Audit
Assignment #1
Question: 1a; What do you mean by auditing? Explain the difference between auditing and investigation.
Definition: Audit is the examination or inspection of various books of accounts by an auditor followed by physical checking of inventory to make sure that all departments are following documented system of recording transactions. It is done to ascertain the accuracy of financial statements provided by the organization.
Audit can be done internally by employees or heads of a particular department and externally by an outside firm or an independent auditor. The idea is to check and verify the accounts by an independent authority to ensure that all books of accounts are done in a fair manner and there is no misrepresentation or fraud that is being conducted.
Difference between auditing and investigation:
| BASIS FOR COMPARISON | AUDITING | INVESTIGATION |
|---|---|---|
| Meaning | The process of inspecting the books of accounts of an entity and reporting on it, is known as Auditing. | An inquiry conducted, for establishing a specific fact or truth is known as Investigation. |
| Nature | General Examination | Critical and in depth examination. |
| Evidences | The evidences are persuasive in nature. | The evidences are unquestionable, therefore, its nature is decisive. |
| Time Horizon | Annually | As per requirement |
| Performed by | Chartered Accountant | Experts |
| Reporting | General Purpose | Confidential |
| Obligatory | Yes | No |
| Appointment | an auditor is appointed by the shareholders of the company. | The management or shareholders or one-third party can appoint investigator. |
| Scope | Seeks to form an opinion on financial statement. | Seeks to answer the questions, that are asked in the engagement letter. |
QUESTION: 1B; DESCRIBE THE QUALITIES OF AN AUDITOR.
An auditor must have some qualities. These qualities are given bellow:
Assertive
Auditors must be able to quickly establish confidence with the auditee, and during the audit process must be the one who controls the agenda. They cannot allow the process to get derailed, and must have the assertiveness to pull it back on track. There will be times when the auditor needs to firmly state a position in the face of a hostile reception to bad news.
Punctual
Because auditing involves a whole team of people who come together for the opening and closing meetings, it’s imperative that the process runs in accordance with the audit plan.
Reliable
Auditees typically invest a lot of time and energy in preparing for an audit and it is important to harness this energy. Letting people down on the day of an audit may adversely affect the reputation of the auditor and affect ongoing relationships, which in turn can affect the ability to get the information required from the audit. Your ideal auditor is a person who soldiers on in spite of not feeling 100% from time to time. Reports too must be prepared on time and to the required quality – there is nothing worse than keeping people endlessly waiting for the audit report to be issued.
Determined
Determination is a key attribute for an auditor. They need to have the determination to dig down to the evidence they need to make a compliance decision – when the auditee is trying desperately to steer them in another direction. Determination is also required to not take the easy way out, and to get to the truth. Auditing is not for the faint-hearted.
Articulate
Auditors need to explain a lot of things, and the more clear and succinct they can be, the better. They need to be able to explain why a regulation or procedure applies in a variety of circumstances, and the thinking behind their decisions. They also need to be able to write clear reports and recommendations in a way that people can understand and accept them without taking offence. Auditors need to be able to communicate well to all levels within an organization: one moment they will be discussing requirements with people on the shop floor, the next they are explaining results to senior management in a closing meeting. To say you need to be a diplomat is an understatement!
Independent
Auditors often work alone and have to travel long distances to do their work. The work itself is lonely too, as they are generally on the other side of the fence from the people they’re auditing and have to make some tough decisions on their own. Auditors need to enjoy their own company, be happy to eat meals on their own and otherwise entertain themselves while away from their home base and family.
Principled
Because of the subjective nature of this role, it’s important that auditors have high ethical work standards and boundaries in order to make effective decisions.
You only need to examine the Enron case to learn the vital importance of principled thinking and actions on the part of those we trust to be our compliance eyes and ears and sometimes, brain.
QUESTION: 1C; DISCUSS THE DIFFERENT TYPES OF AUDITS.
Types of audits include:
Financial – Financial audits typically involve a focus on financial controls as they relate to reporting. These audits focus on accounting controls present in the general ledger or sub-ledger systems. Financial statement auditing is the focus of our external auditors. Internal Audit will complement the work they perform based on an agreed plan.
