii. 8ead the board minut es to ensur e that all such ad"ances
are subDect to proper board minut es.
i". -nsure compli ance with the law.
". 7ull disclosur e as required shoul d be made.
"i. If the direct ors fail to gi"e all the rele"ant informati on in
the account s the audit or is required to gi"e that
informati on in his report .
8/ .. 'E#I7ICA"I%N %7 2IABI2I"IES
Hener ally speaki ng, the audit orJ s dut y with regard to liabilities can be
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summari sed as follows:
(. To "erify the exist ence of all liabilities shown in the balance
sheet .
$. To "erify the correct nes s of the money amount of such
liabilities. That is they are all compl et el y account ed for and
properly "alued.
*. To "erify that the description gi"en to the liabilities in the
account s is appropri at e and the disclosur e is adequat e.
%. To "erify that all existing liabilities act ually occurred and ha"e
been properl y included in the account s.
8/ ../ . -eneral 'erii cat i on +roce dur e s
(. +bt ain or prepar e a schedul e for e"ery class of liability. This
would usually show the make up of the liability with the openi ng
balance, any changes if any, and the closing balance.
$. 1ut off: the audit or would usually "erify cut- offs by ensuring
that where a ser"ice has been recei"ed before the year end, the
correspondi ng liability has been set up. #nd wher e a liability
has been set up, the correspondi ng benefit has been recei"ed.
*. 8e"iew for reasonabl enes s: the auditor must consider
reasonabl enes s of a liability ensuring that ther e are no
circumst ances which may put him upon enquiry.
%. 8e"iew of internal controls: the auditor should det er mi ne,
e"aluat e and test the internal control procedur es surroundi ng
that liability.
5. 2re"ious yearJ s liability: consider the liabilities at the pre"ious
year end and see whet her they ha"e been properl y clear ed or
are still applicabl e beari ng in mind the stat ut e of limit ation.
&. Terms and 1onditions: the auditor should re"iew all ter ms and
conditions agreed when accepti ng a liability bet ween his client
and the creditor. =e shoul d then ensur e that the agree me nt is
being compli ed with.
K. #uthori:ation: aut horit y for all liabilities shoul d be sought .
These can be found in the companyJ s minut es, direct orJ s
minut es and for some items the aut horit y is in the
,emor andum and #rticles.
9. /isclosur e and /escription: the auditor must ensur e that the
description in the account s is adequat e.
'. Inspection of /ocument s: the audit or has to exami ne all
rele"ant document s. In the case of liabilities, these include
in"oices, correspondence, debent ur e deeds, loan agree me nt s,
purchas e orders etc.
(4. !ecurities: most liabilities are secur e in one way or anot her by
either fixed or floating charges. The audit or should enquire into
this and enquire that wher e necess ar y, they ha"e been
regist er ed.
((. 1onfirmat i on: the creation of any liability should be "ouched
and ext ernal confirmati on obt ained.
($. #ccounting policies: the audit or needs to certify himself that
appropri at e accept abl e accounti ng policies are adopt ed and
consist entl y applied.
(*. 8elat ed e"idence: re"iew of relat ed e"idence can assist in
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.<6 "he Audi t +roc e s s B 'eri i cat i on
confirmi ng liabilities. 7or exampl e exist ence of loans can be
confirmed by interest payment s.
(%. ,ateri ality: the mat eri alit y of the mat t er has to be taken into
consider ati on.
(5. 8e"iew of post- balance sheet e"ent s: this is a "ery import ant
area and has been co"er ed elsewher e.
8/ ../ 6 Com1l e t e n e s s o 2ia,ili ti e s
In distortion, the direct ors tend to include non- exist ent asset s or
exclude liabilities. !o whereas with asset s we are "ery much
concerned with exist ence, "aluation and beneficial owner shi p, with
liabilities, the maDor concer n is with compl et enes s and hence the
need to de"ot e some space to this area. It is not enough to be
satisfied that all liabilities recorded in the books are correct and
incorpor at ed in the final account s. The audit or must be satisfied also
that ther e are no other liabilities in exist ence which for one reason or
anot her are not included in the books in the account s.
-xampl es of such liabilities are:
aB 1laims by empl oyees for inDury at work which should be co"ered
by workmanJ s compens at i on@
bB 1laims by ex- employees for unfair dismi ssal@
cB <nfunded pension liabilities@
dB )onuses under profit sharing arrange me nt @
eB 8eturnabl e packages or cont ai ner s@
fB 2enalti es for 6#T and other taxes@
gB Warranti es and guar ant ees@
hB /iscount ed bills@
iB 2ending litigation@
DB 0osses on forward contract s penal ti es for breach of contract @
It is import ant that the auditor realises that such liabilities can exist
and he shoul d take reasonabl e st eps to unear t h them if they exist.
The procedur es to adopt include:
(B -nquiry of the direct ors and other knowl edgeabl e officers@
$B 8epresent at i on in a proper lett er of represent at i on from the
direct ors@
*B ,inut es of meet i ngs wher e the exist ence of unrecor ded
liabilities may be mentioned@
%B 2ost- balance sheet e"ent s re"iew in"ol"ing the inspecti on of
purchas e in"oices and payment s after dat e.
5B 8e"iewing last yearJ s working paper s to det er mi ne whet her any
liabilities existing then ha"e been excluded.
&B )eing const ant l y alert to the possibility of such a liability. 7or
exampl e, wher e the client sells goods subD ect to warrant y
period this would alert the auditor immedi at el y of out st andi ng
commi t me nt s.
8/ .6 "rade Credi t or s
Trade creditors may be subst ant i at ed by the re"iew of the syst em of
internal control o"er the purchas es cycle, re"iew of credit orJ s st at eme nt s
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with reconciliation, agree me nt of the control account with the indi"idual
creditorJ s ledger, effecti"e cut off and anal ytical re"iew procedur es. The
auditor may also circularise creditors to obt ai n direct confirmat i on.
8/ .4 +ro0i si on and Accrual s
)efore we consider the audit procedur es with regar d to pro"isions and
accrual s, it is necess ar y to clarify the meani ng of two words in common
use which tend to confuse student s.
aB +ro0i si onB this is any amount ret ai ned as reasonabl y necess ar y
for the purpose of pro"iding for any liability or loss which is
likely to be incurred or is cert ai n to be incurred but uncert ai n as
to amount or as to the dat e on which it will arise. Thus a
pro"ision is a debit to the profit and loss account that reduces
profit and ther efor e future di"idends. It is for a likely or a
cert ai n future payment and the amount or the dat e of payment
is uncert ai n.
bB #es er0eB this is that part of sharehol der s funds not account ed
for by the nomi nal "alue of issued shar e capit al or by the shar e
premi um account .
The need to creat e pro"isions must recei"e serious consider ati on by the
direct ors and also by the audit ors. 8e"iew of post balance sheet e"ent s
often cast s light s on the amount of the pro"ision required. The audit orJ s
duty is to see that any pro"isions set up are used for the purpose for
which they were set up and that any pro"isions which are no longer
needed are transferr ed back to profit and loss account . 1onsider abl e
att enti on needs to be paid to accrual s as like prepayme nt s they are not
checked by the doubl e entry syst em and ther efor e open thems el "es to
distortion of the account s by the senior manage me nt . The auditor must
ensur e that last yearJ s accrual s are writt en back. #ccrual s do not alter
much from year to year and ther efore compari son of last yearJ s and this
yearJ s listing is an essenti al audit procedur e and any that are
subst ant i ally great er or small er would call for in"estigati on.
8/ .; "axat i on
1ompani es suffer corpor ati on tax. The 1ompani es #ct requires that
corpor ati on tax payabl e on the profits of any particul ar year should be
mat ched against those profits in the profit and loss account and
recogni sed as a liability in the balance sheet at the end of the period to
which the profits relat e. This means for exampl e if a company has a
calendar trading year, then the profits for the twel"e mont hs ended *(
/ecember $44* shoul d be shown in the profit and loss account toget her
with the corpor ati on tax payabl e on those profits in $44*. The tax that is
payabl e is comput ed using income tax rules that are different from
accounti ng rules. The audit orJ s procedur es in"ol"e him in:
i. +bt aining the tax comput at i on from his client s and ensuri ng
that it is arithmet i cally correct . The items disclosed as
disallowabl e are support ed by e"idence and the items clai med
as allowabl e for exampl e wear and tear allowances ha"e been
properly comput ed in accordance with the Income Tax #ct.
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ii. 8e"iew of correspondence with the Income Tax /epart ment ,
paying particul ar att enti on to queri es raised and how they ha"e
been resol"ed, det er mi ni ng outst andi ng issues and their current
st at us.
i". +bt aining a schedul e summari si ng the tax liabilities that reflect s
the balance to be charged to the profit and loss account and the
amount to be shown as current liability in the balance sheet .
". /isclosur e of the tax position should be in accordance with
legislation and .#! (4 which both require that the tax charged
be disclosed separ at el y in the profit and loss account and the
tax payabl e be shown in the balance sheet under current
liabilities and a not e to the account s should amplify the basis of
pro"iding for taxation.
8/ .8 *e erre d "axat i on
/eferred Taxation result s from the fact that the income tax depart me nt
use different rules for calculati ng profits from those used by the
account ant in financi al accounti ng, for exampl e, capit al allowances "s.
depr eci ation. These different rules normally result in a reduced profit for
tax purposes in the short ter m, but they result in a pot enti al payment of
deferr ed taxation in the long ter m. #lso the different rules may result in
account s that would mislead the reader if he tries to compar e the tax
charged based on the accounti ng profits with that based on the taxation
profits. To resol"e this probl em the accounti ng profession has come up
with the need to pro"ide for deferred taxation. This can be a highly
subD ecti"e area and the rele"ant aut horit y is I#! ($ -Income Taxes. )efore
we look at the audit work in"ol"ed let us not e the ways in which a
pot enti al charge for deferr ed taxation can arise.
i. !hort ter m timing differences: the tax aut horiti es in the most
deal with items on a payment s and receipt s basis, ther efor e,
gener al pro"isions will not be allowed until they ha"e act ually
been paid. !uch differences must always be pro"ided agai nst .
ii. Wear and tear allowances "s. depreci ati on: wear and tear
allowances usually on a reducing basis are in"ariabl y different
from depreci ati on.
iii. #s a result of trading losses, debit balances may result.
i". 2ermanent differences as a result of items of expendi t ur e that
will remai n per manent l y disallowed by the Income Tax
/epart ment such as depreci ati on on buildings and on the cost
of saloon "ehicles in excess of !hs. (44, 444C - .
I#! ($ requires that deferred taxation be pro"ided for on all timing
differences on the liability met hod. If howe"er, the following
conditions are compli ed with then pro"ision is unnecess ar y. It will be
reasonabl e to assume that timing differences will not re"erse and tax
liabilities will not cryst alli:e if but only if the company is a going
concern and
aB The direct ors are able to foresee on reasonabl e e"idence that
no liability is likely to arise as a result of re"ersal of timing
differences for some consider abl e period ahead Aat least three
yearsB and
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bB There is no indication that aft er this period the situation is likely
to change so as to cryst alli:e the liabilities.
2lease not e that the onus of proof is squar el y on the direct ors, it is
for them to pro"e to the audit or that a pro"ision for deferr ed tax is
not necess ar y and if they cannot pro"e, then a pro"ision must be
made for all timing differences.
We can ther efor e distingui sh the audit functions as follows:
i. To check the calcul ation of timing differences@
ii. To ensur e that per manent differences ha"e not been taken into
account @
iii. 1heck the direct ors "iew of the ext ent of the pro"ision required
by:
aB -nsuring that the company is a going concer n
bB -xami ning the e"idence upon which the direct ors ha"e
based their assumpt i on and that no timing difference has
been re"ersed
i". -nsure that present at i on in the account s is in accordance with
.#! (4, is compr ehensi "e, and unambi guous.
!tage aB is a routine mat t er and the audit ors always exami ne
whet her the company is a going concern, becaus e many "aluations
bases would change if the company were not a going concern. !o
we can now exami ne the difficulties associ at ed with the reliability of
e"idence in support of a reduction in the pro"ision for deferr ed
taxation.
i. 1apit al allowances "s. depr eci ation: If the client can pro"e that
they will maint ai n the existing le"els of in"est ment in real
ter ms, then ther e may be Dustification to accept a reduction of
this cat egory of deferred taxati on howe"er if in"est ment s begin
to decline then deferred taxati on could be cryst alli:ed.
The maint enance of existing capit al expendi t ur e le"els is
dependent upon the sales and profitability of the company, thus
the auditor is required effecti"ely to perfor m an audit of the
profit forecast for at least three years ahead. This would seem
to be agai nst gener ally accept ed accounti ng principles which
ad"ise against auditing of profit forecast s becaus e in a profit
forecast many factors are out side the control of the direct ors.
1apit al expendi t ur e and in"ent ory le"els are to a cert ai n ext ent
within the control of the direct ors. This may seem to be a weak
argument becaus e profitability affect s capit al expendi t ur e and
there is little likelihood of profit if the direct ors do not in"est
prudent l y, although it may well be within their control to do so.
We therefor e only require the auditor to assess whet her
profit ability is likely to fall or not rise sufficiently to warrant or
support plant capit al expendi t ur e. We do not expect him to
assess precisel y what that profitability is going to be. -"idence
is based largely on the companyJ s budget s and longer ter m
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.<: "he Audi t +roc e s s B 'eri i cat i on
forecast s. The procedur es the audit or adopt s are:
aB #ssess the trend of past capit al expendi t ur e to see
whet her it is falling or rising or whet her ther e is no
consist ent pat t er n.
bB #ssess the companyJ s past profit perfor mance to see
whet her it is falling or rising and compar e this perfor mance
with the companyJ s pre"ious budget s and esti mat es to
det er mi ne its ability in forecasti ng as good forecasti ng in
the past pro"ides mor e confidence for the present .
cB #ssess the companyJ s capit al, cash and profit forecast s for
reliability. This in"ol"es det er mi ni ng whet her they ha"e
been made on the basis of reasonabl e dat a or whet her
they are mer e guess work.
dB -xami ne the direct ors minut es for e"idence of policy
changes which might affect future capit al expendi t ur e.
eB Take into consider at i on the economi c situati on particul arly
as it affect s the client J s own indust ry and the companyJ s
exposur e to economi c or legislati"e changes to labour
disruption or mat eri al or component s short ages.
ii. !hort- ter m timing differences. Their re"ersal should be easy to
identify as if they were gener al pro"isions last year we can
follow up their utilisation.
iii. /ebit balances as a result of trading losses. 8e"iew of current
result s, profit forecast s and agreed tax assess me nt s should
pro"ide enough e"idence as to the likelihood of these losses
being fully utilised in the short- ter m.
I#! ($ Income Taxes
(#! ($ requires that a deferr ed tax liability shoul d be recogni :ed for all
taxabl e tempor ar y difference with minor excepti ons Ae. g. goodwill, which
is not allowabl e for tax purpos esB.
2oint s for the audi t or are:
AiB 1onfirm that the company? s policy as regar ds deferr ed tax is in
confor mi t y with I#! ($ and is consi st ent with the pre"ious year
AiiB 1heck the det er mi nat i on of and arithmet i cal accur acy of all
tempor ar y differences and the arit hmet i cal accur acy of the
deferr ed tax calcul ati ons
AiiiB If deducti bl e tempor ar y differences exist Aleadi ng to deferr ed
tax asset sB confir m that the condi tions for recogni ti on ha"e
been met .
Ai"B If a deferr ed tax asset has been recogni:ed for unus ed tax
losses being carri ed forward, confir m that the condi tions
allowing that recogni ti on ha"e been met .
1onfirm that all disclosur e requir eme nt s ha"e been met .
8/ .: S$A#E CA+I"A2
!hare capit al is a speci al type of liability and when it has been issued
during the year then "erification procedur es are as follows:
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(. -nsure that the issue is within the limits aut hori sed by
,emor andum and #rticles of #ssociation.
$. 1hecking the direct orsJ minut es to ensur e that the issue was
aut hori sed.
*. 6ouch the correct recording of moni es recei"ed.
%. -nsure the correct treat ment of any shar e premi um obt ained in
so doing reme mber that the shar e premi um account can only
be used to issue fully paid bonus shares, write off preli mi nar y
expens es, write off expens es of shar e or debent ur e issue, write
off discount s on shar es or debent ur es and to pro"ide for a
premi um payabl e on the redempt i on of redee ma bl e prefer ence
shar es.
5. -xami ne the prospect us if ther e was one, applications,
application and allot ment sheet s, the shar e regist er, the cash
recei"ed records, shar e certificat e count erfoils and repayment
to unsucces sf ul applicant s.
&. 6ouch the payment of underwriting and other fees.
K. When the issue is not for cash but for other consider at i ons e. g.
the goodwill and other asset s of a business, "ouch the
agree me nt and ensur e that all entri es are properl y made.
9. If the issue was subDect to appro"al from the airobi !tock
-xchange, then ensur e that appro"al has been obt ai ned. If it
has not been obt ai ned all the money subscribed is ret urnabl e.
-nsure that all the money was placed in a separ at e bank
account until all conditions were satisfied. -nsure that the
mini mum subscri ption has been recei"ed becaus e if there were
not enough subscri ber s then the whole is ret urnabl e.
When there is no new issue of shar es the audit work includes:
(. /et er mi nat i on of the tot al shar es of each class as stat ed in the
balance sheet and the obt aining of a list shar e holdings which in
tot al should agree with the balance sheet tot al.
$. Testing the balances in the shar e regist er with the list and "ice
"ersa.
*. If the shar e regist er is maint ai ned by an independent firm of
registr ars, the auditor shoul d obt ain a certificat e that the abo"e
work has been done.
%. 6ouch transfer s to the shar e regist er and shar e transfer forms.
8/ .C #ESE#'ES
,o"ement s in reser"es require disclosur e in the balance sheet , the profit
and loss account , the direct ors report s or in the not es to the account s.
The audit ors must ensur e proper aut hori:ation has been gi"en for this
mo"ement s and they must "ouch the recordi ng of this mo"ement . The
auditors must ensur e that mat eri al amount s of reser"es are classified
under appropri at e headi ngs. The capit al redempt i on reser"e fund and the
share premi um account require separ at e identification and the aggregat e
amount should also be shown. 2ro"isions must be re"iewed to ensur e
that they did not cont ai n secret reser"es.
8/ .D 2%N-> "E#! 2IABI2I"IES
A&*I"IN-
.<D "he Audi t +roc e s s B 'eri i cat i on
0ong- ter m liabilities are usually e"idenced by an agree me nt called a
debent ur e. 7or this reason, long- ter m loans are often called debent ur es.
They may be secur ed by a fixed charge o"er a specific asset or secur ed by
a floating charge on all the asset s or they may be unsecur ed in which case
they are called naked debent ur es. !ecured liabilities are somet i mes
referred to as mort gage debent ur es.
'E#I7ICA"I%N +#%CE*&#ES
aB +bt ain a schedul e det ailing the sums due at the beginni ng of
the year, additions and redempt i ons and the sum due at the
year end.
bB ote or phot ocopy the ter ms and conditions of the loan as
e"idenced in the deed.
cB #gree the openi ng balances with last yearJ s account s and
working paper s.
dB If any new loans ha"e been recei"ed, "ouch to board minut es,
memor andum and articles, regist er of debent ur e holders and
charges etc.
eB 8epayme nt s made should be "ouched with debent ur e deeds,
the cash book and the regist er of debent ur e holders and
charges.
fB Interest payment s should be "ouched with debent ur e deeds,
cash books and any out st andi ng amount s should be correctl y
account ed for.
gB If the loans are secur ed, confirm that the charge is regist er ed at
the registr ar of 1ompani es.
hB #gree tot al amount s out st andi ng with the regist er of debent ur e
holders.
iB -nsure disclosur e is in accordance with 1ompani es #cts
requirement s, clearly st ati ng the dat e of redempt i on of the
debent ur es.
8/ .< +endi ng 2iti gat i on
)ecause of the inher ent uncert ai nt y in esti mat i ng the outcome of legal
actions, this is an especi ally difficult area for the audit or. !ome actions
are possibl e that assist in "erifying the exist ence but not necess arily the
amount of liabilities that will arise out of legal action.
These include:
aB 8e"iew of the client syst em for recordi ng clai ms and disput es
and the procedur es for bringing this to the att enti on of the
board.
bB 8e"iew of the arrange me nt s for instructi ng solicitors.
cB -xami nati on of the minut es of the board for references to and
indications of possi bl e clai ms.
dB Inspection of bills render ed by the solicitors.
eB 8e"iew of correspondence with solicitors and obt aining a list of
all mat t er s referred to solicitors with an esti mat e of the possi bl e
ulti mat e liability.
fB Written assur ance in the form of a repres ent at i on lett er from an
appropri at e direct or that he is not awar e of any other mat t er s
referred to the lawyer s other than those disclosed. If the
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audit or is in doubt he should obt ain a direct confirmat i on from
the 1ompanyJ s lawyer s. The request must be sent by the client
not by the auditor.
8/ 65 Ca1i t al Commi t me nt s
The 1ompani es #ct requires that capit al commi t me nt s be disclosed by a
way of not e to the account s. The auditor must ther efore perfor m
sufficient work to ensur e that such amount s are fairly and compl et el y
stat ed. =e may obt ai n this informati on from the direct ors in a lett er of
represent at i on but work must be perfor med to confirm the amount s
stat ed. The direct or?s minut es shoul d be re"iewed for e"idence of
aut horit y to place capit al contract s. -xami nati on of capit al commi t me nt s
must be carried out and discussions held with the appropri at e
manage me nt st aff. 1orrespondence with lawyer s should be perused to
disco"er whet her any instructions ha"e been gi"en for drawing up maDor
contract s. The not e must distingui sh bet ween expendi t ur e aut hori sed by
the direct ors and the contract s which ha"e already been ent er ed into.
IAS 4C +ro0i si ons ? Conti ng e nt Ass et s and Conti ng e nt 2ia,ili ti e s
I#! *K was issued in order to deal with the subD ecti"e area of pro"ision
and to pre"ent the use of Vbig bat h pro"isioni ng? and the practi ce of
profit smoot hi ng.
I#! *K requires that Ain accordance with the definition of a liabilityB a
pro"ision shoul d be made wher e the mat t er gi"es rise to a const r uct i "e
or legal obligati on and wher e ther e is a probability that ther e will be an
outflow of economi c benefit s which can be reliabl y meas ur ed.
In addi tion I#! *K gi"es exampl es of how specific situati ons shoul d be
deal t in ter ms of recogni ti on, meas ur e me nt and disclosur e dependi ng on
the circums t anc es . These include onerous cont r act s, re- organi:at i ons
and rest r uct uri ng cost s, and en"ironment al cont ami nat i on.
1ontingent liabilities and conti ngent asset s are also deal t with by I#! *K.
-"idence is required to suppor t their classificati on and disclosur e is
appropri at e under the st andar d.
The audi t or?s task is to obt ai n sufficient e"idence that the financi al
st at e me nt s include only "alid pro"isions and that they adequat e but not
excessi "e and that adequat e disclosur es ha"e been made. A!ee below
the sections dealing with account i ng esti mat e s and discount i ng
oper at i ons belowB.
(a) 2iti gat i on and cl ai ms
I!# 54( Audit $vidence 6 Additional !onsi derati on for Specific Items
requires that audi t or s shoul d carry our procedur es to become awar e of
nay mat eri al litigati on or clai ms in"ol"ing the entit y. !uch procedur es
woul d include:
AiB ,ake appropri at e enqui ri es of manage me nt includi ng obt ai ni ng
repr es ent at i ons
AiiB -xami ne boar d or manage me nt minut es for indicati ons of
possi bl e clai ms
AiiiB -xami ne corresponde nc e with lawyer s including bills render ed
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655 "he Audi t +roc e s s B 'eri i cat i on
Ai"B -xami ne legal expens e account
A"B +bt ai n a list of mat t er s refer eed t lawyer s with the company?s
esti mat es of possi bl e liabilities
A"iB 8e"iew the client?s syst e m of recordi ng clai ms includi ng the
procedur e for bringi ng them to the att ent i on of manage me nt .
When litigati on or clai ms ha"e been identified or wher e the audit or
belie"es they may exist, the audit or shoul d seek direct communi cat i on
with the entit y?s lawyer s.
The lett er shoul d be prepar ed by manage me nt and sent by the audi t or.
It shoul d specify the litigati on and manage me nt ? s asses s me nt of the
outcome, and request that the lawyer confir m directl y to the audit or the
reasonabl ene s s of the st at e me nt and to pro"ide the audit or with furt her
infor mat i on if the list is incompl et e. If the lawyer is likely to respond to a
mor e gener al enquiry, then that woul d be bet t er - lawyer s are gener all y
unwilling to do this unless ther e is not hi ng to report .
In compl ex situati ons the audi t or may need to meet the lawyer, with the
client?s per mi ssi on and prefer abl y with the client in att endanc e.
Wher e per mi ssi on to communi cat e with lawyer s is refused, a qualified
audi t opinion wll nor mall y follow.
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#n ext ract from such a lett er is set out below:
In connect i on with the pres ent at i on and audit of our financi al st at e me nt s
for the year ended Y the direct or s ha"e made esti mat es of the ulti mat e
liabilities Aincludi ng cost sB which might be incurred, and which are
regar ded as mat eri al, in relation to the following mat t er s on which you
ha"e been consul t ed. We shoul d be obliged if you would confirm directl y
to our audit ors that in your opinion thes e esti mat es are reasonabl e.
,att er
-sti mat ed liability includi ng cost s
0ibel action agai nst the company in .shs$54, 444
1onnecti on with st at e me nt s
#ppeari ng in newspaper
!igned YYYYYYYYYYY
/at ed YYYYYYYYYY..
-tc
AbB +ther 2ro"isions and 1ontingenci es
AiB +bt ai n the client?s schedul e of pro"isions and conti ngenci es
and seek suppor ti ng document a t i on in the form of legal
opinions, corresponde nc e with cust omer s, en"ironme nt al and
techni cal report s.
AiiB #ssess the basi s of pro"isions for reasonabl enes s and
compli ance with I#! *K
AiiiB -nsur e that correct calcul ati ons ha"e been made
Ai"B 2hysically inspect any sit es in respect of which clean up
rest or at i on pro"isions ha"e been made
A"B 1onsider the need for exper t techni cal assi st ance
A"iB #ssess the need for further si mil ar pro"isions
(c) St andar d 2ett er o re@ue s t to the Bank
This is likely to pro"ide the neces s ar y e"idence in respect of bills
discount ed and guar ant e es . This lett er is consi der ed in an earli er lesson
as the pri mar y met hod of "erifying bank bal ances.
(d) 2ett er o #e1re s e nt a t i o n
This will be consi der ed lat er as a form of audi t e"idence. It also act s to
remi nd the direct or s to acknowl edge their responsi biliti es.
A&*I"IN-
656 "he Audi t +roc e s s B 'eri i cat i on
The knowl edge of conti ngent liabilities may "ery well be confined to
manage me nt and is ther efor e a suit abl e mat t er for inclusion in such a
lett er. In addi tion it will remi nd the direct or s of their responsi bilit y to
disclose such mat t er s to the audi t or
8/ 6. Amount s *eri 0e d 7rom +rec e di ng 7inanci al St at e me nt s
2lease not e that the auditor is interest ed in precedi ng yearJ s e"idence
becaus e
(. The 1ompani es #ct st at es that correspondi ng amount s should
be disclosed in respect of e"ery item in a companyJ s balance
sheet and profit and loss account for the financi al year
precedi ng that to which the balance sheet and profit and loss
account relat e. I#! K requires similar informati on for the cash
flow st at eme nt .
$. These figures form the opening position from which the present
yearJ s are deri"ed. The audit or must be assur ed that the
openi ng figures ha"e been properl y brought forward.
*. #ccounting policies must be applied consist entl y from year to
year.
%. 1orrespondi ng amount s must be shown and the audit or should
seek e"idence that they are properl y shown.
The audit or is not required to express an opinion on the
correspondi ng figures, but he is responsi bl e for ensuring that they
are
aB The amount s which appear in the precedi ng yearJ s account s or@
bB They ha"e been rest at ed to achie"e consist ency and
compar ability or@
cB They ha"e been rest at ed due to a change in accounti ng policy
or the correction of a fundament al error as required by I#! 9.
8/ 66 "he Audi t o Account i ng Esti mat e s
#n account i ng esti mat e is defined in I!# 5%4 #udit of #ccounti ng
-sti mat es as Van approxi mat i on of the amount of an item in the absence
of a preci se means of meas ur e me nt ?.
-sti mat es include amount s for accumul at ed depr eci ati on, deferr ed tax@
writ e downs to net reali:abl e "alue, losses on long ter m cont r act s, legal
clai ms agai nst the company, other conti ngent liabilities and other areas
which a significant element of Dudgment is requir ed.
!uch items are inher ent l y mor e risky than non- Dudgment al items and
cont rol risk is usually higher as these are non- routine trans act i ons.
,anage me nt is responsi bl e for maki ng esti mat es.
The audi t of account i ng esti mat e s under I!# 5%4 in"ol"es the following
three st eps:
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
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654
8e"iew and testi ng of the proces s used by manage me nt to
de"el op the esti mat e
This will in"ol"e e"al uati on of the dat a and consi der at i on of
assumpt i ons on which the esti mat e is based. ,anage me nt ? s
esti mat es as to warrant y cost s, for exampl e shoul d be based on past
experi ence as to the le"el of clai ms and be in based. ,anage me nt ? s
esti mat es as to warrant y cost s, for exampl e shoul d be based on past
experi ence as to the le"el of clai ms and be in line with the audit or?s
knowl edge of the busi nes s. It will also in"ol"e checki ng of the
mechani cal calcul ati ons, compari son with esti mat es made in prior
periods and consi der at i on of manage me nt ? s appro"al procedur es.
<se an independent esti mat e Agener at ed by the audit orB to
compar e with manage me nt ? s esti mat e
8e"iew subs eque nt e"ent s which confirm the esti mat e
Wher e in the case of conti ngent liabilities, subs eque nt e"ent s Vcryst alli:e?
the liability ther e will be no need to re"iew manage me nt ? s proces s es or
use independent esti mat es .
The audi t or will nor mall y test the calcul ati ons of the esti mat e, asses the
assumpt i ons made Ae. g. the court is '4T likely to find in our fa"ourB
compar e esti mat es with those made in pre"ious periods and ensur e that
the esti mat e is in accordance with the audi t or?s knowl edge of the
busi ness and the other audi t e"idence obt ai ned.
I7#S 8 Non> Current Ass e t s $el d or Sal e and *i scont i nue d
%1erat i ons
# /isconti nui ng +per ati on is a component of an ent er pri se:
AaB That the ent er pri se, a pursuant to a singl e plan, is:
AiB /isposi ng of subst ant i ally in its entiret y such as by selling the
component in a singl e trans act i on, by demer ger or spin off of
owner shi p of the component to the ent er pri se?s shar ehol der s.
AiiB /isposi ng of pieceme al , such as by selling off the component ?s
asset s and set tling its liabilities indi"iduall y@ or
AiiiB Termi nat i ng through abandonme nt
AbB That repr es ent s a separ at e maD or line of busi ness or geogr aphi cal
area of oper at i ons@ and
AcB That can be distingui shed oper at i onall y and for financi al reporti ng
purpos es.
I78! 5 3on4 current Asset s 5eld for Sale and (isconti nued Operations
prescri bes the account i ng for asset s held for sal e, and the present at i on
and disclosur e of disconti nued oper at i ons. The meas ur e me nt pro"isions
of I78! 5 appl y to all non- current asset s and dispos al groups, except for:
deferr ed tax asset s AI#! ($ Income -a%es B@
asset s arising from empl oyee benefit s AI#! (' $mpl o"ee 7enefi t s B@
financi al asset s within the scope of I#! *' Financial Instrume nt s8
Recogni ti on and 9easure me nt @
A&*I"IN-
65; "he Audi t +roc e s s B 'eri i cat i on
Znon- current asset s that are account ed for in accor dance with the
fair "alue model in I#! %4 Invest me nt Propert " @
non- current asset s that are meas ur ed at fair "alue less esti mat ed
point- of- sal e cost s in accordance with I#! %( Agricult ure @ and
cont r act ual right s under insur ance cont r act s as defined in I78! %
Insurance !ontract s .
Ass et s hel d or sal e
# non- current asset Aor disposal groupB is classified as held for sal e if its
carryi ng amount will be reco"er ed principally through a sal e trans act i on
rat her than through conti nui ng use. That is, the asset Aor disposal groupB
is a"ail abl e for immedi at e sal e and its sal e is highly probabl e.
# non- current asset Aor disposal groupB classified as hel d for sal e is
meas ur ed at the lower of fair "alue less cost s to sell and its carryi ng
amount .
#ny impair ment loss on writ e- down of the asset Aor dispos al groupB to
fair "alue less cost s to sell is recogni :ed in profit or loss. #ny gain on
subseque nt increas e in fair "alue less cost s to sell is also recogni :ed in
profit or loss, but not in excess of the cumul at i "e impair ment loss
already recogni :ed on the asset eit her in accor dance with I78! 5 or I#!
*& Impairment of Asset s .
*i scont i nue d %1erat i ons
# disconti nued oper at i on is a component of an entit y that either has
been dispos ed of or is held for sal e. It may be a subsi di ary, or a maD or
line of busi ness or geogr aphi cal area. It will ha"e been a cash- gener at i ng
unit Aor group of cash- gener at i ng unit sB as defined in I#! *& Impairment
of Asset s .
/isclosur es of disconti nued oper at i ons include:
anal ysi s of the post- tax profit or loss into re"enue, expens es , pre-
tax profit or loss, and the relat ed income tax expens e@
the gain or loss recogni sed on meas ur e me nt to fair "alue less
cost s to sell or on dispos al , and the relat ed income tax expens e@
net cash flows att ri but abl e to oper at i ng, in"esti ng and financi ng
acti"iti es@
asset s held for sal e separ at el y from all other asset s@ and
liabilities of a disposal group held for sal e separ at el y from all other
liabilities.
#s regar ds recogni ti on and meas ur e me nt , I78! 5 does not est abli sh any
separ at e principl es, but relies upon those of I#! *& Impair ment of #sset s
and I#! *K 2ro"isions, contingent 0iabilities and 1ontingent #sset s, and
also on I#! (' -mployees )enefit s and I#! (& 2ropert y, 2lant and
-quipment .
I#! *K expl ai ns when a pro"ision shoul d be recogni:ed on
disconti nuance. In particul ar, a rest r uct uri ng pro"ision shoul d only
include the direct expendi t ur e arising form the rest r uct uri ng which are
bot h@
AiB ecess arily ent ail ed by the rest ruct uri ng, and
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
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AiiB ot associ at ed with the ongoi ng acti"iti es of the ent er pri se
It may be necess ar y, on a disconti nuance, to appl y the pro"isions of I#!
*& in recogni :i ng impair ment losses.
+res e nt a t i on and *i scl os ur e
#n ent er pri se shoul d include the following infor mat i on relati ng to a
disconti nui ng oper at i on in its financi al st at e me nt s begi nni ng with the
financi al st at e me nt s for the period in which the initial disclosur e e"en
occurs.
AiB # descri ption of the disconti nui ng oper at i on
AiiB The busines s or geogr aphi cal segment A sB in which it is report ed
in accor dance with I#! (%
AiiiB The dat e and nat ur e of the initial disclosur e e"ent
Ai"B The dat e or period in which the disconti nuance is expect ed to
be compl et ed if known or det er mi nabl e
A"B The carryi ng amount s as of the bal ance sheet dat e of the tot al
asset s and the tot al liabilities to be dispos ed of
A"iB The amount s of re"enue, expens es, and pre- tax profit or loss
from ordinar y acti"iti es att ri but abl e to the disconti nui ng
oper at i on during the current financi al reporti ng period, and the
income tax expens e rel ati ng ther et o.
A"iiB The amount s of net cash flows att ri but abl e to the oper at i ng,
in"esti ng, and financi ng acti"iti es of the disconti nui ng
oper at i on during the current financi al reporti ng period.
If the initial disclosur e e"en occurs aft er the end of an ent er pri se?s
financi al reporti ng period but before the financi al st at e me nt s or that
period are appro"ed by the board of direct or s or si milar go"er ni ng
body, those financi al st at e me nt s shoul d include the disclosur es
specified abo"e for the period co"er ed by those financi al st at e me nt s .
!epar at e disclosur e is required for each mat eri al disconti nui ng
oper at i on.
When asset s are sold or liabilities set tl ed in disconti nuance, the pre-
tax gai n or loss, and the income tax expens e relati ng to it must be
disclosed on the face of the income st at e me nt but not as an
ext raor di nar y item. A/isclosur es AaB to AgB abo"e may be disclosed by
not e or on the face of the income st at e me nt B .
7or asset s not yet sold but for which a binding sal e agree me nt exist s, the
net selling prices and the expect ed dat e of recei pt must be disclosed by
not e.
Audi t A11roac h
The account i ng and audi ti ng issues are mai nl y concer ned with
identifying the point in ti me at which the initial disclosur e e"en
occurs, and also ensuri ng that lonely appropri at e cost s are included in
any pro"ision for rest ruct uri ng that is est abli shed. #ppropri at e
format s must be used for the infor mat i on to be disclosed.
The key audi ti ng mat t er s arising are that the audi t ors shoul d confir m
whet her they agree with the company?s "iew as to the need for
A&*I"IN-
65: "he Audi t +roc e s s B 'eri i cat i on
disclosur e of propos ed or act ual disconti nuance, and that they agr ee
that the company? s disclosur es are appropri at e.
Typical procedur es would include:
AiB /et er mi ne the client?s policies and procedur es in respect of
disconti nui ng oper at i ons
AiiB 8e"iew board minut es and other rele"ant manage me nt
document a t i on
AiiiB ,ake enquiri es of manage me nt into significant disposal s of
asset s and in"est me nt s
Ai"B -xami ne aft er dat e infor mat i on
A"B 6erify the make up pf disconti nui ng oper at i ons by refer ence
to suppor ti ng document a t i on.
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
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65C
E&ES"I%N %NE
Qou are about to commence the final audit of Higglane !port swear
0imited, a distribut or of sport s equipment and clothing. The internal
auditor informs you that he has carried out a positi"e debt orJ s
circularisati on without your prior knowledge, utilising the following
procedur es:
i. +bt ained a list of out st andi ng debt or s balances Atot al .shs.
*K&, 444B at *( +ctober (';9.
ii. !elect ed e"ery third debt or for circularisation resulting in a
sampl e of *4 debt or s tot alling .shs 54, 444.
iii. 2repar ed and signed the circularisati on lett er himself. The
lett er request ed the debt or to write the balance due to
Higglance 0imited on the reply slip and to return the reply to
the chief account ant .
i". 2repar ed a summar y list of all replies recei"ed for submi ssi on to
the ext er nal audit or.
+nly eight replies A"alue !hs. (4, 544B had been recei"ed to dat e. The
internal audit or is a little disturbed at the fact that you intend to re-
circularise debt ors as he feels that it is a duplication of effort and that
the replies recei"ed are reliabl e audit e"idence.
AaB /escribe the work which you perfor m before you can make
use of any of the work undert aken by the internal audit or.
AbB -xplain to the internal auditor the reasons why you wish to re-
circularise debt or s, comment i ng upon the procedur e adopt ed by
the internal audit or.
AcB /escribe the techni ques which you could adopt to increas e the
respons e rat e of the second debt or s circulation made by you.
AdB -xplain the possi bl e limit ations of positi"e debt or s circulation.
A&*I"IN-
65D "he Audi t +roc e s s B 'eri i cat i on
E&ES"I%N "3%
The following is the draft balance sheet of 0ocksley 0imited for the year
ended *( ,arch (';'.
2%CKS2E( 2I!I"E*
BA2ANCE S$EE" AS A" 4. !A#C$ .<9<
.< 9< .< 9<
N N
7ixed Ass et s
Tangibl e asset s '', %44
K*, 444
In"est ment s 95, (44
(4(, %44
(9%, 544
(K%, %44
/e"elopment expendi t ur e 5', 9(4
$%%, *(4
(K%, %44
Current Ass et s
!tock 59, ('4
&*, 4(4
/ebtors (9%, &*4
(5&, K$4
1ash at )ank and in hand ','K4
&$, &$4
$5$, K'4
$9$, *54
Credi t orsB amount s alli ng due wit hi n one year $K&, 5(4
$(5, '44
et current AliabilitiesBC ass et s A$*, K$4 B
&&, %54
Total asset s less current liabilities $$4, 5'4
$%4, 954
Credi t orsB amount s alli ng due at er more than one year
5*, (44 %&, *$4
2ro"isions for liabilities and charges
/eferred taxati on *,494
$,5$4
Ca1i t al and res er0e s
!hare capit al 9', K44
9', K44
!hare premi um account ((, *44
((, *44
8e"aluation reser"e ',K54
',K54
2rofit and loss account &*, &&4
9(, $&4
(K%, %(4 ('$, 4(4
0ocksley 0td produces garden furniture and has incurred expendi t ur e
during the year ended *( ,arch (';' on the de"elopment of moulding for
a new range of plastic garden furnitur e. The direct ors wish to carry
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
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65<
forward the de"elopment expendi t ur e indefinit el y as they feel that the
company will benefit from the new mouldings for many years. The
product range is being de"eloped becaus e profits ha"e been declining
o"er the last few years owing to the uncompet i ti"enes s of the product s
made by the company. The company has sold many of its fixed asset s
during the year and purchas ed new machi ner y which will enabl e the
companyJ s producti"ity to increase. The direct ors decided not to fund the
abo"e expendi t ur e using out side finance but to gener at e the necess ar y
resources internally by taking ext ended credit from its suppliers and
utilising its liquid funds held at the bank. The company also sold part of
its in"est ment s, which are made up of stocks and shares of public limit ed
compani es.
+ne of the reasons for this met hod of financing the expendi t ur e was that
the company already has a loan of S%5, 444 outst andi ng which has been
included in the figure for credit ors: amount s falling due after mor e than
one year. This loan is secur ed on the fixed asset s of the company and is
repayabl e o"er ten years. The sale of the fixed asset s and in"est ment s
did not yield as much as was expect ed and a small loss on sale of S(, $44
has been included in the profit and loss account as part of the amount s
shown for >ot her expens esJ .
#s well as selling some of its asset s the company had the remai nder
re"alued by a professi onal "aluer. The gain on re"al uation of fixed asset s
has been credit ed by the company to the profit and loss account and
treat ed as an extraordi nar y gain.
The direct ors felt that the sharehol der s should share in this >windfallJ gain
and ha"e increas ed the proposed di"idend accordingl y. +"er '4T of the
shares of the company are held by the direct ors.
AaB 0ist the audit test s the audit or would carry out to "erify the
"alue attribut ed to the de"elopment expendi t ur e in the
balance sheet of 0ocksley 0td.
AbB -xplain to the direct ors why de"elopment expendi t ur e should
not be carried forward indefinit ely in the financi al
stat e ment s, and describe the circumst ances in which the
cost s may be deferred to the future.
AcB 0ist the audit procedur es which shoul d be carried out to
"erify the gain arising on the re"al uation of fixed asset s.
AdB /escribe the audit implications of the direct orsJ decision to
gener at e internally the funds required for the de"elopment of
the business.
E&ES"I%N "$#EE
8ubella Qarns 0td manuf act ur es cott on for sale to the textile indust ry. The
stock of the company is "alued on a standar d cost basis and you are about
to commence the final audit, ha"ing att ended the physical stock count .
AaB !tat e under what circumst ances standar d cost would be a
A&*I"IN-
6.5 "he Audi t +roc e s s B 'eri i cat i on
suit abl e met hod of pricing stocks for financi al accounti ng
purposes
AbB /escribe how you would satisfy yourself, as audit or of
8ubella Qarns 0td that the st andar d cost s has been properly
det er mi ned
AcB /iscuss briefly what action you would take if you disco"er
that ther e are significant "ariances bet ween act ual and
standar d prices for stock.
E&ES"I%N 7%&#
Qour firm has been appoint ed audit ors of 1ompa 8ing 0td in successi on to
anot her firm of 1ertified 2ublic #ccount ant s. The first financi al stat e ment s
on which you are required to express an opinion are for the year ended
*4t h !ept ember (';*.
(ou are re@ui re d to det ai l
AaB Qour responsi bilities in respect of prior period financi al
informat i on, including compar at i "es, and
AbB The procedur es you would adopt in order to discharge your
responsi bilities.
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
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E&ES"I%N 7I'E
AaB What basic legal responsi bility has an auditor to seek
to ascert ai n whet her or not an aspect of the affairs of
a client is being conduct ed in a lawful mannerR
A(4 ,arksB
AbB What action should be taken if, in the course of an audit, an
auditor has reasons to suspect that his client has carried on
fraudul ent tradingR A& ,arksB
AcB What amendme nt s would you recomme nd to be made to the
.enya 1ompani es #ct A1ap. %9&B with a "iew to enhanci ng the
auditor?s social responsi bilityR

A% ,arksB
("ot al
B 65!arks )
o the Study +ack
A&*I"IN-
6.6 "he Audi t +roc e s s B 'eri i cat i on
C%!+#E$ESI'E ASSI-N!EN" No/ 6
"% BE S&B!I""E* A7"E# 2ESS%N 8
*ist anc e 2earni ng Admi ni s t rat i on or marki ng ,y the &ni 0ersi t y
E&ES"I%NS/
Answer A22 Eues t i ons "ime Allowe dB 4 $ours
E&ES"I%N %NE
What do you underst and by the following expressi ons and ter ms and in
which cont ext might they be usedR
AaB 3uality of e"idence
AbB #udit trail
AcB ot mat eri al
AdB 8eser"ati on of title
(65 !arks)
E&ES"I%N "$#EE
AaB Hi"e exampl es of reliance by auditors on the e"idence supplied
by speci alist s A* ,arksB
AbB In what conditions may such reliance be requiredR
A$ ,arksB
AcB What factors indicat e the reliability of the speci alist sR
A* ,arksB
AdB =ow should the audit or e"aluat e the e"idenceR
A5 ,arksB

("ot al B .4 !arks)
E&ES"I%N "$#EE
#uditing working paper s should always be sufficiently compl et e and
det ailed to enabl e an experi enced auditor with no pre"ious connecti on
with the audit subsequent l y to ascert ai n from them what work was
perfor med and to support the conclusions reached.
#e@ui re d
AaB /escribe four benefit s that the audit or will obt ai n from working
paper s that meet the abo"e requirement s
A5 ,arksB
AbB In the case of a significant item requiring exercise of Dudgement
Afor inst ance, a mat eri al clai m for damagesB show what types of
mat t er should be recorded in the current file in respect of it and
gi"e reasons for inclusion. Qou should use a mat eri al clai m for
damages to illustrat e your answer A5 ,arksB
AcB 0ist three types of informati on typically ret ained in the audit
per manent file and st at e why they should be a"ailabl e for easy
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
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reference A& ,arksB
AdB 1omment on the desirability of using standar di sed working
paper s and gi"e an exampl e of such a working paper and its
use. A% ,arksB
("
ot alB 65 !arks)
A&*I"IN-
6.; "he Audi t +roc e s s B 'eri i cat i on
E&ES"I%N 7%&#
In carrying out an audit, the audit or apprai ses and test s the syst em of
internal control in order to ascert ai n that it is capabl e of processi ng
transact i ons or det er mi ni ng quanti ti es and "alues compl et el y and
accurat el y. The auditor further carries out subst ant i "e test s in an att empt
to ensur e that the transacti ons, asset s and liabilities recorded in the
accounti ng records, upon which the figures in the financi al st at eme nt s are
based, are in fact compl et el y and accur at el y recorded.
AaB -xplain the mai n areas which concern the audit or when carrying
out subst ant i "e test s on asset and liability amount s recorded in
financi al stat e me nt s A5 ,arksB
AbB 0ist the subst ant i "e test s the audit or would carry out to "erify
the "alues attribut ed to the following asset s and liabilities in a
companyJ s financi al st at eme nt s:
i. Trade debt or
A9 ,arksB
ii. Taxation payabl e within one year
AK ,arksB

("ot al B 65 !arks)
E&ES"I%N 7I'E
,r # )lack has recentl y acquired the controlling interest in 3uicksand
0imited, who are import er s of sport swear. In his re"iew of the
organi:ational struct ur e of the company ,r )lack became awar e of
weaknes s es in the procedur es for the signing of cheques and the
oper ati ons of the pet t y cash syst em. ,r )lack engages you as the
companyJ s audit or and request s that you re"iew the controls o"er
cheque payment s and pet t y cash. =e does not wish to be a cheque
signat or y himself becaus e he feels that such a procedur e is an
inefficient use of his time. In addition to ,r )lack, who is the
managi ng direct or, the company empl oys $4 personnel including four
other direct ors, and approxi mat el y three hundr ed cheques are drawn
each mont h. 7urther the pet t y cash account normally has a working
balance of about S*44, and S&44 is expended from the fund each
mont h. ,r )lack has again indicat ed that he is unwilling to
participat e in any internal control procedur es which would ensur e the
efficient operation of the pet t y cash fund.
AaB 2repar e a lett er to ,r )lack cont ai ning your recomme ndat i ons
for good internal control procedur es for:
i. 1heque payment s
A& ,arksB
ii. 2ett y cash
A5 ,arksB
A,arks will be awarded for the style and layout of the
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6.8
answerB
AbB /iscuss the audit implications, if any, of the unwillingness of ,r
)lack to participat e in the cheque signing procedur es and pet t y
cash function. A* ,arksB
("
ot alB .; !arks)
EN* %7 C%!+#E$ENSI'E ASSI-N!EN" No/ 6 N%3
SEN* (%&# ANS3E#S "% "$E *IS"ANCE 2EA#NIN-
CEN"#E 7%# !A#KIN-
A&*I"IN-
6.: "he Audi t +roc e s s B 7inal #e0i e w o Audi t o
7inanci al St at e me nt s
2ESS%N SI9
"he Audit +rocessB 7inal #e0iew o Audit o 7inancial
Statements
%B=EC"I'ES
-xplain the re"iew procedur es in relation to opening balances and
compar at i "e figures
8e"iew other informati on for its impact on the opinion on the
financi al st at eme nt s
<nderst and the impact of subsequent e"ent s on the "iew con"eyed
by the financi al stat e ment s
1ritically e"aluat e issues surroundi ng the going concer n basis
C%N"EN"S
(B -"ent s aft er the balance sheet dat e
$B 1ompar ati "es
*B 8elat ed parti es
%B The implications of published un audit ed informati on
5B Hoing 1oncern
&B !ubsequent -"ent s C -"ent s after the balance sheet
INS"#&C"I%NS
#ssigned 8eading
Internati onal 7inanci al 8eporting !tandar ds AI78!B
Internati onal st andar ds on auditing AI!#B
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6.C

