Beruflich Dokumente
Kultur Dokumente
PART II
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SECTION 4
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STUDY TEXT
AUDITING AND ASSURANCE
CONTENT
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- Professional ethics/code of ethics for professional accountants
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- Fundamental principles, threats and safeguards, other professional guidelines on
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audit fees, conflict of interest, advertising and opinion shopping
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10.4 Planning and risk assessment
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- Obtaining clients acceptance and retention
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- Understanding the entity and its environment
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- Audit planning, audit programmes and documentation
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- Emphasis of master paragraph
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- Features of audit reports
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10.10 Auditing in the Public Sector
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- Introduction to auditing in the Public Sector; regulatory provisions
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- Establishment, mandate and functions of public sector auditors; Kenya National Audit
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Office (KENAO) and similar national audit bodies
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- Role of internal audit function in public entities
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CONTENT
TOPIC PAGE
1. Assurance engagements………………………………………………………………..5
2. Nature and purpose of an audit………………………………………………………12
3. Legal framework and regulation………………………………………………….….31
4. Planning and risk assessment…………………………………………………………66
5. Overview of forensic accounting…………………………………………………….113
6. Internal control systems…………………………………………………….…….…..125
7. Audit evidence……………………………………………………………….….……..139
8. Overall audit review……………………………………………………….………….193
9. Audit reports…………………………………………………………….….…………211
10. Auditing in the Public Sector………………………………………………...….…..224
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Revised on: November 2016
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TOPIC 1
ASSURANCE ENGAGEMENTS
Audit engagement refers to audit performed by an auditor. It is the very first stage of an audit
procedure where the client is notified by the auditor that the work pertaining to audit has been
accepted by him/her and also provides clarifications with regard to the scope and purpose of
audit. To be more specific, audit engagement can be referred to the written letter that the
auditor uses to notify the client that he/she would be engaging in auditing services. Thus, the
audit engagement procedure is basically a negotiation based on professional terms that takes
place between prospective customer and a public accounting entity. This procedure is used for
finding new customers and offer accounting related services to different businesses.
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The auditor uses the term ‘audit engagement’ when the entity has to undergo the auditing
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procedure. This could imply varied things and therefore it is necessary that the auditor clarifies
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what she/he exactly means by the term. Irrespective of the definition followed by the auditor,
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he/she makes it a point to follow certain specific guidelines and procedure for offering the
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services.
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Full Engagement
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Audit engagement consists of several steps that basically revolve around planning,
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substantiation, control testing and finalization. The very first step involves providing a letter to
the client reminding him about the audit. Once the client has been contacts, both the auditor
and client meet with each other to determine how, why and when the auditing would take
place. In addition to this, the client also needs to provide the auditor with relevant resources
for conducting the procedure smoothly. Following this, the auditor carries out surveys to find
out more about the organization and its controls. This is followed by testing of controls and
garnering of as much detail and information as is possible. On the basis of the results and
information, the auditor prepares a temporary draft and shares the same with client. Once the
client has gone through the draft report, he responds to the recommendations and findings
made in it. After this, the auditor prepares a final audit report and may also request the client
to fill a survey form to better understand his/her performance. The audit is completed after a
follow up meeting with client, which usually happens within 6 months.
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NON-ASSURANCE ENGAGEMENTS
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Non-assurance Engagements
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If an engagement lacks the five elements of assurance engagements, it is considered non-
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assurance (residual definition). Examples of non-assurance engagement are the following:
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1. Agreed-upon procedures
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2. Compilations engagements
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4. Management advisory services and Consulting
5. Engagement that includes rendering of professional opinions not intended to be an
assurance report
There are five elements that must all be present in order to qualify the engagement as an
assurance engagement.
The subject matter and the subject matter information of an assurance engagement can take
many forms, such as:
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Sufficiency is the measure of the quantity of evidence
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o The quantity of evidence needed is affected by the risk of the subject matter
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being materially misstated.
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Appropriateness is the measure of the quality of evidence, that is, its relevance and
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reliability
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o The reliability of evidence is influenced by its source and by its nature, and is
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Suitable Criteria
1. As to level of assurance:
i. Reasonable Assurance – the objective is a reduction in assurance engagement
risk to an acceptably low level as the basis for a positive form of expression of a
practitioner’s conclusion. (e.g., audit of historical financial statements)
ii. Limited Assurance – the objective is a reduction in assurance engagement risk
to a level that is acceptable in the circumstances of the engagement, but where
the risk is greater that for a reasonable assurance engagement, as the basis for a
negative form of expression of the practitioner’s conclusion. (e.g., review of
historical financial statements
2. As to structure of engagement:
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i. Assertion-based – the evaluation or measurement of the subject matter is
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performed by the responsible party, and the subject matter information is in the
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form of assertion to the intended users.
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ii. Direct Reporting – the practitioner either directly performs the evaluation or
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measurement of the subject matter, or obtains a representation from the
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responsible party that has performed the evaluation or measurement that is not
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available to intended users. The subject matter information is provided to the
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TOPIC 2
Definition of an Audit:
An audit is the independent examination of an expression of an opinion on the financial
statements of an economic entity by appointed auditor in pursuance of that appointment and in
compliance with any relevant statutory obligation
The objective of an audit is to enable the auditor express an opinion whether financial
statements show a true and fair view of the company state of affairs in accordance with an
identified financial reporting framework.
The purpose of an audit is not to provide additional information but rather it is intended to
provide the users of the accounts with assurance that the information provided to then by
directors is reliable. However, the users should not assume the auditor’s opinion is one to
efficiency with which management has conducted the affairs of the entity.
Financial statement: According to the Companies Act, the company accounts refers to the
balance sheet and the profit and loss account but due to development in business practice and
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shareholders information needs, these are inadequate as to the information regarding financial
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position and performance of the company. Since most balance sheets and profit and loss
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accounts are summarized statements amplified by notes to the statements, the business
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community and the accountancy profession require that a cash flow statement as well as a
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statement of changes in equity be prepared. The terms company accounts and financial
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statements have the same meaning.