Operational – Operational audits focus on the review and assessment of a business process. The activities of the business process may result in a direct or indirect financial impact to the organization such as the collection of student tuitions or patient account balances. Internal Audit primarily focuses on operational audits but can extend the scope to include accounting procedures that can impact financial reporting.
Compliance – Compliance audits review the level of compliance with internal policies or external regulatory requirements.
Information Systems – Audits of Information Systems look at the overall infrastructure and network of the University and the controls that relate to the security of the network and the systems that are maintained in support of the goals of the University. They also include technical operations, data center operations, project management procedures, and application controls.
Integrated Audits – Integrated audits look at controls that address financial, operational, compliance and information systems risks. These audits are typically centered on a business cycle or a specific part of a cycle or process.
QUESTION: 2A; EXPLAIN THE IMPORTANCE OF INTERNAL CONTROL.
Internal controls are the standards and rules used by companies to ensure that they achieve their stated goals in the marketplace. Profitability is not only achieved through high sales and meeting consumer demand, but also from controlling costs and limiting excessive spending. Management should on a regular basis review all aspects of their company and insert internal controls that will strengthen the company and increase profitability.
Operating Environment
Internal controls help promote strong daily operations that produce high-quality goods and services at the lowest cost possible. Limiting excessive inventory, high equipment costs, and excessive utilities ensure that operational costs are maintained within a reasonable budget. Managers ensure that as goods and services are produced, machines or other equipment are properly used so any malfunctions can be avoided. Improperly using company assets can create downtime if goods have to be re-produced because of product defects.
Risk Assessment
Risk assessment is an important internal control. Every business decision comes with a certain amount of risk; avoiding or mitigating this risk is achieved through strong internal controls. Controls that mitigate risk could include capping the levels of debt used to finance operations or acquisitions, ensuring reinvestment of cash into the business, or guidelines to avoid risky securities when generating cash from investment activities. These types of internal controls prevent executive management from making potentially dangerous decisions that would have long-term effects on a company.
Company Policies
Companies use policies to ensure a safe and profitable business environment. These policies are internal controls that help management in areas including human resources, community awareness, and business-to-business relations. Companies inform employees of these internal controls to ensure that the company’s reputation is not tarnished as a result of improperly educated employees. Publicly held companies have strong internal control policies to assure that investors are not improperly influenced by informal communications outside normal company standards.
Financial Information
The most important internal controls usually preside over the financial information of a company. Improperly reporting financial information is considered fraud and will quickly cause problems. Companies usually develop internal controls for financial information and then test them periodically to ensure that they are adequate safeguards. Publicly held companies are required to have outside auditors test their internal controls as part of the federal Sarbanes-Oxley regulations passed in 2002.
Performance Measurements
Many companies link internal controls to performance evaluations for mid-level managers and other employees. This style of performance evaluation allows companies an opportunity to educate and review internal controls with employees on a regular basis. This teaches employees the value of achieving goals through following company policy, ensuring higher profitability for the company.
QUESTION: 2B; DISTINGUISH BETWEEN INTERNAL CHECK AND INTERNAL AUDIT.
Internal check is a preventive control mechanism implemented by management to ensure no errors occur in business processing or even if they occur, are timely detected to mitigate any further losses attributable to such errors. One example of internal check in business organizations can be the supervision of work by a floor manager/supervisor in a factory premises of a manufacturing unit. Internal check can be said to be taken up by personnel of the business organization in question. It is a system of cross check implemented to ensure more efficiency in the processing of data or preparation of financials. Internal check mostly takes care of procedural errors.
Internal audit is more of a detective control implemented by a business organization. The person taking up internal audit may or may not be a employee or personnel of the business organization. But, even the findings of internal audit are to be reported to the management of the business organization as is done in the case of Internal check. Internal audit apart from addressing procedural errors also checks for violations of rules and regulations that a business organization is to abide by.
To sum up, the results of internal check assist in more efficient discharge of the internal audit function and the results/ report of internal audit assists in more efficient discharge of the duties of a statutory auditor.
QUESTION: 2C; HOW WILL YOU EVALUATE THE INTERNAL CONTROL? EXPLAIN.