:/ 5 "he 7inal #e0i e w o the 7inanci al St at e me n t s
The work we ha"e consider ed so far has shown that the auditor first
gat her s fact s about the ent er pri se and the en"ironment it operat es in.
The next stage was the gat heri ng of audit e"idence about indi"idual items
and groups of items which toget her form the account s. We then find that
the audit or is in a position of knowing that he has sufficient e"idence to
subst ant i at e the det ail of the account s. =e then needs to form an opinion
as to whet her the account s as a whole cont ai n cert ai n qualities and this is
when a final re"iew is carried out.
This is a stage of the audit carried out by senior member s of the audit
team using the financi al stat e ment s. This is further to the analytical
re"iew procedur es carried out as part of subst anti "e test s. The aims of
this re"iew are:
i. To pro"ide audit e"idence by det er mi ni ng if the financi al
st at eme nt s pro"ide informati on that is internally consist ent with
other informat i on in the possessi on of the audit or and
ii. #lso to det er mi ne if the financi al st at eme nt s ha"e been
prepar ed using accept abl e accounti ng policies, they compl y
with I78! and other requirement s and that ther e is adequat e
disclosur e of all rele"ant mat t er s.
I would stress howe"er, the following two issues:
i. 3ualities of the audit or who perfor ms this re"iew: this auditor
must ha"e:
aB #n ability to distingui sh bet ween non- mat eri al, mat eri al
and fundament al items@
bB #n ability to assess the accur acy and compl et enes s of
informati on gat her ed in the audit@
cB ,ust posses s skill, imaginati on and good Dudgement
particul arly on professi onal and economi c issues@
dB #n ability to recogni se appar ent inconsist enci es and
abnor maliti es which might indicat e areas where errors,
omissions, frauds, irregul arities ha"e occurred which might
not ha"e been re"eal ed by the routine audit procedur es
and@
eB #n ability to assess whet her or not an audit opinion is
possi bl e.
ii. The qualities required of the final account s: the final account s must
possess cert ai n qualities and these are:
aB <se of accept abl e accounti ng policies, appropri at e to the
business and consist ent l y applied@
bB They must show the result s of oper ati ons in the profit and
loss account , stat e of affairs in the balance sheet , changes
in the financi al position in the st at eme nt of source and
application of funds and all other informat i on included in
the financi al stat e me nt should be compat i bl e with each
other and with the auditorJ s knowl edge of the ent erpri se@
cB #ll appropri at e mat t er s should be adequat el y disclosed
A&*I"IN-
6.D "he Audi t +roc e s s B 7inal #e0i e w o Audi t o
and informati on cont ai ned in the account s should be
suit ably classified and present ed@
dB There must be compli ance with stat ut or y requirement s@
eB There must be compli ance with other rele"ant regul ations@
fB There must be compliance with .enya #ccounti ng
!tandar ds.
The final re"iew may re"eal:
aB #ll is well or
bB 7urther audit e"idence is required in some areas or
cB That it may be desirabl e to make amendme nt s to the
account s and
dB That a qualified report may be required.
The re"iew stage is "ery import ant in moder n auditing as current auditing
opinion is mo"ing more towards a consider ati on of the "iew gi"en to users
by financi al stat e ment s. The det ail is still import ant but the "iew gi"en
must be true in det ail and fair in tot ality.
.
:/ . -oi ng Concern Consi der at i ons
IAS / Present ati on of Financial Stat e me nt s recogni:es the going concern
assumpt i on as one of the fundament al assumpt i ons that underlie the
periodic financi al stat e me nt s of ent er pri ses. The meani ng of going
concern can be said to be that the financi al st at eme nt s assume that the
ent er pri se will continue in operational exist ence for the foreseeabl e future,
or put anot her way the financi al st at eme nt s assume no intention or
necessi t y to liquidat e or curt ail significantl y the scal e of oper ati on or put
mor e simpl y that the ent erpri se can meet its financi al obligations as they
fall due. The going concer n idea is "ery well est ablished in accounti ng and
ther e is an aut horit ati"e document , I!# 5K4 Hoing 1oncern, The student is
ad"ised to read it in det ail. The point s to not e howe"er are:
i. The import ance of the principle
ii. The audit orJ s duty
iii. Indications of the inapplicability of the principle
i". 1ount er indications
". #udit procedur es
"i. The impact on audit report s in practice.
:/ .. "he im1ort anc e o the 1ri nci 1l eB
We will probabl y under st and bet t er how import ant this principle is if we
consider the implications of abandoni ng it. The effect s of abandoni ng the
principle include among others the following:
aB 7ixed asset s would need to be "alued at realisabl e "alues
and not depr eci at ed cost.
bB 7ixed asset s would ha"e to be classified as current asset s
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as they would ha"e no future benefit s to the organi:ati on.
cB !tock would ha"e to be regar ded at lower of cost or forced
sale net realisabl e "alue.
dB 2repayment s and intangi bl e asset s may ha"e no future
benefit s.
eB ew liabilities may appear such as redundancy pay, lea"e
pay and closure cost s.
fB 0ong- ter m liabilities may cryst alli:e and become
immedi at el y payabl e hence they cannot be classified as
long- ter m liabilities.
gB The depart ur e from the assumpt i on, the reasons for this
depar t ur e and its effect need to be explained in the
account s in accordance with I#! (.
:/ .6 "he audi t orK s dut y
The auditor has a dut y to express an opinion on the trut h and fairness and
compliance with legislation, of the account s. The "aluation basis adopt ed
in prepari ng the account s assumes that the company is a going concer n in
accordance with I#! (. Therefore, for the audit or to form an opinion he
shoul d consider whet her he has reasonabl e grounds for accepti ng the
applicability of the going concern assumpt i on. It follows therefor e@ he
must carry out sufficient work to ensur e that this assumpt i on is Dustified.
=e therefor e looks for e"idence that the company is likely to continue
trading for at least the next ($ mont hs from the balance sheet dat e or &
mont hs from the dat e of the audit report or more practically, he looks for
e"idence that ther e is no indication to the contrar y. =e must howe"er
take account of significant e"ent s which are likely to occur e"en later.
In the e"ent that the auditor consider s that the company is not a going
concern, he shoul d ad"ise the direct ors accordi ngly and ensur e that the
account s are prepar ed on a market "alue or a break- up basis. If the
direct ors refuse to compl y then the audit or will ha"e to qualify the
account s as a whole to the effect they are not true and fair. It is not
possibl e for the auditor to rely on an assess me nt of the going concer n
position at the balance sheet dat e alone becaus e the account s usually
only become public knowledge much lat er after the balance sheet dat e. It
ther efor e becomes necess ar y to take into account e"ent s taking place
aft er the year end and before the #H, which may affect the company as a
going concern.
:/ .4 Indi cat i ons o ina11l i ca,i l i t y o goi ng conc ern
Insol"ency, unfort unat el y, is a growt h indust ry as the economy suffers a
down turn and ther efor e for a maDorit y of ent erpri ses in .enya, the
abandonme nt of the going concern assumpt i on is no longer a remot e
possibility. 1onsequent l y, on all audit s the auditor must consider whet her
or not his client is a going concern. I!# 5K4 gi"es numer ous indications of
going concern inapplicability.
:/ .; Count er> indi cat i ons
A&*I"IN-
665 "he Audi t +roc e s s B 7inal #e0i e w o Audi t o
That the auditor has found indications of going concern non- applicability
does not of itself Dustify immedi at e conclusion that the entit y is not a going
concern. =e must also seek for count er- indications or mitigati ng factors.
This may include the following:
aB #bility to raise cash by selling asset s
bB #bility to obt ain new sources of finance for exampl e
leasing, factoring debt s, hiring plant.
cB +pport uniti es of rearrangi ng debt repayment s or
con"ersion of long ter m debt into equit y.
dB The possi bility of a right s issue.
eB !upport from other group compani es or from associ at ed
compani es.
fB The possi bility of making alternati "e trading
arrange me nt s .
:/ .8 "he audi t or s 1roc e dur e s
In forming an opinion on the going concern position of a
company, the auditor should:
aB In"estigat e the company, its background, its plans for the
future, re"iew of cash flows and financing plans@
bB #t e"ery st age of the audit search for and e"aluat e
e"idence for and against the going concer n applicability@
cB If he is in doubt , and the direct ors ha"e formul at ed plans
for the continuati on of the company, he should e"aluat e
these plans, ensuring that:
(. #ll part s of the plan are consist ent with each other@
$. If the plans are contingent on the respons e of third
parti es then he shoul d seek third parti es writt en
confirmati ons@
*. #scert ai n that the plans are specific rat her than
gener al@
%. 8e"iew the supporti ng e"idence for the plans if
a"ailabl e for reasonabl enes s@
5. !eriousl y consider any professi onal ad"ice obt ained
by the direct ors@
&. 1onsider any pot enti al support from other group
compani es by looking at any contract ual obligations,
direct ors intentions and the ability of the group
company to gi"e the support .
dB 1onsider whet her he has sufficient e"idence to form an
opinion on the applicability of the going concern
assumpt i on.
:/ .: Audi t #e1ort s
In the "ast maDorit y of cases, the going concern assumpt i on is appropri at e
and if applied no mention need be made in the audit orJ s report.
In rare incidences, not es to the account s may make reference to the going
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66.
concern assumpt i on. This may include references to continued fa"ourabl e
trading or a"ailability of finance. It may be that the going concer n
assumpt i on is not in doubt , but for a full underst andi ng of the account s
ther e is need for amplification of these not es. In such cases, the auditor
may use an emphasi s of mat t er which is not a qualification and is allowed
in I!# K44
When the audit or has compl et e doubt about the going concer n
assumpt i on he may be required to qualify his report and this is a highly
charged area for the auditor becaus e an expressi on in his audit report that
a company is not a going concern may in itself bring about the closur e of
the company. The audit or shoul d ther efore:
aB ot refrain from expressi ng a qualified opinion e"en
though this may lead to recei"er shi p or liquidation@
bB The audit or shoul d consider mat eri alit y, if the adDust ment s
required on abandoni ng the going concern assumpt i on are
not mat eri al, then no qualification should be gi"en@
cB If the audit or concludes that there is doubt then he should
consider the consequences for the figures in the account s.
7or exampl e, he should obt ain an esti mat e of the
necess ar y pro"ision agai nst stock or the redundancy
payment s.
In practice becaus e of the difficulties in"ol"ed in making adDust ment s to
the account s and produci ng them on a break up basis, account s in most
cases in .enya are produced on the going concer n assumpt i on and
qualified by the audit or on the grounds that the going concern assumpt i on
may not be appropri at e.
:/ 65 Su,s e @u e nt E0ent s
*ei ni ti on
I#! (4 $vent s Aft er t&e 7alance S&eet (at e prescri bes the account i ng
for, and disclosur e of, e"ent s aft er the bal ance sheet dat e.
E0ent s at er the ,al anc e she e t dat e are those e"ent s that occur
bet ween the bal ance sheet dat e and the dat e when the financi al
st at e me nt s are aut hori:ed for issue.
-"ent s #fter the )alance !heet /at e may be classified into two cat egori es:
#dDusting e"ent s and
on- adDusti ng e"ent s.
#n entit y adD ust s the amount s recogni sed in the financi al st at e me nt s to
reflect adDusti ng e"ent s aft er the bal ance sheet dat e.
AdHus t i ng e0e nt s are those that pro"ide e"idence of condi tions that
exist ed at the bal ance sheet dat e Ae. g. the set tl eme nt of a court case
aft er the bal ance sheet dat e that confir ms that the entit y had a present
obligati on at the bal ance sheet dat e@ the bankr upt cy of a cust omer that
occurs aft er the bal ance sheet dat e usuall y confir ms that a loss exist ed
at the bal ance sheet dat e on a recei"abl eB.
#n entit y does not adDust the amount s recogni:ed in the financi al
st at e me nt s to reflect non- adDusti ng e"ent s aft er the bal ance sheet dat e.
A&*I"IN-
666 "he Audi t +roc e s s B 7inal #e0i e w o Audi t o
Non> adHus t i ng e0e nt s are those that are indicati"e of condi tions that
arose aft er the bal ance sheet dat e Ae. g. a decline in the market "alue of
in"est me nt s bet ween the bal ance sheet dat e and the dat e when the
financi al st at e me nt s are aut hori:ed for issueB.
7or each mat eri al cat egor y of non adDusti ng e"ent aft er the bal ance
sheet dat e, an entit y discloses the nat ur e of the e"ent and an esti mat e of
its financi al effect .
/i"idends decl ar ed aft er the bal ance sheet dat es are not recogni:ed as a
liability at the bal ance sheet dat e.
7inanci al st at e me nt s are not prepar ed on a going concer n basi s if
manage me nt det er mi nes aft er the bal ance sheet dat e eit her that it
int ends to liquidat e the entit y or to ceas e tradi ng, or that it has no
realistic alt ernat i "e but to do so.
The financi al st at e me nt s disclose the dat e when the financi al st at e me nt s
wer e aut hori:ed for issue, and who ga"e that aut hori:at i on.
:/ 6. Audi t ors +roce dur e s
The rele"ant aut horit y on post balance sheet e"ent s is I!#. The
prepar at i on of profit and loss account and balance sheet will always
in"ol"e the consider at i on of e"ent s which ha"e or will occur aft er the
balance sheet dat e. The reason being ther e are numer ous transacti ons in
progr ess at the balance sheet dat e whose outcome is uncert ai n and
ther efor e e"ent s subsequent to the balance sheet dat e which ha"e
occurred or are expect ed to occur need to be exami ned to det er mi ne the
appropri at e "alues of asset s and liabilities. -xampl es abound such as the
collect ability of debt s, the net realisabl e "alue of old stocks, the outcome
of litigation. -"en the "alue of fixed asset s is a function of their expect ed
future useful life.
!ince the direct ors in prepari ng the account s will in"ari abl y use post
balance sheet e"ent s, the audit or must obt ain e"idence that all post
balance sheet e"ent s ha"e been consider ed and where appropri at e used
and balance sheet "alues correctl y incorpor at e post balance sheet e"ent s.
The questions that arise are concer ned with what
subsequent e"ent s should be taken into account and how
shoul d they be treat ed in the account s
+ri nci 1l e s
i. 7inanci al stat e me nt s shoul d be prepar ed on the basis of
conditions existing at the balance sheet dat e.
ii. # mat eri al post balance sheet e"ent requires changes in the
amount s to be included in the financi al st at eme nt s where:
aB It is an adDusting e"ent or
bB It indicat es that application of the going concern
assumpt i on to whole or a mat eri al part of the company is
not appropri at e.
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664
iii. # mat eri al post balance sheet e"ent shoul d be disclosed wher e:
aB It is a non- adDusting e"ent of such mat eri ality and its non
disclosur e would affect the ability of the users of financi al
st at eme nt s to reach a proper under st andi ng of the
financi al position or
bB It is the re"ersal or mat urit y aft er the year end of a
transacti on ent er ed into before the year end, the
subst ance of which is pri marily to alter the appear ance of
the companyJ s balance sheet .
i". In respect of each post balance sheet e"ent which is required to
be disclosed under paragr aph AiiiB abo"e, the following
informati on should be stat ed by way of not e in the financi al
st at eme nt :
aB The nat ur e of the e"ent and
bB #n esti mat e of the financi al effect or a stat e ment that is
not practicabl e to make such as esti mat e.
". The esti mat e of the financi al effect should be disclosed before
taking account of taxation and the taxation implication should
be explained wher e necess ar y for a proper underst andi ng of the
financi al position.
"i. The dat e on which the financi al st at eme nt is appro"ed by the
board of direct ors should be disclosed in the financi al
st at eme nt s.
2ost balance sheet e"ent s occupy a "ery import ant place in auditing and
ther efor e there is usually a progr am of work that is carried out in this
area. This includes:
i. # routine exami nat i on of such e"ent s such as collection of
debt s, sale of stocks, payment of creditors, resolution of
pendi ng litigation@
ii. # compari son of significant ratios before and aft er the year end,
seeking explanat i ons for any mat eri al differences as they may
indicat e the presence of adDusti ng or non- adDusting e"ent s or
ha"e going concer n implications.
iii. -xami nati on of all mat eri al pro"isions and contingent liabilities
at the latest feasible dat e prior to signing of the account s to
det er mi ne whet her any additional e"idence exist s that may
affect original esti mat es used.
i". 8e"iew of direct or?s minut es looking for any maDor new contract
or losses of cust omer s or losses of maDor contract s, capit al
expendi t ur e commi t ment s, and changes in accounti ng policy,
new borrowing or shar e issues, extra- ordinary or abnor mal
transacti ons, changes in market conditions or product s.
". /iscussions with the manage me nt , a re"iew of manage me nt
account s, re"iew of profit forecast s and cash flow proDections,
re"iew of non- risk areas and
"i. 8e"iew of rele"ant ext ernal informati on e. g. report s in
newspaper s. This re"iew must be as near as possi bl e to the
dat e of signing the audit report .
A&*I"IN-
66; "he Audi t +roc e s s B 7inal #e0i e w o Audi t o
It shoul d ,e not e d that
i. The audit or must always dat e his audit report . This dat e should
be as close as possibl e to the dat e of appro"al of the financi al
st at eme nt by the direct ors but must be after that dat e. I!# K44
requires that the dat e the direct ors appro"e their account s must
be disclosed.
ii. !peci al situation. These are relati"ely rare circumst ances but
possi bl e:
aB If the audit or becomes awar e bet ween the dat e of his
report and the #H, when the account s will be present ed,
of informat i on which would change his report then he
should:
(. /iscuss the mat t er with the direct ors who may wish
to amend the account s
$. 1onsider taking legal ad"ice
*. 1onsider making a stat e ment at the #H, as he is
allowed to by the 1ompani es #ct.
bB If the direct ors wish to amend the account s bet ween the
dat e of the report and the posting to the member s, the
audit or shoul d
(. 1onsider if the proposed amendme nt requires a
change in his report
$. 8e dat e his report
*. 8e"iew post balance sheet e"ent s up to the re dating.
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668
E&ES"I%N %NE
I#! ( 2resent at i on of 7inanci al !tat ement s refers to three fundament al
accounti ng assumpt i ons which call for no expl anati on in published
account s and the obser"ance of which is presume d unless it is stat ed
otherwi se. +ne of the fundament al accounti ng assumpt i ons is the >going
concernJ assumpt i on.
#e@ui re d
0ist the point s which you, as auditor of a medi um- si:ed manuf act uri ng
company, would consider in det er mi ni ng whet her it is appropri at e that the
account s are prepar ed on a >going concer nJ basis.
E&ES"I%N "3%
It has been your practice for some years to obt ain lett ers of represent at i on
from the manage me nt of audit client compani es. The newly appoi nt ed
managi ng direct or of a client company has, howe"er, express ed
reluct ance to sign a lett er of repres ent at i on, a suggest ed draft of which
you sent him, and he makes the following obser"ati ons in his reply to your
request for such a lett er.
i. The company employs se"er al qualified account ant s who are
responsi bl e for prepari ng accur at e account s which compl y
with the 1ompani es #cts and st at eme nt s of st andar d
accounti ng practice. It is his under st andi ng that it is the
responsi bility of the audit ors Awho recei"e a subst ant i al fee
for their ser"icesB and not his responsi bility to "ouch for the
accuracy of the account s and the auditors ha"e access to all
accounti ng records, direct orsJ minut es, correspondence and
internal audit depar t ment report s, etc and e"en aut horit y to
approach third parties to enabl e them to draw their own
conclusions.
ii. =e is not an account ant or lawyer and is not qualified to
comment on some mat t er s cont ai ned in the lett er.
iii. =e and a fellow direct or will be signing the balance sheet
before the report is signed.
#e@ui re d
/raft your reply to the managi ng direct or
A&*I"IN-
66: "he Audi t +roc e s s B 7inal #e0i e w o Audi t o
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66C
E&ES"I%N "$#EE
Qou are the part ner in the firm of 1ertified 2ublic #ccount ant s in charge of
the audit of Textile /istribut or s 0imited and are re"iewing the financi al
stat e ment s for the year ended *4 !ept ember (';$ ha"ing compl et ed the
re"iew of the det ailed audit work perfor med by your staff. The company is
a wholesal er of textile product s, it has an annual turno"er of about S%
million and it is not part of a group of compani es. It buys from a wide
range of suppliers and sells to a large number of small shops within a 54
.m radius of its warehous e.
Qou are required to describe the work you would perfor m in re"iewing the
financi al stat e me nt s of Textile /istribut or s 0imited for the year ended *4
!ept ember (';$, di"iding your answer into the following sections:
AaB #ccounti ng policies@
AbB 2rofit and loss account @
AcB )alance sheet @
AdB !tat ut or y disclosur e requirement s@
AeB +ther factors you would consider and trends you would
expect to see during a period of economi c recessi on.
E&ES"I%N 7%&#
AaB Why are relat ed part y transacti ons import ant R
AbB =ow can the audit or go about identifying relat ed parti esR
AcB What audit work is done in the area of relat ed parti esR
AdB Hi"e exampl es of relat ed parti es.
o the Study +ack
A&*I"IN-
66D
S1eci al i G e d Audi t Sit uat i ons
2ESS%N SE'EN
S1ecialiGed Audit Situations
%B=EC"I'ES
-xplain, discuss and carry out audit s in speci alised situations
C%N"EN"S
(. )anks and other financi al institutions
$. Insurance 1ompani es
*. 1harities and non profit making organi sati ons
%. 2ension !chemes
5. #d"ocat es
&. 1o- oper ati"e !ocieti es
K. 2arast at al s
9. 2ublic and local aut horiti es
'. #udit of =olding 1ompani es and Hroup #ccount s
(4. Goint #udits
INS"#&C"I%NS
(. #ssigned 8eading:
$. 1ompl et e answer s to 8e- enforcing 3uestions at the end of this
lesson without reference to the model answer s.
*. 1heck your answer s against those gi"en in 0esson (4 of the !tudy
2ack.
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C/ 5 Introduct i on
1ompani es carry on thousands of different types of trade, business or
professi onal acti"ities. It is not possibl e in a manual on gener al auditing
procedur es to consider the speci al audit problems of each of them. In
.enya ther efore, when we are talking of speci alised audit situations, we
would be talking about the financi al sect or, including institutions such as
banks, financi al institutions, building societi es, insurance compani es, hire
purchas e compani es. We are also concer ned with charit abl e
organi sati ons, non- profit making organi sati ons, lawyers practices and
public entities such as cooper at i"e societi es, parast at al s and local
go"ernment aut horiti es.
C/ . 7inanci al Insti t ut i ons
/ue to the recent collapse of many financi al institutions, this is now a
hea"ily regul at ed area. The banks and financi al institutions and building
societi es are now subD ect to close super"i sion by the 1entral )ank of
.enya and insurance compani es are subDect to strict control by the
1ommi ssi oner of Insurance.
C/ .. Banks
The #uthorit ati"e document s are:
The 1entral )ank of .enya #ct,
The 1ompani es #ct 1ap %9&
I#! *4 /isclosur e in the 7inanci al st at eme nt s of )anks and !imilar
financi al Institutions
I#2! (444 Inter- bank confirmat i ons procedur es
I#2! (44% The 8elationshi p bet ween !uper"isors of )anks and
)anks -xternal #uditors
I#2! (44& #udits of the 7inanci al stat e ment s of )anks
Key audi t 1oi nt s are
(. Internal control especi ally with regar d to comput eri sat i on
and internal audit.
$. 2ro"ision for doubtful debt s on ad"ances.
*. The manner of describing the profit figure and balance
sheet items which include hidden inner result s.
%. 1ritical re"iew of the banks financi al position and reser"es
(a) +roi t and los s account B When looking at a bankJ s profit and
loss account the account ant should seek to disco"er what
proportions of the bankJ s profits are deri"ed from sust ai nabl e
business and how much comes from sources of income that are
specul ati"e or uncert ai n. The three maDor sources of income
that require exami nat i on are: the net interest bet ween lending
and borrowing, dealing profits deri"ed from the banks
in"est ment s portfolio and fees and commi ssi ons.
(,) Current st at us : #lthough he may be auditing a prior period
the audit or shoul d discuss with the manage me nt any current
problems to disco"er whet her profits are still being made in the
current trading period.
(c) #e0i e w o 1roH ect e d 1roi t sB -nquiries shoul d be made to
ascert ai n whet her proDect ed profits take into account suspended
interest , bad debt s pro"ision and any other decline in the
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realisabl e "alue of asset s.
(d) 7re@ue nc y o re0i ews : The audit or shoul d enquire whet her
pro"isions are being re"iewed on a regul ar basis.
(e) 7urther en@ui ri e s B 7urther enquiries are made in the following
areas: in"est ment s, certificat es of deposit s, foreign exchange,
land and propert y and loans. The fee earni ng acti"ities of the
bank are also in"esti gat ed in the areas of loan commi t me nt ,
accept ances, portfolio manage me nt and corporat e ad"isory
work.
)anks are incorpor at ed under the 1ompani es #ct like any other
business but are grant ed speci al pri"ileges under the same
1ompani es #ct and subD ect ed to "ery strict controls by the 1entral
)ank of .enya. #part from frequent "isits from the 1entral )ank and
regul ar report s to the 1entral )ank on liquidity le"els the auditor is
also required to submi t a copy of his audit report to the 1entral )ank.
The audit or should re"iew the report s submi t t ed to the 1entral )ank
and the report s submi t t ed to the bank by the 1entral )ank as a result
of the "isits. The auditor is also concerned with enquiring into
compliance with the )anking #ct. In theory, banks are allowed to set
up secret reser"es by writing down asset s or creati ng excessi "e
pro"isions without disclosing that they ha"e done so. The effect of
this is:
AaB The real position may be bet t er than that disclosed but ne"er
worse.
AbB In good years, secret reser"es are creat ed and in bad years
they are run down. The effect of this is to e"en out the profits
and the cust omer s are not then tempt ed to withdr aw their
deposit s if the bank has a bad year.
If the bank was to take ad"ant age of these pro"isions then it would
not be possibl e for the audit or to gi"e a true and fair "iew report on
the account s. In practice banks in .enya do not take ad"ant age of
the pro"isions and therefore the audit or carries out a normal audit
and gi"es a report in true and fair ter ms.
C/ .6 Insuranc e Com1ani e s
#uthorit ati"e document s include:
The Insurance #ct
The 1ompani es #ct
I78! % Insurance 1ontract s
The main legislation go"erni ng insurance compani es and their
conduct is the Insurance #ct
Key audi t areasB 7or an insurance company these are:
(. In"est ment s,
$. unear ned premi ums, and
*. -xpired risks, this is when a cat egor y of business has
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pro"ed to be unprofit abl e pro"ision is made for future
losses on risks already accept ed,
%. +utst andi ng clai ms,
5. #scert ai nment of debt ors and creditors,
&. #ctuari al "aluation re: life insurance.
Insurance compani es like banks are also subD ect to speci al exempt i ng
pro"isions in the 1ompani es #ct and in the Insurance #ct. <nlike
banks, not only do they take ad"ant age of the speci al pro"ision but
are in fact required by the 1ommi ssi oner to take ad"ant age of the
pro"isions. The auditor therefor e, in practice gi"es two audit report s
for an insurance company and is also required to sign "arious report s
that are submi t t ed to the 1ommi ssioner of Insurance. The insurance
company prepar es stat ut ory account s which are audit ed in the
normal way and a true and fair "iew report gi"en and these are
submi t t ed to the member s in the nor mal way and adopt ed and
di"idends paid on their strengt h. The 1ommi ssi oner then requires
account s to be prepar ed in accordance with insurance regul ations
taking ad"ant age of creati ng secret reser"es. These are also audit ed
and report ed on accordingl y by the auditor but not in true and fair
"iew ter ms but rather by simply st ati ng compli ance with the
insurance act.
Key audi t areas in det ai l
(a) Ascert ai nme nt o de,t ors and credi t ors / Insurance compani es
do not maint ai n their personal ledgers in such a way as to produce
directly a separ at e list of debt or s and credit ors. Their ledger s inst ead
reflect the section of the market from which the business originat es
e.g. broker, reinsur er, direct policy holder etc, hence it is quit e
possibl e that bot h debt or and creditor balances will exist in one
ledger someti mes for the same person. The legal position with
regard to right of set off bet ween debit and credit balances with the
same person is not clear. 7rom a professional point of "iew the
auditor must ensur e therefor e that the company adopt s a
consist ence approach in est ablishi ng the separ at e amount s of
debt or s and credit ors.
(,) &nearne d 1remi ums B This repres ent s the appropri at e portion of a
premi um recei"ed during the year under re"iew but is applicabl e to
lat er accounti ng periods. +nce agai n, a consist ent approach should
be adopt ed and the account s shoul d declare the basis select ed by the
insurance company under the headi ng of accounti ng policies. The
most common basis adopt ed for annual premi ums is the $%t h basis.
(c) Ex1ired risks : This represent s the carry forward of pro"isions to the
next accounti ng period in circumst ances wher e it appear s that
insurance business undert aken in the period under re"iew is
unprofit abl e. This makes it similar to the pro"ision on long ter m
contract s in the const ructi on indust ry. The audit difficulty is that a
consider abl e element of adDust ment ent er s the comput at i on of such
risks, the issue is for the auditor to form an opinion on the need for
such a pro"ision and if one exist s whet her the sum pro"ided is
adequat e.
(d) %ut st andi ng clai msB We can classify these clai ms in the following
three cat egori es:
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i. Those which ha"e been notified and agreed but are still
out st andi ng at the balance sheet dat e
ii. Those which ha"e been notified before, but not yet agreed
at the balance sheet dat e and
iii. Those which ha"e arisen but ha"e not yet been notified to
the company by the balance sheet dat e.
# good deal of esti mati on is needed with regard to cat egor y AiiB and
AiiiB abo"e. The audit procedur es ther efor e would in"ari abl y include,
re"iew of the clai ms files in order to appr ai se the companyJ s
esti mat es. We must also compar e the a"erage cost of out st andi ng
clai ms for each class of business with current experi ence and finally
the auditor should exami ne st ati stical element s compari ng past
esti mat es with act ual result s.
C/ .4 Buil di ng Soci et i e s
)uilding !ocieti es are organi sati ons which exist to offer a sa"ings and
in"est ment medi um to the public and to lend to indi"idual s money to
enabl e them buy their own houses taking as securit y the deeds of
the houses. They are not limited compani es but are run by a board
of direct ors elect ed by the in"est ors and per manent st aff. There are
strong similarities in the legislation co"ering building societi es and
that co"ering compani es.
There are additional control probl ems peculiar to building societi es:
i. The large "olume of deposi t s and withdrawal s of small amount s
of cash@
ii. The granti ng of loans on mort gage
iii. 1ontrol o"er document s of title
i". 1ontrol o"er in"est ment s and their relat ed income
It shall be the dut y of the auditors of a building societ y to carry out such
in"estigations as will enabl e them to form an opinion as to the following
mat t er.
AaB Whet her the societ y has kept proper books of account @
AbB Whet her the societ y has mai nt ai ned a satisfact or y syst em of
control o"er its transacti ons and records@
AcB Whet her the balance sheet s and re"enue and appropri ation
account are in agree me nt with the books of account and
records of the societ y and if the auditors are of the opinion that
the societ y has failed to keep proper books of account or proper
records or a proper syst em of control they should st at e that fact
in their report .
Key Audi t Areas
(. The auditor must exami ne the procedur e for checking deeds on
receipt from the lawyers to ensur e that they are compl et e in
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accordance with the ad"ance records properl y execut ed and
st amped@
$. -xami ne the maint enance of records that show the location of
all deeds and the dat es of any changes in the location of any of
them.
*. -xami ne the procedur e that ensur es that the deeds are
recei"ed from the societ yJ s lawyer s without undue delay@
%. -xami ne the aut horit y required for the release of deeds for a
tempor ar y period from their nor mal cust ody and the proper
control for their prompt ret urn@
5. -xami ne whet her ther e is a continuous independent check of
the deeds agai nst the ad"ance records or the borrower s ledger
account s@
&. -xami ne the necessi t y for satisfact or y cross reference bet ween
the ad"ance records, the cash book, the borrowerJ s ledger
account and the deed.
K. -xami ne the procedur e for the releas e of deeds on redempt i on
of the mort gage.
+ther mat t er s the auditor needs to be concerned with are:
Exami nat i on o dee ds
I -nsure that the mort gage is in the name shown in the ad"ance
records@
I That there is a document of title to the propert y under mort gage
and that the societ yJ s lawyers ha"e been satisfied as to the
borrowerJ s title@
I The amount of the ad"ance as stat ed in the mort gage deed is not
less than that shown on the ad"ance records@
I The mort gage deed is stamped, properl y signed, witness ed and is
pri ma facie in order@
I The propert y is adequat el y insured, the premi um is paid up to dat e
and the societ yJ s interest as mort gage is endorsed in the
insurance policy.
Share and de1os i t s
!hares may consist of subscription shares and paid up shares. Interest on
shares may be credit ed to the account s inst ead of being paid to ensur e
proper control the following should be co"er ed by the syst em:
o There should be proper cust ody of unused shar e and deposi t
pass book, recei pt forms and share certificat es@
o There should be proper instructions to the st aff as to the
maki ng of entri es in the pass books and the issue of recei pt s@
o Withdrawal ter ms, notice and speci men signat ur es@
o #uthori:ation of withdrawal s by the ledger depart me nt or
against the pass books@
o 8ecords of deat hs, marri ages, powers of att orney and
trans mi ssi on of shar es and deposit s@
o The compari son of the balance shown in the pass book with
that shown in the ledger.
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Cash
2ossibility of error and misappr opri ati on always accompany the handling
of cash. )uilding societi es transacti ons to a large ext ent are in cash. This
howe"er does not in"ol"e audit consider at i ons which differ in principle
from those encount er ed in any other business. !o ther e should be
surprise cash count s and any discrepanci es shoul d be in"estigat ed in
det ail.
3indow *res si ng
#uditors should exami ne transacti ons which ha"e the effect of showing as
at the balance sheet dat e a st at e of affairs particul arly the societ yJ s
liquidity which is mat eri ally bet t er than it was during the year and shortly
aft er. +f particul ar att enti on are:
(. 0arge deposi t s recei"ed shortly before the year end and repai d
shortly aft er@
$. 0arge mort gage repayment s recei"ed shortly before the year
end and read"anced on the same propert y shortly aft er@
*. <nusual delay until after the year end in making payment s in
accordance with applications recei"ed for withdrawal s of shares
or deposit s@
%. #n abnor mal year end accumul ati on of commi t ment s for
ad"ances followed by the making of the ad"ances shortly after
the year end@
5. The significance of items in the bank reconciliation st at eme nt s.
ot only does the audit or report to the member s on the financi al
stat e ment s, he is also suppos ed to gi"e a report to the registr ar of
societi es to accompany the annual return.
C/ .8 Chari ti e s and Non -o0ernme nt al %rgani Gat i ons
.ey audit areas:
(. Income: donations are hard to "erify therefor e good internal
control is needed particul arly on the openi ng of mail. #
published list of donors can be "ery helpful in "erification@
$. +utgoings: !hould be minut ed and be subD ect to delegat ed
aut horit y@
*. In"est ment s: ,any charities ha"e in"est ment s and these are
"erified in the nor mal way of "erifying in in"est ment s.
The audit report is usually qualified on grounds that it is not possi bl e
becaus e of the nat ur e of the societ y to "erify whet her all the income
recei"abl e in the form of donations has been fully account ed for.
Control 1ro,l e ms in chari ti es
AaB /oor to door collections: 6olunt eer s should be issued with
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number ed boxes, the boxes should be seal ed, the boxes shoul d
be opened and count ed regul arly prefer abl y in the presence of
the "olunt eer and one or more trust ees. #ll cont ent s should be
prompt l y ent er ed in a regist er kept for that purpose and
banked. The entri es in the book shoul d be initialled by those
counting.
AbB /onations recei"ed by post: Two peopl e including a trust ee
should open the mail. 8eceipt s should be ent er ed in a regist er
kept for the purpose and the entri es initialled. )anking should
be immedi at e.
AcB /eeds of co"enant : # regist er of donors under deed shoul d be
kept. 1hecks should be made regul arly to see that all amount s
ha"e been recei"ed or donors followed up.
AdB =arambee and other fund raising e"ent s: The plans for the
e"ent s especi ally expendi t ur e should be appro"ed in ad"ance
by the trust ees. 8ecords shoul d be kept of all det ails of these
e"ent s. Indi"idual s should be politely instruct ed in their
financi al duties. #ll cash and cheques should go to the societ yJ s
bank account . #ll proceeds should be count ed in the presence
of a trust ee and banked promptl y. #n account should be drawn
up after the e"ent appro"ed by the trust ee and publicised to all
the member s.
AeB /onations of equipment and mat eri al s: # full regist er of such
donations should be mai nt ai ned. #n esti mat e should be made
of the market "alue of all items. ,aint enance mat eri al s should
be properl y stored.
AfB #ll cash payment s should be made out of cash drawn from the
bank, unless any donor obDect s the annual report shoul d cont ai n
a full list of donors. The annual report and the account s should
be as det ailed as possi bl e.
C/ .: +ensi on 7unds
2ension funds are set up by compani es or other organi:ations:
AaB To admi ni st er the pension payabl e to retired empl oyees and
AbB -nsure that funds are a"ailabl e to pay pensions e"en if the
sponsori ng organi:ati on goes into liquidation. The auditors
duties include:
i. -xami ning the trust deed that set up the fund and
ensuring that its pro"isions ha"e been correctl y carried
out@
ii. 6erifying that ther e is proper control o"er the transacti ons
of the fund@
iii. 6erifying the portfolio of in"est ment s. #ll changes should
be aut horised by trust ee minut es and all income must be
recei"ed@
i". 6erify that the funds are sufficient to meet its future
commi t me nt s. These are usually det er mi ned act uari ally,
prefer abl y annually. ,any schemes incorpor at e an
undert aki ng by the sponsor to make good any deficiency.
C/ .C Ad0ocat e s
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The st at ut or y pro"ision regul ati ng the handling of client J s moni es are
co"er ed in the ad"ocat eJ s act.
2urpose of the rules:
I To require a lawyer to keep client J s money separ at e from his own
money@
I To ensur e that a lawyer keeps adequat e records of his
transact i ons so that his books show money recei"ed and paid and
balance held on account of each client@
I To ensur e that one clientJ s money is clearly distingui shed from
that of other client s and from any other money passi ng through
the lawyerJ s account s.
)road effect s of the rules:
I That money recei"ed by a lawyer which does not belong to him
shoul d be dealt with through the client account @
I That his own money is kept in an office account
"he Account ant K s #ol e
-"ery year a lawyer who handl es client J s money is required to produce to
the 0aw !ociet y of .enya a report by a qualified account ant that he has
complied with the rules in the ad"ocat eJ s act. This report is required once
e"ery year, howe"er, a compl et e audit is not required nor is there a
requirement for the prepar ati on of the profit and loss account or balance
sheet . 7or the purpose of gi"ing his report the account ant must :
(. #scert ai n from the lawyer particul ars of all bank account s kept
or operat ed by the lawyer in connection with his practice.
$. -xami ne the book keepi ng syst em in e"ery office of the lawyer
to see that the syst em complies with the following
requirement s:
o That there is a ledger account for each client
o The ledger account s show separ at el y particul ars of all client
money recei"ed, held or paid on account of each client
o Transactions relating to client s money are recorded in the
lawyers books so as to distingui sh them from transacti ons
relating to any other moni es
o Test check postings to client J s ledger account s from records
of recei pt s and payment s of clientJ s money
o ,ake test checks of cast s of such account s
o 1ompar e a sampl e of lodgement s and payment s as shown in
the bank stat e me nt with the lawyerJ s records of receipt s and
payment s of client J s moni es
o -nquire into and test check the syst em of recordi ng cost s
and of maki ng withdr awal s in respect of cost s from the client
account
o !atisfy himself by test exami nat i on that financi al transacti ons
are in accordance with the rules and that any entries in
ledger account s reflect the transacti on in a manner which
complies with the rules
o -xtract all client J s ledger balances at least two dat es in the
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year and reconcile the cash book balance with that confirmed
direct to the account ant by the bank
o ,ake test exami nat i on to ascert ai n whet her payment s from
client account ha"e been made on any indi"idual account in
excess of the money held on behalf of that client
o 2eruse the office ledger, cash account s and bank st at eme nt s
to see whet her client money has not been paid into a client
account
The account ant is not required
(. To ext end his enquiries beyond the informati on cont ai ned in the
rele"ant document s as suppl ement ed by such informat i on and
explanat i ons as he may obt ain from the lawyer.
$. To enquire into stocks shar es other securities or document s of
title held by the lawyer on behalf of client s.
*. To consider whet her the books of account s of the lawyer were
properly writt en up in accordance with the rules at any other
time than at which his exami nati on took place.
C/ .D Co> o1erat i 0e Soci et i e s
#n audit in this case is carried out as a nor mal audit except you
shoul d not e that the auditor is appoint ed by the 1ommi ssi oner of 1o-
oper ati"es and although he report s to the member s the account s
must be regist er ed with the 1ommi ssi oner. +f speci al not e is that he
is required to carry out speci al in"estigations on the bad debt s
pro"ision to det er mi ne its adequacy and on the good debt s he has to
confirm their reco"er ability.
C/ .< +u,li c Sect or Audi t s
C/ 65 +aras t at al s
These are subD ect to audit s by the #uditor Hener al .The audit is
carried out as for any other company.
C/ 6. Central -o0ernme nt and 2ocal Authori ti e s
The audit of these account s is go"erned again by the #udit and
-xchequer #ct and is carried out by the 1ontroller and #uditor
Hener al who is account abl e to the ational #ssembl y
C/ 4 Audi t o $ol di ng Com1ani e s and -rou1 Account s
#uthorit ati"e document s are:
The 1ompani es #ct 1ap %9&
I#! $K
I#! $9
I#! *(
I78! *
I!# &44 <sing the work of anot her auditor
The 1ompani es #ct requires that wher e a company at its year end
has a subsidi ary then the direct ors of that company called a holding
A&*I"IN-
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company are required to produce consolidat ed account s or group
account s which show a true and fair "iew of the st at e of affairs and
the result s of the company and its subsi di ari es so far as they
concer n the member s of the holding company.
Audi t o -rou1 Account s
The maDor problems in this area can be split into three sections:
(. The audit of the holding company obt aining and confirming
informati on about subsi di ari es
$. 1hecking consolidation working paper s and
*. 2lacing reliance on the work of other audit ors
The audit of the account s of a holding company follows the same
lines as any company audit. =owe"er, speci al consider at i on has to
be gi"en to the dealings with and present at i on of in"est ment s in
subsi di ary compani es.
Audi t work on the hol di ng com1any
We will concent r at e on the "erification of in"est ment s in subsi di ary
compani es.
(. +bt ain a schedul e which should cont ai n the following
informati on. #ll the dat a which the 1ompani es #ct requires to
be disclosed in the holding companyJ s own account s, copies of
the account s of each subsi di ary with a not e who the auditor is,
det ails of any qualifications in any of the audit report s,
summar y of mo"ement s in in"est ment s in subsi di ary and on
current and loan account s with its subsi di ary, reconciliations of
intercompany balances.
$. -xist ence and ownershi p must be "erified by exami ni ng the
shar e certificat es and ensuri ng that they are in the name of the
holding company. If not, then blank signed transfer forms
should be a"ailabl e from the nomi nees. If the shar e certificat es
are held by third parti es, then an appropri at e certificat e must
be obt ained.
*. 1urrent and loan account s: Their "erification is nor mally done
by obt aining a certificat e from its subsidi ary confirmi ng the
balances. #lso if the audit or of the holding company is the
audit or of the subsidi ary, he can reconcile entri es in bot h set s of
books himself. The auditor must satisfy himself that dealings
bet ween group compani es are not used to co"er up mat eri al
errors.
%. 6aluation: 6aluation is "erified as follows: If the shar es were
acquired in the year consider cost and aut hori:ation. -xami ne
accounti ng treat ment of any premi um or discount on acquisition
and any di"idends recei"ed out of pre- acqui sition profits. The
balance sheet "alue of its subsidi ary must be consider ed and
this could include re"iew of each indi"idual subsi di aryJ s account
to confirm that it is still a going concern.
Checki ng cons ol i dat i on 1a1ers
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The auditor pays particul ar att enti on to the calculation of:
aB Hoodwill arising on acqui sition and consolidati on
bB 2re- acqui sition and post- acqui sition profits
cB ,inority interest
dB Treat ment of intercompany profits in stocks
eB #greement s of intercompany indebt ednes s
fB ecessar y cancellations in respect of intercompany cash in
transit
gB Turno"er, excluding group trading
hB ecessar y adDust ment s in respect of group compani es with
different accounti ng period ends
iB Taxation
The consolidat ed account s must compl y with all rele"ant accounti ng
and legal requirement s.
#eli anc e on the work o ot her audi t orsB
The pri mar y auditor or the principal audit or is solely responsi bl e for the
holding companyJ s account s. It is ine"it abl e howe"er that in large groups
the holding companyJ s auditor thus the principal auditor are not always
the audit ors of the subsidi ary company, therefor e, ther e is need for then
to rely on the work of other auditors. The student must not e that the
principle auditors are fully responsi bl e for their opinion on the group
account s and need not for this reason refer in their report to the fact that
the account s of some subsidi ary or associ at ed company ha"e been
audit ed by other firms. I refer you to the following import ant topics
co"er ed in the I!#. #ccounti ng policies, a"ailability of informat i on, scope
of work of the secondar y audit ors or other audit ors, the mat eri alit y of the
amount s in"ol"ed. If the principal auditor is satisfied that the account s
present a true and fair "iew and compl y with the 1ompani es #ct the
auditor will be able to issue a an unqualified audit report . =owe"er,
qualification will be necess ar y in the following circumst ances.
(. # mat eri al subsi di ary if qualified then ther e may be need for this
qualification to be not ed in the holding companyJ s report .
$. 7ailure by the principal audit or to obt ain satisfact ory informati on
with regard to mat eri al subsi di ary or mat eri al amount s that
ha"e been consolidat ed from an audit ed account .
*. ,ateri al disagr ee me nt with any of the consolidation
calcul ations.
%. on- compli ance with legal or professional requirement s as far
as disclosur e is concerned.
The student is strongly ad"ised to read the I!# on reliance on the
other audit ors and keep in mind the following requirement s:
(. # compl et e list of subsi di ari es showing the share holdings of the
holding company and other group member s should be kept. =e
should ha"e copies of the account s of each subsi di ary noting
qualified audit report s, agree me nt of intercompany balances,
di"ision bet ween pre and post acqui sition profits, accounti ng
policies adopt ed and ensur e that each set of account s is
properly signed by direct ors and auditors.
A&*I"IN-
6;5
$. 3uestionnai r es used to det er mi ne the work undert aken by
subsi di ary company auditors.
*. #ny lett ers of weaknes s sent by each subsi di ary company
audit or.
%. # checklist showing compani es act requirement s and I#! $K and
I#! $9.
%ther mat t ers to ,e co0er e d are
(. #ccounting policies: these should be unifor m throughout the
group and should be properl y disclosed.
$. 1onsolidat ed adDust ment s shoul d be carried out correctl y both
concept ually and mat he ma t i cally.
*. =e should ensur e that all mat eri al subsidi ari es ha"e been
audit ed.
%. =e should in"esti gat e all known co- ter mi nus account s.
5. =e should in"esti gat e for window dressi ng
&. =e should consider foreign subsi di ari es if any.
IAS 6C
I#! $K applies to the prepar at i on and present at i on of consolidat ed
financi al st at e me nt s for a group of entiti es under the cont rol of a par ent .
It also applies to account i ng for in"est me nt s in subsi di ari es, Dointly
cont roll ed entiti es and associ at es in the separ at e financi al st at e me nt s of
a par ent .
Summary o IAS 6C
# parent present s consolidat ed financi al st at e me nt s in which it
consolidat es its in"est me nt in subsi di ari es Athose entiti es that it
cont rol sB, unless cert ai n conditions are met allowing it not to prepar e
consolidat ed financi al st at e me nt s . The consolidat ed financi al st at e me nt s
are prepar ed using unifor m account i ng policies. The reporti ng dat e of the
par ent and its subsi di ari es shall not be mor e than * mont hs apart .
When separ at e financi al st at e me nt s are prepar ed, in"est me nt in
subsi di ari es, Dointly cont rolled entiti es and associ at es shoul d be
account ed for eit her at cost or in accor dance with I#! *'. The same
account i ng shoul d be applied for each cat egor y of in"est me nt s.
I#! $K specifies disclosur es to be made in consolidat ed and separ at e

I#! $9 applies in accounti ng for in"est ment s in associ at es, except those
held by:
I 6entur e capit al organi sati ons, or
I ,utual funds, unit trust s and similar entities including in"est ment - linked
insurance funds
that upon initial recogni tion are designat ed as at fair "alue through profit
or loss or are classified as held for trading and account ed for in
accordance with I#! *' 7inanci al Instrument s: 8ecognition and
,easur e ment .
Summary o IAS 6D
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on Se0e n
6;.
#n associ at e is an entit y o"er which the in"est or has significant influence
and that is neither a subsi di ary nor an interest in a Doint "ent ur e.
!ignificant influence is the power to participat e in financi al and oper ati ng
policy decisions of the in"est ee but is not control or Doint control o"er
those policies. !uch influence is presumed to exist if the in"est or owns $4
per cent or more of the "oting power of the in"est ee. #n in"est ment in an
associ at e is account ed for using the equit y met hod. The equit y met hod is
not used when:
I The in"est ment is classified as held for sale in accordance with I78! 5
on- current #sset s =eld for !ale and /iscontinued +perations@ or
I The in"est or is itself a subsidi ary, its owners do not obDect to the equit y
met hod not being applied, and its debt and equit y securiti es are not
publicly traded. In this case the in"est or?s parent must present
consolidat ed financi al st at eme nt s that compl y with I78!s.
The in"est or?s financi al stat e me nt s are prepar ed using unifor m accounti ng
policies for like transacti ons and e"ent s in similar circumst ances. #ny
difference bet ween the reporti ng dat e of the in"est or and its associ at e
must not be mor e than * mont hs.
#n in"est or disconti nues the equit y met hod from the dat e that it ceases to
ha"e significant influence o"er the associ at e. 7rom that dat e it account s
for the in"est ment in accordance with I#! *', pro"ided the associ at e does
not become a subsi di ary or a Doint "ent ur e as defined in I#! *(.
I#! $9 specifies disclosur es to be made in the in"est or?s financi al
stat e ment s about
associ at es.
C/ ; =%IN" A&*I"S
E&IO
aB /iscuss the procedur es usually followed in conducti ng an audit
by mor e than one firm of account ant s and the di"ision of work
bet ween them.
bB /iscuss the gener al ad"ant ages and disad"ant ages of Doint
audit s.
ANS3E#
aB #ll auditors may be liable to the consequences of loss
arising from negligence. -ach Doint auditor accept s all the
obligations of the office of audit or and this can mean that
losses flowing from a wrong audit orJ s report may be
reco"er ed from either of bot h auditors. Thus a Doint
audit or might be financi ally responsi bl e for losses arising
as a consequence of the negligence or incompet ence of his
fellow auditor.
)efore accepti ng a Doint office, an audit or must :
i. 1onsider whet her he is prepar ed to ser"e Dointly with
the other auditor. =e may well ask himself if he
would take him as a part ner.
A&*I"IN-
6;6
ii. #ssure himself that adequat e control and re"iew of all
aspect s of the audit can be organi sed.
iii. -nsure that professional indemni t y insurance co"er
can be obt ained to co"er the speci al situation.
!e"er al possi bl e arrange me nt s could be made:
i. -ach Doint auditor could conduct its own audit with its
own st andar d document at i on and files. 0eading
schedul es would need to be phot ocopi ed and
exchanged.
ii. # unified set of document s and files could be
produced by both firms. This may in"ol"e some
modification of each firmJ s met hods.
iii. -ach firm could use one st andar d set of document s
and files using the st andar ds of the larger of the two
firms.
What e"er the met hod is used, ext ensi"e discussi on and
planning must precede the commence me nt of any audit
work.
The consider ati ons which are likel y to dict at e the
di0i si on o work are
i. -xpertise: -ach firm may ha"e speci al experti se e.g.
in cert ai n types of client, comput er s etc.
ii. Heography: The particul ar location of the firms and
their branches must be consider ed.
iii. 1ompet ence: +ne of the Doint auditors may be
especi ally compet ent with small client s, the other
with large client s.
i". !i:e and a"ailability of st aff.
". 1ost: #udit cost s may be mini mi sed by a particul ar
di"ision of work.
,) "he general ad0ant a g e s and di sad0ant a g e s o Hoint audi t s
are
Ad0ant a g e s
i. #ll work and fees are welcome to audit firms.
ii. #n opport uni t y to closely inspect the auditing
met hods of anot her firm.
iii. The other firm may ha"e speci al experti se which
might fit well in a Doint business.
i". The other firm may ha"e geogr aphi cal location
possibilities which compl eme nt .
". The other firm may be of such a si:e that a client
company can be ser"iced which may otherwi se be
beyond a"ailabl e resources.
"i. 7lexibility of working arrange me nt s with anot her firm
may a"ert bottlenecks owing to staff short age at peak
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on Se0e n
6;4
times.
*isad0ant a g e s
i. !hared legal responsi bility. 0iability for co- auditorJ s
negligence.
ii. 0ack of control. The other firm may ha"e different
audit standar ds which may be unsati sfact or y.
iii. #ny shared work or responsi bility may lead to
personalit y clashes.
A&*I"IN-
6;;
E&ES"I%N %NE
aB What is the criterion of prudent manage me nt laid down by the
)uilding !ocieti es #ctR
bB In drawing up the audit programme, which areas shoul d particul ar
att enti on be paid to which are of particul ar significance or unique to
building societi esR In which areas shoul d subst ant i "e test s
concent r at e onR
cB +n the st ati stical ret urns to the 1entral )ank of .enya by a building
societ y what opinions is the auditor required to form on the
informat i on cont ai ned therei nR
E&ES"I%N "3%
a. What areas constit ut e significant banking market sR
b. Hi"e exampl es in the following control areas of controls which may
be compliance test ed o"er cust omer s account s and cash.
i. !egregat i on of duties
ii. 2hysical
iii. #uthorisati on and appro"al
i". #rithmeti cal and accounti ng
". !uper"ision
E&ES"I%N "$#EE
,uungano =ardwar es 0td. a wholly owned subsidi ary of ,. =oldings 0td.
is a leading hardwar e manuf act ur er in the count ry. #pproxi mat el y 94T of
the product s are sold to distribut ors, and the remai ni ng portion to a small
number of ret ailers.
While recei"ing the audit ed account s for the year ended *( /ecember
$44* the direct ors of ,. =oldings ha"e noticed that ,uungano had
incurred a trading loss. This was due to a subst ant i al fall in the gross
profit margi n compar ed with pre"ious years.
Qour firm has been appoint ed as auditors of the ,uungano group of
compani es for the first year in $4*. The direct ors of ,. =oldings ha"e
request ed your firm to carry out an in"esti gati on to find the reasons for
the dramat i c fall in the ,uunganoJ s gross profit margi n.
The group internal auditor of ,uungano, whose work you ha"e concluded
you can place reliance on, has informed you that:
i. The direct ors had not expect ed the loss incurred in ('9'
since the mont hl y account s upon which they rely are
calculat ed using historical gross profit percent age.
ii. The company does not ha"e a proper syst em of compari ng
act ual cost s with esti mat e cost s and does not mai nt ai n basic
stock records.
iii. The range of product s manuf act ur ed and sold by the
company has not changed significantly in the past 5 years.
i". 2urchases and sales cut off were correctl y carried out on *(
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on Se0e n
6;8
/ecember ('9'.
". In cert ai n areas the standar d of the work perfor med by the
pre"ious audit ors was not as high as would be nor mally
expect ed.
#e@ui red
/escribe the in"esti gati ons you would make and the work you would carry
out to find the reasons for the fall in gross profit mar gi n for the year ended
*( /ecember ('9'.

("ot al B .D !arks)
E&ES"I%N 7%&#
a. In addition to the st at ut ory audit, the audit ors of insurance compani es
are required to report on "arious other schedul es submi t t ed to the
1ommi ssi oner of Insurance. ame these other schedul es.
b. What are the import ant control obDecti"es relating to premi um and
clai ms that are unique to the insurance businessR
c. What import ant ratios need to be consider ed by the auditorR
d. What subst ant i "e test s of det ail Aon areas known as technical
pro"isionsB are of import ance to the audit orR
E&ES"I%N 7I'E
7or informati on purposes only, the balance sheet of a typical medi um-
si:ed building societ y is shown below:
NK 555
#sset s $4, %9'
0iquid asset s
1ommer ci al asset s
#d"ances secur ed on residenti al propert y (4$, 4%4
+ther ad"ances secur ed on land %,(4(
Tangibl e fixed asset s
$,9&(
+ther asset s &&
($', 55K
0iabilities and 8eser"es
!hares and deposi t s
8et ail funds and deposit s ((5, %(%
Wholesal e funds *,'$'
+ther liabilities
Income and corporation tax $,%(*
+ther &$
2ro"ision for liabilities and charges
2ro"ision for deferr ed tax &4'
Total liabilities ($$, %$K
Hener al reser"e K,(*4
($', 55K
A&*I"IN-
6;:
#e@ui red
AaB 0ist and describe the audit checks you would perfor m o"er
the granti ng of ad"ances to mort gages from the initial
application by the mort gage e to the payment of the
mort gage sum.
AbB /escribe the controls which should exist o"er the cust ody and
mo"ement of deeds of properti es and briefly describe how you
would check these controls.
AcB /escribe the audit checks you would perfor m to "erify the amount
owing to ret ail share and deposit account holders, as shown in the
balance sheet .
AdB /efine a dormant account . Why are they a high risk area of the
audit and what audit test s would you carry out to "erify that no
frauds are taking place on these account sR
o the Study +ack
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on Se0e n
6;C
C%!+#E$ENSI'E ASSI-N!EN" N%/ 4
"% BE S&B!I""E* A7"E# 2ESS%N C
*ist anc e 2earni ng Admi ni s t rat i on or marki ng ,y the &ni 0ersi t y
E&ES"I%NS/
Answer A22 Eues t i ons "ime Allowe dB 4 $ours
E&ES"I%N %NE
Qou ha"e been appoint ed the audit or of Genga yumba )uilding
!ociet y which has branches in all the maDor towns in .enya. The
head office and all the branches are fully comput eri sed.
Qou are required to list down the aspect s of controls which are of
particul ar rele"ance to building societi es in addition to controls
common to other banking and non- banking financi al institutions. In
each case stat e the obDecti"es of e"ery control and show how it can
be strengt hened.

(65 !arks)
E&ES"I%N "3%
Qour firm has been appoint ed to a Doint audit with anot her firm of
1ertified 2ublic #ccount ant s of .enya. In case of Doint audit s:
AaB /iscuss the procedur es usually followed in conducti ng an audit
by mor e than one firm of account ant s and the di"ision of work
bet ween them.
AbB /iscuss the gener al ad"ant ages and disad"ant ages of Doint
audit s. (65 marks)
E&ES"I%N "$#EE
AaB The expressi ons Omanage me nt audit, oper ati onal audit, and
efficiency auditO are "ery often used these days.
/o they differ from internal audit sR If so, to what ext ent R
/iscuss.
AbB Write short not es on O6alue for ,oney audit sO with a speci al
reference to go"ernment and quasi- go"ernment bodies.
(65 !arks B
E&ES"I%N 7%&#
AaB /escribe briefly the responsi bility of the auditors of a holding
company when reporti ng upon group account s which
incorpor at e the account s of subsi di ary and associ at ed
compani es of which ha"e not been audit ed by them A*
,arksB
AbB /et ail the principal mat t er s which must be consider ed by the
auditors before placing reliance on account s not audit ed by
A&*I"IN-
6;D
them. A' ,arksB
AcB The audit ors of the holding company usually prepar e
questi onnair es to be compl et ed by the out side firms of
auditors. !uggest eight import ant mat t er s relating to
accounti ng policies or scope of the audit which would be
included in the questi onnai r e under the section on stock and
work- in-progr ess.

A9 ,arksB

("ot al B 65 !arks)
E&ES"I%N 7I'E
What det ails require exami nati on by the #ccount ant with regard to the
lawyer s? recordsR

