Audit theory and Practice

;.

The NATURE, PURPOSE AND SCOPE OF AUDITING

Auditing is a professional to carrying heavy responsibility and more skill with proper judgment.
In olden days the methods of maintenance of account was not properly because size of the
business was very small with amount of capital for that purpose the number of transactions to be
recorded by each individual himself.

Auditing might have been introduced in the period of 18 th century when the practice of large
scale production was developed with the result of industrial revolution after the industrial
revolution the number of business concern like sole trading, partnership and joint stock co
developed in a greater extent.

Meaning of audit

The word audit is derived from the Latin word “AUDIRE” which means to hear. Initially
auditor was a person appointed by the owners to check account whenever there could be
suspected fraud, he was to hear explanation given by the person responsible for financial
transactions. Emergence of joint stock companies changed the approach of auditing as ownership
was pestered from management. The emphasis now is clearly on the verification of accounting
date with a view on the reliability of accounting statement.

Definitions

An examination and verification of a company’s financial and accounting records and supporting
documents by a professional, such as a certified public accountant/chartered accountant to
identify whether the financial statements reflect a true and fair view.

Auditing can be defined as a systematic and independent examination of data, statements,

records, operations and performance (financial or otherwise) of an enterprise for a stated
purpose. The auditor perceives and recognizes the propositions before him for examination,
gathers evidence, evaluates the same and on this basis formulates his opinion which is
communicated through his audit report.

Auditing can also be defined as such an independent examination of books of accounts and
vouchers of business, will enable the auditors to satisfy himself that the balance sheet is properly
drawn up, so as to give true and fair view of the state of affairs of the business and that the profit
and loss account gives true and fair view of the profit/loss for the financial period, according to
the best of the information and explanation given to him and as shown by the books.

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Auditing can again be defined as the independent verification of the books of accounts and
vouchers of the business with the view of forming an opinion as to whether these have been kept
properly according to the company’s Act and whether the financial statements drawn portray a
true and affair view of the company’s state of affairs at a given period of time.

Meaning of true and fair view – the auditor’s opinion in the audit is expressed in terms of true
and fair about the financial statements of the organization.
True means that the information is factual and conforms with the reality of the financial
statements that the required accounting standards are kept and have been correctly extracted
from the books of accounts.
Fair means that the information is free from discrimination, bias and are in compliance with the
expected standards.
Scope of Audit.
The scope of audit is increasing with the increase in the complexities of the business. It is said
that long range objectives of an audit should be to serve as a guide to the management future
decisions.

Today most of the economic activities are largely conducted through public finance. The auditor
has to see whether these larger funds are properly used. The scope of audit encompasses
verification of accounts with a intention of giving opinion on its reliability. Hence it covers cost
audit, management audit, social audit etc. It should be remembered that an auditor just expressed
his opinion on the authenticity of the account. He has no power to take action against anybody,
in this regard it’s said that “an auditor is a watch dog but not a blood hound”.

Features or aspects of auditing

1. Audit is a systematic and scientific examination of the books of accounts of a business

2. Audit is undertaken by an independent person or body of persons who are duly qualified
for the job.

3. Audit is a verification of the result shown by the profit and loss account and the balance
sheet.

4. Audit is a critical review of the system of accounting and internal control

5. Audit is done with the help of vouchers, documents, information and explanations.

6. The auditor has to satisfy himself with the authenticity of the financial statements and
establish whether they exhibit a true and fair view of the state of affairs of the business

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 Audit theory and Practice

7. The auditor has to inspect, compare, check, review, scrutinize the vouchers transactions
and examine correspondence, minute book of share holders, directors, memorandum of
association and AOA, in order to establish the correctness of the books of accounts.

8. Audit is done periodically, at the end of every year as per the Company Act

9. Auditing always provides true and fair report of financial statements

10. The scope of audit is not only limited to the business concern but also extended to other
entities like educational institutions, health department, charitable organizations and
others.

Auditors are basically concerned with verifying whether the accounts exhibit true and fair view
of the business. The objectives of auditing depend upon the purpose of his appointment.

OBJECTIVES OF AUDITING

Primary objective.
The primary objective of an auditor is to report to the owners of the business expressing his
opinion whether account exhibits true and fair view of the state of affairs of the business. It
should be remembered that in case of a company, he reports to the shareholders who are the
owners of the company and not to the director. The auditor is also concerned with verifying how
far the accounting system is successful in correctly recording transactions. He had to see whether
accounts are prepared in accordance with recognized accounting policies and practices and as per
statutory requirements.

Secondary Objective:
The following objectives are incidental to the main objective of auditing.
1. Detection and prevention of errors: errors are mistakes committed unintentionally because
of ignorance, carelessness. Errors are of many types:
a. Errors of Omission: These are the errors which arise on account of transaction into
being recorded in the books of accounts either wholly partially. If a transaction has been
totally omitted it will not affect trial balance and hence it is more difficult to detect. On
the other hand if a transaction is partially recorded, the trial balance will not agree and
hence it can be easily detected.
b. Errors of Commission: When incorrect entries are made in the books of accounts either
wholly, partially such errors are known as errors of commission. E.g. wrong entries,
wrong Calculations, postings, carry forwards etc such errors can be located while
verifying.

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c. Compensating Errors: when two/more mistakes are committed which counter balances
each other. Such an error is known as Compensating Error. E.g. If the amount is wrongly
debited by 3000/= less and Wrongly Credited by 3000/= such a mistake is known as
compensating error.
d. Error of Principle: These are the errors committed by not properly following the
accounting principles. These arise mainly due to the lack of knowledge of accounting.
E.g. Revenue expenditure may be treated as Capital Expenditure.
e. Clerical Errors; A clerical error is one which arises on account of ignorance,
carelessness, negligence etc.

Location of Errors: It is not the duty of the auditor to identify the errors but in the process
of verifying accounts, he may discover the errors in the accounts. The auditor should follow
the following procedure in this regard.
1. Check the trial balance.
2. Compare list of debtors and creditors with the trial balance.
3. Compare the names of account appearing in the ledger with the names of accounting in
the trial balance.
4. Check the totals and balances of all accounts and see that they have been properly shown
in the trial balance.
5. Check the posting of entries from various books into ledger.

2. Detection and Prevention of Fraud: A fraud is an Error committed intentionally to deceive/

to mislead/ to conceal the truth/ the material fact. Frauds may be of 3 types.
a. Misappropriation of Cash: This is one of the majored frauds in any organization it
normally occurs in the cash department. This kind of fraud is either by showing more
payments/ less receipt.
The cashier may show more expenses than what is actually incurred and misuse the extra
cash. E.g. showing wages to dummy workers. Cash can also be misappropriated by
showing less receipt
E.g. not recording cash sales. Not allowing discounts to customers. The cashier may also
misappropriate the cash when it is received. Cash received from 1st customer is misused
when the 2nd customer pays it is transferred to the 1st customer’s account. When the 3rd
customer pays it goes forever. Such a fraud is known as “Teaming and Lading”/lapping.
To prevent such frauds the auditor must check in detail all books and documents,
vouchers, invoices etc.
b. Misappropriation of Goods: here records may be made for the goods not purchased, not
issued to production department; goods may be used for personal purpose. Such a fraud
can be deducted by checking stock records and physical verification of goods.

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c. Manipulation of Accounts: this is finalizing accounts with the intention of misleading

others. This is also known as “WINDOWS DRESSING”. It is very difficult to locate
because it’s usually committed by higher level management such as directors. The
objective of WD may be to evade tax, to borrow money from bank, to increase the share
price etc.
To conclude it can be said that, it is not the main objective of the auditor to discover
frauds and irregularities. He is not an insurance against frauds and errors. But if he finds
anything of a suspicious nature, he should probe it to the full.

ADVANTAGES OF AUDIT:
1. Audited accounts are detected as an authentic record of transaction.
2. Errors and frauds are detected and rectified.
3. It increases the morale of the staff and thus it prevents frauds and errors.
4. Because of his expertise the auditor may advise on various matters to his clients.
5. An auditor acts as a trustee of his shareholders. Hence he safeguards their financial interest.
6. For taxation purpose auditing of account is a must.
7. In case of any claim is to be made from the insurance company only audited account should
be submitted.
8. Even in case of partnership firm auditing of accounts helps in the settlement of claim at the
time of retirement/death of a partner.
9. Auditor account helps in managerial decisions.
10. They are useful to secure loan at the of amalgamation, absorption, reconstruction etc.
11. Auditing safeguards the interest of owners, creditors, investors, and workers.
12. It is useful to take certain financial decisions like issuing of shares, payment of dividend etc

Differences between Accounting and Auditing.

Accounting Auditing
1. It’s a continuous process carried out 1. It’s a onetime activity after the closure of
throughout the year. accounting year.
2. No prescribed qualification is required to 2. He must be the member of ICPAU or ACCA
be an accountant. to become an auditor.
3. An accountant is an employee of the 3. An auditor is an independent professional.
company.
4. An accountant gets regular salary for his 4. He gets remuneration for his professional
work. work. Audit fees.
5. Accounting is concerned with recording of 5. Its concerned with verification of accounts
business transactions systematically. prepared by the accountant.

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6. Accounting proceeds, auditing. 6. Auditing succeeds accounting.

Users of audited information

Audited information is required by many groups of people and these include among other;
Investors, Lenders/bank, Customers, Government, Public, Suppliers and other creditors,
Employees, Shareholders. These groups of people are interested in audited information for many
reasons.

Types /Classification of Audits

Audits are classified into two ways

i. According to the nature of work done

ii. According to the method of approach to the work done

According to the nature of work done

1. Statutory audit; these are audits which are performed according to the provision of the
law of the country and they are compulsory.

These audits are governed by the following;

The company Act for companies

The cooperative act for cooperative audit or societies

Other established act such as bank of Uganda Act, Financial institutions Act and many others

The company Act requires that all limited companies must have all their accounts audited
annually and published of their financial statement before the any annual general meeting. The
scope and extend of audit depends on the provision of the Act of the concerned organization.

2. Private / Non Statutory Audit

Private or voluntary audit is that which is not legally required for publication in the press. The
purpose of the audit may vary from one business to another as it can be for assessing the tax
liability, to get a loan, or any other objective.