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Financial Reporting framework: According to International Auditing Standards (ISA 200, the
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and presented annually and are directed at common informational needs of a wide range of
users.
Many of the users rely on the financial statements as their major source of additional
information to meet their specific information needs. Therefore financial statements need to be
prepared in accordance with one or combination of:
International Financial Reporting Standards (IFRS)or IASs
National accounting standards
Any other authoritative and comprehensive financial reporting framework designed for
use in financial reporting and is identified in the financial statements. In Kenya the
financial reporting framework adopted is as prescribed by IFRS.
The auditor's opinion on the financial statements deals with whether the financial
statements are prepared, in all material respects, in accordance with the applicable
financial reporting framework: Such an opinion is common to all audits of financial
statements.
The auditor's opinion therefore does not assure, for example, the future viability of the
entity nor the efficiency or effectiveness with which management has conducted the
affairs of the entity. In some jurisdictions, however, applicable law or regulation may
require auditors to provide opinions on other-specific matters, such as the effectiveness
of internal control, or the consistency of a separate management report with the financial
statements.
While the ISAs include requirements and guidance_ in relation to such matters to the
extent that they are relevant to forming an opinion on the financial statements, the
auditor would be required to undertake further work if the auditor had additional
responsibilities to provide such opinions.
STAGES OF AN AUDIT
The suggested audit approach is designed to gather sufficient and reliable evidence to support
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the audit opinion in the most efficient and effective way and to enable the engagement team to
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fully understand the client's business. There is no difference between an audit of a large and a
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small entity except that the procedures adopted may differ depending on the particular
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circumstances of each audit
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i. Preliminary Engagement Activities
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ii. Planning
iii. Execution ea
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Planning
Planning is an essential component in focusing the audit efforts. The key components of
Identifying the scope of the assignment
Developing an audit strategy taking into consideration the scope of the engagement; the
business and the regulatory environment in which the entity operates; entity specific issues
including reliance on the work of internal audit; reporting objectives, timing of the audit and
the nature of communication required; matters affecting the direction of the audit including
preliminary setting of materiality levels, preliminary review of risk including fraud risk,
preliminary review of internal control including the control environment, the process adopted
by the entity to identify, measure, monitor and control risks.
- Developing, based on the above, the overall audit plan detailing the nature, timing and
extent of the audit procedures to be performed in order to reduce the audit risk to an
acceptably low level; the nature of tests to be adopted; procedures to be adopted at the
assertion level; and tailoring the audit programmes.
- Ascertaining the nature and the extent of the resources required to perform the audit.
iii) Execution
- The key components of the execution stage are:
- Carrying out the test of controls and substantive tests on transactions and balances
including substantive analytical procedures to obtain sufficient and appropriate audit
evidence to enable the engagement team to draw reasonable conclusions on which to
base the audit opinion.
- Evaluating significant assumptions used in fair value measurement to determine the
reasonableness of the basis used and the disclosures.
- Identification of related parties and obtaining sufficient and appropriate audit evidence
in respect of measurement and disclosure of related party transactions.
- Documenting the nature, timing and extent of the audit procedures performed and the
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results and conclusions drawn from the audit evidence obtained
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While pre-printed forms and programmes are available in the Manual, the extent and the
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timing of the tests should be tailored to the specific assignment. Different tests and different
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levels will be appropriate for each assignment. The control of the audit at this stage must be
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maintained by a senior team member with the appropriate experience and expertise.
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iv) Review and Completion
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The review and completion procedures focus on ensuring that sufficient and appropriate
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evidence has been obtained to support the audit opinion. This involves ensuring that:
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presentation and disclosure. In the context of Kenya, this in most cases will be the
IFRS's.
- The engagement partner has reviewed the audit file and is satisfied that sufficient and
appropriate evidence has been obtained to support the conclusions derived and the audit
opinion to be issued. As much of the audit evidence obtained is persuasive rather than
conclusive, absolute certainty is rarely obtainable and .therefore the engagement partner
should ensure that the audit risk is reduced to the lowest level possible.
- Where applicable, sufficient and appropriate procedures have been performed to
identify subsequent events tip to the date of the audit report and ensure that all items
that require adjustment or disclosure in the financial statements have been appropriately
dealt with:
- Where appropriate, an engagement quality .control review has been undertaken and all
the issues arising from the review have been fully dealt with and cleared with the
reviewer.
- At the end of each audit, the engagement team is de-briefed, the audit objectives set out
for the assignment have been achieved and that the engagement team has gained
experience from the assignment which will enhance their personal development.
Though not covered by the terms of audit engagement, the engagement team may, as part of
the audit process carry out a business review of the key issues facing the entity and take a
strategic look at the business and at areas where the firm can add value to the entity. In
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providing other value added services, the firm and in particular the engagement partner should
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be conscious of the independence requirements of the code of ethics
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AUDIT AS AN ASSURANCE ENGAGEMENT
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It is often not possible to check things for yourself, whether quality, accuracy, performance or
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existence.
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You might not have the skills or the time, or you might be in the wrong location. Therefore
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you must rely on someone else to give you assurance. This means you have to decide:
- What standards should be applied?
- What represents 'good', 'acceptable' or 'unacceptable?
- How much checking should be done? All checking and assurance has an associated cost
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TOPIC 3
STATUTORY REGULATIONS
Auditor’s liability
Auditors are potentially liable for both criminal and civil offences. The former occur when
individuals or organizations breach a government imposed law; in other words criminal law
governs relationships between entities and the state. Civil law, in contrast, deals with disputes
between individuals and/or organizations.
Civil liability
Companies Act Section 206 of the provides that officers of the company and for these
purposes auditors are considered as officers may be liable for financial damages in respect of
the civil offences of misfeasance and breach of trust. This section which is only relevant to
winding up refers to a situation where officers have misused their position of authority for the
purposes of - personal gain e.g. if the auditor uses information acquired in course of an
engagement for his financial gain or for benefit of another party.
