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Pinnacle Business

School
AUDITING & INVESTIGATIONS
INVESTIGATIONS
This is independent inquiry commissioned by a client for his own purpose.
TYPES OF INVESTIGATIONS
i)
Acquisition of company
ii)
Purchase of a business
iii)
Prospective investments
iv)
Fraud investigation
v)
Companys Act investigation
vi)
Tax Investigations e.t.c
The range of clients who can commission investigations include:
Companies
Individuals
Government departments e.g. KRA, department of Trade and industry
Lending institutions such as banks and Local authorities.
STAGES OF INVESTIGATION
Types of investigations are carried out through the following stages.
1. Obtain precise written instructions from the client.
2. Professional courtesy.
3. Organizing the investigation.
4. Obtaining background information
5. Preliminary information.
6. Report outline.
7. Investigation proper.
8. Draft the report.
9. Discuss the report verbally with client.
10. Type the report and submit it to the client and be available for further
investigation.
Stages of Investigations.
1. Obtain written precise instructions from the client.
This involves the auditor obtaining the following information from the client.
A clear view of the objective of the investigation.
Scope of the investigation particularly the past time to be covered, the
person or section of the company to be investigated.
Degree of detail required e.g. fraud investigations involve examining
million of documents so that one can be able to prepare a case for
prosecution.
The person or group to whom the accountant must address his report.
2. PROFESSIONAL COURTESY
Professional courtesy requires that if the investigations are carried out in
the affairs of the organization which have their own auditors then these
auditors must be communicated with to observe the usual courtesy and
obtain their cooperation.
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3. ORGANIZING THE INVESTIGATION


This involves the accountant assessing the aims of investigation, estimating
the time to be taken and likely costs to be incurred in carrying out the
investigation and also ensuring that appropriate staff will be available to
carry out the investigation.
4. OBTAINING BACKGROUND INFORMATION
This is particularly useful when carrying out investigations involving take
over or business purchase propositions. E.g. if the client is contemplating to
purchase a sugar factory then one will need to determine all he knows
about sugar business in general. This will include e.g.
The size of industry and structure.
Regulations governing the operation of the industry.
History since commencement.
Investment information and accounting ratios.
Recent prices paid for firms of similar sizes.
Future prospects of the sugar industry.
This type of information is available from published sources such
government statistics, trend associations and journals.
5. PRELIMINARY INFORMATION
This is information to be gathered on the subject to be investigated and
information to be collected includes: Company location
The market share of the company .
The accounting and I.C.S
Personnel manning the company
Past annual reports and accounts.
Corporate planning statements and budgets.
6. REPORT OUTLINE
After obtaining background information and preliminary information, the
auditor should be able to write out a report outline before conducting the
full investigation in detail. This is important because it will assist in drafting
the final report and it will also discipline and control the staff engaged in the
investigation. Most report outlines on the investigation are carried out on
the following outlines.
Introduction where we give reference in instructions given and the
objective of the investigation must be clear from the introduction.
A summary of all instructions given
A statement of the scope of investigation including the period covered.
A statement of documents to be produced during investigations.
An outline of the actual work done
A summary of information obtained
Further information which could be of use to the client but did not come
out clearly from the investigations
Recommendations of the accountant in giving recommendations, the
accountant must always ensure that: He gives information from which the client can draw his own
conclusion.
Avoid presenting information in such a way that the clients
judgment is influenced.
If the information is based upon assumptions, then the assumption
must be stated in full.
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The recommendations must be practical.


7. INVESTIGATION PROPER
This will be in the form of facts or evidence gathering exercise. Here the
accountant moves out to collect the actual facts concerning the
investigation.
In collecting the evidence the accountant must ensure that: Always obtain supporting evidence for statements made.
Facts and evidence gathered should be consistent with other information
obtained.
Obtain a complete story with no loose ends.
Maintain good working papers and documents. The findings must be
recorded down fully since this may be needed as evidence of work done
in a court of law.
8. DRAFT THE REPORT.
The report should be drafted along the guidelines given in stage six. This
will enable the client to reach conclusive opinion on investigations carried
out.
9. DISCUSS THE REPORT VERBALLY WITH CLIENT
This is because the report may require some amendments or clarifications
as the client may deem necessary.
11. TYPE THE REPORT AND SUBMIT IT TO THE CLIENT.
if the company is investigated the report should be given to the
management i.e. Board of Directors or if its an individual then it should be
addressed to the specific persons.
INVESTIGATIONS INVOLVING ACQUISiTION OF A COMPANY
Accountants are frequently requested by individuals or a company to
investigate a business of the client is contemplating to purchase. The client is
simply asking the accountant to help him in making up his mind on: Whether to buy or not
If to buy at what price and for what consideration.
The accountant approach to this assignment will depend on the instructions
given and the investigation may be carried out along the following lines.
1. Obtain written instructions.
Throughout the investigation the accountant should bear in mind the
purpose of the investigation and any particular criteria the client should
wish to be applied during the investigation e.g. there may be constraints
such as the minimum rate of return on the investment, cost of
investigation and the scope of the investigation.
2. Establish relationship with the client, the subject of investigation, the
professional advisors of the client including the accountant and auditors.
3. Examine and draft the accounts for a period of years and this information
should be put in a column form. This will enable the trends and ratios to
be determined using the draft accounts. The accounts should be
redrafted for a period of at least three years. One year being considered
to be too short because there is no comparative, two years also
considered to be too short because theres no trend, three years
considered appropriate because theres trend and a comparative.
At this stage we eliminate all non-reoccurring items and all those items
which will not apply after change ownership and will include notional
amounts for those items that will become applicable after change of
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ownership. This may involve redrafting of the accounts using different