An evaluation of internal control involves an examination of the effectiveness of an organization's system of internal controls. By engaging in this evaluation, an auditor can determine the extent of other tests that must be performed in order to arrive at an opinion regarding the fairness of the entity's financial statements. A robust system of internal controls reduces the risk of fraudulent activity, which moderates the need for additional audit procedures. The examination concentrates on such issues as:
· The separation of duties
· Checks and balances
· Safeguarding of records
· The training level and competence of employees
· The effectiveness of the entity's internal audit function
The steps involved in this evaluation process include the following:
\1. Determine the extent and types of controls being used by the client.
\2. Determine which of these controls the auditor intends to rely upon.
\3. Based on the first two steps, determine which audit procedures should be expanded or reduced.
\4. Make recommendations to the client regarding how to improve its system of internal controls.
The last of the preceding steps is useful for improving the control environment for the auditor in the following year's audit.
QUESTION: 3A; EXPLAIN THE POINTS THAT NEED TO BE NOTED IN A VOUCHER.
vouchers. 14 important points are listed below.
An Auditor should consider the following features in vouching while verifying vouchers. 14 important points are listed below.
\1. Check whether the vouchers are printed, numbered and arranged in the order of the date of occurrence of transactions.
\2. The entries in the books of accounts should also be numbered and the number and date should correlate with the concerned voucher.
\3. The name of the person with whom the transaction is carried out, the details of the transaction and the amount involved should be clearly stated in the voucher.
\4. All payments of Rs.500/- and above should be supported by a stamped voucher.
\5. The transactions should be clearly classified into revenue or capital transactions and accordingly entered in the books of accounts.
\6. The vouchers should bear the signature of the authorizing officer.
\7. The transaction should relate only to the business aspects of the organization and transactions of personal nature should not be recorded.
\8. Some transactions may be entered twice or some voucher may be used as an evidence for two different transactions entered in the books of accounts. So, the auditor should stamp the vouchers already verified by him to avoid such frauds.
\9. Wherever necessary, the supporting documents are to be attached with the vouchers, so that the transaction can be verified in depth. If the supporting evidences are not available, the auditors may ask for more information and explanation concerning such transactions.
\10. The auditor should verify that the prepaid and outstanding amounts are duly accounted for the period to which such transactions relate.
\11. After completing the vouching, the auditor may make a separate note of explanation sought in support of the transactions. He shall also make out a list of missing vouchers.
\12. An auditor should ensure that the alterations made in the vouchers are duly authorized.
\13. While vouching, the auditors should use different types of “rick marks” which may be helpful for them for their future reference. Each mark made by them conveys different meanings which could be useful to them for future reference.
\14. Vouching should be continuous and vouching for a specified period and for a specified nature of transactions should be done at a stretch and completed at one go which may reduce the chances of errors and frauds.
QUESTION: 3B; DISCUSS THE DUTIES OF AN AUDITOR IN CONNECTION WITH CREDIT PURCHASE.
Duties of Auditor
The Auditor has to check and verify the following −
· Record of all purchase orders.
· Verification of quantity, price and payment terms of purchase invoice with purchase orders.
· Verification about whether goods actually received.
· Verification about proper recording of purchase bill in purchase book.
· Goods purchase should be for business purpose only, not for any personal use of any partner, director or officer of the company.
· The Auditor should verify the statements of accounts of suppliers.
QUESTION: 3C; DISCUSS THE DUTIES OF AN AUDITOR IN CONNECTION WITH CREDIT SALE.
Duties of Auditor
· An Auditor should verify the complete internal control system of sale as described above.
· The sale invoice should check with sale order.
· Sale register will check through sale invoices.
· Sale of capital goods should not be recorded in sale account.
· Calculation of sale invoice should be check in case of manual invoicing.
· Accounting for taxes should be in separate account like excise duty, service tax, VAT, Central Sales Tax, etc.
· No sale invoice should be unrecorded in the sales book.
· Only the sales of the current year should be recorded for the current year.
· Cancelled invoices should be kept separate for verification of Auditor.
· No separate entry for trade discount should be passed; it should be adjusted in the sales value.