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Criminal liability
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Companies Act Section 46 of the states that an auditor shall be criminally liable if he 'willfully
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makes a materially false statement in any report, certificate, financial statement with an
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intention to deceive or mislead etc. Willfully implies fraudulently and can be difficult to
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prove. Whereby, it is held that where an officer of a body corporate with intent to deceive
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members or creditors, publishes or concurs in publishing a written statement of account which
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Auditors may uncover criminal offences committed by a client or an employee of the client.
This puts them in a difficult position, but the auditor should act carefully and correctly and if-
necessary„ take legal advice. The auditor must not commit a criminal offence himself. It is felt
that he would have committed a criminal offence if:
a) He advises his client to commit a criminal offence;
b) Aids the client in devising or examining a crime;
c) If he agrees with a client to conceal or destroy evidence or mislead the police with 'false
statements;
d) If he knows that his client has committed an arrest able offence and tries to impede his
arrest and prosecution. Impede does not include refusing to answer questions or
refusing to produce documents without the client's consent;
e) If he knows that his client has committed an offence. and agreed to accept consideration
to withhold information;
f) If he knows that the client has committed treason and fails to report the offence to the
proper authority.
Case history
The application of the law of tort in the auditing profession, and the way in which auditors
seek to limit their exposure to the ensuing liabilities, has been shaped by a number of recent
landmark cases. The most notable of these are Caparo Industries Plc (Caparo) v Dickman
(1990) and Royal Bank of Scotland (RBS) vs Bannerman Johnstone MacLay (Bannerman)
(2002).
In the first case Caparo pursued the firm Touche Ross (who later merged to form Deloitte &
Touche) following a series of share purchases of a company called Fidelity plc. Caparo alleges
that the purchase decisions were based upon inaccurate accounts that overvalued the company.
They also claimed that, as auditors of Fidelity, Touche Ross owed potential investors a duty of
care. The claim was unsuccessful; the House of Lords concluded that the accounts were
prepared for the existing shareholders as a class for the purposes of exercising their class
rights and that the auditor had no reasonable knowledge of the purpose that the accounts
would be put to by Caparo.
It was this case that provided the current guidance for when duty of care between an auditor
and a third party exists. Under the ruling this occurs when:
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there is sufficient ‘proximity’ of relationship between the defendant and the pursuer,
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it is 'fair, just and reasonable' to impose a liability on the defendant.
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In the second case RBS alleged to have lost over £13m in unpaid overdraft facilities to
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insolvent client APC Ltd. They claimed that Bannerman had been negligent in failing to detect
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a fraudulent and material misstatement in the accounts of APC. The banking facility was
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provided on the basis of receiving audited financial statements each year.
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In contrast to Touche Ross, who had no knowledge of Caparo’s intention to rely upon the
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audited financial statements, Bannerman, through their audit of the banking facility letter of
APC, would have been aware of RBS’s intention to use the audited accounts as a basis for
lending decisions. For this reason it was upheld that they owed RBS a duty of care. The judge
in the Bannerman case also, and crucially, concluded that the absence of any disclaimer of
liability to third parties was a significant contributing factor to the duty of care owed to them.
Decided legal cases have not been consistent on the issue of auditor's liability. Discussed
below are few, of the decided cases on auditors liability
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AUDITOR'S PROFESSIONAL LIABILITY UNDER ETHICAL STANDARDS
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A member of ICPA K is guilty of professional misconduct if:
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He allows any person to practice in his name as an accountant unless such a person is a
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holder of a practicing certificate and lie is in partnership with him or employed by him.
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partnership with a person who does not hold a practicing certificate or secures any
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Every company shall at each annual general meeting appoint an auditor or auditors to hold
office from the conclusion of that, until the conclusion of the next, annual general meeting.
At any annual general meeting a retiring auditor, however appointed, shall be deemed to be
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reappointed without any resolution being passed unless —
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a) he is not qualified for reappointment; or
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b) a resolution has been passed at that meeting appointing somebody instead of him or
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providing expressly that he shall not be reappointed; or
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c) he has given the company notice in writing of his unwillingness to be reappointed:
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Provided that where notice is given of an intended resolution to appoint some person or
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persons in place of a retiring auditor, and by reason of the death, incapacity or disqualification
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of that person or of all those persons, as the case may be, the resolution cannot be proceeded
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with, the retiring auditor shall not be deemed to be automatically reappointed by virtue of this
subsection.
Where at an annual general meeting no auditors are appointed or are deemed to be
reappointed, the registrar may appoint a person to fill the vacancy.
The company shall, within seven days of the registrar's power becoming exercisable, give him
notice of that fact, and, if a company fails to give notice as required by this subsection, the
company and every officer of the company who is in default shall be liable to a default fine.
Subject as hereinafter provided, the first auditors of a company may be appointed by the
directors at any time before the first annual general meeting, and auditors so appointed shall
hold office until the conclusion of that meeting:
Provided that—
i. the company may at a general meeting remove any such auditors and appoint in their
place any other persons who have been nominated for appointment by any member of
the company and of whose nomination notice has been given to the members of the
company not less than fourteen days before the date of the meeting; and
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TOPIC 4
In the current business environment, it not only makes good business sense to consider client
due diligence, but certain client acceptance and continuance procedures are required by the
auditing and assurance standards.
ISA 210 Agreeing the terms of the audit engagement establishes the preconditions for
accepting an audit, which are:
An acceptable financial reporting framework has been used in the preparation of the
financial statements
Those charged with governance agree that they acknowledge and understand their
responsibilities.
If the preconditions for an audit are not present, the auditor must discuss the matter with those
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charged with governance. Unless required by law or regulation to do so, the auditor must not
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accept the engagement.