accounting policies.
4. Establish the reliability of the accounts. If the accounts have been
audited by a reputable firm then little verification will be required apart
from inquiring whether there are any qualified audit report and
accounting policies.
If the accounts have not been audited then the following matters will
require further investigations.
Sales: be on the lookout for false sales or sales from other business.
Purchases: look out for exclusion of purchases.
Cut-off: this is particular important as potential sellers have been
known to switch sales in the final period in order to boost turnover
and gross profit.
Stock and W.I.P: its important to arrange for an independent stock
take at the take over date.
Gross profit ratios: They should be consistent year to year and with
the average of the industry.
Assets values: Be on the lookout for the adequacy of debtors and the
valuation of debtors. If the business has been experiencing frequent
repairs and renewals then the assets values may have been impaired.
Undisclosed liabilities:
This may include tax obligations,
compensation for redundancy, and pension obligations.
5. Commercial considerations upon change of ownership. This includes: Determining the period of the lease of the premises and whether the
leases will be renewed.
Personal connection of the vendor with the customers. Will the
customers continue to come to the business after change of
ownership.
Necessity of a covenant with the vendor/seller to ensure that he does
not start up a similar business next to the vendor.
Development plan for the district.
6. Future prospects. The most important matters here are the future of the
industry the need for working capital in order to invest in non-current
assets.
7. Other matters: Such as the reason for the sale of the business.
Methods used to value a business
Investigations involving prospective lending (Request for a loan).
The bank in wishing to give loans requires certain information from the
applicant. The bank or lender wants to know:a) The purpose for which the loan is required.
b) The adequacy for that purpose of the amount being sought.
c) The nature and adequacy for the underlying.
d) The proposed arrangement for payment of interest and the period over
which the payment of the principal sum will be complete. Therefore to
carry out an investigation of this type the following procedures are
generally adopted
The background and professional standing of the promoter of the
company.
The viability of the concerned in light of current to future requirements in
the area of operation.
The size of the existing market and the likelihood of a success for a new
venture.
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The availability of suitable locations of the premises at an economical


rent.

Financial procedures
The bank wants to know the extent to which the promoter can match with their
own resources.
The past success or failure in business ventures.
The personal names of the guarantors and the security given.
Reliability, honesty and integrity of the client in business dealings.
Schedules to be included in the presentation:
1. Cash flow budget for the proposed concern.
2. Estimate set out month by month of income and expenditure incurred in
earning revenue.
3. Estimate once again set out month by month of fixed and set up costs likely
to be incurred from the inception of the enterprise. Such expense will cover
advertising costs, cost of acquiring computer and furniture administrative
expenses such as installation of telephone, rent, light and heat.
All this information will help the lender to assess the risk they will be
undertaking if they have to lend their money to you.
Investigations involving incoming partners
i.
An agreement in writing of the work to be done including the scope of
investigations, the period to be covered and the date of the report should
be considered.
ii.
Obtain permission to approach the other partners and the auditors of the
partnership since these people will supply the relevant information.
iii.
Obtain documentary evidence of the partnership deed including the
previous year accounts and if possible the supporting schedules.
iv.
Redraft the accounts for the last three years ensuring that in each year
adjustment is done for the trends and ratios to be easily identified.
v.
Prepare a forecast of the future results based on the trends and making
adjustments for any known differences such as rent and interest.
vi.
Seek a professional valuation of the properties of the partnership in an
attempt to determine their fair values.
vii.
Examine any proposed valuation of the goodwill.
viii. Examines and review the partnership agreements both the proposed one
and the current ones and ensure that the proposed terms are reasonable
in terms of the profit share.
ix.
Enquire into any partnership debts particularly the long-term liabilities.
x.
Ensure that agreements can be reached on matters such as audit, book
keeping and financial statements preparation.
xi.
Prepare the report and discuss it with the client.
xii.
If the report is agreed upon, it should be submitted to the client for
action.
Investigations for Tax purposes
Revenue Authorities carry out investigations to determine whether the
enterprise has reported its taxable income properly. Examination of the
accounts of the entity is done to ensure proper and complete returns are filed.
Procedure adopted
1. The objective of investigations is to check the internal consistency of the
data recorded in the books or statements presented by the enterprise. This
is done by the use of checks e.g. the budgets of other ratios to enable
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2.
3.
4.
5.
6.

establish whether the accounting records and the statements are basically
consistent and correct.
Gross profit ratio is worked out to establish the credibility of the trading
accounts.
Valuation of stocks should be examined in depth. Reference to the sales
and purchases close to the financial year could disclose the material
omissions or falsifications.
Check on the expenses claimed against the revenues earned and no
personal expenses should be charged to the business income.
The bank statements should be properly scrutinized to ensure that all the
deposits are properly accounted for as well as the payments made
Where the individual does not keep proper books of accounts, estimate of
the total payments made during the year should be reconciled with the
declared sources of income to assess the tax liability.

