The Audit Process for

an Audit of Historical
Financial Information
2
FOUR STEPS OF THE AUDIT
PROCESS
 PHASE I: PLAN AND DESIGN AN AUDIT APPROCH BASED ON
RISK ASSESSMENT PROCEDURES

 PHASE II: PERFORM TESTS OF CONTROLS AND SUBSTANTIVE

TEST OF TRANSACTIONS

 PHASE III: PERFORM SUBSTATIVE ANALYTICAL PROCEDURES

AND TESTS OF DETAILS OF BALANCES

 PHASE IV: COMPLETE THE AUDIT AND ISSUE AN AUDIT REPORT

PHASE I
Plan and Design an
Audit Approach

3
PHASE II
Perform Tests of
Controls and
Substantive Test of
Transactions

4
 PHASE III
 Perform
substantive
analytical
procedures and
tests of details
5 of balances
PHASE IV
 Complete the
audit and issue
an audit report

6
 Understand objectives and responsibilities
7 for the audit – ISA 200

 ISA 200 sets out the overall objectives of an independent

auditor, and explain the nature and scope of an audit
designed to enable the independent audtior to meet those
objectives.
 The purpose of an audit is to provide financial statement
users with an opinion by the auditor on whether the financial
statements are presented fairly, in all material respects, in
accordance with the applicable financial accounting
framework. An auditor’s opinion enhances the degree of
confidence that intended users can place in the financial
statements.
 An audit conducted in accordance with ISAs and relevant
ethical requirements enables the auditor to form that opinion.
PHASE I: PLAN AND DESIGN OF AUDIT APPROCH

Accept Client and Perform Initial Audit Planning

a. Client intimation to be appointed
as auditor
b. Evaluate integrity of
management
c. Identify special circumstances
and unusual issues
d. Assess competence to perform
audit
e. Prepare engagement letter and
f. Develop audit
8 objectives
 Accept Client and Perform Initial Audit Planning [2]
9

a. Client intimation to be appointed as auditor

 Auditor has to receive the client’s intimation.

 Soliciting clients or professional work either directly

or indirectly by circular, advertisement, personal
communication, interview or by any other means will
be treated as professional misconduct. [Under para 9
of schedule C, part-1 vide page-law 134 of the BD
chartered Accountants page-laws, 2004]
 Accept Client and Perform Initial Audit Planning [3]
10

b. Evaluate Integrity of management:

 i. Communicate with predecessor auditor or review the
communication made by the predecessor auditor.
 On the ethical ground any intending auditor should
communicate the predecessor auditor for his clearance.
 Code of ethics – The existing auditor should advise
whether there are any professional reasons why the
proposed successor auditor should reject the
engagement. (Take clearance letter)
 ii. Make inquires of other third parties:
 iii. Review previous experience with existing clients:
 Accept Client and Perform Initial Audit
11
Planning [4]
c. Identify special circumstances and
unusual risk:
 i. Identify intended users of audited F/S:
 Auditor should consider the clients status as private or
public Ltd. company.
 ii. Assess prospective client’s legal and financial
stability:
 iii. Evaluate entities’ audit ability: Audit ability declines--
 Poor or absent condition of accounting records.
 No or poor internal control system.
 Previous incidence of imposing restrictions to conduct any
 Accept Client and Perform Initial
12
Audit Planning [5]
 d. Assess competence to perform audit:
Following steps to be considered.
 i. Identify the audit team – including the partners,
seniors and staff assistants who will do the audit
job.
 ii. Consider need for consultation and the use of
specialists.
 iii. Competence of auditing in a computer
information systems (CIS) environment.
 iv. Competence of auditing in service organization
 Accept Client and Perform Initial
13
Audit Planning [6]
 e. Preparation of engagement letter (ISA 210)
 It is in the interest of both client and auditor that the
auditor sends an E\L, preferably before the
commencement of the engagement.
 It documents and confirms the auditor’s acceptance of
the appointment, the objective and scope of the audit,
the extent of the auditor’s responsibilities to the client
and the form of any reports.
14 Purpose of an Engagement Letter