(65 !arks)
EN* %7 C%!+#E$ENSI'E ASSI-N!EN" No/ 4
N%3 SEN* (%&# ANS3E#S "% "$E *IS"ANCE 2EA#NIN- CEN"#E
7%# !A#KIN-
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on Eight
6;<
2ESS%N EI-$"
E9"E#NA2 A&*I"%#S #E+%#"S AN* %"$E# #E+%#"S
%B=EC"I'ES
When you ha"e studi ed this lesson you shoul d be abl e to:
/iscuss and expl ai n the concept of Vtrue and fair? and appr eci at e
its rele"ance to the work of an audit or
2repar e audit report s to meet different specified situati ons
2repar e report s for manage me nt
C%N"EN"S
Introduction to audit or?s report s
#uditors 8eport s to !harehol der s
#uditors 8eport s to ,anage me nt
#ccount ant s 8eport s:
o <naudit ed 7inancial Informati on,
o 2rospect us es,
o Interi m financi al stat ement s,
o 2roforma financial stat ement s and Tax certificat es
-lectronic 1ommuni cation
1ompliance with I78!s
8e"iew 8eport s
!mall 1ompany report s
Assi gne d #eadi ngs
The !e"ent h !chedul e to the compani es #ct 1ap %9&
I!# K44 The #uditor?s 8eport on 7inanci al !tat e me nt s
I!#- *444 #ssur ance -ngage me nt s
I!#- *%44 The exami nat i on of prospect i "e financi al infor mat i on
INS"#&C"I%NS
1ompl et e #nswers to 8einforcing questions at the end of the lesson
without reference to the model answer s
1heck your answer s with those gi"en in 0esson (4 of the !tudy 2ack
A&*I"IN-
685 Ext ernal Audi t ors
#e1ort s and %ther #e1ort s
D/ 5 Introduct i on
The audi t report is the final st age in the process of an audit . The ter ms
Vtrue and fair?
Vpresent fairly? ha"e speci al significance in the audi t report . #t this le"el
you will be
required to draft unmodified and modified audit report s in accor dance
with I!# K44. -&e
audit or's report on financi al stat e me nt s taking into account a "ariet y of
circums t anc es
which may affect the audi t opinion. The lesson also co"er s other report s
or lett er s sent
by the audit or to the client?s direct or s and manager s in accor dance with
I!# (44K
!ommuni cat i on :it & mana gement . 7inally, we consi der some speci al
purpos e audit
report s.
D/ . "rue and 7air
(a) $ist ory
Internat i onal !tandar ds on #uditing AI!#sB make it quit e clear that the
ter ms Vtrue and fair? and Vpresent fairly? which are used in audit report s
in many other count ri es, mean the same thing. There is no definition of
eit her ter m in legisl ation or st andar ds anywher e. #lthough bot h ha"e
exist ed for a long ti me.
I#! ( Are"isedB Present at i on of Financial Stat e me nt s st at es that financi al
st at e me nt s shoul d Vpresent fairly? the financi al position, perfor mance and
cash flows of and ent er pri se and goes on to st at e that financi al
st at e me nt s prepar ed in accor dance with I#!s Awith additional disclosur es
if neces s ar yB will gener all y resul t in fair present at i on. The Vtrue and fair?
o"erride, as used in the <., that allows any account i ng st andar d to be
depar t ed from, in the int er est of gi"ing a true and fair "iew, is only to be
applied on Vextremel y rare circums t anc es?.
The ter m true and fair was first used in the <., wher e it originat es, in
legisl ati on of ('%9. =owe"er, prior legisl ati on had used si milar phras es.
1ompani es legisl ation dat ed (9%% required <. compani es to present a
full and fair balance s&eet , though the meani ng of this phras e was ne"er
defined. # company was required to keep full and true account s . )y
('44 the audit or was required to st at e whet her the bal ance sheet was
properl " dra:n up so as to e%&i bi t a true and correct vie:, This phras e
was ret ai ned until ('%9.
The .enya 1ompani es #ct 1ap %9& is based on the <. 1ompani es #ct of
('%9
#t no st age has any legal definition of the meani ng of thes e ter ms been
pro"ided. I!#s does not set out what is meant by eit her Vtrue and fair? or
Vpresent fairly?.
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on Eight
68.
(,) Att em1t s at dei ni ti on o the Ptrue and airA 0i ew
The following quot at i ons repr es ent aut hori t ati "e "iews on the meani ng of
true and fair "iew.
# true and fair "iew implies that all st at ut or y and other infor mat i on is not
only a"ail abl e but is present ed in a form in which it can be properl y and
readily appr eci at ed. A!ir 8ussell .ettleB.
# true and fair "iew implies appropri at e classification and groupi ng of
items .. AandB consi st ent applicati on of gener all y accept ed principl es.
AThe Instit ut e of 1hart er ed #ccount ant s in #ustrali a P 8ecomme nde d on
#ccounti ng 2rincipl es ('&%B.
Y the meani ng att ached to Athe words true and fairB has been built up
o"er the year s by st andar ds of present at i on specifically requir ed by the
#ct@ est abli shed account i ng techni ques@ case law decisions@ the nat ur al
desire of responsi bl e direct or s of compani es and audit ors to ensur e that
the fact s and figures which are pres ent ed in the public properl y reflect
the position@ and last but not least common sens e. A!ir =enry )enson
('&$B.
7or an audi t or to be abl e to say that a financi al st at e me nt is true and fair
it must be:
AaB 8ele"ant to the busi ness trans act i ons etc it purport s to descri be
AbB +bDecti"e, being free from any bias Y and being based on
unpr eD udi ced and "erifiabl e e"idence which us capabl e of
suppor ti ng it A0eeB.
Y true and fair has become a ter m of art. It is gener all y under st ood to
mean a present at i on of account s drawn up accor di ng to accept ed
account i ng principl es using accur at e figures as far as possi bl e and
reasonabl e esti mat es otherwi se, and arrangi ng them so as to be show
within the limit s of current account i ng practice as obDecti"e a pict ur e as
possi bl e free from willful bias, dist orti on, mani pul ati on or conceal me nt of
mat eri al fact s. A0eeB.
It must be concl uded that ther e has been little at t empt preci sel y to
define true and fair.
The 1ompani es #ct requires an auditor to report in true and fair "iew
ter ms as regar ds the balance sheet and the profit and loss account .
The 1ompani es #ct howe"er, does not define what constit ut es a true
and fair "iew. We ha"e no decided case in .enya or anywher e in the
world that has gi"en a definition of true and fair "iew.
It has therefor e been left to the professi on to try to define the
meani ng of true and fair "iew or at least to det er mi ne what not a true
and fair "iew is. The 1ompani es #ct in the &th !chedul e gi"es the
mini mum disclosur e requirement s of items in the balance sheet and
profit and loss account . It would therefore seem to follow that
compliance with the requirement s of the &th !chedul e, would result
in the account s gi"ing a true and fair "iew.
A&*I"IN-
686 Ext ernal Audi t ors
2rofessional thinking has tried to put a meani ng to this expressi on by
analysi ng the two words separ at el y. If we took this approach we
would come up with the following decision:
(c) "rue
!eani ng o Ptrue and airAF 1re s e nt airl yA
Truth in account i ng is quit e different form scientific trut h. #ccounti ng
does not deal with that type of trut h which has a fixed and unchangi ng
qualit y. 1ost s and re"enues for any account i ng period which is less than
the full life of each "ent ur e in"ol"ed cannot be det er mi ned with
preci sion. In account i ng only cash draws close to the concept of
scientific trut h, but since the "alue of cash changes with ti me, it lacks
tot al correspondence with the preci sion of scientific trut h.
The audi t or shoul d at t empt to ensur e that the account s which are subD ect
of his audi t present clearly and equit abl y the financi al st at e of affairs of
the ent er pri se. This suggest s that in order to achi e"e the st at ut or y true
and fair "iew it is neces s ar y not only to present cert ai n infor mat i on
impar ti ally but also that this dat a is shown in such a way that it is clearl y
under st ood by the user.
# dictionary definition of true includes such words as:
I In accordance with reality@
I In accordance with reason, or correct number s or percei"ed
st andar d@
I We can also think of trut h as meani ng: not false, or not fictitious
and in accordance with facts.
We can clearly identify that account s cont ai n element s of trut h in that if
the balance sheet stat es that the company has got land and buildings
"alued at (4 million shillings then it is either true or not true that the
company owns the land. Therefore stat e ment s made in the account s can
be test ed to pro"e whet her they are true of false. In this case, we are
concerned with ownershi p of asset s and liabilities, we are concerned with
their exist ence and we are concer ned with their proper definition or
description and classification. =ence the auditor looks for e"idence to
confirm stat ed and implied asser ti ons in the account s. True does not
relat e to "alue becaus e "alue is dependent on many factors.
(d) 7airnes s
The word fair can ha"e the following meani ngs: on the one hand clear#
distinct and plain and on the other impartial# just and e1uit abl e . #ll can
be consi der ed rel e"ant when fair is used in an account i ng text .
We ask oursel"es the questi onsNfair to whomR #nd it seems that we
shoul d be fair to the user of the account s in that the user of the account s
has cert ai n expect ati ons. =e expect s that account s will compl y with the
1ompani es #ct requirement s and he also expect s that the account s will
confor m to gener ally accept ed accounti ng principles and the I#!, hence if
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
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we can satisfy the expect ati ons of the user it can be felt that we ha"e
been fair. This therefore leads us to rele"ance, in other words, the
account s must gi"e a "iew that is rele"ant to the needs of the user. It will
ther efor e be expect ed that the account s will show the resources employed
in the company, clai ms agai nst those resources, the changes in the
resources and clai ms o"er a period of time. The account s also report on
historical e"ent s. They are therefore not intended to be used for decision
maki ng although they are regul arly used for this purpose.
%,Hecti 0i t y
,ost accounti ng figures are subDecti"e and cont ai n subst ant i al element s of
subD ecti"e Dudgement . ,any business transacti ons ha"e financi al effect s
that spread o"er many years. /ecisions are therefore to be made, as to
the ext ent to which expendi t ur e incurred in one year can reasonabl y be
expect ed to produce benefit s in the form of re"enue in other years.
+bDecti"ity ther efore requires that account s stat e ext er nally "erifiabl e
changes rather than subD ecti"ely consider ed opinions. The account s must
ther efor e be free from bias, thus the producer of the account s shoul d not
allow personal preferences to ent er into their account s prepar at i on work.
In practice, all acti"ities are influenced by personal experi ence and
preDudice. #n import ant thing is for the auditor to be awar e of this and
also for him to be awar e of the tendency to bias in all financi al reporti ng.
Con ormi t y
#lthough the user of the account s expect s the account s to confor m to
gener al accept ed accounti ng principles and the I78!s, simpl e rigid
confor mi t y can lead to a misleadi ng "iew. Thus if we simpl y included
profits from o"erseas branches and those profits are not a"ailabl e to
sharehol der s becaus e of exchange control restrictions, then the account s
would be misl eadi ng.
Cons er0at i s m
The concept of prudence is highly est ee me d in the accounti ng professi on.
=owe"er, taken to extremes it could result in account s not gi"ing a true
and fair "iew as in the case of long ter m const ructi on contract s,
contingent liabilities and in subst ance o"er form transacti ons. The
account ant is a pessi mi st by nat ur e but the auditor must guard agai nst
o"er conser"at i s m.
Account i ng +rinci 1l es and +olici es
The user of the account s expect s that the accounti ng principles and
policies used will be in confor mi t y with I#!, be gener ally accept ed, be
widely recogni sed and support ed and be appropri at e and applicabl e in the
particul ar circumst ances. It is cruci al for the auditor to get e"idence that
the accounti ng policies used are appropri at e in the circumst ances, not
only accept abl e.
Su,s t anc e o0er 7orm
Transaction should show the commer ci al reality rather than the legal form.
These would require therefore that the account s should show all the
asset s and liabilities of the organi:ation e"en though legally the asset s or
liabilities do not relat e to the organi:ati on.
A&*I"IN-
68; Ext ernal Audi t ors
+res e nt at i on and *iscl os ur e
The o"erall result and final position can only be appreci at ed by
aggr egat i ng transact i ons and balances into suit abl e classes and
cat egori es. The description gi"en to these classes and cat egori es must
show their true nat ur e.
!at eri al i t y
#n item is mat eri al if its disclosur e or non- disclosur e would make any
difference to the "iew recei"ed by the user of the account s. 7airness is
ther efor e a function of mat eri alit y. The account s must not be clutt er ed
with tri"ialities or amount s and st at eme nt s that are insignificant to the
o"erall "iew gi"en by the account s. The auditor has to keep the concept
of mat eri ality in mind at all times.
D/ 6 #egul at i ons go0erni ng Audi t #e1ort s in Kenya
The requirement s of the 1ompani es #ct 1ap %9&
Internati onal 7inancial !tandar ds AI78!sB
Internati onal !tandar ds on #uditing AI!#sB
D/ 6. "he #e@uire me nt s o the Com1ani e s Act
The se"ent h schedul e to the 1ompani es #ct gi"e the mat t er s which must
be expressl y
stat ed in the #</IT+8J! 8-2+8T
(. Whet her they ha"e obt ained all the informat i on and
explanat i ons which to the best of their knowl edge and belief
were necess ar y for the purposes of their audit.
$. Whet her, in their opinion, proper books of account ha"e been
kept by the company, so far as appear s from their exami nati ons
of those books, and proper ret urns adequat e for the purposes of
their audit ha"e been recei"ed from branches not "isited by
them.
*. i. Whet her the companyJ s balance sheet and Aunless it is
framed as a consolidat ed profit and loss account B profit
and loss account dealt with by the report are in agree me nt
with the books of account and returns.
ii. Whet her, in their opinion and to the best of their
informati on and accordi ng to the expl anati ons gi"en them,
the said account s gi"e the informati on required by this #ct
in the manner so required and gi"e a true and fair "iew:
aB In the case of the balance sheet , of the stat e of the
companyJ s affairs as at the end of its financi al year@
and
bB In the case of the profit and loss account , of the profit
or loss for its financi al year, or
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
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as the case may be, gi"e a true and fair "iew ther eof subD ect to the non-
disclosur e of any mat t er s Ato be indicat ed in the reportB which by "irtue of
2art III of the !ixth !chedul e are not required to be disclosed.
%. In the case of a holding company submi t ti ng group account s
whet her in their opinion, the group account s ha"e been properl y
prepar ed in accordance with the pro"isions of this #ct so as to
gi"e a true and fair "iew of the stat e of affairs and profit or loss
of the company and its subsidi ari es dealt with ther eby, so far as
concer ns member s of the company, or, as the case may be, so
as to gi"e a true and fair "iew thereof subD ect to the non-
disclosur e of any mat t er s Ato be indicat ed in the reportB which
by "irtue of 2art III of the !ixth !chedul e are not required to be
disclosed.
"he !eani ng o +ro1er Books o Account s
!.(%K of the 1ompani es #ct requires e"ery company to keep in the -nglish
language proper books of account s with respect to:
aB #ll sums of money recei"ed and expended by the
company and the mat t er s in respect of which the
receipt and expendi t ur e takes place. =ence, most
compani es will ha"e a cash book to compl y with this
requirement but not e that the 1ompani es #ct does
not specifically call for a cash book nor does it lay
down any hard rules on what form these records
should take.
bB #ll sales and purchas es of goods by the company: ,ost
compani es compl y with this requirement by maint ai ning
sales and purchas es Dournal s or day books. #gain, the
1ompani es #ct does not specify the form which these
records should take.
cB #sset s and 0iabilities: ,ost compani es compl y with this
requirement by maint ai ning personal and gener al ledgers
with regard to asset s and liabilities of the company and
changes therei n.
The books of account s gener ally speaki ng can be kept anywher e the
direct ors deem fit and are open to inspection by the direct ors at any time.
The 1ompani es #ct also requires that a company keeps the following
stat ut ory books.
(. # regist er of direct ors and secret ari es
$. # regist er of charges, fixed and floating
*. ,inut e )ook of meet i ngs of the company, meeti ng of its
direct ors
%. #n indexed regist er of account s
5. #n indexed regist er of each direct orJ s sharehol di ng
It also requires that public compani es must keep a regist er of maDor
sharehol der s, thus an interest of 5T or more in the nomi nal "alue of the
"oting shar e capit al is a maDor holding.
2roper books of account s are such books that are necess ar y to gi"e a true
and fair "iew of the st at e of affairs and to explain its transact i ons. The
A&*I"IN-
68: Ext ernal Audi t ors
auditor?s interest in the stat ut or y books is:
aB They are usually concer ned with account s@
bB They are audit e"idence in their findings and det ails of
items in the account s@
cB 7ailure to mai nt ai n proper books of account s cast s doubt upon
the accur acy and reliability of the books gener ally.
The 1ompani es #ct principles requires that where a company has
branches, then returns must be recei"ed from those branches that can
expl ain its transacti ons as for the main company.
D/ 66 "he Audi t orK s #e1ort to Sharehol der s
"he Cont e nt and !eani ng o &n@ual i i e d and !odi i e d Audi t
#e1ot s
The audi t re1ort is usually the only channel of communi cat i on bet ween
the audi t or and the shar ehol der s of the company whose financi al
st at e me nt s ha"e been subD ect to audi t. #s such the report act s as a
bridge taking the large "olume of infor mat i on posses s ed by the audi t or s
and con"eyi ng it to the shar ehol der s in a much abbr e"i at ed form.
In order to con"ey infor mat i on in a succinct from the audi t report has
become ext re mel y formali:ed group of phras es, each of which has
speci al significance. #ny de"i ation from the st andar d format is regar ded
by an account ant as being significant and may pro"ide import ant ext ra
dat a.
The possi bilities are as follows:
AaB an unqualified audit report
AbB a modified audi t report which required an audit qualification
AcB a modified audi t report which, although the opinion is unqualified,
may require additional det ail emphasi :i ng particul ar mat t er s
cont ai ned within the financi al st at e me nt s .
I7#1 has issued I!# K44 -&e Auditor's Report on Financial Stat e me nt s in
order to reduce the differences which pre"iousl y exist ed in the met hod of
reporti ng so that shar ehol der s and other user s of financi al st at e me nt s
could grasp mor e easily the st andar di :ed mess age which the audit or is
int endi ng to con"ey.
It is import ant that you recall from your earlier st udi es that audi t or s do
not Vguar ant e e? or Vcertify? that financi al st at e me nt s are Vcorrect?, they
expr es s opinions on the mat t er s requir ed by I!# K44 i.e.
AaB Whet her they gi"e a true and fair "iew
AbB Whet her they are properl y prepar ed in accor dance with the
financi al reporti ng framewor k.
Wher e appropri at e, the audi t or will also report whet her the financi al
st at e me nt s compl y with rele"ant local st at ut or y requir eme nt s such as
the compani es #ct 1ap %9&
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#s an alt er nat i "e to the phras e Vtrue and fair "iew? the audi t or may
report that the financi al st at e me nt s are Vpresent ed fairly in all mat eri al
respect s?. These two expr essi ons are equi"al ent and emphasi :e that the
audi t or is only concer ned with mat eri al items.
The cont ent of the audit orJ s report is go"erned by the 1ompani es #ct,
!e"ent h !chedul e to
The 1ompani es #ct and the I!# K44, The #uditor?s 8eport on 7inanci al
!t at e me nt s
The 1ompani es #ct lays down no specific requirement s as to the wording
to be used in the audit report so long as all the mat t er s as menti oned in
the !e"ent h !chedul e are specifically menti oned in the audit orJ s report.
The auditing standar d seeks to pro"ide guidance on the form of wording
that is accept abl e.
The auditing standar d requires the audit or to:
aB Identify those to whom his report is address ed i.e. the member s
of the company@
bB The audit or shoul d identify the financi al st at eme nt s on which he
is reporti ng, this is done by numberi ng the pages of the
account s@
cB The audit or shoul d refer expressl y to whet her the financi al
st at eme nt s ha"e been audit ed in accordance with the appro"ed
auditing st andar ds@
dB The auditors must st at e expressl y whet her in their opinion the
financi al st at eme nt s gi"e a true and fair "iew of the st at e of
affairs, profit and loss, and wher e applicabl e source and
application of funds@
eB The audit or shoul d refer expressl y to any mat t er s described by
rele"ant legislation or any other requirement s.
D/ 64 Circums t anc e s in 3hich Eualii cat i on Is Nece s s ary
When the audit or has no reser"ati ons on the mat t er s required by the
!e"ent h !chedul e, he issues a clean report . If he has any reser"ati ons, he
may issue a qualified report. The circumst ances which cause auditors to
introduce qualifying st at eme nt s into their report s where the mat t er s at
issue are mat eri al include the following
aB If the auditors are unabl e to obt ai n all the informati on and
expl anati ons they consider necess ar y for the purposes of their audit,
for exampl e, if they are unabl e to obt ain satisfact or y e"idence:
i. of the exist ence of owner shi p of mat eri al asset s or of the
amount s at which they ha"e been stat ed on the basis
adopt ed@
ii. of the "alidity of payment s@
iii. That the records properly reflect all transacti ons of the
business becaus e the e"idence has been lost or dest royed
or is otherwi se not forthcomi ng or has ne"er exist ed.
bB If in the opinion of the audit ors:
A&*I"IN-
68D Ext ernal Audi t ors
i. 2roper books of account s ha"e not been kept in
accordance with the 1ompani es #ct@
ii. 2roper ret urns adequat e for their audit ha"e not been
recei"ed from branches nor "isited by them@
iii. The balance sheet and the profit and loss account are not
in agreeme nt with the accounti ng books and ret urns.
cB If in the opinion of the audit ors the account s though based
on proper books of account fail to gi"e the informati on
required by the act for exampl e, a failure to compl y with
specific disclosur e requirement s of the 1ompani es #ct in
mat eri al respect s.
dB If in the opinion of the audit ors the account s though otherwi se
compl yi ng with the disclosur e requirement s fail to disclose a
true and fair "iew for exampl e:
i. )ecaus e in the audit orJ s opinion the underl ying accounti ng
policies do not confor m to accounti ng principles
appropri at e to the circumst ances and nat ur e of the
business@
ii. )ecaus e they are prepar ed on principles inconsist ent with
those pre"iously adopt ed and without adequat e
explanat i on and disclosur e of the effect s of the change@
iii. )ecaus e the auditors are unabl e to agree with the
amount s at which an asset or a liability is stat ed@
i". )ecaus e the auditors are unabl e to agree with the amount
at which income or expendi t ur e or profit is stat ed@
". )ecaus e the account s do not disclose informat i on though
not specifically required by the compani es act, is
necess ar y for the present at i on of a true and fair "iew@
"i. )ecaus e additional informat i on gi"en in a not e or in the
direct orJ s report mat eri ally alt ers the "iew otherwi se gi"en
by the account s.
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eB If in the case of a holding company submi t ti ng group
account s it is the opinion of the auditors that the group
account s ha"e not been properl y prepar ed in accordance
with the pro"isions of the act so as to gi"e a true and fair
"iew of the profit and loss of the company and its
subsi di ari es so far as it concer ns the member s of the
company.
,ore than one of the circumst ances in which qualification is
necess ar y may be present in any particul ar case. Where the auditor
has these reser"at i ons, he must inform the shar ehol der s in his audit
report.
D/ 6; +rinci 1l e s o Eualiyi ng #e1ort s
# qualified report is not necess ar y unless the amount s at issue are
mat eri al. If a qualified report is called for the auditors must decide:
aB To which specific mat t er s their reser"ati ons apply@
bB Whet her they acti"ely disagr ee or on the other hand lack
sufficient e"idence to enabl e them form an opinion as regar ds
mat eri al items in the account s@
cB Whet her in either e"ent the mat t er s in question are so mat eri al
as to affect the present at i on of a true and fair "iew.
If for inst ance the items in doubt or disagr ee me nt are limit ed and
ther efor e not so mat eri al as to cast doubt on the "iews shown by the
account s as a whole, the audit ors will be able to report that in their
opinion subDect to specific reser"ati ons or with specific exempt i ons
the account s present a true and fair "iew. There may howe"er be
cases wher e the subst ant i al items or those in disagr ee me nt are so
mat eri al that the audit s must report stating their reason either:
i. that they are unabl e to form an opinion whet her the account s
present a true and fair "iew or@
ii. that in their opinion the account s do not present a true and fair
"iew. # qualification in this extreme ter m is only made in rare
circumst ances.
The 1ompani es #ct lays down no specific requirement s as to the manner
in which audit ors shoul d when they Dudge it necess ar y, qualify their report .
This can only be decided in the circumst ances of each particul ar case. It
would be undesir abl e to suggest st andar d forms of working that might be
appropri at e to the "ariet y of circumst ances in which it may be necess ar y
for audit ors to gi"e a qualifying report . The guiding principle is that it is
the duty of an audit or to con"ey informat i on not mer el y to arouse inquiry.
)efore qualifying their report, auditors shoul d discuss the account s with
the companyJ s manage me nt and make their "iews clear. This enabl es the
direct ors to exami ne the mat t er at issue and as far as they Dudge it
practical and appropri at e they may take steps to pro"ide the missing
informat i on or to amend the account s in such a way as to enabl e the
A&*I"IN-
6:5 Ext ernal Audi t ors
auditors gi"e a report without qualification. # qualifying stat e ment should
be direct and informat i"e. It should be phrased as to lea"e the reader in
no doubt as to its meani ng. Therefore, it shoul d:
aB )e as concise as is consist ent with clarity@
bB )e specific as to the items and facts as far as possi bl e the
amount s in"ol"ed@
cB Within the limits of the informati on a"ailabl e to the
auditors make clear its effect s on the account s and@
dB -xpress the auditorJ s opinion without the possibility of
misint erpr et at i on.
The obDect is to gi"e in clear and unequi"ocal ter ms so far as
circumst ances per mi t such informat i on in augment at i on of that pro"ided
by the account s and not es ther et o as will in the audit orJ s opinion pro"ide
the informati on required by the act s and ensur e that the account s will
then gi"e a true and fair "iew. It must be emphasi sed that the fact that
the audit ors Dudge it necess ar y to include qualifying stat e ment s in their
report does not necess arily imput e the financi al integrit y of a companyJ s
direct ors who are ultimat el y responsi bl e for the form and present at i on of
the account s and the informati on they cont ai n. It is the dut y of the
auditors to exercise their Dudgement and express their opinion, their
obligation is inescapabl e. It would be wholly inappropri at e for inst ance for
auditors to seek to a"oid qualifying their report s by resigning before the
expiry of their ter m of office simpl y becaus e they are dissati sfied with the
position disclosed by their audit.
i. it identifies the nat ur e of circumst ances and recogni ses only two
which are uncert ai nt y and disagr ee me nt .
&ncert ai nt y
The auditor may be unabl e to express an opinion on a set of
account s as a result of uncert ai nt y. This would seem to imply
that to some ext ent he has been unabl e to obt ai n all the
informati on and explanat i on which he deemed necess ar y for the
purposes of the audit. These can be as a direct inter"enti on or
lack of cooper at i on by the manage me nt or the manage me nt
can gi"e him all the help he needs but he is still unabl e to
express an opinion due to circumst ances beyond a
manage me nt J s control and limitations from the a"ailabl e
informati on. The standar d recogni:es that uncert ai nt y can arise
as a result of limitations in the scope of the audit and as a result
of inher ent uncert ai nti es.
<ncert ai nt y can be of two le"els, mat eri al and not fundament al
and fundament al . #n uncert ai nt y is mat eri al but not
fundament al if the audit or has reser"ati ons on only a particul ar
aspect of the account s and not on the account s as a whole. In
this situation the auditor is able to form an opinion on the
account s as a whole with particul ar reser"ati ons on a specific
mat t er. =e therefore disclai ms opinion on only an aspect of the
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account s and not the account s taken as a whole.
#n uncert ai nt y becomes fundament al when its impact on the account s
taken as a whole is to make them meani ngl ess for any decision maki ng
purposes and to reduce their informati onal "alue. In this situati on, the
auditor is unabl e to form an opinion on the account s taken as a whole and
he therefor e disclai ms his opinion altoget her by st ati ng that he is unabl e
to form an opinion as to whet her the financi al stat e ment gi"es a true and
fair "iew.
*isagr e e me nt
The I!# gi"es circumst ances in which disagr ee me nt could arise bet ween
the auditor and the manage me nt .
These are:
I /epart ur es from accept ed accounti ng practices wher e AiB
there has been failure to compl y with the rele"ant I#! and
the auditor does not concur AiiB an accounti ng policy not
the subDect of a I#! is adopt ed which in the opinion of the
audit or is not appropri at e to the circumst ances of the
business or AiiiB exceptionally a I#! has been followed with
the result that the financi al st at eme nt s do not present a
true and fair "iew.
I /isagr ee me nt as to the fact s or amount s included in the
financi al stat e me nt .
I /isagr ee me nt as to the manner or ext ent of disclosur e of
facts or amount s in the financi al st at eme nt s.
I 7ailure to compl y with the rele"ant legislation or other
requirement s.
Where the auditor disagr ees with the manage me nt on Dust an
aspect of the account s, he will indicat e in his report that he has
exceptions as against reser"ati ons not ed under uncert ai nt y and
he will menti on in his report that to the ext ent of the exceptions
the account s do not gi"e a true and fair "iew. This is where the
disagr ee me nt is mat eri al but not fundament al . # disagr ee me nt
becomes fundament al wher e its impact on the financi al
st at eme nt s is to make them misleadi ng as a whole. In this
situati on the audit or will stat e that the account s taken as a
whole do not gi"e a true and fair "iew.
!at eri al i t y
The audit ors will not clutt er their opinion with tri"ial mat t er s and ther efor e
their audit is carried out with emphasi s on mat t er s that could ha"e
mat eri al impact on the report. # mat t er gener ally is held to be mat eri al if
its disclosur e or non- disclosur e would affect the "iew gi"en by the
account s. ,ateri ality may be consider ed in the cont ext of the financi al
stat e ment as a whole, the balance sheet , the profit and loss account , or
indi"idual items within the financi al stat e ment . In addition, dependi ng
upon the nat ur e of the mat t er mat eri ality may be consider ed in relati"e or
A&*I"IN-
6:6 Ext ernal Audi t ors
absol ut e ter ms. If therefore the audit or concludes that , Dudged against
criteria he belie"es to be most appropri at e in the circumst ances, the
mat t er does not mat eri ally affect the "iew gi"en by the financi al
stat e ment s he should not qualify his opinion.
,ateriality is essenti ally a mat t er of professi onal Dudgement and ther efore
an indi"idual item can be Dudged mat eri al if knowl edge of that item could
reasonabl y be deemed to ha"e influence on the users of the financi al
stat e ment . The issue of mat eri ality arises in two situations:
AiB det er mi ni ng the ext ent to which det ail ed audit work should
be perfor med in specific areas and AiiB det er mi ni ng whet her
errors or other mis- stat e ment s ha"e affect ed the true and fair
"iew.
#n amount is not mat eri al solely by reason of its si:e. +ther factors
including those set out below must be consider ed in making decisions as
to mat eri ality: AaB the nat ur e of the item i.e. whet her it is a factor ent eri ng
into the det er mi nat i on of net income, unusual or extra- ordinary,
contingent upon an e"ent or condition, det er mi nabl e based upon existing
fact s and circumst ances and required by stat ut e or regul ation AbB the
amount itself in relation to the financi al stat e ment s taken as a whole, the
tot al of the amount of which it forms or should form a part, relat ed items
Ae.g. if the figure under re"iew is the doubtful debt pro"ision then debt ors
would be relat ed itemsB, the correspondi ng amount s in pre"ious years or
the expect ed amount s in future years. It has been found that it is possi bl e
to ha"e quanti t ati"e guidelines as to mat eri ality and these range bet ween
5 and (4 percent when compar ed to an appropri at e base. )elow 5T
would not normally be mat eri al unless it is one of those transact i ons which
must be disclosed by stat ut e e.g. direct ors emol ument s.
ii/ 7undame nt al i t y
When a mat t er is fundament al then it is consider ed so crucial to the "iew
gi"en by the account s that it can render them tot ally misleadi ng or
meani ngl ess. This usually arises in "ery rare circumst ances. 8emember
that an uncert ai nt y ceases to be Dust mat eri al and becomes fundament al
when its impact on the financi al stat e me nt s is to make them meani ngl ess.
# disagr ee me nt ceases to be Dust mat eri al and becomes fundament al if its
impact on the financi al st at eme nt s taken as a whole is so great as to
make them tot ally misleadi ng. It would appear that failure to compl y with
I#! and the requirement s of legislation would aut omat i cally make a
disagr ee me nt fundament al becaus e compliance with the I#! and
1ompani es #ct is necess ar y for account s to gi"e a true and fair "iew.
When the audit or is faced with a situation of uncert ai nt y whet her it is
limit ation of scope or inherent but it is only restrict ed to an item in the
account s and not the account s as a whole then he shoul d use a OsubD ect
toO form of report.
Where the uncert ai nt y is consider ed fundament al then the auditor should
use a disclai mer of opinion.
When it is a situation of disagr ee me nt on an aspect of the account s then
the auditor uses an Oexcept forO opinion.
When the disagr ee me nt is fundament al , then he gi"es an ad"erse opinion
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on Eight
6:4
Em1hasi s o mat t er
The st andar d st at es as a gener al principle, the audit or issuing an
unqualified opinion shoul d not make reference to specific aspect s of the
financi al st at eme nt s in the body of his report as such a reference may be
misconst r ued as being a qualification. In rare circumst ances the reader
will obt ain a bet t er under st andi ng of the financi al st at eme nt s if his
att enti on is drawn to import ant mat t er s. These situations arise when
ther e is an unusual e"ent , an unusual accounti ng policy, or an unusual
condition and it is felt that awar enes s of such a situation is fundament al to
the under st andi ng of the financi al st at eme nt , ther efore to a"oid being
misconst r ued as being a qualification reference which are intended to be
of emphasi s of mat t er should be mini mal and shoul d be made not in the
opinion paragr aph of the report but in a separ at e and subsequent
paragr aph introduced with the phrase OWithout qualifying our opinion
abo"e, we draw att enti on to....O,
D/ 6: Basi c Eleme nt s o the Audi t orA s #e1ort
The audi t or?s report includes the following basic element s , ordinarily in
the following layout :
AaB Title@
AbB #ddress ee@
AcB +peni ng or introduct or y paragr aph
AiB Identification of the financi al st at e me nt s audi t ed@
AiiB # st at e me nt of the responsi bility of the entit y?s manage me nt
and the responsi bilit y of the audi t or@
AdB !cope paragr aph Adescri bi ng the nat ur e of an audi tB
AiB # refer ence to the I!#s or rele"ant national st andar ds or
practices@
AiiB # descri pti on of the work the audit or perfor med@
AeB +pinion paragr aph cont ai ni ng:
AiB # refer ence to the financi al reporti ng framewor k used to
prepar e the financi al st at e me nt s Aincludi ng identifying the count r y
of origin* of the financi al reporti ng framewor k when the
framewor k used is not Internat i onal #ccounti ng !t andar dsB @
and
AiiB #n expr es si on of opinion on the financi al st at e me nt s @
AfB /at e of the report @
AgB #uditor?s addr es s@ and
AhB #uditor?s signat ur e.
# meas ur e of unifor mi t y in the form and cont ent of the audi t or?s report is
desirabl e becaus e it hel ps to promot e the reader?s under st andi ng and to
identify unusual circumst ance s when they occur.
(a) "itl e
The audi t or ?s report shoul d ha"e an appropri at e title. It may be
appropri at e
to use the ter m EIndependent #uditorF in the title to distingui sh the
audi t or?s report from report s that mi ght be issued by other s, such as by
officers of the entit y, the board of direct or s, or from the report s of other
A&*I"IN-
6:; Ext ernal Audi t ors
audi t or s who may not ha"e to abide by the same et hical requireme nt s as
the independe nt audit or.
(,) Addres s e e
The audi t or?s report shoul d be appropri at el y addr es s ed as requir ed by
the circums t anc es of the engage me nt and local regul ati ons. The report is
ordinarily addr es s ed either to the shar ehol der s or the boar d of direct or s
of the entit y whose financi al st at e me nt s are bei ng audit ed.
(c) %1eni ng or Introduct ory +aragra1h
The audi t or?s report shoul d identify the financi al st at e me nt s of the entit y
that ha"e been audit ed, includi ng the dat e of and period co"er ed by the
The report shoul d include a st at e me nt that the financi al st at e me nt s are
the responsi bility of the entit y?s manage me nt % and a st at e me nt that the
responsi bility of the audit or is to expr ess an opinion on the financi al
st at e me nt s based on the audi t.
7inanci al st at e me nt s are the repr es ent at i ons of manage me nt . The
prepar at i on of such st at e me nt s requir es manage me nt to make
significant account i ng esti mat es and Dudgment s , as well as to det er mi ne
the appropri at e account i ng principl es and met hods used in prepar at i on
of the financi al st at e me nt s . This det er mi nat i on will be made in the
cont ext of the financi al reporti ng framewor k that manage me nt chooses,
or is requir ed, to use. In cont r ast , the audi t or?s responsi bility is to audi t
these financi al st at e me nt s in order to expr es s an opinion ther eon.
(d) Sco1e +aragra1h
The audi t or?s report shoul d descri be the scope of the audit by st ati ng
that the audi t was conduct ed in accor dance with I!#s or in accor dance
with rele"ant national st andar ds or practi ces as appropri at e. E!copeF
refers to the audi t or?s ability to perfor m audit procedur es deeme d
neces s ar y in the circums t anc es . The reader needs this as an assur ance
that the audi t has been accor dance with est abli shed st andar ds or
practices. <nless other wi se st at ed, the audi ti ng st andar ds or practi ces
followed are presume d to be those of the count ry indicat ed by the
audi t or?s addr es s.
The report shoul d include a st at e me nt that the audit was planned and
perfor med to obt ai n reasonabl e assur ance about whet her the financi al
st at e me nt s are free of mat eri al misst at e me nt .
(e) "he audi t orA s re1ort shoul d des cri ,e the audi t as incl udi ngB
AaB -xami ni ng, on a test basi s, e"idence to suppor t the financi al
st at e me nt amount s and disclosur es@
AbB #ssessi ng the account i ng principl es used in the prepar at i on of
the
financi al st at e me nt s @
AcB #ssessi ng the significant esti mat e s made by manage me nt in
the prepar at i on of the financi al st at e me nt s @ and
AdB -"aluati ng the o"er all financi al st at e me nt pres ent at i on.
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
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() "he re1ort shoul d incl ude a stat e me nt ,y the audi t or that
the audi t 1ro0i de s a reas ona,l e ,asi s or the o1i ni on/
#n illustr ati on of thes e mat t er s in a scope par agr aph is:
EWe conduct ed our audit in accor dance with Internat i onal !t andar ds on
#uditing Aor refer to rele"ant national st andar ds or practicesB. Those
!t andar ds requir e that we plan and perfor m the audit to obt ai n
reasonabl e assur ance about whet her the financi al st at e me nt s are free of
mat eri al misst at e me nt . #n audit includes exami ni ng, on a test basi s,
e"idence supporti ng the amount s and disclosur es in the financi al
st at e me nt s . #n audi t also includes asses si ng the account i ng principl es
used and significant esti mat e s made by manage me nt , as well as
e"al uat i ng the o"er all financi al st at e me nt pres ent at i on. We belie"e that
our audit
pro"ides a reasonabl e basi s for our opinion. F
(g) %1ini on +aragra1h
The opinion paragr aph of the audi t or?s report shoul d clearly indicat e the
financi al reporti ng framewor k used to prepar e the financi al st at e me nt s
Aincluding identifying the count r y of origin of the financi al reporti ng
framewor k when the framewor k used is not Int ernat i onal #ccounti ng
!t andar dsB and st at e the audi t or?s opinion as to whet her the financi al
st at e me nt s gi"e a true and fair "iew Aor are present ed fairly, in all
mat eri al respect sB in accor dance with that financi al reporti ng framewor k
and, wher e appropri at e, whet her the financi al st at e me nt s compl y with
st at ut or y requir eme nt s.
The financi al reporti ng framewor k is det er mi ned by I#!s, rules issued by
recogni :ed st andar d set ti ng bodi es, and the de"el opme nt of gener al
practice within a count r y, with an appropri at e consi der at i on of fairness
and with due regar d to local legisl ati on. To ad"i se the reader of the
cont ext in which the audit or?s opinion is expr ess ed, the audit or?s opinion
indicat es the framewor k upon which the financi al st at e me nt s are based.
The audi t or refers to the financi al reporti ng framewor k in such ter ms as:
EY in accor dance with Int ernat i onal #ccounti ng !tandar ds Aor [title of
financi al reporti ng framewor k with refer ence to the count r y of origin\B
Y.F
In addi tion to an opinion on the true and fair "iew Aor fair present at i on, in
all mat eri al respect sB, the audit or?s report may need to include an
opinion as to whet her the financi al st at e me nt s compl y with other
requireme nt s specified by rele"ant st at ut es or law.
#n illustr ati on of thes e mat t er s in an opinion paragr aph is:
EIn our opinion, the financi al st at e me nt s gi"e a true and fair "iew of Aor
present fairly, in all mat eri al respect sB the financi al position of the
1ompany as of /ecember *(, $4;(, and of the
resul t s of its oper at i ons and its cash flows for the year then ended in
accor dance with Internat i onal #ccounti ng !t andar ds Aor [title of financi al
reporti ng framewor k with refer ence to the count r y of origin\B Aand
compl y with ...B.F
(h) *at e o #e1ort
A&*I"IN-
6:: Ext ernal Audi t ors
The audi t or shoul d dat e the report as of the compl et i on dat e of the audit .
This infor ms the reader that the audi t or has consi der ed the effect on the
financi al st at e me nt s and on the report of e"ent s and transact i ons of
which the audit or beca me awar e and that occurr ed up to that dat e.
!ince the audit or?s responsi bility is to report on the financi al st at e me nt s
as prepar ed and present ed by manage me nt , the audit or shoul d not dat e
the report earli er than the dat e on which the financi al st at e me nt s are
signed or appro"ed by manage me nt .
(i) Audi t orA s Addres s
The report shoul d name a specific locati on, which is ordinarily the city
wher e the audi t or mai nt ai ns the office that has responsi bility for the
audi t.
(H) Audi t orA s Si gnat ur e
The report shoul d be signed in the name of the audi t firm, the personal
name of the audi t or or bot h, as appropri at e. The audit or?s report is
ordinarily signed in the name of the firm becaus e the firm assume s
responsi bility for the audi t.
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on Eight
6:C
"he ormat o the un@ual i i e d audi t re1ort
=ere is the illustr ati"e unqualified report from I!# K44
Audi t orA s #e1ort
A#228+28I#T- #//8-!!--B
We ha"e audit ed the accompanyi ng bal ance sheet of the #)1 1ompany
as of /ecember *(, $4x(, and the relat ed st at e me nt s of income, and
cash flows for the year then ended. These financi al st at e me nt s are the
responsi bilit y of the 1ompany?s manage me nt . +ur responsi bility is to
expr ess an opinion on thes e financi al st at e me nt s based on our audi t.
We conduct ed our audi t in accordance with Int ernat i onal !t andar ds on
#uditing Aor refer to rele"ant national st andar ds or practi cesB. Those
st andar ds requir e that we plan and perfor m the audi t to obt ai n
reasonabl e assur ance about whet her the financi al st at e me nt s are free of
mat eri al misst at e me nt . #n audit includes exami ni ng, on a test basi s,
e"idence suppor ti ng the amount s and disclosur es in the financi al
st at e me nt s . #n audit also includes asses si ng the account principl es used
in significant esti mat es made by the manage me nt , as well as e"al uat i ng
the o"er all financi al st at e me nt present at i on. We belie"e that our audit
pro"ides a reasonabl e basi s for our opinion.
In our opinion, the financi al st at e me nt s gi"e a true and "iew of Aor
Vpresent fairly, in all mat eri al respect s, ?B the financi al position of the
1ompany as of /ecember *(, $4x( and of resul t s of its oper at i ons and its
cash flows for the year then ended in accor dance with Y Aand compl y
with Y.B
#</IT+8
/at e
#ddress?
7oot not es:
(. 8efer ence may be by page number s
$. Indicat e I#!s or rele"ant national st andar ds
*. 8efer to rele"ant st at ues or law
D/ 6C !odii es #e1ort s
There are four situat i ons in which the audit or will depar t from the form of
report gi"en abo"e.
,att er s that do not affect the audit or?s opinion
AaB -mphasi s of a mat t er
A&*I"IN-
6:D Ext ernal Audi t ors
,att er s that do affect the audit or?s opinion
AaB 3ualified opinion
AbB /isclai mer of opinion
AcB #d"erse opinion
(a) Em1hasi s o !att er
#n emphasi s of mat t er is an extr a paragr aph insert ed in the report to
draw at t ent i on to a significant mat t er affecti ng the financi al st at e me nt s
which is expl ai ned mor e fully in a not e to the financi al st at e me nt s .
#n emphasi s of the mat t er par agr aph shoul d follow the opinion
par agr aph and will nor mall y refer to the fact that the audit or?s opinion is
not qualified.
(,) -oing Concern
The audit or shoul d modify the audi t or?s report by addi ng a paragr aph to
highlight a mat t er regar di ng a going concer n probl em.
(c) Si gni i cant &ncert ai nt y
The audi t or shoul d consi der modifying the audi t or?s report by addi ng a
par agr aph if ther e is a significant uncer t ai nt y Aother than a going concer n
probl emB , the resol ution of which is dependent upon futur e e"ent s and
which may affect the finical st at e me nt s . #n uncert ai nt y is a mat t er
whose out come depends on future actions or e"ent s not under the direct
cont rol of the entit y but that may affect the financi al st at e me nt s .
Illustrat i on
#n emphasi s of mat t er par agr aph relati ng to a pendi ng lawsui t mi ght
take the following form:
VWithout qualifying our opinion we draw at t ent i on to ot e ; to the
financi al st at e me nt s . The company is the defendant in a law suit
alleging infringeme nt of cert ai n pat ent right s and clai mi ng royalti es and
puniti"e damage s . The company has field a count er action, and
preli mi nar y heari ngs and disco"er y proceedi ngs on bot h actions are in
progr ess. The ulti mat e outcome to the mat t er cannot present l y be
det er mi ned and no pro"ision for any liability that may resul t has been
made in the financi al st at e me nt s .
It is import ant to reali:e that an emphasi s of mat t er does not affect the
audi t opinion@ it mer el y draws at t ent i on to nay significant mat t er s so that
the reader is abl e to obt ai n a full under st andi ng of the finical st at e me nt s .
D/ 6D "he @uali i ed o1i ni on? discl ai mer or o1i ni on and ad0ers e
o1i ni on
These three modifications to the audit or?s report are used when ther e is
eit her:
AaB a limit ati on on the scope of the audi t or?s work or@
AbB disagr ee me nt with manage me nt regar di ng the accept abilit y of the
account i ng policies sel ect ed, the met hod of their applicati on or the
adequacy of financi al st at e me nt disclosur es.
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on Eight
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The effect of thes e circumst a nc es can be mat eri al or fundame nt al . The
qualified report is used for mat eri al probl ems.
If a limit ati on on scope or a disagr ee me nt is so mat eri al and per"asi "e
tat a si mpl e qualificati on is not sufficient , one of the two stronger forms
are used.
AaB # @ual i i ed o1i ni on shoul d be expr es s ed when the audi t or
concludes that an unqualified opinion cannot be expr es s ed but that the
effect of any disagr ee me nt with manage me nt , or limit ati on on scope is
not so mat eri al and per"asi "e as to require an ad"er s e opinion or a
discl ai mer of opinion. # qualified opinion shoul d be expr es s ed to being
Vexcept for? the effect s of the mat t er to which the qualification relat es.
AbB # di scl ai mer o o1i ni on shoul d be expr ess ed when the possi bl e
effect of a limit ati on on scope is so mat eri al and per"asi "e that the
audi t or has not been abl e to obt ai n sufficient appropri at e audit e"idence
and accor di ngl y is unabl e to expr ess an opinion on the financi al
st at e me nt s .
AcB #n ad0er s e o1i ni on shoul d be expr es s ed whet the effect of a
disagr ee me nt is so mat eri al and per"asi "e to the financi al st at e me nt s
that the audi t or concl udes that a qualification of the report is not
adequat e to disclose the misl eadi ng or incompl et e nat ur e of the financi al
st at e me nt s .
Whene"er the audi t or expr es s es an opinion that is other than
unqualified, a clear descri pti on of all the subst ant i "e reasons shoul d be
included in the report and unl ess impr act i cabl e, a quantificati on of the
possi bl e effect AsB on the financi al st at e me nt s . +rdinarily, this
infor mat i on would be set out in a separ at e par agr aph precedi ng the
opinion or disclai mer or opinion and may include a refer ence to a mor e
ext ensi "e discussi on, if any, in a not e to the financi al st at e me nt s .
Exam1l e s o modi i ed re1ort s
(a) 2imitati on on sco1e
(i) 2imi t at i on on sco1e Q @ual i i ed 1ers on
VWe ha"e audit ed YAremai ni ng words are the same as illustr at ed in the
introduct or y paragr aph of the unqualified abo"eB.
-xcept as discuss ed in the following paragr aph, we conduct ed our audit
in accordance with Y.Aremai ni ng words are the same as illustr at ed in the
scope par agr aph of the unqualified report abo"eB.
We did not obser"e the counti ng of the physical in"ent ori es as of
/ecember *(, $4x(, since that dat e was prior to the time we were
initially engaged as audi t or s fir the company. +wing to the nat ur e of the
company?s records, we were unabl e to sati sfy oursel "es as to in"ent or y
quant i ti es by other audit procedur es.
A&*I"IN-
6C5 Ext ernal Audi t ors
In our opinion, except for the effect s of such adDust me nt s , if any, as
might ha"e been det er mi ned to be neces s ar y had we been abl e to sati sfy
oursel "es as to physical in"ent or y quanti ti es, the financi al st at e me nt s
gi"e a true and Aremai ni ng words are the same as illustr at ed in the
opinion par agr aph of the unqualified report abo"eB. ?
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on Eight
6C.
AiiB 0imit ation on scope P discl ai mer of opinion
VWe are engaged to audi t the accompa nyi ng bal ance sheet of the #)1
1ompany as of /ecember *( $4x( and the relat ed st at e me nt s of income,
and cash flows for the year then ended. These financi al st at e me nt s are
the responsi bilit y of the 1ompany?s manage me nt . A+mit the sent ence
st ati ng the responsi bility of the audit orB.
AThe par agr aph discussi ng the scope of the audit would either be omit t ed
or amended accordi ng to the circums t anc es . B
A#dd a paragr aph discussi ng the scope limit ati ons as follows:B
We were not abl e to obser"e all physi cal in"ent ori es and confirm
account s recei "abl e due to limit ati ons placed on the scope of our work by
the company.
)ecaus e of the significance of the mat t er s discuss ed in the precedi ng
paragr aph we do not expr es s an opinion on the financi al st at e me nt s .
(,) *isagre e me nt
AiB /isagr ee me nt on #ccounti ng 2olicies- Inappr opri at e #ccounti ng
met hod P 3ualified +pinion
VWe ha"e audit ed Y.Aremai ni ng words are the same as illustr at ed in the
introduct or y paragr aph of the unqualified report abo"e. B
We conduct ed our audi t in accordance with Y Aremai ni ng words are the
same as illustrat ed in the scope paragr aph of the unqualified report
abo"eB.
#s discuss ed in ot e ; to the financi al st at e me nt s , no depr eci ati on has
been pro"ided in the financi al st at e me nt s which practice, in our opinion,
isn?t in accor dance with Int ernat i onal #ccounti ng !tandar ds. The
pro"ision for the year ended /ecember *(, $4x( shoul d be based on the
strai ght line met hod of depr eci ati on using annual rat es of 5T for the
building and $4T for the equi pme nt . #ccordingl y the non current asset s
shoul d be reduced by the accumul at ed depr eci at i on of xxx and the loss
for the year and accumul at ed deficit shoul d be increas ed by xxx and xxx
respect i "el y.
In our opinion, except for the effect on the financi al st at e me nt s of the
mat t er referr ed to in the precedi ng par agr aph, the financi al st at e me nt s
gi"e a true and Y. Aremai ni ng words are the same as illustrat ed in the
opinion par agr aph of the unqualified report abo"eB.
AiiB /isagr ee me nt on #ccounti ng 2olicies P inadequat e disclosur e P
qualified opinion
A&*I"IN-
6C6 Ext ernal Audi t ors
VWe ha"e audit ed Y Aremai ni ng words are the same as illustr at ed in the
introduct or y paragr aph of the unqualified report abo"eB.
We conduct ed our audi t in accordance with. . Aremai ni ng words are the
abo"e.
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
2es s on Eight
6C4
+n Ganuar y (5, $4x$, the company issued debent ur es in the amount of
xx for the purpos e of financi ng plant expansi on. The debent ur e
agree me nt rest rict s the payme nt of futur e cash di"idends to earni ngs
aft er /ecember *(, $4x(. In our opinion, disclosur e of this infor mat i on is
requir ed by Y. Ainsert refer ence to st at ut or y or regul at or y requir eme nt B .
In our opinion, except for the omi ssi on of the infor mat i on included in the
precedi ng par agr aph, the financi al st at e me nt s gi"e a true and Y
Aremai ni ng words are the same as illustr at ed in the opinion par agr aph of
the unqualified report abo"eB.
AiiiB /isagr ee me nt on #ccounti ng 2olicies P inadequat e disclosur e P
ad"er s e opinion
We ha"e audit ed Y Aremai ni ng words are the same as illustr at ed in the
introduct or y paragr aph of the unqualified report abo"eB.
We conduct ed our audi t in accordance with. . Aremai ni ng words are the
abo"e.
In our opinion, becaus e of the effect s of the mat t er s discuss ed in the
precedi ng par agr aphA sB, the financi al st at e me nt s do not gi"e a true and
fair of A or do not Vpresent fairly?B the financi al position of the company as
at /ecember *(, $4x(, and of resul t of its oper at i ons and its cash flows
for the year then ended in accor dance with Ainsert rele"ant I#!s or
national st andar dsB .. and do not compl y with YY Ainser t rele"ant
st at ut es or lawB.
"he ext e nt to whi ch users unders t and the audi t re1ort
<sers of account s ha"e infor mat i on needs, and the audit or?s report as an
independe nt att est at i on lends credi bility to the account i ng infor mat i on.
=owe"er ther e has been the tendency for user s to place far mor e
reliance on the audi t report than its act ual function meri t s.
Typical, and erroneous, beliefs of user s, ha"e included the following:
AaB #uditors are the persons responsi bl e for ensuri ng the
account s show a true and fair "iew
AbB #uditors are responsi bl e for pre"ent i ng andC or det ecti ng
fraud.
AcB #uditors guar ant e e that the company is going concer n.
$ow @uali i cat i on may ,e a0oi de d ,y negot i at i on with
manag e me nt
)efore deci di ng on the nat ur e of the audit opinion, the audit or shoul d
re"iew the impact of the !ummar y of #udit /ifferences. # meet i ng
bet ween the audi t or and the direct or s shoul d be held to discuss the
issues which may affect the opinion and re"i ew the audit differences. In
A&*I"IN-
6C; Ext ernal Audi t ors
practice, aft er negoti at i on, it is often the case that a compr omi s e will be
reached with the client such that some audit differences are adDust ed
whilst those that do not mat eri ally affect the "iew gi"en by the financi al
st at e me nt s are left as they are.
,anage me nt are gener all y keen to a"oid qualificati ons in the audi t
report becaus e:
AaB #d"erse publicit y may arise from the medi a
AbB If the qualification concer ns a mat t er of st at ut or y account i ng
policy, the power s of the court s may resul t in the prepar at i on of
re"ised account s.
AcB 0oanC debent ur e deed may refer to an audit qualificati on as gi"ing
rise to a breach of a co"enant , thus gi"ing loan not e holder s an
immedi at e right to repayme nt or the right to appoi nt a recei "er.
Therefor e if the audit ors ha"e a cont ent i ous issue, the direct or s will oft en
reconsi der their deci sion on a particul ar policy pro"ided that the audit ors
present the mat t er in an effecti"e way with manage me nt . Thus can
somet i mes be a difficult and sensi ti"e area becaus e the audit or woul d
nor mall y want to a"oi d ant agoni :i ng or losing the client , although of
court s, the need for Vtrut h and fairness? must pre"ail.
D/ 4 Audi t re1orti ng im1li cat i ons o o1eni ng ,al anc e s and
com1arat i 0e s
D/ 4. %1eni ng ,al anc e s
I!# 5(4 Initial $ngage me nt s 6 Openi ng 7alances requir es that when
audi t or s take on a new client , they must ensur e that :
AaB Openi ng balances do not cont ai n misst at e me nt s that mat eri ally
affect the current period financi al st at e me nt s .
AbB 2rior period closing bal ances ha"e been correctl y brought forwar d
or rest at ed
AcB #ppropri at e account i ng policies ha"e been consi st ent l y applied, or
changes adequat el y disclosed.
Wher e the prior period was audi t ed by anot her audi t or the current
audi t or may be abl e to gain sufficient appropri at e e"idence from a
re"iew of his working paper s.
=e shoul d ob"iousl y consi der the professi onal compet ence and
independe nc e of the predeces s or audit or. The predeces s or may or may
not be willing to cooper at e in practi ce and is under no et hical obligati on
to open his file to anot her audit or. If the prior period audit report was
modified with an emphasi s of mat t er or a qualificati on, particul ar
att ent i on shoul d be pai d to the modificati on.
Wher e the prior period was not audi t ed or was not adequat el y audit ed,
some e"idence can be obt ai ned from current audi t procedur es such as
the checki ng of recei pt s and payme nt s of cash to subst ant i at e
recei "abl es and payabl e figures. In"ent ori es are mor e difficult,
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addi tional procedur es maybe neces s ar y. These may include the
obser"at i on of current physical in"ent or y taking and reconciliation back
to openi ng quant i ti es testi ng of openi ng figures and the re"iew of gross
mar gi ns. 7or non current asset s and liabilities, underl yi ng
document a t i on can be checked.
Wher e ther e is insufficient e"idence, the audi t or issues an Vexcept for? or
discl ai mer of opinion si mil ar to the following:
VWe did not obser"e the counti ng of the physical in"ent or y st at ed at ;;;
as at /ecember *(, $4x( since that dat e was prior to our appoi nt me nt s
as audit ors. We were unabl e to sati sfy oursel "es as to the in"ent or y
quant i ti es at that dat e by other audi t procedur es.
In our opinion, except for the effect s of such adDust me nt s , if any, as
might ha"e been det er mi ned to be neces s ar y has we been abl e to
obser"e the conti nui ng of physi cal in"ent or y and sati sfy oursel "es as to
the openi ng bal ance of in"ent or y, the financi al st at e me nt s gi"e a true
and fair "iew of Aor Vpresent fairly, in all mat eri al respect s. ?B the financi al
position of Y. #s at /ecember *(, $4x$ and the resul t s of its oper at i ons
and its cash flows for the year then ended in accordance with Y?.
Wher e misst at e me nt s on openi ng bal ances are not properl y account ed
for or adequat el y disclosed, and wher e account i ng polices ha"e not been
consi st ent l y appli ed or rest at ed an Vexcept for? or ad"er s e opinion is
issued.
D/ 46 Com1arat i 0e s
I!# K(4 !omparati ves requir es that compar at i "es compl y in all mat eri al
respect s with the identified financi al reporti ng framewor k. The I#!)?s
Frame:or for t&e Preparation and Present at i on of Financial Stat e me nt s
and IAS / Present at i on of Financial Stat e me nt s bot h require that financi al
st at e me nt s show compar at i "es.
Two cat egori es of compar at i "es exist :
AaB Corres 1o ndi ng i gure s P which are an int egr al part of the
current period?s financi al st at e me nt s and are not int ended to
st and alone. The audi t report in this case only refers to the
financi al st at e me nt s of the current period which encompa s s e s the
prior period figure, and does not refer specifically to correspondi ng
figures.
#udit work in respect of correspondi ng figures is significantl y less than
that requir ed for the current period. It is limit ed to ensuri ng that
correspondi ng figures ha"e been correctl y report ed or rest at ed and
appropri at el y classified.
If a mat t er in respect of which the prior period audit report was qualified
is unresol "ed, the current report shoul d also be qualified in respect of
correspondi ng figures. Wher e the mat t er is resol"ed, an emphasi s of
mat t er paragr aph may still be appropri at e.
If prior period financi al st at e me nt s turn out to be mat eri ally mi sst at ed,
and the correspondi ng figures are proper t y rest at ed in the current
period, an Vemphasi s mat t er? paragr aph may also be appropri at e.
A&*I"IN-
6C: Ext ernal Audi t ors
0ocal regul ati ons somet i me s per mi t a refer ence to the fact that the prior
period was audit ed by anot her audi t or. If prior period financi al
st at e me nt s wer e not audi t ed at all, the audi t report shoul d st at e that
fact.
If the correspondi ng figures are mat eri ally misst at ed, a qualified audit
report shoul d be gi"en.
AbB Com1arat i 0e inanci al st at e me nt s P which are included for
compari son with the current period but do not form part of the
current period?s financi al st at e me nt s . The audi t report her e refers
specifically to each period present ed Aas is in the <!, three year s
for the income st at e me nt and two year s for the bal ance sheet . B
The audi t or s asses s whet her the account i ng polices are consi st ent with
the prior period or ha"e been properl y adDust ed and disclosed. They also
ensur e that prior period figures agree with prior period financi al
st at e me nt s or ha"e been properl y adDust ed.
It is perfectl y possi bl e for the opinion on one set of financi al st at e me nt s
to be different from that on the other s. If an opinion different to one
pre"iousl y issued is gi"en in any year, an Vemphasi s of mat t er? paragr aph
shoul d be gi"en.
When prior periods were audi t ed by anot her audit or, the predeces s or
audi t or may reissue the audit report on the prior year in the current year,
or the incomi ng audit or shoul d indicat e that the prior period was audi t ed
by anot her audi t or and gi"e det ails of the report issued.
Wher e prior period financi al st at e me nt s audi t ed by anot her audit or
require rest at e me nt , eit her the predeces s or audit or issues a report on
the re"ised financi al st at e me nt s , or, the incomi ng audi t or st at e in his
report that adDust me nt s to the prior period financi al st at e me nt s ha"e
been made and that they ha"e been audit ed.
Wher e prior financi al st at e me nt s ha"e not been audit ed the audi t repot
shoul d st at e that fact.
D/ ; Communi cat i ons on int ernal control
Introduct i on
It shoul d be nor mal practice at the end of an audit to send a lett er to the
client set ti ng out weaknes s e s in the syst e m of int ernal cont rol. 1ert ai n
rules shoul d be obser"ed when prepari ng such a lett er Aknown as the
manage me nt lett er, the lett er of weaknes s , the int ernal cont rol
memor andu m, the lett er of recomme nd a t i ons or the const r ucti "e ser"ice
lett erB.
Hener al point s of good practice are as follows:
AaB it shoul d make clear that the obDect of the audit is not to disco"er
fraud, but to report on the financi al st at e me nt s . The mat t er s
referr ed to ha"e been disco"er ed incident all y to the mai n
obDecti"e.
AbB The point s shoul d be list ed logically.
AcB There is no point in drawi ng att ent i on to a weaknes s which is
inher ent in the nat ur e or si:e of the busines s, or its tot ally tri"ial.
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AdB +nly the weaknes s shoul d be not ed. It shoul d not be implied that
no fraud is taking place alt hough the possi bl e consequence s of the
weaknes s es can be expanded upon.
AeB 8ecomme nda t i ons for impro"e me nt s shoul d be made in respect of
each weaknes s es .
AfB 1ommuni cat i ons in respect of recomme nd a t i ons shoul d be made
on a ti mel y basi s.
The manage me nt lett er will nor mall y be a nat ur al by- product of the
audi t, and the audi t or shoul d incorpor at e the need to issue the lett er in
the planni ng of the audi t. The lett er shoul d be sent as soon as possi bl e
aft er compl et i on of the audit procedur es gi"ing rise to the need to
comme nt . Wher e audi t work is carri ed out in mor e than one st age it may
be appropri at e to issue a lett er at the int eri m audit st age as well as the
final audit st age.
It is import ant that the manage me nt lett er is sent and responded to on a
ti mel y basi s Aat the audit compl eti on st ageB in order to ha"e impact , be
effecti"e and act ed upon by the client . It is import ant to discuss all the
point s in the lett er with manage me nt befor e the lett er is issued. #ny
significant mat t er s shoul d be brought to manage me nt ? s at t ent i on
immedi at el y first "erbally followed up in writing. It is essent i al that the
cont ent s of the lett er are consi der ed by the manage me nt . # copy of the
lett er with replies shoul d be kept on the file. !ignificant mat t er s shoul d
be followed up aft er the client?s respons e by way of discussi on or the
perfor manc e of syst e m test s. ormally, it is usual for the audi t or to
re"iew point s made in pre"ious year s at the first subseque nt audi t "isit.
When a group of compani es is in"ol"ed, the manage me nt of the holding
company may want to be infor med of significant point s arising in the
report s o the manage me nt f the subsi di ari es. The audit or must obt ai n
per mi ssi on from the manage me nt of the subsi di ar y before rel easi ng such
infor mat i on.
#ny report made to manage me nt shoul d be regar ded as confident i al
communi cat i on. The audit or shoul d ther efor e not nor mall y re"eal the
cont ent s of the report to any third part y without the prior writt en consent
of the manage me nt of the company.
In practi ce, the audit or has little cont rol o"er what happens to the report
once it has been dispat ched. +ccasi onally, manage me nt may pro"ide
third parti es e. g. their banker s, with copi es of the report .
The audit or can use a discl ai mer of liability agai nst foreseen liability to
third parti es but this may not gi"e full prot ecti on from liability wher e the
audi t or knows or ought to know that a report to manage me nt may be
passed to a third part y who woul d rely on it.
Exam1l e o a manag e me nt lett er
There are other accept abl e layout s which you may ha"e seen in practice@
columnar format s with the headi ngs Vweaknes s?, Vimplicati on? and
Vrecomme nda t i on? are common. #gain it is not neces s ar y to learn this
exampl e, as the point s would not be appropri at e for all ent er pri ses. ot e
howe"er the type pf point s made.
A&*I"IN-
6CD Ext ernal Audi t ors
+#I'A"E AN* C%N7I*EN"IA2
The /irect ors
Garibu 0td.
airobi
,oro"i a
(5
th
,ay $4x9
/ear !irs
=ari,u 2td/
Audi t or the year ende d 4. *ece m, e r 65xC
In accordance with our nor mal practi ce, we are writing toe you with
regar d to mat t er s arising out of our audit for the year ended *(
/ecember $4xK which we consi der shoul d be brought to your at t ent i on.
+ur responsi bilities as audi t or s are go"er ned by the AI#!sC national lawsB
and principally require us to report on the account s laid befor e the
company in gener al meet i ng.
This report has been prepar ed for the sole use of the direct or s of <pper
plc. one of its cont ent s may be disclosed to third parti es without our
writt en consent . !wift and 1o assume s no liability to nay other persons.
The mat t er s det ail ed in this report reflect mat t er s coning to our at t ent i on
during the course of our audi t. They are not int ended to be a
compr ehe nsi "e st at e me nt of all weaknes s es that may exist or of all
impro"e me nt s that could be made. We set out below those mat t er s
which we consi der to be of fundame nt al import ance. +ther mat t er s of
lesser significance, but which ne"er t hel es s requir e your att ent i on, are
deal t with in not e form in the att ached appendi x.
(a) !anag e me n t re1ort i ng
# funda me nt al requir eme nt to allow proper cont rol o"er your busi ness
is the regul ar and timel y prepar at i on of accur at e manage me nt
account s. 2refer abl y those shoul d be prepar ed mont hl y, compar ed
with budget s and submi t t ed for formal consi der at i on and adopti on by
the full boar d of direct or s. #t the mome nt no such syst e m exist s.
(,) Int ernal cont rol Q account i ng sys t e m
AiB The company exerci ses no cont rol o"er the input , processi ng or
out put of infor mat i on proces s ed by the comput er bureau.
8eliance is placed on the comput er bureau to ensur e compl et e
processi ng of account i ng infor mat i on. In our opinion the
direct or s shoul d ensur e that the company effect s proper cont rol
o"er the compl et ene s s and accur acy of infor mat i on proces s ed.
AiiB There are other areas co"eri ng aspect s of in"ent or y, non- curent
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
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asset s and recei"abl es wher e cont rol is lacking or inadequat e
which are deal t with in the appendi x at t ached.
AiiiB +ur audi t work was made consi der abl y mor e difficult by the
absence of care in filing suppor ti ng document a t i on which was
ther efor e difficult to trace. The proper mai nt enance of records
is not only a requir eme nt of the Anational lawsCI#!s but is also
necess ar y for the efficient runni ng of your busines s.
(c) +re1arat i on o account s
The qualit y of the draft financi al st at e me nt s submi t t ed to us for audit
was poor.
AiB The financi al st at e me nt s wer e produced lat e without proper
suppor t . When suppor t was pro"ided in some cases it failed to
agree with the amount s st at ed in the draft financi al
st at e me nt s .
AiiB # number of items requir ed to be disclosed under the
AI#!Cnati onal lawsB was omit t ed. -xt ensi "e discussi ons wer e
necess ar y with you to ascer t ai n the infor mat i on to be disclosed
in respect of direct or?s int er est s and capit al expendi t ur e.
To reduce the ti me spent on the audit , and this the cost to you, all
suppor ti ng document a t i on shoul d agr ee with the financi al st at e me nt s
and st at ut or y disclosur e infor mat i on would be asse mbl ed prior to our
exami nat i on.
We would be pleas ed to discuss thes e point s with you at your
con"eni ence.
Qours faithfully
!wift M 1o
A11e ndi x
=ari,u 2td/ Q year ende d 4. *ec e m, e r 65xC
(a) com1ut e r 1roc e s s i ng
3eakne s s e s B
0ack of cont rol exerci sed o"er comput er processi ng.
Im1li cat i ons
The compl et ene s s , accur acy and "alidity of the account i ng records
may be under mi ned.
#ecomme n d a t i o n s B
AiB #uthori:ati on of input especi ally Dournal s not arising from books
of pri me ent ry.
AiiB )atch cont rol s using regi st er s o"er all input in ter ms of "alue
and number of document s C t r ans act i ons proces s ed.
AiiiB <se of hash tot al s
A&*I"IN-
6D5 Ext ernal Audi t ors
Ai"B ,anage me nt cont rol o"er mast er file amendme nt s
A"B 8econciliation to cont rol account s
A"iB 1lear audit trial for the correcti on and resubmi ssi on of nay
reDect ed
A"iiB #ll financi al infor mat i on process ed at one location
A"iiiB # back up syst e m shoul d be a"ail abl e if the bureau is unabl e to
process the input .
(,) +ayrol l
3eakne s s e s
o e"idence of appro"al
Im1li cat i ons
<naut hori :ed changes may occur
#ecomme n d a t i o n s
,anage me nt shoul d e"idence their appro"al of the payroll, changes in
rat es of pay and the empl oyme nt of new st aff.
(c) In0ent ory
3eakne s s e s
0ack of physical and financi al cont rol o"er times of in"ent or y
1ut off errors wer e disco"er ed for widget s dispat ched prior
to the year end but un in"oiced
+"erhead allocati on in "aluati on of widget s lacked suppor t
Im1li cat i ons
In"ent or y could be misappr opri at ed
The year end in"ent or y figure could be misst at ed
AiiB # si mpl e syst e m of perpet ual in"ent or y shoul d be impl eme nt e d
at each locati on. This shoul d be used to check for the dispat ch
and recei pt of in"ent or y and woul d pro"ide good o"er all cont rol
to enabl e a compari son of:
-xpect ed use to act ual by compari son with order s, and
)ook in"ent or y to act ual aft er regul ar in"ent or y checks
AiiiB Impro"e me nt s shoul d be made to the syst e m of cont rol to
facilitat e a re"i ew of the dispat ches at the year end to ensur e
that a proper cut off is achi e"ed.
Ai"B The "aluati on of widget s depends on the esti mat ed throughout
during the year. It is import ant that the number of widget s
produced is properl y recorded and that consi der at i on is gi"en
to nor mal producti on le"el s to allow compli ance with
account i ng st andar ds.
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(d) Non> current as s e t s
3eakne s s e s
0ack of physical cont rol
0ack of clear capit ali:ati on policy
#sset s will nil net book "ale subD ect to depr eci at i on char ge.
Im1li cat i ons
2ort abl e asset s could be misappr opri at ed.
Items could be incorrectl y capit ali:ed
The depr eci ati on figures in the account s could be o"erst at ed.
AiB # regist er shoul d be introduced to record all asset s at cost
toget her with associ at ed depr eci ati on
AiiB In pre"ious year s capit al additions, not abl y the impro"e me nt s
to the leasehol d premi s es, ha"e been writt en off. #lso, asset s
scrapped ha"e not been writt en off. The effect of thes e cancel
out and ther efor e we ha"e not propos ed an adDust me nt to
openi ng figures. # capit ali:ati on shoul d be laid down and
adher ed to.
AiiiB # regist er woul d enabl e the identificati on of fully depr eci at ed
asset s and allow them to be excluded from the depr ecat i on
calcul ati ons.
(e) +urchas e s o 1ayme nt s
3eakne s s e s
0ack of proper allocati on of cost s
0ack of suppor ti ng document s
0ack of cont rol o"er cheque books
<naut hori :ed char ges
2oor cont rol o"er unrecor ded liabilities
Im1li cat i ons
2urchas es in the account s may be mi sst at ed
2ayabl es may be under st at ed if unrecor ded liabilities are not
cont rolled
AiB #ll charges incurred shoul d be allocat ed to the rele"ant cost
cent r e to promot e account abilit y of thes e cent er s.
AiiB 2roper suppor ti ng docume nt s for all payme nt s must be
ret ai ned and proper t y filed for easy retri e"al.
AiiiB 1ontrol o"er payment s would be impro"ed if only one cheque
book was in sue at any one time.
Ai"B /ocument s suppor ti ng char ges shoul d be aut hori:ed by an
appropri at e le"el of manage me nt
A"B # purchas es Dournal shoul d be introduced. 2ayment s shoul d be
marked off. This would pro"ide cont rol o"er unpai d in"oices
and a means for regul ar cont rol account reconciliation.
A&*I"IN-
6D6 Ext ernal Audi t ors
D/ 8 Communi cat i ons o Audi t !att ers with thos e Charge d with
-o0ernanc e
ISA )00 !ommuni cat i ons of Audit 9att ers :it& -&ose !&arged :it &
Governance . The st andar d requir es audi t ors to communi cat e, on a
ti mel y basi s, mat t er s of go"er nance int er est to those with the
go"er nance of an entit y.
This rat her obscur e form of words means that audit ors shoul d
communi cat e to manage me nt mat t er s such as the following:
AaB The gener al approach and o"er all scope of audi t, includi ng any
expect ed limit ati ons ther eon, or any additional requireme nt s .
AbB The sel ecti on of, or changes in, significant account i ng polices and
practices that ha"e, or could ha"e, a mat eri al effect on the entit y?s
AcB The pot ent i al effect on the financi al st at e me nt s of any significant
risks and exposur es, such as pendi ng litigation, that are required
to be disclosed in the financi al st at e me nt s .
AdB #udit adDust me nt s , whet her or not recorded by the entit y, that
ha"e or could ha"e significant effect on the entit y?s ability to
conti nue as a going concer n.
AeB ,at eri al uncert ai nt i es relat ed to e"ent s and condi tions that may
cast sufficient doubt on the entit y?s ability to a continue as a going
concer n.
AfB /isagr ee me nt with manage me nt about mat t er s that , indi"iduall y
or in aggr egat e, could be significant to the entit y?s financi al
st at e me nt s or the audi t or?s report . This communi cat i on includes
consi der at i on of whet her the mat t er has, or has not, been
resol"ed, and the significance of the mat t er .
AgB -xpect ed modificati ons to the audi t or?s report .
AhB +ther mat t er s, such as mat eri al weaknes s in int ernal cont rol,
questi ons regar di ng manage me nt int egri t y and fraud in"ol"ing
manage me nt .
AiB #ny other mat t er s agreed upon in the ter ms of the engage me nt .
D/ : #ecent *e0el o1me nt s
D/ :. Electroni c Communi cat i ons
#n increasi ng number of compani es are posti ng financi al st at e me nt s ,
including the audit or?s report ont o their websi t es or allowing
shar ehol der s to recei"e the annual report in elect roni c from in place of a
hard copy "ersion. In these circumst a nc es audit ors check that the
elect roni c "ersion of the financi al st at e me nt s is identical in cont ent to the
manuall y signed account s. AIn the <. guidance for audi t ors to perfor m
procedur es as sugges t ed abo"e has been issued in this mat t er . B
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
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D/ :6 *iscl ai mer
!ome of the maD or firms are now including a disclai mer par agr aph in an
att e mpt to rest rict liability to third parti es. #n exampl e of such
par agr aph Ashown aft er the opinion par agr aphB based on
2ricewat er hous e1ooper s audi t report is as follows:
VWe do not, in gi"ing this opinion, accept or assume responsi bility for any
other purpos e or to any other person to whom this report is shown or in
whose hands it may come, sa"e wher e expr es sl y agreed by our prior
consent in writing.?
IA+S .5.; #e1orti ng on Com1l i anc e with Internat i onal 7inanci al
#e1orti ng Standards
The purpos e of this I#2! is to clarify when financi al st at e me nt s are in full
compli ance with I#!CI78! and propos es additional guidance when the
audi t or expr es s es an opinion on financi al st at e me nt prepar ed in
accor dance with:
I#!CI78!
)oth I#!CI78! and national st andar ds
8ele"ant national st andar ds but disclosur e not es in the financi al
st at e me nt s which expl ai n the ext ent of compli ance with I#!CI78!.
The issue is of increasi ng rele"ance as mor e count ri es become requir ed
to compl y with I#!CI78! and clai m compli ance. A-.g. #ustrali a and the -<
as from Ganuar y $445B.
NB IAS C55 and IAS :.5 are current l y ,ei ng re0i s e d
D/ C S1eci al +ur1os e Audi t #e1ort s
D/ C. #e1ort s on Summari Ge d 7inanci al Stat e me nt s
#n entit y may prepar e financi al st at e me nt s summar i :i ng its annual
audi t ed financi al st at e me nt s for the purpos e of infor mi ng user group
int er est ed in the highlight s only of the entit y?s financi al position and the
resul t of its oper at i ons. <nless the audi t or has expr es s ed an audi t
opinion on the financi al st at e me nt s from which the summar i :ed financi al
st at e me nt s were deri"ed, the audit or shoul d not report on summar i :ed
!ummari :ed financi al st at e me nt s are present ed in consi der abl y less
det ail than annual audi t ed financi al st at e me nt s . Therefor e, such
financi al st at e me nt s need to clearly indicat e the summari :ed nat ur e of
the infor mat i on and caution the reader that for a bet t er under st andi ng of
an entit y?s financi al position and the resul t s of its oper at i ons,
summari :ed financi al st at e me nt s are to be read in conDuncti on with the
entit y?s mist recent audi t ed financi al st at e me nt s which include all
disclosur es requir ed by the rele"ant financi al reporti ng framewor k.
!ummari :ed financi al st at e me nt s need to be appropri at e titled to identify
the audi t ed financi al st at e me nt s from which they ha"e been deri"ed, for
A&*I"IN-
6D; Ext ernal Audi t ors
exampl e, V!ummari s ed 7inanci al Infor mat i on prepar ed from the #udit ed
7inanci al !tat e me nt s for the Qear -nded /ecember *(, $4x(
!ummari s ed financi al st at e me nt s do not cont ai n all the infor mat i on
required by the financi al reporti ng framewor k used for the annual
audi t ed financi al st at e me nt s . !onse1uent l "# :ording suc& as ;true and
fair' or ;present fairl"' in all mat eri al respect s' is not used b" t&e audit or
:&en e%pres si ng an opinion on summari < ed financi al stat e me nt s ,
The audit or?s report on summar i :ed financi al st at e me nt shoul d include
the following basic element s ordinarily in the following layout :
AaB Title
AbB #ddress e e
AcB #n identification of the audi t ed financi al st at e me nt s from
which the summari :ed financi al st at e me nt s were deri"ed
AdB # refer ence to the dat e of the audit report on the
unabri dged financi al st at e me nt s and the type of opinion
gi"en in that report
AeB #n opinion as to whet her the infor mat i on in the summari :ed
financi al st at e me nt s is consi st ent with the audit ed financi al
st at e me nt s from which it was deri"ed. When the audi t or
ahs issued a modified opinion on the unabri dged financi al
st at e me nt s yet is sati sfied with the present at i on of the
summar i :ed financi al st at e me nt s , the audi t report shoul d
st at e that alt hough consi st ent with the unabri dged financi al
st at e me nt s , the summar i :ed financi al st at e me nt s wer e
deri"ed from financi al st at e me nt s on which a modified audit
report was issued.
AfB # st at e me nt , or refer ence to the not e within the
summar i :ed financi al st at e me nt s , which indicat es that for a
bet t er under st andi ng of an entit y?s financi al perfor mance
and position and of scope of the audi t perfor med, the
summar i :ed financi al st at e me nt s shoul d be read in
conDuncti on with the unabri dged financi al st at e me nt s and
the audit report ther eon.
AgB /at e of the report
AhB #uditor?s addr es s, and
AiB #uditor?s signat ur e
-xampl es of 8eport s on !ummari s ed 7inanci al !t at e me nt s
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When an <nqualified +pinion was -xpress ed on the #nnual #udit ed
#</IT+8?! 8-2+8T T+ YYYYYY
We ha"e audit ed the financi al st at e me nt s of #)1 1ompany for the year
ended /ecember *( $4x, from which the summar i :ed financi al
st at e me nt s were deri"ed, in accordance with Int ernat i onal !t andar ds on
#uditing Aor refer to rele"ant national st andar ds or practi cesB. In our
report dat ed ,arch (4 $4x( we expr ess ed an unqualified opinion on the
financi al st at e me nt s from which the summari :ed financi al st at e me nt s
were deri"ed.
In our opinion the accompa nyi ng summar i :ed financi al st at e me nt s are
consi st ent , in all mat eri al respect s, with the financi al st at e me nt s from
which they wer e deri"ed.
7or a bet t er under st andi ng of the 1ompany?s financi al position and the
resul t s of its oper at i ons for the period and of the scope of our audi t, the
summar i :ed financi al st at e me nt s shoul d be read in conDuncti on with the
financi al st at e me nt s from which the summari :ed st at e me nt s were
deri"ed and our audit report ther eon.
/at e
#</IT+8
Addre s s
When a 3ualified +pinion was -xpress ed on the #nnual #udit ed 7inanci al
!t at e me nt s
#</IT+8?! 8-2+8T T+ YYYY.
We ha"e audit ed the financi al st at e me nt s of #)1 1ompany for the year
ended /ecember *( $4x, from which the summar i :ed financi al
st at e me nt s were deri"ed, in accordance with Int ernat i onal !t andar ds on
#uditing Aor refer to rele"ant national st andar ds aor practicesB. In our
report dat ed ,arch (4 $4x( we expr ess ed an unqualified opinion on the
financi al st at e me nt s from which the summari :ed financi al st at e me nt s
were deri"ed ga"e a true and fair "iew of Aor Vpresent ed fairly, in all
mat eri al respect s?B Y except that in"ent or y had been o"erst at ed by
YY..
In our opinion the accompa nyi ng summar i :ed financi al st at e me nt s are
consi st ent , in all mat eri al respect s, with the financi al st at e me nt s from
which they wer e deri"ed and on which we expr ess e d a qualified opinion.
7or a bet t er under st andi ng of the 1ompany?s financi al position and the
resul t s of its oper at i ons for the period and of the scope of our audi t, the
summar i :ed financi al st at e me nt s shoul d be read in conDuncti on with the
financi al st at e me nt s from which the summari :ed st at e me nt s were
deri"ed and our audit report ther eon.
/at e
A&*I"IN-
6D: Ext ernal Audi t ors
#</IT+8
D/ D #e0i s ed Account s
It may be disco"er ed aft er the audi t ed financi al st at e me nt s ha"e been
present e d to member s andC or filed that they are defecti"e. This is a
relati"el y rare e"ent .
/ependi ng on the particul ar national requir eme nt s such as Vdefecti"e?
account s must be, may be or may not be, re"ised. Wher e re"ision is
required or per mi t t ed the re"isions shoul d relat e only to mat t er s arising
before the original account s were appro"ed and in respect of
funda me nt al errors of fact Aand not for changes in account i ng policiesB.
8e"ision of account s may be by way of:
8e"ision by repl ace me nt Ain which case the original "ersion is
withdr awnB or
8e"ision by suppl eme nt ar y not e.
The mai n duti es of the audi t or are to co"er the following point s:
AaB -nsur e that re"isions are properl y prepar ed in accordance with the
applicabl e reporti ng framewor k
AbB The re"ised account s show a Vtrue and fair "iew?C?ar e pres ent ed
fairly?, as seen at the dat e when the original account s wer e
appro"ed.
AcB -nsur e that the original account s failed to compl y with the local or
national requireme nt s C appli cabl e account i ng st andar ds. #
company cannot re"ise account s without good reasons.
Typical audi t procedur es shoul d include
8e"iew the original audit plan and consi der what furt her
audi t e"idence may be requir ed
8eass es s the mat t er s of Dudgment in"ol"ed
+bt ai n specific e"idence in respect of the adDust me nt s
required to the original account s
-xt end the post bal ance sheet re"iew period Afrom the dat e
on which the original account s were appro"edB
2erfor m a Vfinal re"iew? on the re"ised account s
1onsider any legal or regul at or y consequence of the
"ersion.
#n exampl e of an opinion par agr aph included in the audit or?s report
re"ised account s is as follows:
VIn our opinion, the re"ised financi al st at e me nt s gi"e a true and fair "iew
Aor Vpresent fairly, in all mat eri al respect s?B as at the dat e the original
financi al st at e me nt s wer e appro"ed, of the financi al position of the
1ompany as of /ecember *( $4x( and of the resul t s of its oper at i ons
and its cash flows for the year then ended in accordance with Anati onal
legisl ationB.
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+r
In our opinion, the original financi al st at e me nt s for the year ended
/ecember *( $4x( failed to compl y with Arele"ant national st andar ds or
legisl ationB.
D/ D. *istri ,uti ons oll owi ng an audi t @ualii cati on
# company is limit ed in the amount of di"idends it can pay to its
shar ehol der s by the tot al distribut abl e profits a"ail abl e. These can be
defined as:
#ccumul at ed reali:ed profits, so far as not pre"iousl y utili:ed by
distribut or or capit ali:ati on, less accumul at ed reali:ed losses.
In some count ri es ther e are addi tional rest rictions for public compani es.
In order to det er mi ne the amount of distribut abl e profits, refer ence is
made to the lat est audi t ed account s. If those account s ha"e been
qualified, and direct or s want to pay a di"idend, audi t or s are nor mall y
required Aunder national legisl ationB to st at e in writing whet her in their
opinion the qualificati on is mat eri al for det er mi ni ng whet her the
propos ed distributi on is legal.
D/ < IAS .; Segme nt re1orti ng
I#! (% is mandat or y for ent er pri se whose equit y or debt is publicly
quot ed or about to be publicly quot ed. I#! (% encour age other
ent er pri se to pro"ide segme nt al infor mat i on, and if they do they shoul d
compl y with the pro"isions of I#! (%.
When consolidat ed financi al st at e me nt s are present ed as well as those of
the parent , the segment al anal ysi s need only be disclosed on a group
basi s.
D/ <. *ei ni ti ons
I#! (% cont ai ns the following definitions:
(i) Busi ne s s Seg me nt
# busines s segme nt is a distingui shabl e component of an ent er pri se
that is engaged in pro"iding an indi"idual product or ser"ice or a
group of relat ed product s or ser"ices and that is subD ect to risks and
ret urns that are different from those of other busines s segme nt s .
(ii) -eogra1hi c al Seg me nt
# geogr aphi cal segme nt is a distingui shabl e component of an
ent er pri se that is engaged in pro"iding product s or ser"ices within a
particul ar economi c en"ironme nt and that is subD ect to risks and
A&*I"IN-
6DD Ext ernal Audi t ors
ret urns that are different from those of component s oper at i ng in other
economi c en"ironme nt s.
(iii) #e1ort a,l e Seg me nt
# report abl e segment is a busi ness segme nt or a geogr aphi cal
segment identified based on the foregoi ng definitions for which
segment infor mat i on is requir ed to be disclosed buy this st andar d.
(i0) Seg me nt re0e nue
!egment re"enue is re"enue report ed in the ent er pri se?s income
st at e me nt that is directl y att ri but abl e to a segme nt and the rel e"ant
portion of ent er pri se re"enue that can be allocat ed on a reasonabl e
basi s to a segment , whet her from sal es to ext er nal cust omer s or from
trans act i ons with other segme nt s of the same ent er pri se.
!egment re"enue includes a Doint "ent ur e?s shar e of the re"enue of a
Dointly cont roll ed entit y that us account ed for by proporti onat e
consolidati on in accor dance with I#! *( 7inanci al reporti ng of
Inter est s in Goint 6ent ur es.
(0) Seg me nt ex1e ns e
!egment expens e is expens e resul ting from the oper at i ng acti"iti es of
a segment that is directl y att ri but abl e to the segment and the
rele"ant portion of an expens e that can be allocat ed on a reasonabl e
basi s to the segme nt , including expens es relati ng to sal es to ext er nal
cust omer s and expens es relati ng to trans act i ons the other segme nt s
of the same ent er pri se.
!egment expens e includes a Doint "ent ur e?s shar e of the expens e of a
Dointly cont roll ed entit y that is account ed for by propor ti onat e
consolidati on in accor dance with I#! *(.
D/ <6 Ext ent o Segme nt al Anal ysi s
In "iew of thes e definitions, it may be seen that segment al anal ysi s of
the income st at e me nt is only requir ed as far as oper at i ng profit,
presuma bl y becaus e allocati ons of finance cost s woul d be likely to be
arbitrar y. -"en gener al admi ni st r at i "e cost s are excluded.
!egment al anal ysi s of asset s and liabilities must be consi st ent with
that for re"enue and expens e s.
D/ <4 #e1ort a,l e Segme nt s
In det er mi ni ng whet her a segment is a report abl e segment , a (4 per
cent rule is adopt ed. # segme nt is a report abl e segme nt if most of its
sal es are to ext er nal cust omer s and it has at least (4 per cent of:
AiB Total sal es, including sal es to other segme nt s , or
AiiB Total profit of all profit maki ng segment s, or tot al loss of all loss
maki ng segme nt s or
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AiiiB Total asset s of all segme nt s
# segme nt which is below thes e le"el s may still be desi gnat ed as a
report abl e segme nt .
# segment below the (4 per cent threshol ds and not desi gnat ed as a
report abl e segme nt may be combi ned with anot her si mil ar segment .
If this is not possi bl e, it is included as an unallocat ed reconciling item.
D/ <; Identi yi ng #e1ort a,l e Segme nt s
The mai n choice in identifying segme nt s is bet ween busines s
segment s and geogr aphi cal segme nt s . In fact, I#! (% requir e some
segment al anal ysi s for bot h of these, but the I#! (% disclosur e
requireme nt s are based on the idea of Vpri mar y? and Vsecondar y?
segment reporti ng format s. If classificati on by busines s is the
pri mar y format , a full segme nt al anal ysi s is required on this basi s,
with limit ed disclosur e in the secondar y geogr aphi cal format , and "ice
"ersa if the geogr aphi cal format is chosen as pri mar y.
,ost busines s es will probabl y choose anal ysi s by busines s as their
pri mar y format . +ne could also en"isage a singl e product ent er pri se
which produced geogr aphi cal anal ysi s only.
The geogr aphi cal anal ysi s may be done in two ways P by locati on of
asset s and by locati on of cust omer s. There are thus three possi bl e
choices for the pri mar y format :
)usiness Aanal ysi s by different product or ser"icesB
Heogr aphi cal by location of asset s
Heogr aphi cal by location of cust omer s
D/ <8 Im1li cati on o IAS .; or Audi t ors
There is significant amount of discreti on allowed to the direct or s in
appl ying I#! (%. The audit or will need to est abli sh the basi s for the
anal ysi s pro"ided by the direct or s and check whet her they ha"e followed
the guidance gi"en in I#! (% regar di ng significant segment s. The
segment s need to be consi st ent with pre"ious periods but ther e can be
"alid reasons for changes as the relati"e import ance of different sect or s
changes .
Test checks to source document a t i on will need to be made of the
anal yses suppli ed and then reconcil ed to the aggr egat e figures in the
D/ <: IAS C Cash 7low Stat e me nt s
The amount s appeari ng in the cash flow st at e me nt are deri"ed mai nl y
from the bal ance sheet and the income st at e me nt particul arl y wher e the
indirect met hod has been used and "erified accor di ngl y. Wher e the
direct met hod has been used the amount s shoul d be "erified by
refer ence to the source account i ng records Afor exampl e the cash bookB.
The audi t or shoul d also ensur e that the items ha"e been properl y
A&*I"IN-
6<5 Ext ernal Audi t ors
classified and that cash and cash equi"al ent s fall within the definition in
the st andar d. #rithmet i cal test s shoul d be perfor med on the cash flow
st at e me nt and it shoul d be re"iewed for compli ance with the disclosur e
requireme nt s of I#! K.
Thus if the audi t or has qualified becaus e of a disagr ee me nt o"er the
account i ng treat me nt , the audit or will adDust the account s for his own
preferr ed account i ng treat me nt and comput e whet her the propos ed
di"idend would be affect ed.
#n exampl e of a report Abased on <. legisl ati onB is as follows:
A&*I"%#SA S"A"E!EN" "% "$E !E!BE#S %7 9(O +2C (%# 2"*)
We ha"e audit ed the financi al st at e me nt s of ;QX plc for the year ended
*( /ecember $4. . in accordance with #uditing !tandar ds issued by the
#uditing 2ractices )oard and ha"e expr es s ed a qualified opinion ther eon
in our report dat ed Y..
Basi s o o1i ni on
We ha"e carri ed out such procedur es as we consi der ed necess ar y to
e"al uat e the effect qualified opinion has for the det er mi nat i on of profit s
a"ail abl e for distributi on.
%1i ni on
In our opinion, this qualificati on is not mat eri al for the purpos e of
det er mi ni ng whet her the distributi on of SY.. propos ed by the company is
per mi t t ed under section $&* of the 1ompani es #ct ('95.
1ertified #ccount ant s and
#ddress
8egist er ed #uditor
/at e
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E&ES"I%N %NE
(. It has been said that an audit orJ s report is the formal result of all his
effort s. This being the case it is "ery import ant that the reader well
under st ands the meani ng of the #udit 8eport, particul arly where the
auditor wishes to qualify his opinion on the financi al stat e ment s
subD ect to audit.
#e@uired
AaB -xplain how the Internati onal !tandar ds on #uditing att empt to
ensur e that the #udit 8eport is clearly under st ood.
AbB /escribe clearly the circumst ances in which an #d"erse +pinion
and a /isclai mer of +pinion would be appropri at e. AHi"e two
exampl esNone eachNt o illustrat e your answerNa full audit
opinion shoul d not be gi"enB.
AcB /o you belie"e that a disclai mer of opinion is largely "aluel essR
Hi"e reasons to support your opinion.
E&ES"I%N "3%
AaB What report s should be made to manage me nt R
AbB When should these report s be madeR
AcB What names are gi"en to these report sR
AdB 0ist the cont ent s of such report sR
E&ES"I%N "$#EE
AaB 0ist the circumst ances in which the Kth !chedul e requires
qualification in audit report s
AbB 0ist the circumst ances in which the I!# K44, OThe #uditors
8eport on 7inanci al !tat ement sO regards as in"ol"ing inher ent
uncert ai nt y
AcB What types of qualification are thereR
AdB Hi"e exampl es of limitation of scope
AeB Hi"e exampl es of disagr ee me nt
AfB /istinguish bet ween mat eri ality and fundament alit y
AgB What is emphasi s of mat t erR
E&ES"I%N 7%&#
Qou are an audit senior in a firm of account ant s which has been request ed
by one of the direct ors to carry out an exami nati on of the accounti ng
policies, calculations and procedur es adopt ed by the company in
prepari ng a profit forecast . The client requires an #ccount ant J s 8eport to
accompany the profit forecast . +ne of the part ner s has asked you to deal
with this inquiry.
(ou are re@uired
AaB To record the preli minary consider ati ons and in particul ar those
mat t er s that the firm needs to agree with the direct ors of the
client s company before accepti ng the assignment .
A& ,arksB
AbB To record the main point s which will need to be consider ed
when carrying out the assignment before prepari ng the
#ccount ant J s 8eport . A& ,arksB
A&*I"IN-
6<6 Ext ernal Audi t ors
AcB To record the point s that need to be consider ed when drafting
the #ccount ant J s 8eport .