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ISA 220 Quality control for an audit of financial statements deals with those aspects of
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engagement acceptance that are within the control of the auditor. The engagement partner
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must be satisfied that appropriate procedures regarding the acceptance and continuance of
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client relationships and audit engagements have been followed, and must determine that
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conclusions reached in this regard are appropriate. ea
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Information such as the following assists the engagement partner in determining whether the
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appropriate:
the integrity of the principal owners, key management and those charged with
governance of the entity
whether the engagement team is competent to perform the audit engagement and has
the necessary capabilities, including time and resources
whether the firm and the engagement team can comply with relevant ethical
requirements
Significant matters that have arisen during the current or previous audit engagement
and their implications for continuing the relationship.
Ethical requirements
Audit firms should expect the same commitment to quality and integrity on the part of their
clients as they do of themselves. As a result, many have developed and implemented improved
processes for approving new clients as well as reviewing relationships with existing clients.
An important part of the client acceptance process is for the prospective auditor to
communicate with the existing auditor in writing. A professional clearance letter enquires
whether there are any professional or other reasons why the engagement should not be
accepted. For example, one such reason may be a disagreement with some particular
accounting treatment the client wishes to adopt. However, before the existing auditor can pass
on any information to the prospective auditor, they must have the client’s authority to discuss
its affairs. If the client refuses permission then all the existing auditor can do is advise the
prospective auditor that there are matters they would like to discuss but the client has refused
permission for this, and this should speak volumes.
Adequate resources
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such as time and access to experts. The increasing complexity and regulation of audit requires
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a significant investment of practice resources to maintain audit competence. Internal and
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external reviews are an important mechanism to help practitioners decide whether they are
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competent and adequately equipped to perform audits.
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Key message
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Typically the process of handling audit client acceptance and continuance varies with the size
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of the firm, and such directives should be included in a firm's quality control manual. The
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process should provide the audit firm with information to judge whether the entity meets or
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exceeds the necessary standards of integrity and whether the firm has the capacity to perform a
quality audit. if these standards are not clearly met, the engagement should not be accepted. If
a client no longer meets the firm's standards, or when the firm cannot commit sufficient
resources to deliver a quality audit to the client, the auditor should not accept the engagement.
As with any auditing procedure, the process should be documented and all correspondence
retained as audit evidence.
The cost of client due diligence is a small fraction of the value of the engagement, and if the
outcome is acceptance this cost should be passed onto the client as part of the audit fee. If the
prospective client is not accepted, then clearly this is time and money well spent. The key
message is that audit firms can turn work down, a firm does not have to accept an audit
engagement, it can say “no” to clients that do not fit the risk profile of the firm and capital will
go where it is deserved. This will contribute towards developing a healthy and profitable
business.
Engagement letters
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The engagement letter will be sent before the audit. It specifies the nature of the contract
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between the audit firm and the client and minimises the risk of any misunderstanding of the
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auditor's role.
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It should be reviewed every year to ensure that it is up to date but does not need to be reissued
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every year unless there are changes to the terms of the engagement. The auditor must issue a
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new engagement letter if the scope or context of the assignment changes after initial
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ISA 210 requires the auditor to consider whether there is a need to remind the entity of the
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existing terms of the audit engagement for recurring audits and many firms choose to send a
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In addition to the above the engagement letter may also make reference to:
The unavoidable risk that some material misstatements may go undetected due to the
inherent limitations in an audit;
Arrangements regarding the planning and performance of the audit;
Recurring Audits
On recurring audits, the auditor should consider whether circumstances require the terms of
the engagement to be revised and whether there is a need to remind the client of the existing
terms of the engagement.
The auditor may decide not to send a new engagement letter each period. However, the
following factors may make it appropriate to send a new letter:
Any indication that the client misunderstands the objective and scope of the audit. Any
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revised or special terms of the engagement.
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A recent change of senior management or those charged with governance.
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A significant change in ownership.
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A significant change in nature or size of the client's business.
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Legal or regulatory requirements.
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Acceptance of a Change in Engagement
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An auditor who, before the completion of the engagement, is requested to change the
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engagement to one which provides a lower level of assurance, should consider the
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A request from the client for the auditor to change the engagement may result from a change
in circumstances affecting the need for the service, a misunderstanding as to the nature of an
audit or related service originally requested or a restriction on the scope of the engagement,
whether imposed by management or caused by circumstances. The auditor would consider
carefully the reason given for the request, particularly the implications of a restriction on the
scope of the engagement.
A change in circumstances that affects the entity's requirements or a misunderstanding
concerning the nature of service originally requested would ordinarily be considered a
reasonable basis for requesting a change in the engagement. In contrast a change would not be
considered reasonable .if it appeared that the change relates to information that is incorrect,
incomplete or otherwise unsatisfactory.
Before agreeing to change an audit engagement to a related service, an auditor. who was
engaged to perform an audit in accordance with ISAs would consider, in addition to the above
matters, any legal or contractual implications of the change.
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TOPIC 5
Definition
Forensic accounting is the use of accounting skills to investigate fraud or embezzlement and to
analyze financial information for use in legal proceedings
Forensic accounting in its present state can be broadly classified into two categories
encompassing litigation support and investigative accounting.
1. Litigation support - is the provision of assistance of an accounting nature in a matter
involving existing or pending litigation. It is primarily focused on issues relating to the
quantification of economic damages, which means a typical litigation support
assignment would involve calculating the economic loss or damage resulting from a
breach of contract. However, it also extends to other areas involving valuations, tracing
assets, revenue recovery, accounting reconstruction and financial analysis. Litigation
support also works closely with lawyers in matters involving, but not limited to,
contract disputes, insolvency litigation, insurance claims, royalty audits, shareholders
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disputes and intellectual property claims
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2. Investigative accounting - in contrast, investigative accounting is concerned with
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investigations of a criminal nature. A typical investigative accounting assignment could
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be one involving employee fraud, securities fraud, insurance fraud, kickbacks and
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advance fee frauds. No doubt in many assignments, both litigation support and
investigative accounting services are required. ea
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Forensic accounting is the specialty area of the accountancy profession which describes
engagements that result from actual or anticipated disputes or litigation. „Forensic" means
suitable for use in a court of law" and it is to that standard and potential outcome that forensic
accountants generally have to work. It is often said „Accountants look at the numbers but
Forensic accountants look behind the numbers. Forensic accountants are trained to look
beyond the numbers and deal with the business realities of the situation. Analysis,
interpretation, summarization and presentation of complex financial and business related
issues are prominent features of the profession Bhasin 2007.