Similarities between statutory and private audit

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 Both are conducted by qualified auditors who must be qualified as per the company Act
provisions

 In both audits, the auditor is supposed to give advice to the clients as regards to the
running of their business in particular to the internal control system.

 Both auditors are guided by the international standards on auditing

 Both audits are used as a basis for decision making

Differences between Statutory and Private Audit.

Statutory Private

It’s a legal requirement i.e. company Act Not legal requirement

Scope is defined by the company Act and open Scope is determined by the agreement between
the auditor and the client, and may be restricted
by the client.

Appointment is done according to the company Appointment is done by the client business.
Act

Its mandatory at the end of each financial year Not mandatory, at can be at any time even at
the end of their third year.

Report is addressed to the shareholders Report is addressed to the owner

3. Internal audit –this is an independent appraisal of activities established within an

organization aimed at ensuring that management operates effectively so as to manage the
business better. This audit is conducted by the internal auditor who is an employee of the
organization. The main purpose is to perform the function of examining and evaluating
the adequacy and effectiveness of the internal control system in the organization.

4. External audits, this is an audit which is concerned by independent audit who is not an
employee of the organization called the external auditor. The external is an independent
person appointed by the owners/shareholders of the business from outside their
organization.

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According to the method of Approach in audit.

In this classification, the method of audit refers to the extent of work to be performed and the
manner in which it is executed.

1. Continuous audit: a continuous audit is one in which the auditor visits his client’s office at
regular intervals throughout the year to verify the account. The objective of CA may be-
a. To get final account audited immediately after the closure of accounting year.
b. When the business is very large.
c. When interval control system is into effective.
d. When regular final accounts are required.

ADVANTAGES:
a) Errors and frauds are discovered and rectified quickly.
b) The chances of fraud are reduced.
c) The workers will be careful in their work.
d) Continuous audit acts as a valuable morale check on the staff.
e) Final audit becomes easier and faster.
f) If the company wants to declare interim dividend it’s easier to prepare interim account.
g) It increases the efficiency and accuracy in the accounts.
DISADVANTAGES:
i. After the auditor’s visit is over, alternative may be made.
ii. It affects the regular work.
iii. It’s not suitable for small organizations.
iv. The auditor may lose the line of work if he does not complete his work in a visit.

Precautions to be taken for continuous audit:

 He should record important balances; totals etc and verify the same in his next visit.
 Strict instructions should be given prohibiting the alteration of figures after checked by
the auditor.
 For each visit special ticks should be used.
 It’s always better to verify the nominal account at the end of the year.
 An exhaustive audit programme must be prepared.
 He should ensure that normal working is not affected.
 As far as possible, he should pay surprise visits.
Interim audit

This is that type of audit conducted within the accounting period and is aimed at assessing the
company performance so as to pay/declare interim dividends. These are paid at the middle of the

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financial year; however, balance sheet items are left till the end of the year. This audit will only
concentrate on profit and loss account items.

Merits

 It is ideal for companies under which the company is required to publish figures for the
purpose of paying interim dividends.

 It facilitates completion of the final audit as part of the company’s financial period will
have been covered in the interim audit.

 Errors and frauds which have been perpetrated will be revealed in this interim audit
before they are extensive to occasion heavy loss to the company.

 It has a moral effect on the staff of the client in that they will be up to date in as much as
they expect this interim audit to be undertaken which will disclose inefficiencies.

 In case of partnership, this audit serves as a basis for settlement of claims for the
company’s assets in case of a partner retiring in the financial period.

 It is less expensive than continuous audits because will spend less time in the company in
interim audits.

Demerits

 Figures already audited can be changed after this audit.

 It entails a lot of note taking in particular balance up to mid financial period to

minimize any alterations

 It will interrupt the clients work as his books will be taken away for the purpose of
audit.

 The clients staff may develop the habit of depending upon the audit staff to solve
their accounting problems which may endanger the independence of the auditor

 Questions raised may not be answered at their period and chances are that this period
and chances are that this will distort the impression on the accounts at the end of the
financial period.

 The auditor undertaking interim audits may not have sufficient time to gather
sufficient evidence from third parties such as debtors, creditors, banks, agents because
these parties may delay to answer the auditor’s letters leading to unbalanced opinion.

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Procedural audits

This is an examination and review of the company’s internal procedures and records in order to
ascertain their accuracy and reliability as basis of the decision making process and to ascertain
whether the procedures are economic in relation to company’s operations. It is applicable to big
organizations with complete operations. The auditor’s report will relate to only these procedures
and will suggest;

 Those procedures that need to be scrapped off or improved and modified

 New procedures that can replace old ones during the audit, particular attention should be
paid to;

i. The company’s internal control system to do with procedures

ii. Check whether the laid down guidelines are followed on procedures

iii. To ensure that no changes have been made to the internal control system over
procedures without notification of the auditor

Merits

 This audit is will provide feedback to the management regarding procedures which were
not followed and these can be rectified before it is too late.

 The audit results will reveal which procedures are out dated and uneconomical and which
calls for replacement or modification to suit company needs.

 It enables management to identify the strength and weaknesses in the internal control
system regarding procedures and steps can be taken to rectify any weakness.

 The audit ensures harmony and coordination of the company’s operations which may
boast profitability.

 This audit will highlight which areas of the company are bureaucratic and such
tendencies may be corrected.

Demerits

 It may be a very expensive audit since the auditor may be in the business for quite
some time so as to be familiar with the procedures.

 It may mean duplication of efforts if the same procedures are examined in the final
audit

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 It may be frustrated by management as they can not reveal their inefficiencies in the
presence of the auditor.

 It is ideal for big organizations which are dynamic in nature

 Where internal control system is weak the procedural audit will be limited in its
applicability thus almost impossible to have it under weak ICS.

Management audit

This type of audit is aimed at investigating managerial aspects of the business from the higher
governing executive to the rank and file personnel. It is guard at assessing the efficiency of the
management in running of the business which is essential for its profitability.

Advantages

 This audit will improve the quality of the management of the business and boast its
profitability as the management can’t relax if this audit is to be conducted.

 The audit will identify how decisions are made in the business and if there are any
bureaucratic tendencies are solved immediately.

 It can also help to identify the strength and weaknesses in ICS for top management point
of view and there after these weaknesses can be rectified.

 It will reveal the efficiency of budgetary system and how these affect the company
direction.

 If the auditor gives unqualified report, it will imply that the company is well managed;
this will have a positive image on 3rd parties.

 It does not interrupt the company operations as fewer of its books are checked.

 The management audit report will identify where areas have not been managed properly
as laid down in the company policies and corrective measures can be taken to rectify the
situation.

Disadvantages

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 It may lower the moral of top management which may lead to apathy if this audit is not
conducted properly.

 It is not possible for the management and staff to reveal their inefficiencies in the
auditor’s presence and this may lead to biased report.

 Inefficiencies of one department may usually be due to those other departments and great
care must be exercised to identify which department is inefficient.

 Some company’s charts to identify who is who in the organization may be nonexistent in
which case the line of authority will not be specific, thus making it difficult to analyze the
causes of inefficiencies.

 Better management performance is a relative phenomenon in that the management may

appear to be doing well at present and may change abruptly due to situations which may
render them inefficient, e.g. personal problems of the few top managers, change in
managerial staff among others.

Standard audit

This audit entails a complete check of all kinds of entries and this is aimed at ascertaining
whether such entries are genuine. It is ideal for situations under which the client company has
very good accounting system and strong ICS.

This audit is very expensive because it will take quite some time to finish. It is ideal under
conditions of contemplated mergers, amalgamation and acquisitions. This audit covers a period
equivalent to one financial year.

Balance Sheet audit

This audit falls under partial audit and is a phenomenon of USA accounting systems. In this audit
the auditor starts his work from the balance sheet working backwards. It is a limited audit, can
only be conducted after testing the strength of ICS.

Activity 1 the merits and demerits of BSA

Final Audits

It is conducted at the end of financial period when accounts have been balanced and profit and
loss account and balance sheet prepared. However, this audit may as well commence before the
end of financial period and will continue nonstop till the end of financial period. In this audit, the
auditor will take possessions of all books of accounts, check them and finally form an opinion

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and write a report to shareholders of the company regarding the true and fair view of their
company’s performance and thus dividends will be approved and paid on the basis of this report.

Merits

 It eliminates notes taking which is a phenomenon of other audits

 It is flexible as the auditor can prepare good programs to cover all areas well.

 Chances of figures being changed are minimal

 It is ideal for small businesses whose transactions are few and be audited at one sitting

 This audit does not interrupt clients work as it is conducted at the end of the financial
year.

 It’s not expensive because the auditor may not spend a lot of time and do a lot of work as
it is for other audits.

Demerits

 If the auditing firm has several firms with similar financial year ends, it may be difficult
for the auditor to schedule his staff to cover all his clients work in time.

 It is ideal for small businesses whose transactions are few and thus may not meet the
needs of big companies.

 Final audit may take a long time to finish if the ICS is weak and this may delay the report
thus delaying the AGM.

Disadvantages of audit in general

 In case the auditor has many clients such audit may be tedious and planning this audit
may be difficult which may leave some errors or even fraud undetected.

 It is an expensive operation and some small companies may not afford it.

 The audit report is a big financial leak to competitors who can use it to compete the
company whose accounts have been exposed to it especially public company.

 In case the auditor gives rise to a qualified report, this will reveal the weaknesses of the
company under audit and this will reduce its good will from third parties.

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 The client may rely on the auditor staff to solve their accounting problems which may
compromise their independence and which may lead to a biased report.

 An audit may disrupt the clients work especially if the audit is conducted on continuous
session.

 The audit report may delay due to problems with the audit staff and this may delay the
AGM, acquisitions of loans and statutory payments.

Vouching audit

It is that audit where the auditor checks each and every transactions right from the origin in the
books of entry till they are posted the final accounts are prepared and the final accounts are
prepared. This audit requires a lot of work and is popular in large organizations where the
transactions run into million and where internal control system is in use.

These days the auditor relies on examination as some of the transactions scientifically selected at
random.