A(4 ,arksB

("ot al B .: !arks)
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6<4
E&ES"I%N 7I'E
1omput er ,aint enance !er"ices 0td. are comput er -ngineer s with a
current annual turno"er of !h.9, 444, 444. Hener ally cust omer s are
in"oiced for maint enance work at the time that ser"ice is pro"ided
although the company offer their cust omer s a three year ser"ice contract
on payment of a non- refundabl e fixed sum at the beginni ng of the
contract .
Qou ha"e been appoint ed auditor, your predeces sor s ha"ing resigned aft er
compl eti ng the audit for the year ended *4 !ept ember ('9'. Their report
was unqualified.
Qou ha"e commenced planning the audit of the financi al stat e me nt s for
the year ending *4 !ept ember (''4 and ha"e found that on the basis that
payment s for three year ser"ice contract s are non- refundabl e, the
direct ors ha"e in pre"ious years taken credit for all such income at the
time that the contract is ent er ed into.
The manage me nt account s for the year to dat e show that direct cost s
represent approxi mat el y 94T of the ser"ice contract income. The net
profit for the year ended *4 !ept ember ('9' was !h. %94, 444 and income
from ser"ice contract s ent er ed into during that year amount ed to
!h.$, (54, 444.
Qou are required to write a formal lett er to the direct ors set ting out:
AaB Qour reser"ati ons, if any, on the accounti ng policy adopt ed for
three year ser"ice contract s, and
AbB Qour recomme nde d treat ment of such income, toget her with the
disclosur es you consider necess ar y in order for the financi al
st at eme nt s to show a true and fair "iew.
(.:
!arks)
C$ECK (%&# ANS3E#S 3I"$ "$%SE IN "$E 2ESS%N .5 %7 "$E
S&*( +ACK
A&*I"IN-
6<;
2es s on Nine
2ESS%N NINE
Audit In0estigations? #ecei0ershi1s? 2i@uidations and
Current Issues in Auditing
%B=EC"I'ES
When you ha"e studi ed this chapt er you shoul d be abl e to:
-xplain and carry out audi t in"esti gat i on
2repar e "arious account ant s report s
-xplain and discuss the mai n principl es of independenc e
/iscuss the role of audit commi t t e es
/iscuss the ad"ant age s and disad"ant age s of carryi ng out non
audi t work for an audit client
-xplain and discuss the funda me nt al principl es of professi onal
et hics
/iscuss the forms of organi :at i ons a"ailabl e to professi onal firms
C%N"EN"S
In"estigations
!pecific Types of in"esti gations
o 8equest s for 0oans
o 7raud In"estigations
o )ack /uty In"estigations
The #ccount ant s 8eport on 2rospect us es
1onduct an in"esti gat i on into and prepar e an audit or?s report on
prospect i "e financi al infor mat i on and on proDecti ons of financi al
infor mat i on.
In"estigation by the 8egistrar of 1ompani es
8ecei"ershi ps and 0iquidations
#uditor Independe nc e
-n"ironment al #uditing
,anage me nt #uditing
on #udit work
INS"#&C"I%NS
#ssigned 8eadi ngs The !tudy text is sufficient .
1ompl et e answer s to 8einforcing 3uestions at the end of this lesson
without reference to the model answer s.
1heck your answer s agai nst those gi"en in 0esson (4 of the !tudy
2ack.
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
Audi t In0es t i g at i o ns ? #ecei 0 er s hi 1s and 2i@ui dat i ons
6<8
</ 5 In0es t i gat i ons
#n in"esti gati on can be defined as an enquiry commi ssi oned by a
client for some purpose of his. The scope of enquiry, the range of
possibl e client s and the number of purposes can be "ery large. We
shall ther efore confine oursel"es to the most common types of
in"estigations that the professional account ant may be called upon to
do.
</ . Common ty1e s o in0e s t i gat i ons B
aB #cquisition of compani es@
bB 2urchas e of business@
cB 2rospecti"e in"est ment s@
dB #dmission of new part ner s@
eB 2rospecti"e lending@
fB 7raud@
gB !yst ems breakdown@
hB 1ompany #cts in"estigations@
<nder this headi ng we shall also consider, prospect us es and profit
forecast s.
In"esti gati ons may be needed whene"er fact s are in doubt or in
disput e or wher e knowledge is required. #nybody can commi ssi on
an in"estigation and you will find that compani es, indi"idual s,
financi al institutions and banks, local aut horities, the tax aut horiti es
can all commi ssi on "arious in"estigati ons.
</ 6 In0es t i gat i ons B "he Stage s
#ll in"estigations are carried out in the same way, therefore the
student must reme mber this section of this chapt er.
Stage .B
Qou must always obt ain precise writt en instructions from the client.
This must incorpor at e a "ery clear "iew of the aims of the
in"estigation, the scope of the in"esti gati on, the degree of the det ail
required, the degree of secrecy to be obser"ed, the person to whom
the account ant must address his report . #t this le"el, consider ati on
must be gi"en to the resources the client is ready to utilise and the
cost of the Dob, bot h in ter ms of money and time.
Stage 6B +ro e s s i onal court e s i e s
2rofessional etiquet t e requires that if in"estigati ons are carried out in
the affairs of organi:ations to which the account ant is not the auditor
then the audit ors must be communi cat ed with. This is to obser"e the
usual court esi es and to obt ain their cooper at i on.
Stage 4B %rgani Gat i on o the in0es t i gat i ons
This in"ol"es the account ant assessi ng the aims of the in"esti gati on,
esti mati ng the time to be taken and the likely cost s and ensuri ng
that the appropri at e st aff will be a"ailabl e.
A&*I"IN-
6<:
2es s on Nine
Stage ;B %,tai ni ng the ,ackground inormat i on
This is particul arly import ant in in"esti gati ons in acqui sition of
business. It in"ol"es gat heri ng as much background informat i on as
possibl e about the obDect of the in"estigation, the si:e of the indust ry and
its struct ur e, history since commence me nt , the future prospect s, the
rele"ant legislation affecting that indust ry, in"est ment informat i on and
rele"ant accounti ng ratios. This informat i on is usually a"ailabl e from
published sources such as go"ernment st ati stics, trade associ ations and
the financi al st at eme nt s.
Stage 8B -atheri ng 1rel i mi nary inormat i on
This informati on has to be gat her ed on the subDect to be
in"estigat ed. This informat i on includes the location of the subD ect , its
product s, its range of ser"ices and its share of the market , key
personnel , maDor accounti ng control syst ems and past report s.
Stage :B +re1ari ng the re1ort outli ne
# report that meet s the needs of many accounti ng in"esti gati ons is
as follows:
+art AB Introducti on whereby we ha"e references to the
instructions gi"en. The obDect of the in"esti gati on must be
appar ent from the introducti on.
+art BB # summar y of the instructions must be gi"en.
+art CB # stat e ment of the precise obDecti"es of the in"esti gati on
and the report .
+art *B # st at eme nt of the scope of in"esti gati on st ati ng the time
period and the area co"er ed.
+art EB # st at eme nt of the document s used. If it is necess ar y to
reproduce any of these document s this is usually done in
an appendi x.
+art 7B #n outline of the work act ually done, agai n it may be
necess ar y to put some of this mat eri al in an appendi x.
+art -B # summar y of the informati on obt ai ned.
+art $B 7urther informat i on which could be of use to the client but
does not flow from the in"estigation proper.
Stage IB 8ecomme ndat i ons of the account ant . In gi"ing
recomme nda t i ons, the account ant must always ensur e
that :
aB =e gi"es informat i on from which the client can draw
his own conclusions
bB #"oid present i ng informat i on in such a way that the
client s? Dudgement is influenced
cB If informati on is based upon assumpt i ons, then the
account ant must st at e the assumpt i ons in full and
subst ant i at e them if possi bl e
dB ,ake no forecast s
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
6<C
eB If you are gi"ing opinions, esti mat es or forecast s,
then the account ant must st at e who made them and
what qualifications they had to making them
fB The recomme ndat i ons are practical
gB The in"esti gati on has been compr ehensi "el y
compl et ed.
hB The report is draft ed and discuss ed with the client
iB The final report is submi t t ed
</ 4 S1eci i c In0es t i gat i ons
</ 4. Ac@ui si ti ons (Int ere s t Ac@ui si ti on Audi t s)
"hes e are agre e d 1roce dur e s engag e me n t s .
#ccount ant s are frequent l y request ed by indi"idual s or compani es to
in"estigat e a business or a company of which the client is
cont empl ati ng purchas e. What the account ant is being asked to do
is to help his client make up his mind on whet her to buy or not and if
to buy at what price and for what consider ati on. The account ant J s
approach will depend on his instructions. #n in"esti gati on of this
nat ur e might be carried along the following lines:
i. +bt ain writt en instructions. This is to det er mi ne the purpose of
the in"estigation and any particul ar criteria the client may wish
to apply. !o, we must know the cash a"ailability, the
consider ati on to be offered, the mini mum ret urn on the
in"est ment , the scope and cost of the in"esti gation.
ii. -stablish cont act s. The account ant must open up a relationshi p
with his client, the subDect of the in"esti gati on, its professional
ad"ices particul arly account ant s and audit ors.
iii. -xami ne and redraft the account s for a period of years. This is
usually taken to be * years, one year being consider ed too short
becaus e ther e are no compar at i "es, two years being consider ed
too short becaus e ther e is no trend, three years being
consider ed opti mum becaus e you ha"e a compar at i "e and
trend. ,ore than three years is consider ed to be purely of
historical "alue. <nder this stage, we eliminat e all the non-
recurring items and all items which will not apply after the
change of ownershi p and we include notional amount s for items
that will become applicabl e aft er the change of ownershi p.
These may in"ol"e redrafting of the account s using different
accounti ng policies.
i". -stablishing the reliability of the account s: If they ha"e been
audit ed by a well recogni:ed firm, then little "erification is
required apart from consideri ng any qualifications in the
audit ors report s and the appropri at enes s of the accounti ng
policies used. If the account s ha"e not been audit ed, then you
require some more informati on in the following areas:
aB !ales: Qou ha"e to in"estigat e for inclusion of fictitious
sales or sales from other business es@
bB 2urchas es: 0ook out for exclusions@
cB 1ut off: This is import ant as pot enti al sellers are well
known for switching sales into final periods to boost
A&*I"IN-
6<D
2es s on Nine
turno"er and profits@
dB Work in progress and stock: It is import ant to check the
quantit y and "alue somet i mes an independent stock take
should be arranged at the take o"er dat e@
eB Hross profit ratios: This shoul d be consist ent year to
year and with the indust ry a"er age@
fB #sset "aluations: #dequacy of depreci ati on and the "alue
of debt or s need to be looked at critically. 0ook out to see
whet her necess ar y repairs and renewal s of asset s ha"e
been ignored@
gB <ndisclosed liabilities: Items may include pension
obligations compens at i on for redundanci es and taxation
liabilities.
". 1ommer ci al consider at i ons: The "arious factors to be
consider ed include:
aB 8equiring a knowledge of the spread of cust omer s and
product s@
bB .nowing the de"elopment plans for the district@
cB 0engt h of leases of premi ses and the possibilities of
renewal@
dB The continuit y of trading arrange me nt s@
eB The personal connections of the "endors will the
cust omer s continue to patroni se the business aft er change
in ownershi p@
fB 2ersonnel consider at i ons@
gB The need for an agree me nt that the "endor will fill in from
original.
"i. 7uture prospect s: The import ant factors here are:
aB The future of the indust ry@
bB The future of the ent erpri se within the indust ry@
cB The capit al working needs and the fixed asset s in"est ment
needs, you may find cash flow forecast s essent i al@
dB ,iscellaneous issues: Qour client will be interest ed in being
gi"en facts upon which he can form an opinion. =e would
also like to know the reason for the sale of the business
and he may be interest ed in working met hods that are
ordinarily used for "aluing business es.
</ 46 #e@ue s t s or 2oans
The bank in wishing to gi"e loans requires cert ai n informati on from
the applicant . The bank want s to know:
aB The purpose for which the loan is required
bB The adequacy for that purpose of the amount being sought
cB The nat ur e and adequacy of the underl ying securit y and the
ease with which it may be realised if necess ar y
dB The proposed arrange me nt for the payment of interest and the
period o"er which repayme nt of the principal sum will be
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
6<<
compl et ed
!o, to carry out an in"estigati on the following procedur es are
gener ally adopt ed:
-eneral
aB The background and professi onal standi ng of the promot er s of
the company@
bB The "iability of the concer n in the light of current and probabl e
future requirement s in the area of operation@
cB The si:e of the existing market and the likelihood of success for
a new "ent ur e@
dB The quality of the goods and ser"ices to be offered must be
compar ed with what is already a"ailabl e including compari son
of price@
eB The a"ailability of suit ably locat ed premi ses at an economi c rent
possessi ng per mi ssion for the use intended.
7inanci al
aB The bank want s to know the ext ent which the promot er s can
mat ch the request ed finance with their own resources@
bB Their personal financi al st at us, the possibility of pro"iding
personal guar ant ees as securit y for the loan sought @
cB Their past success or failure in business "ent ur es@
dB Their ability to pro"ide references as to their commer ci al
acumen, honest y and integrit y in business dealings.
Schedul e s incl ude d in the 1res e nt at i on
aB The cash flow budget s of the proposed concer n for the first two
years of operation Ausually the most difficult for new
business esB. #t this st age cash budget s are far mor e significant
than profitability, although the bank will ob"iousl y wish to be
satisfied as to pot enti al future profitability@
bB -sti mat es, set out mont h by mont h, of income from
salesC ser "ices, net of direct Ai.e. "ariabl eB expendi t ur e incurred
in earni ng that re"enue@
cB -sti mat es, once agai n set out mont hl y, of the fixed and set up
cost s likely to be incurred from the inception of the ent erpri se.
!uch expens es would co"er:
i. #dministr ati"e salaries including direct ors drawings@
ii. -stablishment expens es e.g. rent and rat es, premi ums on
leases, inst allation of telephones, light and heat @
iii. 8efurbishing and decorati ng cost s to meet the companyJ s
initial requirement s@
i". 1ost of acquiring furniture, typewrit ers etc.@
". Initial and regul ar ad"erti sing direct mail, st ationer y@
"i. 8epairs and maint enance@
"ii. Interest charges on the finance which it is hoped the bank
will ext end as a result of the present at i on@
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2es s on Nine
dB # duplicat e set of esti mat es and under Aa - cB abo"e except that
they should be prepar ed on the basis of a worst position.
</ 44 7raud In0es t i gat i ons
The nat ur e and scope of a fraud in"esti gati on are dependent on the
instructions gi"en. The main probl ems usually are:
aB The past time period that needs to be in"esti gat ed. This could
be a few days or many years.
bB The scope of the in"esti gation. We ha"e to det er mi ne
whet her we are in"esti gati ng an indi"idual, a whole
company, a whole depar t ment or a group of compani es.
cB The questioni ng of indi"idual s. This can be a "ery painful
exercise and the following gener al rules can be helpful:
i. The questioner should ha"e a colleague present @
ii. The person being inter"i ewed should be allowed to ha"e a
friend present @
iii. #ccusations shoul d not be made but e"idence should be
present ed and expl anati ons request ed@
i". The questioni ng shoul d be in pri"at e@
". If necess ar y, Dudges rules should be obser"ed. This means
that a person being questi oned underst ands the nat ur e of
the question and shoul d not unwittingly incri minat e
himself@
"here are two ,road cat e g ori e s o raud
aB 7raud in"ol"ing the mani pul ation of the records and the
account s usually by the companyJ s senior officer with a "iew to
benefiting in some way from the false picture which they
con"ey.
bB 7rauds usually by empl oyees in"ol"ing the theft,
misappr opri ati on or embe::l ement of the companyJ s funds
usually in the form of cash or other asset s.
)elow is a summar y of procedur es the in"esti gati ng account ant will
be required to follow in arri"ing at esti mat es of losses from case AbB,
assumi ng that it is already known that a defaulting empl oyee has
been at work.
i. =e has to ascert ai n the le"el of aut horit y and the nat ur e of
duties of the defaulting employee@
ii. 1ast and "ouch the cash book and obt ain certificat es of openi ng
and closing balances from the bank@
iii. 1heck the cash book against bank stat e ment s paying particul ar
att enti on to the dat es of lodgement to ascert ai n whet her
receipt s were banked promptl y@
i". -xami ne pay- in-slips at the bank and compar e with count erfoils
as these may re"eal teemi ng and lading@
". 1arry out a positi"e circularisati on of debt or s@
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
45.
"i. !can the cash book for any appar ent l y irregul ar payment s@
"ii. -xami ne ret urned cheques compari ng names or payees with
the det ails in the cash book and in"oices@
"iii. +bt ain duplicat es of missing expendi t ur e "oucher s@
ix. 6ouch all amount s shown as part ner s or direct ors drawings or
loans@
x. 6ouch and cast the pet t y cash book@
xi. 1onfirm names of all empl oyees shown on payroll with the chief
account ant and the personnel manager and confirm amount s
payabl e to them@
xii. If the defrauder has access to all books then all postings should
be checked and a trial balance extract ed@
xiii. 1onfirm all bad debt s writt en off, discount s allowed and ret urns
of goods@
xi". 1heck the order book against the sales day book, or copy sales
in"oices in order to det ect any unrecor ded sales@
x". 6ouch purchas e in"oices with purchas es day book and see that
none of them has been process ed twice@
x"i. +bt ain duplicat es of all missing purchas e "oucher s@
x"ii. 1ompar e the creditors st at eme nt s agai nst purchas e ledger
balances@
x"iii. 1heck goods inwards book or order against in"oices to ensur e
that the latt er relat e to genui ne purchas es.
</ 4; Back *uty In0es t i gat i ons
Where the income tax aut horiti es ha"e reason to suspect that a resident
indi"idual subD ect to taxation has not made compl et e and accurat e return
of income for taxation purposes, they may require an in"estigati on to
det er mi ne the correct position. This in"estigation is ordinarily called a
back dut y in"estigation. The "icti m is required to appoi nt his own
account ant to carry out the in"esti gati on at his own cost. The
appoi nt ment has to be appro"ed by the income tax depart ment . #
stat e ment known as a capit al st at eme nt is usually the form in which the
result s of this in"esti gation are summari sed. The purpose of the
stat e ment is to att empt a reconciliation of net wort h at the openi ng and at
the close of the period respecti"el y by reference to known and esti mat ed
sources of income and expendi t ur e. The final discrepancy that is re"eal ed
being the closest possi bl e approxi mat i on of the undisclosed income which
ga"e rise to the in"estigation in the first place.
The following procedur al point s shoul d be not ed: The in"estigation relat es
to the income and expendi t ur e of the tax payer in his pri"at e as well as
business capacit y. The enquiries must therefore ext end to his wife and
children and other dependant s. #ll sources of pot enti al informat i on must
be tapped such as: bank st at eme nt , deposi t receipt s, brokers not es,
insurance policies, interest and di"idend count erfoils etc. 8eceipt s and
payment s ha"e to be traced through to source and destination
respecti"el y. /o not ignore small items since they may indicat e the
exist ence of asset s pre"iousl y undisclosed. The amount of insurance
co"er ed shoul d be ascert ai ned since it may indicat e the approxi mat e
"alue of the underl ying asset s. The final report should refer to the
deficiences in the informati on pro"ided as well as the assumpt i ons and
esti mat es which it has ther efore been necess ar y to make.
A&*I"IN-
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2es s on Nine
!peci al point s which arise in this in"estigati on are: the period to be
co"er ed which could be many years, the appar ent cash a"ailabl e for li"ing
compar ed with the tax payer s act ual standar d of li"ing, the accumul ati on
of capit al compar ed with known sources of such accumul ati on, the
exist ence of other sources of income and capit al must be in"estigat ed.
This will include: gambling wins, gifts and legaci es. The result of the
in"estigation may be that undecl ar ed income comes to life. This will
in"ol"e the payment of tax on the income, interest ther eon, and a
negoti at ed penalt y in some cases strangel y "ery rare, the tax payer may
be Dailed. The st at eme nt of capit al may look like this.
Taxpayer. . . . . .. .......................................................................................
2eriod co"er ed by this
in"estigation. . . .. .. ...........................................................

S"A"E!EN" %7 NE" 3EA2"$ A" %+ENIN- AN* C2%SIN-
*A"ES
Kshs/ Kshs / Kshs / Total
wealt h of taxpayer, wife and dependant s
at the commence me nt of the in"estigati on period xx,xxx
#dd: .nown sources of earned income decl ar ed xx,xxx
.nown sources of unear ned income decl ar ed xx,xxx
2rofits on sales of:
N In"est ment s xx,xxx
N 8ight s issues xx,xxx
N +ther issues Aspecified in det ailB xx,xxx
1apit al increases from:
N Hifts xx,xxx
N 0egaci es xx,xxx
N 0ife policies mat ur ed xx,xxx
N 0ife policies surrender ed xx,xxx
N Windfall gains xx,xxx
N +ther items Aspecified in det ailB xx,xxx
xx,xxx
0ess: .nown expendi t ur e account ed for and,
acknowl edged to be consist ent with
the taxpayer J s st andar d of li"ing xx,xxx
0osses on sales of:
N In"est ment s xx,xxx
N +ther asset s Aspecified in det ailB xx,xxx
1apit al decreas ed:
N Hambling losses xx,xxx
N Hifts xx,xxx
N +ther losses, including asset s worn
outCscrapped Aspecified in det ailB xx,xxx
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
454
xx,xxx
xx,xxx
!urplusC/eficiency:
OotionalO Total Wealt h at the close of the period xx,xxx
#ctual Total Wealth at the close of the period Aas
admi t t edB xx,xxx
/iscrepancy due to undisclosed source of income xx,xxx
</ 48 "he Account ant s #e1ort on +ros 1e c t us e s
aB "he cont e nt s o the Account ant s #e1ort or the 1ur1os e s
o a 1ros 1e c t us areB
i. Title of report and identification of the reporting
account ant s, with det ails of their address.
ii. #ddressee - usually the /irector of the company.
iii. 8eport with the following informat i on:
aB -xami nati on of audit ed account s of the company for
the years required, 8eport on proposed issue stating
number of shar es and nomi nal "alue.
bB The account s ha"e been prepar ed in accordance with
gener ally accept ed accounti ng practices. The
accounti ng policies used disclosed.
cB Whet her reporti ng account ant s ha"e also been
auditors of the company, if not the audit ors are
menti oned.
dB Whet her any account s ha"e been made up for
submi ssi on to the member s subsequent to pre"ious
balance sheet .
eB +pinion on trut h and fairness of the account s@
fB !ignificant accounti ng policies that ha"e been used in
prepar at i on of the account s@
gB 2rofit and 0oss #ccount s for the last fi"e years that
must show earni ngs per share, profit before taxation,
taxation and extra- ordinary items, direct ors
emol ument s.
hB 0atest balance sheet .
iB 1apit al commi t me nt s and contingenci es not pro"ided
for.
DB /at e of report , signed.
bB 2ro"ision is made for disclosur e of the adDust ment s made by
reporting account ant s in arri"ing at the informati on included in
the report . The purpose of these adDust ment s is to reflect past
result s in future conditions so far as these are known. This is a
reasonabl e principle accept abl e under the third schedul e
pro"isions. #s a result of these adDust ment s it may be difficult
to reconcile report ed figures with those in the past published
account s of the company.
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2es s on Nine
The published st ewar dshi p account s are prepar ed by a
companyJ s direct ors for present at i on to commi t t ed shar ehol der s
in order to acquai nt them with the result of the companyJ s
acti"ities during the last compl et e year of st ewar dshi p. There is
no o"er- riding need for the account s to be compar abl e and
consist ent with each other. In a prospect us, the informati on is
address ed to pot enti al in"est or s in such a way as to enabl e
them to form an opinion on the likely prospect s of the company
under future trading conditions so far as they can be assess ed.
The purpose must be met , consist ency and compar ability must
be achi e"ed but also future conditions must be taken into
consider ati on.
-xampl es of situations in which adDust ment s would be
appropri at e are:
i. Income andC or expendi t ur e which has arisen in the past ,
but which it is known will not arise in the future may be
eliminat ed, e.g. nationalised subsidi ari es, uninsur ed losses,
extra- ordinary items etc.
ii. 8e"aluati on of asset s causing a change in depr eci ation
charges. This should be adDust ed only if re"ised figures
can be produced with reasonabl e cert ai nt y otherwise it
may be prefer abl e to explain the position in a not e to the
account s.
iii. # significant change in accounti ng policies at any point
during the period report ed on, in which e"ent the account s
for all affect ed periods should be adDust ed to reflect the
accounti ng policies which are known to be applicabl e in
the future.
</ 4: "he Account ant s #e1ort on +ros 1e c t i 0 e inanci al inormat i on
#uditing procedur es for hist orical financi al infor mat i on are well
est abli shed. =owe"er compani es often prepar e and publish prospect i "e
financi al infor mat i on such as profit forecast s. In order that the forecast s
shoul d ha"e credi bility the company may ask the audit or to exami ne and
expr es s an opinion on the prospect i "e financi al infor mat i on. This
exami nat i on does not amount to an audi t. =owe"er, user s of the
prospect i "e financi al infor mat i on do get some assur ance from an
exami nat i on of the prospect i "e financi al infor mat i on by the audit or.
#ccordi ng to Int ernat i onal st andar d on #ssurance engage me nt s o. *%44
-&e $%ami nati on of Prospect i ve Financial Informati on# V2rospect i "e
financi al infor mat i on? A27IB means financi al infor mat i on based on
assumpt i ons about e"ent s that may occur in the futur e and possi bl e
actions by an entit y. It is highly subD ecti"e in nat ur e and its prepar at i on
requires the exerci se of consi der abl e Dudgment . 2rospect i "e financi al
infor mat i on can be in the form of forecast , a proDecti on or a combi nat i on
of bot h, for exampl e, a one year forecast plus a fi"e year proD ection.
The purpos e of the I!#- *%44 is to est abli sh st andar ds and pro"ide
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
458
guidance on engage me nt to exami ne and report on prospect i "e financi al
infor mat i on including exami nat i on procedur es for best Pesti mat e and
hypot het i cal assumpt i ons. This I!#- does not a appl y to the exami nat i on
of prospect i "e financi al infor mat i on expr es s ed in gener al or narr ati "e
ter ms, such as that found in manage me nt ? s discussi on and anal ysi s in
an entit y?s annual report , though many of the procedur es outlined herei n
may be suit abl e for such an exami nat i on.
I!#- *%44 defines a Voreca s t A as prospect i "e financi al infor mat i on
prepar ed on the basi s of assumpt i ons as to futur e e"ent s which
manage me nt expect s to take place and the actions manage me nt expect s
to take as of the dat e the infor mat i on is prepar ed Abest Pesti mat e
assumpt i onsB.
# P1roH ect i onA is defined as prospect i "e financi al infor mat i on prepar ed
on the basi s of:
AaB hypot het i cal assumpt i ons about futur e e"ent s and
manage me nt actions which are not neces s aril y expect ed to
take place, such as when some entiti es are in a st art Pup
phas e or are consi deri ng a maD or change in the nat ur e of
oper at i ons, or
AbB a mixt ur e of best- esti mat e and hypot het i cal assumpt i ons
27I can include financi al st at e me nt s or one or mor e element s of financi al
!t at e me nt s .
In effect a forecast is an infor med opinion on what will happen and a
proDecti on is an opinion on what mi ght happen in cert ai n circumst ance s .
+ften a one- year forecast is gi"en toget her with a fi"e year proD ection.
Acce1t anc e o enga g e me n t
)efore accept i ng an engage me nt to exami ne prospect i "e financi al
infor mat i on, the audit or woul d consi der, among other things:
The int ended use of the infor mat i on.
Whet her the infor mat i on will be for gener al or limit ed distributi on
The nat ur e of the assumpt i ons, that is, whet her they are best P
esti mat e or hypot het i cal assumpt i ons
The element s to be included in the infor mat i on@ and
The period co"er ed by the infor mat i on.
+ur1os e s o +ros 1e c t i 0e 7inanci al Inormat i on
2rospect i "e financi al infor mat i on can be issued:
AaB as an int ernal manage me nt tool e. g. to support a possi bl e capit al
in"est me nt
AbB or distributi on to third parti es, for exampl e
In a prospect us
In an annual report
To infor m lender s or to support an applicati on for finance.
The prepar at i on of 27I in"ol"es the following st eps:
,ake best esti mat e assumpt i ons about the futur e e. g. sal es will
rise by %T, int er est rat es will remai n st abl e and exchange rat es
will fluct uat e.
A&*I"IN-
45:
2es s on Nine
/et er mi ne the account i ng policies used in the past which must be
used in prepari ng the 27I.
Issue the 27I with the mat eri al assumpt i ons clearl y disclosed,
including an indicati on as to whet her they are best esti mat e
assumpt i ons or hypot het i cal assumpt i ons.
2repar e the 27I on the basi s of the assumpt i ons and account i ng
policies.
Assuranc e +roce dur e s
#n audit or may be engaged to report on the 27I. The audi t or will
nor mall y carry out the following procedur es:
#gree a lett er of engage me nt
+bt ai n a sufficient knowl edge of the busi ness P the audi t or shoul d
ha"e the knowl edge
1onsider the period to be co"er ed P in the case of a forecast this
cannot be "ery long, nor mall y not mor e than a year.
#ssess the source and reliability of the e"idence supporti ng
manage me nt ? s best esti mat e assumpt i ons. -"idence can be
obt ai ned from int ernal sources Ae. g. past financi al st at e me nt s B and
ext er nal sources Ae. g. the audi t or?s knowl edge of current economi c
circums t anc es B . #ny plans shoul d be within the client?s capaci t y.
The audi t or shoul d consi der, when hypot het i cal assumpt i ons are
used, whet her all implicati ons of such assumpt i ons ha"e been
taken into account . 7orecast s shoul d consi der the capit al
spendi ng needs, product i"e capaci t y, st aff recruit ment , working
capit al, cash flow and all other aspect s of a propos ed plan. #ny
hypot het i cal assumpt i ons shoul d be realistic.
The audi t or shoul d make arit hmet i cal checks on the forecast s and
suppor ti ng schedul es Abudget ed financi al st at e me nt s B . The whol e
set shoul d be int ernall y consi st ent and in accor dance with
propos ed manage me nt actions and with assumpt i ons.
The audi t or shoul d focus on areas which are particul arl y sensi ti"e
to "ari ation.
When part of the period, which is the subD ect of the forecast , has
already elapsed, the audit or shoul d exami ne e"idence for the
financi al resul t s already achi e"ed. If the client?s year end is *(
/ecember , a forecast for the year endi ng *( /ecember $4x* may
be made in say ,ay $4x* when four mont hs or so ha"e already
elaps ed.
The audit or shoul d obt ai n writt en repr es ent at i ons from
manage me nt on the int ended use of the prospect i "e financi al
infor mat i on, the compl et ene s s of significant manage me nt
assumpt i ons and manage me nt ? s accept ance of its responsi bility
for the prospect i "e financi al infor mat i on.
The audit or shoul d asses s the pres ent at i on and disclosur e of the
prospect i "e financi al infor mat i on.
7inally the audit or shoul d issue a report .
Consi s t e nc y
The 27I shoul d be based on budget ed financi al st at e me nt s . It shoul d
take into account the assumpt i ons and ensur e that all items are
consi st ent with each other and that account i ng policies nor mall y adopt ed
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
45C
by the company ha"e been used.
*iscl os ur e
The prospect i "e financi al infor mat i on must be properl y and
compr ehensi "el y disclosed and present ed, which means that :
The infor mat i on is not mi sl eadi ng
The account i ng policies used are clearl y disclosed in the not es to
the prospect i "e financi al infor mat i on
The assumpt i ons are adequat el y disclosed in the not es to the
prospect i "e financi al infor mat i on. It needs to be clear whet her the
assumpt i ons repr es ent manage me nt ? s best - esti mat e s Ae. g.
inflation will be at *T which agree with go"er nme nt forecast sB or
hypot het i cal Alet us assume that our market shar e increas e to %&T
from %*T, which may be unreali sticB. If the assumpt i ons are
mat eri al and subD ect to a high degr ee of uncer t ai nt y, the
sensi ti"it y of the forecast to these assumpt i ons must be
adequat el y disclosed.
The dat e when the forecast was prepar ed must be disclosed
!omet i mes the forecast is in the form of a range, and the basi s of
sel ecti on of the point s on the range must be unbi as ed and
disclosed
#ny change in account i ng policy since the last set of financi al
st at e me nt s must be disclosed toget her with the reason for the
change and the effect on the prospect i "e financi al infor mat i on.
#e1orti ng %n +ros 1e c t i 0 e 7inanci al Inormat i on
Cont e nt s o the #e1ort
The report by the audi t or shoul d cont ai n the following:
(B Title
$B #ddress ee
*B Identificati on of the prospect i "e financi al infor mat i on
%B # refer ence to the audi ti ng st andar d appli ed Ae. g. I!# 9(4B, if any
5B # st at e me nt that the manage me nt is responsi bl e for the
prospect i "e financi al infor mat i on includi ng the assumpt i ons on
which it is based
&B When applicabl e, a refer ence to the purpos e andC or rest rict ed
distributi on of the prospect i "e financi al infor mat i on
KB # st at e me nt of negat i "e assur ance as to whet her the assumpt i ons
pro"ide a reasonabl e basi s for the prospect i "e financi al
infor mat i on
9B #n opinion as to whet her the prospect i "e financi al infor mat i on is
properl y prepar ed on the basi s of the assumpt i ons and is
present e d in accordance with the rele"ant financi al reporti ng
framewor k
'B #ppropri at e ca"eat s concer ni ng the achi e"abilit y of the resul t s
indicat ed by the prospect i "e financi al infor mat i on
(4B /at e of the report , which shoul d be the dat e procedur es
ha"e been compl et ed
((B #uditor?s addr es s
($B !ignat ur e
#e1ort s on 1roi t orecas t s
#n exampl e of such a report is set out below:
A&*I"IN-
45D
2es s on Nine
#uditors? report on the profit forecast issued by the /irect or s of ) 0imit ed
and co"eri ng the twel"e mont hs endi ng *( /ecember $4x*
To the )oard of /irect or s of ) 0imit ed
We ha"e exami ned the profit forecast co"eri ng the twel"e mont hs endi ng
on *( /ecember $4x* set out on earli er.
We carri ed out our exami nat i on in accordance with Int ernat i onal
st andar d +n #ssurance -ngage me nt s AI!#-B *%44: The exami nat i on of
prospect i "e financi al infor mat i on.
,anage me nt is responsi bl e for the forecast includi ng the assumpt i ons
set out on pages ;; and ;; on which it is based.
)ased on our exami nat i on of the e"idence suppor ti ng the assumpt i ons,
not hi ng has come to our att ent i on which caus es us to belie"e that these
assumpt i ons do not pro"ide a reasonabl e basi s for the forecast . 7urther,
in our opinion the forecast is properl y prepar ed on the basi s of the
assumpt i ons.
#ctual resul t s are likely to be different from the forecast since anticipat ed
e"ent s frequent l y do not occur as expect ed and the "ariation may be
mat eri al .
#)1M1+
airobi
(* #pril $4x*
Not e the oll owi ng 1oi nt sB
The negat i "e assur ance gi"en Anot hi ng has comeY. . B
If the forecast is present ed in accor dance with a rele"ant reporti ng
framewor k Ae. g. the national legisl ation of I!#-s or an I-8!B, that
fact shoul d be st at ed.
# st at e me nt that the forecast may turn out to be wrong
,anage me nt responsi bility
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
45<
#e1ort s on +roH ect i ons
The following is an exampl e of a report on a proD ection
We ha"e exami ned the proDecti on of the profits to be earned by 1 0td. in
the fi"e year s endi ng *( /ecember $4x5 set out on pages ;; to ;; of
this document in accordance with Internat i onal !tandar ds on #ssur ance
-ngage me nt s applicabl e to the exami nat i on of prospect i "e financi al
infor mat i on. ,anage me nt is responsi bl e for the proDecti on includi ng the
assumpt i ons set out in ot e ; on which it is based.
This proDecti on has been prepar ed for the purpos e of the offer for sal e of
(4T con"er ti bl e debent ur es.
#s the entit y is in a st art up phas e the proD ection has been prepar ed
using a set of assumpt i ons that include hypot het i cal assumpt i ons about
future e"ent s and manage me nt ? s actions that are not necess aril y
expect ed to occur. 1onsequent l y, reader s are cauti oned that this
proD ection may not be appropri at e for purpos es other than that descri bed
abo"e.
)ased on our exami nat i on of the e"idence suppor ti ng the assumpt i ons,
not hi ng has come to our att ent i on which caus es us to belie"e that these
assumpt i ons do not pro"ide a reasonabl e basi s for the proDecti on,
assumi ng that sal es growt h of (4T annuall y is achi e"ed. 7urther, in our
opinion the proDecti on is properl y prepar ed on the basi s of the
assumpt i ons and is present ed in accordance with gener all y accept ed
account i ng principl es.
-"en if the e"ent s anticipat ed under the hypot het i cal assumpt i ons
descri bed abo"e occur, act ual resul t s are still likely to be different from
the proD ection since other anticipat ed e"ent frequent l y do not occur as
expect ed and the "ariation may be mat eri al.
#)1 M 1o
airobi
(* #pril $4;5
Inade@uat e *iscl os ur e s
The audi t or may form a conclusi on that the present at i on and disclosur e
of the prospect i "e financi al infor mat i on is not adequat e. This may arise
becaus e the financi al infor mat i on fails to disclose adequat el y the
consequence s of any assumpt i ons that are highly sensi ti"e. In such
cases the audit or may:
-xpress a qualified opinion
-xpress an ad"er s e opinion
Withdr aw from the engage me nt
In practice the audi t or would discuss the issue with manage me nt and
persuade them to change the forecast .
EuiG
$o1e ul
#s a respons e to a falling shar e price, =opeful, list ed compani es, who are
A&*I"IN-
4.5
2es s on Nine
maga:i ne print er s, ha"e issued a profit forecast with the annual account s
for the year endi ng *( /ecember $4x9. The annual account s wer e
signed off on $% #pril $4x'. The forecast is for profits in $4x' of U$&
million which cont r ast s with the current profit of U$(. 5 million. This
depends on increasi ng turno"er by KT and reduci ng o"erheads by %T.
To gi"e assur ance to shar ehol der and other in"est or s, the company has
asked !wallow and 1o, the audit ors, to report upon the forecast .
#e@ui red
AaB -xplain the ter m Vprospect i "e financi al infor mat i on? and identify the
principal probl em which reporti ng on such infor mat i on raises for audit ors.
A(4 marksB
AbB !ummari :e the procedur es that !wallow shoul d carry out in order to
be in a position to report on the forecast .
A(5 marksB
("ot al B 68
marks )
Summary o the Audi t ors #es1ons i ,i l i t y
aB 2reliminar y consider ati ons:
i. The account ant must ha"e sufficient time to carry out his
re"iew. In tense and fast mo"ing takeo"er situations the
account ant may be asked to conduct a re"iew, literally
o"ernight . They must not allow thems el "es to conduct a
re"iew at a fast er pace than the probl em merit s.
ii. It must be clearly est ablished and made clear to all parti es
that the account ant s are reporting only on accounti ng
bases and the calculations as distinct from the
assumpt i ons including commer ci al assumpt i ons.
iii. The account ant should only re"iew the current period, and
if a significant part of that has elapsed, then the next
following period.
i". 8eporting account ant s cannot relie"e the direct ors of their
responsi bility for profit forecast s which may be used and
relied upon by outsider s.
". The account ant must est ablish the purposes for which the
forecast s ha"e been prepar ed.
"i. The account ant must be sure that the direct ors assume full
responsi bility for the forecast s by:
aB # minut ed board resolution@
bB # st at eme nt to that effect in the document cont ai ning
the forecast .
"ii. The account ant must take not e of the other ad"isers acting
in the mat t er.
bB The mai n point s to be consider ed in conducti ng the re"iew:
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
4..
i. ature and background of the companyJ s business.
-stablish its acti"ities, product s, cust omer s, market s,
labour force, prospect us, and the trends of its financi al
result s.
ii. #ccounting policies. -stablish the accounti ng policies
adopt ed for interi m and final account s and forecast s.
-nsure that they are accept abl e and consist entl y followed
especi ally in the forecast s. !peci al areas to be watched
include stock and work in progress "aluations,
depreci ati on, the met hod of taking profit on long ter m
contract s, exceptional and extraordi nar y items, and
deferred tax.
iii. The assumpt i ons:
aB These should be st at ed@
bB The forecast should be consist ent with the
assumpt i ons which may be economi c Ae.g. growt h in
H..2B, financi al Ae.g. interest rat e mo"eme nt ,
marketi ng Ae.g. market shareB, Ae.g. out put pot enti alB,
labour relations Ae. g. strike free periodsB etc.
The account ant is not concerned with the correct nes s of
these assumpt i ons although he should be sure the
direct ors are responsi bl e for them and that they are
report ed on by the ad"isers.
i". The procedur es adopt ed by the company to prepar e the
forecast s: the account ant should in"esti gat e:
aB Whet her forecast s are regul arly prepar ed for
manage me nt or prepar ed only for this occasion.
bB If they are regul arly prepar ed, the degree of accuracy
and reliability achi e"ed.
cB Whet her the forecast s are best esti mat es, honestl y
belie"ed to be achi e"abl e, or simply target s.
dB The ext ent to which forecast s for wholly or partly
expired periods are co"ered by reliable interi m
account s.
eB The ext ent to which the forecast s are built up from
det ailed di"isional or acti"ity based sectional
account s, distingui shi ng those with steady
perfor mance from those with mor e "olatile result s.
fB The treat ment of mat eri al, extraordi nar y, and
excepti onal items.
gB The adequacy of pro"isions for future losses and
contingenci es.
hB The adequacy of working capit al. If finance will be
required to fulfil the forecast , this shoul d ha"e been
arranged and confirmed.
cB The report :
This will be address ed to the direct ors and will cont ai n:
A&*I"IN-
4.6
2es s on Nine
i. # st at eme nt that the reporting account ant s ha"e carried
out a re"iew of the accounti ng bases and calcul ations on
which the profit forecast s ha"e been based.
ii. !pecific identification of the forecast s and document s to
which the report refers.
iii. If, as is likely, the account ant s ha"e not carried out an
audit of esti mat ed result s of expired periods, a st at eme nt
to that effect.
i". Whet her in the opinion of the reporti ng account ant s the
forecast s ha"e been properl y compil ed on the basis of the
assumpt i ons made by the )oard of /irectors, as set out in
the prospect us or circular, and are present ed on a basis
consist ent with the accounti ng practices normally adopt ed
by the company.
". If the account ant s ha"e mat eri al reser"ati ons about any
part of the forecast , they should qualify their report .
</ 4C 2ett ers o Cons e nt
If a prospect us cont ai ns any st at eme nt purporting to be made by an expert
Ae.g. the reporti ng account ant B, then the expert must ha"e gi"en and not
withdr awn his consent to the issue of the prospect us with the st at eme nt in
the form and cont ext in which it is included.
# st at eme nt that consent has been gi"en and not withdrawn must be
included in the prospect us.
An exam1l e o a lett er o cons e nt is
We hereby consent to the issue of the prospect us dat ed (%t h ,ay $44%
issued in connection with the offer for sale of ten million shar es of Hoing
2laces Hroup 0td with the inclusion therei n of our report dat ed (%t h ,ay
$44% and the references theret o, and the references to our name. In the
form and cont ext in which they appear. We att ach a copy of the
document initialled by us for the purposes of identification.
The lett er of consent should be a"ailabl e for public inspection and except
for quot ed compani es, be filed with the 8egistrar of 1ompani es.
)efore signing a lett er of consent , the reporting account ant should
re"iew the whole prospect us to ensur e that the informat i on in it is
not inconsi st ent with anyt hi ng in his report . =e is none- the- less not
responsi bl e for anyt hi ng except his own report.
</ 4D Com ort 2ett er
The reporti ng account ant may be asked by the direct or or by the
sponsor to prepar e report s on other mat t er s. These lett ers are not
for publication and are not required by stat ut e or other regul ations.
The reason for them is that the direct ors must make st at eme nt s in
the prospect us on such mat t er s as:
aB The adequacy of working capit al
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
4.4
bB The aggregat e of borrowings at the latest practicabl e dat e
cB #ny pro- forma financi al stat e ment shown in the prospect us to
indicat e the effect of a maDor acquisition or re- organi sati on
dB Taxation clear ances and indemni ti es
eB #ny other financi al informat i on anywher e in the
prospect us.
1learly the direct ors or sponsor must be sure these
mat t er s are correctly st at ed and thus ask the reporting
account ant to in"esti gat e and gi"e a comfort lett er that all
is well.
-xampl e of a 1omfort lett er
/irectors
=arbridge 0td
Hentl emen
We refer to the document dat ed $nd Ganuary $44* issued by your
company in connecti on with a placing by oursel"es of (,444, 444
shares of $4C ] each. The document cont ai ns a forecast Afor which
you as direct ors are solely responsi bl eB of the companyJ s profits to
the year ending *4t h Gune $44* We ha"e discuss ed with you the
bases and assumpt i on upon which the forecast has been made and
ha"e consider ed the lett er dat ed $nd Ganuary $44* addr ess ed to you
from Wahasi bu M 1o, regar di ng the accounti ng bases and
calculations for the forecast .
In our opinion, the profit forecast for the year ending *4t h Gune $44*
has been prepar ed after due and careful enquiry.
Qours faithfully
H+0/7IH-8 M 1o
,ember of the airobi !tock -xchange
Exam1l e s o the ass um1t i ons and lett ers ass oci at e d wi th a
orecas t are
Assum1t i ons
In arri"ing at the profit forecast by the direct ors for the year ending
*4t h Gune $44% the principal assumpt i ons made are that :
aB Hroup turno"er of .shs$4 million will be achie"ed
bB +"erhead cost s will ha"e increas ed at a rat e of 5T since *4t h
Gune $44*
cB Interest rat es will not "ary significantl y from those ruling at *(st
/ecember $44*
dB o further clai ms will be recei"ed by the direct ors relating to
the profit forecast for the financi al year ending *4t h Gune $44%
A&*I"IN-
4.;
2es s on Nine
The /irect ors
=arbridge 0imited
Hentl emen
We ha"e re"iewed the accounti ng bases and calcul ations for the
profit forecast of =arbridge 0imited Afor which the direct ors are solely
responsi bl eB, for the year ending *4t h Gune $44% as set out in the
document dat ed $nd Ganuary $44% issued by your company in
connecti on with a placing of (,444, 444 ordinary shar es of .shs(4C-
each.
In our opinion the forecast so far as the accounti ng bases and
calculations are concerned has been properly compiled Aon the
footing of the assumpt i ons made by the direct ors set out in the
document B and is present ed on a basis consist ent with the
accounti ng practices normally adopt ed by the company.
Qours faithfully
;QX
1ertified 2ublic #ccount ant s
/irect ors
=arbridge 0td
Hentl emen
We refer to the document dat ed $nd Ganuary (';' issued by your
company in connecti on with a placing by oursel"es of (,444, 444
ordinary shar es of (4C ] each. The document cont ai ns a forecast Afor
which you as direct ors are solely responsi bl eB of the companyJ s
profits to the year ending *4t h Gune (';'. We ha"e discuss ed with
you the bases and assumpt i on upon which the forecast has been
made and ha"e consider ed the lett er dat ed $nd Ganuary (';',
addr ess ed to you from ;QX, regar di ng the accounti ng bases and
calculations for the forecast .
In our opinion, the profit forecast for the year ending *4t h Gune (';'
has been prepar ed after due and careful enquiry.
Qours faithfully
!.). 8+)-8T
airobi !tock -xchange
</ 4< In0es t i gat i ons ,y the #egi s t rar o Com1ani e s
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
4.8
!ection (&% to (K5 of the .enya 1ompani es #ct pro"ide for the inspection
of a compani es affairs by the 8egistr ar of 1ompani es.
!ection (&%, the 8egistrar may appoi nt inspect ors on the application of
either not less than $44 member s or of member s holding not less than
one tent h of the issued shar es of the company.
!ection (&5, the 8egistrar must appoi nt inspect or s if:
aB The company by speci al resolution or
bB )y court order
/eclare that the companyJ s affairs should be in"estigat ed.
!ection (&& empower s the =igh court to appoi nt inspect ors if it
appear s that there are circumst ances suggesti ng that:
aB the business is being run with intent to defraud creditors or in a
manner oppressi ng to any part of its member s or for any
fraudul ent or unlawful purpose, or
bB that persons concerned with the companyJ s formati on for
the manage me nt of its affairs ha"e in connecti on ther ewi t h
been guilty of fraud, misfeance or other misconduct towards
it or its member s, or
cB that its member s ha"e not been gi"en all the informati on with
respect to its affairs which they might reasonabl y expect , or
AdB that it is desirabl e to do so.
!ection (&&: This section gi"es inspect ors power to in"estigat e affairs of
in"estigat ed companyJ s holding or subsi di ary compani es if they consider it
rele"ant to their enquiries.
# team of inspect ors usually consist s of one account ant , and one
ad"ocat e. In"estigations usually take the form of a "ery ext ensi "e audit
in"ol"ing much use of "erification, analytical re"iew and det ail ed test s.
The work can often take many years so it is usual for the inspect or s to
issue interi m report s.
</ ; #ecei 0er s hi 1 and 2i@ui dat i ons
#eme di e s o *e,e nt ur e $ol ders
# debent ur e holder who wishes to release his securit y and reco"er
his money may make use of all or any of the following remedi es:
aB =e may sue on behalf of himself and all other debent ur e holders
to obt ai n payment or to enforce his securit y by sale. The 1ourt s
will appoi nt a 8ecei"er and a manager for the companyJ s
business, if necess ar y, and declare the debent ur es to be a
charge on the asset s of the company, and order the sale of the
propert y.
bB =e may appoint a 8ecei"er, if the conditions of the issue of the
debent ur es gi"e him the power to do so. The 8ecei"er will sell
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the propert y and the sale proceeds will be utilised for the
payment of the principal sum, interest , and cost s due to
debent ur e holders.
cB =e may apply to the 1ourt s for the foreclosur e of the companyJ s
right s to redee m the debent ur es. This remedy is not common,
as it is necess ar y for all the debent ur e holders of e"ery class to
be parti es to the court action.
dB =e may as a credit or for the principal and interest ther eon,
present a petition for the winding up of the company, or if ther e
be a winding up in progr ess, he can pro"e in the winding up for
the amount due to him, but not ha"ing any securit y, he ranks
mer el y with the ordinary credit ors.
eB =e may ha"e the propert y sold by the trust ees if the debent ur e
trust deed per mi t s the sale.
fB If the company is being wound up and his securit y is
insufficient he may "alue his securit y and pro"e for the
whole debt .
A11oi nt me nt o a #ecei 0er
# debent ur e holder can appoi nt a recei"er under the express power
in his debent ur e, or he can apply to the 1ourt s. <nder !ection *%K
the 1ourt s ha"e power to appoint a recei"er on the application of
the debent ur e holder or other credit ors. # recei"er will be
appoi nt ed by the 1ourt s.
aB If the principal sum becomes due
bB If default is made in the payment of principal or interest
cB If the company is being wound up, or the winding up is
immi nent
dB If the company is disposi ng of its undert aki ng in "iolation of
the ter ms of the securit y
eB If there are Dudgement s against the company
fB If the securit y is in Deopar dy, i.e. in danger of loss or serious
det eriorati on in "alue. The question whet her the securit y is
in danger is one of fact in each case.
#lthough the court s will be willing to appoint a recei"er whene"er
the securit y of a debent ur e holder is in Deopardy, they will not do so:
aB If the company is not in fault@ and
bB If the asset s of the company realised would be insufficient to
pay the debent ur e holders in full.
Noti ce o A11oi nt me nt
!ection (4* pro"ides that any person obt ai ning a 1ourt order for the
appoi nt ment of a recei"er or manager , or appoi nti ng a recei"er or
manager under a power cont ai ned in the debent ur e or trust deed
must :
aB Hi"e notice of recei"erJ s appoint ment to the 8egistrar within
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
4.C
se"en days aft er the order of appoint ment @ and
bB If such a person ceases to act as a recei"er, he must within
se"en days gi"e the 8egistrar notice to that effect.
!ection *5(A(B imposes an obligation on a recei"er so appoi nt ed,
that he must forthwit h gi"e notice of his appoint ment to the
company.
+osi ti on o #ecei 0er
# recei"er appoi nt ed by the 1ourt s, being an officer of the court, is not a
mer e agent but becomes personally liable on all contract s which he
makes. In his capacit y as a recei"er he takes the cust ody of the propert y
into his own hands for the benefit of the parti es interest ed in it. Where he
sust ai ns any personal losses as a result of perfor mi ng his dut y as a
recei"er, he is entitled to be indemnified out of the asset s of the company
to the ext ent of its asset s, and beyond this he has no right of indemni t y.
# recei"er may borrow money to carry on the business or to preser"e the
company with the sanction of the 1ourt but not for specul ati"e business.
The sum borrowed will rank in priority to the debent ur es. # recei"er
appoi nt ed by the 1ourt s is not bound by the companyJ s contract s unless
he accept s liability by means of a contract of no"ation.
# recei"er appoi nt ed by the debent ur e holders under power in the
debent ur e is their agent , and they are therefore liable on his contract s,
unless the document conferring the power to appoint a recei"er expressl y
stat es that he is to be the agent of the company.
#emunerat i on o #ecei 0er
The remuner at i on of a recei"er may be by the ter ms of the debent ur es or
by the debent ur e holders in accordance with its ter ms. )ut a recei"er
appoi nt ed by the 1ourt s has the amount of his remuner at i on fixed by the
1ourt s. #lthough a recei"er appoi nt ed by the debent ur e holders under
power in the debent ur es has his remuner at i on fixed by agree me nt , the
1ourt s may, on the application of the liquidat or, fix the amount to be paid
by way of remuner at i on to the recei"er. !ection *54A(B.
*eli 0ery o Account s
Where a recei"er or manager of all Aor subst ant i ally allB the propert y of the
company is appoi nt ed either under the power of the debent ur es or the
1ourt s on behalf of the holders of debent ur es secur ed by a floating
charge, the 8ecei"er must send to the company notice of his appoi nt ment
forthwit h, and the company within fourt een days makes out and submi t s
to him Ai.e. the 8ecei"erB a stat e me nt of its affairs.
Within two mont hs aft er recei"ing this stat e me nt , the recei"er must send
to the 8egistr ar and to the 1ourt s Aif he was appoint ed by the 1ourt sB a
copy of the stat e me nt and any comment s he sees fit to make and must
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send to the 8egistrar a summar y of the stat e ment and of his comment s,
and must send to the company a copy of his comment s, and to the
trust ees and all debent ur e holders a copy of the summar y. !ection *5(.
The recei"er must also within two mont hs aft er the end of each year and
within two mont hs aft er he ceases to act as a recei"er or manager , send
to the 8egistr ar and to the trust ees Aif anyB and the company and the
debent ur e holders any abst r act of his recei pt s and payment s during the
rele"ant period.
1ontra"enti on of the aforesai d requirement s render s the recei"er liable to
a fine of one hundr ed shillings for e"ery day during which the default
continues.
</ 8 Bankru1t cy and Insol 0e nc y
aB )ankrupt cy is a legal stat us which a person Anot a companyB
acquires when the court makes an adDudication order agai nst
him. The order effecti"ely depri"es him of the ownershi p of all
his propert y Awith cert ai n exceptionsB and subDect s him to
cert ai n disabilities.
bB Insol"ency refers to the inability of a person Aincluding a
companyB to pay debt s as and when they fall due. =owe"er,
although a debt or may be insol"ent , he is not a bankrupt until
and unless the court adDudges him to be so.
%,Hect s o ,ankru1t cy laws
The principal obDect s of the law relating to bankrupt cy are as follows:
aB To ensur e that the debt orJ s propert y is distribut ed equit abl y among
his creditors. AIn this cont ext equit abl e is not the same as equal@
cert ai n credit ors are entitled to be paid in full before the other
creditors recei"e anyt hi ng from the st at eB.
bB If the court agrees, to grant the bankrupt a discharge, thereby
freeing him from any further liability for past debt s. Aote, !ection
K of the )ankrupt cy #ct pro"ides for the aut omat i c dischar ge of a
bankrupt , at the end of fi"e years from the day he was first
adDudged bankrupt , if he has not obt ained his releas e before then.
cB To exami ne the debt or in order to see if he has commi t t ed any
offence, and to punish him in appropri at e cases. This procedur e is
ther efor e a prot ection for credit ors and other member s of the public
who might subsequent l y ha"e become credit ors.
3ho can ,e made ,ankru1t R
# debt or who:
aB =as commi t t ed or suffered an act of bankrupt cy within the three
mont hs immedi at el y precedi ng the present at i on of a petition
seeki ng to ha"e him made bankrupt @
bB +wes liquidat ed debt Aor debt sB of at least !hs. (,444C ] to the
present erA sB of the petition, such Adebt sB being due both at the
rele"ant act of bankrupt cy and at the dat e of the petitionJ s
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
4.<
present at i on@ and
cB Is domiciled in .enya or, within the year prior to the petition, was
resident or carried on a business Apersonally or through an agent B in
.enya.
+rocedur e s in Bankru1t cy
+rocedur e in %utli ne
The following are the summari s ed st eps in a typical bankrupt cy:
#B #n act of bankrupt cy commi t t ed or suffered by the debt or@
bB 0odgement of a petition Aby a credit or or by the debt or itselfB@
cB The issue of a recei"ing order against the debt or by the court@
dB The appoint ment of the official recei"er@
eB The pri"at e exami nati on of the debt or@
fB 2repar at i on of a stat e me nt of affairs and deficiency account by
or on behalf of the debt or@
gB The first meet i ng of creditors@
hB A+ccasionallyB a scheme of arrange me nt or composi tion
prepar ed by the debt or@
iB The public exami nat i on of the debt or Aunless excused by the
courtB@
DB #n adDudicati on order against the debt or Amaki ng him a
bankrupt B@
kB The appoint ment of a trust ee in bankrupt cy to deal with
bankrupt J s propert y@
lB The trust eeJ s duties, powers and responsi bilities@
mB 2roofs and proxies@
nB The realisation of asset s by the trust ee@
oB 2ayment s to credit ors@
pB The discharge of the bankrupt @
"he %ici al #ecei 0er
aB The official recei"er is appoint ed, remo"ed and controlled by the
1ourt and is an officer of the court to which he is att ached.
bB =e becomes recei"er of the debt orJ s propert y when the
recei"ing order is made. =e also act s as trust ee in bankrupt cy:
i. In small bankrupt cy Aunless the credit ors want someone
else as trust eeB@
ii. during a "acancy in the office of trust ee@
iii. When a trust ee is released@
i". In bankrupt cy proceedi ngs under penal code@
". in the admi nist r ati on of the est at e of a deceas ed insol"ent
Aunless and until credit ors appoint their own trust ee@
"i. In a composi tion or scheme or arrange me nt until a trust ee
is appoi nt ed Aand during any "acancyB.
*uti e s o the oi ci al recei 0er
aB 8egardi ng the debt orJ s conduct . #s and when required by the
court:
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i. To in"estigat e and report to the court on the debt orJ s
conduct Ain order to det er mi ne whet her a dischar ge should
be grant edB@
ii. To take part in the debt orJ s public exami nat i on Awher e
requiredB@
iii. To take part in the prosecuti on of a debt or accused of
fraud.
bB 8egardi ng the debt orJ s est at e:
i. To act as recei"er, tempor ar y trust ee or speci al manager
Awhere one is needed but no one is acting as suchB@
ii. To aut horise the speci al manager to raise moneys or to
make ad"ances, wher e necess ar y@
iii. To summon and to chair the first meet i ng of creditors@
i". To issue and process forms of proxy for use at meet i ngs of
credit ors@
". to report to credit ors on any proposal for a composi tion or
scheme of arrange me nt @
"i. To arrange for ad"erti seme nt s in the .enya Ha:et t e and
local paper s, as and when necess ar y Ae. g. in respect of the
recei"ing order, the first meeti ng of credit ors, and the
public exami nat i onB@
"ii. To act as trust ee Awhere necess ar y to prot ect asset sB@
"iii. To aut hori se, on occasion, the employment of an
account ant Ae. g. to prepar e the debt orJ s stat e ment of
affairsB.
S1eci al !anager
aB # speci al manager may be appoi nt ed:
i. if the debt orJ s business needs a manager @
ii. at the request of a credit or@
iii. by the official recei"er Aat his discretionB.
bB The debt or himself may be the speci al manager , if the official
recei"er considers it in order for him to act@
cB The speci al manager must gi"e securit y as direct ed by the
court@
dB The speci al manager must submi t account s A"erified by
affida"itB to the official recei"er who, aft er appro"ing them,
adds them to his own account s@
eB The speci al manager J s remuner at i on is fixed by the creditors in
gener al meeti ng, or by the court@
fB The official recei"er can remo"e the speci al manager , if he
considers he is no longer needed. The official recei"er must
remo"e the speci al manager if the credit ors so resol"e Aby
speci al resolutionB.
Com1any 2i@ui dat i ons
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
46.
The life of a company may be ter mi nat ed as follows:
aB 1ompul sory liquidations commenced by petition to the court@
bB 6olunt ary liquidations commenced by resolution of the
member s@
cB 6olunt ary liquidations subDect to the court s super"i sion order.
!hares are "irtually absol ut e@
dB 1ompany transferri ng its undert aki ng to anot her company
under a scheme of reconst ruction or amal ga ma t i on may be
dissol"ed by court order without winding up !ec. $4'.
eB # defunct company may be struck off the regist er by the
8egistrar and so dissol"ed without winding up.
0iquidation and winding up mean the same thing. # company cannot be
made bankrupt .
+owers o the 2i@ui dat or
These powers fall into two cat egori es:
Those which he may exercise without sanction and those which require
sanction.
With the consent of 1 of I, the liquidat or may:-
aB )ring or defend any legal proceedi ngs in the name and on
behalf of the company@
bB 1arry on the companyJ s business so far as may be necess ar y for
its beneficial winding- up@
cB #ppoint a lawyer to assist him@
dB 2ay any class of credit ors in full@
eB ,ake compromi se clai ms arrange me nt s with creditors@
fB 1ompromi se clai ms against contributions for unpai d capit al by
the company against any person.
Without consent of 1 of I, the liquidat or may:-
aB !ell and transfer the companyJ s propert y@
bB /o all act s and execut e all document s in the name of and on
cB 2ro"e in the bankrupt cy of any contribut or y@
dB !ign bills of exchange or promi ssor y not es in the name and on
eB 8aise money on the securit y of the companyJ s asset s@
fB #ppoint an agent to do business which the liquidat or cannot do
himself@
gB To do all things necess ar y to wind- up the company affairs and
distribut e the asset s.
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*uti e s o the 2i@ui dat or under the Act and 3indi ng> u1 #ul es
The liquidat or must :-
aB Take all the companyJ s propert y into his cust ody or control as
soon as possibl e@
bB !ettl e a list of contribut ori es, dischar ge its liabilities and
distribut e any surplus amongst the member s@
cB =a"e regar d to any directions gi"en by resolution of creditors or
contribut ori es at a meeti ng or by 1 of I. /irectors of the
credit ors or contribut ori es o"erride those of the 1 of I. =e must
summon meeti ngs of creditors or contribut ori es at such times
as they, by resolution, direct or when request ed in writing to do
so by ten or more of the creditors or contribut ori es@
dB .eep the prescri bed books and subD ect to the control of the
court, allow any contribut ory or creditor to suspect them@
eB !end an account in the prescribed form of his receipt s and
payment s to registrar@
fB 2ay all money recei"ed by him during the liquidation into the
companyJ s liquidation insol"ency ser"ices account @
gB If the winding- up is not compl et ed within a year after its
commence me nt , send to the 8egistrar at the end of that year, a
st at eme nt in the prescribed form concer ni ng the progr ess of the
liquidation@
hB 2ay into Insol"ency !er"ices #ccount all money repres ent i ng
unclai med or undist ribut ed asset s which ha"e remai ned
unclai med or undist ribut ed for six mont hs. Thereaft er, any
person clai ming any part of such moneys may apply to the
8egistrar for an order for such payment .
</ : Current *e0el o1me nt s in Audi ti ng
</ :. Audi t or Inde1e nd e nc e
There has been much debat e recentl y about the issue of audit or
independe nc e. In particul ar the <! !ecuri ti es and -xchange 1ommi ssi on
A!-1B which regul at es in"est me nt , propos es to make audi t or?s
independe nc e a large issue.
Independe nc e is somet hi ng that is bot h a mat er of fact and a mat t er of
appear ance. It is import ant to be independe nt but it is also import ant to
appear to be independent .
In recent year s auditing firms ha"e seen audi ti ng al most as a loss leader,
gi"ing acces s to a client so that the client can be sold all manner of
addi tional ser"ices, all of which are the really lucrati"e ones for the audi t
firm as a whol e. 7inanci al disast er s of -nron and World1om ha"e
concent r at ed the collecti"e professi onal minds on how to deal with the
issues which ha"e been highlight ed by these cases.
</ :63hat is inde1e nd e nc e R
The !-1 has suggest ed four principl es of independe nc e:
#n audi t or may not ha"e a mut ual or conflicting int er est with
the client
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
464
#n audi t or may not audit his own firm?s work
#n audi t or may not function as manage me nt or as an empl oyee
of the audit client
#n audi t or may not act as an ad"ocat e for the audi t client
</ :4 #ul es
To ensur e bot h independe nc e and the appear ance of independe nc e,
rules ha"e been set out in the professi onal bodi es? et hical codes.
Included in the codes are the following mat t er s which impai r
independe nc e.
<ndue depende nc e on an audi t client as a proporti on of fee
income
#ctual or threat ene d litigati on
7amily or other personal rel ationshi p
)eneficial int er est in shar es and other in"est me nt s
)eneficial int er est in trust s
0oans to or from client
The pro"ision of goods and ser"ices or hospi t alit y
The pro"ision of other ser"ices
</ :4 +ro0i si on o Non Audi t Ser0i ce s (ot her ser0i ce s )
The pro"ision of other ser"ices, has pro"ed particul arl y cont ent i ous, and
this is what concer ns us here
)ook keepi ng or other ser"ices relat ed to account i ng records
2repar at i on of financi al st at e me nt s
7inanci al infor mat i on syst e ms desi gn and impl ement a t i on
#pprai sal or "aluati on ser"ices
Internal audi t ser"ices
,anage me nt functions
+bt ai ni ng or ad"ising on human resources
)rokerC deal er ser"ices
1ontingency fee arrange me nt s
Ad0ant a g e s o audi t ors taki ng on non> audi t work
In economi cs ter ms, an ext ensi "e knowl edge of the client will
enabl e the audi t or to offer his or her ser"ices to his or her
client in cont ext which heC she already under st ands .
The audi t or will not need to obt ai n large amount of backgr ound
knowl edge befor e conduct i ng the other work.
*isad0ant a g e s o audi t ors taki ng on non> audi t work
The audi t or will be percei "ed as not being fully independe nt
The audi t or will in many cases be audi ti ng his or her own work
-ffecti"el y much of this kind of other work in"ol"es
manage me nt functions
A&*I"IN-
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2es s on Nine
!ome of the work may effecti"el y in"ol"e acti ng as and
ad"ocat e for the client .
!houl d an audit or act as a tax ad"i ser and negoti at e on behalf of the
client R The current situati on is that most audi t or s do act in this capaci t y
for their client s especi ally in the !,- Asmall and medi um si:edB sect or.
Indeed many small compani es see the audi t or pri marily as a tax
negoti at or and as an audi t or only secondl y. )ut shoul d an audi t or act in
this wayR
The disput e bet ween the )ig 7our account i ng firms and the !-1 is a
bitt er one. #lthough it only rel at es to list ed <! compani es, its resol uti on
will ha"e reper cus si ons around the world. 2art of the probl em is the
concent r at i on of auditing of list ed compani es with a handful of giant
account i ng firms. This means that thes e firms are also the mai n suppli ers
on non- audi t professi onal ser"ices, and the part ner s and st aff of thes e
firms ha"e rest rict ed opport uni ti es for in"est me nt if they cannot in"est in
their client compani es. This topic has recei "ed addi tional att ent i on
recentl y in the <!# and <. as a resul t of the -nron scandal and
#nderson?s.
</ :; Audi t or inde1e nde nc e and audi t st a Hoini ng cli ent
com1ani e s /
1learly, independe nc e is threat ene d wher e audi t st affs Doin a client
company. 7or exampl e, the knowl edge of audi t approach, perhaps
influence o"er, or close relationshi p with, continui ng audi t st aff could be
fact ors which threat en an obDecti"e approach. The le"el of the threat
woul d in part be det er mi ned by the seni orit y of position in the client
company. A7or exampl e, the former engage me nt part ner becomi ng a
client company direct or would present the great es t riskB.
The firm?s independe nc e procedur es shoul d include safeguar ds to ensur e
that obDecti"it y and independenc e is not compr omi s ed and woul d
include:
on- in"ol"eme nt in client audit st aff lea"i ng
1onsider at i on of whet her to conti nue the audit engage me nt
8ot ati on of audi t part nerC st aff on subseque nt audi t s
8equiring a gap period
Gudgment s. +bDecti"it y is the st at e of mind which has regar ds to all
consi der at i ons rele"ant to the task in hand but no other. It
presuppos e s int ell ect ual honest y.
Ad0ant a g e s o an Ethical 7rame workA a11roac h/
It is also import ant to reali:e that the et hical framewor k approach has
ad"ant ages o"er rule based syst e ms . The mai n ad"ant age s are
consi der ed to be as follows:
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
468
It is "irtually impossi bl e for rule based syst e ms to be abl e to deal
with e"er y situati on that may arise.
The onus is "ery much placed on the audi t or to demons t r at e that
each mat t er is properl y consi der ed within the principl es of the
framewor k
# framewor k is mor e appropri at e to changi ng circumst ance in a
dyna mi cs professi on.
8ule based syst e ms can be int erpr et s narrowl y in order to
circum"ent the underl yi ng Vspirit? or int enti on of the rule.
# framewor k approach may include some specific Vprohi bitions? or
rules to deal with cert ai n specific mat t er s.
</ C A&*I" C%!!I""EES (Introduct i on to Audi t Commi t t e e s and
the #eas ons or thei r -rowt h)
a) "he rol es o an audi t commi t t e e mi ght incl udeB
I To re"iew the companyJ s financi al st at eme nt s prior to their
submi ssi on to the board@
I To re"iew the scope and planning of the audit@
I To re"iew the findings of the independent audit or@
I To ascert ai n whet her the accounti ng and reporting policies of the
company are in accordance with legal requirement s and best
practice@
I To keep under re"iew the effecti"enes s of the companyJ s syst ems
of accounti ng and control@
I To make recomme ndat i ons to the board concer ni ng the
appoi nt ment and remuner at i on of the independent audit ors@
# particul ar role is to assist in the communi cat i on process bet ween
the board and the audit ors throughout the medi um of the non-
executi"e direct ors and it pro"ides a useful way of assisti ng the latt er
in the discharge of their duties.
,) "he ,ene i t s may incl ude
I helping direct ors to meet their legal responsi bilities. 6ery often
main boards spend "ery little time on re"iewing the financi al
stat e ment s. #n audit commi t t ee could spend the time on
compl eti ng this task in dept h@
I enabling non- executi"e direct ors to become deepl y in"ol"ed in the
companyJ s affairs@
I the audit commi t t ee can re"iew the financi al st at eme nt s
obDecti"ely. This may impro"e the quality of financi al reporting
and impro"e public confidence@
I The audit function may become mor e independent as there will be
a quasi- independent body bet ween the board and the auditors. It
may paradoxically impro"e communi cat i ons bet ween auditor and
board@
I Impro"ement in the quality of the accounti ng and auditing
functions. # continuous re"iew of the functions of financi al
manage me nt and internal and ext er nal audit will ine"it abl y result
in higher st at us to the practitioner s and superior perfor mance.
A&*I"IN-
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2es s on Nine
c) Some o the argume nt s agai ns t the ormat i on o Audi t
Commi t t e e s
I #udit commi t t ees would split the board@
I #udit commi t t ees would pre- empt Aand hence delay the comi ngB of
two- tier boards Awhich is the -uropean practiceB@
I #udit commi t t ees would creat e conflicts within compani es@
I #udit commi t t ees would encroach on manage me nt J s
responsi bilities@
I #udit commi t t ees would be a talking shop with no real power@
I There are not enough non- executi"e direct ors@
I #udit commi t t ees would take too much time and cost too much@
I #udit commi t t ees would be least effecti"e in compani es which
need them most Ae. g. compani es domi nat ed by ambitious and
unscrupul ous entrepr eneur sB.
I The production of financi al stat e ment s may be delayed.
d) *et ai l ed mat t er s to ,e consi der e d ,y the Chairman o a new
audi t commi t t e e
I -nsuring the commi t t ee has the full backing of the board@
I The precise constit ution and program of the commi t t ee@
I #dequat e resources Asecret ari al, communi cati on, time etc must be
made a"ailabl eB@
I The correct number of member s. Three to fi"e is probabl y
opti mal@
I ,ember shi p - probabl y but not essent i ally non- executi"e@
I =is own role as chair man@
I The frequency of meet i ngs@
I The est ablishment of agendas@
I The est ablishment of admi ni st r ati"e arrange me nt - calling
meeti ngs, in"ol"ing other peopl e, audit ors, manager s etc. taking
minut es@
I The dissemi nat i on of findings to the offers responsi bl e for changes
consequent upon the findings.
I The relationshi ps required with the main board, ext ernal audit,
internal audit, financi al manager s etc.
I any publicity requirement s.
</ D *e0el o1me nt in the &S
In the <! the !arbanes +xley #ct A$44$B has been enact ed. This
att e mpt s to addr es s many aspect s of audit or independenc e and
corpor at e go"er nance issues. 7or exampl e it places rest rictions on the
nat ur e of non- audi t ser"ices that can be perfor med by h audit ors and
also require that the audit commi t t e es appro"e any allowed additional
ser"ices.
</ < *e0el o1me nt s in the &K and other count ri e s /
ew meas ur es for the <.?s account ancy professi on, ai med at pre"ent i ng
-nron- styl e financi al scandal s, ha"e been announced by the
go"er nme nt . The propos al s include a new, singl e regul at or go"er ni ng
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
46C
account i ng st andar ds, and limit s on how long audit ors can work on the
account s of one company.
!enior audi t or s will not be allowed to spend mor e than fi"e year s
working on a singl e company?s books
ew "olunt ar y rules will stop part ner s and senior empl oyees of
audi t firms mo"i ng to Dobs with the compani es they ha"e audit ed
for two year.
# singl e regul at or go"er ni ng account i ng and audi ti ng st andar ds
will also be creat ed
The code on corpor at e go"er nance of list ed compani es would be
strengt hene d requiring that half of boar d member s and the
chair man shoul d be independe nt
</ .5 "he Cons ul t anc y and Audi ti ng +ro e s s i on
Tiers in the 2rofessi on. The audi ti ng professi on is currentl y seen as
ha"i ng three layer s or tiers:
The )ig 7our Apre"iousl y the )ig 7i"e before -nronLB int ernat i onal
firms
The second tier P small er firms which ha"e numer ous branches
and int er nat i onal connect i ons
The small firms
The great maD orit y of list ed company audi t s are conduct ed by the )ig
7our with the remai nder conduct ed by the second tier. The
concent r at i on of the market into "ery large firm has come about becaus e
of the growt h of globali:ati on in world market s e"er ywher e. #s a resul t
audi t firms ha"e to ha"e the resour ces and exper ti se to oper at e in e"ery
count r y and ha"e to know how to audit highly regul at ed moder n
busi ness e s. The larger firms found that amal ga ma t i ons amongs t the
audi t firms were the way forwar d and as a resul t the world audit market
is now concent r at ed in "ery few firms.
There are clearly benefit s to this as these firms ha"e exper ti se and global
facilities and can in"est in expensi "e syst e ms and the neces s ar y
Informat i on Technol ogy to meet their int ernat i onal client s? needs. The
disad"ant a ge s are the lack of compet i ti on and choice particul arl y for
large compani es.
Hlobali:ati on of busines s is now est abli shed fact and local fact ori es, shop
and ser"ice organi :at i ons in many count ri es are likely to be foreign
owned or cont rolled. The probl em with global busi nes s es is that they
oper at e in widely different legal and et hical syst e ms . +nly the large
audi t firms can acquir e the global exper ti se to handl e such audi t s.
</ .. "he 7uture o the +ro e s s i on
1urrent trends are still towar ds mor e mer ger s bot h of firms in the
count ri es wher e the professi on is mor e highly de"el oped, for exampl e
<!# and many -uropean count ri es with firms in o"erseas locati ons.
#nother trend is the debat e about audit firms offering other ser"ices and
the trend may be for audit firms to di"est thems el "es of such
A&*I"IN-
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2es s on Nine
consul t ancy ser"ices. # possi bl e scenari o is for firms to offer only a
relati"el y limit ed range of ser"ices such as auditing, account i ng and
taxat i on. A!ome firms ha"e already sold off their consul t ancy ser"icesB.
</ .6 +art ners hi 1 or Incor1orat i on
In the past account i ng firms were always sol e trader s or part ner s hi ps.
The mai n reason for this form of tradi ng was the requireme nt for
unli mi t ed liability. 7irms who damage their client s in any way may ha"e
damage s awar ded agai nst them and all the part ner s in the firm are then
Dointly and se"er all y liable up to the limit of their personal est at es.
This liability still exist s in many count ri es and is a subst ant i al worry to
the professi on.
2ossi bl e alt er nat i "e forms of tradi ng for audi t firms are as follows:
!ole tradi ng for the one man band
Hlobal part ner s hi ps
0ocal part ner s hi p with a loose connect i on bet ween them but
shari ng exper ti se, syst e ms and the name
0imit ed part ner s hi ps
Incorpor at i on as compani es but with unli mi t ed liability
0imit ed liability company
7ew firms ha"e as yet opt ed for incorpor at i on. In the <. the 0imit ed
0iability 2art ner s hi p #ct recei"ed the royal assent in $444 and is now
law. 2robabl y many firms will regist er under this st at ur e A.2,H ha"e
already done soB. 8egist r at i on under this st at ut e gi"es firms the
organi :at i onal and tax flexibility they need and also limits liability to
some ext ent . If a member of the firm is negligent and has to pay
damage s then the 002 is fully liabl e as well as the member . 7urther the
negligent member may be required to cont ri but e to asset s up to the limit
of his est at e but other member s are not so liabl e unl ess they agr ee to
be.
</ .4 Inormat i on "echnol ogy and the Audi t or
</ .4/ . Audi t Aut omat i on
#utomat i on and rapid de"el opme nt s are affecti ng all aspect s of life and
the audi ti ng professi on is no excepti on. Whilst the essent i al proces s of
the audit is the same the comput eri :ed techni ques and soft war e
a"ailabl e to the audi t or ha"e de"el oped significantl y.
<seful packages include the following:
7ile int errogat i on packages, e. g. sear ch sal es ledger
#udit progr amme gener at or s
1hecklist softwar e
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
46<
!preads he et s for calcul ati ons, listings etc
Word process or s to gener at e docume nt s and store audi t working
paper s and report s
8elational dat abas e s
8eference infor mat i on o"er the int er net P all regul ati ons and rules
go"er ni ng auditing and account i ng can be searched
!yst e ms document a t i on
8isk anal ysi s softwar e
Trial bal ance process or s
Time manage me nt soft war e
</ .4/ 6 7il e Int errogat i on so t war e
7ile int errogat i on softwar e has been around for a long ti me. Its principal
uses include the following:
Totaling and subt ot ali ng files
!tratifying and anal y:i ng files
8e- perfor mi ng calcul ati ons
2roduci ng except i on report s
/et ecti ng gaps or duplicat e ent ri es
!electi on of audi t sampl es includi ng monet ar y unit sampli ng
1ompari son of infor mat i on on separ at e comput er files
,ultiple file format handling, so that client files writt en in different
format s can still be worked.
</ .4/ 4 Aut omat i ng +rocedur e s
There are ob"ious benefi t s in aut omat i ng audi t procedur es and these
7iles are kept in a mor e compact form
!yst e ms desi gned for opti mal auditing are adher ed to by audit
st aff
#utomat i c gener at i on of audi t plans, progr amme s , schedul es and
procedur es
Inst ant a"ailability of infor mat i on on a wide range of audi t relat ed
subD ect s
The creati on of dat a for audit exami nat i on or anal ytical re"i ew that
is not readily a"ail abl e from client s recor ds
!a"ings due to mor e efficient working
)ett er compli ance with audit firm procedur es and I!#s
)ett er 2ublic 8elations as client s expect and demand that their
audi t or s are up to dat e and efficient
7reei ng audit personnel to think rat her than mer el y to go through
procedur es
1reati on of net works so that online super "i si on becomes possi bl e
8apid shari ng of infor mat i on
#s indicat ed abo"e ther e are many benefit s in aut omat i ng audi t
procedur es. =owe"er aut omat i on also brings probl ems. Increas ed
aut omat i on Aadded to the need for firms to be compet i ti "eB may reduce
the le"el if trained and experi ence st aff used on the audit ther eby
increasi ng the risk of errors not being det ect ed. 7urt her mor e ther e is
A&*I"IN-
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2es s on Nine
also a danger that aut omat i on may resul t in a Vst andar d? approach to
audi t work being followed rat her than being tailored to the busi ness
audi t ed.
</ .; IA+S .5.4 Electroni c Commerc e Q Eect on the Audi t
7inanci al Stat e me nt s
"hi s IA+S was issued in $44$ and this new guidance responds to the
increasi ng use of the int ernet for busi ness to consumer busines s to
busi ness, busines s to go"er nme nt and busines s to empl oyee e1ommer c e
and how emer gi ng new element s of risk need to be consi der ed when
planni ng and perfor mi ng the audi t of financi al st at e me nt s . This new I#2!
helps audit or s addr es s e- commer ce issues by focusi ng on, among other
mat t er s the le"el of skills and knowl edge requir ed to under st and the
effect of e- commer ce on the audit@ the busi ness, legal, regul at or y and
other risk faced buy entiti es engaged in e- commer ce acti"iti es@ int ernal
cont rol consi der at i ons, such as an entit y?s securit y infrast r uct ur e and
trans act i on int egrit y@ and the effect of elect roni c on audi t e"idence.
</ .8 "he 7uture o Audi ti ng
There are many factors that are continually causi ng changes in the
auditorJ s approach to his work. !ome of these relat e to the nat ur e of
the ser"ice that the auditor pro"ides while other s reflect ext ernal
demands on the role of the audit or in societ y. !ome ha"e already
been mentioned but are included here for compl et enes s:
aB 1hanges in reporti ng obDecti"es and the introducti on of
accounti ng and auditing st andar ds@
bB The increasi ng compl exit y of the business unit, e. g.
conglomer at es and multinati onal compani es@
cB The widespr ead use of elect ronic dat a processi ng and, in
particul ar, of real time, dat a base syst ems and microcomput er
syst ems@
dB Increased go"ernment awar enes s of the professi on exemplified
by the increasi ng number of account ant s in the 1i"il !er"ice.
eB The increased responsi bility that account ant s bear towards third
parti es, as a result of such cases as Geb 7ast ener s 0imited ".
,arks )loom and 1o.
fB The reaction of client s to alar mi ng increas es in audit fees. This
has prompt ed many account ant s to feel that it is essenti al that
the profession de"el ops new ways of increasi ng the efficiency of
audit work, and may well lead to great er use of st ati stical and
other anal ytical re"iew techni ques.
gB Increased public awar enes s and criticism of the auditing
profession, resulting in the -thical Huidelines.
hB The de"elopment of public sect or auditing beyond the
traditional role of reporti ng on financi al stat e ment s in ter ms of
trut h and fairness, into the real ms of meas uri ng economy,
efficiency and effecti"enes s of an entit y - so called J"alue for
moneyJ auditing.
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
44.
E&ES"I%N %NE
AaB What is a "alue for money auditR
AbB What are the rele"ant st at ut or y pro"isions with regar d to
in"estigations by the 8egistrar of 1ompani esR
E&ES"I%N "3%
Qou are a part ner in a firm of 1ertified 2ublic #ccount ant s and a member
of the local golf club. +ne day whilst at the club you are approached by
anot her club member , Games )ryden, who seeks your professional ad"ice.
Games has the opport uni t y of acquiring a one- third shar e in the part ner shi p
business of ,essrs 0ong, Tall and !hort. #t present these three
gentl emen are equal part ner s but as 0ong is due to retire. ,essrs Tall and
!hort would like someone to take o"er 0ongJ s shar e of the part ner shi p.
The firm which has been in business o"er twent y years speci alises in the
ret ailing of car accessori es. #fter ha"ing a brief discussi on with Games it is
agreed that you will act for him.
#e@ui red
/escribe the procedur es you will adopt following your initial discussi on.
E&ES"I%N "$#EE
Qou are the audit or of 8oaches 1oaches 0td. Qou ha"e been asked to
re"iew the manage me nt and account s of 8oaches 1oaches 0td for the
ele"en mont hs ended *4t h o"ember (';5, which the company intends to
submi t to its banker s before *(st o"ember (';5 in support of an
application for further facilities to fund the increasi ng working capit al
requirement s of the company and the replaceme nt of half of its fleet of $%
coaches. In the past it has been the companyJ s policy to repl ace %
coaches e"ery year, with proceeds on disposal usually equati ng to half of
the original cost. /uring the last three years no coaches ha"e been
replaced due to lack of funds.
The companyJ s turno"er for the current year is expect ed to be in the
region of S544, 444 and consist s mainly of contract hire. The coaches are
housed and maint ai ned in the companyJ s own freehol d garages and
workshops.
#e@ui re me nt s
AaB +utline the approach you would take to carry out the re"iew, and
stat e those mat t er s to which you would pay particul ar att enti on.
AbB !tat e the ext ent to which such a re"iew will ha"e an effect on the
stat ut ory audit for the year ending *(st /ecember (';5.
A&*I"IN-
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2es s on Nine
E&ES"I%N 7%&#
AaB 1ritically, exami ne the following stat e ment :
OIn"estigati on is a critical exami nat i on of records and is,
therefore similar to an auditO.
AbB What precauti ons are necess ar y before undert aki ng an
in"esti gati onR !tat e the procedur e that you would adopt in an
in"esti gati on on behalf of a bank proposi ng to ad"ance a loan to a
pri"at e limited company.
("ot al B 65!arks )
C$ECK (%&# ANS3E#S 3I"$ "$%SE -I'EN IN 2ESS%N .5 %7 "$E
S"&*( +ACK
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
444
C%!+#E$ENSI'E ASSI-N!EN" No/ ;
"% BE S&B!I""E* A7"E# 2ESS%N <
*ist anc e 2earni ng Admi ni s t rat i on or marki ng ,y the &ni 0ersi t y/
E&ES"I%NS/
E&ES"I%N %NE
# regist er ed charity, constit ut ed as a trust , has recentl y commenced
oper ati ng in airobi to pro"ide accommodat i on and other social ameni ti es
to elderly citi:ens.
The charit y has been grant ed a licence by the 1ity 1ommi ssi on to occupy
a social centr e free of charge, although all mai nt enance and running cost s
are to be borne by the charit y.
The charity recei"es income from the following sources:
i. /oor- to- door collections by "olunt eer s with boxes@
ii. /onations in the form of cheques and cash mai nt enance
recei"ed through the post al syst em@
iii. /onations under deeds of co"enant ent er ed into by indi"idual s@
i". =arambee fund raising e"ent s organi sed from time to time@
". !ales of refreshment s at the social centr e.
In addition, some local business es ha"e donat ed equipment and
maint enance mat eri al s to the charit y.
The trust ees ha"e appoi nt ed you as auditor of the trust.
Qou are required to write a formal lett er to the trust ee set ting out:
AaB The controls o"er the abo"e income which you would expect the
trust to oper at e, and
AbB Those aspect s which could gi"e rise to problems in reporting in
Otrue and fairO ter ms without qualification.
(65 !arks)
E&ES"I%N "3%
!tylus is a medi um si:ed list ed engi neeri ng company with sal es re"enues
of .shs ($ million and a workforce of (54 empl oyees. 7ra:er and
1ompany ha"e been the audit ors of !tylus for four year s. !tylus is one of
a number of client s that ha"e been refer eed to 7ra:er and 1ompany by
1oult ar d )ank. The bank recei "es a commi s si on from 7ra:er and
1ompany of (4T of the first year?s audit fee for thes e referr al s.
/uring the earl y st ages of the final audit for the year ended *4
!ept e mber $4x' the following issues arose:
Taylor, a publicly list ed company, is a maker cust omer of !tylus. #t *4
A&*I"IN-
44;
2es s on Nine
!ept e mber $4x' the work in progr es s and trade recei"abl es of !tylus
cont ai ned .shs(. $ million and .shs944, 444 respect i "el y relati ng to
cont r act s with Taylor. 7ra:er and 1ompany are also audi t or s of Taylor
and acti ng in this capaci t y, they are awar e that Taylor is in se"er e
financi al difficulti es and will be unabl e to carryon tradi ng much longer.
#s a consequence it is likely that Taylor will not be abl e to pay the
amount it owes to !tylus nor be abl e to accept the work that it has on
order and currentl y in progr ess with them. The mat eri alit y of the abo"e
amount is such that the losses that !tylus shoul d sust ai n may put its
going concer n st at us in doubt .
<ntil "ery recentl y !tylus had not paid the audi t fee and expens es for the
year ended *4 !ept e mber $4x9. #n associ at ed company of the practice,
V7ra:er 1onsul ti ng?, pro"ides most of the st aff of the int ernal audi t
depar t me nt of !tylus in a consul t ancy capaci t y. #gain a consi der abl e
amount of fees for this work were unpai d. In "iew of the possi bility that
!tylus may itself soon be in financi al difficulties, the part ner s of 7ra:er
and 1ompany had insist ed that before any further work was under t aken
all amount s due to the practi ce must be paid toget her with a payment on
account for the current year. # si mil ar action was taken by the direct or s
of 7ra:er 1onsul ti ng. )anker s draft s wer e obt ai ned from the direct or s of
!tylus and thes e wer e present ed to the bank for Vspeci al clear ance?.
/ue to its speci alist knowl edge, 7ra:er and company ha"e a number of
client s in the proper t y letting sect or. The fee income from one particul ar
client is a significant proporti on of the tot al practi ce income. 7ra:er and
company is in explor at or y mer ger talks with )radl ey and company, a
si mil ar si:ed audi t firm. <nfort unat el y anot her of 8a:er and company?s
client s, Toddy 2roper t y ,anage me nt , recent l y went into recei"er shi p
aft er specul ati "e in"est me nt s made by the direct or s, using client s?
money result ed in huge losses. The recei"er of Toddy 2ropert y
,anage me nt has appoi nt ed )radl ey and 1ompany to in"esti gat e the
collapse and in particul ar the role of the audit or, 7ra:er and company.
#e@ui red
AaB /escribe the et hical issues and probl ems in relation to:
AiB The audit of !tylus, and
A9 marksB
AiiB The propos ed mer ger of 7ra:er and company with )radl ey and
company A5 marksB
AbB #s the audit or of !tylus, descri be the work you woul d perfor m and the
action you woul d take in regar d to the work in progr es s and account s
recei"abl e of !tylus which relat e to Taylor
AK marksB