6. Arbitration
7. Partnership and corporation disputes
8. Shareholder disputes (minority shareholders claiming
9. Civil and criminal actions concerning fraud and financial irregularities - cross
examination, formulate questions
10. Fraud and white-collar crime investigations
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3. Communication of findings in the form of reports, exhibits and collections of
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documents;
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4. Assistance in legal proceedings, including testifying in court as expert witness and
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preparing visual aids to support trial evidence.
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To properly carry out these functions, the forensic accountant must also be familiar with legal
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concepts and procedures, including the ability to differentiate between substance and form
when struggling with any issue. ea
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The forensic accountant can provide more specific assistance in the following ways.
Investigative accounting
1. Reviewing the factual situation and providing suggestions on alternative course of
action.
2. Assisting in the preservation, protection and recovery of assets.
3. Co-ordinating with other experts, including private investigators, expert document
examiners, consulting engineers and other industry specialists;
4. Assisting in the tracing and recovery of assets through civil, criminal and other
administrative or statutory proceedings.
Litigation support
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Key Benefits of Using Forensic Accountants
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1. Objectivity and credibility - there is little doubt that an external party would be far more
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independent and objective than an internal auditor or company accountant who
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ultimately reports to management on his findings. An established firm of forensic
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accountants and its team would also have credibility stemming from the firm's
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reputation, network and track record.
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2. Accounting expertise and industry knowledge - an external forensic accountant would
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add to the organisation's investigation team with breadth and depth of experience and
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organisation.
3. Provision of valuable manpower resources - an organisation in the midst of
reorganisation and restructuring following a major fraud would hardly have the full-
time resources to handle a broad-based exhaustive investigation. The forensic
accountant and his team of assistants would provide the much needed experienced
resources, thereby freeing the organisation's staff for other more immediate
management demands. This is all the more critical when the nature of the fraud calls for
management to move quickly to contain the problem and when resources cannot be
mobilised in time.
4. Enhanced effectiveness and efficiency - this arises from the additional dimension and
depth which experienced individuals in fraud investigation bring with them to focus on
the issues at hand. Such individuals are specialists in rooting out fraud and would
recognise transactions normally passed over by the organisation's accountants or
auditors.
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who have committed the crime. The forensic expert undertakes a detailed review of
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the available documentary evidence and forms his/her opinion based on the
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information gleaned during the course of that review.
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(iv) Professional Negligence
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The forensic accountant might be approached in a professional negligence matter to
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investigate whether professional negligence has taken place and to quantify the loss
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which has resulted from the negligence. A matter such as this could arise between
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any professional and their client. The professional might be an accountant, a lawyer,
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an engineer etc. The forensic expert uses his/her investigative skills to provide the
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TOPIC 6
Introduction
When carrying out the audit, the auditor first needs to carry out an evaluation of the internal
control systems and evaluate its operating effectiveness and its efficiency. This will help the
auditor to ascertain the degree of reliance he or she is going to place on the controls and hence
the level of the level of tests the needs to be carried on the final balances. To ascertain the
effectiveness of these controls, the auditor carries out tests of control. The tests of control will
also help the auditor have a better understanding of the entity. Internal control is covered by
the International Standard on Auditing (ISA) 315 on Understanding the entity and its
environment and assessing the risk of material misstatement.
Internal audit is normally set up by the management to help in the risk assessment process and
to ensure the company adheres to good corporate governance. This function can either be
carried out in-house whereby the employees of the company employed as the internal auditors
or it can be outsourced. Internal auditing is covered by the International Standard of Auditing
(ISA) 610 on considering the work of internal auditing.
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ISA 400 defines an accounting system as the series of tasks and procedures by which
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transaction are procedures as a means of maintaining proper financial records. The accounting
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system identifies, assembles, analyses, defines, records and summarizes transactions of an
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entity the mgt requires complete and accurate accounting and other records to assist in
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executing their responsibilities which are:
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Safeguarding the company assets and preventing fraud and error
Selecting suitable accounting policies and applying them consistently ea
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Ensuring that the company keeps proper accounting records as per the Companies Act.
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Delivering to the government agency, court or stock exchange a copy of the company’s
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ISA 400 defines internal control system as all the policies and procedures adopted by
management to in achieving objectives as far as practicable. The objectives of an internal
control system are: -
Orderly and efficient conduct of business.
Adherence to management policies.
Safeguarding of company assets
1. Risk assessment
Audit risk means the risk that the auditor may give an inappropriate audit opinion i.e. the
auditor may report that the financial statements show a true and fair view while in reality they
are materially misstated.
Audit risk is composed of:
a) Inherent risk
b) Control risk
c) Detection risk
d) Inherent risk
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a) Inherent risk
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This is the risk that the account balances are transactions could be materially misstated
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assuming that there were no internal control system. Inherent risk could increase a result of an
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adverse attitude of managers on the internal control system i.e. if they view internal control
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system as unimportant.
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b) Control risk
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This is the risk that a material misstatement could occur in an account balance or clan of
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transactions which will not be prevented or detected in a timely manner by the entity‟s
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For the audit model, audit risk equals inherent risk multiplied by the control risk and detection
risk.
Disadvantages
The model gives an impression of accuracy which is unrealistic as in practice its
difficult to put a quantitative value on inherent risk.
For the model to be useful, the number of items being tested need to be sufficiently
large to allow for valid statistical conclusions to be made. This rule out the use of the
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model in many small audits.
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The model has a danger of adapting an overly mechanistic approach and that the
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auditor may lose his „feel‟ for the audit assignment.
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It requires proper knowledge of the burden to be able to assess the audit risk.
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A wrong assessment of inherent and control risk will lead to over or under auditing.
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2. Control Environment
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ISA 400 refers control environment as being the overall attitude, awareness and actions of
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directors and management regarding the internal control system and its importance to the
entity.