System Based

This is the modern scientifically planned audit contracted by sampling, i.e. selective basis where
by only essential aspects of the business are investigated.

Activity 2 merits and demerits of standard audit

Why are auditors not responsible for fraud detection?

1. Because auditors use sample techniques only for testing frauds in big firms
2. Because of the sophisticated accounting system like computerized accounting system,
they test adequacy, control of the system not the transactions.
3. Auditors are not exposed to legal action for failure to detect frauds
4. Auditors do not run the firm on daily basis as the directors do
5. Because it is the judiciary duty of the directors to safe guard company assets and not the
auditor as per the company act provisions.
Expectation gap- this is the difference between the apparent public perceptions of the
responsibility of the auditor on the one hand and the legal and professional reality on the other.
I.e. what the auditors do and what people think about what they do.

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Causes of this gap

a. Misunderstanding of the nature of audited financial statements by the Public
b. Misunderstanding as to the type and extend of work undertaken by the auditor
c. Misunderstanding as to the level of assurance provided by auditors in their audit report.
Wrong perceptions
 That with fraud, the entity will continue to exist as a going concern for at least the next
accounting period
 That the auditor provides absolute assurance yet figures in the financial statements are
correct
 That clean report means that no fraud has occurred
 That the auditor’s report be read to the directors rather than shareholders but the opposite
is true.
 That the auditor’s duty is to detect fraud whereas this is the responsibility of the directors.
How to reduce the gap
 By educating the public on the role of the auditor
 By the auditor improving their performance
 By improving auditing standards.
Auditing standards and guidelines
In 1980, the auditing practice committee approved the issue of series of standards and guidelines
governing the audit practice.
Auditing standards- these prescribe the basic principles and practices which members are being
carried out.
Auditing guidelines- these give guidance on procedures and their application but do not prescribe
the basic principles and practices. These guidelines give guidance on procedures, by which the
standards may be applied, the application of the auditing standards to specify items and the
techniques being used in auditing.
Research on the common terms used in auditing

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AUDITORS PROFESSIONAL AND LEGAL REQUIREMENTS

Auditor’s term of office
These are requirements which should be fulfilled in respect of appointment, resignation and
removal of an external auditor of a limited company.
In his term of office, there are some statutory regulations duties, rights and ethics which he the
external auditor should pay due care.
Purpose of The Company’s Act to the Auditor
 To define the scope of work and responsibility of the auditor
 To provide the rights and privileges to the auditor to enable him/her carryout the duties
 To control and regulate the auditor’s removal and resignation from office
Qualities of an auditor
If the auditor is to perform his work his work more effectively and fairly. The following are the
qualities of an auditor,
 A person appointed should preferably be qualified as a member of the body of
accountants like ACCA, ICAPU and should be recognized by the company Act
 Such person should be suitably experienced and widely knowledgeable of the theory and
practice of accountancy and auditing principles.
 He should be tactful, pain taking and systematic in approach when auditing the accounts.
 Should be intelligent not submissive but objective in thought of approach
 The person should be trustworthy, mainly show the highest standard of professional
independency, impartiality and confidentiality.
 A person should be mature in age not a minor or not less than 21 years of age with
integrity, honest and humility character in order to maintain credibility and compliance
with the Generally accepted auditing standards (GAAS)
 He should be conversant with the company’s Act 1985/2012
 He must be objective in formulating his opinion without any bias
 He must be independent and must not compromise his independence.


Professional Ethics/independence of the auditor

This is a concept fundamental to the accounting profession. It is essential, an attitude of mind

characterized by integrity and objectivity approach to professional audit work.

The auditor must be free from conflicts while discharging his duties but when in doubt the users
of financial statements may not rely on the expression given in the financial statements.

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Therefore, the auditor’s independence is the most important concept in the auditing profession.
The company Act 1985 contains a number of provisions to ensure the independence of auditors.
The areas concerned;

 The auditor must not be an officer or servant of the company or partner and an
employee of the business enterprise under audit.

 The auditor must be professionally qualified to bring him under control of professional
bodies with high standards.

 Specific procedure including the approval of members are necessary to remove the
auditors

 Auditors must be reappointed annually by members

A part form the above statutory requirements, the professional bodies issues to members a guide
to professional ethics which deals with the auditors independence. The guidelines include the
following;

 Fees- it is undesirable for an auditor to deserve too much or large commission of his
income from the clients. The present view is that the fess paid should not exceed 15% of
the gross income. The role is to avoid undue pressure from a large client who can seek a
different auditor in the event of dispute.

 Professional relationship. Close personal relationship can compromise the auditors

independence thus close friendship or related relationship by blood or marriage between
the auditor and the client should be avoided. Auditing a firm for long period of time also
creates friendship between the auditor staff and the client. The relations that compromise
professional independence include;

i. Where the same member or senior staff member worked for number of years on
the same audit team in the company

ii. Where anyone in practice has mutual business with the officer or employee of the
client.

iii. Where the member has interest in joint venture with the client

iv. Where close relationship exits by blood or marriage

v. Where work is being done by a company dominated by one individual

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 Financial involvement with clients- beneficial shareholdings; where an auditor partners or

managers of the audit firm acting as auditors of the client comparing has acquired the
shareholding in the client company to aggregate value of 5% of the registered share
capital. I.e. in general, partners spouse or minors or children should not own share in the
Clients Company.

 Loans to and from clients- auditor should not make loans to his client more should be
receive any loan from his client or do not give guarantee to the client to obtain a loan

 Hospitality also possesses a similar threat, like acceptance of a bottle of beer at the party
or Christmas can be accepted but if it continues daily, it is dangerous and compromises
the auditors independence.

 Receiving commission- many auditors receive commission from their clients but this
should always be clear and put in writing

 Conflicts of interest-where the audit firm appointed to act as the auditor of the client has
been allowed to provide accountancy, taxation and consultancy services in addition to the
audit to the same client, such conflicts may arise.

 Acting for competing clients-this comprises of doing same business and they are
competing.

 Client in disputes- it’s difficult for an auditor to continue advising clients who are in
dispute unless both parties are prepared to accept the auditor’s assistance putting forward
proposals to end the dispute.

 Preparation of the accounting records, the auditor should not audit client where he ahs
also prepared the accounting records.

 Current appointment in the company- the company Act forbids the auditor to be the staff
of the client company to be audited.

Importance of auditor’s independence

 As an agent or a watch dog for the shareholders, he must be independent of the directors
and management who look after the interest of the shareholders in the company.

 The profession requires that auditor to be independent so as to able to express a balanced

opinion on the account

 To minimize as far as possible the exposure to potential risks and liabilities to the auditor

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 To make the auditor or accountant become objective to the true and fair view

 To conform to the adherence to the ethical consideration governing auditors

 It is a requirement of the company Act.

Procedures for appointment of external auditor

The company Act 1985 sec 159(6) requires that all companies should appoint an external auditor
who will oversee the affairs of the company for given financial period on their behalf. The Act
provides that the auditor can be appointed through the following ways;

1. Appointment by the members during the annual general meeting

2. Appointment by the Board of directors

3. Appointment by the registrar of companies

Auditor’s appointment in case of a new and first auditor

 The auditor of the company is appointed by the directors within 30 days after the
company has registered. The appointed of the auditor shall be valid till the next AGM.

 If the directors fail to appoint an auditor then the registrar of companies may appoint till
the next AGM.

 The shareholders in the next AGM remove the auditor appointed in 1 and 2 above and
shall be replaced by any other person nominated by them.

 If the members at the AGM remove the auditor but disagree to reappoint one, then the
registrar of companies shall help to appoint a new one

 Members may also delegate this duty to one of the directors.

 If there is no resolution passed at any meeting to remove the first auditor appointed as per
the above, then he is automatically re-appointed.

 If the first auditor does not give a notice of resignation within 28 days, then he is
confirmed to have been reappointed.

Auditor’s appointment in case of old and retiring auditor

According to sec 167(1) of Company Act 2012, every company shall at each AGM appoint an
auditor to hold office from the conclusion of that AGM, until the conclusion of the next, AGM.

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Notwithstanding sub sec (1), at any annual general meeting a retiring auditor, however,
appointed, shall be taken to be re-appointed without any resolution being passed unless-

a. He or she is not qualified for reappointment

b. A resolution has been passed at that meeting appointing somebody instead of him or her
or providing expressly that he or she shall not be reappointed

c. When the auditors has given a notice to the company in writing indicating his intention
not to be reappointed

If a notice is given of an intention to appoint somebody else to replace him, retiring auditor shall
not be deemed to have been automatically reappointment

Where at the AGM no auditors have been appointed then the registrar of company may appoint a
person to fill the vacancy. Therefore, it is the duty of the company director to give a notice to the
registrar of companies that they have failed to appoint an auditor.

When a casual vacancy falls in one office of the auditor due to;

a. His death, the directors may have to fill such a vacancy

b. Auditors incapacitation, e.g. madness, disabilities, the directors can fill such vacancy

c. By the auditors resignation, one of the shareholders can fill this vacancy

Qualification for appointment of auditors

According to the company Act provision the following parties can appointed as auditors

 Qualified and registered accountants

 Practicing accountants holding valid practicing certificates issued by the registrar of

accountants board in accordance with Cap 266 of the accountants Act

 An auditor firm recommended and approved by the ICPAU or chartered accountants

recommended by the registrar of companies.

 Any member of the recognized institution of accountancy recognized by the registered

accountancy board whereby all those holding Bachelors of commerce (accounting and
auditing) can be registered as auditors.

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Disqualification of the auditors

Section 169 (2) of the Company Act 2012, stipulates that none of the following persons shall be
qualified for appointment as auditor of the company-

 An officer or a servant or employee of the company.

 A person who is a partner of or in the employment of an officer or servant of the

company.

 All persons who have been disqualified as auditors of their profession by the accountancy
board of the country like ICPAU

 A body corporate.

 Any person holding more than 5% of the company’s authorized share capital.

Sec 169(6) of company Act 2012, states that where a person who is not qualified to act is
appointed as auditor of a company that person and the company and every officer in default is
liable to a default fine of twenty five currency points.