 Define clearly the extent of the firm's

responsibilities and so minimize the
possibility of any misunderstanding
between the client and the firm.
 Provide written confirmation of the
firm’s acceptance of the appointment,
the scope of the engagement and the
form of their report
 Preparation of Engagement Letter (ISA
15 210) [2]
 Principal Contents of E\L: (para: 6)
 The objective of the audit of financial
statements.
 Management's responsibility for the financial
statements.
 The scope of the audit, including reference to
applicable legislation, regulations, or
pronouncements of professional bodies to which
the auditor adheres.
 The form of any reports or other communication
16

 The fact that because of the test

nature and other inherent limitations
of an audit, together with the inherent
limitations of any accounting and
internal control system, there is an
unavoidable risk that even some
material misstatement may remain
undiscovered.
 Unrestricted access to whatever
records, documentation and other
information is requested in connection
 Preparation of Engagement Letter (ISA
17 210) [3]
The auditor may also include- (para: 7)
 Arrangements regarding the planning of the audit.
 Request for the client to confirm the terms of the
engagement by acknowledging receipt of the
engagement letter.
 Description of any other letters or reports the
auditor expects to issue to the client.
 The confidentiality of any reports issued, and, if
relevant, the terms under which they can be shared
with third parties.
 Basis on which fees are computed and any billing
 Preparation of Engagement Letter (ISA
18 210) [7]
 Recurring Audits
The auditor should consider whether
circumstances require the terms of the
engagement to be revised and whether there is a
need to remind the client of the existing terms of
the engagement.
The following factors may make it appropriate to
send a new letter –
* Any indication that the client misunderstands
the objective and scope of the audit.
 Preparation of Engagement Letter (ISA
19 210) [8]
Recurring Audits
* Any revised or special terms of the
engagement.
* A recent change of senior
management, board of directors or
ownership.
* A significant change in nature or size of
the client’s business.
* Legal requirements.
 Steps to Develop
audit Objectives

20
 Understand Objectives and Responsibilities for the
21 Audit
 Distinguish management’s responsibility from the auditor’s
responsibility
 Management is responsible for:
– Managing the business so as to achieve company objectives
– Assessing business risks to those objectives being achieved
– Safeguarding the company's assets
– Keeping proper accounting records
– Preparing company financial statements and delivering them
to the Registrar
– Ensuring the company complies with applicable laws and
regulations
 It is not the responsibility of the auditors of a company to
do any of the above.
22 Assurance providers'
responsibilities
The responsibility of the external provider of assurance
services is determined by:
 The requirements of any legislation or regulation
under which the engagement is conducted, and/or
 The terms of engagement for the assignment, which
will specify the services to be provided, (you learnt
about engagement letters in your studies for
Assurance)
 Ethical and professional standards
 Quality control standards
23
The legal requirements are currently contained in the
Companies Act 1994. In the case of an audit of financial
statements under the Companies Act 1994, it is the external
auditor's responsibility to:
 Form an independent opinion on the truth and fairness of
the accounts
 Confirm that the accounts have been properly prepared in
accordance with the Companies Act 1994
To achieve these objectives, the auditor has to ensure
that:
 The audit is planned properly
 Sufficient appropriate audit evidence is gathered
 The evidence is properly reviewed and valid
conclusions drawn.
 PROFESSIONAL SKEPTICISM
24

Audit must be planned and performed with an attitude of

professional skepticism in all aspects of the engagement.
Professional skepticism consists of two primary components:
 a questioning mind and
 a critical assessment of the audit evidence.
“Trust but Verify”
 Need to overcome the judgment biases and they need to be
continually reminded of the importance of maintaining
appropriate professional skepticism and recognize that the
risk of material misstatements is present in all audits.
 PROFESSIONAL SKEPTICISM [2]
25

Six characteristics of skepticism:

 1. Questioning mindset—a disposition to inquiry with
some sense of doubt
 2. Suspension of judgment—withholding judgment until
appropriate evidence is obtained.
 3. Search for knowledge—a desire to investigate beyond
the obvious, with a desire to verify.
 4. Interpersonal understanding—recognition that
people’s motivations and perceptions can lead them to
provide biased or misleading information.
 PROFESSIONAL SKEPTICISM [3]
26

Six characteristics of skepticism:

 5. Autonomy—the self-direction, moral independence, and
conviction to decide for oneself, rather than accepting the
claims of others
 6. Self-esteem—the self-confidence to resist persuasion and
to challenge assumptions or conclusions
Awareness of these six elements throughout the engagement
can help auditors fulfil their responsibility to maintain an
appropriate level of professional skepticism.
 1

2
Steps to
Develop 3
audit
Objectives 4

5
27
 Divide Financial statements into Cycles
28
 Audits are performed by dividing the financial
statements into smaller segments or components. The
division makes the audit more manageable and aids in
the assignment of tasks to different members of the
audit team.
 After the audit of each segment is completed,
including interrelationships with other segments, the
results are combined. A conclusion can then be
reached about the financial statements taken as a
whole.
 Divide Financial statements into Cycles [2]
29
 A common way to divide an audit is to keep closely related
types (or classes) of transactions and account balances in
the same segment. This is called the cycle approach.
 Sales and collection cycle
 Inventory and warehousing cycle
 Acquisition and payment cycle
 Capital acquisition and repayment cycle
 Payroll and personnel cycle
 Know Management Assertions about
30
Financial Statements
 What is Management Assertions?
Management assertions are implied or expressed
representations by management about classes of transactions
and the related accounts and disclosures in the financial
statements.
The Public Company Accounting Oversight Board (PCAOB)
describes five categories of management assertions:
 Existence or occurrence—Assets or liabilities of the
public company exist at a given date, and recorded
transactions have occurred during the period.
 Know Management Assertions about
31
Financial Statements
 Completeness—All transactions and accounts that
should be presented in the financial statements are so
included.
 Valuation or allocation—Assets, liability, equity,
revenue, and expense components have been included in
the financial statements at appropriate amounts.
 Rights and obligations—The company holds or
controls rights to the assets, and liabilities are
obligations of the company at a given date.
 Know Management Assertions about
32
Financial Statements
 Presentation and disclosure—The components of the
financial statements are properly classified, described, and
disclosed.
 Know Management Assertions about
33
Financial Statements
International auditing standards and AICPA auditing
standards further divide management assertions into three
categories:
 1. Assertions about classes of transactions and events for
the period under audit
 2. Assertions about account balances at period end
 3. Assertions about presentation and disclosure
Assertions relating to classes of
transactions
Transactions recognized in the financial statements have occurred and
Occurrence relate to the entity.

All transactions that were supposed to be recorded have been recognized

Completenes
in the financial statements.
s
Transactions have been recorded accurately at their appropriate amounts.
Accuracy
Transactions have been recognized in the correct accounting periods.
Cut-off
Transactions have been classified and presented fairly in the financial
Classification statements.

34
Assertions relating to account balance

Existence Assets, liabilities and equity balances exist at the period end.

Completenes All assets, liabilities and equity balances that were supposed to be
recorded have been recognized in the financial statements.
s
Entity has the right to ownership or use of the recognized assets, and the
Rights and liabilities recognized in the financial statements represent the obligations
Obligations of the entity.

Assets, liabilities and equity balances have been valued appropriately.

Valuation

35
 Assertions relating to disclosure

Occurrence Transactions and events disclosed in the financial statements have occurred
and relate to the entity.

Completeness All transactions, balances, events and other matters that should have been
disclosed have been disclosed in the financial statements.

Disclosed events, transactions, balances and other financial matters have been
Classification and
classified appropriately and presented clearly in a manner that promotes the
Understandability understandability of information contained in the financial statements.

Accuracy & Transactions, events, balances and other financial matters have been disclosed
accurately at their appropriate amounts.
Valuation
36
 Exercise
There are no unrecorded fixed asset in use. Completeness

The Company has a valid title to the asset owned. Rights &
Obligation

PP&E are recorded at the proper amount. Valuation/

Allocation

The company has a contractual right for use of Rights &

leased assets. Obligation

PP&E items are known and disclosed. Presentation &

Disclosure 37
 Exercise
Expense accounts do not contain amounts that
Classification
should have been capitalized.