The control environment has an effect on the effectiveness of the specific control procedures.
A strong control environment i.e. one with tight budgetary control and an effective internal
audit function can significantly complement specific control procedures. Thus the control
environment sets the tone of the entity by influencing the control consciousness of people. It
may be viewed as the foundation of other components of internal control.
The function of the board of directors or the audit committee. The control environment
is significantly influenced by the effectiveness of the board of directors or the audit
committee. This effectiveness is determined by the extent of its independence from
management, experience and status of members and the extent to which it raises and
pursues difficult matters with management and also its relationship with internal and
external auditors.
Management philosophy, style and ease with which managers could override controls.
Management philosophy refers to whether the management likes taking risk in business
or has a conservative approach. This has an impact on the overall reliability of financial
statements. If they are risk takers, losses are likely and may want to hide them. If they
are conservative to risk, there may be no business hence low profits and this may lead
to falsification of financial statements.
The implementation of organizational structure and methods of assigning authority and
responsibility. This determines how well employees understand the limits placed upon
their powers and responsibilities. The objective is to separate responsibility for
authorizing a transaction, keeping records for the transaction and custody of assets
acquired from the transaction.
Personnel policies and procedures. Employees should be recruited on basis of skills and
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knowledge essential for the performance of their jobs and if necessary, be trained
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3. Control procedures
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These are the policies and procedures in addition to the control environment, which the
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management has established to achieve the entity‟s specific objectives. The mix of types of
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controls implemented by mgt will depend on the control objectives and the size of the entity.
a) Organizational plan chart ea
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Companies should have proper organization plans. An organized plan shows clearly the
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various departments within the company, their functions and persons charged with ensuring
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that such functions are fulfilled. They seek to ensure that the entity is properly
departmentalized preventing duplication of duties across departments and boosting
accountability within the entity. Delegation and limits of authority should be well and clearly
defined.
b) Segregation of duties.
This refers to separation of various duties and responsibilities such that one person cannot
process and record a complete transaction from beginning to the end without being checked by
another person. E.g. in purchase of fixed assets, an individual should not authorize the
purchase, place the order, receive the assets, record the transaction and keep custody of the
assets. To minimize risk of error and or intention the following should be performed by
different individuals and departments as much as practicable.
Initiation of transaction. This is where if an item is found to be out of stock and a
requisition is made.
Authorization Different levels of management should be given limits as to what they
can authorize or to what extent they can commit company resources.
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TOPIC 7
AUDIT EVIDENCE
FINANCIAL STATEMENT ASSERTIONS AND AUDIT EVIDENCE
Financial Statement Assertions are the implicit or explicit claims and representations made
by the management responsible for the preparation of financial statements regarding the
appropriateness of the various elements of financial statements and disclosures.
Financial Statement Assertions are also known as Management Assertions and Audit
Assertions.
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The entity owns or controls those buildings;
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The buildings are valued accurately in accordance with the measurement basis;
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All buildings owned and controlled by the entity are included within the carrying
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amount of sh.10 million.
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Types & Examples
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Assertions may be classified into the following types:
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Assertions relating to assets, liabilities and equity balances at the period end
Assertions Explanation Examples: Inventory balance
Assets, liabilities and equity Inventory recognized in the balance sheet exists at the
Existence
balances exist at the period end. period end.
All assets, liabilities and equity
All inventory units that should have been recorded
balances that were supposed to
have been recognized in the financial statements. Any
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Completeness be recorded have been
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inventory held by a third party on behalf of the audit
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recognized in the financial
entity has been included in the inventory balance.
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statements.
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Entity has the right to
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Audit entity owns or controls the inventory
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ownership or use of the
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recognized in the financial statements. Any inventory
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Rights & recognized assets, and the
held by the audit entity on account of another entity
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Obligations liabilities recognized in the
financial statements represent ea
has not been recognized as part of inventory of the
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audit entity.
the obligations of the entity.
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captions affected by the related party
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contained in the financial
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transactions and balances and can
statements.
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easily ascertain their financial effect.
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Transactions, events, balances and Related party transactions, balances
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Accuracy & other financial matters have been and events have been disclosed
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Valuation disclosed accurately at their accurately at their appropriate
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appropriate amounts. amounts. ea
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AUDIT EVIDENCE
Audit evidence refers to the information obtained by the auditor in arriving at the conclusions
on which audit opinion on the financial statements is based. Audit evidence comprises of
source documents and accounting records underlying the financial statements. The accounting
records generally include:
The sources and amount of evidence needed to achieve the required level of assurance is
determined by the auditor’s judgment. The auditor’s judgment will be influenced by the
materiality of item being examined, the relevance and reliability of evidence available from
each source and cost involved in obtaining it. Audit evidence is obtained through an
appropriate mix of tests of controls and substantive procedures where internal control system
is considered weak; evidence may be obtained entirely from substantive procedures.
Substantive tests are procedures carried out to test the accuracy and validity of accounting
records. They are of two types i.e. analytical review procedure and test of detail.
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ISA 500 requires that „the auditor should obtain sufficient audit evidence to be able to draw
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reasonable conclusions on which to base the audit opinion.‟
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What do we mean by:
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a) Sufficiency
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b) Appropriate ea
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Sufficient means that there needs to be enough evidence. What is enough is a matter of
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professional judgment.
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a) Relevance.
Relevance of audit evidence should be considered in relation to the overall audit objective of
forming an opinion and reporting on financial statements. It therefore refers to the ability of
the evidence to assist the auditor in testing management assertions.
b) Reliability
Reliability of audit evidence refers to the credibility of that evidence the credibility is
influenced by its source and its nature
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TOPIC 8
Subsequent events are transactions occurring after the balance sheet date, but before the
financial statements are either issued or available to be issued.
Auditors must take steps to ensure that any such events are properly reflected in the financial
statements.
To identify any such events, a subsequent events review is carried out.