Duties of an auditor (owning to his profession to others)

 To a report on the financial statements of the organization to the members/shareholders

 To report whether the statements of accounts do comply with company act or statute and
if they are true and fair.

 To investigate whether or not proper accounting records have been kept and if the
statement of accounts are in agreement of against the accounting records.

 To verify the existence of all the assets and liabilities of the company.

 To include any information omitted by the directors from the accounting records in his
report.

 To consider whether the information in the management report is consistent with the
financial statement.

 To qualify the report if the anomalies in the financial statements are more of intention
than innocent.

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Responsibilities, rights and powers of an auditor

The following are the rights of an auditor,

 Access to all material information required of him and relieves audit work such as all
vouchers, books of accounts costing books, the memorandum and articles of association
of the company.

 A right to attendance of any AGM and relieve all notices where he can speak and defend
his accounts on behalf of the company as well as to give necessary.

 A right to call for any information and explanation form the company

 A right to receive a notice within 21 days to attend the AGM where he can speak subject
to any discussion of the company’s accounts.

 A right to report to any member of the company of failure on the side of the directors to
supply necessary information and explanations needed.

 A right to retain the drafted report, B/S, working papers and all books of accounts of the
company in case his outstanding fees for the work done is not paid.

 The right to speak during and discuss at every meeting about his removal, to send and
read his representation to the company which will be circulated to all shareholders,
receive a notice within 28 days to attend the AGM to discuss his removal.

It is therefore noted that the company Act of 2012 stipulates that it is a criminal offence to give
the auditor false and misleading information either in writing, verbal by the employee of the
company, on this account, he has the right to sue these culprits.

Remuneration of an auditor

According to section 167(10) of the company Act 2012, the auditor’s remuneration is fixed by;

 Whoever made the auditor’s appointment.

 The company AGM determines the auditors remuneration

 Shareholders can delegate to directors to fix the remuneration in case of failure in i and ii
above

 In case all the above fails, the registrar of companies can do so.

Thus auditor remuneration will depend on the following circumstances;

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 If appointed by the board of directors the same board shall fix his fees and expenses

 If appointed by the registrar of companies then the auditor’s fees shall be determined by
the him/her

 If appointed by the shareholders at AGM, the shareholders shall determine the auditor’s
fees. In most case this can be delegated to the managers and directors

 If the auditor is asked to do extra work like preparation of company accounts, assessing
income tax, he deserves extra remuneration.

Qn. Discuss any 6 rights of external auditor

Auditor’s resignation

Auditor’s resignation is a situation where by the auditor is not willing to continue acting as
company’s auditor.

Circumstances surrounding the auditor’s resignation

 Where the auditor is not qualified for appointment

 Where the auditor is not willing to be reappointed

 Where the auditor has disagreed with the directors because he has qualified the report and
he is certain for replacement in the next AGM

 Where the auditor’s scope of work has been restricted by the board of directors.

The auditor may resign at anytime he has to have a notice to the company specifying the
conditions for his registration such as,

a) He must deposit a notice of registration at the companies registered office before

vocation of the office.

b) Such notice deposited by the retiring auditor will bring his office to an end of the date on
which it was deposited or at a later date as may be specified there in.

c) He should issue statement which satisfies that, he was a reason of signing and wishes to
that information to members during the A.G.M.

d) the company shall be within 14 days , send such a copy of the auditors notice to the
registrar of companies, in case the notice contains a statement to be brought to members
or every person entitled to be sent a copy of the account.

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 Audit theory and Practice

e) The auditor has a right to ask for extra ordinary general meeting to consider the reasons
to why he has resigned

f) The director shall give 21 days notice to the meeting of the members.

Qn. Explain any five reasons that may lead an auditor to resign

Auditor’s removal

This is a situation where by the management and the shareholders of the company are not willing
for the auditor to continue as the company auditor

An auditor can be dismissed at any time before the end of his term of office; this removal is by
the ordinary resolution at a meeting with specific notice within 28 days having been served

Reasons for removal of auditors

 Disagreement between the policies and findings by the auditors and shareholders

 The threat to expose management fraud

 Incompetence of the auditor

 Change of ownership of business or take over

 Incompatibility between management and the auditor

The procedures for removal

If any shareholder wishes to nominate another person to replace the existing auditor he must
give a special notice for the resolution at the AGM for appointing another auditor.

On receipt of the copy of the notice, the company shall then send a copy to the retiring auditor
and this should be done in not less than 28 days before the AGM

The retiring auditor shall make a written representation to the company regarding the resolution

If his response is not sent to the members in time, the auditor has a right to read it during the
AGM unless court has ruled out that they shall not be sent or read out. This procedure prevents
the directors from quietly removing the auditors without consent of the members.

An auditor appointed by the shareholders through the directors to hold office until the next
AGM, he may be removed by the directors before the expire of his term of office provided a
notice of 28 days has been given to him.

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 Audit theory and Practice

The auditor ha s a right to defend himself at AGM about his removal

When the auditor has been removed, the registrar of companies must be informed within 14 days
after the meeting of the removal of auditor.

Auditor’s right of lien

There are two types of auditor’s lien namely;

General lien and particular lien

a. General lien-this refers to the right which entitles a person in possession of the company
property to retain it till all his claims or accounts against the owner are satisfied

b. Particular lien- this is a right over a property of the company which can be retained only
till payment of particular debt due in respect of it is paid to the auditor.

How lien affects the company Act

The company Act requires all books of accounts to be kept at the registered office of the
company or at such place open for inspection by them. However, it has been the practice in the
company court to recognize the possibility of the auditor’s lien and make orders accordingly.

Also the company Act empowers the secretary of state to require a company to produce its books
of accounts and appear as department may require without prejudice to any lien claimed.

Conditions for lien

A right of lien only exists where all the four following conditions are present

1. Where the document must have come into the possession of the auditor by proper
means

2. Where documents retained by the auditor must be property of the client who owes the
company not of the 3rd party

3. The auditor must have carried out the audit work upon such documents

4. The fees for which lien is exercised must be out standing in the respect of such work
and not in respect of other related work the auditor could have rendered.

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Criminal and civil liability of the company auditor

Due to risk exposures to the assignments, the auditor is exposed finally to liabilities. This means
that the user to the financial information audited can claim some honest against the audit. The
statutory report made by the auditor can be subject to allegations of false statements or
disloyalty. The action by the auditor on the financial statements can be attributed to negligence.

Criminal liabilities

An auditor can be penalized for criminal offence under the following circumstances

 If he/she has helped the management to commit a fraud

 If he/she has failed to detect a material fraud in statutory audit

 If he/she has shown circumstances of negligence in his audit work

 If the auditor fails to request for branch information from the branches during audit

However, in order to succeed against the auditor for criminal offence, one has to prove the
following

a. The auditor owed the primary duty of acre

b. The auditor had breached the primary duty of care

c. That the act of the auditor contributed primary act

Civil liabilities

Under civil liabilities, the auditor owes a duty of care to his client and third parties during the
audit work. He should therefore exercise the highest degree of diligence during the course of
audit.

Negligence may a raise against him due to lack of diligence in case of contract or by whom such
person may owe the duty of care.

In order to sue the auditor successfully against the civil liability caused, the client must proof to
the court the following

 That the auditor was negligent

 That the act of the auditors negligence , the client suffered a financial loss

 The financial loss must be qualified and material so as to warrant redress

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However, the auditor can be liable to 3rd parties under the following conditions

 Where the party has suffered a financial loss solely as a result or relaying on the report
made by the auditor

 Where it can be proved that the auditor did not use his professional skills and judgment
during the course of his audit work.

 Where the auditor made his report while aware that such report could be used by the 3 rd
parties to make investment decision.

Duty of care

The term duty of care means

The auditor must be seen to be reasonable and fair while reporting the financial statements.

That the auditor must employ skills and competences in achieving the objectivity fort audit.

Qn. Explain any 4 ways through which the auditor can minimize liabilities

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AUDIT PLANNING

Planning the audit of the Client (ISA 300)

ISA 300 requires the auditor to adequately plan control and record his audit work. Planning stage
is initial stage in the audit process upon which controlling and documentation are based.

Definition.

Planning is the process of developing the general strategy necessary for the auditor to understand
the audit, access risk and materiality, pay keen attention on the important areas of the audit,
identify the potential problems and perform the audit in a very good manner.

Stages involved in planning

There are four main stages involved in the planning process namely,

1. Acquiring knowledge about the client business and industry

2. Preparing a comprehensive overall audit plan
3. Preparing audit programs for the audit
4. Drawing up time, usage and cost budget

Acquiring knowledge about client business and industry, the audit manger must have
thorough knowledge about the client business through, visitation of the client premises to
identify the location of departments, obtain the legal documents, agreements and contracts
governing the client activities and its operation, revisit the meeting minutes of the board of
directors, discuss with management of the client about the audit and the entity.

Comprehensive overall audit plan, this incorporates the following functional plans, planning
for the interim audit field visit, planning for the year end audit, planning for analytical review
procedures among others

Audit programs

An audit program is defined as the step by step breakdown of the audit work should be carried
out by the auditor and members of the audit team from the beginning of the audit up to the
completion of the audit. Audit programs are prepared by the auditor to serve as guidance to the
professional audit work, potential risks promptly identified.

Audit programs are of two categories, standard, pre-prepared and pre-determined programmes
and progressive audit programs.

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Audit program is a step by step break down of the audit work from the beginning of the audit up
to the completion.

Sample

Week one

Document /item Cash book T/balance Balance sheet Sales ledger

Checked by Okello John Nelson Ronald

Advantages of audit programs

1. Programs facilitate the completion of the audit work

2. Effective programs ensures that no part of the audit work is overlooked
3. Through programs the auditor is able to allocate the duties among the staff
4. New recruits can be trained using the programs
5. They serve as means of documenting the audit work
6. Minimizes supervision in the conduct of the audit

Disadvantages

1. No audit programs however elaborate it might be would cover the areas of the operation
2. Inefficient audit staff may rely on the programs to complete the little work delegated to
them not to be effective in other areas
3. Some programs prepared by the auditor are technical to be understood by the juniors
4. The audit staff program prepared by the auditor may be based by the experience on the
audit therefore may not lead to the objectivity of the client audit.