E&ES"I%N "$#EE
The est ablishment of audit commi t t ees to act as a liaison bet ween the
ext ernal audit ors and the board of direct ors is widespr ead in orth
#merica. It would be a "ery good idea to introduce similar audit
commi t t ees here in .enya.
#e@ui red
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
448
/iscuss the case for and agai nst the est ablishment of audit commi t t ees.
(65 !arks)
E&ES"I%N 7%&#
!aidia ,asikini /e"elopment #gency A!,/#B had been funding proDect s in
.enya since independence. The proDect s support ed by !,/# are those
which the #gency considers most beneficial to the less ad"ant aged social
groups. ,ost of !,/#Js proDect s are locat ed in rural areas although some
are based in urban centr es.
2roDect s are managed by locally recruit ed staff support ed by one or two
expat ri at e technical ad"isers. The Ho"ernment of .enya is in"ol"ed in the
proDect s through the /istrict /e"elopment 1ommi t t ees and the rele"ant
,inistries.
8ecentl y !,/# compl ai ned to the host Ho"ernment about the millions of
shillings of proDect funds which it A!,/#B suspect ed were being siphoned
out of the proDect s. #fter consult ati ons, it was decided that an
independent firm of auditors be appoint ed to probe !,/#Js allegati ons.
The auditors were appoi nt ed and ter ms of reference agreed on.
Qou are re@ui red as the auditor in charge of this assignment , to stat e in
det ail the procedur es you would undert ake in in"estigati ng the allegations
made by !,/#.

(65 !arks)
E&ES"I%N 7I'E
Qou ha"e been approached by a firm of stockbroker s to prepar e a report
for a prospect us for a pri"at e company, which is about to issue shares to
the public.
Qou are required to:
AaB /et ail the rele"ant financi al statistics on which you will need to
report and
AbB /escribe the rele"ant aspect s and items shown in the financi al
stat e ment s during the pre"ious fi"e years that may require
amendme nt for the purposes of your report.
EN* %7 C%!+#E$ENSI'E ASSI-N!EN" No/ ;
N%3 SEN* (%&# ANS3E#S "% "$E *IS"ANCE 2EA#NIN- CEN"#E
7%# !A#KIN-
A&*I"IN-
44:
2es s on "en
2ESS%N "EN
#e0ision aid
C%N"EN"S
KASNEB syll a,us
.) !odel ans wer s to rei n orc e me nt @ues t i ons
0esson (
0esson $
0esson *
0esson %
0esson 5
0esson &
0esson K
0esson 9
0esson '
6) Sel ect e d 1ast 1a1ers
/ecember (''K
Gune (''K
/ecember (''&
Gune (''&
4) Answer s to 1ast 1a1ers
/ecember (''K
Gune (''K
/ecember (''&
Gune (''&
%B ,ock exami nati on paper s
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
#e0i si on Aid
44C
S(22AB&S
+A+E# N%/ .C/ A&*I"IN- AN* IN'ES"I-A"I%NS
A&*I"IN- AN* IN'ES"I-A"I%NS
%B=EC"I'E
To ensur e that the candi dat e has compet ence in the auditing of public
and pri"at e instit uti ons and to carry out audit in"esti gat i ons.
S+ECI7IC %B=EC"I'ES
# candi dat e who pass es this subD ect shoul d be abl e to:
/escri be the professi onal and legal framewor k within which
audi ti ng is practiced
2lan and execut e all types of audit s
2repar e and anal y:e compr ehe nsi "e audit report s
2repar e all speci ali:ed report s required of an account ant .
C%N"EN"
+ro e s s i o nal and 2egal *e0el o1me nt
#ccounti ng st andar ds and the audi t or
#udit st andar ds and guidelines, comme nt s and re"iew
#uditors professi onal et hics and disciplinar y procedur es
#uditor?s independenc e
0egal liability of audi t or s.
!truct ur e of audi t report s
The cost- benefit anal ysi s of an audi t
#uditing beyond the financi al st at e me nt s
Control s and !oni t ori ng Sys t e ms
1ontrol s and the de"el opme nt of comput er technol ogy@
Impact of de"el opme nt in infor mat i on technol ogy on the audit or,
auditing techni ques, cont rol s within a comput eri :ed account i ng
syst e m
The utili:ation of an int ernal audit depar t me nt
#udit commi t t e es
Impact of cont rol s and infor mat i on technol ogy on sufficiency,
rele"ance and reliability of audi t e"idence.
Audi ti ng o 7inanci al St at e me n t s
!ampli ng and risk asses s me nt of e"idence from financi al
st at e me nt s
#udit of asset s, liabilities and equiti es
#udit of profit and loss items
#udit of group account s
2ost bal ance sheet audi t s.
#udit #pproach of !peci alised +rgani:at i ons
)anks, financi al instit uti ons, building soci eti es, insur ance
compani es and hire- purchas e compani es
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1hariti es and no- profit maki ng organi:at i ons
1o- oper at i "e soci eti es, public aut hori ti es and local aut hori ti es
!mall busi nes s es? audi t s
2ensi on sche me s
Account i ng #e1ort s
<naudi t ed financi al st at e me nt s
8eport s on prospect us e s
Interi m and profor ma financi al st at e me nt s
Tax certificat es
Audi t In0es t i g at i o ns
,eani ng and import ance of audi t in"esti gat i ons
Types: Interest acqui si tion audit s@ 7raud and error in"esti gat i ons@
,anage me nt audit s@ 2rofessi onal tasks under t aken on behalf of
st at ut or y aut hori ti es such as 8egist r ar of 1ompani es, 1ontroll er
and #uditor Hener al and #uditor Hener al
A1orpor ati onsB.
#ecei 0er s hi 1 and 2i@ui dat i ons
#uditors responsi bilit y in recei "er shi ps and liquidati ons
!truct ur e and cont ent s of report s
-thical issues in recei"er shi p and liquidati ons.
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!%*E2 ANS3E#S "% #EIN7%#CIN- E&ES"I%NS
2ESS%N .
E&ES"I%N %NE
a. The duti es of an auditor of .... 0td, as for all compani es are set out
in the 1ompani es #ct as:
i. To make a report to the member s of .... 0td. on all account s
exami ned by him and laid before the company in gener al
meeti ng, stating whet her the account s:
o Hi"e a true and fair "iew
o =a"e been properly prepar ed in accordance with the
pro"isions of the 1ompani es #ct.
ii. To in"esti gat e, and form an opinion on, whet her:
o 2roper accounti ng records and returns ha"e been kept
o The account s are in agreeme nt with the accounti ng records
and returns. =e must report if either of these are not so and
also if he fails to recei"e all the explanat i ons and informati on
which he requires.
iii. The 1ompani es #ct requires that the auditor gi"es cert ai n
informat i on on the remuner at i on of and other transacti ons of
the company other transacti ons of the company with the
direct ors, if these are not gi"en in the #ccount s.
In addition the auditor must compl y with the #uditing !tandar ds
appro"ed by his professional body.
The direct ors can add to these duties with the agreeme nt of the
auditors but cannot reduce them.
b. There is no st at ut ory or #uditing !tandar d relationshi p prescribed
bet ween audit ors and direct ors. The audit or has prescri bed
relationshi p with the company and in the reporti ng sense with its
member s.
In practice the auditor has to est ablish modus "i"endi with the
direct ors.
c. The auditors right s include:
i. #ccess at all times to the books, account s and "oucher s of the
company.
ii. 8ight to such informati on and explanat i ons as he thinks
necess ar y for the perfor mance of his duties.
iii. To recei"e notice of, att end and speak at meeti ngs of the
member s.
i". To report in his report to the member s.
". To be informed of and make prot est at i ons in any att empt to
unseat him.
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d. In theory, the direct ors ha"e no aut horit y to dismi ss an auditor.
=owe"er, in practice, a resolution put to the company to dismi ss the
auditors will often be passed becaus e of the passi"e attit ude of
sharehol der s. In most small compani es, the direct ors and
sharehol der s are the same peopl e.
e. The following steps shoul d be taken:
i. /iscuss with the board the role of the auditor as outlined in the
1.#ct and make sure that an appoi nt ment can be made by the
member s with all parti es fully knowl edgeabl e about all the
fact s.
ii. /et er mi ne whet her appoint ment as auditor to .... 0td will
infringe legal or ethical requirement s and whet her there are any
practical reasons for non- accept ance.
iii. #gree a lett er of engage me nt with the direct ors.
E&ES"I%N "3%
a. ,att ers rele"ant to the credibility of the audit or Aother than
independence include: N
Com1e t e nc e / #n audit or must be a good account ant and auditor
and must be compet ent at accounti ng, auditing syst ems, and
informat i on technol ogy and he must be able to communi cat e.
=udge me nt / #n auditor must be able to make sound Dudgement s,
not only in professional mat t er s but also of peopl e.
Int egri t y/ #n audit or must be, and be seen to be, honest , a follower
of the ethical code of his professional body, a man of discretion and a
manC woma n awar e of hisCher wide responsi bilities.
The professional bodi es ha"e taken or might take the following st eps
to secur e these qualities in auditors:
i. 8equirement of "ery compr ehensi "e exami nati ons for entry into
the professi on Aas you knowLB
ii. Introducti on of a requirement for a good gener al educati on
before entry into training.
iii. 8equirement of a mini mum period of practical experi ence
before qualifying.
i". 8equirement of a mini mum period of public practice experi ence
before a practi sing certificat e is gi"en Aan account ant cannot be
an auditor without a practi sing certificat eB.
". Issue of .#!s to refine the concept of Otrue and fairO.
"i. Issue of auditing st andar ds and guidelines.
"ii. Issue of ethical guidelines.
"iii. Issue of guidelines in many other areas.
ix. Issue of maga:i nes and other technical literat ur e.
x. # post qualification educati on programme.
xi. -xist ence of in"estigation and disciplinary commi t t ees.
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b. The following comment s can be made in these cases:
i.
o The audit part ner hold no shar es in the client.
o The audit manager holds (T of the shar es in #ndrew 0td
Aimmat eri al in the cont ext of #ndrew 0tdB but possibly "ery
mat eri al to the audit manager .
o The audit manager may wish to enhance or pre"ent a decline
in the "alue of his shar es by o"erlooking some lapse of trut h
and fairness in the account s.
o It would be desirabl e for anot her audit manager to manage
this audit or for the audit manager to sell his shar es.
ii.
The audit part ner is not the reporti ng part ner for Games 0td.
The personal friend concerned is not a direct or.
2ersonal relationshi ps bet ween audit or and manage me nt
personnel are undesirabl e but ine"it abl e.
!o long as the audit part ner concerned does not audit Games
0td, all is well.
iii.
The ethical guidelines suggest (5T as the maxi mum
fee from any one client but this is for guidance only
and the precise circumst ances must be looked at in
maki ng a Dudgement .
This fee is (%. $T
The firm will be "ery reluct ant to lose this fee income
and obDecti"ity must be assiduousl y guarded at all
times.
i".
This is clearly of negligible import ance to the )ank.
It might be of mat eri al import ance to the audit senior.
It would not compromi se or appear to compromi se the
audit seniorJ s independence if the ter ms of the loan
were ordinary commer ci al ter ms eg. if the senior had
not recei"ed a speci al interest rat e.
".
This is a case of conflict of interest . In assisti ng =arry
Ausing ine"it abl y, confidenti al knowl edge of GeanB Gean
may be preDudiced as =arry may not be the opti mal
supplier.
The firm shoul d not ad"ise =arry 0td.
=arry 0td should be told the position and ad"ised to
seek professional assist ance from anot her firm. The
audit part ner could no doubt suggest a firm who would
not poach the audit.
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E&ES"I%N "$#EE
#. 1ommi ssi on. ,any account ant s recei"e commi ssi ons from financi al
institutions as building societi es and insurance when client s act on
their ad"ice. It shoul d be seen that any ad"ice is in the best interest
of the client. The client should be informed in writing that
commi ssi on will be recei"ed and as far as possibl e what ter ms.
). 1onflicts of Interest
1onflicts of interest can arise bet ween an account ant and his client.
#s we ha"e seen, it may pay the account ant to place a clientJ s
insurance with an insurance company that gi"es a (5T commi ssi on
rather than one that pays only (4T and charges lower premi um.
1onflicts of interest can also arise bet ween a client and anot her
client, and an account ant should not act for both parti es if the parti es
are in disput e. 7or exampl e the account ant may be called upon to
ad"ise two client s who are tenderi ng for the same contract . +r he
may be ad"ising a company and one of its direct ors who are in
disput e. In all such cases the account ant shoul d not accept
assignment s where he is put in a position wher e he must ad"ise bot h
sides. +ne the other hand he may well be able to put forward
proposal s to set tl e the disput e.
!pecific exampl es of conflicts of interest include:
(. 2ro"ision of other ser"ices to audit client s. It is cust omar y for
auditors in many cases to pro"ide other ser"ices as well as the
audit, for exampl e prepari ng account s. This is perfectly
accept abl e pro"iding the ser"ice does not in"ol"e perfor mi ng
executi"e functions or maki ng executi"e decisions. 7or exampl e
discussi ng the annual di"idend decision with the board would be
an executi"e action and hence unaccept abl e.
$. 2repar ati on of accounti ng records. 1are should be taken that
the client takes responsi bility for the work done and that
obDecti"ity in auditing is not impaired. The accounti ng records of
public company client s should not be prepar ed by the auditor.
*. # practice should not report on an audit client if a part ner or
member of staff is an officer of the company. This enlarges on
the 1ompani es #ct requirement in prohibiting employees of a
practice from being officers of audit client s.
%. o person in an accounti ng firm should take part in the
reporti ng function Ai.e. take part in the auditB if he or she has in
the accounti ng period or in the pre"ious two years been an
officer or empl oyee of that company.
5. 8ecei"ershi p, liquidation and audit s. In gener al audit ors shoul d
not accept recei"ershi p or liquidat orshi p of client compani es
without a two year gap bet ween the assignment s. 1learly a
liquidat or of a company would be inhibit ed from taking a
negligence action against the audit or if he had himself been the
auditor.
1. 8estrictions on ad"erti sing include:
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(. The ad"ert should not reflect ad"ersel y on the ad"erti ser, his
professi onal body or on the profession. 7or exampl e, it should
not be "ulgar.
$. The ad"ert should not discredi t the ser"ices offered by others or
clai m superiority o"er other firms.
*. The ad"ert should not be misleadi ng, either directly or by
implication. 7or exampl e, implying that the firm is large when it
is, in fact, small.
%. The ad"ert must not fall short of the requirement s of legality,
decency, honest y and trut hfulness.
5. The compet i ti"enes s of firms shoul d be maint ai ned despit e
differences in financi al resources. To that end, ad"ert s shoul d
be intended to inform not impress.
&. #d"ert s may refer to the basis on which fees are calculat ed.
=owe"er, no hourly or other charging rat es are per mi ssi bl e.
/. -xampl es of accept abl e publicity include:
o #d"ertising for staff, or part ner s for sub- contract work
o #d"ertising on behalf of a client
o 2ublishing the openi ng of new premi ses, of a new
part ner shi p, etc.
o -ntries in a direct ory
o 2ublishing literat ur eNmany firms produce a guide to the
budget . !uch literat ur e can be sent to client s, business
cont act s Ae.g. banker s, solicitorsB or other s who ask for it, it
may not be sent unsolicit ed to non- client s.
o 8ecei"ing public acknowl edge me nt of donati ons to charities
etc.
o 2articipati ng in exhibitions, semi nar s, etc.
#ccount ant s may now ad"erti se for work and engage in other forms
of publicity. =owe"er there are still some restrictions:
(. #ccount ant s may not directly approach a prospecti"e client nor
instigat e such an approach by a third part y.
$. #ccount ant s may not directly gi"e any commi ssi on, fee or
reward to a third part y for introduci ng client s. !uch
commi ssi ons may, howe"er, be gi"en to his employees or other
practising account ant s.
-. <se of "ideo
Qes so long as that company has in"ited him to quot e. It must be
accompani ed by a lett er clearly st ati ng that it is only for the client J s
use and should not be shown to others.
7. 8emuner at i on
The nor mal basis for chargi ng for professi onal work, is on the time
spent on the work calculat ed at appropri at e hourly rat es for
principals, seniors and other staff. The hourly rat es may "ary
according to the difficulty or compl exit y of the work in"ol"ed. It is up
to the account ant to decide upon his hourly rat es dependi ng on his
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cost struct ur e, profit requirement , market conditions. It is not
per mi ssi bl e to charge:
(. +n a percent age basis except where law or cust om allows, e.g.
in liquidation and recei"er shi p work. ,any account ant s are
Dealous of the percent age chargi ng met hod of est at e agent s,
archit ect s, solicitors, etc., but these professi onal peopl e
gener ally do not ha"e recurring work from client s and
continually need to seek new client s.
$. +n a contingency basis. This means account ant s cannot accept
work on a percent age of tax sa"ed basis or anyt hi ng similar.
#ccount ant s who recei"e commi ssi ons from stockbroker s, insurance
brokers, etc. for transacti ons effect ed for client s or for trust s of which
the account ant is a trust ee should either:
(. 2ass on the commi ssi ons to the client or trust by deducti ng the
amount s recei"ed from his fee in"oice and showing the
deducti on.
$. .eep the commi ssi ons if he has been specifically aut hori sed to
do by the client.
E&ES"I%N 7%&#
Answer a11are nt rom the text o the manual ? the sect i on on
audi t o 1art ners hi 1s and sol e 1ro1ri et or s /
E&ES"I%N 7I'E
AaB <nder the law of contract , an audit or may be sued by the company
for loss resulting from negligence on the part of the auditor A7oss "
=arbot tl e (9%*B. The case of 1andl er " 1rane 1hrist mas A('5(B
exemplified the "iew that there was pri"ity of contract bet ween the
auditor and the company. This "iew precluded third parti es from
suing for losses.
The position was altered in ('&% by the case of =edley )yrne " =eller
A('&%B in which it was Dudged that in the absence of a disclai mer of
liability, a duty of care to third parti es would arise. This suggest ed
that audit ors would be liable to third parti es with whom ther e was a
>speci al relationshi pJ , for inst ance, the prospecti e purchas er of a
business who was relying on audit ed account s in maki ng his decision
to buy. This decision relat ed only to cases where a specific
interest ed part y exist ed and the audit or knew or should ha"e known
of their interest in the account s. The principle of liability to unknown
third parties was still unchanged from the <ltramar es " Touche case
A('*$B wher e Gudge 1ardo:o comment ed that audit ors should not be
subD ect ed to >liability in an indet er mi nat e amount for an
indet er mi nat e time to an indet er mi nat e classJ .
The position is still under goi ng modification. Three cases are rele"ant
here: Geb 7ast ener s " ,arks, )loom M 1o A('9(B, re Twomax A('9*B and
1aparo Indust ri es " /ickman A(''4B. The Geb and Twomax cases bot h
in"ol"ed plaintiffs who had relied on audit ed account s in purchasi ng
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shares of the rele"ant compani es, but whose exist ence was not known to
the audit ors. In the Geb case, the auditors knew that the company was
likely to be looking for outside finance, as it was in difficulties. It was held
that the auditors had a duty of care to the third part y, albeit an unknown
one, who was likely to be relying on the account s@ this clearly ext ended
the "iew of liability taken in the =edley )yrne case. The plaintiffsJ action
was, howe"er, dismi ssed on the grounds that they would ha"e made their
in"est ment e"en if the account s had gi"en a fair picture of the companyJ s
position.
In the Twomax case, the same approach to auditor liability was adopt ed,
and the Dudge found for the plaintiffs. The auditor, it was held, >shoul d
ha"e foreseen. . . . that these account s might be relied on by a pot enti al
in"est orJ .
The recent 1aparo case is of great interest becaus e it appear s to reDect
the two earlier cases. It was stat ed that the audit ors could not ha"e
known, or be expect ed to know, that 1aparo would rely on their work in
deciding to in"est in a company. There was a need for a close relationshi p
to exist bet ween the maker and recipient of negligent misst at eme nt s for
a dut y of care to exist. +n appeal, although it was held that auditors ha"e
a dut y to indi"idual sharehol der s, this did not ext end to pot enti al
in"est or s. This approach seems to be in line with the comment s of Woolf G
in the ('95 0loyd 1heyham " 0ittleDohn case that there is a dut y of care to
known third parti es, but they should still prot ect thems el "es by making
>the usual enquiriesJ before in"esti ng. The =ouse of 0ords ruling in the
1aparo case narrowed the scope of the dut y of care still further. It was
ruled that the audit ors owed a duty of care to shar ehol der s as a body, but
not to third parti es nor to indi"idual shar ehol der s considering buying mor e
shares.
It is e"ident , in conclusion, that the auditorJ s liability was ext ended aft er
the 1andl er case, although the ext ent of liability to third parti es is
uncert ai n, and appear s to ha"e been se"er el y limited by the 1aparo
finding.
AbB #udit risk may be defined as the risk that the audit or will deli"er
an inappropri at e or incorrect audit opinion on the financi al
st at eme nt s. The auditorJ s assess me nt of risk shoul d be an
intrinsic part of the planni ng and execution of an audit. The
audit or should plan the distribution of audit effort by identifying
the areas in"ol"ing great est audit risk, in ter ms of their
mat eri ality, the exist ence of adequat e internal controls, and
pre"ious experi ence. /et ailed testing can then be concent r at ed
on high risk areas.
#udit risk is reduced by appropri at e quality control procedur es.
These include:
i. The obser"ati on of rele"ant #uditing !tandar ds and
Huidelines@
ii. The est ablishment , maint enance and obser"ance of
st andar ds of quality within the audit firm@
iii. 2rocedur es for ensuring that st aff and part ner s ha"e the
ability and knowl edge required to do the Dob. This implies
suit abl e procedur es for recruit ment , super"ision and
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training@
i". #udit files properl y re"iewed with point s of difficulty or
error being cleared before the audit report is signed@
". 2eer re"iew procedur es. In addition to routine re"iew of
files during the audit, part ner s should take part in peer
re"iew to ensur e that the firmJ s standar ds are mai nt ai ned@
"i. 2rocedur es on deciding whet her to accept an engage me nt .
)efore accepti ng an engage me nt , the audit or should
consider its implications for the firm. Will it threat en the
firmJ s independenceR =as the firm the resources to carry
out an adequat e auditR /oes the client present a pot enti al
risk becaus e of the nat ur e of its business or its financi al
positionR
AcB It is in law the duty of the direct ors of a company to produce
account s which are true and fair, but it is the audit or who is
required to report on the trut h and fairness of the account s.
There is to this ext ent a Doint responsi bility for the account s.
#lthough the full significance of the audit report is often
misunder st ood, it is regar ded by users of account s as
independent e"idence that the account s are reliabl e. It is
arguabl e that the in"est ors ha"e a duty to thems el "es to >make
the usual enquiri esJ before in"esting, but this cannot and shoul d
not absol"e the auditors of a dut y of care. It may be that in
some cases, in"est or s and other s take action against audit ors
becaus e they are known to ha"e liability insurance whilst
direct ors do not, but it seems inescapabl e that audit ors and
direct ors shar e responsi bility for financi al st at eme nt s.
2ESS%N 6
E&ES"I%N %NE
AaB 7our areas of risk concerni ng a comput er syst em are as follows.
i. $ardwar e
The comput er hardwar e may be stolen or damaged,
especi ally the moder n >desk- topJ type peripher al s. #
syst em which does not incorpor at e physical controls will
be subDect to such risk.
ii. &naut hori s e d acce s s
If ter mi nal s are not secur e it might be possi bl e for
unaut hori sed users to obt ain or corrupt informat i on held
on file.
iii. Syst e m ,reakdown
If the syst em does not incorpor at e retrie"al procedur es
there might be a loss of dat a if the syst em breaks down for
any reason such as power failure.
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i". Corru1t il es
If stringent checks are not carried out on dat a, input files
may be corrupt ed, with the consequent fall in the quality of
out put .
AbB 7orms of control which may be institut ed to safeguar d agai nst
these risks are as follows.
i. +hysi cal control s
#ll hardwar e and files should be kept in secur e locations with
access only a"ailabl e to aut horised personnel . The use of
speci al rooms, storage cupboar ds and strict control o"er keys
will assist in est ablishing secur e locations. To prot ect the
hardwar e and files from damage they should be locat ed away
from possi bl e ha:ards such as fire and flood which might arise
near a cant een or washroom facilities. The inst allation of
smokeC heat alar ms and other det ect or s of en"ironment al
ha:ar ds should also be carried out.
ii. Acces s control s
This will be partly helped by physical controls such as locked
-/2 rooms. In addition to this ter mi nal keys should be issued to
aut hori sed personnel . These ensur e that the ter mi nal will only
become li"e for a "alid user. The use of unique passwords will
further impro"e control becaus e, in the e"ent of a key being
stolen, the syst em will still be unaccessi bl e without a "alid
password.
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iii. #etri e0al control s
There should be procedur es which will enabl e all dat a to be
retrie"ed if the syst em breaks down. -xampl es of these are the
syst em displ ayi ng or output ti ng the stat e of the file and the
st age of the process immedi at el y before the breakdown so that
rest art can be made at the appropri at e place. #lso, backup
facilities should be pro"ided so that processi ng can continue if
part of the syst em goes down. 8egul ar dumpi ng of files will
help to recreat e any lost dat a due to a syst ems breakdown.
i". In1ut control s
There should be controls o"er the "alidity of input dat a. These
can be a combi nati on of manual and comput er checks. ,anual
checks may encompas s calcul ation of control tot al s and
aut hori sati on of dat a by an official prior to input. 1omput er
checks will include dat a- "et procedur es such as range, format
and sequence checks. #ll items which fail these edit checks
should be output and in"estigat ed by a person independent of
the person who input the dat a.
E&ES"I%N "3%
.AaB +ari t y check
# char act er is repres ent ed by a comput er as a series of binary :eros
and ones Ausing negati"e and positi"e polarity of ferrit e coresB. In a
machi ne with an odd parit y syst em, the comput er adds an additional
bit to each charact er so that the tot al number of bits which are, say,
:ero is an odd number . !ubsequent l y whene"er that char act er is
used by the comput er it will check that the parit y bit is in the correct
stat e and thus that the char act er has been accur at el y mo"ed from
one store to anot her.
AbB 7il e 1rot ect i on ring
This is a piece of plastic which fits into the centr e of a reel of tape. If
the ring is not present it will be impossi bl e to write to a tape and only
readi ng can occur. Thus it prot ect s a tape from being inad"ert ent l y
corrupt ed as a decision to write to the tape must be accompani ed by
the insertion of a ring.
AcB "a1e la,el l i ng
This is part of the tape at the beginning and end, called a header and
trailer label respecti"el y. It is encoded by the comput er and
identifies things such as the type of informat i on on the tape, the
number of records on the tape, hash tot al s of the records, the dat e of
creation and the dat e before which writing- o"er must not take place.
The comput er will check this dat a when the tape is loaded to be used
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with a program and ensur e it is the correct tape.
AdB #ecord count
8ecord count s are used as a processi ng control. The comput er
count s and out put s the number of records used during a run and this
can be checked against a predet er mi ned tot al. It is also a tot al of the
number of records of each tape which can be amended after each
run.
AeB Control tot al
This is an accumul ati on by the comput er of the dat a in a numerical
field such as amount s on an in"oice, which can be used to check the
compl et enes s of processi ng when compar ed to a predet er mi ned
manuall y- prepar ed tot al.
E&ES"I%N"$#EE
#. Hener ally, the manner in which the manage me nt run their ent erpri se
is of great rele"ance to an audit or. # well controlled company with
efficient production, marketi ng syst ems and good document at i on and
recording syst ems with good internal controls is usually easy to audit
as much reliance can be placed on compliance test s and informati on
is readily a"ailabl e. !yst ems are mor e than the sum of the part s and
an auditor always has to look at the whole syst em.
i. Carry on /// manner
1learly the con"er se Adisorder and inefficiencyB will be
unsati sfact ory from any point of "iewNmanage me nt , owners,
lender s cust omer s etc. It will also be difficult to audit records of
disorderly and inefficient business. 7or exampl e, informati on will
be una"ailabl e, det ailed subst ant i "e testi ng will be required, it
will be difficult to obt ai n sufficient audit e"idence eg. of the
adequacy of stockt aki ng.
ii. Ensure /// 1oli ci e s /
# company without policies is likely to collapse into chaos or
anarchy. 2olicies can be gener alNproduct s, market s, location of
premi ses and also det ail edNpay rat es of Dunior typist s, life and
type of repsJ cars, and also depreci ati on policy, stock "aluation
policy etc. The auditor is particul arly interest ed in manage me nt
policy in areas such as budget s, aut hori sati ons, recording,
document i ng and internal controls, and accounti ng policies.
iii. Sa e guard the ass e t s .
!afeguar d the asset s means meas ur es to directly safeguar d
Aagainst theft, damage wear and tearB the asset s by physical
meansNlocks, keys, safes, insurance etc. It also means -
ensuri ng all items sold to cust omer s are in"oiced, all incomi ng
in"oices are for goods and ser"ices act ually recei"ed.
The auditor is interest ed becaus e:
A&*I"IN-
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2es s on "en
o 8ecords are likely to be compl et e Ae.g. sales in"oicesB
o Hood safeguar di ng increas es the reliability of all e"idence
collect ed.
o The exist ence of all asset s Aand conditionB is a proposition for
which audit e"idence is required.
i". Secure /// records
The manage me nt cannot effecti"ely manage a business without
adequat e records. They also ha"e a st at ut or y dut y to mai nt ai n
records. The auditor has a stat ut ory dut y to in"estigat e whet her
proper books of account ha"e been kept and report if they ha"e
not. 1learly also financi al stat e ment s prepar ed from incompl et e
or inacur at e records are unlikely to show a true and fair "iew or
compl y with the 1ompani es #ct requirement s.
E&ES"I%N 7%&#
AaB #udit risk, the risk that the auditor will draw an in"alid
conclusion from his work, is made up of three element s:
>Inher ent riskJ describes the risk arising from the nat ur e of the
clientJ s business or indust ry and en"ironment prior to the
consider ati on of the internal control syst em by the auditor. It
will "ary bet ween different account items and different types of
indust ry.
>1ontrol riskJ is the risk that errors will not be pre"ent ed or
det ect ed by audit procedur es.
>/et ection riskJ is the risk that mat eri al error will not be
det ect ed by audit procedur es.
AbB In assessi ng audit risk on a company audit assignment , the
audit or shoul d bear the following factors in mind.
Inherent risk
i. The nat ur e of the business, its product s or ser"ices, and its
market position@
ii. The companyJ s present and likely future financi al position@
iii. The audit orJ s pre"ious experi ence of that company@
i". The exist ence of circumst ances which could put pressur e
on manage me nt to mani pul at e result s@
". The suscepti bility of the companyJ s asset s to fruad@
"i. The exist ence of relat ed part y or unusual transacti ons@
"ii. The possi bility that error could ha"e a mat eri al effect on
the financi al stat e me nt s.
Control risk
i. The quality and effecti"enes s of manage me nt and the
degree of super"i sion exercised by manage me nt @
ii. The exist ence and quality of internal controls@
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iii. The compet ence of accounti ng st aff@
i". The nat ur e of accounti ng records kept@
". The exist ence and effecti"enes s of the internal audit
depar t ment , if there is one.
AcB # mat eri al error in financi al stat e ment s is one which would
significantly influence the reader of the financi al stat e ment s. In
deciding whet her an error or misst at eme nt is mat eri al, the
audit or shoul d consider not only the companyJ s profit figure, but
also its balance sheet tot al and the trend in its result s. It is
possi bl e that a number of indi"idually immat eri al errors may in
tot al ha"e a mat eri al effect on the companyJ s account s. 7or this
reason, the auditor shoul d record all errors not ed in order to
est ablish whet her in tot al they reach a le"el which requires
adDust ment . ,aterial error is normally thought of in relation to
monet ar y amount s, but it also relat es to the way accounti ng
informati on is present ed in the financi al stat e ment s. Thus, it
would be possibl e for account s to show a fairly stat ed profit
figure, but to be mat eri ally misleadi ng becaus e, for inst ance,
asset s and liabilities were net t ed off inst ead of being separ at el y
disclosed.
AdB The use of a predet er mi ned mat eri ality le"el has some clear
ad"ant ages. It enabl es the audit or to rest rict the scope of audit
work, and hence to make the most efficient use of time and
st aff, by a"oiding unneces s ar y testi ng of immat eri al items. The
use of pre- set mat eri ality limits does, howe"er, also ha"e some
drawbacks. The choice of mat eri ality le"el may ha"e to be
made before the final account s are a"ailabl e, and may as a
result pro"e to be too high or too low if the act ual result is much
different from that anticipat ed. The choice of a limit is in any
case a subDecti"e one@ ther e is not hing to decide what figure is
appropri at e in any gi"en case.
The use of a mat eri ality limit implies that errors below a cert ai n
si:e may not be det ect ed by the audit orJ s work. This may not
be satisfact or y to the audit client, who may, for inst ance, wish
to be sure that all defalcations, howe"er tri"ial in amount , will
be report ed. There is also a possibility that indi"idually
immat eri al errors may in tot al result in mat eri al misst at eme nt .
8igid application of a pre- set limit may result in this being
o"erlooked.
,ateri ality limits clearly play a useful role, but not if they are
applied rigidly. The audit or should be prepar ed to adDust limits
if they appear to be inappropri at e, and should be awar e of the
possi bility that indi"idually immat eri al errors may amount to a
mat eri al tot al in aggr egat e.
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2es s on "en
E&ES"I%N 7I'E
AaB 8esponsi bility for the /et ection of 7raud and -rror
The responsi bility for the pre"enti on and det ection of fraud and error
rest s with manage me nt through the implement at i on and continued
oper ati on of an adequat e syst em of internal control. !uch a syst em
reduces but does not eliminat e the possibility of fraud or error.
The obDecti"e of an audit financi al informati on is to enabl e an auditor
to express an opinion on such financi al informati on. In forming his
opinion, the audit or carries out procedur es designed to obt ai n
e"idence that will pro"ide reasonabl e assur ance that the financi al
informat i on is properl y stat ed in all mat eri al respect s. 1onsequent l y,
the audit or seeks reasonabl e assur ance that fraud or error which
may be mat eri al to the financi al informati on has not occurred or that ,
if it has occurred the effect of fraud is properl y reflect ed in the
financi al informati on or the error is correct ed. The audit or ther efor e,
shoul d plan his audit so that he has a reasonabl e expect ati on of
det ecti ng mat eri al mis- stat e me nt s in the financi al informati on
resulting from fraud or error. The degr ee of assur ance of det ecti ng
errors would nor mally be higher than that of det ecti ng fraud, since
fraud is usually accompani ed by act s specifically designed to conceal
its exist ence. /ue to the inherent limitation of an audit ther e is a
possibility that mat eri al misst at eme nt s of the financi al informati on
resulting from fraud and to a lesser ext ent , error may not be
det ect ed. The subsequent disco"ery of mat eri al misst at e me nt of the
financi al informat i on resulting from fraud or error existing during the
period co"er ed by the audit orJ s report does not, in itself indicat e that
the audit or has failed to adher e to the basic principles go"erni ng an
audit. The questi on of whet her the auditor has adher ed to the basic
principles go"erni ng an audit is det er mi ned by the adequacy of the
procedur es undert aken in the circumst ances and the suit ability of the
auditorJ s report based on the result s of these procedur es.
AbB 8isk of 7raud and -rror
In planning and perfor mi ng his exami nati on the audit or should take
into consider at i on the risk of mat eri al misst at e me nt of the financi al
informat i on caused by fraud or error. =e should inquire of
manage me nt as to any fraud or significant error which has occurred
in the reporti ng period and modify his audit procedur es if necess ar y.
In addition to weaknes s es in the design of the internal control syst em
and non compliance with identified control procedur es, conditions or
e"ent s which increas e the risk of fraud or error include:
AaB 3uestions with respect to the integrit y or compet ence or
manage me nt @
AbB <nusual pressur es within an entity@
AcB <nusual transacti ons@
AdB 2roblems in obt ai ning sufficient appropri at e audit e"idence.
-xampl es of these conditions or e"ent s as well as additional factors
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unique to an -/2 en"ironment are set forth.
Exam1l e s o Condi ti ons or E0ent s 3hi ch Increas e the #isk o
7raud or Error
(. Eues t i ons wi th res1e c t to the int egri t y or com1e t e nc e o
manag e me nt
i. ,anage me nt is domi nat ed by one person Aor a small
groupB and there is no effecti"e o"ersi ght board or
commi t t ee@
ii. There is a compl ex corpor at e struct ur e where compl exit y
does not seem to be warrant ed@
iii. There is a continui ng failure to correct maDor weakness es
in internal control where such corrections are practicabl e@
i". There is a high turno"er rat e of key accounti ng and
financi al personnel@
". There is a significant and prolonged under st affing of the
accounti ng depart me nt @
"i. There are frequent changes of legal ad"isors or audit ors.
$. &nus ual 1res s ur e s wi thi n an enti t y
i. The indust ry is declining and failures are increasi ng@
ii. There is inadequat e working capit al due to declining profits
or too rapid expansi on@
iii. The quality of earnings is det eriorati ng, for exampl e
increas ed risk taking with respect to credit sales, changes
in business practice or selection of accounti ng policy
alt ernati "es that impro"e income@
i". The entit y needs a rising profit trend to support the market
price of its shar es due to a cont empl at ed public offering, a
takeo"er or other reason@
". The entity has a significant in"est ment in an indust ry or
product line not ed for rapid change@
"i. The entit y is hea"ily dependent on one or a few product s
or cust omer s@
"ii. 2ressur e is exert ed on accounti ng personnel to compl et e
financi al st at eme nt s in an unusually short time period.
*. &nus ual trans act i ons
i. <nusual transacti ons, especi ally near the year- end that
ha"e a significant effect on earni ng@
ii. Transactions with relat ed parti es@
iii. 2ayment s for ser"ices Afor exampl e, to lawyer s,
consult ant s or agent sB that appear excessi"e in relation to
the ser"ices pro"ided.
%. +ro,l e ms in o,t ai ni ng sui ci ent a11ro1ri at e audi t
e0i de nc e
i. Inadequat e records, for exampl e, incompl et e files,
excessi "e adDust ment s to books and account s, transacti ons
A&*I"IN-
48;
2es s on "en
not recorded in accordance with nor mal procedur es and
out of balance control account s@
ii. Inadequat e document at i on of transacti ons, such as lack of
proper aut hori:ati on, supporti ng document s not a"ailabl e
and alteration to document s Aany of these document at i on
probl ems assume great er significance when they relat e to
large or unusual transact i onsB.
iii. #n excessi "e number of differences bet ween accounti ng
records and third part y confirmati ons, conflicting audit
e"idence and unexpl ainabl e changes in oper ati ng ratios.
i". -"asi"e or unreasonabl e respons es by manage me nt to
audit inquiries.
5. 7act ors uni @ue to an E*+ en0i ronme nt whi ch rel at e to the
condi t i ons and e0ent s in A through * a,o0e incl udeB
i. Inability to extract informati on from comput er files due to
lack of, or non- current , document at i on of record cont ent s
or programs@
ii. 0arge number s of program changes that are not
document ed, appro"ed and test ed@
iii. Inadequat e o"erall balancing of comput er transact i ons and
dat a bases to the financi al account s.
1. +rocedur e s when there is an indi cat i on that raud or error
may exi st
If circumst ances indicat e the possibl e exist ence of fraud or error, the
auditor should consider the pot enti al effect on the financi al
informat i on. If the audit or belie"es the suspect ed fraud or error
could ha"e a mat eri al effect on the financi al informat i on, he should
perfor m such modified or additional procedur es as he det er mi nes to
be appropri at e. The ext ent of such modifications or additional
procedur es depends on the audit orJ s Dudgement as to:
AaB The types of fraud or error that could occur@
AbB The relati"e risk of their occurrence@
AcB The likelihood that a particul ar type of fraud or error could ha"e
a mat eri al effect on the financi al informat i on.
2erformi ng modified or additional procedur es will normally enabl e
the auditor to confirm or dispel a suspicion of fraud or error. Where
confirmed, he should satisfy himself that the effect of fraud is
properl y reflect ed in the financi al informat i on or the error is
correct ed.
=owe"er, the auditor may be unabl e to obt ain audit e"idence either
to confirm or dispel a suspicion of fraud. In this circumst ance, the
auditor shoul d consider the possi bl e impact on the financi al
informat i on and the effect on his report . The audit or will also need to
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consider rele"ant laws and regul ations and may wish to obt ai n legal
ad"ice before renderi ng any report on the financi al informati on or
withdr awi ng from the engage me nt .
<nless circumst ances clearly indicat e otherwi se, the auditor shoul d
not assume that an inst ance of fraud or error is an isolat ed
occurrence. If the fraud or error ha"e been pre"ent ed or det ect ed by
the syst em of internal control, the auditor should reconsi der his prior
e"aluation of that syst em and, if necess ar y, adDust the nat ur e, timing
and ext ent of his subst ant i"e procedur es.
When fraud or error in"ol"es a member of manage me nt , the audit or
shoul d reconsi der the reliability of any repres ent at i ons made by that
person to the auditor.
A&*I"IN-
48:
2es s on "en

2ESS%N 4
E&ES"I%N %NE
#. It is of great import ance that an audit is planned in ad"ance becaus e:
(. The intended means of achei"ing the audit obDecti"es must be
est ablished.
$. #ttention can be focussed on to critical and high risk areas and
the work can then be compl et ed economi cally and to time scal e
requirement s.
). !att ers to take int o account
(. The work to be perfor med in addition to the audit.
$. 8e"iewing last years working paper s.
*. 1hanges in legislation Ae. g. 1ompani es #ctB or auditing or
accounti ng practice Aa new guidline, a new .#!B
%. #nalytical re"iew of manage me nt account s, consulting with
manage me nt .
5. 1hanges in the business or its manage me nt .
&. 1hanges in syst ems or accounti ng procedur es.
K. Timing requirement s.
9. -xtent of prepar ati on by the client of analyses and summari es.
'. <se of internal audit.
(4. /egree of reliance on internal controls.
((. Goint auditors if any.
($. 8otational testi ng.
E&ES"I%N "3%
(a) Audi t +lanni ng !emorandum
,ost audit firms prepar e an audit planni ng memor andum which set s
out factors to be taken into account , the met hods by which the audit
obDecti"es will be achi e"ed and the organi sati onal mat t er s to be put
in train.
2lanning memor andum might cont ai n:
(. "erms o engag e me n t
work to be doneNaudi t, precise accounti ng work to be done for
the client, tax etc., lett ers to be sentNlet t er of weakness etc.
$. "he cli ent and its ,ackground
history, product s, locations, especi ally noting factors like a new
managi ng direct or, a new comput er , a new product .
*. Im1ort i gure s and rati os
from pre"ious years and if a"ailabl e, from manage me nt and
draft account s.
%. Audi t risk areas
this might include stock, work in progr ess, or dealings with a
company under common ownershi p.
5. 2isti ng o all ass e t s ? lia,ili ti es ? re0enue s and ex1e ns e s
with summari es of the procedur es to be adopt ed to "erify them.
&. Ext ent o in0ol 0e me nt o int ernal audi t
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K. #e@ui re me nt or in0ol 0e me nt o s1eci al i s t s
these may be from within the audit firm e.g. comput er audit or
rarely ext er nal speci alist s.
9. Set ti ng o mat eri al i t y le0el s
'. Client assi s t anc e
assist ance from the client may be required in pro"iding
document s and anal ysi s, pro"iding comput er time, arrangi ng
"isits to branches.
(4. "he audi t a11roac h
The ext ent of reliance on internal control, the use of subst ant i"e
test s and analytical re"iew procedur es.
((. "imet a,l e
dat es of interi m, year end and final audit s and of deadlines to
meet e. g. #.H.,. of the company.
($. Stai ng re@ui re me nt s
(*. Budge t and ee
b. Knowl e dg e o the cli entK s indus t ry? ,usi ne s s and
organi s at i on
It is essent i al that all the member s of the audit team fully under st and
the client J s indust ry, business and organi sati on. This is so becaus e
only that way can they Dudge the risks associ at ed with the
engage me nt . #lso an economi cal and effecti"e audit can only be
carried out with a full knowl edge of significant en"ironment al ,
oper ati onal and organi sati onal factors. .nowledge of such factors
also helps in communi cati on with the clientJ s staff, in assessi ng the
reliability of manage me nt represent at i ons and in Dudging the
appropri at enes s of accounti ng policies and disclosur es. This
knowledge can be gained from:
o The client J s annual report and account s
o #nalytical re"iew of the client s interi m account s, financi al
report s "ariance analysis etc.
o Internal audit report s
o "isits to the client J s premi ses and discussi ons with
manage me nt and staff
o 2erusal of minut es of shar ehol der s, direct ors and audit
commi t t ee, budget commi t t ee etc.
o 2re"ious years audit files including the per manent file
o 1onsider ati on of the st at e of the economy Aaudit staff are no
doubt a"id reader s the or financi al sections of the daily
newspaperB
o 8eport s from within the audit firm which may be rele"ant to
the client e. g. tax depar t ment and manage me nt consult ancy.
o 2erusal of rele"ant literat ur e from credit rating agenci es,
stockbroker s, in"est ment analyst s
o 2erusal of rele"ant trade maga:i nes and Dournal s.
c. +racti cal 1ro,l e ms that can ari s e in im1l e me nt i ng audi t
1l anni ng may incl udeB
A&*I"IN-
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2es s on "en
i. the work to be done may not be spread e"enly during the year.
7or exampl e, many client s ha"e similar year ends especi ally
,arch *(st and /ecember *(st.
ii. #ny gi"en audit will not accord to the plan as Oput upon
enquiryO situations may arise.
iii. 1lient s may cause delays or require unexpect ed speed ups.
i". =igh st aff turno"er is common in professional offices and st aff
tend to often absent thems el "es through illness, holidays and
att endance at courses.
". the particul ar a"ailability of staff in ter ms of DuniorCseni or or
experi encedCi nexperi enced may be what is required for opti mal
planni ng.
"i. ew audit s requiring rapid att enti on may interrupt the planni ng
flow of audit work, as may speci al assignment s in fields like
insol"ency and in"esti gati ons.
,inimising these problems can be achi e"ed by:
i. 1lose liaison with client s to achi e"e as much flexibility with their
requirement s as possi bl e.
ii. 2utting as much work as possi bl e into the interi m audit. /elays
and problems at the final audit are much more disrupti"e.
iii. 2lanning staff requirement s, training programme s and
recruit ment as long in ad"ance as possibl e. ,any absences are
known long in ad"ance.
i". The use of long range planning so that difficulties can be
en"isaged in time to be sol"ed. There shoul d be strat egi c plans
and tactical plans both for the office as a whole and for
indi"idual client s.
". The use of speci al depart me nt s to deal with randoml y recei"ed
assignment s such as insol"ency and in"estigati ons.
#rrangeme nt s for swappi ng speci alist st aff with other firms can
also be a useful idea.
E&ES"I%N"$#EE
It is recogni sed that each firm has its own needs dependi ng on si:e,
geogr aphi cal spread, speci al experti se etc but all firms must organi se
procedur es which ensur e audit s are perfor med:
a. In accordance with appro"ed auditing standar ds
b. In confor mi t y with stat ut ory Ae.g. 1ompani es #ctB and contract ual
Alett er of engage me nt B requirement s
c. In confor mi t y with personalAet hicalB standar ds
d. In confor mi t y with any professional st andar ds set by the firm itselfN
many firms pride thems el "es on their professi onalism
e. -conomi cally and to time schedul es
f. With mini mum risk
The procedur es required are:
a. each firm shoul d est ablish a set o 1rocedur e s and communi cat e
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these to all part ner s and staff. 0arger firms empl oy print ed manual s
but smaller firms may ha"e to rely on "erbal instructions.
b. Acce1t anc e and rea11oi nt me nt s as audi t or . There should be a
procedur e of e"aluati ng prospecti "e client s with consider ati on of the
firms ability to meet client J s needs and for maki ng the decision on
accept ance which may be made by an indi"idual part ner, or by a
commi t t ee. The integrit y of clientJ s manage me nt is not menti oned in
the guideline but many firms regard this relati"ely new idea as
import ant .
c. +ro e s s i onal et hi cs . 2rocedur es to ensur e all part ner s and staff are
awar e of and adher e to the principles of independence, obDecti"ity,
integrit y and confidenti alit y. It is import ant to instruct st aff who are
not member s of professional bodi es and to monit or obser"ance of
ethical st andar ds. 7or exampl e, staff might not be awar e of the
prohibition on ownershi p of shar es in client compani es or may be
unwilling to sell them if they are so awar e.
d. Skill s and com1e t e nc e . The obDecti"e is to ha"e a fully compet ent
and skilled set of part ner s and staff. 2rocedur es include:
i. 8ecruit ment only of suit abl y qualified and expert st aff. !taffing
needs shoul d be planned ahead.
ii. Technical training and updati ng. #ll part ner s and st aff shoul d be
encour aged to learn, and to keep up- to- dat e with technical
mat t er s. The firm could pro"ide literat ur e, maint ai n a technical
library, send peopl e on courses and hold courses thems el "es.
!ome firms produce a speci al newl et t er at inter"al s to updat e
staff with technical de"elopment s.
iii. +n- the- Dob training and professi onal de"elopment . 2lanning,
1ontrolling and 8ecording emphasi ses the import ance of
relating st aff abilities to client needs but opport uni ti es should
also be pro"ided for staff to ha"e adequat e experi ence on a
range of client s as on- the- Dob training. 2erfor mance of staff
shoul d be e"aluat ed and the e"aluati on discuss ed with the staff
concerned. This kind of assess me nt and feedback is now
common practice in all walks of life.
e. Cons ul t at i on . Indi"idual member s of the firm shoul d not take
decisions on probl em areas without consulting with others. 2roblem
areas might be technical Ae. g. in comput er s where expert member s
of staff should be consult edB or mat t er s of risk Ae. g. to qualify or not
to qualifyB. !ole practitioner s are ad"ised to consult with other firms
or with professi onal ad"isory ser"ices.
f. !oni t ori ng the irms @ual i t y control 1rocedur e s . !uit abl e
procedur es shoul d be introduced to ensur e that all procedur es are
working adequat el y. This is dealt with in the re"iew section.
%n Indi 0i dual Audi t s
The control procedur es to be applied to indi"idual audit s include:
a. Allocat i on o st a Nstaff allocat ed should ha"e appropri at e
training, experi ence, proficiency and , if required, speci al skills Ae. g.
in computi ngB.
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b. +ro1er ,ri ei ng o st a Nstaff should be properl y informed on:
i. obDect of the audit
ii. Timing requirement s
iii. The o"erall plan of the audit
i". !ignificant accounti ng and auditing problems
". relat ed parties
"i. The need to bring problems and put upon enquiry situations to
superiors
c. Audi t com1l e t i on checkl i s t Nwith sections for compl etion by staff
and reporti ng part ner. It is a common experi ence, that in the rush to
compl et e an audit on time, mat t er s of import ance can be o"erlooked.
d. Cont e nt i ous mat t er s Nall probl ems, speci al difficulties, and
pot enti al qualifications must be identified, recorded and discuss ed
by, if necess ar y, the reporti ng part ner with colleagues or e"en
anot her practitioner.
e. *ocume nt at i on Nall audit work and conclusions reached must be
fully recorded in the working paper s.
f. #e0i ews Nall audit work must be fully re"iewed. This is dealt with in
the next section.
g. Acknowl e dg e me n t Nall audit work and re"iew action should be
acknowl edged in writing by the perfor mer.
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#. )enefit s of, and needs met by, planni ng, controlling and recording of
audit s:
I The audit will achi e"e its obDecti"esNt he gi"ing of an opinion on
trut h and fairness etc. of financi al st at eme nt s.
I The audit will be done within the time requirement s of the client
I The audit will be economi cal from the point of "iew of the auditor
and of the client
In particul ar:
o planni ng will ensur e compr ehensi "e co"er age, focus on risk
areas and timely compl eti on
o control will ensur e that the audit is carried out as planned,
and the st aff perfor m in an accurat e, consci enti ous and
timely manner
o 8ecording will ensur e that the audit can be controlled, no
work is omitt ed, the work done can be re"iewed, an opinion
can be formed by the reporti ng part ner and e"idence is
a"ailabl e of work perfor med.
). !teps to be taken prior to the audit of an existing client:
2repar ati on of an audit plan by manager or part ner
8e"iew of pre"ious years files.
1larification of problem areas from pre"ious years.
8esearch into the current background to the client
i. -conomi c and indust ri al mat t er s
ii. #ny new legislation affecting the client.
iii. #ny new !!#2J s or auditing guidelines affecting the client.
/iscuss with manage me nt to elicit:
i. #ny changes in business
ii. #ny changes in key personnel
iii. #ny changes in bookkeepi ng syst ems and accounti ng policies.
1. 8e"iew of interi m account s, manage me nt accounti ng report s,
internal audit report s etc.
o Identification of high risk areas to focus the audit.
o /et er mi nati on of client J s timing requirement s and ability to
supply schedul es.
o 1onsider ati on of cooper ati on with internal audit.
o 1onsider ati on of staff requirement s.
o )rief audit staff including instruction on risk areas and relat ed
parti es.
o 0iaison with secondar y or Doint audit ors if any
o 2repar ati on of time and cost budget .
1ompliance with the audit orsJ operational st andar d. #ssurance of
confor mi t y can be obt ai ned by:
i. planni ng the audit as in ). abo"e. 2articularly, planni ng should
ensur e a focus on risk areas, the use of suit abl e, well briefed
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staff and the compl eti on of all necess ar y work.
ii. 1ontrolling and super"ising the work at all times.
iii. ,aint enance of compr ehensi "e working paper s.
i". 8e"iewing the client J s syst em for recording transacti ons and
internal controls thereon.
". det er mi ni ng the ext ent to which the controls can be relied upon
and perfor mi ng sufficient compliance test s.
"i. +bt aining sufficient rele"ant and reliabl e audit e"idence on all
aspect s of the financi al st at eme nt s.
"ii. 2erformance by a suit abl e experi enced and compet ent person
of an anal ytical re"iew.
"iii. # re"iew of the working paper s by the reporti ng part ner to see
that all has been done that should be done.
ix. !peci al att enti on to the audit opinion and steps from which it
was built
x. speci al consider at i on of risk, put upon enquiry, the concept of
audit e"idence and the briefing and debri efing of st aff.