Depreciation is determined in accordance with an Valuation/

acceptable method and is materially correct as Allocation/
computed. Accuracy
Details of PPE agree with general ledger. Valuation/
Allocation
PPE are recorded at the correct amount. Accuracy

Accruals for PPE items are recorded in the correct Cut-off

38
period
 Setting Audit Objectives
39

Auditors conduct financial statement audits using the cycle

approach by performing audit tests of the transactions making
up ending balances and also by performing audit tests of the
account balances and related disclosures.
 Transaction-related audit objectives
 Balance-related audit objectives.
 Presentation and disclosure- related audit objectives.
 Transaction-related audit objectives
40
 General transaction related audit Objectives

 Specific transaction related audit Objectives

41 General transaction related audit Objectives
•Focus on broader principles applicable to all
transactions.
•Ensure that financial records and processes meet
general audit standards such as accuracy,
completeness, authorization, and timeliness.
Examples include ensuring that:
•Transactions are recorded in the correct period.
•The amounts and accounts involved are correct.
•Proper documentation exists.
42 Specific transaction related audit Objectives

 Tailored to specific types of transactions (e.g., sales,

purchases, payroll).
 Involve audit tests that address the unique risks and
controls for a particular type of transaction.
Examples include verifying:
 Sales transactions include appropriate revenue
recognition criteria.
 Payroll expenses align with actual hours worked.
 Relationships among management assertions and
43 transaction-related audit Objectives - Applied to Sales Transactions
 Relationships among management assertions
44
and balance-related audit Objectives -
45
Presentation and Disclosure-related
audit Objectives
46
FOUR STEPS OF THE AUDIT
PROCESS
 PHASE I: PLAN AND DESIGN AN AUDIT APPROCH BASED ON RISK
ASSESSMENT PROCEDURES

 PHASE II: PERFORM TESTS OF CONTROLS AND SUBSTANTIVE

TEST OF TRANSACTIONS

 PHASE III: PERFORM SUBSTATIVE ANALYTICAL PROCEDURES

AND TESTS OF DETAILS OF BALANCES

 PHASE IV: COMPLETE THE AUDIT AND ISSUE AND AUDIT REPORT
47 PHASE II: PERFORM TESTS OF CONTROLS AND
SUBSTANTIVE TEST OF TRANSACTIONS
Test of Controls:
These are audit procedures designed to evaluate the effectiveness of
internal controls in preventing or detecting material misstatements in
financial statements.
• Purpose:
• To ensure that controls are designed and operating effectively.
• To assess whether the reliance on controls is appropriate.
Example:
 Inspecting evidence of proper authorization (e.g., management sign-
off: The term "management sign-off" refers to the formal approval or
acknowledgment by management)
 Observing segregation of duties in accounting processes.
48

Auditors also evaluate the client’s recording of

transactions by verifying the monetary amounts
of transactions, a process called substantive
tests of transactions.
For example, Compare employee payroll entries
to timesheets or attendance records to verify
payments are accurate and only for actual work
performed.
49 PHASE III: PERFORM SUBSTATIVE ANALYTICAL
PROCEDURES AND TESTS OF DETAILS OF
BALANCES
Substantive analytical procedures are audit methods
used to assess the reasonableness of financial statement
balances by analyzing the relationships between financial
and non-financial data. They involve comparing expected
results (based on trends, ratios, or benchmarks) with
actual results in the financial statements.
Compare revenue trends over multiple periods or
calculate revenue growth rates. Example: If sales
increased by 10%, but production costs decreased
unusually, investigate the cause (e.g., recording errors or
fraud).
50

Tests of details of balances are specific procedures

intended to test for monetary misstatements in the
balances in the financial statements.
An example of checking the existence of accounts
receivable is sending written requests to customers,
asking them to confirm if they owe the amount
recorded.
Tests of details of ending balances are essential to the
conduct of the audit because much of the evidence is
obtained from third-party sources and therefore is
considered to be of high quality.
51 PHASE IV: COMPLETE THE AUDIT AND ISSUE AND
AUDIT REPORT

After the auditor has completed all procedures

for each audit objective and for each financial
statement account and related disclosures, it is
necessary to combine the information obtained to
reach an overall conclusion as to whether the financial
statements are fairly presented.
This highly subjective process relies heavily on the
auditor’s professional judgment. When the audit is
completed, the CPA must issue an audit report to
accompany the client’s published financial
statements.
52

Reference: Auditing And Assurance services. An integrated

Approach
Sixteenth edition. Global edition By
 Alvin A. Arens; Randal J. elder; Mark S. Beasley; Chris E.
Hogan

 Thank You