NATURE OF AUDIT TEST
Decision about the nature of audit test are related to the
auditors choices about the type of evidence that they collect to support an
opinion. There are three common type of audit procedures :
- Risks assesment procedures that are designed to help the
auditor assess the risk of material maisstatement in an assertion, wether
performed early in the audit engagement or in the response to new information.
Recall that the auditor uses risk assessment procedures to obtain evidence
about inherent risks and the risk of fraud.
- Test of Control that are designed to provide evidence
about the operating effectiveness of various aspect of internal control. Tests
of control provide evidence to support control risk assessment below the
maximum.
- Substantive test that are designed to provide evidence
about to fair presentation of management's assertions in the financial
statements. Substantive test include :
1. Initial procedures that involve understanding the
economic substance of the account balance or transaction being audited and
agreeing on detailed information about an account to general ledger (such as
comparing an accounts receivable subsdiary ledger to the general ledger)
2. Substantive analytic procedures that involve the use of
comparisons to assess the fairness of an assertion. For example, the auditor
might evaluate sales per square foot or retail space in testing the
reasonableness of revenues.
3. Test of detail transactions that involve examining
documentary support for transactions. For example, an auditor might inspect
sales orders and a bill of landing behind a recorded sales invoice.
5. Test of detail
accounting estimates that involve obtaining evidence in support of the client's
estimations process and ensuring that the estimation process is applied
consistently from period to period.
6. Test of details of disclosures that involve examining
support for financial statement disclosures. For example, the auditor might
read a loan contract to ascertain the maturity schedule and debt covenants for
the loan
Substantive test provide the evidence that allows the
auditor to achieve the desired detection risk and ensure that overall audit
risk and ensure that overall audit risk is reduced to an appropriately low
level.
Recall the risk assessment, for example. For assertion 1,
the existence of inventory, the nature of auditor's evidence would include
significant test of controls (testing of effectiveness of the client's
perpetual inventory system) as well as some limited substantive test (direct
observation of inventory). For assertion 2, the valuation of inventory, auditor
would perform few test of controls because controls are not expected to be
effective. However, the auditor would plan to obtain significant evidence by
testing the pricing of inventory to underlying vendor's invoices (substantive
test of balances). In addition, the auditor would obtain evidence about sales
price after years-end to support a conclusion about the lower of cost of market
objective (substantive test of an accounting estimate).
OVERVIEW OF THE AUDIT PROCESS
The overall objective of a financial statement audit is the
expressions of an opinion on whether the client’s financial statement are
presented fairly, in all material respect, in conformity with GAAP. The
diagnostic process of making judgments about the accounts likely to contain
material misstatement and obtaining reasonable assurance about fair
presentation in the financial statements involves six distinct phrases.
1. Perform risk assessment procedures.
2. Assess the risk of material misstatement.
3. Respond to assessed risks.
4. Perform further audit procedures.
5. Evaluate audit evidence.
6. Communicate audit findings.
6. Communicate audit findings.
TYPES OF AUDIT
Financial Statement Audit
A financial statement audit involves obtaining and
evaluating evidence about an entity’s presentation of its financial position,
result of operation, and cash flows for the purpose of expressing an opinion on
whether they are presented fairly in conformity with established
criteria-usually generally accepted accounting principles (GAAP).
Compliance Audit
A compliance audit involves obtaining and evaluating evidence to determine whether certain financial or operating activities of an entity conform to specified conditions, rules, or regulations
Operational Audit
An operational audit involves obtaining and evaluating evidence about the efficiency and effectiveness of an entity’s operating activities in relation to specified objectives.
TYPES OF AUDITORS
1. Independent Auditors
Independent auditors are usually CPA’s who are either
individual practitioners or members of public accounting firms who render
professional auditing services to clients. In general, licensing involves
passing the uniform CPA examination and obtaining practical experience in
auditing.
2. Internal Auditors
Internal auditors are employees of the organization they
audit. This type of auditors is involved in an independent evaluation of
evidence, called internal auditing, within an organization as a service to the
organization. The objectives of internal auditing is to assist the management
of organization in the effective discharge of its responsibilities.
3. Government Auditors
Government auditors are employed by various local local,
state, and federal governmental agencies. At the federal level, the three
primary agencies are are the General Accounting Offices (GAO), the Internal
Revenue Services (IRS), and the Defense Contract Audit Agency )(DCAA).LIMITATIONS OF AN AUDIT
A financial statement audit is subject to a number of
inherent limitations. One constraint is that the auditor works within fairly
restrictive economic limits. Following are two important economic limitations.
Reasonable cost. A limitations on the cost of an audit
results in selective testing or sampling, of the accounting records and supporting
data. In addition, the auditor may choose to test internal controls and may
obtain assurance from a well functioning system of internal controls.
Reasonable lenght of time. the auditor's report on many
public companies is usually issued three or five weeks after the balance sheet
date. This time constraint may affect the amount of evidence that can be
obtained concerning events and transactions after the balance sheet date that
may have an effect on the financial statements. Moreover, there is a relatively
short time period available for resolving uncertaintes existing at the
statement date.
Another significant limitations is the established
accounting framework for preparing financial statements. Following are two
important limitations associated with the established accounting framework.
Alternative accounting Principles. Alternative accounting
principles are permitted under GAAP. Financial statement users must be
knowledgeable about a company's accounting choices and their effect on
financial statements.
Accounting Estimates. Estimates are an inherent part of the
accounting process, and no one, including auditors, can foresee the outcome of
uncertainties. Estimate range from the allowance for doubtfull accounts and an
inventory obsolescence reserve to impairment tests of fixed assets and
goodwill. An audit can not add exactness and certainly to financial statements
when these factors do not exist.
AUDIT PROCEDURES
AUDIT PROCEDURES ARE THE METHODS OR TECHNIQUE THE AUDITOR
USES TO GATHER AND EVALUATE AUDIT EVIDENCE. THE AUDITORS PERFORMS AUDIT
PROCEDURES TO ACCOMPLISH THE FOLLOWING OBJECTIVES :
1. To obtain an understanding of the entity and its
environment, including its internal control, to asses the risk of material
misstatement at the financial statement level and at the level (risk assessment
procedures).
2. To test the operating effectiveness of control in
preventing or detecting material misstatement at the assertions level (test of
control). Test of control are required when the auditor plans to assess control
risk below the maximum and below the maximum and develop an audit strategy that
assumes the operating effectiveness of internal control.
3. To support an assertions or detect material misstatement
at the assertions level (substantive test). The auditor plans and performs
substantive test that are responsive to assessed risk.