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#. 8eason why it is desirabl e for the auditor to send a lett er of
engage me nt
i. It defines the ext ent of the audit orJ s responsi bilities and so
mini mi ses the possi bility of any misunder st andi ng bet ween the
manage me nt of the ent erpri se and the auditor.
ii. It document s and confirms the auditorJ s accept ance of the
appoi nt ment , the obDecti"e and scope of the audit, the ext ent of
his responsi bilities, and form of his report s.
). The point s to be included in an engage me nt lett er under the
headi ngs indicat ed are as follows:
i. *ei ni ti on and sco1e o the audi t /
It should be made clear that an audit in"ol"es the exami nati on
of, and expressi on of opinion on, the financi al stat e me nt s of an
ent er pri se by an appoi nt ed audit or in pursuance of that
appoi nt ment , and in the case of st at ut ory audit, that the
mat t er s to be report ed upon are laid down in the 1ompani es #ct
('&$ or in other rele"ant legislation. In case of non- st at ut or y
audit the mat t er s to be dealt with in the report should be
agreed in writing bet ween the auditor and his client.
The lett er should expl ain the scope of an audit and st at e that
the auditor will re"iew the accounti ng syst em in order to assess
their adequacy as a basis for the prepar at i on of the financi al
stat e ment s. 7urther mor e, the lett er should stat e the audit or will
need to obt ai n rele"ant and reliabl e e"idence sufficient to
enabl e him to draw reasonabl e conclusions therefrom. To this
end, the lett er shoul d stat e that if the auditor plans to place
reliance on any internal controls, he will ascert ai n and e"aluat e
those controls and perfor m test s on their operation. In this
respect , reference should be made to the auditor reporti ng to
the manage me nt any significant weaknes s es in, or obser"ati ons
on the companyJ s syst ems which come to the audit orJ s notice
and which he thinks should be brought to the manage me nt J s
att enti on.
,ention should be made of any recurring speci al arrange me nt s
concerni ng the audit, such as:
(. The relationshi p with internal audit ors.
$. #rrangeme nt s for audit s of di"isions.
*. audit sCr e"i ews of o"erseas subsi di ari es, and
%. #rrangeme nt s for in"ol"ement of any other auditors.
The lett er should stat e that the auditor will carry out his work
and make his report in accordance with appro"ed auditing
standar ds and, where appropri at e, will ha"e regard to I#! when
re"iewing the financi al stat e me nt s.
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It should be made clear that the client, not the auditor, is
responsi bl e for the prepar at i on of financi al stat e me nt s gi"ing a
true and fair "iew, and for mai nt ai ni ng proper accounti ng
records and a syst em of internal control which is appropri at e to
the ent er pri se.
ii. 7raud or irregul ari ti e s
The responsi bility for the pre"enti on and det ection of fraud and
error rest s with the manage me nt and this responsi bility is
fulfilled mai nly through the implement at i on and continued
oper ati on of an adequat e syst em of internal control. The
engage me nt lett er shoul d indicat e that it is not the main
purpose of an audit to disco"er fraud and other irregul ariti es
and that the exami nati on shoul d not be relied upon to disclose
all irregul arities that may exist. It should howe"er explain that
the audit or would plan his audit so that he has a reasonabl e
expect at i on of det ecti ng mat eri al mis- stat e me nt s in the
financi al st at eme nt s resulting from irregul arities and fraud. If a
speci al exami nat i on of irregul ariti es, which goes beyond the
scope of the audit, is required by the client, then this should be
specific in the engage me nt lett er.
iii. Account i ng? taxat i on and other ser0i c e s
The auditor may undert ake the ser"ices for his client in addition
to his stat ut or y duties as audit or. The lett er should delineat e
clearly the account ant J s and the client J s responsi bilities in
relation to these ser"ices and to the day- to- day bookkeepi ng,
the mai nt enance of all accounti ng records and the prepar at i on
of financi al stat e me nt s.
If purely accounti ng ser"ices are being pro"ided to a client such
as a sole trader or part ner shi p, the lett er of engage me nt shoul d
make it clear that this is done without any audit work being
carried out.
In the case of taxati on ser"ices, the responsi bility for the
"arious procedur es such as the prepar at i on of tax comput at i ons
and submi ssi on of ret urns to the rele"ant aut horities should be
clearly set out, either in a section of the mai n lett er or in a
separ at e lett er where necess ar y.
i". 7ees
,ention should normally be made of fees and the gener al basis
on which fees are comput ed and render ed.
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#. i. 7lowchart o com1anyK s 1ayrol l syst e m
#el e0anc e
This will constit ut e an import ant part of the recording of the
companyJ s syst ems, to be held along with other det ails on the
per manent audit file. It will assist the auditorJ s e"aluati on of the
strengt hs and weakness es of the companyJ s syst em in this area
and thus the ext ent to which the audit or will wish to place
reliance on the syst em should compliance test s show that it is
oper ati ng satisfact orily in practice.
#eli a,i li t y
#s audit e"idence which is gener at ed by the audit or himself,
forming part of the audit working paper s, this is an extremel y
reliabl e source of audit e"idence, particul arly as the accur acy of
the chart appear s to ha"e been backed up by the compliance
test in the area of the payroll.
%ther e0i de nc e re@ui red
Hi"en the appar ent l y satisfact ory result s of compliance test s in
the area of the companyJ s payroll routine, the only further
e"identi al mat t er required would appear to be that gained from
limit ed subst ant i"e testing in this area.
ii. +roduct i on direct orK s esti mat e o worki ng lie o new 1l ant
#el e0anc e
The auditor has to form an opinion on the adequacy of the companyJ s
depr eci ation policy. If the companyJ s financi al st at eme nt s are to
show a true and fair "iew of the "aluation of fixed asset s, then it will
be necess ar y for an assess me nt to be made of the useful life of the
plant to the business.
#eli a,i l i t y
#s a gener al rule document ar y e"idence will be seen as mor e reliabl e
than oral e"idence. The uncorrobor at ed oral represent at i ons of
manage me nt will therefore, by thems el "es, constit ut e a particul arly
reliabl e source of audit e"idence.
+ne way in which the audit or should seek to confirm the production
direct orJ s esti mat es is by consideri ng the past experi ence of the
company with similar items of plant , in relation to its effecti"e
working life.
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iii. News 1a1e r re1ort on im1act o new technol o gy on sal e s
#el e0anc e
-"idence which suggest s a possibl e significant curt ail ment in the
le"el of the companyJ s sales will be import ant to the auditorJ s
assess me nt of the future "iability of the company and whet her it may
be properly regar ded as a going concer n.
#eli a,i l i t y
#s e"idence obt ai ned indirectly from a third part y source which is not
subD ect to the influence of the client, this should be seen as a reliabl e
source of audit e"idence.
The audit or will need to test the reliability of the newspaper report by
seeki ng e"idence of similar assess me nt s of the likely impact of new
technol ogy from other sources. Those sources might include trade
Dournal s, discussion with manage me nt and a re"iew of current sales
trends Aincluding post balance sheet salesB.
i". 2ett er rom com1anyK s ,ankers conirmi ng o0erdra t acili t y
#el e0anc e
The ext ent to which the company is dependent on short- ter m finance
and the continued a"ailability of such finance Ain the form of an
agreed o"erdr aft facilityB will once agai n be an import ant factor in the
auditorJ s assess me nt of whet her or not the company may properl y
be regarded as a going concer n at the balance sheet dat e.
#eli a,i l i t y
The bank lett er is an exampl e of e"idence which originat es outside of
the business but then forms part of the records maint ai ned by the
client. It will ther efor e be mor e reliabl e than e"idence both originat ed
and forming part of the records maint ai ned by the client J s st aff but
less reliable than that which the audit or himself obt ai ns directly from
third parties.
The audit or should ensur e that this import ant mat t er is also
confirmed by the direct communi cati on which, with the client J s
per mi ssi on, he has with the companyJ s banker s.
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". *et ai l s recorde d ,y audi t st a duri ng att endanc e at cli entK s
st ock account
#el e0anc e
!tock is often one of the most import ant single items within the
companyJ s financi al stat e ment s and as with all asset s of the
company, the audit or must be satisfied as to owner shi p exist ence
and "aluation. otes taken by audit st aff will be import ant with
particul ar regar d to the audit orJ s assess me nt of exist ence and
condition, which in turn has a direct beari ng on the subsequent
"aluation.
#eli a,i l i t y
#s audit e"idence obt ained directly as a result of the auditorJ s own
test s and enquiries this is an exampl e of the most reliabl e audit
e"idence a"ailabl e.
The audit or should ensur e that the det ails recorded by his own staff
agree with the det ails in the final in"ent ory prepar ed by the client.
"i. +osi ti 0e re1l y to de,t or conirmat i on re@ue s t
#el e0anc e
This will assist the auditor in both assess me nt of the effecti"e
working of the companyJ s syst ems in the area of sales and debt ors
and in his consider ati on of the reasonabl enes s of the figure for
debt or s shown as an asset in the balance sheet .
#eli a,i l i t y
#s audit e"idence is obt ained directly from third parti es this would be
second only in reliability to that audit e"idence which the auditor
himself gener at es as a result of his own test and enquiri es.
The auditors ensur e that there is no question of the debt or being a
relat ed part y as this would mean that they were under the influence
of the client, which would in turn reduce the reliability of the
e"idence obt ai ned.
E&ES"I%N"3%
#. #n ext ernal auditor must consider the following mat t er s in deciding
the ext ent to which he can rely on the work of an internal audit or.
i. *egre e o inde1e nde nc e rom the account i ng uncti on
The internal auditor should not be reporti ng on the work of
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those who control his salary, and promoti on prospect us. =e
shoul d report to the )oard or an audit commi t t ee and ha"e free
access to the ext ernal auditor.
ii. Sco1e and o,H ect i 0e s o the int ernal audi t de1art me nt
If their primary task is to re"iew non- financi al decisions and
syst ems, then their work will be of limit ed use to the ext er nal
auditor.
iii. +ro e s s i onal standards
This can be gauged by the audit manual in use, if any, the
exist ence and implement at i on of adequat e procedur es for
ensuri ng the assignment s are planned, controlled recorded and
re"iewed and whet her quality control work is done and report s
are followed up.
i". "echni cal com1e t e nc e
This can be assess ed from a re"iew of training, experi ence and
qualification of st aff.
". Euali t y o work done
The ext ernal auditor can compar e his findings with those of
internal audit and should also consider const r ai nt s affecting the
work of internal audit such as lack of st aff or equipment or non-
cooper at i on of manage me nt .
). !E!%#AN*&!
To: G Wragg, Internal #uditor, Higglane !port swear 0td
7rom: # #uditor, Tom /ick , =arry M 1o.
/at e: *4 o"ember (';9
/-)T+8!J 1I81<0#8I!#TI+
#s you know, I do not think that I can rely sufficientl y on the result s
of your debt orsJ circularisation to come to a conclusion on the
exist ence and "aluation of trade debt or s as at *( +ctober (';9. I
ther efor e intend to reperfor m the circularisation. I realise that this is
incon"eni ent and does not repres ent an efficient use of our time or
resources, and so would suggest that next year we hold a planning
meeti ng well in ad"ance of the audit to est ablish the best way of
co"ering all the necess ar y ground bet ween us.
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I list below my reasons for reperfor mi ng the circularisation.
i. The respons es co"er only the tot al "alue of debt ors and as such
the e"idence which they pro"ide is "ery limited with regar d to
reachi ng a conclusion on whet her the tot al of the debt or
balances is fairly stat ed@
ii. !tatistical sampling techni ques would ha"e helped o"ercome
the sampling risk that your techni ques were subDect to.
!tratification would ha"e been a cost- effecti"e strat egy to
adopt . #ll account s abo"e a cert ai n "alue could ha"e been
select ed for circularisation, with statistical sampling being
applied to the remai nder@
iii. !peci al att enti on should ha"e been paid to unusual items, credit
or nil balances, and account s which were long o"erdue@
i". Qour circularisati on was not designed to maxi mi se the "alue of
the third part y e"idence to be produced. Qou do not appear to
ha"e cast the debt orsJ listing to ensur e that the tot al "alue of
account s on the printout agreed to the sales ledger control
account @ you cannot otherwi se be sure that no account s were
suppr ess ed to pre"ent their in"esti gati on. !imilarly, you should
ha"e asked the consumer to reply directly to me so that the
possibility of suppr essi ng the request s and replies could be
eliminat ed. 7or the same reason, you should ha"e in"esti gat ed
discrepanci es in the replies yourself or left it to me to do.
1. The respons e rat e could be impro"ed by:
i. -nclosing a pre- addr ess ed, prepai d or stamped en"elope with
the request @
ii. !ending the request lett ers with the mont hl y st at eme nt s Aif the
auditor ret ai ns control o"er the filing and posting of the
en"elopesB or enclosing an anal ysi s of the balance so that the
cust omer s can "ouch the in"oices if they cannot agree the
balance Afor exampl e, they ha"e open item syst emsB@
iii. <se of telex, facsi mile trans mi ssi on or recorded lett ers might be
mor e effecti"e in some cases than ordinary lett er post by
imparti ng a sense of urgency and import ance, and in the case
of o"erseas cust omer s the first two will be quicker and possi bly
cheaper@
i". The lett ers would ha"e mor e weight in the cust omer J s eyes if
signed by a senior member of manage me nt like sales or
financi al direct or, and this would ha"e the added ad"ant age
that any lett ers unlikely to be answer ed might be weeded out at
this early st age. =owe"er, the auditor would be put upon
enquiry by a request not to circularise a particul ar cust omer and
shoul d empl oy alternati "e "erification procedur es for these
balances.
/. # debt or sJ circularisati on is a st andar d procedur e in auditing the
trade debt ors balance but it should be reme mber ed that it is a
means to an end and not an end in itself. There is a risk that whoe"er
replies to a circularisation in the debt orJ s nameNand in practice this
may be a relati"ely Dunior sales clerkNhas not taken adequat e steps
to "erify the account before replying positi"ely. +ther procedur es
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such as anal ytical re"iew may be import ant as procedur es
compl eme nt ar y to the carrying out of a circularisati on. Where it is
not expect ed to produce a good respons e rat e or wher e most
cust omer s set tl e their account s before the final audit, it may be more
efficient to dispose with a circularisati on altoget her. =owe"er, this
decision shoul d be carefully thought through as a carefully planned
and execut ed circularisation pro"ides third part y e"idence and as
such is a "ery "aluabl e techni que.
E&ES"I%N "$#EE
The managi ng direct or is "ery persuasi "e. +ne tends to agree with himL
# good start to the answer must be to st at e the purpose of the lett er of
represent at i on "i:.:
a. 8eduction to writing of oral stat e me nt s by the direct ors.
b. The lett er is a form of e"idence.
c. -"idence a"ailabl e to a court that the direct ors knew their
responsi bilities.
d. The 1ompani es #ct strengt hens the "alue of writt en e"idence from
direct ors.
Addi ti onal 1oi nt s
!ome mat t er s of fact are not obt ainabl e from the e"identi al sources
menti oned, e.g. all liabilities included.
!ome mat t er s of opinion ha"e no other e"idence a"ailabl e e.g. life of
plant, obsol escence.
It is a remai nder to manage me nt of those mat t er s in the account s which
they must take particul ar care o"er.
#lthough the direct or is not an account ant or lawyer, he does ha"e a legal
duty with respect to the prepar ati on of the account s.
In theory point * is well taken but in practice few direct ors sign the
account s after careful re"iew.
E&ES"I%N 7%&#
#. #es1ons i ,i l i ti e s or 1ri or 1eri od inanci al inormat i onB
o The openi ng figures form part of Ocost of salesO. #ll such
figures must be subDect to audit opinion obt ained through
audit e"idence.
o The pre"ious and current year account s must be consist ent
in accounti ng policies.
o The pre"ious yearJ s figures form the compar at i "e figures. The
auditor must see that they are indeed the figures Apossi bly
rest at edB appeari ng in the pre"ious yearJ s account s.
). +rocedur e s
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o The direct ors shoul d ha"e rest at ed the figures to confor m to
the new formatN"erify that this has been done
o det er mi ne if openi ng figures are correctl y brought forward
and are correct , by seeking e"idence from:
i. 1urrent year work
ii. 1onsulting with manage me nt
iii. 8e"iew of clientJ s records in pre"ious year
i". If necess ar y, enquiry of pre"ious audit or to det er mi ne the
adequacy of his audit procedur es.
8e"iew accounti ng policy consist ency: changes will need to be in
confor mi t y to I#! ( and I#! 9
8e"iew rest at e me nt of pre"ious yearJ s figures to confor m to new
format . This may be the difficult part. -speci ally difficulties may
arise on anal ysi s of expens es into cost of sales, admi nist r ati"e
expens es and distribution cost s.
E&ES"I%N 7I'E
AaB 8isk- based auditing refers to the de"elopment of auditing
techni ques which are responsi"e to risk factors in an audit,
which can be anal ysed as follows:
i. The risk that mat eri al error will occur A inhere nt risk B@
ii. The risk that the client J s syst em will not pre"ent or det ect
such error Acontrol risk B@
iii. The risk that undet ect ed mat eri al errors will be o"erlooked
by the auditor Adet ec t i on risk B.
The audit or applies Dudgement to det er mi ne what le"el of risk
pert ai ns to different areas of a client J s syst em and de"ises
appropri at e audit test s. This approach should ensur e that the
great est audit effort is direct ed at the riskiest areas, so that the
chance of det ecti ng errors is impro"ed and time is not spent on
unnecess ar y testing of >safeJ areas.
AbB 2otenti al high risk areas in an audit might include the following:
i. If manage me nt is under pressur e to produce fa"our abl e
result s Afor inst ance, to a"oid the threat of closure by a
parent company or wher e the company is approachi ng
insol"encyB, there is a risk such that they will att empt to
inflat e profit ability by fraudul ent means such as
o"erst ati ng asset s Astock, debt or sB or concealing liabilities.
ii. 6aluabl e asset s readily subDect to misappropri ation Afor
inst ance, high "alue stockB may be stolen if adequat e
physical controls are not in force.
iii. #n en"ironment wher e controls are inadequat e or non-
exist ent Afor inst ance a new and expandi ng business which
has not de"eloped suit abl e accounti ng syst emsB gi"es rise
to a risk of "arious kinds of fraud or of error resulting in
under or o"erst at eme nt in any accounti ng area.
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i". Where there are numer ous relat ed part y transacti ons Ae. g.
bet ween the company and its direct orsB or transacti ons of
an appar ent l y unusual nat ur e, the audit or is dependent on
obt aining expl anati ons from manage me nt .
AcB The increased use of risk- based auditing reflect s two factors:
i. The growing compl exit y of the business en"ironment
increases the danger of fraud or mis- stat e ment @ factors
such as the de"el opi ng use of comput eri sed syst ems and
the growing internati onalisati on of business are rele"ant
here@
ii. 2ressur es are increasi ngl y exert ed by audit client s for the
audit or to keep fee le"els down while pro"iding an
impro"ed le"el of ser"ice.
8isk- based auditing is responsi "e to both factors. It allows risk
areas to be identified, so that the auditor can concent r at e on
the areas presenti ng the great est danger of fraud or
misst at e me nt . #udit work can be kept to a mini mum on low
risk areas, making the best use of audit st aff time and effort.
AdB 8isk- based auditing and st ati stical sampling techni ques
are often associ at ed becaus e sampl e si:e will be affect ed
by the degr ee of audit assur ance the auditor plans to
obt ain from the result s of the sampl e. The great er the
degree of assur ance required, the great er the sampl e si:e.
The auditor will relat e the degr ee of assur ance required to
the risk that the audit procedur es may be in"alid, becaus e
of the three risk factors described in the answer to AaB
abo"e. !tatistical sampling allows a sampl e si:e to be
obDecti"el y det er mi ned by reference to the degree of risk
the audit or is prepar ed to accept .
!tatistical sampling is appropri at e in areas wher e the audit or
wishes to arri"e at a conclusion about a homogeneous
popul ation, and can do so by making a random selection of
items which will be represent at i "e of that popul ation. 7or
inst ance, if an audit or wishes to test that sales in"oices are
correctly calcul at ed, in a situation wher e a large number of
in"oices are issued all under the same syst em, it would be
appropri at e to select a sampl e by statistical techni ques.
# st ati stical approach is not appropri at e when an auditor wishes
to exami ne indi"idual items which ha"e a particul ar significance
Ae. g. all items o"er a cert ai n "alue or in"oices relating to a
particul ar product or cust omerB. It will not be possi bl e to use a
sampling approach in these cases.
AeB The ter m >confidence le"elJ relat es to the degr ee of assur ance
that the audit or obt ains from a particul ar test or combi nat i on of
test s. In st ati stical sampling, this is express ed as a percent age.
7or inst ance, a '4T confidence le"el means that the audit or is
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'4T sure that the obDecti"e of a test has been att ai ned Ae. g.
that purchas es are properly aut hori sedB. The higher the
confidence le"el, the less the risk of misst at e me nt .
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2ESS%N 8
E&ES"I%N %NE
#. #n ext ernal auditor must consider the following mat t er s in deciding
the ext ent to which he can rely on the work of an internal audit or.
i. *egre e o inde1e nde nc e rom the account i ng uncti on
The internal auditor should not be reporti ng on the work of
those who control his salary, and promoti on prospect us. =e
shoul d report to the )oard or an audit commi t t ee and ha"e free
access to the ext ernal auditor.
ii. Sco1e and o,H ect i 0e s o the int ernal audi t de1art me nt
If their primary task is to re"iew non- financi al decisions and
syst ems, then their work will be of limit ed use to the ext er nal
auditor.
iii. +ro e s s i onal standards
This can be gauged by the audit manual in use, if any, the
exist ence and implement at i on of adequat e procedur es for
ensuri ng the assignment s are planned, controlled recorded and
re"iewed and whet her quality control work is done and report s
are followed up.
i". "echni cal com1e t e nc e
This can be assess ed from a re"iew of training, experi ence and
qualification of st aff.
". Euali t y o work done
The ext ernal auditor can compar e his findings with those of
internal audit and should also consider const r ai nt s affecting the
work of internal audit such as lack of st aff or equipment or non-
cooper at i on of manage me nt .
). !E!%#AN*&!
To: G Wragg, Internal #uditor, Higglane !port swear 0td
7rom: # #uditor, Tom /ick , =arry M 1o.
/at e: *4 o"ember (';9
/-)T+8!J 1I81<0#8I!#TI+
#s you know, I do not think that I can rely sufficientl y on the result s
of your debt orsJ circularisation to come to a conclusion on the
exist ence and "aluation of trade debt or s as at *( +ctober (';9. I
ther efor e intend to reperfor m the circularisation. I realise that this is
incon"eni ent and does not repres ent an efficient use of our time or
resources, and so would suggest that next year we hold a planning
meeti ng well in ad"ance of the audit to est ablish the best way of
co"ering all the necess ar y ground bet ween us.
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I list below my reasons for reperfor mi ng the circularisation.
i. The respons es co"er only the tot al "alue of debt ors and as such
the e"idence which they pro"ide is "ery limited with regar d to
reachi ng a conclusion on whet her the tot al of the debt or
balances is fairly stat ed@
ii. !tatistical sampling techni ques would ha"e helped o"ercome
the sampling risk that your techni ques were subDect to.
!tratification would ha"e been a cost- effecti"e strat egy to
adopt . #ll account s abo"e a cert ai n "alue could ha"e been
select ed for circularisation, with statistical sampling being
applied to the remai nder@
iii. !peci al att enti on should ha"e been paid to unusual items, credit
or nil balances, and account s which were long o"erdue@
i". Qour circularisati on was not designed to maxi mi se the "alue of
the third part y e"idence to be produced. Qou do not appear to
ha"e cast the debt orsJ listing to ensur e that the tot al "alue of
account s on the printout agreed to the sales ledger control
account @ you cannot otherwi se be sure that no account s were
suppr ess ed to pre"ent their in"esti gati on. !imilarly, you should
ha"e asked the consumer to reply directly to me so that the
possibility of suppr essi ng the request s and replies could be
eliminat ed. 7or the same reason, you should ha"e in"esti gat ed
discrepanci es in the replies yourself or left it to me to do.
1. The respons e rat e could be impro"ed by:
i. -nclosing a pre- addr ess ed, prepai d or stamped en"elope with
the request @
ii. !ending the request lett ers with the mont hl y st at eme nt s Aif the
auditor ret ai ns control o"er the filing and posting of the
en"elopesB or enclosing an anal ysi s of the balance so that the
cust omer s can "ouch the in"oices if they cannot agree the
balance Afor exampl e, they ha"e open item syst emsB@
iii. use of telex, facsi mile trans mi ssi on or recorded lett ers might be
mor e effecti"e in some cases than ordinary lett er post by
imparti ng a sense of urgency and import ance, and in the case
of o"erseas cust omer s the first two will be quicker and possi bly
cheaper@
i". the lett ers would ha"e mor e weight in the cust omer J s eyes if
signed by a senior member of manage me nt like sales or
financi al direct or, and this would ha"e the added ad"ant age
that any lett ers unlikely to be answer ed might be weeded out at
this early st age. =owe"er, the auditor would be put upon
enquiry by a request not to circularise a particul ar cust omer and
shoul d empl oy alternati "e "erification procedur es for these
balances.
/. # debt or sJ circularisati on is a st andar d procedur e in auditing the
trade debt ors balance but it should be reme mber ed that it is a
means to an end and not an end in itself. There is a risk that whoe"er
replies to a circularisation in the debt orJ s nameNand in practice this
may be a relati"ely Dunior sales clerkNhas not taken adequat e steps
to "erify the account before replying positi"ely. +ther procedur es
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such as anal ytical re"iew may be import ant as procedur es
compl eme nt ar y to the carrying out of a circularisati on. Where it is
not expect ed to produce a good respons e rat e or wher e most
cust omer s set tl e their account s before the final audit, it may be more
efficient to dispose with a circularisati on altoget her. =owe"er, this
decision shoul d be carefully thought through as a carefully planned
and execut ed circularisation pro"ides third part y e"idence and as
such is a "ery "aluabl e techni que.
E&ES"I%N "3%
#. The rele"ant audit test s are as follows:
i. The auditor should obt ain from the client a breakdown of the
figures for de"elopment expendi t ur e, which makes it possibl e to
trace the amount s spent to the nomi nal ledger and the final
account s.
ii. 1ompliance test s should be perfor med to ensur e that a syst em
exist s for controlling the aut hori sing and the recording of
de"elopment expendi t ur e, and that the syst em is oper ati ng
adequat el y. AThis work may be co"er ed wher e practicabl e by
the audit test s perfor med on the companyJ s purchas es and
payroll syst emsB .
iii. Indi"idual amount s shoul d be "ouched by reference to
supporting document at i on. The rele"ant document at i on will
"ary according to the type of expendi t ur e, but test s might
include:
(. #gree purchas es to requi sitions, orders, and goods
recei"ed not es, in"oices, cashbook and bank stat e me nt .
$. #gree labour cost s to the payroll and to supporting
e"idence, such as time sheet s or Dob cards.
*. If o"erheads ha"e been included in the de"elopment
figure, ensur e that they ha"e been calculat ed on a basis
consist ent with that used gener ally by the company.
The audit or will wish to set a mat eri ality le"el for testing
indi"idual items@ this will ha"e to be est ablished when the
breakdown of the tot al figure is known. 7or inst ance, it may be
possibl e to rest rict testi ng consider abl y if one or two large
in"oices represent the bulk of the rele"ant expendi t ur e.
i". The arithmet i cal accur acy of the schedul e of expendi t ur e shoul d
be checked.
". The audit or should ensur e that ther e has been no doubl e-
counti ng, ie that de"elopment items capit alised ha"e not also
been charged as an expens e in the profit and loss account .
". 7inally, the audit or should carry out a re"iew of the
de"elopment figure in order to be satisfied that it is reasonabl e
and consist ent with what else is known about the company and
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its business.
). I#! *9 lays down the basis on which de"elopment cost s may be
carried forward. They may be carried forward only if, and to the
ext ent that, they repres ent an asset which is likely to gener at e
income for the company in the future. It would contra"ene the
prudence concept to carry forward expendi t ur e which is not
reasonabl y expect ed to gener at e future income.
#ccording to I#! *9, de"elopment expendi t ur e shoul d be writt en off
in the year it is incurred, unless there is a clearly defined proDect , and
the relat ed expendi t ur e is separ at el y identifiabl e.
The out come of the proDect must then be exami ned for:
i. Its technical feasibility@ and
ii. Its ulti mat e commer ci al "iability consider ed in the light of such
factors as:
o likely market conditions Aincluding compet i ng product s or
ser"icesB@
o 2ublic opinion
o 1onsumer and en"ironment legislation.
The proDect will be of "alue
i. +nly if further de"elopment cost s to be incurred on the same
proDect, toget her with relat ed production, selling and
admi ni st r ati on cost s, will be mor e than co"ered by relat ed
re"enues@ and
ii. #dequat e resources exist, or are reasonabl y expect ed to be
a"ailabl e, to enabl e the proDect to be compl et ed and to pro"ide
any consequent i al increas es in working capit al.
If taking a prudent "iew of the a"ailabl e e"idence, these conditions
are met , de"elopment cost s may be deferred and amorti sed o"er the
period expect ed to benefit.
1. The following audit procedur es may be perfor med to "erify the
re"aluati on gain arising on fixed asset s:
i. -nsure that the "aluer appear s to be appropri at el y qualified and
independent of the company. If these conditions are not
fulfilled, the auditor will need to consider their possibl e impact
on the result s of the "aluation.
ii. )y reference to the instructions gi"en to the "aluer and the
"aluerJ s report , ensur e that the "aluation has been perfor med
on a basis which is reasonabl e and consist ent with pre"ious
"aluations.
iii. 1heck that profits or losses on indi"idual fixed asset s ha"e been
correctl y calcul at ed by reference to the fixed asset regist er and
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the det ailed anal ysi s of the re"al uation.
i". 1heck arithmet i cal accuracy of the compil ation of the
re"aluati on schedul e and of the calcul ation of asset profits and
losses.
/. The decision to finance de"elopment internally has result ed in a large
increas e in credit ors and decreas e in cash balances. This may lead to
liquidity probl ems, especi ally since the company will still need funds
to finance new product s. These funds will ha"e to be gener at ed
either by sale of further in"est ment s, the raising of loan from the
direct ors or an outside in"est or, or by the issue of shares. If funding
is not a"ailabl e, the de"el opment expendi t ur e shoul d be writt en off
on the basis that it will not be possibl e to compl et e the proDect. This
would eliminat e the profit and loss reser"e and would creat e doubt s
about the companyJ s stat us as a going concer n.
The audit or should discuss with the direct ors their plans for obt ai ning
additional finance and request that they produce cash flow forecast s
in support of these. If the audit or does not obt ai n satisfact or y
e"idence of the companyJ s ability to obt ain finance, it may be
necess ar y to qualify the audit report on grounds of going concern.
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E&ES"I%N "$#EE
#. !tandar d costing is widely used for manage me nt accounti ng as it is
often not practicabl e to relat e expendi t ur e to specific units of stock.
=owe"er it is only accept abl e for financi al accounti ng if it produces a
"aluation approxi mat i ng to act ual cost. ,anage me nt should thus be
re"iewing standar ds regul arly Aat least once a yearB to ensur e that
they bear a reasonabl e relationshi p to act ual cost s incurred in the
period. !uch a re"iew should include:
i. 1onsider ati on of the suit ability of o"erhead allocation bases and
absorpti on rat es@
ii. -xpect ed mat eri al s usage and labour hours@
iii. #mendment s to technical specification@ and
i". 1hanges in prices, wage rat es and capaci t y.
,anage me nt should also in"estigat e all significant "ariances from
standar ds and act on them. #ny changes to standar ds should only be
made on the aut horit y of a suit abl e senior employee.
). If the auditorJ s re"iew of the standar d costing syst em re"eal s that
ther e are internal controls in respect of stock "aluation which can be
relied on, com1l i anc e tes t s shoul d be carried out to test these
controls.
Com1l i anc e test s
i. #ssess the adequacy of procedur es for re"iewing standar ds.
ii. -stablish that all re"isions to standar ds ha"e been properly
aut horised.
iii. 1heck that manage me nt ha"e spot t ed and act ed on all
significant anomali es in gross mar gi ns and price and usage
"ariances.
Su,s t ant i 0e test s
i. 1ompar e standar d cost s with act ual cost s as e"idenced by
supplierJ s in"oices and price lists, payroll, union agree me nt s on
wages and pay scal es.
ii. #ssess the accuracy of standar d hours and quanti ti es by
re"iewing product specifications, recent time and motion
studi es, union agreeme nt s and production records and
compari ng the result s with standar ds.
iii. If o"erhead absorption costing is in use, the auditor must ensur e
that only direct o"erheads are included in year end "aluation. If
margi nal costing is used, then direct o"erheads shoul d be
added to the stock "aluation to confirm with I#! $.
i". +"erheads shoul d only be absorbed on the basis of normal
acti"ity le"els, taking one year with anot her. The cost of unused
capaci t y should be writt en off in the year incurred. The auditor
shoul d ensur e that normal capacit y does not differ markedl y
from the capaci t y esti mat ed for o"erhead absorption by
re"iewing the budget s for current and future periods and act ual
le"els of producti on for current and prior years.
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". The auditor should ensur e that appropri at e bases are used for
absorbti on of o"erheads. If, for exampl e, o"erheads are being
absorbed by labour hours then this is a sensi bl e basis fro
super"isory personnel cost s but rat es, for exampl e, would be
bet t er absorbed on the basis of floor space.
1. The calculation of the "ariances should first be checked for arithmet i c
accuracy and the "ariance further analy:ed, if necess ar y. #ny
"ariance arising from pilfering, wast age and so on should be writt en
off in full in the period when incurred, as should idle time cost s, and
no adDust ment to st andar d cost s should be made in this case.
The company should, howe"er, adDust stock "alued at standar d cost to a
closer approxi mat i on to act ual by a suit abl e proportion of the price
"ariances which arose in the period. In this case, the audit or must ensur e
that only the "ariances which arose o"er the same period as the stock
balances are taken into account @ that is, if stock quanti ti es are held at
approxi mat el y two mont hsJ purchas es, then only price "ariances which
arose in the last two mont hs of the year should be added to stock "alues.
=e should also check that the standar ds ha"e not been changed since the
"ariances arose.
+ther, non- price, "ariances shoul d be re"iewed to est ablish whet her they
arise from such factors as tempor ar y fluctuati ons in usage, capaci t y, or
whet her the st andar ds are out of dat e or unrealistic, in which the case the
standar d should be amended.
E&ES"I%N 7%&#
Work to be perfor med on the re"iew of the financi al st at eme nt s
A/ Account i ng 1oli ci e s
i. 1ompl et e check list of compliance with I#!.
ii. 8e"iew especi ally compli ance with any recent I#!.
iii. 8e"iew accounti ng policies for consist ency with pre"ious years,
appropri at enes s to the business and gener al accept ance.
i". If ther e has been a change see that this has been expl ained in
the not es to the #ccount s and if necess ar y included as a prior
year adDust ment under I#!.
". 8e"iew disclosur e of accounti ng policies complies with I#!.
B/ +roi t and 2oss Account
i. !ee that turno"er increas eC decr eas e is in line with expect ati ons
and knowl edge of the business.
ii. 8e"iew gross profit margi n with pre"ious year, expect ati ons and
known business conditions e.g. price increas es.
iii. 1ompar e all expens es headi ngs with correspondi ng amount s for
pre"ious year.
i". 8e"iew for correct disclosur e of extraordi nar y and excepti onal
items and prior year adDust ment s.
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". 8e"iew the tax comput at i on. 1apit al allowances should agree
with capit al expendi t ur e, I#! ($ should be accorded with.
"i. 8e"iew the profit and loss account to see that it reflect s any
known post- balance sheet e"ent s and the audit orJ s knowledge
of the business and its en"ironment .
C/ Bal anc e She e t
i. 8e"iew fixed asset additions. These should confor m to the
auditors knowl edge of the business and pre"ious periodJ s
capit al expendi t ur e contract s placed or appro"ed.
ii. 8e"iew depreci ati on to det er mi ne if rat es are adequat e.
Indications will include scrappi ngs, excessi "e profitsClosses on
sales and new technol ogy.
iii. #ny asset re"al ued should be correctl y treat ed and the mat t er
disclosed Acredit to capit al reser"e, show name of "aluer etc.B.
i". 8e"iew stock, compar e turno"er rat e with pre"ious year and
knowledge of market conditions@ re"iew treat me nt of stock at
net realisabl e "alue, if any.
". 8e"iew debt or s with turno"er Arat e should be compar ed with
pre"ious year and market conditionsB. 2ro"ision for doubtful
debt s should be re"iewed in the light of aging schedul e Ain the
working paper s and market conditions.
"i. 1reditors. 8e"iew with input s and compar e ratio with pre"ious
year. 8e"iew post balance sheet e"ent s exami nati on in the
working paper s to test if all liabilities are included.
"ii. )ank. 8e"iew with o"erdr aft facilities and the bank lett er.
"iii. TaxationNsee profit and loss account .
ix. /i"idends. 8e"iew for legality, appro"al by direct ors and see
that the #.H.,. agenda includes it.
x. 0ong ter m loans. 8e"iew new issues. 8e"iew with interest
charges in the profit and loss account , borrowing powers in the
memor andum and repayme nt requirement s with new arranged
facilities and cash flow forecast s.
xi. !hare capit al. 8e"iew new issues.
xii 8e"iew liquidity ratios and trends.
xi". 1ompl et e check list on going concern.
*/ Stat ut ory di scl os ur e re@ui re me nt s B
These should be exami ned by means of check list.
E In a 1eri od o reces s i on the oll owi ng shoul d ,e
consi der e dF e x 1 e c t e dB
i. 0ower gross and net profit margi ns.
ii. 8educed sales.
iii. =igher stocks, with net realisabl e "alue probl ems.
i". !lower paying debt or s with doubtful debt probl ems.
". 0iquidity problems and pressur e from credit ors.
"i. 7ixed asset s may not all be in use and should then be writt en
down.
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"ii. 8edundancy and closure cost s.
"iii. #ttempt s by manage me nt to window dress account s.
ix. Hoing concern probl ems.
x. /ifficulties in meeti ng loan and o"erdr aft agreeme nt s.
xi. #greed gearing ratios exceeded.
Eues t i on ;
#nswers appar ent from the text
E&ES"I%N 7I'E
#nswers appar ent from the text
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2ESS%N :
E&ES"I%N %NE
There are numer ous possibl e indications that a client is no longer a going
concern. =ere is a check list of some of them:
To det er mi ne insol"ency that is inability to meet debt s as they fall due:
(. #d"erse current ratio or trend.
$. #d"erse acid test ratio or trend.
*. +"erdue 2#Q-, 6#T.
%. /ependence on short ter m finance for long ter m needs.
5. Hearing ratios high or increasi ng.
&. )orrowing in excess of debent ur e trust deed agree me nt s.
K. /efault s on loan interest or capit al repayme nt .
9. 2reference di"idends in arrear.
'. -xcess stocks.
(4. -xcessi"e debt or s
((. +"erdraft s in excess of facilities grant ed.
($. 8estriction on trading ter ms Aeg, cash only by suppliersB.
(*. 0ong ter m loans becomi ng due with no arrange me nt s for refinance.
(%. -xcessi"e reliance on high interest finance Aeg. =2B.
(5. 1redit ter ms taken in excess of agreed ter ms.
(&. 8ecurrent oper ati ng losses.
(K. /eficiency of shar e capit al and reser"es.
(9. ecessi t y to seek new sources or met hods of finance.
To det er mi ne other possibl e causes of a business disconti nui ng:
(. 0oss of key manage me nt or staff.
$. /elay in filing document s at compani es house.
*. 0abour difficulties Aeg. a prolonged strikeB.
%. !ubst ant i al dependence on one uncert ai n proDect.
5. <neconomi c long ter m commi t ment .
&. 0egal proceedi ngs.
K. 0oss of key franchi se.
9. 2at ent s running out.
'. 0oss of principal supplier or cust omer .
(4. 2olitical risks.
((. Increasi ng import penet r at i on.
($. 7oreign exchange mo"ement s.
(*. Technical obsol escence.
(%. 7inanci al failures of suppliers, cust omer s or others in the same
indust ry.
(5. 6olunt ary or imposed output restrictions.
(&. Imposed competi ti"enes s Aeg. abandonme nt of cart el arrange me nt B .
(K. 1ontinued use of old plant becaus e of lack of funds to replace it.
(9. 2otenti al losses on long ter m contract s.
Ans wer s to @ue s t i ons 6? 4? ; and 8 are a11are nt
rom the text /
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E&ES"I%N %NE
AaB The criteri a of prudent manage me nt under the )uilding !ocieties #ct
are:
i. ,aint enance of adequat e reser"es@
ii. ,aint enance of a struct ur e of commer ci al asset s such that at
least '4T of asset s are loans secur ed by first mort gage for
owner- occupi ed housi ng@
iii. ,aint enance of adequat e asset s in liquid form@
i". ,aint enance of arrange me nt s for ensuring the adequacy of
securit y o"er mort gage loans i.e. proper "aluation of properti es
in det er mi ni ng the amount of loan that can be ad"anced@
". mai nt enance of requisit e accounti ng records, syst ems of
control, and syst ems of inspecti on and report @
"i. /irection and manage me nt by fit and proper direct ors and
officers, and with prudence and integrit y@
"ii. 1onduct of the business with adequat e professi onal skills.
AbB In drawing up the audit progr amme, particul ar att enti on shoul d be
paid to the following areas which are either unique to building societ y
oper ati ons or are of particul ar significance:
i. #d"ances and repayme nt s of mort gages@
ii. In"est orJ s account s@
iii. 1ommuni cati on bet ween the societ y and in"est or s and
borrower s@
i". #ccounting records at branches and agenci es@
". comput er syst ems@
!ubst ant i"e testi ng will be import ant in "erifying@
i. -xist ence and compl et enes s of in"est orsJ and borrower sJ
balances@
ii. -xist ence of deeds held as securit y on loans@
iii. -xist ence, ownershi p and "aluation of propert y, in"est ment s
and cash@
i". 1ompl et enes s and occurence of interest recei"ed and paid.
#nalytical re"iew procedur es are likely to be of particul ar import ance.
These will include the det er mi nat i on of ratios of significance to
prudent manage me nt , such as the maint enance of adequat e
reser"es and a compari son of the societ yJ s perfor mance and financi al
position with readily a"ailabl e published statistics on trends amongst
societi es.
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^ The exact nat ur e of st ati stical ret urns and which of them will need to
be exami ned and report ed on by the audit or will be det er mi ned by
the 1entral )ank of .enya specifically for each bank.
The auditor is required to form an opinion on whet her the informati on
cont ai ned in the ret urns is:
i. 1ompl et e in the sense that there is no informati on in the
accounti ng and other records required to be included that has
not been included@
ii. #ccurat e in its reflection of informat i on cont ai ned in the
accounti ng and other records@
iii. 2repar ed in accordance with the 1entral )ank of .enya
requirement s@
i". )ased on accounti ng policies consist ent with those used in the
annual account s.
The audit or is not required to form an opinion as to the reliability of
the accounti ng and other records on which the ret urns are based. +f
course, he report s separ at el y on internal control. =e may, howe"er,
consider it prudent to re"iew changes in internal controls since the
dat e of the last annual report on internal control.
E&ES"I%N "3%
The following summar y pro"ides an idea as to the range and
compl exit y of banking acti"ities.
i. The maki ng of loans and ad"ances and the pro"ision of trade
credit@
ii. The manage me nt of cust omer account s and the associ at ed
mo"eme nt s of cash and other transfer s of funds@
iii. -ngagi ng in money market acti"ities@
i". /ealing in foreign exchange market s, futures market s, options
market s and commodi t y market s@
". /ealing in shar e market s as agent s or principal s and relat ed
acti"ities such as underwriting@
"i. The pro"ision of ad"isory ser"ices such as portfolio
manage me nt and acting as trust ees.
Segre g at i on o duti e s
AaB #dequat e segr egat i on of duties bet ween those who control
receipt and cust ody of cash, transfer and recei"e funds and
mai nt ai n accounti ng records@
AbB /ual control o"er signat ur e plat es for cheque- signing machi nes@
AcB !ignat ur e controls on banker sJ payment s, cheques and draft s
and effecti"e re"iew of underlying document at i on@
AdB /ual control o"er receipt of mail@
AeB adequat e control procedur es in relation to staff holidays.
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+hysi cal
AaB Teller area has adequat e physical prot ection@
AbB 2hysical control o"er till cont ent s@
AcB 1ontrol o"er spar e keys to tills@
AdB !urprise count s of cash, and "ault funds accordi ng to a
syst emat i c plan@
AeB 8elief tellers ha"e separ at e float s or transfers of float s bet ween
tellers properly document ed@
AfB 8eser"e cash kept in "ault under adequat e securit y
control@
AgB 1ontrols o"er stocks of unused cheques, banker sJ draft s,
banker sJ payment s, tra"ellersJ cheques and other blank
document at i on@
AhB #ccess to cont ent s of #T,s properl y secur ed.
Authori s at i on and a11ro0al
AaB 7ormal policies est ablished@
AbB #uthorisation procedur es for withdr awi ng from reser"e cash@
AcB 1ontrol procedur es relating to issue of tra"ellersJ cheques@
AdB #uthorisation controls on non- -7T payment s@
AeB properly aut hori sed reconciliations of branch and head office
clearings account s to control account s, re"iew and follow- up
procedur es for all old and unusual items and excepti on
reporting syst em for o"erdue respons eC cl ear ance items and
usually high balances@
AfB -"idence of identit y for withdrawal s, e.g. !ignat ur e, cheque
guar ant ee card and checking identit y prior to cheque clear ance@
AgB )alance enquiry to support e"idence of sufficient
fundsC undr awn for withdrawal s@
AhB 0imits on tellersJ funds and "ault cash to reduce exposur e@
AiB 1ash cards issued only to properly aut hori sed cust omer s@
ADB 1ontrol o"er dormant account s.
Arithme t i c al and account i ng
AaB Immedi at e recordi ng in books@
AbB 1heques restricti"el y endorsed on receipt @
AcB /aily balanci ng of tills and in"esti gati ons of "ariances@
AdB 8egul ar reconciliation of control account s@
AeB 1ontrol o"er openi ng account s@
AfB !equence control o"er banker sJ payment s, cheques and
banker sJ draft s@
AgB /et ailed analysis of branch and head office clearings account s
readily a"ailabl e@
AhB 2roper reconciliation procedur es go"erni ng relat ed control and
suspens e account s relating to #T,s@
AiB 1ontrol o"er standi ng dat a amendme nt s .
Su1er0i si on
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AaB 2olicies est ablished subDect to regul ar re"iew at an appropri at e
le"el.
2oans? Ad0anc e s and "rade 7inanc e
AaB #greement of facilities and drawdowns Ao"erdr aft limitsB to
source document s@
AbB Testing calculation of interest and accrual s@
AcB 8e"iew of pro"isioning procedur es and assess me nt of the
adequacy of loan pro"isioning@
AdB 8e"iew of loan files@
AeB Testing of mast erfile amendme nt s@
AfB testingC checki ng securit y@
AgB 8e"iew of exceeded facilities@
AhB 8e"iew of suspens e account s@
AiB 2erfor mance of circularisation of balances or transacti ons@
ADB Inspection of collat er al or circularisati on of holders of collat er al@
AkB #nalytical re"iew of balances and income compar ed with prior
periods or budget s.
Cust ome r Account s ? Cash and "rans er o 7unds
AaB 1hecking of cash records including cash count s@
AbB 1hecking of daily clearing reconciliation: in- debit s and credit s,
out- debit s and credit s and other payment s and recei pt s, such as
direct debit and 1=#2s A1learing =ouse #utomat ed 2ayment sB@
AcB #greement of entri es to source document s@
AdB Testing of interest calcul ation and recordi ng@
AeB Testing of amendme nt s to mast erfiles@
AfB Testing of !WI7TCtelex control logs, including sequence and
cont ami nat i on testing to ensur e no unregi st er ed transfer s@
A!WI7T is the electronic funds transfer syst em used by banks
internati onallyB@
AgB 1ircularisation of cust omer account s@
AhB Testing of suspens e account s@
AiB Testing of interest accrual s@
ADB Testing of cutoff.
SourceB IA+S
7inal #e0i e w
The auditor will need to consider carefully the appropri at enes s of
accounti ng policies adopt ed and the accounti ng treat me nt of
particul ar transacti ons in "iew of the opport uni ti es for window
dressi ng, for off-balance sheet finance, for mani pul ati ng the "aluation
of asset s as bet ween cost and market "alue and for alt ering the
timing of re"enue recognition. The draft I#2! >)anksJ , paragr aph 54
identifies the following probl em areas in bankJ s account s:
i. 2ro"isions for bad and doubtful debt s@
ii. 6aluation of securities@
iii. +ff-balance sheet transacti ons@
i". Treasur y instrument s@
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". 7oreign exchange@
"i. 7ees and commi ssi ons@
"ii. Taxation.
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E&ES"I%N "$#EE
The crucial point to not e first is that gross profit margi n is arri"ed at
as follows:
!ales ;
1ost of sales
+peni ng !tocks ;
2urchas es ;
0abour ;
2roduction o"erheads ;
;
0ess: 1losing stock A;B ;
Hross 2rofit ;
Hross profit margi n T
Theoretically the gross profit mar gi n should be st eady from year to year
as any increase in cost s are passed on to the consumer by the company.
It is thus expect ed that all the abo"e cost component s would ret ain the
relationshi p to the sales figure. They therefore all ha"e to be in"estigat ed
to det er mi ne their contribution to the fall in the mar gi ns.
Sal es
1ompar e sales "alues with pre"ious years. /et er mi ne "olumes and the
mix of sales to det er mi ne whet her increas e in turno"er is as a result of
price increases or "olume increases.
/et er mi ne market demand for the product s and whet her discount s ha"e
been gi"en to encour age higher "olume sales. /et er mi ne whet her any
price increas es were introduced during the year. /et er mi ne the sales mix
and whet her any changes occurred therei n.
%1eni ng St ocks
/et er mi ne whet her the accounti ng policies used in "aluing openi ng stocks
ha"e been consist entl y applied in (''4. /et er mi ne whet her the "alues
att ached to these stocks were based on an act ual stock- take at end of
('99 and re"iew the working paper s on this for any ob"ious errors.
1onfirm that the amount brought forward is the closing amount for the
pre"ious year. !elect mat eri al or high "alue items at end of ('99 and
in"estigat e their mo"ement s during ('9' for "olumes and cost s.
+urchas e s
1ompar e purchas es with pre"ious years det er mi ni ng whet her any price
increas es result in increases in sales prices. 8e"iew the syst em of internal
control ensuri ng that all goods purchas ed are recei"ed into the warehous e
in the quanti t y and quality order ed at appro"ed prices AThe recei pt should
be support ed with a goods recei"ed not e and entry into stock records, but
basic stock records are not maint ai ned in this companyB.
2a,our and +roduct i on %0erhe ads
1onfirm that the basis of absorpti on has remai ned consist ent .
In"esti gat e increases in the cost s, seeki ng to est ablish whet her they
mat ch sales price increases.
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In"esti gat e and confirm that empl oyees exist, and that they are paid for
work done at appro"ed rat es.
1onfirm no labour strikes had result ed in non- producti"e time.
Closi ng Stock
/et er mi ne whet her a stock- take was carried out at the year end and
check the quantiti es used in "aluing stocks for account s purposes.
/et er mi ne the ext ent of damaged slow- mo"ing and obsol et e stock items
and how they were treat ed in the account s. In"esti gat e the possibility of
pilferage and non- recei pt of goods purchas ed.
-eneral
=old discussions with the manage me nt and the pre"ious auditors as to the
causes of the drop in the gross profit mar gi n.
8e"iew the gener al economi c en"ironment and particul arly the indust ry in
which your client operat es, and det er mi ne the a"er age perfor mances
ther ei n. #ccess the age of machi ner y used and its capacit y, ensur e that it
is still economi cal and efficient.
The result s of these in"esti gati ons will re"eal the reasons for the falls in
the margi n.
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E&ES"I%N 7%&#
The most import ant control obDecti"e relating to premi ums and clai ms that
are unique to the insurance business are as follows:
+remi ums
i. 8isks are underwrit t en and co"er grant ed only on laid- down
ter ms:
AaB 2articulars of risks that may be underwrit t en are laid
down@
AbB #uthority for underwriting risks and det er mi ni ng ext ent of
co"er is specified@
AcB <p- to- dat e rat e books are mai nt ai ned and issued to agent s
and brokers@
AdB Inter medi ari es from whom business is accept ed are
properly "ett ed@
AeB 2olicies are only issued in respect of risks that ha"e been
properly e"aluat ed in accordance with laid- down
procedur es.
ii. 2roper control is est ablished o"er all proposal s accept ed, risks
underwrit t en and policies issued: policy document s shoul d be
prenumber ed and control mai nt ai ned o"er blank forms@
iii. 2roper control is maint ai ned o"er premi ums due to ensur e that
premi ums are recei"ed in respect of all business accept ed@
i". Inwards reinsur ance treati es are aut horised at an appropri at e
le"el of aut horit y:
AaB )usiness is accept ed only from appro"ed reinsur er s@
AbB 8einsur ance stat e me nt s are re"iewed as being in
accordance with the treat y@
AcB There are controls to ensur e that regul ar stat e ment s are
recei"ed in respect of all inwards reinsur ance business.
". +utwards reinsur ance treati es are appro"ed at an appropri at e
le"el of aut horit y:
AaB )usiness is ceded only to appro"ed reinsur er s@
AbB )usiness ceded is compl et e and in accordance with the
ter ms of the treat y@
AcB !tat ement s of reinsur ance ceded are sent regul arly and
are in agree me nt with the companyJ s records.
"i. #cquisition cost s are properly aut hori sed:
AaB 1ommi ssi ons paid are properly calcul at ed in respect of
proposal s accept ed from agent s and brokers@
AbB #cquisition cost s are properly calculat ed.
"ii. 2remi um income is properly calcul at ed and the amount of
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unear ned premi um income properl y det er mi ned.
Clai ms
i. #ll clai ms are fully recorded:
AaB 2rocedur es exist for identifying and recordi ng clai ms
at the earliest possi bl e opport uni t y@
AbB 1laims inti mat ed are e"aluat ed to ensur e that a "alid
policy was in force at the dat e of occurence,
premi ums ha"e been paid and the e"ent appear s to
relat e to an underwrit t en risk@
AcB 1ontrol is est ablished o"er all clai ms intimat ed and
o"er all informat i on recei"ed in respect of each clai m.
ii. -sti mat es of clai ms out st andi ng are properl y det er mi ned:
AaB 2rocedur es exist for maki ng reliabl e esti mat es of
clai ms out st andi ng which are re"ised each time new
informati on becomes a"ailabl e@
AbB procedur es exist for ensuring that the esti mat es are
compl et e with respect to all clai ms outst andi ng.
iii. 1laims are admi t t ed and set tl ed on proper aut horit y:
AaB 2ayment s are properl y aut horised, agreed to
e"idence that fully support s the amount and liability
of the clai m, and made to persons entitled to recei"e
payment @
AbB # release is obt ained from policy holders in respect of
all set tl ement s@
AcB 2roper records are mai nt ai ned of clai ms payment s@
AdB 8ecords of the clai m are transferr ed from clai ms
out st andi ng@
AeB 1ontrol is maint ai ned in respect of any reco"eri es or
sal"age owing to the company.
i". 1laims are properl y notified to reinsur er s and account ed
for on stat e ment s to the reinsur er s.
E&ES"I%N 7I'E
,y checks would be principally by way of perfor mi ng compliance test s
o"er the oper ati on of the syst em of control o"er mort gages
ad"ances.
i. I would select of mort gage applications and check that they
were e"idenced as ha"ing been "erified with respect to writt en
confirmat i on of the applicant J s salary from the empl oyer and
the report of the societ yJ s "aluer as to the "aluation of the
propert y, which Dointly det er mi ne the maxi mum per mi ssi bl e
ad"ance@
ii. I would check final appro"al of the ad"ance by a senior official
confirmi ng that the application met the requirement s of the
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)oardJ s policy for the granti ng of ad"ances@
iii. I would select a sampl e of cheque disburse me nt aut horisations
in respect of mort gage ad"ances and sight e"idence that they
had been checked against :
I The appro"ed application@
I 8eceipt of a st ati sfact or y solicitorJ s report as to title@
I The undert aki ng by the solicitor to deli"er the title deeds to
the societ y as soon as the change of title had been
regist er ed@
I ,ortgage document s signed by the applicant .
i". I would check that the document s supporti ng the disburse me nt
in AiiiB abo"e were e"idenced as ha"ing been sight ed by the
cheque signat ori es at the time of signing the cheque and in
such a way as to pre"ent their being re- used@
". I would finally check the procedur e for ensuri ng that securit y
document s required to be deli"ered to the societ y were duly
deli"ered. I would do this by checking comput er appliaction
controls o"er the syst em whereby the issue of a cheque on a
mort gage ad"ance aut omat i cally opened an entry in the
regist er of deeds held by the societ y indicating that the deeds
and other appropri at e document s, such as a copy of the
insurance policy on the propert y, were outst andi ng. I would
further check that appropri at e action was taken in respons e to
periodic listings of out st andi ng document s to enquire into
reasons for their non- deli"ery.
In addition to compliance test s I would also perfor m a number of
subst ant i "e test s using the record of cheque disburseme nt on
mort gage ad"ances as my st arti ng point and "erifying these
backwar ds with the appro"ed mort gage application and other
supporting document s and forwards to the recei pt of the securit y
document s.
AbB The )uilding !ocieti es #ct imposes a specific responsi bility on the
societ y to est ablish and mai nt ai n a syst em to ensur e the safe
cust ody of all document s of title relating to propert y mort gaged to
the societ y, and on the audit ors to report to the 8egistrar on whet her
or not the syst em complies with the #ctJ s requirement s.
1ontrols should exist to ensur e that:
i. #ll mo"eme nt s of deeds are recorded@
ii. #ll deeds are checked on recei pt for legal requirement s and for
agree me nt with the accounti ng records@
iii. #n in"estigation is made to enquire into the reasons for any
deeds not being recei"ed when due@
i". There is strict securit y o"er access to the deed room@
". /eeds are releas ed only on proper aut horit y@
"i. There is periodic agree me nt of deeds held with the accounti ng
records.
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The audit or should perfor m compliance test s to "erify the proper
functioning of these controls, and subst ant i"e test s o"er the exist ence of
deeds and the compl et enes s of the records.
Import ant compliance test s will include:
i. 6erifying application controls o"er the comput er recordi ng of
mort gage account s to ensur e that for e"ery mort gage ad"ance
an entry would be made in the regist er of document s held of
the rele"ant title deeds, and that such record could not be
remo"ed until the mort gage was properly dischar ged@
ii. +bser"ing the procedur e for the recording of the physical
mo"eme nt of document s into and out of the deed room@
iii. !ighting e"idence of the legal aut henti cati on of deeds recei"ed@
i". !ighting e"idence of the follow up of deeds not recei"ed when
due@
". +bser"ati on of deed room securit y@
"i. !ighting the aut horit y held in support of the remo"al of deeds@
"ii. +bser"ati on of the compari son of deeds held with accounti ng
records by persons independent of both the cust ody and
recordi ng of deeds.
#n import ant subst ant i "e test will be the selection of a sampl e of deeds
from the regist er for inspection and checking that the deeds are, pri ma
facie, "alid.
AcB #t the time of the interi m "isit I would check compli ance with
the control syst em and perfor m a number of subst anti "e test s
to det er mi ne the compl et enes s and occurrence of all
transacti ons affecting shar e and deposi t account s. ,y audit
test s would include the exami nat i on of passbooks of deposit ors
making deposit s or withdrawal s and "erifying passbook entries
agai nst the accounti ng records. I would also check controls
o"er entri es through the aut omat i c teller machi nes.
#t the final audit "isit, with the use of comput er audit softwar e, I
would:
i. 1heck the additions of share and deposit account s and
agree the tot al to the account s@
ii. 1heck entri es to and from the account s around balance
sheet dat e to records of mo"eme nt s in cash in the same
period to "erify cutoff@
iii. !elect a sampl e of account s for circularisation and
in"esti gat e differences report ed.
AdB #n dor mant account is one where the deposit or cannot be
traced, or wher e no transacti ons ha"e taken place for a
specified period, or where a request for non- communi cat i on has
been recei"ed.
The risk with such account s is that employees could withdraw
funds from such account s for their own benefit without the
account holderJ s knowl edge.
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I would check the societ yJ s procedur es for dealing with such
account s. The comput er should be programme d to identify
such account s and to >markJ them to indicat e that withdrawal s
need to be subD ect ed to extra controls such as by recordi ng,
agai nst the withdr awal record, the passwor d of the teller or
other employee recordi ng the withdrawal .
I would perfor m compli ance test s to ensur e that the laid- down
controls were operati ng properl y such as by the use of a test
deck to ensur e that dor mant account s are properly identified
and withdr awal s properly checked.
I would also carry out subst anti "e test s using comput er
audit softwar e to search for dor mant account s not marked, and to obt ain
det ails of a sampl e of withdr awal s from dormant account s to "erify their
aut henti cit y, such as by compari ng signed withdr awal request s agai nst the
account holderJ s speci men signat ur e.
I would include a number of inacti"e account s with subst ant i al
balances in my circularisation but this test could not be
ext ended to account s wher e the client could not be traced or
declined to recei"e communi cati ons.
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2ESS%N D
E&ES"I%N %NE
a. The audit ors report is short and concise. To be fully underst ood it is
"ital that uniform wording should be used so that reader s can easily
recogni se the informat i on being con"eyed. The .enya #uditing
!tandar d OThe auditing reportO requires the inclusion of:
o Those to whom it is addr ess ed and identification of the
financi al stat e me nt s and the auditors and the dat e of their
report.
o Whet her the auditing st andar ds ha"e been complied with.
o #ny mat t er s prescribed by rele"ant legislation.
1learly auditing is a compl ex mat t er and full underst andi ng can only
be gained by the well "ersed. =owe"er the standar d does require an
import ant mini mum of informat i on.
The standar d largely st andar di sed qualified audit report s and ha"e
mostly eliminat ed ambi"al ent and "ague qualified report s.
b. #n ad"erse opinion will be gi"en if the audit or disagr ees with the
"iew gi"en by the #ccount s and the mat t er is so fundament al that a
compl et el y false or misleadi ng "iew is, in the opinion of the audit or,
gi"en.
#n exampl e is the use of the going concern con"enti on when the
auditor thinks it is inappropri at e.
# disclai mer of opinion is gi"e when the auditor is unabl e to gi"e an
opinion due to lack of audit e"idence on some mat t er of fundament al
import ance in the #ccount s. The mat t er may be inher entl y uncert ai n
Ae.g. a long ter m contract B or caused by inability to carry out
necess ar y audit procedur es. #n exampl e might be the failure of the
client to take stock
c. # disclai mer of opinions means that the audit or is unabl e to express
an opinion. +n the face of it, it would appear that the auditor has
failed to fulfil his dut y of expressi ng an opinion, making the report
usel ess.
)ut closer scrutiny would show that a disclai mer where e"eryt hi ng is
expl ained, gi"ing enough informat i on on the uncert ai nti es
surroundi ng the ent er pri se and the financi al stat e ment enabl es the
reader of those financi al st at eme nt s to under st and the account s, and
in the case of limitation of scope that the direct ors are at fault and in
the case of inherent uncert ai nt y that the company may ha"e
probl ems. # disclai mer is ther efor e not largel y "aluel ess.
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
#e0i si on Aid
4<C
A&*I"IN-
4<D
2es s on "en
E&ES"I%N "3%
The procedur es to adopt will include:
a. #greement in writing of the work to be done including scope and
ext ent of the in"estigation required, the period to be co"er ed and
the dat e of the report.
b. +bt ain per mi ssi on to approach the part ner s and also the audit ors.
These peopl e will suppl y you with informati on.
c. +bt ain document ar y e"idence of the part ner shi p including@ the
part ner shi p agree me nt , se"er al years account s and, if possibl e,
supporting schedul es, det ails of the history of the business, syst ems
of accounti ng and control, loan agreeme nt s, propert y leases etc.
d. +bt ain background dat a e. g. inter firm compari son dat a from trade
associ ation, go"ernment statistics, published sources such as -xtel
and ,oodies.
e. 2repar e a schedul e of account s for se"er al years. -nsure each is
adDust ed so that they are compar abl e. ote ratios and, more
particul arly, trends.
f. 2repar e a forecast of future result s based on budget s or
extrapol ations from the past adDusting for known differences e.g.
rent or interest .
g. -xami ne the "alues of asset s especi ally any propert y Aa
professi onal "aluation may be requiredB and the expiration of any
lease.
h. -xami ne and re"iew the part ner shi p agreeme nt s bot h the present
one and the proposed one. !ee that the proposed ter ms are
reasonabl e in ter ms of the profit share and capit al share obt ai ned in
return for consider at i on, time and experti se to be input.
i. -xami ne any proposal for the "aluation of goodwill.
ii. -xami ne the reason why the part ner shi p change is proposed
and why your client was select ed.
k. -nquire into any part ner shi p debt s and especi ally contingent
liabilities, long ter m contract s, long ter m liabilities for dilapidati ons
or redundancy pay.
i. -nsure agree me nt can be reached on mat t er s such as taxati on,
audit, book keepi ng and financi al stat e ment s.
m. 2repar e the report in draft and discuss it with your client.
n. If agreed, type the report and submi t it formally.
E&ES"I%N "$#EE
a. The cont ent s of the #ccount s 8eport for the purposes of a
prospect us are:
i. Title of report and identification of the reporting account ant s,
with det ails of their addr ess.
ii. #ddress eeNusually the /irector of the company.
iii. 8eporting with the following informat i on:
(. -xami nati on of audit ed account s of the company for
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
#e0i si on Aid
4<<
the year required. 8eport on proposal issued, stating
the number of shar es and nomi nal "alue.
$. The account s ha"e been prepar ed in accordance with
gener ally accept ed accounti ng practices. The
accounti ng policies used disclosed.
*. Whet her reporti ng account ant s ha"e also been
auditors of the company, if not the auditors are
menti oned.
%. Whet her any account s ha"e been made up for
submi ssi on to the member s subsequent to pre"ious
balance sheet .
5. +pinion, trut h and fairness of the account s,
&. !ignificant #ccounting policies that ha"e been used in
prepar at i on of the account s.
K. 2rofit and loss account s for the last fi"e years that
must show earni ngs per share, profit before taxation,
taxation and extra ordinary items, direct ors
embur s e me nt s.
9. 0atest balance sheet .
'. 1apit al commi t ment s and contingenci es not pro"ided
for
(4. /at e of report signed.
b. 2ro"ision is made for disclosur e of the adDust ment s made by
reporti ng account ant s in arri"ing at the informat i on included in the
report. The purpose of these adDust ment s is to reDect past result s in
future conditions so far as these are known. This is a reasonabl e
principle accept abl e under the *rd schedul e pro"isions. #s a result
of these adDust ment s, it may be difficult to reconcile figures with
those in the past published account s of the company.
The published stewar dshi p account s are prepar ed by a companyJ s
direct or for present at i on to commi t t ed shar ehol der s in order to
acquai nt them with the result s of the companyJ s acti"ities during
the last compl et e year of st ewar dshi p. There is no o"er- riding need
for the account s to be compar abl e and consist ent with each other.
In a prospect us, the informati on is addr ess ed to pot enti al in"est or s
in such a way as to enabl e them to form an opinion on the likely
prospect s of the company under future trading conditions as far as
they can be assess ed. This purpose must be met , consist ency and
compar ability must be achie"ed but also future conditions must be
taken into consider ati on.
-xampl es of situations in which adDust ment s would be appropri at e
are:
i. Income andC or expendi t ur e which has arisen in the part, but
which it is known will not arise in the future may be
eliminat ed, e. g. nationalised subsi di ari es, uninsur ed losses,
extra- ordinary items, etc.
ii. /e"aluation of asset s causi ng a change in depreci ati on
charges. This should be adDust ed only if re"ised figures can
be produced with remar kabl e cert ai nt y. +therwise it may be
A&*I"IN-
;55
2es s on "en
preferabl e to explain the position in a not e to the accounti ng
iii. # significant change in accounti ng policies at any point
during the period report ed on, in which e"ent the account s
for all affect ed periods shoul d be adDust ed to reflect the
accounti ng policies which are known to be applicabl e in the
future.
E&ES"I%N 7%&#
Answer a11arent rom the text o the manual ? the
sect i on on audi t o 1art ner s hi 1s and sol e
1ro1ri et or s /
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
#e0i si on Aid
;5.
E&ES"I%N 7I'E
#(. The /irect or Tick and 1ast
1omput er ,aint enance 1ertified 2ublic #ccount ant s
!er"ices 0imited 2.+. )ox ;QX
2. +. )ox #)1 airobi
airobi
/ear !ir,
We ha"e commenced planni ng the audit of the financi al st at eme nt s
for the year ending *4 !ept ember , (''4. #s already mentioned in
our lett er of engage me nt dat ed ( #pril (''4, our audit is designed to
gi"e us in the main reasonabl e assur ance that the financi al
stat e ment s gi"e a true and fair "iew as at the balance sheet dat e.
It ther efore in"ol"es consider ati on of significant accounti ng adopt ed
by the company as to their suit ability.
It is gener ally held that for an accounti ng policy to be suit abl e it must
be:-
i. #ccept abl e, i.e. in accordance with gener ally accept ed
accounti ng principles@
ii. 1ommonl y adopt ed within that particul ar indust ry@
iii. 1onsist ent l y applied o"er the years@
i". 1onsist ent l y applied throughout the ent erpri se@
". #ppropri at e and applicabl e to the particul ar circumst ances@
"i. In compli ance with any rele"ant I#!
"ii. #dequat el y disclosed in accordance with I#!.
+ur initial re"iew of the significant accounti ng policies has re"eal ed
that the accounti ng policy adopt ed with regard to ser"ice contract
income might not be suit abl e for the following reasons: -
i. +ne of the fundament al accounti ng assumpt i ons is that of
mat chi ng re"enues with the cost s of gener at i ng that re"enue.
These ser"ice contract s are for a three year period and the
company ther efor e has to commi t itself to cost s o"er the period
of the ser"ice contract .
#ccounting for income at the dat e of the contract but charging
cost s as they are incurred would imply that the company is not
mat chi ng re"enue with relat ed cost s. 1ontract re"enue is so
significant to the oper ati ons of the company that this policy
would seem to be imprudent as profits are likely to be o"er
st at ed.
ii. This policy is not commonl y adopt ed within the indust ry in
which you oper at e.
We recomme nd that the contract re"enue is credit ed to the profit
and loss account o"er a three year period, based on the proportion of
the act ual cost incurred during each year.
7or the financi al st at eme nt s to gi"e a true and fair "iew we further
recomme nd that amount of contract re"enue taken credit for any one
year be separ at el y disclosed as a not e for the financi al st at eme nt s,
so that the reader of the account s can det er mi ne the uncredit ed
reser"e at the beginning of the year, amount credit ed during the
year, amount of new contract s ent er ed into the year, the balance at
the end of the year disclosed as unear ned income.
#lso the accounti ng policy not e to the financi al stat e ment s should
A&*I"IN-
;56
2es s on "en
disclose this accounti ng policy.
In our opinion adoption of this policy will ensur e that the account s
present fairly the result s from oper ati ons and the profits will not be
o"erst at ed.
2lease do not hesit at e to cont act us for any clarification you may
consider necess ar y.
Qours faithfully
TI1. M 18+!! 1#!T
1-8TI7I-/ 2<)0I1 #11+<T#T
2ESS%N <
E&ES"I%N %NE
Ans wer s to @ue s t i on . are a11are nt rom the
rel e0ant sect i ons o the text / +l eas e re0i e w/
E&ES"I%N "3%
The procedur es to adopt will include:
a. #greement in writing of the work to be done including scope and
ext ent of the in"esti gati on required, the period to be co"ered and the
dat e of the report.
b. +bt ain per mi ssion to approach the part ner s and also the auditors.
These peopl e will suppl y you with informati on.
c. +bt ain document ar y e"idence of the part ner shi p including@ the
part ner shi p agree me nt , se"er al years account s and, if possibl e,
supporting schedul es, det ails of the history of the business, syst ems
of accounti ng and control, loan agreeme nt s, propert y leases etc.
d. +bt ain background dat a e.g. inter firm compari son dat a from trade
associ ation, go"ernment statistics, published sources such as -xtel
and ,oodies.
e. 2repar e a schedul e of account s for se"er al years. -nsure each is
adDust ed so that they are compar abl e. ote ratios and, more
particul arly, trends.
f. 2repar e a forecast of future result s based on budget s or
extrapol ations from the past adDusting for known differences e.g. rent
or interest .
g. -xami ne the "alues of asset s especi ally any propert y Aa professional
"aluation may be requiredB and the expiration of any lease.
h. -xami ne and re"iew the part ner shi p agree me nt s bot h the present
one and the proposed one. !ee that the proposed ter ms are
reasonabl e in ter ms of the profit share and capit al share obt ai ned in
return for consider at i on, time and experti se to be input.
i. -xami ne any proposal for the "aluation of goodwill.
ii. -xami ne the reason why the part ner shi p change is proposed
and why your client was select ed.
k. -nquire into any part ner shi p debt s and especi ally contingent
liabilities, long ter m contract s, long ter m liabilities for dilapidati ons or
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
#e0i si on Aid
;54
redundancy pay.
i. -nsure agreeme nt can be reached on mat t er s such as taxation,
audit, book keepi ng and financi al stat e ment s.
m. 2repar e the report in draft and discuss it with your client.
n. If agreed, type the report and submi t it formally.
A&*I"IN-
;5;
2es s on "en
+AS" C+A E9A!INA"I%N +A+E#S
KEN(A ACC%&N"AN"S AN* SEC#E"A#IES NA"I%NA2
E9A!INA"I%N B%A#*
C+A +A#" III
*ECE!BE# .<<C
Ans wer A22 @ue s t i ons / !arks all ocat e d to each @ue s t i on are
shown at the end o each @ue s t i on/
E&ES"I%N %NE
,odern 7urnit ur e 0td., a furnit ur e manuf act ur er which is an audi t client
of your firm has decided to acquire $(
st
cent ur y 7urnit ur e 0td. # company
is the same busi ness.
#s audi t part ner in char ge of ,odern 7urnit ur e 0td., you ha"e been asked
to carry out brie re"iew of $(
st
1ent ur y 7urnit ur e 0td.?s oper at i ons with
particul ar emphasi s on its account i ng practices, its current tradi ng
perfor manc e and futur e prospect s. ,r. 7red 8ansl ey, the managi ng
direct or of ,odern 7urnit ur e ltd. )elie"es $(
st
1ent ur y 7urnit ur e ltd. =as a
sound and expandi ng busines s which offers at tr acti "e prospect s to
,odern 7urnit ur e 0td. The managi ng direct or of $(
st
cent ur y 7urnit ur e
0td. Is ,iss 1laire !mit h. 7rom your inquiries, you disco"er the following:
(. #bout (4T of $(
st
1ent ur y 7urnit ur e 0td.?s sal es are to /eedee ltd.
Two member s of the board of direct or s of $(
st
1ent ur y 7urnit ur e
0td. =old a minorit y int er est in /eedee 0td. 2rices arranged
bet ween $(
st
1ent ur y 7urnit ur e ltd. #nd /eedee 0td. #ppear to be
at ar m?s lengt h basi s.
$. The current year?s resul t s reflect an excepti onal profit of
!h. 9, %94, 444 form the sal es of a proper t y which had been carri ed
in the books at hist orical cost .
*. ,anage me nt account s for the first six mont hs of the current year
ha"e been used to support an applicati on to the bank manager for
addi tional loan facility.
This facility has been request ed to enabl e repl ace me nt of
direct or s? mot or "ehicl es and to build a new st aff cant een and
washr oom facilities insist ed upon by the unions. The account s
submi t t ed to the bank cont ai n stock and debt or bal ances which
exceed the figures in the books of account s by !h. $(, $44, 444.
This Vdifference? has also been added to report ed profit. #fter
careful enquiry, you est abli shed that the boar d agreed to thes e
re"isions in order to assi st with their loan applicati on. # down run
in tradi ng necessi t at ed the re"isions in order to demons t r at e to
the bank that $(
st
1ent ur y 7urnit ur e 0td. was on budget for the
year. ,iss 1laire !mit h tells you that she is "ery confident of a
reco"er y in demand for the company? s product s which will enabl e
resul t s to exceed budget .
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
#e0i si on Aid
;58
%. o pro"ision for sal es ret urns is made ion the company?s account s.
o reliabl e infor mat i on is readily a"ail abl e as to the "olume of
ret urns as a proporti on of sal es and the ext ent of repair work
needed to rectify the fault s. ,iss 1laire !mit h infor ms you that
from past experi ence the impact of sal es ret ur ns is not mat eri al to
the financi al resul t s of $(
st
1ent ur y 7urnit ur e 0td.
o other mat t er s of significance arise from your re"iew. Qou are
pro"ided with a budget forecast for $(
st
1ent ur y 7urnit ur e 0td. 7or
the current year and for the following year to append to your
report . These reflect s arising profit trend.
#e@ui re d
7rom your brief re"i ew as specified by your client , draft a report to the
boar d of ,odern 7urnit ur e 0td. 1ont ai ni ng your findings, concl usi ons and
recomme nda t i ons.
(68 marks )
E&ES"I%N "3%
Qou are the audit or of T2 Hroup and its subsi di ari es. T2 Hroup
0imit ed, a company quot ed on the airobi !tock -xchange is the holding
company of a group of compani es in"ol"ed in "arious speci ali:ed
acti"iti es connect ed with the printing indust r y. Qour audi t of the
account s for the year ended *4 !ept e mber (''K disclosed the following:
(. # freehol d proper t y occupi ed and owned by the group was sold
during the year and leased back on a long lease. The proceeds
from the sal e and rent s payabl e under the lease are bot h well in
excess of open market . The proceeds of the sal e and lease back
trans act i ons ha"e been used as a basi s for capit ali:ing the
proper t y in the account s and for det er mi ni ng the finance lease
obligati on which is to be incorpor at ed in the bal ance sheet .
$. The holding company has gi"en guar ant e e s on bank borrowi ngs by
subsi di ari es which are not ed in the account s. =owe"er, ther e is no
pro"ision in the holding company?s account s for one subsi di ar y
which is insol"ent and depende nt upon increasi ng suppor t from
the bank.
*. <nlist ed in"est me nt s include a trade in"est me nt in a significant
suppli er st at ed at original cost. The in"est me nt repr es ent s ($_T
of the equit y of the suppli er concer ned and no di"idend ha"e been
paid for many year s. The suppli er may be seeki ng per mi ssi on for
its shar es to be list ed in the airobi !tock -xchange and ther e is
specul at i on that the market "alue may be great l y in excess of the
original cost.
#e@ui re d
AaB 1omme nt on the treat me nt of the items det ail ed abo"e
A' marksB
AbB !ugges t possi bl e alt er nat i "e treat me nt s which you consi der could be
adopt ed
in order for the account s to show a true and fair "iew.
A' marksB
A&*I"IN-
;5:
2es s on "en
("ot al B .D
marks )
E&ES"I%N "$#EE
Qou are the audi t or of ,otor 6ehicle 2art s 0td., an engi neeri ng company
produci ng component s for the mot or car indust r y. 7ollowing your
discussi ons with the fianc` direct or, it appear s that the company may
ha"e a liquidit y probl em.
#e@ui re d
/escri be the fact ors which, by thems el "es, or taken toget her , could
indicat e that the going concer n concept of the company may be brought
into questi on.
(.Dmarks )
E&ES"I%N 7%&#
In carryi ng out an audit , the independent audi t or must consi der the
reliability of audi t e"idence. #mong other things, the audi t or is requir ed
to pay att ent i on to reliability of e"idence from third parti ed and
speci alist s. The audit procedur es must ensur e that the audi t or is abl e to
"erify and ascer t ai n the reasons for mat eri al differences bet ween
bal ances st at ed in the books of the cline and those a"ail abl e from
ext er nal sources.
#e@ui re d
AaB Hi"e a conci se definition of:
AiB #udit e"idence
A$ marksB
AiiB Third part y A$
marksB
AiiiB !peci alist e"idence A$
marksB
AbB /et ail the procedur es you would follow in "erifying mat eri al
differences, st at ed in
the abo"e preambl e, with regar d to:
AiB ,att er s confir med in the lett er, the audi t or recei "ed direct
from the bank
A% ,arksB
AiiB The replies to a debt or s? circul ari:ati on
A% ,arksB
AiiiB 6aluation of the company?s proper ti es by a "aluer. The
"aluati on is to be
Incorpor at ed in the company?s account s
A% ,arksB
AcB 1onsider the reliability of st at e me nt s made by the direct or s in the
lett er of
repr es ent at i on
A% ,arksB
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
#e0i si on Aid
;5C
("ot al B 66
marks )
E&ES"I%N 7I'E
Informat i on re"ol uti on using comput er s in the banki ng sect or has meant
si mplifying the process es of:
(. Transfer of funds
$. 2ayment of cheques at cash count er s by the cashi er without referr al
to their seni ors
withdr awal and banki ng of funds using #utomat i c Teller ,achines
#e@ui re d
With refer ence to a full comput eri :ed banki ng syst e m, expl ai n for each of
the three areas specified abo"e, the cont rol s the audi t or would expect to
find in place to ensur e that the risk of errors and fraud is mini mi :ed.
(.C marks )
A&*I"IN-
;5D
2es s on "en
E9A!INA"I%N B%A#*
C+A +A#" III
=&NE .<<C
E&ES"I%N %NE
Qou are the audi t or of airobi 0orry 1o. Qou ha"e been asked to re"i ew
the manage me nt account s of the company for the ele"en mont h ended
*4 #pril (''K, in suppor t if an applicati on to a bank for furt her facilities
to fund the increasi ng working capit al requireme nt s of the company and
for the repl ace me nt of half of its fleet of twent y four lorries. In the past ,
it has been the company?s policy to repl ace four lorries e"er y year with
proceeds on dispos al usually equat i ng to half of the original cost . /uring
the last three year s no lorries ha"e been repl aced due to lack of funds.
The company? s turno"er for the current year is expect ed to be in the
region of !h. 54 million and consi st s mai nl y of cont r act hire. The 0orries
are housed and mai nt ai ned in the company? s own freehol d gar ages and
workshop.
#e@ui re d
AaB +utline the approach you woul d take to plan and carry out the
re"iew, and st at e those mat t er s to which you would pay particul ar
att ent i on. A5 ,arksB
AbB !t at e the ext ent to which such a re"i ew will ha"e an effect on the
st at ut or y audit for the year endi ng *( ,ay (''K.
A5,arksB
("ot al B 65
marks )
E&ES"I%N "3%
Qou are the audi t or of .enya !hoes Wholesal er s 0td., a shoe whol es ali ng
company, whose financi al year is endi ng on *4 !ept e mber (''K. The
company int ends to det er mi ne quant i t y and "alue of each line of stock at
a physi cal stock check to be held on !at ur day $K and !unday $9
!ept e mber (''K, and then adDust for the mo"e me nt s bet ween $9 and *4
!ept e mber . The purchas es and sal es ledger will be closed at *4
!ept e mber .
The company has a fast mo"i ng stock but oper at es a sati sfact or y
recordi ng syst e m which incorpor at es goods inwards and dispat ch
records.
#e@ui re d
/escri be the audit procedur es that you woul d adopt to sati sfy yourself
that the company? s cut off disciplines including "aluati on are adequat e.
Qou can assume that the company does not mai nt ai n perpet ual stock
records.
("ot al B 65
marks )
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
#e0i si on Aid
;5<
E&ES"I%N "$#EE
Qou are the audi t or of a maD or organi :ati on whose financi al records wer e
transf err ed at the end of (''& to an online dat abas e comput er syst e m
oper at ed by a cent r al comput er section with ter mi nal s locat ed in "arious
st ati ons.
#e@ui re d
AaB +utline the cont rol s or procedur es you would expect to be
incorpor at ed into the
syst e ms to count er act the risks of pot ent i al losses arising from the
possi bilities of human errors, hardwar e or softwar e errors, nat ur al
disast er s or deliber at el y malicious actions.
A(5,arksB
AbB /iscuss the implicati ons for your audi t for the year endi ng *(
/ecember (''K on
disco"eri ng that ther e were many deficienci es in the oper at i ng of
the syst e m during the first six calendar mont hs of (''K, but none
of any significance are expect ed ther eaf t er.
A5
,arksB