Matters to be covered by the program

Obtain and examine the schedule of the fixed assets prepared and maintained by the company to
obtain evidence about them.

Obtain the policy of the company in a case of first audit over acquisitions and disposals of fixed
assets

Obtain the previous annual accounts in particular year’s balance sheet to determine the closing
balances of the assets

Read through the meeting minutes of the board of directors

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Obtain the asset registers to examine the original cost, accumulated depreciation, net book value
etc

Advantages of Audit Planning

1. Planning enables the auditors to direct and co ordinate the audit work

2. Effective planning assists the auditor in indentifying the potential risk exposures in the
audit

3. Planning helps to complete the audit work of the client

4. Through planning the auditor is able to understand the client business, geographical
distributors and industry.

5. Effective planning enables the auditor to document the audit work

Limitations

1. The accounting system of the client may be complicated to the auditor to understand and
operate and this may make it difficult for planning of the audit work.

2. The auditing standard on planning gives guidance on the planning process of existing
client ignoring the planning procedures to the audit of the new client.

3. Even though an audit can be properly planned for. The achievement of the objectivity
still requires the auditor to supervise the audit.

4. It is difficult for the auditor to pan for audit of the small business.

5. Planning the audit involve budget in which is an element of cost and therefore the audit
firm may not be able to service the entire cost for the planning process.

Audit control, this involves the following;

1. Delegating the audit work to the audit assistance , trainees

2. Directing and coordinating the audit of the assistance

3. Supervising the audit of the audit staff

4. Quality controls

Note: Quality controls, these are defined as policies and procedures employed by the audit firm
to ensure that the audit work of the client are carried out in accordance to the standards

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requirement. Examples include; personal qualities like integrity, independence, confidentiality,

competence, due care and skills, professional behavior etc

Audit Review

Review means critical examination of the completed audit work by the auditor in charge to agree
them with the audit work manuals, quality control and standard requirements.

There are two main types of audit review namely;

Internal reviews, they are also called cold reviews or in house review. It is the review of the audit
work by the audit manager. It is also called post audit review.

Purpose

1. To provide evidence as per whether the audit works was carried out in accordance with
the audit program.

2. To confirm whether the accounting sources that were adopted by clients were in
agreement with the GAAPS.

3. To identify any possibility of risk exposures that might have resulted in the conduct of
audit.

External reviews

This is also called hot review or peers review. It is carried out by another audit firm or the
institute purposely for;

1. To confirm whether the quality controls of the audit firm are properly updated, desirable
and acceptable.

2. To check whether the audit firm employed technical expertise knowledge and skills in the
conduct of the audit work of the client.

3. To identify any omissions in the audit programs that was circulated for the audit during
the field visit.

4. To determine whether the audit firm collected quality evidence that was necessary to
support the opinions reached on the financial statements.

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Audit Flow Chart

These are diagrammatic representation of the company accounting system and procedures. The
horizontal lines on the flow chart will indicate the movement of items across departments. Example of a
flow chart of purchase function is shown below

Purchasing dept Receiving dept Stores dept Accounting dept

X X X X

O O O O

O O O O

Key X-Operations O- files

Merits of flow charting

 It simplifies the recording of ICS such that it may be understood by the new audit staff

 The auditor may get a whole picture of the company operation

 It is a consistent system of recording .i.e. it is standard

 Weaknesses in ICS can be spotted easily through gaps in flow charts

Demerits

 Unless explained they may be very difficult to follow and draw conclusions

 It does not contain all the information as such notes have to be taken

 It is time consuming like each step will call a separate flow chart.

 Symbols used in flow charts are not uniform and this may cause problems

Internal control questionnaires

These are set of questions prepared by the audit manager given to his client to answer or be
answered by the audit assistant from the client’s responses. These questions need short /simple
answers like yes/no/not applicable.

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The yes answers indicate strength in ICS, the No answers indicate weakness in ICS and not
applicable indicates weaknesses in ICS.

Qualities of ICQs

 Questions should be suitable and comprehensive

 Questions should be designed in a such a way that answers are possible to be given

 Should be simple and clear

Merits

 They assist the auditor to know the books kept by the client and information contained
there in

 Makes it easier to assess the strength or weaknesses of ICS

 They are used for future reference

Activity three. Demerits of ICQs

Audit Note Book: an audit note book is one of the most important documents maintained by the
auditor. It is defined as a record used mainly in recording audit, containing data on work done
and comments made. Audit Note book contains information regarding the day to day work
performed by the audit staff, notes about errors, explanations required etc. the auditor can use it
as an authentic evidence in the court if there is any case against him.

Contents of Audit Note Book:

1. Nature of business and important documents such as MOA, AOA, Partnership deed etc.
2. List of books of accounts.
3. List of officials, their duties and responsibilities.
4. Copy of the audit program.
5. Information on missing receipts, vouchers etc.
6. Details of errors discovered.
7. Explanations sought from the officials.
8. Points to be included in the audit report.

An audit note book should be preserved by the auditor as it contains valuable information in
respect of the work done by its staff.

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WORKING PAPERS

ISA 230 states that the auditor should adequately plan control and record his audit work. Audit
recording refers to;

 The process of documentation of the audit work and process of maintaining audit papers.

 The term documentation means, booklets, manuals, information.

Audit Working Papers.

The term audit working papers refers to information, documents and records, all used by the
auditor to support the conclusions reached on the financial statements.

Contents of Audit Working Papers.

i. Information relating to the legal framework and organizational structure of the entity.

ii. Copies of the important legal documents, agreements, contracts between the entity
and third parties.

iii. A brief history of the entity and summary of its annual results(prospectus)

iv. Extracts of MOU and articles of association.

v. Extracts and copies of meeting minutes of shareholders, board of directors and

important committees

vi. Schedules for analytical review

vii. Audit planning and audit programs

viii. Descriptions of the accounting system and related forms of controls

ix. A list of important officers names, addresses, signatures, titles and telephone numbers

x. Correspondences made by the auditor with the clients, third parties and previous
auditors and specialists

xi. Organizational chart or structure of the company

xii. Schedules used by the auditors like internal control questionnaires, flow charts or
checklists

xiii. Names and address of the audit firm

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xiv. Name and address of the client company

xv. Accounting period covered by financial statements

Purpose of maintaining working paper:

1. They show the extent to which accounting principles and auditing standards have adhered to.
2. They provide the required support for the auditor’s report.
3. They also reveal the efficiency with which the audit work was done.
4. They can be used as evidence in the court to defend himself against negligence in his duty.
5. They help the auditor in finalizing his report quickly.
6. They help the auditor to understand the efficiency of the accounting system, internal check
system etc.
AUDIT FILES

There are mainly two main files, permanent and current audit files

Permanent audit files- this working paper is prepared by the auditor to provide evidence about
those important matters throughout the audit of the client. It is updated annually and it is kept by
the auditors as a source document. It contains documents, records and information considered to
be important for the audit. Examples include;

Memorandum of association , brief history of the company and the summary of the annual
results, organization structure , key staff, copy of engagement letter, description of the
accounting system and related control, principal activities and locations of the business, specific
legislation regulations governing the entity, letters of representation, list of company advisors
such as bankers, clients internal audit and auditing instructions.

Current audit file

This working paper provides evidence to the auditor about the information, records and
documents which are relating to the current audit. This paper is prepared and maintained at each
and every audit. It provides evidence to the auditor in support to the audit opinion on the
financial statements. Examples include;

Copies of the financial statements for the current audit, meetings minutes of the board of
directors, correspondence made between the auditor and the client third parties previous auditor
and specialists, planning and audit programs, schedules for analytical review, extracts from the
stock taking instructions and the stock sheets, copy of management letter, copy of representation
letter.

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Commencement of an audit
Before making a decision to accept an appointment as an auditor in a new organization the
auditor should consider the following aspects
 Assess whether the audit firm has got the capability and resources to enable it carryout a
given audit arrangement.
 Assess whether the audit firm is related to the client. I.e. blood relations, financial
relations.
 Assess the nature, purpose and scope of the audit, the fees charged and other matters.
 Request the client to communicate with the outgoing or previous auditor in order to find
out why he is no longer the company auditor.

AUDIT OF AN OLD (EXISTING CLIENT)

When an auditor has been re-appointed to undertake the audit work of an old client, before
commencement of the work, the following consideration should be met;
 Prepare audit plan.
 The auditor should review the previous year’s audit papers both current and permanent.
 Clarify the problem areas from the previous year’s audit paper files.
 Research on the client background concerning the previous economic and industrial
matters, new changes in business etc
 Discus with directors any change in the business cooperation, book keeping and
accounting policies.
 Review interim management accounts, internal auditing and regards’ companies’
performance.
 Determine the degree of co-operation expected from the internal auditing department.
 Assess staffing requirements.
 Prepare an audit program.
Audit letters
Under these we have the following,
 Engagement letter for a new appointment as an auditor,
 Management letter and
 Letter of representation.
Letter of engagement
This is the contract between the auditor and the client. It is written by the auditor, sent to the
client.
It should be written under the following guidance
The auditor and client should agree on the terms of engagement
Separate letter is needed for non audit work
Auditor should regularly review the terms in the engagement

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The contents should be discussed by the management before it is sent back to the auditor
It is effective for one appointment
It needs annual review to reflect changes in term if any
Each subsidiary company should have its own letter if terms are different
It is addressed to the board of directors of audit committee
Content of Engagement letter
 A statement of management responsibilities to keep proper accounting records and to
prepare the financial statements
 Statement of management responsibility for detection of fraud and errors
 A description of auditor’s responsibility informing their opinion on the financial
statements
 An explanation of the scope of audit stating what would be carried out in accordance with
audit standards
 An explanation of the need to obtain a written management letter of representation in
certain circumstances
 Details of the basis for charging and paying fees normally
 Applicable law governing the letter i.e. company Act
 Proposed time table for engagement
 A reference to any further agreements between the auditor and the client.
Importance of Engagement letter
 It explains the duties of auditor and the existing contract; it minimizes disputes and
misunderstanding about the auditors
 It stipulates the auditors scope, this is governed by the company Act
 It explains the duties of directors
 Clarifies that it is not the auditors’ responsibilities to detect errors and fraud but his
procedures should have a reasonable expectation of detecting material error and fraud.
 It minimizes auditor’s liabilities to 3rd party.
Management letter
This is a letter written by the auditor to the management (directors) drawing their attention about
the short coming and weaknesses with in the company’s internal control system. The weaknesses
are always discovered during the course of the audit and suggestions are given to be undertaken
to improve on the ICS. It is always done before the issue of final report.
Letter of representation
This is a letter written by the directors of the company and is addressed to the auditor at the end
of the audit work. In this letter directors confirm in writing that all items of assets and liabilities
both financial and non financial at the balance sheet date have been included in the financial
statements. The letter acknowledges that it has been the duty of management to prepare final

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accounts, to establish ICS and that the auditor has been provided with all the necessary
information and documents for his work.
AUDIT EVIDENCE
Audit evidence is defined as the information and facts the auditor do obtain from sources under
his own control, management of the entity and to a large extent from the third parties considered
sufficient appropriate upon which conclusions can be drawn on the financial statements. The
auditor does not require absolute truth about the true and fair view or accuracy and reliability of
the financial records but only that part which represents sufficient appropriateness.