Investigations involving theft and misappropriation of companys


assets.
1. Ascertain the level of authority and nature of duties of defaulting employee.
2. Cast and vouch the cashbook and obtain such figure of closing and opening
balance from the bank.
3. Check the cashbook against the bank statement paying particular attention
to date whether the receipts were banked immediately.
4. Carry out a positive circularization of debtors.
5. Scan the cashbook for any irregular payments.
6. Obtain duplicates of missing expenditure vouchers and find out whether
they were authorized.
7. Examine returned cheques from the bank comparing the names of the
payees with the details in the cashbook and the vouchers.
8. Vouch all the amount shown as directors/partners drawings and confirm
they were authorized by reading the board minutes.
9. Cast the sales day book and match it with related customers orders, sales,
invoices and goods dispatch notes.
10. Obtain explanations from respective officer or employer if some of the
sales, invoices are missing and they have not been matched with the
respective customers orders.
Investigators Report
1. He should give introduction where he should mention the instructions given
to him, the matters on which he relied upon and the work he carried out.
2. He should deal with the history and nature of the business.
3. He should report on the state of the structure of the enterprise, officials,
duties and responsibilities entrusted.
4. He should give a brief summary of his finding and recommendations to
facilitate understanding of the report.
PROSPECTIVE FINANCIAL INFORMATION (PFI)
PFI is based on assumptions about the future events and the possible actions
by the management of an entity.
Forecast
Its prepared on the basis of assumptions about the future events and the
steps management expects to take and the date information is prepared. Key
forecasts, which the auditor may be interested in are:i.
Capital expenditure forecasts
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ii.
iii.

Profit forecasts
Cash flow forecasts

Accepting an engagement to examine PFI


The main factors to use considered by the auditor include:1. The nature and background information of the company business. The
auditor will need to obtain some knowledge about the business
particularly concerning its main activities, type of products, customers,
location and trends of the business.
2. The accounting policies normally followed by the company.
The
accounting policies which are used to prepare the normal financial
statement are the same policies to be used in preparing the PFI. If there
are changes they should be justified.
3. The assumptions on which the PFI is based on: the auditor should
examine the assumptions and find out whether they are best estimates
or hypothetical assumptions.
4. The procedures followed by the company in preparing PFI: the main
issues the auditor should pay focus on include.
i.
Whether the forecast results under review is based on the forecast
which are regularly prepared for the purpose of the management or
it has been prepared to meet the specific purpose.
ii. If the forecasts are regularly prepared for management purpose,
then the degree of accuracy and reliability previously achieved will
need to be determined.
iii. The extent to which the forecast results for the expired periods are
being supported by reliable interim financial statement which are
published by the management.
iv. How the forecast has taken into account any extra-ordinary items
and the previous year adjustments, their nature and how they are
represented
v.
Whether adequate provisions have been made for foreseeable
losses and other contingencies, and how the forecast has taken into
account factors that make the assumptions not to hold.
vi. The auditor should check the arithmetical accuracy of the forecast
to ensure the calculations are accurate.
PROFIT FORECAST.
1. Verify projected income figures to suitable evidence and these may involve:a) Comparison of the basis of the projected income figures to similar
existing projects in the firm.
b) Review the market prices of the product or service and find out what
competitors are successfully charging in the market.
2. Verify projected expenditure figures to suitable evidence. There is likely to
be more evidence about expenditure which may take the form of:a) Quotations provided to the firm.
b) Current bills for similar expenditure.
c) Information rate assumptions may be compared with the bank current
rate.
d) Costs such as development can be compared with the relevant capital
expenditure projections.
CAPITAL EXPENDITURE FORECAST.
The auditor should check the capital expenditure for reasonableness e.g. if the
projection relates to buying land and developing it then it should include a sum
for the purchases of land.
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The projections can be verified with quotations provided to the firm.


Projections can be reviewed for reasonableness by comparing it to the
prevailing market rate where such information is available.
CASH FLOW FORECAST.
The auditor should review the cash flow forecast to ensure that the timing
involved reasonable e.g. its not reasonable to say that the building would be
bought from day one as properly transactions usually take longer than one day.
The auditor should check the cash flow forecast for consistency with any profit
forecast e.g. income and expenditure will be audited in the same way as it was
done on the profit forecast but its just the timing that may be different.

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