There are two types of subsequent events:
1. Adjusting event
Event after the reporting period that provides further evidence of conditions that existed
at the end of the reporting period, including events that indicates that the going concern
assumption in relation to the whole or part of the enterprise is not
2. Non-adjusting event
Events after the reporting period that are indicative of a condition that arose after the
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end of the reporting period.
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Example 1
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You are the trainee accountant of Gabriella Enterprises Co and are preparing the financial
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statements for the year-ended 30 September 2012. The financial statements are expected to be
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approved in the Annual General Meeting, which is to be held on Monday 29 November 2010.
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Today’s date is 22 November 2010. You have been made aware of the following matters:
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1. On 14 October 2010, a material fraud was discovered by the bookkeeper. The payables
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ledger assistant had been diverting funds into a fictitious supplier bank account, set up
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by the employee, which had been occurring for the past six months. The employee was
immediately dismissed, legal proceedings against the employee have been initiated and
the employee’s final wages have been withheld as part-reimbursement back to the
company.
2. On 20 September 2010, a customer initiated legal proceedings against the company in
relation to a breach of contract. On 29 September 2010, the company’s legal advisers
informed the directors that it was unlikely the company would be found liable;
therefore no provision has been made in the financial statements, but disclosure as a
contingent liability has been made. On 29 October 2010, the court found the company
liable on a technicality and is now required to pay damages amounting to a material
sum.
3. On 19 November 2010, a customer ceased trading due to financial difficulties owing
$2,500. As the financial statements are needed for the board meeting on 22 November
2010, you have decided that because the amount is immaterial, no adjustment is
required. The auditors have also confirmed that this amount is immaterial to the draft
financial statements.
Required:
(a) For each of the three events above, you are required to discuss whether the financial
statements require amendment.
Answer:
When presented with such scenarios, it is important to be alert to the timing of the events in
relation to the reporting date and to consider whether the events existed at the year-end, or not.
If the conditions did exist at the year-end, the event will become an adjusting event. If the
event occurred after the year-end, it will become a non-adjusting event and may simply
require disclosure within the financial statements.
1. Fraud
Clearly the fraud committed by the payables ledger clerk has been ongoing during, and
beyond the financial year. Fraud, error and other irregularities that occur prior to the year-end
date – but which are only discovered after the year-end – are adjusting items, and therefore the
financial statements would require amendment to take account of the fraudulent activity up to
the year-end.
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2. Legal proceedings
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At the year-end, the company had made disclosure of a contingent liability. However,
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subsequent to the year-end (29 October 2010), the court found the company liable for breach
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of contract. The legal proceedings were issued on 20 September 2010 (some 10 days before
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the year-end). This is, therefore, evidence of conditions that existed at the year-end. IAS 10
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requires the result of a court case after the reporting date to be taken into consideration to
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determine whether a provision should be recognised in accordance with IAS 37, Provisions,
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Contingent Liabilities and Contingent Assets at the year-end. In this case, the financial
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3. Loss of customer
A customer ceasing to trade so soon after the reporting period indicates non-recoverability of a
receivable at the reporting date and therefore represents an adjusting event under IAS 10,
Events After the Reporting Period. Assets should not be carried in the statement of financial
position at any more than their recoverable amount and, therefore, an allowance for
receivables should be made.
The auditor should obtain sufficient appropriate audit evidence about whether events occurring
between the date of the financial statements and the date of the auditor's report that require
adjustment of, or disclosure in, the financial statements are appropriately reflected in those
financial statements in accordance with the applicable financial reporting framework;
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to eventual selling prices.
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• Obtaining, from management, a letter of representation.
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Subsequent events review — changes triggered by the signing of the audit report
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The stage of completion of the annual financial statements determines the procedures the
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auditor must undertake in performing subsequent event reviews.
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Auditors have an active duty to search for all material events between the balance sheet date
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TOPIC 9
AUDIT REPORT
Companies Act stipulates the statements that should be expressly stated in the auditor’s
report. These are;
1. Whether they have obtained all the information and explanations which to the best of
their knowledge and belief were necessary for the purposes of their audit.
2. Whether in their opinion, proper books of account have been kept by the company, so
far as appears from their examination of those books, and proper returns adequate for
the purposes of their audit have been received from branches not visited by them.
3.
- Whether the company's balance sheet and (unless it is framed as a consolidated profit
and loss account) profit and loss account dealt with by the report are in agreement
with the books of account and returns.
- Whether, in their opinion and to the best of their information and according to the
explanations given to them, the said accounts give the information required by this
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Act in the manner so required and give a true and fair view—
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(a) in the case of the balance sheet, of the state of the company's affairs as at the
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end of its financial year; and
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(b) in the case of the profit and loss account, of the profit or loss for its financial
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year; or, as the case may be, give a true and fair view thereof subject to the
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non-disclosure of any matters (to be indicated in the report) which by virtue of
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Part III of the Sixth Schedule are not required to be disclosed.
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4. In the case of a company which is a holding company and which submits group
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accounts whether, in their opinion, the group accounts have been properly prepared in
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accordance with the provisions of this Act so as to give a true and fair view of the state
of affairs and profit or loss of the company and its subsidiaries dealt with thereby, so far
as concerns members of the company, or, as the case may be, so as to give a true and
fair view thereof subject to the non-disclosure of any matters (to be indicated in the
report) which by virtue of Part III of the Sixth Schedule are not required to be
disclosed.
When financial statements are finalised, they usually must contain an evaluation – an auditor's
report - from a licensed accountant or auditor. This report provides an overview of the
evaluation of the validity and reliability of a company or organization’s financial statements.
The goal of an auditor's report is to document reasonable assurance that a company’s financial
statements are free from error.
An audit of a company’s financial statements should result in a report wherein the accountant
or auditor is free to share their opinion about the validity and reliability of a company’s
financial statements.
In this report, the auditor should provide an accurate picture of the company and their financial
statements. The auditor should also state whether they are externally or internally connected to
the company.
Within the report, the auditor can share any reservations about the condition of the company’s
finances or relevant additional information. Reservations could arise if the auditor disagrees
with something found in the financial statements, e.g. if the auditor disagrees with
management about the valuation of an asset because they believe that this has a more
significant impact on the financial statements.