Types of audit evidence

1. Primary audit evidence, this evidence is obtained from the accounting records and source
documents, originates from within the entity of the client and obtained by the auditor
through inspections, computations or analytical review procedures.

2. Secondary audit evidence, this evidence is obtained by the auditor from external sources,
originates from customers and suppliers.

3. Circumstantial audit evidence, this evidence is obtained by the auditor from within the
business through observations procedures. The auditor draws conclusions based on the
findings he/she is able to obtain from such undertakings.

4. Hearsay audit evidence, this is oral evidence which is obtained by the auditor through
interviews and questionnaires. Hearsay audit evidence is used by the auditor to draw
conclusions about those matters that have been supported by other sources of evidence.

Sources of Audit Evidence

The accounting records and source documents, tangible assets, management and employees,
customers and suppliers with adequate knowledge about the business or dealing with the
company and bankers.

Quality Audit Evidence.

Evidence is said to be representing quality if it meets the following requirements;

 It is relevant to the audit, it is reliable to the auditor, it is sufficient for opinion forming, it
is of relevant time and cost requirement, it is detailed and complete, and it is justifiable to
the auditor.

Techniques of Obtaining Audit Evidence

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Inspections

During the conduct of the audit the auditor would examine the documents, ledgers, cash books
and accounts to confirm for their accuracy, validity and completeness. The auditor may carry
physical examinations of the transactions and account balances to find out their authority,
recording, occurrence and management obligations , he/she also inspects physically the assets to
identify whether these have been properly disclosed, valued, do exist and properly owned by the
business.

Observations

Observations is the process of witnessing the occurrence of transactions, records or activities

purposely to agree them with recommended accounting policies, policies and procedures and the
current expectations.

Inquiry and confirmations

Inquiry is the process of conducting interviews with questionnaires to obtain some evidence by
the auditor upon which conclusions can draw. Inquiries do provide oral evidence to the auditor
and therefore for the auditor to obtain quality he/she must subside it by carrying out 3 rd party
confirmations. 3rd party confirmations call for the evidence to be received through debtor’s
circularization process and bank standard letter.

Computations

During the conduct of audit the auditor will inspect a number of documents, records and account
balances supposedly to obtain evidence about the ownership, existence, valuations of the assets,
liabilities, commitment and provisions. Some of these documents do require the auditor to carry
out some computations necessary to confirm for the fair valuations of the assets. Computations
do confirm the arithmetical accuracy and reliability of balances.

Analytical Review Procedures

These refer to the study of relationships that do exist between two or more variables purposely to
provide for any variation which appears to be unusual and that can call for investigations. This
can be carried out at the planning stage, during the conduct of audit and at the completion of the
audit.

Qualities of good audit evidence

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 Sufficient; the audit evidence should be complete enough to get. Therefore, the judgment
of the auditor should constitute sufficient audit evidence.
 Relevancy- audit evidence should be relevant to the purpose for which is required. This
relies on overall audit objectives.
 Reliability; audit evidence is reliable it is considered correct and accurate. The auditor
can rely more on documentary evidence.
Factors that influence the amount evidence to be gathered

 The strength of ICS can give assurance to the auditor that the evidence gathered is
reliable.

 The materiality (factual) of an item being checked.

 The degree of estimation when is considered reasonably in arriving at the given item e.g.
depreciation provision for bad and doubtful debtors.

 The possibility of management bias mostly when the business is being run by un
professionals.

Limitations of gathering audit evidence

 There are chances that the 3rd parties may coincide with the management which may lead
to biased opinion.
 3rd parties may delay in replying to the auditor’s letter or may delay or ignore these letters
all together.
 The comparison of the company performance using ratios and percentages may not be
possible due to changes
 Vouching will be used with samples which may be biased leaving some areas with errors
or frauds.
 The trial balance may not give the evidence because it can balance even when there are
errors.
 Where the ICS is weak, the auditor cannot gather sufficient information/evidence as the
available evidence can’t be relied upon.
 Lack of cooperation between management and the auditor which may lead to delay in
submitting documents hence limiting the primary evidence.
Reliability of audit evidence
 Documentary audit evidence is more reliable than oral or hear say
 Evidence obtained from external sources is more reliable than evidence obtained
within/internal sources
 Evidence obtained from internal source is more reliable if related internal forms of
control apply

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 Evidence obtained by the auditor himself is more reliable than evidence obtained from3rd
parties
 Evidence obtained from the original copies is more reliable than evidence obtained from
photocopies.

Audit tests
These are techniques which are employed and carried out when obtaining audit evidence during
an audit. Below are some of the tests
1. Walk through test: This procedure involves the auditor tracing a small number of
transactions of one or two selected items. This checking of transactions confirms to the
auditor that the information gathered about the clients business are correctly recorded
according to the accounting standards and that they give a comprehensive view of a
strong ICS. The procedures are based on inquiry and tests basis into all sections covering
the flow regarding documentation e.g. on sales dispatch of goods, receipts of cash
For example, making inquiry into the system by discovering who controls and operates
the system. Recording the system by drawing flow chart and preparing notes and
confirming the system by conducting overall and walk through tests.
2. Substantive tests; these are audit tests which seek to provide audit evidence in the
accounting system of the organization. The main purpose is to enable the auditor
establish whether the accounting procedures and standards are being followed and
applied as per the company Act. The auditor will concentrate on the ICS which is the
fundamental aspect to efficiency, accuracy of processing and record keeping.
3. Compensatory controls; these are controls which may be taken into consideration by the
auditor to ascertain whether certain aspect of the internal control system have not been
followed in accordance with laid down policies and procedures by Management. Say,
where the store keeper may not have an invoice, the credit note can be shown and
corresponding records in the goods out words book.
4. Evaluation tests; this will be carried out once and the overall picture of whole
organization has been received and the information there is obtained. This stage will
involve evaluation of the infectiveness of the internal control system is formal and
operational on a sound basis. This will cover areas of weakness and strength which are
likely to face any business. Normally the auditor uses evaluation forms.
TECHNIQUES OF APPLYING AUDIT TESTS.

 Decide on the reason reason for the test e.g. recording data and accuracy.
 Select a sample on which these tests are to be applied randomly.
 The sample selected must be comprehensive covering all the items for the financial
period.

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 Take large samples of items in the first and last months of financial period .These stand
high chances of having errors and frauds.

Sampling

Auditor’s operational standards in respect to quality evidence require the auditor to obtain
relevant and reliable evidence sufficient to enable him or her draw reasonable conclusions
therefore. Evidence obtained by the auditor may originate from sources under this own control
usually through the audit working papers.

Meaning

Sampling is defined as the applications of compliant and substantive testing to less than 100% of
class of transactions and record or an account balance. It means that during the audit, the audit
will not check all the transactions completely but will undertake the following;

 Obtain a population of transactions of account balances

 Select a sample size from the population

 Test and evaluate all the sample units in the sample size using a compliant and
substantive testing to obtain evidence about their characteristics.

 Draw conclusions on the remaining population necessary to enable you conclude on the
truth and fairness of the transactions, records and account balances.

Terms Used In Sampling

1. Population:- the term population means the entire transactions, records or account
balances, contained in the ledger, cash book or day book from which a selection of
sample units can be done by the auditor either randomly or systematically.

2. Sample units:- means the selected transactions, selected by the auditor purposely for
testing or evaluation. The sample units are usually commonly selected randomly to make
the sample size become representative and to give each item an equal chance of being
selected.

3. Tolerable error:- during sampling the auditor comes across with errors which can be
divided into;

i. Tolerable error: is the maximum amount of an error that the auditor would come
across during sampling in respect to transactions done, records or account

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balances beyond which the auditor would not accept and still concludes that the
account reveals a true and fair view.

ii. Actual error: is the amount of an error the auditor does detect through substantive
testing.

iii. Expected error is the normal audit error that would be reviewed by compliance
testing.

4. Confidence level: this is the difference between the absolute error rate in percentages and
the maximum amount of an error usually 100%. E.g. when absolute error rate is 5%,
10%, 15% and 20% then the confidence level becomes 95%, 90%, 85% or 80%. Meaning
that as the absolute error rate increases the confidence level reduces and vice versa. When
the confidence level reduces, the risk exposures increases because each error becomes
material.

5. Attribute sampling: this is a sampling approach whereby the auditor selects units from a
given population, tests and evaluates them to obtain the results which is then approach
the auditor would expect the sample units tested to behave in a certain manner,
characteristic or quality which can be used to draw conclusions on account balances,
records or transactions.

6. Variable sampling: this is a sampling approach carried out by the auditor whereby the
sample units selected, tested and evaluated provides evidence on the accuracy, validity
and completeness which are again used to draw conclusions on the financial statements.

7. Sampling risks: this arises during sampling whereby the conclusions drawn by the auditor
from the sample result differs with the conclusions drawn by the auditor from other
alternative audit procedures.