E&ES"I%N 7%&#
#gro- 1hemi cal 0imit ed is a large manuf act uri ng company produci ng
fertili:ers and other agro- chemi cal s. It empl oys about *,444 worker s.
#ttendance by fact ory hands and other wage empl oyees is e"idence by
the use of clock card, wher eby each worker clocks in and out of the
fact ory. Time keeper man the clocking machi ne and at the end of each
week a summar y is prepar ed of record of att endanc e of each empl oyee.
These weekl y summari s e ser"e as the input for the prepar at i on of
payrolls at the end of the mont h.
/uring the course of your audit of the company? s wages expendi t ur e, you
disco"er ed that fraud had taken place and the manage me nt has
commi s si oned you to in"esti gat e it.
#e@ui re dB
AaB 1learly st at e and descri be fi"e possi bl e ways in which wages fraud
can be
commi t t ed in an organi:at i on
A5,arksB
AbB /et ail the areas and audi t test s you will conduct to asses s the
ext ent of the fraud.
A(5
marksB
("ot al B 65
marks )
E&ES"I%N 7I'E
AaB VThe concer n of audit ors is to limit the scope of their responsi biliti es,
public opinion, on the other hand, belie"es that their audit
responsi bilities shoul d be ext ended?.
A&*I"IN-
;.5
2es s on "en
#e@ui re d
AaB /iscuss those areas in which the public belie"es the audi t or s
responsi bilities shoul d be ext ended and pro"ide comme nt s from
an audi t or?s point of "iew. A(4 ,arksB
AbB VThe account i ng professi on needs to de"el op a concept ual
framewor k for the
prepar at i on and int erpr et at i on of financi al st at e me nt s .
/iscuss the benefi t s of such a framewor k for bot h the user s and audi t ors
of financi al st at e me nt s and consi der the difficulti es in de"el opi ng a
framewor k that is useful in practi ce.

A(4 ,arksB
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
#e0i si on Aid
;..
E9A!INA"I%N B%A#*
C+A +A#" III
*ECE!BE# .<<:
E&ES"I%N %NE
Qou are a part ner in an est abli shed practi ce. ,r. )rown, a direct or of
)rown .eer ltd. approached you to in"esti gat e a suspect ed comput er
fraud in his company.
The company suppli es ci"il engi neeri ng ser"ices to the public and pri"at e
sect or. ,ost of its work is done through subcont r act or s. #s many as (44
subcont r act or s may be working on proDect s for the company at any one
ti me.
The company comme nc e d busi nes s fi"e year s ago with about (5
empl oyees and has since grown rapi dl y. It cruel t y empl oys &44
per mane nt st aff.
#s a resul t of the rapid expansi on of the company, the account i ng
syst e ms were comput eri :ed in (''% and ha"e since been upgr aded and
impro"ed. #t the end of (''% the company disconti nued cheque
payment s to subcont r act or s and instit ut ed the met hod of direct
payment through the banki ng syst e m. !ince then, the engi neer s in
charge of the "arious proDect s ha"e sent facsi mil e copi es of engi neeri ng
certificat es of work compl et ed through to the head office in airobi.
These are recei "ed by the $$ day of each mont h and ser"e as the
aut hori:at i on docume nt for updat i ng subcont r act or s? account s. #ll
cont act work certified in this way is process ed by the $5 day of each
mont h. # magnet i c tape cont ai ni ng compl et e det ails of the payment s to
subcont r act or s is deli"er ed the following day to the company? s bank.
The bank process es the rele"ant dat a and pass es the payment s for the
credi t of the subcont r act or s? account s through to the rel e"ant banks for
bat ch processi ng during the e"eni ng of the $K day of each mont h. -ach
subcont r act or?s bank account is thus credit ed by the mor ni ng of $9 day
of each mont h within amount equal to the "alue of work certified up to
the $$ day of that mont h.
7rom your discussi on with ,r. )rown you est abli sh the following:
(. ,r. !olo, a sole practitioner , has been the audi t or of )rown .eer
0td. since incepti on
$. The engi neer in charge of one of the large proDect s recentl y
reques t ed a compl et e
proDect cost anal ysi s aft er he had been quest i oned by
manage me nt regar di ng excessi "e expendi t ur e compar ed with the
original tender. =e subs eque nt l y est abli shed that a number of
fictitious subcont r act or s had been paid for work that he had not
certified. 7urther in"esti gat i on re"eal ed that fraudul ent
engi neeri ng certificat es had been recei"ed for proces si ng form the
,ombas a office. 2ro"isional in"esti gat i ons indicat e that the fraud
A&*I"IN-
;.6
2es s on "en
st art ed earl y in (''5.
*. ,r. !olo issue unqualified audit report s for the year ended *(
,arch (''5 and *( ,arch (''&, and had not brought any
weaknes s es in the company? s int ernal cont rol syst e m to the
att ent i on of the manage me nt during the year s co"er ed by those
audi t s.
%. ,r. !olo has been infor med of the suspect ed fraud but he is
unabl e to under t ake the in"esti gat i on immedi at el y as he does not
ha"e a"ail abl e st aff.
#e@ui re d
AaB !t at e, in point form, the fact ors you must consi der and the
procedur es your firm must follow befor e accept i ng this assi gnme nt
A&,arksB
AbB /escri be the int er nal cont rol weaknes s e s and account i ng probl ems
that can nor mall y be expect ed in circums t anc es wher e a small
company grows so rapi dly A9,arksB
AcB 0ist the mai n cont rol s which could ha"e assi st ed in the pre"ent i on
or ti mel y det ecti on of fraud such as that which took place in the
circums t anc es outlined abo"e A',arksB

E&ES"I%N "3%
Qou are audi t or of a large manuf act uri ng company, 2roduct !upplies 0td.
The maD or asset of the company is stock. In prior year s, no use has been
made of the comput er when auditing stock. The hard copy of the year
end stock mast er file was used as the basi s for sel ecti ng stock items for
det ail ed testi ng.
Qour firm has recentl y purchas ed a limit ed number of personal
comput er s Ahard disk capaci t y of %4,)B and speci ali:ed soft war e to
enabl e you to acces s infor mat i on stored on a mai n frame comput er . Qou
are ext re mel y keen to use a personal comput er to assi st in the audi t of
stock in the current year.
The account ant pf 2roduct !uppli es ltd. has agr eed that you may access
the company? s mai nframe comput er as he belie"es that this will lead to a
mor e efficient and effecti"e audit of stock.
=e referr ed you to the dat a proces si ng manager with whom you
discuss ed the possi bility of coupling your personal comput er to 2roduct
!upplies 0td.?s mai nfr ame comput er .
The dat a processi ng manager request ed cert ai n det ail s regar di ng your
personal comput er . #fter exami ni ng the det ails, he coupl ed your
personal comput er to the mai nframe.
#fter gaini ng acces s to the stock dat a base, you identified the following
dat a fields:
2roduct number
/escri pti on
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
#e0i si on Aid
;.4
3uanti t y of stock on hand
0atest purchas e dat e, includi ng det ails of suppli er and order
number
0atest sal es dat e and sal es in"oice number
,inimum stock requir eme nt s
,axi mum stock requir eme nt s
,ost current selling price
Identificati on of stock locati on
Qou int end sorting the dat a that will be requir ed for purpos es by using
your firm?s speci ali:ed softwar e. The report s that you require will be
ext ract ed from the stock mast er file and stored on the hard disk of your
personal comput er for futur e use.
#e@ui re d
AaB Identify the cont rol s required to ensur e the int egri t y of the client?s
stock dat a A& ,arksB
AbB 0ist the ad"ant age s that the coupling of your personal comput er to
the mai nframe of your client will ha"e abo"e the con"ent i onal
manner in which the audit of stock was perfor med in pre"ious
year s. AQou may assume that ther e are sufficient cont rol s to
ensur e the int egrit y of the dat a baseB.
A% ,rksB
AcB 0ist fi"e report s you would extr act from the stock mast er file using
the personal
comput er and discuss how each report would assi st you in
perfor mi ng the neces s ar y audi t test s and stock.
A(5 marksB
("ot al B 68
marks )
A&*I"IN-
;.;
2es s on "en
E&ES"I%N "$#EE
Qou are the audi t or of 17 0td., a company oper at i ng a chai n of twel"e
stores in a turno"er in the region of !h. %54 million per annum and
empl oyi ng approxi mat el y (44 st aff. The finance direct or has infor med
you that the company is to set up an int er nal audi t depar t me nt
responsi bl e to hi m with a st aff of three officers who will be responsi bl e
for re"iewi ng and recomme ndi ng impro"e me nt s to the syst e ms of
int ernal cont rol. In addi tion, the finance direct or has sugges t ed that in
order to impro"e existing syst e ms of int ernal cont rol, the int ernal audi t
depar t me nt would be required to aut hori:e all payment s o"er a specified
limit, the payment of sal ari es to all st aff and the issue of credit not es.
#e@ui re d
Write a formal lett er to the finance direct or comme nt i ng on the ext ent to
which you woul d be prepar ed to rely upon the work of the int ernal audi t
depar t me nt in carryi ng out your audi t of the account s of 17 0td.
In your answer fi"e at t ent i on to the mai n feat ur es of a properl y planned
lett er laid out in paragr aphs gi"ing emphasi s to int ernal audit functions,
reliance on int ernal audi t under nor mal circums t anc es , ext ent to which
you would rely on this particul ar audi t depar t me nt and suit abl e
conclusi on regar di ng the mat t er s at hand.
("ot al B 65
marks )
E&ES"I%N 7%&#
8ecentl y the 1ent r al )ank of .enya issued a guideline to banks and non-
bank financi al instit utions ad"i si ng them to consi der set ti ng up audi t
commi t t e es .
Qou are required to set out below:
AaB The purpos e and obDecti"e of an audit commi t t e e
A 5 ,arksB
AbB 1omposi tion of an audi t commi t t e e
A$ ,arksB
AcB 8esponsi bilities of an audi t commi t t e e A&
marksB
AdB The relati onshi p bet ween the audit commi t t ee and the ext er nal
audi t or s
A$
marksB
AeB The rel ationshi p bet ween the audi t commi t t e e and the board of
direct or s
A$
marksB
("ot al B .C
marks )
E&ES"I%N 7I'E
With refer ence to appropri at e Int ernat i onal !t andar ds on audi ti ng,
discuss the ext ent to which the audit or can rely on repr es ent at i on made
by manage me nt which are not capabl e of independent "erificati on by the
audi t or.
("ot al B .8
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
#e0i si on Aid
;.8
marks )
A&*I"IN-
;.:
2es s on "en
E9A!INA"I%N B%A#*
C+A +A#" III
=&NE .<<:
E&ES"I%N %NE
Qou are the newl y appoi nt ed financi al direct or of .3 !hoes 0td., which
oper at ed a chai n of 54 ret ail stores, selling on a cash only basi s. The
stores are admi ni st er ed and moni t or ed from a cent r al head office and all
stock is issued to the stores from a cent r al warehous e at ret ail selling
price. +ne of your key functions is to re"iew the quart erl y branch
account s.
# det ail ed anal ysi s of the branch account s for the last quart er re"eal ed
that the a"er age gross profit mar gi n for the 54 stor es was %&T whilst
fi"e stor es report ed mar gi ns below$4T.
)eing most concer ned about this finding, you asked your int ernal audi t or
to recount the stock of the fi"e stores and prepar e their branch account s
to the dat e of the second stock take. 7ollowing this second stock take
si mil ar gross profit mar gi ns were report ed, thus confir mi ng your
suspicion of theft in the fi"e stores.
Qou approached the manager s of the stor es in quest i on and they all
ascri bed the stockC cas h losses to week branch int er nal cont rol syst e ms .
Qou conceded that the company has grown rapi dl y and that no formal
branch syst e ms or cont rol s exist .
Qou report ed your findings to the managi ng direct or who asked you to
desi gn branch syst e ms and cont rol s which woul d highlight theft from
stores and result in a const ant gross profit mar gi n at all outl et s.
#s a resul t of the number and distributi on of the stor es, it is not possi bl e
to comput eri :e branch acti"ities alt hough all proces si ng at head office is
comput eri :ed.
#e@ui re d
/esign branch syst e ms and cont rol s which will highlight theft from the
stores and result in a const ant gross profit mar gi n at all outl et s.
Qour syst e ms and cont rol s shoul d be det ail ed under the following
headi ngs:
AaB /ispat ch from war ehous e to stores
A5 ,arksB
AbB 8ecei"ing of goods by stores
A5 ,arksB
AcB 2hysical store and stock cont rol s A&
marksB
AdB ,ark down of stock
A5 ,arksB
AeB 1ash cont rol s A%
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
#e0i si on Aid
;.C
marksB
*et ai l e d com1ut e r a11l i cat i ons nee d not ,e cons i der e d
("ot al B 68
marks )
A&*I"IN-
;.D
2es s on "en
E&ES"I%N "$#EE
The published annual report of a public limit ed company, may include
financi al and a st ati stical infor mat i on within the direct or s? report and the
chair man? s st at e me nt s well as the audit ed financi al st at e me nt s .
#e@ui re d
AaB !t at e the responsi biliti es of the audi t or for the financi al st at e me nt s
co"er ed by his
audi t report A&
marksB
AbB !t at e the responsi biliti es of the audi t or for the financi al and
st ati stical infor mat i on
included within the direct or s? report and chair man? s st at e me nt
A% ,arksB
AcB /iscuss the "arious actions which could be taken by the audi t or if
he consi der s and such financi al or st ati stical infor mat i on refer eed
to in AbB cont ai ns a mat eri al misst at e me nt or inconsi st ency with
the financi al st at e me nt s co"er ed by his audi t report
A5 ,arksB
("ot al B .8
marks )
E&ES"I%N 7%&#
Qou are the audit or of .enya drinks 0td., a company which import s and
distribut es whisky to a wide range of cust omer s in the count ry. In recent
year s company has experi enced low profit ability as the popul ari t y of
whisky has declined. The draft account s as at *4 #pril (''& show net
liabilities of !h. (&, 444, 444. The company?s maD or source of finance is a
bank loan of !h. %4, 444, 444 which is due for repayme nt in full on *4
!ept e mber (''&. The company is negoti at i ng with its banker s for a
repl ace me nt long ter m loan of !h. 94, 444, 444 and int ended to use these
addi tional funds to finance an expansi on of its acti"iti es into the
pot ent i ally mor e profit abl e busi ness of importi ng and distributi ng wines.
The direct or s are opti mi sti c that the bank will agr ee to make the loan
a"ailabl e in "iew of the profit forecast for the year to *4 #pril (''K which
they submi t t ed with their loan applicati on. =owe"er, they do not expect
negoti ati ons to be compl et ed befor e the #nnual Hener al ,eeti ng on $*
#ugust (''&.
The det ail ed audit work has been compl et ed with the excepti on of
obt ai ni ng the neces s ar y confirmat i on from the bank and no other audi t
probl ems ha"e been not ed. The direct or s ha"e asked you not to
approach the bank becaus e of the negoti ati ons.
#e@ui re d
AaB !t at e the enqui ri es you would make and the procedur es you woul d
perfor m with
regar d to est abli shi ng the st at us of .enya /rinks 0td. as a going
concer n A9 marksB
AbB /iscuss the alt er nat i "e audi t opinions which may be rel e"ant to
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
#e0i si on Aid
;.<
the account s of
.enya /rinks ltd. toget her with the circumst ance s in which each
woul d be appropri at e
AK
marksB
((ou are not re@ui re d to dra t ull audi t re1ort )
("ot al B .8
marks )
E&ES"I%N 7I'E
AaB /iscuss whet her it is practi cal and desirabl e within the limits of
procedur es and cost s, for the audit or to accept a gener al
responsi bility to det ect fraud and other irregul ari ti es
A($
marksB
AbB With refer ence to decided cases briefly expl ai n the ext ent and
limit s of an audi t or?s obligati on to det ect error and fraud
A9
marksB
("ot al B 65
marks )
#E'ISI%N +A+E#
E&ES"I%N %NE
Qou are the senior audit manager in charge of the final audit of +ld
Traders 0td. )efore finalising the audit for the year ended *4 !ept ember
$44*, you sit back and reflect on the "arious cont enti ous issues which
ha"e come to light in the course of the audit. Qou ha"e recorded the
following maDor point s in your working paper s.
i. The 7inance ,anager of +ld Trader s 0td. has present ed you
with his draft account s@ some of the figures appear to be
incorrectl y stat ed. =e informs you that the figures are final and
cannot be adDust ed under any circumst ances.
ii. While checking the "aluation of stocks you disco"er ed that the
clerk used the cost s in force before Guly $44*. Qou are awar e
that there was a (4T gener al price increas e bet ween Guly and
!ept ember $44*
iii. The 7inance ,anager has also informed you that the maDorit y of
the fixed asset s are mot or- "ehicles. o depr eci ation was
charged in the year in "iew of the fact that Othe "ehicles can be
A&*I"IN-
;65
2es s on "en
resold at the end of the fi"e years to realise mor e than K5T of
their original costO. The companyJ s depreci ati on policy is
straight- line at $4T per year. The second reason for not
charging depreci ati on is that all the mot or "ehicles were fitted
with new tyres during this year and therefore in his opinion the
high repairs expens e ob"iat ed the need to charge depr eci ation.
The company does not intend to sell the mot or- "ehicles in the
near future.
i". Included in debt ors is an amount of !h. 594, 444 which is owed
by ,afut a /istribut ors. Qou reme mber readi ng in the mid Gune
$44* issue of the local daily newspaper that ,afut a /istribut ors
was put under recei"ershi p. It is the +ld Traders 0td. policy not
to pro"ide for doubtful debt s.
". o pro"ision for tax payabl e has been made. The 7inance
,anager mai nt ai ns that a pro"ision is not necess ar y since plans
ha"e already been finalised for +ld Traders 0td. to acquire a
dor mant company with huge tax losses.
"i. The following are extract s of the financi al stat e ment s for the
company:
%2* "#A*E#S 2"*/
AB#I*-E* BA2ANCE S$EE" AS A" 45 SE+"E!BE# 6554
6554 6556
ShK 555K ShK 555K
7ixed #sset s 1ost &,444 &,444
#ccumul at ed depr eci ation A*,544 B A*,544 B
/ebtors &44 544
!tocks (,(44 944
1ash (44 554
1reditors AK44 B A&44 B
!hare 1apit al A$,&44 B A$,&44 B
8e"enue reser"es A(,444 B A(,(54 B
-4 - -4 -
AB#I*-E* +#%7I" AN* 2%SS S"A"E!EN" 7%# "$E
(EA# EN*E* 45 SE+"E!BE#? 6554
6554 6556
ShK 555 ShK 555
Turno"er &,%44 %,544
Hross profit 5,%44 %,444
/epreci ation charge N A(,$44 B
8epairs and mai nt enance A(,%54 B A (54 B
+ther expens es A%,(44 B A(,K44 B
Tax charge N A (44 B
et 2rofit aft er tax A(54 B 954
#e@ui red
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
#e0i si on Aid
;6.
AaB 2repar e a memor andum to the )oard of /irectors of +ld
Traders 0td. to expl ain your obser"ati ons, reser"ati ons and
suggesti ons with regard to the mat t er s raised abo"e.
A($ ,arksB
AbB /raft an adDust ed set of account s in the same format as that
present ed by the 7inance ,anager but incorpor ati ng the
suggesti ons you ha"e made to the )oard of +ld Traders 0td.
A& ,arksB
AcB In the e"ent that the )oard refuses to accept your
suggesti ons, draft an appropri at e audit report .
A& ,arksB

("ot al B 6; !arks)
E&ES"I%N "3%
Qour firm act s as audit ors of ew .enya Harment s ,anufact uring 0imited
A.H,B. The company buys all its yarn and textile mat eri al s locally. It
oper at es only one factory. 1loth is sold to "arious distribut or s from this
factory.
Qou are currentl y engaged in the audit of .H, whose year end is *(
+ctober $44* To your dismay you learn that in the mont h of +ctober
$44*, the purchas e ledger clerk lost all the loose leaf pages of the
purchas e Dournal s, purchas e day books and purchas e ledger cards for
!ept ember and +ctober $44*. The 7inance /irector has informed you that
he will not be able to re- write these books from the a"ailabl e source
document s in "iew of the large "olume of transacti ons in"ol"ed and the
lack of time. =e has, howe"er, told you that the manual nomi nal ledger is
still intact. The ledger has control account s for purchas es, creditors, sales
and cash.
The final audit clearance on the account s of .H, is required in two
weeks time.
#e@ui red
/escribe the audit procedur es you would empl oy to satisfy yourself that
creditors as at *( +ctober are not mat eri ally mis- stat ed /
("ot al B 66 !arks)
E&ES"I%N "$#EE
!ummari se the law relating to the auditors dut y of care to the users of
A&*I"IN-
;66
2es s on "en
published account s. In your summar y outline the key court decisions on
the tort of negligence and discuss the rele"ance of these decisions to the
accounti ng profession in .enya today. ("ot al B .D !arks)
E&ES"I%N 7%&#
1ritically discuss the concept of e"idence in auditing. In your decision
show the impact of cust om, con"ention and auditing standar ds on what
constit ut e e"ident ual mat t er in .enya today.
("ot al B .D !arks B
E&ES"I%N 7I'E
Whilst the obDecti"es and end result s remai n the same, it is true that the
audit approach for comput er based syst ems differs significantly from that
adopt ed for con"enti onal manual syst ems.
#e@ui red
1ritically exami ne the "alidity of the abo"e asser ti on paying speci al
att enti on to the choice of audit approach, ext ent , timing and nat ur e of
audit test s / ("ot al B .D !arks)
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
#e0i si on Aid
;64
Sugg e s t e d Sol ut i ons to Sel ec t e d +as t
+a1er s
and the #e0i si on +a1er
*ECE!BE# .<<C
E&ES"I%N %NE
!%*E#N 7&#NI"&"E 2I!I"E*
The /irect or s
,odern 7urnit ur e?s limit ed
2.+.)ox xy:
airobi
/ear !irs
#EB #E'IE3 %7 "$E %+E#A"I%NS %7 6.
S"
CEN"#&#(
7&#NI"&#E 2"*
IN"#%*&C"I%N
In accor dance with your instructi ons we ha"e carri ed out a brief
re"iew of the oper at i ons of $(
st
1ent ur y 7urnit ur e 0td with
particul ar emphasi s on its account i ng practi ces, its current
tradi ng perfor manc e and futur e prospect s.
%,Hect i 0e o the re0i e w
"o det er mi ne
(. The suit ability of the account i ng practi ces adapt ed.
$. The profit ability and the financi al position of the company
*. The futur e prospect s of the company.
%ur indi ng s
Account i ng 1ract i c e s
The excepti onal item of profit of kshs 9,%94, 444 is not a
recurri ng tradi ng item. It is an excepti onal item that is not
likely to recur. The current I#! 9 accept s its treat me nt as
excepti onal although pre"iousl y it would ha"e been
recogni :ed as an extr a ordinar y trans act i on
,anage me nt has engaged in creat i"e account i ng. The
report ed profit for six mont hs has been mani pul at ed. /ebt or s
and stocks are o"erst at ed with an amount of ksh $($, 444, 444
hence profit is also o"erst at ed by the same agai n.
ecess ar y pro"isions are not being set up to mat ch re"enues
with cost s. !ales ret ur ns are account ed for in the year they
occur wher eas the relat ed sal es are account ed for in a
different period. This mismat ch is e"en mor e appar ent in the
non- pro"ision for rectificati on cost s.
A&*I"IN-
;6;
2es s on "en
Current tradi ng 1er or ma nc e
The company appear s to be unabl e to meet its budget , ther e has
been a downt ur n in trade and company?s product s appear to
ha"e limit ed demand.
7ut ure 1ros 1e c t s
The company is disposi ng of its proper t i es and leasi ng premi s e.
Therefor e increas ed oper at i onal cost are likely in the futur e on
account of rent and hire. The manage me nt is opti mi sti c about
the futur e prospect s.
Concl us i ons and rom indi ngs
(. The company? s account i ng practices are not in accordance
with appro"ed account i ng practi ces. The asset s of the
company could be o"erst at ed and liabilities under st at ed.
$. The profit ability of the company is lower than disclosed in the
*. The futur e of the company is bleak and the forecast s are o"er
opti mi stic.
#ecomme n d a t i o ns
(. 2roper financi al st at e me nt s shoul d be prepar ed in accor dance
with appro"ed account i ng st andar ds, the I#!s.
$. The true and fair "iew of thes e account s shoul d be confir med
by audit work.
*. 7ixed asset s, stocks and debt or s be properl y det er mi ned,
through physical count and inspect i on or circul ari:ati on and
be properl y "alued.
%. The audi t ed financi al st at e me nt s shoul d be re anal y:ed to
eli mi nat e the Eexcept i onal F profits from dispos al of proper ti es
as thes e will not arise in the future and to incorpor at e notional
amount s for expens es such as rent s which will appl y in the
futur e and adequat e pro"isions be made for ret ur ns and
rectificati on work.
5. # mor e realistic budget be worked out as the current one
shows increasi ng profits, which are not backed by current
perfor manc e.
Concl us i on
+ur abo"e report is based on a brief re"iew of the oper at i ng
resul t s of the $(
st
1ent ur y 7urnit ur e 0imit ed and discussi ons with
the company? s manage me nt . It cannot form the basi s of
concludi ng a buy- out arrange me nt unl ess the recomme nda t i ons
st at ed abo"e are impl ement e d. =owe"er, shoul d you requir e any
clarification do not hesi t at e to cont act us.
Qours faithfully
Turu M 7eya
1ertified public account ant s.
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"N+ -rou1
7or an account i ng treat me nt to be appropri at e and
7ully accept abl e it must fall within an accept ed framewor k. Treat me nt of
items in the financi al st at e me nt s is go"er ned by the suit abilit y of the
account i ng policy adopt ed by the entit y. 7or an account i ng policy to be
suit abl e, it must sati sfy the following conditions.
It must be gener all y accept abl e, that is, in accor dance with
gener all y accept ed account i ng principl es
It must be appropri at e to the circumst ance s of the entit y
It must be consi st ent l y appli ed from one account i ng period to the
next , within the account i ng period and within entit y
Ideally it shoul d be a met hod that is commonl y adopt ed within the
indust r y
It shoul d be in accor dance with an I.#.!. P if ther e is one co"eri ng
the mat t er
It shoul d be adequat el y disclosed, if it is
!ignificant in the det er mi nat i on of "alues for asset s or liabilities or
charges and credi t s to the income st at e me nt .
aB )eari ng the abo"e in mi nd, the following comme nt s and
alt ernat i "e treat me nt could be made.
.) Sal e and 2eas e Back
The aut hori t y on sal e and leaseback trans act i ons is I.#.!. (K,
which pro"ides as follows:
If a sal e and leaseback transact i on resul t s in a finance lease@ any
excess of sal e proceeds o"er the carryi ng amount shoul d not be
immedi at el y recogni :ed as income in the financi al st at e me nt s .
!uch excess shoul d be deferr ed and amor ti sed o"er the lease
ter m.
It further pro"ides that the amount to be used for capit ali:ati on
and recogni ti on of obligations shoul d be the fair "alue.
The treat me nt adopt ed is not consi st ent with I.#.!. (K. It
recogni :es the asset at other than fair "alue, and is ther efor e not
suit abl e.
6) -uarant e e to Su,si di ary
I.#.! $9, on 1onsolidati on of !ubsi di ar y 1ompani es pro"ides that if
the going concer n assumpt i on is not Dustified in the case of a
subsi di ary that has suffer ed a a per mane nt di mi nuti on in "alue
through losses then a pro"ision shoul d be made in the
consolidat ed profit and loss account .
The subsi di ary descri bed abo"e would appear to ha"e suffered a
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per mane nt di mi nuti on in "alue and shoul d accordi ngl y
be pro"ided for to recogni:e its real "alue. The met hod adopt ed
by this client ther efor e is not suit abl e.
4) In0es t me nt s
I.#.! *' deal s with #ccounti ng and /isclosur e of In"est me nt s. It
pro"ides that long ter m in"est me nt s can be carri ed at cost or a
"aluati on.
The compani es #ct requires that wher e in"est me nt s are shown at
cost a direct or?s "aluati on be disclosed by way of not e. The
treat me nt gi"en by the a manage me nt is accept abl e. What may
be questi onabl e is its adequacy in infor mat i on cont ent .
bB #lternati "e treat me nt to ensur e true and fair "iew bei ng shown
.) Sal e and 2eas e ,ack
The possi bl e alt ernat i "e that could be
#dopt ed for the account s to show a true and fair "iew would be for the
asset to be capit ali:ed at its pres ent book "alue and the proceeds to be
shown as cash at bank and the financi al obligati on to be shown at the
amount of the proceeds. In other words the asset is not re"al ued but the
proceeds are recogni :ed as a loan.
6) -uarant e e to Su,si di ary
The subsi di ary could be "alued at a reali:abl e "alue and a pro"ision set
up in the consolidat ed profit and loss account for the per mane nt
di mi nuti on in "alue.
If the going concer n assumpt i on is not Dustified it could be mi sl eadi ng to
consolidat e the subsi di ary and accordi ngl y the holding company shoul d
also recogni:e the loss in its own profit and loss account and reduce the
"alue of in"est me nt s in its own bal ance sheet .
4) In0es t me nt s
The direct or s could "alue the trade in"est me nt and as an
addi tional piece of useful infor mat i on for the reader disclose the
cost in the bal ance sheet and in not e to the amount s or on the
face of the bal ance sheet also disclose the direct or?s "aluati on of
the trade in"est me nt .
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E&ES"I%N "$#EE
!ot or 'ehi cl e +art s 2td
3hen 1l anni ng and 1er or mi ng audi t 1roc e dur e s and in
e0al uat i ng the res ul t s there o ? the audi t or shoul d consi der the
a11ro1ri at e n e s s o mana g e me n t A s us e o the goi ng conc er n
as s um1t i o n in the 1re1arat i on o the inanci al st at e me nt s /
The going concer n assumpt i on is a funda me nt al principl e in the
prepar at i on of financi al st at e me nt s . <nder the going concer n
assumpt i on, an entit y is ordinarily "iewed as continui ng in busi ness for
the foreseea bl e future with neit her the int enti on nor the neces si t y of
liquidati on, ceasi ng tradi ng or seeki ng prot ect i on from credi t or s pursuant
to laws or 8egul ati ons. #ccordingl y, asset s and liabilities are recorded on
the basi s that the entit y will be abl e to reali:e its asset s and dischar ge its
liabilities in the nor mal course of busines s.
-xampl es of e"ent s or conditions, which indi"idually or collecti"el y, may
cast significant doubt about the going concer n assumpt i on, are set out
below. This listing is not all- inclusi"e nor does the exist ence of one or
mor e of the items always signify that a mat eri al uncer t ai nt y exist s.
7inanci al
I et liability or net current liability position.
I 7ixed- ter m borrowi ngs approachi ng mat uri t y without realistic prospect s
of renewal or repayme nt @ or excessi "e reliance on short- ter m borrowi ngs
to finance long- ter m asset s.
I Indicati ons of withdr awal of financi al suppor t by debt or s and other
credi t or s.
I egati "e oper at i ng cash flows indicat ed by hist orical or prospect i "e
I #d"erse key financi al ratios.
I !ubst ant i al oper at i ng losses or significant det eri or ati on in the "alue of
asset s used to gener at e cash flows.
I #rrear s or disconti nuance of di"idends.
I Inability to pay credit ors on due dat es.
I Inability to compl y with the ter ms of loan agree me nt s .
I 1hange from credi t to cash- on- deli"ery transact i ons with suppli ers.
I Inability to obt ai n financi ng for essent i al new product de"el opme nt or
other essent i al in"est me nt s.
%1erat i ng
I 0oss of key manage me nt without repl ace me nt .
I 0oss of a maD or market , franchi se, license, or principal suppli er.
I 0abor difficulties or short ages of import ant suppli es.
%ther
I on- compli ance with capit al or other st at ut or y requir eme nt s.
I 2endi ng legal or regul at or y proceedi ngs agai nst the entit y that may, if
succes sf ul , result in clai ms that are unlikely to be sati sfi ed.
I 1hanges in legisl ation or go"er nme nt policy expect ed to ad"er s el y
affect the entit y.
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The significance of such e"ent s or conditions oft en can be mitigat ed by
other fact ors. 7or exampl e, the effect of an entit y being unabl e to make
its nor mal debt repayme nt s may be count erbal anced by manage me nt ? s
plans to mai nt ai n
adequat e cash flows by alt ernat i "e means, such as by disposal of asset s,
rescheduli ng of loan repayme nt s , or obt ai ni ng addi tional capit al.
!imilarly, the loss of a principal suppli er may be mitigat ed by the
a"ailability of a suit abl e alt er nat i "e source of suppl y.
E&ES"I%N7%&#
E#udit e"idenceF is all the infor mat i on used by the audi t or in arri"ing at
the conclusi ons on which the audi t opinion is based, and includes the
infor mat i on cont ai ned in the account i ng records underl yi ng the financi al
st at e me nt s and other infor mat i on. #uditors are not expect ed to addr es s
all infor mat i on that may exist . ( #udit e"idence, which is cumul ati "e in
nat ur e, includes audit e"idence obt ai ned from audi t procedur es
perfor med during the course of the audit and may include audi t e"idence
obt ai ned from other sources such as pre"ious audi t s and a firm?s qualit y
cont rol procedur es for client accept anc e and continuance.
!peci alist e"idence refers to the e"idence pro"ided by an expert . E-xpert F
means a person or firm posses si ng speci al skill, knowl edge and
experi ence in a particul ar field other than account i ng and audi ti ng. When
using the work perfor med by an exper t , the audit or shoul d obt ai n
sufficient appropri at e audit e"idence that such work is adequat e for the
purpos es of the audit .
E&ES"I%N 7I'E
Control s in a com1ut eri G e d ,anki ng syst e m
.) "rans er o unds
This relat es to transfer of funds bet ween account s of indi"idual
cust omer s, bet ween the bank and its branches or other banks. The
following controls would be expect ed,
AiB <se of passwor ds which are regul arly changed to effect the
transfer of funds. The comput er will be programme d to check
the passwor d agai nst its list of aut hori:ed passwor ds.
AiiB <se of designat ed ter mi nal s, which are closely monit ored to
effect transfer s.
#uthorit y limits to the amount s that can be transferr ed by any
person or persons.
AiiiB The comput er should gener at e sequenti al number s for all
transfers. These transfers should then be logged and the log
shoul d be regul arly scrutini:ed by a responsi bl e official to det ect
any aut hori sed transfer s.
Ai"B Transfers effect ed by cust omer s at their offices should be
through a dedicat ed line whereby access is only per mi t t ed by
the banks mainframe comput er after it has itself dialled the
dedicat ed number.
A"B !tat ement s sent out to cust omer s regul arly so that they can
det ect irregul ar transfers.
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2es s on "en
6) +ayme nt o che@ue s at cash count er s wit hout re erral to
thei r seni ors
<se of ,I18 technol ogy to aut omat i call y read the correct number ,
account number and branch numbe
A"iB The comput er should gener at e sequenti al number s for all
transfers. These transfers should then be logged and the log
shoul d be regul arly scrutini:ed by a responsi bl e official to det ect
any aut hori sed transfer s.
A"iiB Transfers effect ed by cust omer s at their offices should be
through a dedicat ed line whereby access is only per mi t t ed by
the banks mainframe comput er after it has itself dialled the
dedicat ed number.
A"iiiB !tat ement s sent out to cust omer s regul arly so that they can
det ect irregul ar transfers.
6) +ayme nt o che@ue s at cash count er s wit hout re erral to
thei r seni ors
<se of ,I18 technol ogy to aut omat i call y read the correct number ,
account number and branch number
4) 3ithdrawal and ,anki ng usi ng Aut omat e d "ell er !achi ne s
AiB # limit woul d be est abli shed as to how much can be withdr awn
per week using the #T,. The comput er would then moni t or the
withdr awal s and ensur e that they do not exceed the limit.
AiiB #n account holder will be expect ed to ha"e a card and 2I to
facilit at e acces s.
AiiiB The #T, would be expect ed to ret ai n the card wher e the 2I
error occurs, say aft er three unsucces sf ul att e mpt s .
Ai"B In addi tion to a cash counti ng, machi ne, the comput er woul d be
linked to a scanner to not only identify the denomi nat i on of the
currency but also that it is genui ne cash for banki ng of funds.
A"B #n ad"ice slip would be sequent i all y number ed and logged so
that each type of trans act i on is fully det ail ed.
8egul ar st at e me nt to cust omer s to confirm bal ances on their
account s
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E&ES"I%N %NE
#. The following approach would be adopt ed
AaB +bt ain precise writt en instructions clearly specifying the
obDecti"es of the in"esti gati on@
AbB +bt ain copies of the audit ed account s for the pre"ious $ years@
AcB +bt ain copies of the manage me nt account s for the pre"ious $
years@
AdB +bt ain copies of the manage me nt account s under re"iew@
AeB +bt ain copies of the budget s and report s to manage me nt on
"ariances bet ween budget and act ual as per manage me nt
account s@
AfB #nalyse the account s est ablishing trends@
AgB =old a discussi on with the manage me nt on the prospect s of the
indust ry the client is in, their present condition and the
operati ng styl es of compet i t or s@
AhB 8e"iew the accounti ng policies used in the prepar ati on of the
manage me nt account s and ensur e that they are consist ent with
those used in prepari ng the audit ed account s and ha"e been
properly applied@
AiB 1ompar e past manage me nt account s with final audit ed
account s for the same years to det er mi ne the nat ur e of
adDust ment s made to the manage me nt account s so that they
can be published as audit ed account s.
ADB 6isit the companyJ s premi ses and inspect the conditions of the
coaches to det er mi ne whet her they ha"e any realisabl e "alue@
AkB /iscuss the future plans with the direct ors and confirm that
prospect ed cash flows will ensur e that the qualities can be
ser"iced profitabl y@
AlB 1onsider the companyJ s underl ying securit y for the facilities and
its accept ability by the bank@
AmB 1onsider the proposed repayment ter ms and det er mi ne the
"alidity of the proDect@
AnB I would re"iew the treat ment of the following:
I !tocks of spar es
I 8epairs and maint enance@
AoB The operations of the garage need to be re"iewed to see if it
can be self supporti ng.
). I If adequat e anal ytical re"iew procedur es can be carried out on the
manage me nt account s, similar work need not be carried out on
the final audit ed account s. This will therefore pro"ide e"idence as
to the reliability of the audit ed account s@
I 8e"iew of the plans of the manage me nt will pro"ide the auditor
with e"idence as to the going concern applicability to the
company@
I =a"ing ret ai ned some coaches well beyond their normal useful life
the account s may be showing a misleadi ng portion with regard to
the depr eci ation charged, accounti ng policies adopt ed and
A&*I"IN-
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2es s on "en
necess ar y disclosur e as .#! (K on fully depreci at ed asset s still in
use.
#ccordingly the "iew gi"en by the account s will need to be
consider ed to ensur e that it is fair.
I The audit or can circularise debt or s early and the inspection of the
coaches at the re"iew stage will mean that similar inspection is not
necess ar y at the final audit.
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*ece m,e r .<<:
E&ES"I%N %NE
aB
7act ors to consi der befor e accept i ng the assi gnme nt
When a professi onal account ant is approached by a
prospect i "e client to accept an assi gnme nt and anot her
professi onal account ant is pro"idi ng auditing ser"ices to
that prospect i "e client the fact ors to consi der are: -
a. Whet her ther e may be reasons, professi onal or
otherwi se why the assi gnme nt cannot be accept ed.
b. Whet her ther e are adequat e resources in ter ms of
manpower and skill to perfor m the assi gnme nt
c. Whet her the timing and other requireme nt s of the
client are realistic
#fter consi deri ng the abo"e fact ors the account ant then
follows the following procedur es before accept i ng the
appoi nt me nt .
(. =olds a meet i ng with the direct or s of the company to
est abli sh in det ail the ai ms of the in"esti gat i on, the
scope of the in"esti gat i on, the degr ee of det ail
required, the degr ee of secr ecy required, the cost of
assi gnme nt the ti mi ng requireme nt s , includi ng the
period to be in"esti gat ed and the empl oyees to be
in"esti gat ed. These discussi ons are essent i al to form
the basi s of the engage me nt lett er, which shoul d be
recei "ed befor e the work can begi n.
The account ant must obt ai n preci se writt en
instructi ons.
$. The account ant must obser"e professi onal etiquet t e or
court esi es by infor mi ng the audi t or, ,r. !olo, of the fact
that he has been approached to accept an assi gnme nt
to in"esti gat e fraud in his client . In addition to
obser"i ng usual court esi es, this helps to obt ai n the
cooper at i on of the audit ors, as it may be required at
some point . The account ant ensur es that he obt ai ns
the per mi ssi on of the prospect i "e client to
communi cat e with the audit or.
aB Internal cont rol weaknes s e s and account i ng probl ems in
small entiti es.
When a company is small the following char act eri sti cs are
clearly appar ent .
(. There is a concent r at i on of owner shi p or oper at i onal
cont rol in one or a few indi"idual s Aowner- manager
domi nanceB .
A&*I"IN-
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2es s on "en
$. There is a limit ed segr egat i on of functions within the
account i ng syst e m becaus e of the small number of
empl oyees.
*. There is great er pot ent i al for manage me nt o"erride
of int ernal account i ng cont rol s.
%. ,anage me nt personnel or empl oyees ha"e limit ed
account i ng knowl edge.
5. There is an inacti"e or ineffecti"e policy maki ng
body Ae. g. )oard of /irect or sB.
&. 1lerical personnel ha"e easy acces s to asset s.
K. ,anage me nt does not hire or is unabl e to hire
empl oyees who ha"e account i ng experi ence or
formal account i ng training.
9. 8ecord- keepi ng syst e ms are often infor mal and
document a t i on of trans act i ons inadequat e.
=owe"er becaus e the trans act i ons are few in number , the owner-
manager is abl e to exerci se direct super"i sion and aut hori:e all
trans act i ons.
When a small company grows rapidly ine"it abl y the syst e ms of
account i ng and int ernal cont rol s do not keep pace with this
growt h and broadl y one ends up with a big busi ness tied down to
small company syst e ms . The following int er nal cont rol weaknes s
and account i ng probl ems can then nor mall y be expect ed.
(. The owner manager is o"er stret ched and cannot
exerci se adequat e direct super"i sion, leadi ng to
increas ed errors and irregul ariti es on the part of the
st aff.
$. !egr egat i on of functions is not adequat e and the
increas ed "olume of trans act i ons will now cont ai n
mor e errors and gi"e room to irregul ari ti es as the
owner manager del egat es some of his functions to
o"erworked and not properl y trained and compet ent
st aff.
*. 8egul ar financi al manage me nt report s essent i al for
cont rolling the busines s are not readily a"ail abl e on
a ti mel y basi s nor are they compl et e and accur at e
as the account i ng records are inadequat e to cope
with the increas ed demands.
%. The asset s of the company can easily be
mi sappr opri at ed as the pri mar y records like
regist er s may not be a"ail abl e and the st aff that
mai nt ai ns the records ha"e access to the asset s
they record, ther efor e openi ng opport uni ti es for
theft and conceal ment .
5. #ccounti ng syst e ms and relat ed int ernal cont rol s are
not planned and get added on hapha:ar dl y to deal
with any current crises. #s such e"en the
comput eri :at i on action is not properl y planned with
the resul t that a few empl oyees may be in a position
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to proces s and record compl et e trans act i ons without
any other aut hori:ati on.
&. Wher eas super"i sion checks on the excess es of
Dunior st aff ther e are usually no means of checki ng
on the acti"iti es of the manage me nt .
K. #ccounti ng records and document s are ill desi gned
to facilit at e compl et e and accur at e document at i on
or recordi ng of trans act i ons.
9. 0imit ed exposur e of st aff to account i ng mat t er s
resul t in use of inappr opri at e account i ng policies.
bB The cont rol s that could ha"e assi st ed in the pre"ent i on or
ti mel y det ect i on of fraud.
(. ,aint ai ni ng a list of appro"ed subcont r act or s
det ailing
The tot al cont r act ed amount due to each sub
cont r act or and
1umul ati "e tot al payment s to dat e
$. 2re numberi ng engi neeri ng certificat es, insisting on
their being issued in numeri cal sequence with the
original copy faxed by the engi neer bei ng
subseque nt l y submi t t ed to head office for
compari son with the faxed one.
*. #n independe nt person at head office shoul d ha"e
been charged with the responsi bilit y of checki ng the
faxed certificat es to confirm the signat ur es of the
engi neer s, check for the reasonabl enes s of the
amount s certified, check for the numeri cal sequence
of the certificat es, then prepar ed the list of genui ne
clai ms for appro"al by the direct or s befor e the
prepar at i on of the magnet i c tape cont ai ni ng the
payment s .
%. The bank shoul d ha"e been asked to pro"ide a hard
copy list of act ual payment s effect ed. These shoul d
ha"e been compar ed to those appro"ed to det ect
any other payme nt s fraudent l y insert ed.
5. 2roDect cost anal ysi s shoul d ha"e been prepar ed
regul arl y with compar at i "e cont r act amount s and
submi t t ed to the engi neer in charge to exami ne and
re"iew and confirm that the cost s were reasonabl e.
The direct or s shoul d also ha"e re"i ewed these
anal yses and sought expl anat i ons for significant
fluct uat i ons of "ari ances
&. The work of the comput er oper at or s shoul d ha"e been
super "i sed and then checked for compl et enes s and
accur acy by a seni or officer befor e the magnet i c tape was
releas e to the bank for payi ng.
K. #n audit trail shoul d ha"e been mai nt ai ned by ensuri ng that
a print out is produced of all proces si ng done by a comput er .
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2es s on "en
# direct or shoul d then ha"e checked them regul arl y to
det ect appar ent l y fictitious ent ri es.
9. <nused import ant st ati oner y, such as the engi neer?s
certificat es shoul d ha"e been kept under lock and key and if
pre number ed their use cont roll ed by a regi st er.
'. <se of the fax machi ne shoul d ha"e been cont rolled to
ensur e that only "alid aut hori:ed document s are
trans mi t t ed.
E&ES"I%N "3%
AaB 1ontrol s include input , proces si ng and out put cont rol s
AbB Include high accur acy, speed, large sampl es, and higher
qualit y audi t s
^ !low mo"i ng stocks, out st andi ng order s, stock bal ances,
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E&ES"I%N "$#EE
,r. Gohn .amau #) M 1o.
The 7inance /irect or 1ertified 2ublic
17 0td. #ccount ant s
2.+. )ox bhb 2.+. )ox xy:
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)efore we can take any deci sion to place reliance on int ernal audit , it is
neces s ar y for us to make a gener al asses s me nt of the likely
effecti"enes s and the rele"ance of the int ernal audi t functions. The
crit eri a for maki ng such an asses s me nt include the following:
AaB "he degr e e o inde1e nd e n c e : #lthough an int ernal audit or is an
empl oyee of the ent er pri se and cannot ther efor e be independent of it, he
shoul d be abl e to plan and carry out this work as he wishes and ha"e
acces s to the highest le"el of manage me nt . 7urt her mor e, an int ernal
audi t or shoul d be free to communi cat e fully with the ext er nal audit or,
who shoul d be abl e to recei"e copi es of all int er nal audi t report s that he
requires. #ny const r ai nt s or rest rictions placed upon int ernal audit will
be carefully e"al uat ed by us.
AbB "he sco1e and o,H ect i 0 e s o the int ernal audi t unct i on P as
ext er nal audit ors we will exami ne the int ernal audi t or?s formal ter ms of
refer ence and ascer t ai n the scope and obDecti"es of int ernal audi t
assi gnme nt s . In most circumst ance s , as ext er nal audi t ors we will regar d
assi gnme nt s as likely to be rele"ant wher e they are carri ed out in areas
of:
(. 8e"iewi ng account i ng syst e ms and int er nal cont rol and
$. -xami ni ng financi al and oper at i ng infor mat i on for manage me nt ,
including det ail ed testi ng of trans act i ons and bal ances.
We will also be int er est ed in the int er nal audi t or?s role in respect of:
(. 8e"iewi ng the economy, efficiency, and effecti"enes s of
oper at i ons and of the functioni ng of non- financi al cont rol s.
$. 8e"iew of he impl ement a t i on of corpor at e policies, plans and
procedur es and
*. !peci al in"esti gat i on: Wher e this has an import ant beari ng on the
reliability of the financi al st at e me nt s o other mat t er s being
report ed on.
(c) *ue 1ro e s s i o nal care P We will also consi der whet her he is free of
any oper at i ng responsi bility, which may creat e a conflict of int er est . We
will check whet her the work of int er nal audi t gener all y appear s to be
properl y planned, cont roll ed, recorded and re"i ewed. -xampl es of the
exerci se of due professi onal care by int ernal audit are the exist ence of an
adequat e manual , gener al int ernal audi t plans, procedur es for cont rolling
indi"idual assi gnme nt s , and sati sfact or y arrange me nt s for reporti ng and
follow- up.
A&*I"IN-
;4D
2es s on "en
(d) "echni cal com1e t e nc e P We will ascer t ai n whet her the work of
int ernal audit is perfor med by persons ha"ing adequat e trai ni ng and
proficiency as audit ors. Indicat or s of techni cal compet ence may be
member s hi p of an appropri at e professi onal body or the posses si on of
rele"ant practical experi ence.
(e) Int ernal audi t re1ort s P We will consi der the qualit y of report s
issued by int ernal audit and ascer t ai n whet her manage me nt consi der s,
responds to and wher e appropri at e act s upon int ernal audit report s, and
whet her this is e"idenced.
+nce we ha"e made the gener al asses s me nt and decided that we can
place reliance on int ernal audi t, the ext ent of that reliance will depend on
the following consi der at i ons:
(. The mat eri alit y of the areas or items to be test ed or the
infor mat i on to be obt ai ned.
$. The le"el of audi t risk inher ent in the areas or items to be test ed
or in the infor mat i on to be obt ai ned
*. The le"el of Dudgment required
%. The sufficiency of compl eme nt ar y e"idence
5. !peci alist skills posses s e d by int ernal audi t st affs.
8eliance will be affect ed by the following mat t er s:
AaB That the int ernal audit unction is to report to you as the fianc`
direct or. #s the fianc` direct or, you are directl y responsi bl e for the
product i on of financi al st at e me nt s . The int ernal audi t or s may ther efor e
not be seen to be independent .
Inst ead of carryi ng out a re"i ew function, the int er nal audi t ors are also
engaged in oper at i ng cert ai n element s of int ernal cont rol@ we may
ther efor e not rely on their work in areas of payme nt s, payment of
sal ari es and issues of credit not es.
These short comi ngs we belie"e can easily be o"ercome by maki ng the
int ernal audit function report to the )oard of /irect or s or an independe nt
audi t commi t t e e and ensuri ng that they perfor m only int ernal audit
functions of which in"ol"eme nt in appro"al , checki ng and aut hori:ati on
procedur es do not fall under.
We hope this clarifies the position and shoul d you requir e nay
clarification do not hesi t at e to cont act us.
Qours faithfully,
7orB ABC S Co/
CE#"I7IE* +&B2IC ACC%&N"AN"S
E&ES"I%N 7%&#
a. The mai n obDecti"es usually associ at ed with audit commi t t ee s
include@
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
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i. Increasi ng public confidence in the credit ability and
obDecti"it y of published financi al infor mat i on includi ng
unaudi t ed int eri m st at e me nt s
ii. #ssisting direct or s Aparticul arl y non execut i "e direct or sB
in meet i ng their responsi biliti es in respect of financi al
reporti ng
iii. !trengt heni ng the independe nt position of a company? s
ext er nal audit or by pro"iding an additional channel of
communi cat i on.
b. It is recomme nde d that compani es shoul d ha"e a commi t t ee
of the board called the audi t commi t t e e. This would consi st of
at least three non- execut i "e direct or s with writt en ter ms of
refer ence which 1leary deal with its aut hori t y and duti es.
c. #n audit commi t t e e has "arious responsi bilities which include:
-
8e"iew of a company? s int ernal cont rol procedur es
8e"iew of the int ernal audi t function. The audit
commi t t e e pro"idi ng an independent reporti ng channel
8e"iew of the company?s current account i ng policies and
possi bl e changes resul ti ng from the introducti on of new
account i ng st andar ds
8e"iew of regul ar manage me nt infor mat i on Ae. g. mont hl y
manage me nt account sB.
8e"iew of annual financi al st at e me nt s present ed to the
shar ehol der s
8e"iew of the resul t s of the ext er nal audit ors exami nat i on
to ensur e that the audit ors ha"e perfor med an effecti"e,
efficient and independe nt audit .
2rocedur es for re"iewi ng published int eri m Apreli mi nar yB
st at e me nt s , draft prospect us, profit forecast s et c
8ecei"ing and dealing with ext er nal audi t or s. 1riticisms of
manage me nt and ensuri ng that recomme nda t i ons of
int ernal and ext er nal audi t ors ha"e been impl eme nt e d.
8ecomme ndi ng nomi nat i on and remuner at i on of the
ext er nal audi t or s.
AaB The relati onshi p bet ween the audit commi t t ee and the
ext er nal audit or shoul d be close such that the audit or
shoul d ha"e unrest ri ct ed access to the commi t t e e. The
audi t or shoul d present his findings regar di ng any fraud
in"ol"ing the manage me nt to this commi t t e e.
AbB It is recomme nde d that a maD orit y of the non- executi "e
direct or s on the commi t t ee shoul d be independe nt of
manage me nt . The notion that the non- execut i "e
member s of the audit commi t t ee can be suit abl y
independe nt may be difficult to achi e"e.
Ideally the audi t commi t t e e shoul d compri se of persons
who ha"e a suit abl e range of professi onal and busines s
skills, sufficient knowl edge of the busi nes s and yet
ha"e not de"el oped close rel ationshi ps with the mai n
A&*I"IN-
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2es s on "en
boar d.
They shoul d ha"e had no recent act ual mo"e me nt with
the direct manage me nt of the organi:at i on, thus their
Dudgment shoul d be impar ti al free from influence and
ther efor e unbi ased.
E&ES"I%N 7I'E
AaB 2ett er o re1re s e nt a t i o n
.) +ur1os e
/uring the course of the audi t many repr es ent at i ons are
made by manage me nt to the audit ors. !ome of thes e are
in respons e to direct enquiri es by the audi t or s@ other s are
implicit in the prepar at i on of financi al st at e me nt s that are
fairly present ed. ,ost of these repr es ent at i ons will be
confir med during the course of the audi t by mor e reliabl e
e"idence such that reliance no longer need be placed on
manage me nt repr es ent at i ons. 7or other repr es ent at i on,
howe"er , ther e will be no independent corrobor at or y
e"idence a"ailabl e. The lett er of repr es ent at i on, ther efor e,
pro"ides formal confirmat i on as to the repr es ent at i ons
made. In doing so, manage me nt may be encour aged to
reflect mor e fully on the compl et enes s of the
repr es ent at i ons made and pro"ide furt her infor mat i on that
may earlier ha"e been o"erlooked.
6) #eli a,i l i t y
7ailure, by the audit ors, to confir m such repr es ent at i ons in
writing would consti t ut e negligence. =owe"er, it is
import ant that audi t or s do not place reliance on
repr es ent at i ons wher e mor e reliabl e e"idence would be
expect ed. The absence of corrobor at or y e"idence would,
in itself, be suspi cious and shoul d lead to furt her audit
enquiry. ,oreo"er, writt en repr es ent at i ons do not
neces s aril y consti t ut e sufficient e"idence. The audit or
must consi der all a"ailabl e e"idence and its reliability in
formi ng an opinion. 7or exampl e, in a small busines s
wher e significant audit reliance must be placed on
manage me nt repr es ent at i ons, audit ors may occasi onall y
form the "iew that , e"en with writt en repr es ent at i on by
manage me nt , ther e is insufficient e"idence on which to
form an opinion.
4) !att er s incl ude d
,att er s that may be included in the lett er of
repr es ent at i on include repr es ent at i ons that :
#ll books of account and suppor ti ng docume nt at i on,
regist er s, minut es of member s and direct or s meet i ngs,
ha"e been made a"ail abl e@
#ll relat ed parti es ha"e been identified
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
#e0i si on Aid
;;.
The entit y is not in breach of any cont r act ual or
regul at or y requireme nt s that could ha"e a mat eri al
effect on the financi al st at e me nt s .
The entit y has title to all its asset s and none are
pledged or otherwi se assi gned other than disclosed in
#ll liabilities and pro"isions ha"e been report ed or
disclosed in the financi al st at e me nt s .
#ll subs eque nt e"ent s ha"e been properl y reflect ed or
disclosed in the financi al st at e me nt s .
There are no plans that may significantl y alt er the
carryi ng "alue of any of the entit y?s asset s.
Not eB +nly three are requir ed. +ther mat t er s may also be
consi der ed rele"ant .
;) #eus al
If manage me nt refuse to pro"ide writt en repr es ent at i on as
reques t ed, the reasons would need to be enquir ed into the effect
on the o"er all sufficiency of e"idence consi der ed. Hener ally, if a
mat t er is sufficientl y import ant as to warrant a reques t for its
inclusion in the lett er, a failure to obt ai n writt en repr es ent at i on
woul d nor mall y consti t ut e a scope limit ati on resul ting in the issue
of a modified audi t opinion which is eit her qualified or which a
discl ai mer of opinion is issued.
AbB !anag e me n t re1ort /
+roc e dur e s
"imel i ne s s
1ommuni cat i on of cont rol weaknes s e s is nor mall y made
shortly aft er compl eti on of the audit . +n larger
engage me nt s wher e cont rol s risk was asses s ed during an
int eri m "isit, a lett er shoul d nor mall y be sent aft er that
"isit as well as on compl eti on of the audi t.
+ccasi onall y the mat t er may be sufficientl y serious as to
warr ant mor e timel y communi cat i on, such as wher e the
exposur e to risk is great or wher e ther e is reason to
suspect that fraud or failure to compl y with laws or
regul ati ons may already ha"e occurr ed as a resul t of the
weaknes s.
!et hod
#s is implied in the title commonl y gi"en, the
communi cat i on is nor mall y made in the form of a lett er.
+ften, howe"er , a preli mi nar y meet i ng is held with
manage me nt directl y responsi bl e in order to confirm the
under st andi ng and to discuss the most appropri at e form of
changes to the syst e m. The lett er is, ther efor e, mor e
likely to be accept ed and its recomme nda t i ons act ed upon.
+ral communi cat i on may also be appropri at e for
weaknes s es that are in urgent need of correcti on followed
up by a writt en communi cat i on
A&*I"IN-
;;6
2es s on "en
2e0el o manag e me n t
#s ment i oned abo"e, it is common to discuss the det ail ed
recomme nda t i ons with line manage me nt befor e issuing the lett er.
The lett er would nor mall y be addr es s ed to the chief financi al
officer. The lett er may refer to minor mat t er s in brief with mor e
det ail ed recomme nda t i ons being sent to financi al officers of
di"isions or subsi di ari es. ,ore serious mat t er s may be
communi cat ed directl y to the boar d of direct or s or, if the entit y
has one, the audit commi t t e e. These woul d include such mat t er s,
as pre"ious recomme nda t i ons ha"e not been impl ement e d wher e
the audi t or s belie"e the risks to the entit y are mat eri al.
(i) Audi t ors res 1ons i ,i l i t y
The audit ors are not pri marily responsi bl e for e"al uat i ng
the effecti"enes s of all int ernal cont rol s and reporti ng all
weaknes s es . In the lett er of weaknes s e s and in the
engage me nt lett er the audi t or shoul d make it clear that
the asses s me nt of cont rol effecti"enes s is rest rict ed to
those cont rol s on which reliance is int ended to be placed
for audi t purpos e. If audit ors int end to place reliance for
particul ar financi al st at e me nt asser t i ons wholly on
subst ant i "e procedur es, they ha"e no responsi bilit y for
cont rol s o"er those asser t i ons.
Wher e the audit ors do become awar e of int ernal cont rol
weaknes s es , howe"er ther e is an expect at i on that they
will warn manage me nt wher e the risk of loss or
mi sst at e me nt is consi der ed mat eri al . #warenes s of
cont rol weaknes s e s may come about from procedur es
other than those direct ed specifically at testi ng cont rol s.
7or exampl e, in obt ai ni ng an under st andi ng of the syst e m
the audit or may become awar e of maD or cont rol
weaknes s es . #lso, in perfor mi ng subst ant i "e procedur es,
in"esti gat i on of errors may alert the audit or to the
presence of cont rol weaknes s e s .
The audit or?s dut y to report on the effecti"enes s of int ernal
cont rol s, under audi ti ng st andar ds is confined to the
manage me nt of the entit y. They ha"e no responsi bility to
report to other parti es. The lett er of weaknes s nor mall y
carri es a discl ai mer of responsi bility to any other person to
whom the lett er might be shown.
#uditors may accept engage me nt s to report on cont rol
weaknes s es , either to manager s, to regul at or s or to third
parti es. =owe"er, such engage me nt s are not part of the
audi t of the financi al st at e me nt s .
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
#e0i si on Aid
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=une .<<:
E&ES"I%N %NE
KE shoe s 2td/
A&*I" %7 S"%CKS
E&ES"I%N "3%
!er"ice calls when a cust omer machi ne st art s to bring probl ems like
produci ng bad copi es the cust omer will cont act the ser"ice depar t me nt
of Image 0td. The recepti oni st at the ser"ice depar t me nt will take down
the cust omer det ail s, mode of the machi ne ascer t ai ni ng from hi m
whet her or not its billabl e or rent al and a brief descri pti on of what woul d
appear to be the probl em with the machi ne.
The det ail s woul d then be recorded in a regi st er or a form e. g a request
for ser"ice form. The recept i oni st will pass on the det ail s to the head of
depar t me nt who ill identify the techni ci an with appropri at e experi ence
of ser"ices to that particul ar machi ne.
The techni ci an would be dispat ched to the cust omer . and would
exami ne the machi ne with "iew to diagnosi ng the probl em with the
machi ne. =e woul d set out part s to be ser"iced, part s needi ng
repl ace me nt and amount of ti me to be taken when ser"icing.
If it is a billabl e machi ne, he will discuss with the manage me nt of the
cust omer gi"ing them an esti mat e of what it woul d cost . If the
cust omer decided they want the ser"ice to proceed when they would
eit her raise a purchas e order and sign or st amp the appropri at e spaces
on the diagnos e form.
If it is a rent al machi ne, the discussi on would not take place with the
cust omer rat her it woul d be with the head of the rent al machi nes who
woul d gi"e a go ahead for ser"icing.
When aut hori:ati on rakes place the techni ci an concer ned then raises a
mat eri al requi sition not e for the part s that need to be repl aced. =e will
ret urn to the head of the ser"ice depar t me nt who will consul t credi t
cont rol to confirm that the cust omer is credi t wort hy and he will appro"e
the mat eri al requi si tion for the techni ci an to proceed to the stores to be
gi"en the part s. The stor es will also raise an issue not e for the mat eri al s
which the techni ci an will sign acknowl edgi ng he has taken those part s.
The techni ci an will then proceed to the cust omer s premi s es, ser"ice the
machi ne and ent er the det ails of the part s used, ti me taken on a
prepri nt ed prenumber ed Dob card.
When the machi ne has been ser"iced and its now functional , the
cust omer will sign on the Dob card that he is sati sfi ed with the ser"ice.
Not e
When the ser"ice is compl et ed as descri bed abo"e a ser"ice call has
been made.
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2es s on "en
/at a fields are the headi ngs for which dat e is to be filled in
appropri at e spaces.
The files are:
AiB Transact i on file
AiiB 8ent al cont r act mast er file
AiiiB 1ust omer mast er file
Ai"B !tock mast er file
A"B !ources render ed price mast er file
A"iB 8et urned used part s mast er file
A"iiB 2ersonnel mast er file
2ossi bl e errors and irregul ariti es
(. !ome docket s may be mispl aces and ther efor e ne"er
reach the comput er room. This can be deliber at e or
inad"er t ence.
$. The techni ci an may fail to put appropri at e dat a in the
dat a fields or ent er dat a wrongl y in the dat a fields.
*. # combi nat i on of errors regar di ng cust omer det ail s e. g.
the correct cust omer name, correct account number but
the seri al number is not of the machi ne as the cust omer
premi s es.
%. # combi nat i on of errors regar di ng the stocks of the pat h
used e. g. a techni ci an may ne"er ha"e ret ur ned the
repl aced part s, the code number may ne"er mat ch the
descri pti on, the quanti t y on the docket may be different
to the amount releas ed for that machi ne, the docket may
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
CUSTOME R NAME : _______________ NUMBE R
CUSTOME R ACCOUN T NO. ________________
DAT E OF SERVI CE INITI ALS/PAYROL L NO.
0 4 0 1 0 3
TECHNI CI AN
TIME TAKE N OB CARD NO.
0 ! " !