In the report there are rules concerning what an auditor's report should include and the order in
which various items should be reported.
Auditor's reports must adhere to accepted standards established by governing bodies. The
governing bodies help to assure external users that the auditor's opinion on the fairness of
financial statements is based on a commonly accepted framework.
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BASIC ELEMENTS
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The Companies Act does not stipulate the form the auditor’s report should take. The auditing
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standards seek to ensure that the auditor’s report is clear and unambiguous. To this end, it
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seeks to standardize the form of the auditor’s report. It does this by giving the basic elements
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of the auditor’s report.
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Auditing standards require that the report be titled and that the title includes the word
“independent‟ e.g. independent auditors report‟. The requirement that the title includes the
word independent is intended to convey to users that the audit was unbiased in all aspects.
ii. Address
The report is usually addressed to the company, its stockholders or the board of directors. For
practical reasons, it limits the users of auditor’s report.
The first paragraph has three purposes, fist, it makes a statement that the practice did an audit.
Secondly, it lists all the financial statements that were audited including the balance sheet
dates and accounting periods for the income statement and cash flow statement. The wording
of the financial statements in the report should be identical to those used by management on
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AUDITING AND ASSURANCE
the financial statements. Thirdly, the introductory paragraph states that the statements are the
responsibility of management and that the auditor’s responsibility is to express an opinion on
the statements based on the audit.
This paragraph is a factual statement about what the auditor did in the audit. This paragraph
states how the audit was planned and performed in accordance with ISAs and states that the
audit is designed to obtain reasonable assurance whether the financial statements are free of
material misstatements.
v. Opinion paragraph
This final paragraph states the auditors conclusions based on the results of the audit. This part
of the report is so important that often the audit report is simply called the auditor’s opinion.
The opinion paragraph is stated as an opinion rather than a statement of absolute fact or a
guarantee.
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The appropriate date for the report is the one on which the auditor has completed the most
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important audit procedures in the field. This date is important to users of financial statements
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as it indicates the last day of auditor’s responsibility for review of significant events that have
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occurred after date of financial statements.
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vii. Name of audit firm
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The firm’s name is used because the entire firm has the legal responsibility to ensure that the
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TYPES OF OPINIONS
a) Unqualified opinion.
b) Disclaimer opinion
c) Qualified opinion
d) Adverse opinion
Unqualified opinion
This is issued when the auditor is satisfied in all material aspects that enable him express the
required opinion on financial statements without any reservation. This is sometimes called a
clean opinion. It is expressed when the auditor concludes that the financial statements give a
true and fair view in accordance with the relevant financial reporting standards.
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TOPIC 10
1. The public-sector audit environment is that in which governments and other public-
sector entities exercise responsibility for the use of resources derived from taxation and
other sources in the delivery of services to citizens and other recipients. These entities
are accountable for their management and performance, and for the use of resources,
both to those that provide the resources and to those, who depend on the services
delivered using those resources, for example citizens, Public-sector auditing helps to
create suitable conditions and reinforce the expectation that public-sector entities and
public servants will perform their functions effectively, efficiently, ethically and in
accordance with the applicable laws and regulations.
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2. In general public-sector auditing can be described as a systematic process of objectively
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obtaining and evaluating evidence to determine whether information or actual
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conditions conform to established criteria. Public-sector auditing is essential in that it
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provides legislative and oversight bodies, those charged with governance and the
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general public with information and. independent and objective assessments concerning
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the stewardship and performance of government policies, programs or operations.
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3. Supreme Audit Institutions serve this aim as important pillars of their national
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democratic systems and governance mechanisms and play an important role in
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1. Providing the intended users with independent, objective and reliable information,
conclusions or opinions based on sufficient and appropriate evidence relating to public
entities;
3. Reinforcing the effectiveness of those bodies within the constitutional arrangement that
exercise general monitoring and corrective functions over government, and those
responsible for the management of publicly-funded activities;
In general, public-sector audits can be categorized into three main types: audits of financial
statements, performance audits and audits of compliance with authorities.
1. Financial audit focuses on determining whether an entity's financial information is
presented in accordance with the applicable financial reporting and regulatory
framework. This is accomplished by obtaining sufficient and appropriate audit evidence
to enable the auditor to express an opinion as to whether the financial information is
free from material misstatement ^ due to fraud or error.
2. Performance audit focuses on whether interventions, programmes and institutions are
performing in accordance with the principles of economy, efficiency and effectiveness
and whether there is room for improvement. Performance is examined against suitable
criteria, and the causes of deviations from those criteria or other problems are analyzed.
The aim is to answer key audit questions and to provide recommendations for
improvement.
3. Compliance audit focuses on whether a particular subject matter is in compliance with
authorities identified as criteria. Compliance auditing is performed by assessing
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whether activities, financial transactions and information are, in ail material respects, in
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compliance with the authorities which govern the audited entity. These authorities may
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include rules, laws and regulations, policies, established codes, agreed terms or the
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general principles governing sound public-sector financial management and the conduct
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of public officials.
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All public-sector audits have the same basic elements: the auditor, the responsible party,
intended users (the three parties to the audit), the subject matter and the criteria for assessing
the subject matter.
1. The auditor: In public-sector auditing the role of auditor is fulfilled by the Head of the
SA1 and by persons to whom the task of conducting the audits is delegated. The overall
responsibility for public-sector auditing remains as defined by the SAI's mandate.
2. The responsible party: In public-sector auditing the relevant responsibilities are
determined by constitutional or legislative arrangement. The responsible parties may be
responsible for managing the subject matter or for addressing recommendations, and
may be individuals or organizations.
3. Intended users: The individuals, organizations or classes thereof for whom the auditor
prepares the audit report. The intended users may be legislative or oversight bodies,
those charged with governance or the general public.
4. Subject matter refers to the information, condition or activity that is measured or
evaluated against certain criteria. It can take many forms and have different
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