8. Judgmental sampling: this is the approach adopted by the auditor whereby he/she would
use his/her own institution to reach conclusions about account balances, records or
transactions. It is a traditional method liked by the auditors when auditing their existing
client.

Reasons for Sampling

1. To obtain quality audit evidence from the account balances, records and transactions
without necessarily checking all the transactions in the ledgers or cash books.

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2. To ensure that the auditor has adopted a methodical approach in the conduct of audit
work that would provide evidence that the audit has been properly controlled, reviewed
and documented.

3. To save the auditors time and cost in the conduct of the audit of the client to ensure for
the objectivity of the audit.

4. To provide value for money audit to the client management and staff by the auditor
spending less time and cost for the audit to be attractive to management.

5. To ensure that auditors are not able to conduct the audit without first identifying and
assessing the risk exposures. In order to decide on the nature, extent and timing of the
audit procedures.

Factors to be considered in determining the size of the sample.

1. If the population is large, increase the size to be tested and vice versa

2. Risks and assurance ascertain the degree of risks exposures and be assured on their levels
in order to determine the size of the sample.

3. Audit objectives confirm whether the objective is to detect errors and frauds or to prove
for the true and fair view, design the sample size according to the objectives.

4. Tolerable and expected errors: ascertain the degree of tolerable error and expected error
in order to increase the sample size or decrease the size.

5. Stratification: confirm if the population is too large to sub divide it into sub population
for easier selection.

6. Confidence level: the higher the confidence level is the lower will be the sample size.

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INTERNAL CONTROL:
Internal control is a broad term which is normally used to control financial and non-financial
activities. It involves a number of checks and controls exercised in a business to ensure efficient
and economic working.

Definition:
Internal Control is defined as “the whole system of controls, financial and otherwise established
by the management in the conduct of a business including internal check internal audit and other
forms of control.
Internal control can also be defined as: ‘all means designed to promote, govern and check upon
various activities for the purpose of seeing that enterprises objectives are met’.
‘The control environment and control procedures. It includes all the policies and procedures
(internal controls) adopted by the directors and management of an entity to assist in achieving
their objectivity of ensuring, as far as practicable, the orderly and efficient conduct of its
business, including ;
 adherence to internal policies
 the safeguarding of assets
 the prevention and detection of fraud and error
 the accuracy and completeness of the accounting records
 the timely preparation of reliable financial information.
It is the responsibility of management to establish and maintain internal controls.

Types of internal control

 Preventative- to prevent risks occurring
 Detective-to detect if any problems have occurred
 Corrective- to address problems that have occurred
Specific Control Procedures include;
-Reporting, reviewing and approving reconciliations.
-Checking the arithmetical accuracy of the records.
-Controlling applications and environment of computer information.
-Maintaining and reviewing control accounts and trial balances.
-Comparing the results of cash, security and inventory counts with the accounting records.
-Limiting direct physical access to assets and records.
-Comparing and analyzing the financial results with budgeted amounts.

According to ISA 400, the auditor should obtain an understanding of the accounting and internal
control systems sufficient to plan the audit and develop an effective audit approach.

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There are various means available to the auditor for ascertaining the internal control systems and
recoding their details,
Ascertaining
a. Examining previous audit work
b. Client’s own documentation
c. Interviews with client’s staff
d. Tracing transactions
e. Observation of client’s procedures
f. Examining client’s documents
Recording
-Narrative notes, organization charts, internal control questionnaires or checklists, flow charts.
Organizational charts
Are good at demonstrating the formal relationships between the individuals in the business, but
ignore informal relationships.
For example, in the chart below, the chief accountant might be the sister of the managing director
and therefore the two could be often in close touch. This is ignored in the formal chart.
Managing Director

Production Manager Sales Director Finance Director

Advert mger
Factory Mger Purchases Distribution mger chief Accant Mgt Acctant
Controller
Evaluating the internal control system
Once the system has been ascertained and recorded, the controls present in the system can be
evaluated, often using internal control evaluation questions
Internal control evaluation documents are based on key control questions (e.g. can goods be
dispatched or leave the premises without being invoiced? Can employees be paid for work not
done?)
Internal control questions are objective questions which focus on specific controls and the
information obtained in completing the ICQs is used to answer the relevant ICE .e.g. can goods
be purchased without proper authority? Are purchases orders and requisitions approved? (ICQ)

Objective or advantages of Internal Control:

1. From the clients point of view.

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a. Internal control system provides authentic and reliable data useful to take business
decisions.
b. It safeguards the physical and non-physical assets in the form of records, documentation
etc.
c. It promotes operational efficiency, by preventing waste, duplication of work and
inefficient use of resources.
d. A good system of internal control provides that the company follows the procedures and
rules as required by the law.

2. From auditors point of view.

An auditor evaluates a system of control before commencing an audit work his work
becomes easier if the control system is efficient. He can also decide whether detail
verification is necessary or not.

Disadvantages of Internal Control:

1. It involves expenditure which may not be affordable by the small organizations.
2. Internal control is concerned with routine transactions many times unusual transactions may
be over looked.
3. The system of internal control may be weakened due to inefficiency in handling of the
system.
4. There are chances of diverse objectives among employees in the departments and staff in
charge of internal control.
5. Management may manipulate the operation of internal control system.

Elements, features characteristics principles of a good Internal Control System:

An effective internal control system should have the following factors:
1. Competent and trust worthy staff: people in charge of internal control system must be
reliable and highly competent about the work. Lack of knowledge and dishonesty will spoil
the efficiency of the system.
2. Records of financial and other organizational plans: A good internal control system must
have good documentation system. Filing, recording, classifying, etc will help in this regard.
3. Segregation of duties: normally, there should be a separate department for internal control
this reduces frauds, bias etc. normally; a clerk in charge of accounting function should not be
in charge of assets also.
4. Supervision: proper reviewing of the operations of the company regularly makes the control
system effective.
5. Authorization: all transactions must be properly authorized. In other words, the authority of
each person should be well defined.

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6. Sound practices: the company should have well established procedures, policies,
delegations organizational manuals etc.
7. Internal Audit: it’s a part of internal control and it should be independent of internal check.
8. Accounting Controls: proper accounting information systems should be established so that
the information relating to accounts is properly collected, recorded and accounts prepared.

Scope of Internal Control or Areas of Internal Control:

1. General financial Control: It’s concerned with control over all finance functions i.e.,
planning, acquiring and investing funds and management of profits. It deals with accounting
supervision recording etc of the finance department.
2. Cash Control: it’s concerned with proper control over receipts payments and balance of
cash. The control system must ensure that misappropriation of cash is prevented.
3. Control over wages: this includes maintenance of time records, wage records, and payment
to workers. The main area of concern in this regard is the check payment to wages for the
work not done and misappropriations of cash.
4. Control over purchases: the system of internal control regarding purchases should be
developed in such a manner that purchasing accounting, handling and issuing of goods are
properly controlled.

Internal Audit:
Large scale organizations usually develop a system to review their activities to identify areas of
non performances. Internal audit is a tool used in this regard.
Definition:
Internal auditing involves a continuous critical review of financial and operating activities by a
staff of auditors functioning as full time salaried employees.
Objective of Internal Audit:
1. To comment of the effectiveness of the internal control system in force and means of
improving it.
1. To verify correctness accuracy and authenticity of the records presented to management.
2. To facilitate early detection of errors and frauds.
3. To ensure that standard accounting practices are followed.
4. To ensure that assets are properly acquired, safeguarded and accounted for.
5. To investigate in the areas as requested by the management.
6. To see that exhibited liabilities are valid.
Advantages of Internal Audit:
1. Internal Audit makes the system of internal control more effective and efficient.
2. It makes the auditor’s work more simpler.
3. Errors and Frauds are detected early.

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4. It increases the morale of the employees.

5. Employees will be more careful as their work will be audited immediately.
Disadvantages of Internal Audit:
1. Small organizations cannot afford to have internal audit system as it’s expensive.
1. The regular work of the organization will be affected.
2. Internal auditor acts as a staff manager hence there are chances of differences of opinion
between the internal auditor and the employees of the company.

Difference between Internal and External Audit:

Internal External.
1. An internal auditor is a regular employee of1. He is a professional auditor appointed by the
the company. company who is not an employee.
2. His duties, rights and responsibilities are 2. The scope of audit work liabilities, duties etc
determined by management. are explained by concerned statutes.
3. He is appointed by the management. 3. He is appointed either by shareholders or by
govt.,
4. It’s not compulsory. 4. It is compulsory for all companies.
5. Internal auditor acts as an advisor to the 5. He is independent of the management.
management.
6. To become an internal auditor professional 6. An independent auditor must have
qualification is not necessary. professional qualification as per the act.
7. Internal Auditor ensures that the system of 7. the internal auditor comment on the true and
accounting is efficient. fair view of business.
8. An internal auditor reports to the 8. The Internal Auditor reports to the
management. shareholders.
9. Internal audit is a continuous process. 9. It’s a periodic process.

To conclude, it can be said that “the internal auditor’s responsibility is to the management and he
is not a servant of the independent auditor. His scope will be decided by the management and eh
should be free to communicate to the external auditor but should not involve himself with the
work of independent auditor.

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Difference Between internal Checks and Internal Audit:

Internal Check Internal Audit.

1. It is an arrangement of duties allocated in 1. It is independent appraisal of operation and
such a way that the work of one person is records of the company.
automatically checked by another.
2. The purpose of IC is to prevent minimize 2. The purpose is to detect errors and frauds
possibilities of errors and frauds. that are already committed.
3. IC doesn’t require separate staff. It 3. It requires separate staff employed only for
represents only the arrangement of duties. this purpose.

4. IC is a continuous process. 4. The Internal auditor has to report

periodically about various inefficiencies
and suggest improvements.
5. IC begins along with the recording of 5. It begins when the accounting process ends.
transactions.
6. It is devices of doing the work. 6. It is a device for monitoring the work.
7. Scope of Internal Check is limited especially 7. The scope of internal audit goes on beyond
to the accounting department. accounting department.

Internal check in a Department Store:

A department store is a large scale retail organization working on self service basis selling the
daily requirements of the customers. These are centrally located and attract customers.