MATE RI AL S USE D
CODE NO. DESCRI PTI ON #UANTI TY
____________ ______________ ____________
____________ ______________ ____________
SERI AL NO.
SI$NAT UR E ________________________
SERVI CE EN$I NE E R
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include part s ne"er releas ed, it may exclude part s
releas ed for that machi ne.
5. The techni ci an could indicat e mor e or less time than he
act ually spent at the cust omer s premi s es. )esides the
cust omer could be o"er or under charged for labour.
&. The ser"ice engi neer could wrongl y mark a billabl e
machi ne as a rent al machi ne and "ice "ersa.
K. The techni ci an though ha"ing a Dob card may fail to raise
a docket or may att e mpt to use the same Dob card to
raise mor e than one docket . These are probl ems of
omi ssi on and duplicati on.
Ans wer
AaB The mai n st eps that I would expect to be execut ed by means of
a comput er progr a m to identify and report ser"ice call billing
errors by Image 0td.
(. There is a possi bility of an error of compl et ene s s wher eby some
docket s can be mispl aced bet ween their prepar at i on by the
techni ci an, "alidati on by the ser"ice engi neer and dat a capt ur e
by comput er room. )y pre- numberi ng you est abli sh a cont rol I
woul d ther efor e expect the syst e m to check the seri al number
and report any missi ng number s for in"esti gat i ons.
$. /uring the proces s of transcri bi ng det ails from the Dob card into
the docket the techni ci an may fail to fill in the rele"ant dat a
fields or fill wrongl y in the appropri at e dat a fields.
Therefor e I would expect the progr a m to execut e:
AaB # missi ng field check to ensur e that all the missi ng dat a
fields like dat a of ser"ice time taken, mat eri al s used and
the seri al number of unit prepar ed are present and are of
the right lengt h as trans act i ons cannot be properl y
proces s ed if neces s ar y dat a is mi ssi ng.
AbB # "alid char act er check to ensur e that the dat a fields
appear s to be of the right type e. g. the dat e of ser"ice
shoul d be all numeri c, the mat eri al s used shoul d be
mixed, time taken shoul d be all numeri c. This is to
ensur e dat a fields appear to be correct .
*. The det ails regar di ng the cust omer shoul d be consi st ent i.e. the
cust omer s name is gi"en, then the account number gi"en must
be of that cust omer in the cust omer s mast er file and the seri al
number on the docket must be the seri al number that belongs
to that cust omer .
#s a combi nat i on of errors can occur regar di ng these det ails
e. g. wrong seri al number or account number , I would expect
the progr a m to execut e a mast er file check of the cust omer
det ails as per the docket s to the cust omer s mast er file.
%. The det ails regar di ng the part s used include the code number
for the par, a "erbal descri pti on of the [art and the quanti t y
used on the Dob. It is possi bl e that the techni ci an can make
errors in filling in the dat a fields. Therefor e I woul d expect the
progr am to:
AaB -xecut e a mast er file check agai nst the ser"ice part s
mast er file to ensur e that the code number gi"en and
A&*I"IN-
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2es s on "en
the descri pti on gi"en are for a part on that mast er file
and that the quanti t y was the quanti t y releas ed for that
machi ne.
AbB -xecut e a mast er file check agai nst the ret urned used
part s mast er file to det ect whet her the techni ci an had
ret urned a si mil ar part aft er pro"idi ng the ser"ice.
AcB -xecut e a check digit to the code number and mat chi ng
the code number to the descri pti on to det ect keyst r oke
errors in the code number and the descri ption.
5. The techni ci an could indicat e mor e or less hours than act uall y
spent at the cust omer s premi ses. 1onsequent l y a cust omer
may be o"erchar ged or under char ged. Therefor e I would
expect the progr am to execut e a limit or reasonabl enes s check
agai nst the st andar d est abli shed for the different possi bl e
combi nat i on of ser"ices as per the ser"ice render ed price
mast er file.
&. The ser"ice engi neer manuall y checks the docket s det ails
agai nst the rent al cont r act mast er file print out. #s a result of
this he indicat es on the docket whet her the machi ne is billabl e
or rent al . =e could wrongl y indicat e a billabl e machi ne as a
rent al machi ne and "ice "ersa. Therefor e I expect the progr a m
to execut e a mast er file check at the seri al number on the
docket agai nst the comput eri :ed rent al cont rol s mast er files
ensuri ng that if the seri al number gi"en is not on that rent al
cont r act mast er file then aut omat i call y this woul d be a billabl e
machi ne.
K. /ocket s may not be raised for some Dob cards a Dob cards may
be used to prepar e mor e than one docket . I would expect the
progr am to execut e the following st eps:
AaB <ndert ake a sequence checks on the Dob card number s
to det ect incidences of duplicati on of Dob card m
number s and to report gaps in numeri cal continui t y of
Dob card number s.
AbB To execut e a mat chi ng routine mat chi ng Dob cards to
docket s ensuri ng for e"er y Dob card ther e is a docket and
"ice "ersa.
9. I would expect the progr am to execut e a reasonabl e test on the
Dob ser"ice agai nst dat e on Dob card to ensur e the dat es are the
same and the trans act i ons will be report ed in the correct
account i ng period when it took place.
'. I would expect to execut e a reasonabl enes s check on the dat a
of ser"ice on the docket and the dat e the mat eri al s wer e
releas ed as per the stocks mast er file and print pout an
excepti on wher e the part y det ails ha"e not been reflect ed on a
docket and particul arl y if they are long out st andi ng.
AbB 2rincipl es of syst e m de"el opme nt stipul at e that when changes
are applied to syst e ms si mil ar requireme nt s would appl y as new
syst e ms . Therefor e if new consi der at i on is gi"en to re"iew, testi ng
and appro"al of new syst e ms it shoul d be not ed that the basic
principl es of the cont rol s are that :
AiB !yst e ms desi gn shoul d include repr es ent at i "es of
comput er depar t me nt , user
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
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/epar t me nt s and int ernal audit as well as the
account i ng depar t me nt .
AiiB The propos ed syst e m would ha"e writt en
specifications that are appro"ed by bot h the
manage me nt and user s.
AiiiB # syst e ms testi ng shoul d in"ol"e bot h user s and the
comput er depar t me nt .
Ai"B The comput er manager user depar t me nt dat abas e
admi ni st r at or wher e appropri at e and the appropri at e
le"els of seni or manage me nt shoul d gi"e final
appro"al to the "iew syst e m before it is placed in
oper at i on and aft er re"i ewi ng the appropri at ene s s
and the resul t s of testi ng.
The appropri at e procedur es and policies for the re"iew testi ng and
appro"al of new syst e ms are best anal y:ed or consi der ed under
the st ages of syst e ms de"el opme nt . The st ages of syst e m
de"el opme nt are nor mall y classified as:
AaB 7easi bility study
AbB !yst e ms anal ysi s and desi gn
AcB 2rogr ammi ng
AdB 2rogr amme testi ng
AeB 2arallel runni ng
AfB 7ile con"er si on and impl ement a t i on
AgB ,onitoring and e"al uat i on
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2es s on "en
E&ES"I%N "$#EE
+&B2IS$E* ANN&A2 #E+%#" %7 A 2I!I"E* 2IABI2I"(
C%!+AN(
"he #egul at i ons go0erni ng Audi t #e1ort s in Kenya are to ,e ound
inB
The requirement s of the 1ompani es #ct 1ap %9&
Internati onal financial reporting standar ds AI78!sB
Internati onal !tandar ds on #uditing AI!#sB
"here or e the res1ons i ,i l i ti e s o the audi t or with regard to
1u,li s he d audi t re1ort s are dei ned ,y the a,o0e regul at i ons /
The se"ent h schedul e to the 1ompani es #ct gi"e the mat t er s which must
be expressl y stat ed in the #</IT+8J! 8-2+8T
(. Whet her they ha"e obt ained all the informat i on and
explanat i ons which to the best of their knowl edge and belief
were necess ar y for the purposes of their audit.
$. Whet her, in their opinion, proper books of account ha"e been
kept by the company, so far as appear s from their exami nati ons
of those books, and proper ret urns adequat e for the purposes of
their audit ha"e been recei"ed from branches not "isited by
them.
*. i. Whet her the companyJ s balance sheet and Aunless it is
framed as a consolidat ed profit and loss account B profit
and loss account dealt with by the report are in agree me nt
with the books of account and returns.
ii. Whet her, in their opinion and to the best of their
informati on and accordi ng to the expl anati ons gi"en them,
the said account s gi"e the informati on required by this #ct
in the manner so required and gi"e a true and fair "iew:
aB In the case of the balance sheet , of the stat e of the
companyJ s affairs as at the end of its financi al year@
and
bB In the case of the profit and loss account , of the profit
or loss for its financi al year, or
as the case may be, gi"e a true and fair "iew thereof subDect to
the non- disclosur e of any mat t er s Ato be indicat ed in the reportB
which by "irtue of 2art III of the !ixth !chedul e are not required
to be disclosed.
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%. In the case of a holding company submi t ti ng group account s
whet her in their opinion, the group account s ha"e been properl y
prepar ed in accordance with the pro"isions of this #ct so as to
gi"e a true and fair "iew of the stat e of affairs and profit or loss
of the company and its subsidi ari es dealt with ther eby, so far as
concer ns member s of the company, or, as the case may be, so
as to gi"e a true and fair "iew thereof subD ect to the non-
disclosur e of any mat t er s Ato be indicat ed in the reportB which
by "irtue of 2art III of the !ixth !chedul e are not required to be
disclosed.
Therefor e the audi t or must ensur e that the abo"e regul ati ons are
met .
With regar d to professi onal pronounce me nt s the audi t or must lay
out his audit re[port in a format that is gi"en in the I!# K44 as
modified by the rele"ant legisl ati on.
)oth regul ati ons require the audi t or to expr es s an opinion as to
the trut h and fairness of the account s which means that the
financi al st at e me nt s are free from mat eri al mi sst at e me nt s .
AbB The responsi bilities of the audit or for financi al and st ati sti cal
infor mat i on included with in the direct or s report and chair man?s
report .
E&ES"I%N 7%&#
The audit or does not ha"e a responsi bility to desi gn procedur es other
than inquiry of manage me nt to test for indicati ons of e"ent s or
condi tions which cast significant doubt on the entit y?s ability to continue
as a going concer n beyond the period asses s ed by manage me nt which,
as discuss ed in par agr aph would be at least twel"e mont hs from the
bal ance sheet dat e.

Addi ti onal Audi t +roc e dur e s whe n E0ent s or Condi t i ons are
ident i i e d
3hen e0e nt s or condi t i ons ha0e ,ee n ident i i e d whi ch may cas t
si gni i cant dou,t on the ent i t yA s a,i li t y to cont i nue as a goi ng
conc ern? the audi t or shoul dB
#e0i e w mana g e me n t A s 1l ans or ut ure acti ons ,as e d on its
goi ng conc ern as s e s s me n t ;
-at her sui ci e nt a11ro1ri at e audi t e0i de nc e to coni rm or di s1el
whet he r or not a mat eri al unc ert ai nt y exi s t s throug h carryi ng
out 1roc e dur e s consi der e d nec e s s ar y? incl udi ng consi deri ng the
e ec t o any 1l ans o mana g e me n t and ot her mi ti gat i ng act ors @
and
See k wri t t e n re1re s e nt a t i o ns rom mana g e me n t regardi ng its
1l ans or ut ure acti on/
-"ent s or condi tions which may cast significant doubt on the entit y?s
ability to conti nue as a going concer n may be identified during the
planni ng of the engage me nt or in the course of perfor mi ng audi t
procedur es. The process of consi deri ng e"ent s or conditions conti nues as
the audi t progr es s es . When the audi t or belie"es such e"ent s or
A&*I"IN-
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2es s on "en
condi tions may cast significant doubt on the entit y?s ability to conti nue
as a going concer n, cert ai n procedur es may take on
added significance. The audi t or inquires of manage me nt as to its plans
for futur e action, including its plans to liquidat e asset s, borrow money or
rest ruct ur e debt , reduce or del ay expendi t ur es, or increas e capit al. The
audi t or also consi der s whet her any addi tional fact s or infor mat i on are
a"ailabl e since the dat e on which manage me nt made its asses s me nt .
The audit or obt ai ns sufficient appropri at e audit e"idence that
manage me nt ? s plans are feasi bl e and
that the outcome of thes e plans will impro"e the situat i on.
+roc e dur e s that are rel e0ant in thi s regard may incl ude the
oll owi ngB
(. #naly:ing and discussi ng cash flow, profit and other rele"ant
forecast s with manage me nt .
$. #naly:ing and discussi ng the entit y?s lat est a"ail abl e int eri m
*. 8e"iewi ng the ter ms of debent ur es and loan agree me nt s and
det er mi ni ng whet her any ha"e been breached.
%. 8eadi ng mi nut es of the meet i ngs of shar ehol der s, the board of
direct or s and import ant commi t t ee s for refer ence to financi ng
difficulties.
5. Inquiring of the entit y?s lawyer regar di ng the exist ence of litigation
and clai ms and the reasonabl ene s s of manage me nt ? s asses s me nt s
of their out come and the esti mat e of their financi al implications.
&. 1onfirmi ng the exist ence, legalit y and enforceabilit y of
arrange me nt s to pro"ide or mai nt ai n financi al support with relat ed
and third parti es and asses si ng the financi al ability of such parti es
to pro"ide additional funds.
K. 1onsideri ng the entit y?s plans to deal with unfilled cust omer
order s.
9. 8e"iewi ng e"ent s aft er period end to identify those that either
mitigat e or other wi se affect the entit y?s ability to conti nue as a
going concer n.
When anal ysi s of cash flow is a significant fact or in consi deri ng the future
outcome of e"ent s or conditions the audi t or consi der s:
(. The reliability of the entit y?s syst e m for gener at i ng such
infor mat i on@ and
$. Whet her ther e is adequat e support for the assumpt i ons underl yi ng
the forecast .
In addi tion the audi t or compar es:
(. The prospect i "e financi al infor mat i on for recent prior periods with
hist orical resul t s@ and
$. The prospect i "e financi al infor mat i on for the current period with
resul t s achi e"ed to dat e.
Audi t Concl usi ons and #e1ort i ng
Bas e d on the audi t e0i de nc e o,t ai ne d? the audi t or shoul d
det er mi ne i? in the audi t orA s Hudgme nt ? a mat eri al uncert ai nt y
exi s t s rel at e d to e0e nt s or condi t i ons that al one or in aggr e g a t e ?
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may cas t si gni i cant dou,t on the ent i t yA s a,ili t y to cont i nue as a
goi ng conc ern/
# mat eri al uncer t ai nt y exist s when the magni t ude of its pot ent i al impact
is such that , in the audit or?s Dudgment , clear disclosur e of the nat ur e and
implications of the uncert ai nt y is necess ar y for the present at i on of the
financi al st at e me nt s not to be misl eadi ng.
-oi ng Concern Ass um1t i on A11ro1ri at e ,ut a !at eri al
&ncert ai nt y Exi st s
If the use of the going concer n assumpt i on is appropri at e but a mat eri al
uncert ai nt y exist s, the audit or consi der s whet her the financi al
st at e me nt s :
#dequat el y descri be the principal e"ent s or conditions that gi"e
rise to the significant doubt on the entit y?s ability to continue in
oper at i on and manage me nt ? s plans to deal with thes e e"ent s or
condi tions@ and
!t at e clearly that ther e is a mat eri al uncert ai nt y rel at ed to e"ent s
or condi tions which may cast significant doubt on the entit y?s
ability to conti nue as a going concer n and, ther efor e, that it may
be unabl e to reali:e its asset s and dischar ge its liabilities in the
nor mal course of busines s.
I ade@ua t e di scl os ur e is made in the inanci al st at e me n t s ? the
audi t or shoul d ex1r e s s an un@ual i i e d o1i ni on ,ut modi y the
audi t orA s re1ort ,y addi ng an em1ha s i s o mat t er 1aragra1h that
hi ghl i ght s the exi s t e nc e o a mat eri al uncert ai nt y rel at i ng to the
e0e nt or condi t i on that may cas t si gni i cant dou,t on the
ent i t yA s a,i li t y to cont i nue as a goi ng conc ern and draws
att e nt i on to the not e in the inanci al st at e me n t s that di scl os e s
the
mat t er s / In asses si ng the adequacy of the financi al st at e me nt
disclosur e, the audi t or consi der s whet her the infor mat i on explicitly draws
the reader?s att ent i on to the possi bility that the entit y may be unabl e to
conti nue reali:ing its asset s and dischar gi ng its liabilities in the nor mal
course of busi ness.
In extr eme cases, such as situati ons in"ol"ing mul ti pl e mat eri al
uncert ai nt i es that are significant to the financi al st at e me nt s , the audi t or
may consi der it appropri at e to expr es s a discl ai mer of opinion inst ead of
addi ng an emphasi s of mat t er paragr aph.
I ade @uat e di scl os ur e is not made in the inanci al st at e me nt s ?
the audi t or shoul d ex1r e s s a @ual i i e d or ad0er s e o1i ni on? as
a11ro1ri at e (ISA C55? J"he Audi t orA s #e1ort on 7inanci al
St at e me nt s ? I/ "he re1ort shoul d incl ude s1eci i c re ere nc e to the
act that ther e is a mat eri al unc ert ai nt y that may cas t si gni i cant
dou,t a,out the ent i t yA s a,i li t y to cont i nue as a goi ng conc er n/
-oi ng Concern Ass um1t i on Ina11ro1ri at e
I? in the audi t orA s Hudgme nt ? the ent i t y will not ,e a,l e to
cont i nue as a goi ng conc ern? the audi t or shoul d ex1re s s an
ad0er s e o1i ni on i the inanci al st at e me n t s ha0e ,ee n 1re1ar e d
on a goi ng conc ern ,asi s / If, on the basi s of the addi tional procedur es
carri ed out and the infor mat i on obt ai ned, including the effect of
manage me nt ? s plans, the audit or?s Dudgment is that the entit y will not be
A&*I"IN-
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2es s on "en
abl e to conti nue as a going concer n, the audit or concl udes, regar dl ess of
whet her or not disclosur e has been made, that the going concer n
assumpt i on used in the prepar at i on of the financi al st at e me nt s is
inappr opri at e and expr ess e s an ad"er s e opinion.
When the entit y?s manage me nt has concluded that the going concer n
assumpt i on used in the prepar at i on of the financi al st at e me nt s is not
appropri at e, the financi al st at e me nt s need to be prepar ed on an
alt ernat i "e aut hori t ati "e basi s. If on the basi s of the addi tional
procedur es carri ed out and the infor mat i on obt ai ned the audi t or
det er mi nes the alt ernat i "e basi s is
appropri at e, the audi t or can issue an unqualified opinion if ther e is
adequat e disclosur e but may require an emphasi s of mat t er in the
audi t or?s report to draw the user?s att ent i on to that basi s.
!anag e me n t &nwi l li ng to !ake or Ext end its Ass e s s me n t
I mana g e me n t is unwi l l i ng to make or ext e nd its as s e s s me n t
whe n re@ue s t e d to do so ,y the audi t or? the audi t or shoul d
consi der the nee d to modi y the audi t orA s re1ort as a res ul t o
the li mi t at i on on the sco1e o the audi t orA s work/ In cert ai n
circums t anc es , the audi t or may belie"e that it is neces s ar y to ask
manage me nt to make or ext end its asses s me nt . If manage me nt is
unwilling to do so, it is not the audit or?s responsi bility to rectify the lack
of anal ysi s by manage me nt , and a modified report may be appropri at e
becaus e it may not be
possi bl e for the audi t or to obt ai n sufficient appropri at e e"idence
regar di ng the use of the going concer n assumpt i on in the prepar at i on of
In some circums t anc es , the lack of anal ysi s by manage me nt may not
precl ude the audi t or from being sati sfied about the entit y?s ability to
conti nue as a going concer n. 7or exampl e, the audit or?s other procedur es
may be sufficient to asses s the appropri at ene s s of manage me nt ? s use of
the going concer n assumpt i on in the prepar at i on of the financi al
st at e me nt s becaus e the entit y has a hist ory of profit abl e oper at i ons and
a ready access to financi al resources. In
other circums t ance s , howe"er , the audit or may not be abl e to confirm or
dispel, in the absence of manage me nt ? s asses s me nt , whet her or not
e"ent s or conditions exist which indicat e ther e may be a significant
doubt on the entit y?s ability to conti nue as a going concer n, or the
exist ence of plans manage me nt has put in place to addr es s them or
other mitigati ng fact ors. In thes e circums t anc es , the audi t or modifies the
audi t or?s report as discuss ed in I!#
K44, EThe #uditor?s 8eport on 7inanci al !t at e me nt s , F
When ther e is significant del ay in the signat ur e or appro"al of the
financi al st at e me nt s by manage me nt aft er the bal ance sheet dat e, the
audi t or consi der s the reasons for the del ay. When the del ay could be
relat ed to e"ent s or condi tions relati ng to the going concer n asses s me nt ,
the audit or consi der s the need to perfor m additional audi t procedur es, as
descri bed in paragr aph $&, as well as the effect on the audit or?s
conclusi on regar di ng the exist ence of a mat eri al uncer t ai nt y, as
descri bed in paragr aph *4.
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E&ES"I%N 7I'E
AaB The purpos e of an audi t is to expr ess an opinion on the trut h
and fairness of financi al st at e me nt s . AInsert the typed answerB
Hood for audit ors to accept :
The public expect s audi t or s to do that
-nhance the image of the audit or and the "alue of the audi t opinion
The ext ra cost s of ext ra work can be born by the shar ehol der s
o:
The purpos e of an audi t is reasonabl e assur ance, #bsolut e assur ance not
possi bl e co: of the limit ati ons of an audi t.
1onclusion: #uditors shoul d not accept . ot possi bl e and not
economi call y Dustifiabl e.
(,)
The users of published account s for simplicity can be summari :ed as the
sharehol der s to whom the audit report is addr ess ed and third
parti es who may use the account s for a "aried number of reasons
among them in"est ment decisions. It is gener ally felt that an
auditor to be held liable to anyone be it under the law of contract or
the law of negligence the following conditions should exist:
i. =e must be pro"ed negligent that is:
AaB =e must ha"e failed to det ect an error or fraud, he
should ha"e reasonabl y been expect ed to det ect and
AbB =e failed to compl y with gener ally accept ed auditing
st andar ds and practices.
ii. The compl ai nant must ha"e suffered loss
iii. #s a direct consequence of reliance on the audit ors report.
A&*I"IN-
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2es s on "en
A S&!!A#( %7 C%&#" *ECISI%NS IS AS 7%22%3S
A&*I"%#KS 2IABI2I"(
<nder the law of contract , an audit or may be sued by the company
for loss resulting from negligence on the part of the auditor A7oss "
Itarbot tl e (9%*B. The case of 1andlier "s 1hrist mas A('5(B
exemplified the "iew that there was pri"ity of contract bet ween the
auditor and the company. This "iew precluded third parti es from
suing for losses.
The position was altered in ('&% by the case of =edley )yrne "s
=elt er A('&%B in which it was Dudged that in the absence of the
disclai mer of liability, a dut y of care to third parti es would arise. This
suggest ed that audit ors would be liable to third parti es with whom
ther e was a speci al relationshi p for inst ance the prospecti "e
purchas er of a business who was relying on audit ed account s in
maki ng his decisions to buy. The decision relat ed only to cases
wher e a specific interest ed part y exist ed and the audit or knows or
shoul d ha"e known of their interest in the account s. The principle of
liability to unknown third parti es was still unchanged from the
<ltramar es "s Touche case A('*$B where Dudge 1ardo:o comment ed
that auditors should not be subD ect ed to liability in an indet er mi ned
amount for an indet er mi nat e time to an indet er mi nat e class.
here, Teb 7ast ener s "s ,arks, )loom and company A('9(B, Trimax A('9*B
and 1apro Indust ri es "s /ickman A(''4B. The Teb and Trimax cases bot h
the audit ors. In this Teb case, the auditors knew that the company was
likely to be looking for out side finance as it was in difficulties. It was held
one, who was likely to be relying on the account s. This clearly ext ends
the "iew of liability taken in the =edley )yrne case. The plaintiffJ s action
position.
In the Trimax case, the same approach to audit or liability was adopt ed,
and the Dudge found for the plaintiffs. The auditor, it was held, should
ha"e foreseen that these account s might be relied on by a pot enti al
in"est or.
known, or be expect ed to know that 1aparo would rely on their work on
deciding to in"est in the company. There was need for a close relationshi p
to exist bet ween the maker and the recipient of negligent mis- stat e me nt s
for a dut y of care to exist. +n appeal , although it was held that audit ors
ha"e a duty to indi"idual shar ehol der s, this did not ext end to pot enti al
in ('95 0loyd 1heyham "s 0ittle Gohn case that there is a dut y of care
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
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known to third parti es, but they should still prot ect thems el "es by maki ng
the usual enquiries before in"esting. The =+<!- +7 0+8/! ruling in the
ruled that the auditors owed a duty of care to shar ehol der s as a body but
shares.
It is e"ident , in conclusion that the auditorJ s liability was ext ended aft er
uncert ai n and appear s to ha"e been se"erl y limited by the 1aparo
findings.
We ha"e no decided case against auditors in .enya. The accounti ng
professi on in .enya has howe"er to take into consider at i on de"elopment s
in other count ri es as it is most likely that should a case act ually come to
court agai nst auditors the court would be direct ed and influenced by
decisions gi"en elsewher e. 7or this reason decided cases in other
count ri es and de"el opment s in this area are rele"ant to the accounti ng
professi on in .enya. #uditing st andar ds and accept ed practices and
procedur es are similar in most part s of the world.
A&*I"IN-
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2es s on "en
"$E #E'ISI%N +A+E#
E&ES"I%N %NE
AaB The )oard of /irect ors, #)1
+ld Traders 0imited, 1ertified 2ublic
#ccount ant s
2. +. )ox (444, 2. +. )ox ;QX
X#,#I X# .#0-. airobi
/ear !irs,
#</IT +7 T=- 1+,2#QJ! #11+<T! - *4 !-2T-,)-8, $44*
We are glad to inform you that we are in the finali:ation stages of
the companyJ s audit for the year ended *4 !ept ember , $44*
1ert ai n mat t er s ha"e howe"er come to light which need to be
resol"ed before we can issue our audit report . They are cont enti on
issues and would affect the form of audit report we will issue.
2lease re"iew our comment s and ad"ise us of the decision of the
)oard, we ha"e been informed by the 7inance ,anager, that the
account s cannot be adDust ed under any circumst ances.
/8#7T #11+<T! - H--8#0 2+IT!
(.( +ur initial re"iew of the draft account s as present ed to us for
audit by the 7inance ,anager re"eal ed that some figures
appear to be incorrectl y stat ed. These are repairs and
maint enance and other expens es in the profit and loss
account .
(.$ 7inanci al st at eme nt s should gi"e a true and fair "iew of the
financi al position of the company and of its result s for the
period under re"iew. #s audit ors, we ha"e to ensur e that the
account s are not misleadi ng in any way before we gi"e a
clear report .
(.* The company manage me nt should show flexibility and a
willingness to ensur e that the account s do gi"e a true and
fair "iew. We suggest that the )oard ensur es that where
figures are incorrectly st at ed they are adDust ed to reflect the
correct position.
S"%CKS
$.( +ur re"iew of stock "aluation has re"eal ed that the cost s
used were those in force before Guly, $44*. We are awar e
that ther e was a gener al price increase of (4T bet ween Guly
and !ept ember , $44*
$.$ We are of the opinion that stocks acquired aft er Guly, $44*
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
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ha"e been "alued at incorrect prices. Hener ally accept ed
accounti ng principles require that stocks be "alued at cost
net reliabl e "alue which is lower.
$.* We suggest that an exercise be carried out to det er mi ne
whet her stocks ha"e been "alued using the correct cost
prices. !tocks acquired after Guly $44* need to be
det er mi ned in quanti t y ter ms and prices pre"ailing then,
shoul d be used.
7I9E* ASSE"S
*.( o depreci ati on has been charged on the companyJ s fixed
asset s, the maDorit y of which are mot or "ehicles. The
reasons ad"anced by the 7inanci al ,anager are that they can
be resold at the end of fi"e years to realise mor e than K5T of
their original cost and that all mot or "ehicles were fitted with
new tyres during this year and thus the need to charge
depr eci ation.
*.$ /epreci ation is charged to ensur e that cost s of earni ng
income are mat ched agai nst that income during the year the
income is earned. 7ailure to pro"ide for depreci ati on is not
prudent as cost s of running the company are being
under st at ed. Increase in "alue of fixed asset s as long as it is
not realised cannot be taken credit for in the profit and loss
account . 1osts of maint ai ning the income earni ng capacit y
of an asset cannot be used as Dustifiabl e reasons for not
depr eci ati ng the asset s. The profits for the year would be
o"erst at ed by the amount of depr eci ation not charged.
1onsist ency must be maint ai ned in application of accounti ng
policies.
*.* We suggest that depr eci ation at the rat e of $4T amount i ng
to .!hs (,$44 be pro"ided for in the profit and loss account .
*EB"%#S
%.( +ne of the companyJ s debt or, ,afut a /istribut ors has been
put under recei"ershi p. #t the year end they owed your
company .!hs. 594, 444. The company does not ha"e a
policy of pro"iding for bad debt s.
%.$ The position adopt ed by the company in"ol"es the prudence
concept and also no consider ati on has appar ent l y been taken
of the pro"isions of Internati onal #ccounting !tandar d o (4,
-"ent s #fter the balance !heet /at e. The report ed loss in
our "iew is underst at ed and this does not gi"e a true and fair
"iew of the result s from oper ati ons and the financi al position
of the company.
%.* We require that the debt of .!hs 594, 444 be pro"ided for and
charged in the profit and loss account .
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2es s on "en
"A9A"I%N C$A#-E
5.( o pro"ision for tax payabl e has been made in the account s
on the grounds that plans ha"e been finalised for the
company to acquire a dor mant company with huge tax
losses.
5.$ This position may be unDustified. 0osses from other
business es under existing taxation rules may only be utili:ed
against future profits from those same business es. The
Income Tax /epart ment may choose to disallow such clai ms
for these losses.
5.* We suggest that pro"ision for the tax be made in the
financi al stat e me nt s until the position has been fully clarified
with tax aut horities.
2lease re"iew our corrections and should you require any further
informat i on do not hesit at e to cont act us.
We stress howe"er, that we would most likely issue a qualified audit
report if the abo"e issues are not resol"ed satisfact orily.
Qours truly,
ABC
Certii ed +u,li c Account ant s
AbB +ld Traders 0imited
#bridged )alance !heet as at *4 !ept ember $44*
6554 6556
ShsK 555 ShsK 555
7ixed #sset s at cost &,444 &,444
#ccumul at ed depr eci ation A%,K44 B A*,544 B
/ebtors $4 544
!tocks (,(44 944
1ash (44 554
1reditors AK44 B A&44 B
!hare capit al A$,&44 B A$,&44 B
8e"enue reser"es '94 (,(54
-4 - -4 -
#)8I/H-/ 28+7IT #/ 1+!T !T#T-,-T 7+8 T=- Q-#8 -/-/ *4
!-2T-,)-8 $44*
Turno"er &,%44 %,544
Hross profit 5,%44 %,444
/epreci ation A(,$44 B A(,$44 B
8epairs and mai nt enance A(,%54 B A(54 B
+ther expens es A%,&94 B
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A(K, 44KB
Tax charge - A(44 B
et AlossB profit after tax A(,'*4 B 954
AcB #</IT+8J! 8-2+8T T+ T=- ,-,)-8! +7 +0/ T8#/-8! 0I,IT-/
(. We ha"e audit ed the account set out on pages 9 to *$ in
accordance with Internati onal !tandar ds on auditing. The
account s are in agreeme nt with the books of account .
We obt ai ned all the informati on and explanat i ons which to
the best of our knowl edge and belief were necess ar y for the
purposes of our audit.
$. !tocks ha"e been "alued using cost s in force before Guly
$44*. In accordance with I#! $, stocks shoul d ha"e been
"alued at the lower of their cost or net realisabl e "alue. We
are unabl e to det er mi ne the ext ent to which any cost s ha"e
been used in "aluing stocks.
*. o depreci ati on has been charged in the profit and loss
account s. =ad such depr eci ation been pro"ided for in
accordance with I#! (& the charge to the profit and loss
account would ha"e reduced the report ed profits by
.!hs. (, $44, 444. In our opinion such a charge should ha"e
been made.
%. # maDor cust omer owing the company .!hs. 594, 444 went
into recei"er shi p in mid Gune. The reco"er y of this amount is
doubtful. o pro"ision has been made in the account s for
this loss. In our opinions such a pro"ision should ha"e been
made.
5. In "iew of the impact of the circumst ances described in
paragr aphs $,* and % abo"e, in our opinion the account s do
not gi"e a true and fair "iew of the stat e of the companyJ s
affairs at *4 !ept ember and of its loss and sources and
applications of funds for the year then ended. In other
respect s, in our opinions proper books of account s ha"e been
kept and the account s compl y with the 1ompani es #ct A1ap.
%9&B
ABC
Certii ed +u,li c Account ant s
(( o"ember $44*
E&ES"I%N "3%
The following audit procedur es can be employed to satisfy the audit ors
that creditors as at *( +ctober, $44* are not mat eri ally mist at ed.
AaB 8e"iew of mo"ement s in the purchas es account in the
nomi nal ledger and compari son of the amount s in"ol"ed with
correspondi ng amount s in the credit ors control account .
A&*I"IN-
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2es s on "en
This is to ensur e that amount s debit ed to the purchas er s
account in the nomi nal ledger are equal to the amount s
credit ed in tot al to the creditor control account . The source
of these figures would be the same, the dest royed loose leaf
pages of the purchas es Dournal.
AbB !imilarly re"iew the mo"ement s on the debit not e of the
creditors control account with the mo"ement s on the credit
side of the cash control account in the nomi nal ledger. #gain
this would reflect the tot al payment s to credit ors.
AcB In"esti gati on of significant items in the credit ors control
account whose source is not identified as the cash book and
the purchas es account .
AdB !elect a sampl e of the maDor shipper s, all abo"e the
mat eri alit y limit est ablished by the auditor. 1ompar e the
balances in their st at eme nt s at the year end with those on
the listing of creditors for the pre"ious year and obt ain
expl anati ons for any maDor "ariances.
AeB 1ircularise credit ors to pro"ide their det ail ed stat e me nt s
showing outst andi ng in"oices. These in"oices are then
mat ched with goods recei"ed not es and act ual payment s if
paid to det er mi ne whet her allocat ed to the proper period.
AfB 8e"iew payment s made to creditors after the year end and
ensur e that the payment s were for liabilities which ha"e
been account ed for in proper period.
AgB 1ompar e purchas es and credit ors le"els with budget s to
ensur e that within the year they ha"e been within
expect at i ons.
AhB 1ompar e purchas es and credit ors le"els with those of the
pre"ious year and obt ai n expl anati ons for any significant
"ariances.
AiB 2erform analytical re"iew procedur es on the following ratios:
i. Hross 2rofit ,argin broken down as follows:
Current (ear
+re0i ous (ear
Turno"er ; ;
1ost of sales
+pening stocks ; ;
2urchases ; ;
1losing stocks ; ; ;
;
Hross profits
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
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Hross profit mar gi n T
T
If not steady or compar abl e this could mean that purchas es
ha"e not been properly account ed for and hence liabilities.
ii. 1urrent asset s: 1urrent liabilities
#gain compari son is for this year with pre"ious year.
#ny significant "ariances to be in"esti gat ed.
ADB 2erform out put asset s on purchas es in"oices. Hoods
recei"ed not es and relat ed stock mo"ement s to ensur e that
all transact i ons are properl y account ed for in the correct
period.
AkB 8e"iew correspondence with suppliers for any disput es or
compl ai nt s of late payment s.
AlB 8e"iew mat eri al outst andi ng purchas e orders and confirm
with rele"ant officials and suppliers that the goods ha"e not
been deli"ered at the year end.
E&ES"I%N "$#EE
The users of published account s for simplicity can be summari :ed as the
sharehol der s to whom the audit report is address ed and third parti es who
may use the account s for a "aried number of reasons among them
in"est ment decisions. It is gener ally felt that an auditor to be held liable
to anyone be it under the law of contract or the law of negligence the
following conditions shoul d exist:
i. =e must be pro"ed negligent that is:
AaB he must ha"e failed to det ect an error or fraud, he
should ha"e reasonabl y been expect ed to det ect and
AbB he failed to compl y with gener ally accept ed auditing
st andar ds and practices.
ii. The compl ai nant must ha"e suffered loss
iii. #s a direct consequence of reliance on the audit ors report.
A&*I"IN-
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2es s on "en
A S&!!A#( %7 C%&#" *ECISI%NS IS AS 7%22%3S
A&*I"%#KS 2IABI2I"(
<nder the law of contract , an audit or may be sued by the company for
loss resulting from negligence on the part of the auditor A7oss " Itarbot tl e
(9%*B. The case of 1andlier "s 1hrist mas A('5(B exemplified the "iew that
ther e was pri"ity of contract bet ween the audit or and the company. This
"iew precluded third parties from suing for losses.
The position was alter ed in ('&% by the case of =edley )yrne "s =elter
A('&%B in which it was Dudged that in the absence of the disclai mer of
liability, a duty of care to third parti es would arise. This suggest ed that
auditors would be liable to third parti es with whom ther e was a speci al
relationshi p for inst ance the prospecti "e purchas er of a business who was
relying on audit ed account s in maki ng his decisions to buy. The decision
relat ed only to cases wher e a specific interest ed part y exist ed and the
auditor knows or should ha"e known of their interest in the account s. The
principle of liability to unknown third parti es was still unchanged from the
<ltramar es "s Touche case A('*$B where Dudge 1ardo:o comment ed that
auditors shoul d not be subD ect ed to liability in an indet er mi ned amount for
an indet er mi nat e time to an indet er mi nat e class.
here, Teb 7ast ener s "s ,arks, )loom and company A('9(B, Trimax A('9*B
and 1apro Indust ri es "s /ickman A(''4B. The Teb and Trimax cases bot h
the audit ors. In this Teb case, the auditors knew that the company was
likely to be looking for out side finance as it was in difficulties. It was held
one, who was likely to be relying on the account s. This clearly ext ends
the "iew of liability taken in the =edley )yrne case. The plaintiffJ s action
position.
In the Trimax case, the same approach to audit or liability was adopt ed,
and the Dudge found for the plaintiffs. The auditor, it was held, should
ha"e foreseen that these account s might be relied on by a pot enti al
in"est or.
known, or be expect ed to know that 1aparo would rely on their work on
deciding to in"est in the company. There was need for a close relationshi p
to exist bet ween the maker and the recipient of negligent mis- stat e me nt s
for a dut y of care to exist. +n appeal , although it was held that audit ors
ha"e a duty to indi"idual shar ehol der s, this did not ext end to pot enti al
in ('95 0loyd 1heyham "s 0ittle Gohn case that there is a dut y of care
known to third parti es, but they should still prot ect thems el "es by maki ng
the usual enquiries before in"esting. The =+<!- +7 0+8/! ruling in the
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ruled that the auditors owed a duty of care to shar ehol der s as a body but
shares.
It is e"ident , in conclusion that the auditorJ s liability was ext ended aft er
uncert ai n and appear s to ha"e been se"erl y limited by the 1aparo
findings.
We ha"e no decided case against auditors in .enya. The accounti ng
professi on in .enya has howe"er to take into consider at i on de"elopment s
in other count ri es as it is most likely that should a case act ually come to
court agai nst auditors the court would be direct ed and influenced by
decisions gi"en elsewher e. 7or this reason decided cases in other
count ri es and de"el opment s in this area are rele"ant to the accounti ng
professi on in .enya. #uditing st andar ds and accept ed practices and
procedur es are similar in most part s of the world.
E&ES"I%N7%&#
#uditing is defined as an independent exami nati on of records and draft
account s produced by a client in such det ail as will enabl e the audit ors to
form an opinion as to their accur acy, trut h and fairness. <nder the
1ompani es #ct, the audit or is further required to in"esti gat e and report on
whet her proper books of account ha"e been kept and whet her the
account s are in agreeme nt with those books. The audit or cannot form his
opinion nor conclude on other mat t er s without seeking and finding
e"idence on which to base such opinion and to reach conclusions.
#uditing therefore can be stat ed to be an e"idence gat heri ng exercise in
the main. +nce the e"idence has been gat her ed he can then re"iew it and
det er mi ne whet her he has a reasonabl e basis for his opinion.
It is recogni sed that the entit y in est ablishing syst ems of internal control
and produci ng account s for audit s makes assertions bot h implied and
stat ed. These asserti ons of exist ence, effecti"eness and continuit y Aas
expounded on in I!# 544 #udit -"idenceB in as far as internal control and
compliance test s are concer ned and exist ence, right s and obligations,
occurence and compl et enes s, "aluation, measur e me nt and present at i on
and disclosur e as for asset s, liabilities and transacti ons and subst ant i "e
test s are concerned require to be confirmed by e"idence a"ailabl e within
and out side the entit y.
I!# 544, pro"ides further guidance on the means of these ter ms. The
auditor in his e"idence gat heri ng exercise requires to exercise Dudgement
but must be able to ensur e that the e"idence he collect s meet s the criteri a
set in the #uditor +perati onal !tandar d.
8ele"ance means e"idence that confirm the asserti ons st at ed or implied
by the manage me nt . The auditors test s are either compliance or
subst ant i "e and they should be so designed to ensur e that he has
obt ai ned enough e"idence to confirm the asserti ons. -"idence that
confirms the asser ti ons is rele"ant e"idence.
A&*I"IN-
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8eliability of audit e"idence is influenced by its nat ur e which can be "isual,
document ar y or oral - and its source which can be ext er nal or internal.
When we gener alise we stat e that :
AaB -"idence obt ai ned from ext ernal sources is more reliable than
e"idence obt ained within the entit y.
AbB -"idence obt ai ned from within the entit y becomes mor e reliable
if the relat ed internal controls are satisfact or y.
AcB -"idence gener at ed by the audit or himself is mor e reliabl e than
that gener at ed from internal sources.
AdB -"idence in the form of document s or writt en repres ent at i ons is
more reliabl e than oral repres ent at i on.
!ufficiency is designed to ensur e that the risk of mist at e me nt is
initially consider ed and mini mi:ed. 7actors that pro"ide guidance to
the account ant in this regard are:
AaB =is knowl edge of the business of the ent er pri se and the indust ry
it oper at es in.
AbB /egree of mist at e me nt through errors and irregul ariti es which is
affect ed by
i. ature and mat eri ality of the items in the financi al
st at eme nt s.
ii. #uditors experi ence as to the reliability of the
manage me nt and st aff of the ent er pri se and its records.
iii. The financi al position of the ent erpri se.
i". 2ossible manage me nt basis.
AcB 2ersuasi "enes s of the e"idence.
=ere therefore the audit or seeks e"idence from as many sources as
possibl e to gi"e him the required degr ee of assur ance.
The cust om in .enya as far as e"idence gat heri ng is concer ned has
been direct ed towards obt ai ning as much e"idence from as a wide
range of sources as possi bl e where it has been felt that manage me nt
could easily misst at e the figures in the financi al st at eme nt s. Thus
cust omarily, auditors ha"e debt or s to confirm their exist ence, writt en
to banker s to confirm facilities and securities held for those facilities
att ended stock- takes to est ablish the condition and exist ence of
those stock takes, writt en to other third parti es to corrobor at e
informat i on in the financi al stat e ment s. They ha"e carried out
compliance test s based on reliance on internal controls. This
howe"er has been carried out by audit ors utili:ing their own
Dudgement .
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
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The introduction of #uditing !tandar ds has brought the need for
auditors to seek more compl et e e"idence and critically consider
whet her the account s do act ually gi"e a true and fair "iew. The
#uditing !tandar ds ha"e howe"er reinforced practices that already
exist ed and introduced in addition mor e discipline on the part of the
account ant s towards ensuri ng unifor mi t y and approach to audit
assignment s. They ha"e widened the range of what constit ut es
e"identi al mat t er in .enya today by for exampl e recogni si ng
analytical renew techni ques as "ery import ant sources of audit
e"idence, requiring a final re"iew of the account s and document at i on
of such re"iew.
1on"enti ons in .enya required a gener alised lett er of represent at i on
from manage me nt . #uditing !tandar ds ha"e introduced the need for
a more specific lett er of represent at i on and the need for the audit or
to ensur e that no conflicting e"idence exist s.
1ert ai n con"enti on and auditing standar ds ha"e now been brought
into line to ensur e that the e"idence obt ai ned by the auditor is
rele"ant , reliabl e and sufficient . It must also be fully ret ained as
e"idence of the work he did.
A&*I"IN-
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2es s on "en
E&ES"I%N 7I'E
<nder the 1ompani es #ct, A1ap %9&B the auditors duties remai n the same
irrespecti "e of the met hods adopt ed by the company in produci ng its
financi al stat e me nt s and in keepi ng proper books of account s. The
obDecti"es which are to form an opinion on the financi al stat e me nt s and to
report ther eon remai n the same under comput eri sed and con"enti onal
syst ems. The end result of gi"ing an opinion has not changed either.
)ut comput eri sat i on does radically alter
AaB The way in which accounti ng dat a is recorded
AbB The way in which such recording must be controlled and
aut hent i cat ed
AcB The training needs and attit udes of the staff responsi bl e at
bot h manage me nt and technical le"els and J
AdB The way in which the process and its result s must be audit ed.
The comput er therefore has implications for the syst em of internal control
on which the auditors may wish to place reliance and on the financi al
informat i on which it produces and on which the audit or is expect ed to gi"e
an opinion.
The implications of comput eri sati on in so far as the audit approach,
ext ent , timing and nat ur e of audit test s is concernced can be summari sed
as follows:
AaB <nder con"enti onal syst em production accounti ng records are
kept in the account s depar t ment , stock records in the stores
and so on. In -/2 syst em all these are in the -/2 depar t ment .
7urther mor e, the st aff in the -/2 depart me nt tend to be far
more identified with the comput er than with the company.
AbB 1omput er hardwar e and records are "ulner abl e to at mospheri c
en"ironment al conditions, elect rical and magnet i c interfer ence,
accident al damage and degener at i on, and human mani pul ation.
The files are also in the form of densel y- packed magnet i c medi a
and so their cont ent s cannot be identified "isually.
AcB The "isible processi ng trial, which is taken for grant ed on
con"enti onal recordi ng syst em is lost in the course of
comput er processi ng, which is itself go"erned by programs
whose reliability implies being capabl e of direct
obser"ati on while functioning.
I!+2ICA"I%N 7%# "$E A&*I"%#
The consequences for the audit or of three maDor control problems
highlight ed abo"e may in turn be summari sed as follows:
AaB .nowlege and experi ence. Technical knowl edge and practical
experi ence on the part of audit st aff are an essent i al accompani me nt
to the planning and executi on of all audit procedur es. This may be
gained by books, through courses of "arying lengt h, and by
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
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appoi nti ng a comput er technician to Doin the audit compl eme nt .
AbB #udit document at i on - the document at i on on the audit files
must reflect the nat ur e of the audit. !tandar d questionnai r es
and checklist s must be accordi ngly redraft ed and the current
file cont ai n a record of all the client s -/2 document at i ons,
det ails of maDor controls included in the programs, flow
diagr ams of syst ems.
AcB Timing of test s - the audit or requires a tot ally re"ised approach
to the timing of audit test s. When compl et e and per manent
record of all transacti ons, asset s and liabilities is a"ailabl e at all
times, audit test on the record may be carried out at any
con"eni ent st age, by mut ual agree me nt bet ween client and
audit or. In -/2 syst em howe"er cont empor ar y, as opposed to
historical, testing is often an inescapabl e imposition.
I 8equest for speci al printout s for audit purposes. These
indicat e reliability only in relation to the specific test
conduct ed and it would be danger ous to rely upon them as
"alid for processi ng which takes place at any other time,
hence the need for regul ar periodic "isits.
I Test packs which, like test s on speci al printout s should be
conduct ed inter mi t entl y throughout the period under audit,
otherwi se it will be impossi bl e for the audit or to draw "alid
conclusions concer ni ng the function of progr ams and
programme d controls during the period as a whole.
I the loss of audit trail due to creation of say, bat ch tot als
which gi"e no breakdown for checking purpose, or for cross-
referenci ng to original document s. The original document s
may thems el "es in some cases, ha"e been resort ed for
anot her purpose, as a result of which the locating of specific
items is render ed unpracti cabl e. +nce, agai n, therefor e, it is
essent i al for the auditor to be present while processi ng is
taking place if he wishes effecti"ely to audit the procedur es
in question.
AdB The incident of audit test s - con"entional records may be
audit ed by "ouching and checking the "isible entries made at
the "ery interface bet ween the aut horised and "alid originating
document s, on the one hand, and the book of account on the
other. In -/2 syst ems, the recording count er par t takes place
within the machi ne and no equi"al ent record is left for
subsequent indi"idual "erification. 7or this reason the audit or is
forced to shift the target of his test s and to concent r at e his
efforts on:
I 3uality control o"er e"ery st age in the creation of the input
I The syst em de"elopment controls responsi bl e for ensuri ng
that this progr am functions correctly
I the admi ni st r ati"e controls which are designed to ensur e that
the correct progr ams are always used that st aff obser"e
designat ed Dob di"isions, that hardwar e and files are
physically secur e and adequat el y support ed by
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reconst ruction and st andby facilities.
I The use made by manage me nt of out put report s, particul arly
exception report s and the control procedur es go"erni ng
reDection of in"alid dat a.
The need for this shift of incident is under st ood when one
reali:es that all test s through the machi ne can, at best pro"ide
indirect affirmation on program functioning, and inferior, from
the audit "iew point, to test in which the accounti ng entries may
be scrutini:ed in their tot ality Aalbeit historicallyB at the "ery
point of their creation.
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
#e0i si on Aid
;:<
!%CK +A+E#
C+A +A#" III
"ime Allowe dB 4 $ours
Answer A22 @ues t i ons / !arks all ocat e d to each @ues t i on are
shown at the end o the @ue s t i on/
E&ES"I%N %NE
AaB The expressi ons Omanage me nt audit, operational audit, and
efficiency auditO are "ery often used these days.
/o they differ from internal audit sR If so, to what ext ent R
/iscuss.
AbB Write short not es on O6alue for ,oney audit sO with a speci al
reference to go"ernment and quasi- go"ernment bodies.
("ot al B 65 !arks)
E&ES"I%N "3%
#n Internati onal #udit practice !tat ement AI#2!B has been issued on #udit
of !mall )usiness es.
#e@ui red
AaB /iscuss the "arious aspect s in which this audit of small
business ent erpri ses differs from that of larger ones.
A9 ,arksB
AbB )riefly outline the argument s which ha"e been ad"anced for
and against the ret ention of small business audit s.
A& ,arksB
AcB !ummari se the pro"isions of the I#2! referred to abo"e.
A& ,arksB

("ot al B 65 !arks)
E&ES"I%N "$#EE
# leading stock broker has approached your firm and asked you to prepar e
an account ant s report to be included in a prospect us for -asy 7ruits 0td.
which is about to issue shar es to the public. Qou learn that -asy 7ruits
0imited is a public company and has been in business for the last (5
years.
#e@ui red
AaB In point form itemi se the cont ent s of your report .
A(4 ,arksB
AbB <sually the case is that some of the items in the past financi al
stat e ment s of the issuing company require amendme nt for the
purposes of the account ant s report.
A&*I"IN-
;C5
2es s on "en
With due regar d to the rele"ant pro"isions of the 1ompani es #ct,
discuss the aspect s and items shown in the financi al st at eme nt s
which may require amendme nt for the purposes of your report .

A(4 ,arksB

("ot al B 65 !arks)
E&ES"I%N 7%&#
Qou ha"e been in part ner shi p with a fellow 1ertified 2ublic #ccount ant for
a number of years. /ue to old age and ill-healt h your part ner has
suddenl y resigned.
<nfortunat el y, some of the client s of your practice ha"e also suddenl y left
you, thereby lea"ing you with few personal client s and only one large
client which, on depart ur e of your part ner, will represent *4T of your tot al
audit fee income.
While re"iewing your business plan and your ethical position, you realise
that in order to make the practice profitabl e and "iable you will need to
expand your client base consider abl y.
#e@ui red
AaB In the light of the #ccount ant J s #ct A1ap. 5*(B and the -thical
Huidelines issued by the Institut e, st at e with reasons whet her you
will ha"e to resign as audit or of the large client.
A9 ,arksB
AbB +utline the st eps you are entitled to take in order to bring in more
client s. AK ,arksB
AcB +utline the actions which are specifically prohibit ed by the -thical
Huidelines for a practice which wishes to bring in more
client s. AK ,arksB

("ot al B 66 !arks)
S"#A"$!%#E &NI'E#SI"( ) S"&*( +ACK
#e0i si on Aid
;C.
E&ES"I%N 7I'E
7or a consider abl e time now, -ast- West #irlines A-W#B has been
experi enci ng numer ous probl ems with their comput eri sed 8eser"ation and
In"oicing !yst em A18I!B. The companyJ s mai n acti"ity is the oper ati on of
a fleet of $5 passenger planes for both domest i c and Internati onal flights.
The direct ors of -W# inform you that they think that the probl ems relating
to the 18I! are due to insufficient input, processi ng and output controls.
1onsequent l y, at he 18I! has to be rest ruct ur ed to incorpor at e the
required controls in the progr ams.
The following additional informat i on is supplied to you.
i. 0ast year the company had an annual turno"er of !h. (, $44
million all deri"ed from ticket sales.
ii. )ookings are made from six comput er ter mi nal s which are
locat ed in six count ri es. The ter mi nal s are connect ed to a
mainframe comput er situat ed at the companyJ s
headquar t er s.
iii. The ter mi nal s are only capabl e of perfor mi ng enquiri es for
a"ailability of #irline seat s. #dditionally all bookings are
confirmed through these ter mi nal s@ such confirmati on being
the basis of simult aneous updat e of the seat s a"ailabl e file
Ain the air ticket comput erB and aut omat i c printing of a
cost ed air ticket Afrom the ter mi nalJ s print erB.
#e@ui red
AaB 2repar e a det ailed report to the direct ors of -W# outlining
the controls which you consider necess ar y in such a
processi ng en"ironment . A(% ,arksB
AbB )riefly describe the new operational and control relat ed
feat ur es which distingui sh bat ch control from real- time dat a
processi ng syst ems. A& ,arksB

("ot al B 65 !arks)
EN* %7 "$E !%CK E9A!
N%3 SEN* "% *IS"ANCE 2EA#NIN- 7%#
!A#KIN-
A&*I"IN-

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