Operation of Department Stores:

As the name itself suggests a dept., store is divided into many small departments, each
department offering a specific product line. These depts., are headed by supervisors assisted by
stock assistants. While the accounting departments, takes care of recording all transactions, in the
cash dept, will be in charge of receipts and payments of cash. As it operates on self service basis
cash is paid by the customer at the counter.

Internal Check as regards Purchase.

Goods are to be purchased as per the order of the G.M. The General Manager prepares purchase
order based on the requisition notes sent by the supervisor. No supervisor should be given
independent charge of purchase. A copy of the purchase order is sent to the accounting
department and stores dept., when once the goods are received the store keeper verifies them

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with the order and approves for payment. The accounts department makes the payments after
verifying the Purchase order and goods.

Internal Check regarding Cash Receipts.

Usually the cash counters are computerized which brings down the human errors. The customers
make the payments directly at the counter. The counter clerk prepares the bill and receives the
cash. Chances of error and fraud are less as goods are coded and price is mentioned against
codes.
As far as petty cash expenses are concerned, the cashier should be in charge of petty cash
expenses, which are recorded on daily basis. The goods are delivered after verifying the bill.

ISA 610 considering the work of internal auditing governs the situation where external auditors
are auditing an entity that operates an internal audit function.

Reasons why the external auditor should use internal audit

-Much duplication of work may eliminated e.g. internal audit may already have detailed systems
descriptions, flowcharts.

-Internal audit may have done detailed work on areas of concern to external audit-such as credit
control and inventory.

-External auditors must obtain a sufficient understanding of the internal audit function.

Where to place,

-internal auditors have carried out relevant

-quality of the work is good.

-area is material, but not so highly critical that the external auditor would be advised to become
deeply involved in order to form his own opinion.

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PRACTICAL AUDITING

Vouching of Transactions

Vouching is defined as the independent examination of source documentary evidence by the

auditor so as to confirm for their authority, recoding, date, name and amount.

A voucher is defined as any supporting documentary evidence in support to an accounting

transaction, record or account balance.

The main objective of vouching is for the auditor to confirm for their accuracy, validity and
completeness. Vouching is an audit procedure which is also carried out when the internal control
system has provided evidence of weakness.

Matters the auditor would pay keen attention to when examining vouchers are;

1. Whether the vouchers have been properly authorized by the rightful authority through
specimen signatures.

2. Whether the vouchers are in the names of the reporting entity.

3. Whether the vouchers have been properly recorded in the books of accounts.

4. Whether the amounts in words do agree with the amount in figures

5. Whether the cost of expense included in the vouchers falls within the financial limits of
the clients

6. Whether the details in the vouchers relates to the clients ordinary transactions

7. Whether the vouchers are mathematically correct

8. Whether the vouchers are serially numbered and filed correctly in the respective files.

9. Whether any alterations, falsifications of cancellation in the vouchers have been properly

Advantages of vouching

1. Vouching enables the auditor to obtain sufficient appropriate evidence necessary to be

able to draw conclusions on the financial statements.

2. Through examination of vouchers the auditor is able to determine the nature and scope of
the audit tests on transactions to be carried out.

3. Vouching facilitates the completion of the audit final review procedures

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4. Errors and frauds can be tested and prevented through vouching

5. Vouching enables the company auditor to understand the nature of the client entity for
future planning purposes.

6. Vouching helps to confirm for the accuracy, validity and completeness of the records.

Disadvantages

1. Some vouchers included may be fictitious vouchers and may not relate to the company

2. Vouching of large transactions may be costly and time consuming

3. Vouching as a technique used by the auditor primarily aims at the detection of errors and
frauds and this may not be practicable where the management are parties to the frauds.

4. The modern audit being a system base approach calls for few areas of vouching

5. The management may create limitation sin the scope of the audit during vouching
procedures and this may make it difficult for the auditor to achieve the objectivity of
vouching in general.

Verification of Assets and Liabilities

Verification is the process of confirming certain n truth about the record or an account balance. It
is an independent examination of the assets and liabilities included in the balance sheet by an
appointed auditor to confirm their ownerships, disclosures, valuations, existence, accuracy and
completeness.

Objectives of Verification

 To determine for the nature of ICS over assets and liabilities

 To observe for the cut- off procedures over assets and liabilities

 To confirm for the physical existence and conditions of the assets

 To obtain evidence in respect to the valuations, ownership and disclosures of the fixed
assets.

 To confirm for the accuracy and completeness in the processing of assets and liabilities.

 To detect any error and frauds over the assets and liabilities.

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Contingent liabilities

A contingent liability is defined as a possible liability at the balance sheet date which is either
determinable or indeterminable in nature arising from the company’s past actions and which
when crystallizes or matures may or may not turn out to be an actual liability and that which
when turns out to be an actual liability will be required to be treated as losses in the company’s
books of accounts. Examples include;

Discounted bills of exchange before maturity, arrears on cumulative preference share dividends,
insurance claims due from the company, guarantees given by the company to its subsidiaries.

Verification of land and buildings

 Examine the nature of ICS to do with the disclosures and acquisitions of land and
buildings

 Obtain the meeting minutes of the shareholders, Board of directors or important authority
to determine for the rightful authority for the purchase of land and buildings

 Consider materiality in disclosures in respect to land and buildings

 Obtain the title deed to examine for the legal ownership of land and buildings

 For newly constructed building obtain an architecture certificate to confirm for the fair
market value.

 Physically inspect the land and buildings to determine for the physical existence.

Leasehold property

 Obtain the lease agreement between the leasor and the lease and determine from the
agreement the period of the lease and the leases charges.

 Obtain an authority from the directors meeting minutes in respect to such lease hire and
ensure that such authority do fall within the provisions of the articles of associations.

 Ensure that the leases are authorized and ensure materiality for their disclosures.

 Review the previous year’s working papers in respect to such leases to determine whether
there is any variation in value that may call for explanations.

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Plant and machinery

 Obtain the authority for the purchase of plant and machinery from the meeting minutes of
the shareholders, board of directors and important committees.

 Check for agreement of such authority through the provisions of the articles of
association of the company.

 Obtain the schedule of plant and machinery to determine materiality and disclosures.

 Examine a plant register for the presentation of plant and machinery and also obtain plant
and machinery in respect to the details of the plant and machinery.

 For ownership examine the logbook or the certificate of ownership to ensure that it is in
the name of the client.

 Take cost less accumulated depreciation to date allowing appreciations, additions,

disposals and repairs during the year all of which must be reasonable to arrive at the
value.

 Inspect the plant and machinery physically, to confirm for its existence and conditions at
the balance sheet date.

Motor Vehicles

 For a first audit check for the authority of the purchase of the motor vehicle through the
meeting minutes of the shareholders, BOD or important committee.

 Obtain the motor vehicle register to determine this materiality in disclosures

 Obtain the log book or motor vehicle certificate to determine for ownership

 Confirm this for agreement through the insurance policy or cover of the motor vehicle or
road license for the motor vehicle.

 Where the motor vehicle is technical obtain a valuer like a mechanic engineer.

 Inspect the motor vehicle physically at the balance sheet to ensure that it does exist and in
good condition.

 Where a motor vehicle is held by the third party request from such a party, a certificate of
ownership, existence and valuation.

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Verification of cash at bank

 Examine the ICS to do with banking by the company

 Ensure that the company does bank its daily takings immediately latest the following day.

 Examine the cash book for the materiality in disclosures of the bank balance

 Check the bank slips for agreement of dates and amount with the records in the cash
book.

 Prepare an independent reconciliation statement to detect for any error and fraud in the
bank balance.

 Write a bank standard letter to the bank branch to confirm existence and value of the
bank balance held in the name of the client.

 Where the client operates several accounts send a bank standard letter to the bank
branches convert the foreign currencies to local currencies to agree with the bank
balance.

Verification of cash in hand

 Visit the client premises at the balance sheet date and order for the physical counting of
cash in hand.

 During physical counting take any authorized promissory notes, cheques, money orders
or postal orders.

 Where the client operates different cash collections centers ensure that the counting is
done simultaneously to avoid borrowing from one centre to cover up a shortage from
another centre.

 Request the client management to avoid keeping large sums in the business as this would
not only be difficult to count but would expose the business to risks.

 Count the cash physically in the presence of the cashier so that in case of any shortage
one would be able to request for certificate of shortage from the cashier.

 In as well as carrying out the above determine the strength or otherwise of the ICS in
respect to cash receipt by the organization.

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Verification of Debtors

 Obtain the company’s policy to do with the approval of credit sales for the trade debtors.

 Determine the ICS over debtor and credit sales

 Examine the sales ledger for the total balances of debtors

 Check for the authority of any discount allowed and provisions for bad and doubtful
debts.

 Observe the cut-off procedures over credit sales and debtors.

 Circularize the debtors positively at the balance sheet date.

Verification of Long term loan.

 Obtain the loan agreement from the lenders to lenders to confirm for the maximum
amount of the amount of loan, the rate of interest and the repayment and repayment
period.

 Read through the meeting minutes of the shareholders, Board of directors and important
committees to confirm for the authority of loan.

 Establish from the company the company’s top officials the reason for the obtaining such
loan.

 Ensure that the loan is obtained for productive projects

 Examining the cash book and bank statement for the recording of bank loan.

 Obtain the cheque used for the repayment of the loan and the interest charged and ensure
that this is accurate in accordance to the loan agreement.

Verification of Overdraft

 For the bank overdraft obtain the authority from the directors to determine how much was
the overdraft.

 Also discuss with the bank manager the reason for issuing or giving the bank overdraft to
the audit client.

 Consider whether the interest rate of the bank overdraft is based on the current market
rates and therefore would be reasonable to the client.

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 Obtain the bank statement to confirm for the disclosures and the valuations of the bank
statement.

 Write a bank standard letter to confirm for the existence of the bank overdraft.

Verification of Creditors.

 Check the nature of the ICS to do with trade creditors

 Observe the cut-off procedures over credit purchase and trade creditors

 Examine the purchase ledger for the accuracy of the purchases invoices

 Circularize the trade creditor’s possibility at the balance sheet date.

 Check the bank statement for the payment to the supplies in respect to the purchases
made.

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Chapter Six Audit Report

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